Fixed Income Performance Attribution Mary Cait McCarthy August 2014
Content 1 2 3 4 5 6 What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August 2014 2
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 2014 3
Content 1 2 3 4 5 6 What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August 2014 4
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 2014 5
Content 1 2 3 4 5 6 What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August 2014 6
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 2014 7
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 2014 8
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 4 3 2 1 0 Yield Curves Yield Curves 31.08.2011 Yield (%) 30.09.2011 Yield (%) 0.25 0.5 1 2 3 4 5 7 10 15 20 25 30 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% 1.5 31.12.2013 14.40 0.75 15.12.2013 17.41 2 30.11.2013 17.95 Subtotal 49.76 >10 Years to Maturity US 6.750% 30YR BOND US 6.500% 30YR BOND US 6.000% 30YR BOND 6.75 15.08.2026 14.07 6.5 15.11.2026 17.09 6 15.02.2026 19.08 Subtotal 50.24 August 2014 9
Content 1 2 3 4 5 6 What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August 2014 10
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 2014 11
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 49.76-0.19 85.31 0.33 0.46-0.26 0.20 50.24 4.53 14.69 9.16 2.68-2.33 0.35 Total 100.00 2.18 100.00 1.63 3.14-2.58 0.55 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 2014 12
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 49.76 2.25-0.19 85.31 4.10 0.33-0.07 0.46-0.18 0.20 50.24 10.25 4.53 14.69 13.58 9.16-1.13 2.68-1.20 0.35 Total 100.00 6.27 2.18 100.00 5.49 1.63-1.20 3.14-1.38 0.55 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 0.33 4.10 0.08 9.16 13.58 0.67 Total 1.63 5.49 0.30 August 2014 13
Content 1 2 3 4 5 6 What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August 2014 14
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 2014 15
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 2014 16
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 2014 17
0.25 0.5 1 2 3 4 5 7 10 15 20 25 30 5 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 0.15 0 Yield Curves Change (%) (%) 0.02 0.04 0.04 0.1 0.11 0.06 0.01-0.11 r s, t e i s, i, t i, t E t D t -0.15-0.3-0.36-0.45-0.6-0.75-0.9-0.49-0.61-0.78-0.89 Security Returns and Exposures (Duration) Measured Returns to Shifts Estimated August 2014 18
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 1.5 1.5 31.12.2013 14.40 0.12 0.50-0.79 0.11-0.40-0.23-0.06 USA TREASURY NTS 0.7 0.75 15.12.2013 17.41 0.06 0.50-0.76 0.11-0.37-0.23-0.03 USA TREASURY BDS 2% 2 30.11.2013 17.95 0.16 0.48-0.84 0.11-0.47-0.22-0.14 Subtotal 1.411 49.76 0.06 0.25-0.40 0.06-0.21-0.11-0.04 >10 US 6.750% 30YR BOND 6.75 15.08.2026 14.07 0.37 2.25 1.89 0.51 3.63 5.01-0.87 US 6.500% 30YR BOND 6.5 15.11.2026 17.09 0.36 2.27 1.96 0.52 3.72 5.05-0.82 US 6.000% 30YR BOND 6 15.02.2026 19.08 0.36 2.25 1.90 0.51 3.64 5.01-0.86 Subtotal 6.37 50.24 0.18 1.13 0.96 0.26 1.84 2.52-0.43 Total 0.24 1.38 0.57 0.31 1.63 2.41-0.47 August 2014 19
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 49.76 2.25-0.19 85.31 4.10 0.33-0.11-0.52 0.26-0.37 50.24 10.25 4.53 14.69 13.58 9.16 0.13 0.69 0.10 0.93 Total 100.00 6.27 2.18 100.00 5.49 1.63 0.02 0.17 0.36 0.55 August 2014 20
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 49.76 2.25-0.19 85.31 4.10 0.33-0.11-1.04 0.78-0.37 50.24 10.25 4.53 14.69 13.58 9.16 0.13 1.38-0.58 0.93 Total 100.00 6.27 2.18 100.00 5.49 1.63 0.02 0.34 0.19 0.55 August 2014 21
Content 1 2 3 4 5 6 What is Performance Attribution? Uses of Performance Attribution Drivers of Return in Fixed Income Returns Based Attribution Factor Based Attribution Successive Revaluation August 2014 22
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 2014 23
Contacts Do you have questions? We look forward to hearing from you Mary Cait McCarthy, CFA, FRM Head Investment Reporting Credit Suisse Zurich: +41 44 332 95 02 E-mail: mary.c.mccarthy@credit-suisse.com August 2014 24
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