Performance Attributions

Attribution Analysis Consultants (AAC)

The Services of AAC

The ongoing financial crisis and the continuing stream of scandals across the financial world have raised many doubts about the integrity and competency of those trusted to take care of investors’ capital. For many there has been the realisation that the primary drive within the financial industry has been to generate wealth for itself rather than its clients.

AAC offers clients a fully independent analysis of the performance (returns, risk, liquidity, fees, etc) of their portfolios (at the individual asset, portfolio and aggregated portfolio levels) and their fund managers. Since the financial crisis it has been difficult for fund managers to offer the performance they have traditionally promised and clients are finding it equally difficult to understand the true performance of their invested funds and those charged to take care of them. AAC has been created to answer all the questions facing clients in today’s financial climate: Do I really know the total fees I am paying and how the total fees are made up? Do I know if these fees are warranted given the true performance of the funds or are managers paying themselves for short term timing benefits, inflation effects and/ or general market trends? Do I understand the risks I am taking and are the returns (and possible management performance charges) just a reflection of high risk taking and luck? How stable are my portfolios, how much loss might I face and how easily can I liquidate asset positions? AAC is fully independent and not tied to any financial houses, and our service to clients is an honest and understandable picture of the performance of their invested funds and their fund management.

In summary, AAC has been established to provide clients with the true independence, rigour, skills and data so as to be able to gain a fully objective and impartial analysis of their portfolios and the added values provided by their investment managers.

Independence – you will have been told no doubt that your funds are invested in some of the best investment houses on the planet - houses which employ the brightest and the best. The financial crisis and the ongoing scandals within the financial industry should have taught us all that while being the brightest and the best is important it is not the whole story – integrity and independence are qualities of at least equal importance, and because of the pressures and the complex interlocking relationships within the financial industry these qualities seem to have been somewhat sidelined. While the AAC team has studied, researched and advised within the financial sector for the past 25 years, it has been extremely careful to protect its total independence and integrity – because without these qualities its research and findings would not have the same impact or credibility. For example, when the City of London wanted an analysis of its future compared to other global financial centres, it turned to Professor Kevin Keasey because of his skills and experience, but most importantly it knew he was not tied to any investment house within the system and would give a fully independent analysis of the matter. The team is proud that it has built on its academic heritage and the impartiality it is able to bring to the analysis of financial sectors across the world.

Financial Knowledge – two further issues raised by the financial crisis are that the financial industry has had a capacity to produce ever more complex products (which seem to have been rarely fully understood by those selling the products and those managing investor portfolios) and that its global nature makes it difficult for investors to properly aggregate and track their investments. The AAC team has been established to tackle these two matters head on. It is our core function to analyse, understand and teach the fundamentals of financial markets – and it is these fundamentals which form the basis of any financial product devised anywhere across the globe. It is our deep understanding of the financial principles and fundamentals which allows us to make the claim that we can understand and evaluate any financial product from simple equities and bonds to the most esoteric financial derivatives. We have studied, analysed, taught and advised on the nature of financial products and financial markets for the past 25 years – and we do this at the very cutting edge of knowledge. For example, banking regulators across the globe have become very concerned about the systemic risk of individual financial institutions – namely, the ability of one failing institution to stress the whole financial system (think Lehman). Attributing the risk of an individual institution within a system context is far from straightforward and not surprisingly a number of competing alternatives have been suggested. The complexity of the suggested alternatives has left the regulators in limbo as they have been unable to compare their efficacy. The AAC team has answered this challenge by having the mixture of skills, experience and knowledge to properly evaluate the systemic risk potential of the major financial institutions across the globe. By comparing and contrasting all the major banks in every major country against a common but complex set of benchmarks they identify which are the most likely to fail or to face financial difficulties in the future – this is a world first and is testimony to the considerable skills of the AAC team.

The second issue raised by the crisis is the global nature of financial markets. The AAC team is international in make-up and we spend our days analysing data from all the major global financial markets. For example, some of our current projects are the development of private equity within China, banking risk within Scandinavia and Europe, the micro structure of US and UK equity markets, equity earnings drift in the US and intraday foreign exchange rate forecasting.

Skills and Data Management– Attribution Analysis needs a range of technical skills and data. To properly assess the returns, risks, liquidity, costs and style of asset portfolios and the performance of fund managers needs a familiarity and comfort in using the common metrics – this is what the AAC team does on a daily basis. It informs all of our work on the performance of banks, the impact of catastrophes on the value of insurance companies, how information is impounded into stock prices, profitability of trading rules, measurement and impact of transaction costs, etc. This is our stock in trade. Equally important, however, are the computing abilities to aggregate diverse portfolios, deal with large amounts of data and be able to use the financial tools of the trade given these conditions. Again, this is what the AAC team does. Charlie and Jacky have built their careers on being able to manage and analyse billions of ’bits’ of financial data. In the past we have built our own computers and written our computer code to tackle these problems – the scale of the technical data and computing problems involved in analysing some the financial issues tackled by the AAC team equate to those faced in analysing deep space dust clouds in astro-physics – this really can be like rocket science! An example, of the analytical, programming and computing skills in the AAC team can be gauged by a project which looked at the nature of the way UK stocks impound information into share prices – this used 20 years of data for all UK stocks and this meant dealing with many, many billions of items of data.

Rigorous financial modelling requires the development and application of advanced statistical and analytical tools. Two of the most important techniques for a full and proper understanding of the attributes of portfolios are volatility and correlation. The AAC team has a long heritage of being able to customise the approach to these two factors through advanced modelling such as dynamic conditional correlation and the copular modelling of asset cross-dependency, which in layman’s terms means we are equipped with the most advanced tools available for evaluating the risk of a portfolio. These models are proven to be useful in capturing time-varying relationship between investments.

The second component under this heading is having the data to accurately benchmark the performance of individual assets and portfolios. The AAC team accesses and uses all the major global financial datasets – the appendix lists all the datasets commonly used by the AAC team.

How Can This Help You and Your Investment Portfolios

Investors need to feel their capital is protected (and hopefully growing), the fund managers know what they are doing and they can trust what they are being told by the fund managers. The financial crisis has shown that none of these core elements to investment management can be taken for granted.

The AAC team’s attribution analysis gives investors, trustees, and other professional advisers the information they need to make informed decisions on the quality of wealth preservation, the true risks they are facing and the quality of fund management decisions. The information provided by AAC can be tailored to meet the exact requirements of the investor/trustee/professional advisers. More specifically, depending on the needs of the individual client, AAC offers the following types of analysis – please note, these are only a subset of what can be offered.

Complete Overview – a major issue faced by investors is that they often struggle to gain a single view of their total wealth and their various investments because they are held in different portfolios, which are sometimes managed by different investment managers. The task of integration is not easy from a pure mechanical process as the portfolios are often held with different data structures. Tackling this problem is second nature to the AAC team. Virtually all of our research involves combining data from a variety of sources to tackle a specific question. Furthermore, an overview of investment managed by different managers generated from a consistent and independent evaluation approach would provide clients not only a complete view of their investment but also an objective comparison among the managers’ performance which are important for making future allocation decisions.

Detailed Risk and Liquidity Analysis – once portfolios have been properly aggregated it is then possible to properly assess where duplication of assets across portfolios unduly add to risk and liquidity concerns. As we all know, risk is not a simple additive function but depends on the weight of portfolios in specific assets, the volatility of those assets and the correlation across assets – these can only be properly assessed from a ‘one view of the world’. Detailed risk analytics is a key strength of the research undertaken by the AAC team in the recent years. Risk components and contribution to risk under a risk management framework have been widely investigated by the team in the context of banking and through the developments of new empirical techniques. The most recent examples include an analytical decomposition of bank volatility and the quantification of systemic risk exposure and systemic risk contribution at the bank level. The extension of such technique into the application of portfolio analysis means it will produce a clear account for the source of risk generated from an investment portfolio.

Realistic and Meaningful Benchmarks – a fair assessment of portfolio performance requires comparison with benchmarks that reflect the risk profile of the investor. Furthermore, only the evaluation of the performance in relative terms with respect to the selected benchmarks allows an understanding of the fund manager skills. Benchmarking selection and testing is at the core of the research of the AAC team. For example, in our analysis of the risk effect of bank mergers the identification of proper benchmarks was essential to distinguish the effect on bank risk produced by normal market trends from that linked to mergers and acquisitions. Our understanding in the financial products and the composition of major indices provides necessary support to the identification of benchmark and interpretation of any deviation in performance.

Ghost Portfolios – any asset decision for an investment sale is never definitive and one means of assessing the quality of the investment decisions being made is to form a small number of ghost portfolios – in essence, this opportunity to track the performance of an actual portfolio against its earlier sales/purchases is to help understand the added value the investment manager is providing to your portfolio.

Cash Aggregation, Real Returns and Management Fees – it is the norm of the financial industry to quote returns on the net amount invested in an asset; essentially management fees do not form part of the return calculations. From an individual asset perspective, this is correct but from a portfolio perspective it is not correct. What matters to the investor is what cash he/she can expect back from the total cash invested – and this has to include management fees; if not, wrong conclusions could be reached. For example, imagine an investor gives a fund manager £10k to invest and the fund manager takes £1k of fees and invests the rest in equities which give back £9900 when they are realised. From an asset perspective, the asset looks to give a 10% return but from a portfolio perspective the return is -£100/£10,000 – ie. -1%. From an investor perspective it is, therefore, critical that full account is taken of mana-gement fees and costs - if not, he/she may not be making proper comparisons of returns. Such an analysis is only possible when a single view of the portfolios and the cash invested across the portfolios can be taken via aggregation.

The effect of fees on return is even more profound when one considers the other admin fees. For example, if a client had invested in an investment portfolio and the fees was 1% per annum plus various admin fees (custodian fees, trustee fees, charging for the platform that the portfolio sits upon, establishment fees or annual fees for administration and accounting plus commissions for sales and purchases). Taking into account of all these fees it could easily produce an aggregate fee or total expense ratio (TER) in the region of 2% to 3%. Such measure of total ratio of fees to the actual amount of return to the client is a key element here. For example, if the gross investment return were at 4%, a 2.5% of fees would have taken almost two thirds of the overall return. This total cost effect is difficult to find until you itemise all of the different fees that are being taken. While details of the fee information may normally disclosed together with mountains of other transaction information, proper analysis on the fees is rarely produced by the fund managers with obvious reason. ACC would provide clients an objective analysis on the total expense ratio.