CIPM Experts Review Course

Transcription

1 CIPM Experts Review Course Reading: Practical Performance Measurement and Attribution 1 Attribution Refresher Principles Curriculum focused on single period, and single currency micro attribution Pure Allocation: Incremental return from over/under weighting sectors. Within Selection: Incremental return from over/under weighting securities Allocation/Selection Interaction: A catch all classification. Note: The Brinson & Fachler method is what you learned last time! 2 1

2 Arithmetic Attribution Principles Curriculum focused on single period, and singlecurrency micro attribution Pure Alloca on: = (w Pi w i ) (r i r ) Within Selec on: = w i (r Pi r i ) Allocation/Selection Interaction: = (w Pi w i ) (r Pi r i ) * Note: Even though the example uses various country specific equities as the asset classes, assume all returns are expressed in the domestic currency. 3 Micro Attribution Weight weight Financials 30% 25% 3% 2% Tech 50% 50% 2.5% 2% Energy 20% 25% 4% 3.5% Total 100% 100% Pure Within Interaction Total Value Added = (W1 R1) + (W2 R2) + (W3 R3) 4 2

3 Micro Attribution Weight weight Financials 30% 25% 3% 2% Tech 50% 50% 2.5% 2% Energy 20% 25% 4% 3.5% Total 100% 100% 1.15% 1.375% Pure Within Interaction Total Value Added Pure Allocation: Assuming benchmark returns, determine the affects of weighting decisions = (W Pi W i ) (r i r ) 5 Micro Attribution Weight weight Pure Financials 30% 25% 3% 2% 0.168% Tech 50% 50% 2.5% 2% 0% Energy 20% 25% 4% 3.5% 0.106% Total 100% 100% 1.15% 1.375% 0.274% Within Interaction Total Value Added Within Selection: Assuming benchmark weightings, determine the affects of security selection decisions = W i (r Pi r i ) 6 3

4 Micro Attribution Weight weight Pure Within Financials 30% 25% 3% 2% 0.168% 0.25% Tech 50% 50% 2.5% 2% 0% 0.25% Energy 20% 25% 4% 3.5% 0.106% 0.125% Total 100% 100% 1.15% 1.375% 0.274% 0.125% Interaction Total Value Added Allocation/Selection Interaction: Assuming all differences between the portfolio and benchmark are in play = (W Pi W i ) (r Pi r i ) 7 Micro Attribution Weight weight Pure For the exam: 1. Calculate the effect for the sector. 2. Calculate the total effect. 3. Interpret where the manager added/lost value. Within Interaction Total Value Added Financials 30% 25% 3% 2% 0.168% 0.25% 0.05% 0.468% Tech 50% 50% 2.5% 2% 0% 0.25% 0% 0.25% Energy 20% 25% 4% 3.5% 0.106% 0.125% 0.025% 0.006% Total 100% 100% 1.15% 1.375% 0.274% 0.125% 0.075% 0.22% 8 4

5 Arithmetic vs. Geometric Arithmetic implies simple addition and subtraction of numbers (in this case, returns). Geometric operations imply multiplication and division of numbers, such as TWR = (1 + r 1 ) (1 + r 2 ) (1 + r n ) 1 Arithmetic operations are easier to calculate and understand, but geometric operations are more correct when dealing with returns. Arithmetic is what leads to the compounding effect of fees 9 Geometric Attribution Pure Allocation: = Same as Brinson & Fachler, but uses geometric excess return. (1 + ) (1 + ) 1 (1 + ) Combines Stock Selection and Interaction effects. Does not use benchmark weights Semi Notional benchmark return tells you what you what the portfolio weightings would have returned if entirely invested in benchmark securities.* Selection/Interaction = 10 5

6 Multi Period Attribution Arithmetic attribution cannot be added over time to produce multi period attribution. Smoothing algorithms can correct for this estimation error, and allow the use of arithmetic attribution over multiple periods. The derivation of the formulas is not essential to calculate and explain 11 Cariño smoothing Smoothing factor: Revised Attribution w/ Smoothing: * Can be used for any length of period Working with natural logs: Enter: LN or 1.2 LN * Remember to use some mental math to save you keystrokes! 12 6

7 GRAP Formulas appear confusing, so let s try a conceptual approach: Every attribute in each period is scaled or buffered by geometricallylinking any portfolio returns for preceding periods, and benchmark returns for subsequent periods. P1 = A (1 + b2) (1 + b3) (1 + b4) P2 = (1 + r1) A (1 + b3) (1 + b4) P3 = (1 + r1) (1 + r2) A (1 + b4) P4 = (1 + r1) (1 + r2) (1 + r3) A 13 Multi period Attribution Effects This is merely an extension of the processes we just learned. Geometric Excess returns for a period can be compared by: 1 Individual sectors can be geometrically linked to get excess returns over a quarter or year. Attributes for the year still reconcile with the total geometric excess return. 14 7

8 Multi period Attribution Summary Arithmetic: Simple, intuitive, and attribution effect add up to the arithmetic excess return. Over multiple periods, attribution effects do not add up. Geometric: More complex and less intuitive. Attribution effects geometrically link to the geometric excess return. Can be used over multiple periods. More mathematically accurate. 15 K&S Multicurrency Attribution Simple currency management just uses allocation decisions. Active currency management will hedge currency exposure, using futures or forward contracts. If a currency exchange rate is completely hedged, you are assumed to return the risk free rate of the country. 16 8

9 K&S Multicurrency Attribution 1. Benchmark Premium: Assumes benchmark returns and weights, but subtracts the local interest rate. Therefore, it isolates just the benchmark premium, above the local interest rates (i.e., assumes currency hedging). 2. Currency + Interest Benchmark : This isolates the return due only to market allocation (currency + local interest rates). This is still not considering currency hedging activity. 17 K&S Multicurrency Attribution 1. Allocation Effects: Similar to other attribution models, but sector/country return subtracts local interest rates, and is compared against the Benchmark Premium. 2. Selection Effects: Uses portfolio weights, and compares the excess portfolio return over the local interest rate, to the benchmark return over the local interest rate. 3. Currency Management 18 9

10 K&S Multicurrency Attribution 3. A Currency Management component is thrown in, and is divided between the underlying investments, and the forward contracts: A. Currency Management of Underlying: Market allocation decisions, times the excess of currency + interest rate returns, over the Currency + Interest Benchmark. Notice the similarities/difference to the Allocation component. B. Currency Management of Forward Contracts: Just like the underlying, but analyzing the Forward weighting differentials. 19 K&S Multicurrency Attribution Finishing up: Total Currency Management effects is the sum of the management effects for underlyings and forwards. Excess return for each country is sum of Allocation, Selection, and Currency Management. Sum of the excess component returns equals the arithmetic excess of over the Benchmark. Know how to calculate the total returns of the portfolio and benchmark! 20 10

11 Naïve Currency Attribution Uses geometric attribution again. Provides a shortcut to calculate currency allocation effects, without calculating the individual country effects. Needs the Semi Notional Benchmark return again (portfolio weights times benchmark local returns). Allocation and Select effects are same as single currency geometric attribution. Also needs portfolio and benchmark returns in base currency 21 Naïve Currency Attribution Pure Allocation: = Same as before Selection/Interaction: (1 + ) (1 + ) 1 (1 + ) Same as before Currency Management 1. Calculate and Benchmark market returns in Base Currency: r DC = r FC + r FXdirect + (r FC r FXdirect ) 2. Currency is geometric difference between portfolio base currency return, and portfolio local currency return. 3. Currency Management is geometric difference between portfolio currency return, and benchmark currency return

12 Holdings vs. Transactions Holdings based Attribution Simple to implement Less data needed Does not account for holdings adjustments. returns will not reconcile with actual portfolio. Transaction based Attribution Most complete form of attribution. Includes impact of transaction costs. More data intensive. Can reconcile with actual portfolio returns. 23 Security Level Attribution Appropriate for bottom up stock pickers. Performed exactly like Geometric Attribution, except: Asset Allocation Stock Allocation Stock Selection Timing s = Benchmark returns, except when transaction occur

13 Off benchmark Attribution Two scenarios presented: 1. Security selected for its own merits: Conduct attribution as normal, but substitute the total benchmark return (unadjusted) in any place where the sector benchmark return would be needed. 2. Allocation is added outside the benchmark, and securities are researched to fill the position Conduct attribution as normal, but you must find an index to act as a proxy for the security. Attribution formulas are standard geometric approach