Performance Attribution Methods
There are multiple performance attribution methods used in performance attribution. The three most popular methods are returns-based, holdings-based, and transaction-based attribution. On this page, we discuss how to choose the appropriate method depending on the available data and the investment process measured.
The returns-based attribution approach uses regressions to analyse the portfolio returns over some period and isolates the asset class components through indexes that would have generated these returns. This approach does not attempt to determine the actual holdings of the portfolio. Instead, regressions of broad market indexes are run against the portfolio returns to decompose investment performance.
Frequently, returns-based attribution is used in analysing alternative investments where it is difficult to obtain the actual holdings of the fund. It is the easiest attribution method to implement, but also the least reliable, and the slowest to detect style drift.
The second approach is the holdings-based approach. The accuracy of this approach is higher and improves further as the time interval for the analysis becomes smaller. Since holdings-based attribution does not adjust for any portfolio changes that are made after the initial period, this analysis frequently does not match the actual portfolio returns.
This method is used mostly for passive funds and other strategies that have very little turnover. Holdings-based attribution offers a higher level of quality and can detect style drift much faster.
Transactions-based attribution improves upon the holdings-based attribution by updating the attribution of the portfolio’s beginning-of-period holdings with any subsequent trades. Both the weights and the returns of the portfolio will reflect the actual transactions.
This approach is the most reliable approach. It is also the most complicated, time-consuming, and complex since fund holdings and transaction data are needed.
We discussed three approaches to perform attribution analysis, the returns-based approach, holdings-based approach, and the transactions-based approach.