Compass. Increased uncertainty on stock markets at the beginning of the year. Investment strategies in times of high volatility

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1 Compass April 2016 Increased uncertainty on stock markets at the beginning of the year Investment strategies in times of high volatility Caution with high dividend yields! Hedging strategies Your wealth, our responsibility.

2 Causes of recent share price fluctuations and how you can protect your portfolio! Since the beginning of the year, prices on global equity markets have been fluctuating and unsettling investors. Seen from our perspective, this has three main causes: the slowdown in economic activity in China, the drop in crude oil prices and the increasing risks in the banking sector. In this environment, it is important to follow the right investment strategy. But even so there are some insidious traps, particularly with high dividend paying stocks. Over the longer term, it is above all stocks with low price fluctuations that have proved their value. Historically, the so-called minimum volatility strategy has generated a higher return with less risk. As a result of falling commodity prices and increasing debt, the risk premiums on many corporate bonds have risen. They currently offer an acceptable return. But here too some caveats apply! As part of our Knowledge & Experience series, we are presenting in this edition three possible ways to protect your portfolio against stock market slides. We explain what a put option is, how a futures contract works, and how you can use Short ETFs to protect your portfolio. Reducing the allocation to gold in favour of equities As a result of increased uncertainty in the global equity markets (see Basic Trends 1, 2 and 3), the gold price has risen since the beginning of the year. However, we are working on the assumption that this increase is not sustainable. For this reason, we are reducing the weight of gold and, as a countermove, are increasing the proportion of shares for all reference currencies. Within equities, we are making two sectoral re-allocations. Due to the deteriorating momentum, we are reducing the weighting of the financial sector (see, in addition, Basic Trend 3) and are increasing the weight of industrial stocks to neutral. In the case of bonds, we continue to give preference to corporate rather than government bonds. Regarding emergingmarket and high-yield bonds, we are leaving in place the slight underweighting for each class. In an environment in which various central banks continue to pursue an expansionary monetary policy, it is difficult to make a prediction about currencies. For this reason we are at present leaving the neutral position in all foreign currencies. Asset Allocation recommendation as of April 1st, 2016 for investors with CHF as their reference currency. Investment classes Equities Bonds Gold Cash Real Estate CH Equity Sectors Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecom Services Utilities Bonds Government bonds Corporate bonds Emerging markets High-yield bonds Currencies US-Dollar Euro Pound sterling Swiss franc strong slight neutral slight strong underweight overweight Dreyfus Compass April 2016 Page 2

3 Basic Trend: Causes of falling share prices in recent months Basic Trend 1: Yuan/USD Dec. 14 Feb. 15 Apr. 15 Jun. 15 Aug. 15 Oct. 15 Dec. 15 Feb. 16 Chinese Yuan/USD (left-hand scale) MSCI AC World Index (right-hand scale) Index value Is China s slow down turning into a hard landing? In recent months, significant price losses have been observed in global equity markets. One of the reasons is the economic trend in China. The engine of the global economy has been faltering for some time now. China s export industry in particular is suffering. In order to boost Chinese exports, the central bank of China has devalued the yuan against the USD several times within a few weeks. At the same time, however, this has made imports to China more expensive. This is affecting above all companies in industrialized countries that export their products to China. Their earnings, as well as their share prices, are falling. The devaluation of the yuan is commonly regarded as an indication of lower global economic growth. Basic Trend 2: Crude oil price in USD Dec. 10 Dec. 11 Dec. 12 Dec. 13 Dec. 14 Dec. 15 Crude oil price per barrel (WTI) Crude oil price is weighing on share prices in emerging markets Until recently the price of crude oil had been constantly falling. Today it is far below the prices once seen of over USD 100 per barrel for the West Texas Intermediate (WTI) grade. In the view of many analysts, this is a result of political influences. For example, a low oil price weakens Russia, which is dependent on oil exports. Furthermore the lifting of economic sanctions against Iran is also increasing the supply of oil. Consequently, the profits of crude oil-producing companies and their share prices are falling. These companies often originate from emerging countries. That is one of the reasons why emerging-market equities have recently lost more value than those of oil-consuming OECD countries. Basic Trend 3: Indexed performance in USD Dec. 14 Mar. 15 Jun. 15 Sep. 15 Dec. 15 MSCI AC World Index MSCI AC World Banks Index Bank shares: Increasing risks with shrinking margins Another cause of the weakness seen on stock markets recently is the performance of banking shares. The risks for banks have increased significantly since the middle of last year. The default risk of oil companies has increased as a result of lower crude oil prices (see basic trend 2). In addition, banks profits have been reduced by provisions for imminent or payable penalties for prohibited practices. Last but not least, low interest rates and more and more new regulatory requirements are ensuring that banks profitability is falling. Unstable earnings are ultimately causing risk premiums for banks to rise, and their share prices to fall. For these reasons, financial companies have been underweighted for quite some time in Dreyfus Banquiers asset allocation. Dreyfus Compass April 2016 Page 3

4 Current Topic: Investment strategies in times of high volatility Current Topic 1: MSCI World Energy Index Dividend yield 6% 0 0% Dec. 05 Dec. 07 Dec. 09 Dec. 11 Dec. 13 Dec. 15 Earnings per share (left-hand scale) Dividend per share (left-hand scale) Dividend yield (right-hand scale) Source: Datastream 5% 4% 3% 2% 1% Deceptive dividend yields on energy stocks Following sharp price corrections in the wake of the drop in oil prices, shares from the energy sector have looked attractive with dividend yields of 4% on average for the next 12 months. For yield hunters, these shares have never been as cheaper since the financial crisis than today. However, it is not sufficient to consider only the dividend earned. This is because oil companies earnings have also collapsed in tandem with the oil price. In response, oil companies began to slash their dividends at the end of 2014, but much too hesitantly. Currently they are paying out more to shareholders than they earn, and are thus destroying substantive assets. If the oil price remains low in the long run, dividend cuts or even capital increases will be inevitable. Current Topic 2: Indexed performance in USD 200% 150% 100% Current Topic 3: Interest rate and spread 50% Mar. 06 Mar. 08 Mar. 10 Mar. 12 Mar. 14 Mar. 16 4% 3% 2% 1% 0% Dec. 12 Dec. 13 Dec. 14 Dec. 15-1% -2% -3% MSCI World High Dividend Yield Index Net Return MSCI World Index Net Return MSCI World Minimum Volatility Index Net Return U.S. government bonds (ø duration 7 y.) Credit risk premium (OAS ø A-) USD/CHF hedging costs Yield to maturity in USD Yield to maturity hedged in CHF Caution with high-dividend shares The risk of sizable asset values being destroyed also exists outside of the energy sector. Thanks to central banks low interest rate policy, companies have been able to borrow at low interest rates in recent years. Instead of investing, dividends were increased. Failing the test for quality, high-dividend shares do not turn out to be superior to the overall market, and in times of crisis the high dividends offer little protection against losses. Instead of maximizing dividends, we recommend relying on risk minimization, by selecting noncyclical stocks that do not fluctuate much. Such a minimum volatility strategy not only offers better protection against losses, it has also beaten the market contrary to theory over a whole cycle. Increased return on USD corporate bonds As a result of weak commodity prices and increasing debt, the risk premiums on corporate bonds have risen. Commodity and energy bonds suffered the most. But sectors such as telecoms, media, retailing and utilities, where the accumulation of debt was particularly marked, are also affected. Despite record-low interest rates on government bonds, corporate investment grade bonds in US dollars still offer attractive yields to maturity. Even when hedged in Swiss francs, yields are still acceptable despite the high short-term interest-rate differentials (= hedging costs). But when selecting bonds, it is absolutely essential to conduct a debtor quality examination, particularly in the energy sector. Dreyfus Compass April 2016 Page 4

5 Knowledge & Experience: How you can hedge your portfolio to protect against the worst! Knowledge & Experience 1: Insurance against financial risks Profit Loss Exercise price Security value Option premium Equity investments should always be made with a longterm perspective in mind. If this rule was heeded, investors over the past few decades could be pleased about the gratifying performance of stock markets. But those markets did not always move linearly upwards, as they were characterized by cycles of different duration. To protect themselves against possible short-term price slides in phases of great uncertainty, investors can buy put options. Put options work like an insurance policy. As with an insurance policy, the investor pays a premium for protection. If no loss event occurs, the option expires and has no value. But if the security were to lose value, the insurance protection comes into effect, in the form of an appreciation of the option. Knowledge & Experience 2: Performance Dec. 15 Jan. 16 Feb. 16 Mar. 16 Knowledge & Experience 3: Indexed performance Sale of index futures contract Index Hedged portfolio 90 Dec. 14 Mar. 15 Jun. 15 Sep. 15 Dec. 15 Mar. 16 Index Short ETF Futures as an alternative to selling If an investor is convinced of an imminent price correction, he or she could sell all positions in order to protect his/her assets. Depending on the negotiability of the positions, this can take a long time and be cost-intensive. A possible alternative is the sale of instruments known as futures. Futures are standardized obligations in which a contract provides for the exchange of a particular good at a specified price, on a specified date. If the composition of the portfolio corresponds to that of an index, the portfolio can be hedged with a single transaction. If the investor would like to participate in the market again, he can do so by passing on the obligation to another market participant at a reasonable price. Fine tuning through short ETFs Futures are a fast, efficient and cost-effective way of hedging a portfolio, thanks to standardization and exchange trading. However, the downside of this is the large denomination. A futures contract corresponds to several tens of thousands of francs, depending on the security. An alternative is required for investors needing more granularity. Short ETFs offer precisely this. ETFs (Exchange Traded Funds) are exchange-listed and -traded funds that replicate the performance of an index. For hedging, the product has to move in the opposite direction to that of the underlying portfolio. This is precisely what products designated short offer. Dreyfus Compass April 2016 Page 5

6 The prices used in our analysis are end-of-period prices. The figures used for our valuation model are estimates referring to dates and therefore carry a risk. These are liable to change without notice. The usage of valuation models does not rule out the risk that fair valuations over a specific investment period cannot be attained. A complex multitude of factors influences price developments. Unforeseeable changes could, for instance, arise from technological innovations, general economic activities, exchange-rate fluctuations or changes in social values. This discussion of valuation methods makes no claim to be complete. Dreyfus Sons & Co Ltd publishes Compass four times a year since June The publication is aimed at clients of the bank and interested parties. It describes some of the instruments and methods the bank uses to monitor everything to do with the financial markets. A description of the investment process can be obtained from your client advisers or our website. Compass provides guidance but cannot take the circumstances of an individual portfolio into account. Dreyfus Sons & Co Ltd, Banquiers Contact: Dr. Uwe Heller, CFA Dreyfus Sons & Co Ltd, Banquiers Aeschenvorstadt 16 P.O. Box 4002 Basel Switzerland Telephone Fax Dreyfus Compass April 2016 Page 6

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