Due Diligence 101: Attribution By: Gabriel PotterMBA, AIFA® 2014.01.30

A big part of my job is investment manager due diligence.  That means I’ll periodically check in with investment managers and their sales representatives to talk about their products’ performance and try to understand the reasons why things happened the way they did.  Investment managers and sales reps are usually delighted to speak with me when they are outperforming their peers and an appropriate benchmark, but it is a more difficult conversation to have if they are lagging behind.

Not surprisingly, I’ve never once had an investment manager call me and say, “this product is simply uncompetitive and it should be eliminated from your investment lineup.”  It is an admittedly difficult sales pitch, so I would not expect to hear it often, but still, I am genuinely surprised that an investment wholesaler hasn’t used that pitch against an obviously foundering product to try and earn some credibility for other funds in their stable.  But no, representatives generally toe the company line, arguing for the unique advantages of every product, no matter how much the markets are under appreciating their selections.  Sadly for the sales representatives, their fervent defense of underperforming funds appears a little silly when, several months later, the investment management company will themselves fire a portfolio manager for underperformance and place a new captain in charge of the product.  Now, the sales reps have to assert that we should trust the NEW team to steward their hard-earned dollars. 

Analysts with an preference towards prudence should favor consistency in approach, if not results.   Analysts should always be very wary of a product when the stories change.

The attribution process – calculating the relative performance of a product relative to peers by looking individual pieces of the portfolio – can be a great help to understanding the causes.  For example, if you have a large value fund that specializes in financial sector analysis, and overweights that sector accordingly, than you’d expect to see a proportionate outperformance in the fund if the financial sector is doing well.  Similarly, if your international fund underweights emerging markets, then it may lag behind peers if emerging markets rally ahead of developed international markets. 

There are a variety of easily quantifiable attributes – style, capitalization, sector bias, cash investment, and a dozen competing definitions of “quality” – which can convincingly determine sources of relative performance.   I’m used to hearing a variety of methods of attribution which, although harder to define, but also completely valid.  For example, US Large Growth Manager ABC will only select companies with long term track records of growth, so they’ll avoid stocks of companies with a speculative business model; so, manager ABC might avoid startup companies with large growth potential, no matter how compelling they are or how much the market favors them at the time. 

Attribution is a vital element to investment manager due diligence.  Understanding the reasons for relative performance in the short term is, of course, useful, but the real value of attribution is that you now have a track record for reference.  Looking at trends of attribution can give an analyst insight into how managers perform in different market environments.  Most importantly, a history of attribution can help determine if the stories that investment managers or sales reps tell change over time.

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

More about Gabriel Potter
Sign up for our Newsletter
Sign up for our Newsletter