Unlocking global value

More documents

Info

GLOBAL INVESTOR 2.07 Basics — 20 with a worse Sharpe ratio. Although commodities (CRB index) have performed well in the past couple of years, they were the underperforming asset class for the time period analyzed. Figure 4 charts total returns for the main asset classes. Since their launch in 1997, the historical total return performance of TIPS has been better than that of nominal US T-Notes, namely 6.6% versus 6.1%. This higher total return of TIPS was achieved with a better Sharpe ratio (which measures the excess return over T-Bills per unit of risk), 0.51 for TIPS versus 0.43 for T-Notes. Figure 5 highlights the annual total returns of equities, T-Notes and TIPS, and illustrates the negative correlation between TIPS and equities, which is desirable from the standpoint of portfolio diversification. The general feature of government ILBs is that both the principal and the coupon increase in line with the linked consumer price inflation index. Breakeven (BE) inflation is defined as the difference between the real yield of an ILB and the quoted nominal yield of a normal government bond of the same maturity. Figure 6 shows the development of the real yield and the BE inflation for the 10-year TIPS. Real yields have declined since the year 2000. BE inflation has remained relatively stable at around 2.5% since 2003. Figure 7 shows a rise in real yields of around 40 basis points over the same period. TIPS in total return portfolios TIPS make a beneficial contribution to fixed income, equity and balanced equity-fixed income portfolios in terms of improving the efficient frontier. Constructing efficient portfolios with TIPS produces a beneficial diversifying effect in most contexts. In our view, a comparison of the returns of various asset classes is only a credible exercise when the risk differentials across the classes are taken into account. The expected returns and asset class volatility of our analysis are based on the monthly data from March 1997 to end-December 2006. Table 3 shows that the correlation between T-Notes and TIPS is relatively high at 0.79. From Table 3 we see that the correlation between TIPS and equities is negative, at –0.19, hence we would expect a very strong diversification effect from mixing the two asset classes. Figure 8 shows how the performance volatility of a portfolio of T-Notes (government bonds) and equities can be reduced by the addition of TIPS. Inflation-linked bonds offer investors a certain protection of their assets against future inflation, contingent on how well an investor’s inflation risk is aligned to the CPI to which a particular bond is linked. These instruments provide the opportunity for “real” asset/liability matching. Generally speaking, it is attractive to invest in ILBs when real yields are high and BE inflation is low. The solid risk/reward ratio of TIPS and their low correlation with other asset classes make them a valuable diversifying alternative investment class for both strategic and tactical asset allocation. It is particularly worth noting that TIPS exhibit a negative correlation to equities. Figure 3 CPI for various countries (logarithmic scale) Headline Consumer Price Index, normalized to 100 in 1960, for selected industrialized countries. Source: Credit Suisse, Bloomberg % 10,000 1,000 Figure 5 Returns for equities, T-Notes and TIPS Annualized returns for USD equities, government bonds and inflation-linked bonds, illustrating the negative correlation between equities and TIPS. Source: Credit Suisse, Bloomberg, Datastream % 100 Figure 4 30 20 10 0 –10 –20 –30 Figure 6 01/60 01/65 01/70 01/75 01/80 01/85 01/90 01/95 01/00 2000 2001 2002 2003 2004 2005 2006 Equities T-Notes TIPS Real yields and BE inflation Development of real yield and breakeven inflation for 10-year TIPS. Source: Credit Suisse, Bloomberg 01/05 France Switzerland Germany UK Italy USA Japan Total returns by asset class Cumulative total returns by USD asset class, normalized to 100 in March 1997. Source: Credit Suisse, Bloomberg, Datastream % 450 350 250 150 50 03/97 03/98 03/99 03/00 03/01 03/02 03/03 03/04 03/05 03/06 EMBI+ Hedge funds Equities Real estate TIPS T-Bills CRB Photo: Corbis Paul Volcker was born in New Jersey in 1927 and studied economics at the universities of Princeton and Harvard and at the London School of Economics. He is best known for his time as Chairman of the Board of Governors of the Federal Reserve System, 1979–1987. He is also a former Undersecretary of the Department of the Treasury and President of the Federal Reserve Bank of New York. He is Professor Emeritus of International Economic Policy at Princeton University. % 4.5 3.5 2.5 1.5 0.5 Jan. 97 Jan. 00 Jan. 03 Jan. 06 10-year real yield from TIPS 10-year breakeven inflation
GLOBAL INVESTOR 2.07 Basics — 21 Figure 7 Real yields have risen Real yields have risen across the TIPS yield curve since the end of 2005. Source: Credit Suisse, Bloomberg % 2.5 2.0 1.5 Figure 8 TIPS help reduce portfolio volatility Adding TIPS to an equity/bond portfolio helps reduce return volatility due to the negative correlation of TIPS to equities. Source: Bloomberg, Datastream, Credit Suisse 220 180 140 100 2008 2013 2018 2023 2028 Maturity 03/97 03/98 03/99 03/00 03/01 03/02 03/03 03/04 03/05 03/06 12 February 2007 30 December 2005 100% equities 100% TIPS 50% equities, 50% T-Notes 14% equities, 47% T-Notes, 39% TIPS Table 1 Government ILB bond indices Key parameters of Barclays Capital government inflation-linked bond (ILB) indices. Source: Barclays Capital, Credit Suisse Issuer No. issues Mkt. val. USD bn Avg. real yield % Avg. maturity years US 21 401 2.37 9.96 Euro Gov 17 261 2.05 9.51 UK 11 257 1.42 16.82 Japan 10 41 1.24 8.79 Sweden 6 35 1.85 10.91 Canada 4 31 1.78 22.43 Japan 10 41 1.24 8.79 Australia 3 7 2.63 9.34 Table 2 Risk/return of USD assets Historical annual total returns, excess returns over cash, volatility and risk-adjusted returns (Sharpe ratio) for various asset classes. Source: Credit Suisse, Bloomberg Risk/return overview EMBI+ Hedge funds Equities Real estate TIPS T-Notes T-Bills CRB Average return 10.55% 9.78% 8.05% 15.92% 6.62% 6.07% 4.10% 2.10% Excess return 6.45% 5.68% 3.94% 11.82% 2.52% 1.97% 0.00% –2.01% Std. dev. 15.03% 7.09% 15.45% 14.23% 4.98% 4.56% 0.59% 10.85% Sharpe ratio 0.43 0.80 0.26 0.83 0.51 0.43 0.00 –0.19 Table 3 Correlation of USD assets Historical correlation of various asset classes and CPI. Source: Credit Suisse, Bloomberg Correlation matrix EMBI+ Hedge funds Equities Real estate TIPS T-Notes T-Bills CRB CPI EMBI+ 1.00 0.49 0.53 0.35 0.16 0.05 –0.02 0.19 0.01 Hedge funds 0.49 1.00 0.47 0.22 –0.06 –0.02 0.07 0.15 –0.06 Equities 0.53 0.47 1.00 0.28 –0.19 –0.23 0.06 0.13 –0.13 Real estate 0.35 0.22 0.28 1.00 0.13 0.01 –0.10 0.14 –0.05 TIPS 0.16 –0.06 –0.19 0.13 1.00 0.79 –0.01 0.16 0.06 T-Notes 0.05 –0.02 –0.23 0.01 0.79 1.00 0.16 –0.01 –0.10 T-Bills –0.02 0.07 0.06 –0.10 –0.01 0.16 1.00 –0.21 –0.01 CRB 0.19 0.15 0.13 0.14 0.16 –0.01 –0.21 1.00 0.18
Page 1: Issue 02 May 2007 Expert know-how f
Page 5 and 6: What moves the world 2 … valuatio
Page 7 and 8: GLOBAL INVESTOR 2.07 Editorial —
Page 9: GLOBAL INVESTOR 2.07 Content — 09
Page 12 and 13: GLOBAL INVESTOR 2.07 Lead — 12 6
Page 14 and 15: GLOBAL INVESTOR 2.07 Lead — 14 Ta
Page 16 and 17: GLOBAL INVESTOR 2.07 Lead — 16 Ta
Page 18 and 19: GLOBAL INVESTOR 2.07 Basics — 18
Page 22 and 23: Real interest rates in selected EM
Page 32 and 33: GLOBAL INVESTOR 2.07 Enrichment —
Page 42 and 43: GLOBAL INVESTOR 2.07 Switching —
Page 56 and 57: GLOBAL INVESTOR 2.07 Services — 5
Page 58 and 59: GLOBAL INVESTOR 2.07 Services — 5
Page 60 and 61: GLOBAL INVESTOR 2.07 Disclaimer —
Page 62 and 63: GLOBAL INVESTOR 2.07 Disclaimer —
Page 64: www.credit-suisse.com/research GIE

Unlocking global value

Create successful ePaper yourself

Delete template?

Save as template?