Fixed-Income Performance Attribution
Fixed income performance attribution has been a popular CFA Level 3 exam topic in the past. Test questions could include solving for one of the missing return components (given the overall return and each of the others), explaining one of the return components, or most commonly, evaluating the relative performance of two managers based on their different sources of returns and their stated strategy for outperformance. You would almost always be given a table which breaks down each component’s return so make sure you are comfortable interpreting it.
Evaluating the performance of fixed-income looks at sector specific and security specific performance. However, because it is fixed income we’re talking about here, duration and interest rates are the two dominant sources of return, and managers don’t have control over either of those.
That’s why evaluating a fixed income manager always frames his or her performance against an expected performance within the external interest rate environment. In other words, since fixed income managers don’t have control over twists and shifts in the yield-curve they shouldn’t be punished or rewarded for that. Their performance is measured on a more relative basis.
The 5 Keys for Evaluating Fixed-Income Managers
The most important aspects of evaluating fixed income performance include:
Interest rate management
Measures the manager’s ability to predict changes in interest rates and adjust the portfolio duration and convexity. We compare the duration/convexity of the portfolio as if each bond was a risk free bond and compare the overall position against actual treasury yields to capture the duration and convexity changes. You can subdivide into duration, convexity, and yield-curve shape attributes.
Looks at what happens to yield spreads on the actual sector and quality of bonds a portfolio manager holds (i.e. non-treasury bonds). So if a manager overweights corporate bonds and the corporate bond spread widens, the portfolio will underperform against a treasury-only portfolio (remember spreads narrowing = good)
Looks at the actual bonds selected. So in our previous example, if the corporate bonds actually held by the manager did not widen as much as the overall corporate bond sector, the manager would have a positive security selection for the sector since his or her bonds outperformed their benchmark. It’s basically the same as security selection for equities.
This is the fixed income plug figure. It catches things like transaction/trading costs etc.