Performance attribution
Decomposing portfolio return into contributions from asset allocation, security selection, and FX. Tells you whether you made money from skill or just from being in the right asset class.
Understanding performance attribution helps a Nigerian retail investor figure out where their returns are coming from. Imagine you've been trading stocks on the Nigerian Exchange (NGX) and you've noticed your portfolio has grown. Performance attribution breaks down this growth to show if it was due to smart stock picking, the right mix of assets, or favorable market conditions. It's like checking if your profit from selling yams at the market came from buying the freshest produce or just because the demand for yams went up.
In practical terms, let's say you have invested in both equity and fixed income. If the Central Bank of Nigeria (CBN) raises the Monetary Policy Rate (MPR) to 27.50%, fixed income investments like Treasury bills might yield higher returns, boosting your portfolio. Performance attribution helps you understand if your gains are due to this interest rate change or because you chose the right Treasury bills to invest in. It's similar to knowing if your profit from a savings account came from the higher interest rate or from your initial deposit amount.
The concept also looks at the impact of currency fluctuations. If you have investments denominated in foreign currency, changes in the Naira (₦) exchange rate can affect your returns. Performance attribution will show you how much of your return is due to the Naira strengthening against the dollar, and how much is from the actual performance of your foreign investments. Think of it like buying dollars when the Naira is weak and selling them when it's strong to see how much profit you made from the currency movement versus the actual business you invested in.
Dividends and capital gains also play a role. If you earn dividends from Nigerian stocks, you'll have to pay a 10% Withholding Tax (WHT). Similarly, if you sell your shares at a profit, you'll owe a 10% Capital Gains Tax (CGT). Performance attribution will help you see how much of your after-tax returns are actually from your investment decisions, not just from avoiding these taxes. It's akin to buying a goat, rearing it, and then selling it at a profit, while also accounting for the government taxes you paid along the way.
Why it matters: Knowing where your returns come from allows you to make better, more informed decisions going forward. If your returns are mainly from being in the right asset class, you might want to diversify more. If your gains are from picking the right stocks, you might want to focus on enhancing your stock-picking skills. In the end, performance attribution helps you understand your investment journey better, much like knowing whether your success in a business came from good location, good products, or just being in the right place at the right time.