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How Overweighting an Asset Can Drive Allocation Performance

Article Quant Q&A · Author: Betty
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Summary

The document explains asset allocation contribution by comparing each sector’s return contribution under the fund’s weights with its contribution under benchmark weights. In the example, sector returns are held constant while the weights differ; the difference between the two contributions isolates the allocation effect shown in the table. The fund’s overall result exceeds the benchmark, and real estate accounts for the largest positive allocation difference.

Real estate contributes because the fund holds a larger weight there than the benchmark and the sector earns a satisfactory return. It does not have the highest sector return. The example therefore distinguishes an allocation decision from simply selecting the best-performing sector: relative weights and sector returns jointly determine the contribution. The figures illustrate one attribution calculation, but the document does not explain other attribution effects, such as security selection or interaction, or specify the broader assumptions behind the benchmark comparison.

Key ideas

  • Allocation contribution compares sector contributions using fund weights with those using benchmark weights.
  • A sector can drive allocation outperformance through an overweight even if its return is not the highest.
  • Real estate has the largest positive allocation difference in the example because of its overweight and adequate return.
  • The example addresses allocation attribution and does not cover selection or interaction effects.

Tags

Portfolio constructionEquities
Full text
# Highest asset allocation contribution to the fund’s performance


# Highest asset allocation contribution to the fund’s performance












I am preparing for 2020 May FRM II test and will appreciate any explanation for this question:

In terms of asset allocation contribution, why is real estate made the highest asset allocation contribution? Is it because it overperformance the benchmark?

## Answer by nbbo2 (score 2, accepted)

https://quant.stackexchange.com/a/51546

Comparing the contributions using Fund Weights versus using Benchmark weights:

```
Sect ret  fundw contrib   ret  bweigt contrib   difference
   A 0.3  0.45  0.135     0.3  0.5    0.15      -0.015
   B 0.1  0.1   0.01      0.1  0.2    0.02      -0.01
   C 0.2  0.2   0.04      0.2  0.1    0.02       0.02
   D 0.25 0.25  0.0625    0.25 0.2    0.05       0.0125

Total           0.2475                0.24       0.0075
```

Conclusion: the fund's chosen asset allocation outperformed the benchmark by 75 bps (return of 24.75% versus benchmark return 24%), this was mostly due to Sector C (Real Estate) which had a generous overallocation (20% instead of 10%) and satisfactory (but not top) returns (20%) resulting in an 0.02 difference (last column). Sector D also contributed to outperformance, but to a lesser degree (0.0125).

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.