What is the security selection effect primarily concerned with?

The security selection effect is primarily focused on assessing the performance of a specific security in relation to the average performance of the sector it belongs to. This concept is critical for portfolio managers and investment analysts as it helps them understand how well they are selecting individual securities compared to the expected returns based on the overall sector’s performance.

When the selection effect is positive, it indicates that the securities chosen by the manager have outperformed the average returns of the sector, highlighting effective security selection. Conversely, a negative selection effect suggests underperformance relative to the sector. This analysis allows for a more nuanced evaluation of investment performance, distinguishing it from broader market trends or movements that might affect entire sectors.

In contrast, focusing solely on the individual performance of a specific security does not provide context regarding how it performs relative to its sector. Evaluating an entire sector's average performance lacks the precision needed to understand individual security contributions. Lastly, analyzing historical volatility while important for assessing risk, does not directly tie into the concept of security selection, which is fundamentally about return differences.