Asset allocation
Asset allocation describes the way in which the portfolio is weighted between different categories, such as geographical spread, industrial sector (utilities, property, biotech etc.), or asset class (stocks, bonds, property, cash etc.). A company may outperform its benchmark by being over-weight in the markets that perform the best within the index (even though performance within each section of the portfolio might only be in line with the individual market index). Alternatively, the company may maintain market weightings exactly in line with the index but outperform in each market segment by picking better stocks. In practice, however, performance – good or bad – will be a combination of these factors.
Attribution analysis
Attribution analysis seeks to explain the extent to which different aspects of the investment policy have contributed to the returns generated by the portfolio and the variance from the benchmark.
A typical analysis will aim to separate the contributions from asset allocation decisions and stock selection decisions.
Directors can use attribution analysis to help to understand what has caused the good or bad results for the year. They can use it to question the manager about why certain asset allocation decisions has been made, or the reasons for poor stock selection in particular markets. There may be good reasons for the outcome, but regular failures in certain areas may highlight fundamental problems in the manager’s investment approach.
Attribution analysis will be more relevant for some companies than others. For an investment company that invests only in the UK equity market, a geographic analysis will be irrelevant, but an analysis which separates the returns attributable to sector weightings against those derived from stock selection may be of value, particularly if the investment process is designed to help identify strong sectors. Attribution analysis is certainly useful in showing whether gearing has added value and whether it has been right to make tactical decisions to reduce effective gearing by holding cash.
There can be shortcomings in attribution analysis and it is proper that the manager explains the outcome and places it in context before the board draws any conclusions. Some judgement may be required in allocating stocks to sectors, and changes in the balance and composition of a portfolio during the course of a year will complicate the calculation. Nevertheless, this type of analysis is of value for identifying areas of weakness or possible failures in the investment process.
Example of attribution analysis
A simple example of attribution analysis is below:
| % | |
|---|---|
|
Net asset value total return Benchmark total return |
26.0 24.0 |
|
Relative return Analysis of relative return Allocation effect |
2.0
0.3 |
| Total | 2.0 |
This example shows that the company has marginally outperformed the benchmark for the period under review and that the main reasons for this were:
- The stocks selected by the manager have performed better than those in the benchmark, although the asset allocation decisions have had little impact;
- The company’s gearing strategy (or cash position) during the period also made a positive contribution to its outperformance against the benchmark;
- However, the benefits of the positive stock selection and gearing strategy were dragged down by the level of fees incurred by the company, both in terms of management and other fees, and also quite significantly by the payment of a performance fee.
