What is quantitative analysis and how do you implement it?
With in a asset
management world, quantitative analysis or Quants involves analyzing
the returns, risk and characteristics of securities. Market and portfolios
.As one might imagine, this is a hugely complex and demanding field, not
least because of the huge amounts of accurate data that is required to
provide performance and risk analyses. Quants teams not only provide performance
and risk analyses.
Quants teams not only provide data for internal management purpose but
also for external consumption. This includes analysis for the funds
Trustees and Clients on each funds performance, turnover and risk.
It is obviously absolutely key that the figure produced are of the highest
possible accuracy, other wise the asset management firm could be liable
to FSA sanction for misrepresentation. Because of the requirement for
accuracy and the complex tasks involved, Quants staffs are often qualified
to actuarial standard.
Performance Analysis:
It is basically falls in to two categories: return calculations and performance attribution, performance return calculations and performance attributable to the fund managers actions. Attribution takes performance analysis to a more detailed level and seeks to explain the performance of the fund manger by analyzing the funds return and breaking it down in to different risk categories impacting the fund . Thus performance return calculation tells us what the performance was, whist performance attribution analysis tell us why the figures were good or bad.
Performance Return:
The Return calculation is fairly straight forward. It is however important to ensure that the figure calculate reflects the fund mangers decision making and judgment, and not external events beyond his control. In general, changes to the portfolios value can occur for the following Reasons.
Change
|
Source
of Change
|
Fund
Manager Action?
|
Prices of Securities in Fund | Market Forces | Yes |
Coupon | Security Holding | Yes |
Right Issue | Security Holding | Yes |
Scrip Issue | Security Holding | Yes |
Capital Inflow / out Flow | Client Decision | No |
Fund Management | Asset Manager | No |
In order fairly to asses the fund managers performance, it is obviously important to ensure that items not under his control are excluded from the performance return. Thus a huge capital inflow should have no effect on the performance figure reported. More subtle refinements to the measurement of return, such as attempting to eliminate the effects of the timing of a particular cash flow, are covered later.
How can one assess
whether a funds return is good, bad or indifferent? This first step
is to compare the funds step is to compare the funds return to that
of its benchmark. The funds benchmark performance is generally calculated
from changes in the value of the indices underlying the bench mark. Ideally,
these indices would be provided at stock level in order to give the greatest
flexibility in performance reporting; how ever, data is not always available
to this level of granularity.
In order to calculate the benchmark return, two elements usually need
to be combined, these being the top level benchmark split
and the percentage change in the underlying indices. Lets assume
that a benchmark had been set by the trustees to be 75% equalities and
25% bonds, ad the underlying indices were specified as being the MSCI
world index to represent equities and the JP Morgan Government Bond index
to represent bonds. The benchmark performance for a single period would
be calculated in the following way:
Index | Index weight (from split ) | Index Level start | Index Level End | Index Level | Bench Return |
MSCI World | 75% | 300.00 | 330.00 | 10% | 7.5% |
JP Morgan | 25% | 240.00 | 208.00 | -15% | -3.75% |
Total | 100% | 3.75% |
If Performance is required for more than one period , the returns for each period can be Chain linked using the standard geometric calculation :
Return = { (1+ return ) x ( 1+ Return ?)x etc } -1
This data can then be used to calculate the relative performance of the fund against the benchmark. The calculation of the funds performance needs to take accounts of those items. That are not under the control of the fund manager. In order to achieve this modified Dietz return calculation is generally used
Return = Fund
value + Income cash flow fund value
______t= 1 _________________________________
Fund Value t=0
A general time period is used, since this calculation can be used for
any periodicity and then chain linked as above. We can now calculated
the relative return of the fund to its benchmark (generally simply by
subtracting the bench mark performance from the fund performance), which
gives a measure of how well the fund manager has done.
Performance Attribution:
Having calculated
the return of the fund, the next level of details normally required by
fund mangers, trustee and increasingly clients, is a breakdown of the
sources of the performance of the fund. Attribution essentially provides
an analysis of what fund mangers are relatively good at, i.e. which influences
on his fund he is good at forecasting. We should be able to see whether,
for example, an equity fund mangers relative returns come mainly
from selecting the best performing markets or whether they come from picking
the best performing stocks.
Since there are a large of different influences on the value of a portfolio,
attribution can be carried out in an enormous variety of ways, it is important
that attribution is carried out in the way that decisions regarding investment
in the fund are carried out. If attribution is carried out in some other
way, the result will be best meaningless and at worst very misleading.
Fixed Interest Performance Analysis:
Fixed interest return calculation and attribution is carried out in much the same way, but naturally using attributes relevant to fixed interest investment, such as yield curve allocation. Fund managers can also take an overall long position against the bench mark, the effect of which can be calculated. Since fixed interest portfolios are constantly changing, attribution analysis Is only really meaningful for the length of time that a strategy is in place. These trades are generally in place for fairly short period.
Data Issues:
The bane of quantitative analysts live in the sourcing and preparation of the data required to carry out performance analysis. Problem include the following
· Non
availability of the correct level of transaction data, eg Income entitlements
and receipts being linked to underlying securities.
· Benchmark Adjustment, such as those required to maintain Benchmark
position with in fixed top level % splits and adjusting calculated
benchmark.
· Having to adjust for publishes performance figures, i.e. where
performance figures have been released, and are subsequently found to
be in correct.