Practical Portfolio Performance Measurement and Attribution

Cover
Title Page
Copyright
Contents
Acknowledgements
1 Introduction
	Why Measure Portfolio Performance?
	The Performance Measurement Process
	The Purpose of This Book
	The Role of Performance Analysts
	Book Structure
2 The Asset Management Industry
	Asset Classes
	Public Equities
	Bonds (or Fixed Income)
		Cash (and near cash)
	Private Assets
		Real estate
		Private equity
		Private debt
		Infrastructure
		Natural resources
	Commodities
	Derivatives
		Futures
		Forwards
		Swaps
		Options
		Option price sensitivity (the Greeks)
		Warrants
		Convertible bonds
		Contracts for difference (CFDs)
		Overlay strategies
	Currency
	Hedge Funds
	Asset Allocation
		Strategic asset allocation
		Tactical asset allocation
3 The Mathematics of Portfolio Return
	Simple Return
	Continuously Compounded (or Logarithmic) Returns
	Money‐weighted Returns (MWRs)
		Internal rate of return (IRR)
		Ex‐ante internal rate of return
		Simple internal rate of return
		Ex‐post internal rate of return
		Simple Dietz
		ICAA method
		Modified Dietz
	Time‐weighted Returns (TWRs)
		True time‐weighted
		Unit price method
		Unit price method with distributions
	Time‐weighted versus Money‐weighted Rates of Return
	Approximations to the Time‐weighted Return
		Index substitution
		Regression method (or β method)
		Analyst\'s test
	Hybrid Methodologies
		Linked modified Dietz
		BAI method (or linked IRR)
	Which Method to Use?
		Late trading and market timing
	Self‐selection
		Large Cash Flow
		Self‐selection of methodologies
	Annualised Returns
		Since‐inception internal rate of return (SI‐IRR)
		Modified IRR (MIRR)
		Return hiatus
	Gross‐ and Net‐of‐fee Calculations
		Estimating gross‐ and net‐of‐fee returns
		Initial fees
		Performance fees
		Asymmetric or symmetric
		Crystallisation
		Performance fees in practice
		Equalisation
		Reporting hierarchy
	Overlay Strategies
		Overlay performance return calculations
	Base Currency and Local Returns
		Currency conversions
	Hedged Returns
		Currency overlay returns
		Perfectly hedged returns
	Portfolio Component Returns
		Money‐weighted component returns
		Time‐weighted component returns
		End of day
		Beginning of day
		Intra‐day weighted
		Differentiated
		Actual time
		Rule‐based
		Extremely large cash flows
		Which timing assumption to use for time‐weighted returns?
		Carve‐outs
		Sub‐portfolios
		Cash sectors
		Individual security returns
		Multi‐period component returns
		Abnormal returns
		Short positions
	Contribution to Return
	Composite Returns
4 Benchmarks
	Benchmarks
		Benchmark attributes
		Best benchmark practice
	The Role of Benchmarks
	Types of Benchmarks
	Commercial Indexes
		Calculation methodologies
		Aggregate price index (price‐weighted index or Carli type)
		Geometric (or Jevons type) index
		Market capitalisation index
		Laspeyres index
		Paasche index
		Marshall–Edgeworth index
		Fisher index
		Equal‐weighted indexes
		Fundamental indexes
		Optimised indexes (efficient or minimum variance indexes)
		Style‐ and factor‐based indexes
		Fixed income indexes
		Index providers
		Choice of index provider
		Self‐indexing
		Benchmark regulation
		Choice of index
		Currency effects in benchmarks
		Hedged indexes
	Customised Indexes
		Capped indexes
	Peer Groups and Universes
		Percentile rank
	Random Portfolios
	Exchange‐traded Funds (ETFs)
	Target Returns
	Blended Benchmarks (or Balanced Benchmarks)
		Fixed‐weight and dynamised benchmarks
	Spliced Indexes
	Money‐weighted Benchmarks (or Public Market Equivalents)
	Normal Portfolio
	Benchmark Statistics
		Index turnover
		Up‐capture indicator
		Down‐capture indicator
		Up‐number ratio
		Down‐number ratio
		Up‐percentage ratio
		Down‐percentage ratio
		Percentage gain ratio
	Excess Return
		Arithmetic excess return
		Geometric excess return
5 Risk
	Definition of Risk
		Risk types
		Risk management versus risk control
		Risk aversion
		Ex‐post and ex‐ante
	Descriptive Statistics
		Mean (or arithmetic mean)
		Mean absolute deviation (or mean deviation)
		Variance
		Bessel\'s correction (population or sample, n or n – 1)
		Sample variance
		Standard deviation (variability or volatility)
		Annualised risk (or time aggregation)
		The central limit theorem
		Frequency and number of data points
		Normal (or Gaussian) distribution
		Histograms
		Skewness (Fisher\'s or moment skewness)
		Sample skewness
		Kurtosis (Pearson\'s kurtosis)
		Excess kurtosis (or Fisher\'s kurtosis)
		Sample kurtosis
		Bera‐Jarque statistic (or Jarque‐Bera)
		Covariance
		Sample covariance
		Correlation (ρ)
		Sample correlation
	Performance Appraisal
		Sharpe ratio (reward to variability, Sharpe index)
		Roy ratio
		Risk‐free rate
		Alternative Sharpe ratio
		Revised Sharpe ratio
		Adjusted Sharpe ratio
		Skew‐adjusted Sharpe ratio
	Relative Risk
		Tracking error (or tracking risk, relative risk, active risk)
		Information ratio
		Geometric information ratio
		Modified information ratio
	Regression Analysis
		Regression equation
		Regression alpha
		Regression beta
		Regression epsilon
		Capital asset pricing model (CAPM)
		Beta (β) (systematic risk or volatility)
		Jensen\'s alpha (Jensen\'s measure or Jensen\'s differential return or ex‐post alpha)
		Annualised alpha
		Bull beta (????+)
		Bear beta (????−)
		Bear beta (&rmbeta;−)
		Beta timing ratio
		Market timing
		Systematic risk
		Correlation
		R2 (or coefficient of determination)
		Specific (or residual) risk
		Treynor ratio (reward to volatility)
		Appraisal ratio (or Treynor‐Black ratio)
	Factor Models
		Fama decomposition
		Selectivity
		Diversification
		Net selectivity
		Fama‐French three‐factor model
		Three‐factor alpha (or Fama‐French alpha)
		Carhart four‐factor model
		Four‐factor alpha (or Carhart\'s alpha)
		Multi‐factor models
	Drawdown
		Average drawdown
		Maximum drawdown
		Largest individual drawdown
		Recovery time (or drawdown duration)
		Drawdown deviation
		Ulcer index
		Pain index
		Calmar ratio (or drawdown ratio)
		MAR ratio
		Sterling ratio
		Sterling‐Calmar ratio
		Burke ratio
		Modified Burke ratio
		Martin ratio (or ulcer performance index)
		Pain ratio
	Partial Moments
		Downside risk (or semi‐standard deviation)
		Downside potential
		Pure downside risk
		Half variance (or semi‐variance)
		Upside risk (or upside uncertainty)
		Mean absolute moment
		Omega ratio (Ω)
		Bernardo and Ledoit (or gain–loss) ratio
		d ratio
		Omega–Sharpe ratio
		Sortino ratio
		Reward to half‐variance
		Downside‐risk Sharpe ratio
		Sortino–Satchell ratio
		Upside potential ratio
		Volatility skewness
		Variability skewness
		Farinelli–Tibiletti ratio
		Prospect ratio
	Fixed Income Risk
		Pricing fixed income instruments
		Redemption yield (yield to maturity)
		Weighted average cash flow
		Duration (effective mean term, discounted mean term or volatility)
		Macaulay duration
		Macaulay–Weil duration
		Modified duration
		Portfolio duration
		Effective duration (or option‐adjusted duration)
		Duration to worst
		Convexity
		Modified convexity
		Effective convexity
		Portfolio convexity
		Bond returns
		Duration beta
		Reward to duration
	Miscellaneous Risk Measures
		Hurst index (or Hurst exponent)
		Bias ratio
		Active share
		Value at risk (VaR)
	Risk‐adjusted Return
		M2
		M2 excess return
		Differential return
		Adjusted M2
		Skew‐adjusted M2
	Types of Excess Return (or Alpha)
	A Periodic Table of Risk Measures
		Periodic table design
		Why measure ex‐post risk?
		Which risk measures to use?
		Hedge funds
		Smoothing
		Outliers
		Data mining
		Time period
6 Return Attribution
	What Is Attribution?
		Definition
		Attribution as an asset management tool
		Early development
	Types of Return Attribution
		Returns‐based (regression or factor) attribution
		Holdings‐based (or buy/hold) attribution
		Transaction‐based attribution
	Arithmetic Attribution
		Brinson, Hood and Beebower
		Asset allocation
		Security (or stock) selection
		Interaction
	Brinson and Fachler
	Interaction
	Geometric Excess Return Attribution
		Asset allocation
		Stock selection
	Sector Weights
	Frequency of Analysis
		Security‐level attribution
		Transaction costs
		Off‐benchmark (or zero‐weight sector) attribution
		Attribution consistent with the investment decision process
		Market‐neutral attribution
		Attribution for 130/30 funds (or extended short funds)
		Leverage (or gearing)
	Attribution Including Derivatives
		Attribution including equity index futures
		Attribution analysis using options
	Multi‐currency Attribution
		Ankrim and Hensel
		Karnosky and Singer
	Geometric Multi‐currency Attribution
		Naïve currency attribution
		Compounding effects
		Geometric currency allocation
		Currency timing
	Interest Rate Differentials
		Revised currency allocation
		Revised country allocation
		Incorporating forward currency contracts
		Summarising
		Other currency issues
	Fixed Income Attribution
		The yield curve
		Yield curve analysis
		Carry
		Credit (or spread)
		Yield curve decomposition
		Wagner and Tito
		Weighted duration attribution
		Geometric fixed income attribution
		Campisi framework
		Yield curve decomposition
	Multi‐period Attribution
	Smoothing Algorithms
		Carino
		Menchero
	Linking Algorithms
		GRAP method
		Frongello
		Davies and Laker
		Multi‐period geometric attribution
		Annualisation of excess return
		Attribution annualisation
	Contribution Analysis (or Absolute Return Attribution)
	Risk‐adjusted Attribution
		Selectivity
	Multi‐level Attribution
		Balanced attribution
	ABOR, IBOR or PBOR
	Evolution of Performance Attribution Methodologies
7 Performance Presentation Standards
	Why Do We Need Performance Presentation Standards?
	Global Investment Performance Standards (GIPS®) – A History
	Advantages for Asset Managers
	The GIPS Standards
	Fundamentals of Compliance
		Definition of the firm
		Maintaining policies and procedures
		Providing GIPS Reports
		Benchmark selection
		Correcting errors in GIPS Reports
		Composite descriptions
		Record keeping
		Linking of theoretical and actual performance
		Portability
		Use of time‐weighted or money‐weighted returns
		Claiming compliance with the GIPS standards
	Input Data and Calculation Methodology
		Firm assets, composite assets and pooled fund assets
		Overlay exposure
		Returns
		Valuation
		Time‐weighted returns
		Money‐weighted returns
		Net returns
		Composite returns
		Private market investments
		Real estate
		Net‐of‐fees carve‐out returns
		Wrap fee, side pockets and subscription lines of credit
	Composite and Pooled Fund Maintenance
		Composite maintenance
		Carve‐outs
	Presentation and Reporting
		Composite time‐weighted return report
		Composite money‐weighted reports
		Composite since‐inception paid‐in capital
		Composite since‐inception distributions
		Composite cumulative committed capital
		Total value to since‐inception paid‐in capital (TVPI) or multiple of investment capital (MOIC) or investment multiple
		Since‐inception distributions to since‐inception paid‐in capital (realisation multiple or DPI)
		Since‐inception paid‐in capital to cumulative committed capital (PIC multiple)
		Residual value to since‐inception paid‐in capital (unrealised multiple or RVPI)
	Disclosures
		Claim of compliance
		Firm, composite and benchmark definitions
		Fee disclosures
		Inception date, creation date, availability of lists of composite policies and procedures, leverage and estimated transaction costs
		Significant events, redefinition, minimum asset levels and withholding tax
		Conflicts with regulation, carve‐out disclosures and subadvisors
		Benchmark disclosures
		Significant cash flow disclosure and material errors
		Risk measures, overlay strategy, real estate valuation and theoretical performance disclosures
	Sample GIPS Composite Report
	GIPS Advertising Guidelines
		Fundamental requirements of the GIPS Advertising Guidelines
		GIPS advertisements that do not include performance
		GIPS advertisements for composites
		GIPS advertisements for a broad distribution pooled fund
	Verification
		Performance examination
	Achieving Compliance
	Maintaining Compliance
	GIPS Standards for Asset Owners
8 Bringing It All Together
	Effective Dashboards
	Data Visualisation Tools
	Manager Selection
		Asset manager selection
		Manager evaluation
		Portfolio evaluation
		Monitoring and control
	The Four Dimensions of Performance
		Ex‐post return (the traditional dimension)
		Ex‐post risk (the neglected dimension)
		Ex‐ante return (the unknown dimension)
		Ex‐ante risk (the “sexy” dimension)
		Risk efficiency ratio
		Performance efficiency
	Risk Control Structure
	Risk Management
A Simple Attribution
	A.1 Attribution Methodology
		A.1.1 Scenario
		A.1.2 Portfolio returns
		A.1.3 Benchmark returns
		A.1.4 Semi‐notional returns
		A.1.5 Relative performance
	A.2 Stock Selection
	A.3 Asset Allocation
	A.4 Summary
B Multi‐Currency Attribution Methodology
	B.1 Scenario
		B.1.1 Portfolio returns
		B.1.2 Benchmark returns
		B.1.3 Semi‐notional returns
		B.1.4 Relative performance
	B.2 Stock Selection
	B.3 Asset Allocation
	B.4 Currency Effects
		B.4.1 Naïve currency performance
		B.4.2 Measured currency returns
		B.4.3 Compounding effects
		B.4.4 Currency attribution
		B.4.5 Cost of hedging
		B.4.6 Total currency effects
	B.5 Summary
Bibliography
About the Author
Index
EULA