The task of performance attribution is to explain the decisions that the portfolio manager took to generate this 220 basis points of value added.
As opposed to determining the contribution of uncontrollable market factors to active return, the type of analysis described here is meant to evaluate the effect of each (type of) controllable decision on the active return, and "interaction" is not a clearly defined controllable decision.
Decision attribution also needs to address the combined effect of multiple periods over which weights vary and returns compound.
In addition, more structured investment processes normally need to be addressed in order for the analysis to be relevant to actual fund construction.
Such sophisticated investment processes might include ones that nest sectors within asset classes and/or industries within sectors, requiring the evaluation of the effects of deciding the relative weights of these nested components within the border classes.
They might also include analysis of the effects of country and/or currency decisions in the context of the varying risk-free rates of different currencies or the decisions to set fund or bucket values for continuous properties like capitalization or duration.
[2] In 1968, the Bank Administration Institute's Measuring the Investment Performance of Pension Funds for the Purpose of Inter-Fund Comparison study proposed common methods of comparing pension fund performance to differentiate between the abilities of their respective managers.
[3] In 1972, Eugene Fama's Components of Investment Performance suggested decomposing observed returns into returns from "selectivity", or the ability of managers to pick the best securities given a level of risk, and "timing", or the ability to predict general market price movements.
[5] In 1972, a working group of the Society of Investment Analysts (UK) published The Measurement of Portfolio Performance for Pension Funds.
This paper introduced the idea that active performance can be analysed by comparing the returns of different notional portfolios.
[15] In 1993, Eugene Fama and Kenneth French proposed the Fama-French three-factor model, consisting of the market return, and factors relating to size and value.
In 1991, Gregory Allen introduced geometric returns and neutralized portfolios as tools for performance attribution in a multi-currency context.
Proponents of adaptive benchmarking maintain that by understanding the characteristics of the portfolio at each point in time, they can better attribute excess returns to skill.
For complex or dynamic portfolios, risk-based profit attribution may have some advantages over methods which rely only on realized performance.