Performance Perspectives Blog

Concerns with holdings-based attribution

by | Apr 17, 2012

On my “to do list” is the task to write an article an article for The Journal of Performance Measurement(R), detailing some of my findings from research I’m doing regarding the impact of trading on the accuracy of the holdings-based approach to performance attribution. Recall that firms can either (a) use a “buy and hold” approach, that only uses the starting position weights, ignoring any intraperiod activity (holdings-based) or (b) begin with the starting position weights, and then adjust them for trades, income, corporate actions that occur across the period (transaction-based).

We have known that the use of holdings-based models can result in a “residual.” Let’s briefly speak about this term. A “residual” is a non-zero difference between the sum of the attribution effects and the associated excess return. It can occur in two ways: across periods, as the result of linking arithmetic attribution subperiod effects (geometric attribution doesn’t have these residuals) or within a period, by the use of a holdings-based model.

And so, we recognize that there’s a flaw in using just the starting holdings and ignoring the activity. But, as with the “across periods” approach, there is often the assumption that the error is proportionate to the results, meaning that one could smooth the residual across the effects without encountering much of an error. My research has shown that this isn’t the case. In fact, there’s a second, more significant problem: the misassignment of effects. That is, we can have, for example, the allocation effect reflecting a totally incorrect value (e.g., negative when it should be positive).

My research will continue for the next several months, and I hope to have something that speaks to this in much greater depth later this year. In the mean time, I will provide an update on my most recent findings at this year’s TSG PMAR conferences.

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