RESEARCH INSIGHTS

Fundamentals of Performance Attribution:

The Brinson Model

Damien Laker Director of Performance Attribution Strategy

Damien Laker is Director of Performance Attribution Strategy at Barra. Damien joined Barra in December 2002 when Barra acquired Investment Performance Objects (IPO), a company that Damien founded in 1998. IPO provided cutting edge investment performance analytics software for global asset managers. At the time of the acquisition, IPO had five clients in Australia, and one client in the UK. Damien has been involved full-time in developing and delivering innovative solutions for performance measurement, attribution and reporting for about ten years. Over the past year, Damien has done consulting and workshops in Sydney, London, Singapore, Hong Kong, Malaysia and the USA. He has also published half a dozen journal articles on various aspects of performance attribution. He has practical experience doing attribution and other performance analysis on hundreds of portfolios valued at many hundreds of billions of dollars. Damien has a B.Sc. and a B.A. from the University of New South Wales, Australia.

Article 1 of 5 originally written for the PRA Newsletter, 2002.

Copyright 2003 Barra, Inc. and/or its subsidiaries and affiliates (Barra). All rights reserved. This research paper may be used for your internal business use or personal use only. This research paper shall not be reproduced, copied or redistributed without the express written permission of Barra. Barra is a registered trademark of Barra, Inc. All other company, organization, product or service names referenced herein are used for identification purposes only and may be trademarks of their respective owners. The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. None of the information or opinions herein constitute a recommendation or a solicitation by Barra or a recommendation or solicitation that any particular investor should purchase or sell any particular security in any amount, or at all. The information herein is intended for general education only and not as investment, tax or legal advice. Charts herein are provided for illustrative purposes only. Neither such information nor such charts are intended for use as a basis for investment decisions, nor should they be construed as advice designed to meet the needs of any particular investor. Please contact a qualified investment professional for advice regarding the evaluation of any specific information, opinion, advice, or other content. Barra and/or its subsidiaries or affiliates and their employees or directors may have positions in securities referenced herein, and may, as principal or agent, buy from, sell to or advise customers regarding such securities. Barra and/or its subsidiaries or affiliates may perform investment advisory or other services for any company mentioned herein.

F U N D A M E N TA L S O F P E R F O R M A N C E AT T R I B U T I O N : T H E B R I N S O N M O D E L

Introduction
One of my physics professors at university used to say that he enjoyed teaching Physics 1 because he always learnt something new while preparing for the lectures. Similarly, I hope that this series of articles will be informative for the inexperienced, but also thought-provoking for even the most experienced performance analyst. I have deliberately selected a range of topics where I feel I may have some insight to offer, leaving other topics to other authors. To facilitate the practical application of the techniques presented in this paper, some worked examples are available as spreadsheets at http://www.barra.com/products/ spreadsheets.aspx.

Brinson Attribution
Perhaps the best-known approach to performance attribution is the Brinson method. Brinson and Fachler in the Journal of Portfolio Management presented this in 1985. However, the method goes back much further than that. One earlier description was published by a working group of the Society of Investment Analysts in London, back in February 1972. It is worth spending a few minutes reviewing the basics of Brinson attribution because they lead quickly to new and interesting territory. This section uses the Single-Period Brinson spreadsheet as a simple example of Brinson attribution. The example fund has three sectors, with the following weights and returns:
Sector Benchmark Weight Return Portfolio Weight Return

1 2 3
Total

20% 30% 50%

100%

2.00% 3.00% 4.00%

3.30%

10% 30% 60%

100%

2.00% 4.00% 9.00%

6.80%

The Brinson method uses three of the most powerful tools in performance analysis: 1. Weighted sums; 2. Compounding; and 3. Value-added. Weighted sums are the basic technique that performance analysts use to combine returns when a group of assets are grouped together. In Excel, the SUMPRODUCT function is an easy way to calculate a weighted sum, as shown in several cells on row 6 of the Single-Period Brinson spreadsheet. Compounding and value-added are two other fundamentals in performance analysis.

@ BARRA 2003

To use a quick example, if a funds returns are 5% in one month and 3% in the following month, the combined performance will (as every performance analyst knows) be 8.15% (calculated as 1.05 x 1.03 1 ), rather than just 8%. If the benchmark return over the combined period was 4%, one could say that the value-added over the combined period was
4.15%.

Table 1

Notional portfolios described in Brinson et al. (1986)

Portfolio Sector Weights

Portfolio Sector Returns

Benchmark Sector Returns

(Q4) Portfolio

w jp rjp
j

(Q2 ) Active Asset Allocation Fund

w jp rjb
j

Benchmark Sector Weights

(Q3 ) Active Stock Selection Fund

(Q1 ) Benchmark

w
j

b j

rj

w jb rjb
j

Table 1 (which has been adapted from the original sources) depicts the fundamental method that the Brinson model uses for understanding active performance. The benchmark and portfolio returns for each fund are considered as weighted sums of the sectorlevel benchmark and portfolio returns. For example, in quadrant 1, the fund-level benchmark return is calculated as the weighted sum of sector-level benchmark weights and sector-level benchmark returns (see cell C6 the Single-Period Brinson spreadsheet). Quadrant 4 does a similar calculation to obtain the fund-level portfolio return (cell E6). Quadrants 2 and 3 get a bit more interesting. Quadrant 2 calculates a weighted sum of portfolio weights and benchmark returns (cell
L6). It is interesting to think what this calculation means. By multiplying the portfolio sector

weights and benchmark sector returns, this calculates the return that would have been obtained if the fund held an active asset allocation, but tracked the benchmark exactly in each sector. In other words, this captures the pure effect of the portfolios asset allocation between sectors, without any stock selection effect in the sectors. Therefore, any valueadded by quadrant 2 compared with quadrant 1 (the benchmark return), is attributable solely to active asset allocation. This is how the Brinson attribution model defines the asset allocation effect. When you reflect on it, this definition is hard to argue with. Similarly, quadrant 3 multiplies benchmark sector weights and portfolio sector returns (cell M6). This captures the return that would have been realised if the asset allocation were strictly neutral, but the stock selection was active. If this return is higher than the

@ BARRA 2003

F U N D A M E N TA L S O F P E R F O R M A N C E AT T R I B U T I O N : T H E B R I N S O N M O D E L

benchmark return, this could only be because of stock selection (since by using benchmark sector weights, we have by definition assumed that there is no active asset allocation taking place). In the example, the return for quadrant 3 was 6.10%, while the benchmark return was only 3.30%. Hence, the stock selection effect was 2.80%. This is intuitive when you look at the sector-level returns, since there was no sector that under-performed its benchmark (in other words, stock selection added value in each sector of the fund). Looking back to quadrant 2, its return was 3.50%, which was only 20 basis points better than the benchmark return of 3.30%. Therefore, the total asset allocation effect was 20 basis points. So far, we have calculated that 280 basis points of active performance were due to stock selection, and 20 basis points were due to asset allocation. But the total value-added was
350 basis points. Where did this come from? It was an interaction between stock selection

and asset allocation. This is harder to explain than the other attributes. To understand interaction, one needs to look at the results sector by sector. For more detail, refer to Laker 2000. However, to provide a brief summary, the Brinson model produces a positive interaction effect when the asset allocator overweights sectors that beat their benchmark, or underweights sectors that under-perform their benchmark. In terms of the quadrant returns, the interaction term provides the missing piece that makes the attributes sum exactly to the active return: Asset Allocation Stock Selection Interaction = Q2 Q1 = Q3 Q1 = Q4 Q3 Q2 + Q1

Total Value-Added = Q4 Q1 Because the attributes sum exactly to the value-added, the Brinson model is said to be an additive model. Because compounding is a multiplicative process, many firms have adopted so-called geometric (or multiplicative) attribution models. In short, those models explain the value multiplied rather than the value-added.

Multiple Period Attributes

It would be conventional at this point to show how to calculate sector-level attributes. However, for reasons that will soon become obvious, we will instead consider multi-period attribution. Everybody understands that its possible to compound portfolio and benchmark returns over time in order to calculate the return over any number of periods. In terms of the Brinson model, this means compounding the returns for quadrant 1 and quadrant 4. It is also common knowledge that the active return over any period is simply the difference

@ BARRA 2003

between the compounded portfolio return and the compounded benchmark return (i.e. it is still Q4 Q1, but using compounded returns). The first worksheet in the Multi-Period Brinson spreadsheet hows how this works over three monthly periods, on row 27. However, not everybody realises that it is just as easy to obtain multiple-period attributes in just the same way as single-period attributes, using the compounded quadrant returns. For example, the asset allocation attribute over any period is Q2 Q1 (using compounded quadrant returns), etc. These multiple-period attributes are also shown on row 27 of the front worksheet in the Multi-Period Brinson spreadsheet. Since there have been so many journal articles published that use high-powered mathematics to try and obtain multi-period attributes, it may seem hard to believe that the solution is so simple. However, it is hard to avoid the conclusion that this method provides an exact solution to Brinson attribution over any number of periods because:
1. The quadrant returns represent the definition of how to calculate Brinson attributes;

and
2. It is provable (both algebraically and by testing with sample numbers) that the multi-

ple-period attributes, calculated with compounded quadrant returns, sum exactly to the value-added over any period. In other words, there is no residual. If you wish to double-check this result, try changing the weights and returns in the columns B to E of the first worksheet in the Multi-Period Brinson spreadsheet.

Practical Implications
A number of well-known journal articles have been based on the premise that there is no exact solution to multiple-period attribution in the Brinson model. Consequently, most software packages for performance attribution use different methods for calculating multiple-period attributes. Two methods that are commonly found in attribution software are the well-known Cario method and another method called dollar attribution. The last worksheet in the MultiPeriod Brinson spreadsheet provides a summary of the differences in results between these methods and the exact solution. It would appear, based on this particular example, that dollar attribution introduces more distortion. One could use simulation to provide a more rigorous comparison of different methods. The calculation method that uses the quadrant returns does produce exact multi-period attributes at the fund-level. However, there is no obvious way to extend it to sector-level returns. Indeed, there are sound reasons to believe that there is simply no exact solution for multi-period sector-level returns in an additive model such as Brinson. This leaves three main alternatives:
1. Use a method such as Cario or dollar attribution, fully aware of the fact that they

produce inexact fund-level attributes when an exact solution exists. If there were

@ BARRA 2003

F U N D A M E N TA L S O F P E R F O R M A N C E AT T R I B U T I O N : T H E B R I N S O N M O D E L

nothing better on offer, this would be a reasonable choice because sector-level attributes are normally considered to be an essential part of an attribution report.
2. Use a geometric (i.e. non-additive) approach to attribution. Traditionally, geometric

attribution has been popular in Europe, while additive attribution has been more popular in the USA. It is universally accepted that additive attribution is more intuitive. However, a key benefit of geometric attribution has been the perception that it makes multi-period attribution easier. The existence of exact fund-level attributes in additive models weakens this argument, but does not abolish it because there is still a need for sector-level attributes.
3. Use the exact method to obtain exact multi-period fund-level attributes, and some

other method for calculating the multi-period sector-level attributes. This would at least take advantage of the fact that additive attribution models are more intuitive, and it would also at least have exact fund-level attributes. The only compromise would be in having sector-level attributes that are not exact. Later in this series, we will explore option 3. However, there are lots of other interesting topics in performance attribution, and we will cover some of them in the next installment.

References
Brinson, Gary P., and Nimrod Fachler, Measuring Non-US Equity Portfolio Performance, Journal of Portfolio Management, Spring 1985, pp. 73-76. Brinson, Gary P., L. Randolph Hood, and Gilbert L. Beebower, Determinants of Portfolio Performance, Financial Analysts Journal, July-August 1986, pp. 39-44. Brinson, Gary P., Singer, Brian D., and Gilbert L. Beebower, Determinants of Portfolio Performance II: An Update, Financial Analysts Journal, May-June 1991, pp. 40-48. Cario, David, Combining Attribution Effects Over Time, Journal of Performance Measurement, Summer 1999, pp. 5-14. Davies, O. and Laker, D., Multiple-Period Performance Attribution Using the Brinson Model, Journal of Performance Measurement, Fall 2001, pp 12-22. Kirievsky, Leonid and A. Kirievsky, Attribution Analysis: Combining Attribution Effects Over Time Made Easy, Journal of Performance Measurement, Summer 2000, pp. 49-59. Laker, Damien, What is this Thing Called Interaction? Journal of Performance Measurement, Fall 2000, pp. 43-57. (Working Group of) The Society of Investment Analysts (UK), The Measurement of Portfolio Performance for Pension Funds, 1972.

@ BARRA 2003