Private Wealth Management- Performance Attribution Approach, Methodology, Features & Benefits

Private Wealth Management- Performance Attribution Approach, Methodology, Features & Benefits

Introduction Investors expect active fund managers to beat the benchmark all the time. In a competitive environment today, asset managers need to fulfill the demands of the investors with minimized risks. While the fund managers are in the pursuit of achieving these objectives, some times the markets do not behave managers expected them to behave. May be for better or may be for worse. It is important for the fund managers to know the reasons for such deviations to take corrective actions. Performance Attribution is a technique which helps to understand the causes for such deviations. The excess return (positive or negative) is explained through Sector allocation and Security selection strategies for the Equity portfolio. For the debt portfolio the same is explained primarily through Duration and Credit calls of the fund managers. CRISIL Irevna s Approach Equity Attribution CRISIL Irevna employs Brinson- Fachler approach for performing Attribution analysis. This is a Top- down approach to such analysis. The model rewards or penalizes action by the active fund manager s depending upon his allocation to out-performers or under-performers. The following diagram explains the analysis in a nutshell. Sector / security returns in Portfolio vs Benchmark Positive Negative Sector / security allocation in Portfolio vs Benchmark Overweight Underweight +ve Outperformance -ve Underperformance - Review allocation / selection -ve Underperformance - Review allocation / selection +ve Outperformance Private Wealth Management Performance Attribution, Approach, Methodology, Features & Benefits 2

Active fund managers actions are judged on two parameters 1) Sector Allocation 2) Security Selection skills. 1) Sector Allocation The approach first identifies whether a specific sector is an outperforming or under-performing sectors within a benchmark. The returns of the sectors in the benchmark are compared against total benchmark return. Then the next test is that whether the fund manager is over-weighted or under-weighted on such out-performing or under-performing sectors. Fund manager is rewarded for - Over-weighing on an out-performing sector & Under-weighing under-performing sectors. Similarly penalized for - Over-weighing on an under-performing sector & Under-weighing out-performing sectors. Sector Level Attribution - Allocation effect reflects the payoffs for allocation strategies of the Fund Manager, whereas Selection effect reflects the Security selection skills. The sectors circled in green are the ones with positive contribution & the one circled with red are draggers. Private Wealth Management Performance Attribution, Approach, Methodology, Features & Benefits 3

Mathematically speaking Allocation Effect = (Rsb- Rb)*(Wps-Wbs) Where Rsb Return of the sector in Benchmark, Rb Return of overall Benchmark. Wps Portfolio weight in the sector, Wbs Benchmark weight in the sector. 2) Security Selection Selection skills are judged on the basis of securities picked up by the active fund manager and allocation made to such securities within the sector. The approach first identifies whether a security is an out-performing or underperforming sectors within a benchmark sector. The returns of the security in the benchmark are compared against total benchmark sector returns. Then the next test is that whether the fund manager is over-weighted or under-weighted on such outperforming or under-performing security. Fund manager is rewarded for - Overweighing on an out-performing security & Under-weighing under-performing security. Similarly penalized for - Over-weighing on an under-performing security & Underweighing out-performing security. Private Wealth Management Performance Attribution, Approach, Methodology, Features & Benefits 4

Decision support reports Mathematically speaking Selection Effect = (Rscb- Rsb)*(Wpsc-Wbsc) Where Rsb Return of the sector in Benchmark, Rscb Return of the security. Wpsc Portfolio weight in the security, Wbsc Benchmark weight in the security. Allocation and Selection effects explain the excess or underperformance of the Fund managers portfolio vis-à-vis a benchmark portfolio. Private Wealth Management Performance Attribution, Approach, Methodology, Features & Benefits 5

Debt Attribution Fixed income fund manager earns returns from different factors as compared to the factors those of Equity fund managers. Allocation to sectors and Selection of stocks are not the factors which drive debt fund manager s investment decisions. The debt fund manager is concerned primarily with duration and credit risk involved. Hence any good debt attribution model applied should consider these two factors while performing the analysis. CRISIL Irevna employs a factor based approach for conducting a debt attribution. The excess return is decomposed at Duration effect, Spread effect and the residual is distributed amongst Allocation & Selection effect. Computational method - Excess return - The excess return is computed based on weighted average return of each bond in the benchmark and fund portfolio. Bond return - Bond level return is calculated by summing up price return and accrued interest return. Duration effect Yield differential between two periods multiplied by duration of the bond. Spread effect - Spread (of bond over benchmark government securities) differential between two periods multiplied by duration of the bond. Features of CRISIL Irevna s Performance Attribution tool (CRISIL Xpert) Equity and Fixed Income Multiperiod Performance Attribution Asset level attribution for Hybrid portfolios. Simulation features to assume constant portfolios forward or backward. Concentration and Contribution analysis through graphs and diagrammes. Relevant Risk Ratios. Time charts for Security performance. Management summary reports highlighting Sectors/Stocks with significant Private Wealth Management Performance Attribution, Approach, Methodology, Features & Benefits 6

Benefits For Asset Management Companies a) CRISIL Xpert facilitates constant monitoring of portfolio performance vis-à-vis benchmarks. Identifies causes and assists in the process of corrective action. b) Fund managers can compare own portfolios to Peer group to understand better picture of market dynamics. c) MIS reports help identifying Sectors and Securities which need attention. d) Helps identify Risk factors through concentration analysis or Risk ratios, thus assists the process of Risk management. For Distributors a) Provides a scientific explanation to deviations between various Funds and their benchmarks. b) Helps judge skills of the fund manager in a better manner so as to provide well informed advice to own clients. Private Wealth Management Performance Attribution, Approach, Methodology, Features & Benefits 7