What is the formula for calculating pure sector allocation?

The formula for calculating pure sector allocation is focused on determining the impact of allocation decisions on a portfolio's performance relative to a benchmark. The chosen formula, which represents the differences in weights between the portfolio and the benchmark, directly correlates these differences to the performance differential between the portfolio returns and the benchmark returns.

In this context, the formula works as follows: By subtracting the benchmark weight from the portfolio weight, you can identify how much more or less the portfolio is invested in a particular sector than the benchmark. When this result is multiplied by the difference in returns (the return of the portfolio minus the return of the benchmark), it reflects the pure effect of allocation decisions—essentially isolating the impact of sector weights from other performance factors.

This method effectively evaluates how strategic sector allocation choices (overweighting or underweighting certain sectors compared to the benchmark) influence the overall performance, enabling a clearer analysis of investment decisions without the noise from returns or cash flows unrelated to sector allocation.