On Portfolio Performance, Remember: Attribution Tells the Story

This analysis shows that the strategy’s market cap weightings detracted 3.72% from its relative performance for the year, which overshadows the impact of stock selection. Indeed, this manager has a relatively high number of microcap stocks, and the portfolio’s overweight toward stocks in the smallest quintile detracted 2.46% from performance. With this report, an advisor can quickly and accurately tell investors that the portfolio’s bias towards microcap stocks is the main reason it did not keep up with its benchmark.

Other managers, meanwhile, like to invest in what are considered to be high-quality stocks, the resulting portfolios of which tend to lag their benchmarks during sharp market rallies. Advisors, as a result, have an opportunity to proactively explain this tendency to their clients. More than that, the advisor can put it all into numbers by running a return on equity attribution showing how the high-quality factor impacted performance over time.

Similarly, the volatility of a portfolio, usually measured by beta, can affect relative performance. Low-beta portfolios, for example, tend to underperform during sharp market rallies. Usually comprising high-quality companies with sustainable competitive advantages and lower levels of debt, these portfolios are typically out of favor in market rallies that prefer lower quality and higher-beta postures.

They All Add Up to the Story

In the end, an investment in an actively-managed portfolio of stocks is, intentionally or not, more than just buying a collection of publicly traded companies. The investment is actually in a collection of different factors that will perform better or worse in different market environments; that is why the phrase “stock selection” can be misleading. In practice, many traditional long-only portfolio managers hold stocks for several years, so analyzing and explaining which stocks they ‘selected’ each quarter can give the wrong impression.

Since stock selection and sector exposures by themselves don’t provide an entirely valid basis for judging managers and portfolio performance over time, it’s necessary to consider a variety of other factors, particularly those related to the manager’s investment strategy and the current market environment. Having a grip on the factors within portfolios is almost always a more efficient manner to evaluate performance behavior and explain past results. Said another way, running attributions on these different factors is a useful way to put actual numbers to the story. 

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Author’s disclaimer: For investment professional use only. Past performance is not indicative of future results. The opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. Information obtained from third party resources are believed to be reliable but not guaranteed. Any mention of a specific security is for illustrative purposes only and is not intended as a recommendation or advice regarding the specific security mentioned. Diversification does not guarantee a profit or guarantee protection against losses.