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  • 1. Deutsche Bank Corporate & Investment BankThe Markets in 2011Foresight with Insight Deutsche Bank Markets in 2011—Foresight with Insight
  • 2. ForewordChallenges and opportunities in 2011As the world economy slowly recovers from the mostfar-reaching dislocation in living memory, the outlook formarkets in 2011 will continue to be uncertain.Even so, we do expect to see three themes Having long been active in emerging markets,continuing to drive our clients’ investment we will continue to facilitate capital flowsdecisions: between developed and emerging markets for our clients, and to support the development ofThe global economic recovery is set to continue, the local EM markets.albeit at an uneven pace. Growth in the matureeconomies will be anaemic despite central banks In this guide, we have attempted to provideflooding markets with liquidity. some clarity on the outlook for the year ahead by bringing together insight and analysis from ourSovereign debt markets in peripheral Europe will most experienced market experts.remain under pressure, although we do not thinka default in 2011 is likely. As you determine where to invest and how to mitigate risk in 2011, we aim to distinguishThe seismic move in the balance of power from ourselves through the breadth and depth of ourWest to East will continue, as demographic analysis and our willingness to take a view.trends ensure that emerging markets continue tooffer superior long-term growth potential. We hope you find this guide valuable. Anshu Jain Head of the Corporate & Investment Bank Member of the Management Board Deutsche Bank Markets in 2011—Foresight with Insight
  • 3. Markets in 2011—Foresight with Insight Deutsche Bank
  • 4. ContentsLeaders Markets Risk Management1.1 Global Economic Outlook 3.1 Regulatory Change 5.1 Equity Hedging Prospects and worries for 2011 What’s coming up Look beyond the put1.2 Corporate Multinationals 3.2 Asian Equities 5.2 Credit Risk Management Strategies in 2011 Signs of euphoria Getting easier1.3 Emerging Market Capital Flows 3.3 European Equities 5.3 Rate Hedging Will the wave continue? Price rises ahead Key risks for 20111.4 Mergers & Acquisitions 3.4 US Equities 5.4 FX Risk Management Outlook for the year ahead Strategic case is compelling Going super-sized1.5 Chinese and Indian Multinationals 3.5 EM Equities 5.5 Longevity Risk Companies to watch out for Watch out for FX Live long and prosper1.6 Risk Management 3.6 Foreign Exchange 5.6 Inflation 10 key risks to hedge in 2011 Don’t get complacent No need for panic but1.7 Capital Raising 3.7 Commodities take precautions How easy will it be to raise Outlook for 2011 5.7 Commodity Risk Management money? 3.8 Rates What risks are worth hedging?1.8 Credit Rising in Q2 The final hoorah 3.9 US Real Estate Financing Outlook for 2011Economics 3.10 Asset Backed Securities 6.1 Bond Market Outlook Investor demand returns Uncertainties need resolving2.1 The EMU Crisis 3.11 Art 6.2 IPO Market Outlook Will Portugal and Spain Four artists to watch in 2011 Encouraging trends follow Ireland? 6.3 Trade Finance in Asia Pacific2.2 China Trading Embracing the old Japanese ghosts, and the outlook 6.4 Bank Recapitalisation for 2011 4.1 High Yield Credit Possible responses2.3 United States Ten high yield trades for 2011 6.5 Bail-Ins: Pros and Cons What’s different this time? 4.2 Investment Grade Credit A fast-track option2.4 Germany Trading ideas for the year 6.6 Infrastructure Outlook for 2011 4.3 Foreign Exchange Privatisation rises up the agenda2.5 Emerging Markets Ten FX trades for 2011 Another good year but not for all 4.4 Commodities Investing2.6 ASEAN and North Asia Ten commodity trades for 2011 Still attached to the G3? 4.5 Rates 7.1 Asset Allocation Ten rates trades for 2011 A model portfolio for 2011 4.6 Asset Backed securities 7.2 Stock Picking Strategies Ten ABS trades for 2011 What value analysis tells us 4.7 Carry Trading 7.3 Exchange Traded Funds Is the FX carry trade dead? On the march 7.4 Hedge Funds: EU Directive Impact of the new rules 7.5 Managed Accounts Good news for investors and hedge fund managers 7.6 Asset and Liability Management New rules for European insurers 7.7 Portfolio Theory Binary outcomes, bimodal returns 7.8 Green Investing Opportunities ahead Deutsche Bank Markets in 2011—Foresight with Insight
  • 5. 1 Leaders Global Economy Corporate Multinationals Emerging Market Flows Mergers & Acquisitions Asia on the March Risk Outlook Financing CreditMarkets in 2011—Foresight with Insight Deutsche Bank
  • 6. Deutsche Bank Markets in 2011—Foresight with Insight
  • 7. 1.1 David Folkerts-LandauLeaders Global Head of ResearchOutlook for Global Economy 2011Prospects and worries for 2011The coming year is likely to prove challenging The world economy is looking for a recovery in private demand to takefor the world economy and policy makers over the baton from government spending, which is likely to be cut inalike. After a strong bounce from the worst many countries now facing recordrecession in decades during 2009 and early peace-time budget deficits and looking to repair public finances battered by2010, thanks to unprecedented monetary the recession. Interest rates in the US, Europe and Japan are at recordand fiscal stimulus, 2011 is likely to be slower low levels and are likely to remain soand more difficult for much of the world, throughout the year as central banks try to keep economies growing in theespecially developed economies such as the face of this fiscal retrenchment.US, Japan and the Eurozone. Many emerging We see the world economy growingeconomies will continue to perform relatively by a modest 3.9% in 2011, down from 4.7% this year. We think a double-dipstrongly, however, as the shift in global is unlikely and, while we agree with the US Federal Reserve that deflationeconomic power continues apace. But they is a threat, we think this, too, will bewill not be immune to slower growth in the avoided. But much of the world will see lacklustre growth by historic standardsdeveloped world. next year, and slower than 2010. We expect the US economy to expand at a similar modest pace to 2010 in 2011. We’re anticipating growth of around 2.5% after the Fed, disappointed at the lack of strong growth in the US economy and stubbornly high unemployment, in early November 2010 launched a second round of quantitative easing, or QE2. We think this was necessary, particularly because further fiscal support is unlikely after the mid-term elections, and it should modestly boost growth and inflation next year. But the country’s weak housing market and continued debt reduction by households remain major downside risks to our forecast. The Eurozone, hampered by the ongoing sovereign debt crisis, should only manage to expand by around 1%, down from 1.5% this year. Indeed, the bloc’s economyMarkets in 2011—Foresight with Insight Deutsche Bank
  • 8. has already begun to decelerate as very low bond yields. The inflows Figure 1: Widening gap betweenthe peripheral economies are cutting into emerging markets are tending to EM and G3spending sharply and raising taxes to depress yields there at a time when Source: IMF G3 EMtry to bring their huge budget deficits many countries’ authorities are looking 10 GDP growth % yoy DB Forecastback under control. Growth for the for higher interest rates, not lower. 8area slowed sharply to 0.4% in the China has announced a series of policy 6third quarter of 2010 from 1% in the tightening measures in the recent past 4previous three months. designed to prevent inflation in some 2 parts of its economy. 0We are likely to continue to see a two- -2speed Europe with core countries such International discord is a major -4as Germany continuing to perform concern for next year. The unity shown -6strongly but many of the peripheral by the G20 nations during the worsteconomies remaining in recession. of the financial crisis in 2008 and 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11The recent problems surrounding 2009 has, unfortunately, dissipated.Ireland and, to a lesser extent, Many countries, in particular GermanyPortugal, highlight the vulnerability and Brazil, have been critical of theof the European economy should Fed’s QE2, arguing that the US ismarkets continue to test various intentionally trying to drive down its Figure 2: Global growthgovernments’ resolve. In response currency and thus risks igniting a Source: IMFto the recent volatility, the European global currency war. We think that 6 % yoy DB ForecastCentral Bank has postponed its exit these fears are totally misplaced as the 5from its emergency liquidity support principal aims of QE2 are to avoid the 4for the continent’s banking system. very real threat of deflation as well as 3We do not see it raising interest rates to spur economic growth. 2from the current 1% level before Q3 12011 at the earliest. We also believe that China’s policy 0 on the yuan: of real appreciation via -1Japan, recently overtaken by China as domestic inflation, while gradually 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11the world’s second largest economy, adjusting the band within which itswe see barely expanding at all in 2011, currency can fluctuate, is the rightafter a reasonable showing of over 3% one. This should result in gradualin 2010. The country remains mired yuan appreciation and allow domesticin recession and deflation. China and demand to expand and help reduceIndia we expect to grow robustly the global imbalances that wereat 8.7% and 8.1% respectively, but partly to blame for the financialthose rates are down slightly because crisis. November’s G20 summit inneither will be able to entirely shrug off Seoul made little progress on thethe slowdown in Western economies. fundamental issue of economic imbalances. As the year draws to aIndeed, in many Asian countries, close, there is a real risk of furtherinflation remains more of a concern tension in 2011 if emerging economiesthan deflation. The situation has not continue to restrict capital inflows,been helped by inflows of capital from the dollar continues to weaken orthe developing world as investors if US Congress backs protectionistseek higher returns in emerging measures against China andmarkets (EM) than they are able to others it considers to be ‘currencyget in the US, for example, with its manipulators’. Deutsche Bank Markets in 2011—Foresight with Insight
  • 9. 1.2 Jacques BrandLeaders Co-Head of Investment Banking Coverage & Advisory Edward Chandler Chariman, Global Corporate Finance Stephan LeithnerCorporate Multinationals Co-Head of Investment BankingStrategies in 2011 Coverage & Advisory2010 has been an extraordinary year: record low interest rates,massive currency swings and rising stock markets juxtaposedwith faltering western economies, banks failing stress tests,funds seized by regulators and, of course, several countries inactual or impending financial crisis prompting social unrest andassociated shifts in political regimes.Yet corporate multinationals have The fiscal impasse in the United States counterparts and, above all, defendingnavigated these unprecedented times is unresolved. While the flexibility their own home markets.with apparent equanimity, by and and resilience of the US economy islarge delivering on their forecasted undoubtedly without parallel, moves All these factors will continue to haverecovery in earnings. Some have to resume sustained consumer led a profound impact on companies ofcapitalised on the crisis by completing growth seem likely to impose stresses all sizes and in virtually all sectors inmergers or acquisitions. Others have on the international financial system 2011. The key issues that multinationalopted to wait out the storm, tightening which many outside the US will find boards will need to confront are:their belts wherever possible, investing research and development, How to weigh the near-term risks ofstrengthening their balance sheets The banking sector will continue to emerging markets against their long-and adapting their risk management absorb resources. Even as we move term rewards?procedures to the new environment. towards industry stability, banks It is clear that Asian consumptionAll, however, have been alive to the remain under-capitalised and exposed will drive global growth, and thatchanging growth patterns in the global to risky assets. Balance sheets will companies which can continue toeconomy and to the opportunities – need to be buttressed as institutions strengthen their market positionsand challenges – this presents for their exit the period of state ownership and in China and India, in particular, willstakeholders. support. Adding to this uncertainty is benefit in terms of the way they are the daunting amount of new regulation valued by the investment community.As we look to 2011, the road ahead which is set to place additional But emerging market economicappears uncertain. The sovereign debt restrictions on lending capacity. growth and capital inflows appear tocrisis is entering a new and potentially be on an unsustainable trajectory. Themore dangerous phase which will test Meanwhile, a new world order is risk of a bubble – coupled with socio-the limits of international coordination continuing to develop as the fast economic and environmental fragilityas the IMF, ECB, central banks, national growing economies in the eastern and – reminds us that growth cannot begovernments and supranationals seek southern hemispheres spawn major taken for tread the narrow line between multinationals of their own, competingpolitical practicalities and capital for human resources, technologies andmarkets reassurance. markets head on with their westernMarkets in 2011—Foresight with Insight Deutsche Bank
  • 10. How and when to deploy record How to manage currency and interestamounts of low yielding cash? rate volatility and the headwinds ofWith corporate liquidity nearing regionalised inflation?levels last seen in 2007, we expect We expect higher currency andcompanies to come under increasing interest rate volatility to be a featurepressure to spend their cash or of markets for the foreseeable future,return it to shareholders. Emerging causing added volatility in corporatemarket M&A present risks: valuations earnings and complicating capitalare expensive and execution more investment decisions. In addition,complex. We therefore expect EM- ‘managed inflation’ will be one of theoriented M&A to be balanced by an principal tools used by some of theincreasing number of European and more exposed economies to addressUS market transactions, as companies the aftershock of the credit crisis,seek to enhance their product and with consequences for commodityservice offerings better to tackle the and food prices and, in turn, foropportunities in third markets. Small the management of pension fundand medium sized companies will also liabilities. Finally, additional capitalembrace M&A as never before. constraints imposed on banks will force up the cost of traditional hedgingWill funding be available to support techniques and favour the adoptionexternal growth? of alternative approaches. All of theseThe answer to this question is a factors will force renewed attention onresounding ‘yes’. At least for the time risk management and hedging policiesbeing, shareholders would much around the board table.rather trust corporate managementteams to deploy cash resources than Will shareholder structures change?making those judgements themselves. We think so, gradually. For example,And they will express this view via a we detect a noticeable increasetolerance for longer pay-back periods in focus by the major sovereignon acquisitions than the traditional two wealth funds on European and USto three years, as well as a willingness companies (as opposed to financials),to support M&A with fresh equity if especially those that are the globalcircumstances require. As for the debt leaders in their sectors, or have strongmarkets, the continued compression exposure to so-called ‘secular growth’in corporate spreads in recent months sectors such as natural resources,points to high levels of liquidity and energy efficiency and certain sub-the availability of extraordinary funding segments of the food and healthcareopportunities – hybrids, long dated industries. Moreover, the lure of highissues and low coupon convertibles valuations on IPOs in Asia and Brazilto mention a few. The predominant will encourage many companiestheme, however, will continue to be to monetise parts of their business‘bonds rather than banks’. portfolios in those regions. Deutsche Bank Markets in 2011—Foresight with Insight
  • 11. 1.3 Marc BalstonLeaders Head of EM Quantitative Research Robert Burgess EMEA Chief Economist, ResearchEmerging Market Flows: Will the Wave Continue?Is a bubble coming? How will central banks stop one?Private capital flows into emerging market (EM)economies have rebounded strongly over the pastyear. Continued strong inflows will stretch theability of EM economies to productively absorbthem. In this environment, there is a risk thatasset price bubbles will start to form.While foreign direct investment (FDI) 2010, with over $50 billion of flowsremained relatively stable through the over the last quarter alone (figure 2).crisis, bank lending and investments inbond and equity markets were much The direction of investment hasmore volatile. These shorter-term also shifted, away from EMEA andflows recovered to an estimated $450 towards Asia and Latin America.billion in 2010, still some way off their Led by a sharp reduction in bankextraordinary pre-crisis peak of almost credit lines, shorter-term investments$800 billion but well up from their into Hungary, Romania, Russia,crisis-low of less than $100 billion in and Ukraine are expected to reach2008 (figure 1). barely 20% of their peak 2007 levels in 2010 (figure 3). Flows into Brazil,Bank lending accounted for much of Chile, China, Indonesia, and Thailand,the run up in inflows during the last however, look set to rebound above orwave of inflows into EMs, but has close to their recent peaks.been largely absent during the pastyear as major financial institutions Will capital continue to flow intoin advanced economies continue to emerging markets in 2011?rebuild their balance sheets. Instead, The flows are motivated by a variety ofthe current wave of inflows is more factors, many of which are long termconcentrated on debt and equity in nature and should continue to drivemarkets. Inflows into EM equity and inflows well into 2011. Fundamentalsdebt funds have been running at are supportive: EM economies arerecord levels in the second half of likely to enjoy a sustained growthMarkets in 2011—Foresight with Insight Deutsche Bank
  • 12. premium over developed markets, sustainable inflows into new markets markets (as opposed to foreignwhile also exhibiting a lower level of that ended abruptly and painfully are currency lending) will make for lessindebtedness compared to mature well known, from the Latin American painful and disruptive burden International investors debt crisis of the 1980s through to Central banks also have much largerremain underweight exposure to the Asian crises of the late 1990s. cushions of foreign exchange reservesEM, certainly in comparison to their Most recently, we saw credit booms on which to draw.share of global GDP (33%) and also in central and eastern Europe turn torelative to their share of world stock bust as the foreign bank lending that Nevertheless, there is inevitably amarket capitalisation (also 33%) and fuelled them dried up. risk that the volume of inflows willtheir share of world government debt start to stretch the ability of emergingoutstanding (16%). Anecdotal evidence Will it be different this time? economies to productively absorbindicates that many major developed Much of the emerging world is a them. In this environment, the riskmarket institutional investors hold fundamentally less risky place for that inflation accelerates and assetless than 5% in EM equities and less investors than it was 10–15 years ago. price bubbles form is substantial. Earlythan 2% in EM debt. And if these Public and private sector balance warning signs are already appearingfactors were not sufficient, the sheets are less leveraged than before among countries that have receivedcurrent exceptionally easy monetary and indeed much less leveraged than the largest capital inflows. Inflationconditions in the US, Europe, and their mature market counterparts. has started to drift upwards in Brazil,Japan are a further motivation to move Financial sectors are more developed Turkey, and parts of Asia. And policycapital from advanced to EMs. and better able to intermediate flows. makers in Hong Kong, China, and And, should things go wrong, the Israel, have taken steps to curb rapidWe have, of course, been here many relatively high share of investments growth in local property markets.times before. Episodes of seemingly into equity and local currency debtFigure 1: Figure 2:Private (non-FDI) capital flows to emerging markets by year ($ billion) Cumulative inflows to emergingSource: IIF Portfolio and other Bank credit markets mutual funds since the start of 2008 ($ billion) EM Equity funds (lhs)800 $ billion EM Debt funds (rhs) Source: EPFR700600 100 $ billion 40500 75 30400300 50 20200 25 10100 0 0 0-100 -25 -10 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 -50 -20 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11Figure 3:Private (non-FDI) capital flows to EM by country ($ billion)Source: IIF 2007 2010F160 $ billion140120100 80 60 40 20 0 Korea India China Indonesia Phillipines Malaysia Thailand Russia Polan Turkey Romania Sth Africa Ukraine Hungary Brazil Mexico Argentina Venezuela Peru Chhile Colombia Asia EMEA Lat Am Deutsche Bank Markets in 2011—Foresight with Insight
  • 13. 1.3LeadersWhat are the policy options for taming In practice, countries have adopted a big rise in the value of the realthese extremes? different combinations of these and large interest rate differentialsGiven this, a key question is how approaches depending on their which push up the costs of sterilisedcentral banks in EMs will respond particular circumstances. Central intervention, has twice raised its taxto continued flows. Their first banks in Latin America, emerging on foreign bond inflows.option is simply to allow currencies Europe, and Africa, for example, haveto appreciate. However, with past typically been more comfortable Where does this leave investors?crises still fresh in their minds, EM with currency flexibility whereas The anticipated continued asset-policymakers are acutely aware that those in Asia have intervened more allocation shift towards higher weightsthe loss of competitiveness associated aggressively in the foreign exchange for EM in global portfolios is likelywith even transitory currency strength markets (figure 4). In Latin America, to underpin the performance of EMcan take time to recoup. an increase in reserves equivalent to assets for the coming year. While about 6% of GDP between January ongoing measures to stem inflowsA second option is to limit appreciation 2006 and August 2008 coincided with will likely reduce the attractiveness ofby intervening. However, the resulting a 25% real exchange rate appreciation, some specific investments – notablyaccumulation of foreign reserves can whereas in Asia, much larger reserve domestic fixed income in countriesexacerbate overheating in already accumulation of 20% of GDP helped willing to impose controls, such asfast-growing economies, causing to limit real exchange rate appreciation Brazil and Taiwan – they are unlikelycredit growth, inflation, and possible to 7%. to change the overall attractiveness ofasset price bubbles. Sterilising the the asset class.intervention can help to prevent More recently, we have seen centralmoney and credit growth. But by banks step up their foreign exchange The extent of the inflows does raisekeeping interest differentials high, it purchases in Colombia, Israel, Peru, the risk of inflation and asset bubblesalso encourages even further inflows. South Africa, and Turkey. Others have within EM which argues for a bias implemented more direct controls on towards real assets. The extent ofAnother option is to try to stem inflows, though these vary widely in the flows also presents a real risk ininflows directly via capital controls or nature. Indonesia, for example, has that if it were to reverse it could beother forms of prudential limits. Their introduced minimum holding periods destabilising. However, we fail to seeaim is to curb flows of so-called ‘hot for some forms of debt. Thailand has any catalyst for such a reversal andmoney’ while prioritising the ‘stickier’ imposed a withholding tax on returns are confident that this is a risk whichcategories of overseas capital, such as on bond holdings, a measure also is unlikely to materialise before 2012 atforeign direct investment. being considered by South Korea. the earliest. Meanwhile Brazil, concerned aboutFigure 4: Different approaches to dealing with capital flowsFigure 4: Different approaches to dealing with capital flowsFour data points for each region shows: Latin AmericaSource: INF(i) Jan 06; (ii) crisis peak in REER and reserves; Latin America EMEA(iii) post crisis trougheach region shows: andFour data points for REER and reserves; EMEA Asia(iv)Jan 06;observation(i) latest (ii) crisis peak in REER and reserves; Asia Asia (ex China)(iii) post crisis trough REER and reserves; and Asia (ex China)(iv) latest observationSource: Deutsche Bank135 Reserves (% 2006-08)130 (iv) (ii)125120115110105 (iii) (i)100 95 90 85 REER (2005=100) 0.0 10.0 20.0 30.0 40.0 50.0 60.0Markets in 2011—Foresight with Insight Deutsche Bank
  • 14. Deutsche Bank Markets in 2011—Foresight with Insight
  • 15. 1.4 Henrik AslaksenLeaders Global Head of Mergers and AcquisitionsOutlook for Mergers & Acquisitions in 2011Cheap debt and strong cash levels will turn corporates to M&AUnderneath the overhang of fiscal deficits,currency swings and sluggish macroeconomicgrowth, the ground appears fertile for mergerand acquisition (M&A) activity.With access to cheap debt and high As we look to 2011, what remains the after tax cost of debt). The latestlevels of corporate cash levels1, as the most telling indicator during 12-month P/E of the S&P 500 is aboutboardrooms are faced with a choice: the upturn is where the pools of 14.7x, which gives the index a value ofreturn capital to shareholders or capital are. The most robust capital 27, about the highest it has ever growth. markets are found in highly developed By comparison, during the peak of the countries– like the United States up cycle in 2007, the index stood atFor corporates struggling with and western Europe. These markets circa 13.anaemic growth in their home also play host to some of the world’smarkets, the choice will be easier to largest companies with the strongest Underpinning this is an arbitragemake. Expect deal making to continue appetites for growth. Since capital is opportunity: low interest rates havesteadily increasing in 2011 as a result. mobile, it is fair to assume the deal significantly reduced the costs of flow will follow the money. funding a transaction using debtPools of capital providing an alternative source forPrevious upswings in deal activity We recently developed an ‘affordability corporates to fund growth.focused on particular sectors or deal index’, which tracks the gap betweenstructures – the technology boom in the implied P/E multiple of single A Disciplined approach to deal makingthe late 1990s/2000 and leverage in rated debt and the P/E multiples of In the early stage of this recovery,2007 – but the upturn in this deal cycle broad market indices such as the S&P companies kept an inward focusis spread quite broadly across various 500 and Euro Stoxx 50. The greater by streamlining assets and pruningsectors and transaction types. the index value, the more ‘affordable’ it portfolios. As M&A activity is for a company that can raise single continued, we saw the market forAt the turn of this past year, some A rated debt to fund the acquisition of leveraged buyouts trickle back,predicted certain sectors such as a target trading at levels comparable especially in the institutions and oil and gas to that of the broader the hotbeds for M&A activity. In With greater stabilisation in the capitalretrospect, the market hardly followed To illustrate, the composite yield on markets and corporate cash pilesthis trend. The top 20 deals of the year 10-year single A rated corporate debt increasing, the boardroom moodspan almost every sector and included in the US is currently approximately appears to have shifted from reactivecorporate reorganisations, strategic 4%. For an acquirer whose marginal to, asset disposals and emerging tax rate is 40%, the implied P/E of newmarket activity2. debt is therefore 41.7x (the inverse of Since funding growth is cheap, boards have a strong argument to pursueMarkets in 2011—Foresight with Insight Deutsche Bank
  • 16. deals as long as they are disciplined these countries in the near-term. Lack Deal volume in the near-term willon price. This strategy is likely to drive of developed capital markets outside likely follow a similar pattern ofmedium-sized transactions in the China and little knowledge of how to growth relative to their respectiverange of $1–5 billon, large enough to navigate new regulatory schemes, like regions, however the majority ofprovide meaningful synergies and/or Brazil’s, will continue to make deal activity will continue to come fromgrowth in emerging markets. making challenging, though developed economies. Regardless not impossible. of where the deals are, the upswingWhen BHP’s $43 billion offer for looks set to continue.Potash Corporation was rebuffed by Until these channels are betterregulators, we were reminded that developed, the BRIC deals that 1. Cash/market capitalisation ratios for S&P of 11.6% as of Q3 2010, and 12.2% for Euro Stoxxstakeholders will play a role in deal- crop up will be sporadic. For this 2010E; Source: Compustat and Deutsche Bankmaking that is equal to or greater than reason, the ‘bread and butter’ deals estimatesthat of shareholders. should continue to originate from 2. Source: Thomson Reuters the developed economies, where 3. Source: Deutsche Bank Economic ResearchThis stakeholder influence is a factor gross domestic products arethat will continue to be a characteristic growing at stable rates and capitalof deal activity. is readily available.BRICs Towards stable growthEvery corner of the market has focused Economic growth is undeniable inon how to invest in the BRIC countries emerging markets. Real GDP forecastof Brazil, Russia, India and China. for 2011, for example, is estimated to be 7.4% for Asia (excluding Japan),Though these markets present long- and 4.5% for both Brazil and Russia3.term growth potential, we believe Real GDP for G7 economies ischallenges remain for deal activity in projected to grow 2.2% in 2011. Deutsche Bank Markets in 2011—Foresight with Insight
  • 17. 1.5 Colin FanLeaders Head of Global Credit Trading and Emerging MarketsThe Rise and Rise of Chinese and Indian MultinationalsWhat companies to watch out forIt tells you a lot about the strength of China’s domesticeconomy that Industrial and Commercial Bank ofChina (ICBC) is the world’s largest bank by marketcapitalisation despite barely having started to ventureoffshore. It’s not alone: all of China’s top lenders, despitehaving done little more than build a few branchesoverseas, rank among the world leaders by marketvalue. When companies that are so powerful at homedecide it is time to expand overseas in earnest, there arealmost no limits to how big they could become.At multinationals across the region, purchases, like China Petrochemical current acquisition boom andthat’s exactly what is starting Corp’s $8.83 billion purchase of Addax Japan’s in the 1980s is that Chineseto happen. Chinese and Indian Petrolum in 2009. Indian companies companies are state-owned and makecompanies, having built vast customer have also been active: Bharti acquisitions for geopolitical reasonsbases and balance sheets at home, are Airtel’s $9 billion purchase of Zain’s as well as for profit.increasingly seeking to acquire and telecommunication assets in Africaexpand overseas. Everything is in their this year showing the scale of this new There are, though, challenges forfavour. They have cash at a time when found ambition. Indian companies in going overseas.potential targets elsewhere in the world International capital flows into India canare cheap, they are buoyed by fast Many Indian companies deleveraged slow very quickly if market sentimentexpanding domestic economies and during the expansion in the Indian turns, and domestic liquidity, thoughthey now have the confidence to grow. equity markets and now have ready plentiful, comes with a caveat: debt access to debt finance. Chinese raised onshore can’t be used forThere were more than 100 merger companies, meanwhile, are in many acquisitions, just for working capital.and acquisition transactions with cases even more cash-rich and enjoyChinese acquirers each year from almost unfettered access to capital Availability of domestic capital is not a2007 to 2009, compared to less than from banks as well as debt and equity problem in China. League tables of top30 in each of the first four years of markets on and offshore. equity and debt bookrunners in Asiathe decade1. Meanwhile, the value are packed with home grown Chineseof foreign acquisitions by Chinese Chinese and Indian businesses have names, but Chinese companiescompanies increased more than various reasons for buying offshore, seeking to acquire overseas attract30 times between 2003 and 2008. chiefly market access, technology a great deal of suspicion from theirChinese companies have also begun and resources they lack at home. targets’ governments and electorates,to make jumbo cross-border The big difference between China’s because the bidding companies areMarkets in 2011—Foresight with Insight Deutsche Bank
  • 18. usually state-owned. There are well to be enormously important. A series We may see greater activity fromknown examples of this, such as of liberalisations over the last year have Chinese banks, who despiteCNOOC’s failed bid for Unocal, and it set up Hong Kong as a proving ground accounting for 26% of all Chineseis unlikely to get any easier. for RMB liberalisation in a host of M&A over the last 10 years2, have so areas from trade finance to investment far only taken tentative steps towardsPrivate sector Chinese companies products, foreign exchange and local international expansion, such asface less interference. Look at Ping currency bonds. All of these will, in time, ICBC’s purchase of 20% of SouthAn Insurance’s acquisition of assets help to open up the onshore market Africa’s Standard Bank. The mostfrom Fortis or Huawei Technologies’ to foreign players, and in turn give active acquirers will be firms thatpurchase of parts of IBM. domestic champions more flexibility to import and export rather than firms in use their profits should they choose to sectors such as property and retailingBut no matter how genuinely go overseas. where domestic growth should becommercial a company’s aspirations, sufficient for years to come.the spectre of state ownership causes Outlook for 2011problems in other countries (although Expect to see further expansion There are a host of companies tonot, notably, in Africa, where many by Asian multinationals in 2011. watch: Chalco, which may buy bauxiteof the energy acquisitions have taken Companies in India will focus on mines for alumina refining; Jiangxiplace). In Europe and the Americas, natural resources. Coal India, which Copper, seeking foreign mines; Chinahowever, Chinese companies should recently completed the largest IPO Mobile, which is targeting developingcontinue to expect interference with in Indian history, has $8.4 billion on market telecommunications operators;their bids. its balance sheet and is looking for port operators China Merchants acquisitions in Indonesia, South Africa, and Cosco Pacific, again targetingIn India, where buyers are more Australia and the US. Oil and gas emerging markets; internet-relatedfrequently pure private sector rather assets are also likely to be in demand groups like Tencent and Alibaba, railthan state-owned, politics is less of a among Indian companies, although equipment companies such as CSR,problem. Names like Tata, whose most areas of previous activity – telecoms, coal companies seeking coking coalrecent acquisitions include Jaguar financial services, pharmaceuticals, exposure and buyers from otherLand Rover and Corus, or Reliance automotive – may be quieter. sectors including healthcare, steel andIndustries, which has been buying utilities.shale assets in North America, are For Chinese companies, resourcesconsidered credible partners who will also be a key target, but China Whatever happens, prepare forbring expertise to the table without the is also keen to secure infrastructure expansion both next year and for aagenda of a state mandate. assets in order to participate in the long while to come. real economy of foreign countries.FX is an issue in both countries. It’s less Despite potential political opposition 1 & 2. Source: Thomson Reutersof a problem in India, where the rupee is to such bids, China is unlikely torelatively liberalised, but the FX regime privatise state-owned companies tostill creates challenges such as the facilitate foreign acquisitions. Instead,ability of Indian companies to provide it will wait to see if the European crisiscorporate guarantees. It’s much more of develops to make Chinese capitalan issue in China, but here the gradual more attractive.internationalisation of the RMB is going Deutsche Bank Markets in 2011—Foresight with Insight
  • 19. 1.6 Ram NayakLeaders Global Head of Structuring10 Key Risks of 2011What to hedge against and howThe range of risks faced by borrowers andinvestors in 2011 is perhaps greater than at anytime since World War 2: an economic slowdown,sovereign defaults, inflation, rate hikes it isa formidable list.The good news is that nearly all Against this difficult background, thethese risks can be hedged thanks to best approach will be to identify andthe growth and development of the prioritise the risks that really matter,global derivatives market over the past and then to examine the differentdecade. options available. A top-down view on risk will also be helpful not onlyThe bad news is that it is likely to be to reduce correlation risk but to findexpensive – using plain vanilla options ways to bring hedging costs down byat least – because of huge uncertainty linking risks together.among dealers about where themarkets are heading. With this in mind, here are the ten risks that I believe cannot be ignoredSome companies will take the view this year (not in order of severity orthat the cost of hedging outweighs probability) and some suggestions onthe benefit. We believe this would be which to hedge and how.unwise given the scale of the potentialdownside.Others will prefer not to take anyrisk at all until the outlook becomesclearer. This, too, is a strategy wewould not recommend given theseismic changes underway in theglobal economy.Markets in 2011—Foresight with Insight Deutsche Bank
  • 20. 1. Eurozone Sovereign Default 4. Commodity Price Rises 8. LongevityI do not believe that a major Eurozone Commodity prices are expected An absolute must for insurancesovereign will default in 2011 but if by Deutsche Bank Research to rise companies and pension funds withone does, the results would be so significantly during the first half of policy holders living longer than ever.catastrophic that it does seem a risk 2011 as supply remains constrained The old approach was to buy long-worth hedging. Buying CDS protection and investors and consumers demand dated bonds but longevity swaps offeron a euro sovereign index may for commodity price participation greater precision and are much morecost you 400 basis points or more. increases. Risk management liquid than they used to be.Alternatives are to go short the euro strategies include extendible forwards,or wideners on the EUR/$ cross options and hybrids. 9. Regulatory Changecurrency basis. We may not know the details yet but 5. Rate Hikes it looks certain that within the next 182. Capital Markets Freeze Deutsche Bank Research expects months, many users of derivatives willTwice in 2010, we saw the bond rates to start rising in the US in Q2 and have to clear their trades via a centralmarkets close down to most forms for the European Central Bank to begin exchange rather than on an OTC basis.of new debt issuance. The issue – tightening earlier than expected. For We strongly advise all companiesEurozone sovereign risk – is still live. investors, front end payers would be a to get their back offices up to speedSolutions include front loading your good solution for both. ahead of time and do a full evaluationissuance calendar, private placements on how the changes will impactand loans secured by equity stakes. In 6. US Dollar Weakness profitability and infrastructure.the event of an equity capital markets Deutsche Bank FX Research’s view isshutdown, OTC structured alternatives that the US dollar may surprise on the 10. Borrowing Cost Risesare available. Another related risk upside this year. But for companies With banks cutting back for Baselis the emergence of a backlog in with extensive US assets, the risk may 3 and bond investors focusing onIPOs. Remedies for this include be too great to leave unhedged. Going emerging markets or safe havens, apre-IPO macro hedging and pre-IPO short the dollar via a forward is the rise in funding costs cannot be ruledconvertibles. obvious choice but comes with a stiff out for many firms. Asset backed opportunity cost price tag. Purchased finance and loans linked to proprietary3. EM Equity Bubble options could offer better value. trading indices can bring costs downIf Asian central banks fail to control to manageable proportions.inflation or take too aggressive 7. Inflationaction against it (thereby provoking Not an immediate risk for US anda slowdown), we may start to see European investors but one withthe flow of funds from the US and the potential to cause havoc in theEurope into Asia slow significantly medium-term given rising inflation inand perhaps start to flow the other Asia and the long-term effects of QE.way. We would look to go short Asian We recommend getting in early whilecurrencies. Investors can protect hedging levels remain attractive viathemselves against both using equity collars, swaps, inflation linked bondsput options (expensive) or put options and swaps.linked to volatility (cheaper). Deutsche Bank Markets in 2011—Foresight with Insight
  • 21. 1.7 Ivor DunbarLeaders Global Head of Capital MarketsFinancing OutlookHow easy will it be to raise money in 2011?2011 should provide among the most favourablefinancing conditions for companies in years,despite headwinds buffeting the global economyand the volatility disrupting capital markets.The outlook is highly attractive for opportunities for infrequent orcompanies looking to lock in low debut borrowers.rates for their bonds. There is a wallof cash looking for exciting equity We saw large numbers of debut issuesstories, and the market has shown it in Europe in 2010 and this trend willwill be supportive of well-considered, continue as European companies learnstrategic mergers & acquisitions. to master the post-crisis environment by reducing their reliance on bankFor companies seeking to tap bond lending as a preferred method ofmarkets, borrowing rates are at an financing. With banks continuing toall-time low and should remain so as deleverage in the wake of tough newcash-rich credit investors hunt capital requirements such as Basel 3,for yield. this theme of disintermediation should continue, with more companies going2010 saw a glut of sovereign straight to the capital markets for theirissuance, but 2011 should provide an financing needs.opportunity for corporate borrowers,particularly those that tapped the At the same time, the crisis and themarkets in 2009 when rates were ensuing regulatory climate has sparkedhigh, to take advantage of the low-rate innovation in financing, with banksenvironment, and push back the wall seeking to issue contingent capital – anof debt maturing in 2012 to lock in instrument that is at once a relativelynew funding at attractive rates. cheap form of financing and also a capital buffer. However, before theyIt is not just big names that are become a mainstream funding methodattracting investor attention. Record for banks in 2011, there remains alow interest rates of close to zero are question mark over the regulatoryforcing investors to hunt lower down status of tier one capital.the ratings chain for yield, providingMarkets in 2011—Foresight with Insight Deutsche Bank
  • 22. Equity investors are proving they to credit research and assessment. However, they should not preventare ready to support initial public Recent events indicate that large cap company boards from executingofferings. In 2010, there was a companies have generally done better strategic plans for which funding isscramble for growth stories such in IPOs than smaller, lesser known available. The ability with which BHPas the $20.5 billion flotation of AIA, companies. The difference between a Billiton was able to raise $45 billionthe Asian operation of AIG, which successful equity or bond issue and a for its ultimately unsuccessful bid forwas the third biggest IPO in history failure will lie in whether the company Potash proved there was life in theby volume and which was multiple has a strong story to tell and can syndicated loans market, and well-times over-subscribed. In the US, communicate it to investors. run companies with strong balanceinvestors showed a similar hunger sheets should find that marketsfor GM, whose $18.1 billion IPO was The challenges of 2010 should will be supportive of M&A deals ofalso heavily oversubscribed. Since continue into 2011 and beyond. strategic importance. With growth inSeptember, the majority of IPOs in the The shape of the global economic emerging markets outstripping thatUS have priced above or within the recovery remains uncertain, while in developed western economies, wefiling range and outperformed in we expect volatility to continue to expect companies to look increasinglythe aftermarket. be a feature of the capital markets towards financing M&A deals to gain as investors maintain a hawkish an edge.However, the apparent ‘perfect stance on sovereign and credit risk.storm’ of pent-up investor demand Crises such as those experienced The losers in 2011 will likely be thoseand borrowers’ increasing use of the by Greece and Ireland in 2010 are unable to come firing out of the blockscapital markets for their financing disruptive influences on markets that because their balance sheets are stillneeds is tempered by a more can temporarily prevent companies being repaired. But for the winners,discerning investor base taking a more accessing the capital markets. 2011 should be a year when they candiligent and sophisticated approach put rivals to the sword. Deutsche Bank Markets in 2011—Foresight with Insight
  • 23. 1.8 Jim ReidLeaders Chief Credit Strategist, ResearchIs 2011 the Last Year of the Credit Cycle?The final hoorahOne of our main secular views is that post thefinancial crisis, the world will return to the shorterlength of business/credit cycles that prevailedthrough history before the 25-year ‘goldenage’ that came to an end with the 2007 greatrecession. If we are correct, then 2011 could seeus entering the last full year of expansion, albeita year of expansion where there are plenty ofpotential flash points given the legacy of the debtsuper-cycle that the developed world has enduredsince the early 1980s.The more optimistic analyst might complacency as investors and policyconclude that while the developed makers extrapolated out the extremelyworld has problems, globalisation benign pre-crisis economic conditionsand once in a generation levels of as far as the eye could see. The lackemerging market (EM) growth could of inflation also allowed policy makersallow smoother and longer business to ‘fix’ every problem during thiscycles to prevail over the next few period, thus preventing the creativeyears. However we feel there is an destruction process that arguablyargument that globalisation has allows a reasonably efficient allocationdestabilised the economic system of resources. This also allowed afor the developed world. The secular tolerance of debt from investors,30-year reduction in inflation and consumers and policymakers alike,the ‘great moderation’ that have had that would have been unthinkable atheir roots in globalisation, reduced decade or two earlier.the number and severity of businesscycles in the developed world during The debt-burdened developed worldthe ‘golden age’. This arguably led to will now likely have periodic fundingMarkets in 2011—Foresight with Insight Deutsche Bank
  • 24. issues for the foreseeable future as in December 2007, then statistically it looks to fund a colossal amount of – if we are correct – the start of the private and public debt. With interest next US recession could be between rates now constrained by the zero August 2011 (median) and August bound and high historical levels of 2012 (average). public debt, the hands of governments are collectively tied, leaving policy This means that, again if we are makers with much less flexibility than correct, we could be entering the last they have had for at least 30 years. few quarters of the credit/business This means that recessions are likely cycle. We can’t know what will cause to happen more naturally over the next it to end but we suspect that policy few years and given the complete lack makers will be more powerless to of policy flexibility they may occur prevent it than they have been for with a higher frequency than the long- several decades. The dilemma for term average. investors is that while the business cycle is ongoing, then all risk assets Figure 1 shows that the last three (including credit) will likely perform complete US economic expansions fairly well. However be warned that were three of the five longest in the we are nearer to the end of the cycle 33 we’ve experienced since 1854, than the beginning and 2011 may be likely due to the complete flexibility the final hoorah. the authorities had to manage the business cycle. The average length of the completed cycle (expansion and recession) over the entire period is 4.7 years, with the median length being 3.7 years. Given that the last recession started Figure 1: US economic expansion lengths (months) since 1854 Source: Deutsche Bank, NBER 120 100 Average Median 80months 60 40 20 0 Dec 1854 Jun 1861 Dec 1870 May 1885 May 1891 Jun 1897 Aug 1904 Jan 1912 Mar 1919 Jul 1924 Mar 1933 Oct 1945 May 1954 Feb 1961 Mar 1975 Nov 1982 Nov 2001 Deutsche Bank Markets in 2011—Foresight with Insight
  • 25. 2 Economics EMU Crisis China United States Germany Emerging Markets ASEANMarkets in 2011—Foresight with Insight Deutsche Bank
  • 26. Deutsche Bank Markets in 2011—Foresight with Insight
  • 27. 2.1 Gilles MoecEconomics Co-Head European Economics Research Mark Wall Co-Head European Economics ResearchThe EMU CrisisWill Portugal and Spain follow Ireland?A key question for the Eurozone as the new ‘permanent crisis mechanism’ to August peak, is still at around EUR40end of a turbulent year approaches replace the EFSF when it expires in billion – or 7.1% of total bank assets, ais whether Portugal, and even Spain, 2013, spooked investors, especially similar level to Ireland’s 7.6%.will be forced to follow Greece and when German Chancellor AngelaIreland into seeking a rescue package Merkel said bond holders would have Meanwhile, Portugal’s governmentfrom the European Union and IMF. to share any losses in a sovereign has failed to make sufficient progressAnd a longer-term question for all default. That, unsurprisingly, led to on spending cuts. In 2010, its budgetfour countries is whether they will be a sell-off in the bonds of peripheral deficit actually increased. It also hasable to reduce their budget deficits economies and pushed government a persistently high current accountsufficiently to return their public borrowing costs up to record highs – deficit of around 10% of GDP,finances to a sustainable position, with in turn, threatening the ability of those indicative of a deeply entrenched lackor without external help, or will they countries to service their enormous of competitiveness.end up with no choice other than a debts.debt default? The government has to refinance Will Portugal follow? EUR10 billion of debt in the first threeWhy did the Irish crisis happen? At the time of writing, these two months of 2011, while banks willIn asking what may happen to external factors are still valid, so it is have EUR5 billion to roll over, so it isPortugal and Spain, it is instructive not surprising that Portugal is coming probably rational for the Portugueseto consider the fate that befell under marked pressure. Is Portugal government to call for rescue soonerIreland. During 2010, Ireland’s budget Ireland? Well, the liquidity position rather than later. This is especially thedeficit continued to widen despite of Portuguese banks is very fragile. case as the negotiation process withunprecedented austerity measures. ECB lending to the country’s banking the IMF/EU could be long because,At the same time, over-indebted system, although down from itsbanks were unable to shake off theimpact of the ongoing property slump,forcing the government, which hadagreed to underwrite the country’sentire banking system, to dramaticallyincrease its support to the point ofjeopardising its own finances.November’s crisis, however, was dueto external developments. First, theEuropean Central Bank made it clearit wished to begin withdrawing theextraordinary support to banks that ithad given at the height of the financialcrisis, since the European FinancialStability Fund – the support systemset up in the wake of the Greek crisisin May – was now in place. Ireland’sbroken banks were heavily dependenton ECB funding and so the entirebanking system came under strain.Second, the initiatives by Germanyand France in October to create aMarkets in 2011—Foresight with Insight Deutsche Bank
  • 28. unlike Ireland, Portugal’s economy Portugal, the ECB knows that Spain is What about Portugal?requires extensive structural reform so much bigger that it would represent As regards a future debt restructuringto boost its competitiveness. The a systemic risk for the euro. mechanism, nothing is yet certaingovernment is also a minority one, although reports indicate that ameaning the opposition will have to Will debt restructuring be necessary? permanent crisis mechanism wouldbe involved in negotiations to change Many investors argue that debt include changes in sovereign bondsthings such as the country’s pension restructuring (e.g. via maturity issued after 2013 to include ‘collectiveor welfare systems. lengthening or ‘haircuts’) is action clauses’, extensions in the unavoidable for some euro member duration of debt and ‘haircuts’ asIs Spain at risk? countries, especially Greece. The a last resort. This could, of course,Market concern that Spain will need argument goes that even the three raise risk premiums on the bondsto be bailed out has been a consistent years the rescue package buys the and so raise the cost of financefeature of the markets for nearly country to reform its finances and to governments, but that woulda year. Fortunately, the country’s enable it to get in a position to service depend on the existence of otherfiscal and economic developments its debts on the open market will support arrangements too, such ashave gone in the right direction, simply not be enough. the continuation of an EFSF-typemaking the country fundamentally mechanism.different from Ireland and Portugal. Greece’s public debt-to-GDP ratioThe budget deficit is falling, as is the could reach 170% by 2013 if growthcurrent account deficit, and banks is only slightly weaker than the IMFare enjoying easy access to money currently expects. This would make itmarkets for funding, making them very difficult, although not impossible,less dependent on ECB lending (which to service that debt on the openonly accounted for 1.9% of total bank markets from 2013. We continue toassets in October 2010). believe, however, that given enough time and external support, a unilateralWe think that the cuts made thus far restructuring of sovereign Greek debtand the budget for 2011 are enough to can be avoided.get Spanish public finances back on asounder footing. This being the case, We think Ireland should be able towe don’t think Spain should engage in return to market financing of itsfurther austerity for fear of damaging deficit by 2013, even including thegrowth and thus worry markets about enormous cost of bailing out its banks.the speed of the country’s private Spain and Portugal may yet havesector debt adjustment. But we believe to recapitalise their banks if marketthe country does need to speed up the pressure persists. In this regard, Spainrestructuring and recapitalisation of looks safer than Portugal. Public debtits banking sector to address market there should reach only 73% of GDPconcerns on this point. by 2013, thanks to a very low initial level (53%). This gives it a margin toEven if markets do continue to pay for recapitalisation, especially aspush Spanish interest rates up, we its recapitalisation vehicle (the ‘FROB’)think the ECB could provide a crucial can issue up to EUR90 billion, or 9%circuit-breaker by providing lots of of GDP.liquidity to Spain’s banks. Althoughit has proved unwilling to providemeaningful support to Ireland or Deutsche Bank Markets in 2011—Foresight with Insight
  • 29. 2.2 Brad JonesEconomics Asia Investment Strategist, Research Jun Ma Chief Economist Greater China, ResearchChina and the Ghosts of Japan’s Heisei BubbleWill China repeat Japan’s boom and bust?As international pressure intensifies now also set to decline. Both countrieson China to step away from renminbi have employed a socio-political(RMB) intervention, the ghosts model in ‘state-based capitalism’of Japan’s battle with currency with the principle aim of minimisingappreciation are resurfacing. unemployment rather than maximising shareholder returns.Some economists and analysts whobelieve Japan’s Heisei boom of the However, upon closer investigation,1980s, and subsequent bust, was we find the hypothesis that sustainedcaused by the relentless appreciation yen strength was the root cause ofof the yen, fear that a similar fate Japan’s problems to be unconvincingmight befall China in the years ahead. – as we do the idea that China will likely lapse into Japan syndrome asDuring the 1980s, US public opinion the RMB inevitably strengthens. Forperceived US hegemony to be under a start, Germany’s revaluation of thethreat from Japan. A book by Harvard mark was not followed by a Japan-Professor Ezra Vogel entitled Japan style bust. Furthermore, Japan hasas Number 1: Lessons for America continued to run a sizeable tradebecame a bestseller, and Japanese surplus. Rather, we believe ill-directedsalarymen were reported to sprinkle financial sector deregulation andgold-flakes on their noodles. monetary policy error were the major contributors to Japan’s undoing.By 1989, Tokyo accounted for morethan half of the world’s stock market The squeeze on lending margins incapitalisation, with the Nikkei trading Japan in the early stages of financialat 70x earnings. By 1991, property in sector deregulation prompted a sharp The lines of demarcationTokyo’s Ginza district was said to be deterioration in lending standards The following factors suggest to us aselling for $93,000 per square foot and an increase in loans to suspect more benign adjustment for China.with Tokyo land values worth more SMEs. The proceeds of capital raisings First, at just 47% currently, China’sthan all the land in Britain, Germany by corporates were also frequently urbanisation rate is well below Japan’sand France, and the grounds of the used for speculative land and stock at the peak of the bubble (63%), withImperial Palace being more valuable purchases (a process known as the UN projecting a further 270 millionthan the state of California. ‘zaitech’). But the eventual collapse people will become urbanised in China in asset prices resulted in a self- over the next two decades. Second,At first glance, the parallels between reinforcing cycle of loan defaults and the consumption share of GDP in1980s Japan and China today might negative earnings, compounded by China is just 35%, and so hasappear striking. Both countries have extensive bank cross-shareholdings significant scope to take over thesuccessfully employed a mercantilist (banks counted unrealised capital baton of growth as fixed assetexport model to help fast-track gains on equities as capital). As for investment decelerates, while Japan’seconomic development. Partial monetary policy error, the Bank of consumption/GDP ratio was alreadyderegulation of the banking sector Japan initially eased too vigorously in around 54% in the 1980s. Third,in Japan was followed by a sharp the short-lived 1985 recession, and Japan’s stock market lookedexpansion in credit and a boom in then refrained from withdrawing the manifestly overvalued, peaking at 5.5xproperty prices as it has in China. A monetary punch bowl for too long in book and a PE ratio of 70x, whilepeak in the working age share of the the subsequent recovery. The collapse China’s stock market currently tradespopulation in Japan coincided with the in the real policy rate from 4.6% in at 2.3x book and 14x PE, and with atop in equity and land prices. China’s 1983 to -0.5% in 1989 helped fan the considerably lower degree of bankworking age share of the population is flames of the asset bubble. cross-shareholdings. Fourth, China’sMarkets in 2011—Foresight with Insight Deutsche Bank
  • 30. banks have boosted capital ahead of 3. For domestic residents, valuationBasel 3 and a potential rise in NPLs, and policy support will favour equities Outlook for 2011and the ratio of private credit/GDP is over property as long-term real wealthmuch lower in China than in Japan in preservers, while the corporate bond For 2011 as a whole, we maintain our1989 (127% versus 193%). Fifth, market remains small and low-yielding GDP growth forecast of 8.7%, downbroadening pension coverage, from a bank deposits uninviting. Less than from 10% in 2010. We expect qoqvery low base, should support local 15% of the population has direct growth to slow from Q2 of 2011 onasset markets over the medium term. exposure to stocks. the diminishing impact of inflation expectation on orders, monetaryInvestment implications 4. With consumer stocks in China tightening, slower property investments,We believe there are a number of trading at elevated valuations, cheap and deceleration in export growth.investment implications that follow large caps in the developed markets We expect nominal export growthfrom China’s broad policy and that increasingly derive their revenues to slow to 15% in 2011 (from 30% indemographic trends: from China appear interesting. 2010), nominal fixed asset investment growth to decelerate to 20% in 20111. China is on the cusp of exporting 5. China’s new five-year plan points (from 23% in 2010), while retail salesinflation abroad, as the working age to slower but better quality growth, growth to remain largely unchanged.cohort in China peaks, wage growth and hence lower shareholder dilutionaccelerates above productivity risk in strategic sectors like banking We expect H1 2011 to see risinggrowth in key sectors, and trend and energy. inflation, with H2 witnessingRMB appreciation raises US import disinflation. We expect monetaryprices from China (note Emerging Asia 6. Unlike Japan, China is unlikely policy to get tighter until mid 2011.accounts for nearly a third of total US to fully liberalise its capital account Benchmark interest rates will likely riseimports). while the RMB is still significantly 75bps in the coming seven quarters, undervalued. The RMB is likely to have and yoy loan growth should decelerate2. To help secure its strategic needs and already undertaken a significant part to around 14% in 2011 from nearlyrebalance its existing foreign portfolio of its journey towards fair value by the 20% in 2010.(which is very exposed to inflation), time liberalisation has materialisedChina will likely shift its focus to real in five to 10 years. As such, we think For H2 2011, we expect macroassets, including stocks (89% of its longer-dated RMB forwards offer policies to shift towards relaxation onUS asset holdings are in Treasuries investors good value. disinflation as well as moderation inand agencies, just 5% in stocks). Note sequential GDP growth.that China’s FX reserves can now Brad Joneshypothetically purchase 25% of the Fiscal policy in 2011 will also likely Sources: United Nations, become less expansionary, although itS&P500 market cap (versus 1% a Deutsche Bank, Bloomberg et al.decade ago), and 100% and 150% of the will still likely be labeled as “proactive”.market cap of the MSCI World Materials We expect the deficit/GDP ratio will toand World Energy indices respectively. fall to 2% in 2011, down from 2.5% in the 2010 budget.Figure 1: Due to inflationary pressure, we expectChina is on the cusp of Figure 2: the government to postpone thea shift in real assets RMB appreciation will feed expected hikes in water, gas, power andSource: US Treasury Dept, DB Global Markets Research into US inflation oil prices in the coming months. OtherData as at Sept – 2010 Source: US Bureau of Labor Statistics, reforms, such as the increase in state China’s holdings of US assets (lhs, $ billion) DB Global Markets Research China’s holdings as % of all US asset holdings (rhs) US import prices from China owned enterprise dividend payment 12 month change in RMB versus $ ratios, promotion of manufacturing900 60% 10% upgrade, RMB internationalisation, tax800 cuts on service industries, and deposit 50700 8% rate deregulation will likely see progress in 2011.600 40 6500 4 The key risk for 2011 is that if the 30400 government fails to implement 2 aggressive policies (e.g. rate hikes and300 20 credit tightening) now it may end up 0200 with higher inflation later in the year. If 10100 -2 inflation rises to 6-7%, the government will have no choices but to take 0 0 Treasuries Agencies Corporate Short-term Equities -4 draconian actions that could lead to a Bonds fixed income Dec 05 Dec 06 Dec 07 Dec 08 Dec 09 Dec 10 hard landing of the economy. Jun Ma Deutsche Bank Markets in 2011—Foresight with Insight
  • 31. 2.3 Peter HooperEconomics Co-Head of Global Economics, ResearchOutlook for the US EconomyWhat’s different this time?The year ahead is likely to remain and durables goods – face ongoing into uncomfortably low territorychallenging for the US economy adjustment. Excess stocks of vacant relative to the Fed’s objectives, andfollowing a disappointing pace of homes and commercial properties this development has been one factorrecovery in 2010 from the deepest built during the boom years still need that induced the Fed to take out somerecession in decades. We see growth to be worked off, and households may more insurance via QE2. Thanks toof real output running modestly above want to raise saving rates further for the Fed’s aggressive easing, whichits estimated trend rate of about a time to recoup some of the wealth has also helped to anchor inflation2.5% for 2011 – enough to generate losses they incurred following the expectations at comfortably positivesignificant job growth but not a plunge in home prices and equities levels, we expect core inflation tosubstantial reduction in the current during the downturn. stabilise soon and to edge higherhigh rate of unemployment. However, over the year ahead. The Fed willongoing adjustment of household and The key headwinds most likely complete its intendedbusiness sector balance sheets will So far, only one of the economy’s QE2 commitment of making anotherclear the way for stronger growth to four key cyclical drivers is functioning $600 billion in new purchases ofcome in 2012, if not sooner. normally: business spending on Treasury securities. However, with capital equipment which is growing prospects improving for a faster paceThe normal cyclical pattern in the fairly robustly from very depressed of recovery still to come, furtherUS is one where inflation rises as levels. The other three key drivers purchases seem unlikely, and interestthe economy overheats, leading the – residential and non-residential rates will eventually be movingFed to step on the brakes and raise construction and spending on substantially higher.interest rates to slow interest-sensitive consumer durables – are still lagging,spending and push the economy into but they should begin to join in as therecession. The Fed then cuts rates excess stock of vacant homes andand interest-sensitive discretionary commercial properties is run downspending rebounds, leading the and as household balance sheets areeconomic recovery: the deeper the further repaired. How long will thesedownturn, the stronger the recovery. adjustments take? Probably at leastThis time around, the recovery another year, and this, along withprocess should be a good deal more the unwinding of fiscal stimulus, isprolonged. why we are cautious about growth prospects for 2010. But there isSo what’s different this time? considerable uncertainty around suchThis time around, the pace of recovery estimates, and we could as easilyhas been painfully and abnormally be surprised by a faster recoveryslow despite the extreme depth of than a slower one. Once all fourthe downturn and an unprecedented cyclical drivers are back on track, thedegree of monetary and fiscal expansion will look and feel a goodpolicy stimulus. This is because the deal more robust.recent recession was caused not byaggressive Fed tightening to deal Inflation uncomfortably lowwith inflation but by the inflation and for the Fedbursting of residential and commercial As a result of the very weak labourreal estate bubbles and an ensuing market, labour cost inflation has beenfinancial crisis. The sectors that low and declining, contributing to anormally lead the economy in the downtrend in overall US consumerrecovery phase – household and price inflation. Excluding food andbusiness spending on structures energy, inflation has begun to moveMarkets in 2011—Foresight with Insight Deutsche Bank
  • 32. Deutsche Bank Markets in 2011—Foresight with Insight
  • 33. 2.4 Tom MayerEconomics Chief Economist, Deutsche Bank Group, Research The Outlook for Germany Germany is back! Germany is back – and not just in soccer and Formula One. Its economy has weathered the crisis extremely well, surprising all market observers. With 2010 growth of 3.75%, Germany was the growth star among the G7 countries. Moreover, it had the highest growth rate since unification, reversing a hefty 4.7% slump in 2009 and proving that German companies and politicians got much right before the crisis. The success story will continue in 2011, albeit not with the exceptional growth rates seen last summer when real GDP expanded by almost 6.5%Markets in 2011—Foresight with Insight Deutsche Bank
  • 34. (qoq annualised). Corporate Germany on the German labour market. While favourable wage drift and a soundhas been thinking and acting globally elsewhere politicians are fretting labour market indicate, therefore, thatfor many years. Its focus on capital about jobless recoveries, the average private consumption should increase bygoods and high end consumer goods number of unemployed should fall to around 1% – twice the annual averagehelps explain its success in emerging almost 3 million in 2011. of the last decade.Asia. Politicians have embarked ona path of social reform which other So where is the catch? The strong recovery and the labour-countries are now starting to follow. In part, despite all the structural market upswing should bring relief improvements, almost half of for public sector budgets. Due toPrudent fiscal policy, which should Germany’s impressive growth rate the position in the cycle and thebring the fiscal deficit clearly in 2010 is down to pent-up demand reduction of the structural deficit bybelow 3% in 2011, has added to and the catch up in investment in half a percentage point, we believeGermany’s clout in reforming the Germany and abroad. The recovery the overall budget deficit will drop justStability and Growth Pact and in important export markets began below 3% of GDP. Germany will beimplementing a permanent crisis to lose steam at the end of 2010. The the only large country in the Eurozoneresolution mechanism. The results fact that favourable depreciation rules to fulfil the Maastricht criteria.of these reforms are clearly visible will run out at the end of the year will Furthermore, there is limited risk that also weigh on investment activity, German inflation will rise perceptibly, while continuing low interest rates which should be somewhat reassuring will support spending. Against this for the ECB as it deals with the backdrop, growth looks set to slow wider needs of European peripheral to almost 2% this year. But economic countries in the doldrums. growth should be robust and again markedly above potential which we estimate at 1.25%. The hotly debated question then is whether private consumption – the Achilles heel of the German economy – will take over from net exports and investment as the major growth engine. The signs are encouraging. The recent uptrend in vacancies and the high number of companies that are planning to create new jobs point to continuing employment growth. Despite the imminent discussion about larger wage hikes in 2011, wages are unlikely to grow by much more than 2.5% in 2011, especially since only a minor part of the collective wage agreements is up for renewal this year. As many German companies rely on global value chains and can shift production elsewhere, wage growth that is too strong would quickly lead to job losses in Germany. One-off payments, a Deutsche Bank Markets in 2011—Foresight with Insight
  • 35. 2.5 Gustavo CanoneroEconomics Head of EM Economics ResearchOutlook for Emerging Market EconomiesAnother good year ahead but not for allThe year ahead looks set to be EM economies currently enjoy The reinforced case for EMchallenging for the global economy. stronger economic fundamentals The traditional case for EM growthHowever, 2011 should be another than most developed countries – outperformance is largely based onrelatively good year for emerging lower public debt, healthier financial continued income and technologicaleconomies particularly when systems, relatively low private sector convergence. The poorer the country,compared to the industrialised world. leverage, lower external debt and the greater the scope for convergenceThe smaller and more open emerging financing needs, better population tends to be. Beyond this convergencemarket (EM) economies should remain dynamics, etc. These factors we argument there are a few specificquite sensitive to developments in expect to facilitate faster economic EM factors that are likely to helpadvanced economies, making the growth and further fundamental sustain high levels of growth in theserecovery of the industrialised countries improvement ahead. According to economies. For example, lowera central risk to performance. The Day After Tomorrow, a new book urbanisation rates in EM suggest theHowever, the larger emerging by the World Bank, the diverging potential for sizeable productivityeconomies look likely to outperform growth prospects will continue in the gains. Likewise, demographics shouldagain this year. For them, the impact of medium term, with EM maintaining continue to work in favour of mostsignificant capital inflows represents the upper hand, and regions like East EM for the time being. Similarly,the critical danger, albeit more from and South Asia, Latin America, and financial development is still narrow,a medium-term perspective. How soon Africa, having the potential to providing substantial scope forEM manage the availability of cheap turn into ‘newly developed’. increases in productivity of capital.financing, which has led to excesses Also, factor endowments, particularlymany times in the past, will be the We agree with this view although we commodities and labour, seem to beultimate test of their economic and note that such an outlook does not ample, while commodities are likely toinstitutional maturity. necessarily apply to all EM countries. continue benefiting from the changing Large and relatively closed economies global demand balance.As described in the other outlook in EM with limited leverage, like Brazil,pieces of this document, significant China, India, Indonesia, and Russia, EM have received an additionaluncertainty about the future of the although to a lesser extent, are likely to boost from the recent financial crisismost advanced economies should continue differentiating positively from which has pushed up public debtcontinue next year, suggesting that the rest of the world in most global in industrial countries on top of areturning to financial stability and scenarios. Similarly, robust economic negative spending dynamic due todecent economic growth in the systems with solid fiscal and external ageing. Public sector debt in theindustrialised world will take a while. situations like Chile, Peru, Philippines, main economies is likely to exceedBut EM economies and assets are Colombia, South Africa, Turkey, 110% of GDP during the next decadeprojected to do well, offering faster and Argentina are also expected to while the median EM country debteconomic growth and robust asset outperform. Most other countries in ratio is sure to remain below 50% orreturn. Specifically, EM economies are the EM universe have either weak decline further. Such a fiscal burdenprojected to grow by 6% in 2011 after economic fundamentals or are too in the developed world togethergrowing 5% in 2010. Industrialised exposed to global forces. For the first with undercapitalised bankingcountries are forecast for 2% growth. group, outperformance means further systems will only help the case of EMThe difference in these forecasts is strengthening in currencies, likely outperformance in years to come.*exacerbated by China’s economic tightening or stable credit spreads,projections, but China is not the only and further converging real interest Vulnerabilities and risksdriver, with EM GDP growth excluding rates. For the second group, 2011 The above arguments notwithstanding,China forecast to be close to 4.5% in could be a difficult year, but unlikely to we have some concerns. A traditional2011.* resemble the sharp economic swings reason for caution about EM is of the past. based on the relatively weak basisMarkets in 2011—Foresight with Insight Deutsche Bank
  • 36. EM’s growth differential versus advanced economies Source: World Bank, Growth differential EM versus Industrial Country DB Global Markets Research Avg. differential per decade 7 6 5 4 3 2 1 0 -1 -2 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007for rapid and sustained growth given by large production of tradable goods. Similarly, we are likely to witness theproduction factor bottlenecks; i.e. However, in our view, moving countries continuation of growing instabilitythe lack of enough accumulation like China away from this specialisation and uncertain support for reformingof capital goods, human capital, in manufacturing could slow Chinese administrations in EMEA. There isand technological progress in many medium-term growth by over 2% a no evidence as yet of such politicalEM economies. While lack of fixed year, reflecting the inherent instability shifts in emerging Asia, althoughinvestment might not be a concern of the current global balance. one could view the growing Naxalitein many emerging Asian countries movement in Northeast India, which(given the revealed preference for high Another typical concern about the has weakened central governmentsavings and investment), investment current conjuncture is related to authority in much of the territory andin education and human capital is a the political economy equilibrium disrupted investments in commoditymuch less advanced in Latin America that demands a slow process of re- extraction, as to some extent aand some EMEA countries, where balancing. The rise of protectionist reaction against the way in which freefixed investment ratios have remained rhetoric in the US and Europe is the market economics has been broughtbelow 20% even after achieving most evident expression of such to the region.improved growth performance amid concern. Disillusion with the prevailingsteady macroeconomic stability. international order was probably the In summary, there are a number of main cause of the end of the previous reasons to question, at least, a rosySimilarly, while a young population large wave of globalisation, largely EM outlook in any global scenario forseems to be a common advantage of precipitated by the Great Depression. any emerging economy. Indeed, oneEM countries versus more developed could further argue that improvedones, this is not a general situation. Furthermore, even after a few years macro fundamentals might wellMany eastern European countries of political stability in EM, we cannot reflect a super pro-cyclical natureface worrying population dynamics, in totally rule out political shocks in the of these indicators, further raisingsome cases as bad as Western Europe future. Undoubtedly, democracies doubts about the actual sustainabilityor Japan. are dominating and political stability of such improvement. However, the has been gaining robustness thanks main candidate for trouble in theLikewise, a potential new global to improving economic performance. next couple of years could be theequilibrium where the big savers of Nonetheless, EM investors could still continuation of the capital bonanza.emerging Asia would have to consume face a 180-degree change in Peru’s That has led to booms and burstsmore and export less could be a risk policy if the left wing opposition were in the past and avoiding them willfor growth in EM. Some economists to win in the presidential election of demand prudent policies and abelieve that emerging Asia’s growth in April next year (which looks unlikely cautious political stance, not yet athe past few years has been facilitated but yet is a possible scenario). guarantee in many EM countries. *Source: Deutsche Bank Research Deutsche Bank Markets in 2011—Foresight with Insight
  • 37. 2.6 Taimur BaigEconomics Chief Economist India, Indonesia and Philippines, Research ASEAN Outlook Still attached to the G3? Three years ago, as the global growth applying a multiplicative factor of 3. picture began to fray, there was In other words, through the course a great deal of discussion about of this crisis, East Asian economies decoupling. The proponents argued have revealed themselves to be tightly that because of their relatively coupled with the fate of the G3. stronger fundamentals, the economies of East Asia would differentiate Since our G3 forecast for 2011 is lower themselves by not slowing down while than 2010 (US: 3%, EU: 1%, Japan industrial country growth decelerated 0%), do we therefore believe that East in 2008. There seemed to be some Asia’s growth will be proportionately merit in this line of reasoning: Asian lower as well? Indeed, we have economies, by and large, enjoyed low lowered our growth forecast for the fiscal deficits and debt (both public region to 4.6%, dovetailing with the and private), generous reserves cover, expectation that euro area growth sound banks, manageable inflation, will be lower by 0.5% and Japan’s by and high savings. They were also 2.5%. Despite the US forecast being characterised by a sizeable pick-up in essentially the same as the expected intra-regional trade. Surely this would outcome for 2010, Asian economies insulate them from a slowdown in will find external demand weaker external demand, the argument went. because of the other two parts of the G3. The expectations turned out to be premature. While their fundamentals The reason for the tight attachment is are undeniably strong, the open, not surprising. There exists remarkably trade-oriented economies of Asia still close linkage between regional exports seem to be attached closely to the and consumption. Even investment economic cycle of the G3. The macro looks to follow the export cycle data from the past couple of years closely. In recent years this linkage underscore that point. Outside of has not waned, underscoring why China and India, the rest of Asia’s real the East Asia region remains a strong GDP grew by 3.3% in 2008, followed beta to G3 growth. Of course there is by almost zero growth in 2009, and is substantial heterogeneity among the expected to grow by 7% in 2010. This countries in the region. Singapore, pattern of growth can be derived by Hong Kong and Taiwan reveal the taking the G3 growth trajectory and highest degree of export reliance andMarkets in 2011—Foresight with Insight Deutsche Bank
  • 38. elasticity with respect to G3 growth. dynamic of ASEAN and North Asia inflows in the new year. We haveMalaysia, Thailand and Korea follow, remains remarkably similar. This is already seen several episodes ofwith substantial but relatively smaller of course due to the fact that China’s easy liquidity-driven surges in flowscorrelation with industrial country role in Asia today is still largely as a which have caused complicationsdemand. Indonesia is a stand out, processing location for the rest of with regard to reserve accumulation,looking closer to India/China with its Asia’s exports – goods are exported exchange rate appreciation, assetinternal demand dynamic dominating to China, processed (often with little price spikes, and lending booms.the export dynamic, although the marginal value added) and re-exported We expect these issues to remaincountry’s fortune remains tied to the from China (mainly to the US and front and centre as investors arecommodity price cycle to some extent. the EU). likely to maintain their interest in Asian markets as growth and interestIn addition to the notion of decoupling, While growth should likely slow rate differentials stay compelling. Inthere is also this tendency to think of somewhat, inflation risks could reaction, more measures to reducethe Association of Southeast Asian resurface in 2011 in East Asia as flow volatility ought to be expected.Nations (ASEAN) countries as a commodity prices firm up further. There could also be an addedgroup, distinct from the North Asian Food prices may also pick up after a complication if the secular rise ineconomies. The distinctions, however, relatively benign year. But we don’t flows is interspersed with periodsdissipate under closer scrutiny. ASEAN think that policy makers would have to of risk aversion owing to the fiscalincludes both Asia’s most export- raise rates in a hurry as prices should problems in EU’s peripheral countries.dependent economy (Singapore) likely rise gradually barring shocks.and also its least sensitive economy Other than Indonesia, we don’t find All in all, 2011 should not look a(Indonesia). As a region, ASEAN is on any other East Asian economies whole lot different from 2010. In ouraverage slightly less open and slightly flirting with overheating. Policy rates view growth will slow and inflationless sensitive to global growth than should rise eventually in the region, will rise, but only somewhat. EastNorth Asia. Also, ASEAN has a lower but at small increments, and mostly in Asia will remain coupled to G3share of its exports going to China the second half of the year. demand. Since we don’t expect muchthan North Asia. Still, it doesn’t seem vigour in the G3, there should notto matter. Whether exports are going The region will likely continue to be much in the way of spectacularto China or elsewhere, the export struggle with managing capital performance in this region either. Deutsche Bank Markets in 2011—Foresight with Insight
  • 39. 3 Markets Regulation Asian Equities European Equities US Equities EM Equities FX Commodities Rates Real Estate Asset Backed Securities Art55Markets in 2011—Foresight with Insight Deutsche Bank
  • 40. Deutsche Bank Markets in 2011—Foresight with Insight
  • 41. 3.1 Daniel TrinderMarkets Global Head of Regulatory Policy Stephen Wolff Managing Director, Strategic Investments Regulatory Change What’s coming up and what to do about it The rules governing financial markets need to be overhauled to make them and financial institutions are likely to compatible with clearing houses. change more in 2011 and 2012 than at More significantly, it will also change any time since the markets were first the amount of margin that is posted. regulated in the 1930s. Many clients who have never had to post margin before, will have to, many Every major company of note will be clients already posting margin will affected from corporates and banks likely have to post more. Derivative to hedge funds, insurers and pension pricing and costs are almost certain funds. The cost will be enormous. to change. Details of derivative trades Billions of euros will need to be spent will start to be made public. on new IT systems and operational infrastructure between both market Key details such as which derivatives participants and the authorities that must be executed on a swap over see them. The impact on the execution facility (SEF) and which can markets will be as great, if not greater, continue to be done on an OTC basis, than the Big Bang in the UK in 1986 what constitutes a swap execution and the repeal of Glass Steagall in facility, which derivatives must the US in 1999. But many of the be cleared centrally, and whether final details have yet to be decided; some types of organisations will be opportunity still exists for businesses excluded from the rules, have been likely to be affected to make their left to the Commodity Futures Trading voice heard so that the changes Commission (CFTC) and the Securities benefit rather than harm the world’s and Exchange Commission (SEC) to financial markets. determine. So what are the key changes, when The details of regulatory reform are will they take place, what impact will expected to be in place by July 2011 they have, and what will companies with implementation beginning for need to do comply with them? some rules in the third quarter of 2011 (after a 60-day period following OTC derivatives publication); while other rules will only This is the big one. Under the Dodd- come into effect in 2012. Frank Act, US organisations will no longer be able to trade most forms We expect the final rules to require of derivatives over the counter with financial institution clients using brokers and banks, without also ‘flow’ derivatives on a wide range clearing them through an approved of asset classes, such as equity, central clearing house. foreign exchange, credit or interest rates to centrally clear transactions. This means that all the back office Corporates will be largely excluded systems and trading networks of from this requirement. derivative market participants willMarkets in 2011—Foresight with Insight Deutsche Bank
  • 42. European organisations will almost to them. There is still time to make acertainly be subject to similar difference to the final details of therestrictions. Plans to move to central proposed changes.clearing, and plans for increasedtransparency, are included in both Short sellingthe European Market Infrastructure Regulators are keen to implement newDirective (EMIR) and the Markets measures on short selling – indeed thein Financial Instruments Directive German government already has.(MiFID) respectively. The two piecesof legislation are at different stages of Under initial EU proposals, shortdevelopment; but further details on sellers will need to disclose positionsboth were scheduled for publication to regulators and large positions toby the end of 2010 with a final version the general public. They will also needof EMIR being agreed in mid-2011 for to have located the stock, makingimplementation in early 2012. uncovered short selling impossible. It will also be possible for nationalAs a regulation, EMIR does not need European regulators to restrict or banto be approved by national parliaments short selling in their the EU to come into force so thetimetable is more likely to be met. If badly crafted, these changes could impair legitimate investment and riskThe rules in Europe are expected to management strategies. A regime thatbe broadly similar to those of the US generates greater consistency andexcept that the rules forcing trading to transparency should be welcomedbe conducted on electronic platforms but we are particularly concerned thatmay be less strict. if these measures are not thought through they will have significantAlthough changes are not expected detrimental effects on market liquidity,to occur anywhere in the first half trading volumes and bid-ask spreads.of 2011 – and only in the US in thesecond half – it is critical that users of The rules are not likely to be finalisedOTC derivatives likely to be affected in mid-2011 and come into effect inby the new rules prepare a strategy to with them. Commodity marketsFirst off, they will need to choose a Commodity markets are generatingclearing partner. Second, they need the attention of regulators onto stay closely in touch with market several fronts. Concerns about adevelopments and, as appropriate, lack of transparency, asymmetry ofmake their views known to legislators information and speculative activityand regulators on matters important are leading to increased oversight, Deutsche Bank Markets in 2011—Foresight with Insight
  • 43. 3.1Marketswith position limits and more Corporate governance In response to the ‘too big to fail’comprehensive trade reporting under The UK has already issued a broad problem, the G20 have endorsed theconsideration. based call for proposals on how to principles set out by the Financial improve governance in the financial Stability Board for banks consideredHedge funds services sector. EU proposals for systemically important (eitherHedge funds are to be subject to tighter governance rules for financial nationally, internationally or globally)more regulation due to the Alternative services firms will be issued in the and further detail will follow in mid-Investment Fund Managers Directive spring. Together with reform of the 2011. This is likely to result in capitalin Europe and similar, though less way auditors are regulated, these surcharges (higher for a group ofprescriptive proposals in the US. corporate governance proposals have some 20 or so globally systemicAlthough the EU proposal is less the potential to significantly impact firms), increased regulatory scrutinysevere than originally drafted, it the way firms are supervised and how and coordinated decision-makingwill still give rise to many new they relate to and act as shareholders. by regulators. The Basel Committeeorganisational and governance As in other areas the dynamic is going is also working on the mechanicsrequirements for hedge fund to be more intervention in markets not of countercyclical capital buffersmanagers such as stricter internal less. and a number of proposals relatingcontrols, reporting lines, board to contingent capital and ‘bail in’,composition and management Financial sector taxation designed to reduce the likelihood ofstructure, and client service issues for While the idea of an international tax payers’ money being used to ‘bailprime brokers. ‘Tobin’ tax, or ‘Financial Transaction’ out’ banks in future. tax, has lost momentum at the G20Shadow banking level, France as the next G20 chair Also in the near-term, preparationsNumerous regulators and politicians may look to reinvigorate thinking in continue for implementation ofhave expressed concern about the this area. The EU is also committed Basel 2.5, which introduces new‘shadow banking system’, such to developing a ‘Financial Activities’ mechanisms to capture the risks in theas money market funds and non- tax, targeting overall profits and trading book and stricter treatmentbank investment vehicles. This pre- remuneration for financial firms. of securitisation and correlationoccupation is unlikely to go away. trading, essentially trebling theOnce again a perceived lack of With sluggish growth and tight amount of capital held against tradingtransparency may generate a review of fiscal conditions, the temptation for instruments.where the boundaries of regulated and governments to reach for additionalnon-regulated should be set. financial sector taxes should remain Predictions about the impact of strong – as has already been seen Basel 3 on the global economy and with the proliferation of bank levies availability of credit vary. However it introduced across the EU (UK, is clear that the next few years will Germany, France, Portugal, Hungary, see increased bank capital raising Sweden and Austria). and, as the detail is digested, strategic revision of individual banks’ business Regulatory capital models. However, reaching this The G20 mandated various bodies to stage is simply the end of the first tighten up regulatory capital rules. act: across the world regulators now The most high profile initiative is have to implement the agreement the Basel 3 Accord which narrows through national law and there is the definition of regulatory capital, significant concern within the industry significantly increases the minimum and politically about the potential for requirements and introduces global inconsistency, particularly in the US, standards for liquidity and introduces EU and Asia. a leverage ratio. An additional capital conservation buffer will be required so as to absorb losses in stressed periods and, as it is used up, will increasingly constrain banks’ ability to distribute earnings. The G20 have endorsed the headline requirements and phasing in approach (ahead of full implementation in 2019). Work continues on the detailed text.Markets in 2011—Foresight with Insight Deutsche Bank
  • 44. EU regulatory proposalsSource: Deutsche BankInitiative Focus Impacts Timing Clients affectedShort selling – Pan-European legislation including – Public disclosure will lead to Legislative proposal – All short sellers in private and public disclosure reduced participation in equity expected Q1 2011 the EU markets, – Uncovered positions in Credit markets particularly hedge Default Swaps (CDS) – Detrimental to market ‘early funds – Disclosure of sovereign CDS warning’ system – Pension funds that lend stockOTC derivatives (EU – Aim of greater transparency – Trading on venues hampered by End 2012 to come into – All regulated firmsMarket Infrastructure – CCP clearing for standardised insufficient liquidity full effect trading in the OTCRegulation -EMIR) derivatives – Reduced ability to fully hedge markvets – Move to trading on recognised exposures – Corporate end- venues (via MiFID) – Lower profitability of derivative users (but subject – Reporting via trade repositories trades and reduced liquidity as a to exemptions result of bid/ask compression and trigger – Need for clients to re-assess thresholds still to clearing solutions be determined)Review of markets in – Micro-structural issues (HFT, dark – Decreased liquidity/trading volumes Legislative proposal – All investmentFinancial Instruments pools) – Increased regulation of, or expected May 2011. firms as definedDirective (MiFID) – Solve fragmentation of market data restrictions on, HFT, dark pools, 2012/13 for final law under MiFID – More transparency in fixed income broker crossing networks – Possible increased markets – Position limits for commodities regulation for – Transaction reporting commodity tradersAlternative Investment – Cross-border marketing – Stricter depository liability Law has been agreed but – Hedge fundsFund Managers Directive – Governance – Remuneration guidelines for hedge further rule-making will – Prime brokers(AIFMD) – Use of depositories fund industry and more robust take place in 2011 – Custodians control requirementsMarket Abuse Directive – Extension of market abuse rules to – New requirements may go too wide Legislative proposal due – All market(MAD) instruments traded on a Multi- or create confusion due to differing in Q1 2011 participants Lateral Trading Facility (MTF) regimes for different market – Extension of inside information segments provisions to commodity derivativesBank levies – UK: 0.07% (0.04% in 2011) on banks – Unclear how US, UK & German EU proposal expected – EU banks with liab. > GBP20 billion approaches will overlap – potential end of 2010; US still – German: 0.04% for banks with liab. for double-taxation under legislative review > EUR100 billion (smaller levy for – Possible implications for moving smaller banks) businesses – US: 0.15% on banks with assets > – Competitive advantage for non-levy $50 billion – still under legislative regions (e.g. Asia) reviewUS regulatory proposals (via Dodd-Frank Act)Source: Deutsche BankInitiative Focus Impacts Timing Clients affected‘Volcker’ rule (ban on – Ban on proprietary trading in – Liquidity implications for market Within 2 years – Primarily US banksproprietary trading) deposit-taking banks, although dependent on how ‘proprietary (extensions possible) several exemptions exist trading’ is defined by rule-makers – PE/HF investment capped at 3% – Elimination of P and L from proprietary tradingSwap desk push-out – Swaps moved into separately – No federal assistance for swap Within 3 years – Primarily US banks capitalised non-bank affiliates trading entities (extensions possible) with large equity (excludes hedging own risk, interest and commodity rate, FX, certain metals – approx. derivatives 80% of OTC today) businessOTC Derivatives – OTC derivatives required to be – Cleared derivatives will be Rule-making due to be – Commodity centrally cleared, although many exchange-traded, which will cause completed July 2011 traders exemptions exist bid/ask compression – FCMs – Less focus on exchange trading and – Non-cleared trades subject to – End-users (subject standardisation greater capital requirements to exemptionsCapital – U.S. BHCs of foreign banks required – Significant implications for foreign 5-year phase-in for – Non-US banking to be capitalised in line with U.S. bank holding companies foreign banks groups banks – Capital requirements TBD Deutsche Bank Markets in 2011—Foresight with Insight
  • 45. 3.1MarketsGlobal regulatory capital proposalsSource: Deutsche BankInitiative Focus Impacts Timing Clients affectedSecuritisation (via Capital – 5% risk retention (10% in Germany), – More stringent than US rules, come Dec 31, 2010 – All regulated financialRequirements Directive2 greater due diligence and disclosure into effect sooner institutions (except- CRD 2 - and Dodd- – Higher risk weighting on (re-) – Disadvantages for foreign banks insurance companiesFrank Act) securitised assets with US securitisation businesses which are subject to the Solvency 2 proposals which we do not reference here)Basel 2.5 / CRD 3 – New trading book rules: correlation – Significant capital impact Dec 31, 2011 – All regulated financial trading, trading book securitisation, – EU competitive disadvantage due to (with phase-ins) institutions (except stressed VaR, incremental risk remuneration limits Dec 31, 2010 insurance companies charge – Stringent diligence requirements on (for remuneration) which are subject – Remuneration restrictions securitisation to the Solvency 2 proposals which we do not reference here)Basel 3 / CRD 4 – New capital rules: capital – Calibration and limits TBD Dec 31, 2012 – 2020 – All regulated financial deductions, equity treatment, – Restrictions on what counts as Tier (various phase-ins) institutions (except composition of capital, capital 1 (strong push to equity) insurance companies buffers, leverage ratio – Fixed leverage ratio which are subject – New liquidity rules: liquidity – Cost of regulatory capital will to the Solvency 2 coverage ratio, net stable funding increase proposals which we do ratio not reference here)What to do? beyond. A frequent plea from policy-We recommend that all companies makers is that they want, and need,assess their business, scope of to hear from the investor and clientoperations and future strategy very community.rigorously before the new regulationscome into effect. Engaging in the regulatory debate is critical when the stakes are so high.At present, the various initiatives Earlier in 2010 the initial proposals onbeing pursued are not always joined new capital requirements would haveup and even simple questions such seen banks needing to acquire anas where a trade is executed, booked, extra $5.6 trillion in reserves. Also, thesettled, cleared or where the custody increased activity of the hedge fundaccount is held could have significant community helped to ameliorate partsimplications in terms of what rules of the EU hedge funds proposal.apply, with added consequences forprocesses, resourcing and costs. The magnitude of some of these issues has shifted the dynamic ofIt is especially important for the regulatory debates. There is a politicalinvestment community to become dimension to regulatory risk that alsomore vocal. Many of the crucial needs to be managed.proposals are not yet finalised orwill have further consultation andrule-making phases during 2011 andMarkets in 2011—Foresight with Insight Deutsche Bank
  • 46. Ajay Kapur 3.2Head of Asia Equity Strategy, Research MarketsOutlook for Asian EquitiesSigns of euphoriaDeutsche Bank’s ‘risk-love barometer’ Cyclically, some of the leading History tells us that the ratio of people– which tracks the number of Asian indicators of capex – the availability in their 40s to 20s – the Demi-Ashtonequity indicators showing extreme of credit, CEO confidence and global ratio – is a key driver of long-term realeuphoria minus the number exhibiting operating cash flows – look to be equity returns.extreme panic – has gone off the scale rolling over, but the levels look recent months to reach euphoric We think that once confidence in Here, the news for Asia is excellent.levels. Nearly every investor we talk to regulations, fiscal policymaking, trade Almost all countries within the regionis a committed bull. and currency policy, and central bank are expected to see an explosion control is established, the severe of their Demi-Ashton ratios in theGiven this and our relative pessimism under-investment in this cycle should next 20 years. Conversely, the Demi-about the US dollar, our near-term be behind us. Asia is doing a lot more Ashton ratios in developed marketsrecommendation on Asian equities is capex on a sector-by-sector basis are projected to fall until 2015 and rise‘neutral, recognising downside risk.’ compared with the rest of the world. very gently thereafter. The relative rise The region that tends to over-invest in EM Demi-Ashton ratios versus thePutting aside concerns about tends to lag in terms of prospective US (as a proxy for developed markets)excessive investor enthusiasm, a lot ROEs in the next cycle. Asia under- is remarkable – it rises all the way toof good things are coming together invested in the post-crisis 1997-2002 2030, with a decline thereafter.for Asian equities: absolute valuations period and its ROEs caught up withlook fair, our proprietary leading the US in the 2003-08 period. In the For long-term investors, a largegrowth indicators are bottoming, last few years, the US and Europe overweight in EMs versus developeddeflation risks are evaporating, the have been under-investing versus markets is strongly recommended,terms of trade for Asia are rising, the Asia. Consistency demands we expect based on projected demographicworld’s central banks are easing in the Asia’s ROEs to be beaten by the differentials. Over the next 5-10 years,meatiest part of the US presidential underinvesting US and Europe. The the Demi-Ashton ratios are projectedcycle, the early monetary tightening Asian debt-driven crisis of 1997-98 is to rise the most in Indonesia, India andin Asia is relatively unthreatening, and long gone from corporate memories, the Philippines in Asia.technicals are robust. and a new cycle of over-confidence could well see a new leverage cycle in Overall, prospects for the region’sMany of these indicators were hostile a Asia to finance new capex, mergers equity markets look strong for 2011.few months ago – the turnaround has and acquisitions and cross-borderbeen swift. Historically, little good has acquisitions to secure markets andcome from jumping on the bandwagon technology.when equity sentiment on emergingmarkets (EM) is as bullish as now. We While the price of entry is the key forthink any pullback in equities/sentiment cyclical entry points into equities, wewould offer a much better opportunity think longer-term investors shouldto recognise substantially improved rely on the Demi-Ashton ratio (theequity fundamentals in Asia. The ratio of people in their 40s to 20s)usual winners in Asia ex-Japan – value to guide equity allocations. Equityand earnings momentum – are again allocations are low for those indemonstrating their potency. These their 20s and 30s, when people aretwo factors and profitability form the buying ‘stuff’ – a house, education,core of our bottom-up stock selection automobiles, furniture etc. Whenprocess. Our favourite markets include they reach their 40s, they raise theirHong Kong, Korea and Malaysia. Our equity allocations sharply, worriedfavourite sectors are retailing, autos, about impending retirement and withcapital goods and banks. excess savings to invest. Deutsche Bank Markets in 2011—Foresight with Insight
  • 47. 3.3 Michael BiggsMarkets Co-Head of European Equity Strategy, Research Gareth Evans Co-Head of European Equity Strategy, ResearchThe Credit Impulse and the Outlook for European EquitiesPrice rises aheadThe macroeconomic environment is excellent forEuropean equities at present: global growth isrecovering more strongly than expected and centralbanks are keeping interest rates low in an attempt tolower unemployment. We expect the Stoxx 600 to riseto 315 by the end of 2011, for a total return of 20%.European equities are essentially a The US non-financial private sector GDP globally. The equilibrium levelplay on the global economy, and we paid down debt aggressively in 2009 of borrowing is probably somewhereexpect real global GDP growth of 3.8% (Figure 1), and as the pace of de- between 5% and 10% of GDP, andin 2011, supported by a sustained leveraging slowed in 2010 and the while it is difficult to know where newrecovery in emerging market (EM) and amount of new borrowing increased, borrowing is going to be next quarter,US GDP growth of 3%. the credit impulse turned positive and it is highly likely that new borrowing real private sector demand growth will return to these equilibrium levelsOur optimism is based on the rebounded (Figure 2). We expect the in the coming years. And while newexceptionally low levels of new pace of de-leveraging to slow further borrowing rises, the credit impulseborrowing currently, and our belief in 2011, and for the recovery in real will on average be positive, and realthat all that is required for a recovery private sector demand growth to be domestic demand growth should bein demand is that new borrowing rises. stronger than the market expects. stronger than potential.In other words, credit growth doesnot need to turn positive. We call this This bullish argument is not only If real global GDP growth is 3.8% inchange in new borrowing the ‘credit relevant to 2011. Private sector new 2011, we would expect real earningsimpulse’. borrowing is currently around -2% of growth on the Stoxx 600 of 12%Figure 1: Figure 2:US new borrowing as a % of GDP US credit impulse and private demand growthSource: Deutsche Bank, US Federal Reserve, BEA Forecast Source: Deutsche Bank, US Federal Reserve, BEA Credit impulse (lhs) New borrowing as a % of GDP, Private demand growth (c+l, rhs) non-financial private sector20 % of GDP 8 change, % of GDP % yoy 12 615 8 4 210 4 0 5 -2 0 -4 0 -4 -6 -8-5 -8 -10-10 -12 -12 1952 1959 1966 1973 1980 1987 1994 2001 2008 2015 1967 1972 1977 1982 1987 1992 1997 2002 2007 2010Markets in 2011—Foresight with Insight Deutsche Bank
  • 48. (Figure 3). The impact of the GDP The consensus expectation for US potential. This is very rare. Historically,growth is magnified on earnings growth in 2011 is around 2.3%, companies that pay high dividendsdue to margin widening, driven by and the increase in GDP growth we have generally not offered greatoperational gearing on one hand and anticipate towards 3% should be growth potential and vice versa. Butlow unit labour costs stemming from sufficient to trigger the next leg of the today, there are plenty of stocks thathigh unemployment on the other. equity rally. seem to offer both.The outlook for ratings is equally So if you agree with our optimistic A higher risk strategy would be to gocompelling. The earnings yield has outlook for European equities, what long mid-cycle cyclical sectors suchbeen well correlated with the real stocks should you buy? as media, technology and, potentially,Fed funds rate over time (Figure 4). At We believe that companies offering financial services.present, equities have already priced high dividend yields will be the bestin a normalisation of policy rates and, place to start. The latter offers the biggest potentialif interest rates remain lower in future for gains but does have fairly sizeablethan they have been in the past, we Dividend yields on many European downside risk in the shape of furtherwould expect equity ratings to be large cap stocks are significantly sovereign debt events.higher. higher than the returns on cash or fixed income enabling investors to All in all, though, our view is that theEquities also look extremely good increase portfolio returns without a outlook for European equities is veryvalue relative to credit – the earnings significant increase in risk. strong.yield on the S&P500 is at 25-yearhighs relative the real BBB corporate Significantly, there are plenty ofbond yield. companies out there that offer good dividend yields and good growthFigure 3: Figure 4:Global GDP growth and European earnings Drivers of earningsSource: Deutsche Bank, Datastream, IMF Global growth (PPP) Source: Deutsche Bank, Datastream, IMF Real Fed Funds rate DS Europe real EPS growth (rhs) Earnings yield (rhs) Irrational exuberance 6 % yoy % yoy 30 12.5 % yoy 16 5 20 10.5 14 4 10 8.5 12 3 0 6.5 10 4.5 8 2 -10 2.5 6 1 -20 0.5 4 0 -30 -1.5 2 -1 -40 -3.5 0 1980 1984 1988 1992 1996 2000 2004 2008 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 Deutsche Bank Markets in 2011—Foresight with Insight
  • 49. 3.4 Binky ChadhaMarkets Head of US Equity Strategy, Research Keith Parker Director, US Equity Strategy, Research Outlook for US Equities Strategic case is compelling Twenty months after the March 2009 credit yields is running at 5% (versus bottom in equities and the beginning 2.5% historically). If investors do not of economic recovery, US equities shift allocations in favour of equities remain cheap, both on an absolute to close this gap, corporates will basis compared to historical valuations arbitrage the differential by issuing and relative to other asset classes. We debt or using their cash flows to think the strategic and tactical cases buy back stock as they have already for US equities will come together in started doing recently. 2011 to produce strong returns (S&P 500 YE 2011 target 1550 representing The tactical case for equities in 2011 a 29% return). 1. The economic recovery is strengthening. In our reading, key The strategic case for US equities is components of GDP grew solidly over compelling: the past 20 months (retail sales 6.2% 1. Equity returns have tended to follow annualised; core durable goods new long 10 to 15 year cycles. Despite the orders 17%) even during the period 80% bounce from the March 2009 of rising concerns about a double dip lows, the 10-year return on equities is recession. This is now spilling into a near 100 year lows and the strategic recovery in the labour market which upside over the longer-run is large should see an acceleration in the overall pace of recovery. 2. Equities are very cheap to Treasuries and credit. The differential between 2. Economic forecasts remain timid, the Operating Cash Flow yield on the implying plenty of upside for positive S&P 500 (ex-Financials) and Treasuries data surprises going into 2011. Equities is running at a very significant 8% have been strongly correlated with (versus a very stable 4.6% historically). our macro data surprise index, which The differential versus corporate is only slightly above the mid-point of S&P 500 10yr rolling returns S&P 500 10yr Rolling Returns (Simple returns excluding dividends) (Simple returns excluding dividends) Source: Bloomberg, Robert Shiller 400% 400% 350 350 300 300 250 250 200 200 150 150 100 100 50 50 0 0 -50 -50 -100 -100 1955 1961 1967 1973 1979 1985 1992 1998 2004 2010 1881 1887 1893 1899 1905 1911 1918 1924 1930 1936 1942 1948Markets in 2011—Foresight with Insight Deutsche Bank
  • 50. its historical band implying plenty of lost seats in Congress. sell-off in equities just as rate hikesroom to rise further. did in 1994, but this should prove a 6. The demand and supply balance temporary buying opportunity as it3. The bar for earnings also remains for equities has improved significantly did then.low in the near term, as it has been for and the outlook is very favourable.the last seven quarters, and we expect Over the last two and a half years,Q4 earnings – due to start reporting in demand has essentially been flatmid-January – will beat again. (outflows from mutual funds offset by inflows into ETFs). Supply rose4. The multiple is low, at 14x 2010 significantly, starting in late 2007 andearnings. While many arguments have through end 2008, as financials werebeen made for low equity multiples forced to issue equity, and corporatesgoing forward, we note that the curtailed buybacks to retain cash onmultiple averaged 16.5 in the 1930s, their balance sheets. Demand remainsabout what we consider to be fair flat, but our expectation is that flowsvalue, at a time when unemployment will return to equities once it is clearreached 25%. It averaged 18.5 (typical that the Fed is done trying to lowerrecovery multiple) between the two rates. But even if demand remains flat,recessions in the 1930s. the acceleration in buybacks means the demand-supply balance will5. The year after mid-term elections remain favourable. There is a stronghas historically seen a large anomaly correlation (75%) between this simplein S&P 500 returns, with an average demand-supply balance and S&P 500return over the last 80 years of 18%. quarterly returns, implying this will beWe believe this reflects moves back reflected in returns.towards the centre in policy makingpost the mid-term elections where the 7. Don’t fret the end of QE2 aroundpresident’s party has almost always mid-2011. It is likely to result in aS&P 500 Ex Financials OCF Yield Recession Recession Field OCFS&P Bloomberg, Robert ShillerSource: 500 ex financials OCF yield Spread above 10 year OCF Field yeilds (avg. 4.6%) Spread above 10 year yields (avg. 4.6%)25% 25%20 2015 1510 105 50 0-5 -5% Jan – 81 Oct – 82 Jul – 84 Apr – 86 Jan – 88 Oct – 89 Jul – 91 Apr – 93 Jan – 95 Jul – 98 Apr – 00 Jan – 02 Oct – 03 Jul – 05 Apr – 07 Jan – 09 Oct – 10 Oct – 96 Deutsche Bank Markets in 2011—Foresight with Insight
  • 51. 3.5 John-Paul SmithMarkets Head of EM Equity ResearchOutlook for Emerging Market Equities (Ex Asia)Watch out for FXPredicting the direction of emerging low relative to developed market economists are forecasting lowermarket (EM) equities in 2011 is harder currencies in order to protect exports. rates of global growth over the nextthan ever, for three reasons. few years as compared to the EM bull Were the Chinese to allow the market of 2002 – 2008. The directionFirst, there are a large number of currently undervalued RMB to of the wider economy is importantmoving parts in government and appreciate in 2011, again other EM because the outperformance of keycentral bank policies, which will be currencies would follow. This would Latin American and EMEA marketsinstrumental in driving the markets. hit their exporters’ profitability in the over most of Asia, which we haveHow EM governments and central short term but have a very positive seen over the past decade has beenbanks respond to issues such as short effect in the longer term by helping to largely predicated on generalisedterm overheating in their economies rebalance the entire global economy. commodity price inflation driven bycan have drastic effects on overall demand from developed economiesmarkets and individual stocks. If however, other EM countries mimic which is unlikely to continue at pre China by keeping their currencies 2008 levels.Second, the range of outcomes for undervalued relative to developedglobal growth over the next twelve economies, the result would be initially Another cause for uncertainty in EMmonths is extremely wide and over the good for exporters’ margins but equity prices is the lack of generalpast decade global emerging markets ultimately poor for global growth. trends over the last year, which makeshave generally been a geared play on it harder to identify broad investmentglobal growth. There is also a strong possibility themes across EM countries. Instead, that more emerging countries will stock pickers are likely to be muchFinally, there are very few obvious follow Brazil’s example and take more reliant on the structuralvaluation anomalies either on a measures aimed at restricting the fundamentals of individual countriescountry or sector level within Global inflow of capital. The Central Bank and stocks. We favour specific countryemerging markets (GEM). In general, of Brazil recently introduced a tax on plays like long Turkey, short Russiamarkets appear to be priced in a foreign bond investors and other EM over general long positions on CEMA.relatively rational manner. However, countries including Korea and ThailandGEM equities look cheap relative to have adopted similar measures in This won’t be easy because relativefixed income, just like all the other an attempt to stem capital inflows valuations give us very little usefulmajor equity regions. and prevent their currencies from information. Russia, South Korea and appreciating. Brazil look cheap on most measuresFor now, the key issue is the impact but are all structurally challengedthat any major changes in exchange Some prominent commentators have in some way. Similarly India, Turkeyrate parities will have on the emerging predicted that continued inflows will and Chile which all appear relativelyeconomies and their equity markets. result in an EM equity bubble but this expensive arguably have superiorMoves in the value of the Chinese seems very unlikely to happen until fundamentals at both a country andrenminbi should be the most there is a solution to the exchange rate an average stock level.influential. This is because many EM conundrum.countries compete with China and By sector, the material and energytherefore follow its lead in keeping One reason EM equities may be stocks, which look cheapest, aretheir own currencies artificially less attractive in 2011 is that our discounting the likely downturnMarkets in 2011—Foresight with Insight Deutsche Bank
  • 52. in economic activity and in manycases, company specific corporategovernance issues. In contrast, theconsumer-linked sectors look fairlyexpensive due to the widespreadexpectation that currencies willappreciate somewhat across emergingeconomies, leading to a switch fromexport to import-led demand asexports become less attractive toforeign buyers.Since EM markets look generallypriced rationally going into 2011,equity valuations do not give aclear lead on where prices mightgo. Likewise, a lack of economicmomentum – the outlook for EMcountries is generally steady andforecasts have not been reviseddramatically in recent months –points to considerable volatility in EMmarkets, which is likely to best suitcontrarian investors.Overall valuations do not seemexcessive and there is scope forequities, which are looking cheaprelative to fixed income, to rally – butthis is only likely to happen once someof the major uncertainties overhangingthe global economy are resolved. Deutsche Bank Markets in 2011—Foresight with Insight
  • 53. 3.6 Bilal HafeezMarkets Global Head of FX ResearchOutlook for FX In 2011Don’t get complacentWhile 2008 was the unravelling of the USshadow financial system, 2009 was the policycounterattack, 2010 was the splintering of theeuro-area system, 2011 will likely be the yearof emerging markets (EM). Whether it will bebenign or more ominous or both is yet to bedetermined, but the largest currency moveswill likely occur in EMs.Euro likely to remain in choppy range ECB and Fed unlikely to change policy much in 2011like first half of 1990s Fed policy rate ECB policy rate Euro1.70 71.50 6 51.30 41.10 30.90 20.70 10.50 0 80 81 83 85 86 88 90 91 93 95 96 98 00 01 03 05 06 08 10 99 00 01 02 03 04 05 06 07 08 09 10Markets in 2011—Foresight with Insight Deutsche Bank
  • 54. In the developed world, the Fed is could become the equity story for the The biggest concern would be thatunlikely to alter monetary policy international investor, which could see consensus on EMs is so strong thatsignificantly over 2011, unless dollar strength or risk aversion could expectations could be too high.unemployment falls significantly. dominate, which would support the While the backdrop is not identicalAnd with the absence of support yen. to the mid-1990s (notably most EMfrom interest rates, the dollar will currencies are now free-floating),struggle to gain traction. What will EMs provide a richer array of there are less signs of excess credithelp the dollar is that the backdrop possibilities. Inflation is a bigger issue, growth and asset price overvaluations,amongst the other majors is not so notably in Asia, which could lead to the belief in the resurgence of EMpositive either. The eurozone is likely a tightening in monetary policy and is similar. Therefore, we would beto continue to suffer from pangs of greater tolerance of currency strength keeping a close eye on any signs ofexistential crisis, the UK will struggle over 2011. China may continue to financial instability in EM and Asiato overcome its many structural liberalise its currency regime, through particularly. The lesson of the last fewdrags and Japan will be reliant on the development of the offshore years has been not to be complacent.the external economy. The majors, market. Consequently, we couldtherefore, are unlikely to exhibit any see broad-based currency strength.strong trends, rather follow broad Meanwhile, if Fed policy starts to gainranges over the course of 2011. Of traction in the economy, stronger UScourse, there could be some surprises growth could translate into strongerthat could break the deadlock; the growth in Latin America. Mexico, inECB could hike before the Fed, which particular, could benefit and see itswould spur euro strength, the US currency strengthen.Korea and Mexico notably undervalued Asia inflation risingReal effective exchange rate, rebased to sample average (100) Mexico China Korea India US140 20130120 15110 10100 90 5 80 70 0 60 50 -5 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 99 00 01 02 03 04 05 06 07 08 09 10 Deutsche Bank Markets in 2011—Foresight with Insight
  • 55. 3.7 Michael LewisMarkets Global Head of Commodities ResearchOutlook for Commodities In 2011Price rises likelyWe believe 2011 will be characterised by freshinvestment inflows into the commoditiescomplex. The sector’s appeal reflects investorappetite to gain exposure to emerging markets(EM), as a tool to hedge against tail events andmarket anxiety towards higher inflation ahead.Moreover investors are now able to gain directexposure to an increasing array of commoditieswhich have typically been outside the investmentuniverse, such uranium, iron ore and coal.Our bullish outlook for the commodity markets, we believe a rally in the oilcomplex is based on four key price will be more sustainable if crudebeliefs: emerging market growth oil inventories fall to more normalwill be strong, the Fed’s efforts to levels and if the crude oil forwardstimulate growth will be successful, curve moves into backwardation.European sovereign risk will eventually We believe this bullish scenario forbe contained, and the physical crude oil will become a reality as 2011fundamentals of many markets unfolds. However, the weakness inwill tighten because of supply side US natural gas markets in responseconstraints. However, we believe the to the surge in domestic shale gasincreased level of macroeconomic production has left a significantuncertainty will intermittently overhang in storage levels whichcontaminate sentiment for risky assets we expect to take several monthssuch as commodities. to work off.Of the five broad commodity sectors, We believe China remains a bullishthe energy and industrial metals factor for commodity marketssectors seem most vulnerable to despite short tem disruption riskdisruption risk. While oil prices have from monetary tightening. In 2010,been driven higher by the Fed’s the country became an even greaterprogramme of quantitative easing source of demand for commoditieswhich has contributed to US dollar such as thermal coal, silver, soybeansweakness and a recovery in US equity and cotton. While industrial metalsMarkets in 2011—Foresight with Insight Deutsche Bank
  • 56. demand has the highest correlation indicator remains above 50 we believeto credit growth and consequently we will see sustained downwardwould be the most sensitive to pressure on the gold to silver ratio.monetary tightening measures, webelieve the underlying growth outlook Financial factors may also provein China remains positive. Indeed if bullish for the industrial metalsone compares this cycle to previous complex in 2011. The launch ofmonetary tightening periods, the physically backed ETFs in the complexcentral bank has been more pre- will have the ability to significantlyemptive today in tackling inflation tighten market fundamentals. Indeedthan in the boom-bust periods of on our estimates if investment1989 and 1994. demand was to represent just 2% of global copper demand this would beIn an environment of heightened equivalent to approximately 65% ofmacro-economic uncertainty, we copper inventories. As a result, webelieve gold prices will continue to view copper as the most susceptiblebenefit from central bank buying and to price spike risk if these newongoing inflows into physically backed products attract investment capital.ETFs. In fact gold price overshooting isa high probability event since investors In agriculture, we see sustained priceare buying gold when the US dollar is rallies occurring across the sectorrising as well as falling and as a hedge as a result of low inventories, foragainst inflation as well as deflation. example in corn and sugar, risingWe estimate that gold prices would shortages of commodities in Chinaneed to reach $1,455/oz to represent an such as soybeans, and the sector’sall time high in real terms and surpass vulnerability to supply disruptions$2,000/oz to represent a bubble. such as occurred in the wheat market in 2010. However, historyWe believe silver has an even more would suggest that the durationattractive outlook than gold. Not only and magnitude of price rallies inwill silver benefit from its status as a agriculture will be shorter and lesssafe haven, it also tends to outperform powerful than those in the energy andgold when the US manufacturing industrial metal sectors.sector is expanding. Indeed as longas the US ISM business confidence Deutsche Bank Markets in 2011—Foresight with Insight
  • 57. 3.8 Dominic KonstamMarkets Global Head of Rates Research Francis Yared Head of European Rates ResearchOutlook for US and European Rates in 2011Rising in Q2 but not by muchRates in developed markets are to rise – with US 10 years reaching tightening has yet to take place.intrinsically below their long-term fair 3.25% by year end – for the followingvalue relative to the long-term growth four reasons: In Europe, the ECB is faced with aand inflation outlook. difficult dilemma of helping peripheral The four catalysts for the start of rate members to avoid sustained recessionOur 2011 outlook revolves around ‘normalisation’ will be: and assisting core members inthe beginnings of some kind of keeping down inflation. The problemnormalisation towards higher rates. 1. Core inflation is likely to drift remains unresolved: real rates areYet there are a lot of tensions that upwards towards 1.3% (which is in line too low for core and too high for thecloud this year’s outlook in respect of with the central tendency of the most periphery. One solution is for the ECBthe path towards higher rates. These recent FOMC forecast). Food inflation to maintain full allotment tendersinclude the debate as to whether will add further pressure. and possibly hike rates. The risks ofquantitative easing is or can be premature tightening in Europe aresuccessful in the face of a still weak 2. Concerns about the Eurozone also significantly higher than in thefinancial sector and lack of housing sovereign crisis should ease in Q2 US and the UK, which increases therecovery; whether inherently sound as the refinancing hurdle faced by medium-term deflation risks for thecorporate balance sheets can be Spain is cleared and Portugal most Eurozone area (at least relative to thea springboard for meaningful job likely follows Ireland under the EFSF US and UK).growth; concerns for deteriorating umbrella.sovereign risk, particularly in the US There are significant risks aroundand Germany and an uncertain fiscal 3. Fiscal policy in the US should remain this relatively benign scenario. Takeoutlook; spillovers from the European gridlocked save for an extension of US fiscal policy, probably the mostperiphery crisis; and whether Asia’s the Bush tax cuts. In the absence of important factor driving rates this year.and the broader emerging market spending cuts, rates will have to go up If spending cuts are implementedgrowth success is sustainable. to meet investor demands. Sovereign too early, the US economy may risk risk fears due to the lack of fiscal a double dip, prompting the Fed toOur view is that US rates will remain discipline take over from weak growth extend quantitative easing whichlow in Q1 staying around 2.5% at the concerns associated with the lack of would lead to a significant rally in10-year part of the curve, as the pre- fiscal stimulus. rates.committed part of QE2 (all $600 billionof it) flows into the market. 4. Asian currencies should appreciate Conversely, if the data surprises on the against the US dollar as Asian rates upside, the Fed is likely to discontinuesOther factors that should keep rates rise to combat inflation. This would QE, which will lead to a significantlow will be persistently depressed make the US more competitive, upward re-pricing of rates to reflectinflation, an unemployment rate that spurring growth and inflation. the unwind of the QE premium andfails to decline significantly from better economic fundamentals.current elevated levels, and continued Whether the sell-off in US rates willuncertainty about European sovereign be more sustainable than the one that On balance, however, our forecast isrisk. occurred in Q1 2010 is still uncertain, for a relatively moderate increase in and will primarily depend on fiscal both US and European rates from Q2But from Q2 onwards they should start policy in the US where significant onwards.Markets in 2011—Foresight with Insight Deutsche Bank
  • 58. Deutsche Bank Markets in 2011—Foresight with Insight
  • 59. 3.9 Harris TrifonMarkets Head of Commercial Real Estate Debt ResearchOutlook for US Real EstateFalling but not so fastIn 2011 we expect prices in the US Another factor contributing to the partly because of the competitivecommercial and residential real estate stabilisation of prices in 2011 should be financing market for these to continue to decline, albeit the increased demand for CRE debt. In 2011, we don’t believe the trend willat a much slower rate compared to Over the last few months of 2010, CRE change much.the last few years. However, price debt has been one of the best performers.stabilisation in selected markets which In the residential markets, we expectwas the most significant trend in 2010, The rally in the fixed income markets the US housing market to declineshould spread to more markets in the in 2010 has contributed to the another 3%-5.5% in 2011 which willcoming year. We believe commercial reemergence of the CRE financing likely be followed by a tepid recovery.real estate prices will be generally market which has in turn supported A complete recovery will likely takestronger than residential, in part due to property prices. However, much of four to six years primarily due to anthe stronger underlying fundamentals the impact so far has only affected excess supply of homes relative to ourof the sector. top-tier properties in the best markets, estimates of demand.In the commercial real estate (CRE)markets, one of the most positivedevelopments in the nascent recoveryhas been the seemingly insatiable bidfor properties in ‘A-list’ cities. Morespecifically, most of the demand hasbeen concentrated on the very bestquality properties in these markets.We attribute much of the demand tothe global investment community’scontinued search for incrementalyield among assets deemed to bestable and safe. However, propertiesin New York, Washington DC, SanFrancisco and Boston are trading athigher implied risk premiums thanother major cities in Europe and Asia.Prices in these US markets shouldcontinue to outperform in 2011 as riskpremiums continue to decline (and asa result prices increase).Markets in 2011—Foresight with Insight Deutsche Bank
  • 60. The US housing downturn has Global and US CRE Risk Premiumdestroyed $6 trillion of housing Source: Deutsche Bank, Real Capital Analytics, Bloomberg Finance LPwealth, equivalent to $80K perhousehold. Home prices would need Global Market (ex China and US) Global CRE risk premium US Market US CRE risk premiumto rise approximately 38% nationally London 3.22% NYC 4.03%to restore the lost wealth. Housing Tokyo 4.74% DC 4.36%wealth destruction is the worst in the Hong Kong 1.33% Los Angeles 4.87%four sand states California, Florida,Arizona, and Nevada, where values of Paris 3.56% San Francisco 4.07%housing markets have been reduced Singapore 3.57% Chicago 4.93%by $2,339 billion, $842 billion, $324 Seoul 2.16% Boston 4.80%billion and $192 billion respectively. Global Average 3.10% US Average 4.51%We expect NY metro and Santa Note: MSAs sorted by traded volume. Averages are based only on the top six cities.Barbara, CA to perform the worstdue to the low level of affordability,with expected declines of 11% and9% respectively. Minneapolis, MN Spread tightening comparisons (September to November 2010)and Austin, TX we expect to perform Source: Deutsche Bank, Markit and Bloomberg Finance LPthe best due to robust job marketsand relatively lower inventory ofdistressed properties. 50%We expect home prices in both 40these markets to appreciate by 1.3%.The most significant impact of thehousing bubble has been the impact 30the wealth destruction has had onconsumer spending. 20 10 IG Corporates HY Corporates REIT CDS CMBX 4 AJ Deutsche Bank Markets in 2011—Foresight with Insight
  • 61. 3.10 Tom CheungMarkets Head of Credit Solutions Group, Americas Daniel Pietrzak Head of Credit Solutions Group, EuropeOutlook for US and European ABS MarketsGlobal investor demand comes back stronglyThe asset backed securities (ABS) The parabolic growth of the ABS secure higher ratings on their bonds,market was hit harder by the financial market from 2000 to 2006 was largely and we will not see a revival ofcrisis than many other markets. After driven by home equity and CDO highly leveraged collateralised debtgrowing every year since the US issuance, both highly dependent on obligations (CDOs) solely backed byABS market began in 1985, issuance the performance of the underlying subordinate residential mortgagevolumes began to fall for the first time US residential mortgages. Much has backed securities (RMBSs).in 2007 from $1.24 trillion in 2006 to been written about what happened$864 billion in 2007 and $160 billion in in that market and how that has We remain relatively pessimistic2008. In Europe, the ABS market was played out. To date, the market for US about a broad re-emergence ofeffectively at a standstill during the private sector mortgage backed bonds US private mortgage securitisationsecond half of 2007, 2008 and the first remains essentially closed with credit for new non-agency loans in thehalf of 2009. spreads making the loans uneconomic near future. This will likely require to originate compared with mortgages US property prices to stop falling,The downturn affected everyone from the US agencies. But the US something that is not expected thisin the market: ‘flow’ consumer ABS issuance year, and investor demand to tighten1. Investors, who found themselves (including auto loans, credit cards the pricing between US agency RMBSowning bonds with marks at only a and student loans) has been relatively and private MBS. The agency RMBSfraction of what they had paid for them. steady for the past two decades. market has essentially supplanted2. Financial institutions, who were no private mortgage securitisation,longer able to access financing for In the European ABS market, the partly because allowable agency loantheir credit card, mortgage, auto run on the securitisation market in balances increased from $417,000loan portfolios 2007 and 2008 was driven by a lack pre-crisis to $729,750 today. 20103. Individual consumers and of investor demand; however, credit securitisation of agency RMBS hasbusinesses, with all types of credit fundamentals remained largely immune been robust with issuance of moreratings, who were largely unaware of to this technical meltdown. European than $1.4 trillion in new agency poolsthe ABS market yet found it hard or residential mortgage securities and more than $450 billion in agencyimpossible to gain access to credit. have seen limited actual credit REMICs. Those volumes are likely to losses, resulting from better asset go up in 2011.Investor demand began to emerge performance, less vintage issues andin the US and Europe in 2009 and higher levels of credit enhancement We are cautious about the growthsurged in 2010, leading to greater new than US mortgage securities. As a prospects for US credit card backedissuance opportunities and significantly result, recent investor demand for bonds. The contraction of householdtighter spreads. Issuance was possible UK and Dutch residential mortgage debt within the US has led to lowerfor a wide range of ‘flow’ deals in the transactions has been very strong. credit card balances at the banks.US (consumer ABS market, including Combined with cheap funding forauto loans and leases, equipment We believe that the outlook is banks in the deposit market andleases, floorplan loans, rental care broadly positive and robust. Global new accounting consolidation rules,fleet financing and credit cards) and investor demand for asset backed the issuance of credit card backedin Europe (UK and Dutch residential securities has returned, enabling a bonds may therefore remain modest.mortgages, German auto loans). wide range of financial institutions But investor demand for credit cardBeyond the flow market, investor and corporations to issue debt bonds, long a core element of the ABSdemand (US and Europe) grew for backed by an increasingly broad market, remains strong. The studenthigher yielding ‘non-flow’ issuance. range of assets. That said some loan market remains challenged, elements of the pre-crisis market with disruptions both in the overall will not return. We do not expect to US government guaranteed FFELP see the re-emergence of monoclines program and challenges in the private providing guarantees to help issuers issuance market.Markets in 2011—Foresight with Insight Deutsche Bank
  • 62. In Europe, the primary market will Late in 2010, the investor refrain hascontinue to remain active out of been ‘is there any more product’?already started benchmark sectors We have seen a movement wheresuch as German auto ABS and UK the demand has been insatiable forprime RMBS. Additionally, the market ‘flow’ issuance and the search forshould continue to broaden as seen yield has lead investors to ‘non-flow’recently with deals backed by UK issuance. Deutsche Bank has beennonconforming mortgages and Italian a leader within this market, bringingresidential mortgages. New issuance varied transactions from cell towersyndication in Europe has reverted lease, rental truck fleet, time-shareback to a more widely distributed issuers and other private asset-backedmodel in the last two months as large offerings. Other sectors which haveanchor investors relinquish their hold experienced limited access to theon demand side liquidity. However, ABS capital markets in the past fewsuch large investors will still form years, such as hard assets (aircraft,a key part of the market for some rail, container) and CLOs, have beguntime to come. All leading European to see a thawing, and a pipeline offinancial institutions will be able to opportunities is developing.issue ABS this year however weexpect much greater investor scrutiny To sum up, we believe that theof issuance out of Ireland, Portugal, recovery seen in the global ABSSpain and Greece. Despite the short markets in 2010 will continue, andterm volatility due to sovereign issues, offer abundant opportunities for bothwe remain bullish on senior ABS in issuers and investors.the long term. This is due to our beliefthat the product should weathersovereign issues well relative to otherasset classes and that spreads aredislocated relative to vanilla credit andUS ABS.The net result of recent market trendsis a conspicuous lack of issuancevolume for investors when comparedto the amount of cash available toinvest. The dramatic growth in thehome equity and CDO markets leadingup to 2007 now means higher levelsof cash coming back to investors astheir holdings amortise. Further, manystructured finance investors havereceived greater portfolio allocations in2010 as tightening spreads have leadto outperformance compared withother markets. The combined effect is astrong technical demand for issuance. Deutsche Bank Markets in 2011—Foresight with Insight
  • 63. 3.11 Alistair HicksMarkets Curator, Deutsche Bank Art CollectionOutlook for ArtFour artists to watch in 2011Detail, Gabriel Orozco, UK Atomist (Lateral Diagram 1-4), 2009, tempera and gold leaf on digital print oncanvas. Courtesy of the artist and Kurimanzutto, Mexico City.In February, Deutsche Bank will be They would nod wisely and advise markets and the inherent nationalismnaming sixty floors of its Frankfurt that in times of economic turbulence is precisely what the ‘agents ofheadquarters after artists born after it is safer to steer away from change’ are fighting. Not that Phillips’1957 from around the world. The speculative ‘new names’ and buy old will lose out as the second wave ofheadquarters will effectively be masters, Impressionists and the High artists emerging from these countriesa survey of ‘world art’. The most Modernists, but there are many people will be among the world leaders in theexciting trend is a new determination sensing big changes in the market. change the world rather than justsnipe at the mechanics of markets Francois Curiel of Christie’s has Cao Fei is very much an artistand failing structures. For this article been despatched to Asia to try propelled by interest within China andI will concentrate on four artists and ensure that the auction house she works in Beijing. She makes films,who reflect this desire for change: competes effectively with the rapid photographs, operas, installationsFrancis Alÿs, (a Belgian living in rise of Chinese competitors. He is and interactive works. At Frieze sheMexico fascinated in redrawing the the first to point out that already created a room of her own Room 608world map), Cao Fei (born 1978 in four of the top auction houses in the which included some of her favouriteGuangzhou and so not part of the first world are from China, nine in the things, including a highly realisticwave of Chinese propelled to fame by top 20. Equally their rivals Sotheby’s imitation mail-order baby (she is aexternal speculation), Gabriel Orozco recognises a redrawing of the art recent mother). Her photographs are(a Mexican sniping brilliantly at central world, as otherwise why would they still under EUR10,000. Her ideas arecontrol and structures) and Nedko have devoted all their Bond Street socially inclusive. She has made anSolakov (a genuinely funny Bulgarian galleries to Robert Devereux’s British artwork on ‘Second Life’ on the webideas man who draws like a dream). contemporary collection to raise called ‘RMB City’. This interactiveTheir work can be seen at major around £5 million for his new African construction is apparently populated,institutions this year. Arts Trust. Phillips’ approach at first as the artist observes, mainly by sight looks more commercial with young people trying to escape theirThere are many ‘sages’ in the market their creation of BRIC sales, but this everyday lives: “All the COSPLAYERSplace who would disagree with me. direct correlation between money and are extremely young, their heads full ofMarkets in 2011—Foresight with Insight Deutsche Bank
  • 64. dreams, from an early age spending all his signature, which springs up like a One beautiful and funny series oftheir waking hours in virtual realities, virulent but beautiful disease on his drawings is devoted to his superplaying video games. So that when paintings and drawings. hero El Bulgaria, who in contrasteventually they grow up, they find to El Greco’s emaciated figuresthat they are living a lifestyle that is Francis Alÿs also lives in Mexico wears a cloak that cannot hide hisfrowned upon and rejected by society but he was born in Belgium and unfashionably round figure.and family alike. With no available is a professional migrant. Many ofchannels of expression for their his filmed performances involve The art world’s eyes have for the lastfeelings and aspirations, they resort walking. He walks along and through 150 years hardly left Paris, New Yorkto escapism, allowing themselves disputed borders. He believes art can and London. Much has been madeto become alienated. However, in help change the world. Gone is the in the last few years of Brazil, Russia,the very instant that they are turned dream of an absolute solution, but as China and India as the powerfulinto genies, chivalrous knights, fairy witnessed by his project to move a emerging markets, but this is just partprincesses or geeks, the pleasures dune, When Faith Moves Mountains, of the story. For the first time ever it isand pains of escapism are fulfilled, Lima 2002, he has inherited the possible to live anywhere in the worldfleetingly, even if the reality they live passionate belief of Joseph Beuys and make an international name as anin has not changed in the slightest.” that artists can help make the world artist. Solakov lives in Sofia and doesShe is not advocating escapism from a better place. Despite the absurdity not like to travel by air, so has justharsh realities, but rather stressing of what he was trying to do, there is travelled overland to his exhibition inthat our internal lives are just as a new sense of reality. He made this China. It is artists like Alÿs, Fei, Orozcoimportant. “I am not trying to divorce work in the run up to a contentious and Solakov, who are leading themy thinking from the modern reality in election in Peru. A 1984 government way. It is not surprising that my fellowChina. We live in the New Great Leap. document had declared ‘everything is advisor to Deutsche Bank, Hou Hanru,We have demolished everything and an illusion but power’ By persuading has dubbed them ‘agents of change.’are building anew. There is an aura of 500 students to shovel dirt to move aconstruction everywhere.” mountain the artist was demonstrating that ‘illusion is also power.’ There is an Francis Alÿs at MOMA, New York May –Gabriel Orozco equally emphasises element of the old adage ‘mind over Nedko Solakov can be seen at the Singapore Biennale in March and at Ikon, Birmingham,that “the idea of construction is very matter,’ but it is also questioning the England, in September.important. It is not enough to cut a integrity of our own minds, which are Gabriel Orozco will be at Deutsche Guggen-car in half. You have to build it up under a constant barrage of mind- heim in Septemberagain.” In his case he famously cut washing – mind control. As well as Cao Fei will participate in the inaugural exhi-a Citroen into three pieces, took out his films and installations Alÿs paints bition the Museum of the Moving Image inthe centre third and reassembled beautiful small paintings, which New York opening Januaryit. As a Mexican he is particularly can now already command aboveinterested in investigating the idea of EUR100,000 and makes series ofcentrality, not just political, but the drawings.change in the way we are trying tomove away from centrally-controlled Bulgarian Nedko Solakov is constantlythinking. His work is so diverse that it kicking against the status quo,is almost impossible to pin down. His but his dealers now are beginningmajor sculptures and paintings cost to rack up the prices. Until veryhundreds of thousands, but you can recently one could pick up singlefind beautiful drawings he has done drawings for around EUR3,000, buton bank notes at around $35,000. now if you want the best you have toAs he explores the question of the buy series of work and will probablycentre, the circle has become like need to lay out at least EUR20,000. Deutsche Bank Markets in 2011—Foresight with Insight
  • 65. 4 Trading High Yield Credit Investment Grade Credit Foreign Exchange Commodities Rates Asset Backed Securities Carry TradingMarkets in 2011—Foresight with Insight Deutsche Bank
  • 66. Deutsche Bank Markets in 2011—Foresight with Insight
  • 67. 4.1 Richard PhelanTrading Head of European Credit Research Anthony Klarman Head of US High Yield ResearchTen High Yield Credit Trades for 20111. Long Intelsat 4. Long Avaya 7. Long VantageIntelsat has nearly four years’ worth Avaya is the second largest provider Vantage operates a fleet of highof revenue already in non-cancellable of unified communications solutions. specification drilling units that hasbacklog and has the potential for It was taken private by Silver Lake long term firm contracts. Catalystssome additional upside with recent and TPG in 2007. We see future for further tightening include thesatellite launches. We believe the principal upside and spread tightening drillship starting work on Jan 1, 2011next phase of spread tightening for through steady, secular industry which should turn FCF positive andIntelsat will come through partial debt trends, aggressive cost cutting plans, decrease leverage (with increasedrecapitalisation, potential merger with integration of the recent acquisition of EBITDA) from about 11x now to 4x byTelesat, potential IPO and growth from Nortel Enterprise Solutions, and the the end of FY 11E.some recently launched/purchased potential for the extension of currentsatellites. bank debt through an Amend & 8. Long Ineos Extend and/or partial refinancing. Global and diversified chemical2. Long Norwegian Cruise Line producer benefiting from improvingNCL is one of the leading cruise ship 5. Long Fox acquisition credit fundamentals, stronger liquidityoperators and currently operates FOXACQ owns eight TV stations via divestitures and access to capitalten ships with 22,110 berths, 9.4% serving eight mid-sized markets markets serving to lengthen debtof total North American capacity by across the US including Denver, amortisations.berths. We believe spread tightening Cleveland, St Louis, Salt Lake City, andwill continue given improved Milwaukee. Seven of the eight stations 9. Long ONOfundamentals, lower leverage and are affiliated with FOX network (the Material improvement in FCF (frompossible IPO. Its secured debt offers exception is 1 CBS). The company negative to positive) and EBITDA11.75%, its unsecured 9.5%. has benefited from the rebound in growth should lead to deleveraging. advertising spend in 2010. Positive Considering asset cover and size of the3. Long Rite-Aid drivers for 2011 include growth notes, they should be refinanced. Y2WRite Aid is a top three US drugstore in core advertising, and the fall in not appropriate, as will be refinancedchain that is being prepared for sale programming expenses. It offers a ahead of maturity over the next twoby the management team brought in 13.375% cash-pay coupon. years.from its successful sale of Pathmark,Inc. It has over $1 billion of liquidity, 6. Long HCA Hospitals 10. Long Norske Skog byno meaningful maturities until This dominant for-profit US hospital selling two-year CDS2014/15, and over $6.5 billion of operator is 4.9x levered with strong Selling 2 year protection should be theasset value, supported by an average free cashflow. We see little chance best way to position for positive eventindustry M&A multiple of 9.3x. for another dividend as it would push risk in the next six months or so. WeSpread tightening should come from leverage too close to comparative expect to see Norske Skog achievefront-end traction from its consumer hospital company enterprise values of newsprint selling price increases inloyalty programme, stabilisation of 6–6.5x and diminish the potential IPO January, refinance the EUR400 millionpharmacy reimbursement rates, new value. Upside is the IPO. Feb-12 bank facility in H1 2011, andgeneric introductions, and continued potentially participate in Europeanconsolidation of independent newsprint industry consolidation inpharmacies and regional chains. 2011.Markets in 2011—Foresight with Insight Deutsche Bank
  • 68. Richard Salditt 4.2Credit Trading Strategist North America TradingJames MaxwellHead of European Credit Trading StrategiesInvestment Grade Credit Trading Ideas for 2011We expect European credit markets to In the defensive European utilities UScontinue to be dogged by sovereign sector we favour the higher-yielding In the US, we favour sectors that standfears, just as they have been in 2010. International Power bonds where we to benefit from improving domesticInvestors have responded by favouring believe an upgrade to mid-BBB is growth and inflation including selectedcorporate credits (investment grade on the cards following the imminent US banks, REITs, commodities andand high yield) over financials. With reverse take-over by GDF Suez. energy companies. Specifically,corporate balance sheets in good The company’s better geographic we would be buyers of Anadarkoshape but financials still subject to diversification, stronger financial Petroleum, Citigroup, Dow Chemical,political and regulatory risk, there profile and liquidity package from Energy Transfer Partners, Internationalseems little reason for this trend GDF Suez are supportive for its credit Paper, Kinder Morgan Energy, Rioto change. That said, we still see quality. Tinto and Simon Property.opportunities across the capitalstructure in the financial sector for Among European industrials, we We’d also take long positions inthose investors willing to withstand see value in the mining industry strong credits trading cheap to peerssome mark-to-market volatility. where higher commodity prices drive including InBev, Motorola via basis, significant discretionary cash flows NBC Universal, and RR Donnelley.In the US, we foresee a moderate year and deleveraging. In particular we arefor corporate debt investors with total constructive on Xstrata and Glencore While we do not expect a return toreturns being less spectacular than in cash and CDS given their exposure 2006/2007 LBO mania, we do seein 2010 but still positive. We expect to favourable coal and copper markets. intentional releveraging as the biggestto see additional bouts of volatility We also see steel markets improving risk to $ credit next year and so woulddriven by macro events outside the during 2011 and would expect avoid those credits that are maybeUnited States. Equities are likely to ArcelorMittal spreads to outperform more likely to add material leverage.outperform credit for the first time peers thanks to its vertical integration We would also avoid credits whosesince 2006 with high yield probably and geographic mix. We are also credit profiles remain under pressure.again outperforming investment grade constructive on the semi-conductoras it did in 2010. sector, Infineon in particular, where We’d prefer not to make a big bet disposals and a capital increase have in either direction in US financialsEurope improved credit fundamentals. away from a few specific long/shortIn European financials, we expect pairs as the volatility associatedregulatory change to drive institutions For those looking to enhance yield with macro risks may continue toto build and restructure capital. We without sacrificing issuer quality, outweigh positive underlying creditprefer low cash-price Tier 1 securities we advocate the corporate hybrid quality and technical trends, renderingon pending Basel 3 proposals that sector, many offering more than outperformance in financials relativeshould encourage banks to continue 300bp additional yield over equivalent to the market difficult to achieve.calling their subordinated capital – senior bonds. We favour hybrids fromwe particularly favour RBS, ABN and German bellwethers such as RWE,UBS in this context. We also favour Siemens and Linde, where we seethe incremental yield available in limited coupon deferral or extensioncontingent capital securities (‘CoCos’) risk and consider the risk stemmingas the search for yield from strong from subordination as very low.issuers such as UBS and CS underpins Among the sub-investment gradethe ‘low-trigger’ CoCos (i.e. those issuers we like Santos which offerssecurities where the conversion trigger a significant yield pick-up and has ais just 5% of Core Tier 1). proven track record of defending its ratings Deutsche Bank Markets in 2011—Foresight with Insight
  • 69. 4.3 Bilal HafeezTrading Global Head of FX Research Ten FX Trades for 2011 1. Sell $/JPY 6. Buy PLN/CZK Japan’s current account surplus and Polish rates likely to rise earlier and trade links to the rest of Asia should further than those in Czech Republic. keep JPY well supported. Intervention unlikely to prevent JPY reaching new 7. Sell GBP versus EUR all-time highs just as it did in 1995 UK may suffer from weakness in during intervention. Capital flow Irish financial institutions. UK deficit, data that appears to show increased negative real rates and poor growth hedging activity and less use of JPY prospects should also weigh on GBP. as a funding currency is helping JPY. 8. Sell $/PEN 2. Buy Asian FX basket versus $ A Latin American “catch up” trade led Asian central banks will become more by dollar weakness, rising commodity tolerant of currency rises because of prices, and rate hikes inflationary pressure, with stronger in Peru. growth providing further support. 9. Sell $/RUB 3. Buy MXN versus $ Higher oil prices, CBR intervention, Mexico looks seriously undervalued prospects of inflows on the back of given its strong link to the US expansion of privatisation programme economy which we expect to surprise (2011–2013) to RUB2 trillion from on the upside in 2011. RUB1 trillion and the forthcoming issuance of RUB denominated 4. Buy CAD/AUD Eurobonds. Russia an exception not Australian dollar looks overvalued and considering capital controls (see much good news has already been recent comments by presidential priced in, while Canada should benefit advisor Arkady Dvorkovich). Also, from US economic recovery budget is outperforming and equities continue to look relatively cheap. 5. Sell $/TRY A strong carry trade. Turkish rates are 10. Sell EUR/HUF 7% compared with 0.25% in the US. Room for further catch-up with valuation metrics.Markets in 2011—Foresight with Insight Deutsche Bank
  • 70. Michael Lewis 4.4Global Head of Commodities Research Trading Ten Commodity Trades for 2011 1. Long gold fundamentals are bearish with Gold is enjoying new sources of sluggish growth in European demand, demand from central banks and higher imports of LNG in addition to private investors. We believe gold the risk of Atlantic arbitrage via US will continue to attract investment re-export. capital in the current low interest rate environment. We believe gold prices 7. Long thermal coal would need to surpass $2,000/oz to We believe thermal coal will benefit represent a bubble. from strong Chinese and India demand. Moreover we expect 2. Long silver infrastructure problems in South Africa We expect silver to out-perform gold and Australia to persist during the first for as long as the US manufacturing half of 2011. sector activity is expanding. Silver is also trading cheap compared to gold. 8. Long corn We believe rising Chinese shortages 3. Long copper and the increasing use of corn as a We expect demand for copper to feedstock for the US ethanol industry remain strong at a time when mine will continue to push prices higher. production growth is likely to struggle. We view increased US acreage as the The possibility of a physically backed main hazard heading into the second copper ETF would tighten the market quarter of the year. still further. 9. Long soybeans 4. Short crude oil contango We expect rising Chinese imports and As global growth continues to recover the possibility that US farmers reduce we expect physical fundamentals plantings in soybeans to be bullish in the oil market to tighten and the developments for the market. overhang in US and OECD crude oil inventories to be slowly eliminated, 10. Long EUA carbon emissions encouraging a flattening in the crude We believe higher prices will be oil forward curve. triggered by European utilities in general, and German generators in 5. Bullish long dated crude oil particular, starting to sell forward We prefer bullish long dated strategies larger volumes of electricity for 2012 in crude oil given the threat of and 2013 delivery. This will encourage market disruption affecting near term hedging of their associated demand demand. Bullish long dated strategies for EUAs. With Phase-3 EUAs as yet also exploit the fact that finding costs unavailable on the market, and very are rising across the sector. unlikely in our view to be available until the second half of 2011 at the 6. Short UK NBP gas earliest, we believe forward selling of We look to sell weather induced power for both 2012 and 2013 will bid rallies in UK gas as a result of cold up Phase-2 EUA prices. weather. We believe medium term Deutsche Bank Markets in 2011—Foresight with Insight
  • 71. 4.5 Dominic KonstamTrading Global Head of Rates Research Francis Yared Head of European Rates ResearchTen Rates Trades for 20111. Bullish US Treasuries near-term, 3. EUR 2Y–10Y flattener 8. Long front breakevens in the USbearish long term Likely to get increasingly hawkish and UKSupply demand imbalance and statements from the ECB about With real GDP growth of 2.5% toelevated risk aversion levels should monetary policy, even if liquidity is 3%, the risk of deflation in the US issupport Treasuries over the 1M to 3M maintained to support peripheral low. We actually expect inflation tohorizon with yields falling to around countries. The risk of policy error normalise towards 2% by the end of2.5% or below. Beyond, improving increases medium term with deflation 2011 while the market seems to befundamentals and higher core risks in the euro area. Favour pricing in less than 1% inflation ininflation levels should trigger a partial implementing the trade in swap space 2011. UK inflation appears sticky andnormalisation of 10-year UST rates in case the tightening of liquidity leads the BoE’s spare capacity argument isabove 3% later on. We recommend to a spike in Libor rates. subject to uncertainty in estimationzero-cost 6Mx10Y 1x2 payer ratios. The of the output is mildly bullish in the short run 4. 2Y10Y flattener in EURbut should provide significant upside in versus steepener in the US 9. 5Y–30Y flattener in the UKa moderate sell-off as we move towards While we expect the 2Y10Y curve to UK 5Y–30Y curve close to historicallyexpiry. The trade should only lose bear flatten in Europe, in the US, with steep levels, driven by increasedmoney in 6 months if the underlying the short end anchored, a sell-off in issuance at the long end and therate sells-off by more than 90bp from rates should lead to a steepening of relatively weak balance sheet of ALMcurrent (Dec 2010) levels. the curve. players. Q1 2011, (which is the last quarter of the UK FY) will see only2. Bearish EUR short end 5. Short France on ASW basis limited supply at the long end. BoE QE,Real rates for core countries are not France scores poorly on our twin if delivered, will target the long end asjustified by the robust economic deficit measure of fiscal and current well given the low free float of bondspicture. Tapping of the EFSF facility account deficits. Tapping of the EFSF already bearish for core rates, as the core facility increases the contingentcountries bear contingent liabilities. liability of the core countries and 10. Cross market trade: equity putThe ECB is likely to increasingly should be bearish for core rates. conditional on a rate sell-offdifferentiate between rate setting Any re-pricing of the bond riskand liquidity policies, with liquidity 6. Long Italy in the 2Y sector premium which is not accompaniedrequired for the weaker peripherals but Investors in search of yields should by significant improvements inrates too low for the core countries. favour Italy as a relatively safe the economic outlook should beWe recommend paying EUR 1y1y peripheral play. The 2Y sector looks detrimental to the equity market.swap which is only 43bp above 1Y most attractive from a carry/roll down This could occur either if sovereignswap and prices no risk premium to perspective. risk is re-priced or in a stagflationaryspeak off. environment. To hedge against this 7. Long Ireland in the 2Y sector risk, while cheapening the premium The EFSF support package should paid, one could consider equity draw a line under banking sector woes (S&P500 and FTSE) puts conditional in Ireland. We see limited room for a on rates being 150bp above spot. default/restructuring on Ireland in the The conditioning reduces the option near term, as long as Ireland sticks to premium by about 55%. fiscal consolidation measures.Markets in 2011—Foresight with Insight Deutsche Bank
  • 72. Conor O’Toole 4.6European Securitisation Research TradingSteven AbrahamsUS Securitisation ResearchTen ABS Trades for 20111. Long UK non-conforming mortgage 4. Long UK buy-to-let MBS 9. Long AAA-Rated traditionalSenior AAA-rated UK non-conforming At 280-300 bp (as of early December) consumer ABS (credit cards,bonds offer returns of 250 to 200 basis AIREM senior bonds offer pick up to autoloans) versus lower ratedpoints (as of Dec 2010). High credit vanilla paper. Credit performance has consumer ABSenhancement ranging between 30% – stabilised (late stage arrears at 3.8%), With increased macro market40% means principal impairment risk losses readily absorbed by excess volatility, AAA rated ‘on-the-run’ ABSremote – 95% of pool can default with spread while credit enhancement is likely to outperform versus cuspier,40% loss severity. Negative default stands at 18%. lower-rated product.convexity boost returns, while lowCPR scenarios still provide returns in 5. Long UK non-conforming 10. Long US Government guaranteedexcess of 200 bp. mezzanine (FFELP) student loans versus US credit Focus on 2006 mezzanine UK non- cards2. Long new issue residential conforming bonds that display Credit cards are unsecured consumermortgage backed securities (RMBSs) principal impairment resiliency under credit risk. FFELP student loansof lower rated sponsors, and legacy stressed scenarios and pro-rata trigger benefit from a 97% US governmentRMBS of higher rated sponsors upside such as RMAC 2006-NS2 that guarantee. For this reason, studentThere is little pricing differentiation offers over 1000 bps (as of Dec 10) has loans almost always trade tighter thanbetween legacy and new issue bonds. seen 6.9% cumulative defaults, and cards. Today the inverse is true. ForYet new issue paper has punitive can withstand a further 28% defaults example, in 5-years, cards are tradingstep up coupons compared to legacy under our base scenario. at a spread to LIBOR of 43 bps, whilemarket. We expect sponsors in Dutch FFELP student loans are at 75 bps.and UK prime RMBS to continue 6. Long US CLO versus Short That difference should compress.calling bonds or providing necessary European CLOsupport in the case of master trusts. Single-A/Triple-B European CLOs tradeHowever, as a defensive tail-risk hedge wide to similar US paper but there iswe recommend accumulating new greater concentration risk in Europeanissue bonds to insure against bond pools, 50 obligors versus typicallyextension risk reappearing. 100+ in the US.3. Long Granite AAAs 7. Long US floating-rate CMBSGranite’s AAA bonds (as of early The re-emergence of the CREDecember) were offering 262 basis financing market will allow morepoints. Even if CPR falls to 8% for life loans to successfully refinance anddm still healthy at 165 bps. Continuing significant deleveraging.deleverage likely to see hard creditenhancement build to 27.5% by end 8. Long US 2005–2006 conduit CMBSof 2011, without a corresponding Focus on mezzanine tranchesdeterioration in pool performance. from transactions which have an overexposure to properties in top tier markets. The credit performance for these properties will continue to improve and values will recover to pre- crisis levels. Deutsche Bank Markets in 2011—Foresight with Insight
  • 73. 4.7 Rashid HoosenallyTrading Global Head of FX StructuringIs the FX Carry Trade Dead?A time-honoured trading strategy under the spotlightThe FX carry trade is as old as the global capitalmarkets themselves which can trace theirorigins to the end of the gold standard and theSmithsonian agreement in the 1970s. So with the40th anniversary of the carry trade approaching,are its best years behind us or does the carrytrade still have relevance post-crisis?The fundamentals are not This indicates that carry trades will Another solution is to change the riskencouraging. Interest rates are at all remain a compelling trading stratgegy profile of the trade. Instead of havingtime lows, the outlook for risky assets in 2011. The downside is drawdown a simple long-short basket (whichis uncertain, and both the actual and risk. is typically referred to as a Delta-1predicted level of currency volatility is exposure), buy call options on carryhigh and we expect it to remain high. As carry traders found out in 1997 instead. This limits drawdowns and and 2007, carry trades can go wrong potential losses to the premium paid.And yet, this was broadly the case extremely quickly. In both years, In a world in which understanding andin 2009 too, when carry was a top the dollar, yen and swiss franc predicting stressed exposures and riskperforming currency strategy as strengthened, whilst sterling, the New is increasingly desirable, this type ofthe chart (which shows the return Zealand dollar, Icelandic krona and strategy has clear benefits.of Deutsche Bank’s flagship carry many emerging market high-yielderstrading strategies: Harvest and Haven) fell dramatically, forcing traders to A similar and broadly equivalentdemonstrates. unwind carry trades. strategy has many of the economic benefits of this type of risk managedSo can it continue? So how can you carry on doing the approach to carry without the need toThe key to carry trades is interest rate carry trade without becoming exposed pay premium explicitly.differentials between currencies. So too heavily to drawdown risk?long as they persist, carry trades are One solution is to diversify: broaden A third solution is to make one’slikely to earn excess returns. the basket to include EM currencies, exposure to carry ‘dynamic’, by whilst ensuring G10 currencies still reducing exposure based on someWe believe they will persist given the feature in long and short baskets. type of forward-looking risk indicatorfact that economic performances (and As well as improving diversification, so that in times of increased marketby extension interest rates) diverging this accesses significantly higher risk or stress when large carryrather than converging, with the Fed yield differentials. More importantly, unwinds and market illiquiditykeeping rates low and EM central it reduces drawdowns and provides manifest themselves, exposure isbanks raising them to combat inflation. significantly improved returns as a either reduced or avoided altogether. result.Markets in 2011—Foresight with Insight Deutsche Bank
  • 74. 340 320 300 280 260 240 220 200 180 160 140 120 100 80 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 99 Dec 05 Dec 06 Dec 07 Dec 08 Dec 09Figure 1: DB Harvest Balanced ER Index Figure 2: DB Haven ER Index340 340320 320300 300280 280260 260240 240220 220200 200180 180160 160140 140120 120100 100 80 80 Dec 00 Dec 01 Dec 02 Dec 99 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec 09 Dec 00 Dec 99 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec 09Disclaimer: Past performance is not a guarantee of future results340320We also consider spikes in front-end300EUR/$ vols to be a simple but liquid,280 What is a carry trade?observable and reliable indicators260 In its simplest form, a carry trade involves investing in assets in countriesof short term market risk, and thus240 with high nominal yields to generate positive investment returns over time.a good forward-looking predictor of220200carry drawdowns. Deutsche Bank’s180 Specifically, this would be done by combining a long position in cash orHaven index attempts to exploit160 bonds in a high-yielding currency with a loan or short position in a low-this indicator in order to generate140 yielding one. 120positive returns from carry trading100while managing risk by deleveraging 80 In 2005 and 2006, the Australian and New Zealand dollars were popularin advance of drawdowns. Figure ‘longs’ (high-yielders) and the Japanese yen was a common ‘short’ or low- Dec 00 Dec 99 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec 092 shows its historic returns on a yielding currency.backtested basis. Figure 1 shows thereturn of our benchmark dynamic In theory, carry trades shouldn’t work: any excess yield in one currencycarry trading index, DB Harvest. versus another should, over time, be eroded away by losses in currency depreciation of the ‘weak’ currency – a theory known as uncovered interest parity. In fact, not only do currencies of high-yielding countries not depreciate over time sufficiently quickly to erode the extra yield, they as often as not actually appreciate, giving their holders both the interest rate excess, or carry, and a currency gain to boot. Deutsche Bank Markets in 2011—Foresight with Insight
  • 75. 5 Risk Management Equities Credit Rates Foreign Exchange Longevity Inflation CommoditiesMarkets in 2011—Foresight with Insight Deutsche Bank
  • 76. Deutsche Bank Markets in 2011—Foresight with Insight
  • 77. 5.1 Vijay PopatRisk Management Head of Institutional Equity Structuring Amit Bordia Global Head of Equity StructuringEquity HedgingLook beyond short dated collars and putsThe most popular ways to hedge againstfalling equity markets is to buy short-dated put options or through short-datedcollars. Buying puts is very expensiveover time because of the large number ofpeople looking for protection and the smallnumber of dealers willing to sell them.Markets in 2011—Foresight with Insight Deutsche Bank
  • 78. It can be shown historically that over performance of an optimised forward equity index which is managed so thattime the shorter dated collars greatly variance strategy – such as Deutsche the realised volatility is stable.erode equity performance because so Bank’s ELVIS index – may be a goodmuch of equity performance can be alternative.  This is easier said than done butconcentrated in a single year. They can fortunately a number of products haveboth be used effectively but require Long-Dated equity collars been developed recently that allowmarket timing and are essentially Investors willing to cap their returns over investors to get this hedge quite easily.opportunistic. They are not effective as 10 years at around 8.4% compounded (aa way to structurally reduce equity risk gain of 123% over 10 years), can finance Our own version of one such productover the medium or longer terms. So protection from 90% to 50% using long- is called TEMPO which tracks a longwhat will work? We feel three strategies dated equity collars. position in a major index (e.g. thewill be effective: going long forward EuroSTOXX 50) that moves partiallyvariance, long-dated equity collars and This implies that if over 10 years into cash when volatility exceedslonger-dated put protection strategies. the market lost 50%, the protected 18% so that the index has a stable portfolio would only lose 10%. realised volatility.Hedging with varianceAcademic research indicates that This is a dramatic reduction in risk The premiums on options on TEMPOthere is a very strong correlation that is achieved only at the cost of can be substantially lower than thatbetween volatility and stock market capping returns at above levels that are of plain vanilla options: 1.65% a yearperformance: when stock markets somewhat optimistic (8.4% at the time compared to 2.7% for 5-year 80%fall significantly, volatility tends to of writing would represent an equity strike puts on the Eurostoxx 50 indexgo up1. risk premium of over 5.5% over bonds). for example. This is because the dealer does not have to price it using inflatedBy going long volatility via variance On a risk adjusted basis – i.e. if implied volatilities and can dynamicallyswaps (which pay a return based investors increased their collared risk manage the exposure becauseon how volatile stocks are), investors equity portfolio allocation to provide they know its upper level.can get protection against market falls. a similar risk budget usage – the portfolio would outperform an In addition the performance of theseUnfortunately, they are often as uncollared portfolio in a rising market volatility stabilised indices can be quiteexpensive as put options because they up to the point where returns were favourable compared to passive indices.are priced on implied volatility but pay 11% compounded over 10 years: aout on the basis of realised volatility, gain of 189%. We believe this would be a particularlyand generally realised volatility is 2% good way to hedge EM equity riskto 3% lower. Longer-dated put protection strategies where investors want to increase Longer-dated options (5 to 10 years) allocations but where there isHowever, this problem can be look significantly cheaper than short- substantial potential risk.overcome by going long forward dated options: for example on 100%variance which tracks not the strike puts on the S&P500, 4% a yeardifference between implied volatility compared to 10% on a one-year put 1. DB Global Markets Research: ‘Hidden Assets’and realised volatility over a given rolled over for five years. However, Investing Series - Equity Hedging with Volatility, by Pam Finelli and Mehdi Alighanbariterm but rather on changes in implied both are still fairly expensive becausevolatility over time. By optimising the of strong demand from insurers in Projections are based on a number of assumptionspart of the volatility term structure, particular and a lack of natural sellers.  as to market conditions. There can be no guarantee that the projected results will be acheived.the costs of hedging can be reducedsignificantly and as a result form an Dealers are only really willing to Source of statistics: Deutsche Bankattractive way to reduce equity risk. price options that they can hedge out and with so few natural sellersThis strategy may be difficult for of protection, this has resulted inmany investors to implement both premiums for 10-year options thatoperationally and in terms of on-going imply more volatility than at any timerisk management. since the 1929 crash.For these institutions, a fund or swap One way to avoid these inflatedlinked to an index that tracks the premiums is to buy an option on an Deutsche Bank Markets in 2011—Foresight with Insight
  • 79. 5.2 Antoine CornutRisk Management Head of European Credit TradingCredit Risk ManagementGetting easier and, in many cases, cheaperCredit risk has become easier and, in many cases,cheaper to hedge thanks to changes in the creditdefault swap market.In recent years, credit default swaps Perhaps the most important change example and there is a default after aor CDS, which provide compensation was the establishment of fixed strike year they would have pay $1.6 the event of a default, have not prices. Before, as protection, a buyer However, if a user chooses a 500 strikealways been an efficient hedging paid a spread – similar to an insurance they would be paid 100 basis points, ortool for corporates and institutional premium – that reflected the annual $100,000, upfront for the five-year CDSinvestors. The main deterrents have price of protection quoted in basis (a total of $500,000) and would have tobeen the high cost of obtaining points of the notional contract. So, for pay 500 basis points, or $500,000 forprotection against the most difficult example, if a user wanted five-year the first year’s running coupon –risks, the lack of liquidity in the market protection for a $10 million position giving a total cost of just $400,000.and the difficulty of getting out of on an investment grade companybespoke contracts. quoted at 400 basis points, they would Strike advantages have to pay 400 basis points a year, Standardised strikes also meanBut the introduction of centralised or $400,000, as a premium. Over the that a 100 strike, for example, isclearing and the creation of lifetime of the contract, protection available for a given investment-standardised and simplified trading would cost $2 million. grade credit, regardless of whethermodels has greatly reduced these the CDS has a one-year or 10-yearproblems. Bid-offer spreads on the Now, under the new system, a user maturity. In the past, it wasbenchmark iTraxx index – which tracks pays a running coupon of either complicated to buy forward CDSa broad universe of credits – are now 100 basis points or 500 basis points because of differing spreads and theabout 0.5 basis points compared to (dealers quote both for many names), requirement to transact through aone basis point two years ago. The with the differential between that single counterparty: any transactioncost of protection on many credits has level and the overall cost of protection would have to be bespoke for thatalso halved over the past two years paid upfront. So, for example, if a user client and consequently illiquid.from 200 basis points to 100 basis chooses a 100 strike for the example Now standardised strikes make itpoints on most investment grade above they would have to pay 300 straightforward for any CDS usercorporate names (figure 1). basis points, or $300,000, upfront to express sophisticated views and for each year of the CDS (a total of change them as necessary.Meanwhile, it has become significantly $1.5 million), and 100 basis points, oreasier to unwind positions: before it $100,000, a year. For example, if a telecoms companycould take weeks to get out of a in the United States has exposuretrade, now trades can be unwound Although the total cost of protection to a European telecoms company itin seconds. is the same under the old system, may be confident that its position is the costs paid for a 100 or 500 strike secure over the next year, given theSmall and Big Bangs in the first year differ hugely. It is supportive effects of quantitativeReform of the CDS market began in advantageous to use a 500 running easing on liquidity in the funding2009 with the Small and Big Bangs coupon where possible from a cash market: the European telecomswhich saw dealers adopt standardised flow perspective and also in case of company will continue to be ableCDS maturities, coupon prices and default early in the contract. If a user to borrow and will remain solvent.procedures following credit events. chooses a 100 strike for the above However, the US company may beMarkets in 2011—Foresight with Insight Deutsche Bank
  • 80. concerned about its European peer’s In recent years, the increasing in which the underlying asset islonger term outlook and want to lock- numbers of defaults, especially of denominated. For US dollar bondsin protection at current prices from high yield names, and widely varying from US issuers, it is straightforwardyears two to five. Using fixed price recovery rates have prompted clients to buy US dollar protection. However,strikes, it is easy for the US company to put pressure on dealers to address it is more complicated if the risk is in ato buy five-year protection and sell this problem. Dealers have responded different currency to that of the mostone-year protection: the return from with the development of a liquid liquid CDS. The majority of Britishselling one-year protection cancels recovery swap market, which has Telecom loans, for example, are inout the cost of buying the first year grown by a factor of 10 in the past sterling and dollars but 90% of theof five years of protection, so that year. Recovery swaps enable users to company’s CDS traded are in euro,the US company only begins to pay lock-in a recovery rate at the time they meaning that holders of protectiona premium for protection in year two. put on the CDS trade. Users decide against a default are mismatchingIf, after one year, the US company a recovery rate they would want to their assets and liabilities. With foreignchanges its mind and decides it receive in the event of default and in exchange volatility set to continuedoes not need protection against return swap the eventual real recovery in the foreseeable future, CDS usersthe European telecoms firm for the rate. Should default not occur, the need to ensure they effectivelyfollowing year, it can simply sell swap expires with no payment to manage this quanto risk.another one year of protection to cover either party. Instead of having to waitthe costs of its protection for that year. for a committee to determine the In the past, it was not necessarily recovery rate, the buyer can be cost-effective to hedge in a currencyAccurately hedge notionals certain of their pay-out. other than the most liquid for a givenCompanies, unlike financial institutions, name. However, the standardisationusually use CDS to hedge a specific By combining CDS with recovery of CDS brought about by the Big Bangamount of risk to which they are swaps, it is possible to more and Small Bang has, in addition toexposed. Historically, this has been accurately manage credit risk: a user increasing volumes in euro (which aredifficult in the CDS market because the can hedge a notional and be confident the most liquid for European names)pay-out in case of default is par minus that if a default occurs, they will be and dollars (which are most the liquida recovery rate, which is determined paid the exact amount they anticipate for North American names), led to anby a committee a month after default. in cash. For example, if a user believes exponential increase in liquidity forRecovery rates vary considerably: the that a bank will default in the coming other currency CDS. Consequently, therecovery rate for Dutch chemicals year and seeks protection against it, cost of currency-accurate hedging hascompany LyondellBasell in April 2008, they can buy CDS protection and sell a fallen significantly. Indeed, analysis byfor example, was around five cents recovery swap at 30 cents on the euro, Deutsche Bank indicates that the CDSon the euro in contrast to French ensuring a pay-out ratio of 70% in the market is currently under-pricing themultimedia firm Thomson’s bankruptcy event of default. required premium to trade a currencyat the end of 2009, which had a other than the most liquid: for example,recovery of 60 cents on the euro. In Guard against currency volatility dealers are charging a premium oforder to achieve a desired payment, CDS users usually buy protection in 3%–5% of spreads to hedge Europeancompanies have frequently over- the most liquid currency for CDS on companies in dollars (a worthwhilehedged, which is costly. that name, rather than in the currency trade given that much outstanding European company debt is in dollars) when the real cost is more than 10%. There now appears to be an attractive opportunity to cost-effectively lock-inFigure 1: Cost of Protection Going Down currency accurate hedging.Data: Markit iTraxx Europe index. Source: Deutsche Bank250 Basis points MARKIT ITRAXX EUROPE 12/15200150100 50 0 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Disclaimer: Past performance is not a guarantee of future results Deutsche Bank Markets in 2011—Foresight with Insight
  • 81. 5.3 Dominic KonstamRisk Management Head of Rates Research Francis Yared Head of European Rates ResearchRate Risk ManagementKey rate risks for 2011 and how to hedge themThe range of rate risks facing Extreme euro tensions and 10Y-30Y breakeven steepenersborrowers and investors in 2011 is Our base case scenario is one where would hedge against this outcome.wide. While there are some historical Spain withstands the market pressure We would also recommend a widenerprecedents for the financial shock which is likely to persist until the of the 10Y20Y CPI swap versus 5Y5Yof recent years (e.g. Japan and the Spanish banking system is more CPI swap. The spread is trading closeGreat Depression), the policy reaction convincingly recapitalised. However, to flat, as of early December 2010, andfunction has been markedly different the risks of a self-fulfilling rise in is pricing in no inflation risk premiumand their impact on the real economy borrowing costs and/or significantly (against 40bp before 2008).is highly uncertain. This uncertainty is higher recapitalisation costs remain.compounded by the threat posed to The EFSF, together with the EFSM ECB hiking rates earlythe Eurozone by diverging economies and the IMF, could lend up to EUR560 Early growth in core Europe has beenand the need to rebalance the global billion, which would leave EUR425 extremely robust, with Germanyeconomy. billion to support Spain if both running at close to 3% GDP growth Portugal and Ireland require EUR67.5 annualised. While growth shouldFor us, the four outstanding risks that billion each. However, even if the EFSF decelerate somewhat, it is likely tomust be addressed are: could technically support Spain, the remain strong and above potential political and economic implication of given that (a) neither the public norUS deflation a Spanish bailout would significantly the private sectors are over-levered,The underlying dynamics of the sub- raise the risk of a euro break-up. The (b) the economy remains competitivecomponents of core inflation suggest more obvious way to hedge against at the current exchange rate,that US inflation should stabilise and this risk is to buy protection on the (c) unemployment is back to pre-crisisrise modestly in 2011. However, the euro, as any breakup is likely to occur levels, (d) most assets (housing) aresustainability of this rebound crucially with the stronger countries leaving. not overvalued, and (e) real rates seemdepends on real growth in the US We would also implement wideners too low.staying above 2% and the current on the EUR/$ cross-currency basis andoutput gap not weighing on inflation on the Euribor/Eonia basis in order to While the uncertainty around theexpectations. This risk will rise if the capture a flight to quality towards the global outlook and the situation inUS tighten fiscal policy prematurely, US dollar and growing tensions in the peripheral Europe remains high, thewhich is possible given the recent European banking system. ECB should remain on hold. However,shift in Congress. To hedge against there is a risk that the ECB decidesthis scenario, we would recommend USD crisis to raise its policy rates earlier thanout-of-the-money receivers on There is a risk that we will see a shift currently expected, especially ifthe long-end to protect against an away from the $ as a reserve currency, it decides to maintain some of itsextended period of low rates. We precipitating its sharp fall. Given the extraordinary liquidity provisions.also recommend purchasing 5Y lack of alternatives to the $ at the Front-end payer spreads offer a gooddeflation floors, financed by selling moment and the keenness of the key hedge against this risk.10Y deflation floors. Despite a higher emerging market countries to avoidrisk of experiencing subdued inflation disorderly FX moves, this risk is small.levels or a deflation in the next few However, it could be exacerbated byyears, rather than over the next 10 the backlash that followed the QEyears, the trade actually generates announcement at the end of 2010 anda premium take out according to could be supported by the transitionour estimates. China is currently undertaking from an export-led growth model to a consumption growth model (as confirmed by the latest five-year plan). High strike payers on the long endMarkets in 2011—Foresight with Insight Deutsche Bank
  • 82. Deutsche Bank Markets in 2011—Foresight with Insight
  • 83. 5.4 Rashid HoosenallyRisk Management Head of FX Structuring Foreign Exchange Risk Management Going super-sized Currency risk has become a crucial issue for many companies since the 2008 crisis, with exchange rate volatility increasing dramatically. Greater trends in currency markets EUR/$ Spot 1.70 Greater trends in currency markets We expect this volatility to continue EUR/$ Spot in 2011 for two reasons. First, recent macro developments point to a 1.60 widening, rather than a narrowing in macro divergences globally, which suggest continued strong currency 1.50 trends. Second, with interest rates at historic lows, an increasing amount of the macro adjustment burden is falling 1.40 on currencies. This volatility may be compounded 1.30 for many companies in 2011 by the probability that much of the risk is likely to be in emerging markets where 1.20 an ever larger share of their value and cashflow at risk is centred. 1.10 We may also see currency risk go 2006 2007 2008 2009 2010 ‘supersized’ for corporates if adverse currency moves coincide, as they may Source: Deutsche Bank well do, with negative growth shocks and collapsing export volumes. This means the ‘pass-through’ of volatility to financials could become much higher. FX risk has the capacity to severely impact the bottom lines of individual companies. In some situations, currency moves have not only impacted profitability, but also breaches of debt covenants, leverage, net equity, capital adequacy and solvency ratios.Markets in 2011—Foresight with Insight Deutsche Bank
  • 84. Transaction and translation risk Source: Deutsche Bank Most corporates will seek to be exempted from requirements to clear hedging instruments centrally. Transaction Monetary Translation Competitive So what is the solution? One answer could be the appropriate • Operating cash flows • Liquid assets • Earnings • International competitors use of certain risk-reducing • Foreign liabilities • Net equity derivatives, especially purchased • Growth metrics options. These can provide corporates • Covenants with the flexibility they will need to manage less certain exposures and eliminate costly mis-matches. More importantly, they also neatly Direct cash flow Direct value Impact Accounting Business avoid the potential pitfalls of hedging impact impact impact with OTC forwards, cross currency- swaps or listed/cleared derivatives by Typical Treasury Focus Typical Management Focus limiting counterparty exposure and, therefore, liquidity and funding risk.To hedge FX risk effectively, it is They will be required to stress such The same will be true for other typesnecessary to identify how it affects exposures much more, leading to a of market risk typically hedged withdifferent parts of the business and sharp increase in the calculated size of OTC instruments including interestfinancial statements. There are, in counterparty risk. Not only this, they rate and commodity risk. Indeed, it mayessence, the two broad categories will also have to provision much more even be the case that bundling theseof currency risk: transaction and extensively against this magnified risks together and hedging aggregatetranslation (see table above). risk. So both the quantity and price net exposure will create efficiencies. of credit valuation adjustments willWhile transaction risk has a increase materially. Purchased options also provide otherdirect impact and has, therefore, benefits. Analysts, investors and otheralways been actively managed, we Corporates with significant economic counterparties includingestimate only 20% of corporates are uncollateralised OTC exposures to banks and suppliers reward companiesextensively managing their translation banks could find their credit spreads with clear and well communicatedrisk. This is despite an increased suffer from technical selling as banks risk management strategies, and afocus by analysts and investors on are forced to actively purchase credit quantifiable value and cashflow-at-risktranslation hedging, specifically protection to hedge counterparty hedge book. Purchased options hedgethe hedging of net equity in foreign credit exposures. In extremis, this programmes are well suited to thissubsidiaries and expected earnings. could crowd out liquidity and funding purpose. available for general purposes.Looking ahead, it seems likely that it 2011 should be a good time to refinewill become more expensive to hedge Nor are listed and/or cleared risk management policies to createusing traditional instruments. instruments, in our view, ideally suited hedge strategies based on purchased to corporate hedging. They will require optionality that address concernsRegulatory changes imply that significant liquid collateral to meet over premium outlay and accountingbanks are likely to have to reserve margin calls on instruments that are impact, whilst still providingsignificantly more capital against OTC hedges for non-cash items, creating compelling economic advantageshedging instruments in the future. a liquidity mis-match and a similar to the hedger that can be clearly crowding out of funding capacity. communicated to stakeholders. Deutsche Bank Markets in 2011—Foresight with Insight
  • 85. 5.5 Rashid ZuberiRisk Management Head of Complex Life and Pensions ManagementHedging Longevity RiskLive long and prosperOpportunities for pension funds to protectthemselves against pensioners’ increasing lifeexpectancy – so-called longevity risk – areincreasing, through the growth of the longevityswap market.Historically, the longevity swap market concept: any financial contract that For counterparties to take on longevityhas been too small and illiquid to guarantees payments to an individual risk, there must be a measurableprovide effective hedges in the size until death means that the writer of financial benefit to them. This willand cost required. such contracts is exposed to the risk transform longevity risk from a one- of the individual living longer than sided problem for the insurance andBut after years of sporadic deals, expected, so-called longevity risk. pensions industry, into a burgeoningthe longevity hedge market is now market of risk takers and sellers.approaching the critical mass needed Who traditionally takes on this risk?to offer compelling risk management The two dominant longevity risk There now seems to be a genuinesolutions to a wide range of funds. takers are insurance companies that increase in the presence of protection write annuities and pension funds that sellers. For these sellers, the conceptIn 2010, Deutsche Bank arranged a £3 promise to pay lifelong benefits. of sufficient reimbursement is key: itbillion hedge for BMW’s UK pension may not be straightforward financialscheme using longevity swaps, the For pension providers, longevity risk sits compensation. Most notably, theselargest transaction of its kind by some alongside the risks created by interest risk takers are reinsurance companiesmargin. rates, used to value liabilities, and those for whom this new risk acts as a created by inflation, often used to adjust portfolio diversifier as well as addingUnder this deal, the pension scheme the value of promised benefits. While some return via the premium theyswapped a fixed stream of projected very liquid capital markets in interest charge. In the future other investorscash flows, which it pays to the rates and inflation allow pension funds may emerge.hedger, for ‘floating’ payments from to manage these two risks, no suchthe hedger. These floating payments market exists in longevity. While talking about longevity mayincrease if the pensioners live longer sound morbid, the fact is that ifthan expected and decrease if people By definition, a ‘liquid’ market means pensioners want the security thatlive for less time than expected. that there are a large number of comes from having an income for life buyers and sellers and therefore prices after reaching retirement, they needWe believe that the success of this are observable and driven by supply pension funds and insurers to feeldeal will pave the way for other and demand. But longevity risk, unlike able to manage the longevity risk thatpension funds to do similar deals that associated with interest rates or arises from offering lifetime annuities.which will, in turn, deepen and expand inflation, has a sizeable number of The increasing presence of longevitythe market, making longevity risk ever sellers and a distinct lack of buyers. underwriters will hopefully make thischeaper and easier to hedge. This is a serious problem: there is easier to do. circa £1 trillion of outstanding UKThe risk that people will live longer pension liabilities in defined benefitthan expected is certainly not a new schemes exposed to longevity risk.Markets in 2011—Foresight with Insight Deutsche Bank
  • 86. Daragh McDevitt 5.6Global Head of Inflation Structuring Risk ManagementInflation Risk ManagementNo need for panic but take precautionsAs the world emerges from the If inflation does rise in developed UK. Investors who already hold bondslongest and deepest recession since economies, it is going to be imported that diversify into the inflation-linkedthe Second World War, core inflation – via rising food and energy prices, market are, in effect, getting paid toin industrialised countries is at multi- external factors outside the control do it, given the limited risk premium1.year lows. of western governments and central banks. Emerging markets are at Another option for investors whoCentral banks have implemented greater risk. Since late 2010 consumer are concerned about the impact ofaggressive monetary policies to hasten price inflation has been creeping up in rising inflation is to invest in inflation-economic recovery and ward off the countries including China and Taiwan, linked swaps which provide purethreat of deflation. However, in 2011 partly because the weighting accorded inflation protection. Participants in thisthese trends are likely to be reversed, to food in their inflationary ‘baskets’ is market pay a known future amount inand the inflation risk will likely switch greater than in developed countries. exchange for cumulated inflation fromto the upside. trade date to maturity. Investors can The Asian countries’ policy of pegging also buy options on inflation to protectThe great fear that some investors their currencies to the US dollar themselves from tail events.have is that the combination of loose intensifies inflation risk, since it canmonetary policy and quantitative require them to adopt interest rates Buying a collar on inflation (i.e. buyingeasing (QE) – ‘printing money’ – in which are potentially inappropriate a ‘cap’ and selling a ‘floor’ ratherdeveloped countries, together with for their faster-growing domestic than a swap) is a more attractivea diminishing ability of emerging economies. They are also vulnerable to investment. Instead of doing a swapmarkets to ‘export’ deflation to the the inflationary effects of QE2-driven at say 2%, investors can buy a cap atrest of the world, is going to lead to capital inflows. 3.5% and, in order to pay for that, sellrampant inflation. a floor at 0%. In the event of inflation Investors are increasingly recognising remaining normal and benign, thereBut investors should not exaggerate that pre-crisis assumptions about would be no payoff and no impact.the risks; the chances of Weimar bond yields no longer apply. In the Deutsche Bank has also recentlyRepublic or Zimbabwe-style inflation past, investors assumed that low launched a new range of Exchangeare extremely slim. The worst case nominal bond yields implied low Traded Funds containing inflationscenario for 2011 is probably that inflation – but with central banks protection in the shape of inflationinflation will be higher than expected. promising to maintain policy rates bonds or inflation swaps in them.In two or three years’ time, there is at low levels for some time into thea chance it could move higher still. future, rising inflation expectations Investors’ fears of inflation haveHowever, given the uncertainty about simply push real yields lower. been causing markets to behaveinflation expectations, investors more erratically than is justified bycould consider taking precautionary Portfolios can clearly be vulnerable the underlying economics. And,measures to protect themselves from to massive losses at times of extreme considering what most economists arefuture inflationary risk. inflation or extremely low inflation or forecasting, there does not appear to deflation – especially if their liabilities be sufficient inflation risk priced intoEven the experts seem incapable are inflation linked. So rather than these markets – which clearly presentsof agreeing about inflation’s future running scared from the spectre of investors with opportunities givenpath, with members of the Bank of high inflation, investors could consider the changed outlook. However, in ourEngland’s Monetary Policy Committee, seeking to hedge out risk with some of view, investors should avoid the use ofUS Federal Reserve’s Open Market the readily-accessible and good-value gold, oil or random equities as inflationCommittee and the Capitalise products available on the market. hedges. There is no evidence that suchMonetary Policy Committee divided assets have any stable correlation withon likely outcomes. The unreliability Inflation-linked bonds currently look an inflation. We believe they should focusof existing inflation models against attractive option, given their zero risk on inflation hedges that’s economic backdrop further premium. The market for index-linked 1. Source: Deutsche Bankmuddies the water, intensifying bonds is deep and liquid – it is worthuncertainty about the medium-term $600 billion in the US, EUR320 billionoutlook. in the Eurozone and £240 billion in the Deutsche Bank Markets in 2011—Foresight with Insight
  • 87. 5.7 Sorin IonescuRisk Management Commodities StructuringCommodity Risk ManagementWhat risks are worth hedging and how?To hedge or not to hedge? That will be the key questionin 2011 for all companies that produce or consumecommodities – from the largest mining conglomerate tothe smallest transportation company.The argument in favour of hedging typically for a year – at say $8,300 per strike price of $6,000. On a one-yearis compelling. Commodity prices tonne in an over-the-counter trade tenor, this would cost around 4%, orare likely to be just as volatile in with its bank. According to the terms roughly $330 per tonne on a current2011 as they were in 2010, and of the forward, the bank will guarantee price of $8,300. The advantage ispossibly more so because of the the price at $8,300 and if the price is that should prices rally, the companyincreased uncertainty about the below that when the forward expires, enjoys all of the upside.economic outlook. the bank will reimburse the difference. Producers wanting protection againstIf prices move the wrong way, profits A vanilla forward fixes the selling price, the slightest volatility from the currentwill be seriously impacted. If coal so if the price soars, the company will price can opt for an at-the-moneyprices go up by 30%, for example, not benefit from the upside. One way option, which provides protection formost power generators that rely on to address this and retain some upside any fall in price. This would be morecoal will see their input costs rise exposure is to use an extendable expensive, closer to $1,300 per over 20%, an increase that they forward, in which the company givesmay not be able to pass onto their the bank an option to extend the A mining company producing bothcustomers because of fixed contract after a year, with the same copper and gold may choose toelectricity price agreements with terms. In this scenario, the bank would separately hedge its exposure to thetheir national regulators. allow the producer to lock in at a higher two commodities, by purchasing price, say $9,000, but the bank has the put options. Assuming for the sakeSo what should companies do? Our option of whether or not to extend the of simplicity that the exposure toview is that a substantial amount contract by a further year. the two commodities is similar, theof risk should be hedged given the average price of the two put optionsscale of the potential moves, and that The advantage of forwards is that would be around 12.5% (assuming acompanies should seek to find ways to they offer downside protection 1-year tenor and at-the-market strike).reduce the cost of that hedge either by without the company having to If instead, the producer were to buylimiting the amount of protection they pay an upfront premium. a basket option (a put option payingare buying or by exploring alternative the average performance of the twohedging strategies. For producers that want to benefit commodities), the premium can be from the upside of pricing in a volatile reduced to 10.5%, a reduction of moreCompanies will choose the best market, they can choose an options than 15% in the hedging cost.alternative based on their own risk contract, which involves an up-evaluations, but there are three front premium. This locks any price All these strategies can be adaptedmain options. movement beyond a certain level. For to meet the needs of investors. example, a copper producer may be Commodities have become anThe first is a vanilla forward contract. comfortable with price volatility down integral part of investor portfoliosA copper producer can protect against to $6,000 a tonne, but may want also due to their diversification benefitsa fall in price of the commodity by to retain any upside potential. In this and potential to protect againstfixing the price for a portion of its scenario, the producer could buy an inflation production for a fixed period – out-of-the-money put option with aMarkets in 2011—Foresight with Insight Deutsche Bank
  • 88. Deutsche Bank Markets in 2011—Foresight with Insight
  • 89. 6 Financing Bonds IPOs Trade Finance Recapitalisation Bail-Ins InfrastructureMarkets in 2011—Foresight with Insight Deutsche Bank
  • 90. Deutsche Bank Markets in 2011—Foresight with Insight
  • 91. 6.1 Zia HuqueFinancing Head of Global Risk Syndicate Outlook for Bonds Uncertainties need resolving How the markets evolve following the resolution of the peripheral sovereign crisis in Europe will be one of the defining themes in the bond market during 2011. While the situation in Greece and Ireland is thought to be reasonably well understoood, insufficient clarity related to the position of Portugal and indeed Spain still exists. Liquidity in the global sovereign and supranational market will be significantly impacted by this, until a much-anticipated resolution has been reached– most likely during the first quarter of the year. In the bank market, liquidity, funding, be, the market has been left in limbo. and capital requirements will remain Critical terms need clarification, and the most pressing concerns in 2011. only once this has happened can new As of now, none of these topics products and funding strategies be are sufficiently clear for issuers or developed. Again, there should be investors. The current debate around more clarity on these issues by the potential bail-in characteristics end of the first quarter of 2011. But and questions related to debt and what we do know is that the covered capital requirements of systemically bond market will continue to grow important financial institutions (SIFIs) in importance with the valuation show that investors may not know differential between these instruments the full extent of the risks associated and senior unsecured funding growing with buying senior unsecured debt ever larger. The implied structural from global financial institutions. subordination of senior debt means Additionally, on the capital side, that financial institution liabilities will uncertainty with regards to the become more akin to corporate debt characteristics of hybrid capital leaves and without implied umbrella support no clear delineation of what the from governments and with potential loss absorption capability will be of dramatically low recovery value upon instruments that are not pure equity. default, restructuring or bail-in. As there is no agreement or conformity Arguably the most fundamental yet among global regulators on what change in approach for institutional hybrid capital characteristics need to investors in 2011 will be in theirMarkets in 2011—Foresight with Insight Deutsche Bank
  • 92. attitude to emerging markets (EM). Global investors, therefore, need to capital regime requires significantlyThe delineation between looking stop looking at EM as a separate greater capital, restricts leverage andat market sectors and valuing and distinct asset class, despite puts a much higher cost on risk-them within a range-bound return its volatility. In global fixed income weighted assets (RWA). This forciblyhas gone out of the window. asset portfolios, EM assets should increases financing costs, the netEuropean sovereigns are trading no longer be 5% to 10% of alpha effect of which will be that bankanywhere between mid-swaps flat creation, they need to become a lending to global corporates and SMEsand 12% while certain double-B core part of gross portfolio and will fall on a relative basis. This createsrated EM sovereigns are trading asset diversification strategies. a supply and demand gap that mustthrough Spanish and Italian We see the importance of EM be met by the capital markets.government bonds. assets in G3 currencies and in local currency product. Ratings have alsoYou can no longer look at asset experienced a massive migration toclasses and trade them with investment grade within EM. This hasa historically acceptable risk lead to the establishment of a solidreturn profile. The spread and demand base including traditionalrate of return dynamics are now investment grade buyers.completely different for EM credits.Fundamentals in EM are in many Finally, given the new bankingcases superior to those in the US regulatory framework we operate inand Europe on both the sovereign, today, lending financial institutionscorporate and financial level. They globally will inevitably continue tohave significant potential for growth readjust their global corporate lendingin a constrained-growth world. profiles. The new regulatory and Deutsche Bank Markets in 2011—Foresight with Insight
  • 93. 6.2 Edward SankeyFinancing Co-Head of Equity SyndicateOutlook for IPOsEncouraging trendsThis year saw the first credible year, and signs of stabilisation The outlook for IPO issuance insigns of a return to health in the in the global economy. 2011 is promising with the themesIPO market since 2007, with around seen in 2010 likely to continue and$246 billion of new issuance in A significant amount of IPO develop notably strong volumesthe first 11 months of the year, issuance was driven by corporate coming out of emerging markets,a 260% increase on 2009.* spin offs, private equity exits and the selective nature of the buy side, privatisations, with most of the deals the preference for larger, more liquid2010 also saw a much more balanced coming from emerging markets deals and the vulnerability of deals tomix of business, both in terms of especially Asia because of continued macro events and market volatility.sectors and issue types. In 2008 uncertainty about the sustainabilityand 2009, new equity issuance was of the western macro recovery and Private equity and governmentdriven by balance sheet repair, with sovereign debt risk in Europe. sell downs are likely to continueover 50% coming from financials. In to be a good source of new deals,2010, that fell significantly and IPO’s China alone accounted for over with the sectoral spread beingwere over 30% of total issuance $90 billion of IPOs last year (Jan to as wide as it was in 2010.compared with just 12% last year. Nov 28), almost three times that of the United States. Asia as a whole One key trend that will continue toHowever, IPOs had their challenges accounted for around $140 billion or be a focus is the continued flux in theand overall volumes, especially approximately 56% of the global total.* demand dynamics from the investingin the developed markets, were universe. Since the collapse of Lehmanless than many expected. Two of the largest IPOs in history a number of the usual investors seen came out of Asia last year in the in IPOs in previous years have lostMarket volatility, caused by form of Agricultural Bank of China assets and become smaller in termsmacro events especially around and AIA. Petronas’ IPO was the of their potential appetite; indeed athe sovereign space, was another largest SE Asian IPO ever. number have closed altogether. Thisproblem, with some IPOs falling has resulted in a concentration ofvictim to issues out of the control Demand for these deals was demand amongst the large ‘long-only’of sellers and bookrunners. exceptional with inflows into EM names and the bigger hedge funds equity funds, strong appetite for that has become more acute as assetsVolatility has always been one of the growth and an explosive increase have flowed in their direction. Thisdetermining factors of the success in retail demand in the region changes the pricing dynamics and hasor failure of an IPO because of the leading to huge order books. to be taken into account in execution.length of time it takes to execute This, in turn, allowed many sellersa deal (between two and four to price the shares at the top But the trend of investors using theweeks from launch to execution). end of the valuation ranges. primary calendar to access liquidity due to a continued fall in secondaryBetween 2004 and H1 2007, This is not to say that the developed market volumes is set to continue –volatility was relatively benign so markets were dead. Europe had its meaning broader market conditionsit did not pose much of a risk. But fair share of successful IPOs with permitting, that IPOs are likely toit increased significantly during markets such as the UK, Germany be a key driver of equity issuancethe second half of 2007 and and Poland being particularly active. for the next 12 to 24 months.made IPOs almost impossible to And the US recently saw the largest *Source: Dealogiccomplete through 2008 and 2009. IPO of all time in the form of the GM IPO. Aftermarket performanceThe return of IPOs in 2010 reflects generally has also been good, oftenthe decline in volatility during the outperforming the various indices.Markets in 2011—Foresight with Insight Deutsche Bank
  • 94. Deutsche Bank Markets in 2011—Foresight with Insight
  • 95. 6.3 Kaushik ShapariaFinancing Head of Trade Finance and Cash Management Asia PacificTrade FinanceEmbracing the old and newTrade finance is enjoying a renaissance in theAsia Pacific region with traditional instrumentsthat had been somewhat sidelined in past yearsreturning to the forefront of the market.Before the financial crisis, there heights. The region has reshaped its Evolutionary too, is the response towas an excess of liquidity in most trade model, driven by China’s growth the developing internationalisation ofmarkets. The financial community and the need to diversify, and become the Renmimbi (RMB). The expansionwas more liberal in its approach to less reliant on trade with the west. of the RMB Offshore Trade Settlementrisk, and bank lending was easily This is being demonstrated in Japan, Program will undoubtedly facilitateavailable to corporates. With alternate for example, where exports to China further trade growth in the region.sources of funding easily available, jumped by 80% in 2009 returning to This will enable importers andclients did not need to rely on trade pre-crisis levels.* their counterparties to reduce theirfinance instruments for funding their exposures to foreign currencies andworking capital. As intra-region trade grows with settle trades in RMB. Furthermore, suppliers strewn across a vast this will increase transparency aroundPost-crisis, there has been a lack continent, the financial supply chain costs, pricing, settlement and FXof liquidity, banks have raised their (FSC) issues that have been gathering adjustments. Deutsche Bank is now ancontrols around risk and many pace in recent years are becoming active player in offshore RMB, which iscorporates outside the top tier have increasingly important. The crisis poised to increase significantly in thehad to fall back on traditional trade has crystallised some of the thinking short-to products for financing their around FSC and the concerns ofworking capital. corporates that their suppliers may not Like all markets, the trade finance necessarily have access to liquidity. world can be impacted by dislocation,Risk mitigation remains at the top but the momentum that has built upof the agenda for many corporates, The challenge for trade finance over the past 12 months, and the nearso letters of credit, bills of exchange providers is to develop financial supply and medium-term outlook for theand guarantees are likely to remain chain solutions for their clients, in Asian economies, is positive.popular. Many suppliers want to be particular integrated offerings thatpaid quickly and, likewise, buyers encompass foreign exchange (FX) as *Source: Deutsche Bankwant their goods immediately – hence well as trade and cash. It became verythese instruments are still considered clear during the financial crisis thatrelevant forms of payment. Invariably, cash flow management, trade financethey have been accompanied by and hedging requirements are indeliblyan increase in demand for credit linked and are important componentsinsurance and related products. of the working capital cycle. A consolidated approach to these issuesWe anticipate this resurgence will not only streamlines the operation forcontinue into 2011, especially as intra- clients, but is the natural evolution inAsian trade looks set to scale new supply chain solutions.Markets in 2011—Foresight with Insight Deutsche Bank
  • 96. Neil Kell Stephen Westgate 6.4Head of Financial Institutions, Director, European Financial Institutions FinancingEquity Capital MarketsBank RecapitalisationPossible responses to regulatory andmarket pressure to raise new equityA robust recapitalisation of the European bankingsector will play an important role in stabilising thewider financial system by restoring bank viability,boosting market liquidity for bank debt andrebuilding and maintaining investor support andconfidence.There is a strong incentive from The level of bank recapitalisation both levels and quality, in otherregulators to adequately recapitalise activity in the public equity markets markets. This market-imposed riskthe banking system to ensure banks in 2011 will be a function of four could also affect banks falling outsidehave a stronger liquidity position and key factors: greater certainty of the the SIFI designation which could bebetter funding outlook, which will new regulatory capital framework, pulled to SIFI levels of capitalisation byimprove the sector’s standing among especially definitions, required the investors. The efficacy of regulatory capital levels, timingindividual bank recapitalisation will be for achieving new levels, and the How banks respond to thesedetermined by how and when financial availability of credible alternatives pressures in terms of capital strategyinstitutions implement fundraising for banks needing to bolster their and timing depends on their currentstrategies and the market’s view of capital levels. capitalisation levels and the ‘gap’their adequacy. to new requirements, the credibility Regulatory clarity is a pre-condition of proposed capital strategies andDespite the injection of substantial for market clarity though certain organic capital generation throughequity capital into the European elements remain unknown. Exact retained earnings and deleveraging.banking system by private investors definitions of equity capital should How banks react is also subject to theand governments since 2008 and have emerged this month (December availability of ‘self-help’ alternativesa significant reduction in banking 2010), while buffer requirements for to equity raising, mitigating actionsasset balances, the banking system global systemically important financial to reduce risk-weighted assets orremains under-capitalised relative institutions are expected by mid-2011 regulatory capital deductions such asto the expected Basel 3 regulations. and for national SIFIs later that year. asset sales and changes in businessRegulatory pressure, together with Aside from Switzerland, national practices, or alternative, non-dilutivewidely disparate capitalisation levels regulator implementation of regulatory qualifying capital instruments such asbetween individual banks, ongoing proposals and application of super- contingent convertibles.uncertainty over asset values and equivalence remains unknown.impairment levels, elevated bank credit National variations will arise in the Whilst the Basel Committee permitsspreads and weak credit availability, form of capital levels and timing and banks to implement proposed changessupport further equitisation of the the treatment of individual capital on a phased basis until 2019, thebanking system. items, such as deferred tax assets or market has formed its own view on holdings in financial entities. individual bank timing, based on theHowever, despite an increase in credibility of capital strategy. Banksbank equity issuance in the second There is a risk that the market will that provide highly credible capitalhalf of 2010, versus H1, regulatory adopt a ‘highest threshold’ approach, plans and greater disclosure on howuncertainty prevented a larger number forcing banks with similar business their glide path to capital sufficiencyof banks from recapitalising in 2010. models to match peer capitalisation, will evolve will be allowed longer Deutsche Bank Markets in 2011—Foresight with Insight
  • 97. 6.4Financingphase-in periods. A national Some banks may undertake reactiveregulator could impose a shorter capital raisings, if the anticipatedperiod than 2019 and markets may organic strategy is inadequate.favour early adopters. With the majority of European banks favouring the ‘self-help’ approach,National regulators are moving the higher the eventual capitalat a different pace to regulatory level requirements, the greater thereform. Switzerland is well above number of banks undertaking reactivethe regulatory minimum and views capital raisings.its new regime to be adequatelysuper-equivalent, whatever the Recapitalisations may be triggeredeventual outcome from the Basel by positive or negative eventsCommittee. Some banking systems independent of the new regulatoryin European peripheral countries may regime. Negative triggers includebecome subject to short-term, forced accelerating loan losses due toequitisation by their governments to slowing economic growth and risingsupport sovereign solvency. unemployment, unexpected asset impairments or losses on sovereignDuring the third quarter of 2010, or bank debt. Positive triggers includebanks saw mitigating actions as a improvements to sovereign riskpriority to achieving required capital perception, merger and acquisitionratios without recourse to the equity activity or rapid economic recovery,markets. It is likely that not all will be and expansion of credit growth.successful. The market will demandmuch greater clarity on proposed In the current environment, weactions and impact of profitability in would expect an orderly series ofthe first quarter of 2011. recapitalisations by the weaker European banks, and governmentInstitutions currently viewed as support for those with insufficientundercapitalised relative to peers are public equity market support.likely to launch pre-emptive capital However, this view could change ifraisings in the first quarter, market final regulation at a global or nationalconditions permitting. These banks are level proves surprisingly penal orlikely to ‘front run’ absolute regulatory if losses are imposed on Europeanclarity in order to demonstrate an sovereign debt or a further recessionability to satisfy the new framework causes accelerating loan losses.when it is implemented fully. The efficacy of individual bank recapitalisation will be determined byBanks may look to alternative, how and when financial institutionsnon-dilutive instruments to meet implement strategies to improve theircapital requirements once there is capital positions and the market’s viewclarity later in 2011 on the framework of their adequacy.for non-equity capital, such ashybrid and contingent convertiblesand their ability to supplementregulatory capital.Markets in 2011—Foresight with Insight Deutsche Bank
  • 98. Vinod Vasan Nigel Howells 6.5Head of European Financial Director, Capital Solutions Team FinancingInstitutions, DebtCapital MarketsBail-Ins: Pros and ConsA fast-track option for recapitalisationRegulators are evaluating the optimal There are a number of considerations interest margin and organic generationmeans to limit future government of how and when bail-in could of capital will be negatively impacted ifcapital injections into ‘too big to fail’ be implemented. These include senior debt funding costs increase. Abanks in times of stress, to ensure a willingness on a political level, key debate is to what extent and whenmore equitable outcome in respect the interaction of statutory and bail-in will be priced in and the risk ofof sharing losses and, if ultimately contractual rights, and determining creating greater differentiation in therequired, appropriate mechanisms a workable timeline to implement banking sector, particularly marketto make bank failures manageable. effective national policy frameworks. access for non-systemic banks. Importantly, the FSB recognises thatThe Financial Stability Board (FSB) the interaction of different rules and Appropriate triggers and interactionis proposing rules to regulate approaches in a multi-jurisdiction of different liability classes remainsystemically important financial group is a key question to be resolved. ambiguous and will remain a focus ofinstitutions (SIFIs) and its latest the analysis and market acceptance ofannouncement in November 2009 Legal challenges may arise over the any ‘new-style’ security by investors.suggests bail-ins be considered protection of rights of creditors versus Whilst the ‘bail-in’ concept continuesinitially for global SIFIs (G-SIFIs). the ability of a regulator to exercise to be approached with suspicion byThe recommendations for institutions bail-in features in a timely way. Market investors if the event can be assesseddesignated as such will be made participants would prefer a trigger as sufficiently remote and investorsby December 2011. to be transparent but the regulator is are compensated for the additional likely to require maximum discretion risk solutions may be found.The bail-in concept is one of a number so the question of how and whenof potential alternatives for enhancing regulators should intervene and The next step will be a matter ofloss absorption in a bank’s capital whether any intervention is assessed regulators assessing whether there isstructure, and is viewed as a ‘fast as fair on the grounds of law or a need for stringency or sufficiencytrack’ solution. judgement will arise. of alternatives. Will sufficient volume of loss-absorbing capital dampenThe rationale from regulators is Quantifying the net benefits to the regulatory incentives? Will bail-inthat by gaining access to the large financial system against the net debt become a real alternative givenvolumes of outstanding senior increased cost of senior debt will investor acceptance and relative costdebt, bail-ins can be considered an only play out over time. The impact of the instrument? These fundamentalalternative to over-regulation and upon senior debt access and liquidity questions are very difficult to answerpunitive capital volume increases. of imposing bail-in could create but will need to be addressed over the additional, more significant issues in coming year.However, all capital instruments will respect of available liquidity, cost ofhave greater loss absorbing features funding and margins. In particular,under the Basel 3 proposals. Increased balancing the interests of senior What is a bail-in? Bail-in is the concept commonly referred tocapital requirements, particularly unsecured debt that is subject to bail- whereby the principal amount owed on seniorfor systemic banks, will also see in versus secured instruments and to unsecured debt is reduced, resulting in asignificant buffers of capital being what extent short-end funding should transfer of some of the burden of bank losses onto bondholders, as compared with bail-outavailable to absorb unforeseen losses. be excluded to facilitate immediate where additional capital is injected. How andFurthermore, contingent capital, liquidity remain to be considered. when a bail in is implemented is dependentdepending on the final regulatory on establishing workable regulatory and national policy frameworks. Also important, isobjectives, would boost common A flight to secured funding not subject the acceptance of bail-in debt by the investorequity in a time of stress and, to bail-in would depend on the ability community, the relative cost to competingimportantly, investors are aware of, and appetite of banks to issue and funding instruments and its potential impact on market liquidity.and compensated for, the instrument’s such debt may not be considered arisk profile in advance. regular funding source. A bank’s net Deutsche Bank Markets in 2011—Foresight with Insight
  • 99. 6.6 Paul MalanFinancing Managing Director, Infrastructure Investment GroupInfrastructure BacklogPrivatisation rises up the agendaSustained global growth in recent decades,combined with economic and social demands forimproved infrastructure, has resulted in a significantand increasing backlog of required spending oninfrastructure facilities such as energy networks,water utilities, airports, roads and railways.Infrastructure shortfalls are a shared Figure 1: Infrastructure investment needs by region and countryissue for both developing and Canada: CAD350–400 EU: EUR1 trillion investment Central and Eastern Europe:developed countries. The World billion of total municipal, required over the next decade EUR500 billion shortfallEconomic Forum recently estimated provincial and federal in the EU’s energy system compared with Westernthe global infrastructure investment upgrading and new (EC, 2010) Europe (Deutsche Bank, 2004) infrastructure needsdeficit at $2 trillion per year over (Mirza, 2009)the next 20 years. Figure 1 shows aselection of estimates of infrastructureneeds for regions compiled by a range US: $2.2 trillionof industry observers. estimated investment need over next 5 years Asia: $300 billion per (ASCE, 2009) annum demand forSuch facilities and services have infrastructure finance inhistorically been provided by national LatAm: $800 billion Asia (ADB, 2010) investment requiredgovernments but accumulated debt through 2014 (WEF, 2010)and the large budget deficits of manysovereigns means that they will not MENA: Requirement to invest between $75–100 billion perbe able to meet these infrastructure annum to sustain growth Sub-Saharan Africa: $93 billion per Australia: AUSD130 billionshortfalls on their own. rates and boost economic annum over 10 years required to raise needed to provide critical competitiveness Africas infrastructure endowment to a economic infrastructure (World Bank, 2010) reasonable level (World Bank, 2009) projects (KPMG, 2008)As a result, they are increasingly lookingto the private sector to fill the gap fornew investment as well as revisiting the For example, the State Government of infrastructure investment the countryscope for privatisation of existing public Victoria in Australia sold approximately needs, using all the available leverssector assets as an alternative source A$30 billion of public assets in the right across the range of private andof funding. Figure 2 outlines general 1990s and privatised services valued public ownership models.”goals articulated by some countries and at a further A$10 billion. As a result,identifies potential privatisation targets. the ratio of state public debt to GDP Governments are not alone in looking fell from 27% in June 1995 to 3% in to address capital scarcity andPrivatisation programmes involving June 2000. maximise asset and balance sheetinfrastructure have been a key source efficiency. An increasing number ofof government funding since the Looking forward, it seems inevitable privately-owned companies which1980s. The OECD estimates that that governments across the world will are active in the infrastructure sectorover $1.4 trillion of state-owned need to move increasingly towards the have also signalled their intentionenterprises were privatised during this policy outlined by the UK government to rationalise asset portfolios andperiod with infrastructure comprising in its recent National Infrastructure refocus activities. E.ON, for example,approximately 60% of proceeds. Fiscal Plan which stated its commitment to recently announced a significantimperatives have been a key driver. playing “its full part in promoting the disposal program with a target ofMarkets in 2011—Foresight with Insight Deutsche Bank
  • 100. Figure 2: Planned and possible privatisationsCountry General Objectives Sample of Possible Asset SalesUK June 2010 budget provided for – High Speed 1 £1.5 billion of central government – Sold for £2.1 billion in November 2010 realisations in 2010/11 (already – National Air Traffic Service (49%) exceeded). Budget 2009 outlined the – Advisers appointed government’s plan to realise £16 billion – British Waterways in the period 2010-11 to 2013-2014 by – Oil and Pipelines Agency selling assets and property. – Trust Ports (eg. Port of Dover, Port of Tyne, Harwich Haven. Milford Haven Port) – Network Rail – British Rail Board Properties – Dartford Crossing – WithdrawnGreece Privatisation target to yield EUR7 – Hellenic Railways Organisation, OSE billion within three years, including (up to 49% out of 100%) EUR1 billion in 2011 (increased from – Athens International Airport EUR3 billion target announced in June (up to 55%) 2010). – Athens Water Company, Eydap (10% out of 61%) – Thessaloniki Water Company, Eyath (23% out of 74%) – DEPA (up to 65%)Ireland No explicit statement - National – Dublin Airport Authority Recovery Plan 2011-2014 forecast (incl. Dublin, Cork and Shannon Airports and EUR1 billion of capital receipts over Aer Rianta International) the period. As a result, possible asset – Port Companies sales are only a sample of state-owned (incl. Dublin, Cork, Drogheda and Galway) enterprises potentially attractive to – Electricity Supply Board investors. – Bord Gais Eireann – Eirgrid – Irish Aviation Authority – Irish Rail – Environmental businesses (incl. wind farms, CHP, waste management, WTE, etc)EUR15 billion of proceeds before general economic activity), capital2013 connected with its strategy of security and the high cash yieldreduced asset ownership. E.ON’s component of returns.announcement follows similarinitiatives from other corporates. The participation of these investors will become increasingly importantWhere will the financing come from? in the years to come, particularly asBanks have been the predominant outstanding infrastructure debt fallssource of debt funding for due. We estimate that around EUR50infrastructure investments. The billion of European infrastructure debtavailability of bank loans has, is due for refinancing between 2012however, been adversely affected and increasing capital constraints,market retrenchment and the loss of The main source of equity capital forsyndication avenues. Borrowers have infrastructure has historically been thealso been confronted with issues in public equity markets. Over the pastselect public markets such as the US five years, however, we have seenmunicipal bond market. the rapid emergence of new private sources of equity capital: infrastructureAs a result, infrastructure companies funds and direct institutional investorshave started to look to other sources (including pension funds, insuranceof capital such as the bond and private companies and sovereign wealthplacement markets. funds). Approximately $100 billion was invested in private infrastructure fundsInvestor demand for infrastructure between 2006 and 2008 and a furtherassets is high because of their $25 billion has been invested in suchattractive investment characteristics. funds thus far in 2010. Such alternativeThese include a high degree of cash- sources of capital are expected to playflow predictability, linkage of returns an increasingly important role in theto inflation (and, in certain cases, financing of infrastructure assets. Deutsche Bank Markets in 2011—Foresight with Insight
  • 101. 7 Investing Model Portfolio Stock Picking Exchange Traded Funds Hedge Funds Managed Accounts Asset and Liability Management Portfolio Theory Green InvestingMarkets in 2011—Foresight with Insight Deutsche Bank
  • 102. Deutsche Bank Markets in 2011—Foresight with Insight
  • 103. 7.1 Vinay PandeInvesting Chief Investment Advisor, Research A Model Portfolio for 2011... and Beyond What assets to hold in an unstable world In today’s world of unprecedented uncertainty, it is no longer possible to optimise investment portfolios on an asset class by asset class basis, nor are naïve asset allocation strategies acceptable. More focused investment strategies are required. Our recommended multi-asset This simulated portfolio has portfolio (see figure 1) is specifically consistently outperformed both a designed to address and benefit from portfolio of government bonds and an unstable and unpredictable world. an index of hedge funds every quarter since June 2006 with a total return The portfolio is liquid and, for all of 163% (versus 47% and 22% intents and purposes, unlevered (with respectively) a compound annual the exception of some relative value growth rate of 25% (versus 9% and positions and some substantial long 5%). Volatility has been confined to volatility or option positions). the 7-10% range, unless deliberately allowed to rise when the portfolio is experiencing a large option payoff (See figures 2 and 3). Figure 1 Recommended Portfolio  Max positive  Cash exposure equicalent (levered positions) Weight Strategic Assets Weight Defensive Assets  Global Equities  European Utilities  Emerging Market Equities  CAD & NOK TWI  Long EStoxx Mar ‘11 2900 call  Latin American Equities Weight Defensive Hedges  Brazil Real Bond 2045  S&P 500 6-mo Variance Swaps, 2-mo fwd  Gold  EURO STOXX 50 6-mo Var. Swaps, 2-mo fwd  Diversified Commodities  Long 1-mo 5.0% AUD 10-Yr Receiver Swaption  Agricultural Commodities  Long 1-mo 1.25 EUR Put 8 Long 1-mo 1.35/1.30 EUR Put spread Tactical Overlays / Relative Value  Long 1-mo 1.40/1.475 EUR Call spread Weight Traders and other Assets  Long 3.5-mo 3.65% USD 10-Yr Payer Swaption 20%  Long 3.5-mo 4.05% GBP 10-Yr Payer Swaption of the portfolio  Long 2-mo GBP Put/YEN Call spread 1.5 Long 2-mo GBP Put/EUR Call spread Weight FX Overlays / Hedges  Long 2-mo AUD/Yen 77.5 Put  Short (short $, long RMB) 2-Mo NDF on RMB 15% Short Euro, $, and GBP bskt versus of the portfolio Long EM FX basket Portfolio recommendations as of Nov 22 ‘10; for more details, refer to out website in 2011—Foresight with Insight Deutsche Bank
  • 104. The portfolio is divided into so on. In all cases, as we do in the case hedged back to EM currencies (e.g.five main parts: of strategic assets, we are looking for Western European regulated utilities);1. Deutsche Bank Research’s strategic cheap options on assets or derivatives or assets that mirror the behaviourassets, including equities in both with large asymmetric payoffs. of EM currencies (e.g. agriculturaldeveloped and emerging markets, commodities, gold). Each of theseemerging market bonds, EMFX 4. A relative value book, in which the asset classes should be boughtoverlays, gold and commodities. These largest trade is long US and European whenever they are attractivelyare assets we consider to have the equities and short investment grade priced, using capital accumulatedbiggest positively-biased asymmetric bonds (acquired synthetically) in the by astutely navigating the currentpayoff profile, on an option-adjusted same two regions. treacherous markets.valuation basis, across multiplescenarios. This involves an assessment 5. A currency overlay of long emerging The essence of the investmentof the nature and intensity of each market foreign exchange versus USD, philosophy is that it is forward-scenario against the option adjusted EUR and GBP. looking. We never assume that thevaluation of the asset in question. future will resemble the past, unlessCurrently equities and commodities There is currently no excess cash there is strong reason to believe so.score high marks on this reckoning. recommended but there are large cash The experience of the very stable positions available against the face 1980s and 1990s has caused a lot of2. Defensive assets, principally long amount of derivative positions. lazy habits to get institutionalised asregulated utility positions in Europe. conventional and acceptable practice We recognise that the unstable world as many market participants are3. Defensive hedges, including we live in will not last forever. Indeed learning to their cost.equity variance swaps and a number we suspect that by the end of theof short-dated currency and rate decade we will enter a world of loweroption positions. For example, a real growth, of emerging marketlarge out-of-the-money receiver currency appreciation and of possibleposition in Australian interest rates is higher inflation.intended to address a debt deflationscenario, in which Australia’s strong In such a world owning the longest-domestic economic fundamentals are duration, highest real yielding assetsoverwhelmed by global fundamentals. available is a good strategy. IdeallyLarge short dated EUR options are these should be denominated indesigned to protect a multi currency emerging market (EM) currenciesportfolio from USD appreciation, (e.g. Brazilian inflation-linked bonds);especially in a euro crisis scenario. And or should be assets capable of being Deutsche Bank Markets in 2011—Foresight with Insight
  • 105. 7.1InvestingDeutsche Bank research’s central Figure 2: Simulated portfolio Figure 3: Simulated portfolioscenario is that we come out of this performance since June 2006 realised volatilitycrisis alive; it is a sentiment that Source: Datastream, Hedge Fund Research Inc., iBoxx, DBIQ, Deutsche Bank GMR Source: Datastream, Hedge Fund Research Inc., iBoxx, DBIQ, Deutsche Bank GMRwe subscribe to. We have suffered 18-qtrs return = 163% Simulated Portfolio 3-mo rolling Simulated Portfolio Compound Annual Growth Rate iBx $ Treasuries 10Y+ ann. volatility iBx $ Treasuries 10Y+a market failure, of that there is no = 25% p/a Hedge Fund Research Fund Hedge Fund Research Fund Weighted Comp Ind Weighted Comp Inddoubt, and powerful policy medicineneeds to be applied (and is being 280 40 3 – Mo rolling ann. volatility, %applied) to further the healing process. 260 35There is no guarantee that these 240policy measures will work and the 220 30ex-ante probability of failure has to 200 25be assumed to be considerable. The 180 20reason for our cautious stance isthat the consequences for portfolio 160 15performance of such an outcome is 140 10likely existential. 120 5 100However an isolated market failure 80 0is NOT proof that free markets can Jun 06 Dec 06 Jun 07 Dec 07Jun 08 Dec 08 Jun 09 Dec 09 Jun 10 Dec 10 Jun 06 Dec 06 Jun 07 Dec 07Jun 08 Dec 08 Jun 09 Dec 09 Jun 10 Dec 10now never work, and it is in thatcontext that rampant bearishness Figure 4: Euro Stoxx 50 OAS/ERP Figure 5: S&P 500 OAS/ERPand pessimism looks misplaced. An Source: Datastream, Bloomberg Finance LP, PricewaterhouseCoopers, Standard & Poors, Deutsche Bank GMR Source: Datastream, Bloomberg Finance LP, PricewaterhouseCoopers, Standard & Poors, Deutsche Bank GMRessential part of the policy medicine Euro Stoxx 50 ERP S&P 500 ERP Euro Stoxx 50 OAS/ERP S&P 500 OAS/ERPis to keep interest rates well behavedfor an extended period and hence 11% 11%Deutsche Bank’s bullish central 10 10argument for bonds. 9 9 8 8The reason we do not own US and 7 7European bonds in our portfolio is 6 6that we are not constrained to own 5 5them. We would also rather receive 4 4this policy subsidy than pay it and 3 3find bond performance a not very 2 2challenging hurdle rate for a well 1 1constructed portfolio. As figures 4 0 0and 5 show, the spreads on some risk 00 01 02 03 04 05 06 07 08 09 10 97 98 99 00 01 02 03 04 05 06 07 08 09 10assets, especially equities, are close tounprecedented levels versus much of Figure 6: Equity risk premiathe fixed income universe, especially convergence: EM versus USbonds. That risk assets of these kinds Source: Datastream, Bloomberg Finance LP, PricewaterhouseCoopers, IBES, Deutsche Bank GMRearn their place in our portfolio on ERP spread (MSCI EM in USD less S&P 500) EM FX indextheir own merit should be evident fromthese charts. 7% EPR Spread EM FX 120 6 110 5 100 4 90 3 80 2 70 1 60 01 02 03 04 05 06 07 08 09 10Markets in 2011—Foresight with Insight Deutsche Bank
  • 106. Deutsche Bank Markets in 2011—Foresight with Insight
  • 107. 7.2 Francesco CurtoInvesting Managing Director Head of CROCI ResearchStock Picking Strategies for 2011?What value analysis tells usWith so much uncertainty hanging over markets,which equity strategies will work in 2011? In ourview, valuation-focused stock picking proved itsworth in the volatile environment of the past yearand will do so again in the year ahead.The drawbacks of macro-oriented CROCI (Cash Return On Capitalstrategies were evident in the risk- Invested) is a proprietary equityon, risk-off trading that characterised valuation process. It was developedmuch of 2010. Investors who bought in 1996 to help Deutsche Bank’sin April on hopes of a sustained global institutional investor clients comparerecovery would have entered at the stock valuations across a broad rangepeak of the market. of industries and countries on a like- for-like basis. It does this by removingThose who sold positions in June – the noise created by reported accountsfearing that Europe’s sovereign and ironing out differences betweendebt crisis would spark a systemic accounting treatment of things likemelt-down – would have exited inflation in different the bottom and missed a 20%run-up in global stock indices Of course, identifying real value is noduring September. simple task. Emerging markets, one of the supposedly hot investment themesMarket patterns in 2010 highlight of 2011, are a case in point. Massivethat equity prices tend to move investment flows have been directedahead of macro data; which is why to the emerging world in recentwe believe the strategies that will months, partly on the expectation thatwork best in 2011 will be those that emerging markets will drive the globallook past the macro distractions economic recovery, but also because,and continue pursuing value. Our on the surface, emerging equitiesanalysis shows that, in the 12 months trade at a significant discount to theirto last November, focusing solely developed world peers.on identifying value among the 750companies that the CROCI team cover Our research shows that, althoughwould have generated 400 basis points emerging markets may appearof outperformance. undervalued at an aggregate level, on Economic PE (the CROCI versionMarkets in 2011—Foresight with Insight Deutsche Bank
  • 108. of the price-earnings ratio), most about 30% of its sales from emerging tightening. However, value-focusedof the discount stems from the fact markets – that still represent value. investors may be able to turn thethat regional benchmarks are heavily resulting volatility to their advantage.weighted towards commodities, CROCI analysis has revealed other Provided the global economy is notutilities and financials. Strip out the traps investors should be wary of in about to slip back into recession – andsectoral bias, and emerging markets 2011. With US ex-financials yielding so far governments and central bankslook considerably less attractive on a close to 10-year Treasuries, dividends have shown themselves prepared torelative basis. are becoming an attractive asset class. do whatever it takes to prevent that However, only 15% of companies outcome – buyers should considerIn any case, emerging market equities we analysed passed our dividend using the dips as entry points.will not necessarily provide the sustainability screen. In fact, sectors A steady nerve will be required,best exposure to emerging market with the highest yields (telecoms, but – armed with the right strategy –economies. The engine of economic utilities and energy) ranked the lowest investors should not be deterred.activity is supposed to be the in their ability to maintain dividendconsumer, and yet consumer sectors pay-outs. To see rising dividendsare significantly underrepresented in across the board we will need top-lineemerging indices. We think investors growth, which looks challenging inare better off looking at select the current environment. Once again,consumer companies in Europe and there are opportunities here, butthe U.S. that have sizeable emerging selectivity will be operations. But as the CROCImodels have been flagging since the Staying true to a value strategy inmiddle of 2010, value opportunities are 2011 will require discipline. A raft ofscarce in consumer sectors worldwide. macro worries still overhang markets,Nevertheless, we have identified a including the sovereign debt crisis,number of consumer companies – such currency wars and Chinese policyas Procter & Gamble, which derives Deutsche Bank Markets in 2011—Foresight with Insight
  • 109. 7.3 Thorsten MichalikInvesting Head of Exchange Traded Funds Manooj Mistry Head of ETF StructuringExchange Traded FundsOn the marchExchange-traded funds (ETFs) are well on theway to becoming accepted as mainstreaminvestments by institutional investors who areincreasingly recognising the benefits of using theproducts for their daily investment needs. Thechallenge is to get more European retail investorsto also see those benefits.The European exchange-traded US, Europe, Asia-Pacific ETF assets under managementproducts (ETP) market, covering both 160§0 Asia Pacific ($) 3000exchange-traded funds (ETF) and Europe ($) US ($)exchange-traded commodities (ETC), 1400 Number of ETPshas grown exponentially over the last 250010 years, and continues to do so. By 1200mid-November 2010, European ETF 2000 1000assets under management (AUM) Number of ETFs AUM ($ billion)were up almost 30% year-to-date, 800 1500taking the total AUM figure to EUR219billion1. The European market is 600 1000dominated by institutional investors, 400so much of this substantial growth 500can be attributed to the increasing 200use of ETFs by pension funds, assetmanagers and other professional 0 0investment groups. 2003 2004 2005 2006 2007 2008 2009 2010 YTD*1. Source: Deutsche Bank, Bloomberg Finance LPMarkets in 2011—Foresight with Insight Deutsche Bank
  • 110. ETFs are low cost index products a sector rotation strategy, which holding equity risk. However, it isthat trade on stock exchanges just involves taking exposure to, or surely also a reflection of the factlike regular shares. As such, ETFs are cancelling exposure to, particular that US retail investors are betterbeing used by institutional investors sectors depending on that sector’s informed in terms of understandingfor a variety of purposes. economic prospects. Dynamic the benefits of using ETFs. The institutional investors can also challenge for European providersGeneral asset allocation use ETFs to put in place strategies is to communicate those benefitsInstitutional investors traditionally gain designed to generate ‘alpha’ – above to Europe’s retail market, whilediversification by buying and selling market returns – by combining long continuing to embrace increasingacross the entire range of a portfolio. and short strategies. For instance, if a usage by institutional investors.But this is costly and time consuming. manager is bearish on US equities butInstitutions can take advantage of bullish on commodities then he or shethe diversification built into ETFs to could take a short term position in ansimplify this process while saving on S&P 500 inverse daily ETF, which givestrading costs. For example, ETFs offer short S&P 500 exposure, and combinean effective method of implementing it with a position in the Deutsche Banka ‘core/satellite’ strategy where, for Liquid Commodity Index ETF, whichinstance, the investor might have tracks the performance of 14 differentthe conservative, core part of the commodities.portfolio invested in well-known About db x-trackers db x-trackers are Exchange Traded Fundsequity and fixed income benchmarks Fixed income and credit adjustments (‘ETFs’). db x-trackers was launched inwhile placing the outer, satellite parts ETFs are an effective way for liability- January 2007 and is now one of the leadingin ETFs linked to emerging markets driven investors to alter duration and ETF providers in Europe.equities, or to alternative assets, such credit exposure to meet specified db x-trackers ETFs are listed on nine differentas commodity or currency indexes, targets, while ETFs that single out exchanges across Europe and Asia (Borsaor even to hedge fund indexes (all of inflation risk, and therefore can be Italiana, Borsa de Madrid, Frankfurt Xetra,which are accessible in ETF format). used to rein in inflation exposure, are Paris Euronext, London Stock Exchange, Zurich SIX Swiss Exchange, NasdaqOMXETFs are also effective tools for filling also available. Stockholm, Singapore Exchange and Hongany sector or regional exposure gaps Kong Stock Exchange).in a portfolio. In short, ETFs are becoming increasingly popular with institutional The ETFs are based on various asset classes including equities, fixed income, currenciesCash equitisation investors partly because they let and commodities. Investors are able to investAll professional fund managers will those investors engage in the kinds of in a very transparent, flexible and efficientat times find they have cash sitting activities they have always engaged way. db x-trackers ETFs are domiciled in eitheridle as it awaits allocation. The cheap in but in a cheap, liquid and reliable Luxembourg or Dublin and comply with the UCITS III regulations.and easy way in which ETF are traded format, and/or because they letmeans idle cash can be put to work them meet contemporary asset- More information on db x-trackers can bein the short-term while a longer- liability management challenges. The found on www.dbxtrackers.comterm allocation is being decided. institutional take-up of ETFs should,This lowers cash drag on a portfolio, therefore, only continue to grow.boosting returns overall. The real challenge for EuropeanHedging strategies ETF providers at the moment lies inBecause they can be sold short, convincing higher numbers of retailETFs can be used as an alternative investors to use ETFs. This is whereto derivatives for hedging portfolios. the European market currently lags,Also, unlike futures positions, ETF by a long way, the market in the US.positions do not have to be rolled over. In the US, ETF use is roughly split equally between retail and institutionalDynamic trading strategies client segments. Partly this is becauseETFs can be used by active investors most ETFs are linked to stock marketin a number of ways. For example, returns, and the US retail market hasthey can be used to implement a tradition of being comfortable Deutsche Bank Markets in 2011—Foresight with Insight
  • 111. 7.4 Anthony ByrneInvesting Global Head of Securities Lending, European Co-Head of Prime Finance The EU Directive on Hedge Funds How will the new rules affect hedge funds and investors? The EU Alternative Investment Marketing Fund Managers Directive (AIFMD), Central to the directive is a marketing approved by the European Parliament passport under which an AIFM in November 2010, will have a major authorised in one EU member state impact on European hedge fund will be able to market an AIF to industry and potentially far-reaching investors in other member states implications for European investors in without additional authorisation or alternative funds. registration requirements. After much discussion and many revised drafts The key changes concern the way of the text, it was finally agreed that in which funds are marketed to the passport will automatically be investors, the amount of leverage a available to EU AIFMs managing EU fund can take, and the introduction of AIFs, but its extension to cover the a depositary requirement. marketing of non-EU AIFs (by both EU and non-EU managers) was deferred They are less onerous than those by two years to early 2015. originally proposed but remain significant, requiring hedge funds to The most significant positive make significant alterations to their development for non-EU AIFs is the business model. extension of the national private placement regimes (NPPRs) until at It is important to note that while the least 2018. This is the regime used directive has been passed by the by the majority of the hedge fund European Parliament, the details are industry for marketing to European still being finalised under the Level 2 investors today and will not be rule making process. The box on the ‘switched off’ in 2018 unless there opposite page sets out the timetable. is a workable passport in place. So there is still a risk on the horizon, but The directive applies to all alternative it is a much better situation than was investment fund managers (AIFM), originally proposed. both inside and outside the EU, who wish to market their funds to European investors. It sets out a harmonised regime for authorisation of EU AIFMs, common transparency as well as operational requirements. It also establishes a new marketing regime for EU and non-EU alternative investment funds (AIF) by any manager. The two most hotly debated issues relate to the marketing of the funds of non-EU managers to EU investors and depository liability.Markets in 2011—Foresight with Insight Deutsche Bank
  • 112. Depository and other provisions What’s next?Unfortunately there are still many As mentioned above, the Level 2 rule Timetableundefined areas which may place making process is upon us and manysignificant liabilities on service in the industry view this with some November 11, 2010providers and hence will increase concern. The European leadership Final text adopted by Europeancosts to the fund and ultimately, decided they would need to reform Parliament and Level 2 secondaryinvestors. For example, each AIFM will the supervisory system in the wake of rule making beginsbe required to appoint a depository the crisis and will create the Europeanresponsible for custody, monitoring Securities and Markets Authority Early 2013subscriptions and redemptions, cash (ESMA) on the 1st January, 2011. It will Member states required toflows and valuation. While wording be responsible for all matters related transpose the Directive into theiraround the depository liability and to securities markets, exchanges, national laws. Both EU and Non-delegation of responsibility was asset management, rating agencies EU managers who manage non-softened in the final draft, it still and also clearing houses and while EU funds will be able to continueraises many questions which could it will not have direct supervisory to make use of the Nationalfundamentally change the legal and powers, it will act as an umbrella Private Placement Regimeoperating model of prime brokers and organisation for regulators. Notably if (NPPR’s) until at least 2018.custodians. there are disputes between competent authorities ESMA will be allowed to 2015The AIFM must also comply with other settle them in a binding manner. Passport for Non-EU managersrules covering delegation of functions, The decision of ESMA will be the final may (but also may not be)leverage, remuneration, annual determination as to how the dispute switched on. The Passport willreports, disclosures to investors, should be resolved. run in parallel with the existingreporting obligations to authorities, private placement regime untilvaluation and conflicts of interest. In relation to AIFMD, there are many 2018.Details of these are yet to be finalised different areas in which ESMA willand while most firms capture the play an important role, ranging from 2017information, these requirements will publishing guidelines through to rule Directive subject to review on itsplace a significant burden in both time making. It is expected to provide the application and scope.and cost to report and measure. main policy and technical input to the Commission and most expect its 2018 powers to increase over time. If the Passport is determined to be successful, the National Many industry participants and Private Placement Regime may observers feel the end result, be switched off. while still uncertain, presents a workable solution for most hedge funds utilising the NPPRs while details regarding the passport are determined in the Level 2 process. Deutsche Bank Markets in 2011—Foresight with Insight
  • 113. 7.5 Martin FothergillInvesting Director Global Fund Derivatives Group Hedge Fund Investors Turn to Managed Accounts Good news for investors and hedge fund managers Around twenty percent of the money being invested in hedge funds is not going directly into hedge funds but into managed accounts. This is a huge shift on past years when Managed accounts offer investors managed accounts accounted for less similar returns to the main hedge than 5% of inflows to hedges funds. fund offered by a firm. But they differ from direct investment in several key So what’s driving this trend and respects, offering improved liquidity, what are the implications for investors transparency and investor control. and managers? They also allow clients to segregate their investments in vehicles separate The rise in managed accounts can be from the main hedge fund, meaning traced back to the well-documented investors retain control over their events of 2008 which had a profound assets, usually with the ability to impact on the way that hedge fund redeem much more frequently than managers and their investors interact. the main fund. The desire, and in many cases The Madoff fraud is often cited as the necessity, for investors to receive key catalyst in catapulting hedge fund more detailed information regarding managed accounts to centre stage. their investments and have more While it – and other smaller frauds – control over their liquidity resulted in have undoubtedly had a meaningful a positive reaction by many hedge impact, we have found that, two years funds. on, it is the liquidity issues that the industry suffered that seems to have This manifested itself in numerous left the most indelible impression. ways ranging from hedge funds simply being more forthcoming in providing The problem was an asset-liability investors with information, improving mismatch between the liquidity of the liquidity terms, and in some cases, hedge vehicle (i.e. the liquidity offered fully restructuring their offerings. In an to investors) compared to the liquidity increasing number of cases the result of the underlying portfolio. In the dark was to allow investors to implement days of H2 08 the ‘perfect storm’ managed account solutions where occurred, with investors requesting to the investor has more control over redeem significant amounts of capital and transparency with their own from hedge funds during a period of investments. extreme market illiquidity.Markets in 2011—Foresight with Insight Deutsche Bank
  • 114. This had an impact across a wide and control the liquidity of the an important tool being embraced byrange of hedge funds, ranging securities is a significant benefit to many managers because managedfrom previously liquid hedge fund investors, and a meaningful change accounts – and managed accountportfolios with for example monthly from the ‘arm’s length’ arrangement platforms in particular – are attractiveliquidity to illiquid strategies with of investing in a regular fund vehicle. not only to existing hedge fundmuch longer redemption terms. The This is one of the core principles investors but, more importantly, to ancommon theme was the mismatch behind managed accounts and one entirely new client liquidity which caused difficulties of the reasons why they are beingfor all participants. Firms with less increasingly embraced by investors. Another twist on this theme is forliquid strategies commonly suspended firms to offer their funds in regulatedtheir funds, or gated them (limiting What about the hedge fund managers UCITS III vehicles, either as singlethe amount of capital that could be themselves? funds or in ‘index’ products whichredeemed each month or quarter) or We have seen a number of trends. combine a series of managedtransferred the most illiquid portion of Many hedge funds are increasingly accounts into a UCITS III compliantthe portfolio into ‘side-pockets’. Even open to the idea of managed accounts index which can be wrapped as athose hedge funds which remained and the concept of providing fund or ETF. Such combinations offully liquid during the period suffered associated levels of transparency liquid, transparent and risk controlledas investors turned to them as a and liquidity. Furthermore, some managed accounts combined withprovider of much needed redemption funds are in a better position to offer UCITS III regulation has proved veryproceeds. managed accounts because they popular with investors over the last have addressed the asset-liability 12 months.Consequently investors faced either imbalance, typically by removinginvestment losses or delays in the illiquid portfolio componentretrieving their cash, realising that just which proved so troublesomebecause a fund offered monthly or during the crisis.quarterly redemptions that would notnecessarily happen. Firms are also looking closely at their investor bases, the concentration ofThese crisis-related difficulties which contributed to their difficultiesprompted a reassessment of how during the crisis. They are concludingbest to tackle hedge fund investment, that the traditional offshore fundand led directly to an increase in the structure will not capture a sufficientlypopularity of managed accounts. diverse investor base and actuallyHence, having transparency in a precludes them from many investorportfolio and the ability to monitor, types. Offering managed accounts is Deutsche Bank Markets in 2011—Foresight with Insight
  • 115. 7.6 Anthony VaughanInvesting Director, Institutional Client GroupEuropean Insurers Face New Solvency RulesRisk management becomes vital2011 is likely to be a very important year forinsurance companies across Europe as themajority of them prepare to reorganise theirentire approach to risk and capital in time forthe introduction of the Solvency II regulatoryframework for EEA insurance companies.Due to come in to force on 31st standardised formula, or an internalDecember 2012, Solvency II is a set model. The use of an internal modelof principles for European insurance enables a bespoke assessment ofcompanies which, in three pillars, the risks that are specific to thatlays out a framework for capital particular firm and allows for a moreadequacy and risk management, with accurate and appropriate measurethe ultimate aim of enhancing the of risk than the standard afforded to policyholders. Internal models are commonplaceThe directive will look to align risk among UK, Scandinavian and Dutchmanagement with risk measurement, insurers who have been operating onand, along with strong public and risk-based capital adequacy regimesprivate disclosure procedures, require for many years (such as the Individualthat insurance companies hold an Capital Adequacy Standards regimeamount of capital commensurate in the UK), but will be a daunting andwith their risk profile. The lower this ambitious new project for those inmeasure of risk, the less capital the many other European jurisdictions.firm needs to hold. Moving to a risk-based frameworkAt the heart of the capital adequacy for capital reserving is an eminentlycalculations is the Solvency Capital sensible idea, and has been in placeRequirement (SCR) within Pillar 1, for banks since the adoption of thecalculated annually, which aims to Basel 2 Capital Accord in 2008. Itcover all quantifiable risks faced by means those insurers that managethe insurance company for a 1-in-200 their risk (be it market, counterparty,year event. The SCR, used to calculate operational, or other risks) efficiently,the Minimum Capital Requirement the lower their SCR, and hence(MCR), which is the very lowest level the more capital can be deployedof capital a firm shall be allowed for writing new business, with theto hold, is calculated either using a resulting improvement in return-on-Markets in 2011—Foresight with Insight Deutsche Bank
  • 116. capital. Those firms that look to reduce Along with risk management, Deutsche Bank has been atinterest rate risk, by duration, or cash Solvency II is likely to affect the forefront of managing andflow-matching their liabilities using investment management, as insurers understanding the risks run by itsinterest rate swaps, or credit risk using look to adjust their asset portfolios insurance company clients acrosstranched index credit derivatives, or to incorporate instruments that Europe for many years, and one oflongevity using the emergent longevity are capital-efficient under the new the lessons we have learned in thisswaps market, can reduce their SCR. guidelines, such as: time is the importance of being able to swiftly and accurately quantifyLife assurers in the UK, Scandinavia 1. Inflation-linked government bonds on the market risks of a business, fromand the Netherlands have for many ‘fixed rate asset swap’, to provide high- both an economic and regulatoryyears used the derivatives markets yielding duration-bearing instruments standpoint. Risk managementto quantify, manage and in some with almost-zero capital charge. solutions are then merely an extensioncases immunise their market risks of the quantified risk.and reduce their regulatory capital 2. Negative-basis packages, i.e.requirements, and we believe corporate bond plus matched maturity Awareness of the quantum of suchSolvency II will encourage a wave of credit default swap protection, which, risks, familiar to many but unfamiliarsimilar activity in those jurisdictions by making use of the ‘risk mitigant’, to more, will in 2011 becomewhere the new principles represent can potentially be treated under the crucial to operating a successfula wholesale shift in the way capital less-punitive counterparty module insurance business. As the rest ofis measured. If, as the spirit of the rather than spread risk module. Europe prepares to embark on theproposed principles contained within path already explored by their UK,the fifth Quantitative Impact Study 3. Collateralised lending arrangements Scandinavian and Dutch counterparts,(QIS5) implies, the swaps curve is whereby spread is earned by liquidity- bringing experience and knowledgeto be used to discount liabilities, we rich insurance companies who, for an attained over the past decade,expect to see increased demand for agreed time period, switch their liquid Deutsche Bank looks forward tolong-dated swaps and might see instruments for less liquid instruments accompanying them on the hike.downward pressure on the long end with a liquidity-poor counterparty,of the EUR swaps curve. Furthermore, such as a of government bonds for theirduration-bearing properties will resultin a ‘swap spread’ mismatch, whichmay result in a higher capital chargeif accurately captured by internalmodels. We therefore expect to seeinsurers looking to eliminate this swapspread risk by entering into derivativecontracts known as ‘spreadlocks’, justas UK insurers looked to eliminateswap spread risk resulting frominterest rate swap assets durationmatching gilt-discounted liabilities.The use of options and option spreadson swap spreads may emerge in 2011as demand for ‘non-linear’ exposure toswap spreads grows. Deutsche Bank Markets in 2011—Foresight with Insight
  • 117. 7.7 Vinay PandeInvesting Chief Investment Advisor, ResearchPortfolio TheoryBinary outcomes, bimodal returnsThe key problem that investors have Why established portfolioto wrestle with in today’s markets is theories don’t worklack of certainty. This uncertainty can Figure 1 shows how different the lastbe summarised as doubt over which of decade has been from the 1980s andthe following economic forces is going 1990s (and how reminiscent of the lastto prevail at a global level, whether period of instability, the 1970s).in the near term or over much of thecoming decade: a) the extraordinarygrowth impulse coming from rapid Figure 1emerging market integration, or b) the S&P 500 price index rolling 1-yr returns for selected periodsequally extraordinary drag coming Source: Bloomberg, Standard and Poors, Deutsche Bank Actual distributionfrom the problems of groups of people Theoretical Normalor regions that are excluded from Dec 30 ‘27 – Apr 20 ’10or are losing out from the current 0.04 Mean 7.23 Median 8.24globalisation process. Max. 171.20 0.03 Min. -70.60 Std. Dev. 20.97 DensityIn contrast, paradoxically, the outlook 0.02 Skewness Kurtosis 0.19 5.80for the more distant future (end of the 0.01decade and beyond) is far less muddy. 0.00 -75 -63 -50 -38 -25 -13 0 13 25 38 50 63 75 88 100 113 125 138 150 163 175Many of the problems that create Returns %headlines today (including large netindebtedness of consumers and Dec 31 ‘71 – Dec 31 ’76governments in some countries) 0.04 Mean Median 0.28 1.01are really symptoms of the inherent 0.03 Max. Min. 39.08 -43.25instabilities in the global economy. Density Std. Dev. 19.13 0.02 Skewness -0.11 Kurtosis 2.04Not only are asset returns highly 0.01unstable but the level of volatility 0.00itself is unstable. In such uncertain -75 -60 -45 -30 -15 0 15 30 45 60 75times, there is one word we need to Returns %paste across our foreheads: ‘caution’. Jan 2 ‘80 – Dec 31 ’99The guiding principle for investors 0.04 Mean 14.55should be to maximise, for every Median 15.30 Max. 59.08dollar invested, the responsiveness 0.03 Min. -23.35 Densityof their portfolios to a range of 0.02 Std. Dev. Skewness 14.82 -0.12macroeconomic outcomes. Or in Kurtosis 2.71plain English, to ensure that returns 0.01are maximised irrespective of what 0.00happens in the markets. -60 -45 -30 -15 0 15 30 45 60 Returns % Jan 3 ‘00 – Apr 20 ’10 0.04 Mean -1.22 Median 4.27 Max. 68.57 0.03 Min. -48.82 Density Std. Dev. 19.83 0.02 Skewness -0.05 Kurtosis 2.72 0.01 0.00 -75 -60 -45 -30 -15 0 15 30 45 60 75 Returns %Markets in 2011—Foresight with Insight Deutsche Bank
  • 118. This is by no means just an equity Multi-year bear markets like the The returns are widely dispersed onphenomenon; over the past decade Nikkei and multi-year bull markets either side of zero and in a way thatinvestment-grade credit and peripheral like the Bovespa and Hang Seng look has made the task of long-only assetEuropean bonds have also exhibited materially the same (figure 3). managers enormously difficult.extremely dispersed and even bimodalreturns (figure 2). Consider trying to answer the layman’s question – ‘is this market cheap or expensive?’ Whereas this is a reasonably straightforward question in a unimodal world, it is impossible to answer in a bimodal world such asFigure 2 Figure 3 today’s. Indeed one doubts whether itInvestment grade CDS: rolling Selected equity markets: rolling 1-yr is even relevant. To assume a problem1-yr returns since January 2005 returns since Jan 2000 can be dismissed as a ‘tail event’Source: Bloomberg Finance LP, DBIQStandard & Poor’s, Deutsche Bank GMR Actual distribution Theoretical norm Source: Bloomberg Finance LP, Deutsche Bank GMR Actual distribution Theoretical norm or a ‘black swan’ event would be to seriously underestimate risk. TheCDX IG 5-yr: 1-yr returns Nikkei 225: 1-yr returns mean-variance framework, particularly0.60 Density Mean -0.35 0.03 Density Mean - 2.20 Median 0.26 Median -1.82 the use of Value At Risk (VAR) as a0.50 Max 7.55 Max 58.44 Min Std. dev. -8.10 3.04 Min Std. dev. -54.35 25.25 risk measure, can be of some value0.40 0.020.30 Skewness Kurtosis 0.09 2.93 Skewness Kurtosis 0.24 2.07 in a unimodal world. But in the new0.20 0.01 bimodal world, its value is much more0.10 questionable.0.00 0.00 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 -75 -60 -45 -30 -15 0 15 30 45 60 75 Variance and Co-variance matrices Returns % Returns % based on historic data, still widely used by investors and consultantsiTraxx IG 5-yr: 1-yr returns Hang Seng: 1-yr returns when making asset allocation0.80 Density Mean Median -0.07 0.43 0.04 Density Mean Median 6.59 11.25 decisions, deliver misleading answers0.700.60 Max Min 6.48 -5.85 0.03 Max Min 101.25 -60.17 in a world where the matrices0.50 Std. dev. Skewness 2.20 0.12 Std. dev. 27.86 Skewness -0.02 themselves are unstable. In such an0.400.30 Kurtosis 3.28 0.02 Kurtosis 2.56 environment, hedge assets quickly0.20 0.01 become risk assets, especially at 0.10 times of stress.0.00 0.00 -7 -6 -5 Returns % -4 -3 -2 -1 0 1 2 3 4 5 6 7 -110 -90 -70 Returns % -50 -30 -10 10 30 50 70 90 110 Whether it’s by force of habit, or due to their lack of experience ofGreece Govt 6% July 19* BOVESPA: 1-yr returns periods of unstable returns, many0.180.16 Density Mean Median -2.99 -3.11 0.02 Density Mean Median 21.34 23.84 market participants still tend to Max 9.670.14 Min -27.90 Max Min 130.07 -51.07 superimpose on reality an abstraction0.12 Std. dev. 8.980.10 Skewness Kurtosis -0.21 1.91 Std. dev. Skewness 37.20 0.30 (such as a version of a bell-shaped Kurtosis 2.460.08 0.01 distribution curve). 0.00 -35 -25 -15 -5 5 15 25 35 -70 -50 -30 -10 10 30 50 70 90 110 130 Returns % Returns % *rolling 4-mo returns, Mar 5, 2009 – Apr 29, 2010 period Deutsche Bank Markets in 2011—Foresight with Insight
  • 119. 7.7Investing This leads them to make the following The counterparties of cash-market basic errors: participants in the derivatives – They exaggerate the probability space, options-traders, make similar of low probability moderate misjudgments when selling volatility return outcomes, a recipe for or insurance. underperformance because it leads to overinvestment in sleepy assets; Figure 4 shows the return profiles – They underestimate the probability of the cash instrument (S&P); a of higher oscillation, high frequency proprietary equity swap variance outcomes, a recipe for poor risk product on the S&P offered by management and unexpected losses; Deutsche Bank called ELVIS (note the ‘x’ axis is laterally inverted); and a Figure 4 combination of these two. Equities and forward variance swaps: 1-yr returns for the Jan 3, 2000 – After buying this sort of insurance, Apr 20, 2010 period Deutsche Bank has been able to Source: Bloomberg Finance LP, DBIQ Standard & Poor’s, Deutsche Bank GMR Actual distribution Theoretical norm enhance investment performance by about 3.5% per annum at the same 6-mo variance swaps, 3-mo forward (S&P 500) time as reducing volatility by one-third, 0.40 Density Mean 3.92 every year over the last decade. Such Median -0.75 0.30 Max Min 75.54 -32.94 mis-pricing opportunities exist not just Std. dev. Skewness 20.94 0.49 in equities and equity variance but 0.20 Kurtosis 2.29 across other asset classes as well. 0.10 As a general principle the best way 0.00 of maximising returns in a unimodal 80 60 40 20 Returns % (Inverted scale) 0 -20 -40 -60 -80 world (where discovering price is our objective) is to own cheap options. S&P 500 By extension, discovering the correct 0.40 Density Mean -1.22 price of volatility or insurance is Median Max 4.27 68.57 more relevant in a bimodal world and 0.30 Min Std. dev. -48.82 19.83 therefore owning options on volatility 0.20 Skewness Kurtosis -0.05 2.72 makes good economic sense. That is exactly what is being achieved in the 0.10 equity exercise above. 0.00 -80 -60 -40 -20 0 20 40 60 80 The variance swap with insurance Returns % works because it combines assets with volatility counterparts that have S&P 500 plus 6-mo variance swaps, 3-mo forward attractive, asymmetric payoffs. It is 0.40 Density Mean Median 2.68 2.40 has the ability to produce what is 0.30 Max Min 42.75 -32.65 effectively an option on a volatility Std. dev. 13.12 Skewness 0.38 position. Step one is to combine 0.20 Kurtosis 2.83 assets with positively-biased 0.10 asymmetric payoffs and liabilities (or 0.00 short positions) with the opposite. The next step is to seek out options on -80 -60 Returns % -40 -20 0 20 40 60 80 these assets and liabilities whose price does not reflect the asymmetric nature of the payoffs.Markets in 2011—Foresight with Insight Deutsche Bank
  • 120. Deutsche Bank Investment Advisory 2. Valuation unlevered and liquid portfolio withGroup puts together its multi-asset The valuation process leads us to volatility confined to approximatelyportfolios, and regularly fine-tunes assess option-adjusted spread across 7%-10% per annum, unless we arethem to maximise returns in a three- asset classes, a calculation that receiving a large option payoff, instage process which includes mapping suggests what are currently among which case we let our gains run untilmacroeconomic scenarios, valuation the most attractively priced assets we choose to delta hedge in order toand payout profile: around – US and European equities. restore volatility to the 7%-10% per annum zone.1. Mapping macroeconomic scenarios 3. Payout profileWe outline plausible medium-term The next stage is to establish the The objective is, as figure 5 belowmacroeconomic scenarios. Currently desired payout profile, subject to demonstrates, to achieve a finelythese include crises for the Eurozone, constraints. For reasons including tuned portfolio profile to address allthe dollar and emerging markets, abundant caution, the portfolios are scenarios in a way that more naïveand, on the other side, more positive over-engineered to seek a convex single or multi asset portfolios cannotoutcomes for risk assets. We then profile across scenarios; the more hope to achieve, even if they use basicrepeat the exercise over a longer violent the outcome, the greater the option strategies.timeframe. Having identified the gain that we are seeking.scenarios, we assess how a range ofasset classes might perform against The constraint set under whicheach scenario. we operate is to design a largelyFigure 5Forecast 1 year returns DB Investment Advisory Group Cross- Asset Portfolio Long-dated US Treasury hedged with 1Yr Strike= 4.2%, OTM 19Yr Payer Swaption 50% S&P500 hedged with Put and 50% Long-dated US Treasury hedged with Payer Sw aption S&P500 hedged with 1Yr Strike=1150 Put Long-dated US Treasury 50% S&P500 and 50% Long-dated US Treasury S&P500 70% IG & 30% HY Corporate Bonds Source: Bloomberg, Standard and Poors, Deutsche Bank40% 60% 40%30 20 10 0-10-20-30-40-50 High return for risk assets case return for risk assets assets case Disaster case: $ crisis Bad outcome: Govt back market Bad outcome: Euro accident Bad outcome: EM crisis Disaster case: Debt deflation Moderate Low return for risk Deutsche Bank Markets in 2011—Foresight with Insight
  • 121. 7.8 Caio Koch-WeserInvesting Vice Chairman, Deutsche Bank GroupInvesting in Green GrowthOpportunities aheadGreen sectors and industries are set channelling these funds through local in low carbon infrastructure andto grow dramatically. This growth will banks. This, in turn, will strengthen technology, driven by environmentalrespond to the need to address climate the ability of domestic financial and energy security concerns.change – but it will also be driven institutions to fund further low-carbon Deutsche Asset Management willby concerns about energy security, projects. The fund uses an innovative soon begin raising a fund to invest innational security, and access to natural structure that offers different tranches low-carbon power generation assetsresources in a rapidly growing world. of shares and notes, each with a in North America. Specific sectors different risk and return profile. Money that the fund will invest in includePolicymakers around the world are from the German government will natural gas, solar, wind, and biomassresponding to these concerns, and take a first loss equity stake, while power generation, transmission andmany countries, states, and cities development finance institutions distribution, and midstream energyare now engaged in a race to build including KfW will supply mezzanine projects. The targeted capitalisation oflow-carbon industries, create green debt. These tranches will shield private $1 billion will be sourced from existingjobs, and secure future competitive investors from losses. By using this and new third-party clients as limitedadvantage for themselves. Business is risk mitigation structure, the fund partners.responding, with 93% of CEOs saying aims to mobilise at least $500 millionthat sustainability will be critical to of investment from the approximately Climate change is a pressing globalthe future success of their companies $100 million that has been pledged by challenge – and it also represents onein a recent survey conducted by the the German government and KfW. of the major investment opportunitiesUN Global Compact and Accenture. of the coming decades. There areAnd investors are deploying capital in Other similar investment products many attractive investment strategiesthe space: according to New Energy that target projects in the developing in the space, and Deutsche Bank isFinance, in the first three quarters world are also in development. The committed to offering products thatof 2010, there was over $106 billion UK’s Department for International channel money into this dynamicof new financial investment in clean Development, the Asian Development growth sector to its alone. Bank, the IFC, and the P8 group of institutional investors have beenWhat are the opportunities for collaborating on the design of ainvestment in this major future growth regional Public Private Partnershiptrend? Climate Fund for Asia, known asThere are many attractive options. the CP3. Donors would contributeDeutsche Bank was recently selected toward the cornerstone equity of theto be the fund manager for the Global fund, and would allow private fundClimate Partnership Fund. The fund managers to bid for part of the equityhas been established by the German to build their own funds. Risk reducingEnvironment Ministry in cooperation mechanisms and technical assistancewith KfW, the German development from international financial institutionsbank. It will foster energy efficiency would be applied at scale to the fund.and renewable energy investmentsfor small and medium enterprises and And in the developed world, similarhouseholds in developing countries, partnerships are being built to investMarkets in 2011—Foresight with Insight Deutsche Bank
  • 122. Deutsche Bank Markets in 2011—Foresight with Insight
  • 123. Key Awards and Rankings in 2010 Institutional Investor, Greenwich Associates, Asia ex JapanIFR Awards, Review of the year Research Ranking Fixed Income Strategist Report 2010– Derivatives House of the Year – No. 1 for Germany and General – No. 1 Government Bonds*– Interest Rate Derivatives House Retail Sector, European – No. 1 Interest Rate Derivatives* of the Year – No. 1 for Large Cap Banks– European Loan House of the Year Sector, US– Investment-Grade Corporate Bond – No. 1 for Gaming & Lodging Sector, House of the Year Asia ex-Japan – No. 1 for Pulp & Paper Sector, LatAm Global Custodian, Prime Brokerage Survey 2010 – No. 1 Global Overall Prime Broker and Top Rated Global Prime BrokerEuromoney, Awards for Excellence – No. 1 in North America and Europe– Best Global Investment Bank– Best Global Credit Derivatives House– Best Global Risk Management House Structured Products, Asia Awards 2010– Best FX House in Europe, Asia, Latin – ETF Provider of the Year, Asia Energy Risk, Awards America, Central and Eastern Europe – Electricity Europe– Best Debt House in Australia House of the Year Risk Magazine, Risk AwardsGreenwich Associates, European Fixed – Hedge Fund Derivatives HouseIncome Strategist Report 2010 of the Year– No. 1 Interest Rate Swaps The Banker, Investment Awards 2010 and Options* – Most Innovative Investment Bank– No. 1 High Yield Cash Bonds and for Risk Management Credit Derivatives and New Issues*– No. 1 Emerging Market Fixed Income Securities* Euromoney, FX Poll – No. 1 Overall, 6 years in a row Asia Risk – No. 1 in North America, 6 years in – Credit Derivatives House of the Year a row – Prime Brokerage House of the Year – No. 1 in E-Trading Proprietary Platforms by market share, 6 yearsRisk, Interdealer Rankings in a row– No. 1 in Derivatives Global Finance World’s Best FX Banks Awards – World’s Best FX Bank every year Greenwich Associates, US Fixed since 2006Energy Risk Asia Awards Income Strategist Report 2010– Derivatives House of the Year – No. 1 Overall Across All Fixed– Base Metals House of the Year Income Products* – No. 1 Interest Rate Swaps and Mortgage Pass Through Securities* – No. 1 Credit Default Swaps* *Based on market shareMarkets in 2011—Foresight with Insight Deutsche Bank
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