Performance measurement, attribution and investment governance
This domain tests whether you can measure performance fairly, explain the sources of return and set governance that holds managers accountable without distorting behaviour.
Measurement
Time-weighted return removes the effect of external cashflows and measures manager skill. Money-weighted return reflects the investor's actual experience and is affected by cashflow timing. GIPS-style presentation requires consistent, disclosed methodology.
Attribution
Brinson attribution decomposes active return into allocation, selection and interaction. Allocation measures overweighting or underweighting sectors; selection measures stock picking within sectors. A benchmark must be investable and consistent with the mandate.
Governance
Good governance defines objectives, risk limits, delegated authority, reporting lines and escalation. It separates oversight from execution and manages conflicts of interest.
Worked example
A fund starts at 100. Before a 20 contribution it rises to 110, so the first sub-period return is 10%. After the contribution the fund is 130 and ends at 132, a second sub-period return of 132/130 - 1 = 1.54%. The time-weighted return is 1.10 x 1.0154 - 1 = 11.69%. The money-weighted return would be lower if the large contribution arrived just before a poor period, because more capital was exposed to that period.
Traps
- Using money-weighted return to judge manager skill when cashflows are large.
- Selecting a benchmark that the manager cannot hold.
- Double-counting allocation and selection effects.
- Ignoring fees and transaction costs in net performance.