Factor Attribution of Bond Portfolio Return. A sample assignment is attached.2012 Vol. 1 Bond...

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Factor Attribution of Bond Portfolio Return. A sample assignment is attached.

2012 Vol. 1 Bond Performance Attribution SEB Asset Management Editorial SEB Asset Management SEB-huset Bernstorffsgade 50 1577 Copenhagen V Phone: +45 33 28 14 00 Authors: Portfolio Manager, TAA: Peter Lorin Rasmussen Phone: +45 33 28 14 22 E-mail: [email protected] Portfolio Manager, Fixed Income: Michael Denbæk Phone: +45 33 28 14 53 E-mail: [email protected] Portfolio Manager, Fixed Income & TAA: Tore Davidsen Phone: +45 33 28 14 25 E-mail: [email protected] This document produced by SEB contains general marketing information about its investment products. Although the content is based on sources jud- ged to be reliable, SEB will not be liable for any omissions or inaccuracies, or for any loss whatsoever which arises from reliance on it. If investment research is referred to, you should if possible read the full report and the disclosures contained within it. Information relating to taxes may become outdated and may not fit your individual circumstances. Investment products produce a return linked to risk. Their value may fall as well as rise, and historic returns are no guarantee of future returns; in some ca- ses, losses can exceed the initial amount invested. Where either funds or you invest in securities denominated in a foreign currency, changes in exchange rates can impact the return. You alone are responsible for your investment decisions and you should al- ways obtain detailed information before taking them. For more information, please see the relevant simplified prospectus for the funds, and the relevant information brochure for funds and for structured products. If necessary you should seek advice tailored to your individual circumstances from your SEB advisor. SEB is under supervision by Finanstilsynet in Denmark. Skandinaviska Enskilda Banken A/S, Bernstorffsgade 50, 1577 København V Disclaimer Table of Contents Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Price Source and Mortgage Model . . . . . . . . . . . . . . . . . . . . . . . 3 Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Time (Carry). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Curve. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 OAS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Residual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Return Attribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Performance Attribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Attribution Over Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Appendix - Calculation of Return Contributions . . . . . . . . . . 12 Page 3 Introduction Price Source And Mortgage Model In this note we present our fixed income return attribution model. The pur- pose is to explain how to interpret the numbers and what you can and can- not do with them. With this knowledge the model becomes an invaluable tool in the communication between the portfolio manager and the client. It quantifies the contribution to the portfolio return from changes to the yield curve, volatility, option-adjusted spreads; as well as the contribution from time (carry). In short, it quantifies the effect of our active positioning. Furthermore, if a benchmark is associated with the portfolio, it allows us to quantify the contribution from the above-mentioned effects on the relative return (i.e. the difference between the return on the portfolio and the ben- chmark). The purpose of this note is not to describe the underlying mathematics of our mortgage bond model; see the appendix for this. However, in order to clarify certain aspects we are forced to describe some tools that we use. We do hope that you, as the reader, is not intimidated by this, and the essence of the model should not be lost even though a couple of the mathematical expressions might seem exotic. Not surprisingly, most clients will find that the primary return driver, besides carry, is changes to the yield curve. In other words the shifts, steepenings and bends of the curve. In addition most clients should, if all goes well, find a considerable pickup in the OAS component. This is the component that can most honestly be attributed our ability to select the right bonds in the Danish mortgage bond segment. Before we dive into the actual model there are a couple of potential caveats which we shall mention. First, the pricing source for the model is SEB Merchant Bank. This should not matter for the portfolio returns, as it is the same source that we use for standard reporting. However, it may matter for the benchmark return. So for example if we report a return on an EFFAS index, it might not be the same return that one would find on the official EFFAS pricing source (i.e. Bloom- berg). In practice however the difference should be minimal - especially over longer periods of time. Second, to calculate the option-adjusted spread (OAS) and volatility effects for Danish mortgage bonds, an advanced statistical mortgage bond model must be used. Being a forward looking model the output (i.e. MOAD, OAS, OAC) is based on statistical estimates. In SEB, we have our own proprietary mortgage model, which has a long history of persistently performing better than our competitors. Page 4 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 0 0.5 1 1.5 2 2.5 3 3.5 Ac cu m ul at ed re tu rn c on tr ib ut io n, % PF BM Factors Time (Carry) The model attributes the return of all relevant bonds to five main compo- nents. A time effect (carry), a curve effect, a volatility effect, an OAS effect, and finally a residual. We calculate

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FACTOR ATTRIBUTION OF BOND PORTFOLIO RETURN
FACTOR ATTRIBUTION OF BOND PORTFOLIO RETURN
Student Name –
Student ID –
Unit –
Referencing - Harvard
Words - 3052
Contents
1. INTRODUCTION:	2
2. PRICE SOURCE AND MORTGAGE MODEL:	3
3. FACTORS:	3
4. TIME (CARRY):	4
5. CURVE:	5
6. VOLATILITY:	7
7. OAS:	8
8. RESIDUAL:	10
9. RETURN ATTRIBUTION:	10
10. PERFORMANCE ATTRIBUTION:	12
11. ATTRIBUTION OVER TIME:	14
12. SUMMARY:	15
APPENDICES:	16
REFERENCES:	16
1. INTRODUCTION: 
This article is mainly on the factor attribution of bond portfolio return. It is important to understand the return from a particular portfolio of bond in order to compare if the return are worth as per the risk. So, return of the individual securities is decomposed to understand the source and the amount of risk available on that particular security (Daul, Sharp and Sørensen 2010).   
In this article fixed income of the chosen organization, SEB Asset Management has been analyzed from the perspective of attribution model. The numbers will be interpreted to calculate different attributes. This model will help the portfolio manager to establish a communication with the clients. The changes in the contribution from time (carry), yield curve and volatility have been scrutinized to get the return from the particular portfolio. In case of benchmarked portfolios, relative return has also been taken into account to understand the full effect of contribution. The return has also been measured in terms of attribution over time to get the time value of money. Ultimately, the current active positioning will be depicted. 
The purpose of this article is not just defining the mathematical calculations for the return but to present different performance measures and the tools used to enhance different aspect of the portfolio. Some mathematical expressions are little technical but has been presented for the ease of understanding.   
It can be assumed that the readers of this article will be mostly interested in finding the time (carry) along with primary driver for return that is changes in the yield curve in the form of bends, steepening and shifts of the curve. Volatility and OAS has also been calculated for the ease of the understanding of the readers since OAS is very helpful in determining the right kind of bond portfolio from a wide variety of options available. 
2. PRICE SOURCE AND MORTGAGE MODEL: 
There are some limitations to this article which needs to be mentioned before proceeding to the actual model. The prices used in this article have been directly taken from the chosen organization, SEB Merchant bank. The source is used for standard reporting and so can be easily used for portfolio return. But contradiction might arise for benchmark return. So, the pricing figures used for this article might differ from pricing used by official EFFAS or Bloomberg. So, the returns reported in this article might differ from the returns of EFFAS index. But over a long period of time, the differences have the chance of getting minimized. But in the short run, there are high chances that the differences will stay. 
The next limitation is that the outputs have been calculated based on the statistical estimates using the forward looking model like MOAD, OAS, OAC where actually to calculate effects of volatility and option-adjusted spread (OAS) for mortgage bonds of Danish, the model which should be used is an advanced statistical mortgage bond (Kariya, Ushiyama and Pliska 2011). But often proprietary model has proved to be as useful as most of the other models in use.    
3. FACTORS: 
The focus has been maintained on the main five components of the return attributes (Beaver, Correia and McNichols 2012) which are effect of time (carry), effect of a curve, effect of volatility, effect of an OAS and effect of residual. All the components are co-related to each other and can give a combined effect. So, the return of the bond can be calculated by adding up the percentage return of the above mentioned five components. 
In this article, each of the five components has been discussed separately, so understand the individual effect and in the end the summation effect has been given to understand the return of bond. 
4. TIME (CARRY): 
This attribute helps to understand the return to be obtained from the bond with the passage of the time keeping all the other factors static including option-adjusted spread, volatility and the yield curve. So, this attribute helps to understand the time value effect on the return of the bonds (Favero, Pagano and Von Thadden 2010). Generally over the period of time, this attribute creates a linear effect. 
In the following figure, the mutual funds and the chosen benchmarks of the organization which has been taken into account, SEB Asset Management. The past records prove that thee carrying amount of the government bonds are not at par with the carrying mount of mortgage bonds. The internal sources of the organization revealed that a difference exist between the benchmark and the carrying value of the portfolios which can be due to the fact that the benchmarks are mostly consist of Danish government bonds and the organization is mostly exposed to the mortgage bonds and not to the Danish government bonds. 
                                   
Figure 1: The accumulated carry effect or Accumulated return contribution % for the year 2019 (SEB 2020).
5. CURVE: 
This attribute takes into consideration the return from the changes in the yield curve. This attribute can be subdivided into four parts, which are as follows (Guibaud, Nosbusch and Vayanos 2013):
· Effect of shift: This effect is being created due to shifting of the yield curve in the parallel way.
· Effect of steepness: This effect is being created due to the change in the slope of the yield curve that is change in the steepness. 
· Effect of curvature: This effect is being created due to change in the curvature of the yield curve. 
· Residual: This takes into account the remaining changes of the yield curve. The above mentioned three effects cover the vital portion of the yield curve variance, rest of the small variations are cover under this effect. The movement of the yield curve is reviewed periodically for a proper observation.
The total effect of the change in the curve is the summation of all the four effects mentioned above that is decomposition of singular effect lead to the full effect. Considering the individual effect of the above mentioned factors helps to understand the total change in the return attributes. 
Although the yield curve attribute is already very important to calculate the return of the bond portfolios yet as the volatility of the yield curve increases its important increases even more since then it takes over the time (carry) effect.

2012 Vol. 1 Bond Performance Attribution SEB Asset Management Editorial SEB Asset Management SEB-huset Bernstorffsgade 50 1577 Copenhagen V Phone: XXXXXXXXXX Authors: Portfolio Manager, TAA: Peter...

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