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1 September 2016 CFA Institute Journal Review

Process Attribution: Revisiting Equity Attribution and Decision Making (Digest Summary)

  1. Chen Sui

Traditional performance attribution for actively managed equity portfolios can fail to fully capture the investment process. The authors revisit process attribution, an alternative approach, and show how it can be used to give more insight into the value added at each stage of the investment process.

What’s Inside?

The authors present a framework for better attributing a portfolio's return to the decision-making and portfolio construction process, thus providing detailed feedback on the whole investment process. This approach relies on the construction of several notional portfolios that reflect the context of decisions taken during each step of the investment process.

How Is This Research Useful to Practitioners?

Equity portfolio performance attribution aims to explain how the return of a portfolio was generated. It is typically used by asset owners and active managers to analyze the outcome of their investment processes and, by extension, the value added or subtracted by active management. One of the most popular methods is the methodology outlined by Brinson, Hood, and Beebower (Financial Analysts Journal 1986). This approach allows the manager’s asset allocation and stock selection decisions to be isolated.

Portfolio construction processes are rarely simple and frequently consist of a myriad of decisions and executions. Expanding on the process attribution approach, the authors show how to align the technique with the decisions taken during portfolio construction. This alignment is achieved by deconstructing the portfolio into several notional portfolios, each relating to a phase of the portfolio construction process and each phase consisting of several steps. The phases and steps suggested by the authors are as follows:

  1. Stock analysis—initial screening, quality screening, and valuation screening
  2. Portfolio construction—strategic asset allocation, tactical asset allocation, and market timing
  3. Execution—ability to obtain the best entry/exit price

The ability to decompose a portfolio’s return into these components can provide significant insight into where value is added in the investment process and provides a powerful feedback mechanism for that process.

Abstractor’s Viewpoint

Process attribution makes a great deal of sense, and I view this approach as complementary to existing attribution methodologies. The ability to quantify the value added at each stage of the investment process can provide more valuable feedback than traditional methodologies. Of most interest to practitioners is the framework detailed by the authors, who show how the process attribution approach can be adapted to the needs of individual investment managers. This framework is key because each investment manager is likely to have a unique investment process and will want to be able to measure the value added through that process.

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