A pension board celebrates 180 bps of outperformance from its new equity manager. Attribution reveals: 220 bps from overweighting a sector that happened to rally, while stock selection was negative in every sector. The manager was not picking better stocks, the manager was making an uncompensated sector bet.
A complete CFA® evaluation framework has three pieces, and each one answers a different question.
- Performance measurement asks "what was the return?" It computes time-weighted and money-weighted returns over the evaluation period and reconciles them to the official net asset value (NAV).
- Performance attribution asks "where did the return come from?" It decomposes active return into the decisions that drove it: allocation, selection, factor exposures, duration, currency, and so on.
- Performance appraisal asks "was the return any good?" It uses risk-adjusted ratios and statistical tests to judge whether the manager added value beyond chance.
The three components feed each other in order. Measurement is the input to attribution (you cannot decompose what you have not measured).
Common mistakes
- Using portfolio weights in the selection effect formula. Selection uses BENCHMARK weights to isolate stock-picking from the overweight/underweight decision. Using portfolio weights conflates selection with interaction.
- Dividing alpha by tracking error in the appraisal ratio. The appraisal ratio divides alpha by residual (unsystematic) risk from the factor regression. Tracking error is the volatility of active return against the benchmark, a different quantity whenever beta differs from 1. Mixing them changes the answer and the ranking.
- Treating positive allocation effect as skill. Overweighting a sector that subsequently outperformed could be luck. Attribution tells you WHERE returns came from, not whether the decisions were skillful. Multi-year attribution patterns are needed to assess skill.
Bottom line
- Brinson attribution decomposes active return into allocation, selection, and interaction effects, which must sum to total active return: allocation = (portfolio weight - benchmark weight) x (benchmark sector return - total benchmark return); selection = benchmark weight x (portfolio sector...
- Macro attribution operates at the total fund level: policy, timing, and manager selection
- The Level III appraisal set: Sortino ratio (downside deviation), appraisal ratio (alpha over residual risk), upside/downside capture, maximum drawdown, drawdown duration
- Performance evaluation has three components: measurement (return), attribution (sources), and appraisal (skill)
Exam shortcut
For Brinson calculations, build a 5-column table: sector, portfolio weight, benchmark weight, portfolio return, benchmark return. Compute total benchmark return first. Then apply the three formulas column by column. The three effects must sum to total active return, use this as a check.
The full lesson (about 5,733 words, 38 min read) adds 2 worked examples, all 12 common mistakes, a self-check, free in the app.
Learning objectives
- portfolio eval
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