Capital preservation strategy update

Transcription

1 Client Education Summit 2012 Capital preservation strategy update Head of Institutional Fixed Income Investments, Americas October 9, 2012

2 Topics for discussion 1 Capital preservation strategies Moving to customized solutions Conservative and higher alpha target options Recommended portfolio strategy Investment implications Client Education Summit

3 Capital preservation strategies Primary objective is preservation of capital Willing to accept some price volatility Minimum needs for liquidity Limited tolerance for losses Client Education Summit

4 Consider trade-off between liquidity and incremental return Target duration and investment universe should match client s expected investment horizon and general risk tolerance Competing forces Return objective Target return Benchmark Liquidity needs Liabilities Tax issues Legal / regulatory Unique circumstances Risk tolerance Time horizon Policy constraints Comfort level Client Education Summit

5 Short duration: Historically outperforms cash Encouraging positive return profile Comparison of Barclays 1-5 Yr Gov/Credit vs. 3 Mo LIBOR 12 Month Rolling Yield Yield (%) Average LIBOR 3M, 3.61 Average Barclays Gov/Credit 1-5 Yr, 4.21 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 LIBOR 3M Barclays Gov/Credit 1-5 Rolling Trailing 12 Month Total Return 12 Month Total Return (%) Average LIBOR 3M, 4.44 Average Barclays Gov/Credit 1-5 Yr, Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan LIBOR 3M Barclays Gov/Credit 1-5 From January 1994 to September 2012 Source: Barclays, Bloomberg Client Education Summit

6 Clients are moving to customized and tactical solutions Planning and dialogue are key to successful strategy Diversification benefits never go out of style Always own some US Treasuries or other government securities Understand issuers, potential sector returns and risks when changing guidelines Studying and monitoring potential options should lead to best long-term performance...it now may include looking at other asset classes Liquidity needs are being carefully planned Yield doesn t always win - downside risk management matters! Quick sales of questionable credits have often rewarded short duration investors Take advantage of selective trading opportunities Investment strategy is both qualitative and quantitative (politics and regulations) Client Education Summit

7 Longer holding periods offset price movements Assumptions: 1-3 year A-rated USD corporate bonds (trading at par value) A parallel shift of spot rate curve by 50, 100, and 200 basis points Immediately after the yield change, bond prices decline according to duration However, if the bonds are held, after 1 year the 1 year bond will be paid at par value, so there is no effect from the rate hike the 2 and 3 year bonds will pay their coupons, and in addition they roll down the yield curve, meaning that e.g. the 3 year bond will become a 2 year bond. Due to lower rates at shorter maturities the bond prices rise This roll down effect is larger with higher rates, offsetting some of the losses due to the rate hike Return after yield change Return 1 year later Maturity 1 Year 2 Years 3 Years 1 Year 2 Years 3 Years Yield 0.75% 1.43% 1.92% Rate change: 0 bps 0.00% 0.00% 0.00% 0.75% 2.10% 2.88% 50 bps -0.49% -0.96% -1.42% 0.75% 1.60% 1.90% 100 bps -0.98% -1.92% -2.82% 0.75% 1.11% 0.94% 200 bps -1.95% -3.79% -5.55% 0.75% 0.14% -0.95% Illustrative example Source: Bloomberg,. This analysis does not take into account other factors such as downgrades, defaults, or changes in spread that may still lead to negative outcomes. Client Education Summit

8 Sovereigns: Watch for downgrades S&P rating (foreign currency long-term) Developed markets Big emerging Other emerging markets Latest Change USA AAA AAA AA+ -1 Japan AA- AAA AA- 0 Spain AAA AA+ BBB+ -7 Ireland AAA AA+ BBB+ -7 Portugal AA- A+ BB -8 Greece A A- CCC -11 Brazil BB BB+ BBB 3 China A- A+ AA- 3 India BB+ BBB- BBB- 1 Mexico BBB BBB+ BBB 0 Russia BBB BBB BBB 0 Poland BBB+ A- A- 1 Colombia BB BB+ BBB- 2 Indonesia B+ BB- BB+ 3 Panama BB BB+ BBB 3 Turkey B+ BB- BB 2 Uruguay B BB BBB- 5 Source: Bloomberg. Rating shown as of May in each year. As of 10/1/2012 Client Education Summit

9 Fed on hold: Rates likely to trade in a narrow range Historical annual range of US two-year treasury note yields Starting Point Max Min Range Average Range 1.53 Biggest Range 2.60 Year 2001 Smallest Range 0.19 Year Year US Treasury Annual Yield Range Interest Rates 8% 7% 6% 5% 4% 3% 2% 1% 0% Starting Point Source: Bloomberg and, October 1, Past performance is not an indication of future results. Client Education Summit

10 New client funding: Fed on hold strategy A yield-oriented short duration strategy should perform well in the current environment. Higher interest rates are not likely in the near-term The additional yield from corporate bonds and other spread sectors will likely outperform high quality government issuers Most clients use 1 3 year or 1 5 year benchmarks We also suggest using floating rate securities to help stabilize returns Given current interest rates and spreads, 1 5 year fixed and floating rate assets produce portfolio yields of close to 1% These rates are attractive compared to current money market rates and should do a good job of protecting principal over 1 to 2 year horizons As of October 1, 2012 Client Education Summit

11 Many existing clients are getting diverse with allocations More global fixed income exposure Equities High yield bonds Emerging markets Overlay strategies Local market investments As of April 30, 2010 Client Education Summit

12 Illustrative example: Targeting higher real yields Barbell strategies that use the entire yield curve could add longer-term value 1 YR 2 YR 3 YR 5 YR 10 YR 30 YR Average Spread Biggest Spread Smallest Spread Ending Point Range Spread between CPI and Rates (%) Historical Treasury Spread Range between CPI* and Treasury Yield ( ) 1 YR 2 YR 3 YR 5 YR 10 YR 30 YR Maturity Average Spread Ending Point Source: Bloomberg and, October 2012, *Consumer Price Index..Past performance is not an indication of future results. Client Education Summit

13 TIPS investments: Potential return and diversification Source: calculations. Bloomberg, October 05, Based on GVQI and GVA0 1-5Y ML Indices. Past performance is not an indication of future results. Client Education Summit

14 Our market outlook: Stable rates, spread sectors still have value, diversify with global allocations Moderate economic growth should lead to a limited increase in rates Inflation low now, and should stay low for a while Periodic volatility is helpful Corporate bonds have both strong fundamentals and technicals ABS and covered bond markets greatly improved MBS market benefiting from slow prepays Sovereign landscape is changing (upside down world) Small FX and global bonds positioning can add value Greater use of Treasury Inflation Protected Securities (TIPS) Consider overlay strategies As of April 30, 2010 Client Education Summit

15 Determining the optimal positioning for positive returns Interest rate increase required to offset 1.00% yield (12-month horizon) Required Rate Increase Maturity For illustrative purposes Source: calculations. Durations calculated using on-the-run US Treasuries. Past performance is not an indication of future results. Client Education Summit

16 Yield advantages come from corporate bonds and MBS Yield vs Maturity 6 months 1 years 2 years 3 years 5 years US Treasuries US TIPS * 1.00% NA US TIPS * 2.00% NA Excess returns: 2009 US TIPS * 3.00% NA US Agencies Swaps ABS - AAA Cards ABS - AAA Auto CMO/PACs Corporates A Rated Industrials A Rated Financials BBB Rated Industrials BBB Rated Financials As of September 28, 2012 Source: Bloomberg and. Past performance is not an indication of future results. Client Education Summit

17 Investment guidelines: Opportunities to mitigate risk and expand investment universe Review guidelines frequently and ask manager to review and comment Broad and tactical usage of sectors adds to long-term diversification Securitized sectors have not faded away (MBS, covered bonds) Increasing usage of lower investment grade credit qualities BBB credits add diversification away from financial issuers Avoid smaller issue sizes (less than $250MM) if possible Portfolio limits should be inclusive of benchmark limitations Recommend changing guidelines when changing benchmark Client Education Summit

18 Summary: Investment implications Yield-oriented short duration portfolios have a good potential to outperform cash-only portfolios for clients who do not have near-term liquidity needs Diversification and liquidity allocations are an important component to a successful strategy Downside risk management is critical We see US Treasury rates trading in a range this year, but recognize that rates are at a generally low historical level Global government and FX strategies may add to total return Many short duration assets add substantial yield Credit quality should remain firm over the near-term investment horizon Constantly review strategy to make sure it is appropriate for both institutional needs and meets return expectations Client Education Summit

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