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FRM Part II · FRM Exam Part II · Portfolio Performance Evaluation

A portfolio manager's benchmark has a 60% weight in equities and 40% in bonds. The actual portfolio holds 70% in equities and 30% in bonds. In a Brinson-style attribution, the difference between the portfolio's and benchmark's asset class weights, multiplied by the benchmark sector returns (relative to the total benchmark return), is best described as which effect?

This is the allocation effect. It captures the value added or lost by holding sector weights different from the benchmark, measured with benchmark sector returns. Selection effect instead reflects return differences within sectors, and interaction reflects the joint effect of both weight and return differences.

  1. AAllocation effectCorrect
  2. BSelection effect
  3. CInteraction effect
  4. DCurrency effect

Explanation

Allocation (asset allocation) effect measures the value added from over- or underweighting sectors relative to the benchmark, using (wp - wb) times the benchmark sector return less total benchmark return. Selection concerns return differences within sectors at benchmark weights. Interaction combines weight and return differences together.

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