It’s still early 2013, and advisors around the country are doubtlessly still talking about 2012 investment performance with their clients. A big part of those discussions will be around individual portfolio manager results. It’s great, of course, when a manager meets or beats expectations. Conversations about those kinds of results are fairly straightforward. But experience tells us that a manager or two will have disappointed. In those instances, advisors are on the spot to explain why. Quantifying results is the nature of our business, and we suggest that advisors need to look to attribution to manage this important point of discussion with clients.
There Are Numbers…
When it comes to equity portfolios, it’s easy enough to compare results to indexes like the Russell 1000 or the MSCI EAFE. Typically, performance is analyzed versus a benchmark by running an attribution report that looks at stocks within different sectors. Below is an example of an attribution table that explains why a small-cap investment manager underperformed the Russell 2000 Index for the 2012 calendar year.
This type of attribution is a quick way to help tell the portfolio’s performance story. In a nutshell, the two columns towards the right—“Sector Weighting” and “Selection”—explain the bulk of the performance difference: Sector Weighting added 1.04% to total performance while Selection, primarily in the Consumer Discretionary sector, detracted 3.22%. In this example, the ‘story,’ then, would read something like this: “In 2012, weak stock selection, particularly among Consumer Discretionary issues, accounted for most of the portfolio’s underperformance versus its benchmark.”
…and Then There Are Numbers…
This kind of useful analysis is accurate as far as it goes, but the stock selection story may not go far enough. The fact is that portfolios have many different factors within them—lquality, volatility, market capitalization, style and so on—that result from their manager’s investment approach. As such, it’s useful to look at the impact that these factors had on performance.
Below, for example, is an attribution analysis for the same equity strategy for the same time period, this time looking at the ‘size’ factor: