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

A portfolio manager's equity portfolio is benchmarked to a broad index. In a Brinson-Fachler style attribution, the manager overweights a sector relative to the benchmark, and the sector's return is lower than the total benchmark return but higher than zero. What is the sign of the allocation effect for this sector?

The allocation effect is negative. In Brinson-Fachler attribution it equals the active weight times the sector's benchmark return minus the total benchmark return. An overweight in a sector that lagged the overall benchmark gives a positive weight times a negative excess return, so the effect is negative.

  1. ANegative, because the sector underperformed the total benchmark while being overweightedCorrect
  2. BPositive, because the sector's return is above zero
  3. CZero, because allocation depends only on security selection
  4. DPositive, because overweighting always adds value

Explanation

In the Brinson-Fachler approach the allocation effect is (wp - wb) x (Rb,sector - Rb,total). The weight difference is positive and the sector return minus total benchmark return is negative, so the product is negative. A positive absolute return is irrelevant, which is why the second option is wrong.

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