The Coming Volatility Lowell Bolken, CFA Vice President and Portfolio Manager Real estate Securities June 18, 2015 www.advantuscapital.com
S&P 500 Percent Daily Change in Price September 2008 to April 2009 1400 1300 1200 1100 1000 900 800 700-10% 10% 10% -10% 600 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 15% 10% 5% 0% -5% -10% -15% SPX Index Price % Change in Price Source: Bloomberg. 2
5 Year Treasury Percent Daily Change in Price September 2008 to April 2009 Percent 3.5 3.0 2.5 2.0 1.5 1.0 0.5 16% -21% 20% 15% 10% 5% 0% -5% -10% -15% -20% 0.0-25% Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 Five U.S. Treasury 5yr Treasury % Change Source: Bloomberg. 3
Baa Credit Spreads Percent Daily Change in Price September 2008 to April 2009 Basis Points 900 800 700 600 500 400 300 12% 8% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% 200-6% Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09-5% US Baa Intermediate Spread % Change Source: Bloomberg. 4
Equities
The Coming Volatility Volatility During Stress: Treasury Bonds and the S&P 500 Are Both Affected 310 90 260 210 160 110 60 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 80 70 60 50 40 30 20 10 MOVE Index VIX Index Source: Bloomberg. VIX is the Chicago Board of Exchange Volatility Index. MOVE is the Merrill Lynch Option Volatility Estimate Index. 6
Volatility in the Market Has Been Abnormally Low History Shows that a Run-Up in the S&P 500 Presages an Increase in Volatility 70 60 50 40 30 20 10 2500 2000 1500 1000 500 0 0 May-95 May-99 May-03 May-07 May-11 May-15 VIX Index S&P 500 Source: Bloomberg. VIX is the Chicago Board of Exchange Volatility Index. 7
What the Fed Does Matters Yield Curve Inversion Often Presages Future Volatility 70% 60% 50% 40% 30% 20% 10% 0% May-79 May-84 May-89 May-94 May-99 May-04 May-09 May-14-4 -3-2 -1 0 1 2 3 4 Percent Points Volatility 10Y 2Y Spread Volatility is the rolling standard deviation of the last 90 daily returns multiplied by the square root of 252 (252 trading days per year). Source: Bloomberg, Advantus Capital Management. 8
Why Should You Care? Bond Yields are Correlated with Equities 1.0 0.8 Correlation Between 1D Change In S&P 500 & U.S. Treasury Yield Risk On-Risk Off 0.6 0.4 0.2 0.0-0.2 Taper Tantrum -0.4 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Trailing 3 Month Correlation Dollar Strengthening As of 5/31/15. Bloomberg, Advantus Capital Management. 9
Corporate Bond Spreads are Correlated to Broader Equities Basis Points 800 700 600 500 400 300 200 100 0 Apr-95 Apr-98 Apr-01 Apr-04 Apr-07 Apr-10 Apr-13 70 60 50 40 30 20 10 0 Baa Intermediate Spreads VIX (right axis) Source: Barclays, Bloomberg. 10
Bonds
Treasury markets were quite turbulent in the spring and summer of 2013, when the Fed hinted that it soon would slow its asset purchases on one day, October 15, 2014, Treasury securities moved 40 basis points, statistically 7 to 8 standard deviations an unprecedented move an event that is supposed to happen only once in every 3 billion years or so, Jamie Dimon, J.P. Morgan CEO, in a letter to shareholders on April 8, 2015. 12
Recent Concerns Still Pale in Comparison Treasury Bond Volatility: Last 13 Months 2014-2015 vs. 2008-09 300 250 200 150 100 10/15/14: Jamie Dimon Expresses Concern on Bond Market Volatility 9/2008-10/2009 Still < 2008-09, however: 50 3/2014-05/2015 0 Month 1 Month 3 Month 5 Month 7 Month 9 Month 11 Month 13 MOVE Index 2008-09 MOVE Index 2014-15 For the periods 9/2/08 to 10/8/09 and 3/25/14 to 5/1/15. Source: Bloomberg, Advantus Capital Management. 13
The biggest worry of the buy side around the world is that there has been a dramatic decline in liquidity from the sell side for many fixed income products I think it s a big risk and is one of the unintended consequences of regulators trying to prevent another financial crisis, David Hunty, CEO, Prudential Investment Management, April 13, 2015 14
Concerns Related to Future Bond Volatility The Volcker Rule Basel III The liquidity coverage ratio 15
Non-U.S. Government Bonds Have Suppressed U.S. Treasury Yields German Bonds Lead U.S. Yields German 5yr Gov't Bond Yield 3.0 US-German 5yr Yield Spread 200 2.5 150 Percent 2.0 1.5 1.0 0.5 Basis Points 100 50 0 0.0-50 -0.5-100 As of 6/5/15. Source: Bloomberg. 16
But the Tide May Be Turning Percent German 5 Year Government Bonds Yields 0.25 0.20 0.15 0.10 0.05 0.00-0.05-0.10-0.15-0.20 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Source: Bloomberg. 17
Managing the Volatility
A Formula for Managing Volatility Without Sacrificing Return + + Stable Income Diversification Option Overlays 19
Higher Current Income Suppresses Volatility versus Broader Equity Market over Cycles 45% 40% 35% 30% 25% 20% 15% 10% 5% Three Year Rolling Returns S&P 500 Total Return - S&P 500 Price Return 0% 1931 1938 1946 1953 1961 1969 1976 1984 1991 1999 2006 2014 As of 12/31/14. Source: Bloomberg, Advantus Capital Management. 20
Maximum Drawdown Dynamic versus Static 60/40 Allocation October 2007 to March 2009 100 95 90 85 80 75 70 65 60 55 50 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Static 60/40* Dynamic 60/40 *(Static 60% S&P 500/40% Barclays U.S. Credit Bond Index) Shown for the period 10/9/07 to 3/9/2009. Source: Bloomberg, Advantus Capital Management. See disclosures at the end of this presentation. For illustrative purposes only. 21
Maximum Drawdown Actual Benchmark versus SDI Custom Benchmark October 2007 to March 2009 95 85 75 65 55 45 35 25 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 S&P 500 MSCI REIT SDI Benchmark Shown for the period 10/9/07 to 3/9/09. Source: Bloomberg, Advantus Capital Management. The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S. The MSCI US REIT Index is a free float market capitalization weighted index that is comprised of Equity REITs securities that belong to the MSCI US Investable Market 2500 Index. The SDI Benchmark consists of: 45% MSCI U.S. Real Estate Securities Index, 13.33% S&P 500 Utilities Index, 13.33% Alerian MLP Total Return Index, 13.33% Barclay s Capital Government Inflation-Linked Bond Index, and 15% Wells Fargo Hybrid & Preferred REIT Index. Results were calculated by Advantus for the period shown. 22
Diversification as a Driver of Lower Volatility Low Historical Correlations Key for Lower Equity Volatility MSCI REIT REIT Preferred Alerian MLP S&P Utility TIPS MSCI REIT 1.00 0.38 0.45 0.47-0.17 REIT Preferred Alerian MLP 0.38 1.00 0.65 0.32 0.01 0.45 0.65 1.00 0.52-0.07 S&P Utility 0.47 0.32 0.52 1.00-0.11 TIPS -0.17 0.01-0.07-0.11 1.00 This table shows the correlations between the MSCI REIT Index, MSCI REIT Preferred Index, Alerian MLP Index, S&P 500 Utility Index and the TIPS component of the Barclay s Aggregate Index. See disclosures at the end of this presentation. Source: Bloomberg. Correlations calculated for the period 1/3/2000-12/31/2014. 23
The Three R s
Reward vs Risk on a Relative Basis For a Potential Outcome-Based Solution Equity Participation + f( )= Yield Relative Risk Investor Solution 25
Outcome Based Solutions Strategies Not Style Box Approaches Managed Volatility Strategic Dividend Income 26
The Coming Volatility Lowell Bolken, CFA Vice President and Portfolio Manager Real estate Securities June 18, 2015 www.advantuscapital.com
Dynamic 60/40 Disclosures This document shall not constitute an offer to sell or the solicitation of an offer to buy any security. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. The Dynamic 60 Equity/40 Fixed Allocation model ( Dynamic 60/40 ) assumes a baseline allocation of 60% to the S&P 500 Index and 40% to the Barclays U.S. Corporate Bond Index in periods of moderate volatility. The allocation is increased or decreased daily depending on the trailing 20-day average volatility of the S&P 500. The S&P 500 Index allocation is capped at a maximum equity exposure of 90%, for a total net exposure of 130%, with leverage financing costs calculated based upon S&P 500 price returns and the 3-month treasury bill yields. The Dynamic 60/40 model differs from the actual management of the strategy in that the strategy historically has not typically exceeded an equity exposure of approximately 84%. The Barclays U.S. Corporate Bond Index allocation is static. The performance presented for the Dynamic 60/40 Model reflects hypothetical performance an investor may have obtained had it invested in the manner shown and does not represent performance that any investor actually attained. Certain of the assumptions have been made for modeling purposes and are unlikely to be realized. No representation or warranty is made as to the reasonableness of the assumptions made or that all assumptions used in achieving the returns have been stated or fully considered. Hypothetical returns have many inherent limitations and may not reflect the impact that material economic and market factors may have had on the decision-making process if client funds were actually managed in the manner shown. Hypothetical returns are also developed with the benefit of hindsight. Actual performance may differ substantially from the hypothetical performance presented. Changes in the assumptions may have a material impact on the hypothetical returns presented. The periods presented include multiple market cycles; different periods may have different results, including losses. There can be no assurance that Advantus will achieve profits or avoid incurring substantial losses. The returns do not reflect the anticipated fees and expenses of the strategy, including brokerage, custody, advisory and other fees. Actual fees may vary depending on, among other things, the applicable fee schedule and portfolio size. Advantus fees are available upon request and also may be found in Part 2A of its Form ADV. For example, if $100,000 were invested and experienced a 10% annual return compounded monthly for 10 years, its ending value, without giving effect to the deduction of advisory fees, would be $270,704 with annualized compounded return of 10.47%. If an advisory fee of 0.95% of the average market value of the account were deducted monthly for the 10-year period, the annualized compounded return would be 9.43% and the ending dollar value would be $246,355. Past performance is no guarantee of future results. The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented in this article has been developed internally and/or obtained from sources believed to be reliable; however, Advantus does not guarantee the accuracy, adequacy or completeness of such information. Predictions, opinions, and other information contained in this article are subject to change continually and without notice of any kind and may no longer be true after the date indicated. Any forwardlooking statements speak only as of the date they are made, and Advantus assumes no duty to and does not undertake to update forward-looking statements. Forwardlooking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Actual results could differ materially from those anticipated. 28
Additional Disclosures The Barclays IG Corporate Index is the investment grade corporate component of the Barclays Capital Aggregate Bond Index. The index is market-weighted to cover the fixed rate bond market. The index includes government and corporate securities, agency pass-through securities and asset backed securities. The Barclays Government Inflation Linked Index is the TIPS* component of the Barclays Capital Aggregate Bond Index. The index is market-weighted to cover the U.S. treasury inflation linked securities market. The S&P 500 is a market value weighted index of 500 stocks chosen by Standard and Poors for their market capitalization, liquidity and industry grouping. The S&P 500 Utilities Index is the utilities component of the S&P 500. The MSCI US REIT Index is a free float market capitalization weighted index that is comprised of Equity REITs securities that belong to the MSCI US Investable Market 2500 Index. The Alerian MLP Index is a market-cap weighted, float-adjusted index created to provide a comprehensive benchmark for investors to track the performance of the energy MLP sector. The Wilshire Real Estate Securities Index is an unmanaged, market capitalization weighted index of 101 publicly traded real estate securities that invest predominantly in the equity ownership of real estate. The Wells Fargo Hybrid and Preferred Securities REIT Index is composed exclusively of preferred shares and depository shares of U.S. real estate investment trusts. 29