Core Focus: The methodology of performance attribution, the decomposition of excess returns into duration, curve, spread, and security selection components, and the empirical evidence from the ECB’s reserve managers.
In-Depth Notes:
Performance attribution is the analysis of the sources of excess returns relative to the benchmark. It provides a detailed understanding of how portfolio managers generated (or lost) value, enabling better assessment of manager skill and the effectiveness of investment strategies .
The Attribution Framework:
Research has developed a novel framework to attribute the excess returns obtained by fixed-income portfolio managers to typical active strategies: (1) duration, (2) curve, (3) spread, and (4) security selection . This framework allows for a granular decomposition of performance:
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Duration Contribution: Returns generated by positioning the portfolio’s interest rate sensitivity (duration) differently from the benchmark. If a manager expects rates to fall, they may extend duration; if they expect rates to rise, they may shorten it.
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Curve Contribution: Returns generated by taking positions on the shape of the yield curve. This involves overweighting or underweighting specific maturity segments relative to the benchmark.
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Spread Contribution: Returns generated by taking positions on credit spreads or other spread products (e.g., corporate bonds, agency debt) relative to government bonds.
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Security Selection Contribution: Returns generated by selecting specific securities within an asset class that outperform the average for that class. This reflects the manager’s ability to identify mispriced securities.
Empirical Evidence from the ECB:
Applying this model to the group of reserve managers investing the ECB’s official reserves in US dollars (worth around $43 billion) in the period 2006-2010 yielded important findings . Among the performance layers, the spread contribution seemed the most relevant; curve and duration bets, with some exceptions, provided little value added . The ECB reserve managers displayed a positive ability at security selection overall. Two portfolio managers showed market timing ability after adjusting for the non-linearity of the benchmark returns. For one portfolio manager, market timing ability was significantly related to the efficient use of public information .
Diversified Investment Styles:
The analysis supported the view that portfolio managers adopt diversified investment styles. This may explain the non-negligible result of the aggregate reserve portfolio, averaging 10 basis points on an annual basis, net of transaction costs. The more diversified the investment styles are, the more likely it is that portfolio managers make independent bets, which in turn may positively affect the risk-adjusted return of the aggregate portfolio .