Fixed Income Research

Attribution of
Portfolio Performance
Relative to an Index
March 1998
Lev Dynkin 212-526-6302
ldynkin@lehman.com
Jay Hyman 212-526-0746
jay@lehman.com
Prashant Vankudre 212-526-8380
pvankudr@lehman.com

Summary
We introduce a model and an analytics framework for attributing portfolio
outperformance of an index to allocation differences along relevant risk dimensions. We illustrate the use of the model to separate performance due to curve
positioning, sector allocation, and security selection.
We present a detailed example of performance attribution calculations and
reports available in the current implementation and indicate the path of future
development of this methodology.
We compare various quantitative techniques for portfolio analysis relative to
indices: curve-adjusted excess return, return attribution model for individual securities, performance attribution model, and multifactor risk analysis. We highlight the differences, similarities, and scope of applicability for each methodology.

Publications: M. Parker, D. Marion, V. Gladwin, A. DiTizio, C. Triggiani, B. Davenport, J. Doyle

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Lehman Brothers

March 1998

INTRODUCTION

THE MODEL

In the quest to outperform their benchmarks, portfolio

managers have two mechanisms at their disposal. First
is portfolio asset allocations, which can underrepresent
one or more segments of the market covered by the
targeted benchmark. This will be offset either by overweighting other market segments relative to the benchmark, or by introducing exposures to markets outside the
benchmark. Asset allocation allows expression of directional views on yield curves, structures, sector spreads,
volatility, and relative value between markets. Second,
managers choose the securities that will represent each
market segment in the portfolio to reflect their views on
relative value and individual credits. No matter how
closely the portfolio allocations match the benchmark,
security selection can give rise to significant performance differences within each market segment. In large
organizations, decisions on asset allocation and security
selection, and on different types of asset allocation (e.g.,
curve and sector), are often made by different teams of
investment professionals.

The model begins with an analysis of the portfolio

that reveals how the managers allocations to various market segments differ from the market-weighted
allocations of the benchmark. It then attempts to
answer two separate questions. First, if the portfolio earned within each market segment the exact
return of the index, how much would it differ in performance? This difference, due solely to the difference in the weights assigned to each segment, is
attributed to the high level allocation decision.
Second, how much extra return was achieved due
to difference in returns within each market segment? This portion of return may be attributed to
security selection.
To answer these questions, we use a hypothetical portfolio that follows the high level allocation of the portfolio
but matches the benchmark return exactly within each
market segment. The benchmark return r B can be
represented in terms of its sector weights w sB and its
returns rsB within each sector s, as

At the close of a review period, investors compare performance to the benchmark. A natural goal is to measure the performance due to each allocation decision.
Complications can result from the fact that allocation
differences exist simultaneously in multiple dimensions. For example, portfolio return within a given sector
will depend on the duration of its holdings and on the
selected issuers.

r B = w sB rsB .
s

The returns on a portfolio, P, can be expressed in

similar form,

r P = w sP rsP ,
s

This report describes a new Lehman Brothers model

and its corresponding analytical tools to address this
need. A performance attribution feature is now available within Lehman Brothers portfolio management
software. The current implementation allows selection
of a two-dimensional grid, characterized by a term
structure axis (duration, maturity, or average life) and a
sector axis to define the market segments that best
correspond to the allocation process. This second axis,
which we call the sector axis, can reflect allocations
to any non-yield-curve-related market segments. For
example, it allows analysis of a mortgage portfolio by
allocations to seasoning levels and a corporate portfolio
by quality. The outperformance of the portfolio versus
its benchmark is explained in terms of the decisions
made by a portfolio managercurve positioning (allocation along the term structure axis), sector allocation,
and security selection.
Lehman Brothers

(1)

(2)

noting that both the sector weights and the returns in

each sector have changed. Our hypothetical portfolio, P, combines portfolio weights with benchmark returns:

r P = w sP rsB .
s

(3)

By comparing the returns of the portfolio and the benchmark to those of the hypothetical portfolio, we can split
the performance difference into two terms. The first
term, the return difference between the hypothetical
portfolio and the benchmark, is due to the differences in
allocations. The second, the difference between the
real portfolio and the hypothetical one, reflects differences between portfolio and benchmark composition
within each sector.

March 1998

r P r B = (r P r B ) + (r P r P )
= ( w sP rsB
s

Yield Curve Allocation

Figure 2 shows a breakdown of the outperformance
due to curve positioning. The portfolio and index are
broken into half-year duration cells, and returns of each
duration cell of the index are compared to the whole
index return. (Choice of a narrow duration range is
significant because it ensures a close match between
portfolio and index durations within a single range.)
In the 1.0- to 1.5-year duration cell, the index earned
0.61%, underperforming the overall index return of
1.19% by 0.58%. In the 12.5- to 13.0-year duration cell,
the index earned 2.23%, outperforming by 1.04%. Meanwhile, the allocations of the portfolio are compared to
those of the benchmark. This difference in allocation to
a cell is multiplied by the outperformance of the cell
relative to the index. Thus, for the 1.0- to 1.5-year cell,
the portfolio has underweighted by 8.26% a market
segment that underperforms by 0.58%, providing a
return boost of (-0.0826 x -0.058 = 0.00048), or 4.8 bp.
Similarly, the overweighting of 5.60% to the 12.5- to
13.0-year cell, which outperforms by 1.25%, contributes 7.0 bp of outperformance. Negative contributions
to excess return indicate either an overweighting of an
underperforming segment (e.g., 2.5- to 3.0-years) or
an underweighting of an outperforming segment
(e.g., 10.5- to 11.0-years). The contributions to excess return are then summed across all duration cells
to find the total outperformance of 10.7 bp due to
curve positioning.

w sB rsB )
s

+ ( w sP rsP w sP rsB )
s

= (w sP w sB )rsB + w sP (rsP rsB ) . (4)

s

Our model applies this technique repeatedly in a hierarchical fashion. First, this technique is used to evaluate
the portfolios positioning along the term structure by
allocation to narrow duration ranges. It is then applied
again to analyze the sector composition within each
duration range. In principle, the return differences between portfolio and benchmark in any market segment
can always be broken down further by partitioning along
more dimensions.1 A full mathematical presentation is
provided in Appendix A.
The model is best illustrated by example. The Lehman
Brothers Aggregate Index posted a return of 1.19% for
June 1997. Our sample portfolio, ABC, held positions in
25 of the more than 6000 fixed-income securities that
compose this index. At the start of the month, ABC was
long duration (5.22 years versus 4.68 years for the
index) and long spread product (77% versus 50%)
relative to the index. ABC earned 1.36% in June,
beating the index by 17.5 bp. Figure 1 shows a top-level
breakdown of this outperformance using our model.
Positioning along the yield curve accounts for 10.7 bp,
with the remainder split between sector allocation
(3.2 bp) and security selection (3.6 bp).

Sector Allocation
The next step is to analyze the effect of the portfolio
overweighting and underweighting of sectors within each
duration cell. This analysis calculates a contribution to
outperformance for each sector/duration cell. These
contributions, shown in Figure 3, can be summed across
duration cells, to give the marginal contributions to excess return of overweightings or underweightings to
each sector shown in the bottom row of the figure. The
right-most column sums these contributions across sectors. This gives the net contribution to excess return due
to sector allocation differences within each duration
cell. This report does not show all the details of the
calculation but it can direct attention to the market segments contributing large positive or negative amounts
to outperformance. Of the 3.2 bp of outperformance
attributed to sector allocation, 1.5 bp comes from the
Government sector and 1.4 bp from corporates. Likewise, the largest contribution of any duration cell is
0.9 bp in the 6.5- to 7.0-year cell.

1 The implementation in Lehman Brothers current portfolio analytics platform

(PC Product and Sunbond) is limited to two-dimensional partitions. Our next
generation portfolio analytics platform, currently in development, will support a
wider range of partitioning schemes.

Figure 1.

Summary of Performance

Portfolio: ABC
Benchmark: Lehman Brothers Aggregate Index
Pricing Date: 06/30/97
Performance Due to:
Curve Positioning
Sector Selection
Security Selection
Total

Lehman Brothers

10.7 bp
3.2
3.6
17.5

March 1998

Figure 2.

Outperformance due to Curve Positioning

Portfolio: ABC
Benchmark: Lehman Brothers Aggregate Index
Pricing Date: 06/30/97
Return
Dur. Cell
0.0- 0.5 yr.
0.5- 1.0
1.0- 1.5
1.5- 2.0
2.0- 2.5
2.5- 3.0
3.0- 3.5
3.5- 4.0
4.0- 4.5
4.5- 5.0
5.0- 5.5
5.5- 6.0
6.0- 6.5
6.5- 7.0
7.0- 7.5
7.5- 8.0
8.0- 8.5
8.5- 9.0
9.0- 9.5
9.5- 10.0
10.0- 10.5
10.5- 11.0
11.0- 11.5
11.5- 12.0
12.0- 12.5
12.5- 13.0
13.0+
Total

Benchmark
0.54%
0.59
0.61
0.72
0.83
0.92
1.01
1.06
1.19
1.27
1.32
1.31
1.35
1.40
1.49
1.68
1.16
1.87
1.96
1.99
2.03
2.08
2.18
2.20
2.23
2.44
3.31
1.19

Diff. from Avg.

-0.64%
-0.60
-0.58
-0.47
-0.36
-0.27
-0.17
-0.13
0.00
0.08
0.13
0.12
0.16
0.21
0.30
0.49
-0.02
0.68
0.77
0.81
0.84
0.89
1.00
1.01
1.04
1.25
2.12
0.00

Portfolio
0.00%
0.00
0.00
0.00
3.18
16.07
18.69
3.18
18.73
6.23
2.98
3.16
0.00
6.56
3.04
3.90
0.00
0.00
0.00
4.65
3.76
0.00
0.00
0.00
0.00
5.87
0.00
100.00

Difference
-0.25%
-0.37
-8.26
-7.31
-4.66
7.65
7.18
-5.12
9.84
-0.90
-2.36
0.33
-2.88
3.32
1.52
3.12
-0.91
-1.13
-0.63
3.72
0.66
-2.66
-2.21
-2.01
-1.13
5.60
-0.17
0.00

Contribution to
Outperformance
0.2 bp
0.2
4.8
3.4
1.7
-2.1
-1.2
0.6
0.0
-0.1
-0.3
0.0
-0.5
0.7
0.5
1.5
0.0
-0.8
-0.5
3.0
0.6
-2.4
-2.2
-2.0
-1.2
7.0
-0.4
10.7

The largest single outperformance contribution from

the MBS sector was the 0.3 bp shown in Figure 3 for the
5.0- to 5.5-year duration cell. As shown in Figure 4, the
portfolio allocation to this duration cell was 2.98%, with all
of it (100%) in the MBS sector. However, of the 5.34% of
the index in this duration cell, only 2.11%, or 39.5% of the
cell, is in the MBS sector. Thus, attribution of outperformance within this cell shows a 60.5% overweighting of a
sector that outperformed the overall cell return by 18 bp
(1.50% - 1.32%), for a 10.9 bp outperformance within this
duration cell. Multiplying by the 2.98% weight of this
duration cell in the portfolio means it contributed 0.3 bp to
overall portfolio outperformance. The corresponding
underweighting of governments and corporates provides
additional outperformance, as both of these sectors
underperform the benchmark within this duration cell.

To understand the source of the outperformance due to

sector allocation, we examine the market structure
report that underlies these calculations. A portion of this
report is shown in Figure 4. First, we compare the overall
sector allocations. The portfolio has allocated only
23.08% to Governments versus 50.41% for the index, for
an underallocation of 27.34%. Meanwhile, the index
return on Governments (+1.12%) lagged the overall
index performance (+1.19%) by 7 bp. This underallocation
to an underperforming sector gives rise to outperformance,
as does the overallocation to corporates, which outperformed the index. While this level of analysis can give a
rough estimate of the effectiveness of the portfolios
sector allocations, a more precise analysis must take into
account the positioning along the curve as well. The
portfolio has overweighted the MBS sector by 13.77%.
Even though the performance of the MBS sector of the
index (1.17%) is 2 bp under that of the index, we report
an outperformance of 0.4 bp due to this sector. This is
because our allocation to the MBS sector, which has a
shorter duration than Governments and corporates, must
be evaluated on a duration-neutral basis.
Lehman Brothers

Market Value (%)

Index
0.25%
0.37
8.26
7.31
7.84
8.42
11.51
8.31
8.88
7.12
5.34
2.84
2.88
3.24
1.52
0.77
0.91
1.13
0.63
0.93
3.10
2.66
2.21
2.01
1.13
0.27
0.17
100.00

A similar analysis of outperformance in the 7.0- to

7.5-year and 7.5- to 8.0-year duration cells reveals
outperformance of 0.4 and 0.0, respectively, for
corporates. In both these cells, the portfolio is 100%
invested in corporates, and corporates outperformed

March 1998

Figure 4.

Governments by approximately 30 bp. In the 7.0- to

7.5-year cell, the benchmark is 67% Governments and
33% corporates. As a result, the reported return for the
cell (+1.49%), for which we were given credit at the level
of curve allocation, is largely a Government return, and
corporates outperformed handily, by (1.67% - 1.49% =)
18 bp. Contribution to outperformance is therefore
given by the 3.04% portfolio weight to the duration cell
times the overweight (100%-33%) times the return
advantage of 18 bp = 0.37 bp. In the 7.5- to 8.0-year
duration cell, by contrast, the index is 81% corporates
(0.62%/0.77%). This causes the index return for the cell
to be much closer to the corporate return, leaving
corporates only 6 bp of return advantage. Simultaneously, the same 100% portfolio allocation no longer
looks like a strong overweight. The contribution to
outperformance in this cell is therefore 3.90% x (100%
- 81%) x 6 bp = 0.04 bp.

Portfolio: ABC
Benchmark: Lehman Brothers Aggregate Index
Pricing Date: 06/30/97
Duration
5.0-5.5 yr.
Portf. Return
Bench. Return
Diff. Return
Portf. %
Bench. %
Diff. %
5.5-6.0
Portf. Return
Bench. Return
Diff. Return
Portf. %
Bench. %
Diff. %

Security Selection

6.0-6.5
Portf. Return
Bench. Return
Diff. Return

In all but the most passively indexed portfolios, the

actual composition of the portfolio within a given market

Figure 3.

Portf. %
Bench. %
Diff. %

Outperformance due to
Sector Allocation, in bp

6.5-7.0
Portf. Return
Bench. Return
Diff. Return

Portfolio: ABC
Benchmark: Lehman Brothers Aggregate Index
Pricing Date: 06/30/97
Dur. Cell
0.0- 0.5 yr.
0.5- 1.0
1.0- 1.5
1.5- 2.0
2.0- 2.5
2.5- 3.0
3.0- 3.5
3.5- 4.0
4.0- 4.5
4.5- 5.0
5.0- 5.5
5.5- 6.0
6.0- 6.5
6.5- 7.0
7.0- 7.5
7.5- 8.0
8.0- 8.5
8.5- 9.0
9.0- 9.5
9.5- 10.0
10.0- 10.5
10.5- 11.0
11.0- 11.5
11.5- 12.0
12.0- 12.5
12.5- 13.0
13.0+
Total

Govt.
0.0
0.0
0.0
0.0
0.1
0.1
0.0
0.1
0.0
0.2
0.2
0.2
0.0
0.3
0.2
0.2
0.0
0.0
0.0
0.1
0.1
0.0
0.0
0.0
0.0
-0.3
0.0
1.5

Lehman Brothers

Corp.
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.1
0.1
0.1
0.0
0.5
0.4
0.0
0.0
0.0
0.0
0.1
0.6
0.0
0.0
0.0
0.0
-0.5
0.0
1.4

MBS
0.0
0.0
0.0
0.0
-0.1
0.0
0.1
0.1
0.0
0.1
0.3
-0.2
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.4

Two-dimensional Market Structure Analysis

of Portfolio and Benchmark by
Duration Cell and Sector, Abbreviated

ABS
0.0
0.0
0.0
0.0
-0.1
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
-0.1

Total
0.0
0.0
0.0
0.0
-0.1
0.0
0.2
0.2
0.0
0.4
0.5
0.2
0.0
0.9
0.6
0.2
0.0
0.0
0.0
0.2
0.8
0.0
0.0
0.0
0.0
-0.8
0.0
3.2

Portf. %
Bench. %
Diff. %
7.0-7.5
Portf. Return
Bench. Return
Diff. Return
Portf. %
Bench. %
Diff. %
7.5-8.0
Portf. Return
Bench. Return
Diff. Return
Portf. %
Bench. %
Diff. %
Total
Portf. Return
Bench. Return
Diff. Return
Portf. %
Bench. %
Diff. %

Govt.

Corp.

MBS

ABS

Total

0.00
1.17
-1.17

0.00
1.25
-1.25

1.50
1.50
-0.01

0.00
1.23
-1.23

1.50
1.32
0.18

0.00
1.86
-1.86

0.00
1.32
-1.32

2.98
2.11
0.88

0.00
0.05
-0.05

2.98
5.34
-2.36

0.00
1.17
-1.17

1.35
1.37
-0.02

0.00
1.68
-1.68

0.00
0.00
0.00

1.35
1.31
0.05

0.00
1.53
-1.53

3.16
0.90
2.27

0.00
0.41
-0.41

0.00
0.00
0.00

3.16
2.84
0.33

0.00
1.24
-1.24

0.00
1.43
-1.43

0.00
1.78
-1.78

0.00
1.39
-1.39

0.00
1.35
-1.35

0.00
1.24
-1.24

0.00
1.54
-1.54

0.00
0.02
-0.02

0.00
0.07
-0.07

0.00
2.88
-2.88

0.00
1.31
-1.31

1.69
1.53
0.16

0.00
1.72
-1.72

0.00
0.00
0.00

1.69
1.40
0.29

0.00
1.97
-1.97

6.56
1.27
5.29

0.00
0.00
-0.00

0.00
0.00
0.00

6.56
3.24
3.32

0.00
1.40
-1.40

2.17
1.67
0.50

0.00
0.00
0.00

0.00
0.00
0.00

2.17
1.49
0.68

0.00
1.02
-1.02

3.04
0.50
2.54

0.00
0.00
0.00

0.00
0.00
0.00

3.04
1.52
1.52

0.00
1.43
-1.43

1.63
1.74
-0.11

0.00
0.00
0.00

0.00
0.00
0.00

1.63
1.68
-0.05

0.00
0.15
-0.15

3.90
0.62
3.28

0.00
0.00
0.00

0.00
0.00
0.00

3.90
0.77
3.12

1.34
1.12
0.22

1.67
1.42
0.26

1.20
1.17
0.03

0.83
0.87
-0.03

1.36
1.19
0.18

23.08
50.41
-27.34

29.80
18.43
11.36

43.95
30.18
13.77

3.18
0.97
2.20

100.00
100.00
0.00

March 1998

segment will consist of positions in far fewer securities

than the index, and may experience significantly different returns. Figure 5 shows the contributions to outperformance that can be traced to differences in portfolio
and benchmark composition within each market segment. The largest single contribution is in 7.0- to
7.5-year corporates, which generate 1.5 bp of return
due to security selection. Referring to Figure 4 shows
that while this segment of the index achieved a return of
1.67%, the portfolio earned 2.17%, for an advantage of
50 bp. This gain, multiplied by the 3.04% allocation to
this cell, gives a 1.5 bp boost to the overall performance
of the portfolio.

6.5- to 7.0-year duration cell, the GE Capital and the

AT&T Corp. bonds provide 1.52% and 1.86%, respectively, compared to 1.53% for the corresponding market
segment of the index. For the AT&T bond, the 33 bp of
outperformance relative to its peer group results in a
contribution of 1.09 bp to portfolio outperformance. A
smaller underperformance of -0.05 bp is attributable to
the GE issue. The two securities combine for a total
outperformance of 1.04 bp for this market segment
(shown in Figure 5 as 1.0 bp for the cell).

Investing Outside the Benchmark

Often, a portfolio manager will seek to enhance returns
by including non-index securities in a portfolio. Our
model calculations assume that the performance of any
portfolio investment in a sector outside the benchmark
is typical of that sector and defines the performance of the
benchmark in that sector (albeit with zero weight). If the
portfolio includes CMOs against a Government/Corporate Index benchmark, we have no appropriate peer
group information available, but using the CMO durations, we can include them in the calculation of performance due to curve positioning. The remaining effect of
the addition of CMO holdings to the portfolio is assumed
to be attributable entirely to sector allocation. Assessment of performance due to security selection will not be
done without a measurable peer group.

We can break these results down still further to view

the contributions to outperformance of each security in
the portfolio. Figure 6 gives a detailed view of the
performance of the ABC portfolio. Of the nine corporate
bonds in the portfolio, only one falls in the 7.0- to
7.5-year duration cell. The Duke Power issue represents 3.04% of the portfolio and provides the entire
1.5 bp of outperformance described above. In the

Figure 5.

Outperformance due to
Security Selection, in bp

Portfolio: ABC
Benchmark: Lehman Brothers Aggregate Index
Pricing Date: 06/30/97
Dur. Cell
0.0- 0.5 yr.
0.5- 1.0
1.0- 1.5
1.5- 2.0
2.0- 2.5
2.5- 3.0
3.0- 3.5
3.5- 4.0
4.0- 4.5
4.5- 5.0
5.0- 5.5
5.5- 6.0
6.0- 6.5
6.5- 7.0
7.0- 7.5
7.5- 8.0
8.0- 8.5
8.5- 9.0
9.0- 9.5
9.5- 10.0
10.0- 10.5
10.5- 11.0
11.0- 11.5
11.5- 12.0
12.0- 12.5
12.5- 13.0
13.0+
Total

Govt.
0.0
0.0
0.0
0.0
0.0
-0.1
0.2
0.0
0.4
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
-0.5
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.1

Lehman Brothers

Corp.
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.4
0.0
0.0
0.0
0.0
1.0
1.5
-0.4
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
2.5

MBS
0.0
0.0
0.0
0.0
0.0
1.2
0.1
0.0
-0.1
-0.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.9

ABS
0.0
0.0
0.0
0.0
0.1
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.1

In some cases, it is possible to attribute performance to

sector allocation and security selection even for securities outside the benchmark. If an appropriate Lehman
Brothers index is available for the asset class in question,
this index may be included in a composite index benchmark with a weight close to zero. This approach will
enable our analytics to attribute performance to sector
allocation and security selection, even for sectors outside the true benchmark. For a portfolio that included
MBS in an effort to outperform the Government/Corporate Index, we could redefine the benchmark as a
combination of the actual Government/Corporate Index
and a negligible percentage of the MBS Index. Portfolio
performance due to allocation to the MBS sector would
then be computed based on the return of the MBS Index.
Performance due to MBS security selection would use
the MBS Index as the peer group.

Total
0.0
0.0
0.0
0.0
0.1
1.0
0.3
0.0
0.8
-0.3
0.0
0.0
0.0
1.0
1.5
-0.4
0.0
0.0
0.0
-0.5
0.0
0.0
0.0
0.0
0.0
0.0
0.0
3.6

Implementation Notes
Our current implementation of performance attribution
analytics offers a flexible definition of the market
segments to which portfolio and benchmark allocations

March 1998

are compared. These segments are defined by a twodimensional grid, based on values of two security
attributes chosen as coordinates. The first coordinate,
which is meant to define term structure, is constrained
to be a time-related field, such as duration, maturity, or
average life. (The attribute usually selected for this
coordinate is the modified-adjusted duration at the beginning of the month.) Cells can then be defined based
on arbitrary ranges of this attribute (e.g., half-year
duration cells). It is important to subdivide the market
into duration segments narrow enough to insure that
within a given range portfolio duration is very close to
that of the index.

coupon range or liquidity as measured by age, while in an

all MBS portfolio it could be origination year or price level
(current coupons, premiums, and discounts).
The explanatory power of the performance attribution depends on how well the selected grid reflects
the actual views on allocation decisions specific to
this portfolio.
At present the software implementation assumes
a static portfolio over the reporting period and does
not account for intra-period trading and cash flows in
and out of the portfolio. While this assumption is always
true for indices, it constrains the ability to analyze
actively traded portfolios. Overcoming this limitation
is a high priority for the Lehman Brothers software
development team.

The second dimension of the attribution methodology (for

which we used sector as an example) is defined according to the portfolio. In a pure Treasury portfolio it could be

Figure 6.

Returns due to Security Selection, in %

Portfolio: ABC
Benchmark: Lehman Brothers Aggregate Index
Pricing Date: 06/30/1997

Mod.
Par
Adj. Dur.
Value
Beg. (yr.) Sector ($ mill.)
2.65
UST
2,000
3.40
UST
2,000
4.47
USA
1,000
9.62
UST
1,000
12.56
UST
2,000
6.11
8,000

Ptfol.
% Beg.
6.23
6.20
3.18
1.59
5.87
23.08

Total
0.84
0.96
1.20
1.61
2.29
1.34

Returns (%)
Market
Sec.
Cell Excess Select. (bp)
0.86
-0.02
-0.12
0.92
0.03
0.21
1.07
0.14
0.43
1.91
-0.30
-0.47
2.29
0.00
0.00
0.06

# Issuer
1 U.S. Treasury Notes
2 U.S. Treasury Notes
3 Federal Home Ln. Mtg. Corp.
4 U.S. Treasury Strips
5 U.S. Treasury Bonds
Government Totals

Coupon
6.375
6.250
7.125
0.000
6.500

Maturity
05/15/2000
04/30/2001
11/18/2002
05/15/2007
11/15/2026

6 Travelers Inc.
7 Phillip Morris Cos. Inc.
8 Repsol Intl Finance
9 General Electric Capital
10 AT&T Corp.
11 Duke Power
12 Delta Airlines, Inc.
13 News AM Holdings
14 United Airlines Inc.
Corporate Totals

6.125
7.625
7.000
7.875
7.750
7.500
10.375
8.000
9.750

06/15/2000
05/15/2002
08/01/2005
12/01/2006
03/01/2007
08/01/2025
02/01/2011
10/17/2016
08/15/2021

2.65
4.07
6.00
6.70
6.71
7.20
7.66
9.56
10.01
6.81

FIN
IND
FOC
FIN
TEL
ELU
IND
IND
IND

1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
9,000

3.14
3.18
3.16
3.27
3.29
3.04
3.90
3.06
3.76
29.80

0.88
1.25
1.35
1.52
1.86
2.17
1.63
2.09
2.24
1.67

0.88
1.11
1.37
1.53
1.53
1.67
1.74
2.09
2.24

-0.00
0.14
-0.02
-0.01
0.33
0.50
-0.11
-0.01
0.01

-0.00
0.44
-0.05
-0.05
1.09
1.51
-0.43
-0.02
0.03
2.52

15 GNMA I Single Family

16 FNMA 7-Years Balloon
17 FNMA Conventional Interm.
18 FNMA Conventional Long T.
19 GNMA I Single Family
20 FHLM Gold Guar Single F.
21 GNMA I Single Family
22 FNMA Conventional Long T.
23 GNMA I Single Family
24 GNMA I Single Family
Mortgage Totals

30yr
30yr
15yr
30yr
30yr
30yr
30yr
30yr
30yr
30yr

9.000
6.500
6.500
8.000
8.000
7.500
7.500
7.000
7.500
6.500

11/01/2015
06/01/2026
03/01/2008
12/01/2023
06/01/2026
04/01/2026
09/01/2022
09/01/2022
02/01/2027
03/01/2023

2.93
3.18
3.35
3.43
3.53
4.16
4.19
4.46
4.59
5.35
3.88

GNa
FNd
FNc
FNa
GNa
FHb
GNa
FNa
GNa
GNa

2,000
1,000
1,000
2,000
1,000
1,000
1,000
2,000
2,000
1,000
14,000

6.69
3.07
3.06
6.36
3.18
3.12
3.13
6.12
6.23
2.98
43.95

1.17
0.99
1.03
1.15
1.14
1.25
1.17
1.27
1.28
1.50
1.20

0.99
1.08
1.08
1.08
1.13
1.24
1.24
1.24
1.33
1.50

0.18
-0.08
-0.05
0.08
0.01
0.00
-0.08
0.03
-0.04
-0.01

1.17
-0.26
-0.15
0.49
0.03
0.01
-0.24
0.15
-0.27
-0.02
0.92

25 Discover Card Tr. 93-B

Asset-backed Totals

A-1

6.750

02/15/2002

2.35
2.35

ABS

1,000
1,000

3.18
3.18

0.83
0.83

0.80

0.04

0.12
0.12

Lehman Brothers

March 1998

RELATIONSHIP TO
OTHER LEHMAN ANALYTICS

First, the basis for excess return comparison is not a

benchmark selected by the investor but a Treasury
universe duration-matched to the portfolio. Second,
this duration-matching procedure precludes the evaluation of return due to yield curve positioning. In fact, the
goal of the analysis is to strip out the effect of yield curve
positioning to see what is left.

The analysis of returns, both projected and observed,

is a central task of portfolio and index analytics. There
is some overlap between the new performance attribution model and several other analytical models
used at Lehman Brothers. Each of these tools takes
a slightly different view of portfolio returns. Figure 7
summarizes the essential characteristics of each of
these models. Below, we highlight the similarities and
differences among these features and discuss some
of their interrelationships.

An example shows the difference between excess

return and performance attribution. For an investor who
runs performance attribution on half-year duration cells
with the Treasury Index as a benchmark, performance
attribution uses a hypothetical portfolio P with portfolio
weights and benchmark returns (see Equation 3). The
return on P minus the benchmark return gives the
outperformance due to curve positioning. By definition,
excess return is portfolio return minus the return on a set
of duration-equivalent Treasuries. In this example, this
set is the same as hypothetical portfolio P. Therefore,
in this case outperformance due to factors other than
curve positioning is equivalent to excess return. Appendix B defines excess return and shows its application to
analyzing portfolios and indices.

Excess Return over Treasuries2

Used in Global Relative Value Analysis, this feature
measures the curve-adjusted excess return of a given
portfolio or index relative to a duration-matched position
in U. S. Treasuries. Each month, we calculate the
average returns on Treasuries in half-year duration
cells from 0.0 to 12.5 years. An excess return is calculated for each security as the difference between the
securitys total return and the total return on Treasuries
in the corresponding duration cell. These excess returns can be aggregated to the portfolio level or broken
down according to any partition specified by the portfolio manager. The methodology used is thus similar to
performance attribution with several key differences.

Return Attribution
Since June 1996, Lehman Brothers has provided return
attribution reporting for portfolios and indices.3 This
approach seeks the causes of return by breaking the
return of each security in a portfolio or index into
components due to passage of time (coupon, accretion,

2Excess return is used in this section for individual security return over
duration-matched Treasuries (see Appendix B). This is not to be confused
with the excess return over the benchmark used in the performance attribution framework.

Figure 7.

The Lehman Brothers Return Attribution Model, Lehman Brothers, May 1996.

Key Characteristics of Quantitative Models for Analyzing Risk and Return of Fixed Income Investments

Analytical Model Applies to

Explains

Analyzes Term
Structure by

Analyzes Spread
Sectors by

Used for

Key Outputs
curve-adjusted
return

Excess Return

security

historical excess
return

duration cells

comparison to
duration-equivalent
Treasuries

relative value

Return
Attribution

security

historical return
components

shift, twist,
butterfly

volatility return,
spread return

detailed attribution time, yield curve,

volatility, and
of past returns
spread returns

Performance
Attribution

portfolio vs.
benchmark

historical
outperformance

duration or
maturity cells

sector cells

attribution of
outperformance

outperformance
due to curve
positioning, sector
allocation, and
security selection

Risk Analysis

portfolio vs.
benchmark

projected variance
of outperformance

curve risk
factors

historical spread
variances and
correlations

risk projections

tracking error and

its components

Lehman Brothers

March 1998

Risk Analysis

rolldown), changes in the yield curve (shift, twist, butterfly, and residual), volatilities, and spreads. It can be
applied to any portfolio or index in isolation.

The differences between a portfolio and its benchmark

span many axes simultaneously. A portfolio manager
might adjust exposures relative to the benchmark
by structure, sectors, quality, coupon levels, and
optionality. More frequently, a manager might consciously control two or three of these factors and express no view on others. Risk analysis quantifies all
these exposures simultaneously and evaluates the contributions to tracking error (volatility of portfolio versus
benchmark performance differences) due to each category. It also breaks out nonsystematic tracking error,
which reflects the exposure of the portfolio to specific
issuers and securities and is typically small for welldiversified portfolios.

In the new performance attribution feature, by contrast,

the goal is to explain return differences between a portfolio and a benchmark. Rather than subdividing the total
return of a security, performance attribution explains
portfolio performance relative to the benchmark in terms
of allocation differences between the two. The benchmark is so central to performance attribution that the
method cannot be applied to a portfolio in isolation.
When return attribution is run simultaneously on a portfolio and a benchmark, it will calculate the return on each
due to changes in the Treasury yield curve. The difference between these two returns is closely related to the
outperformance due to curve allocation calculated in
performance attribution, and the numbers will often be
similar. However, these two calculations are conceptually different. In return attribution, yield curve return
considers only changes in pricing due to movement of the
Treasury curve. The duration cell approach used in
performance attribution considers simultaneously all
curve-dependent components of total return, including
coupon differentials, changes in the term structure of
spreads, etc. Especially if the spread sectors figure
prominently in the portfolio or the benchmark, these
various effects can lead to apparent discrepancies between the two forms of analysis. For instance, if spread
changes over the period increased with maturity, the
performance attributed to curve allocations in this new
methodology will have spread effects associated with it.
Complete separation of the curve and spread effects
cannot be achieved in performance attribution based on
allocation differences between portfolios and indices. It
requires attribution of single security returns.

Risk analysis thus provides an expectation of the volatility of tracking error and its various subcomponents.
Those subcomponents of projected return differences
can be mapped onto the components of historical return
differences measured by our performance attribution
model. The projected tracking error due to term structure relates to observed return differences from curve
allocation. The tracking error due to effects other than
term structure (combined effect of sector, quality, prepayment, and other risks) relates to outperformance
due to sector allocation. The magnitude of the tracking
error from nonsystematic risk (also known as special or
concentration risk) relates to outperformance due to
security selection.

CONCLUSION
The new Lehman Brothers model attributes portfolio
performance relative to a benchmark to
allocation differences between the two in multiple dimensions; and
security selection within each market segment.

The option-adjusted spread (OAS)-based return attribution methodology of single security returns identifies a
spread return due to change in OAS. We chose not to
subdivide spread return into sector-related and individual
security components as part of our return attribution
model. We found that this subdivision requires a flexible
definition of sectors, which is outside the scope of this
security-specific model. However, the performance attribution approach allows flexible sector definitions. It
therefore can help distinguish between broad spread
trends across a market sector and credit events affecting
specific issuers.
Lehman Brothers

The model is a practical and effective tool for explaining

historical returns. Its implementation offers flexibility in
defining risk dimensions to match a particular portfolioindex combination. It can be used for reporting components of portfolio performance to plan sponsors. Combined with attribution of individual security returns and
projections of portfolio risk relative to the benchmark, this
model provides the analytical tools to trace achieved results
to the asset allocation decisions of a portfolio manager.

10

March 1998

i =1

t =1

t =1

s =1

P
P
P
P
w i = xt = xt z st

APPENDIX
A. Portfolio Composition and Returns
The composition of a portfolio can be expressed at
several levels: as a collection of individual securities, in
terms of allocation to duration cells, or in terms of allocation to segments in a two-dimensional grid, such as
duration/sector cells. To avoid confusion as we switch
among these different views, we use the following notation for discussing the composition and return of a portfolio
P composed of allocation to a universe of I securities, and
further partitioned into T (nonoverlapping) duration cells
and S sectors.

MV P

market value of portfolio P at

the beginning of the month,

MViP

market value of portfolio P invested in security i,

w iP

= MViP

MV

{the set of securities which fall

in duration cell t} ,

B st

{the set of securities which fall

in sector s and duration cell t},

x tP = w iP
i Bt

P
y st
= w iP
i Bst

P
P
z st
= y st
x tP

T S

t =1s =1

t =1s =1i Bst

P
w i = 1.

The segmentation of a single duration cell t into its

sector allocations can be stated equivalently as
P
P
P
S
S
s =1z st = 1 or s =1y st = x t .
As we analyze portfolio return, we will use the same
symbol r to denote all returns, and rely on the subscript and superscript to distinguish among the
following quantities:

ri

return on security i
(independent of portfolio composition),
I

r P = w iP ri

return on portfolio P,

i =1

percentage of portfolio P allocated to security i,

Bt

T S

P
= y st
=

rtP = w iP ri

P
w i return on portion of portfoi Bt
lio in duration cell t, and

rstP = w iP ri

P
w i return on portion of porti Bst
folio in sector/duration
cell st.

i Bt

i Bst

As with the allocations, the return of the portfolio can be

represented in several equivalent ways:

percentage of portfolio P allocated to duration cell t,

i =1

t =1

t =1

s =1

P P
r P = w iP ri = x tP rtP = x tP z st
rst

percentage of P in duration
cell t and sector s, and

T S

T S

t =1s =1

t =1s =1i Bst

P P
rst =
= y st

relative percentage of the

portfolios allocation to duration cell t which is in sector s.

P
w i ri .

Attribution of Excess Return

(The symbols and denote the operators for summation and set membership, respectively. For example,
P
P
the expression x t = i Bw i describes the summation of
t
weights across all securities i within the set defined by
duration cell t.)

The segmentation of portfolio return can be applied

simultaneously to both a portfolio and a benchmark. (The universe of securities I is assumed to
include the union of all securities found in either
the portfolio or the benchmark, with weights w i = 0
where appropriate.)

Using this notation, we now have several equivalent ways to express that the allocations must sum
to 1:

To help analyze the difference between the portfolio

return r P and the benchmark return r B, we start with
the benchmark return as a base and introduce two

Lehman Brothers

11

March 1998

intermediate points in which we modify the benchmark

return to reflect the portfolio allocation. Thus, let

Each of the latter two terms can be rolled into higher

levels by summing terms within a sector or duration cell.
Thus, we can define terms for the summary quantities
available in the Lehman Brothers reports:

e = r P r B = ecurve + e sector + e security

excess return, where
T

e curve = xtP rtB r B ,

sec tor

e ssec tor = e st

t =1

t =1

t =1

s =1

t =1

P B
e sec tor = xtP z st
rst x tP rtB , and
T

t =1

s =1

sec tor

etsec tor = est

s =1

P B
e sec urity = r P xtP z st
rst .
sec urity
est

Thus, the excess return due to curve allocation is the

return advantage over the benchmark that would have
been obtained by a strategy that perfectly replicated
the benchmark composition within each duration cell
but scaled the allocation to each duration cell to match
the portfolio allocation xtP . The excess return due to
sector allocation is the advantage over this strategy
that would be obtained by a further rebalancing to
P within
match the portfolio allocations to sectors z st
each duration cell. Both of these terms depend solely
on benchmark returns and portfolio allocations. Any
return differences between the portfolio and benchmark within a sector/duration cell will be subsumed
under excess return due to security selection.

sec tor
est

excess return due to sector allocations within

duration cell t,
excess return due to security selection within sector
s, duration cell t,

sec urity
excess return due to
essec urity = est
t =1
security selction within
sector s, and

sec urity
excess return due to
etsec urity = est
s =1
security selection within
security cell t.

A positive subcomponent of excess return may be

achieved either by over-weighting a market segment that
outperforms the benchmark or by under-weighting an
underperforming segment. The derivation of these formulas involves switching among the several equivalent
representations of portfolio composition and return. The
idea of such an intuitive definition of a market segment
contribution to overall performance difference is quite
simple. Lets use allocation to duration cells as an example. Of all duration cells in an index, some performed
better than the index, some worse. It should be beneficial
to the portfolio to exceed benchmark allocations to outperforming cells and to be underweighted in
underperforming ones. We redefine curve return in terms
of contributions by individual cells such that this property
holds. While this has no effect on the overall attribution of
return to curve movement, it will make contributions of
individual duration ranges intuitively clear.

Telling a portfolio manager that the portfolio

underperformed by 3 bp due to allocations to duration
cells, or 2 bp due to sector allocations, or 5 bp due to
security selection, will not necessarily answer all the
questions. Rather, it is likely to raise a whole set of new
questionswhich duration cells? which sectors? which
securities? Each component of excess return defined
above can be further subdivided into subcomponents
corresponding to each individual allocation decision:

etcurve

excess return due to

allocation to sector s,

excess return due to allocation to duration cell t,

excess return due to allocation to
sector s within duration cell t, and

eisec urity excess return due to portfolio allocation to security i.

Lehman Brothers

12

March 1998

e curve = x tP rtB r B r B + r B

To evaluate the performance contribution of each security in the portfolio, we compare its return to that of the
finest level cell of the benchmark against which its return
has been measured in the previous steps of the analysis.
In this case, that would be the return rsB(i ),t (i ) that the
benchmark achieved in the sector and duration cell
corresponding to security i.

t =1
T

t =1

t =1

= xtP rtB x tB rtB

T

t =1

t =1

r B x tP + r B x tB

)(

T
T
= xtP xtB rtB r B etcurve .
t =1

P B
e sec urity = r P x tP z st
rst

t =1

t =1

T S

s =1
T S

P P
P B
rst y st
rst
= y st
t =1s =1

Within a given duration range t, with benchmark return

rtB , our analysis centers on the portfolios sector allocaP . It was beneficial to have an overexposure to
tions z st
sectors that outperformed the average return of the index
in this duration range. The performance contribution of
allocations to individual sectors within each duration
range are thus redefined using rtB as a basis.
T

t =1
S

s =1

t =1

w Pr
i B i i

= w iP st P
t =1s =1 i Bst w i
i Bst
T S

T S

w iP rstB
t =1s =1 i Bst

P B
e sec tor = xtP z st
rst xtP rtB

T S

t =1s =1i Bst

P
B
w i ri rst

P B
= x tP z st
rst rtB

t =1 s =1
T

t =1s =1

)
I

= w iP ri rsB(i ),t (i ) eisec urity .

T
S P B

rst rtB rtB + rtB

= x tP z st

t =1 s =1

i =1

i =1

T
S
S
S P B S B B
P
B
= x tP z st
+ rtB z st
rst z st rst rtB z st

t =1
s =1
s =1
s =1
s =1

)(

T
S
T S
P
B B
sec tor
rst rtB est
= xtP z st
z st
.
t =1

s =1

Lehman Brothers

t =1s =1

13

March 1998

B. Methodology for Calculating Excess Return

on all Treasuries that began the month with durations between 2 and 2.5 years was 0.73%.

I. Form a table of Treasury returns by duration:

A. Measure performance of all Treasury securities
in a given month and group them in half-year duration cells. For each duration cell, calculate the
average return of all Treasuries in that cell. Figure B-1 shows the results of this grouping for May,
1997. For example, the average return for May

B. For any empty cells (indicated by an asterisk),

assign a return by interpolating between the returns of the nearest non-empty duration cells on
either side. For example the three cells from 7.5
to 9 years duration contain no bonds from which
to form a return estimate; the table is filled in by
interpolating between the value of 1.05 obtained
for the 7.0- to 7.5-year cell and the 1.10 return of
the 9.0-9.5 year cell.

Figure B-1. Treasury Returns by Duration, May 1997

Beginning
Mod. Adj.
Duration
0.0- 0.5 yr.
0.5- 1.0
1.0- 1.5
1.5- 2.0
2.0- 2.5
2.5- 3.0
3.0- 3.5
3.5- 4.0
4.0- 4.5
4.5- 5.0
5.0- 5.5
5.5- 6.0
6.0- 6.5
6.5- 7.0
7.0- 7.5
7.5- 8.0
8.0- 8.5
8.5- 9.0
9.0- 9.5
9.5- 10.0
10.0- 10.5
10.5- 11.0
11.0- 11.5
11.5- 12.0
12.0- 12.5
12.5+

II. For any bond, calculate excess return over Treasuries:

Treasury
Total Return
0.54%
0.59
0.66
0.71
0.73
0.75
0.78
0.78
0.80
0.92
0.97
1.03
1.11
1.05
1.05
1.06*
1.08*
1.09*
1.10
1.11
1.11
1.15
1.18
1.21
1.16
1.16*

A. Based on beginning duration, find the corresponding duration cell for each bond.
B. Calculate excess return for each bond by subtracting the Treasury return from the associated
duration cell from the total return of the bond,
as illustrated in Figure B-2. For example, the Rite
Aid issue, with a beginning duration of 6.71, maps
to the 6.5-7.0 duration cell, for which the average Treasury return was 1.05. The observed
total return of 1.72 thus represents an excess
return of 0.67.
III.To calculate excess return for a portfolio or index, take
the market-weighted average of the excess returns
calculated for each bond. This will be equivalent to
the total return difference between the portfolio and
an all-Treasury portfolio composed using a bond by
bond duration match.

Figure B-2. Illustration of Excess Returns on Individual Bonds, May 1997

Issuer
Colombia, Rep. of
Rite Aid Corp.
News AM Holdings
Delta Airlines, Inc.
Quebec Prov. Canada

Lehman Brothers

Coupon
7.250
7.125
8.000
9.750
7.125

Maturity
2/23/04
1/15/07
10/17/16
5/15/21
2/9/24

Beg. Duration
5.16 yr.
6.71
9.58
9.81
11.08

Total Return
2.25%
1.72
1.82
1.02
1.85

14

Treasury Cell
5.0-5.5 yr.
6.5-7.0
9.5-10.0
9.5-10.0
11.0-11.5

Treasury Return
0.97%
1.05
1.11
1.11
1.18

Excess Return
1.28%
0.67
0.71
-0.09
0.67

March 1998