Fixed Income – Challenges in a low interest rate environment
Maurizio Pedrini
April 2010
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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
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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”!
Source: Arbor Research
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Social Security Trust Funds – Buying nothing but U.S. Treasuries
Source: SocialSecurityOnline
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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
Last data point: 31.12.2009 Source: Datastream, Credit Suisse / IDC
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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
%
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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
Last data point: 26.02.2010 Source: Datastream, Credit Suisse / IDC
%
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Inflation will Remain Tame in the Short Run
Source: Arbor Research
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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
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.
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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
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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
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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
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.
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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
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.
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Appendix
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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) ($)
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Portfolio manager: MACS Fixed Income, Zurich
Fund currency: EUR, CHF, USD
Benchmark: Libor 3 months in EUR, CHF and
USD
Management fee p.a.: EUR 1.00%, CHF 0.50%, USD 0.70%
Issuing commission: As per bank fees
ISIN (B tranche): EUR: LU0155951089
CHF: LU0155952053
USD: LU0155953705
Credit Suisse Fund (Lux) TOPS (€) (SFr) ($)
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Portfolio manager: MACS Fixed Income, Zurich
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%
Issuing commission: As per bank fees
ISIN (B tranche): EUR: LU0175163459
CHF: LU0175163889
USD: LU0175164267
Credit Suisse Fund (Lux) Inflation Linked (€) (SFr) ($)
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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
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