Performance attribution is aimed at identifying and quantifying the sources of returns that are significantly different from the chosen benchmark. Performance attribution at the investment manager level is known as micro performance attribution. It has three components, including pure sector allocation, allocation or selection interaction, and within-sector selection. In pure sector allocation, the performance is attributed to holding a different weight for each sector in the portfolio relative to the benchmark.
The allocation or selection interaction return shows the joint effect of choosing both the sectors and individual securities. Within-sector allocation estimates the impact of security selection decisions only.
Locate Sector Weights and Returns of the Portfolio
Locate the sector weights of the portfolio, sector weights of the benchmark, benchmark return of the sector, overall return on benchmark, return on portfolio and portfolio return of the sector from the annual performance report published by the firm manager.
Multiply Sector Weights by Differences in Returns
Subtract the weight of each sector in the portfolio from the weight of the same sector in the benchmark. Multiply the difference obtained with the difference in returns between the benchmark return of the sector and the return on the portfolio’s benchmark.
Calculate Aggregate Estimate for Pure Sector Allocation
Add all the sector allocations estimated in Step 1 to obtain the aggregate estimate for pure sector allocation.
Calculate Sector Weights by Differences in Returns
Subtract the weight of each sector in the portfolio from the weight of the same sector in the benchmark. Multiply the difference obtained with the difference in returns between the portfolio return of the sector and the benchmark return of the sector.
Calculate Aggregate Estimate for Returns
Add all the allocation or selection interaction returns estimated in Step 3 to obtain the aggregate estimate for allocation selection returns.
Multiply Benchmark Weight by Difference in Returns
Multiply the benchmark weight of sector by the difference in the portfolio return of sector and the benchmark return of sector.
Calculate Aggregate Estimate for Within-Sector Selection
Add all the estimates obtained in step 5 to obtain the aggregate estimate for within-sector selection.
Obtain Value-Added Return
Add all the components of performance attribution estimated in Step 2, 4 and 6 to obtain the value-added return.
Before making the performance attribution calculation, make sure you calculate the portfolio return of each sector, the benchmark return on each sector and the return on the portfolio’s benchmark. For performance and return records, refer to the distributions and analysis shown in the funds periodic reports.
Approach the attribution calculation problem according to the mentioned steps in order to avoid making any attribution calculation errors. Critically evaluate the performance returns shown in the financial reports to make sure they have not been manipulated in any way.
- "Investment performance attribution"; Spaulding, D; 2003
- "Global asset management and performance attribution"; Karnosky, D and Singer, B; 1994
- Riordan Consulting: Performance Attribution Analysis
- Deloitte: Performance attribution
- Investopedia: Attribution Analysis
- "Investment performance measurement"; Fiebel, B; 2003
- performance report image by Christopher Hall from Fotolia.com