Fundamentals of Performance

Measurement

Module #3: Performance Attribution

John D. Simpson, CIPM
Copyright © The Spaulding Group, Inc. 2018 1

Background on …
◼ The Instructor
http://www.spauldinggrp.com/john-simpson/
◼ The Spaulding Group

1
 The Spaulding Group, Inc. is the leading provider of
performance and risk measurement products and services
to the investment industry. It is the fastest growing GIPS
verification firm, hosts the annual PMAR conferences and
Performance Measurement Forum and Asset Owners’
Roundtable, provides consulting services (which include
operations reviews and software certifications), publishes
The Journal of Performance Measurement® and the
Spaulding Series of books, and conducts training classes,
both open enrollment and in-house, which can be
customized to meet our client’s needs.

What we’ll cover

Day 1

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 What we’ll cover
Topics
• Day
Brief 1
introduction
• Absolute attribution (contribution)
• Equity attribution
• Fixed income attribution
• Currency attribution
• Geometric vs. arithmetic attribution
• Multiperiod attribution
• Other topics…

But first… make sure you have a

calculator or Excel handy…

◼ In general, assigning responsibility for some

result
◼ Identifying the cause(s)

3
 Attribution
(Where did the
return come from?)

Fundamentals
What is attribution?

◼ In general, assigning responsibility for some

result
◼ Identifying the cause(s)

4
 Performance Attribution

◼ The act of attributing an event to its

underlying cause(s); determining what
action(s) contributed to an event
◼ A technique to quantify the excess returns of
a portfolio against its benchmark into
conscious decisions of the investment
management process
◼ Answers the why and where questions

Performance Attribution Analysis

The process of
attributing the
actual portfolio
return to those
investment
management
activities that
contributed to the
return.

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5
 Gary Brinson (pictured),
Randolph Hood,
Gil Beebower
“Performance
Attribution,
while not new,
is still an
evolving
discipline.”
FAJ, July/Aug 1986

11

What does a
boxer do
before going
into the
ring?

12

6
 “When
“When I’m
preparing
preparing for for aa
fight,
fight, II look
look at at
two
two things.
things. First,
First, II
look
look atat my
my guy’s
guy’s
weaknesses
weaknesses and and
figure
figure out
out how how toto
exploit
exploit them.
them.
Steve “2 Pound” Forbes Second,
Second, II looklook atat
Former IBF Titleholder his
his strengths
strengths and and
Contestant on The
Contender
make
make suresure II
Men’s Health. (November respect
respect them.”
them.”
2006: 84)

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For example:

14

7
 An investment
manager can do the
same thing
◼ The “opponent” is the
benchmark
◼ Identify the strengths and
weaknesses
◼ Develop a strategy to win
◼ Then, evaluate (via attribution)
what worked, what didn’t

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Equity
^

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 The “top down”
approach

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The Top-Down Approach

Economic Data
Also, Political & World Data
(CPI, Unemployment Stats,
(Candidate polls, world events)
Production Figures, Interest Rate)

18

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 The Top-Down Approach (cont’d)
Economic Data Also, Political & World Data
(CPI, Unemployment Stats, (Politics, world events)
Production Figures Interest Rates)

19

An example of how politics

can influence the markets

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 The Top-Down Approach (cont’d)
Economic Data Also, Political & World Data
(CPI, Unemployment Stats, (Politics, world events)
Production Figures Interest Rates)

Predict the impact on Index Allocation

Industry Sectors (observe the weights Decision/Strategy
(which sectors will benefit, of each sector) (which sectors to overweight,
which will suffer) which to underweight)

We will want to
Security Selection assess the
Decisions / Strategy
Allocation decisions
Selection decisions

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The “Bottom
Up” Approach

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 The Bottom-up Approach
Even though a manager may not have made
conscious allocation decisions, can’t there be a
benefit to review the allocation effects? Won’t it
provide additional insights? It still constitutes a
source of return and needs to be recognized!

Industry Allocation
results from stock selection

We will want to
Begins with
Stock Selection
assess the
selection decision

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Is it possible to beat every sector

and still under perform the index?
Returns Sum of Apparently, it
Basic Mat'ls
Portfolio Index Differences
0.25% 0.15% 0.10%
is…
Industrials 1.02% 0.51% 0.51% but how is this
Cons Cyc
Utilities
1.05% 1.04%
-0.71% -0.78%
0.01%
0.07%
possible?
Energy 2.08% 2.04% 0.04%
Fin'l -0.20% -0.36% 0.16%
Healthcare 0.84% 0.79% 0.05%
Technology 0.56% 0.54% 0.02%
Telecom -0.19% -0.21% 0.02%
Cons, Non-Cyc -0.50% -0.52% 0.02%
Portfolio 0.23% 0.46% 1.00%

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 From asset allocation

Port Index Port Index Excess Active Value

Sector Return Return Weight Weight Return Weight Added
Basic Materials 0.25% 0.15% 13% 9% -0.31% 4% No
Industrials 1.02% 0.51% 13% 10% 0.05% 3% Yes
Cons Cyc 1.05% 1.04% 4% 13% 0.58% -9% No
Utilities -0.71% -0.78% 12% 9% -1.24% 3% No
Energy 2.08% 2.04% 5% 13% 1.58% -8% No
Financial -0.20% -0.36% 13% 8% -0.82% 5% No
Healthcare 0.84% 0.79% 6% 11% 0.33% -5% No
Technology 0.56% 0.54% 11% 11% 0.08% 0% No
Telecom -0.19% -0.21% 12% 9% -0.67% 3% No
Cons Non-Cyc -0.50% -0.52% 11% 7% -0.98% 4% No
Total 0.23% 0.46% 100% 100%

So, doesn’t it make sense to look at the

impact of the asset allocation “decisions” on
the return?
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The many approaches to attribution

Relative or Arithmetic vs.

Absolute Geometric
(Contribution)
Time- vs.
Attribution Money-weighted
Transaction
Daily or or Holdings-
Monthly based

How handle Security-level

interaction? Which attribution vs. Sector-level
model? Which linking
model?

A lot to consider
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13
 Relative vs. absolute attribution:
what we look at

Excess
Return
Returns

Return
Total
Return

Relative Attribution Absolute Attribution

Portfolio Index Portfolio

Where did the excess Where did the total
return come from? return come from?
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Performance Attribution Identifies

the Sources of the Active Returns
Equity Attribution Effects

• Allocation: What was the effect of over- /

underweighting the various sectors?

How well did the manager choose the

• Selection: various securities relative to the
benchmark?

How did the allocation across different

• Currency: currencies benefit performance?

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14
 ATTRIBUTION
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Absolute Attribution
a.k.a. Contribution
A process to assess how individual
securities, sectors, asset classes,
strategies, etc. contribute to the return

◼ Contribution = Weight * Return

◼ Weight = the relative market value
VBi
Weight i = n

V
i =1
Bi

(C) The Spaulding Group 2019 30

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 Security Level: How has each security
contributed to the return?
Security ROR
A 2%
B 2%
C -1%
D 2%
E 2%
F -1%
G 2%
H -2%
I 3%
J 141%
Portfolio 22.28%

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Security Contribution

Security ROR Weight Contribution

A 2% 8% 0.16%
B 2% 8% 0.16%
C -1% 4% -0.04%
D 2% 15% 0.30%
E 2% 7% 0.14%
F -1% 9% -0.09%
G 2% 12% 0.24%
H -2% 8% -0.16%
I 3% 14% 0.42%
J 141% 15% 21.15%
Portfolio 22.28% 100% 22.28%

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 Contribution of not having a
benchmark stock
◼ (Portfolio Total ROR - Security ROR) *
Security Weight in index
◼ Example: IBM in index; not in portfolio
◼ 5% of benchmark
◼ 0% of portfolio
◼ ROR of IBM = 8%
◼ Overall Portfolio ROR = 6%
Contribution = (6%-8%)*0.05 = -0.1%
◼ Might the use of the benchmark’s
sector return be a better gauge?

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Segment Level Contribution

Sector ROR Weight Contribution
Basic Mat'ls 0.25% 10% 0.03%
Industrials 0.50% 11% 0.06%
Cons Cyc 1.00% 8% 0.08%
Utilities -0.80% 12% -0.10%
Energy 2.00% 7% 0.14%
Fin'l -0.30% 6% -0.02%
Healthcare 0.80% 15% 0.12%
Technology 0.60% 9% 0.05%
Telecom -0.20% 13% -0.03%
Cons, Non-Cyc -0.50% 9% -0.05%
0.29% 100% 0.29%
Note: sum of contributions = ROR; our goal

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 Another example: We have a residual (total
contribution ≠ ROR)
Security ROR Weight Contribution
A 1.50% 11% 0.17%
B 1.82% 12% 0.22%
C 2.08% 1% 0.03%
D 0.53% 2% 0.01%
E 3.36% 22% 0.74%
F -1.15% 1% -0.02%
G -0.30% 11% -0.03%
H 1.00% 20% 0.20%
I 0.20% 7% 0.01%
Cash 1.26% 13% 0.16%
1.43% 100% 1.49%

Why? Because of monthly activity

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A way to improve the accuracy

(to reduce or eliminate the residual)
◼ Previous formula assumes buy-and-hold
A holdings-based approach to contribution
◼ We can improve by taking into consideration
the intra-period cash flows:
BMV + Weighted Flows will improve accuracy
◼ This would be a transaction-based approach
to contribution
Transaction-based attribution

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 Day-Weighting Factor
End-of-day Start-of-day*
CD − Di CD − Di + 1
Wi = Wi =
CD CD

Cash flow on 3rd day of a 31-day month:

31 − 3 28 31 − 3 + 1 29
Wi = = = .9032 = 90.32% Wi = = = .9355 = 9355%
.
31 31 31 31

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Enhanced Contribution
Contribution = (Weight + Weighted Flows) * Return

Security ROR BMV CF Amt CF Day CF Wt Wtd Flow EMV Wt % Contrib

A 1.50%11,000 11,165 11.00% 0.17%
B 1.82%12,000 3,000 3 0.94 2,806.45 15,270 14.81% 0.27%
C 2.08% 1,200 1,225 1.20% 0.03%
D 0.53% 1,500 1,508 1.50% 0.01%
E 3.36%22,000 -3,500 3 0.94 -3,274.19 19,130 18.73% 0.63%
F -1.15% 1,300 1,285 1.30% -0.02%
G -0.30%11,000 10,967 11.00% -0.03%
H 1.00%20,000 2,000 8 0.77 1,548.39 22,215 21.55% 0.22%
I 0.20% 7,000 7,014 7.00% 0.01%
1.26%13,000 -2,000 8 0.77 -1,548.39 11,650 11.92% 0.15%
Cash 500 3 0.94 467.74
Portfolio 1.43% 100,000 101,429 100.00% 1.43%

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 Advantages of Contribution
◼ The math is quite simple
◼ Easy to comprehend
◼ Easy to explain
◼ Often, it’s what managers initially mean
when they say they want attribution
◼ Usually, we look at the top 5 or top 10, and
bottom 5 or bottom 10 holdings
◼ Could also calculate for the index

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Other ways we see contribution used

◼ “Macro” attribution:
◼ A technique available to plan sponsors to assess
the sources of return
◼ Fixed income attribution:
◼ Common approach (although not universal) to
approach attribution (begin w/contribution
effects of portfolio + benchmark, and then
compare to derive attribution effects)
◼ Hedge funds:
◼ Hedge funds typically “absolute” investments

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 Relative Attribution:
Attribution vs. Benchmark
◼ Applicable to active
managers; not passive
◼ What can a manager
do, relative to the
benchmark?
◼ Vary asset allocation
◼ Vary individual security
allocations
◼ Pick different securities

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Determine the effect of

the manager’s decisions

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 Determine the effect of the
manager’s decisions

◼ Changes in security/weights
◼ Changes in sector allocations/weights
◼ Changes in allocations/weights across
different countries / currencies

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The First “Law” of

Performance Attribution

The attribution model chosen

should represent
the management approach

44

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 Can model selection make a
difference?

YES!

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Equity Attribution Terms

Selection

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 The manager’s
decision to
allocate assets
differently than
the benchmark
by sector (or
other factor)
47

Selection
The manager’s
decision to pick
securities that
may or may not
outperform
those in the
benchmark
(within sector or
factor)

48

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 Interaction
The overlap that naturally occurs between
the allocation & selection decisions

It measures the impact of the allocation decision

when the performance of the portfolio’s selected
securities differ from that of the benchmark
49

Attribution Formulas
◼ Different approaches
exist
◼ Many firms use
standard, published
models, some use
variations on these,
while others use
custom approaches

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 The Second Law
of Performance Attribution
The sum of the attribution effects
should equal the excess return
n

 AE
i =1
i =

RP − RB
For geometric
models,
the product of
the effects
(C) The Spaulding Group 2019 51

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Equity Formula #1
(Variation of Brinson, Hood, Beebower)

Sector Allocation

Allocation = rBi  w Pi − wBi ( )

Stock selection
StockSelection = w Pi  rPi − rBi ( )
(C) The Spaulding Group 2019 52

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 How allocation decisions are treated by the
BHB model
Index =
Technology = +2%
+4%
BHB =
BHB BF
Allocation
Overweight Positive Negative
( )
n
Underweight Negative  rBi  w Pi − wBi
Positive
i =1
Index =
Technology = -2%
-4%
Overweight Negative Positive
Underweight Positive Negative
(C) The Spaulding Group 2019 53

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Asset Allocation Signs

◼ If Index ROR is positive and we overweight?
◼ Positive; will contribute to the portfolio return
◼ If Index ROR is positive and we underweight?
◼ Negative; will detract from portfolio return
◼ If Index ROR is negative and we overweight
◼ Negative; will detract from portfolio return
◼ If Index ROR is negative and we underweight
◼ Positive; will contribute to the portfolio return

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 Attribution Example
ROR Weight Market Effects
Portfolio Index Portfolio Index Alloc’n
Stk Sel Ind Alloc
Cons 3.84% 3.75% 8% 6% 0.01% 0.08%
Ind -11.52% -14.00% 14% 9% 0.35% -0.70%
Trans 5.09% 5.21% 12% 11% -0.01% 0.05%
Util 6.57% 6.20% 7% 10% 0.03% -0.19%
Merch 8.30% 8.00% 15% 12% 0.05% 0.24%
Fin Svc 4.75% 4.50% 9% 8% 0.02% 0.05%
Banks -11.60% -12.00% 11% 12% 0.04% 0.12%
Cong 3.50% 3.10% 6% 9% 0.02% -0.09%
Tech 14.06% 10.11% 10% 13% 0.40% -0.30%
Telecom 6.85% 5.50% 8% 10% 0.11% -0.11%
Portfolio 2.33% 2.18% 100% 100% 1.00% -0.86%

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What if, our manager had been sector neutral?

ROR Weight Market Effects
Portfolio Index Portfolio Index Alloc’n
Stk Sel Ind Alloc
Cons 3.84% 3.75% 6% 6% 0.01% 0.00%
Ind -11.52% -14.00% 9% 9% 0.22% 0.00%
Trans 5.09% 5.21% 11% 11% -0.01% 0.00%
Util 6.57% 6.20% 10% 10% 0.04% 0.00%
Merch 8.30% 8.00% 12% 12% 0.04% 0.00%
Fin Svc 4.75% 4.50% 8% 8% 0.02% 0.00%
Banks -11.60% -12.00% 12% 12% 0.05% 0.00%
Cong 3.50% 3.10% 9% 9% 0.04% 0.00%
Tech 14.06% 10.11% 13% 13% 0.51% 0.00%
Telecom 6.85% 5.50% 10% 10% 0.14% 0.00%
Portfolio 3.22% 2.18% 100% 100% 1.04% 0.00%

A gain of almost 100 basis points!

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 Equity Formula #2:
Brinson, Hood & Beebower Method
Selection
Actual Passive
Actual
(IV) (II)
Actual Policy and
Portfolio Timing
Return Return
Timing
Passive

(III) (I)
Policy and Policy Return
Security Selection (Passive Portfolio
Return Benchmark)

57

Equity Formula #2:

Brinson, Hood & Beebower Method
Selection
Actual Passive
Actual

(IV) (II)
Actual Policy and
Portfolio Timing
Return Return
Timing
Passive

(III) (I)
Policy and Policy Return
Security Selection (Passive Portfolio
Return Benchmark)

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 Equity Formula #2:
Brinson, Hood & Beebower Method
Selection
Actual Passive
Actual
(IV) (II)
Actual Policy and
Portfolio Timing
Return Return
Timing
Passive

(III) (I)
Policy and Policy Return
Security Selection (Passive Portfolio
Return Benchmark)

59

Quadrant Meanings

◼ Quadrant I: Policy: the fund’s long-term asset

allocation plan. Fund’s benchmark return.
◼ Quadrant II: Policy and timing’s return effects. The
strategic decisions regarding the variation in asset
class weightings relative to the normal weight.
◼ Quadrant III: Policy and security selection returns.
The active selection of investments within an asset
class.
◼ Quadrant IV: The fund’s actual return.

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 BHB Quadrant Formulas
n

Quadrant I = w
i =1
Bi  rBi

n
Quadrant II = w
i =1
Pi  rBi
n
Quadrant III = w
i =1
Bi
 rPi
n
Quadrant IV = w
i =1
Pi  rPi

(C) The Spaulding Group 2019 61

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Calculating the BHB

Attribution Effects:
Due to allocation: II – I Due to stock selection: III–I
n n

 wBi  rPi −  wBi  rBi =

n n

w Pi  rBi −  wBi  rBi =

i =1 i =1 i =1 i =1

( )
n

r ( )
n

i =1
Bi  w Pi − wBi = Formula #1
w
i =1
Bi  rPi − rBi

Other: (interaction) Total: IV-I

IV-III-II+I

( ) ( )  (w ) ( )
n n
w Pi − wBi  rPi − rBi i Pi  rPi − wBi  rBi
i =1 i =1
(C) The Spaulding Group 2019 62

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 A word about interaction

63

It’s somewhat
controversial!
• What is it?
• Is it relevant?
• What does it means
• Is it an error?

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 Stock selection options

StockSelection = w Pi  rPi − rBi i ( )

StockSelection = wBi  rPi − rBi ( )

(C) The Spaulding Group 2019 65

65

Our Earlier Attribution Example

Using the BHB Variation

ROR Weight Market Effects

Portfolio Index Portfolio Index Stk Sel Alloc’n
Ind Alloc
Cons 3.84% 3.75% 8% 6% 0.01% 0.08%
Ind -11.52% -14.00% 14% 9% 0.35% -0.70%
Trans 5.09% 5.21% 12% 11% -0.01% 0.05%
Util 6.57% 6.20% 7% 10% 0.03% -0.19%
Merch 8.30% 8.00% 15% 12% 0.05% 0.24%
Fin Svc 4.75% 4.50% 9% 8% 0.02% 0.05%
Banks -11.60% -12.00% 11% 12% 0.04% 0.12%
Cong 3.50% 3.10% 6% 9% 0.02% -0.09%
Tech 14.06% 10.11% 10% 13% 0.40% -0.30%
Telecom 6.85% 5.50% 8% 10% 0.11% -0.11%
Portfolio 2.33% 2.18% 100% 100% 1.00% -0.86%

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 Applying the
Brinson, Hood & Beebower Model
ROR Weight Market Effects
Portfolio Index Portfolio Index Stk Sel Alloc’n
Ind Alloc Interaction
Cons 3.84% 3.75% 8% 6% 0.01% 0.08% 0.00%
Ind -11.52% -14.00% 14% 9% 0.22% -0.70% 0.12%
Trans 5.09% 5.21% 12% 11% -0.01% 0.05% 0.00%
Util 6.57% 6.20% 7% 10% 0.04% -0.19% -0.01%
Merch 8.30% 8.00% 15% 12% 0.04% 0.24% 0.01%
Fin Svc 4.75% 4.50% 9% 8% 0.02% 0.05% 0.00%
Banks -11.60% -12.00% 11% 12% 0.05% 0.12% 0.00%
Cong 3.50% 3.10% 6% 9% 0.04% -0.09% -0.01%
Tech 14.06% 10.11% 10% 13% 0.51% -0.30% -0.12%
Telecom 6.85% 5.50% 8% 10% 0.14% -0.11% -0.03%
Portfolio 2.33% 2.18% 100% 100% 1.04% -0.86% -0.04%

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Contrasting the Methods

BHB BHB Variation

Stk Sel Ind Alloc Interaction Alloc’n
Stk Sel Ind Alloc
Cons 0.01% 0.08% 0.00% 0.01% 0.08%
Ind 0.22% -0.70% 0.12% 0.35% -0.70%
Trans -0.01% 0.05% 0.00% -0.01% 0.05%
Util 0.04% -0.19% -0.01% 0.03% -0.19%
Merch 0.04% 0.24% 0.01% 0.05% 0.24%
Fin Svc 0.02% 0.05% 0.00% 0.02% 0.05%
Banks 0.05% 0.12% 0.00% 0.04% 0.12%
Cong 0.04% -0.09% -0.01% 0.02% -0.09%
Tech 0.51% -0.30% -0.12% 0.40% -0.30%
Telecom 0.14% -0.11% -0.03% 0.11% -0.11%
Portfolio 1.04% -0.86% -0.04% 1.00% -0.86%

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 Exercise:
Find the Attribution Effects for Banks only using
the BHB model
Rate of Return Weights
Portfolio Index Portfolio Index
Banks 2.00% 3.00% 40.00% 25.00%
Tech 3.00% 2.00% 20.00% 25.00%
Chem 4.00% 5.00% 30.00% 25.00%
Util 5.00% 4.00% 10.00% 25.00%
3.10% 3.50%

 ( wi − w i )
n

( )
n
StockSelection =  w i  ri − r i Allocation = r
i =1
i
i =1

 (w − wi )  (ri − r i )
n
Interaction(Other ) = i
i =1

69

Solution:
Attribution Effects – BHB Model

Effects
Allocation Stk Sel Interaction Total
Banks 0.450% -0.250% -0.150% 0.050%
Tech -0.100% 0.250% -0.050% 0.100%
Chem 0.250% -0.250% -0.050% -0.050%
Util -0.600% 0.250% -0.150% -0.500%
0.000% 0.000% -0.400% -0.400%

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 Equity Formula #3
Brinson/Fachler Model

Selection with interaction (same as the BHB model)

SelectionEffect = wBi  rPi − rBi ( )
( ) (
InteractionEffect = w Pi − wBi  rPi − rBi )
Selection without interaction (same as the BHB variation model)
SelectionEffect = w Pi  rPi − rBi( )
Allocation – the real difference with this model

(
AllocationEffect = rBi − RB  w Pi − wBi) ( )
(C) The Spaulding Group 2019 71

71

Key difference:
Allocation effect

Allocation BHB =
Relative return
( )
n

r
i =1
Bi  w Pi − wBi difference

Allocation BF =

 (r ) ( )
n

Bi − RB  w Pi − wBi
i =1
(C) The Spaulding Group 2019 72

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 Allocation BHB =
Key difference:
 r  (w − wi )
n

Allocation effect i i
i =1

Index =
Technology = +2%
+4%
BHB BF
Overweight Positive Negative
Underweight Negative Positive
Index =
Technology = -2%
-4%
Overweight Negative Positive
Underweight Positive Negative

73

Key difference: Allocation BF =

Allocation effect (r i − R)  ( wi − w i )

Index =
Technology = +2%
+4%
BHB BF
Overweight Positive Negative
Underweight Negative Positive
Index =
Technology = -2%
-4%
Overweight Negative Positive
Underweight Positive Negative

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 BF Model
Industry Selection Signs

◼ If Index ROR is positive and we overweight?

◼ Positive, if sector beats benchmark; otherwise, negative
◼ If Index ROR is positive and we underweight?
◼ Negative, if sector beats benchmark; otherwise, positive
◼ If Index ROR is negative and we overweight
◼ Negative, if sector beats benchmark; otherwise, positive
◼ If Index ROR is negative and we underweight
◼ Positive, if sector beats benchmark; otherwise, negative

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Questions to ask when comparing

BHB w/BF
◼ Which method better represents the manager’s
decisions?
◼ Is the manager making decisions to have a return > 0
◼ Or, are the decisions being made to beat the
benchmark?
◼ The BHB and its variation measure the sector
affect relative to zero; an “absolute” assessment
◼ While Brinson/Fachler measures relative to
benchmark

76

38
 A visual comparison:
BHB vs. BF
Banks Banks
Technology Technology
BF View:
Overweight if
Sector Return
Auto BHB View: Auto
> Index
Overweight if
BF View:
Sector Return > 0
Overweight if
Sector Return Telecom Telecom
3%
Telecom
> Index
Signs will flip
Fin'l Index Fin'l
Fin'l
Return
0% 0%
Signs will flip Cons Cyc Cons Cyc BF View:
- 3% Underweight if
Industrials Industrials Sector Return
BHB View: < Index
Healthcare Underweight if Healthcare
BF View: Sector Return < 0
Underweight if
Sector Return
< Index
Energy Energy

Utilities Utilities

Negative Index Return Positive Index Return

77

Exercise: Calculate the Allocation Effects,

using the BF and BHB Models
◼ Weight in portfolio 5%
◼ Weight in index 10%
◼ Return of Technology 6%
◼ Overall Index ROR 8%

( )
n
Allocation BHB =  rBi  w Pi − wBi
i =1

( ) ( )
n
Allocation BF =  rBi − RB  w Pi − wBi
i =1

(C) The Spaulding Group 2019 78

78

39
 ◼Weight in portfolio 5%
◼ Weight in index 10%
◼ Return of Technology 6%
◼ Overall Index ROR 8%
The Sector Allocation Effects
BHB Method: 6% C (5%-10%)=-0.30%
BF: (6%-8%) C (5%-10%) =+0.10%
A 40 bp swing, from negative to positive!!!
79

Applying the BF Model

to our portfolio
ROR Weight
Portfolio Index Portfolio Index Mkt Effect
A B C D Stk Sel Alloc’n
Ind Sel
Cons 3.84% 3.75% 8% 6% 0.01% 0.03%
Ind -11.52% -14% 14% 9% 0.35% -0.82%
Trans 5.09% 5.21% 12% 11% -0.01% 0.03%
Util 6.57% 6.20% 7% 10% 0.03% -0.12%
Merch 8.30% 8% 15% 12% 0.05% 0.17%
Fin Svc 4.75% 4.50% 9% 8% 0.02% 0.02%
Banks -11.60% -12% 11% 12% 0.04% 0.14%
Cong 3.50% 3.10% 6% 9% 0.02% -0.02%
Tech 14.06% 10.11% 10% 13% 0.40% -0.23%
Telecom 6.85% 5.50% 8% 10% 0.11% -0.06%
Portfolio 2.33% 2.18% 100% 100% 1.00% -0.86%

80

40
 Comparing the Allocation Effects
BHB BF
Cons 0.08% 0.03%
Ind -0.70% -0.82%
Trans 0.05% 0.03%
Util -0.19% -0.12%
Merch 0.24% 0.17%
Fin Svc 0.05% 0.02%
Banks 0.12% 0.14%
Cong -0.09% -0.02%
Tech -0.30% -0.23%
Telecom -0.11% -0.06%
Portfolio -0.86% -0.86%
Overall total the same; differences at each sector

81

82

41
 Fixed Income Attribution
Recall our first
Law of
Attribution:
The model you
use must match
the investment
approach

83

Fixed income investing

◼ Much of the decision process revolves
around allocation decisions
◼ Allocations along the yield curve (duration)
◼ Allocations across sectors (bond types:
corporates, governments, municipals, etc.)
◼ Allocations across risk levels (ratings)

84

42
 The Investment management process
Fixed income managers anticipate:
◼ Interest rate movement (yield Yield Curve

curve changes) and impact on:

8.00%
7.00%
6.00%
Treas T0
5.00%

◼ Shift:
Treas T1
4.00%
3.00%
2.00%

General interest rate movement

1.00%
0.00%
◼

◼ Changes in the shape of the Yield Curve

curve 8.00%
7.00%
6.00%
Treas T0

Different Maturity Banding

5.00%
Treas T1
◼
4.00%
3.00%

fluctuates differently 2.00%

1.00%
0.00%

◼ Credit spread changes

◼ Spread across different credit 8.00%
7.00%
6.00%

ratings
Treas T0
5.00%
Treas T1
4.00%
Corp T0

Bond specific changes

3.00% Corp T1
2.00%

◼ 1.00%
0.00%

◼ Perceived credit quality

Source: Claude Giguere

85

Yield curve changes

Yield Yield

shift Structural changes

maturity maturity

86

43
 A simple example of
Yield Curve Movement
T+1

Twist

T
Shift

Source: Claude Giguere

87

Decision Process
#1: Currency Allocation

Yield Curves may move Interest rates and inflation

First Decision: independently impact yield curve

Allocation to
Different Hedging strategies may
Currencies be used
Each market represented as
separate currency

88

44
 #2: Yield Curve Positioning
(Duration)

Second Decision: By market

Duration /
Allocate funds along To achieve desired overall
Yield Curve
yield curve duration exposure
Positioning
Based upon fund manager's view
of how yield curve will change

89

#3: Sector Allocation

Third Decision: Bond types

(corporates, government,...
Allocate into
Issuer / credit quality
sectors

90

45
 #4: Bond Selection

Fourth Decision:
Select the bonds to coincide
Select the
with the other decisions
bonds

91

The Overall Investment Decision

Process First Decision:
Yield Curves may move
independently
Interest rates and inflation
impact yield curve

Allocation to
Different Hedging strategies may
Currencies be used
Each market represented as
separate currency

Second Decision: By market

Duration /
Allocate funds along To achieve desired overall
Yield Curve
yield curve duration exposure
Positioning
Based upon fund manager's view
of how yield curve will change

Third Decision: Bond types

(corporates, government,...
Allocate into
Issuer / credit quality
sectors

Fourth Decision:

Select the bonds to coincide

Select the
with the other decisions
bonds

92

46
 Comparing Fixed Income
with Equities

Management decisions we look at:

◼ Equities (usually 2 factors):
◼ Stock selection
◼ Sector allocation
◼ Fixed Income (multiple-factors); e.g.,
◼ Yield curve management (duration allocation)
◼ Sector allocation
◼ Rating allocation
◼ Security selection

93

Why do we
need a
different
approach
for fixed
income
attribution?

94

47
95

Duration ◼ Measures the

bond’s sensitivity to
changes in interest
rates
◼ Links the change in
yield of a bond to
its return
◼ Is used by the
manager as an
additional decision
implementation tool

96

48
 Yield Curve Positioning
The position on,
and change in, the
yield curve, also
affects the size
of the position

97

Another point:

“Selection” has little

meaning in the fixed
income world, as bonds
tend to perform in a
homogeneous fashion, if
they have similar
characteristics (e.g., type,
duration and rating)

98

49
 Some of the
challenges facing
fixed income
attribution

99

Outperformance is often
smaller than with equities,
therefore
• Accuracy is more
critical
• Asset/sector
changes are
common

100

50
 There are multiple and
varied processes to fixed
income management
• No “typical” process
• Credit vs. treasury
management may require
different approaches

101

Additional
challenges
• Common use of
more complex
instruments
• Pricing challenges
• Index issues

102

51
 What does a typical
fixed income model
look like?
Portfolio Benchmark
Contribution Contribution
Effects Effects

Duration Duration
Effect Effect
----- -----
Income Income
Effect Effect
----- Compare -----
Spread Spread
Effect Effect
----- -----
Selection Selection
Effect Attribution Effect
Effects

Duration
Effect
-----
Income
Effect
-----
Spread
Effect
-----
Selection
Effect

103

Let’s contrast …

104

52
 f i v e c r i t i c a l

• term of investments • markets

• return potential • risk factors
• significance of a selection effect

105

• lender
f • owner
f
• fixed
F term • permanent
F
• fixed
s payments investment
• fixed
n return • variable
s dividends
• less
t liquid market • entitled
n to a share
of profits
• actively
t traded
bonds stocks

dominated by dominated by
new issues secondary market
106

53
 performance factors
• driven
f by interest • driven
f by
rates (yields) economic sectors
• relevant
s risk: • relevant
s risk:
sensitivity to rate sensitivity to
changes (duration) market (beta)

bonds stocks
selection factor: selection factor:
small huge
107

We’ll look at the

McLaren Model
(okay, a slightly different one)

108

54
 McLaren Model Components
◼ Currency Return: the difference between base and
local returns.
◼ Split between allocation and timing
◼ Duration Return: measured directly from each local
market; generated by interest rate exposure factors
◼ Decomposed into shift and slope (curve reshape)
◼ Risk Premium Return: the difference between local
fund return and duration return. Generated by
credit exposure factors.
◼ Decomposed into spread and selection

109

Notation used by the author

◼ Lai = Local return of the fund (actual) for sector i
◼ Lpi = Local return of the benchmark (passive) for
sector i
◼ Lyi = Local return of the yield curve
◼ Wai = Weight of the fund for sector i
◼ Wpi = Weight of the benchmark for sector i

110

55
 Notation we’ll use
◼ Rpi = Portfolio return for sector i
◼ Rbi = Benchmark return for sector i
◼ Ryi = Yield curve return
◼ Wpi = Portfolio weight for sector i
◼ Wbi = Benchmark weight for sector i

111

The portfolio we’ll use; we’ll focus on

Collateralized / 2-4 years
Portfolio Index Yield Curve
Return Weight Return Weight Return
Maturity 2-4
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%
Corporate 1.650% 15.0% 1.150% 7.0% 1.050%
Gov't 1.100% 15.0% 1.050% 17.5% 1.050%
Maturity 4-6
Collateralized 1.030% 30.0% 1.025% 40.0% 1.150%
Corporate 0.800% 16.0% 1.090% 11.0% 1.150%
Gov't 1.200% 18.0% 1.150% 21.0% 1.150%
Total 1.141% 100.0% 1.078% 100.0%

112

56
 Contributors to the returns

Portfolio Index
113

Portfolio Duration Contribution

Portfolio Index Yield Curve
Return Weight Return Weight Return
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%

Portfolio Duration Contribution (DPi) =

Portfolio Weight * Yield Curve Return

D pi = w Pi  rYi = 0.06  0.0105 = 0.063%

(C) The Spaulding Group 2019 114

114

57
 Portfolio Spread Contribution
Portfolio Index Yield Curve
Return Weight Return Weight Return
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%

Portfolio Spread Contribution (MPi) =

Portfolio Weight *
(Benchmark Return– Yield Curve Return)
M p = w P  (rB − rY ) = 0.06  (0.012 − 0.0105) = 0.009%
i i i i

(C) The Spaulding Group 2019 115

115

Portfolio Selection Contribution

Portfolio Index Yield Curve
Return Weight Return Weight Return
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%

Portfolio Selection Contribution (SPi) =

Portfolio Weight *
(Portfolio Return- Benchmark Return)
( )
S pi = w Pi  rPi − rBi = 0.06  (0.0125 − 0.012) = 0.003%

(C) The Spaulding Group 2019 116

116

58
 Portfolio Selection Contribution
Alternatively, if want Interaction
Portfolio Index Yield Curve
Return Weight Return Weight Return
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%

Portfolio Selection Contribution (SPi) =

Benchmark Weight *
(Portfolio Return- Benchmark Return)
( )
S pi = wB  rPi − rBi = 0.035  (0.0125 − 0.012) = 0.002%

( ) ( )
Interaction = w Pi − wBi  rPi − rBi = (.06−.035)  (.0125−.012) = 0.001%

(C) The Spaulding Group 2019 117

117

Benchmark Duration Contribution

Portfolio Index Yield Curve
Return Weight Return Weight Return
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%

Benchmark Duration Contribution (DBi) =

Benchmark Weight * Yield Curve Return

DBi = wBi  rYi = 0.035  0.0105 = 0.037%

(C) The Spaulding Group 2019 118

118

59
 Benchmark Spread Contribution
Portfolio Index Yield Curve
Return Weight Return Weight Return
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%

Benchmark Spread Contribution (MBi) =

Benchmark Weight *
(Benchmark Return – Yield Curve Return)
M B = wB  (rB − rY ) = 0.035  (0.012 − 0.0105) = 0.005%
i i i i

(C) The Spaulding Group 2019 119

119

Now, to calculate
the relative
contributions:
attribution
effects

120

60
 The McLaren Model borrows from the
BF approach

And makes the duration effect relative to the

overall benchmark duration contribution

( ) (
Dr = w Pi − wBi  rYi − DB )

(C) The Spaulding Group 2019 121

121

Relative Duration Contribution

(Duration Effect)
Portfolio Benchmark Overall BM Total BM
Duration Spread Selection Duration Spread Duration Return
0.063% 0.009% 0.003% 0.037% 0.005% 1.12% 1.078%

Duration Effect (Dr) = (Portfolio Weight –

Benchmark Wt) * Yield Curve Return–
Total Benchmark Duration Contribution)

( ) ( )
Dr = w Pi − wBi  rYi − DB = (.06−.035)  (.0105−.0112) = −0.002%

(C) The Spaulding Group 2019 122

122

61
 Again, the McLaren Model borrows
from the BF approach

And makes the spread effect relative to the

overall benchmark’s risk premium

( ) (
M r = w Pi − wBi  rBi − rYi − ( RB − DB ) ) 

(C) The Spaulding Group 2019 123

123

Calculating the overall benchmark duration

contribution
Portfolio Index Yield Curve
Return Weight Return Weight Return
Maturity 2-4
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%
Corporate 1.650% 15.0% 1.150% 7.0% 1.050%
Gov't 1.100% 15.0% 1.050% 17.5% 1.050%
Maturity 4-6
Collateralized 1.030% 30.0% 1.025% 40.0% 1.150%
Corporate 0.800% 16.0% 1.090% 11.0% 1.150%
Gov't 1.200% 18.0% 1.150% 21.0% 1.150%
Total 1.141% 100.0% 1.078% 100.0%

DB =  wi * r ^
i

(.035+.070+.175)*(.0105)+(.40+.11+.21)*(.0115)=.0112 =1.12%

124

62
 Relative Spread Contribution
(Spread Effect)

Portfolio Benchmark Overall BM Total BM

Duration Spread Selection Duration Spread Duration Return
0.063% 0.009% 0.003% 0.037% 0.005% 1.12% 1.078%

Spread Effect (Mr) = (Portfolio Wt – Benchmark

Wt) * [Benchmark Return–Yield Curve Return) –
(Overall Benchmark Return – Benchmark
Duration Contribution)]

( ) ( )
M r = w Pi − wBi  rBi − rYi − ( RB − DB ) = 
(.06−.035)  (0.012 − 0.0105) − (0.01078 − 0.0112) = 0.005%
(C) The Spaulding Group 2019 125

125

Relative Selection Effect

Since the index doesn’t have a selection effect, we

simply plug the portfolio’s selection contribution as
our effect
Portfolio
Duration Spread Selection
0.063% 0.009% 0.003%

(C) The Spaulding Group 2019 126

126

63
 Our total effects

Effects
Duration Spread Selection Total
Collateralized -0.002% 0.005% 0.003% 0.006%

(C) The Spaulding Group 2019 127

127

Let’s look at the entire portfolio

Portfolio Index Yield Curve
Return Weight Return Weight Return
Maturity 2-4
Collateralized 1.250% 6.0% 1.200% 3.5% 1.050%
Corporate 1.650% 15.0% 1.150% 7.0% 1.050%
Gov't 1.100% 15.0% 1.050% 17.5% 1.050%
Maturity 4-6
Collateralized 1.030% 30.0% 1.025% 40.0% 1.150%
Corporate 0.800% 16.0% 1.090% 11.0% 1.150%
Gov't 1.200% 18.0% 1.150% 21.0% 1.150%
Total 1.141% 100.0% 1.078% 100.0%

We want to reconcile to the excess return: 1.141% - 1.078% = 0.063%

128

64
 Portfolio Contributions
Portfolio
Duration Spread Selection
Maturity 2-4
Collateralized 0.063% 0.009% 0.003%
Corporate 0.158% 0.015% 0.075%
Gov't 0.158% 0.000% 0.007%
Maturity 4-6
Collateralized 0.345% -0.038% 0.001%
Corporate 0.184% -0.010% -0.046%
Gov't 0.207% 0.000% 0.009%
Total 1.114% -0.023% 0.050%
1.141%

129

Benchmark Contributions
Benchmark
Duration Spread
Maturity 2-4
Collateralized 0.037% 0.005%
Corporate 0.074% 0.007%
Gov't 0.184% 0.000%
Maturity 4-6
Collateralized 0.460% -0.050%
Corporate 0.127% -0.007%
Gov't 0.242% 0.000%
Total 1.122% -0.044%
1.078%

130

65
 Our effects:
We reconcile to the excess ROR

Effects
Duration Spread Selection Total
Maturity 2-4
Collateralized -0.002% 0.005% 0.003% 0.006%
Corporate -0.006% 0.012% 0.075% 0.081%
Gov't 0.002% -0.001% 0.007% 0.008% We picked up
5 bps
Maturity 4-6
from
Collateralized -0.003% 0.008% 0.001% 0.007%
selection
Corporate 0.001% -0.001% -0.046% -0.046%
Gov't -0.001% -0.001% 0.009% 0.007%
Total -0.008% 0.021% 0.050% 0.063%
Excess ROR = 0.063%

Our Yield Curve Positioning We gained 2.1 bps

cost us 0.8 bps from our sector and credit allocations

131

We’ll next cover the Campisi model

132

66
 Decomposing returns in
Campisi framework

◼ The return on bonds is equal to the income return

plus the price change
◼ Income return is simply coupon rate divided by beginning
price (current yield)
◼ Price change on bonds comes from yield changes
(changes in the interest rate market)
◼ Bond yields have two components:
◼ An underlying Treasury interest rate, which generally
increases with the time to maturity
◼ A risk premium (or spread above Treasuries) to
compensate for the risk of default of principal and
interest
133

Understanding bond
risk
◼ Bonds exhibit four types of risk, each of which provides a
risk premium:
◼ Interest rate risk: the risk that bond prices will decline
as Treasury rates rise, making the bond held less
attractive
◼ Credit risk: the risk that the issuer (borrower) will not
pay interest and/or principle on time
◼ Prepayment risk: the risk that borrowers will refinance
(call and reissue) their bonds as rates decline, leaving
the investor with the possible loss of expected income
◼ “Equity-type” risk: the additional risk of default
associated with speculative grade bonds
◼ Selection effect is larger with these bonds than other bonds
exhibiting credit risk
134

67
 Sources of fixed-income
returns in Campisi framework
Total Return

Income Return
Price Return
Coupon/price

Treasury Effect Spread Effect Selection Effect

-Duration * Treasury Change Total return minus income return
-Duration * Average Spread Change
minus treasury effect minus spread effect

135

Explaining the sources

of return
◼ Income effect: the amount of return from the
bond’s coupon income compared to cost of
investment
◼ Simply the par value weighted average coupon divided
by the par value weighted average price
◼ Treasury effect: the component of price change
resulting from changes in Treasury interest rates
and the sensitivity of investments to those rate
changes
◼ Calculated as (-modified duration) * (change in Treasury
rate)

136

68
 Estimating price return
◼ We can estimate price return over the period using the relationship:
𝑝𝑟𝑖𝑐𝑒 𝑟𝑒𝑡𝑢𝑟𝑛 ≅ −𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 ∗ (𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒𝑠)

◼ We are estimating for three price return components (Treasury, Spread, Selection)
◼ Thus, we just need the appropriate duration and the appropriate change in interest
rates
◼ We will use overall duration (rather than sector)
◼ For Treasuries: 𝑝𝑟𝑖𝑐𝑒 𝑟𝑒𝑡𝑢𝑟𝑛 ≅ −𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 ∗ (𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑇𝑟𝑒𝑎𝑠𝑢𝑟𝑦 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒𝑠)
◼ For Spread (i.e., average non-Treasury category’s spread vs. Treasuries):
𝑝𝑟𝑖𝑐𝑒 𝑟𝑒𝑡𝑢𝑟𝑛 ≅ −𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 ∗ (𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑝𝑟𝑒𝑎𝑑 𝑟𝑎𝑡𝑒𝑠)
◼ For Selection: 𝑝𝑟𝑖𝑐𝑒 𝑟𝑒𝑡𝑢𝑟𝑛 ≅ −𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 ∗ (𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑠𝑝𝑟𝑒𝑎𝑑 𝑟𝑎𝑡𝑒𝑠)

◼ Rather than requiring all of the yield curve data implied above, we will only use Treasury yield
curve data and approximate the rest using Campisi’s “index portfolio”
137

Explaining the
sources of return (2)
◼ Spread effect: the component of price change from change in risk premium
(interest rate, prepayment, credit and/or equity-type risk)
◼ For the benchmark and index, which have no selection effect, it is all of the return not
explained by the Treasury effect and Income effect
◼ For the portfolio, it is calculated as
(-modified duration) * (index spread change)

◼ Spread change: the change in risk premium, expressed in basis points

◼ Benchmark and index: calculated as (spread effect) / (-modified duration)
◼ Portfolio: change in market spread for index portfolio

◼ Selection Effect: all return not explained by Income, Treasury and Spread
effects

138

69
 What is the “index portfolio?”

◼ It is similar to the Brinson “semi-notional portfolio”

◼ It reflects implementing some of the manager’s decisions, but not others

◼ Not to be confused with the manager’s actual benchmark

◼ By constructing a hypothetical portfolio using the manager’s weights but benchmark

returns:
◼ The index portfolio reflects the manager’s style choices (duration, sector weightings – thus spread choices,
etc.) while excluding the manager’s security selection
◼ Thus, we can back into the manager’s return due to security selection without acquiring nominal spread yield
curve data
◼ We will also back into the benchmark’s spread return after quantifying its income return and Treasury return;
we can then back into spread change in interest rates, which will in turn be used to calculate the portfolio’s
spread return – thus, no need for bond sector yield curves (to determine spread changes)

139

Data needed for Campisi

attribution

The following data is necessary to conduct a performance

attribution analysis using the Campisi framework:
◼ Portfolio and Benchmark data:
◼ Sector weights and returns
◼ Sector par value weighted average coupon and price
◼ Sector market value weighted average duration
◼ Total return (can be obtained by taking sector contributions)
◼ Total market value (actual or hypothetical)
◼ Sector and total par values (can be inferred from market values and sector
prices)
140

70
 Data needed for Campisi
attribution (2)

The following data is necessary to conduct a performance attribution

analysis using the Campisi framework:
◼ Index portfolio:
◼ Portfolio sub-sector weights, benchmark sub-sector returns
◼ Benchmark sector par value weighted average coupon and price
◼ Benchmark sector market value weighted average duration
◼ Total return (can be obtained by taking sector contributions)
◼ Total market value (hypothetical)
◼ Sector and total par values (can be inferred from market values and benchmark sector prices)
◼ Table of changes in Treasury rates for various duration points

141

Example
Assume the following portfolio data:
◼ Total market value of $1,000,000 is assumed
◼ Numbers in bold/italics are calculated from other data
provided
◼ Return and duration are market value weighted averages
◼ Price and coupon are par value weighed averages

Change in
Portfolio Portfolio Portfolio Portfolio Portfolio Treasury
Sectors Return Weight Price Market Value Par Value Coupon Duration Rates
Treasuries -6.22% 2.02% 102.5625% $20,200.00 $19,695.31 6.11% 7.65
Corporates -1.07% 69.85% 98.6375% $698,500.00 $708,148.52 7.03% 5.92
Mortgage-backed 2.60% 22.89% 99.7400% $228,900.00 $229,496.69 7.08% 4.23
High Yield 7.04% 2.56% 87.9800% $25,600.00 $29,097.52 8.19% 5.21
Emerging Markets 15.32% 2.68% 81.3750% $26,800.00 $32,933.95 8.92% 6.94
Total Portfolio 0.31% 100.00% 98.0996% $1,000,000.00 $1,019,371.99 7.118% 5.58 1.79%

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 Example (2)
Also assume the following benchmark data:
◼ Total market value of $1,000,000 is assumed
◼ Numbers in bold/italics are calculated from other data
provided
◼ Return and duration are market value weighted averages
◼ Price and coupon are par value weighed averages

Change in
Benchmark Benchmark Benchmark Benchmark Benchmark Treasury
Sectors Return Weight Price Market Value Par Value Coupon Duration Rates
Treasuries -1.75% 6.00% 107.190% $60,000.00 $55,975.37 6.45% 5.02
Corporates -1.96% 66.00% 102.964% $660,000.00 $641,000.74 6.97% 6.03
Mortgage-backed 1.86% 18.00% 101.980% $180,000.00 $176,505.20 7.03% 1.95
High Yield 2.39% 8.00% 88.690% $80,000.00 $90,201.83 8.02% 4.64
Emerging Markets 23.07% 2.00% 67.040% $20,000.00 $29,832.94 7.20% 3.59
Total Portfolio -0.41% 100.00% 100.653% $1,000,000.00 $993,516.07 7.05% 5.08 1.83%

143

The index portfolio…

The index portfolio total return and weighted average duration are
obtained from the allocations to sub-sectors from the actual
portfolio and benchmark returns in those sub-sectors:
◼ Use of the index portfolio prevents the selection effect from including
return from differences of systematic risk or style (vs. the benchmark) as
reflected in the allocations
Benchmark
Sub-sector Return Portfolio Weight Duration
Treasuries -1.75% 2.02% 5.02
Emerging Markets 23.07% 2.68% 3.59
High Yield 2.39% 2.56% 4.64
CMO 0.00% 0.00% 0.00
Mortgage-backed 1.86% 22.89% 1.95
Municipals -2.06% 0.91% 7.30
Asset-backed 1.81% 8.06% 3.14
Commercial Mortgage Backed
-1.27% 10.00% 5.98
Private Placements -0.17% 23.95% 6.66
Public Corporates -1.96% 26.93% 6.03
Total Portfolio 0.5015% 100.000% 4.90

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 Example (3)

Also assume the following index portfolio data:

◼ Total market value of $1,000,000 is assumed
◼ Numbers in bold/italics are calculated from other data provided
◼ All data from the benchmark, except portfolio weights and market values
◼ Return and duration are market value weighted averages
◼ Price and coupon are par value weighed averages
◼ Note: index portfolio return and average duration are based on sub-
sector data

Change in
Index Port Index Port Index Port Index Port Index Port Treasury
Sectors Return Weight Price Market Value Par Value Coupon Duration Rates
Treasuries -1.75% 2.02% 107.1900% $20,200.00 $18,845.04 6.45% 5.02
Corporates -1.96% 69.85% 102.9640% $698,500.00 $678,392.45 6.97% 6.03
Mortgage-backed 1.86% 22.89% 101.9800% $228,900.00 $224,455.78 7.03% 1.95
High Yield 2.39% 2.56% 88.6900% $25,600.00 $28,864.58 8.02% 4.64
Emerging Markets 23.07% 2.68% 67.0400% $26,800.00 $39,976.13 7.20% 3.59
Total Portfolio 0.50% 100.00% 100.9556% $1,000,000.00 $990,533.98 7.01% 4.90 1.83%

145

The steps of the Campisi

attribution model
1. Decompose the benchmark into contributions due to Income, Treasury and Spread

2. Decompose the index portfolio into contributions due to Income, Treasury and
Spread
a. Obtain the index portfolio spread change

3. Decompose the portfolio into contributions due to Income, Treasury, Spread and
Selection

4. Take the attribution effects to be the relative contributions (portfolio vs.

benchmark)

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 Decomposing the
benchmark: Income

WeightedAverageCoupon
IncomeContribution =
WeightedAverage Pr ice

7.055%
IncomeContribution = = 7.008%
1.00653

147

Decomposing the
benchmark: Treasury

TreasuryContribution = (− mod ifiedDuration) * (ChangeInTreasRates)

TreasuryContribution = (−5.08) * (1.83) = −9.287

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74
 Decomposing the
benchmark: Spread

SpreadContribution = Benchmark Re turn − IncomeContribution − TreasuryContribution

SpreadContribution = −0.41 − 7.008 − (−9.287) = 1.869

149

Decomposing the index

portfolio: Income

WeightedAverageCoupon
IncomeContribution =
WeightedAverage Pr ice

7.015%
IncomeContribution = = 6.95%
1.00978

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75
 Decomposing the index
portfolio: Treasury

TreasuryContribution = (− mod ifiedDuration) * (ChangeInTreasRates)

TreasuryContribution = (−4.90) * (1.83) = −8.97

152

Decomposing the index

portfolio: Spread

SpreadContribution = IndexPort Re turn − IncomeContribution − TreasuryContribution

SpreadContribution = 0.50 − 6.95 − (−8.97) = 2.52

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 Determining the spread
change for the index
portfolio

SpreadEffect
SpreadChange =
(− ModifiedDuration)

2.52
SpreadChange = = −0.514
− 4.90

154

Decomposing the
portfolio: Income

WeightedAverageCoupon
IncomeContribution =
WeightedAverage Pr ice

7.115%
IncomeContribution = = 7.26%
0.981

155

77
 Decomposing the
portfolio: Treasury

TreasuryContribution = (− mod ifiedDuration) * (ChangeInTreasRates)

TreasuryContribution = (−5.58) * (1.79) = −9.98

156

Decomposing the portfolio:

Spread

SpreadContribution = (−ModifiedDuration) * ( IndexSpreadChange)

SpreadContribution = −5.58 * (−.51) = 2.87

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 Determining the portfolio
selection contribution

SelectionCont = Port Re turn − IncomeCont − TreasCont − SpreadCont

SelectionCont = .31 − 7.26 − (−9.98) − 2.87 = 0.17

158

Example (4)
Portfolio Benchmark Index Portfolio
Income Return 7.26% 7.008% 6.95%
Treasury Effect -9.98% -9.287% -8.97%
Spread Effect 2.87% 1.868% 2.52%
Change in Market Spread -0.51% -0.368% -0.51%
Selection Residual 0.17%

Benchmark Index port.

contributions contributions
◼ Income return = .07055/1.00653 = 7.008 ◼ Income return = .07015/1.00978 = 6.95
◼ Treasury effect = -5.08 * 1.83 = -9.287 ◼ Treasury effect = -4.90 * 1.83 = -8.97
◼ Spread effect = -.41-7.008 +9.287 = ◼ Spread effect = -.50 - 6.95+8.97 =2.52
1.869 ◼ Spread change = 2.52/ (-4.90) = -.514
◼ Spread change = 1.868 / -5.08 = -0.368

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 Example (5)
Portfolio Benchmark Index Portfolio Value Added
Income Return 7.26% 7.008% 6.95% 0.25%
Treasury Effect -9.98% -9.287% -8.97% -0.70%
Spread Effect 2.87% 1.868% 2.52% 1.00%
Change in Market Spread -0.51% -0.368% -0.51%
Selection Residual 0.17% 0.17%

Portfolio contributions Attribution Effects

◼ Income return = .07115/.981 = 7.26 ◼ Income return = 7.26 – 7.008 = 0.25%
◼ Treasury effect = -5.58*1.79 = -9.98
◼ Treasury effect = -9.98 + 9.287 = -0.70%
◼ Spread effect = -5.58 * (-.51) = 2.87
◼ Spread effect = 2.87 – 1.868 = 1.00%
◼ Spread change = index spread change =
-.51 ◼ Selection effect = 0.17 – 0 = 0.17%
◼ Selection = .31 – 7.26 + 9.98 – 2.87 = .17

160

Applying Brinson-Fachler to a bond

portfolio… yes, it reconciles, but what does
it explain???

Sector Portfolio Weight Benchmark Weight Portfolio Return Benchmark Return Allocation Selection Total
Treasuries 2.02% 6.00% -6.22% -1.75% 0.05% -0.09% -0.04%
Corporates 69.85% 66.00% -1.07% -1.96% -0.06% 0.62% 0.56%
Mortgage-backed 22.89% 18.00% 2.60% 1.86% 0.11% 0.17% 0.28%
High Yield 2.56% 8.00% 7.04% 2.39% -0.15% 0.12% -0.03%
Emerging Markets 2.68% 2.00% 15.32% 23.07% 0.16% -0.21% -0.05%
Total Portfolio 100.00% 100.00% 0.31% -0.41% 0.11% 0.61% 0.72%

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 Questions?

162

Spreadsheet Exercise :

Please open the Campisi worksheet and calculate the

attribution effects using the Campisi model.

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 some concluding remarks:
• fixed income
requires its own
model
• new models
continue to be
designed
• no widely
accepted models

164

Questions?

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 Currency
attribution
We look at two sources
of the return
◼ Market effects
◼ Currency effects
◼ Sensitive to changes in
foreign exchange rates

166

A Simply (naïve)
Currency Attribution Model
Currency Contribution =
Portfolio Wt * (Portfolio Return in Base -
Portfolio Return Local) -
Benchmark Wt * (Benchmark Return in
Base - Benchmark Return Local)

 ( ) 
CurrencyEffect = w Pi  rPBi − rPLi − wBi  rBBi − rBLi ( )
Note: superscripts indicate base vs. local returns

(C) The Spaulding Group 2019 167

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83
 Currency Attribution Example
◼ Portfolio
◼ Yen exposure (% of assets) 29.46%
◼ Japanese Equity Return (Base currency) 12.47%
◼ Japanese Equity Return (Yen) 12.26%

◼ Benchmark
◼ Yen exposure 9.80%
◼ Japanese Equity Return (Base) 14.30%
◼ Japanese Equity Return (Yen) 14.07%

 (
CurrencyEffect = w Pi  rPBi − rPLi − wBi  rBBi − rBLi )  ( )
Currency Affect = .2946*(12.47-12.26) - .0980*(14.3-14.07) = .039% = .04%
168

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Exercise
Weight Local ROR Base ROR Contrib
Portfolio 50% 7.10% 8.10% 4.05%
Benchmark 35% 7.00% 8.00% 2.80%
Excess ROR 1.25%

◼ Calculate the effects for the local market

return, using the BHB model (allocation,
selection, and interaction)
◼ And, the currency effect, using:

 ( ) 
CurrencyEffect = w Pi  rPBi − rPLi − wBi  rBBi − rBLi ( )
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 The BHB Allocation Effect
(
Alloc' nEffect BHB = rBLi  w Pi − wBi )
= 7.00  (50% − 35%) = 105%
.

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170

BHB Selection
(
SelectionEffect = wBi  rPL − rBL
i i
)
= 35%  (7.10 − 7.00) = 0.035%

(C) The Spaulding Group 2019 171

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85
 BHB Interaction
InteractionEffect =
(w Pi ) (
− wBi  rPLi − rBLi )
= (50% − 35%)  (710%
. − 7.00%) =
0.015%

(C) The Spaulding Group 2019 172

172

The currency effect

CurrencyEffect =

 w  (r
Pi
B
Pi )  (
− rPLi − wBi  rBBi − rBLi )
= 50%  (810%
. − 710%
. )−
35%  (8.00% − 7.00%) =
015%
.

(C) The Spaulding Group 2019 173

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86
 And what do we have?
Bp Bb Alloc’n Selection Interaction Currency Total
8.10% 8.00% 1.05% 0.035% 0.015% 0.15% 1.25%

We have successfully accounted

for 100% of the excess return

(C) The Spaulding Group 2019 174

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Naïve Currency Approach

◼ Advantage: simple / intuitive
◼ Disadvantage: limited: doesn’t provide full
currency attribution analysis / effects of
hedging

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 The Karnosky-Singer Model

176

Recall the BHB Model…

Selection
Actual Passive
Actual

(IV) (II)
Actual Policy and
Portfolio Timing
Return Return
Timing
Passive

(III) (I)
Policy and Policy Return
Security Selection (Passive Portfolio
Return Benchmark)

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 …and the BHB Attribution Effects

Due to timing: II - I
Due to stock selection: III – I
Other IV-III-II+I

178

K-S Model
Security Selection Hedge Selection
Actual Passive Actual Passive

(M)IV (M)II (C)IV (C)II

Actual, Policy and Active Actual, Policy and Active

Local-Currency Allocation, Base-Currency Allocation,
Actual
Actual

Return Premium Local-Currency Eurodeposit Base-Currency

Return Premium Premium EurodepsoitReturn
Currency Selection

Premium
Market Selection

Active Weights, Active Weights, Active Weights, Active Weights,

Active Returns Passive Returns Active Returns Passive Returns
(C)III (C)I
(M)III (M)I
Policy and Hedge, Policy,
Policy and Security, Policy, Selection, Base-Currency
Passive

Selection, Local-Currency
Passive

Base-Currency Eurodeposit
Local-Currency Return Premium Eurodeposit Return
Return Premium Return Premium

Passive Weights, Passive Weights, Passive Weights, Passive Weights,

Active Returns Passive Returns Active Returns Passive Returns

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 K-S Attribution Effects
Market selection M(II) - M(I)
Security selection M(III) - M(I)
Other M(IV) - M(III) - M(II) + M(I)
Total M(IV) - M(I).

Currency selection C(II) - C(I)

Hedge selection C(III) - C(I)
Other C(IV) - C(III) - C(II) + C(I)
Total C(IV) - C(I).

180

Other approaches to attribution

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 Attribution relative to market cap
(capitalization) and/or style
• Large cap, mid cap,
small cap
• Value, growth, core

182

Other Attribution Factors

◼ Duration
◼ Maturity

◼ Quality

◼ Country

◼…

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91
 There are countless ways to “slice
up” a portfolio to provide great
insights to the managers and clients

184

Daily vs. Monthly

◼ Daily
◼ Makes sense with holdings-based,
◼ More costly
◼ Provides intra-month / point-to-point reporting
◼ Monthly
◼ Simpler
◼ Probably sufficient if use transaction-based

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 Arithmetic vs.
Geometric Attribution

186

Arithmetic vs. Geometric

Attribution
◼ Many think that “geometric” refers to
geometric linking; they’re wrong
◼ Has to do with how we view Excess Return
Arithmetic Geometric

RP − RB 1 + RP
−1
1 + RB
(C) The Spaulding Group 2019 187

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93
 Arithmetic vs. Geometric
◼ Arithmetric (aka Additive)
◼ More common in U.S., Continental Europe and
Australia
◼ Standard view of excess returns – more intuitive
◼ Geometric (aka Multiplicative)
◼ More common in the UK
◼ Very different view of excess returns
◼ To avoid confusion, prefer to use “multiplicative”
rather than “Geometric”

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Excess Return Example

Arithmetic Beginning Mkt Value = $1,000,000
Ending Mkt Value = $1,070,000
Profit $70,000 and a return of 7%
Benchmark return 5%
Value of fund $1,050,000 and profit of $50,000
Added value $70,000 -$50,000 = $20,000
or 7% - 5% = 2% or
20,000/1,000,000
Geometric Added value $20,000/ 1,050,000 = 1.9%
or 1.07/1.05 –1 = 1.9%

(C) The Spaulding Group 2019 189

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94
 Some differences
◼ Arithmetic (Excess Return)
◼ Easier to understand, more intuitive for many
◼ Larger absolute value in rising markets
◼ More widely and traditionally used
◼ “Linking challenged”: residuals occur across time; can
be “smoothed away”
◼ Multiplicative (Excess Return)
◼ Compoundable
◼ Convertible
◼ Proportionate
◼ Has “single period” residuals; can be “smoothed” away

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Compoundable
◼ Since actual performance is chain-linked and expressed as :
(1 + r1) x (1 + r2) x (1 + r3) .................... (1 + rn) = (1 + R)

◼ and similarly for benchmark performance

◼ then the geometric out performance over the total period can be expressed as:

(1 + G ) = (1 + RP ) / (1 + RB ) =
(1 + rP1 ) / (1 + rBi )  (1 + rP2 ) / (1 + rB2 )...(1 + rPn ) / (1 + rBn ) =
(1 + G ) = (1 + g1 )(1 + g 2 )...(1 + g n )

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 Convertible
1999 1998 1997

In US Dollars
Portfolio -33.1 16.0 -7.2
Benchmark -25.3 -11.6 -5.2
Arithmetic Difference -7.8 27.6 -2.0

In Sterling
Portfolio -33.9 20.6 -6.5
Benchmark -26.2 -8.0 -4.5
Arithmetic Difference -7.6 28.6 -2.0

In Euros
Portfolio -38.0 35.3 -14.3
Benchmark -30.8 3.2 -12.5
Arithmetic Difference -7.2 32.1 -1.8

Geometric Difference -10.4 31.2 -2.1

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For example…
In US Dollars
Portfolio -33.1 ◼ -(33.1)-(-25.3) = -7.8
Benchmark -25.3 ◼ ((-.331+1)/(-.253+1))-1
Arithmetic Difference -7.8 = -.104 = -10.4%

In Sterling
Portfolio -33.9 ◼ -33.9-(-26.2)=-7.6
Benchmark -26.2
◼ ((-.339+1)/(-.262+1))-1
Arithmetic Difference -7.6 = -.104 = -10.4%

In Euros
Portfolio -38.0
◼ -38.0-(-30.8)=-7.2
Benchmark -30.8
Arithmetic Difference -7.2 ◼ ((-.380+1)/(-.308+1))-1
= -.104 = -10.4%
Geometric Difference -10.4
(C) The Spaulding Group 2019 193

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96
 Proportionate
◼ Which is the better excess return?
51% vs. 50% - or - 11% vs. 10%
◼ Arithmetically, both = +1%
◼ But Geometrically, we get different
results:
1.11 / 1.1 – 1 = .9%
1.51 / 1.50 – 1 = 0.67%

(C) The Spaulding Group 2019 194

194

Brinson-Fachler: geometric
(at total portfolio level)
1+ R
StkSel = −1
1 + Rs
1 + Rs
AssetAlloc = −1
1+ R

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97
 Brinson-Fachler: geometric sector effects
 (1 + r )   1 + r i 
StkSel = wi   i
− 1   
(
 1+ ri )   1 + Rs 


 1+ ri 
Allocation = ( wi − w i )   − 1
 1+ R 

196

Exercise: Find the Geometric

Attribution Effects

Rate of Return Weights

Portfolio Index Portfolio Index
Banks 2.00% 3.00% 40.00% 25.00%
Tech 3.00% 2.00% 20.00% 25.00%
Chem 4.00% 5.00% 30.00% 25.00%
Util 5.00% 4.00% 10.00% 25.00%
3.10% 3.50%

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 Comparing Arithmetic w/Geometric
Brinson-Fachler
Arithmetic Geometric
Stk Sel Alloc'n Stk Sel Asset Alloc
Banks -0.400% -0.075% -0.386% -0.072%
Tech 0.200% 0.075% 0.193% 0.072%
Chem -0.300% 0.075% -0.290% 0.072%
Util 0.100% -0.075% 0.097% -0.072%
Total -0.400% 0.000% -0.386% 0.000%

198

Holdings- vs. transaction-based

• Uses end-of-period • Captures intra-period
holdings transactions
• Misses intra-period • May require more
activity data
• Results can be misleading • Will reconcile to
and in error portfolio return
• Generates residuals • More accurate
• No residuals

Holdings- Transaction-
based based
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99
 Is the added accuracy worth the
added cost?
Capture all activity

Transaction price
vs. end-of-day price

Daily
Cost

Holddings plus
Weighted-Flows

Holdings-based

Improved accuracy

200

And,…
At what point
does the incremental accuracy
fail to justify
the added cost?
Method / Cost

Accuracy

201

100
 Multi-period attribution,

via linking

202

What’s the issue?

We want to extend sub-period returns
(e.g., days to months, months to quarters
or years)

203

101
 The problem:

How to?

204

The Third Law of Performance

Attribution
The sum of the
linked attribution
effects should
equal the linked
excess return
n

 LAE
i =1
i = LRP − LRB

205

102
 Problem: arithmetic attribution is
“linking challenged”
We get “residuals”!
How do we get the
Numbers to tie
out?

206

In general, there
are two approaches

207

103
 Simple methods tend to be
more intuitive, but …
They may also fail to report
correctly, under certain situations

208

Complex methods work

well, but …
They tend to be more difficult to
understand / implement /
explain

209

104
 David Cariño’s
Logarithmic Method
  (r )
?
t
Log
Pt − rBt =RP − RB
t
kt
tLog =
k
ln(1 + RP ) − ln(1 + RB )
kt = ,
RP − RB
ln(1 + RP ) − ln(1 + RB )
k=
RP − RB
ki  Ai ,t
AE = 
i k
(C) The Spaulding Group 2019 210

210

Jose Menchero
Optimized Beta Method
T N  M  ?
  topt    AEi, j  = RP − RB
t =1 i =1  j =1 
 
 RP − RB − A ( RP − RB ) 
T

1 
A= 
( RP − RB ) 
1/ T   t =  ( )
j j
j =1
T  (1 + RP ) − (1 + RB ) 
1/ T  RPt − RBt
 
( )
T 2

 R −R Pj Bj 
 j =1 
 t
Opt
= A + t
RP − RB =

 ( A +  )  (R )
T

t Pt − RBt
i =1

(C) The Spaulding Group 2019 211

211

105
 Can we USE
Attribution?

212

Portfolio Management
• Review / Improve
investment approach
• See what worked,
what didn’t
• Test / evaluate
approaches

213

106
 In Client Meetings
• Identify return
sources
• Confirm claimed
approach to investing
• Identify what
happened, especially
when problems arise
214

Marketing
• Demonstrate success
of investment
approach
• Identify where
performance comes
from

215

107
 Attribution has its
own set of IT Issues

216

Attribution software
searches tend to be
more complex, given
the many approaches
to and aspects of
attribution

217

108
 Performance attribution
requires a lot of data

218

The return from attribution can

differ from the ROR system

14.15%

219

109
 • What attribution is
So, what have • 3 attribution laws
we covered? • Contribution
• Equity and fixed
income attribution
• Currency
attribution
• Arithmetic vs.
Geometric
• Transaction vs
Holdings
• Multi-period
attribution (linking)
• And, much more!
220

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 John D. Simpson,
jsimpson@SpauldingGrp.com
@jdscipm
www.SpauldingGrp.com

Dave’s Blog:
http://www.spauldinggrp.com/investment-performance-guy/
© The Spaulding Group. 2020 Newsletter: https://wc111.infusionsoft.com/app/form/na15
222

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provider of performance and risk
measurement products and services to
the investment industry. It is the fastest growing GIPS
verification firm, hosts the Performance Measurement
Forum, provides consulting services (which include
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223

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