Role of Fixed Income in a Portfolio
Fixed income is also known as debt securities. It is one of the... Read More
Numerous stakeholders are interested in the results of the performance attribution process. Virtually any individual or entity that is affected by the outcomes of the portfolio should want to know how the return (or loss) was achieved. What specific decision made by the manager lead to the final outcome? And ultimately, is the manager effective? Proper performance attribution analysis requires a thorough understanding of the investment decision-making process and should reflect the active decisions of the portfolio manager.
A superior return attribution process should:
Per the CFAI 2022 Level III Curriculum, the above is explained as follows:
“If the return or risk quantified by the attribution analysis does not account for all the return or risk presented to the client, then at best the attribution is incomplete and at worst the quality of the attribution analysis is brought into doubt. If the attribution does not reflect the investment decision-making process, then the analysis will be of little value to either the portfolio manager or the client. For example, if the portfolio manager is a genuine bottom-up stock picker who ignores sector benchmark weights, then measuring the impact of sector allocation against these weights is not measuring decisions made as part of the investment process; sector effects are merely a byproduct of the manager's investment decisions.”
Question
Which of the following is least likely part of an effective return attribution process?
- Account for all of the portfolio’s return or risk exposure, reflecting the investment decision-making process.
- Quantify the passive decisions of the portfolio manager.
- Provide a complete understanding of the excess return/risk of the portfolio.
Solution:
The correct answer is B.
An effective return attribution process must quantify the active decision of the portfolio manager. Passive investing does not require the same level of return attribution as the sources of return would be the benchmarks or indexes tracked. For passive attribution, stakeholders are more interested in knowing how closely the index or benchmark was tracked, i.e. ‘tracking error’.
Both answers A and C are correct.
Reading 12: Portfolio Performance Evaluation
Los 12 (b) Describe attributes of an effective attribution process