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Attribution analysis questioned

A recent report criticised the ability of balanced managers to add value. Michael Good questions the methodology used in the report.

Monday, May 11th 1998, 12:00AM

by Philip Macalister

A favourite tool used by consultants to assess investment managers’ performance is attribution analysis. The objective is to separate the returns achieved by an asset sector from returns achieved across asset sectors.
The former is a focus on added value through stock selection within an asset sector, while the latter is to analyse the benefits of allocation of funds across asset sectors.
Recently, a view has been expressed as to whether balanced managers are able, on average, to add value across asset sectors through market timing i.e. under or over allocating funds into different asset sectors.

This view raises some interesting issues that need to be debated, not at least the credibility of the attribution analysis process:
  1. Asset sectors are arbitrary boundaries. For example, why separate domestic and overseas bonds? Are listed properties securities part of shares or property? Should global shares be allocated on regions, countries or industries? In summary, are conventional asset sectors relevant and sustainable over time?
  2. Cash can be an asset sector and/or play an important role within an asset sector. Managers treat cash holdings in different ways and this can distort the attribution analysis.
  3. The use of options or protective strategies within an asset sector are effectively a form of asset allocation. The impact is only recognised within asset sectors, yet the process can also be regarded as asset allocation.
  4. The management of portfolios has moved on from the pure benchmark relative performance requirement to include protection of capital i.e. providing an absolute return as well as a relative return. Consequently there are times when insurance should be used to protect capital. The cost of this insurance is not reflected in an attribute analysis.
  5. Inter-month activity is not captured in the analysis. Further, sometimes the calculations have been very simplistic and omitted a factor known as interaction.
Asset allocation is a prime determinant of performance. This is reflected in the strategic benchmark established for clients. However, operating a passive holding based on a strategic benchmark limits opportunities and focuses assets into the rigidity of conventional classifications.
Active tactical asset allocation enables managers to add incremental value across asset sectors. Consultants are employed to identify the managers that can consistently add value at both asset sector and asset allocation levels. Attribution analysis is only a crude evaluation of investment skills.
Michael Good is chief investment officer at Guardian Trust.
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