2007 INSTITUTIONAL CLIENT CONFERENCE Innovative Leadership, Creative Solutions © 2007 Northern...

2007 INSTITUTIONAL CLIENT CONFERENCEInnovative Leadership, Creative Solutions

© 2007 Northern Trust Corporation

N O R T H E R N T R U S T

Simon Willcox

Attribution AnalysisAn integral part of the investment management program

Paul D’Ouville

2 Innovative Leadership, Creative Solutions

Presentation Overview

A comprehensive suite for asset servicing Plan Sponsors to asset managers

The attribution and data evolution A generational model A generational range of issues

The asset class / market evolution The ‘simplicity’ of Equities versus the realities of Fixed Income Desire for stock level analysis

Linking performance attribution and risk attribution From performance Attribution to risk adjusted performance attribution

Northern Trust’s development approach The core client requirements of an effective attribution toolkit Asset Owner versus Asset Manager needs

Current trends, future needs


A Comprehensive Suite for Asset Servicing

What has been the return on our assets?

Performance measurement (return, excess return, attribution)

By Manager

By consolidation (e.g. total plan / all passive portfolios / all active portfolios)

By asset class / region / country / sector / stock

Why have the assets performed that way?

Attribution Analysis

Asset Managers Has asset owner received expected performance, ‘true to label’ validation

How has each investment desk performed, consistency and validation of investment process, where to spend time on process

Have the desks interacted effectively (currency management)

Asset Owners

how have their decisions impacted performance, asset v liability monitoring


A Comprehensive Suite for Asset Servicing

Was this within our investment guidelines?

Compliance / Risk Monitoring

External investment restrictions (legal/regulatory).

Internal investment restrictions – placed on individual managers to limit overall plan risk

What risks did we take along the way and what type of risks lay ahead?

Risk Analysis

Ex-Post – Have we taken too much risk, or too little

Ex-Ante – Is our current risk exposure in line with our investment requirements

Asset owners and managers have a fiduciary responsibility to monitor their investments. What analysis is required to enable them to do this?


Attribution Objectives

Meets its purpose Maps to client’s objectives and fund managers’ investment process Accurate and timely delivery

Easily interpreted By clients with supplemental and meaningful commentary from fund managers By fund managers / marketing and sales By third parties /consultants receiving data from multiple sources

An aid to future investment decisions Complementary to in-house risk models and other front office systems Supports previous ex-ante analysis and asset / liability modelling

Automated Scalable Flexible

Each user may have a different purpose and level of understanding, but the output must be understandable and useful to all parties.


Northern Trust’s Approach to Supporting Clients’ Needs

Methodology and formulae Needed “returns based” approach to compliment existing excess return driven reporting Preferred industry standard methodology but wanted integration into infrastructure Algorithms programmed directly into core platform

Delivery and Frequency Daily service essential for asset managers – quantitative analysis and speedy turn around Monthly / quarterly service to compliment daily information – qualitative analysis with commentary Solution – on line reporting via Northern Trust Passport

Review of data integrity – “refining the process” Daily delivery can pinpoint implementation issues prior to month end Investment goals / processes can be reviewed more frequently Solution – daily performance, available daily

Integration in client reporting across segments Headline numbers and impacts needed to be highlighted in client reporting Solution – design and build client reporting blocs, marrying numbers with analysis

A full suite of attribution capabilities is a “must have” for all of clients from a precise methodology through to timely and meaningful reporting

7

The Data Evolution

Delivery implications within a Generational Model of performance delivery:

More detail

More frequency

Data intensity for all models

Cost of delivery

Performance and Risk

Performance Measurement

High Level

Performance Measurement

Detailed

Attribution High Level

Attribution Detailed

RiskOther Ex

Ante

Generation 1

Figures Production

Quarterly Quarterly

Generation 2

Added ValueMonthly Quarterly Quarterly Quarterly

Generation 3

Global Support

GIPS requirements

includedMonthly Monthly Monthly

Monthly with more

detail

Quarterly with more

detail

Generation 4

Focused Cost Centre

More detail

needed

Weekly / daily Monthly

Weekly / daily with more detail

Weekly / daily with

more proof of controls

Monthly with more

detail

Generation 5

Integrated Feedback

More interpretation, and link with attribution / risk

Weekly / daily -more interpretation than

production

Weekly / daily -more interpretation than

production

The development of the servicing of program management has been an evolutionary process and can be represented by five key generations.

Source: Investit Intelligence ‘Outsourced Performance Measurement for Investment Managers’

1990 - 94

1994 - 98

1998 - 2001

2001 - 03

2003 - now


Demands on Attribution Models Through ‘Diversification’

Portfolio, benchmark, broad assets, universes

Equities

Fixed Income

DATA

INTEGRITY

Portfolio, benchmark, broad assets to stock level

Policy / Balanced

Portfolio, benchmark, sensitivity to characteristics

Portfolio holdings and prices Contribution


The Asset Class and Market Evolution

Profile of markets are / have changedPeer groups versus custom benchmarks – move to custom allows for more

frequent attribution reporting (UK move from 75% peer group to less than 10% in last 5 years)

Peer group comparison more relevant in the U.S. with large markets and similar mandates

Equities v Fixed Income v AlternativesLiability matching pressures have seen a move towards fixed incomeUse of alternative assets is growing significantly Increased use of OTC’s – independent models required to derive characteristics

Regulatory RequirementsGlobal Investment Standards are limited with respect to attributionDifficult to point to any one “correct” approach although many are universally

standard (eg: stock level equity attribution)

Risk awarenessAttribution is another useful tool for identifying risk within a policy / mandate


Understanding the Inputs to Attribution Analysis

Increased analysis => Increased need for data integrity => Increased focus

Increased complexity with frequency

Country / currency

More flows

Policy

No flows

Start weights

Manager

Flows?

Average weights

Sector

Classifications

Many different flavours in FI (eg: maturity bands)

Stock

Synthetic trades

Corporate actions and flows between sectors


The Process Needs to be Seemless

Data flow,Understandingdependencies

A true end to end mechanism is essential such that transactional and accounting data flow through to attribution results with no need for human intervention

1.Accounting

Data

3.Positional and

transaction code mapping

2.Portfolio

holdings and transactions

4. Performance calculation

Engine

5. Application ofClassification Schemes to

produce returns

6. Index data

Sources and mapping

7.Apply

formulae and deliver

results

12

Performance Attribution Sample Output (Total Fund)

Total Fund attribution is a tool to quantify the impact of strategic investment decisions and implementation decisions.

13

Performance Attribution Sample Output (Sector Equity)

Sector level attribution is useful for all types of funds, even tracker funds as per this example, to highlight to the manager where extra return is being generated. Was it deliberate?

14

Performance AttributionSample Output (Stock Level Equity)

Stock level attribution is useful to pinpoint where good stocks were chosen and just as importantly which poor performing stocks were avoided.


What Is Fixed Income Attribution Analysis?

Returns-based attribution model

Flexibility to calculate attribution results based on client specific mandate types (eg: Govs. Vs, Corporates)

Excess Return

Market selection Currency

Duration Curve Positioning Sector/CountryBond specific

effects

A technique used to quantify the excess return of a portfolio against its benchmark into active decisions of the investment management process


Equity and Balanced vs. Fixed Income Attribution

SimilaritiesBoth are returns based (portfolio vs. benchmark) and look to decompose

the excess return into the conscious decisions of the investment processTop Down approach

Both look at the impact of investing in specific markets or assets and choice of stocks within the market / category

DifferencesFixed Income portfolios tend to have a greater degree of currency

management within the fund which needs to be measured independently (passive versus active)

Fixed Income models are more risk orientated with the use of duration to measure interest rate sensitivity

Excess returns tend to be smaller, so results in fixed income are much more sensitive to price and characteristic differences

Should different attribution methodologies exist between equity vs. fixed income strategies?


Understanding the Effects

DurationPositive / negative impact on excess return from a parallel shift in the yield curve

Yield Curve PositioningPositive / negative impact on excess return from a change in shape in the yield curve

Sector / CountryYield spread movements between Gov. and Non Gov. Bonds or currencies of issue

Bond SpecificDid we pick good performing bonds along the yield curve? Was credit part of the benchmark?

CurrencyDid we pick good or poor performing currencies ?

If interest rates fall, then the returns are positive so overweight duration in rising markets is good and underweight duration is bad


Understanding the Data Requirements

Portfolio and index (as per the classification scheme)

Market Value (income accrued versus received)

Effective duration (allows for options on bonds)

Effective maturity bands for classification purposes (callable bonds)

Currency of Issue rather than country of risk

Credit rating – official versus implied

Sector classification (Government / Corporate etc)


Considerations for fixed income attribution - General

Different interpretation of added value

Yield spread versus total return

Buy & hold versus transaction based

Arithmetic versus geometric

Data integrity and consistency

Security characteristics

Greater variety of benchmark schema’s/definitions

Front office systems to back office analysis and reporting

Index data requirements – cost, distribution and formatting

Greater complexity with derivatives

Greater portfolio turnover

Greater complexity transitioning historical information

20

Performance Attribution Sample Output (Fixed Income)

Fixed Income Attribution highlights the impacts of effective positions (duration adjusted weights)


Risk Attribution / Risk Adjusted Performance Attribution

Decomposition of ex post and ex ante measures into meaningful factors

Ex ante risk attribution normally built from multi factor model approach

Ex post risk adjusted performance attribution can be built from statistics such as tracking error / information ratio decomposition

Ex Post Risk Attribution

Based on standard deviation of active returns

Attribution built from asset volatility and correlation to tracking error (but using traditional performance definitions of selection and allocation)

Selection impact built from asset weight times active return volatility in asset

Allocation impact built from size of asset active weight times active return volatility in asset relative to overall benchmark.

Ex Post Risk Adjusted Performance Attribution

Information Ratio useful (active return / tracking error)

Use of ‘risk weights’ rather than investment weights – how much of risk budget has been spent on asset


Sample UK Equity – 1 Year Attribution Results

18.37 Return (%) 13.16 Risk (% Std Dev)

22.13 -3.76

13.33 2.78

-0.30 -3.45 N/A

0.28 2.78 N/A

0.00 -0.00 -0.30 0.16 -1.47 -1.61 -0.55

0.00 0.00 0.28 0.19 0.92 1.28 2.18

0.00 -0.00

0.00 0.00

Currency

Selection

Explicit

N/A

Cash-Equity

Currency

Implicit

Indices SelectionSelection

TradingWithin

AssetRisk SectorsRegion

Cost

Transaction

Timing

MarketCurrency

MarketAllocation

N/A

Asset

Total

Benchmark Active

Risk Attribution / Risk Adjusted Performance Attribution


Strategic Approach to Attribution Developments

Full integration within infrastructure remains crucial

Analysis is embedded within Northern Trust infrastructure

Important to ensure that data updates at source flow efficiently through to end analysis and attribution

Industry leading professionals researching new methodologies and approaches

Active participation in external performance conferences

Close ties with performance professionals in the industry

Continued investment in capital expenditure

Senior management continue to comit resources to analysis and decision support capabilities

Displined approach to development, testing and implementation

Staying on current with new investment approaches

Working with clients and asset managers to ensure new investment strategies are captured within performance

Strategic alliances to deliver industry leading capabilities


Recent Developments Around Attribution

Daily relative attribution capability through Passport (Fundamentals)

Equity (regional, country, sector and stock level)

Popular with investment management community

Daily indexes information from all major index vendors

Specialist benchmark team negotiating and managing index vendor relationships

Daily benchmark building functionality

Benchmarks feeding attribution can be built daily and rebalanced monthly

Strategic alliances with third party index and characteristic providers


Current Trends, Future Needs

Absolute / Hedge FundsSome strategies do not lend themselves to relative attribution decompositionContribution analysis is the start…but do need in-depth knowledge of investment decisions (e.g. – pairing)

Derivatives – greater complexity and evolution of purposeAttribution ‘methodologies’ have existed for significant periods of timeTreatment of ETD v OTC’sBut again, need in-depth knowledge of investment decisions to ensure attribution

reflective of investment process Active vs. passive currency management

Need to strip out forward contracts between passive and active decisionsNeed to allocate cost of hedging to appropriate investment deskSeparate measurement of currency overlay programs

LDIA valuation process – decomposition of asset value versus liability valueNon published benchmarks – derived from asset exposure

Characteristics enhancements and custom indexes development

2007 INSTITUTIONAL CLIENT CONFERENCEInnovative Leadership, Creative Solutions

© 2007 Northern Trust Corporation

N O R T H E R N T R U S T

Simon Willcox

Thank You

Paul D’Ouville

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