Answer: Returns on asset classes are a function of systematic factors relevant to those asset classes

## Explanation **Correct Answer: B** Strategic asset allocation is based on the principle that returns on asset classes are primarily driven by systematic factors (market-wide factors) rather than idiosyncratic (nonsystematic) factors. This principle underlies modern portfolio theory and the capital asset pricing model (CAPM). **Why B is correct:** 1. Strategic asset allocation focuses on long-term allocation to asset classes based on their expected returns, risks, and correlations 2. These expected returns are determined by systematic risk factors that affect entire asset classes 3. This principle allows investors to build diversified portfolios that capture systematic risk premiums while minimizing nonsystematic risk **Why A is incorrect:** - Nonsystematic risk (idiosyncratic risk) can be diversified away in a portfolio, so strategic asset allocation doesn't focus on minimizing it through weighting decisions - Strategic allocation is concerned with systematic risk exposures, not individual asset-specific risks **Why C is incorrect:** - While efficient markets require more skill to add value, this is not a fundamental principle of strategic asset allocation - Strategic asset allocation is about asset class selection and weighting based on risk-return characteristics, not about manager skill in inefficient markets

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