Unearthing the roots of fund performance

Analysts use Morningstar's attribution metrics to help assess a fund manager's ability.

Adam Zoll 8 December, 2014 | 6:00PM

Question: In some mutual fund Analyst Reports, Morningstar analysts refer to performance attribution as a way to determine whether a manager is good at choosing stocks. How is this analysis done?

Answer: Performance attribution analysis is a method used by analysts at Morningstar and elsewhere to help determine why a fund performed the way it did during a given time period. Did the fund underperform relative to its benchmark because of a few bad stock picks, or was it because the fund invested too heavily in a poorly performing sector of the market? If a fund outperformed its benchmark, is it because the manager chose the right stocks to invest in, or because he or she managed to avoid stocks that would have weighed down performance? These are the sorts of questions performance attribution analysis can help answer.

Giving credit where credit is due

Although the mathematics behind performance attribution are complex click here to read Morningstar's methodology paper on the subject), the basic idea is simple. A fund's performance is assessed relative to its prospectus (or another) benchmark and based on various factors. Among these factors are:

  • Stock selection: The degree to which the manager's skill at picking individual stocks helped or hurt fund performance relative to the benchmark.
  • Sector allocation: The degree to which the fund's sector weightings helped or hurt performance relative to the benchmark. By overweighting an outperforming sector or underweighting a poorly performing one, a fund may outperform its benchmark, just as doing the opposite of each of these can cause a fund to underperform.
  • Country allocation: For international-stock funds, the degree to which the fund's over- or underweighting in stocks from various countries affected performance.
  • Fees: The degree to which the fund's expense ratio affected performance (reduced its return).

Attribution results are tabulated monthly to account for changes in a fund's portfolio, and these monthly results are used to calculate performance attribution over many years. The process isn't an exact science, especially in the case of funds that turn over their portfolios frequently or include securities for which performance or classification information is unavailable.

Performance attribution information is only available through Morningstar Direct, the platform available to Morningstar's institutional customers and our analysts. But here's a sample of a performance attribution report for Mawer New Canada for the 12-month period ended Nov. 30, 2014 using its prospectus benchmark, the BMO Small-Cap Blended (Weighted) Index. The report spells out the extent to which various sectors and stocks helped or hurt fund performance during that time. The fund has trounced the benchmark by roughly 16 percentage points over the past year. With perennially light stakes in poorly performing basic materials and energy stocks, one might expect the fund’s sectors exposure to explain its strong performance. However, the performance attribution data indicates that sector exposure played only a small role. Indeed, management's stock picks in these sectors, such as Stella Jones SJ and AltaGas ALA, were leading contributors to performance. Meanwhile, other winning picks, such as Constellation Software CSU and Equitable Group EQB, also helped push the fund far ahead of the benchmark. These results were consistent with management's strategy, which is based on bottom-up stock picking rather than sector calls. These strong picks earned managers Martin Ferguson and Jeff Mo Domestic Equity Manager of the Year honours at the 2014 Morningstar Awards.

One piece of the puzzle

Although performance attribution analysis can be useful as a way to gauge a fund manager's effectiveness, it's just one of the tools Morningstar's manager research analysts use, says Christopher Davis, director of manager research for Morningstar Canada. "We use it to understand what has helped and hurt a fund over a given period and to confirm a fund's performance matches management's strategy," Davis says. "Performance attribution also says something about managers' strengths or weaknesses investing in different sectors, styles, countries and company sizes," he added. Davis cautions that, as with fund performance overall, a manager's past success as a stock-picker doesn't necessarily predict future outperformance.

Looking inside your own portfolio's performance

Morningstar's performance attribution statistics are not available on Morningstar.ca, but Premium Members hoping to do a rough analysis of their own portfolios can use the X-Ray tool in Portfolio Manager as a starting point. These tools can provide information about your portfolio's sector and world regional weightings relative to selected benchmarks. (Keep in mind that fund portfolio data is not updated regularly, so X-ray results might not represent current fund holdings.) After you enter your holdings in the X-Ray tool, you can identify significant sector or regional overweightings or underweightings in your portfolio, and the Stock Intersection tab can help you identify which stocks represent the largest percentage of assets in your portfolio.

Knowing where your portfolio is over- and underweight, and comparing the performances of those areas with that of a relevant benchmark, can give you a sense of where your portfolio's strengths and weaknesses are. It's not as precise as the performance attribution tools available in Morningstar Direct, but it can still help you figure out why your portfolio is over- or underperforming.

Have a personal finance question you'd like answered? Send it to AskTheExpert@morningstar.com.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
AltaGas Ltd18.44 CAD-1.23
Constellation Software Inc1,246.29 CAD-3.73
Equitable Group Inc95.28 CAD-1.83
Stella-Jones Inc38.39 CAD-2.46

About Author

Adam Zoll

Adam Zoll  Adam Zoll is an assistant site editor with Morningstar.com