There are three scenarios when it comes to securities:
- The portfolio owns the security but the benchmark doesn't
- The benchmark owns it but the portfolio doesn't
- Both the portfolio and benchmark own it.
Let's consider the storied S&P500(R). It, as the name suggests, is comprised of 500 securities, allocated across 10 GICS(R) (Global Industry Classification Standard) sectors. The largest sector today is Information Technology, which comprises roughly 19% of the index and has 76 securities. Let's say that I am managing against the S&P500 and for technology decide to underweight. And, for this sector I select just three securities: Apple, Microsoft, and IBM (all members of the S&P500). At the sector level, my portfolio will be evaluated on allocation (I underweighted) and selection (my composition differs from the index's). At the security level, I would no doubt have more in my three securities than they have in the index, given that these three must share the allocation with 73 other securities. Is my overweighting going to be evaluated? For what purpose? I underweighted the sector; I'm not overweighting the securities! It's all about selection!
At the security level, contribution or absolute attribution should be employed: not relative attribution!