Question: In some mutual fund Analyst Reports, Morningstar analysts refer to performance attribution as a way to determine whether a manager is good at choosing stocks. How is this analysis done?
Answer: Performance attribution analysis is a method used by analysts at Morningstar and elsewhere to help determine why a fund performed the way it did during a given time period.
Did the fund underperform relative to its benchmark because of a few bad stock picks, or was it because the fund invested too heavily in a poorly performing sector of the market?
If a fund outperformed its benchmark, is it because the manager chose the right stocks to invest in, or because he or she managed to avoid stocks that would have weighed down performance? These are the sorts of questions performance attribution analysis can help answer.
Giving credit where credit is due
Although the mathematics behind performance attribution are complex (click here to read Morningstar's methodology paper on the subject), the basic idea is simple. A fund's performance is assessed relative to its prospectus (or another) benchmark and based on various factors. Among these factors are:
Stock selection: The degree to which the manager's skill at picking individual stocks helped or hurt fund performance relative to the benchmark.
Sector allocation: The degree to which the fund's sector weightings helped or hurt performance relative to the benchmark. By overweighting an outperforming sector or underweighting a poorly performing one, a fund may outperform its benchmark, just as doing the opposite of each of these can cause a fund to underperform.
Country allocation: For international-stock funds, the degree to which the fund's over- or underweighting in stocks from various countries affected performance.
Fees: The degree to which the fund's expense ratio affected performance (reduced its return).
Attribution results are tabulated monthly to account for changes in a fund's portfolio, and these monthly results are used to calculate performance attribution over many years.
The process isn't an exact science, especially in the case of funds that turn over their portfolios frequently or include securities for which performance or classification information is unavailable.
Performance attribution information is only available through Morningstar Direct, the platform available to Morningstar's institutional customers and our analysts. But here's a performance attribution report for HDFC Top 200 for the 12-month period ended March 31 using its prospectus benchmark, the S&P BSE 200.
The report spells out the extent to which various sectors and stocks helped or hurt fund performance during that time. For example, the fund’s consumer-defensive holdings helped it while basic-material stocks provided a negative effect.
Winning stocks for the fund during the past year included ITC, ICICI Bank and Zee Entertainment while Tata Steel, Bharti Airtel and Crompton Greaves, acted as drags on fund performance.
Overall the fund's allocation choices and stock selection caused it to lag the S&P BSE 200 index for the 12-month period, according to the report.
One piece of the puzzle
Although performance attribution analysis can be useful as a way to gauge a fund manager's effectiveness, it's just one of the tools Morningstar's fund analysts use, says Dan Culloton, associate director of fund analysis for Morningstar, based in the U.S.
"It's just another part of the mosaic we try to piece together when rating a fund and manager," Culloton says. "It can help confirm what hurt or helped a fund over a given period or ferret out if a manager who claims to have an expertise in a particular sector or style has actually shown it in the past."
Culloton cautions that, as with fund performance overall, a manager's past success as a stock-picker doesn't necessarily predict future outperformance.
Looking inside your own portfolio's performance
Morningstar's performance attribution statistics are not available on Morningstar.in, but readers hoping to do a rough analysis of their own portfolios can use the Instant X-Ray tool (or the X-Ray feature in Portfolio Manager if you are a Registered Member) as a starting point.
These tools can provide information about your portfolio's sector and world regional weightings relative to selected benchmarks as well as fee-comparison information. (Keep in mind that fund portfolio data is not updated regularly, so X-ray results might not represent current fund holdings.)
After you enter your holdings in the Instant X-Ray tool, you can identify significant sector overweightings or underweightings in your portfolio, which can help you identify which stocks represent the largest percentage of assets in your portfolio.
Knowing where your portfolio is over- and underweight, and comparing the performances of those areas with that of a relevant benchmark, can give you a sense of where your portfolio's strengths and weaknesses are. It's not as precise as the performance attribution tools available in Morningstar Direct, but it can still help you figure out why your portfolio is over- or underperforming.
