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I am preparing for 2020 May FRM II test and will appreciate any explanation for this question:

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In terms of asset allocation contribution, why is real estate made the highest asset allocation contribution? Is it because it overperformance the benchmark?

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Comparing the contributions using Fund Weights versus using Benchmark weights:

Sect ret  fundw contrib   ret  bweigt contrib   difference
   A 0.3  0.45  0.135     0.3  0.5    0.15      -0.015
   B 0.1  0.1   0.01      0.1  0.2    0.02      -0.01
   C 0.2  0.2   0.04      0.2  0.1    0.02       0.02
   D 0.25 0.25  0.0625    0.25 0.2    0.05       0.0125

Total           0.2475                0.24       0.0075

Conclusion: the fund's chosen asset allocation outperformed the benchmark by 75 bps (return of 24.75% versus benchmark return 24%), this was mostly due to Sector C (Real Estate) which had a generous overallocation (20% instead of 10%) and satisfactory (but not top) returns (20%) resulting in an 0.02 difference (last column). Sector D also contributed to outperformance, but to a lesser degree (0.0125).

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  • $\begingroup$ For the exam just remember that Sector Contribution = Sector Weight times Sector Return. $\endgroup$ – noob2 Mar 8 at 21:23

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