Income Oriented Model Portfolios - A Cross Asset Perspective November 2015

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1 For Professional Investors (MiFid etc.) only. For discussion purposes only - not for onward distribution to retail clients and/ or the general public. Income Oriented Model Portfolios - A Cross Asset Perspective November 2015 Eric Wiegand / Patrick Diel / Oliver Trienes

2 Agenda Income Oriented Model Portfolios - A Cross Asset Perspective Compound interest is the most powerful force in the universe. - Commonly attributed to Albert Einstein 01 A More Complex World for Income Investors 02 Accessing Income 03 Combining income-oriented asset classes

3 01 A More Complex World for Income Investors

4 Annual Income from bonds is down across the board Govies, Corporate IG and HY Yields are down more than 5 since 1999 Bond income falls 1 at a faster rate than inflation % US Long Government Bond Yield Average Bond Yield Yield 7% % 3% 1% -1% - Jan 97 Jan 99 Jan 01 Jan 03 Jan 05 Jan 07 Jan 09 Jan 11 Jan 13 Jan 15 Average Ten Years Gov. Bonds Yield (UK,DE,FR,IT) Average Consumer Price Inflation (UK,DE,FR,IT) Inflation Adjusted 10Y Yield Real (Inflation Adjusted) Yield A strong decline in yield produced by Fixed Income across Bond types 3 Expected annual income delivered by a 100,000 portfolio in -denominated government, corporate and high yield bonds invested at different dates 31/12/ /12/ /12/ /06/2015 Markit iboxx Sovereigns Eurozone 5,357 3,654 3,724 1,519 Markit iboxx Euro Liquid Corporates 5,954 3,977 3,709 1,326 Barclays Pan European High Yield 10,587 6,700 10,736 4, Source: Robert Shiller Online Database, Deutsche AWM, US Treasury, Source Bloomberg, Deutsche AWM. Observation period: January 1997-June Source: Markit, Barclays, Deutsche AWM, December 1999-December The costs of investing in the index via financial products are not taken into consideration. 3

5 Shrinking yields across asset classes 1 9% 8% 7% 3% 1% Source: Robert Shiller Online Database, Deutsche AWM, Source: Deutsche AWM, Index Providers, August 2000-June Data series for both itraxx indices start in June Data series for FTSE Global Real Estate and S&P Global Infrastructure indices start in October Dividend Yields are falling 1 Income levels are close to recent historical lows 2 S&P Composite Index Dividend Yield Average Dividend Yield Yields across asset classes are converging 2 Aug 00 Aug 02 Aug 04 Aug 06 Aug 08 Aug 10 Aug 12 Aug 14 MSCI World Global Aggregate Europe High Yield itraxx Europe itraxx Crossover FTSE Global Real Estate S&P Global Infrastructure Fixed Income Equity Infrastr. Real Estate Credit MSCI World Avg=2. MSCI EM Avg=2. Europe Corporates Avg=3.9% Europe High Yield Avg=9.7% US Corporates Avg=5. US High Yield Avg=9. Global Aggregate Avg=3. itraxx Europe Avg=0.8% itraxx Crossover Avg=4.3% FTSE Europe Real Estate Avg=4.1% FTSE Global Real Estate Avg=3. S&P Global Infrastructure Avg=4.3% Current: Current: % 3. Current: 1.3% Current: 4.7% Current: 4.1% Current: 6.9% 6.3% 14.1% Current: 1.8% 1.7% 4. Current: 0.7% % Current: 3.3% % Current: % 6.8% Current: 3.7% % Current: 3.7% % 4

6 02 Accessing Income

7 Income alone is not enough: capital appreciation is critical as well! 60 Income contributed to 91% of bond performance 1 Income contributed to 2 of equity performance % 3% 1% Dez 89 Dez 94 Dez 99 Dez 04 Barclays Global Aggregate Price Return Index Dez 09 Dez 14 Barclays Global Aggregate Total Return Index Barclays Global Aggregate Price Return Index Annualised Returns Barclays Global Aggregate Total Return Index Dez 69 Dez 79 Dez 89 Dez 99 Dez 09 MSCI World (Price) MSCI World (Total Return) Annualised Returns 1 8% MSCI World (Price) MSCI World (Total Return) 1. Source: Deutsche AWM, Bloomberg, December 1989-June Source: Deutsche AWM, Bloomberg, December 1989-June

8 Towards a risk-aware income approach Yield/Risk Profiles across asset classes Yield and Drawdown are somewhat related... 8% Current Yield (left axis) 5 2 Current Yield - -8% -1-1 itraxx Europe Europe Corporates Global Aggregate Max drawdown (right axis) MSCI World MSCI EM DAX itraxx Crossover FTSE Europe Real Estate FTSE Global Real Estate S&P Global Infrastructure US Corporates Europe High Yield US High Yield Max Drawdown But not linearly and some asset classes exhibit better risk/yield profile than others Current Yield/Volatility Ratio Current Yield/Max Drawdown Ratio Source: Deutsche AWM, Bloomberg. Current Yield observed as of 30 th June 2015, Maximum Drawdown observed between August 2000 and June Data for itraxx indices start in September 2006 and for FTSE Global Real Estate and S&P Global Infrastructure indices in February

9 High Dividend Indices at a glance Different approaches to target a higher Dividend Yield High dividend index yields versus their Benchmarks 1 12M DIvidend Yield 3% 1% STOXX 1800 STOXX Global Select Dividend 100 Euro STOXX 50 Euro STOXX MSCI North AmericaMSCI North America Select Dividend 30 High Div MSCI AC Asia ex Japan MSCI AC Asia ex Japan High Div Capital Appreciation and the High Dividend Equity Factor Dez 98 Dez 00 Dez 02 Dez 04 Dez 06 Dez 08 Dez 10 Dez 12 Dez 14 MSCI North America MSCI North America High Div Dez 98 Dez 00 Dez 02 Dez 04 Dez 06 Dez 08 Dez 10 Dez 12 Dez 14 Euro STOXX 50 Euro STOXX Select Dividend Source: Deutsche Bank, Bloomberg as of 30 June Source: Deutsche Bank, Bloomberg, December 1998-June Index levels are rebased at 100 in December

10 Income versus Risk: The Equity case Higher Income comes with similar volatility compared to benchmarks Annualised Returns % Lower Volatility over the period... STOXX Global Select Dividend 100 MSCI AC Asia ex Japan High Div MSCI North America High Div MSCI North America MSCI AC Asia ex Japan Euro STOXX Select Dividend 30 Euro STOXX STOXX % Annualised Volatility Annualised Returns % MSCI AC Asia ex Japan High Div But higher drawdowns MSCI North America High Div MSCI AC Asia ex Japan STOXX Global Select Dividend 100 Euro STOXX Select Dividend 30 MSCI North America STOXX 1800 Euro STOXX Max Drawdown Yield to Risk profile is still improved 4 Current Yield / Volatility Ratio STOXX 1800 STOXX Global Select Dividend 100 Euro STOXX 50 Euro STOXX Select Dividend 30 MSCI North America MSCI North America High Div MSCI AC Asia ex Japan MSCI AC Asia ex Japan High Div Source: Deutsche AWM, Bloomberg, December 2000-June Yield observed as of 30 th June

11 High Yielding Fixed Income at a glance Different approaches to target a higher income Horizontal (duration) Positionning Vertical (Credit Risk) Positionning While such Duration and Credit Risk positioning looks traditional, the current level of the interest rates implies a further risk increase (compared to historical levels) for an investor contemplating higher income. Source: Deutsche AWM, for illustrative purposes only. The relative credit risk levels of different index families may change. 10

12 Income versus Risk: the Fixed Income case Credit risk is key to discriminate between risk / income profiles Current Yield 3% Corp Non Financials Liquid High Yield Liquid High Yield 1-3 iboxx Eurozone Yield Plus Barclays Global Agg Higher Yield DB EM Liquid Eurobond Corp Corp 1% Financials iboxx DE Covered 1-3 Liquid Covered iboxx Eurozone iboxx DE Yield Plus 1-3 8% 1 Covered Annualised Volatility A positive relationship between yield and risk Current Yield 3% Corp Non Financials iboxx 1% EUR Corp iboxx Eurozone Yield Plus Barclays Global Agg Corp Financials Liquid Covered Liquid High Yield 1-3 DB EM Liquid Liquid High Yield Eurobond Higher Yield Higher Drawdown iboxx Eurozone iboxx DE Yield Plus Covered 1-3 Max Drawdown High Yield and Corporate show interesting Yield/Risk Profiles Current Yield/Volatility Ratio iboxx Germany Covered iboxx Germany Covered 1-3 iboxx Sovereigns Liquid Covered Eurozone Yield Plus 1-3 Barclays Global Aggregate iboxx Sovereigns Eurozone Yield Plus DB EM Liquid Liquid Eurobond Corporate 100 Financials Liquid Corporate 100 Liquid Corporate 100 Non Financials Liquid High Yield 1-3 Liquid High Yield Source: Deutsche AWM, Bloomberg, December 2005-June Current Yield observed as of 30th June

13 Income versus Risk: the Credit case Higher Income comes with similar volatility compared to benchmarks 1 Annualised Returns 9% itraxx 3% Europe itraxx Europe 2x itraxx Crossover CDX High Yield itraxx Crossover 2x CDX IG 7% 1 17% Annualised Volatility A positive relationship between yield and risk 1 Annualised Returns 9% itraxx Crossover itraxx Crossover 2x CDX High itraxx Yield 3% itraxx Europe Europe 2x CDX IG Max Drawdown Current Yield/Volatility Ratio Markit CDX North America Investment Grade High Yield Credit show interesting Yield/Risk profiles itraxx Europe itraxx Europe 2x itraxx Crossover itraxx Crossover 2x Markit CDX North America High Yield Source: Deutsche AWM, Bloomberg, March 2007-June Yield observed as of 30 th June

14 Income versus Risk: the Real Estate case REITs tend to demonstrate higher dividend yield than equities Increased volatility and drawdown Annualised Returns 8% 7% FTSE All World FTSE Developed Europe FTSE EPRA/NAREIT Global FTSE EPRA/NAREIT Developed Europe 1 17% 18% 19% 2 21% 2 Annualised Volatility Annualised Returns 8% 7% FTSE All World FTSE Developed Europe FTSE EPRA/NAREIT Global FTSE EPRA/NAREIT Developed Europe 8 Max Drawdown Mixed Results on a Yield to Risk point of view Current Yield/Volatility Ratio FTSE Developed Europe FTSE EPRA/NAREIT Developed Europe FTSE All World FTSE EPRA/NAREIT Global Source: Deutsche AWM, Bloomberg, February 2005-June Yield observed as of 30th June

15 Income versus Risk: the Infrastructure case infrastructure can offer a mix of capital appreciation and income stream Equity like returns and volatility... Annualised Returns 1 9% 3% MSCI AC Asia Pacific Infrastructure MSCI US Infrastructure S&P Global BMI S&P Global Infrastructure MSCI US MSCI Europe MSCI Europe Infrastructure MSCI AC Asia Pacific 1 11% 1 13% Annualised Volatility %...but significantly improved Yield/Risk profiles 3 Current Yield/Volatility Ratio S&P Global BMI S&P Global Infrastructure MSCI Europe MSCI Europe Infrastructure MSCI US MSCI US Infrastructure MSCI AC Asia Pacific MSCI Asia Infrastructure Source: Deutsche AWM, Bloomberg, July 2011-June Yield observed as of 30th June

16 02 Combining income-oriented asset classes

17 High(er) Income: a cross asset perspective Comparison of Equity and Fixed Income higher yielding opportunities 7% Equity Income, Credit and High Yield Indices offer above par income opportunities. with higher risks 1 7% Current Yield 3% Liquid High Yield Liquid Corporate 100 Barclays Global Aggregate DB EM Liquid Eurobond itraxx Crossover S&P Global Infrastructure Euro STOXX Select Dividend 30 FTSE EPRA/NAREIT Global 1% itraxx Europe Annualised Volatility Current Yield Barclays Global 3% Aggregate S&P Global Infrastructure DB EM Liquid Eurobond CDX High Yield itraxx Crossover Liquid Corporate 100 Liquid High Yield Euro STOXX Select Dividend 30 FTSE EPRA/NAREIT Global 1% iboxx Germany Covered Max Drawdown High Div Equities Low correlations across high-income asset classes 2 Real Estate 1. Source: Deutsche AWM, Bloomberg, December 2000-June Current Yield observed as of 30th June Data for credit (itraxx) indices start in March 2007, for real estate indices in February 2005, for fixed income indices in December 2005 and for S&P Global Infrastructure indices in July Source: Deutsche AWM, Index Providers, March 2007-June Correlations were calculated using weekly returns Eurozone Yield Plus EUR Corporate Bond EUR HY Bond itraxx Europe Infrastructure High Div. Equities 10 78% 1% 49% 5 68% Real Estate 78% 10-3% % Eurozone Yield Plus % 27% 9% EUR Corporate Bond 1% -3% % -7% - EUR HY Bond 49% 5 8% 37% 10 51% 5 itraxx Europe % -7% 51% 10 6 Infrastructure 68% 87% 9%

18 Income Portfolio Construction Process at a glance Building a diversified portfolio targeting an expected level of Income A two steps process is used to build the portfolio Define the Investment Universe All income oriented indices available through the ETF platforms of Deutsche AWM form the investment universe. Optimize the portfolio weights Using a mean-variance optimisation, the less volatile portfolio for a given expected level of yield is defined (using 12m historical data) Income Target Process (Annually) Efficient Frontier for an income focused investor Aim Long-term allocation, Disciplined Rebalancing Diversified Portfolio with Income Focus 7% Efficient Frontier i.e. Portfolios that exhibit the lowest historical volatility for a given expected yield Method Weights Mean-variance Optimisation Approach (as developed by Markowitz) 12 Months Historical Variance/Covariance Matrix is used Every Year, the portfolio targets an expected yield of 3% ( resp.) while minimizing historical volatility Expected Yield 3% 1% Portfolio with the lowest volatility for an expected yield of 3% ( resp.) Historical Volatility For illustration purposes only 17

19 Implementing income-oriented portfolios Two investment cases: 3% and Target Yields Volatility and yield/volatility ratios for optimal portfolios 1 Weightings of optimal portfolios Portfolio with Expected Yield Historical Volatility Portfolio with 3% Expected Yield Ratio Current Yield to Volatility Portfolio with 3% Target Yield Portfolio with Target Yield STOXX Global Select Dividend % 15. Euro STOXX Select Dividend FTSE EPRA/NAREIT Global Barclays Global Aggregate iboxx Sovereigns Eurozone Yield Plus % DB EM Liquid Eurobond Liquid Corporate Liquid High Yield itraxx Crossover 8.7% 15. itraxx Europe CDX High Yield S&P Global Infrastructure % Target Yield Portfolio 3% Weightings of optimal portfolios with 3% and target yields 2 Target Yield Portfolio STOXX Global Select Dividend 100 Euro STOXX Select Dividend 30 FTSE EPRA/NAREIT Global Barclays Global Aggregate 9% 13% 8% iboxx Sovereigns Eurozone Yield Plus Liquid Corporate 100 itraxx Crossover CDX High Yield DB EM Liquid Eurobond Liquid High Yield itraxx Europe S&P Global Infrastructure 1. Source: Deutsche AWM, yield levels as at 30 June Historical Volatility is calculated on a simulated basis using the performance of the underlying indices over the following periods: 30 th March 2007 to 30 th June No risk-free asset is included in the optimization. 2. Source: Deutsche AWM, portfolio weightings calculated via an optimization using selected income-focused indices and yield levels as at 30 June Historical volatility is calculated over the following periods: 30th March 2007 to 30th June No risk-free asset is included in the optimization. All calculations are based on the of the performance of the underlying indices. 18

20 Conclusion From the sharp decline of both interest rates and credit spreads has emerged a more complex situation for investors looking for Income. Equity Income, Credit and High Yield Indices offer above par income opportunities, along with non negligible risk increase compared to their respective benchmarks. From plain Equity benchmarks to Higher Dividend strategies and from Sovereigns to High Yield, the ETF range of Deutsche AWM Passive provides a wide investment universe to construct and customize Income Oriented Portfolios. The Deutsche Bank AWM Passive Team's expertise in Portfolio Construction may help investors to further optimise their Income / Risk profile and build on the diversification benefits brought by these different higher income asset classes. 19

21 Executive Summary Interest rates and dividend yields are at or close to historic lows. Investors looking for income need to broaden their horizons and consider opportunities across markets and asset classes. Investors should take a holistic, cross-asset class perspective to generating yield. Our results show that cross-asset diversification can help investors to target higher yield to volatility ratios at the portfolio level. The results presented in this document are further described in a paper to be published on the website 20

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