Question

1. Below is a summary of the portfolio and benchmark weights and returns on six different sectors in the past year. Please perform attribution analysis for the portfolio performance. Specifically, please calculate this portfolio’s allocation effect and selection effect and discuss how they contribute to the portfolio’s performance. (10 points)

	Portfolio Weights (%)	Benchmark Weights (%)	Portfolio Sector Returns (%)	Benchmark Sector Returns (%)
Consumer Discretionary	25	20	12	16
Health Care	25	15	10	7
Industrials	10	20	5	5
Technology	30	20	25	20
Real Estate	10	25	18	15

Answer 1

The portfolio performance is 0.25*12%+0.25*10%+0.1*5%+0.3*25%+0.1*18%= 15.3%

Benchmark performance is 0.2*16%+0.15*7%+0.2*5%+0.2*20%+0.25*15%= 13%.

So, the portfolio outperformed the benchmark by 2.3%

Lets consider Allocation effect.

It can be calculated as (Portfolio weight-Benchmark weight)*(Benchmark return)= (25%-20%)*16%+(25%-15%)*7%+(10%-20%)*5%+(30%-20%)*20%+(10%-25%)*15%= 0.75%.

Allocation effect contributes to the portfolio performance by allocating assets of a portfolio to different segments. By overweighing or underweighing the segments with respect to the benchmark results in the allocation effect of the portfolio.

Lets consider selection effect.

It can be calculated as (Portfolio return-Benchmark return)*(Benchmark weight)= (12%-16%)*20%+(10%-7%)*15%+0+(25%-20%)*20%+(18%-15%)*25%= 1.4%

Selection effect contributes to the portfolio performance by decisions within each sector of the portfolio. For example, in equities, selecting superior stocks compared to benchmark results in better performance of the portfolio.