With the recent implementation of parts of the U.S. Department of Labor’s fiduciary rule, advisors are sharpening their pencils when it comes to performing due diligence on equity and fixed income holdings in their clients’ portfolios. The good news is that advances in financial research and technology have made it much easier to dissect individual funds, or even a combination of funds, in different ways (sector, country, factor, etc.).

These tools help advisors better understand what’s truly driving the results of the funds that they use. Importantly, performance attribution also supports their efforts to ensure that the fees they’re paying for the exposure they desire make sense.


The evolution of active manager attribution models

Notes: This is a hypothetical scenario for illustrative purposes only. It does not represent any particular equity investment. “Noise” refers to the fact that through any period, some degree of randomness always affects results versus the broad equity market. The degree of influence varies and can be difficult to statistically distinguish from alpha without extensive data.

Source: Douglas M. Grim, Scott N. Pappas, Ravi G. Tolani, and Savas Kesidis, 2017. Equity factor-based investing: A practitioner’s guide. Valley Forge, Pa.: The Vanguard Group.


Performance attribution, including through a factor lens as illustrated in the chart above, is a standard part of our due diligence when evaluating the roster of subadvisors of our actively managed funds and our internal active teams. While quantitatively oriented due diligence is important, Vanguard strongly believes that qualitative due diligence of firms, people, philosophies, and processes is critical as well.


Assessing performance

While many advisors may be content with what they find after conducting a performance appraisal, in some cases they may be surprised to learn that what they’ve been getting from a certain traditional active manager is just a consistent, long-term tilt toward one or more well-known style factors (e.g., credit, term, value, small-cap) when their objective for hiring the active manager may have been solely to generate positive alpha.1,2,3 Low-cost options (implementation tools) to tilt portfolios toward many of these factors have existed for more than 20 years, with style box equity and fixed income index funds representing some of the early options.


Two important questions

Fast-forward to today, when hundreds of options allow advisors to add factor tilts across asset classes if they philosophically believe those tilts can help their clients meet a specific investment objective. As a result, advisors who notice that their traditional active managers have demonstrated persistent and steady factor tilts need to ask two important questions:

  1. Is this overweight to a certain factor or set of factors something I desire?
  2. Are the all-in costs for obtaining that exposure suitable, especially if the manager has not delivered positive alpha after adjusting for the factor exposure(s)?

If the answer to the first question is no, then the advisor should consider a more fitting approach or option to achieve the tilt the advisor is looking for. If the answer to the first question is yes, then answering the second question will help make sure that the price the advisor is paying for the types of returns the advisor is receiving makes sense. This is increasingly important now given the growing empirical evidence that, historically, low cost has tended to lead to better long-term performance.4 The trend of cash flows shifting to lower-cost funds was pretty steady over the 15 years ended December 31, 2015, which shows investors are paying attention to costs.


Make sure the price is right

The bottom line is that performance attribution is critical when evaluating the source and efficacy of a traditional active manager’s results. Understand how much factors influence the performance of the equity and fixed income holdings in a client’s portfolio. Don’t pay high fees to traditional active managers if all they’re delivering is market beta with a persistent factor bet if it could be efficiently obtained with greater transparency and risk control at a lower cost.

New research we’ve published, Equity factor-based investing: A practitioner’s guide, offers several examples of how factor-based investing can be used in real-world portfolios and how factors may be used and configured to meet clients’ specific objectives and goals.


Look for my next blog post, in which I’ll discuss some of the challenges of conducting due diligence of factor-oriented and smart beta products.



1 Donald G. Bennyhoff and Jamese Dunlap, 2017. A review of alternative approaches to fixed income indexing. Valley Forge, Pa.: The Vanguard Group.

2 For a study of U.S. active equity managers, see Jennifer Bender, P. Brett Hammond, and William Mok, 2014. Can alpha be captured by risk premia? The Journal of Portfolio Management 40(2):18–29.

3 Positive alpha (manager skill) can be thought of as the production of excess return via dynamic market-timing (across asset classes, factors, or sectors) or successful security selection.

4. Daniel W. Wallick, Brian R. Wimmer, and James J. Balsamo, 2015. Shopping for alpha: You get what you don’t pay for. Valley Forge, Pa.: The Vanguard Group.