How do I attribute returns to yield curve slope and curvature changes?

Question

AcadiFi · Accepted Answer

The yield curve effect captures active return from non-parallel curve changes — overweighting maturities that rallied and underweighting those that sold off. It's typically decomposed using key-rate durations.

Covenant Capital setup:
- Overweight 2-year: active weight +8%, 2-yr yield change -50bps
- Underweight 10-year: active weight -6%, 10-yr yield change +20bps
- Curve steepened (2-10 spread widened by 70bps)

Simplified calculation using partial durations:
- 2-year effect: active weight x partial duration x -(yield change)
- Assume 2-yr partial duration 1.9, 10-yr partial duration 8.1
- 2-year contribution: 8% x 1.9 x -(-0.50%) = 8% x 1.9 x 0.50% = +7.6 bps
- 10-year contribution: -6% x 8.1 x -(+0.20%) = -6% x 8.1 x -0.20% = +9.7 bps
- Combined curve effect: +17.3 bps

```mermaid
flowchart TD
    A[Curve Steepened] --> B[2Y Yield -50bps]
    A --> C[10Y Yield +20bps]
    B --> D[OW 2Y +7.6bps]
    C --> E[UW 10Y +9.7bps]
    D --> F[Curve Effect +17.3bps]
    E --> F
```

The manager correctly anticipated steepening — both positions contributed positively.

Decomposition refinements:
1. Parallel shift (level): average yield change across curve = -15bps
2. Slope change: 10Y-2Y widened 70bps
3. Butterfly (curvature): 2Y and 10Y vs 5Y divergence

Separating level from curve:
- Level component (parallel -15bps) captured in duration effect
- Pure curve effect = total duration/curve attribution minus parallel effect
- Halcyon's 17.3bps curve effect is in addition to the duration effect

Tools: key-rate duration framework (2, 5, 10, 30 yr buckets) or principal component analysis (level/slope/curvature factors) enable clean decomposition.

Manager skill assessment: curve calls require forecasting yield curve regime (bull steepening, bear steepening, flattening). Consistent curve alpha signals genuine macro skill vs random curve luck. Track attribution over 12+ months to distinguish.

How do I attribute returns to yield curve slope and curvature changes?

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