Decision-Driven Fixed Income Attribution

Research

Decision-Driven Fixed Income Attribution

- Match Attribution with Investment Decision-Making Process

October 2012

Pam (Yanqiu) Zhong

+44 (0)20 3134 7577

[email protected] Director,

Agenda



Why

we need attribution matches with decision-making process



How

to align attribution with decision-making process

Why

FI attribution should match with

investment process

Fixed-Income Attribution Challenges



Data volume and complexity



Analysis must be accurate and on time



Multiple process within fixed-income investing



There is no “typical process”



Credit and Government management may require different approaches



Complex derivatives instruments



Pricing challenges

The Fixed-Income Investment Process

Source John Simpson, PMAR Europe 2011

Allocation to

Different Currencies

First Decision:

Duration / Yield

Curve Positioning

Second Decision:

Allocation into

sectors / buckets

Third Decision:

Select the bonds

Fourth Decision:

Each market represented as a separate currency

Currency hedging strategies may be used

Local interest-rate and inflation may affect yield curve and

currency rates

By market

Overall duration position based on manager’s view of

future curve movement

Curve positioning, barbell, butterfly etc.

Sectors

Issuer / Credit Quality

Market-value overweight vs. spread duration overweight

The Implication for Fixed-Income Attribution

Allocation to

Different Currencies

First Decision:

Duration / Yield

Curve Positioning

Second Decision:

Allocation into

sectors / buckets

Third Decision:

Select the bonds

Fourth Decision:

Top-level Allocation

Yield Curve Model

Local Allocation

Partition + Weighting

Currencies

Partition Buckets

Yes

No

Global

Local



Duration



Curve



Convexity & Rest

Total Return

Spread Return

Excess Return

Credit Ticker

Issue

How

to Align attribution with

investment process

A Flexible Fixed-Income Performance Attribution Approach

1) Return splitting

2) Common factors outperformance attribution

3) Excess return attribution into sector allocation and sector management

4) Recursive application of the algorithm to excess return management of each sector

Four-Step Recursive Process

…

Bucket 1

Bucket N

Total

Outperformance

Bucket 2

Excess Return

Sector Allocation

Common

Factors

Excess Return

Sector Management

Step 1 – Return Splitting

Total Return

Intra-Day FX Curve Volatility Spread Mortgage Residual Derivatives Basis Curve Carry Curve Change Spread Carry Spread Duration Spread Convexity Inflation



Total Return is split into a list of factor returns per security on a daily basis

Step 2 – Common Factor Attribution

Flexible Currency Attribution

Outperformance

Local

Return

Attribution

FX Return

Attribution

Outperformance due

to weighting

difference in a local

market and the

performance of this

market in the

benchmark relative to

the overall benchmark

Outperformance

due to return

advantage of the

portfolio over the

benchmark within

a local market

Out-performance due to

the weighting difference

in a currency and the FX

return plus the excess of

local deposit over base

deposit (risk premium).

Any hedging

out-performance is also

included here.



Detailed FX Outperformance Breakdown



Unhedged FX allocation



Hedged FX allocation



FX/Local cross-term



Funding cost advantage



Hedging effects



Flexible Reporting



By currency



By any partition



By instrument



FX Hedging Treatment



FX spot, forwards, swaps and options

Step 2 – Common Factor Attribution (Continued)

Flexible Yield Curve Attribution



Curve Return (Outperformance) = Curve Carry + Curve Change



Curve Change decomposition



Parallel (Duration)



Key Rates (Curve)



Convexity & Rest of Curve



Flexible Curve Attribution Considerations



Choice of base curve – Govt or Swap



Swap spread attribution



Reference yield change



Multi-currency curve attribution

Step 3 – Flexible Excess Return Attribution

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Flexible Excess Return Attribution



Excess return

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

Weights

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

Option to use or not use hurdle rate

h

Step 4 – Recursive Attribution

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Top-Down

Asset Allocation

Common Factors

Security Selection

Allocated Factors

Case Study

Source: POINT®, Barclays Research



Portfolio

: Euro-based portfolio with currency overlay and exposures to other currency

markets

First Decision – Top-Level Allocation

Top-Level <> Currencies

Top-Level = Currencies

Local Outperf.

-146.7

Local

Management

Local Markets

Allocation

USD

EUR

USD

EUR

Yield Curve Asset Allocation Security Selection …….

Excess

Return

Attribution

Asset

Allocation

Security

Selection

Intra-day

Yield Curve

……

Local Outperf.

-146.7

The Second Decision – Curve Attribution

GLOBAL Curve Attribution

Notes: Partial report only.

Carry: -4.1bp

Duration: -23.9bp

Curve: 29.2bp

Curve Outperf.

-15.2

Global Curve

wrt. EUR

USD

10.5

JPY

-29.2

Local

Curve Advantage

…

The Second Decision – Curve Attribution (Continued)

LOCAL

Curve Attribution

Notes: Partial report only.

CHF -19.9

Carry: -1.7bp

Duration: -17.9bp

Curve: -0.2bp

Curve Outperf.

-15.2

EUR

.…..

Carry: -4.4bp

Duration: -14.5bp

Curve: 22.7bp

Rest & Convx: -0.3bp

The Third Decision – Allocation into Sectors

Excess of

Curve Attribution

The Third Decision – Allocation into Sectors (Continued)

Spread Return

Attribution

Conclusion: Match Attribution With Investment Process

Is currency markets

allocation critical?

Top-level Allocation

Currencies

Top-level Allocation

Partition Buckets

Local Allocation

Total Return

Excess Return

Spread Return

Is yield curve

managed globally?

Curve Attribution

Global Curve

Curve Attribution

Local Curve

No

Yes

Yes

No

No

Yes

Is the portfolio

multi-currency?

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