Fixed Income – Challenges in a low interest rate environment Maurizio Pedrini April 2010.

Fixed Income – Challenges in a low interest rate environment

Maurizio Pedrini

April 2010

Produced by: APXDate: April 2010

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Please see “Important Information“ at the end of this material for important disclosures regardingthe data and information contained and the views and opinions expressed in this material.

Contents

Opportunities and Threats in 2010

Liquidity: Engineered funds

Credit-Spreads: TOPS funds

Inflation risk: Inflation-linked funds

Appendix


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Opportunities and Threats in 2010


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Risk/Return Factors in the Fixed Income Asset Class

maturity

yield

credit risk premium

liquidity premium

real yield

inflation premium


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De-leveraging process has just started

Source: Arbor Research


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Housing market – back to normality?

Source: San Francisco Fed


Slide 7/46


U.S.A. – Federal Reserve Assets Have Almost Tripled

Last data point: 31.03.2010 Source: Datastream, Credit Suisse / IDC

0

500

1'000

1'500

2'000

2'500

Dec 07 Apr 08 Aug 08 Dec 08 Apr 09 Aug 09 Dec 09

other assets Treasury securities Mortgage-backes securities

Agency debt Term auction credit loans to depository institutions

Commercial Paper Central bank liquidity swaps Federal Reserve total assets

USD bn


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Long Live the “Carry Trade”!



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Social Security Trust Funds – Buying nothing but U.S. Treasuries

Source: SocialSecurityOnline


Slide 10/46


0

500

1'000

1'500

2'000

2'500

3'000

Mar 74 Mar 78 Mar 82 Mar 86 Mar 90 Mar 94 Mar 98 Mar 02 Mar 06

Treas held by Off Inst

U.S. Treasury Bonds Held by Official Institutions



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Biggest Part of Budget Deficits in Europe is Structural

Source: OECD, Credit Suisse

-14

-12

-10

-8

-6

-4

-2

0

Ireland

Greece

France

Spain

Portugal

Netherlands

Belgium

Austria

Italy

Germ

any

Structural deficit Cyclical deficit Total deficit

% of GDP


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EMU Sovereigns – Indebtedness relative to GDP (%)

Source: Credit Suisse, Datastream

0

50

100

150

200

250

300

350

Portu

gal

Irelan

d

Nethe

rland

s

Spain

Greec

e

Belgium Ita

ly

Austri

a

Franc

e

Germ

any

Finlan

d

Government

Non financial corporates

Households

%


Slide 13/46


0

5

10

15

20

25

30

35

40

J an 99 J an 01 J an 03 J an 05 J an 07 J an 09

M1 M2 Financial Institution Loans National Banking System Loans

Annual change in %

China – Rapid Growth of Monetary Aggregates and Loan Volumes


%


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Inflation will Remain Tame in the Short Run



Slide 15/46


0

20

40

60

80

100

120

140

160

180

USD EUR GBP J PY CHF AUD NZD CAD SEK NOK

Source: Bloomberg, Credit Suisse / IDCLast data point: 02.04.2010

Expected Changes of Money Market Rates for the Next 12 Monthsin bp


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Opportunities and Threats for 2010

Interest Rates– Interest rates are generally on a low level – risk of a sudden rise

– Very steep yield curves mean high opportunity cost of capital– Considerable risks in sovereign bonds (Dubai, Greece,…)

Flexibility of chosen strategy is important (liquidity!)

Credit-Spreads– Economic recovery helps – what happens when government stimulus gets withdrawn? – Credit spreads are still at historically attractive levels

Focus needs to be on issuer selection

Inflation– No immediate threat– Expansionary monetary policy and rising sovereign debts pose significant risks in the

longer term

Inflation risk is not sufficiently discounted by the market


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Liquidity: Engineered Funds


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Traditional vs. Synthetic Fixed Income Funds

(CurrencyForward)

Interest rateswap

Syntheticmoney market

Credit risk

Currency risk

Interest rate risk

Traditional bondsSynthetic bonds + portable alpha

Creditdefault swap

Inst

rum

en

ts a

nd r

isks

Portable alpha②

③

①

④


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Synthetic Money Market and Portable Alpha

Portable Alpha Strategy

– To enhance this money market return, a small part of the fund (5% to 10%) is invested in a portable alpha strategy

– This strategy is a mechanical equity index arbitrage strategy which invests in single stocks subject to corporate events (e.g. inclusions/exclusions from an index) and hedges the systematic equity risk with index futures

– This means that the fund doesn't have any systematic equity risk, only a small additional volatility coming from the excess returns of the portable alpha strategy

①

②

Synthetic money market

– Cash is invested in a diversified equity portfolio which is immediately sold forward, so that the investor doesn’t hold any equity market risk

– The money market equivalent return comes from the interest rate implicit in the forward price


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Interest Rate Risk and Credit Risk (incl. Counterparty Risk) Interest rate risk: Positioning with respect to the benchmark along the

dimensions duration and curve

Credit risk is implemented through index CDS (iTraxx) and single name

sovereign CDS

– Diversification

– Liquidity

– Credit risk can be quickly eliminated with low transaction costs

Counterparty risk is

– only a fraction of the notional exposure

– diversified across several counterparties (best execution)

– subject to limits

– constantly monitored

– actively managed

③ ④


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Performance Credit Suisse Fund (Lux) Relative Return Engineered (Euro)

Expected returns are no forecast or guarantee for future performance. There is no warranty that the expected return can be achieved. Performance data does not include costs and commissions in connection with the purchase and redemption of fund units.

0

1

2

3

4

5

6

7

8

annu

alized

ret

urn

in %

Account 1.52 2.96 5.74 6.15 5.37

Benchmark 0.79 2.20 6.51 5.46 4.76

Tracking Error 1.86 1.61 1.42

Information Ratio -0.41 0.43 0.44

3 months 6 months 1 year 3 years since 01.04.2006

Reporting Period Market Value (EUR end of period in mio.) Performance Type

01.04.2006 - 28.02.2010 533.60 Asset Weighted Gross Return

Base Currency / Reporting Currency Benchmark Note

EUR / EUR J PM GBI EMU Aggregate Traded Please read the disclaimer at the end of this presentation


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Performance Credit Suisse Fund (Lux) Relative Return Engineered (Euro), (net)

96.00

98.00

100.00

102.00

104.00

106.00

108.00

110.00

112.00

114.00

116.00

118.00

120.00

Mrz

06

Jun

06

Sep

06

Dez

06

Mrz

07

Jun

07

Sep

07

Dez

07

Mrz

08

Jun

08

Sep

08

Dez

08

Mrz

09

Jun

09

Sep

09

Dez

09

CSF (Lux) RR Engineered EUR J PM EMU IndexExpected returns are no forecast or guarantee for future performance. There is no warranty that the expected return can be achieved. Performance data does not include costs and commissions in connection with the purchase and redemption of fund units.

NAV price in %


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Credit Spreads: TOPS Funds


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Risk-free curve

Credit curve

maturity

yield

Traditional Bond Fund

TOPS

Focus is on Credit Duration

Source: Credit Suisse


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Credit Spreads USD – AAA to BBB (10 years)

Last data point: 05.04.2010 Source: Bloomberg, Credit Suisse / IDC

0

100

200

300

400

500

600

700

800

J an 99 J an 01 J an 03 J an 05 J an 07 J an 09

AAA bonds against US government curve AA bonds against US government curve

A bonds against US government curve BBB bonds against US government curve

in bp

Expected returns are no forecast or guarantee for future performance. There is no warranty that the expected return can be achieved.


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0

100

200

300

400

500

600

700

J an 08 May 08 Sep 08 J an 09 May 09 Sep 09 J an 10

Austria Greece Germany Hungary Italy Ireland UK USA

in bp

CDS Spreads of Selected EU Countries vs the U.S. & U.K.

Last data point: 02.04.2010 Source: Bloomberg, Credit Suisse / IDC

Expected returns are no forecast or guarantee for future performance. There is no warranty that the expected return can be achieved.


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Enhanced flexibility without higher risk

Target credit exposure

Long Short

100%

30%

100%

30%

130 / 30 concept allows the fund to Maintain credit exposure @100% even

when 30% of portfolio is hedged Take net short positions in individual

names Increase long positions when credit

spreads are expected to tighten materially

BUT: No leverage on cash assets No short position overall possible

(maximum hedge is 100%)


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Key Features

Three return dimensions: interest rates, credit and currency

Independent management of interest rate, credit and currency exposures

Focus on risk control to achieve stable returns and minimize the probability of negative returns

Target volatility: 1%-1.5%

Modified duration: 0 to 3

Average rating: minimum A3/A- (single positions minimum Baa3/BBB-)

Credit duration: 0 to 7


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Credit Suisse Bond Fund (Lux) TOPS US$

0

2

4

6

8

10

12

14

16

18

20an

nual

ized

ret

urn

in %

Account 2.01 5.31 18.71 5.07 4.92 4.16

Benchmark 0.06 0.14 0.56 2.73 3.45 2.85

Tracking Error 3.45 4.84 3.78 3.17

Information Ratio 5.26 0.48 0.39 0.41

3 months 6 months 1 year 3 years 5 years since 01.01.2003

Reporting Period Market Value (mio. USD) Performance Type

01.01.2003 - 28.02.2010 146.44 Asset Weighted Gross Return

Reference / Reporting Currency Benchmark Note

USD / USD LIBOR 3m USD in USD Please read the disclaimer at the end of this presentation



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An Alternative to Reducing The Interest Rate Risk

yield

Real interest rate

Breakeven inflation(= expected inflation+ inflation risk premium)

Nominal interest rate

time

Conventionally, the interest rate risk is reduced by shortening the overall duration of the portfolio (move from point A to B). The disadvantage is that the opportunity cost is high as both the real rate and breakeven curves are steep. The loss in carry is equal to be + r, be is the carry loss on the breakeven curve while r is the carry loss on the real rate curve.

Alternatively, the interest rate risk can be diminished by reducing only the inflation risk, i.e. moving down the breakeven curve (move from point A to C) while maintaining the real interest rate risk constant at point A '. In that case, the loss in carry is equal to be.

A

B

be

A'

r

C


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Inflation Risk: Inflation Linked Funds


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How do Inflation-Linked Bonds work?

Nominal bonds react to movements in nominal interest rates independently from the source of the change, i.e. real rates or breakeven inflation.

Real bonds (ILBs) react only to changes in real interest rates and are immune (protected) against changes in inflation expectations.

yield

Nom

inal ra

te

Real ra

teB

reake

ven

In

flati

on

Bre

ake

ven

in

flati

on

Ris

kp

rem

ium

Exp

ect

ed

inflati

on

time


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Impact of an inflation shock on the bond markets

Source: Barclays Capital Equity Gilt Study

Investors erroneously believe they are conservatively invested with government bonds. This is true from a credit perspective, but not from a purchasing power point of view.

The real return (adjusted for inflation) was disastrous for bond investors during the last inflationary period.

US Treasuries returned -46.5% while UK Gilts lost -68.78%!


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Efficient Frontier with Inflation Linked Bonds

Source: BloombergComparison: Barclays World Government inflation-linked Index unhedged in USD vs Barclays Breakeven Index

100%

0%

Efficient frontier

2004

0%

100% Linkers

1996-20080%

-10%

-5%

0%

5%

10%

15%

20%

25%

4.5% 6.5% 8.5% 10.5% 12.5% 14.5% 16.5%

Portfolio standard deviation

Port

folio y

ield

0%

100% Linkers

2002100% Linkers 0%

100% Linkers40% Linkers


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Investors are not Properly Compensated for Long Term Inflation Risk

Source: Bloomberg (24th March 2010)

90

100

110

120

130

140

150

160

170

180

190

Barclays IL Bond Index - EuropeBarclays Breakeven Index - Europe

Source: Bloomberg (24-Mar-2010)

00 01 02 03 04 05 06 07 08 09 10

NAV price in %


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-0.5

0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

J an 07 May 07 Sep 07 J an 08 May 08 Sep 08 J an 09 May 09 Sep 09 J an 10

10-year BE inflation USD 10-year BE inflation EUR 10-year BE inflation GBP

in %

10-Year Breakeven Inflation

Source: Bloomberg, Credit Suisse / IDCLast data point: 23.03.2010


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Inflation swaps work like plain vanilla interest rate swaps: The fixed leg corresponds to average inflation expectations at inception of the contract. The floating leg is determined ex post by realized inflation

Mechanism of Inflation Swaps

Receive Inflation

Pay Fixed


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PrincipalPay Fixed

Receive InflationNominal Coupon

Bond + Inflation-Swap =

Inflation-Linked Bond

Synthetic Inflation Linked Bonds

In the CHF product, we combine bonds denominated in CHF with swaps on European and US inflation. This represents a proxy hedge that works as long as inflation surprises in these markets are correlated with Swiss inflation


Slide 39/46


An Alternative to Reducing Interest Rate Risk

yield

Real interest rate

Breakeven inflation(= expected inflation+ inflation risk premium)

Nominal interest rate

time

Conventionally, the interest rate risk is reduced by shortening the overall duration of the portfolio (move from point A to B). The disadvantage is that the opportunity cost is high as both the real rate and breakeven curves are steep. The loss in carry is equal to be + r, be is the carry loss on the breakeven curve while r is the carry loss on the real rate curve.

Alternatively, the interest rate risk can be diminished by reducing only the inflation risk, i.e. moving down the breakeven curve (move from point A to C) while maintaining the real interest rate risk constant at point A '. In that case, the loss in carry is equal to be.

A

B

be

A'

r

C


Slide 40/46


Source: OECD, Credit Suisse

Difference of Inflation – Switzerland, France and the USA

France USA EMU (since 1998) Average -2.07% -1.17%-0.97% Standard Deviation 3.46% 2.55% 0.60% Correlation with Swiss Inflation 0.5 0.54 0.81

-20

-15

-10

-5

0

5

56575859606162636465666768697071727374757677787980818283848586878889909192939495969798990001020304050607080910

Swiss minus French inflation

Swiss minus US inflation

Swiss minus EMU inflation


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Performance Credit Suisse Bond Fund (Lux) Inflation Linked EUR (net)

95

100

105

110

115

120

Credit Suisse Bond Fund (Lux) Inflation Linked EURHICP Eurozone

Source: Bloomberg (24-Mar-2010)

2003 2004 2005 2006 2007 2008 2009 2010



Slide 42/46


Risk/Return (Cumulative Performance net of mgmt fees, in EUR)as of December 2009

CAAM-EURO INFLATION BOND-C

CREDIT SUISSE-INFLAT LINK-€B

CS SICAV II-INF LNKD BDS €-B

DEXIA BONDS-EUR INF LINK-C-C

FORTIS L FD-BOND INFL LK €-C

INVESCO EURO INFLATION BD-A

PARVEST EUR INFLAT LNK BD-CC

PIONEER SF-EURO INFL LNK-NAD

SGAM FD-BDS EURO INFLAT L-AC

3.0%

3.2%

3.4%

3.6%

3.8%

4.0%

4.2%

4.4%

3.00% 3.50% 4.00% 4.50% 5.00% 5.50% 6.00% 6.50% 7.00%

Volatility 3Y (ann.)

Per

form

ance

3Y (an

n.)

Peer Group Comparison

Source: Credit Suisse



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Appendix


Slide 44/46


Portfolio manager: MACS Fixed Income, Zurich

Fund Currency: EUR, CHF, USD

Benchmark: JP Morgan EMU Traded TR

SBI Foreign AAA-BBB

JP Morgan GBI USA Traded TR

Management fee p.a.: 1,00%

Issuing commission: As per bank fees

ISIN (B tranche): EUR: LU0230911603

CHF: LU0230912676

USD: LU0230913302

Credit Suisse Fund (Lux) Relative Return Engineered (€) (SFr) ($)


Slide 45/46



Fund currency: EUR, CHF, USD

Benchmark: Libor 3 months in EUR, CHF and

USD

Management fee p.a.: EUR 1.00%, CHF 0.50%, USD 0.70%



CHF: LU0155952053

USD: LU0155953705

Credit Suisse Fund (Lux) TOPS (€) (SFr) ($)


Slide 46/46



Fund currency: EUR, CHF, USD

Benchmark: Barclays Euro Govt. Infl-Linked 1-

10Y (RI) (09/07)

SBI Customized

Barclays US Govt. Infl-Linked 1-10Y

(RI) (09/07)

Management fee p.a.: EUR 1.00%, CHF 0.75%, USD 1.00%



CHF: LU0175163889

USD: LU0175164267

Credit Suisse Fund (Lux) Inflation Linked (€) (SFr) ($)


Slide 47/46


This document was produced by Credit Suisse AG and/or its affiliates (hereafter “CS”) with the greatest of care and to the best of its knowledge and belief. However, CS provides no guarantee with regard to its content and completeness and does not accept any liability for losses which might arise from making use of this information. The opinions expressed in this document are those of CS at the time of writing and are subject to change at any time without notice. If nothing is indicated to the contrary, all figures are not audited. This document is provided for information purposes only and is for the exclusive use of the recipient. It does not constitute an offer or a recommendation to buy or sell financial instruments or banking services and does not release the recipient from exercising his/her own judgment. The recipient is in particular recommended to check that the information provided is in line with his/her own circumstances with regard to any legal, regulatory, tax or other consequences, if necessary with the help of a professional advisor. This document may not be reproduced either in part or in full without the written permission of CS. It is expressly not intended for persons who, due to their nationality or place of residence, are not permitted access to such information under local law. Every investment involves risk, especially with regard to fluctuations in value and return. Investments in foreign currencies involve the additional risk that the foreign currency might lose value against the investor’s reference currency. Historical performance indications and financial market scenarios are no guarantee for current or future performance. Performance indications do not consider commissions levied at subscription and/or redemption. Furthermore, no guarantee can be given that the performance of the benchmark will be reached or outperformed. The investment funds mentioned in this publication are domiciled in Luxembourg and are in conformity with EU Directive 85/611/EEC of 20 December 1985, as amended, relating to undertakings for collective investment in transferable securities. Representative in Switzerland is Credit Suisse Asset Management Funds AG, Zurich. Paying agent in Switzerland is Credit Suisse AG, Zurich. Subscriptions are only valid on the basis of the current sales prospectus and the most recent annual report (or semi annual report, if the latter is more recent). The prospectus, the simplified prospectus, the management regulations and the annual and semi annual reports may be obtained free of charge from Credit Suisse Asset Management Fund Service (Luxembourg) S.A., Luxembourg, from Credit Suisse Asset Management Funds AG, Zurich, and from any bank in the Credit Suisse AG.

Disclaimer

Fixed Income – Challenges in a low interest rate environment Maurizio Pedrini April 2010.

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Transcript of Fixed Income – Challenges in a low interest rate environment Maurizio Pedrini April 2010.