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Beyond Brinson: Establishing the Link Between Sector and Factor Models

Brinson sector-based attribution explains active return in terms of intuitive allocation and selection decisions. However, it cannot easily disentangle competing industry and style effects. We introduce a special type of factor model with five defining characteristics that exactly replicates the classic Brinson model. We show that this “Brinson-replicating” factor model easily extends to explain more general types of investment processes. In this extension, returns are decomposed into style effects and pure industry effects, net of styles. Moreover, much of the classic Brinson model “stock selection effect” is attributed to contributions from a handful of style factors. We show that in this framework risk and return can be attributed to the same set of decision variables. This provides a means of comparing return contributions on a risk-adjusted basis.