I got an email from a client recently, asking how one should treat the case where a manager has zero exposure to one of the sectors in the benchmark.
If you are using one of the Brinson models and simply use the formulas as written, you’ll find that the interaction effect gets most of the credit (or blame) for the decision. But does this make any sense? No!
And so, you may want to shift the interaction results to one of the other effects: selection or allocation.
Now, which do you think it should be? [pause, to allow you to reflect a moment] I think allocation, since the manager made the decision to go void in the sector. Thus, I would move the entire interaction effect there.
I’ll address this in greater detail in this month’s newsletter.