For financial institutions, timely and accurate management
reporting is key to a successful investment management process. There are
four specific reports that are critical to the success of both bank and credit
union investment portfolio managers and should be produced periodically:

  1. A Portfolio
    Holdings Report
  2. An MDRA or
    Multi-Dimensional Risk Analysis Report
  3. A Partial or
    Key Rate Duration Report
  4. An Ex-Post
    Total Return Report

Each of these reports provides critical information to an investment manager and should be utilized to develop a successful portfolio management framework. 

Portfolio Holdings
A portfolio holdings report is a complete list of securities held in a portfolio at a certain point in time. Sound reporting and management decisions start with a complete and accurate representation of a portfolio at a certain time. When trade decisions are made, investment managers look at a holdings report for inventory. The holdings report will also show other pertinent information such as maturity date, current par, and market price, as well as analytics such as duration, average life and Conditional Prepayment Rate (CPR). Exhibit 1 shows an example of a typical holdings report entry.

Exhibit 1

Holdings reports are normally produced by a financial reporting system. The systems put in place must be reliable to produce accurate reports. A report containing inaccuracies usually means that other management reports are also inaccurate and can lead to further problems for a financial institution. In fact, the importance of accurate portfolio representation to successful portfolio management cannot be stressed enough.

A Multi-Dimensional Risk Analysis (MDRA) report is a group of “what-if” scenarios that measures how much portfolio value will change given a set of circumstances. These scenarios provide a portfolio manager with a dynamic view of where different types of risk lie in their portfolio. Common scenarios included would be a parallel shift in interest rates, changes to the slope of the yield curve, and the widening or tightening of spreads. If a portfolio contains securities with optionality, then additional scenarios should be included. These include changes in prepayment speeds and changes to the level of volatility. A comprehensive view of risk in a portfolio can help guide a portfolio manager to make more informed management decisions.

Partial or Key Rate Duration Analysis
Duration is a measure of a bond’s price sensitivity to changes in interest rates. It tells you how much the value of a security or portfolio is expected to change given a 1% parallel shift in interest rates. There are different types of duration, but effective duration is most commonly viewed because it is the only duration measure that considers the impact of embedded options. Portfolio managers will use duration as a key metric for managing a portfolio. Portfolios typically have a duration target that is indicative of their strategy. If the goal of a portfolio is to preserve principal and provide liquidity while generating a return, then the duration target will usually be set low. If the goal of a portfolio is to profit on expected economic trends, then a high duration target may be set.

Effective duration is a very helpful tool in portfolio management, but a parallel shift in interest rates is not a very realistic occurrence. Partial duration or key rate duration analysis measures how the value of a security will change along the entirety of the yield curve. A key rate duration analysis is done by shifting the rates at different maturities along the curve. This analysis is beneficial because it shows from which part of the curve most of the value change is coming and thus is riskiest. Whether it be a need to adjust risk profile or a decision to hedge, it is imperative that a portfolio manager knows at which point on the curve most of their risk exposure lies.

Total Return
Total return is a form of ex-post analysis that shows a complete picture of return over time. Ex-post simply means that the analysis looks at actual historical results. Total return is considered complete because it encompasses price appreciation and interest income earned. In total return reporting, the return of a portfolio should be compared to that of a benchmark to gauge how much value a portfolio manager is generating. (A benchmark is an index or a fund selected to represent the portion of the market that most similarly reflects the portfolio.) The goal of using a benchmark is to select one that represents a similar strategy and risk tolerance as the portfolio.

Excess return,
also known as alpha, is the difference between the return of the portfolio and
the return of the benchmark over the same time period, and it is the focal
point of a total return report.  It determines
if a portfolio manager’s strategy is adding value to the portfolio. Tracking
error is the standard deviation of excess return and it is used to measure how
closely a portfolio is tracking a benchmark. Tracking error looked at by itself
does not provide much value, but it can be beneficial when used as a complement
to excess return. A manager’s historical performance should be reviewed
periodically using these two measures. Exhibit 2 shows an example of how a
total return report may look.

Exhibit 2

These four reports are critical to a financial depository’s successful investment management process. Used in conjunction, these reports can help portfolio managers maintain a successful portfolio management framework. It is important to remember, though, that these reports are only as strong as their timing and accuracy. Late and inaccurate reports can cause serious issues for a portfolio manager and their financial institution.

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