Asset Management

Lecture 15

Outline for today

Performance Attribution

Decomposing overall performance into components

Components are related to specific elements of performance

Example componentsBroad Allocation IndustrySecurity Choice

Performance Attribution

For the managed portfolio P, set up a ‘Benchmark’ or ‘Bogey’ portfolio B:

Suppose there are n asset classes Select a benchmark index for each asset

class B has fixed weights in asset classes

Target weights

Performance Attribution

Calculate the return on the ‘Bogey’ and on the managed portfolio

Explain the difference in return based on component weights or selection

Summarize the performance differences into appropriate categories

Performance Attribution

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B: Bogey portfolio P: the managed portfolio

Formula for Attribution

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Formula for Attribution

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Contribution from asset allocation

Contribution from security selection

Total contribution from asset class i

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Performance Attribution

Portfolio return from ith asset class = rPiWPi

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Example

A portfolio invests in three asset classesEquityBondsCash (money market securities)

The portfolio return over the month is 5.34%

Managed Portfolio Portfolio Actual Portfolio

Component Weight Return Return

Equity 0.7 7.2800% 5.0960%

Bonds 0.07 1.8900% 0.1323%

Cash 0.23 0.4800% 0.1104%

Return on Managed 5.3387%

Example

The choice of Bogey portfolio: a passive benchmarkPassive (index) benchmark in each asset

classPassive (“neutral”, “usual”) asset allocation

Depends on investor risk tolerance

Example

Bogey Portfolio Weight Return on Portfolio

Component Index Benchmark Index Return

Equity S&P500 0.6 5.8100% 3.4860%

Bonds Lehman Index 0.3 1.4500% 0.4350%

Cash Money Market 0.1 0.4800% 0.0480%

Return on Bogey 3.9690%

Excess return of managed portfolio= 5.34%-3.97%=1.37%

Performance Attribution Summary

Asset Allocation 0.3099%

Selection

Equity Returns Weights

Sector Allocation 1.2898% 0.7 0.9029%

Security Selection 0.1802% 0.7 0.1261%

1.4700% 0.7 1.0290%

Fixed Income 0.4400% 0.07 0.0308%

Total Excess Return on the Portfolio 1.3697%

Example

Actual Weight Benchmark Excess Market Performance

in Portfolio Weight Weight Return Contribution

Equity 0.7 0.6 0.1 5.8100% 0.5810%

Fixed Income 0.07 0.3 -0.23 1.4500% -0.3335%

Cash 0.23 0.1 0.13 0.4800% 0.0624%

Contribution of

Asset Allocation 0.3099%

Contribution of Asset Allocation BiBipi rww )(

Performance Attribution Summary

Asset Allocation 0.3099%

Selection

Equity Returns Weights

Sector Allocation 1.2898% 0.7 0.9029%

Security Selection 0.1802% 0.7 0.1261%

1.4700% 0.7 1.0290%

Fixed Income 0.4400% 0.07 0.0308%

Total Excess Return on the Portfolio 1.3697%

Example

Contribution of Security Selection )( Bipipi rrw

Portfolio Index Excess Portfolio Performance

Performance Performance Performance Weight Contribution

Equity 7.2800% 5.8100% 1.4700% 0.7 1.0290%

Fixed Income 1.8900% 1.4500% 0.4400% 0.07 0.0308%

Contribution of

Selection 1.0598%

Performance Attribution Summary

Asset Allocation 0.3099%

Selection

Equity Returns Weights

Sector Allocation 1.2898% 0.7 0.9029%

Security Selection 0.1802% 0.7 0.1261%

1.4700% 0.7 1.0290%

Fixed Income 0.4400% 0.07 0.0308%

Total Excess Return on the Portfolio 1.3697%

Example

Contribution to sector selection BiBipi rww )(

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Performance Attribution Summary

Asset Allocation 0.3099%

Selection

Equity Returns Weights

Sector Allocation 1.2898%

Security Selection 0.1802%

1.4700% 0.7 1.0290%

Fixed Income 0.4400% 0.07 0.0308%

Total Excess Return on the Portfolio 1.3697%

=1.47%-1.2898%

Performance Attribution Summary

Asset Allocation 0.3099%

Selection

Equity Returns Weights

Sector Allocation 1.2898% 0.7 0.9029%

Security Selection 0.1802% 0.7 0.1261%

1.4700% 0.7 1.0290%

Fixed Income 0.4400% 0.07 0.0308%

Total Excess Return on the Portfolio 1.3697%