Credit investing in an inflationary world11 – 13 May 2011
Sterling powered by                          strong jump in inflationImpennata del costo del petrolioe degli alimentari si...
M&G’s Inflation Linked Corporate Bond Funds    Fund facts                                                                 ...
Fund performance                  Since inception in September 2010                         M&G European Inflation Linked ...
Biography    Co-fund managers                       •   Jim Leaviss joined M&G in 1997 from the Bank of England. He       ...
Credit investing in an inflationary worldBen Lord, Fund Manager11 – 13 May 2011
Inflation Quiz 1             What is the current rate of inflation in Zimbabwe?                            (as at January ...
Inflation Quiz 2               What was the rate of inflation in Zimbabwe                             in July 2008?8
Inflation Quiz 3               How much was Z$100 billion worth in Euros                         in October 2008?9
Inflation Quiz 4             How much did a roll of toilet paper cost in Zimbabwe                                in May 20...
Agenda     • Hedging against inflation     • Macroeconomic views     • M&G European Inflation Linked Corporate Bond Fund11
Asset class sensitivity to inflation in the short term     Impact on returns of a 1% increase in inflation              Im...
Inflation hedging over the long term         Asset class reactions to an unexpected increase in inflation         Cumulati...
Agenda     • Hedging against inflation     • Macroeconomic views     • M&G European Inflation Linked Corporate Bond Fund14
Inflation expectations are rising            5 year breakeven rates for US, UK and Germany     3.5            US Quantitat...
It’s rare to get inflation with such weak wage growth       Europe           Unit labour costs less inflation 3q-moving av...
It’s rare to get inflation with such weak wage growth     UK               UK average earnings less RPI (y/y)         6   ...
The demographic case for inflation is strong      12.0%                                                                   ...
European Inflation                 Eurozone HICP all items and HICP ex-tobacco (YoY)         5.5         5.0              ...
The make-up of EU HICP           HICP weightings                                                             9%           ...
Agenda     • Hedging against inflation     • Macroeconomic views     • M&G European Inflation Linked Corporate Bond Fund21
Is there value in government inflation-linked bonds?                German inflation linked real yields          3.5      ...
Innovation 1: A short duration fund with ability to go negative      • The average European government bond has a duration...
What am I buying when I purchase an inflation-linked     corporate bond?                                                  ...
How do inflation-linked corporate bonds perform?                          Real yields on Veolia IL 1.75% 2015 Vs. France I...
Some issuers of Euro and UK inflation-linked corporate bonds26
Innovation 2: synthetic inflation-linked corporate bonds     How to create one                                            ...
Innovation 2: synthetic inflation-linked corporate bonds     Performance                      Glencore 5y SR CDS spreads (...
M&G European Inflation Linked Corporate Bond Fund     Fund positioning      Asset allocation                              ...
Value at Risk      Plenty of headroom to add risk             VaR limits     18%     16%     14%     12%     10%          ...
Summary     If you or your clients fear inflation…     • Inflation expectations have been rising in 2011     • Investors n...
This document is designed for investment professionals‟ use only, not for onward distribution to any other person or entit...
Appendix33
Fund facts     Top 10 holdings                                                  Coupon   Maturity   Fund %               1...
Using futures to manage duration     The maths…         • The fund sold 20 10yr Bund future contracts at launch 16th Sept ...
Synthetic inflation-linked corporate bonds     The maths…      • Nov 26 the fund sold £500k 5yr protection on Glencore at ...
Oil Shocks     Effect on inflation measures of an oil price increase                                      Oil Price       ...
Counterparty risk                                                                     Counterparty                        ...
Inflation Quiz 1      Answer                                 What is the current rate of inflation in Zimbabwe?           ...
Inflation Quiz 2      Answer                                        What was the rate of inflation in Zimbabwe            ...
Inflation Quiz 3       Answer                       How much was Z$100 billion worth in Euros                             ...
Inflation Quiz 4      Answer                    How much did a roll of toilet paper cost in Zimbabwe                      ...
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Eilc presentation bl citywire montreux may 11 screen

  1. 1. Credit investing in an inflationary world11 – 13 May 2011
  2. 2. Sterling powered by strong jump in inflationImpennata del costo del petrolioe degli alimentari si tradurrà inagitazione
  3. 3. M&G’s Inflation Linked Corporate Bond Funds Fund facts UK^ Europe Inception September 2010 Co-fund manager Jim Leaviss Co-fund manager Ben Lord Fund size £231m €29.5m IMA £ Strategic Morningstar EUR Sector Bond Sector Inflation-Linked Bond3 Source: M&G Investment Information, as at 30 April 2011. „^The M&G UK Inflation Linked Corporate Bond Fund is only authorised by the FSA in the UK. The fund has not been authorised nor otherwise approved by a financial regulator in any other jurisdiction.
  4. 4. Fund performance Since inception in September 2010 M&G European Inflation Linked Corporate Bond Fund – performance since inception 105 104 3.90%= Fund 103 2.48% = EU HICP 102 101Indexed to 100 100 -0.11% = € IL Bonds 99 -0.27%= € Corporate Bonds 98 97 96 -3.67%= € Government Bonds 95 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 M&G European Inflation Linked Corporate Bond Fund EU Harmonised Indices of Consumer prices MStar PE EUR Corporate Bond (PG) MStar PE EUR Government Bond MStar PE EUR Inflation-Linked Bond4 Source: M&G, Morningstar as at 30 April 2011. Pan European database, Bid-to-bid, gross income reinvested, Euro A Share class
  5. 5. Biography Co-fund managers • Jim Leaviss joined M&G in 1997 from the Bank of England. He is Head of M&G Retail Fixed Interest • Co Manager of the M&G UK and European Inflation Linked Corporate Bond Funds since Sep 2010 • Has 19 years experience in fixed income markets • Ben Lord joined M&G in 2007 • Fund manager of the M&G High Interest Fund since February 2009 and deputy fund manager for Strategic Corporate Bond and Corporate Bond funds • Ben previously worked at Gordian Knott as a credit analyst covering financial institutions5
  6. 6. Credit investing in an inflationary worldBen Lord, Fund Manager11 – 13 May 2011
  7. 7. Inflation Quiz 1 What is the current rate of inflation in Zimbabwe? (as at January 2011)7
  8. 8. Inflation Quiz 2 What was the rate of inflation in Zimbabwe in July 2008?8
  9. 9. Inflation Quiz 3 How much was Z$100 billion worth in Euros in October 2008?9
  10. 10. Inflation Quiz 4 How much did a roll of toilet paper cost in Zimbabwe in May 2006?10
  11. 11. Agenda • Hedging against inflation • Macroeconomic views • M&G European Inflation Linked Corporate Bond Fund11
  12. 12. Asset class sensitivity to inflation in the short term Impact on returns of a 1% increase in inflation Impact of a 1% rise in inflation by asset class 12 10 Impact on returns over entire history of data Impact on returns since exchange rates were allowed to float (1973) 8 6 4 2 0 -2 -4 -6 U.S. 3- U.S. U.S. SDR- SDR- CRB index Gold spot SDR 60-40 month T- Treasuries Corporate weighted weighted equity- bills (all bonds gov. equities bond maturities) bonds portfolio (10y+ maturities) Commodities are an effective hedge for an increase in inflation of 1% in the short-term12 Source: IMF, Attie, P., and Roache, S., “Inflation Hedging for Long-Term Investors”, April 2009. 12-month returns on annual inflation using overlapping observations. The SDR-based analysis assesses the inflation-hedging properties of broadly diversified international asset class benchmarks.
  13. 13. Inflation hedging over the long term Asset class reactions to an unexpected increase in inflation Cumulative response over 20 years to a one-time inflation „shock‟ Cash Bonds • This model assesses how different Partial hedge Suffer short term, then recover asset classes react to unexpected increases in inflation % % • Unexpected inflation is a rise in the consumer price index that is not anticipated by the model • The model estimates the impact of a Years Years one-time inflation shock on the cumulative total return (or change in Equities Commodities price in the case of commodities), Losses, no meaningful Effective short-term hedge, assuming all coupons and dividends recovery but erodes over time are reinvested % % Standard error bounds Cumulative change in the level of the total return or price index over a 20-year period. Years Years13 Source: IMF, Attie, P., and Roache, S., “Inflation Hedging for Long-Term Investors”, April 2009. A one standard deviation shock, equivalent to about 0.2 percentage points, was applied to inflation.
  14. 14. Agenda • Hedging against inflation • Macroeconomic views • M&G European Inflation Linked Corporate Bond Fund14
  15. 15. Inflation expectations are rising 5 year breakeven rates for US, UK and Germany 3.5 US Quantitative Easing 2 UK announced 3.0 US 2.5 % 2.0 Germany 1.5 1.0 0.5 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Driven by stronger growth, higher commodity prices and taxes, and QE fears15 Source: Bloomberg, 04 May 2011
  16. 16. It’s rare to get inflation with such weak wage growth Europe Unit labour costs less inflation 3q-moving average, (%) 6.5 5.5 4.5 Workers getting richer 3.5 2.5 1.5 0.5 Eurozone -0.5 Germany -1.5 Spain Workers getting poorer -2.5 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 But a stronger labour market should ring alarm bells16 Source: Bloomberg, M&G, 28 February 2011
  17. 17. It’s rare to get inflation with such weak wage growth UK UK average earnings less RPI (y/y) 6 Workers getting richer 4 2 0 -2 -4 Workers getting poorer -6 Ju 0 Ju 1 Ju 2 Ju 3 Ju 4 Ju 5 Ju 6 Ju 7 Ju 8 Ju 9 Ju 0 11 Ja 0 Ja 1 Ja 2 Ja 3 Ja 4 Ja 5 Ja 6 Ja 7 Ja 8 Ja 9 Ja 0 0 0 0 0 0 0 0 0 0 0 1 l-0 l-0 l-0 l-0 l-0 l-0 l-0 l-0 l-0 l-0 l-1 n- n- n- n- n- n- n- n- n- n- n- n- Ja But a stronger labour market should ring alarm bells17 Source: Bloomberg, M&G, 31 March 2011
  18. 18. The demographic case for inflation is strong 12.0% 130.00% Very unproductive 10.0% workforce 120.00% 8.0% 110.00% 6.0% 100.00% 4.0% 90.00% Very productive 2.0% 80.00% workforce 0.0% 70.00% 50 57 64 71 78 85 92 99 06 13 20 27 34 41 48 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 US inflation Non-working age to working age ratio (RHS) But the Japanese ageing experience has been non-inflationary18 Source: Barclays Equity-Gilt Study, M&G, January 2011
  19. 19. European Inflation Eurozone HICP all items and HICP ex-tobacco (YoY) 5.5 5.0 Ex-tobacco 4.5 All items 4.0 3.5 3.0 2.5 % 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 Mar-91 Mar-93 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Mar-1119 Source: Bloomberg as of 31 March 2011
  20. 20. The make-up of EU HICP HICP weightings 9% Food & non-alcoholic beverages MoM: 0.5%, YoY: 2.0% 15% Alcohol & tobacco MoM: 0.2%, YoY: 3.7% 9% Clothing & footwear MoM: 15.1%, YoY: 1.2% 4% Housing & household services MoM: 0.6%, YoY: 5.1% 1% Furniture & household goods MoM: 0.6%, YoY: 0.9% 7% Health MoM: 0.1%, YoY: 1.3% 10% Transport MoM: 1.3%, YoY: 5.6% Communication MoM: -0.2%, YoY: -0.6% 3% Recreation & culture MoM: -0.2%, YoY: -0.3% 16% Education MoM: 0.1%, YoY: 1.7% Restaurants & hotels MoM: 0.2%, YoY: 1.8% 15% Miscellaneous goods & services MoM: 0.5%, YoY: 2.8% 7% 4%20 Source: Eurostat as at 31 March 2011
  21. 21. Agenda • Hedging against inflation • Macroeconomic views • M&G European Inflation Linked Corporate Bond Fund21
  22. 22. Is there value in government inflation-linked bonds? German inflation linked real yields 3.5 3.0 2.5 2.0 % 1.5 1.0 DBRI 1.75% 2020 0.5 DBRI 1.5% 0.0 2016 -0.5 OBLI 2.25% 2013 -1.0 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Medium dated real yields are thin and short dated real yields are negative22 Source: Bloomberg, 04 May 2011
  23. 23. Innovation 1: A short duration fund with ability to go negative • The average European government bond has a duration of 6 years • The average European inflation-linked government bond has a duration of 8 years • The average European corporate bond has a duration of 4 years If interest rates rise by 1% • The average European government bond will fall in price by 6% • The average European inflation-linked government bond will fall in price by 8% • The average European corporate bond will fall in price by 4% • If a bond portfolio has a negative duration of say, -2 years, it will increase in value by 2% A fund should be short (or negative) duration if you expect yields to rise23 Source: Barclays Capital Indices, M&G as at 31 March 2011
  24. 24. What am I buying when I purchase an inflation-linked corporate bond? Pure credit risk = 0.9% pa Veolia I/L 2015 Yield = 1.3% + + inflation Pure interest rate risk (duration) “Risk free” yield = 0.4% pa (2015 OATi) Inflation-linked corporates are a combination of duration risk and credit risk. Principal and coupons are uplifted by EMU HICP24 Source: Bloomberg, M&G 31March 2011
  25. 25. How do inflation-linked corporate bonds perform? Real yields on Veolia IL 1.75% 2015 Vs. France IL 1.6% 2015 7 Money yield = 3.7% 6 = 5 Current HICP ex- tobacco = 2.4% 4 +Real Yield (%) YTM = 1.3% 3 2 Veolia 1.75% 2015 1 France IL 1.6% 2015 0 -1 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Corporate bond returns plus inflation protection over the long term25 Source: M&G, Bloomberg 31 March 2011
  26. 26. Some issuers of Euro and UK inflation-linked corporate bonds26
  27. 27. Innovation 2: synthetic inflation-linked corporate bonds How to create one Credit default swap (Pure Credit Risk): Synthetic Glencore linker Glencore 5y = 1.7% = 1.5% + RPI (currently 5.5%) = Money yield of 7.0% Pure interest rate risk (duration): UKTI gilt 2.5% 2016 “Risk free” yield = -0.17% CDS + government linker = synthetic inflation linked corp27 Source: Bloomberg, M&G as at 31 March 2011
  28. 28. Innovation 2: synthetic inflation-linked corporate bonds Performance Glencore 5y SR CDS spreads (Bps) 280 250 220 Bps 190 160 130 100 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 We sold protection on Glencore senior debt in Oct 201028 Source: Bloomberg as at 31 March 2011
  29. 29. M&G European Inflation Linked Corporate Bond Fund Fund positioning Asset allocation Credit split incl. derivatives Short dated corps, 6.5% FRNs, 11.5% AAA 13.4% Cash, 4.5% IL governments, 1.1% AA 4.9% A 39.0% BBB 30.7% BB 4.4% IL governments with derivative B 1.8% IL corporates & overlay, 35.0% PFI, 41.4% NR 1.3% Cash 4.5% 0% 10% 20% 30% 40% 50% Core of fund in index linked credit, overall fund duration: 1.5 years29 Source: Bloomberg, M&G as at 30 April 2011
  30. 30. Value at Risk Plenty of headroom to add risk VaR limits 18% 16% 14% 12% 10% 9.86% 8% 6% 4% 2% 0.96% 0% 0.09% Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 % VaR Upper Limit Lower Limit Upper Limit: Greater of: 70% Euro BBB Securities 15+ year duration / 30% Euro High Yield B rated and 20 year European Inflation Linked Govts Lower Limit: Euro 3 Month Treasury Bill30 Source: M&G, as at 31 March 2011
  31. 31. Summary If you or your clients fear inflation… • Inflation expectations have been rising in 2011 • Investors need to protect their portfolios – But traditional asset classes are an imperfect hedge • Inflation linked corporate bonds can offer protection against inflation • The M&G European Inflation Linked Corporate Bond Fund is an innovative product allowing investors to protect against inflation …then add inflation protection to your portfolio31
  32. 32. This document is designed for investment professionals‟ use only, not for onward distribution to any other person or entity.For Switzerland: Distribution of this document in or from Switzerland is not permissible with the exception of the distribution to qualified investors according to the SwissCollective Investment Schemes Act, the Swiss Collective Investment Schemes Ordinance and the respective Circular issued by the Swiss supervisory authority("Qualified Investors"). Supplied for the use by the initial recipient (provided it is a Qualified Investor) only.In Spain the M&G Investment Funds are registered for public distribution under Art. 15 of Act 35/2003 on Collective Investment Schemes as follows: M&G Investment Funds (1) reg.no 390, M&G Investment Funds (2) reg. no 601, M&G Investment Funds (3) reg. no 391, M&G Investment Funds (7) reg. no 541, M&G Investment Funds (9) reg. no 930, M&G GlobalDividend Fund reg. no 713 M&G Global Dynamic Allocation Fund reg. no 843 and M&G Optimal Income Fund reg. no 522.The collective investment schemes referred to in this document (the "Schemes") are open-ended investment companies with variable capital, incorporated in England and Wales.This information is not an offer or solicitation of an offer for the purchase of investment shares in one of the Funds referred to herein. Purchases of a Fund should be based on thecurrent prospectus. This prospectus, simplified prospectus, annual report and subsequent semi-annual report, are available free of charge, in paper form, from the ACD: M&GSecurities Limited, Laurence Pountney Hill, London, EC4R 0HH, GB, or one of the following: M&G International Investments Limited, German branch, Bleidenstraβe 6-10, D-60311Frankfurt am Main, the German paying agent J.P. Morgan AG, Junghofstraβe 14, D-60311 Frankfurt am Main, the Austrian paying agent, Raiffeisen Bank International A.G., AmStadtpark 9, A-1030 Wien, the Luxembourg paying agent, J.P. Morgan Bank Luxembourg S.A., European Bank & Business Center, 6 c route de Treves, 2633 Senningerberg,Luxembourg, Allfunds Bank, Calle Estafeta, No 6 Complejo Plaza de la Fuente, La Moraleja 28109, Alcobendas, Madrid, M&G International Investments Limited, 90 avenue desChamps Elysées, 75008, Paris, France or from the French centralising agent of the Fund: RBC Dexia Investors Services Bank France. For Switzerland: Please refer to M&GInternational Investments Ltd., Bleidenstraβe 6-10, D-60311 Frankfurt am Main. For Italy, they can also be obtained from one of the appointed paying agents, details of which can befound by visiting the contact section on the following website: www.mandg-investments.it.Before subscribing you should read the prospectus, which includes investment risks relating to these funds.This financial promotion is published by M&G International Investments Ltd. Registered Office: Laurence Pountney Hill, London EC4R 0HH, authorised and regulated by the FinancialServices Authority and registered with the CNMV in Spain.Past performance is not a guide to future performance.Performance stats are quoted gross of Italian tax (12.5%) on capital gains.
  33. 33. Appendix33
  34. 34. Fund facts Top 10 holdings Coupon Maturity Fund % 1. Germany 2.25% 2013 29.1% 2. Germany 1.5% 2016 7.1% 3. Oresundsbro Konsortiet 3.40% 2014 4.6% 4. Severn River 6.125% 2013 3.9% 5. BT 3.5% 2025 2.7% 6. Tesco 4.0% 2016 2.5% 7. Tesco 3.32% 2025 2.1% 8. Veolia Environnement 1.75% 2015 2.1% 9. Anglian Water 4.125% 2020 2.1% 10. Cades 1.5% 2021 2.1%34 Source: Bloomberg, M&G as at 30 April 2011
  35. 35. Using futures to manage duration The maths… • The fund sold 20 10yr Bund future contracts at launch 16th Sept • Reduced fund duration by approx 1.8 years • 10yr bund yields rose 84bps • On a €10m fund that results in a loss of €151,200 • The value of the futures contract fell by 5.31% over the period – therefore we gain €129,967 • Overall effect: 129,967 – 151,200 = - €21,233 • The futures roughly neutralise the movement in the yield35 Source M&G, Bloomberg as at 28 February 2011
  36. 36. Synthetic inflation-linked corporate bonds The maths… • Nov 26 the fund sold £500k 5yr protection on Glencore at 265bps* • We receive 265bps a year = (0.0265*£500k= £13,250) • Today priced at 170bps • 265 - 170 = 95 • Spread change: 95 * £500k = £4,750 (+ premia received per qtr) • PV of Spread change = value of position • £4,750 * 4.7yrs = £22,325 (small number but adds 22bps to a £10m fund)36 Source M&G, Bloomberg as at 28 October 2010 *maturity date 20/3/12
  37. 37. Oil Shocks Effect on inflation measures of an oil price increase Oil Price EA CPI UK RPI US CPI $/Barrel Ex-Tobacco 90 0.00 0.00 0.00 100 0.16 0.17 0.54 110 0.32 0.34 1.08 120 0.48 0.51 1.63 130 0.63 0.68 2.17 140 0.79 0.86 2.71 150 0.95 1.03 3.25 160 1.11 0.20 3.80 170 1.27 1.37 4.34 180 1.43 1.54 4.8837 Source: Fathom Consulting as at 28 February 2011
  38. 38. Counterparty risk Counterparty BNP Paribas Fund Custodian Credit Suisse Deutsche Bank M&G European Inflation J P Morgan AAA AAA Linked Corporate Bond Fund Government Government Bonds Bonds J P Morgan Cash Cash UBS38
  39. 39. Inflation Quiz 1 Answer What is the current rate of inflation in Zimbabwe? (as at January 2011) 3.3%39Source: Reserve Bank of Zimbabwe, as at 6th May 2011
  40. 40. Inflation Quiz 2 Answer What was the rate of inflation in Zimbabwe in July 2008? 23,11,50,888.9%40Source: Reserve Bank of Zimbabwe, as at 6th May 2011
  41. 41. Inflation Quiz 3 Answer How much was Z$100 billion worth in Euros in October 2008? €0.1041Source: The Guardian
  42. 42. Inflation Quiz 4 Answer How much did a roll of toilet paper cost in Zimbabwe in May 2006? Z$145,75042 Source: NY Times
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