Thursday, June 9, 2011

Goldman Sachs & Currency Attribution

In yesterday's Wall Street Journal, the editorial writer Holman W. Jenkins, Jr. wrote a piece about Goldman Sachs, explaining how they, and their chairman, Lloyd Blankfein, are being vindicated, as the SEC's attempt to shift attention from their (the SEC's) failure to catch Bernie Madoff, to a highly successful firm and individual, is faltering. This is sadly reminiscent of the government in Ayn Rand's Atlas Shrugged, where this populist strategy, to assign blame and negative attention to the successful firms and individuals, is an easy one to employ, as the public often seems willing to damn these targets, which can be akin to killing the proverbial goose that is laying our golden eggs.

And so, what does this have to do with currency attribution? The proper assignment of blame (and credit).

I was speaking with a client recently who explained that because they don't manage currency, they do not do currency attribution; rather, they use the basic Brinson Fachler (BF) model that only shows allocation and selection (they avoid interaction) effects, based on the base (US$) returns in their global and international portfolios. I suspect that many other firms hold to this same approach. And so, is there anything wrong with it?

Well, consider what would happen if, for example, we have a stock in Euroland, that had a zero percent annual return (i.e., its price was unchanged for the year) as measured in local (Euro) terms,during a year where the Euro's return relative to the US dollar was up 15 percent. By using the security's base return (15%, which arises solely from the currency change), we are unable to identify the true source for the security's return, and attribute it entirely to its selection.

To properly evaluate a portfolio's performance, when multiple factors are at work (the local dynamics of the security, coupled with the exogenous impact of currency movements over time), we must separate their contributions in our attribution analysis, by using the local (i.e., Euro in this case; not base, i.e., US$) returns in the BF evaluation of market effects, and a currency attribution approach to complete the job, in order to fully reconcile to our excess return, by addressing the impact of currency movements (and the contributions from any hedging we may have employed).

The decision to use a multi-currency attribution model has nothing to do with the management of currencies, but simply the exposure to two or more currencies, and thus the associated foreign exchange movements which occur, independent of what happens to the securities we invest in.


  1. Your logic is spot on. So why not extend your logic to include other significant structural characteristics that may be driving return, and account for their impact on the so-called "selection" effect? You might start with risk, measured by Beta, or you may recognize that a manager may be neutral to a sector but takes big industry bets. If unaccounted for, these would be mistaken for selection, just as in your currency example.

  2. Steve, you are likewise "spot on." The ability to break the effects down further, into their appropriate contributors makes sense. In some cases these arise from decisions; in other cases, they come from factors which, while not perhaps decision-related, still provide valuable insights into what is occurring.


Note: Only a member of this blog may post a comment.