Reporting
24.1 TREATMENT OF RESIDUALS
Residuals are a fact of life in attribution. Even for the most liquid securities, it is most unlikely that there will be a perfect match between the price as calculated from market curves, and the market price.
The consumer of attribution reports should therefore be deeply suspicious of a report that claims zero residual return. On many occasions, residual return may be redefined as credit return, but this should always be made clear to the user.
The best way to treat residuals is to accept that they convey useful information and that they act as a check that pricing accuracy lies within acceptable limits.
24.2 UNATTRIBUTED RETURN
A very useful technique for business-as-usual reporting is to use an unattributed return bucket on attribution reports.
New securities enter portfolios all the time. Usually, these are based on existing patterns, such as corporate bonds or swaps. However, particularly in the fixed income markets and for larger investors, new security types may often need to be included in a portfolio even if they are not types that are included in the current security library, and so cannot be priced by the attribution application.
In this case the analyst has three courses of action:
- Halt all production attribution reporting until the security can be modelled correctly. This is seldom a practical option, especially as an entirely new security type may require a new build of the underlying software.
- Attempt to represent the new security as an existing type. This may work in the short term but is seldom a satisfactory solution.
- Place its return contribution into an unattributed bucket. This indicates that the attribution system cannot yet handle this asset type, so its contribution to report is placed into a separate category where it may be monitored.
Essentially, this approach defers solution of the problem. As long as its performance contribution is small, the presence of this new security will not substantially affect the overall conclusions of the attribution report, which tells the story of which global risks affected the portfolio’s absolute or active returns. Attribution reporting can then proceed as usual until the security can be modelled in the correct form.
In most cases, the third approach will be preferable to halting the production of attribution reports until the security has been classified.