I’m at the Spring meeting of the North American chapter of the Performance Measurement Forum in Boston. One of the issues that was raised deals with the case when a firm has a different classification structure than the index and the resulting impact this has on performance attribution. For example, if a firm assigns a stock that’s in the index to a different industry than what the index has.

If we ignore this difference then the attribution results are questionable. If we change how the benchmark has the security assigned then we’ve manipulated the benchmark and arguably falsified the comparison. If we change our classification so that it aligns with the benchmark than we might feel that this doesn’t truly represent how we manage. No good solutions.

Probably the best answer is not to have a different classification. But this may not always be practical. Perhaps in those cases where the firm feels that such differences are necessary we should have a new attribution effect: “classification effect.” Just as we can have “pricing effect” to identify pricing differences between the benchmark and portfolio, we can have a “classification effect” to identify the impact of differences in how we classify our securities. To my knowledge no one has done this but it can’t be that difficult to accomplish.

Thoughts?