FRM Part II · FRM Exam Part II · Factor Theory
In a Brinson-style or factor-based performance attribution, a manager's portfolio return exceeds the benchmark. Which finding would most clearly indicate that the outperformance came from factor tilts rather than genuine security selection skill?
Significant factor loadings with an insignificant alpha indicate the outperformance reflects exposure to rewarded factors rather than skill. The factors explain the return, leaving no statistically meaningful residual that could be credited to security selection.
- ARegression on known factors shows significant loadings and an insignificant alphaCorrect
- BRegression shows low R-squared and a significant positive alpha
- CThe portfolio's tracking error is lower than the benchmark's volatility
- DThe portfolio holds more securities than the benchmark
Explanation
If returns are explained by significant factor loadings and alpha is statistically indistinguishable from zero, the excess return is compensation for factor exposure (beta in disguise). A significant alpha with low R-squared suggests skill. Tracking error and holdings count say nothing about the source of returns.
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