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The growing relevance of performance attribution

Authors- Sam Nazari, Senior Director, Corporate and investment strategy, Strategy & Transactions ,
Sara Qureshi, Senior Consultant, Corporate and investment strategy, Strategy & Transaction and
Martin Leroux, Senior Advisor, Corporate and investment strategy, Strategy & Transactions

Explore how performance attribution is transforming into a strategic tool for Chief Investment Officers to enhance portfolio resilience and optimize returns


In brief
  • Performance attribution is evolving, with CIOs increasingly involved in enhancing portfolio resilience and strategic decision-making.
  • Large asset owners are shifting focus from alpha pursuit to deliberate performance sourcing, addressing diverse return optimization questions.
  • Successful performance attribution frameworks require stakeholder alignment, clear goals, and iterative processes to adapt to changing market conditions.

In a constantly evolving environment, it comes as no surprise that the financial and investment landscape is continuing to shift on multiple fronts, including the mundane world of performance attribution. Having been the realm of the middle office for decades, we are noticing a rise in performance attribution usage by CIOs and the front office. 

Here we explore how performance attribution is moving from the bane of portfolio managers vying for first quartile success to the CIO’s strategic confidant in search of a better, more resilient portfolio. 

The state of the market

Large asset owners are enhancing their focus on portfolio resilience with increased emphasis on deliberate performance sourcing 

Following the 2008 financial crisis and the decade that followed, the asset owner investment world was dominated by a key theme: portfolio resilience. This drove some large asset owners to undertake many strategic initiatives, including total portfolio management. 

Effectively, this was an explicit recognition that total fund performance was in large part dictated by the portfolio’s beta, i.e. market exposures. This recognition was in stark contrast to the previous era, when the pursuit of alpha — outperformance relative to a benchmark — was deemed to be the primary endeavour and the ultimate measure of success. 

This new focus forced CIOs to address a series of questions such as:

  • Is my current set of exposures allowing me to capture a diversified set of returns?
  • Do I have a sufficient understanding and fit-for-purpose taxonomy of the total fund exposures?
  • Am I rightsizing and optimizing liquidity?
  • How can we deploy to our targets faster? 

As this model matured differently across asset owners given the reality of their different operational considerations, a new predominant theme began to unfold against an emerging consensus over a more complex and uncertain market environment: deliberate performance sourcing. 

This new theme forced CIOs to grapple with a fresh set of questions, including:

  • Am I optimizing my return sourcing in a cost-effective way? 
  • Where do I expect to deliver alpha with sufficient confidence?
  • What should my target exposure be across multiple dimensions — such as industry, geographies and sectors — including within my various asset classes? 
  • Have we overdiversified at the cost of achieving our total return target?

This demands a comprehensive and nuanced understanding of the various sources of return. To that effect, EY-Parthenon has been supporting asset owners in developing and implementing robust and fit-for-purpose performance attribution frameworks. As such, we have developed a thorough understanding of the key factors to ensure the successful development and implementation of such performance attribution frameworks, from defining a clear ambition and strategic intent, to developing the necessary toolkit. 

Let’s take a look at some key insights, and common pitfalls to avoid. 

Not all performance frameworks are built equal

Large asset owners are stepping up their ambition with performance attribution

Large asset owners can be grouped into different levels, or “personas,” as far as their sophistication with performance attribution.

Of interest, the audience for the legacy persona, oversight, is broad, mostly aiming to satisfy proper reporting. And then there are new personas emerging — insight and strategic — enabling CIOs to better understand, select and complement existing strategies or to aggressively optimize given current market conditions.

These personas are outlined as follows:

While we observe that the majority of asset owners are currently in the oversight category, many have indicated a clear ambition to move towards the insight or ‘strategic’ persona in the near future, with a few going so far as to identifying the shift as a critical organizational priority.

To prepare for the next persona and a successful transition, asset owners must gain alignment from key stakeholders in addition to upgrading their existing toolkits. Ideally, organizations will clearly outline the scope of the new ambition over both the short and medium term. This will enable them to set up the framework in such a way that it not only meets their current needs but also considers future capabilities to ensure enough build flexibility and can continue to adapt to evolving business needs and changing ambitions.

A performance framework is not an IT system

An iterative process designed to deliver the intended value proposition

In our experience, setting up a performance attribution framework requires various key components to deliver the intended value proposition. At EY-Parthenon, we have developed a successful approach that we tailor to reflect our clients’ unique organizational specificities.

As shown, a next-generation performance attribution goes well beyond selecting a vendor or system. Naturally, setting the strategic intent is the first and most important step, which then guides the rest of the process. Additionally, defining a reasonable scope in collaboration with key stakeholders is critical to achieve scope effectiveness, organizational readiness and project impact. 

Though the process can look slightly different based on an organization’s specific circumstances, it’s important to keep in mind that any framework should be calibrated directly to the management actions it is aimed at enabling. 

Because this framework will impact multiple areas of the organization from culture to team structure, it’s of paramount importance to have a clear goal in mind prior to designing and implementing the framework. It’s also essential to ensure all the key stakeholders, executives and resources are involved early in the process to gather valuable input, develop consensus and design a fit-for-purpose framework.   

Execution complexity should not be underestimated

Common pitfalls that impede full value delivery

Through working with many institutional investors, we have observed some common missteps when designing and implementing performance attribution solutions.

Lack of stakeholder alignment 
  • Quit often institutional investors don’t use a collaborative process that engages key stakeholders and rallies the organization.
  • There can be a lack of understanding of stakeholder needs and the management actions investors are seeking to enable. 
  • This includes not gaining alignment on critical aspects, including factor exposures, data requirements and taxonomies, among others.
Not calibrating to impact 
  • Failing to balance the depth of insight with model calibration needs.
  • Dedicating too many, too few or the incorrect resources. 

Too broad a scope 

  • Attempting to implement a solution in one phase for the entire organization and not allowing enough time and opportunity to test the solution and make gradual improvements based on stakeholder feedback. 
  • Significantly exceeding the selected provider’s out-of-the-box solution where customization becomes an additional organizational burden to manage

CONCLUSION

Investment strategies are continuing to become increasingly sophisticated, and mandates are reviewed not only from a return perspective but from their contribution to the total portfolio on multiple dimensions, such as style, industry, ESG and so forth. To deliberately optimize performance sourcing, having the right performance attribution framework is essential as it becomes the critical companion to the organization’s value creation model.1

 

 

  1. We refer to a value creation model as the construct that bridges total mandate return objective (e.g. CPI + 3%) all the way to security selection with clear ownerships across.

Summary 

Investment strategies are continuing to become increasingly sophisticated, and mandates are reviewed not only from a return perspective but from their contribution to the total portfolio on multiple dimensions, such as style, industry, ESG and so forth. To deliberately optimize performance sourcing, having the right performance attribution framework is essential as it becomes the critical companion to the organization’s value creation model.

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