Bond Portfolio Holding Period Return Decomposition

Abstract

Bond portfolio holding period returns are decomposed into four macro components: horizon, spot rate, spread, and interaction. The spot rate and spread could be decomposed further based on modified duration, convexity, and cross-convexity, each of which could be further decomposed into three subcomponents tied to level, slope, and curvature. Applying a parsimonious version of this model to the Morningstar universe of bond funds explains approximately 56% of the variability of the returns. Thus, we provide a powerful approach to attribution of bond fund performance, aiding the many different stakeholders in their efforts to improve their decision-making process.