Adjusted Factor-Based Performance Attribution

Author: Robert A. Stubbs, Vishv Jeet

Factor-based performance attribution is ubiquitously employed in the asset management industry as a way to both understand and assess the management of a portfolio. Unfortunately, this attribution analysis can fail to tell the whole story. One reason is a strong correlation between the factor and specific return contributions that leads to potentially erroneous attributions. This correlation stems from a "misspecification" of the returns model and causes the factors to over- or under-explain the returns of a given portfolio. With the trend towards "smart beta," and factor-investing in general, this correlation is becoming more pervasive and accounting for it is critical when analyzing the return contributions of such factor-based strategies.

We propose an adjusted factor-based performance attribution methodology that shifts the portion of the asset-specific contribution that is correlated with the factor contributions back into the factor portion. The resulting factor specific contributions have near-zero correlation leading to factor contributions that do not over- or under- explain the returns of a portfolio. From a practical perspective, we find that the proposed methodology generally results in attributions that are more intuitive and provide stronger support of factor-based investment mandates. 

Download Whitepaper: