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19 september 2012: Adding risk via Corporate HY Credit and (to a lesser extent) via Europe equity

After the European Central Bank (ECB) and the US Federal Reserve Bank (Fed) announced their intent to further support financial markets by using a combination of bond-buying programs and keeping interest rates low, investors are increasingly willing ….
 

to add risk to their portfolios as imminent tail risks related to funding and liquidity issues have decreased (for now).

Consequently, we adjust our index portfolio by taking out the Stoxx Europe 600 Industrials Short (5% weight), getting rid of our (tail-risk hedging) Short IBOXX Euro Sovereign Eurozone position (15% weight) and shifting the freed-up money into 1) Corporate HY credit (buying the iTraxx Crossover 5Y TR with 10% weight) and 2) the MSCI EM Eastern Europe 10/40 equity index (5% weight), which we consider one of the most under-owned equity indices given relatively low expectations on earnings growth.

We add the remaining 5% to our Gold Euro Hedged position. We prefer to add risk to our portfolio overproportionally via the bond market relative to the equity market as inflow momentum related to bond funds and specifically related to high yield credit funds continues to exceed flow momentum related to total equity funds .

Bond positions in our portfolio now account for a combined index weight of 50% (up from last month’s 25%) versus the 35% weight related to equity positions (up from 25% one month ago).

With more and more central bank intervention globally, currency diversification remains a key element to our global cross asset portfolio (now more than ever). We hold on to our cash position in the EONIA and the Singapore Dollar (5% each), we stick to our MSCI Japan, MSCI India and China CSI Healthcare positions on the equity side (5% each) and to our Emerging Market Liquid Eurobond positions (15%) in the fixed income section.

Portfolio Position Rationale

5.0% MSCI JAPAN TRN Index

Japan had the second highest trade surplus of all countries globally in 2010 and high earnings growth for 2011 of 20% and for 2012E of 25% partly due to recovering earnings after the earthquake. The MSCI Japan also provides Yen exposure and thereby currency diversification outside the Euro. Especially in times of risk aversion, the Japanese Yen should benefit.

10.0% Stoxx 600 Utilities TRN Index

Utilities performance has suffered over the last years and we see rising chances of a recovery. We see the sector as relatively immune to current key risks for the overall European equity market. Further arguments for Utilities  include 1) potential improvement of the supply/demand situation, if loss making generation capacity is closed, 2) the negative impact of the gas-to-oil spread should continue to fade by 2013, 3) a high dividend yield.

5.0% MSCI EM Eeurope TRN Index

EM Eastern Europe Equity index continues to be one of the most under-owned given low earnings growth expectations.

5.0% CSI 300 Healthcare Index

Our case for the China Health Care sector is based on the following key arguments: The sector’s strong volume growth profile continues to be driven by a combination of urbanization, the age-related increase in chronic diseases, exceptionally high government investment in healthcare infrastructure, broader provision of healthcare insurance along with increasing reimbursement and an increasingly wealthy middle class benefitting from growing disposable income per capita along with increasing affordability of medication.

5.0% MSCI India TRN Index

Valuations look attractive with India trading at near 20-year lows on EV/EBITDA and on EV/Sales; also, a turn in leading economic indicators is seen. Admittedly, this is a contrarian call with almost unanimous pessimism among investors.

5.0% EURO-STOXX 50 Implied Volatility ETF

Implied volatility is close to a 12-month low, and E-STOXX 50 implied volatility is low versus European corporate credit default swap levels. Also with expected ECB intervention, the Euro should strengthen, in our view.

5.0% Iboxx Eur Liquid Corporate 100 Non- Financial Index

Investment grade corporates have lowered debt significantly, are cash rich and appear to be in a sweet spot to invest again, which, in turn, is positive for future earnings quality.

15.0% Emerging Markets Liquid Eurobond Index

The main reason for the buy: the attractive coupon. We acknowledge that this is a high-risk investment. It offers some degree of regional diversification to our other largely developed countries exposure, with the two major regional blocks Latin America and Emerging Europe.

10.0% Euro Inflation Swap 5 Year Total Return Index

The inflation swap index offers protection against rising inflation without suffering from rising interest rates. A monetary policy that is too easy at the global level is driving the prices of goods, services, commodities, and assets. The uncertainty about the longer-term inflation outlook has risen substantially in the light of rising oil and commodity prices.

10.0% iTRAXX Crossover 5- Year TR Index

We prefer to add risk to our portfolio over-proportionally via the bond market relative to the equity market as inflow momentum related to bond funds and specifically related to high yield credit funds continues to exceed flow momentum related to total equity funds.

15.0% DB Physical Gold Euro HE

We see the desire for protection from tail events, such as break-up of the euro zone, as sustaining private sector demand for gold. Aside from negative real interest rates and a weak US dollar environment, we believe gold prices have benefited from a significant rise in the US equity risk premium over the past decade. Moreover, gold can have a strong diversification effect in a portfolio as it is likely to move up if risk aversion continues to increase.

5.0% DB SORA Total Return Index

We buy exposure to the Singapore dollar because currency diversification is important for Euro investors due to increasing problems in Spain and uncertainties related to Greece.

5.0% EONIA TR Index

 In light of the high volatility in the last months, we think a cash position is appropriate and principal protection is key.

19092012


Source: 17 September  2012:  Absolute Return Index portfolio – Deutsche Bank AG

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rated “BB”. 13% of the basket is rated “B” and this is one issuer, Venezuela. So the country
with the biggest weight in the index is also the country with the lowest rating. While
Venezuela is clearly a high risk country with 13% weight in the index, the remaining countries
are clearly more solid (for more details on the “MSCI USA TRN” ETF see ETF: Ideas and
Flows, 25 November 2009).
“db x-trackers Currency valuation” ETF 20% weight
In currency markets the majority of the participants are “liquidity seekers”. “Profit seekers”
are a minority in currency markets and can generate returns on the expense of the “liquidity
seekers”. Profit-seekers can generate returns by buying “under-valued” currencies and
shorting “over-valued” currencies. A widely used measure to determine “under-valued” and
“over-valued” valuation for currencies is the concept of “Purchasing Power Parity” where
“fair” exchange rates are calculated by comparing the prices of a basket of goods in different
countries. The ETF “db x-trackers Currency valuation” buys each quarter the three currencies
with the “lowest” valuation out of the universe of the G10 currencies and sells the three
currencies with the “highest” valuation using the PPP concept. In addition, the correlation to
equities and bonds is very low and therefore the currency valuation index helps to diversify
our ETF portfolio. The index is currently long in the US Dollar, New Zealand Dollar, and the
British Pound whereas the index is short in the Swiss Franc, Swedish Krona and the
Norwegian Krona. Risks to the investment include that currencies movements become less
rational again. Especially increased uncertainty about the economic development could
trigger a flight back into expensive currencies like the Swiss Franc (for more details on the
“db x-trackers Currency valuation” ETF see ETF: Ideas and Flows,12 June 2009).
Trading portfolio
We have kept the portfolio unchanged this time. Earlier we bought the “Emerging Markets
Liquid Eurobond Euro Index” ETF with 10% weight and sold the “db x-trackers DJ Stoxx
Global Dividend 100 ETF”. The portfolio targets absolute return and has the EONIA index as
benchmark.

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