Fixed-income attribution is the process of measuring returns generated by various sources of risk in a fixed income portfolio, particularly when multiple sources of return are active at the same time.
Importance The risks affecting the return on a bond portfolio, as an example, include the overall level of the yield curve, the slope of the yield curve, and the credit spreads of the bonds in the portfolio. A portfolio manager may hold firm views on the ways in which these factors will change in the near future, so in three separate risk decisions he positions the assets in the portfolio to take advantage of these expected market movements. If all views subsequently prove to be correct, then each decision will generate a profit. If one view is wrong, it will generate a loss, but the effect of the other bets may compensate. The overall performance will then be the sum of the performance contributions from each source of risk. Attribution is therefore an extremely useful tool in verifying a fund manager's claims to possessing particular investment skills. If a fund is marketed as being interest-rate neutral while providing consistent returns from superior credit research, then an attribution report will confirm this claim. Conversely, if the attribution report shows that this same manager is making non-zero returns from interest rate movements, then his exposure to interest rate risk is clearly not zero and his investment process clearly differs from his stated position. Fixed-income attribution therefore provides a much deeper level of information than is available from a simple portfolio performance report. Typically, such a report only shows returns at an aggregated level, and provides no feedback as to where the investor's true skills lie. For these reasons, fixed-income attribution is rapidly growing in importance in the investment industry; see Financial risk management § Investment management.
Sector-based attribution
Among the simplest fixed income attribution techniques is sector-based attribution. This is based on the standard Brinson-Fachler attribution scheme, where the securities in the portfolio and benchmark are divided up into buckets based on their modified duration. This scheme has the advantage that it is readily understandable, particularly by managers who have an equity background. However, it does not provide a very deep analysis. The overall effects of a parallel change in the yield curve are supplied but there is none of the more detailed analysis supplied by a true fixed-income decomposition. A useful account of sector-based attribution, with worked examples, is provided in Dynkin et al. (1998).
Yield curve attribution A more widely used approach to fixed-income attribution is to decompose the returns of individual securities by source of risk, and then to aggregate these risk-specific returns over an entire portfolio. Typical sources of risk include yield return, return due to yield curve movements, and credit spread shifts. These sub-returns can then be aggregated over time and sector to give the overall portfolio return, attributed by source of risk.
Sources of return Over a given interval, the return of each security will be made up of return from various sub-returns (see below for explanations)
return due to yield (equivalently coupon, or accrued interest, or running yield); return due to rolling down the yield curve; return due to movements in the reference yield curve; return due to credit shifts; other sources of return, such as option-adjusted spread (OAS), liquidity, inflation, paydown, etc.
First principles versus perturbational attribution To calculate the return arising from each effect, we can reprice the security from first principles by using a pricing formula, or some other algorithm, before and after each source of return is considered. For instance, in calculating yield return, we might calculate the price of the security at the start and end of the calculation interval, but using the yield at the beginning of the interval. Then the difference between the two prices may be used to calculate the security's return due to the passage of time. This approach is simple in principle but can lead to operational difficulties. It requires
accurate pricing formulae including, where relevant, ex-coupon, settlement, and country-specific conventions; security-specific data, such as day-count conventions and whether a bond has a non-standard first and last coupons; accurate inputs to these formulae, including market yields and other variable quantities such as the 90-day bank bill swap rate (BBSW) and consumer price index (CPI) factors for floating rate notes and inflation-linked securities, and regular updates for these quantities; a reconciliation function between existing performance measurement systems and the attribution system For these reasons, a pricing model-based approach to attribution may not be the right one where data sourcing or reconciliation is an issue. An alternative solution is to perform a Taylor expansion on the price of a security P ( y , t ) {\displaystyle P\left({y,t}\right)} and remove higher-order terms, which gives
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