What is attribution?
A portfolio manager typically makes a range of different decision types when deciding how best to add value to a managed portfolio. For the equity manager, these decisions include stock selection (which stocks to buy) and asset allocation (how much of each stock to buy). For the fixed income manager, the range of decisions is much more complex and includes asset allocation, yield curve management, credit forecasting, and many other effects.
Although the returns of a portfolio are driven by a range of factors, conventional performance reporting systems usually just generate a single series of numbers: the portfolio’s return. While this allows the portfolio’s performance to be compared to benchmarks and to other portfolios, the raw return conveys no information about the manager’s abilities to manage and generate profit from the individual risk factors that together drive the markets. To dig a level deeper and to provide this information requires the ability to run attribution analysis.
This is what FIA provides. Using sophisticated mathematics and pricing models, the program breaks down the total return of a portfolio into the returns generated by each source of risk in the portfolio.
Why is attribution useful?
Attribution answers the following types of questions:
- How consistently did a manager make returns from their claimed areas of investment expertise?
- To which risks was a manager exposed? Was this consistent with their claimed investment philosophy?
- How well hedged was a manager against risk types that they did not manage?
- Is the manager losing money from risks of which they are unaware?
Attribution has the potential to add significant value to all areas of the investment process. Simply by showing where the manager’s strengths and weaknesses lie, it allows rapid and accurate assessment of skills, so that risk can be concentrated in profit-generating areas and removed from others. The effects on the manager’s bottom line are often rapid and far-reaching.
Where can I learn more about attribution?
We recommend Andrew Colin’s book Mastering Attribution in Finance (Pearsons/FT Press), available here.