Threadneedle Absolute Return Range Threadneedle Absolute Return Bond Fund Threadneedle Credit Opportunities Fund Threadneedle UK Absolute Alpha Fund

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1 OEIC Absolute return Range brochure January 2011 Threadneedle Absolute Return Range Threadneedle Absolute Return Bond Fund Threadneedle Credit Opportunities Fund Threadneedle UK Absolute Alpha Fund

2 Introduction Over the last five years, absolute return funds have become increasingly popular as they aim to offer investors an attractive opportunity to help achieve a consistent return across all market conditions. In this brochure, we explain what absolute return funds are, take a look at how they work and highlight some of the differences between this asset class and traditionally actively managed products. We also introduce our absolute return range of funds. We have also included a jargon-buster glossary on page 10. Please read this important information Threadneedle is unable to provide financial advice and you should not interpret any thing in this guide as advice. If you are unsure about anything you should speak to a financial adviser. For details of one in your area please go to The material in this brochure is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Contents What are absolute return funds? 1 Absolute versus relative 2 Threadneedle s absolute return range of funds 3 Threadneedle Absolute Return Bond Fund 4 Threadneedle Credit Opportunities Fund 5 Threadneedle UK Absolute Alpha Fund 6 Investor profile and key risks 7 Risk control is key 8 Summary 9 Jargon-buster 10

3 Threadneedle Absolute Return Range 1 What are absolute return funds? Until relatively recently, investing was something of a one way street. Fund managers could invest in things that they thought would rise in value or avoid if they thought they were going to fall in value. When prices are rising managers just have to select the investments likely to rise the most and steer clear of any that are likely to disappoint. But what about when asset prices are falling, or when markets are so volatile that it s difficult to tell which investments are going to rise and which are likely to fall? Absolute return funds meet this challenge by taking advantage of regulatory developments that widened the range of tools available to fund managers. There are now a variety of tools at a fund manager s disposal including some that allow the fund to make money when share or bond prices fall, others that are designed to deliver value when market uncertainty rises and those that allow fund managers to express clear views on things like foreign exchange markets or expectations for interest rates. These developments, covered in the UCITS III Directive, enable authorised and regulated funds to hold a wide variety of investments including futures, options and other derivatives. Please see our Investors Guide to UCITS III for a more comprehensive overview of UCITIS III and what this means to investors. For your copy, speak to your financial adviser or visit threadneedle.co.uk Just like a traditional fund, absolute return portfolios rely on fund manager skill. The managers research their markets in order to arrive at a view of what is likely to happen, then build a portfolio to reflect that view. The difference is that with an absolute return fund, there is far more flexibility to convert manager skill into performance in a precise, timely and cost-effective way. And the resulting performance is not tied to the fortunes of a particular market or index. Absolute return funds can focus on any kind of investment, from equities to bonds, property shares or even certain commodity indices for example. The Threadneedle Absolute Return Bond Fund invests primarily in bond and currency markets whilst the Threadneedle UK Absolute Alpha Fund focuses on UK equities.

4 2 Threadneedle Absolute Return Range An actively managed fund might aim to beat the market by 2% each year. If the market is up by 15%, the fund will succeed if it rises by 17%. But if the market is down by 30%, even a fund that meets its objective will be down by 28%. Absolute versus relative Traditional funds are normally relative return investments. They may be passive or index-tracker funds, which aim to produce the same performance as a given market, or they may be actively managed, which means that the manager is aiming to beat a particular market or index. However, in both cases, the fund s performance is tied, to a greater or lesser extent, to the fortunes of an underlying market. Absolute return funds are different. Rather than aiming to beat an index, their objective is to produce a modest positive return over the medium term, irrespective of market conditions. Traditional funds may well do better when markets are strong but, like the tortoise in Aesop s fable, an absolute return fund just aims to make steady progress. There are no guarantees and their prices may fall over relatively short periods but, come rain or shine, absolute return funds aim to deliver a modest gain over the medium term. This dependability is key to their appeal. Differing aims of relative and absolute funds Performance (%) Market scenarios Market Notional relative return fund Notional absolute return fund The chart above is included merely to illustrate the difference between the objectives of relative and absolute return funds. It is in no way intended to indicate the likely performance of a fund in our absolute return range or any other product.

5 Threadneedle Absolute Return Range 3 Threadneedle s absolute return range of funds In choosing an absolute return fund provider, investors need to be comfortable that the company has all the expertise and experience required to manage this kind of portfolio. Threadneedle has been managing regulated UCITS III absolute return funds since 2005 and, in this time, we have developed a reputation as one of the most reliable providers of absolute return products. We have three funds in our absolute return OEIC fund range, all of which are fully authorised and regulated: Threadneedle Absolute Return Bond Fund Threadneedle Credit Opportunities Fund Threadneedle UK Absolute Alpha Fund These Funds all have an absolute return investment aim and each invests in a different area in a bid to deliver this return. Over the following pages, we describe each of these Funds in more detail.

6 4 Threadneedle Absolute Return Range Threadneedle Absolute Return Bond Fund This was the first absolute return bond fund we launched to the retail market and it aims to achieve a total positive return across all market conditions by investing in global bond and currency markets. It aims to deliver a return of 3% over its cash benchmark (3 Month Sterling LIBOR this is the rate at which banks lend to each other) over the medium term. We define the medium term as an month investment horizon. The portfolio is also likely to generate a return greater than zero over a 12 month period. Please note that this is a target and there is no guarantee that the Fund will achieve this return. Launch date: October 2005 Fund manager: Quentin Fitzsimmons, Head of Government Bonds Index: 3 Month Sterling LIBOR Annual management charge: 1.25% How does the Fund work? The bedrock of the Fund is a portfolio of high quality, highly liquid short-dated bonds. This is designed to produce cash-like performance over the medium term. The manager then aims to augment these returns via a range of positions, or strategies, based on the team s views of fixed income or currency markets. They generally operate strategies at any one time. Short-dated, high quality, highly liquid bond portfolio Designed to produce cash-like returns + Approximately strategies reflecting fund managers views Designed to produce incremental returns These strategies fall into four main categories: They might be directional i.e. designed to benefit from outright moves up or down in a given market. They might be so-called relative value trades reflecting our expectation that one market will do better than another. The fund often also has foreign exchange positions whose aim is to make money from changes in exchange rates between currencies. 4. Finally, the managers can exploit differences in performance between shorter and longer-dated bonds via what we call yield curve strategies. Yield curve graphs plot current bond yields against their time to redemption. There are four fundamental shapes to the yield curve. A normal yield curve will show higher yields for longerdated bonds than for short dated issues, while an inverted curve will show the reverse. A yield curve can also be flat or humped. It should be noted that as the Fund employs the wider powers of UCITS III, it has the ability to utilise derivatives, such as options and futures. Whilst this can enhance performance, the Fund s exposure can involve the short sale of securities and leverage which can increase the risk of the Fund. Please read the investor profile and key risks section on page 7.

7 Threadneedle Absolute Return Range 5 Threadneedle Credit Opportunities Fund The Fund aims to achieve a total positive return in all market conditions through exposure to a range of creditrelated instruments. The Fund aims to deliver a return of 3.5% over its cash benchmark (in the case of this Fund, the benchmark is the Citigroup Sterling 1 Month Eurodeposit Index) over the medium term (as for the Absolute Return Bond Fund we define medium term as an month investment horizon) on an annualised basis. The portfolio is also likely to deliver a return greater than zero over a 12 month period. Please note that this is a target and there is no guarantee that the Fund will achieve this return. Launch date: April 2009 Fund managers: Barrie Whitman, Head of High Yield Michael Poole, High Yield Fund Manager Alasdair Ross, Investment Grade Fund Manager Index: Citigroup Sterling 1 Month Eurodeposit Index Annual management charge: 1.25% How does the Fund work? The Fund focuses on opportunities within the high yield and investment grade markets, but can also exploit opportunities that arise within other areas of the credit market. Sources of return High Yield Investment Grade Investments will be made across a wide range of credit instruments, including corporate bonds and derivative contracts. In terms of primary investment strategies, the Fund can hold outright long and short positions, as well as pair trades (long one issuer versus short another), basis trades (long physical versus a short in the equivalent derivative contract or vice versa) and capital structure arbitrage trades (which are designed to exploit pricing anomalies between bonds, loans and equities relating to a given company). Emerging Markets Credit Opportunities Fund Asset Backed Securities Currencies Governments It should be noted that as the Fund employs the wider powers of UCITS III, it has the ability to utilise derivatives, such as options and futures. Whilst this can enhance performance, the Fund s exposure can involve the short sale of securities and leverage which can increase the risk of the Fund. Please read the investor profile and key risks section on page 7.

8 6 Threadneedle Absolute Return Range Threadneedle UK Absolute Alpha Fund The Fund aims to achieve an absolute return, irrespective of market conditions, over the long term by primarily investing in equity securities and equity related derivatives, of corporate issuers headquartered in the United Kingdom. By utilising the wider investment powers permitted under UCITS regulations, the Fund aims to generate 8-10% p.a. over a market cycle. We define a market cycle as typically being a three to five year investment horizon. The portfolio is also likely to deliver a return greater than zero over a 12 month period. Please note that this is a target and there is no guarantee that the Fund will achieve this return. Launch date: October 2010 Fund managers: Chris Kinder, Fund Manager Mark Westwood, Fund Manager Index: 3 Month Sterling LIBOR Annual management charge: 1.50% plus 20% performance fee above benchmark How does the Fund work? The co-fund managers believe that the stock market is influenced by short-term factors. For investors with a contrarian stance, this creates opportunities. The UK Absolute Alpha Fund looks to exploit these situations; Having long positions in those undervalued companies which can benefit from an increase in value. Having short positions in those overvalued companies which are vulnerable to a decrease in value. The Fund will tend to hold positions throughout a period of perception change as the managers believe this is the most efficient way to maximise returns. They therefore take a long-term view to valuing businesses, especially for those businesses offering good total returns (i.e. distribution and capital growth). Whilst there are no formal, automatic stop losses within the Fund at the position or portfolio level, a loss of 10% in absolute terms at the position level will trigger a re-assessment of the position. The overriding risk management philosophy is to run winners by adding capital to successful investments while cutting losers swiftly when the investment thesis is not supported. It should be noted that as the Fund employs the wider powers of UCITS III, it has the ability to utilise derivatives, such as options and futures. Whilst this can enhance performance, the Fund s exposure can involve the short sale of securities and leverage which can increase the risk of the Fund. Each potential addition to the portfolio is backed by an investment thesis and stock specific risk is assessed during this process. We would review a position and consider closing it if: The price target is reached. A competing investment opportunity is identified with a more attractive risk/reward profile. The investment thesis is undermined. Please read the investor profile and key risks section on page 7.

9 Threadneedle Absolute Return Range 7 Investor profile and key risks Threadneedle Absolute Return Bond Fund Investor profile The Fund may be suitable for investors with a medium term investment horizon seeking a total positive return who are prepared to tolerate moderate price fluctuations. Key risks Investors should note that this Fund does not offer any form of guarantee with respect to investment performance and no form of capital protection will apply. The interest rate on corporate bonds and most government bonds will not increase in line with inflation. Thus, over time, the real value of an investor s income could fall. The use of derivatives and forward transactions for efficient portfolio management will not increase the risk profile of the Fund. The use of derivatives for investment purposes may increase the risk profile of the Fund. The Fund s exposure involves short sales of securities and leverage which increases the risk of the Fund. The term short sales refers to an exposure through derivatives to the selling of securities that are not owned by the seller at the time of the sale in anticipation that its value will fall. However, if the value of that security increases, it will have a negative effect on the Fund s value. In a rising market, leverage can enhance returns to Shareholders but if the market falls, losses may be greater. Threadneedle Credit Opportunities Fund Investor profile The Fund may be suitable for investors with a mediumterm investment horizon seeking a total positive return who are prepared to tolerate some price fluctuations. Key risks Investors should note that this Fund does not offer any form of guarantee with respect to investment performance and no form of capital protection will apply. The interest rate on corporate bonds and most government bonds will not increase in line with inflation. Thus, over time, the real value of an investor s income could fall. The Fund invests in high yield and emerging market bonds which may carry increased risk to capital through default (where bond issuers either fail to pay the interest or capital repayment due at maturity). The Fund uses derivatives and forward transactions for both Efficient Portfolio Management (EPM) and investment purposes including short selling and leverage. The use of derivatives and forward transactions for EPM will not increase the risk profile of the Fund. The use of derivatives for investment purposes may increase the risk profile of the Fund. The Fund s exposure involves short sales of securities and leverage which increases the risk of the Fund. The term short sales refers to an exposure to the selling of securities that are not owned by the seller at the time of the sale in anticipation that its value will fall. However, if the value of that security increases, it will have a negative effect on the Fund s value. In a rising market, leverage can enhance returns to Shareholders but if the market falls, losses may be greater. Threadneedle UK Absolute Alpha Fund Investor profile The Fund may be suitable for investors with a long term investment horizon seeking a total positive return who are prepared to tolerate large price fluctuations. Key risks Investors should note that this Fund does not offer any form of guarantee with respect to investment performance and no form of capital protection will apply. The use of derivatives and forward transactions for EPM will not increase the risk profile of the Fund. The use of derivatives for investment purposes may increase the risk profile of the Fund. The Fund s exposure involves short sales of securities and leverage which increases the risk of the Fund. The term short sales refers to an exposure through derivatives to the selling of securities that are not owned by the seller at the time of the sale in anticipation that its value will fall. However, if the value of that security increases, it will have a negative effect on the Fund s value. In a rising market, leverage can enhance returns to Shareholders but if the market falls, losses may be greater.

10 8 Threadneedle Absolute Return Range Risk control is key As absolute return funds are designed to produce modest returns across market conditions, understanding and controlling risk is extremely important. That s why we have put several important checks and balances in place to help control the funds risk profiles. The managers are supported by sophisticated portfolio monitoring tools that allow them to see at any time exactly how each strategy in the Fund is contributing to overall portfolio risk and performance. Managed risk As we have seen already, our absolute return range of funds aim to produce returns by using the full flexibility afforded by recent regulatory developments to convert fund manager skill into performance. This process is not without risk even the most talented fund manager is not always right, and the fund s performance is not guaranteed. However, the risk controls we have built into our funds are designed to limit the potential for long-term loss, and the use of only the most readily saleable investments means that any unprofitable positions can be removed promptly. Please remember that past performance is not a guide to future returns and you may not get back the original amount invested.

11 Threadneedle Absolute Return Range 9 Summary Legislation has widened the range of tools available to fund managers, resulting in the development of absolute return funds: Investors have been drawn to this type of fund because their flexible and opportunistic approach is well suited to volatile markets. Since we launched our first retail absolute return fund in 2005, we have built a very strong reputation in this specialised area of investing and we are now responsible for more than 1.5bn (as at ) in absolute return products. Our absolute return fund range features products that invest in different areas: Threadneedle Absolute Return Bond Fund = fixed income & currency markets Threadneedle Credit Opportunities Fund = corporate bond markets Threadneedle UK Absolute Alpha Fund = UK equities. Robust risk controls are a vital ingredient of successful absolute return fund investing. Threadneedle s systems have been proven over many years in a range of market conditions.

12 10 Threadneedle Absolute Return Range Jargon-buster Long investing is the purchase of an investment with the expectation of an increase in its price. Short investing is the purchase of an investment with the expectation of a decrease in its price. Derivatives are financial contracts or financial instruments whose values are derived from the value of an underlying asset. The main types of derivatives are futures, forwards, options and swaps. Exchange-traded derivatives are derivative products that are traded via specialised derivative exchanges or other exchanges, such as the Chicago Board of Trade. The derivative exchange acts as an intermediary to all related transactions, and takes an initial margin from both sides of the trade to act as a guarantee. The key exchange traded derivative products are the 10-year gilt, 5-year, 10-year and 30-year US Treasuries, Federal Funds and Bunds. Over the counter ( OTC ) derivatives are traded between two private parties, and are not listed on an exchange. The terms of an OTC derivative are unrestricted and may be individually tailored to meet any business need. Key products include options, forwards and swaps. Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on an underlying security. Unlike a future or a forward, the holder does not have to exercise this right. A buyer of a call option has the right to buy a specified quantity of a security at a set strike price at some time up to an agreed date, while buying a put option provides the right to sell. The key benefit of an option is that the buyer can take advantage of the upside whilst limiting the downside (the worst case scenario is that you lose your premium, which is a fee that is paid up-front). Futures are exchange-trade contracts that are standardised by the exchanges on which they trade. The contract details the asset that is to be bought or sold and how, when, where and what quantity is to be delivered. The terms will also specify the currency in which the contract will trade, minimum tick value (the value of a 0.01% change in the price of the future) and the last trading day and expiry or delivery month. Unless the contract is sold to another before settlement date, participants in the contract must buy or sell the underlying security when it expires. Futures contracts are not issued like other securities, but are created whenever open interest increases; that is, when one party first buys ( goes long ) a contract from another party (who goes short ). They are a less expensive and more efficient way to position risk and have greater liquidity than cash bonds. Forward contracts are agreements between two parties to buy or sell an asset at a specified point of time in the future. The price of the underlying instrument is paid before control of the instrument changes. We use currency forwards to alleviate the problem of continual rolling of positions. So we trade all forwards for the last business day of the month, and then close out or roll positions forward.

13 Threadneedle Absolute Return Range 11 Interest rate swaps are where one party exchanges a stream of interest payments for another party s stream of cash flows. They are used by hedgers to manage their fixed or floating assets and liabilities. They can also be used by speculators to replicate unfunded bond exposures to profit from changes in interest rates. Traditionally, if the view is that interest rates were to move lower, one would buy cash bonds whose value would increase as rates fell. Here, the investor enters a floating-for-fixed interest swap in which he would pay a floating rate (which would be lower as interest rates fall) in exchange for receiving a fixed rate. Credit default swaps (or CDS ) are corporate bond-based derivatives contracts between two counterparties. The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults (fails to pay its coupon) therefore it is the seller who takes the risk of the bond defaulting. They are an efficient way of expressing views on corporate bonds and can be used for the purposes of speculation, hedging or arbitrage. CDS spreads will increase as perceived credit worthiness declines. itraxx is the brand name for the family of credit default swap index products covering regions of Europe and Asia. They form a large proportion of the overall credit derivative market. CDS indices allow investors to transfer credit risk in a more efficient manner than using single name CDS. Investors can be long or short according to their view on the market.

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16 Out-performance is our best ideas at work. For more information on Threadneedle and its funds, visit threadneedle.co.uk or speak to your financial adviser. Important information All data as at unless otherwise shown. Past performance is not a guide to future performance. The value of investments and the income from them may go down as well as up, and an investor may not get back the amount invested. Subscriptions to a fund may only be made on the basis of the current Prospectus or Simplified Prospectus and the latest annual or interim reports, which can be obtained free of charge on request. This material is for information purposes only and does not constitute an offer or solicitation to an order to buy or sell any securities or other financial instruments, or to provide investment advice or services. Threadneedle Specialist Investment Funds ( TSIF ) is an open-ended investment company, structured as an umbrella company; incorporated in England and Wales, authorised and regulated in the UK by the Financial Services Authority (FSA) as UCITS schemes. Investors should note the Risk Factors section of the Prospectus in terms of the risk applicable to investing in any fund and specifically the funds shown above. The research and analysis included in this document has been produced by Threadneedle for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. In some instances the information contained in this publication, other than statements of fact, was obtained from external sources believed to be reliable but its accuracy or completeness cannot be guaranteed. Any opinions expressed are made as at the date of publication but are subject to change without notice. Threadneedle Investment Services Limited. 60 St Mary Axe, London EC3A 8JQ. Registered No Authorised and regulated in the UK by the Financial Services Authority. Threadneedle is a brand name, and both the Threadneedle name and logo are trademarks or registered trademarks of the Threadneedle group of companies. threadneedle.co.uk 01.11/ T2924_Valid to 03.11