Practical Portfolio Performance Measurement and Attribution, Second Edition

7

Fixed Income Attribution

His priority did not seem to teach them what he knew, but rather to impress upon them that nothing, not even . . . knowledge, was foolproof.

J.K. Rowling (1965-) Harry Potter and the Order of the Phoenix

 

Gentlemen prefer bonds.

Andrew Mellon (1855-1937)

 

The investment decision process for bond managers is very different from that of equity managers, therefore for most fixed income investment strategies the standard Brinson model is not suitable. Bonds are simply a series of defined future cash flows which are relatively easy to price. Fixed income performance is therefore driven by changes in the shape of the yield curve. Systematic risk in the form of duration is a key part of the investment process. Fixed income attribution is, in fact, a specialist form of risk-adjusted attribution

THE YIELD CURVE

The yield curve is a graph of various bond redemption yields against term to maturity; a snapshot of current market yields. Portfolio managers will seek to add value by anticipating the changing shape of the yield curve over time.

Figure 7.1 shows a typical yield curve. At the short end of the curve to the left the starting point is short-term interest rates, to the right yields gradually increase since we expect greater risk over longer periods; in this example the yield curve is sloping upwards. The actual shape of the yield curve will reflect any expected changes in short-term rates and the risk premium for holding long-term assets. An inverted ...