Question

Preform portfolio analysis for the following portfolio. the portfolios retrun is 6.37%. Their benchmark allocation is 40% equities, 50% bonds and 10% cash. the return for their benchmark indices are 7.89% for equities, 4.56% for the bonds and 0.65% for the money markets. their actual allocations during the period were 49% in equities, 36% in bonds and 15% in cash. The portfolios actual returns in were 8.62% in equity, 5.69% in bonds and 0.68% in cash. What was the portfolios return attributbale to:

a. asset allocation

b. security selection

Answer 1

The following tables summarize the benchmark and actual allocations and returns.

Benchmark
equity	40%	7.89%	5.50%
bond	50%	4.56%
cash	10%	0.65%

Actual
equity	49%	8.62%	6.37%
bond	36%	5.69%
cash	15%	0.68%

As we can see, actual portfolio realized a higher return of 6.37%, than the benchmark portfolio of 5.50%.

(Portfolio Return is calculated as summation of individual allocation x individual return)

Higher portfolio returns are attributable to security selection as well as asset allocation.

1. Security selection: Security selection refers to the process of selecting individual securities within a particular asset class. For example, selecting which equities will form part of equity asset class and which bonds will form part of bond asset class. In the present case, realized returns are higher for all the asset classes (equity, bonds and cash) than the benchmark returns, which means that security selection has been done.

2 Asset allocation: Asset allocation refers to strategy of determining the mix of assets to hold in a portfolio. Allocation has been increased from benchmark of 40% to actual 49% for high return (and hence high risk) component, i.e., equity. Therefore, higher overall returns are higher than the benchmark returns.