What Is Attribution Analysis?
Attribution analysis is a sophisticated method for assessing the performance of a portfolio or fund manager. Otherwise called "bring attribution back" or "performance attribution," it endeavors to quantitatively investigate parts of an active fund manager's investment selections and choices — and to distinguish wellsprings of excess returns, particularly as compared to a index or other benchmark.
For portfolio managers and investment firms, attribution analysis can be an effective apparatus to survey strategies. For investors, attribution analysis fills in as a method for surveying the performance of fund or money managers.
- Attribution analysis is an evaluation device used to make sense of and break down a portfolio's (or portfolio manager's) performance, particularly against a particular benchmark.
- Attribution analysis centers around three factors: the manager's investment picks and asset allocation, their investment style, and the market timing of their choices and trades.
- Asset class and weighting of assets inside a portfolio figure in analysis of the investment decisions.
- Investment style mirrors the idea of the holdings: generally safe, development arranged, and so on.
- The impact of market timing is difficult to measure, and numerous analysts rate it as less important in attribution analysis than asset selection and investment style.
How Attribution Analysis Works
Attribution analysis centers around three factors: the manager's investment picks and asset allocation, their investment style, and the market timing of their choices and trades.
The method starts by distinguishing the asset class in which a fund manager decides to invest. An asset class generally depicts the type of investments that a manager picks; inside that, it can likewise get more specific, portraying a geographical marketplace in which they begin or potentially an industry sector. European fixed income debt or U.S. technology equities could both be models.
Then, at that point, there is the allocation of the various assets — that is, which percentage of the portfolio is weighted to specific fragments, sectors, or industries.
Indicating the type of assets will assist with distinguishing a general benchmark for the comparison of performance. Frequently, this benchmark will appear as a market index, a basket of comparable assets.
Market indexes can be extremely broad, like the S&P 500 Index or the Nasdaq Composite Index, which cover a scope of stocks; or they can be fairly specific, zeroing in on, say, real estate investment trusts or corporate high yield bonds.
Investigating Investment Style
The next step in attribution analysis is to decide the manager's investment style. Like the class identification examined over, a style will give a benchmark against which to measure the manager's performance.
The main method of style analysis concentrates on the idea of the manager's holdings. Assuming that they are equities, for instance, are they the stocks of [large-cap](/huge cap) or small-cap companies? Worth or development arranged?
American economist Bill Sharpe presented the second type of style analysis in 1988. Returns-based style analysis (RBSA) charts a fund's returns and looks for an index with comparable performance history. Sharpe refined this method with a technique that he called quadratic optimization, which permitted him to assign a blend of indices that connected most closely to a manager's returns.
Making sense of Alpha
When an attribution analyst distinguishes that blend, they can formulate a redid benchmark of returns against which they can assess the manager's performance. Such an analysis ought to focus a light on the excess returns, or alpha, that the manager appreciates over those benchmarks.
The next step in attribution analysis endeavors to make sense of that alpha. Is it due to the manager's stock picks, selection of sectors, or market timing? To decide the alpha generated by their stock picks, an analyst must distinguish and take away the portion of the alpha owing to sector and timing. Once more, this should be possible by creating modify benchmarks in view of the manager's chosen blend of sectors and the timing of their trades. On the off chance that the alpha of the fund is 13%, it is feasible to assign a certain cut of that 13% to sector selection and timing of entry and exit from those sectors. The remainder will be stock selection alpha.
Market Timing and Attribution Analysis
However a few managers utilize a buy-and-hold strategy, most are continually trading, pursuing buy and sell choices all through a given period. Portioning returns by activity can be valuable, advising you in the event that a manager's choices to add or deduct positions from the portfolio aided or hurt the last return — opposite a more passive buy-and-hold approach.
Enter market timing, the third big factor that goes into attribution analysis. However, a fair amount of discussion exists on its significance.
Certainly, this is the most troublesome part of attribute analysis to put into quantitative terms. To the degree that market timing can be estimated, researchers point out the significance of checking a manager's returns against benchmarks intelligent of upswings and slumps. Preferably, the fund will go up in bullish times and will decline not exactly the market in bearish periods.
Even thus, a few researchers note that a huge portion of a manager's performance with respect to timing is random, or karma. Thus, by and large, most analysts attribute less significance to market timing than asset selection and investment style.