Chartered Financial Analyst (CFA) Level 3 Practice Exam 2025 - Free CFA Level 3 Practice Questions and Study Guide

Calculating the Pure Sector Allocation return involves analyzing how much of the portfolio's performance can be attributed solely to sector allocation decisions, independent of stock selection within those sectors. This is accomplished by summing the product of sector weights and return differences.

To elaborate, the calculation takes into account the weights (or proportion) of each sector in the portfolio and how these weights differ from a benchmark or the market. By multiplying each sector’s weight by the difference between the sector’s return and the overall benchmark return, you isolate the impact of the active decision to overweight or underweight specific sectors. This approach allows you to measure the effectiveness of the sector allocation strategy without the influence of security selection.

Other methods mentioned, such as finding the average return across all sectors or estimating future returns based on past performance, do not accurately reflect the Pure Sector Allocation return. These approaches may provide a broader view of returns or involve predictions, but they do not focus explicitly on the allocation strategy's contribution to the portfolio's performance.