Introduction
FIA is a powerful and flexible tool for running bottom-up attribution on fixed income portfolios of all types. But the program also offers a wide range of top-down attribution options, such as
- multi-level Brinson attribution on equity portfolios;
- hybrid attribution for balanced portfolios, in which equity and fixed income risks are measured in the same report;
- Brinson attribution on carry or credit return;
- duration allocation on curve and spread returns, including Duration-Times-Spread (DTS) analysis.
Allocation attribution is based on the idea of a classification. A classification simply labels a security as being of a particular type. For instance, a security might be classified by country, industry type or sector group. Click here for more information on how classifications are set up.
FIA sets up some partitions automatically based on security master data, including currency, credit rating, duration and maturity buckets. Duration and maturity bucket holdings are calculated taking into account the passage of time and changes in market conditions.
Brinson attribution
Once your classifications are set up, assign the name of the classification you want to use for attribution to BrinsonAllocationSectors in the configuration file. For instance,
BrinsonAllocationSectors = Country
will use Country as the basis for a Brinson attribution analysis.
Equity securities do not generate return from any of the usual sources of fixed income return. FIA therefore allocates all their return to residual. In an equity context, residual return should be labelled as stock selection, so override the default value of ResidualReturnLabel:
ResidualReturnLabel = Stock selection
Be aware that FIA's performance reports will now only show active return, rather than absolute and relative portfolio and benchmark return. A portfolio’s asset allocation return is only defined relative to a benchmark, so in this case only active attribution return has meaning.
If you choose to run Brinson attribution, the overall active return of the portfolio against the benchmark is unchanged. Brinson attribution simply decomposes returns in a new way, without affecting the overall return.
Multi-level Brinson attribution
Portfolio managers often make asset allocation decisions at several levels. For instance, an investment committee might decide how much capital to invest in different geographical regions, leaving individual managers to decide on allocation by industry sector or country. In this case, the Brinson model will measure the return generated by each level of decision.
To model this process in FIA, simply provide the names of the relevant partitions in the required order, separated by commas. For instance, if the first decision level is Country and the second is Sector, enter
BrinsonAllocationSectors = Country, Sector
in the configuration file. FIA will then generate an attribution report with returns due to country allocation, sector allocation and stock selection.
There is no limit to how many classification levels can be used, although it is unusual to use more than three or four in an attribution analysis.
Variants of the Brinson model
FIA supports two variants of the Brinson allocation algorithm: Brinson-Fachler (BF) and Brinson-Hood-Beebower (BHB). To set up the version you require, set BrinsonModel to BF or BHB in the configuration file.
If you leave BrinsonModel undefined, FIA uses Brinson-Fachler attribution by default.
Interaction attribution
FIA also calculates interaction return, if required, by setting
InteractionAttribution = true
This switch allows you to display interaction return separately, or to combine it with stock selection return. The latter approach is sometimes known as the Parilux approach. If InteractionAttribution is active, interaction return is shown as a separate source of active return in all your reports.
Hybrid attribution for fixed income portfolios
In some cases, a fixed income portfolio manager may make a combination of top-down asset allocation decisions together with bottom-up decisions around curve movements and credit spreads. For instance, a global fixed income fund manger might make an asset allocation decision by country, as well as positioning assets in each country against expected credit spread movements.
FIA makes this case straightforward to model. Simply assign the name of a classification to BrinsonAllocationSectors, just as for an equity portfolio. Your attribution report will now show an additional source of return due to asset allocation, in addition to the usual sources of fixed income return. Note that fixed income returns will be adjusted to take this new source of return into account. Also, attribution reporting will only show active portfolio return, rather than absolute portfolio and benchmark return.
Hybrid attribution supports multiple levels of asset allocation decisions, and all the other features described above.
Brinson attribution on fixed income subreturns
Occasionally you may wish to apply Brinson attribution to particular sources of return, while leaving other returns untouched. For instance, one variant of the Campisi fixed income model applies asset allocation attribution to bond credit returns, while leaving return due to carry and risk-free curve movements unchanged.
FIA supports this type of analysis on both carry return and credit returns, at multiple levels if required, by using the CarryAllocationSectors or ResidualAllocationSectors variables. For instance, suppose we regard the return generated by a portfolio that is not due to carry or risk-free curve movements as credit-driven. This credit return can then be decomposed into asset allocation returns by country and stock selection returns by setting
ResidualAllocationSectors = Country
in the configuration file.
Note that this type of analysis cannot be combined with a full Brinson analysis. Also, FIA does not calculate interaction return for such subreturns.
Duration allocation attribution
Brinson attribution measures the effect of over- or under-weighting portfolio sectors against benchmark, In this context, weight means market weight. However, there are other ways to define the exposure of a sector, of which the most widely used is duration weight, or interest rate exposure.
Suppose a manager decides to assign extra duration weight to a particular market sector. In this case, its exposure to changes in interest rates will be higher than the corresponding sector in the benchmark. If interest rates fall in that sector, the decision to add duration weight will generate outperformance.
Duration allocation attribution (or DAA) is a technique to measure the returns generated by this type of strategy. While DAA has clear parallels with Brinson attribution, there are some extra complications that arise from the additional degree of freedom available in taking duration decisions. In particular, the market allocation of portfolio and benchmark must always be one, but there is no such constraint on the durations of portfolio and benchmark, which can have any value.
The result is that three types of return arise in a duration allocation analysis, rather than the two types (asset allocation and stock selection) of return from a Brinson analysis:
- Market direction return
- Duration allocation return
- Stock selection return
Just as for Brinson attribution, existing curve returns are assigned to stock selection and are rescaled. For instance, if you previously measured the effects of shift and twist movements in the curve, then overlaying a DAA analysis will rescale the overall return from curve movements into return from market direction, duration allocation, and shift and twist returns.
Setting up such an analysis in FIA is straightforward. For duration allocation, set the variable CurveAllocationSectors to one or more classifications. For instance, to use duration buckets for DAA, set
CurveAllocationSectors = Duration
in the configuration file.
Duration allocation attribution only applies to returns generated by movements in yields. Returns due to carry, or FX returns, are unaffected. It is therefore possible to run Brinson attribution on carry returns, and duration allocation attribution on curve returns, in the same analysis.
Spread duration attribution
Spread duration attribution works in a very similar way to duration allocation attribution. The main difference is that returns are generated by changes in security spreads, rather than by movements in the underlying curve.
To run a spread duration analysis, set SpreadAllocationSectors to one or more classifications.
Duration times spread (DTS)
To convert a spread duration analysis to a duration-times-spread (DTS) analysis, set
DTS = true
If required, duration allocation and spread duration allocation attribution can be combined in the same reports.
Restrictions
FIA allows either
- Brinson attribution over all sources of return, or
- any combination of carry allocation, residual allocation, curve allocation and credit allocation.
In other words, Brinson attribution cannot be combined with any of the other allocation analyses listed here. This is unlikely to cause any problems in practice, since the benefit of running both types of analysis together is minimal.
Summary
FIA supports the following types of allocation attribution:
- Brinson (includes hybrid)
- Carry allocation
- Credit allocation
- Duration allocation
- Spread allocation
- Duration times spread