Fixed Income Performance Attribution

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1 Fixed Income Performance Attribution Mary Cait McCarthy August 2014

2 Content What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August

3 1 What Is Performance Attribution? A framework for understanding the results of a portfolio manager s investment decisions on a portfolio s relative return vs. a benchmark Framework Imposes simplifying principles Decision support Evaluates and provides feedback Relative Value conclusions require comparison benchmarks are critical August

4 Content What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August

5 2 Uses of Performance Attribution Provide feedback for decisions within an investment process Framework should mirror investment process Provide feedback about a selected investment process Framework should be more general than investment process Provide feedback within a risk budgeting process Are the returns being generated as intended? August

6 Content What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August

7 3 Drivers of Fixed Income Return Price Sum of all discounted cash flows Discount rate Government interest rate: term structure of rates Spread Systematic: swap spreads, industry spreads, rating spread Issuer/Security specific: supply/demand, issuer specific news Return Received cash flows plus change in price Cash flows: accrued income/coupon payments, prepayments, sinking funds Change in price Change in expected cash flows (e.g. prepayments, optionality) Change in discount rate (government rate or spreads) August

8 3 The Continuum of Performance Attribution Methodologies Factor based with observed shifts Factor based with estimated shifts (Regression) Successive revaluation Duration modified returns based Returns based (Brinson Facher) August

9 Spot Yield (%) 3 An Example for Comparison Period: September 2011 Portfolio: USD Treasury barbell portfolio (with 6 securities) vs. the JPM Traded USD Index Long and short buckets are separated at the 10 years to maturity point Yield Curves Yield Curves Yield (%) Yield (%) Years to Maturity Coupon % of Description Rate Maturity Port <10 Years to Maturity USA TREASURY NTS 1.5 USA TREASURY NTS 0.7 USA TREASURY BDS 2% Subtotal >10 Years to Maturity US 6.750% 30YR BOND US 6.500% 30YR BOND US 6.000% 30YR BOND Subtotal August

10 Content What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August

11 4 Returns Based Attribution An Introduction Seeks to explain return differences between the portfolio and benchmark (R portfolio R benchmark ) Algebraic breakdown using only returns and weights of portfolio and benchmark Flexible groupings Allocates by weighting and selection decisions Often representative of the investment process Usually referred to as Brinson models August

12 4 Returns Based Attribution Example Allocation: Use benchmark to judge good/bad groups Selection: compares portfolio and benchmark return within group Characteristics: Easily customizable to any investment process that concentrates on allocation to groups and selection within groups Easy to understand and interpret Relatively low data requirements Results are easily distorted when the investment process is multi-dimensional e.g. currency, sector and rating Difficult to apply to most fixed income investment processes Duration Portfolio A Benchmark A Relative Return Group Begin Base Begin Base Allocation Selection Total <10 Years to Maturity >10 Years to Maturity Weight Rtn (%) Weight Rtn (%) Effect Effect Total What story does it tell? Allocation effect shows that weighting decisions between the buckets were good due to the overweight of the better performing long bonds Selection effect was negative, especially in the long bonds bucket, but no clarity of cause August

13 4 Can Returns Based Models Be Applied to Fixed Income? Portfolio A Benchmark A Relative Return Group Begin Duration Base Begin Duration Base Duration Allocation Selection Total Weight Rtn (%) Weight Rtn (%) Effect Effect Effect <10 Years to Maturity >10 Years to Maturity Total The methodology can be extended to account for duration choices What story does it tell? Allocation effect remains unchanged long bonds outperformed short bonds In both categories, the portfolio had a shorter duration than the benchmark, giving a negative impact as the return per unit duration is positive About half of the long bucket selection effect comes from duration positioning within the bucket Benchmark Excess Group Base Duration Rtn (%) <10 Years to Maturity >10 Years to Maturity Rtn (%) Duration Total August

14 Content What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August

15 5 Returns Based Attribution An Introduction Seeks to explain return differences between the portfolio and benchmark (R portfolio R benchmark ) as well as portfolio and benchmark returns individually Breakdown of returns based on systematic factors, which are obtained during model creation Regression analysis often used to determine returns or exposures to factors Modeled returns, for portfolio, benchmark and differences, determined based on factor returns and exposures to factors August

16 5 Factor Attribution and Fixed Income Because of the strong mathematical relationship between changes in interest rates and price changes, fixed income is particularly well analyzed with this approach Standard measures of mathematical sensitivity: duration, spread duration, convexity, etc. R 2 for government bonds tends to be above 95% compared to 40% to 50% for equity regression For bonds, factor models help minimize the number dimensions necessary to explain yield curve shifts August

17 5 Designing a Factor Model General model description: Security returns can be expressed as a linear combination of sensitivities to systematic factors and the returns associated with those systematic factors # factors Rs income _ return Exposure s i, i * i s Fixed Income Factors Durations/interest shifts: three factor representation, key rate representation Spread durations/spread shift: flexible granularity Other impacts: prepayments, optionality, etc. A simple factor model for fixed income: R s income _ return s duration s * yield _ curve _ shift s August

18 Measuring the Yield Curve Shift Observed shifts Estimates of underlying curves are made and then shifts are observed/measured The goal is still to break down the observed shift into component parts (our example: a parallel shift) Since underlying curve estimates are easily available, the data requirements are low Estimated shifts The effects of the underlying curve shifts are determined via regression analysis Can account for imperfect responses to expected sensitivities and/or interaction between different kind of shifts Requires a universe of data for regression estimates Yield Curves Change (%) (%) r s, t e i s, i, t i, t E t D t Security Returns and Exposures (Duration) Measured Returns to Shifts Estimated August

19 5 Observed Shifts Which Shift to Take? Observed shifts Given the observed yield curve, which point best proxies the parallel shift of the yield curve? Average: -0.22% 6-year point (~portfolio duration): -0.05% A split: 2-year point (+0.10%) for short and 15-year point (-0.49%) for long (not really parallel) Average 6 Years Split Coupon Maturity % of Carry Duration Residual Duration Residual Duration Residual Description Rate Maturity Port Effect Effect Effect Effect Effect Effect Effect <10 USA TREASURY NTS USA TREASURY NTS USA TREASURY BDS 2% Subtotal >10 US 6.750% 30YR BOND US 6.500% 30YR BOND US 6.000% 30YR BOND Subtotal Total August

20 5 Comparing the Results Observed Shifts For a neutral analysis, we take the average shift (-0.22%) What story does it tell us? The portfolio has lower yielding securities in the short bucket and higher yielding securities in the long bucket Duration impact includes both weight and duration: with an underexposure in the short bucket of -2.4 years and an overexposure in the long bucket of 3.2 years, the duration effect is slightly positive Selection impact is due to weighting: the benchmark had more negative selection in the short bucket and less positive selection in the long bucket Portfolio A Benchmark A Relative Return Group Begin Duration Base Begin Duration Base Carry Duration Selection Total Weight Rtn (%) Weight Rtn (%) Effect Effect Effect <10 Years to Maturity >10 Years to Maturity Total August

21 5 Comparing the Results Estimated Shifts Regression analysis gives a parallel shift of -0.44% What story does it tell us? The portfolio has lower yielding securities in the short bucket and higher yielding securities in the long bucket Duration impact includes both weight and duration: with an underexposure in the short bucket of -2.4 years and an overexposure in the long bucket of 3.2 years, the duration effect is positive Selection impact in short bucket is due to weighting: in the long bucket, the portfolio securities underperformed the duration expectation, whereas the benchmark securities outperformed it Portfolio A Benchmark A Relative Return Group Begin Duration Base Begin Duration Base Carry Duration Selection Total Weight Rtn (%) Weight Rtn (%) Effect Effect Effect <10 Years to Maturity >10 Years to Maturity Total August

22 Content What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August

23 6 Successive Revaluation Successive revaluation involves shifting the curve and repricing all of the bonds: Only one factor shift is applied during each revaluation Shifts can be attained by any of the foregoing methodologies Is a data and calculation intensive attribution methodology Will typically yield a smaller residual security selection August

24 Contacts Do you have questions? We look forward to hearing from you Mary Cait McCarthy, CFA, FRM Head Investment Reporting Credit Suisse Zurich: August

25 Disclaimer This material has been prepared by the Private Banking & Wealth Management division of Credit Suisse ( Credit Suisse ) and not by Credit Suisse's Research Department for information and educational purposes. It is not investment research or a research recommendation for regulatory purposes as it does not constitute substantive research or analysis. This material is provided for informational and illustrative purposes and is intended for your use only. It does not constitute an invitation or an offer to the public to subscribe for or purchase any of the products or services mentioned. The information contained in this document has been provided as a general market commentary only and does not constitute any form of regulated financial advice, legal, tax or other regulated financial service. It does not take into account the financial objectives, situation or needs of any persons, which are necessary considerations before making any investment decision. The information provided is not intended to provide a sufficient basis on which to make an investment decision and is not a personal recommendation or investment advice. It is intended only to provide observations and views of the said individual personnel at the date of writing, regardless of the date on which the reader may receive or access the information. Observations and views of the individual Asset Management personnel may be different from, or inconsistent with, the observations and views of Credit Suisse analysts or other Credit Suisse personnel, or the proprietary positions of Credit Suisse, and may change at any time without notice and with no obligation to update. To the extent that these materials contain statements about future performance, such statements are forward looking and subject to a number of risks and uncertainties. Information and opinions presented in this material have been obtained or derived from sources which in the opinion of Credit Suisse are reliable, but Credit Suisse makes no representation as to their accuracy or completeness. Credit Suisse accepts no liability for loss arising from the use of this material. Unless indicated to the contrary, all figures are unaudited. All valuations mentioned herein are subject to Credit Suisse valuation policies and procedures. It should be noted that historical returns and financial market scenarios are no reliable indicator of future performance. Every investment involves risk and in volatile or uncertain market conditions, significant fluctuations in the value or return on that investment may occur. Investments in foreign securities or currencies involve additional risk as the foreign security or currency might lose value against the investor's reference currency. Alternative investments products and investment strategies (e.g. Hedge Funds or Private Equity) may be complex and may carry a higher degree of risk. Such risks can arise from extensive use of short sales, derivatives and leverage. Furthermore, the minimum investment periods for such investments may be longer than traditional investment products. Alternative investment strategies (e.g. Hedge Funds) are intended only for investors who understand and accept the risks associated with investments in such products. This material is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of, or is located in, any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation, or which would subject Credit Suisse and/or its subsidiaries or affiliates to any registration or licensing requirement within such jurisdiction. Materials have been furnished to the recipient and should not be re-distributed without the express written consent of Credit Suisse. When distributed or accessed from the EEA, this is distributed by Credit Suisse Limited (authorised and regulated by the Financial Conduct Authority) or any other Credit Suisse entities. When distributed in or accessed from Switzerland, this is distributed by Credit Suisse AG and/or its affiliates. For further information, please contact your Relationship Manager. When distributed or accessed from Brazil, this is distributed by Banco de Investimentos Credit Suisse (Brasil) S.A. and/or its affiliates. When distributed or accessed from Australia, this document is issued in Australia by CREDIT SUISSE INVESTMENT SERVICES (AUSTRALIA) LIMITED ABN AFSL Copyright CREDIT SUISSE GROUP AG and/or its affiliates. All rights reserved. August

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