Attribution analysis uses past performance in investments to help show how much of a fund’s results can be based on the approach of the fund managers. As Kyle Tetting explains in a Money Talk Video, attribution is a sophisticated way of testing a manager’s potential. Kyle spoke with Joel Dresang. A transcript of their conversation follows.

Joel Dresang: Kyle, past performance is no guarantee of future results, and yet you have to rely on past performance a lot of times to evaluate which funds to invest in.

Kyle Tetting: Certainly in the absence of that crystal ball, not really able to predict what the future performance of a fund is going to be, the past performance can be a useful tool in evaluating the success of a manager in achieving of a particular objective.

Also see:
Sorting through investment fund managers, a Money Talk Video with Kyle Tetting

And ultimately, that’s the more important piece: Not necessarily what has that past performance been but how have they achieved the objectives they set out to achieve?

Joel: So how do you do that? How do you know what they’ve achieved through skill versus blind luck?

Kyle: We have a tool that we use called attribution. What attribution looks at is actually determining where portfolio return has come from.

So, if an investment manager says that they are very focused on building a portfolio from the bottom up, picking the best stocks that are out there, we can look at the returns of their stocks relative to the benchmark that they compare themselves to and determine are they overweighting the stocks that are out performing, are they underweighting the stocks that are underperforming?

And that’s really how they’re going to add value is by doing those two things.

Joel: So, what about managers who focus on a top-down approach?

Kyle: Not every manager is focused on building from the bottom up. Certainly, they care about stock selection, but a lot of managers have a much broader theme that they invest to and so, those top-down managers or those sector-focused managers, we can also measure how they’re allocating to individual sectors, again, overweighting the outperformers and underweighting the underperformers – so that what we get is attribution to both stock selection and sector allocation.

And we have an idea of then what a manager’s objectives are. We’ve talked to the managers. We know what they’re trying to do, and we can put that attribution number in perspective, then. How are they performing relative to what they’ve said they’re going to do.

Joel: So, how often do you run these attribution studies?

Kyle: It’s something that’s done on a quarterly basis, at a very minimum. But, important to remember that performance in such short time periods is really not indicative of maybe a manager’s longer-term success. But, again, we do keep a pretty close eye on things.

Joel: So this whole attribution analysis sounds pretty technical. What should investors know about it?

Kyle: It is a very technical measure and certainly something that the average investor isn’t necessarily going to look at. But what’s important about it is that in order to get a better idea of a manager’s potential for long-term success, you want to make sure that returns are coming from the things they say they’re trying to accomplish as opposed to just that blind luck.

The hope is that managers who are focused on stock selection are good stock pickers and that managers who are managing to some kind of macro viewpoint or some sector-specific strategy are doing a good job of that.

Joel: And then, what do you do with this when you get it all?

Kyle: You go back to that very first question you asked, which is if past performance is no indication of future success, why do we even look at it? I think ultimately, if you have a manager with strong track record and you have a manger whose attribution indicates that what they’re trying to accomplish is supporting that strong track record, I think ultimately you have a manager who has a good chance of having long-term success.

Kyle Tetting is director of research at Landaas & Company.

Joel Dresang is vice president-communications at Landaas & Company.

Money Talk Video by Jason Scuglik
(initially posted Sept. 30, 2015)

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