Wednesday, November 4, 2009

"New" attribution effects - I

We recently met with a client for whom we're designing a fixed income attribution system. During our meeting the subject of the "pricing" or "price difference" effect came up. This effect identifies the impact when the portfolio and benchmark have different prices for the same security. This is more likely to happen with bonds, because (a) they're less liquid and (b) for the most part they aren't exchange traded, so we probably won't have market prices for most of them.

The conundrum firms face when they encounter different prices is how to deal with them: should they reprice the benchmark with the portfolio's prices or vice-versa? Neither of these options is very good: if you reprice the benchmark, then its return won't match what's published; if you reprice the portfolio then you're using prices which you don't feel are correct and you won't match the return that may be shown in other reports.

The "pricing effect" is a better way to deal with this as it provides visibility without altering returns. It may, however, raise questions which you'll have to be prepared to answer. And, it can only be done if you have the benchmark's constituents (if you don't, then you won't be able to identify pricing inconsistencies).

This topic deserves more detail then we can provide here, so I'll take it up in our newsletter. Stay tuned!

1 comment:

  1. I'm sure you know there are two school of thoughts related to an attribution report: 1) design for external usage (base on market expectation or client needs), and 2) for internal usage (base on portfolio strategy). In my opinon, for external usage, it should be design so that is familiar with the market or client needs. The internal usage should be an extension of the external design report.

    I believe the market seems to be in favor of a BF model analysis for both equity and balance portfolios. I, however, do not find this model to be usedful because clients intrepret the result based on BHB model. Why is that? I simply don't know.

    If you're planning to reintroduce a new model, plese remember to keep it simple. A fixed income attribution could easily have over 100+ factors. Is it helpful to the client or investor to know all the factors?


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