Absolute return: The search for positive returns in changing markets Tuesday, 7 June 2011 Portfolio Manager for Global Fixed Income and Absolute Return Funds www.dbadvisors.com
Topics for discussion What is absolute return? Why are absolute return strategies needed? What are types of absolute return strategies? Have absolute strategies worked? Global Fixed Income Seminar 2011 1
What is absolute return? A fund or mandate whose strategy is to preserve capital and consistently achieve positive returns Absolute returns: Generally measured against cash Can be measured against a real return objective or against a nominal return target Performance should be positive in all market environments Global Fixed Income Seminar 2011 2
Absolute return is not the same as total return Total return performance is generally relative to a market benchmark or against a universe of similar managers Total return will give investors market returns plus a margin. Over a cycle this can be negative necessarily a hedge or leveraged fund, but most hedge funds employ absolute return strategies a guarantee of specific returns Global Fixed Income Seminar 2011 3
Examples of absolute return strategies Descriptions illustrate a wide range of strategies: Absolute return strategies aim to deliver a specified target return above the risk-free rate, while protecting against capital losses in any short sub-period Absolute return strategies aim to deliver a specified target return above the risk-free rate, while protecting against capital losses over the short- to medium-term Target returns above risk-free rate are to be achieved in the long-term. Short- to medium-term negative returns can occur Global Fixed Income Seminar 2011 4
Characteristics of absolute return strategies A fund or mandate that separates alpha from beta Uses well-diversified investments Ability to take long and short positions May be able to use limited leverage (UCITS 3 funds) Neutral cash position* Rigorous risk controls High level of transparency * Neutral positions for real and nominal return targets should also be a risk free rate normally cash Global Fixed Income Seminar 2011 5
Why are absolute return strategies needed? Interest rates (and short dated bond yields) are low Investors in cash/short bonds are looking for higher returns, without taking substantial beta risk Demand for solutions/strategies that work in all environments and are not dependent on a single strategy Investment alternative if rates and yields start rising Used in asset allocation, absolute return strategies can dampen overall risk Global Fixed Income Seminar 2011 6
Who uses absolute return strategies? Pension funds Central banks Asset managers/allocators Fund of fund managers Private clients Hedge funds Global Fixed Income Seminar 2011 7
Who manages absolute return strategies? Traditional asset managers Hedge funds Proprietary trading desks Global Fixed Income Seminar 2011 8
What do absolute return strategies use? Sources of alpha Macro Duration Yield curve Inflation breakeven Country and credit spread Micro Investment-grade credit High yield credit Emerging markets Currencies Securitized assets Equities Commodities Instruments Up to 100% in physical cash plus additional 100% in derivatives (long or short) (UCITS 3 rule) Long positions Short positions Futures Forwards Swaps CDS (single name and index) Global Fixed Income Seminar 2011 9
Types of absolute return strategies Funds using all asset classes on an opportunistic basis Pure fixed income related funds (no equities, commodities or convertibles) Funds with measured risk goals, rather than return objectives Directional strategies Relative value strategies Yield curve strategies Sector strategies Multi-strategy Global Fixed Income Seminar 2011 10
How do absolute return strategies achieve returns? Efficient use of capital Ability to identify multiple investment opportunities Identification of alpha against beta Use of derivatives Focus on risk Focus on transparency Global Fixed Income Seminar 2011 11
What does an absolute return manager need? Investment process that has strong investment disciplines and transparency Full spectrum of investment ideas large team resources Specialist investment skills derivatives, risk Coverage of all areas of markets government, credit, EM, FX Extensive research of key drivers Ability to design correct product Global Fixed Income Seminar 2011 12
What to look for in a absolute return manager Checklist of manager attributes: Investment process Manager s experience in both long and short strategies Manager s performance/volatility track record Approach to leverage Risk management culture Return objectives Global Fixed Income Seminar 2011 13
Performance of managers has varied Absolute return manager performance: July 2008 to May 2011 Index=100 on 7/1/2008 130.00 125.00 120.00 115.00 110.00 105.00 100.00 95.00 90.00 85.00 80.00 Manager A Manager B Manager C Manager D Manager E Manager F Manager G Manager H Manager I Manager J Source: Bloomberg June 2011. For illustrative purposes only. Past performance is no guarantee of future results Global Fixed Income Seminar 2011 14
How have absolute return strategies performed? July 2008 to May 2011 Many products have been shown to be beta products no alpha A number of failing products relied too heavily on credit and illiquid alpha sources Products relying on macro strategies have performed better, on a relative basis Volatility has been major divider between some products Some products appear to be fatally damaged in recent history Source:, June 2011 Global Fixed Income Seminar 2011 15
Dispersion increased during the crisis Absolute return manager performance: July 2008 to Dec 2008 Index=100 on 7/1/2008 120.00 115.00 110.00 105.00 100.00 95.00 90.00 85.00 Manager A Manager B Manager C Manager D Manager E Manager F Manager G Manager H Manager I Manager J 80.00 1/7/08 1/8/08 1/9/08 1/10/08 1/11/08 1/12/08 Source: Bloomberg June 2010. For illustrative purposes only. Past performance is no guarantee of future results Global Fixed Income Seminar 2011 16
How have absolute return strategies performed? H2 2008 With low yields some were tempted into illiquid sectors Credit crunch and redemptions illustrated failings of design Many adopted highly rated ABS/MBS Even rated funds performed no better Forced liquidations meant losses were locked in Assets fell by over 75% some funds closed Source:, June 2011 Global Fixed Income Seminar 2011 17
Manager performance rebounded in 2009 Absolute return manager performance: 2009 Index=100 on 12/31/2008 130.00 125.00 120.00 Manager A Manager B Manager C Manager D Manager E Manager F Manager G Manager H Manager I Manager J 115.00 110.00 105.00 100.00 95.00 90.00 31/12/08 31/3/09 30/6/09 30/9/09 31/12/09 Source: Bloomberg June 2010. For illustrative purposes only. Past performance is no guarantee of future results Global Fixed Income Seminar 2011 18
How have absolute return strategies performed? 2009 Further fall in risk appetite in Q1 2009 showed credit funds Overall recovery in NAV s / performance reflected asset class focus Recoveries proved that concept is successful Investors become more focused on volatility and manager disciplines Major differences are in the product designs Returns overall were positive Source:, June 2011 Global Fixed Income Seminar 2011 19
2010 was a challenging year for managers Absolute return manager performance: 2010 Index=100 on 12/31/2009 112.0 110.0 108.0 106.0 Manager A Manager B Manager C Manager D Manager E Manager F Manager G Manager H Manager I Manager J 104.0 102.0 100.0 98.0 96.0 Source: Bloomberg June 2011. For illustrative purposes only. Past performance is no guarantee of future results Global Fixed Income Seminar 2011 20
How have absolute return strategies performed? 2010 2010 has seen risk appetite decline and Euro deficit concerns Most funds have been affected NAV volatility has increased and become a focus Even well diversified products have been affected by asset class contagion Will be interesting to see how performance develops Source:, June 2011 Global Fixed Income Seminar 2011 21
2011 continues to present challenges for managers Absolute return manager performance: Year-to-date May 2011 Index=100 on 12/31/2010 103.00 102.00 101.00 100.00 99.00 98.00 97.00 96.00 Manager A Manager B Manager C Manager D Manager F Manager G Manager H Manager I Manager E Manager J 95.00 31/12/2010 31/01/2011 28/02/2011 31/03/2011 30/04/2011 31/05/2011 Source: Bloomberg June 2011. For illustrative purposes only. Past performance is no guarantee of future results Global Fixed Income Seminar 2011 22
Implications for absolute return strategies Absolute return strategies will become increasingly popular as rates/yields rise Need to be very diligent in manager selection Ensure a multi-strategy, disciplined and transparent investment approach Focus on volatility as well as returns Make sure the investment target is in line with your requirements Global Fixed Income Seminar 2011 23
Contact 1 Appold Street, Broadgate London, United Kingdom EC2A 2HE www.dbadvisors.com Tel. +44 (20) 754-51767 gordon.ross@db.com Global Fixed Income Seminar 2011 24
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