Performance Attribution and the Fundamental Law

The reported study operationalized the “fundamental law of active management” in the context of a factor-based performance attribution system. The system incorporates factor payoffs in the linear regression framework that many portfolio managers and external reviewers use to judge what is being rewarded in the market. The study indicates that parameters of the fundamental law can be used to approximate and interpret the results of the regression-based performance attribution system. The procedure is illustrated by the use of security holdings, returns, and factor exposure data for two portfolios benchmarked to the S&P 500 Index for April 1995 to March 2004.