Investing in actively managed funds might appeal to you if you’re hoping to beat the market. But before you invest, there’s just one thing to consider: the fund manager. The fund manager’s expertise and the overall allocation of the fund can play a key part in the type of returns you realize. Attribution analysis is a method that’s used to analyze the performance of a portfolio or a fund manager. While it might sound a little technical, working with a financial advisor can help when evaluating the merits of a particular fund or fund manager.
What Is Attribution Analysis?
Attribution analysis is a technique for analyzing and evaluating a portfolio or fund’s performance. Specifically, when you’re applying attribution analysis you’re trying to understand how well an investment did when compared to a specific benchmark. You may also see this term referred to as return attribution or performance attribution.
From an investment perspective, you might be wondering why you would conduct this type of analysis. And the simple answer is to gauge what a fund might be worth to you based on how well, or poorly, the fund manager does their job. The benchmark you’re measuring performing against acts as a baseline for gauging the fund’s relative return.
How Does Attribution Analysis Work?
Attribution analysis works by looking at three distinct things:
- Fund assets and allocation
- The fund manager’s investment style
- Market timing
The goal is to explain why a portfolio or fund performs differently from the benchmark it’s being measured against. You’re looking for the difference between the returns of the portfolio versus the returns of the benchmark. The benchmark itself may be an index, such as the Dow Jones Industrials, that includes a range of assets, similar to the ones in the fund or portfolio.
The fund manager’s selection of investments, their overall investment style and the market timing in which they’re buying and selling investments can all influence how wide or narrow the gap is between returns.
What Does Attribution Analysis Tell You?
Attribution analysis tells you how the returns of a fund or portfolio compare to the returns of a benchmark. That also tells you indirectly how skillful the fund manager is or isn’t.
In terms of how to interpret an attribution analysis, there are three things to zero in on. First, you’re going to look at the allocation of the fund or portfolio overall. Specifically, you’re interested in whether the assets in the fund or portfolio are allocated compared to the benchmark. The purpose of this is to determine which sectors or industries you have more or less exposure to in the portfolio.
The portfolio manager should, in theory, overweight sectors or industries that are likely to produce at or above the level of expected returns while giving less weight to sectors that are likely to underperform. Attribution analysis looks at the return of the portfolio compared to the benchmark to see if the fund manager’s guesses about allocation were correct. It can also clue you into the investment manager’s overall style.
The next step involves taking a closer look at individual segments to see which ones over- or underperform, relative to the benchmark. Again, you’re indirectly weighing the fund manager’s performance since they’re responsible for choosing the assets within each segment.
Finally, you have to consider the timing and any other factors that might influence the fund manager’s decision-making. Getting the market right every single time is virtually impossible, but you can look at a fund manager’s actions to see how good they are at capitalizing on changes in the market. Of course, it’s important to keep in mind that some of what looks like skillful timing may actually just be luck.
Overall, attribution analysis can be a useful tool for highlighting a fund manager’s strengths and weaknesses. If you’re considering investing in a particular fund, you might first look at the fund manager as a gauge for determining how well it might fit into your portfolio.
Attribution Analysis and Fund Alpha
Alpha is the excess returns a fund generates. In other words, alpha shows how well a fund is able to beat the market. If you’re investing in managed funds with the goal of beating the market, attribution analysis can give you an idea of how likely a particular fund is to do that.
The most important thing to keep in mind here is that you need to choose benchmarks that reflect the makeup of the fund you’re analyzing. It wouldn’t make sense, for example, to compare a large-cap fund to an index that includes only small-cap companies. Doing so won’t give you a true sense of whether the fund is capable of beating the market since the fund doesn’t correlate to the index.
Once you understand what a fund is likely to produce in excess returns compared to an appropriate benchmark, you can then take a closer look at the fund itself. For example, you might go through each asset within the fund to see how well it performed and how many winners or losers there are. If just a handful of assets are generating the bulk of returns, then you have to consider how well that fits your overall risk tolerance and investment style.
The Bottom Line
If you lean toward actively managed funds, it’s important to select investments that are likely to justify the higher expense ratios you might pay with higher returns. Attribution analysis can be a helpful tool for evaluating whether a particular investment is right for you. And it could help you to weed out funds or portfolio options that don’t mesh with your style and goals.
Tips for Investing
- Consider talking to your financial advisor about how to complete an attribution analysis for your investments. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Reviewing your portfolio regularly can be a good way to measure how well you’re doing and make any adjustments if necessary. For example, you may need to adjust your asset allocation if you’ve become unbalanced in one particular area or sector.
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