The Use and Misuse of Attribution
| Date: | December 2005 |
| Author: | Peter Ellis |
| Price: | £500 to non-members of the Investit Intelligence member service |
Attribution is the dominant technique performance teams at investment management companies use, in order to explain performance to both internal and external clients. But most investment management firms are not extracting as much value from attribution services as they could do, and should do.
As part of this research, Investit interviewed 17 investment management companies, 10 performance system vendors and also appointed Carl Bacon, an industry-known performance expert, as a special advisor to the research project.
The use of attribution
The use of attribution is growing, in response to both internal and external pressures; pension fund clients want clearer descriptions of performance, and the portfolio managers themselves use attribution to better measure the effectiveness of their process an individual skill. Attribution has become a key business service for investment management companies.
Attribution is a technical subject and, even within performance teams at investment management firms, the understanding of attribution is generally concentrated in a small number of people. Performance teams often work in isolation when designing and implementing attribution solutions. So, it remains a mystery to non-specialists.
The internal and external demands for more detail and greater accuracy in performance attribution is driving the industry towards more sophisticated attribution services and more complex methods. Many investment management firms are struggling to cope with the challenges posed to upgrade their performance services. Unsurprisingly then, in the past five years, vendor systems have merged that support these new models and calculation methods.
The misuse of attribution
Is attribution the only technique that investment managers should use to analyse performance? The dominance of attribution has focused attention on its deficiencies - and the need for other performance techniques. Attribution in isolation can't properly provide explanations of why funds performed the way they did, it only looks at benchmark-relative terms. Internal and external clients of performance teams also want to see the analysis of portfolio manager performance and an analysis of the investment process. Was it successful? What was the impact of indirect factors and so on? The relative return between a fund and its benchmark is only one of five baselines that should be used to determine whether performance is satisfactory. Performance versus targets, peer group performance, past performance and risk also should be used.
So, the growth in reliance on attribution leads investment managers to miss valuable information about the quality of the investment process and portfolio managers. Attribution is being misused.
The quality of attribution services needs to be higher
Delivering good attribution services is costly, in terms of man-hours, and suffers from frequent production difficulties. The most frequent issues are internal to investment management companies, and are usually by poor data. Improvements in service quality and production costs could be achieved if more formal interfaces were introduced between performance teams and administration teams - something that, currently, rarely happens.
Each area of investment managers' businesses has a different requirement - for example, client reporting teams need scalability and reliability of attribution. Portfolio mangers need detail. Different requirements mean different systems and processes. The demand for more detail and greater accuracy of attribution is driving the industry towards more sophisticated attribution services. Many investment management firms are struggling to cope with the challenges that are posed when they upgrade their capability. Transitions to new platforms need to be handled as strategic business change programmes - many firms still run them as departmental initiatives.
What does the future hold?
Will attribution remain a crucial performance technique to investment management firms? Definitely so. But over the next five years attribution techniques are likely to be further refined, to deliver more detail and accuracy. However, the current dominance of attribution as a performance technique will be diluted. Other techniques will be introduced alongside traditional attribution techniques to provide a more complete explanation of how investment processes and portfolio managers deliver performance, in terms other than benchmark-relative return.
Table of contents
| Management Summary | 1 | |||
| 1.0 | Introduction | |||
| 1.1 | Scope of the research | 4 | ||
| 1.2 | Methodology | 5 | ||
| 2.0 | An Introduction to Attribution | 7 | ||
| 2.1 | Definitions of basic terms | 8 | ||
| 2.2 | Performance measurement basics | 10 | ||
| 2.3 | Attribution basics | 13 | ||
| 2.4 | Attribution models | 17 | ||
| 2.5 | Calculation methods | 21 | ||
| 3.0 | The Use of Attribution | 23 | ||
| 3.1 | The clients of attribution | 24 | ||
| 3.2 | The value delivered by attribution | 27 | ||
| 3.3 | Attribution models | 30 | ||
| 3.4 | Delivering attribution | 33 | ||
| 3.5 | The growth of complexity in attribution | 35 | ||
| 3.6 | Attribution systems | 37 | ||
| 4.0 | The Misuse of Attribution | 39 | ||
| 4.1 | Performance analysis | 40 | ||
| 4.2 | Evaluating performance | 41 | ||
| 4.3 | Explaining performance | 45 | ||
| 4.4 | The deficiencies of attribution as a performance analysis technique | 48 | ||
| 4.5 | Problems arising from dominance of attribution | 50 | ||
| 4.6 | Systems issues | 52 | ||
| 5.0 | The Attribution Landscape | 55 | ||
| 5.1 | The evolution of attribution | 56 | ||
| 5.2 | The current state of attribution | 59 | ||
| 5.3 | The future landscape | 60 | ||
| 5.4 | Business impact of enhanced performance analysis techniques | 65 | ||
| 6.0 | Attribution Best Practice | 67 | ||
| 6.1 | Best practice for using attribution in performance analysis | 68 | ||
| 6.2 | Best practice for delivering attribution | 70 | ||
| 6.3 | Best practice for upgrading attribution services | 72 | ||
| 7.0 | Conclusions | 73 | ||
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