For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… l | October 2016 1
Passive Spotlight October 2016
MARKETING MATERIAL – FOR
PROFESSIONAL INVESTORS ONLY
(as defined in MiFID Directive 2004/39/EC
Annex II)
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
Deutsche Bank AG Deutsche Asset Management Mainzer Landstrasse 11-17 Frankfurt am Main, Germany Hotline: +49 (69) 910 30549 [email protected] etf.deutscheam.com Editor Vincent Denoiseux Passive Asset Management [email protected] Authors Olivier Souliac Passive Asset Management [email protected] Shuchang Sun Passive Asset Management [email protected] Content
1. Introduction 1 2. EUR Fixed Income: an upside
down asset class 2 3. Maximising Yield/risk benefits
using the Risk Barbell strategy 11 4. Applications of the barbell for
institutional investors: what makes sense, what does not 17
5. Conclusion 27 6. Annex - Measuring risks in the
fixed income assets 28 References 31
“Копейка рубль бережет”
“Penny and penny laid up will be many”
Russian Proverb
1. Introduction The EUR fixed income asset class has been turned upside down by
the action of central banks, and partly by investors themselves:
yields have turned negative and sovereign risks increased to such
extent that broad corporate bond indices started showing higher
levels of resilience than broad sovereign bond indices!
Also, the adequacy between fundamental risks and market implied
risks has been largely destroyed by large imbalances between
supply and demand. Not only central banks started buying bonds,
but also overall uncertainty combined with sinking yields forced
investors to rush into the asset class as a whole, from AAA
sovereigns to B corporates (cf. Table 1: ETF Fixed Income Flows by
Asset-Classes YTD and Table 2: ECB holdings).
As a consequence of this, not only have the yield spreads
between corporates and sovereigns decreased since the end of
the financial crisis but also the correlation between those two
asset classes increased substantially. This depicts a bleak
outlook for “risk barbell” investors, interested in the diversification
benefits of concentrating their portfolio towards (i) conservative
bonds at acceptable yield costs and (ii) higher yielding bonds at
reasonable costs in terms of yield.
This paper revisits the benefits of traditional barbell and risk barbell
strategies in this context, while pointing out, when relevant, the
added value of using Strategic Beta indices for implementation
purposes. It concludes with several use cases taken from practical
situations faced by fixed income investors: asset managers,
corporate treasurers, investment consultants, pension funds.
The outcome of the paper goes further than what we have seen from
traditional literature on the subject: While traditional barbell
strategies indeed became less and less attractive as interest rates
flattened, a “risk barbelling” approach can still be implemented
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 2
EUR Corporate bonds now
seem to be a better diversifier
versus Equity risk than
sovereign bonds!
as a way to moderately enhance yield and risk-adjusted returns.
However, the traditional use of asset class split (sovereigns vs
corporates) has its weaknesses. Investors therefore need to
reconsider what is risky and what is virtually “risk-free”, both
fundamentally and quantitatively, to ensure proper diversification
benefits between the two components of a barbell.
So as to confirm general common sense, focusing specifically on
fundamental risks for sovereigns helps to avoid the “credit trap” that
characterise peripheral economies and obtain a cleaner “interest
rate” type of signal. Also, looking for yield is a good proxy to increase
risks while maximising returns per unit of risk. Combining these two
approaches presents interesting barbell-friendly features for those
investors willing to carefully increase risks.
2. EUR Fixed Income: an upside down asset class
2.1 Clear Signs of dislocation Triggered by the European debt crisis starting from 2010, the ECB
implemented several unconventional asset purchase and liquidity
programmes due to the emergence of sovereign credit risk in
European peripheral countries. These measures have turned the
market upside down, first impacting periphery government bonds,
later the broader EUR fixed income market. We will however show
that both diversification and investability remain available features in
certain targeted segments of the asset class.
For most European sovereign bonds, diversification benefits versus
equities have been declining since the ECB implemented several
unconventional asset purchase programmes. This can be illustrated
by the moving 5Y correlations among European countries sovereign
bond indices vs. Euro Stoxx 50, which has strongly increased for
almost the whole sovereign bond asset class. While first only
periphery government bonds were affected, risk contagion and
subsequent ECB announcements have also affected near-core
countries such as France and Belgium (Figure 1)1.
1 Note that correlations were calculated on the basis of weekly returns and the picture is the same when using monthly returns
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 3
Figure 1: ECB’s unconventional monetary policies have turned the market upside down
Source: Markit Ltd., Bloomberg Finance LP. Weekly data from 01/03/2005 to 31/07/2016.
This development has resulted in a higher correlation for EUR
sovereigns with Euro Stoxx 50 than for EUR corporates now,
bringing us to the qualification of “upside down” (Figure 2, first
chart)2. As a confirmation of this trend, corporate yields became
somewhat more correlated with interest rates than European
sovereign yields (Figure 2, second chart)3.
Figure 2: Historical relationships between sovereigns and corporates have inversed
2 Note that correlations were calculated on the basis of weekly returns and the picture is the same when using monthly returns 3 The relatively high correlation between corporate bond yields and swap rates can seem counter-intuitive, however possible interpretations are the fact that most corporate bonds are priced off a swap curve plus a variable spread, mechanically increasing correlation with swap rates (Elton et al. (2003))
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 4
This situation may have been
caused by heavy inflows into
the asset class, both from
investors and from the ECB
German sovereigns have
been the most heavily
purchased bonds by the ECB
Source: Markit iBoxx Ltd., Bloomberg Finance LP. Weekly data from 01/03/2005 to 31/07/2016.
2.2 Supply/demand imbalances: Is there a Fixed
Income Bubble? The unprecedented low interest rate policies as well as asset
financing and purchasing programmes have led to unprecedented
price rallies in the fixed income space, therefore it is at least
questionable whether such prices follow sustainable valuations.
From a supply/demand perspective we see oversubscriptions in
many areas of the asset class. On the one hand, we have double-
digit billion ECB purchases, while on the other hand we see ongoing
strong demand for fixed income. The ETF market for European fixed
income products for example saw sizeable inflows (€21bn, +18.7%)
in the course of 2016 year to date, with main flows stemming from
corporate (€12.7bn) and sovereign bond ETFs (€6.9bn) (Table 1).
Taking a look at the supply side, it is worth mentioning that for
sovereign bonds the ECB is currently purchasing more than what is
issued on a net basis4. Italy for example is expected to have net
issuances of around €45.3bn this year compared to ECB purchases
of around €133.3bn just for Italian government bonds. In Germany
the situation is even more significant with net issuances of -€8.2bn
and expected ECB purchases of €191.1bn in 20165. However, for
corporate bonds we see a slightly different picture. In the corporate
space we see a strong supply pickup, driven by the CSPP, with
expected net issuances of €100bn this year6. This will cover the ECB
purchases of about €7.25bn7 per month but it is at least questionable
4 Net issuance is calculated as gross issuance minus the amount of redemptions. 5 See DB Research (2016): Eurozone Sovereign Issuance: 05th Sep - 09th Sep 6 See DB Research (2016): Credit Bites – EUR and GBP Bond Issuance 7 See DB Research (2016): Special Report – Credit Outlook: Balancing Late Cycle with Overwhelming Technicals
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 5
The opportunity costs of
holding AAA sovereign assets
could still seem relatively
high versus sovereign
benchmarks: almost 60 bps
as at 31/07/2016
whether this can cover the current strong demand for corporate
bonds.
Overall there has been strong yield tightening as well as liquidity
deterioration in Europe8, but as we will show in the next section, there
are however interesting opportunities in the AAA sovereign,
Financials and Subordinated space, and not only in terms of
diversification.
Table 1: ETF Fixed Income Flows by Asset-Classes YTD
€ million Net Flows YTD % AuM
Corporates +12,691 +29.3%
Sovereigns +6,937 +12.6%
Overall +1,293 +16.2%
Other +107 1.7%
Total FI +21,029 +18.7% Source: DB Research. All figures as of 31st July 2016.
Table 2: ECB holdings
€ million Sovereigns Corporates IG
ECB Holdings € 1,053 € 13
Approx. Public Market Size € 5,729 € 836
% of Market 18.39% 1.58% Source: European Central Bank (website). All figures as of 31st July 2016.
2.3 The asset allocation perspective: Looking for yield and for diversification
In the current low-yield set-up driven by massive ECB liquidity and
supply/demand imbalances, not all asset classes are rewarding
investors equally for the risks taken. However, as described on Table
3, certain market segments seem to have kept their original virtues,
namely (i) attractive yields (or at least credit premia) for lower quality
or seniority corporate bonds (of course still at the price of higher
risks) and (ii) perceived safety for AAA sovereigns (still at the price
of lower yields, although such price may not necessarily seem
excessive from an historical standpoint).
8 See Passive Insights (2016): ‘ETFs: Catalyst or Mirage for Market Liquidity?’
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 6
But AAA sovereigns are the
only asset class exhibiting
satisfying capital preservation
features for buy and hold
investors.
Table 3: Breaking down Fixed Income into its European sub-components9
Source: Markit Ltd., Bloomberg Finance LP. All figures as of 31st July 2016. (*)Rating is
calculated as average of S&P and Moody’s. Spread volatility is calculated as the standard
deviation of: weekly spread differences multiplied with the corresponding modified duration.
Although AAA sovereign bonds seem unattractive from a yield
seeking perspective, within a diversified portfolio context, investors
may want to keep considering the lowest (and negative) yielding
sovereign bonds. This asset class has consistently helped generate
diversification benefits (Table 4 and Figure 3) versus the widest
range of riskier assets. It is also important to consider that AAA
sovereigns yields may be negative because interest rates are
negative (as an effect of central bank monetary policy), not
necessarily because the asset class would have been particularly
oversubscribed. Although this is arguably the case that especially
German sovereigns have been heavily subscribed as per Table 1
and footnote 5, AAA sovereign yields seem to be a broadly fair
reflection of their fundamental quality and quantitative stability, as
shown in Figure 4.
The point of keeping a very conservative anchor in portfolio
construction may become all the more relevant for yield seeking
investors, who will per definition need to increase risks within their
portfolio.
Table 4: 5Y Correlations showing diversification benefits within the Fixed Income space
Source: Markit Ltd. All figures as of 31st July 2016. Correlation of spreads versus riskless
rates, except for AAA sovereigns where prices were taken into account. As AAA sovereigns
are considered „riskless“ for spread calculation purposes, spreads of AAA sovereigns are
insignificant and would only entail noise. Prior to 01/08/2016 iBoxx Italy was taken for 5Y
calculations as BBB Eurozone has no continuous operating history before 01/03/2011.
9 We excluded covered bonds as they hardly offer any yield pickup to EUR sovereigns and liquidity deteriorated sharply due to three covered bond purchase programmes
undertaken by the ECB.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 7
Diversification benefits from
holding corporate bonds
alongside sovereigns started
diminishing since the end of
the 2011 sovereigns crisis
Diversification benefits are
however partially recovered
by investors concentrating
their portfolio into the
extremes of the EUR IG asset
class: e.g. AAA sovereigns
and Subordinated/BBB
corporates
As a supplement to the correlation table above, Figure 3 illustrates
the moving 5Y correlation versus equities which confirms the point
that the FI market was turned upside down, with the noticeable
exception of the AAA Eurozone sovereign asset class. Two
noticeable examples:
- price correlation between AAA sovereigns on one side
and both (i) BBB sovereigns (not so intuitive result 5
years ago!) and (ii) BBB corporates on the other is clearly
negative,
- spread correlation (i.e. adjusted for interest rate
variations) between corporates and sovereigns is largely
positive with 57%, indicating that European sovereigns
risk does have only limited diversification features versus
Corporate credit risk
Figure 3: Moving 5Y correlations indicating strong stock/bond co-movements
Source: Markit Ltd., Bloomberg Finance LP. Weekly data as of 01/03/2005 – 31/07/2016.
On the “higher yielding” side of the spectrum, BBB sovereigns may
now look attractive, the question remaining whether such yields are
a fair reward for the fundamental risks taken. When looking at a
qualitative analysis of Italy and Spain, their fundamentals 10 are
slightly worse than during the European debt crisis, while their bonds
are trading at substantially lower yields (cf. Figure 4) as a result of
ECB intervention. The reminiscent fundamental weakness of
southern European countries can also be perceived quantitatively
when measuring markets nervousness around the pricing of
10 See Passive Insights (2014): ‘Fundamental Scoring for Fixed Income’
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 8
BBB sovereign bonds may
remain attractive for long-
term or liquidity affine
investors, however offer a
poor “yield vs fundamental
risks” profile for income
investors
periphery countries, as measured by spread volatility. Such spread
volatility is substantially higher than that of safer countries such as
France or Germany indicating that the market is aware of its
fundamental risks.
Figure 4: Qualitatively speaking Italy’s and Spain’s situation is not
better than during the European debt crisis while the quantitative
picture below shows that the market recognizes this risk.
Source: Deutsche Bank, Markit Ltd., Bloomberg Finance LP. As of 31st July 2016. Spread
volatility is calculated as the volatility of: yield minus 10Y EONIA swap as risk-free rate
(100% correlation with 10Y bund yields).
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 9
When comparing the spread volatilities of Italy and of BBB
corporates, the results are similar. Both segments have the same
rating, similar yields (whereas corporate bonds exhibit higher yields
than Italian sovereigns for a given maturity) whereas Italy shows
substantially higher spread volatilities (Figure 5). Note that, however,
southern European sovereigns have both the advantage of
exhibiting high liquidity versus corporate bonds and providing longer
duration exposure, which can be of interest for institutional investors,
especially those looking to increase duration and not worrying about
short term volatility.
Figure 5: Italy has substantially higher spread volatility than BBB
corporates.
Source: Markit Ltd. As of 31st July 2016.
Generating additional income in bonds while only taking marginally
higher risks can generally be obtained via the credit asset class,
although its issuance volume is lower than sovereigns and its
transaction costs are expected to be higher. The chart below (Figure
6) confirms this assumption, showing that corporate credit premia
have not reached pre-crisis levels (even after taking into account the
slight fundamental degradation of the asset class 10 years ago).
Arguably, since corporate bond prices already started incorporating
CSPP effects 11 and ECBs willingness to provide markets with
liquidity, corporate bonds are still trading at comparably attractive
levels of credit risk premia (Figure 6). Therefore, the corporate bond
asset class presents the doubled benefits of diversification with still
11 See DB Research (2016): Credit Outlook - Balancing Late Cycle with Overwhelming Technicals
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 10
EUR corporate bonds credit
premia have remained broadly
stable (although recently
slightly declining) in the past
few years
More specifically, at the
border of the IG Corporate
Bond asset class, certain
subordinated bonds retain
attractive risk/yield features
are they are not eligible for
CSPP and investors tend to
avoid more complex assets
reasonably attractive valuations, despite recent corporate rally in
2016.
Figure 6: Corporate benchmark spread evolution from 2004 to 2016
and average ratings before the global financial crisis and after the
European debt crisis.
Source: Markit Ltd., Factset. Average Ratings as of 31/01/2005 and 31/01/2015
Yield seeking investors may also consider financials (as banks are
excluded from CSPP) as well as subordinated bonds (mostly issued
by banks and insurances) to capture additional risk premia. As an
example, lower tier 2 subordinated bonds issued by banks share the
same default probability as their related senior bonds while
additional risks can be expected to stem from additional complexity
of the bond covenants (driving lower demand and lower liquidity) and
lower recovery rates in case of default. The exclusion of such bonds
in the CSPP made them less sensitive to ECB’s QE, but the
possibility of spill-overs cannot be ruled out. The first effects on
eligible CSPP debt and bank bonds can already be observed when
looking at benchmark spreads12: while benchmark spreads of bank
senior unsecured bonds were trading at lower levels compared to
eligible bonds before the CSPP announcement, this relationship has
now inversed13. However, one should keep in mind that the two
TLTRO 14 programmes undertaken by the ECB had CSPP-like
effects on banks financing, because it allowed banks to access
cheap long-term refinancing while incentivizing lending 15 .
Considering this argument, bank bonds as well as subordinated
bonds may be currently trading at attractive credit risk premia.
12 Markit calculates the benchmark spread as the difference between the yield of the bond and a government bond as proxy of a ‘default-free bond’ (e.g. German
government bonds). For further information see Markit iBoxx Spread Analytics:
https://products.markit.com/indices/download/products/guides/Markit_iBoxx_Spread_Analytics.pdf 13 See DB Research (2016) p. 14, Figure 20 14 Targeted longer-term refinancing operations 15 See DB Research: Credit Bites - Will the ECB Buy Bank Senior Unsecured Bonds?
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 11
The compression of yields
and the re-correlation
between sovereigns and
corporates create an
unfavourable environment for
barbell type investors
This holds particularly true for
maturity barbell investors,
aiming to increase yields from
additional premia offered by
greater durations
3. Maximising Yield/risk benefits using the Risk Barbell strategy
3.1 Revisiting Risk-Barbelling: Is this the end of the bond barbell strategy?
This question has been asked by a senior active asset manager16 in
respect of USD assets recently and deserves equally to be asked
when looking at EUR bonds. Despite the EUR aggregate fixed
income markets have been turned “upside down”, the extremes of
the risk spectrum still exhibit orderly correlations to equities and rates
(See Figure 3). Traditional fixed income investors may want to
reconsider the usual sovereigns/corporates allocation in order to
cope with such central-bank driven market. Therefore, it is worth
revisiting the risk-barbelling concept which is looking at the extremes
to recoup diversification benefits. In this section, we will first review
the theoretical foundation of the barbell strategy and then follow by
recapping the risk-barbelling strategy. Then, we will look at concrete
application examples of risk-barbelling for investors in the EUR
market while specifically also looking at the use of strategic beta
indices by risk-barbelling investors.
3.2 Traditional Barbell and Risk-Barbell strategies The barbell strategy is widely used among asset managers. It
traditionally exists as a yield curve strategy seeking to invest the
portfolio in two extreme maturity. This is in fact relative to a fixed-
maturity strategy which is a portfolio of only concentrating in one
maturity. As an example, a fixed-maturity portfolio which has only 10-
year maturity bonds and a barbell portfolio which has only 5-year and
20-year maturity bonds might have similar overall portfolio duration.
However, the portfolio yield and convexity characteristics can differ
substantially from each other. Given these differences, the barbell
portfolio helps to achieve diversification between both ends of yield
curves especially during periods of large or non-parallel yield curve
shifts. Specifically, the strategy allows to lock-in higher interest rate
due to exposure to longer-term bonds and the short-term bonds
investment provides an income cushion against sharply falling rates.
Note that a barbell strategy may incur an element of turnover when
rolling the short term component and is extremely reliant on the
shape of the yield curve. Due to its flatness, the barbell strategy
recently lost some attractiveness.
16 Is this the end of the bond barbell strategy? By Arif Husain, Online article in Portfolio Adviser, April 2016: http://www.portfolio-adviser.com/viewpoint/1028390/bond-barbell-strategy
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 12
3.3 Risk-Barbell Strategy Applying the traditional yield curve barbell strategy to a portfolio risk
context, risk-barbelling seeks to achieve diversification benefits by
investing at two extreme risk spectrums. It is more and more widely
applied17, as the risky parts of the barbell can be equities or other
diversified sources of risks (and hopefully performance). In the light
of Modern Portfolio Theory (Markowitz, 1952), individual asset risk
can be reduced by holding a diversified portfolio of assets which are
not perfectly positively correlated. Looking from an investment grade
investor’s perspective, this means the risk-barbell portfolio combines
“risky” securities such as corporate bonds with rather “safe”
securities such as sovereign bonds. The corporate bonds have
higher risk as they are significantly more present to idiosyncratic risk
than sovereigns, contrarily sovereign bonds have lower risk and
more sensitive to interest rates. Their sensitivity to different sources
of risks and the fact that interest rates and credit spreads should not
be perfectly correlated unveils the potential portfolio diversification
that can be exploited.
Figure 7 Traditional Barbell Strategy (above) and Risk-barbelling strategy (below)
17 For further reference, see Investors Reach for a New Kind of 'Barbell' in Wall Street Journal, 2014, http://www.wsj.com/articles/more-investors-use-a-barbell-strategy-
to-structure-their-portfolios-1410120110
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 13
As an alternative to the
traditional allocation between
sovereigns and corporates,
an allocation between safer
sovereigns and more yield-
oriented corporates seems to
maintain the original
properties of a barbell
strategy
3.4 Long Live Risk-Barbelling: Applications for EUR Investors
Looking at the current EUR overall fixed income market from a risk-
barbelling perspective, Figure 2 demonstrates the evolution of the
yield curve per rating bucket of the current EUR overall market and
the yield difference between the BBB- and AAA-rated segments. The
current market shows more steepness in the yield curve than the
pre-crisis market in 2005 (cf. Figure 8). This manifests the potential
benefits that can be exploited in the current market situation for a
risk-barbell investor at the two ends of the yield curve. The large yield
difference between AAA-rated segment and BBB-rated segment in
2013 was mainly caused by the sharp increase of Italian Sovereigns
spread followed by its downgrade to BBB in 2012.
Figure 8: Yield per Rating Evolution
Yield Difference BBB-AAA
2005 2009 2013 2016
0.43% 1.59% 2.69% 1.37% Source: Markit Group Limited, Deutsche Bank, from 28.02.2005 to 30.06.2016.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 14
Using traditional index carve
outs such as AAA Sovereigns
and BBB Corporates to
implement a barbell can be a
simple and transparent
solution, however at the price
of more idiosyncratic risks
Source: Markit Group Limited, Deutsche Bank, from 28.02.2005 to 30.06.2016.
Table 5 Current EUR Overall Segment by Market Cap
Table 5 provides an overview of the current EUR overall market,
sovereigns and corporates together currently represent
approximately 78% of the EUR overall market. Furthermore, most of
the rating buckets are dominated by the sovereign issues. However,
the high yielding issues in the BBB sovereigns segment are mainly
longer maturity Italian/Spanish sovereign issues. The BBB
sovereigns yields currently 1.19% and has duration of 6.99, whereas
the BBB corporates yields 1.26% and has duration of 5.13 18 .
Therefore, the yield difference is higher between the BBB corporates
and AAA sovereigns than the BBB sovereigns. In light of this, one
would construct a risk-barbelling portfolio by combining AAA
sovereigns with BBB corporates.
Figure 9 shows that the evolution of their yield and the current
convexity between AAA sovereigns and BBB corporates is 1.26%,
which is favourable for a risk-diversified approach. Main issues with
looking into the “extremes” to maximise diversification benefits are
using carve outs might limit the gain of idiosyncratic risks.
Additionally, rating carve outs do address risk reduction but not
necessarily yield increase and it has less representativeness of the
asset class.
EUR Overall AAA AA A BBB
Collateralized 5.39% 2.39% 0.64% 0.30%
Corporates 0.11% 2.04% 7.32% 7.83%
Sovereigns 14.80% 21.84% 1.59% 22.64%
Sub-Sovereigns 5.86% 5.78% 0.50% 0.97%
Source: Markit Group Limited, Deutsche Bank, data as of 30.06.2016.
18 Data as of 03.10.2016.
0%
1%
2%
3%
4%
5%
6%
AAA AA A BBB
Yiel
d
2005 2009 2013 2016
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 15
Figure 9: Yield Development of EUR Fixed Income Market Indices
Source: Markit Group Limited, Deutsche Bank AG, from 31.08.2009 to 01.09.2016.
Figure 10: 1-year Average Yield Difference of EUR Fixed Income Market Indices
Source: Markit Group Limited, Deutsche Bank AG, from 31.08.2010 to 01.09.2016.
-1
0
1
2
3
4
5
6
7
8
Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16
iBoxx EUR BBB Corporates
iBoxx EUR AAA Sovereigns
0
0.5
1
1.5
2
2.5
3
3.5
Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16
iBoxx EUR BBB Corporates-AAA Sovereigns YieldDifference
iBoxx EUR Corporates Yield Plus-EUR SovereignsQuality Weighted Sovereigns Yield Difference
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 16
Furthermore, both the price of
holding conservative assets
and the additional yield from
holding BBB corporates may
seem unattractive.
As an alternative to such
carve out indices, strategic
beta indices have been
developed that address such
limitations while maintaining
barbell-friendly features, at
the price of slightly increased
risks but lower tracking error
Figure 11: 5-year window moving correlation with equity
Source: Markit Group Limited, Deutsche Bank AG, 31.03.2010 to 25.07.2016.
3.5 Interesting building blocks for a Risk-barbell: Strategic Beta indices
In addition to the rating carve-out indices, Figure 3 also exhibits the
yield evolution of the strategic beta indices. Interestingly, the Markit
iBoxx EUR Corporates Yield Plus index provides slightly higher yield
than the BBB-corporates although it invests in all rating buckets
across the EUR Corporates market. Similarly, the 1-year average
yield difference of the strategic beta indices exhibits comparably
similar historical trend to the yield difference of AAA-rated
sovereigns and BBB-rated Corporates (Figure 10).
On the corporates side, the Corporates Yield Plus strategy 19
repositions the traditional EUR Corporates benchmark to be focused
only on corporate risk premium. The higher risk premium that Yield
Plus strategy provides result in higher positive correlation to equity
instead of interest rate and to the extent that its yield evolution is very
similar to BBB Corporates (5-year correlation: Yield Plus – 36.25% /
BBB Corporates – 33.28% vs. Euro Stoxx 50)20. The traditional BBB
Corporates carve-out maximises the yield at the cost of
diversification, but Yield Plus strategy is able to maintain relatively
similar yield but not losing diversification (the yield plus strategy has
allocation in different rating bucket from AA to BB).
On the Sovereign side, Looking at the historical yield evolution of
AAA Sovereigns vs. that of the Markit iBoxx Eurozone Sovereigns
Quality Weighted index, the quality oriented approach applied to a
19 For further information, please refer to the relevant index guide from HIS Markit on this index:
http://content.markitcdn.com/corporate/Company/Files/DownloadDocument?CMSID=a07bde73403e495fbbb073e184dc4f89 20 Correlation timeframe: 22/08/2011 to 25/07/2016.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 17
broad sovereign benchmark21 is effective in achieving risk reduction
and to an extent that is comparable to (although not as good as) AAA
Sovereigns while maintaining broad market access (Figure 11). The
broad diversification that the quality weighted approach offers is of
great help in avoiding portfolio concentration risks (at the cost of
lower yield than the EUR Sovereigns index). As a result, the Quality
Weighted index has lower correlation to equities than the traditional
EUR Sovereign index (5-year correlation: Quality Weighted - 4.98%
/ EUR Sovereigns - 18.97% vs. Euro Stoxx 50)22. See Figure 5 for
historical correlation evolution.
In a nutshell, both strategic beta strategies seek to reposition
the traditional benchmark indices to recover the diversification
benefits by either via risk reduction or yield enhancement.
Consequently, the correlation benefits in a portfolio context
provided by the strategic beta indices are greater than their
traditional benchmarks and to some extent comparable to that
of the traditional rating carve-out indices (Table 6: Sovereigns
and Corporates CorrelationTable 6).
Table 6: Sovereigns and Corporates Correlation
Correlation Comparison
EUR Sovereigns Quality Weighted
vs. Corporates Yield Plus
EUR Sovereigns vs.
EUR Corporates
EUR AAA Sovereigns vs.
EUR BBB Corporates
45% 59% 44% Source: Markit Group Limited, Deutsche Bank, 07.03.2005-25.07.2016.
4. Applications of the barbell for institutional
investors: what makes sense, what does not23 In this section, we aim to examine the practical added value of the
risk-barbelling strategy by simulating several topical portfolio
strategies. Each portfolio strategy seeks to illustrate the utility of a
risk-barbell portfolio from different investment perspective. For this
purpose, we first studied the benchmark replication approach to
assess the existence of risk-barbelling benefits in the current EUR
overall market, then we looked at the risk-barbelling portfolio strategy
from a total return perspective, then about the positive aspects of
adding sovereign bond exposure for single corporate bond investors
looking to increase yield and last about the positive aspects for broad
EUR sovereign bond investors to slightly reposition their exposure
so as to increase capital preservation and risk-adjusted returns. The
portfolio analysis of this section is based on either daily or weekly
returns of the respective indices from 2005 to 2016. The rebalancing
frequency and procedure is described in details in each following
section.
21 For further information, please refer to the relevant index guide from HIS Markit on this index:
http://content.markitcdn.com/corporate/Company/Files/DownloadDocument?CMSID=a9aa579b36274cf7a78724cfe69da023 22 Correlation timeframe: 22/08/2011 to 25/07/2016. 23 Please note for this section: past performance, actual or simulated, is not a reliable indicator of future performance.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 18
Strategic fixed income
investors may find it
interesting to implement a
risk barbell when looking to
enhance risk-adjusted returns
However, due to higher
idiosyncratic risks, a barbell
based on carve-out indices
implied higher tracking error
versus an aggregate
benchmark than a barbell
based on Strategic Beta
indices in the simulation
Also, lower yields obtained
from carve-out indices
indicate that the performance
benefits of using such
components in this use case
may be limited going forward
4.1 Case 1: SAA: enhancing FI Aggregated returns To validate the theoretical benefits of risk-barbelling, we have re-
constructed the iBoxx EUR Overall Index which represents a
benchmark for the EUR denominated investment grade fixed income
asset class. It is to be noted that this case does not aim to serve as
an investable portfolio strategy but rather as an illustration of
theoretical implications. The EUR Overall on average consists of
61% sovereigns, 16% corporates, 11% sub-sovereigns and 12%
collateralized. We have substituted the sovereigns segment of the
EUR Overall with AAA sovereigns and the corporates segment with
BBB corporates. In a similar vein to demonstrate the added value of
risk-barbelling with strategic beta indices, we have replaced the
sovereigns segment with the iBoxx EUR Eurozone Quality Weighted
Index and the corporates segment with the iBoxx EUR Corporates
Yield Plus Index. The reconstructed portfolios are calculated based
on the daily return and rebalanced annually to comply with the EUR
Overall market-cap weights of the respective segment. Table 7
documents the results from this empirical analysis. Both
reconstructed strategies have outperformed the traditional EUR
Overall benchmark. This validates the empirical added value of the
risk-barbelling strategy. Furthermore, the reconstruction with
strategic beta indices have further outperformed the benchmark
without affecting its risk profile. This demonstrates the further added
value of using index strategies instead of traditional index rating
carve-outs. The outperformance of the strategic beta indices did not
come at the cost of diversification or lower yield. Specifically, the
materially lower tracking error obtained when using strategic beta
indices indicates that the broad market access features of the
Strategic Beta indices helped reduce deviations versus benchmark
compared to the traditional portfolio. It is also worth noting that the
traditional portfolio combining AAA Sovereigns and BBB Corporates
is currently only yielding 20 basis points whereas the strategic beta
portfolio has an annual yield of 49 basis points, in line with that of the
benchmark.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 19
Table 7: Use Case 1 Simulation Results
Use Case 1
Benchmark EUR Overall Reconstruction
EUR Overall
Using AAA Sovs and BBB Corps
Using Strategic Beta Indices
Annualized Return 4.78% 4.93% 5.04%
Volatility (Duration Hedged)
2.61% 2.31% 2.46%
Sharpe Ratio (Duration Hedged)
1.83 2.13 2.05
Turnover N/A 3.67% 3.83%
Max. Drawdown -5.11% -5.21% -5.10%
Drawdown Date 03/18/2009 03/18/2009 03/18/2009
Tracking Error N/A 1.31% 0.44%
Avg. Yield 3.18% 3.00% 3.20%
Avg. Duration 5.56 5.60 5.54
Stress Test: Lehman Default - 200824
-0.79% -0.62% -0.89%
5-year Correlation with EUROSTOXX 50
22% -10% 17%
Annual Yield 0.48% 0.20% 0.49%
Duration 6.74 6.85 6.78
Time frame of analysis is from 28.02.2005 to 31.07.2016. Annual yield and duration data
are as of 29.07.2016.
4.2 Case 2: Replicating aggregate bond returns with only corporates and sovereigns
In accordance with popular practice in the asset management space,
the EUR Overall index can be reconstructed using only sovereigns
and corporates, as such approach requires low implementation
sizes. First, the “Duration + Yield Matching” approach seeks to obtain
the weekly optimal portfolio allocation that minimizes the yield and
duration differences between the reconstructed portfolio and the
EUR Overall index (cf. Bolder, 2015).
The portfolio is rebalanced when the daily “Duration + Yield
matching” target weight of the corporates/sovereigns component
differ by more than 10% from the current corporates/sovereigns
weight in the portfolio (“10% buffer” so as to avoid turnover). The
“Duration + Yield matching” objective function is minimization of ex
ante portfolio yield and duration distance to the benchmark index
(𝐷𝑝)
* 3-Y weekly price correlations between corporates and sovereigns benchmark went up from 46% in September 2012, indicating that sovereign credit risk correlated
little with corporate credit risks during the 2011 crisis, to 75% in August 2016. 24 Please refer to the Annex for further information about this stress test scenario. Source: Bloomberg LLP.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 20
In our historical simulation,
the heuristic way of
replicating aggregate returns
(combining sovereigns and
corporates while trying to
match duration and yield)
recently suffered from an
increase in price correlations*
between corporate and
sovereign bond benchmarks
Using a traditional barbell
allocation helped restore
diversification benefits while
matching benchmark returns
Using a barbell allocation
between Strategic Beta
indices currently helps
increase yields, at lower
tracking error and risk
features in line with the
benchmark in the simulation
𝐷𝑝 = (𝜔′𝑌 − 𝑌𝐵𝑀)2 + (𝜔′𝐷𝑈𝑅 − 𝐷𝑈𝑅𝐵𝑀)2
where ω is a 2-by-1 vector of index weights, Y is an 2-by-1 vector of
asset annual yield, 𝑌𝐵𝑀 is the annual yield of the benchmark index
(i.e. iBoxx EUR Overall Index), DUR is an 2-by-1 vector of index
annual modified durations and 𝐷𝑈𝑅𝐵𝑀 is the annual modified
duration of the benchmark index.
Second, as a simplistic proxy, the 25/75 replication approach
matches broadly the historical market cap allocation of the EUR
Overall index, of which the reweighted (i.e. without sub-sovereigns,
allocated to sovereigns and collateralized, allocated to corporates)
sovereigns and corporates segments represent 75% and 25%
respectively. Such 25/75 allocation is maintained on an annual basis
and the portfolio is calculated based on daily returns. For comparison
purposes, both strategies have been studied based on standard
benchmark corporate/sovereign indices and strategic beta indices.
The standard portfolio uses iBoxx EUR Sovereigns index and iBoxx
EUR Corporates index and the strategic beta portfolio uses iBoxx
EUR Sovereigns Quality Weighted index and iBoxx EUR Corporates
Yield Plus index.
The strategic beta based portfolios of both strategies offered an
improvement of the risk return profile while exhibiting similar levels
of tracking error versus overall benchmark to the use of standard
indices. The strategies have especially outperformed the EUR
Overall benchmark (Table 8) and the simplistic 75/25 strategy
reaches similar effects (at the price of slightly higher duration and
credit risks than the more dynamic approach). See Figure 12 for
the historical weight evolution of the Duration + Yield Matching
strategy. It is interesting to note that the distance minimisation
method did not diverge and remained within a constrained range.
Other portfolio characteristics such as yield and duration have
remained comparably similar to the EUR Overall benchmark.
Broadly similar results can be achieved at level of the AAA Sovs /
BBB Corps based strategy, confirming the added value of looking
into the extremes, however at the price of materially higher tracking
error and currently lower yields.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 21
Table 8: Use Case 2 Simulation Results
Use Case 2
Bench
mark Duration+ Yield Matching 25/75
EUR
Overall
Stand
ard
AAA Sovs &
BBB Corps
Strategic
Beta
Stand
ard
AAA Sovs &
BBB Corps
Strategic
Beta
Annualized Return
4.78% 4.77% 4.98% 5.02% 4.90% 5.09% 5.17%
Volatility
(Duration Hedged)
2.61% 2.46% 1.91% 2.41% 2.95% 2.52% 2.73%
Sharpe Ratio
(dur. Hedged) 1.83 1.94 2.61 2.08 1.66 2.02 1.89
Turnover N/A
21.01%
20.95% 22.95% 1.41% 2.39% 2.27%
Max. Drawdown -5.11%
-4.99%
-5.12% -4.87% -5.75% -5.65% -5.52%
Drawdown Date 03/18 /2009
03/09/2009
06/22/ 2015
03/16/ 2009
03/18/2009
06/10/ 2015
03/18/ 2009
Tracking Error N/A 0.92% 1.74% 0.67% 0.39% 1.45% 0.49%
Avg. Yield 3.18% 3.33% 3.13% 3.36% 3.29% 3.07% 3.34%
Avg. Duration 5.56 5.62 5.77 5.71 5.80 5.84 5.78
5-year
Correlation with EUROSTOXX 50
22% 24% -7% 24% 26% -10% 21%
Annual Yield 0.48% 0.67% 0.36% 0.73% 0.58% 0.26% 0.62%
Duration 6.74 6.71 7.00 6.85 7.03 7.15 7.07
Time frame of analysis is from 28.02.2005 to 31.07.2016 unless specified otherwise. The
Standard portfolio is constructed based on iBoxx EUR Eurozone Sovereigns and iBoxx EUR
Corporates indices. AAA Sovs & BBB Corps portfolio is constructed based on iBoxx EUR AAA
Sovereigns Index and iBoxx EUR BBB Corporates Index. The Strategic Beta portfolio is
constructed based on iBoxx EUR Eurozone Sovereigns Quality Weighted and iBoxx EUR
Corporates Yield Plus indices. Sharpe Ratios are calculated on the basis of zero rates and
rate-adjusted volatility, so as to provide a measure of credit risk adjusted returns
Figure 12: Historical Weight Allocation-Duration+Yield Matching Risk-Barbelling Portfolio
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Feb-05 Feb-07 Feb-09 Feb-11 Feb-13 Feb-15
Markit iBoxx EUR Corporates Yield Plus Index Markit iBoxx EUR Eurozone Quality Weighted
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 22
While following a mean-
variance strategy may
generate additional turnover,
it is a way to illustrate the
added diversification benefits
of using a risk barbell
4.3 Case 3: Simulating an active allocation strategy - Applying minimum variance-based risk barbell to reap diversification benefits
The minimum variance-based strategy capitalises especially on
diversification benefits by minimizing portfolio spread volatility
(weekly basis) especially in case of volatile events to increase the
risk-adjusted returns. We have implemented a 20% rebalancing
buffer for this portfolio to mitigate frequent rebalancing due to the
strategy’s sensitive nature. This means that when the weekly
minimum variance optimization target weight of a
corporates/sovereigns component differs by more than 20% from the
current corporates/sovereigns weight in the portfolio, a rebalancing
is triggered. 20% buffer has been chosen given this strategy’s large
turnover characteristic and targeting an approximate 50%25 turnover
p.a. while remaining dynamic (as opposed to rebalancing regularly
but more seldom, which may be less reactive and more dependent
on the timing of rebalancing). The minimum-variance objective
function is minimization of ex ante (i.e., estimated) portfolio spread
variation (𝜎𝑝2) (Clarke et al., 2013)
𝜎𝑝2 = 𝜔′Ω𝜔
where ω is an 2-by-1 vector of asset weights, and Ω is an 2-by-2
asset benchmark spread variation covariance matrix. The equation
is solved analytically for convenience purposes.
While sovereigns typically offer the lowest spread volatility, it is
interesting to note that a portfolio combination with corporates
started increasing diversification benefits from the start of the
Eurozone crisis in H2 2011. The lower drawdown confirms the
volatility reduction feature of the strategy; meanwhile it generated
attractive outperformance. Such strategy, if implemented, would
suffer relatively high turnover costs26 (cf. Figure 13, Table 9).
This case should be considered a proxy of an active/dynamic
strategy and its results have important implications as the strategy
exploits the aforementioned upside down market situation: The
underperformance of the Standard portfolio (vs. EUR Overall)
confirms the existence of lack of correlations in the traditional
benchmark indices, while the 76 basis points performance pickup
from the strategic beta strategies demonstrate that such
unconventional indices can be helpful in repositioning the asset
class’s correlation and recovering portfolio correlation benefits.
Results are similar if not even more attractive when using the AAA
Sovereigns & BBB Corporates portfolio components, which further
proves our point. The attractive outperformance in the simulation can
25 50% per annum turnover is already an upper limit in terms of portfolio stability. 26 Assuming 50 bps bid-offer costs on corporates index/ETF and 15 bps bid-offer on sovereigns index/ETF, average trading costs would be approx. 19 bps p.a., however
being applied very irregularly over the period.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 23
Applying this dynamic
strategy using Strategic Beta
or carve out indices
contributed to material
improvements in the risk
return profile in the
simulation, especially
lowering risks. However this
occurred at the price of high
tracking error.
however seem slightly less attractive as of now, given the currently
lower yields and slightly higher duration available. This case also
means that the use of strategic beta building blocks lends itself
particularly well to dynamic active allocation strategies aiming at
varying allocation between conservative (risk off) and higher yielding
(risk-on) components.
Table 9: Use Case 3 Simulation Results
Use Case 3
Benchmark Minimum Variance
EUR Overall Standard
AAA Sovs & BBB Corps
Strategic Beta
Annualized Return 4.78% 4.61% 5.88% 5.55%
Volatility
(Duration Hedged) 2.61% 2.33% 2.07% 2.55%
Sharpe Ratio (Duration Hedged)
1.83 1.98 2.84 2.18
Turnover (2-way) N/A 49.71% 48.74% 54.47%
Max. Drawdown (Duration Hedged)
-6.59% -6.50% -5.15% -4.94%
Drawdown Date 03/18/2009 11/28/2011 03/09/2009 03/09/2009
Tracking Error N/A 3.68% 3.48% 3.50%
Avg. Yield 3.18% 3.32% 3.09% 3.06%
Avg. Duration 5.56 5.35 5.82 5.98
5-year Correlation with EUROSTOXX 50
22% 20% -7% 20%
Annual Yield 0.48% 0.61% 0.17% 0.42%
Duration 6.74 6.85 7.34 7.54
Time frame of analysis is from 28.02.2005 to 31.07.2016 unless specified otherwise. The
Standard portfolio is constructed based on iBoxx EUR Eurozone Sovereigns and iBoxx EUR
Corporates indices. The Strategic Beta portfolio is constructed based on iBoxx EUR Eurozone
Sovereigns Quality Weighted and iBoxx EUR Corporates Yield Plus indices.
Figure 13: Historical Weight Allocation-MVP Risk-Barbelling Portfolio
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16
Markit iBoxx EUR Eurozone Sovereigns Quality Weighted
Markit iBoxx EUR Corporates Yield Plus
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 24
Interestingly, adding
corporate bond exposure to a
sovereigns portfolio helped
reduce risks from the end of
2011 in the simulation
Adding conservative
sovereign bond exposure to a
corporate bond helped yield
seeking investors to mitigate
their risk increase in the
simulation.
4.4 Case 4: Corporate bond investors: Yield enhancement by mixing in quality sovereigns
This case simulates the behaviour of a single-line corporate bond
investor who focuses on relatively safe and liquid, large corporates.
As an alternative to their investment behaviour, we look at a yield
enhancement approach which aims to allocate a diversified portfolio
by matching the yield of the Markit iBoxx EUR Liquid Corporates 100
index plus 30 basis points and similarly plus 70 basis points27.
Results can be seen on Table 10. For 30 basis points yield
enhancement, this approach leads to an allocation of 55% in EUR
Corporates Yield Plus and 45% in EUR Sovereigns Quality Weighted
1-15Y. Note that we have used the 1-15Y maturity carve-out of the
Quality Weighted Index to match the duration objective of an
equivalent corporate bond investor. Note the results are similar (if
not better) when using the standard index, at the price of almost 1Y
additional duration. An additional 70 basis points in yield requires an
allocation of 78% in EUR Corporates Yield Plus and 22% in EUR
Sovereigns Quality Weighted (main index as proportion of
sovereigns is limited and their effect on portfolio risk mitigation is
increased as duration is increased).
Adding the sovereigns segment to the portfolio does not only provide
additional safety when looking to increase yields, it may also help
mitigate immediate portfolio liquidity risks, given the current EUR
corporates market has recently been heavily subscribed. Besides
the yield enhancement, this approach aims to maintain similar/
reasonably increase risk levels thanks to better diversification (1136
bonds instead of 100) than a single-line corporate bond investment.
For the 30 basis point case, the historical average yield pickup was
approximately 46 basis points while maintaining the same Sharpe
ratio (based on credit) and even widely improved Sharpe ratio when
using price volatility measurement, which is interesting as more risky
corporate portfolios can rather be expected to offer lower risk
adjusted returns, see for example Leote De Carvalho (2014). The 70
basis point case has achieved historical average yield improvement
of 86 basis points, while delivering higher credit risk (well
compensated by interest rates variations, hence the lower price
volatility) in the past.
It is interesting to note that a pure BBB corporates allocation would
also offer approx. 70 bps of yield enhancement (as of 31/07/2016),
while AAA sovereigns offer negative yields, making the proportion of
AAA-rated sovereigns insufficient to compensate for the risk
increased by the BBB index within the frame of a yield enhancement
portfolio. It is also interesting to note that the stress test figures for
27 Yield matching is considered as at 30.06.2016.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 25
Increasing yields can result in
lower price volatility
historically, which can be
beneficial for certain clients
looking for price stability.
However credit and tail risks
will be materially increased, at
least in our simulation.
BBB bond exposures as of now are slightly worse than the +70bps
Yield Risk Barbelling portfolio, with 4.0% estimated loss upon
Lehman Default instead of 3.8%. Also the price volatility of the BBB
index would be higher.
Table 10: Use Case 4 Simulation Results
Use Case 4
Benchmark Corporate Bonds Case
EUR Liquid Corporates 100
Index
+30 bps Yield Risk Barbelling
55% YP/45% QW 1-15
+70bps Yield Risk Barbelling
78% YP/22% QW
Annualized Return 3.95% 4.67% 4.79%
Volatility 2.74% 2.73% 2.57%
Volatility (Duration Hedged)
2.01% 2.35% 2.83%
Sharpe (Duration Hedged) 1.97 1.99 1.69
Turnover N/A 2.96% 2.16%
Drawdown -8.99% -10.10% -15.38%
Drawdown Date 03/18/2009 03/11/2009 03/17/2009
Tracking Error N/A 1.25% 1.77%
Average Yield 3.24% 3.70% 4.26%
Average Duration 4.16 4.51 4.78
Stress Test: Lehman Default - 2008
-2.01% -2.80% -3.81%
Annual Yield 0.74% 1.04% 1.61%
Duration 4.80 5.26 5.63
Time frame of analysis is from 31.10.2005 to 30.06.2016 unless specified otherwise. QW
refers to iBoxx EUR Eurozone Sovereigns Quality Weighted index and YP refers to iBoxx EUR
Corporates Yield Plus index. Annual Yield and duration data are as of 30.06.2016.
4.5 Case 5: Sovereign bond investors - Looking for additional safety at reasonable opportunity costs, looking to slightly increase yields while maintaining capital preservation features
We have looked at simulating the behaviour of middle term sovereign
bond investors who remained in this little attractive asset class as it
serves diversification or capital preservation features. An example
could be balanced Equity / multi-asset managers invested in
Eurozone sovereigns (as simulated using the iBoxx EUR Eurozone
Sovereigns 1-15Y index carve out) as a means to preserve capital
during equity bear markets situations.
First, an overall “quality improvement” of their sovereigns exposure
can be aimed at by combining a quality oriented sovereigns index (in
this case also limited to 1-15Y maturities so as to avoid duration
biases due to including corporate bonds, to the extent possible) with
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 26
In line with the results
suggested in Use Case 3,
historical simulations show
that adding a limited
corporate bond exposure to a
sovereign bond portfolio
while reducing exposure to
BBB sovereigns can help
slightly improve the capital
preservation features of an
intermediate sovereign
benchmark.
higher risk corporates to match original benchmark yields while
avoiding peripheral exposure.
The second case aims to obtain 20 basis points ex-ante “yield
enhancement” on the sovereign bond portfolio while keeping similar
capital preservation features and similar diversification benefits vs.
equities to a benchmark sovereign index, to the extent possible.
The results (cf. Table 11) have shown noticeable improvements in
terms of capital preservation throughout the 2011 crisis, a sign of
reduction of the exposure to Southern Europe. The “quality
improvement” case shows a risk reduction according to almost all
measurements: lower expected drawdowns in an equity crisis
scenario (here it is worth noting that the Bloomberg engine expects
a very high correlation to apply to bond prices if stocks went to go
down by 10%!) while the correlation versus equities also slightly
decreased (iBoxx EUR Eurozone Sovereigns 1-15Y vs. EURO
STOXX 50: -1% and Yield Matching Risk-Barbelling Portfolio vs.
Euro Stoxx 50: -11 %28), a further sign that objective was achieved
historically. Also, interestingly for the same yield on average, the
performance improved.
For the “yield enhancement” case, objective was also achieved in
terms of realised performance (more than 25 bps p.a. of
outperformance) at no additional cost in terms of capital preservation
(as measured by max. drawdown) and at some element of cost in
terms of diversification benefits versus equities (Yield Matching Risk-
Barbelling Portfolio vs. Euro Stoxx 50: 0%), while certain metrics like
Stress Tests indicate higher potential risks on the back of the yield
increase. It is worth noting, as mentioned in the first part of this
document, that long term sovereigns benefit from higher yields,
therefore making an investment in corporates (with typically 5-year
duration) look less attractive for long term sovereign investors.
28 Correlation figures were calculated on a weekly basis. Using monthly returns, correlations vs Euro Stoxx 50 are respectively -9% for the iBoxx EUR Eurozone
Sovereigns 1-15Y index, -9% for the “quality improvement” portfolio and 15% for the “yield enhancement” portfolio.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 27
Table 11: Use Case 5 Simulation Results
Use Case 5
Benchmark Sovereign Bonds Case
EUR Eurozone Sovereigns1-15
Yield Matching Risk Barbelling
5% YP /
95% QW 1-15
+20 bps Yield Risk Barbelling
26% YP/
74% QW 1-15
Annualized Return 4.45% 4.53% 4.66%
Volatility
(Duration Hedged) 2.87% 2.38% 2.30%
Sharpe Ratio 1.55 1.90 2.03
Turnover N/A 1.11% 2.36%
Max. Drawdown
(Duration Hedged) -6.02% -4.18% -7.86%
Drawdown Date 11/25/2011 03/18/2009 03/18/2009
Tracking Error N/A 0.85% 1.15%
Average Yield 2.77% 2.67% 3.08%
Average Duration 4.66 4.65 4.59
Stress Test:
Lehman Default - 2008 -0.31% -0.48% -1.34%
Stress Test: Equities
down 10% -0.10% -0.07% -0.34%
Annual Yield 0.16% 0.16% 0.45%
Duration 5.37 5.32 5.23
Time frame of analysis is from 31.10.2005 to 31.07.2016 unless specified otherwise. QW
refers to iBoxx EUR Eurozone Sovereigns Quality Weighted index and YP refers to iBoxx
EUR Corporates Yield Plus index.
Note that clearly looking to further enhance yields on the safe
bucket of such investors does not seem to make sense. It may also
be of interest to keep in mind that the motor of returns in the
balanced portfolio is the risky part of it, the mission of the
conservative part of it being often rather oriented towards capital
preservation, at whatever (reasonable) cost.
5. Conclusion As a lot of investors use yields as a proxy to estimate fixed income
returns, may traditional fixed income indices may currently look very
unattractive, leading investors to go down the quality ladder in the
search for yield. The growing imbalances that characterise the EUR
IG fixed income asset class, as mentioned in the first part of this
paper, mean above all that the relation between risk and yield
becomes more and more unclear in many segments of this
asset class, rendering certain traditional bond strategies or
exposures less and less attractive from a yield vs risk perspective.
This being said, neither Risk Barbelling strategy nor Strategic
Beta indices are an adapted solution to all investors nor to all
investors’ issues. As an example, unconstrained, long-term
institutional investors may not be bothered with strong market
variations nor downgrades, and may very well be better served to
look into less liquid or lower rated asset classes. As mentioned by
our active management colleague16, diversifying sources of income
is also key. A barbell strategy should not be used by broad fixed
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 28
income investors from a standalone perspective: the loss in
risk/adjusted returns that can be noticed when replicating an
aggregate component passively with only sovereigns and
corporates is a testament to the importance of diversification,
not only internal (de-correlation) but also external (number of
risk sources) diversification.
Strategies combining broadly diversified tools that are more
explicitly targeted at achieving higher yields on one side and
more quality on the other side, has however become more and
more relevant in light of the current market situation.
Such strategies, when applied to parts of a portfolio, can not only
help investors continue pursuing their usual objectives (e.g.
achieving broad fixed income exposure or actively allocating
between market segments) in a more efficient way, they can also
help less sophisticated investors looking to harness higher yields at
the price of a reasonable risk increase.
Going forward, the strategic beta indices we specifically
analysed can help investors address the scarcity of yields in the
corporates space as well as the high costs of safe assets thanks
to broader market exposure. Although the features of the barbell
using Strategic Beta indices seem slightly less attractive for certain
investors (cf. case 3), those indices offer a good alternative to
standard sovereign/corporate benchmarks on one side (higher
diversification benefits, clearer signals enabling investors to
better implement their views) and to barbell investors on the
other (lower tracking error to overall benchmarks, higher yields
on both sides of the barbell)
6. Annex - Measuring risks in the fixed income assets
In this paper, we mostly measured risk, especially within the frame
of risk/return analysis. While this decision was not made for the lack
of better options, we found that certain measurements may not have
been adequate for this study:
Traditional value at risk measures have been identified as
being weak in predicting credit crises, as identified by
Deventer (2013), especially as in practice higher value at risk
figures in the Investment Grade fixed income market mostly
reflected the higher duration (and especially interest rate
sensitivity) of the bond components analysed. Certain
models dedicated in applying a VAR analysis to credit
spreads are available (see Raunig, 2008), however they
deviate from the natural and intuitive price percentile
approach applied for equity.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 29
Traditional price variation driven measurements such as
volatility or correlation exhibits the same weakness. This is
also important when comparing diversification benefits of
certain fixed income instruments based on covariances of
prices, where all asset classes seem to be much correlated
because they essentially have similar sensitivity to moves in
interest rates. While interest rates risk is a major contributor
of returns in the asset class,
(i) Most investors are fully aware of that risk, which is the
common denominator of the asset class, whereby
certain institutional clients even need this risk, e.g.
For Liability Driven Investment purposes;
(ii) as interest rates and credit risks have been negatively
correlated historically (as confirmed in this paper),
interest rates risks are expected to present an
element of noise when trying to assess other, market
related risks such as (corporate and sovereign) credit
risks
(iii) Even within the frame of a relative value analysis,
removing this common component in asset class
returns is expected to help clarify the analysis.
We, of course, show modified duration in our analyses as that
number is broadly used by academics to measure sensitivity
to interest rates risks.
Equity price volatility, as clearly identified in the Merton model
(Merton, 1974) as one of the potential factor to determine
credit risks, and any implied probability of default from, it,
does unfortunately not cover sovereign credit risks. However,
traditionally, measuring correlation of a fixed income asset
class against equity prices will usually help distinguish how it
reacts to equity market variations, a negative correlation
being intuitively expected for the least risky asset classes and
a positive to the more risky ones. We used this measurement
in our paper as well, as a complement to other measures.
The duration times spread (DTS) measure, calculated by
multiplying duration with the spread of a bond (or an index)
and introduced by Ben Dor et al. (2007) does take into
account credit and its “risk multiplication factor” which is
spread (or credit) duration, therefore giving, in our view, a
very interesting (because transparent and interest rates
neutral) measurement of credit risk. However, one key
limitation of this figure is that it is based on the spread, which
is an implied measurement of the risks of a bond as
determined by market prices. It therefore assumes full
efficiency of the fixed income markets, which is an
assumption that can definitely be challenged by virtue of the
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 30
large offer/demand imbalances in the EUR IG asset class
mentioned in this paper.
Certain low maximum drawdown figures for conservative
fixed income portfolios are mostly driven by interest rates (as
in April 2015) and may not sufficiently be representative of
risk.
We mainly chose to use variation in spreads when measuring risks
and correlations for the following reasons:
Volatility of spreads is an intuitive measure of interest-rates
adjusted market risks that is widely used in the industry (and
specifically by Ben Dor et al. as well).
It being clear that spreads are a premium on top of riskless
rates and therefore encompass all other risks around a bond
price, namely, among others, credit but also liquidity (also
including supply/demand imbalances), “complexity” (due to
convexity, special covenants in the prospectus, non-vanilla
coupon payouts etc.) and long duration, spread volatility has
been observed to also be consistent with fundamental credit
risks in the works of Delianedis et al. (2013).
While spread volatility using daily changes is implied from
price volatility and therefore also assumes market efficiency,
the relative tardiness of the biggest fixed income purchasers
that can be expected to skew the supply demand balance
(such as central banks and banks financed by central banks)
cannot seem to prevent day-to-day spread variations, as
seen in the case of Italian sovereigns in this paper.
We chose to multiply the spread by duration when calculating
volatilities, so as to re-scale the importance of risk by the
maturity of the relevant bond/index29. Note that this approach
comes down (qualitatively at least) to measuring the volatility
of interest rates hedged price variations, which we also used
as a metrics for convenience purposes in this paper.
For the conservative portfolio, we apply a naïve “bullet” interest rate
hedging (using the portfolio duration and simulating a short interest
rates swap exposure as overlay) to calculate maximum drawdown.
It also can help better appreciate risks especially in a situation where
interest rates may not be able to move further down in the negative
territory
As a complement to these measurements, we chose to add the
stress test scenario “Lehman Default - 2008” (a stress event
simulating variation of asset prices, using historical factor returns,
one month following the default of Lehman Brothers) developed by
the Bloomberg Analytics team and the “Equities down 10%” case (a
29 Note that multiplying with duration does not impact correlation figures due to the consistency of duration in indices across time and to the fact that correlations are
normalised.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 31
test mimicking the behaviour of the portfolio should stock prices go
down 10% as of now). Those stress tests are applied to the current
portfolio composition and would be expected to represent the
behaviour of the current portfolio in case a similar situation occurred
again.
Note that this measurement, is far from being comprehensive
especially when applied at level of a single issuer. Despite the ex-
post consistency, at broader levels, in the results obtained by
Delianedis et al., it can only rely on markets perceptions of risks,
which can of course be perceived as limited. This measurement can
and must therefore, in our view, be complemented with fundamental
driven measurements as well as, if possible, with further stress tests
that correspond better to an investors specific perception of risk.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 32
References
Merton, R. C., 1974, On the Pricing of Corporate Debt: The Risk Structure of Interest Rates, Journal of Finance, 29,
Donald R. Van Deventer, Kenji Imai, Mark Mesler, 2013 Advanced
Financial Risk Management: Tools and Techniques for Integrated
credit risk and interest risk management.
Burkhard Raunig, Martin Scheicher, November 2008 - A Value At
Risk Analysis Of Credit Default Swaps – ECB Working Paper
Series No 968 /
Arik Ben Dor, Lev Dynkin, Jay Hyman, Patrick Houweling, Erik van
Leeuwen and Olaf Penninga - DTS (Duration Times Spread) - A
New Measure of Spread Exposure in Credit Portfolios (Journal of
Portfolio Management, Winter 2007)
Delianedis, G., Geske, R., 12/01/2001, The Components of Corporate Credit Spreads: Default, Recovery, Tax, Jumps, Liquidity, and Market Factors, University of California
Bolder, D.J. (2015) Fixed-income portfolio Analytics; A practical guide to implementing, monitoring and understanding fixed-income portfolios. United States: Springer International Publishing AG. Clarke, Roger G and de Silva, Harindra and Thorley, Steven, Risk Parity, Maximum Diversification, and Minimum Variance: An Analytic Perspective (June 1, 2012). Journal of Portfolio Management, Vol. 39, No. 3, pp. 39-53 (Spring 2013). Edwin J. Elton, Martin J. Gruber (15/09/2003), On The Valuation Of Corporate Bonds Using Rating-Based Models, New York University/Nomura
Michal Jezek, Nick Burns, Jim Reid (07/09/2016), Will the ECB Buy Bank Senior Unsecured Bonds?, Deutsche Bank Markets Research
Michal Jezek, Nick Burns, Jim Reid (05/07/2016), EUR and GBP IG Bond Issuance, Deutsche Bank Markets Research Jack Di-Lizia, Abhishek Singhania, Eurozone Sovereign Issuance: 05th Sep-09th Sep, Deutsche Bank Markets Research
Raul Leote De Carvalho, Patrick Dugnolle, Xiao Lu (Spring 2014), Low-Risk Anomalies in Global Fixed Income: Evidence from Major Broad Markets, The Journal Of Fixed Income
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 2
Disclaimer © Deutsche Bank AG 2015 As of: 31.10.2016
This document has been issued and approved by Deutsche Bank AG London Branch. Deutsche Bank AG is authorised under German Banking Law (competent authority: European Central Bank) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject
to supervision by the European Central Bank and by BaFin, Germany’s Federal Financial Supervisory Authority, and is subject to limited regulation in the United Kingdom by the Prudential Regulation Authority and Financial Conduct Authority. Deutsche Bank AG is a joint
stock corporation with limited liability incorporated in the Federal Republic of Germany, Local Court of Frankfurt am Main, HRB No. 30 000; Branch Registration in England and Wales BR000005 and Registered Address: Winchester House, 1 Great Winchester Street, London
EC2N 2DB. This document is a “non-retail communication” within the meaning of the FCA's Rules and is
directed only at persons satisfying the FCA’s client categorisation criteria for an eligible counterparty or a professional client. This document is not intended for and should not be relied upon by a retail client.
Deutsche Asset Management is the brand name for the asset management arm of Deutsche Bank AG.
This document is intended for discussion purposes only and does not create any legally binding obligations on the part of Deutsche Bank AG and/or its affiliates (“DB”).This material was not produced, reviewed or edited by the Research Department, except where specific documents
produced by the Research Department have been referenced and reproduced above. Without limitation, this document does not constitute an offer, an invitation to offer or a recommendation to enter into any transaction. When making an investment decision, you should rely solely on
the final documentation relating to the transaction and not the summary contained herein. DB is not acting as your financial adviser or in any other fiduciary capacity in relation to this Paper. The transaction(s) or products(s) mentioned herein may not be appropriate for all investors and
before entering into any transaction you should take steps to ensure that you fully understand the transaction and have made an independent assessment of the appropriateness of the transaction in the light of your own objectives and circumstances, including the possible risks
and benefits of entering into such transaction. For general information regarding the nature and risks of the proposed transaction and types of financial instruments please go to https://www.db.com/en/content/Risk-Disclosures.htm. You should also consider seeking
advice from your own advisers in making this assessment. If you decide to enter into a transaction with DB, you do so in reliance on your own judgment. The information contained in this document is based on material we believe to be reliable; however, we do not represent
that it is accurate, current, complete, or error free. Assumptions, estimates and opinions contained in this document constitute our judgment as of the date of the document and are subject to change without notice. Any projections are based on a number of assumptions as to
market conditions and there can be no guarantee that any projected results will be achieved. Past performance is not a guarantee of future results. Any opinions expressed herein may differ from the opinions expressed by other DB departments including the Research Department. DB
may engage in transactions in a manner inconsistent with the views discussed herein. DB trades or may trade as principal in the instruments (or related derivatives), and may have proprietary positions in the instruments (or related derivatives) discussed herein. DB may make
a market in the instruments (or related derivatives) discussed herein. You may not distribute this document, in whole or in part, without our express written permission. DB SPECIFICALLY DISCLAIMS ALL LIABILITY FOR ANY DIRECT, INDIRECT, CONSEQUENTIAL OR OTHER
LOSSES OR DAMAGES INCLUDING LOSS OF PROFITS INCURRED BY YOU OR ANY THIRD PARTY THAT MAY ARISE FROM ANY RELIANCE ON THIS DOCUMENT OR FOR THE RELIABILITY, ACCURACY, COMPLETENESS OR TIMELINESS THEREOF.
Markit and iBoxx are trademarks of Markit and have been licensed by International Index Company, a subsidiary of Markit (“Licensor”). The Licensor of the indices listed here make no
representations or warranties concerning the results obtained by using their index and/or index levels or in any other respects, on any given day.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 3
Deutsche Asset Management (Deutsche AM) represents the asset management activities
conducted by Deutsche Bank AG or any of its subsidiaries. Clients will be provided Deutsche Asset Management products or services by one or more legal entities that will be identified to clients pursuant to the contracts, agreements, offering materials or other documentation
relevant to such products or services. This document has been prepared without consideration of the investment needs, objectives or financial circumstances of any investor. Before making an investment decision, investors
need to consider, with or without the assistance of an investment adviser, whether the investments and strategies described or provided by Deutsche Bank, are appropriate, in light of their particular investment needs, objectives and financial circumstances. Furthermore, this
document is for information/discussion purposes only and does not constitute an offer, recommendation or solicitation to conclude a transaction and should not be treated as giving investment advice.
Deutsche Bank does not give tax or legal advice. Investors should seek advice from their own tax experts and lawyers, in considering investments and strategies suggested by Deutsche Bank. Investments with Deutsche Bank are not guaranteed, unless specified. Unless notified
to the contrary in a particular case, investment instruments are not insured by the Federal Deposit Insurance Corporation (“FDIC”) or any other governmental entity, and are not guaranteed by or obligations of Deutsche Bank AG or its affiliates.
Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on
the date of this report and are subject to change without notice and involve a number of assumptions which may not prove valid. Investments are subject to various risks, including market fluctuations, regulatory change,
counterparty risk, possible delays in repayment and loss of income and principal invested. The value of investments can fall as well as rise and you may not recover the amount originally invested at any point in time. Furthermore, substantial fluctuations of the value of the
investment are possible even over short periods of time. This publication contains forward looking statements. Forward looking statements include, but are not limited to assumptions, estimates, projections, opinions, models and hypothetical
performance analysis. The forward looking statements expressed constitute the author’s judgment as of the date of this material. Forward looking statements involve significant elements of subjective judgments and analyses and changes thereto and/or consideration of
different or additional factors could have a material impact on the results indicated. Therefore, actual results may vary, perhaps materially, from the results contained herein. No representation or warranty is made by Deutsche Bank as to the reasonableness or
completeness of such forward looking statements or to any other financial information contained herein. The terms of any investment will be exclusively subject to the detailed provisions, including risk considerations, contained in the Offering Documents. When making
an investment decision, you should rely on the final documentation relating to the transaction and not the summary contained herein. This document may not be reproduced or circulated without our written authority. The manner
of circulation and distribution of this document may be restricted by law or regulation in certain countries, including the United States. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any
locality, state, country or other jurisdiction, including the United States, where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Deutsche Bank to any registration or licensing requirement within such jurisdiction not currently
met within such jurisdiction. Persons into whose possession this document may come are required to inform themselves of, and to observe, such restrictions. Past performance is no guarantee of future results; nothing contained herein shall constitute
any representation or warranty as to future performance. Further information is available upon investor’s request.
This Document may not be distributed in Canada, Japan, the United States of America, or to any U.S. person.
© 2016 Deutsche Bank AG
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 4
Risk Warning Investments are subject to investment risk, including market fluctuations, regulatory change,
possible delays in repayment and loss of income and principal invested. The value of investments can fall as well as rise and you might not get back the amount originally invested at any point in time.
Investments in Foreign Countries - Such investments may be in countries that prove to be politically or economically unstable. Furthermore, in the case of investments in foreign securities or other assets, any fluctuations in currency exchange rates will affect the value of
the investments and any restrictions imposed to prevent capital flight may make it difficult or impossible to exchange or repatriate foreign currency. Foreign Exchange/Currency - Such transactions involve multiple risks, including currency risk
and settlement risk. Economic or financial instability, lack of timely or reliable financial information or unfavorable political or legal developments may substantially and permanently alter the conditions, terms, marketability or price of a foreign currency. Profits and losses in
transactions in foreign exchange will also be affected by fluctuations in currency where there is a need to convert the product's denomination(s) to another currency. Time zone differences may cause several hours to elapse between a payment being made in one currency and an
offsetting payment in another currency. Relevant movements in currencies during the settlement period may seriously erode potential profits or significantly increase any losses. High Yield Fixed Income Securities - Investing in high yield bonds, which tend to be more
volatile than investment grade fixed income securities, is speculative. These bonds are affected by interest rate changes and the creditworthiness of the issuers, and investing in high yield bonds poses additional credit risk, as well as greater risk of default.
Hedge Funds - An investment in hedge funds is speculative and involves a high degree of risk, and is suitable only for "Qualified Purchasers" as defined by the US Investment Company Act of 1940 and "Accredited Investors" as defined in Regulation D of the 1933 Securities Act. No
assurance can be given that a hedge fund's investment objective will be achieved, or that investors will receive a return of all or part of their investment. Commodities - The risk of loss in trading commodities can be substantial. The price of
commodities (e.g., raw industrial materials such as gold, copper and aluminium) may be subject to substantial fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. Additionally, valuations of commodities may be
susceptible to such adverse global economic, political or regulatory developments. Prospective investors must independently assess the appropriateness of an investment in commodities in light of their own financial condition and objectives. Not all affiliates or subsidiaries of Deutsche
Bank Group offer commodities or commodities-related products and services. Investment in private equity funds is speculative and involves significant risks including illiquidity, heightened potential for loss and lack of transparency. The environment for private
equity investments is increasingly volatile and competitive, and an investor should only invest in the fund if the investor can withstand a total loss. In light of the fact that there are restrictions on withdrawals, transfers and redemptions, and the Funds are not registered under the
securities laws of any jurisdictions, an investment in the funds will be illiquid. Investors should be prepared to bear the financial risks of their investments for an indefinite period of time. Investment in real estate may be or become nonperforming after acquisition for a wide variety
of reasons. Nonperforming real estate investment may require substantial workout negotiations and/ or restructuring. Environmental liabilities may pose a risk such that the owner or operator of real property may
become liable for the costs of removal or remediation of certain hazardous substances released on, about, under, or in its property. Additionally, to the extent real estate investments are made in foreign countries, such countries may prove to be politically or economically unstable. Finally,
exposure to fluctuations in currency exchange rates may affect the value of a real estate investment. Structured solutions are not suitable for all investors due to potential illiquidity, optionality, time
to redemption, and the payoff profile of the strategy. We or our affiliates or persons associated with us or such affiliates may: maintain a long or short position in securities referred to herein, or in related futures or options, purchase or sell, make a market in, or engage in any other
transaction involving such securities, and earn brokerage or other compensation. Calculations of returns on the instruments may be linked to a referenced index or interest rate. In such cases, the investments may not be suitable for persons unfamiliar with such index or interest rates, or
unwilling or unable to bear the risks associated with the transaction. Products denominated in a currency, other than the investor’s home currency, will be subject to changes in exchange rates, which may have an adverse effect on the value, price or income return of the products.
These products may not be readily realizable investments and are not traded on any regulated market.
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 5
Notes
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 6
Notes
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 7
Notes
EUR Fixed Income: Navigating an upside down asset class using the risk barbell
For Professional Investors Only – Marketing Material EUR Fixed Income: Navigating an upside down asset class… | October 2016 8
Notes db X-trackers_2083
Deutsche Asset Management represents the asset management activities conducted by Deutsche Bank AG or any of its subsidiaries. Clients will be provided Deutsche Asset Management products or services by one or more legal entities that will be identified to clients pursuant to the contracts, agreements, offering materials or other documentation relevant to such products or services. © 2016 Deutsche Asset Management. All rights reserved.