1. Benchmarking Your Portfolio
January 13, By: David Witthohn, CFA, CIPM, Director

2. Why Benchmark Your Portfolio?

3. What is the Purpose of Benchmarking?
Why wear a watch? Why have a speedometer?
Establish a Standard – Minutes, Speed or Return
Measure Progress – Next Break, Destination or Goals & Objectives
Set Limits – Time, Speed or Risk

4. Isn’t It Just All About Performance?
Would you buy a U.S. Treasury Bond with a yield of 4.27%?
It’s about performance and risk
Risk/Return Tradeoff

5. Portfolio Objectives Preserving principal
Providing sufficient liquidity to meet cash flow demands
Achieving a market rate of return

6. Benchmark used to Achieve Portfolio Objectives
A good benchmark can be used to measure all of the following:
Safety – How much credit risk is in the portfolio? How much interest rate risk? How long is the portfolio’s average maturity?
Liquidity - Can the assets be sold? Are there sufficient funds available to meet cash demands?
Return – What is a market rate of return? Is the portfolio under invested?

7. Performance Measurement

8. Measuring Return There are two different prospectives: Yield Approach
Assumes held to maturity
Simplifies calculations
Smoothes earnings
Makes projections easier
Bases return on true income
Cons
Ignores price movement
Hides risk
Approximates performance
Total Return Approach
Pros
Industry standard
Shows all risks
Gives an accurate value
Allows comparability
Cons
Difficult to calculate
Hard to capture return
Return is erratic

9. Yield Approach – Yield to Maturity (YTM)
Assumptions:
Looks only at the income from the bond
Yield-to-Maturity (purchase yield)
Reinvestment of interest at the YTM
Security held to maturity with no optionality (non-callable)
Annualized for comparison purposes
Approximation of true yield

10. Yield to Maturity

11. Yield to Call Yield-to-Call and Yield-to-Worst
Adjusts the yield based on a call date
Uses the market price as an indication of which securities will be called

12. Yield to Call

13. Amortized Cost Amortized Cost Method
Return = (Interest +/- Accretion/Amortization +/- Realized Gain/loss)
Average Daily Historical Cost
Annualize: divide by # of days in the period and then multiple by 365
Captures sales and purchases, maturities, and called securities
Calculates actual reinvestment rate
Calculates return for period – not just a point in time

14. Total Return – Industry Standard
Total return performance combines both income and change in price.
Total Return = Value End – Value Start Value Start
Doesn’t allow for cash flows for the period (no additions or subtractions)
Assumes you will sell the security today using the current price
Changing prices varies return from period-to-period
Global Investment Performance Standards (GIPS) – These are client returns adjusted for any cash flows

15. Total Return vs. Yield to Maturity (YTM)

16. Total Return – Price vs. Income
Total Return – 5.52% Income Return – 5.51% Price Return - .01%

17. Benchmark Selection
When you select an Index as your benchmark ideally want it to reflect what you are doing in the portfolio. Here are some issues that you might not have thought about:
Indexes don’t include transaction costs
Indexes are passive
Indexes have no transactions

18. Benchmark Selection
The transaction issue can be reduced by splitting the portfolio into liquid funds and core funds.

19. Traditional Portfolio Structure
Provide money market-like liquidity with incremental returns to traditional Rule 2a-7 funds
Capture money market return
Manage liquidity and credit risks
Reinvest cash flows timely (critical to achieving competitive return profile)
Capture best duration risk-adjusted returns with the “Core” portfolio
Allocate to government and high quality sectors, ensuring liquidity if needed
Liquidity Portfolio
1 to 3 Years

20. Selecting a Benchmark For Your Core Portfolio

21. Drivers of Performance
There are three main drivers of portfolio performance for core funds. Generally these are short-term high quality portfolios:
Duration Effect – duration of portfolio
Sector Effect – allocation of portfolio
Selection Effect – securities in portfolio

22. Duration Effect – Selecting a Target
Return vs. Number of Negative Quarters
October 1, 2000 to September 30, 2010

23. Duration Effect - Risk/Return Tradeoff

24. Duration Management
Cutwater adjusts target duration based on current market conditions. We favor a low-risk approach, using an asymmetrical range to limit market risk. When rates are at the upper end of the band, a duration that is 10% above target is appropriate. When rates are low, a target duration as low as 50% of the target limits market risk.
Source: Bloomberg

25. Amortized Cost – Evaluating Market Risk

26. Amortized Cost – Evaluating Market Risk
06/30/10
Final
Effective
Weighted
Issuer /
Maturity
Call Date
Acquisition
% of
Days to
Wtd. Avg.
Average
Security
Coupon
Date
(if any)
Cost
Portfolio
Call
YTM
Yield
FNMA POOL
5.000%
11/01/10
$ 1,438,167.80
2.68%
124
0.308%
3.33
0.008%
4.000%
12/01/10
$ 1,326,607.49
2.48%
154
0.164%
3.81
0.004%
4.500%
01/01/11
$ 1,630,747.40
2.30%
185
0.412%
4.25
0.009%
06/01/11
$ 2,077,436.49
3.88%
336
0.667%
13.02
0.026%
FNMA
2.000%
08/12/13
08/12/10
$ ,500.00
1.86%
1139 43
2.074%
21.20
0.80
0.039%
FHLB
1.000%
05/26/15
11/26/10
$ 1,000,000.00
1.87%
1791
149
33.42
2.78
0.019%
12/30/15
12/30/10
2009
183
37.48
3.41
0.037%
4.100%
07/01/16
07/01/10
$ 1,012,434.23
1.89%
2193 1
3.889%
41.43
0.02
0.073%
2.530%
05/04/17
08/04/10
2500 35
46.65
0.65
0.047%
FHLMC
3.100%
05/19/17
2515
46.93
0.058%
11/27/17
2707
50.51
12/18/17
09/18/10
$ ,000.00
1.39%
2728 80
38.02
1.12
0.028%
3.000%
01/29/18
07/29/10
2770 29
51.68
0.54
0.056%
02/12/18
2784
51.95
2.500%
12/23/19
09/23/10
3463 85
64.61
1.59
02/24/20
02/24/11
3526
239
65.79
4.46
05/19/20
11/19/10
3611
142
67.38
2.65
06/16/20
06/16/11
3639
351
67.90
6.55
FHLMC POOL
6.000%
09/01/21
$ 1,313,080.36
2.45%
4081
4.945%
99.98
0.121%
02/25/22
08/25/10
4258 56
79.45
1.04
0.075%
05/28/24
08/28/10
$ ,000.00
1.80%
5081 59
4.320%
91.49
1.06
0.078%
5.125%
08/19/24
$ ,514.06
0.89%
5164
4.848%
46.11
0.043%
09/30/24
09/30/10
5206 92
97.14
1.72
02/02/25
5331
99.47 CD
12/28/10
$ 14,000,000.00
26.12%
181
2.650%
47.28
0.692%
Money Market
$ 13,594,074.82
25.36%
0.210%
0.25
0.053%
Totals
$ 53,594,961.99
100.00%
346.90
1.850%
Loss to effective 2.85%
Loss to final % Given a 300 basis point increase in rates.

27. Sector Effect – Asset Allocation
It may be difficult to find a standard benchmark that completely matches your asset allocation. Here is an example:

28. Sector Effect – Asset Allocation
It may be difficult to find a standard benchmark that completely matches your asset allocation. Here is an example:

29. Custom Benchmark XYZ City Benchmark Treasury 1-3 Year 10%
Agency 1-3 Year 80%
Corporate A+ 1-3 Year 10%
Blended Benchmark 100%

30. How to Communicate Using Benchmarks

31. Communicating Performance Using Benchmarks
In communication it is helpful to show not only performance of the portfolio but also a measure of risk for the portfolio, like standard deviation or weighted average maturity
Need to swap out with Q1 charts

32. Benchmarking Summary
Benchmarks gauge portfolio return and portfolio risk
Portfolio return is linked to portfolio safety and portfolio liquidity
Performance can be measured by just income or by total return
Cash flow analysis splits the portfolio into Liquidity and Core portions
There are three primary drivers of portfolio performance
Duration is the primary driver of performance
Risk measurement is just as important as performance
Variation from the benchmark means active management