Performance Measurement: The What, Why, And How FROM THE Investment Management Process

Speaking at the 65th CFA Institute Annual Conference, Carl Bacon, CIPM, chairman of StatPro, said that active investment managers must understand the “what, why, and exactly how” of their previous performance to be able to effectively take care of their current clients’ portfolios. A performance measure is a four-step process that entails: (1) standard selection; (2) computation of the portfolio’s surplus come back; (3) performance attribution; and (4) risk evaluations.

Because of the reviews that the performance dimension process provides, Bacon feels that it should be a fundamental element of the investment decision-making process, instead of external to it. The performance measurement process begins with selecting a proper benchmark (ex-ante) that will be subsequently used (ex-post) to assess the performance of the portfolio. The benchmark must be inevitable, accessible, impartial, and relevant.

Excess come back is the difference between a portfolio’s come back and its benchmark’s come back. Arithmetic excess return is more widely used because it is simpler to understand and large and total values in rising marketplaces. However, the geometric return is more appropriate to use when calculating excess profits over multiple periods (compoundable) or in various currencies (convertible), or when you compare earnings (proportionate). Performance attribution quantifies the partnership between a portfolio’s excessive profits and the active decisions of the collection manager. In other words, it relates the excess results of the portfolio (both positive and negative) to the energetic investment decisions of its supervisor.

It provides reviews to profile managers, senior management, and exterior consultants on why the portfolio either outperformed or underperformed its standard. It really is especially useful when the manager has underperformed his benchmark. Probably one of the most trusted attribution models is the Brinson model, which examines performance in conditions of allocation decisions (returns predicated on sector or asset-weighting) and individual security selection decisions. Returns-based attribution, which uses factor evaluation. Holdings-based attribution, which is calculated on a regular basis and uses holdings data.

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The key benefit of using the holdings-based attribution is it is simple to implement just because a variety of prices sources can be used. Two disadvantages are that: it will not reconcile to performance come back, and it can’t be used as an operational tool. Transactions-based attribution, which is calculated from transactions and holdings data.

Unlike holdings-based attribution, transactions-based attribution reconciles to the comeback of the stock portfolio and for that reason can be used as an operational tool. In addition, it identifies all sources of excess return. However, this type of attribution is more difficult to implement and requires accurate and complete data. Risk analysis is important for those who are responsible for both managing and controlling the portfolio’s risk.