Thursday, December 17, 2009

Attribution with an index that values only monthly

A client asked me how they should handle the following situation: the benchmark their client assigned to them is a blend of two indexes, one of which values only monthly (the other, daily). They calculate performance attribution daily and smooth the one index's monthly return across each day of the month (thus assuming a nice linear progression through the month). Is this okay?

No, I would say in general it isn't. And, it occurred to me that there's a better solution!

Our client calculates daily transaction-based attribution. It is my contention (shared by others) that transaction-based attribution can easily be done on a monthly basis with no loss in accuracy: there is no need to do it daily. By virtue of the transaction process, any trades that occur are picked up in the weight, which includes the beginning plus weighted flows (i.e., trades). And so, the ideal approach (I believe) is to use monthly transaction based attribution. This is especially true since they have no valid daily benchmark...the daily results are spurious, at best.

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