Portfolio analysts often use one set of decision variables for attributing
portfolio returns and a different set for attributing risk. This practice
obscures the relationship between the sources of risk and return. This article
demonstrates how to align the attribution model with the investment process. The
attribution methodology can be applied ex ante or ex
post. A factor-based investment process illustrates the general
framework. Specifically, active return, tracking error, and the information
ratio are attributed to a user-defined set of factors that reflect the
manager’s investment decision-making process. A concrete example with
actual market data, a style portfolio, and a parsimonious set of custom factors
illustrates how to apply the analysis.