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On the White Board - August 2009
Aug 15, 2009
Fixed Income Performance Attribution
A fixed income asset manager wants a performance attribution system to inform him about the skills of his various economists, credit analysts and traders. When building an attribution scheme, we start with the first source of return of a bond, its income. More specifically, the income is the return shown by a bond when nothing changes in the marketplace except the passage of time. Second, we need to capture the effects that his economists and analysts focus on, such as yield curves and credit spread movements. To capture these effects, we utilize a framework including factor modeling. The appropriate attribution methodology for fixed income investments starts then by separating the return of each security in income and price change. The price change is further decomposed in Treasury, credit spreads, volatility or inflation effects using factors. As an illustration, a factor capturing a large portion of the Treasury effect is the parallel shift of the risk free yield curve and is linearly linked to the price change by its duration. An attribution system based on such methodology would properly help our asset manager. Notice that an equity-like performance methodology based on reference portfolios, capturing sector allocation and security selection would not be suitable in this context.