When investing in managed funds, you want to make sure the product you’re choosing is one that’ll beat the market. After all, that’s exactly why you’re paying someone a management fee! Many funds will eagerly offer up their average annual return stats or other performance metrics. But it’s important to note these numbers might be deceiving. The best way to get a feel for the true performance of a fund and its manager is through attribution analysis. 

Attribution analysis breaks down total portfolio performance into its individual parts. How did each security held by the portfolio do? How does the portfolio’s allocation stack up to high-performing sectors? And how aggressive or conservative is the fund manager in the face of volatility? Asking these questions and more provides a more in-depth look at exactly what you can expect from a managed fund. 

If you’re wondering whether a fund’s performance is worth the expense ratio, attribution analysis might be worth your while to explore. Here’s how it works and what to look for as you drill down into portfolio performance. 

The Three Pillars of Attribution Analysis

At its core, attribution analysis tests the mettle of a fund based on the stewardship of its management. The fund will only perform as well as the person responsible for it. Therefore, investors need to look at the historical returns of the fund. They would do this through a lens that examines the actions and decision-making of management. 

Here’s a look at the three pillars of attribution analysis and why they’re an important gauge of management.

No. 1 Asset choices and allocation

Review the assets and the allocation of the portfolio. Is it a passive income portfolio or an emerging markets global fund? Small cap technology fund? Healthcare-focused large-cap portfolio? An understanding of the assets and the fund’s allocation will help to inform the performance of the product. It will also make it easier to benchmark those results.  

No. 2 Investment style

Probing the fund can tell you a lot about the manager’s investing style and thesis. Is there a value slant or a growth focus? Again, this provides context for understanding the performance of the fund. It’s also telling when it comes to assessing the risk tolerance of the manager. And also their aggressiveness. 

No. 3 Nature of decision-making

How fund managers behave in the face of certain market variables plays a big part in attribution analysis. Do they have a habit of opportunistic buying in the dip? Do they sell shortly after prices hit a new ceiling? And do they buy and hold through turbulent times? Look for consistency and be wary of sporadic activity. 

These three pillars together form the fundamental basis of attribution analysis. Investors can take a qualitative and quantitative look through each lens to assess the competency of the fund manager. 

Benchmarking Plays a Big Role in Attribution Analysis

One of the most important factors in attribution analysis is the ability to benchmark a fund against comparable market performers. This is why the first and second pillars are so important. The types of assets, their allocation and the investment style of the manager are all variables investors can critique. Examples include:

• A broad market index
• Cap-specific indices
• Sector-specific indices
• Asset-specific indices
• Industry-specific indices

Comparing apples to apples is important in attribution analysis. It’s important to have a clear understanding of a fund manager’s capabilities. To do this you need the ability to compare their outcomes to similar variables on a grander scale. Always strive to find an unbiased standard, like an index. Comparing one managed fund to another is a great way to compare them. However, it’s not necessarily useful for objective attribution analysis. 

Find and Explain the Fund’s Alpha

In investing, alpha represents excess returns, or, another way, market-beating returns. When you invest in a managed fund, you’re effectively paying for alpha. To find that measure, it’s important to benchmark attribution analysis against the larger market. 

For example, if the fund focuses on U.S. small caps, you can use something like the Russell 2000 index as a benchmark. Compare the fund’s performance to the index over a given time period to understand how it behaves accordingly. Ideally, the fund will outperform the index. Calculate how much by looking at the percentage return over the index. 

Once you have alpha, dive into the portfolio. Do this to understand which components were responsible for achieving that return. How many of the individual holdings outperformed the market by a factor of alpha? This will shed light on the real performance of the portfolio. For example, the fund could have 106 securities but only 26 of them outperformed. This is a sign that the fund is coasting on a few big winners. And that it’s underperforming in the majority. Likewise, if 85 of the assets outperformed, it signals a well-managed fund. 

Attribution Analysis: Make Sure You’re Paying for Results

Investing in a mutual fund or other managed investment products means paying a premium for an expert to take command. It’s reasonable to expect market-beating returns on a consistent basis. It’s important to understand if the fund manager is capable of delivering on this promise. To do this, you need to look past surface figures of annual returns or historical average.

Attribution analysis probes the performance of the fund through the decisions of its manager. It looks at the key drivers of ROI. And determines whether they’re the result of strategic, purposeful action and method or luck. Drill down into the performance of a portfolio based on the sum of its parts. This will allow you to set a better expectation for yourself by vetting the fund manager’s performance.