NORTHERN TRUST
Attribution Analysis
An integral part of the investment
management program
Simon Willcox
Paul D’Ouville
2007 INSTITUTIONAL CLIENT CONFERENCE
Innovative Leadership, Creative Solutions
© 2007 Northern Trust Corporation
Presentation Overview

A comprehensive suite for asset servicing

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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
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2
Plan Sponsors to asset managers
From performance Attribution to risk adjusted performance attribution
Northern Trust’s development approach
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The core client requirements of an effective attribution toolkit

Asset Owner versus Asset Manager needs
Current trends, future needs
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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
3
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A Comprehensive Suite for Asset Servicing
Asset owners and managers have a fiduciary responsibility to monitor
their investments. What analysis is required to enable them to do this?
Was this within our investment guidelines?

Compliance / Risk Monitoring
 External
investment restrictions (legal/regulatory).
investment restrictions – placed on individual
managers to limit overall plan risk
 Internal
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
– Is our current risk exposure in line with
our investment requirements
 Ex-Ante
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Attribution Objectives
Each user may have a different purpose and level of understanding,
but the output must be understandable and useful to all parties.
Meets its purpose

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Maps to client’s objectives and fund managers’ investment process
Accurate and timely delivery
Easily interpreted
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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

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Complementary to in-house risk models and other front office systems
Supports previous ex-ante analysis and asset / liability modelling
Automated
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5
Scalable
Flexible
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Northern Trust’s Approach to Supporting Clients’ Needs
A full suite of attribution capabilities is a “must have” for all of clients from
a precise methodology through to timely and meaningful reporting
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
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Delivery and Frequency
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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
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Review of data integrity – “refining the process”

Daily delivery can pinpoint implementation issues prior to month end
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Investment goals / processes can be reviewed more frequently

Solution – daily performance, available daily
Integration in client reporting across segments
6
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Headline numbers and impacts needed to be highlighted in client reporting

Solution – design and build client reporting blocs, marrying numbers with analysis
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The Data Evolution
The development of the servicing of program management has been an
evolutionary process and can be represented by five key generations.
Delivery implications within a Generational Model of performance delivery:
Performance Performance
Measurement Measurement
High Level
Detailed
Attribution
High Level
Attribution
Detailed
Risk
Other Ex
Ante
Generation 1
1990 - 94
More detail
More frequency
1994 - 98
Figures
Production
Generation 2
Added Value
Quarterly

Quarterly



Monthly

Quarterly

Quarterly
Quarterly
Monthly
Monthly
Monthly
Monthly Quarterly
with more with more
detail
detail
Weekly /
daily with
more detail
Weekly /
daily with Monthly
more
with more
proof of
detail
controls
Data intensity for all models
Cost of delivery
1998 - 2001
GIPS
requirements
Global Support
included
Generation 3
Performance and Risk
2001 - 03
Generation 4
Focused
Cost Centre
More detail
needed
Weekly /
daily
Monthly
2003 - now
Generation 5
Integrated
Feedback
7
More interpretation, and
link with attribution / risk
Source: Investit Intelligence ‘Outsourced Performance Measurement for Investment Managers’
Weekly / daily -more
interpretation than
production
Weekly / daily -more
interpretation than
production
Demands on Attribution Models Through ‘Diversification’
D
A
T
A
Portfolio holdings and prices
Portfolio, benchmark, broad assets, universes
I
N
T
E
G
R
I
T
Y
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Portfolio, benchmark, broad assets to stock level
Portfolio, benchmark, sensitivity to
characteristics
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Contribution
Policy / Balanced
Equities
Fixed Income
The Asset Class and Market Evolution

Profile of markets are / have changed
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
 Peer
group comparison more relevant in the U.S. with large markets and similar
mandates

Equities v Fixed Income v Alternatives
 Liability
 Use
matching pressures have seen a move towards fixed income
of alternative assets is growing significantly
 Increased

use of OTC’s – independent models required to derive characteristics
Regulatory Requirements
 Global
Investment Standards are limited with respect to attribution
 Difficult
to point to any one “correct” approach although many are universally
standard (eg: stock level equity attribution)

Risk awareness
 Attribution
9
is another useful tool for identifying risk within a policy / mandate
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Understanding the Inputs to Attribution Analysis
Increased analysis => Increased need for data integrity => Increased focus
Policy
Manager
Country /
currency
Sector
Stock
No flows
Flows?
More flows
Classifications
Synthetic
trades
Start
weights
Average
weights
Many different
flavours in FI (eg:
maturity bands)
Increased complexity with frequency
10
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Corporate actions
and flows between
sectors
The Process Needs to be Seemless
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
7.
Apply
formulae
and deliver
results
6.
Index data
Sources and
mapping
5.
Application of
Classification
Schemes to
produce
returns
11
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1.
Accounting
Data
Data flow,
Understanding
dependencies
2.
Portfolio
holdings and
transactions
3.
Positional and
transaction
code mapping
4.
Performance
calculation
Engine
Performance Attribution
Sample Output (Total Fund)
Total Fund attribution is a tool to quantify the impact of strategic
investment decisions and implementation decisions.
12
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?
13
Performance Attribution
Sample 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.
14
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
Duration
Curve Positioning
Sector/Country
Currency
Bond specific
effects
A technique used to quantify the excess return of a portfolio against its
benchmark into active decisions of the investment management process
15
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Equity and Balanced vs. Fixed Income Attribution
Should different attribution methodologies exist between equity vs. fixed
income strategies?

Similarities
 Both
are returns based (portfolio vs. benchmark) and look to decompose
the excess return into the conscious decisions of the investment process
 Top
Down approach
Both look at the impact of investing in specific markets or assets and
choice of stocks within the market / category

Differences
 Fixed
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
16
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Understanding the Effects
If interest rates fall, then the returns are positive so overweight
duration in rising markets is good and underweight duration is bad
17
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Duration
Positive / negative impact on excess return from a parallel
shift in the yield curve
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Yield Curve Positioning
Positive / negative impact on excess return from a change in
shape in the yield curve

Sector / Country
Yield spread movements between Gov. and Non Gov. Bonds
or currencies of issue

Bond Specific
Did we pick good performing bonds along the yield curve?
Was credit part of the benchmark?

Currency
Did we pick good or poor performing currencies ?
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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
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of Issue rather than country of risk
 Credit
rating – official versus implied
 Sector
classification (Government / Corporate etc)
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Considerations for fixed income attribution - General

Different interpretation of added value
 Yield
 Buy
spread versus total return
& hold versus transaction based
 Arithmetic

Data integrity and consistency
 Security
characteristics
 Greater
variety of benchmark schema’s/definitions
 Front
19
versus geometric
office systems to back office analysis and reporting

Index data requirements – cost, distribution and formatting

Greater complexity with derivatives
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Greater portfolio turnover

Greater complexity transitioning historical information
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Performance Attribution
Sample Output (Fixed Income)
Fixed Income Attribution highlights the impacts of effective
positions (duration adjusted weights)
20
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
21
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Risk Attribution / Risk Adjusted Performance Attribution
Sample UK Equity – 1 Year Attribution Results
Tota l
18.37
13.16
Benchm a rk
22.13
13.33
Return (% )
Ris k (% Std Dev)
Active
-3.76
2.78
As s et
Alloca tion
-0.30
0.28
Reg ion
Selection
0.00
0.00
Ex plicit
Currency
0.00
0.00
22
Currency
Selection
-0.00
0.00
W ithin
Ma rk et
-3.45
2.78
Ca s h-Equity
-0.30
0.28
Ma rk et
Tim ing
0.16
0.19
Im plicit
Currency
-0.00
0.00
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Ris k
Indices
-1.47
0.92
Tra ding
N/A
N/A
Sectors
-1.61
1.28
As s et
Selection
-0.55
2.18
Tra ns a ction
Cos t
N/A
N/A
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
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23
Strategic alliances to deliver industry leading capabilities
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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
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feeding attribution can be built daily and rebalanced monthly
Strategic alliances with third party index and characteristic providers
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Current Trends, Future Needs

Absolute / Hedge Funds
 Some
strategies do not lend themselves to relative attribution decomposition
 Contribution analysis is the start
 …but do need in-depth knowledge of investment decisions (e.g. – pairing)

Derivatives – greater complexity and evolution of purpose
 Attribution
‘methodologies’ have existed for significant periods of time
 Treatment of ETD v OTC’s
 But 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 decisions
 Need to allocate cost of hedging to appropriate investment desk
 Separate measurement of currency overlay programs

LDI
valuation process – decomposition of asset value versus liability value
 Non published benchmarks – derived from asset exposure
A

25
Characteristics enhancements and custom indexes development
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NORTHERN TRUST
Thank You
Simon Willcox
Paul D’Ouville
2007 INSTITUTIONAL CLIENT CONFERENCE
Innovative Leadership, Creative Solutions
© 2007 Northern Trust Corporation