emerging local debt advanced betafinancialmodels.nl/ffh/fixed-income-smart-beta... · 2015. 6....

Wellington Management Company llp

Wellington Management Company llpWellington Trust Company, naWellington Hedge Management llcWMP Management, llc

Wellington Management Canada llc

Wellington Management International LtdWellington Management Switzerland GmbH

Wellington Management Hong Kong LtdWellington Management Hong Kong Ltd – Beijing Representative Office

Wellington Management Singapore Pte LtdWellington Management Australia Pty LtdWellington Management Japan Pte Ltd

Emerging Local DebtAdvanced Beta

Steve BoxerInvestment DirectorWellington Management International Ltd

Copyright © 2015 All Rights Reserved396045_7.2

A Scoring a hat trick in two consecutive games

B Getting in the middle of these two…

C Delivering an exciting fixed income presentation

NFP /

Which of the following is most challenging?


Tailwind

Historical returns, 5% +

Falling yields

Supportive economic back drop

Reasonable volatility

Good liquidity

Headwind

Outlook for returns, ~ 1% +

Already low/negative yields

Unorthodox monetary policy

Low volatility

Challenged liquidity

From tailwind to headwinds in fixed income


In the Netherlands other factors are mandating change

Pressure to reduce fees/costs

Regulatory/reporting constraints

Cheaper simpler products in demand


For illustrative purposes | Source: Wellington Management

Not all fixed income sectors are alike

Relative performance by economic environment

IG corporate bonds

Nominal government bonds

Municipal bonds

High-quality ILBs

EM currencies

EM ILBs

Corporate spreads

High yield

Absolute return/

active risk

Bank loans

EMD

Rising

Rising

Falling

InflationFalling

Growth

Opportunistic


Redefining market exposure

Capitalization-weighted indexes reflect inherent drawbacksLarge disparities in market size across countries lead to distortions

Overvalued securities are over-weighted while undervalued securities are under-weighted

Opportunities to participate in some of the world’s most dynamic markets are foregone

These indexes have not been designed to reflect investors’ risk/return objectives

Various alternatives weighting models have emerged such as weighting markets based onCountries GDP size, fiscal strength, physical area, equity market, and other substitute concepts


Redefining market exposure

4/034/04

4/054/06

4/074/08

4/094/10

4/114/12

4/134/14

100

120

140

160

180

Market cap weighted

GDP weighted

United States

Russia

Canada

Australia

Mexico

Spain

France

United Kingdom

Italy

Japan

-20 -15 -10 -5 0 5 10

% of GDP-weighted index less % of market-cap-weighted index

AustraliaCanada

GermanyUS Japan

0

1

2

3

4

5

6

7

5.9

4.84.6

4.2

1.8

Other alternatives such as countries GDP weighted approaches reflect major biases

Superior performance of GDP weighting is a result of the initial allocation rather than GDP changes over time

Reweighting an index by GDP typically results in more turnover and higher transaction costs

GDP-weighted indexes have outperformed market-cap-weighted indexes…

Data through 30 April 2014 – Cumulative total return, indexed (31 Dec 2002 = 100)

…but mostly because of an underweight to Japan…

Difference in country weightings, GDP weighted vs market-cap weighted – Data through 30 Apr 2014

…which has lagged other major markets

Annualized total returns (%), 31 Dec 2003 – 31 Dec 2013 – Unhedged in local currency


United States

Euro

United Kingdom

Canada

Australia

Mexico

Denmark

Poland

South Africa

Sweden

Alternatives to traditional indexesBenefits of strategic diversification

1 2 3 4 5 6 7 8 9 10

50

70

90

110

Number of markets included

Market cap weighted

Equal risk weighted

Market cap weighted Total risk as % of a US Treasury only portfolio1

Equal risk weighted

1Assume 5-year duration for each country


Emerging Local Debt: What just happened?

The emerging local debt market has fallen by more than 17% since mid-2013

Two waves of decline•TapertantrumpressuresEMcountriesdependentonforeigncapital(2013)•DivergentdevelopedmarketmonetarypolicyleadstostrongUSdollar

rally (2014)

This all occurs in tandem with a relatively soft EM growth cycleCommodities also fall sharply, compounding EM woes

Negative country headlines out of Brazil, Russia, and others further added tothe misery

Capital flows out of local debt assets


Emerging Local Debt: And now? Turning more constructive

Investment caseGlobal growth gradually improving, while global liquidity remains abundant

EM fundamentals remain sound and commodity prices are beginning to recover

Cyclical pressures remain well contained, suggesting limited upside risk for rates

Currency valuations attractive after multi-year correction

Supply/demand trends are supportive

Key risksFed interest rate path: we expect gradual rate increases

China growth: stimulative policy should temper growth concerns


Emerging Local Debt – Good entry point?

Volatility much improved

As of 31 March 2015 | Sources: Bloomberg, Wellington Management, JPMorgan

As of 28 February 2015 | Real effective exchange rate returns from 10-year peak and average | Sources: Bloomberg, Wellington Management, JPMorgan, Bank for International Settlements

EM yields provide cushion over DM yields (%) EM currencies have depreciated (%)

3/05 3/07 3/09 3/11 3/13 3/15

0

2

4

6

8

10

Difference

5-year USD swap yields

GBI-EM yields

BRL COP MXN HUF PLN RUB TRY ZAR IDR MYR THB-45

-30

-15

0

15

Deviation from 10-yr max

Deviation from 10-yr avg


Emerging Local Debt Advanced BetaOur approach

“Direct” currency hedging hedges the full exposure to the local currency versus the base currency. “Base currency” hedging hedges the exposure to the base currency versus a basket of developed currencies. The base currency hedge reduces the risk that the base currency will appreciate relative to global currencies, as represented by the basket of developed currencies, but does not significantly offset the risk that the emerging local currency depreciates relative to global currencies, and the movements of the base and local currencies relative to global currencies can be uncorrelated. Currency carry represents the benefit an investor may derive from having exposure to a currency yieldinga higher interest rate relative to the investor’sbase currency.

Focus universe on intermediate bonds

Adjust target duration based on curve steepness

Directly hedge currency risk of low-carry countries

Optimize to balance risks


Ratio of average monthly returns to monthly standard deviation1

Colombia

Czech Rep

HungaryIndonesia

IsraelMalaysia

MexicoPeru

PolandRussia

S. AfricaS. Korea

Thailand

-0.2

0.0

0.2

0.4

0.6

4 – 7 yr maturities 10+ yr maturities

1Data from July 2008 – November 2014. | Based on monthly hedged returns for all available EM countries that had monthly returns for the full time period in both the 4 – 7 and 10+ year maturity buckets. | Source: Barclays POINT | For illustrative purposes only, not representative of the strategy.

Intermediate maturities have been more efficient than long


-3.0

-1.5

0.0

1.5

3.0

4.5

6.0

0 2 4 6 8 10

Aver

age

yiel

d cu

rve

slope

Average annual return over Libor

S. Korea

ChileIsrael

Mexico

Malaysia

Poland

ThailandS. Africa

Brazil

Colombia

Hungary

Indonesia

Average annual returns vs yield curve slope in Emerging Local DebtADJusT TARGET

DuRATION BAsED ONCuRVE sTEEPNEss

Data from January 2000 – June 2014 for all bonds in the country index that mature between 4 and 7 years. Average yield curve slope is measured as the average yield of all bonds in the country index that mature between 4 and 7 years less the bank rate in each country. Average annual return (%/y) over Libor is hedged to USD. | Countries in the chart include those with data provided by Barclays available for the 4 – 7 year maturity bucket and are: S. Korea, Chile, Israel, Mexico, Malaysia, Poland, Thailand, South Africa, Brazil, Colombia, Hungary, Indonesia. | Source: Barclays | For illustrative purposes only, not representative of the strategy.

Yield curve slope has been correlated with hedged returns


20032004

20052006

20072008

20092010

20112012

2013YTD

Since inception 2

-20

-10

0

10

20

30

Rates Currency

Top quartile Second quartile Third quartile Bottom quartile0.0

0.2

0.4

0.6

0.8

Rates contribution has been stable, currency contribution Directly hedge less so, historically

Index total return in US$,Y/Y % change (total return)1

Sharpe ratio of unhedged returns,by FX carry quartile3

Higher carry currencies have bettersharpe ratios historicallyDIRECTLy HEDGE

CuRRENCy RIsK Of LOw-CARRy COuNTRIEs

1Sources: JPMorgan GBI-EM Global Diversified | 2Annualized December 2002 through 30 September 2014. | 3Data from June 2003 – June 2014 for bonds that mature between 3 and 7 years. FX Carry is measured as the difference between implied Libor of the currency, less USD Libor. Countries in the analysis include those with data provided by Barclays available for the 3 – 7 year maturity bucket and are: Singapore, S. Korea, Chile, Israel, Mexico, Malaysia, Poland, Thailand, S. Africa, Brazil, Colombia, Hungary, Indonesia, India, China. Source: Barclays | For illustrative purposes only, not representative of the strategy.

High carry currencies have produced strong risk-adjusted returns


Top quartile Second quartile Third quartile Bottom quartile0.0

0.3

0.6

0.9

1.2

1.5

FX forward returns Hedged returns

Sharpe ratio of hedged and unhedged returns, by FX carry quartile1

1Data from June 2003 – June 2014 for bonds that mature between 3 and 7 years. FX Carry is measured as the difference between implied Libor of the currency, less USD Libor. Countries in the analysis include: Singapore, S. Korea, Chile, Israel, Mexico, Malaysia, Poland, Thailand, S. Africa, Brazil, Colombia, Hungary, Indonesia, India, China. Source: Barclays

Interest rate and currency risk should be separate decisions


Why Emerging Local Debt Advanced Beta?

Active ELD exposure

Lower volatility

Lower turnover

Low use of derivatives

High Sharpe ratio


Conclusions

NFP /


Emerging Local Debt Advanced BetaKey considerations

Emerging local debt returns are subject to interest rate and currency volatility; in particular, currency volatility may be elevated in certain market environments and may cause higher than expected variability in the total return of the portfolio

Rules regarding market access for both bonds and currencies in emerging markets countries may change as government regulations change; this may include the imposition of taxes or capital controls that restrict the cross-border flow of capital in certain markets, including the ability to repatriate capital; regulations are subject to change

Emerging market debt securities are subject to periods of poor liquidity and higher transaction costs

Derivatives will be used in the portfolio for hedging, market access, and efficient portfolio management purposes. Positions may be exchange traded or over-the-counter.

In certain periods when the portfolio manager is adjusting aggregate risk exposures, transaction costs can be significant

The portfolio may differ significantly from the reference index in regards to the country, interest rate and currency exposure

Base currency hedging over time is expected to reduce the volatility of the portfolio with little cost to expected return, however over shorter periods it can have a significant impact on performance, positive or negative. In periods when the base currency depreciates relative to the basket of global currencies can detract from performance, sometimes significantly.

Investment models are used as part of the investment process for this strategy. All investment models have risks related to mistakes in coding software (e.g., software bugs), inaccurate or stale data inputs and potentially technological failures. Some of these issues may not be detected for a prolonged period before being corrected.


Principal risksCurrency risk – Investments in currencies, currency futures contracts, forward currency exchange contracts or similar instruments, as well as in securities that are denominated in foreign currency, are subject to the risk that the value of a particular currency will change in relation to one or more other currencies.

Fixed income securities market risks – Fixed income securities markets are subject to many factors, including economic conditions, government regulations, market sentiment, and local and international political events. In addition, the market value of fixed income securities will fluctuate in response to changes in interest rates, currency values, and the creditworthiness of the issuer.

Foreign market risks (includes emerging markets) – Investments in foreign markets may present risks not typically associated with domestic markets. These risks may include changes in currency exchange rates; less-liquid markets and less available information; less government supervision of exchanges, brokers, and issuers; increased social, economic, and political uncertainty; and greater price volatility. These risks may be greater in emerging markets, which may also entail different risks from developed markets.

Interest rate risk – Generally, the value of fixed income securities will change inversely with changes in interest rates. The risk that changes in interest rates will adversely affect investments will be greater for longer-term fixed income securities than for shorter-term fixed income securities.

Manager risk – Investment performance depends on the portfolio management team and the team’s investment strategies. If the investment strategies do not perform as expected, if opportunities to implement those strategies do not arise, or if the team does not implement its investment strategies successfully, an investment portfolio may underperform or suffer significant losses.

Risks of derivative instruments – Derivatives can be volatile and involve various degrees of risk. The value of derivative instruments may be affected by changes in overall market movements, the business or financial condition of specific companies, index volatility, changes in interest rates, or factors affecting a particular industry or region. Other relevant risks include the possible default of the counterparty to the transaction and the potential liquidity risk with respect to particular derivative instruments. Moreover, because many derivative instruments provide significantly more market exposure than the money paid or deposited when the transaction is entered into, a relatively small adverse market movement can not only result in the loss of the entire investment, but may also expose a portfolio to the possibility of a loss exceeding the original amount invested.

Emerging Local Debt Advanced BetaInvestments risks


Additional risksConcentration risk – Concentration of investments in a relatively small number of securities, sectors or industries, or geographical regions may significantly affect performance.

Credit risk – The value of fixed income security may decline, or the issuer or guarantor of that security may fail to pay interest or principal when due, as a result of adverse changes to the issuer’s or guarantor’s financial status and/or business. In general, lower-rated securities carry a greater degree of credit risk than higher-rated securities.

Issuer specific risk – A security issued by a particular issuer may be impacted by factors that are unique to that issuer and thus may cause that security’s return to differ from that of the market.

Liquidity risk – Investments with low liquidity can have significant changes in market value, and there is no guarantee that these securities could be sold at fair value.

Past results are not necessarily indicative of future resultsThere can be no assurance nor should it be assumed that future investment performance of any strategy will conform to any performance examples set forth in this material or that the portfolio’s underlying investments will be able to avoid losses. The investment results and any portfolio compositions set forth in this material are provided for illustrative purposes only and may not be indicative of the future investment results or future portfolio composition. The composition, size of, and risks associated with an investment in the strategy may differ substantially from the examples set forth in this material. An investment can lose value.

Emerging Local Debt Advanced BetaInvestments risks (continued)


Wellington Management Company llp (WMC) is an independently owned investment adviser registered with the US Securities and Exchange Commission (SEC). WMC is also a commodity trading advisor (CTA) registered with the US Commodity Futures Trading Commission. In certain circumstances, WMC provides commodity trading advice to clients in reliance on exemptions from CTA registration. WMC, along with its affiliates (collectively, Wellington Management), provides investment management and investment advisory services to institutions around the world. Located in Boston, Massachusetts, Wellington Management also has offices in Chicago, Illinois; Radnor, Pennsylvania; San Francisco, California; Beijing; Frankfurt; Hong Kong; London; Singapore; Sydney; Tokyo; and Zurich. This material is prepared for, and authorized for internal use by, designated institutional and professional investors and their consultants or for such other use as may be authorized by Wellington Management. This material and/or its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients.

In Canada, this material is provided by Wellington Management Canada llc, a US SEC-registered investment adviser also registered in the provinces of Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Quebec, and Saskatchewan in the categories of Portfolio Manager and Exempt Market Dealer. In the UK, this material is provided by Wellington Management International Limited (WMIL), a firm authorized and regulated by the Financial Conduct Authority (FCA). This material is directed only at persons (Relevant Persons) who are classified as eligible counterparties or professional clients under the rules of the FCA. This material must not be acted on or relied on by persons who are not Relevant Persons. Any investment or investment service to which this material relates is available only to Relevant Persons and will be engaged in only with Relevant Persons. In Germany, this material is provided by Wellington Management International Limited, Niederlassung Deutschland, the German branch of WMIL, which is authorized and regulated by the FCA and in respect of certain aspects of its activities by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin). This material is directed only at persons (Relevant Persons) who are classified as eligible counterparties or professional clients under the German Securities Trading Act. This material does not constitute investment advice, a solicitation to invest in financial instruments or financial analysis within the meaning of Section 34b of the German Securities Trading Act. It does not meet all legal requirements designed to guarantee the independence of financial analyses and is not subject to any prohibition on dealing ahead of the publication of financial analyses. This material does not constitute a prospectus for the purposes of the German Capital Investment Code, the German Securities Sales Prospectus Act or the German Securities Prospectus Act.

G1419 /

Disclosure

As of January 2015


In Hong Kong, this material is provided to you by Wellington Management Hong Kong Limited (WM Hong Kong), a corporation licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities), Type 2 (dealing in futures contracts), Type 4 (advising on securities), and Type 9 (asset management) regulated activities, on the basis that you are a Professional Investor as defined in the Securities and Futures Ordinance. By accepting this material you acknowledge and agree that this material is provided for your use only and that you will not distribute or otherwise make this material available to any person. In Singapore, this material is provided for your use only by Wellington Management Singapore Pte Ltd (WM Singapore) (Registration Number 201415544E). WM Singapore is regulated by the Monetary Authority of Singapore under a Capital Markets Services Licence to conduct fund management activities and is an exempt financial adviser. By accepting this material you represent that you are a non-retail investor and that you will not copy, distribute or otherwise make this material available to any person. In Australia, Wellington Management Australia Pty Ltd (WM Australia) (ABN19 167 091 090) has authorized the issue of this material for use solely by wholesale clients (as defined in the Corporations Act 2001). By accepting this material, you acknowledge and agree that this material is provided for your use only and that you will not distribute or otherwise make this material available to any person. Wellington Management Company llp is exempt from the requirement to hold an Australian financial services licence (AFSL) under the Corporations Act 2001 in respect of financial services, in reliance on class order 03/1100, a copy of which may be obtained at the web site of the Australian Securities and Investments Commission, http://www.asic.gov.au. The class order exempts a registered investment adviser regulated by the SEC, among others, from the need to hold an AFSL for financial services provided to Australian wholesale clients on certain conditions. Financial services provided by Wellington Management Company llp are regulated by the SEC under the laws and regulatory requirements of the United States, which are different from the laws applying in Australia. In Japan, Wellington Management Japan Pte Ltd (WM Japan) (Registration Number 199504987R) has been registered as a Financial Instruments Firm with registered number: Director General of Kanto Local Finance Bureau (Kin-Sho) Number 428. WM Japan is a member of the Japan Investment Advisers Association (JIAA) and the Investment Trusts Association, Japan (ITA). WMIL, WM Hong Kong, WM Japan, and WM Singapore are also registered as investment advisers with the SEC; however, they will comply with the substantive provisions of the US Investment Advisers Act only with respect to their US clients.

©2015 Wellington Management Company llp. All rights reserved.

G1419 /

Disclosure (continued)

As of January 2015

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