The Growing Importance of Fixed Income Analytics

Trusted by the Market. Driven by You. www.yieldbook.com The Growing Importance of Fixed Income Analytics Susan Y. Lin Managing Director Regional Head, Asia Pacific The Yield Book and Citi Fixed Income Indices Citigroup Global Markets April 2013 Investment Operations and Custody Conference Shanghai, China

Overview European sovereign crisis has changed the way investors think of sovereign bond markets. While emerging bond markets and other fixed income asset types may seem to be good investment targets, there are many challenges. When managing fixed income portfolios, risk management should be a discipline throughout the portfolio management process. Use of various portfolio analytics on one sample strategy to demonstrate how to evaluate risks. The Growing Importance of Fixed Income Analytics 2

Fixed Income vs Equity Which asset class has better returns? Gross Returns (%) in USD, Unhedged 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 Annualized Returns Std Dev Citi WorldBIG 4.10 5.64 4.38 5.79 7.08 9.80 6.55-4.52 9.29 12.41 5.96 6.07 MSCI World 16.54-5.02 12.34 30.79-40.30 9.57 20.65 10.02 15.25 33.76 8.08 16.23 Gross Returns (%), in USD, Unhedged Last 1 Year Last 3 Year Last 5 Year Last 10 Year Citi WorldBIG 4.10 14.80 30.04 78.47 MSCI World 16.54 24.35-2.96 117.57 Comparisons of Fixed Income and Equity Broad Benchmarks Cumulative returns from January 2003 to December 2012 Cumulative Returns Source: Citigroup Index LLC and MSCI Inc. Data as of December 31, 2012. The Growing Importance of Fixed Income Analytics 3

Fixed Income Sovereign Markets: Index Profiles Markets tracked by Citi Fixed Income Indices Developed markets: 26 countries Developed Markets # of Issues Market Value (USD, billion) Quality YTM United States 214 6054.71 AA+ 0.87 Japan 252 5902.21 AA- 0.53 France 41 1461.81 AA+ 1.33 Italy 51 1358.38 BBB+ 3.72 Germany 50 1297.15 AAA 0.75 United Kingdom 36 1087.09 AAA 1.73 Spain 30 684.05 BBB- 3.79 Canada 32 401.26 AAA 1.52 Netherlands 21 394.81 AAA 1.07 Belgium 23 377.42 AA 1.51 Korea 28 313.14 AA- 2.71 Austria 18 256.67 AA+ 1.17 Australia 16 237.91 AAA 3.12 Taiwan 62 137.23 AA- 1.27 Denmark 9 122.64 AAA 0.91 Ireland 10 114.64 BBB+ 3.33 Portugal 12 112.6 BB 4.78 Sweden 9 93.84 AAA 1.42 Finland 11 89.89 AAA 0.9 Singapore 16 57.96 AAA 0.97 Switzerland 8 55.92 AAA 0.32 Israel 13 53.99 AA- 2.78 New Zealand 5 51.25 AA+ 3.03 Norway 5 47.02 AAA 1.55 Czech Republic 12 45.64 AA 1.32 Hong Kong 43 11.59 AAA 0.47 20,820.82 AA 1.26 Emerging markets: 17 countries Emerging Markets # of Issues Market Value (USD, billion) Quality YTM China 115 692.13 AA- 3.43 India 45 403.08 BBB- 8.01 Mexico 20 162.66 A- 4.93 Poland 16 115.59 A 3.41 South Africa 12 89.7 A- 6.77 Thailand 35 85.26 A- 3.34 Malaysia 25 83.42 A 3.26 Brazil 4 77.56 A- 9.35 Colombia 11 73.69 BBB+ 4.3 Indonesia 30 70.91 BBB- 5.85 Turkey 13 67.44 BBB- 6.54 Russia 17 63.75 BBB+ 6.34 Philippines 15 44.31 BB+ 3.39 Hungary 10 29.28 BB 5.25 Peru 6 13.81 BBB+ 4.37 Chile 18 11.92 AA+ 5.51 Sri Lanka 14 7.65 B+ 11.26 2,092.16 A- 5.15 Source: Citigroup Index LLC. Data as of April 01, 2013. The Growing Importance of Fixed Income Analytics 4

Fixed Income Sovereign Markets: Developed vs. Emerging Markets Definition of Emerging Markets Currency Breakdown within the Markets World Bank income group: low / middle income IMF non-advanced countries GBP, 5.22% Others, 7.83% EUR, 29.53% Developed Markets 90.87% USD 20,820.82 billion Emerging Markets 9.13% USD 2,092.16 billion JPY, 28.35% PLN, 5.52% THB, 4.08% ZAR, 4.29% Others, 25.99% MXN, 7.77% USD, 29.08% CNY, 33.08% INR, 19.27% Note: Amounts exclude bonds <1yr maturity and below specific outstanding amounts. Source: Citigroup Index LLC. Data as of April 01, 2013. The Growing Importance of Fixed Income Analytics 5

Historical Debt / GDP (%) Comparisons of Historical Debt / GDP across Global Markets 250 Reference level for entering EMU is 60% 200 150 100 50 Canada France Germany Italy Japan UK US 0 1991 2001 2011 Source: IMF The Growing Importance of Fixed Income Analytics 6

Trends of G7 Sovereign Markets Yield to Maturity of G7 Countries Ratings of G7 Countries 16 14 12 10 8 6 4 2 0 Jan Jan Jan Jan Jan Jan Jan Jan Jan 1985 1987 1989 2001 2003 2005 2007 2009 2011 Jan Jan Jan Jan Jan Jan Jan Jan 1999 2001 2003 2005 2007 2009 2011 2013 Source: Citigroup Index LLC. Data as of March 01, 2013. The Growing Importance of Fixed Income Analytics 7

Eurozone crisis has lead to consideration of Alternative Weighted Indices (instead of market capitalization weighting) Reduce weights on developed markets including Japan, Eurozone Citi RAFI Bond Index Series uses the following fundamental factors: GDP broad measures of economic size and proxy for capital base Population measures labor force Land proxy for natural resources Energy Consumption proxy for technological sophistication and ability to leverage capital, labor, and resources Non-Euro Indices Asia USD and local currency denominated bonds Emerging markets WGBI Country Characteristics Country Weight (%) S&P Rating Moody s Rating YTM OAS (bps) United States 29.47 AA+ Aaa 0.87 0 Japan 28.73 AA- Aa3 0.53 0 France 7.11 AA+ Aa1 1.33 30 Italy 6.61 BBB+ Baa2 3.72 271 Germany 6.31 AAA Aaa 0.75-26 United Kingdom 5.29 AAA Aa1 1.73-1 Spain 3.33 BBB- Baa3 3.79 298 Canada 1.95 AAA Aaa 1.52 1 Netherlands 1.92 AAA Aaa 1.07 5 Belgium 1.84 AA Aa3 1.51 40 Austria 1.25 AA+ Aaa 1.17 11 Australia 1.16 AAA Aaa 3.12 0 Mexico 0.79 A- Baa1 4.93 0 Denmark 0.60 AAA Aaa 0.91-3 Ireland 0.56 BBB+ Ba1 3.33 242 Poland 0.56 A A2 3.41-1 Sweden 0.46 AAA Aaa 1.42 1 Finland 0.44 AAA Aaa 0.90 0 South Africa 0.44 A- Baa1 6.77 1 Malaysia 0.41 A A3 3.26 0 Singapore 0.28 AAA Aaa 0.97 0 Switzerland 0.27 AAA Aaa 0.32-1 Norway 0.23 AAA Aaa 1.55 2 Source: Citigroup Index LLC. Data as of April 01, 2013. The Growing Importance of Fixed Income Analytics 8

Trends of European Sovereign Markets Spread for European Countries 1200 1000 800 600 400 200 0-200 Jan-99 Jun-99 Nov-99 Apr-00 Sep-00 Feb-01 Jul-01 Dec-01 May-02 Oct-02 Mar-03 Aug-03 Jan-04 Jun-04 Nov-04 Apr-05 Sep-05 Feb-06 Jul-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11 Dec-11 May-12 Oct-12 Mar-13 France Germany Italy Spain Ireland Source: Citigroup Index LLC. Data as of April 01, 2013. The Growing Importance of Fixed Income Analytics 9

Interests in EM Sovereign Markets Low yield environment and European sovereign crisis have lead to strong interests in Emerging Markets sovereign markets. However Governments often introduce taxes and forms of capital controls to limit the accessibility of bond markets Brazil: IOF* tax of 6% on inflows of money Country Purchase Local Bonds Non- Resident Access Withholding Taxes Capital Gain Tax Interest Income Tax Malaysia No Limit Yes No N/A N/A Indonesia No Limit Yes Yes 20% 20% Philippines No Limit Yes Yes N/A 20% Thailand No Limit Yes Yes 15% N/A China Limited via QFII Yes 5% N/A India Limited via FII Yes N/A 20% Sri Lanka Limited Yes Yes N/A 15% Peru No Limit Yes Yes N/A 4.99-30% Colombia No Limit Yes Yes 10-33% 14-33% Chile No Limit Yes Yes 35% 4-35% Mexico No Limit Yes No N/A N/A Brazil No Limit Yes No N/A N/A 80 70 60 50 40 30 20 10 0 Public Debt to GDP Ratio (%) 67.59 64.08 53.05 44.17 43.08 32.18 22.16 Malaysia Thailand China India Colombia Mexico Brazil * IOF, defines as Financial Transaction Tax, is a federal tax levied on credit applications, foreign exchange and insurance. Note: 2012 Estimate data. Source: IMF The Growing Importance of Fixed Income Analytics 10

Index Snapshot What is a realistic target return for different fixed income sectors? How much yield pick up is there by investing in non-sovereign investment-grade bonds? USD Bond Indices Quality Index Name No. of Issues Market Value (USD, Billion) Duration IG USD Broad Investment Grade Index 5,800 15,972 5.09 1.68 3/4 IG, 1/4 HY Asian Broad Bond Index 543 392 5.38 3.63 60% IG, 40% HY Emerging Sovereign Government Bond Index 241 454 7.32 4.41 HY US High Yield Market Index 1,729 981 4.07 6.50 Yield Multiple / Local Currency Indices IG World Government Bond Index 925 20,547 6.90 1.28 6.0% HY Asian Government Bond Index 192 667 6.14 3.05 2.5% HY Asian Government Extended Bond Index 428 1,907 6.34 4.14 IG World Broad Investment Grade Index 7,609 34,621 6.07 1.58 2/3 IG, 1/3 HY Dim Sum Bond Index 93 26 2.81 3.49 Source: Citigroup Index LLC. Data as of April 01, 2013. The Growing Importance of Fixed Income Analytics 11

Asian Fixed Income Bond Markets Asian Government Bond Index (AGBI) Provides investors with a benchmark for performance measurement for the local Asian market. AGBI-Extended Expands the coverage ofthe AGBI markets with additional markets: China, India, Taiwan, Hong Kong and Sri Lanka. Asian Broad Bond Index (ABBI) Provides a comprehensive measure for the Asia fixedincome market across various asset classes and credit spectrum. Dim Sum (Offshore CNY) Bond Index Measures the performance of Chinese Yuandenominated Dim Sum bonds issued and settled outside Mainland China Comparisons of Asian sectors to global markets Cumulative Returns (USD Unhedged) October 2008 to March 2013 200 180 160 140 120 100 ABBI WGBI AGBI WorldBIG 80 Oct-08 May-09 Dec-09 Jun-10 Jan-11 Jul-11 Feb-12 Aug-12 Mar-13 Dim Sum Bond Index introduction to the market Cumulative Returns in various currencies January 2011 to March 2013 135 130 125 120 115 110 105 100 95 USD RMB JPY EUR 90 Nov-10 Feb-11 Jun-11 Sep-11 Dec-11 Apr-12 Jul-12 Oct-12 Jan-13 May-13 Source: Citigroup Index LLC. Data as of April 01, 2013. The Growing Importance of Fixed Income Analytics 12

Dim Sum Bond Markets The Dim Sum bond market has grown at a significant rate in 2013 with the outstanding size of the market reaching CNY 335 billion; the YTD issuance size in 2013 is CNY 68 billion. Yield Difference (CNY-CNH) Yield difference (as shown in the line graph on the right) at short end of curve was tightened this year. Curve movement at long end follows similar pattern with less volatility. Taiwan's central bank (CBC) signed MOU with People's Bank of China to establish CNY clearing in Taiwan at the end of 2012, the market is expecting Taiwan to become another offshore CNY bond market in a foreseeable future. SAFE is aggressively loosening its currency control, the approved QFII amount has reached USD 41.7 billion. Additionally, the approved RQFII amount has reached CNY 70 billion as of April 2013. Dim Sum Bond Index Profile Month & Year Issues Par (Billion) IG* % HY*% & NR*% WAL YTM Apr 2013 93 157.12 58.20 41.80 3.14 3.49 Jan 2013 86 146.93 59.55 40.45 3.20 3.98 Oct 2012 84 148.86 62.86 37.14 3.23 4.07 Jul 2012 69 118.61 57.35 42.65 3.08 4.33 Apr 2012 58 102.11 54.42 45.58 3.21 4.12 Jan 2012 51 91.75 50.79 49.21 3.18 4.53 Oct 2011 47 84.70 53.53 46.47 3.22 3.78 Jul 2011 35 57.83 44.61 55.39 3.03 2.68 Apr 2011 18 30.61 63.10 36.90 3.07 1.78 Jan 2011 15 24.66 77.93 22.07 3.37 1.96 * IG = Investment-Grade, HY High Yield, NR Non-rated. Source: Citigroup Index LLC. Data as of April 01, 2013. The Growing Importance of Fixed Income Analytics 13

Analysis in Portfolio Management Process The Growing Importance of Fixed Income Analytics 14

Risk Analysis in the Portfolio Management Cycle Analysis Summary Individual security analysis Portfolio risk reporting Analyzing Tools Scenario analysis Optimization Return attribution On Track? Scenario Analysis Profile Comparison Tracking error Value at Risk Return Attribution Tracking Error Test Adjust the Portfolio? Why? Transact Optimizer Ex Post Ex Ante The Growing Importance of Fixed Income Analytics 15

Portfolio Issues Report Risk Profile Multi-currency Portfolio Issues Report Source: The Yield Book. The Growing Importance of Fixed Income Analytics 16

Portfolio Benchmark Tracking Report Multi-currency Benchmark Comparison Report Source: The Yield Book. The Growing Importance of Fixed Income Analytics 17

Portfolio Report Package a) b) c) Source: The Yield Book. The Growing Importance of Fixed Income Analytics 18

Scenario Analysis What is Scenario Rate of Return? Projected returns over a specific time period given a beginning price, ending price, and cash flows during the time period. User specifies the direction of interest rates, volatility, prepayments for mortgages, and how a bond will be priced at some time in the future. What can you analyze? Single Securities, Trades, Portfolios, and Indexes What calculations can you get from the analysis? Performance measures (projected returns) Horizon measures (OAS, duration, and more at the end of the period) Risk measures (percentage price change by shifting various inputs) Projected cash flows from a bond or portfolio and versus liabilities The Growing Importance of Fixed Income Analytics 19

Scenario Summary Report Scenario Summary Report (Horizon: 1 Month) Source: The Yield Book. The Growing Importance of Fixed Income Analytics 20

Tracking Error / VaR Methodology The goal of the model is to accurately model the multivariate distribution of risk factors Predicting a wide range of percentiles (not only extreme tails) Computationally efficient Distribution of returns based on 10,000 simulations of changes in risk factors 1. Identify risk factors for each security grouping 2. Use PCA for efficient computation 3. Construct covariance matrix of risk factors (rates, spreads, volatilities, etc.) 4. Simulate correlated returns consistent with the covariance matrix 5. Aggregate returns of all securities to obtain portfolio price distribution The Growing Importance of Fixed Income Analytics 21

Tracking Error / VaR Report Source: The Yield Book. The Growing Importance of Fixed Income Analytics 22

Return Attribution The Return Attribution Model calculates and identifies the sources of return for fixed income securities, trades, portfolios (including dynamic portfolios), and indices. Return Attribution Portfolio managers can quantify how their sector and security decisions contribute to performance. Multi-currency managers can evaluate the impact of their currency hedging decisions Local Currency Return Inter-Currency Return (Multi-Currency Portfolio) Returns are dissected into key factors such as: Yield curve decisions Roll down Parallel shifts Reshaping Excess spread over swap or government curve Volatility changes Prepayments Currency effects including hedging Curve Return (Govt Return) Spread Return Sector Selection A benchmark is needed Issue Selection The Growing Importance of Fixed Income Analytics 23

Spread Return Changes in the last 10 Years Spread return for treasury market is typically close to ZERO US Corporates vs US Treasury from February 2003 to February 2013 6 1-4 -9 2003 2005 2007 2009 2011 2013 While the above statement remained true before the financial crisis, some European sovereign markets started to behave like Corporate markets after 2008. 6 4 2 0-2 -4-6 -8-10 2003 2005 2007 2009 2011 2013 France Germany Italy Spain Source: Citigroup Index LLC. Data as of March 01, 2013. The Growing Importance of Fixed Income Analytics 24

Return Attribution: Portfolio vs Benchmark Source: The Yield Book. The Growing Importance of Fixed Income Analytics 25

Return Attribution: Portfolio vs Benchmark Multi-currency Benchmark Comparison Report Source: The Yield Book. The Growing Importance of Fixed Income Analytics 26

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