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Performance Attribution

http://www.indxx.com/analytics.php - Performance Attribution or Investment Performance Attribution is a set of techniques that performance analysts use to explain why a portfolio's performance differed from the benchmark.

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Performance Attribution

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  1. Performance Attribution

  2. Performance Attribution or Investment Performance Attribution is a set of techniques that performance analysts use to explain why a portfolio's performance differed from the benchmark. This difference between the portfolio return and the benchmark return is known as the active return. The active return is the component of a portfolio's performance that arises from the fact that the portfolio is actively managed.

  3. Different kinds of performance attribution provide different ways of explaining the active return. • Attribution analysis attempts to distinguish which of the two factors of portfolio performance, superior stock selection or superior market timing, is the source of the portfolio’s overall performance. Specifically, this method compares the total return of the manager’s actual investment holdings with the return for a predetermined benchmark portfolio and decomposes the difference into a selection effect and an allocation effect.

  4. History • In 1972, A Working Group of the Society of Investment Analysts (UK) published a paper about analysing the performance of investment portfolios. This paper, although never verified, claims to have introduced the key concept in performance attribution, that active performance can be analysed by comparing the returns of different notional portfolios. In particular, if one examines the performance of a portfolio that holds each sector at the active weight, while earning a passive return within each sector, one can measure exactly the amount of value that is added by asset allocation decisions.

  5. The 1972 paper, if in fact it exists, introduced the key elements of modern performance attribution: notional portfolios, asset allocation, and stock selection. The perhaps fictional paper presents this analytic paradigm as an extension of previously known concepts. Since it was not an academic publication, it did not claim novelty, even though the approach introduced was new and novel. An excerpt from the fictional paper reads: • The working group recommend that the notional fund concept be extended to cover the whole fund, i.e. fixed interest, equity and cash investments and by using appropriate indices the actual fund is compared with a notional fund chosen such that the proportions in the different investment sectors follow those laid down by the trustees.

  6. The 1972 paper is ignored, because there is not any evidence that it was actually published and may be a fictional creation, by many of the standard texts on performance attribution • It is believed that Gary P. Brinson's Brinson et al. 1985 introduced the idea of using notional portfolios to attribute investment performance. For this reason, many of the standard texts correctly acknowledge their work and devote copious numbers of pages to "Brinson Fachler attribution" (pp. 177-180) and "Brinson Hood Beebower attribution" (pp. 29-51). The Brinson-Fachler methodology underpins many public performance attribution analyses. Morningstar, for example, includes a whitepaper[1] on their mode of employing the Brinson-Fachler methodology. Morningstar is known for its analysis of long-only mutual funds, but the Brinson-Fachler analysis is also applicable to hedge ranking funds.

  7. Geometric attribution • The most common approach to performance attribution (found in sources such as Brinson et al. 1985 and Carino 1999) can be described as "arithmetic attribution". It is arithmetic in the sense that it describes the difference between the portfolio return and the benchmark return. For example, if the portfolio return was 21%, and the benchmark return was 10%, arithmetic attribution would explain 11% of value added. • In Europe and the UK, another approach (known as geometric attribution) has been common. If the portfolio return was 21% while the benchmark return was 10%, geometric attribution would explain an active return of 10%. The reasoning behind this is that 10% of active return, when compounded with 10% of benchmark performance, produces a total portfolio return of 21%.

  8. Adherents of the geometric approach consider it to be highly intuitive. See, for example, Bacon (2002). However, not everybody agrees on this. • One advantage of doing attribution in geometric form is that the attribution results translate consistently from one currency to another. It is plausible that this explains the popularity of geometric approaches in Europe. This is discussed further in the external link by Davies.

  9. Contact us • Website : http://www.indxx.com/analytics.php • Address: • USA: 470 Park Avenue South, Suite 8SNew York, NY 10016 1 844 55 INDXX (46399) • India: 930 B3, Spaze I Tech Park,Sec-49, Sohna Road,Gurgaon 122018+91 124 4291430/31 • UK: 40 Bank Street, 30th Floor,London E14 5NR+44 (0) 203 290 3623

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