With market indices disappearing, asset managers will have to look for new partners for fixed income attribution, says Confluence’s Philippe Gregoire
Back in December, when most people were busy wrapping up the year, a news story landed in my inbox and grabbed my attention. Bloomberg was to buy the Barclays index benchmarking business, POINT, which includes some of the fixed income market’s most widely used indices.
It was no surprise that Barclays would want to sell its index business as part of its major restructure. Forced by regulators and cost restrictions, banks have been keen on slimming down their activity to focus only on what they think are their core competencies. Similarly, indexing providers and exchange operators have been eager to expand their operations, with recent cases such as Intercontinental Exchange buying Interactive Data’s business, or the London Stock Exchange buying asset manager and index compiler Russell Investments.
It is understood that POINT will continue to operate for 18 months after the closure of the deal to help clients transition to other providers, including to Bloomberg’s Port product. Barclays will, however, retain its quantitative investment strategy index business, with calculation and maintenance of its strategy indices outsourced to Bloomberg.
But what does that mean for us, the performance measurement providers, if the most widely used benchmarks for measuring the evolution of prices are not widely available anymore?
The bond market is highly fragmented and does not have a central liquid market for trading and pricing like equities. Because of this, asset managers often rely on indices and other measures to track performance. For years, many technology providers have relied on Barclays POINT to deliver fixed income attribution analysis to their clients, so that they would be able to identify and quantify the sources of return for fixed income funds, relative to a benchmark, over a period of time.
When market structure changes, the need for innovative solutions is greater than ever. For companies that may now find themselves in need of alternate solutions, there are several points to consider when selecting a new technology partner for fixed income attribution.
Model selection
Companies should review the different fixed income attribution models to find the one that best suits their investment strategy and risk exposure. For the attribution to be useful, they need a model that explains the contribution of active exposures to each one of the risk factors they have exposure to.
Multifactorial models, as a case in point, will allow a breakdown of the total return into various elements associated with each factor. However, doing this implicitly assumes that the factors are not correlated. For example, the level of credit spread is not dependent on the level of the yield curve. Many factor models exist, such as Tim Lord or Murira Sierra, which would allow the breakdown of returns into risk factors, using observable and accessible data at an efficient cost.
Data governance
Having a good data governance strategy in place, that includes trusted and validated data coming into the system, is essential, or attribution results can be skewed. The fundamental element necessary to ensure quality results, in addition to choosing a model that explains the investment process, is the ability to obtain and validate the data.
For this reason, factor models have a significant advantage over revaluation models. The data is limited to the collection of treasury curves by currency or group of currencies, credit curves for different levels of risk credit (ratings), and data specific to the issue, such as market spread, option adjusted spread, yield to maturity, or sensitivities to risk factors, such as modified duration, spread sensitivity and prepayment sensitivity. By limiting the amount of required data, it is possible to set up a series of validation tests for data quality and also for the results produced.
Re-calculating
Reusing the calculations can help companies to gain control over the investment process. Using a fixed income attribution application fulfils at least two objectives. First, it improves transparency in communication with clients, and second, it strengthens the management control process.
Using attribution, the bond manager can follow the return he obtains according to his choices regarding active exposure to certain risk factors. Management can ensure that individual managers obtain sufficient returns to justify the exposure to risk factors. For a fixed income attribution solution to become an effective tool for management control, it is essential that all third parties understand the models and that the results produced are in line with the changes observed in the treasury curve, the credit curve, the prepayment risk and other sources of risk. Only intuitive and controllable models can achieve this objective.
For those who are using POINT, or for others looking for a new solution, choosing wisely when replacing an attribution tool is critical. If the models are comprehensible and the results are validated and accurate, then fixed income attribution contributes greatly to the asset management value chain.
