Shedding Light on Fixed-Income Performance Attribution

Fixed-income attribution explains the sources of a manager’s active return. A complex process, attribution can be challenging to implement and often plagued by large, unexplained residual returns. Understanding the assumptions underlying a manager’s attribution model and their relation to the investment process, along with a qualitative assessment, can help determine how well the attribution reflects the manager’s decision-making skills and provide a clearer picture of performance. R isk-adjusted performance metrics, such as the Sharpe ratio, the information ratio, and tracking error, can indicate how much risk a manager took and how well that risk taking was rewarded. Such metrics do not, however, specify how the risk was taken or whether that risk was consistent with the manager’s investment process. Performance attribution reconciles the portfolio’s active return—the performance relative to the benchmark—with the manager’s active decisions. Thomas Seay, managing director of research at Hart land & Co., an independent investment consulting firm, evaluates managers’ attribution in conjunction with their performance. “I like to see if a manager’s stated alpha sources are borne out with attribution,” says Seay. “We want to ensure that the manager is managing money in a manner consistent with why we hired them. If we hire a manager whose investment process is based on bottom-up fundamental analysis, we want to see the security selection come through in the decision-making process.” An important tool not only for consultants and clients, attribution also provides valuable feedback to portfolio managers on the sources of performance, whether the active return was intentional, and whether their decision making yielded the anticipated results. Attribution methodologies for equities are relatively standard, but fixedincome investors face a myriad of attribution choices and challenges. Understanding issues inherent in fixed-income performance methodologies can lead to more informative performance assessments.