Product Update: Security Level Contribution to Return Analysis

By James Eaton
james.eaton@jpmorgan.com

While traditional attribution analysis models allow clients to understand how and why their investment manager achieved any over or under performance, it relies on a suitable benchmark being in place that can be deconstructed to the level required for the analysis (e.g., economic sectors, countries, securities, etc.). While in many cases a suitable benchmark does exist and attribution can be provided, there are increasingly many types of alternative investment strategies for which a suitable "attribution" benchmark is not available (or required). In these cases a more appropriate and relevant tool for the client is to understand the drivers of the absolute return of a portfolio through the use of contribution to return reporting.

J.P. Morgan's Investment Analytics and Consulting group (IAC) has developed a range of contribution to return reports which enable clients to understand the drivers of return, whether it be decomposing a Total Pension Scheme return into underlying asset class/investment manager contributions, or as we shall cover in this article, a security level contribution to return analysis.

Available via the J.P. Morgan ACCESS^®, Views Portfolio Reporting tool, IAC can provide clients access to daily or monthly security level contribution to return reporting which allows clients to decompose their Portfolio or Composite returns into the underlying security level contributors. The reporting is available for any type of portfolio, covering any asset class and security, whether long or short. It is therefore a particularly valuable tool when looking to explain the impact of derivatives, exchange traded or OTC's, hedging or short positions within a portfolio. Alternatively, IAC clients can use this reporting function to compare portfolios with the same mandates in order to understand how one investment manager's selection decisions compare to another's.

Methodology

Contribution to return methodology has traditionally used a weight (%) multiplied by return approach to generate the contribution to return. While this methodology will produce an accurate representation of an asset's contribution, it does rely on accurate returns being generated across ALL security positions to ensure contributions are accurate and roll up exactly to the portfolio return. For certain situations that can prove to be more difficult, such as where OTC's are held, market values moving from positive to negative or if there is heavy restructuring activity within a portfolio.

To get around this while still calculating an accurate contribution, IAC uses a monetary gain/loss approach to calculate the security contribution to return. Monetary gain/loss is defined as:

Even in this challenging situation, every security position fed from the accounting system during the holding period, whether they are OTC derivatives, cash receivables/payables or expense accruals, will have at least one of these three data points available in order for the monetary gain/loss to be calculated. Considering the value of a portfolio is always the sum of the underlying security values, it is therefore consistent that the sum of the security level monetary gain/loss will always roll up to the total portfolio level monetary gain/loss. Conceptually, it is this relationship that ensures that when we come to calculate the security level contributions they will always sum up to the total portfolio level return.

So how do we move from a monetary gain loss value to a contribution to return? We do this by firstly working out the weight that each security's monetary gain/ loss forms of the total monetary gain/loss. We then multiply this weight by the total return of the portfolio, whether Net or Gross of fees, to produce the security's contribution to return.

This formula not only provides an accurate calculation of contribution, which takes into account any cash flow timing method set up on the portfolio, but also ensures contributions roll up to the total portfolio even where individual security returns may be missing or difficult to produce.

Multi-period contribution methodology

The methodology outlined above is only accurate for any given single period (one day or one month if reporting frequency is monthly). For longer periods, to ensure the most accurate calculation of the contribution is reported, the security contributions for all single periods within the total period are calculated and then aggregated using an appropriate smoothing algorithm. For example, a three month contribution to return report for a daily service client would calculate daily contributions for each day within the three month period and then aggregate. This extensive but automated calculation ensures highly accurate results over longer periods.

Outputs

As the calculation is always at a security level, the contribution being additive allows us to roll up the contributions to any level within a portfolio's asset class hierarchy. To utilize this, IAC contribution reporting allows clients to group securities by a number of different aggregation options depending on the classification scheme required. The following graphics show examples of available grouping options. Alternatively, clients may just wish to see a full security list sorted by best to worst contributors or a Top 10/Bottom 10 output.

Security contribution to return by Economic sectors/industries

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Security contribution to return – Top X Bottom X*

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Composite level outputs

In addition to a portfolio view of the security contributors, the contribution to return reporting can also be performed at a composite level. When run at a composite level, an additional option is available which allows securities to be reported on an aggregated or un-aggregated basis. When run using the aggregated option, security positions are aggregated across all underlying portfolios. Only one position per security is reported at the composite level and no reference to the underlying manager holding that position is made. This option provides the same view of a composite as you see for an individual portfolio. When the un-aggregated option is selected, the contribution report reflects each individual position per underlying portfolio; therefore you may see the same security several times if held by more than one underlying portfolio. Details of which portfolio is holding each position is shown on the report in this case. This option allows clients to see how each portfolio's security position contributed to the overall composite return. The following graphics are examples of un-aggregated output.

Security contribution to return – Composite Level – Un-aggregated view

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Should you be interested in receiving contribution reporting as part of your performance measurement service from J.P. Morgan's Investment Analytics and Consulting group, please contact your IAC representative.

*Client can input "X" (e.g., 10)

This article is for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. All market prices, data and investment holdings within are solely for illustrative purposes. This document contains information that is the property of J.P. Morgan. It may not be copied, published, or used in whole or in part for any purposes other than expressly authorized by J.P. Morgan.