The Role of Fixed Income Benchmarks. May 2007 Lev Dynkin, Managing Director Global Head of Quantitative Portfolio Strategies

Transcription

1 The Role of Fxed Income enchmarks May 2007 Lev Dynkn, Managng Drector Global Head of Quanttatve Portfolo Strateges

2 Why use a benchmark? Is the portfolo manager addng value vs a nave ( zero skll ) nvestment strategy gven the opportunty set and constrants? What s the long term rsk appette? Long-term strategc asset allocaton Most asset management mandates come wth a specfed benchmark and constrants on devaton from t Most mutual funds have a stated benchmark to let buyers know the nature of major allocatons Reasons for benchmark customzaton: Lablty-based benchmarks Reflect constrants 2

3 Common and Dstnct Features of ond Indces ond ndces are market weghted average returns of ndvdual securtes Most fxed ncome securtes trade OTC and are prced by the ndex provder or a thrd party servce Lehman bond ndces have ndex statstcs (rsk senstvtes to yeld curve and spread changes, avg. yeld, avg. coupon) n addton to returns Standard Lehman bond ndces nclude securtes that meet pre-specfed rules Customzed ndces may follow a dfferent set of rules for ncluson of securtes Indces may be produced for strateges (long corporate bonds, short duratonmatched Treasury bonds) or dervatves (swap ndces) 3

4 Customzed Indces Lehman publshes daly on ts webste about 2,000 standard ndces coverng a broad range of asset classes n 30 currences and over 5,000 customzed ndces for specfc nvestors Customzed ndces reflect constrants of specfc nvestors Constrants on realzed gans or losses book yeld ndces Lablty-matchng constrants Changes to ndex ncluson crtera (e.g. only bonds rated A and above) Target specfc asset class weghts (e.g. 50% govt, 50% corporates) Issuer caps (e.g. no more that 2% of portfolo n any ssuer) 4

5 Man Dlemma of Indces Investable vs representatve ndces: baskets of securtes broad-based reflecton of the opportunty set Under-samplng vs over-samplng Prcng a broad unverse of securtes Systematc rsk vs dosyncratc rsk Lehman s ond Market Indces are broad-based representatons of the nvestment opportunty set 5

6 What defnes a good benchmark? A good benchmark should nclude the followng propertes] Unverse s well defned, wth transparent rules Securtes are nvestable; benchmark s replcable Daly performance data s avalable Current characterstcs are avalable (e.g., prce, coupon, duraton, etc.) Hstorcal nformaton s avalable Investment style s clearly defned Rsk profle s well defned enchmark s specfed n advance Turnover s low The Lehman Global Famly of Indces meets these crtera. All ndces are rules-based, meanng that ncluson n a Lehman rothers ndex depends on satsfyng clearly pre-specfed crtera. Comprehensve statstcs about each ndex are readly avalable to nvestors, and performance results are avalable daly for most ndces. [1] 6

7 Assets under Management enchmarked vs. Major Lehman rothers Indces December 2006 Total: $6.11trn Lehman rothers Index U.S. Aggregate U.S. Unversal Global Aggregate U.S. Government / Credt Pan-Euro Aggregate Euro Aggregate U.S. Hgh-Yeld Custom / Other AUM (Estmated) $2.40trn $194bn $1.10trn $613bn $105bn $483bn $82bn $1.10trn 7

8 Lehman rothers Global Famly of Indces: May Indces; 7 Flagshp Indces Global Aggregate, U.S. Aggregate, U.S. Unversal, Pan-European Aggregate, Euro-Aggregate, Asan-Pacfc Aggregate, Multverse Multverse Other Debt and Swaps Indces U.S. Unversal Global Aggregate Global Hgh-Yeld Global Asset Class Indces Floatng-Rate Indces Dollar, Euro, Sterlng, & Yen Swap Indces Global Captal Securtes Hgh-Yeld Issuer Capped / VLIs U.S. Convertbles Index Zero-Coupon Nomnal & Inflaton Swaps Indces U.S., Euro, Yen CDS/ CDX Traxx TR Indan Government U.S. Muncpals Swss Franc Aggregate Mexcan Government ond Index CMS Hgh-Yeld Short U.S. Gov/Credt Chnese Aggregate Index CMS IO Non-U.S. Aggregate U.S. HY Corp Euro dollar 144A Non- ERISA CMS U.S. EM U.S. Aggregate U.S. Treasury U.S. Gov- Related U.S. Corporate U.S. Securtzed AS Euro Aggregate Euro Treasury Euro Gov- Related Euro Corporate Euro Securtzed Pan-European Aggregate Sterlng Aggregate Glt Non-Glt Non- EMU Swedsh Aggregate Dansh Aggregate Norwegan Aggregate Eastern Europe Treasury Dansh MS Asan-Pacfc Aggregate Japan Agg Non- Japan Asa-Pacfc Treasury Asa-Pacfc Gov-Related Asa-Pacfc Corporate Asa-Pacfc Securtzed GHLC RMS (Japan Agg Only) Other Global Agg Components Canadan Aggregate ZAR, CHP, MXN Treasury Investment -Grade EM Euroyen Eurodollar Ex Agg 144A Ex Agg U.S. HY Pan Euro HY CMS HY EM HY Global Inflaton- Lnked U.S. TIPS UK Glt Eurozone JG Canada Global Treasury G-7 Majors Others Global Credt Global Inv- Grade Corp 144-A s Eurodolla r Global HY Corp Global Securtzed MS CMS AS Covered Global Emergng Markets USD EUR GP JG FRN U.S. AS FRN Pan Euro AS FRN U.S. Corp. FRN Pan Euro Corp FRN U.S. HY FRN U.S. HY Loan Emerged ERISA CMS Non-Debt Indces MS Fxed Rate Passthroughs Commodty Index (LCI) FX Indces Global Hedge Fund Indces Hybrd ARM (U.S. Agg Only) 8

9 Index Rules & Constructon

10 asc Prncples of Lehman Indces Rules-ased Monthly Reset Market Value Weghted Total Return Calculatons 10

11 Monthly Index Dynamcs: uldng a Rules-ased Index Returns Unverse Statc unverse set at begnnng of month Avods httng a movng target Includes bonds that durng the month have been Called Downgraded below nvestment grade Sunk below $250MM Used to report ndex performance (returns) Returns Unverse ackward Forward Statstcs Unverse Statstcs Unverse Dynamc unverse changes daly Used for rebalancng purposes Includes bonds that durng the month have been Newly ssued Upgraded to nvestment grade Used to forecast next month s returns unverse 11

12 Global Aggregate Index: Factsheet / Rules Index Overvew The Global Aggregate Index provdes a broad-based measure of the global nvestment-grade fxed-rate debt markets. The Global Aggregate Index contans three major components: the U.S. Aggregate Index (USD 300 mllon), the Pan- European Aggregate Index (EUR 300 mllon), and the Asan-Pacfc Aggregate Index (JPY 35 bllon). In addton to securtes from these three benchmarks (94.4% of the overall Global Aggregate market value), the Global Aggregate Index ncludes Global Treasury, Eurodollar (USD 300 mllon), Euro-Yen (JPY 35 bllon), Canadan (CAD 300 mllon), and Investment-Grade 144A (USD 300 mllon) ndex-elgble securtes not already n the three regonal aggregate ndces. The Global Aggregate Index famly ncludes a wde range of standard and customzed subndces by lqudty constrant, sector, qualty, and maturty. Sector reakdown as of 12/31/2006 Qualty reakdown as of 12/31/2006 Access to the Index Securtzed 20.4% Corporate 16.0% Government- Related 15.0% Treasury 48.7% Aa 28.2% A 11.1% aa 5.2% Aaa 55.5% LehmanLve Webste Daly ndex returns and statstcs Hstorcal tme seres downloadable nto Excel Standardzed market structure reports Fully customzable vews Index prmers and shelf reference documents Latest ndex and portfolo strateges research publcatons 12

13 Global Aggregate Index: Factsheet / Rules Rules for Incluson Amount Outstandng The mnmum lqudty crteron s based on elgble currences, as follows: For U.S. Aggregate, Canadan, Eurodollar, and Investment-Grade 144A Index securtes, USD 300 mllon (or equvalent) mnmum par amount outstandng. CMS and AS securtes must belong to a deal wth a mnmum aggregate transacton sze of USD 500 mllon. For Pan-European Aggregate Index securtes, EUR 300 mllon currency equvalent mnmum par amount. For Asan-Pacfc Aggregate and Euro-Yen Index securtes, JPY 35 bllon mnmum par amount outstandng. For GP denomnated securtes, GP 200 mllon currency equvalent mnmum par amount outstandng. For securtes n other elgble currences, mnmum amount outstandng s pegged to one of the four major currences above, usng an exchange rate that s reset once a year on the last busness day of November. WM/Reuters exchange rates are used. Qualty Maturty Currency Must be rated nvestment grade (aa3/-/- or above) usng the mddle ratng of Moody s, S&P, and Ftch, respectvely. When all three agences rate an ssue, a medan or two out of three ratng s used to determne ndex elgblty by droppng the hghest and lowest ratng. When a ratng from only two agences s avalable, the lower ( most conservatve ) of the two s used. When a ratng from only one agency s avalable, that ratng s used to determne ndex elgblty. Unrated securtes are ncluded provded that an ssuer ratng s applcable. Domestc local currency soveregn debt wll be use the most observed bond level ratng for all outstandng bonds. At least 1-year untl fnal maturty, regardless of optonalty. For securtes wth coupon that converts from fxed to floatng rate, at least 1-year untl the converson date. MS must have a weghted average lfe of at least 1-year; AS must have a remanng average lfe of at least 1 year; CMS must have an expected maturty of at least 1-year. Perpetual securtes are ncluded n the ndex provded they are callable or ther coupons swtch from fxed to varable rate. These are ncluded untl one year before ther frst call date, provdng they meet all other ndex crtera. Currences elgble for ncluson must be freely tradable and hedgeable; local currences soveregn bonds (both local and foregn) must have an nvestment-grade soveregn ratng usng the mddle ratng. The lst of elgble currences s revewed once a year. Tha baht debt was removed from the ndex on March 1, U.S. and Canadan Aggregate Index securtes: USD, CAD. Pan-European Aggregate Index securtes: EUR, GP, CZK, DKK, HUF, NOK, PLN, SKK, SEK. Asan-Pacfc Aggregate Index securtes: JPY, AUD, HKD, KRW, NZD, SGD, TWD, MYR. Addtonal elgble currences: CLP, MXN, ZAR. 13

14 Global Aggregate Index: Factsheet / Rules Sources & Frequency Prcng Quotes d or Offer Sde Frequency Index Changes Renvestment of Cash flows New Issues Prcng & Related Issues Unless noted otherwse, ndex bonds are prced by Lehman rothers traders at md-month and month-end. On a daly bass, a subset of the ndex contnues to be trader prced, wth the remanng bonds model/ matrx prced usng actvely traded benchmark securtes to generate ssuer prcng curves and populate a spread matrx algorthm or sourced from thrd partes. U.S. Aggregate Index, Eurodollar Index, 144A Index: Treasures are trader prced daly; up to 1,000 benchmark Corporates are trader prced daly; some Agency debentures are trader prced daly; MS bonds are prced by traders on a daly bass, wth generc prces derved from these marks; AS spreads are marked weekly to generate daly prces usng changes n the Treasury and swap curves; CMS spreads are marked daly. Pan-European Aggregate Index: Lehman rothers traders prce more than 75% of the market value of the ndex; the remander s prced by thrd party sources or by a spread matrx algorthm. Tradtonal Pfandbrefe are curve-based, Jumbo Pfandbrefe and Dansh MS are vendor prced. Asan-Pacfc Aggregate Index, Euro-Yen Index, and Other Currences: Daly prces provded by outsde sources f trader marks are unavalable. Canadan Index: Daly prcng s provded by Scota Captal. onds can be quoted n a varety of ways ncludng nomnal spreads over benchmark securtes/treasures, spreads over swap curves, or drect prce quotes as a percentage of par. In most nstances the quote type used s a spread measure that results n daly securty prce changes from the movement of the underlyng curve (swap or treasury) and/or changes n the quoted spread. onds n the ndex are prced on the bd sde. The ntal prce for new corporate ssues enterng the ndex s the offer sde; after that, the bd sde prce s used. Rebalancng The composton of the Returns Unverse s rebalanced monthly, at each month end and represents the set of bonds that returns are calculated on. The Statstcs Unverse changes daly to reflect ssues droppng out and enterng the ndex, but s not used for return calculaton. On the last busness day of the month, the composton of the latest Statstcs Unverse becomes the Returns Unverse for the followng month. Durng the month, ndcatve changes to securtes (maturty, credt ratng change, sector reclassfcaton, amount outstandng) are reflected n both the statstcs and returns unverse of the ndex on a daly bass. Interest and prncpal payments earned by the returns unverse are held n the ndex wthout a renvestment return untl month-end when t s removed from the ndex. Qualfyng securtes ssued, but not necessarly settled, on or before the month-end rebalancng date qualfy for ncluson n the followng month s returns unverse. 14

15 Global Aggregate Index Returns (Hedged and Unhedged n ILS) Monthly Global Aggregate Index Returns Snce 2001 (n Israel Shekel) Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Unhedged Hedged 15

16 Global Aggregate Index Returns (Hedged and Unhedged n ILS) Cumulatve Global Aggregate Index Returns Snce 2001 (n Israel Shekel) Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Unhedged Hedged 16 Cumulatve Return (%)

17 Non-tradtonal benchmarks Tradtonal ndces represent the nvestment opportunty set n proportons to market captalzaton enchmark may represent a no vew nvestment portfolo Any nvestment process can be benchmarked: Corporaton Z generates ts revenue n US$ and Euro, but reports earnngs n US$. The Treasurer can hedge expected Euro revenue nto US$ 1 year out and take the rsk of revenue fluctuaton or hedge monthly and take the currency rsk. How should the Treasurer be evaluated at the end of the year? 17

18 Managng a Portfolo Relatve to a enchmark

19 asc Steps n Quanttatve Portfolo Management vs. an Index Standard and custom ndces Justfcaton of asset class selecton n the benchmark Settng a benchmark duraton target Justfcaton of nvestment style Proflng of the portfolo vs. benchmark to examne ntentonal and unntentonal exposures (Market Structure) Measurng portfolo rsk relatve to benchmark (Rsk Model) Comparng projected scenaro returns (Scenaro Analyss) Attrbuton of acheved return advantage to manager decsons (Performance Attrbuton) 19

20 Market structure example: Proflng the portfolo relatve to the enchmark 80/20 Composte vs. Govt/Corp Index Portfolo (%) enchmark (%) Dfference (%) Portfolo Dur. mk. Dur. Dfference Portfolo Cnt. Dur. mk. Cnt. Dur. Dfference Govt Corp Total 80.00% 69.66% 10.34% % 30.34% 10.34% % % 0.00%

21 Scenaro Analyss 80/20 Composte vs. Govt/Corp Index Scenaro (1-month horzon) Poston Return % enchmark Return % Dfference % Up 50 bps s Steepen 20 bps No Change s Flatten 20 bps Down 50 bps Spreads wden 20%

22 Why do we need a Rsk Model? Quantfy the market rsk embedded n a portfolo In absolute terms: expected volatlty of the portfolo total returns In relatve terms: trackng error volatlty Attrbutes ex-ante rsk to major decsons mplemented by fund managers Currency allocaton Interest rate management: duraton and yeld curve exposure Swap spreads Interest rate volatlty Credt allocaton Name and securty selecton Can be used n Montorng actve rsk Portfolo optmzaton Rsk budgetng Scenaro analyss 22

23 Example Rsk Model Report What are the sources of rsk? Trackng error volatlty (TEV) s the prmary measure of portfolo rsk vs. the benchmark TEV s the projected standard devaton of the return dfference between the portfolo and the benchmark It s calculated based on dfferences between portfolo and benchmark exposures to rsk factors from several categores 23

24 Example Rsk Report: Factor Exposures What s the portfolo s senstvty to rsk factors? For each market rsk factor, there s a contrbuton to trackng error: TE mpact of rsk factor = Net exposure x Factor volatlty The overall TEV of the portfolo consders correlatons among factors as well as ther volatltes Modelng can be very specfc: for example, yeld curve exposures are modeled by key rate duratons along the curve, not just a sngle duraton 24

25 Performance Attrbuton Explan portfolo outperformance relatve to the benchmark n terms of manager decsons: Postonng along the yeld curve (duraton, etc.) Sector allocaton Securty selecton Answers two types of questons: Assume portfolo earns benchmark returns n each rsk sub-category. What outperformance results from weght dfferences alone? Portfolo return dffers from benchmark return wthn the most narrowly defned cell. What outperformance results from ths dfference n securty selecton? 25

26 26 ascs of Performance Attrbuton ( ) ( ) ( ) ( ) + = + = + = = = P P P P P P P P P P P P P r r w r w w r r w r w r w r w r w R R r w R r w R Securty selecton Securty selecton Allocaton Allocaton ( ) P w w ( ) R r sector overweght sector outperf vs. ndex

27 Index Replcaton A portfolo of 50 corporate bonds can replcate a corporate ndex of 3,000+ securtes wth a TEV (Trackng Error Volatlty) of 15 bp/month A portfolo of TA securtes can replcate the MS ndex of 360+ securtes wth a trackng error of 4 bp/month RI SM (Replcatng ond Index) baskets of lqud dervatves (Treasury futures, nterest rate swaps, CDX/Traxx & FX forwards) can replcate the Global Aggregate Index of 11,000+ securtes wth a TEV of 5 bp/month RI s a servce mark of Lehman rothers, patent pendng 27

28 Concluson enchmarks provde an objectve way to measure portfolo performance enchmarks can be customzed to ft almost any mandate enchmark selecton shfts the strategc asset allocaton decson from the portfolo manager to the plan sponsor enchmarkng changes the framework for measurng rsk: Actve rsk nstead of absolute rsk Measured by trackng error volatlty (TEV) Keep track of net exposures vs. the benchmark Index replcaton technques can help buld portable alpha strateges desgned to outperform a desred benchmark 28

29 Analyst CertfcatonThe vews expressed n ths report accurately reflect the personal vews of Lev Dynkn, the prmary analysts responsble for ths report, about the subject securtes or ssuers referred to heren, and no part of such analyst's compensaton was, s or wll be drectly or ndrectly related to the specfc recommendatons or vews expressed heren. Important DsclosuresLehman rothers Inc. and/or an afflate thereof (the "frm") regularly trades, generally deals as prncpal and generally provdes lqudty (as market maker or otherwse) n the debt securtes that are the subject of ths research report (and related dervatves thereof). The frm's propretary tradng accounts may have ether a long and / or short poston n such securtes and / or dervatve nstruments, whch may pose a conflct wth the nterests of nvestng customers.where permtted and subject to approprate nformaton barrer restrctons, the frm's fxed ncome research analysts regularly nteract wth ts tradng desk personnel to determne current prces of fxed ncome securtes.the frm's fxed ncome research analyst(s) receve compensaton based on varous factors ncludng, but not lmted to, the qualty of ther work, the overall performance of the frm (ncludng the proftablty of the nvestment bankng department), the proftablty and revenues of the Fxed Income Dvson and the outstandng prncpal amount and tradng value of, the proftablty of, and the potental nterest of the frms nvestng clents n research wth respect to, the asset class covered by the analyst. Lehman rothers generally does and seeks to do nvestment bankng and other busness wth the companes dscussed n ts research reports. As a result, nvestors should be aware that the frm may have a conflct of nterest.to the extent that any hstorcal prcng nformaton was obtaned from Lehman rothers' tradng desks, the frm makes no representaton that t s accurate or complete. All levels, prces and spreads are hstorcal and do not represent current market levels, prces or spreads, some or all of whch may have changed snce the publcaton of ths document.lehman rothers' global polcy for managng conflcts of nterest n connecton wth nvestment research s avalable at obtan copes of fxed ncome research reports publshed by Lehman rothers please contact Valere Monch (vmonch@lehman.com; ) or clents may go to. Legal DsclamerThs materal has been prepared and/or ssued by Lehman rothers Inc., member SIPC, and/or one of ts afflates ("Lehman rothers"). Lehman rothers Inc. accepts responsblty for the content of ths materal n connecton wth ts dstrbuton n the Unted States. Ths materal has been approved by Lehman rothers Internatonal (Europe), authorsed and regulated by the Fnancal Servces Authorty, n connecton wth ts dstrbuton n the European Economc Area. Ths materal s dstrbuted n Japan by Lehman rothers Japan Inc., and n Hong Kong by Lehman rothers Asa Lmted. Ths materal s dstrbuted n Australa by Lehman rothers Australa Pty Lmted, and n Sngapore by Lehman rothers Inc., Sngapore ranch ("LIS"). Where ths materal s dstrbuted by LIS, please note that t s ntended for general crculaton only and the recommendatons contaned heren do not take nto account the specfc nvestment objectves, fnancal stuaton or partcular needs of any partcular person. An nvestor should consult hs Lehman rothers' representatve regardng the sutablty of the product and take nto account hs specfc nvestment objectves, fnancal stuaton or partcular needs before he makes a commtment to purchase the nvestment product. Ths materal s dstrbuted n Korea by Lehman rothers Internatonal (Europe) Seoul ranch. Any U.S. person who receves ths materal and places an order as result of nformaton contaned heren should do so only through Lehman rothers Inc. Ths document s for nformaton purposes only and t should not be regarded as an offer to sell or as a solctaton of an offer to buy the securtes or other nstruments mentoned n t. No part of ths document may be reproduced n any manner wthout the wrtten permsson of Lehman rothers. Wth excepton of the dsclosures relatng to Lehman rothers, ths report s based on current publc nformaton that Lehman rothers consders relable, but we do not represent that ths nformaton, ncludng any thrd party nformaton, s accurate or complete and t should not be reled upon as such. It s provded wth the understandng that Lehman rothers s not actng n a fducary capacty. Opnons expressed heren reflect the opnon of Lehman rothers' Fxed Income Research Department and are subject to change wthout notce. The products mentoned n ths document may not be elgble for sale n some states or countres, and they may not be sutable for all types of nvestors. If an nvestor has any doubts about product sutablty, he should consult hs Lehman rothers representatve. The value of and the ncome produced by products may fluctuate, so that an nvestor may get back less than he nvested. Value and ncome may be adversely affected by exchange rates, nterest rates, or other factors. Past performance s not necessarly ndcatve of future results. If a product s ncome producng, part of the captal nvested may be used to pay that ncome. Lehman rothers may, from tme to tme, perform nvestment bankng or other servces for, or solct nvestment bankng or other busness from any company mentoned n ths document. No part of ths document may be reproduced n any manner wthout the wrtten permsson of Lehman rothers Lehman rothers. All rghts reserved. Addtonal nformaton s avalable on request. Please contact a Lehman rothers' entty n your home jursdcton. 29