How to Calculate Performance Attribution

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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.

Tips

  • 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.

Warnings

  • 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.

References

Resources

  • "Investment performance measurement"; Fiebel, B; 2003

About the Author

Kevin Sandler started his writing career as an academic researcher in 2005, and has since than been involved in writing for various magazines and academic specialists including Academic Knowledge, Scholastic Experts and eHow, among others. His specialities include personal finance, investments, business and project management. He has a Master of Science in finance from Tulane University, and is actively involved in the finance profession.

Photo Credits

  • performance report image by Christopher Hall from Fotolia.com