Portfolio Management

CHAPTER 13Performance Measurement and Attribution

Chapter Outline

1. 13.1 Introduction
2. 13.2 Performance Measurement
3. 13.3 Performance Attribution
4. 13.4 Performance Appraisal: Incentive Effects
   1. Summary
   2. Problems
   3. Appendix: Calculation of Risk Measures
   4. Endnotes

13.1 INTRODUCTION

Performance measurement, attribution, and appraisal are vital elements in the investment management process. Though often not given the same attention as asset allocation or security selection, they are the essential feedback loop in this dynamic process. Portfolio evaluation has three steps:

1. Performance measurement is the process of calculating portfolio returns and risk over the evaluation period. It attempts to answer the question of how well the portfolio performed. This is the input to performance attribution.
2. Performance attribution attempts to identify the source of portfolio returns. This is an attempt to identify the risk factors that best explain performance and, by inference, the impact on performance of the manager's investment decisions.
3. Performance appraisal is the subjective evaluation of performance results and analysis to determine if the manager has demonstrated skill. That is, were returns due to greater market risk or to the asset class and security selection skills of the portfolio manager?

Performance measurement, attribution, and appraisal allow investors, PMs, and chief investment officers (CIOs) to

• Evaluate decisions: Investors want to evaluate the success of their own financial ...