Steve and Suzie’s quarterly return was (2.0 * .7) + (1.0 * .2) + ( .5 * .1) = 1.65%. Their index’s return was (2.5 * .6) + (1.2 * .3) + ( .5 * .1) = 1.91%.

The difference between the index return and the actual return shows their portfolio’s performance. In this case, this portfolio underperformed its benchmark by –.26 percent for the quarter.

a. Security selection contributed –.39 percent to performance. This is calculated as follows:

        
Contribution of security selection = –0.39 percent

(1) Managed fund’s return less the index fund’s return (2.0%– 2.5%)

(2) Actual weight of the managed portfolio

(1*2) Contribution of asset class security selection to the portfolio

b. Asset allocation contributed .13 percent to performance. This is calculated as follows:

Contribution of asset allocation = 0.130 percent

(3) Weight of actively managed fund less the benchmark weight (negative = underweight)

(4) Asset class return less total portfolio return (equity is 2.50 –1.91 = .59%; bond is 1.20–1.91 =  –.71)

(3*4) Contribution of the asset class to the total portfolio

c. Steve and Suzie’s actively managed portfolio underperformed the benchmark by .26 percent, or 26 basis points (1.65 percent–1.91 percent). This underperformance was a combination of a –.39 percent contribution from security selection and a .13 percent contribution from asset allocation. They did well having more invested in an asset class versus their asset allocation targets; however, they did not do as well picking the specific assets in the asset classes that performed well.

If this performance continues for twenty-four to thirty-six months, they should consider indexing their stock selection decision (i.e., buy index funds). They should keep doing what they are doing regarding their asset class decisions.

 

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