Investment decisions are made by individuals—and therefore individual decision-makers should be held accountable for investment performance, according to AlphaEngine’s Arun Muralidhar.
“The first step in the performance attribution process should be a clear articulation of who is making the decision and what the decision is.”Because decision-making at institutional funds is distributed across staff, boards, consultants, and external managers, responsibility for a particular decision is often diffused, explained Muralidhar, adjunct professor of finance at George Washington University and founder of Mcube Investment Technologies and AlphaEngine Global Investment Solutions.
Although decision-based performance attribution has been practiced for over a decade now, he argued that the approaches currently in use miss out on a “key facet” of investing: the delegation of duties.
“Performance attribution is important as it helps those in charge of portfolios recognize the sources of added value, both positive and negative, so that they can emphasize the good and correct the bad,” wrote Muralidhar. “The first step in the performance attribution process should be a clear articulation of who is making the decision and what the decision is.”
Currently, he explained, performance is attributed to strategic asset allocation, tactical asset allocation, manager selection, manager allocation, and security selection decisions—but not to the individuals and institutions who made those decisions.
“While clearly the [decision-based attribution] method accounts for every last basis point, it is silent on who in the organization made the decision, what was the risk-adjusted return (in basis points), and how confident can we be about the skill content in added value,” he wrote.
Muralidhar recommended an updated model that allows staff to report who the decision-makers are, what they did, how much impact they had, how good their decisions were, and whether they were skillful.
By holding individual decision-makers accountable, funds can avoid inefficiencies and improve risk management, he argued.
“Only what is measured gets monitored and managed,” Muralidhar concluded.
Related: AIMCo: Better Performance Attribution = Better Performance