Incremental Return Contribution Reading 32

CFA Level III
#1

Can some clever guy explain why we have to use this formula to calculate incremental return: rIS=∑i=1A∑j=1Mwi×wij×(rBij−rCi) to compute incremental return % for “asset category” instead of just taking the incremental gain/loss movement in $/ and divide by opening balance. For example the table below is from Exhibit 6 Reading 26. I would have computed the “asset category” incremental return as 6,272,658/ 187,944,879 = 3.34%; yet the incremental return per CFAI is 3.36%. The difference appears small but in other questions, the difference can be quite huge. The same applies to working out all the incremental returns eg investment Managers or Value of Active Management category.

And could you explain the formulas for Incremental Return Contribution for Asset category; Benchmarks; Investment managers; Allocation effects etc --and whats the intuition of these.

#2

This is because the incremental return include risk free rate and contributions. The formulas are not actually as important as you understand the concept. All what you need to know is what would be the incremental return if the fund manager replicate the policy allocation (sponser benchmark) and after external cash flow ? Say your portfolio generated 200 mil return, yet if you replicated the sponser benchmark and contributions plus all the above return categories =190 millions so your incremental return due to policy allocation is 10 millions