Wealth Reports - Volume 7

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In the absence of flows, compounding daily performance can be simplified and only initial and final values are required:. In the presence of flows this simplification is impossible as the intermediary terms cannot be eliminated. The consolidation of portfolio performance may lead to results that a client may find surprising. It is not uncommon for portfolios to hold investment positions and loans. A loan may be used to increase the value of the investments or for another purpose with the investments acting as a guarantee for the loan.

To determine the performance achieved by the investments in a portfolio containing loans the portfolio is separated into two hypothetical portfolios, one holding the investments and one the loans. Interest payments are transferred out of the investment portfolio without altering its performance and are paid from the loan portfolio with a performance impact. Consolidating the two portfolios gives a final value of The performance calculations for the hypothetical loan portfolio bring up issues which will be illustrated in the next section.

Extracting the loans from the portfolio allows for a better assessment of manager performance but adds the challenge of explaining the performance of the isolated loan to the client. While not very common, portfolios can have negative net asset values as a result of poor performance, typically in the presence of loans or derivatives with collateral held outside the portfolio.

In such circumstances performance analysis may yield unexpected results. Here are a few examples starting with performance annualization. The calculation is simple:. Performance compounding can also be an issue for a portfolio whose net asset value turns negative as it must have been worth zero at some point in time. To understand, consider that a portfolio with a negative net asset value holds a short position in an asset whose performance is being measured. While this approach allows for making sense of performance numbers and permits the compounding of performances it is difficult to grasp for clients and presents difficulties when indexing track records.

To compare, on the same graph, the performance of the portfolio from end of May to end of August to that of other portfolios, all the compared portfolios are indexed by first assuming that they start the period with a value of and then applying their respective performances starting from this value of Indexing the portfolio results in the following series:.

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While mathematically correct, such an indexed graph will leave not only the client but also investment professionals thoroughly confused. An option to side-step such pitfalls is to inverse the performance sign when the start value, V start , is negative and then when indexing to inverse the performance if the index value to which it is applied is negative.

Such a calculation method would result in the more comprehensible performance and indexed series:. The reporting of the performance of portfolios with negative asset values presents many challenges. While the methods presented above allow for certain of these issues to be circumvented, it is recommended to provide the client with didactic guidance in the interpretation of the results of portfolios with negative asset values. In this section we will shift from portfolio performance issues to those of position performance.

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As the topic is very broad we have chosen a few themes with which to illustrate it: position contribution, realized and unrealized profits and bond yields. In the presence of an intra period transaction, using the start of period weights is unsuitable. A solution could be to split the period at transaction time, calculate the contributions for both sub periods and aggregate to obtain full period numbers. But can we combine sub-period contributions? Breakdown of the preceding example into 2 sub periods see Table 4. The same is not true for position contributions.

Summing sub period contributions 6. Why is this? Splitting the analysis has introduced a cross position element which renders aggregation problematic.


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And this before even considering transactions! So, while position percentage contribution, in its simple form, is an appealing measure it is best suited for single period analysis and in the presence of transactions it is an approximation. At opening, a portfolio of is fully invested in a single position whose value reaches at year end. At the following year end the full holding is sold for In year one the portfolio had a profit of 10 which was unrealized. In year two the portfolio had a profit of 20 and a greater realized profit of 30 from the sale of the position. How can this be?

Table 4. Breakdown of period position contribution into that of two sub periods. The 20 of profit in year two is composed of 30 realized minus 10 unrealized profit at start of year.

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How should the unrealized profit at start of period be treated? This can be answered by considering that combining the analysis for year one and two should give the same result as the full period analysis see Table 5. This is somewhat confusing as the analysis for year two shows an unrealized loss of 10 when the portfolio holds no position at year end!

To comprehend this, consider that the analysis provides the change of unrealized profit over the period rather than its absolute value. Table 5. Breakdown of period profit into realized and unrealized componenents. Table 6. A year later the banker informs the client that the environment for bonds has improved with higher yields available and suggests increasing bond exposure.

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An environment which is described as improving for bonds purchases is actually detrimental to the valuations of previously acquired bonds. If yields subsequently rise his bond will appear unattractive to potential buyers and its value will fall.


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Alternatively, if yields fall the value of his bond will rise. When a portfolio manager describes the environment as improving for bond purchasing it may seem unclear to the client why under such positive circumstances his current bond portfolio has been performing poorly. It is recommended to provide the client with didactic guidance on portfolio manager assertions that may create confusion and risk undermining the credibility of the reports.

For wealth management banks, portfolio reporting is a key channel of communication with their clients. It is therefore important that the reporting be transparent and comprehensive in nature and comprehensible to clients in order to maintain their confidence. For example, in the presence of a loan it is important to explain to the client the impact of the loan on the performance of his portfolio.

Comprehensive reporting comes at a price, which is that the client reporting, which is based on complex mathematical calculations, becomes thus far more complicated. The possibility of including in portfolios high-end financial products such as derivatives further increases the complexity of reporting. The contribution of this paper is to specifically address some of those reporting pitfalls that regularly cause problems of understanding for clients.

The pitfalls discussed in the above.

Table 7. In parallel to that, clients have also, thanks to digitalization, access to new technology that enriches and complements the financial reporting provided by banks. This also can create some confusion for the client. For all these reasons, we believe that the examples we provide in this paper cover an important part of the problematic cases. They are, in the paper, articulated around the following four categories: from portfolio profit and loss to performance; details of portfolio performance calculation; portfolio consolidation and breakdown; positions performance.

Each example presented corresponds to a typical pitfall that clients of wealth management face. To maintain client trust in their reporting it is key to identify areas of potential misunderstanding prior to providing reports and offering clear explanations for the unusual numbers identified. We intend to continue this research in the future in subsequent papers to address more explanations regarding pitfalls that are not covered here. Indeed, and this is the main limitation of this paper, we investigate solely a part of the issues of actual portfolio reporting.

Indeed, undeniably, it may happen that as immersed in the Swiss banking ecosystem we have addressed some pitfalls that are especially important for a given clientele. Thus, there are maybe also very important pitfalls for other countries that are not covered in that paper. Practical Portfolio Performance Measurement and Attribution 2nd ed. Fundamentals of Corporate Finance. Determinants of Portfolio Performance. Financial Analysts Journal, 42, Financial Analysts Journal, 47, Portfolio Performance Measurement and Benchmarking.

Investment Performance Measurement. Inside the Yield Book. Performance Measurement for Traditional Investment.