Mutual Fund Investment Discretion and the Asset Allocation Problem

This article questions whether mutual fund investors attempting to follow an asset allocation plan can determine the appropriateness of a particular mutual fund in their portfolio simply by the fund name, the announced fund objective, or the classification of the fund by an independent organization. One reason for this difficulty may be the discretion fund managers are given in the fund's investment composition. If a small cap value fund invests heavily in large growth companies, or a domestic equity fund invests significantly overseas, or an aggressive growth fund is heavily positioned in cash, then the investor's asset allocation model may be unknowingly violated. We argue that this problem exists, and that true, effective asset allocation requires careful study of the manager's discretion over the composition of each fund's investments, as well as periodic review of the investment allocation of the fund.