Top Two Reasons You Should Consider Economic Exposure-Based Performance Analysis

By Richard Mailhos, Product Manager, Eagle Investment Systems


What is the exposure of your investment portfolio? Is it the daily priced market value of each position in your portfolio? Or is it the total economic exposure of all positions? Economic exposure is the notional market value of all positions, providing a more accurate picture of leverage in a portfolio. Notional values are often ignored or simply not supported by most custodians and accounting systems. At Eagle, we produce notional values through our enrichment engine as a value-add to accounting processes. Here we list some key reasons you may be missing the full picture if you aren’t looking at notional market value:

Performance

When positions and transactions are enriched with exposure-based notional values, a firm can then derive performance on instruments that otherwise have a zero or misleading market value. While the accounting view capturing the current market value is technically correct, that information cannot be effectively used by the front office to understand performance. This is particularly important for structured instruments and those that require synthetic cash positions to eliminate false leverage when analyzing results at the segment and total portfolio levels.

Risk Management

The market value of a futures contract provides no indication that the instrument has exposure to an underlying asset. For example: a $0.00 market value future contract might provide $1,000,000 exposure to Euros. Accounting systems will track Futures positions at a value of $0.00 but usually do not value the $1,000,000 exposure to Euros currency. When the exposure to underlying assets is not understood, a firm’s risk management processes are compromised. By gaining a view of the notional value of an asset, a firm can be aware of their leverage, exposures, and be prepared to answer investor questions pertaining to this information.

At Eagle, we’re committed to keeping our clients at the cutting edge of technology in investment management. As investment instruments grow in complexity, we stay ahead of the curve in adapting our technologies with your feedback. We encourage you to respond in the comments if you have questions about how notional value computations can benefit your business or any comments regarding to this post.

 

2 Responses to Top Two Reasons You Should Consider Economic Exposure-Based Performance Analysis
  1. Richard Mailhos

    Notional market values are critical toward understanding the economic exposure of an investment instrument. Many derivative instruments lack a realistic investment value to judge exposure or gains/losses. For example a futures contract is usually carried in a portfolio with a zero market value and experiences flows for margin calls and fees only. A notional market value for a future would take into account the underlying security to arrive at a theoretical valuation based on exposure to the underling instrument and futures contract terms.

    When you are able to produce notional market values for all holdings in a portfolio you will then be able to generate returns for each instrument and the total without adjusting for zero or minimal market values on certain derivative holdings. With a complete set of security level returns for all instruments in a portfolio, a manager can do detailed bottom up performance analysis like selection and allocation attribution. These forms of analysis would be severly hampered without reliable valuations for all instruments.

  2. Ryan T

    Can you discuss more in depth how notional market value is important for analyzing derivatives positions?

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