Residual-Free Attribution

In response to the need for transparent factor-based, long-only strategies, investors have devised distinct residual-free attributions designed to leave little active return unexplained. The lack of information on how most of these operate is a problem. In this article, the author demonstrates that the solution of the constrained multifactor mean–variance optimization can be fully decomposed into a combination of underlying constrained factor portfolios that allows for a theoretically sound residual-free attribution of performance. The proposed decomposition also provides a unique perspective of the impact of investment constraints on the optimal portfolio.