MANAGING RISK FACTORS TO BUILD A BETTER PORTFOLIO. Investment products: No bank guarantee I Not FDIC insured I May lose value

Transcription

1 MANAGING RISK FACTORS TO BUILD A BETTER PORTFOLIO Investment products: No bank guarantee I Not FDIC insured I May lose value

2 Important information Investments in mutual funds involve risk. Stocks may decline in value. Bond and loan investments, including mortgage-backed securities, are subject to interest-rate and credit risks. When interest rates rise, bond prices generally fall. Credit risk refers to the ability of an issuer to make timely payments of principal and interest. Investments in lower-quality ("junk bonds") and non-rated securities present greater risk of loss than investments in higher-quality securities. Floating rate loans tend to be rated below investment grade. As interest rates change, issuers of higher (or lower) interest debt obligations may pay off the debts earlier (or later) than expected causing a fund to reinvest proceeds at lower yields (or be tied up in lower interest debt obligations). Investing in derivatives entails special risks relating to liquidity, leverage and credit that may reduce returns and/or increase volatility. Investing in foreign securities, particularly those of emerging markets, presents certain risks, such as currency fluctuations, political and economic changes, and market risks. In certain situations, it may be difficult or impossible to sell an investment at an acceptable price. Some funds may be non-diversified and take larger positions in fewer issues, increasing potential risk. Some funds may lend securities to approved institutions. Investing in derivatives entails special risks relating to liquidity, leverage and credit that may reduce returns and/or increased volatility. Investing in foreign securities, particularly those of emerging markets, presents certain risks, such as currency fluctuations, political and economic changes, and market risks. There are additional risks associated with investing in high-yield bonds, aggressive growth stocks, non-diversified/concentrated funds and small- and midcap stocks. Any fund that concentrates in a particular segment of the market will generally be more volatile than a fund that invests more broadly. Investing in commodities such as oil, gold and natural resources entail special risks. Regulatory and economic changes may have a significant impact on a commodity investment s performance. Additional, with commodity investments, a counterparty with whom the investment does business may decline in financial health and become unable to honor its commitments, which could cause losses. There are special risks associated with an investment in real estate, including real estate investment trusts (REITs). These risks include credit risk, interestrate fluctuations and the impact of varied economic conditions. There are special risks associated with an investment in infrastructure. Different countries have different political, regulatory and legal frameworks. Due to the size of some assets, the limited number of potential buyers and regulatory approval requirements, divestments of infrastructure assets can take a significant amount of time and effort. Also, as a relatively new asset class, infrastructure does not have reliable return data comparable to other asset classes which makes it difficult to model in an asset allocation. Infrastructure and both domestic and global real estate should be considered part of a diversified portfolio. 2

3 Definitions The Bloomberg Barclays 1 3 Year U.S. Aggregate Index measures the performance of domestic, taxable investment-grade bonds with average maturities of one to three years. The Bloomberg Barclays Corporate 1-Year Duration Index tracks the performance of the short term U.S. corporate bond market.the Bloomberg Barclays Emerging Market Index tracks the performance of external-currency-denominated debt instruments of the emerging markets. The Bloomberg Barclays Mortgage Backed Securities Index tracks the U.S. agency mortgage pass-through sector of the U.S. investment grade bond market. The Bloomberg Barclays Municipal Bond Index tracks the performance of investment-grade, fixed-rate municipal bonds with maturities greater than two years. The Bloomberg Barclays Municipal Long 22+ Year Index is a subset of the Bloomberg Barclays Municipal Bond Index including maturities of 22 or more years. The Bloomberg Barclays U.S. Aggregate Index tracks the performance of the broad U.S. investment-grade, fixed-rate bond market, including both government and corporate bonds. The Bloomberg Barclays U.S. Corporate High-Yield Bond Index tracks the performance of fixed-rate non-investment-grade debt. The Bloomberg Barclays U.S. Corporate Index (alternately the Bloomberg Barclays U.S. Corporate Investment Grade Index) tracks the performance of the investment-grade, fixed-rate, taxable, corporate bond market. The Bloomberg Barclays U.S. Credit Index is a sub-index of the Bloomberg Barclays U.S. Government/Credit Index, tracks the performance of both corporate (industrial, utility and finance) and non-corporate (sovereign, supranational, foreign agency and foreign local government) sectors. The Bloomberg Barclays U.S. TIPS Index tracks the performance of U.S. Treasury-linked securities. The Bloomberg Barclays U.S. Treasury Bellwether 30-Year Index tracks the performance of Treasury bills with a maturity of 30 years. The Bloomberg Barclays U.S. Treasury Index tracks the performance of U.S. Treasury obligations with a remaining maturity of one year or more. Basis point is one basis point equals 1/100 of a percentage point. Beta measures a security s sensitivity to the movements of it s benchmark or the market as a whole. A beta of greater than one indicates more volatility than the benchmark or market, while a beta of less than one indicates less volatility. Book value is the value at which an asset is carried on a balance sheet. The Bloomberg Commodity Index tracks the performance of futures contracts on physical commodities. Cash Return On Capital Invested (CROCI ) is a proprietary investment research discipline of DWS. The CISDM Merger Arbitrage Index tracks the performance of merger arbitrage managers reporting to the CASAM CISDM hedge fund database. Correlation measures how assets perform in relation to each other. The Credit Suisse Leveraged Loan Index measures the balance and current spread over LIBOR for fully funded term loans. The Credit Suisse Managed Futures Index tracks the performance of managed futures strategies. Credit quality measures a bond issuer s ability to repay interest and principal in a timely manner. Rating agencies assign letter designations such as AAA, AA and so forth. The lower the rating, the higher the probability of default. Credit quality does not remove market risk and is subject to change. Currency hedging is the act of entering into a financial contract in order to protect against unexpected, expected or anticipated changes in currency exchange rates. The Dow Jones Brookfield Global Infrastructure Index tracks the performance of infrastructure companies. The Dow Jones Credit Suisse Hedge Fund Index tracks the performance of liquid, investable hedge funds. Downside capture ratio measures a portfolio s performance in down markets relative to the investment universe (with down markets defined as those that have a negative monthly return); the lower the downside capture ratio, the better the portfolio performed during a market downturn. Duration, which is expressed in years, measures the sensitivity of the price of a bond or bond fund to a change in interest rates. EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. Enterprise value is a measure of the market value of the firm that includes not only financial liabilities (such as debt) but also operational liabilities (such as warranties, pension funding, specific provisions, operating leases, etc.). An exchangetraded fund (ETF) is a security that tracks an index or asset like an index fund, but trades like a stock on an exchange. The federal funds rate is the interest rate, set by the U.S. Federal Reserve Board, at which banks lend money to each other, usually on an overnight basis. The FTSE Developed Core Infrastructure Index is designed to represent the performance of companies in a set of industries that FTSE defines as being involved in infrastructure. FTSE applies minimum infrastructure revenue thresholds of 65% for constituents of this index. This index covers developed markets. The FTSE EPRA/NAREIT Developed Markets Real Estate Index tracks the performance of developed-market REITs. 3

4 Definitions (continued) Floating-rate loans are debt instruments with floating-rate coupons that generally reset every 30 to 90 days. While floating-rate loans are senior to equity and fixed-income securities, there is no guaranteed return of principal in case of default. Floating-rate loans often have less interest-rate risk than other fixed-income investments. Floating-rate loans are most often secured assets, generally senior to a company s secured debt and can be transferred to debt holders, providing potential downside potential. The Dow Jones U.S. Real Estate Index tracks the performance of the real estate industry of the U.S. equity market. A hedge fund is a private pool of capital actively managed by an investment adviser. The Morningstar/Ibbotson SBBI Intermediate-Term Government Capital Appreciation Index tracks the performance of intermediate-term government bonds. The HFRI Multi-Strategy Index tracks the performance of strategies that employ components of both discretionary and systematic macro strategies. Market capitalization is the total dollar market value of a company s outstanding shares. Mortgage-backed securities (MBS) are bonds that are secured by mortgage debt. The MSCI ACWI ex-usa Index is designed to track the performance of the large- and midcapitalization non-u.s. equities. The MSCI ACWI ex-usa U.S. Dollar Hedged Index is calculated using the same methodology as its corresponding MSCI ACWI ex-usa Index, but is designed to mitigate exposure to fluctuations between the value of the U.S. dollar and non-u.s. currencies. The MSCI EAFE Index captures large- and mid-cap representation across developed markets around the world, excluding the United States and Canada. The MSCI EAFE U.S. Dollar Hedged Index is calculated using the same methodology as its corresponding MSCI EAFE Index, but is designed to mitigate exposure to fluctuations between the value of the U.S. dollar and non-u.s. currencies. The MSCI Emerging Markets Index captures large- and mid-cap representation across 21 emerging markets The MSCI Emerging Markets U.S. Dollar Hedged Index is calculated using the same methodology as its corresponding MSCI Emerging Markets Index, but is designed to mitigate exposure to fluctuations between the value of the U.S. dollar and non-u.s. currencies. The MSCI Europe Index is designed to measure the equity market performance of the developed markets in Europe. The MSCI Europe U.S. Dollar Hedged Index is calculated using the same methodology as its corresponding MSCI Europe Index, but is designed to mitigate exposure to fluctuations between the value of the U.S. dollar and non-u.s. currencies. The MSCI Japan Index is designed to track the performance of the large- and mid-cap segments of the Japanese market. The MSCI Japan U.S. Dollar Hedged Index is calculated using the same methodology as its corresponding MSCI Japan Index, but is designed to mitigate exposure to fluctuations between the value of the U.S. dollar and non-u.s. currencies. The MSCI World Index tracks the performance of stocks in select developed markets around the world, including the United States. The MSCI World Infrastructure Sector Capped Index tracks the performance of listed infrastructure stocks. Its capped weighting is designed to reduce excessive concentration in large sectors without over-inflating small sectors. Net capital invested is a measurement of economic valuation using in the CROCI methodology that is adjusted for inflation and includes intangible capital such as research & development and brand advertising. Return on equity is the amount of net income returned as a percentage of shareholders equity. Quantitative easing is the introduction of new money into the money supply by a central bank. Sharpe ratio measures an investment s performance per unit of risk for a given period. The S&P 500 Index tracks the performance of 500 leading U.S. stocks and is widely considered representative of the U.S. equity market. The S&P Global Gold Broad Market Index tracks the performance of gold. The S&P/LSTA Leveraged Loan Index tracks outstanding balance and current spread over LIBOR for fully funded loan terms. Standard deviation is often used to represent the volatility of an investment. It depicts how widely an investment s returns vary from the investment s average return over a certain period. The higher the standard deviation, the higher the volatility. Treasury Inflation Protected Securities (TIPS) are U.S. Treasury securities that are indexed to inflation. Upside capture ratio measures a portfolio s performance in up markets relative to the investment universe (with up markets defined as those that have a positive monthly return); the higher the upside capture ratio, the better the portfolio performed during a market upturn. 4

5 Overview Managing risk factors to build a better portfolio Asset-allocation decisions are driven by risk and return expectations that are often based on long-term historical averages for various asset classes Investor experience can be different than expectations Less downside capture is important Managing potential risks Consider potential solutions by asset class 5

6 Managing risk factors

7 Traditional asset allocation by asset class In theory, asset classes should be unique and complement one another The assumptions behind this approach are that markets are efficient, returns are distributed randomly over time, and regime dependence and valuation bubbles do not exist or cannot be monetized In reality, common factors drive the correlations among asset classes Equity U.S. Large-, mid-, and small-cap Value, core, and growth International Region, country and sector Emerging market Alternatives Commodities Real estate Infrastructure Hedge funds Private equity Fixed income Short-term Intermediate Long-term High-yield TIPS, bank loans, and non-traditional Emerging-market See pages 3 and 4 for definitions of technical terms used on this page. 7

8 Impact of losses: The importance of mitigating downside volatility The greater the loss, the longer it takes to recover 900% The horizontal axis (light blue) shows the potential loss of an investment. The vertical axis (dark blue) shows the return an investor would need to recover from such a loss. 900% 700% 500% 400% 300% 233% 100% 11% 25% 43% 67% 100% 150% -100% 0-10% -20% -30% -40% -50% -60% -70% -80% -90% Source: DWS Group as of 12/31/17. Performance is historical and does not guarantee future results. This data is for illustrative purposes and does not represent any DWS product. Equity index returns include reinvestment of all distributions. Index returns do not reflect fees or expenses, and it is not possible to invest directly in an index. See pages 3 and 4 for index definitions and definitions of technical terms used on this page. 8

9 Guide to upside and downside capture ratios Upside capture ratio Downside capture ratio What s better? Higher number Lower number If ratio more than 100% If ratio less than 100% The fund captured more than 100% of the benchmark s gains The fund captured less than 100% of the benchmark s gains The fund captured more than 100% of the benchmark s losses The fund captured less than 100% of the benchmark s losses Sample returns of various hypothetical upside and downside profiles Market return Return of a portfolio if upside capture is 75% and downside capture is 50% Return of a portfolio if upside capture is 75% and downside capture is 90% Period 1 16% 8% 14% Period 2 20% 15% 15% Period 3 6% 3% 5% Period 4 10% 8% 8% Full period 4.2% 10.3% 0.1% Source: DWS Group as of 12/31/17. Performance is historical and does not guarantee future results. This data is hypothetical, is for illustrative purposes and does not represent any DWS product. Actual rates of return cannot be predicted and will fluctuate. See pages 3 and 4 for definitions of technical terms used on this page. 9

10 The key to managing downside: Identifying and managing risk factors Type of risk Impact Ways to help manage Interest-rate risk Value falls as interest rates rise Active duration management Default /downgrade risk Loss of principal or cash flows Active credit quality management Tax risk Higher taxes to an investor Municipal investments Inflation risk Beta risk Currency risk Liquidity risk Erosion of wealth in constant dollars Sensitivity to market swings, as high beta magnifies downside Global investments add a layer of volatility Cannot be traded quickly enough to prevent loss Real-return investments Low beta via stable cash flows and dividend growth Currency-hedged vs. unhedged Liquid alternatives Valuation risk Stocks are not correctly valued Economic P/E ratio See pages 3 and 4 for definitions of technical terms used on this page. 10

11 Summary Asset-class returns can vary substantially from expectations Investor returns may lag the market returns due to investor behavior Investors may abandon their long-term plans due to volatility Less downside capture can potentially lead to better long-term results via compounding Identifying and actively managing specific risk factors can potentially lower downside volatility DWS understands these risks and offers multiple solutions to help manage them See pages 3 and 4 for definitions of technical terms used on this page. 11

12 Managing potential risks Fixed-income risks

13 Managing fixed-income risks Risk factors facing fixed-income investors Interest-rate risk Credit risk Inflation risk Higher taxes Potential solutions for fixed-income investors Mortgage-backed securities Floating-rate loans Municipal bonds Different income investments involve different risks. Bond and loan investments, including mortgage-backed securities, are subject to interest-rate, credit, liquidity and market risks to varying degrees. When interest rates rise, bond prices generally fall. Credit risk refers to the ability of an issuer to make timely payments of principal and interest. Investments in lower-quality ("junk bonds") and non-rated securities present greater risk of loss than investments in higher-quality securities. Floating rate loans tend to be rated below investment grade. As interest rates change, issuers of higher (or lower) interest debt obligations may pay off the debts earlier (or later) than expected causing a fund to reinvest proceeds at lower yields (or be tied up in lower interest debt obligations). Diversification cannot protect against a loss. See pages 3 and 4 for definitions of technical terms used on this page. 13

14 Fixed-income investors face additional headwinds with historically low interest rates 10-year U.S. Treasury yield (%) 20% 15% 10% Time period 6/30/54 4/30/70 Rise in interest rates 5.01% Bond cumulative principal return 20.32% 10 yr Yields 12/99 3/18 Cash 5.33% 1.73% Short-term bonds 6.50% 2.50% Intermediate-term bonds 7.49% 3.37% 5% 0% Apr-53 May-57 Jun-61 Jun-65 Jul-69 Aug-73 Aug-77 Sep-81 Oct-85 Oct-89 Nov-93 Dec-97 Dec-01 Jan-06 Feb-10 Feb-14 Mar-18 Bond cumulative principal returns by decade 12.67% 6.99% 24.22% 3.71% 12.06% 10.46% 1950s 1960s 1970s 1980s 1990s 2000s Source: U.S Federal Reserve Board (Fed), Morningstar and Bloomberg Barclays as of 3/31/18. Performance is historical and does not guarantee future results. This data is for illustrative purposes and does not represent any DWS product. Asset class representation is as follows: interest rates, 10-year U.S. Treasury; bonds, Morningstar/Ibbotson SBBI Intermediate-Term Government Capital Appreciation Index; cash, 3-month U.S. Treasury bill yield; short-term bonds, Bloomberg Barclays U.S. Aggregate 1-3 Year Index yield to worst; intermediate-term bonds, Bloomberg Barclays U.S. Aggregate 7-10-Year Index yield to worst. Index returns do not reflect fees or expenses, and it is not possible to invest directly in an index. See pages 3 and 4 for index definitions and definitions of technical terms used on this page. 14

15 Investors fixed-income allocations aren t prepared to deal with today s volatility and low yields Assets in current taxable U.S. fixed-income mutual fund Morningstar categories 40.87% Category 2018 net new flows YTD Intermediate-term bond $31,502,631,977 High-yield bond $13,828,272,185 Bank loan $4,558,030,098 Ultrashort bond $6,354,781,004 Intermediate-term bonds had the highest net flows of any Morningstar category over seven of the past ten calendar years ( ) Intermediate-term bond has more assets than the High-yield bond, Intermediate government, Bank loan and Ultrashort bond categories combined 9.83% 7.75% 7.53% 7.46% 3.93% 3.93% 3.85% 3.51% 3.05% 3.04% 1.89% 1.19% 0.66% Intermediate-Term Bond Short-Term Bond High Yield Bond World Bond Multisector Bond Ultrashort Bond Bank Loan Nontraditional Bond Inflation-Protected Bond Corporate Bond Intermediate Government Emerging Markets Bond Short Government Long Government Source: Morningstar as of 3/31/18. Performance is historical and does not guarantee future results. This data is for illustrative purposes and does not represent any DWS product. Numbers may not equal 100% due to rounding. Assets in Morningstar categories do not show performance; they represent the portion of bond investment in each respective Morningstar category. It is not possible to invest directly in a category. See pages 3 and 4 for definitions of technical terms used on this page. 15

16 Interest-rate risk: Remembering 1994 In one rising-rate environment, the U.S. Federal Reserve Board raised the federal funds rates seven times, from 3.0% to 6.0%, in one year (February 4, 1994, through February 1, 1995). During that period, 10-year U.S. Treasury yields increased by 1.9%, from 5.8% to 7.7% Peak-to-trough returns, (2/1/94 to 2/1/95) Morningstar category Total return Worst three months Short-Term Bond 0.40% 2.21% Short-Term Government Bond 0.56% 2.36% Intermediate-Term Bond 3.93% 5.23% Intermediate-Term Government Bond 3.37% 4.85% Long-Term Bond 6.18% 7.02% Long-Term Government Bond 6.63% 7.77% High Yield Bond 4.44% 4.84% World Bond 5.44% 4.89% Source: UBS and Morningstar as of 9/30/17. Performance is historical and does not guarantee future results. This data is for illustrative purposes and does not represent any DWS product. Other interest-rate environments will produce different results. Category returns assume reinvestment of all distributions. It is not possible to invest in a category. See pages 3 and 4 for definitions of technical terms used on this page. 16

17 Managing interest-rate risk: A rise in interest rates may have a significant impact on principal Capital preservation is a big concern and coupon cushion is small given the low-interest-rate environment. A portfolio's return is comprised of income and capital gain or loss, which combine to equal total return. Even if the income stays the same (1.8% in the hypothetical example below), the total return can vary widely based on the size of the capital gain or loss. Estimated impact over a one-year period Income + Capital gain or loss = Total return Hypothetical interest-rate change +2.0% 1.8% 18.0% 16.2% +1.0% 1.8% 9.0% 7.2% +0.25% 1.8% 2.3% 0.5% Source: UBS and Bloomberg as of 9/30/17. This data is hypothetical, is for illustrative purposes and does not represent any DWS product. Actual rates of return cannot be predicted and will fluctuate. This represents a snapshot in time and assumes an immediate rise in interest rates. See pages 3 and 4 for definitions of technical terms used on this page. 17

18 Interest-rate volatility remains elevated Fixed-income asset classes during recent interest-rate environments (12/18/08 3/31/18) In % Rates rise 190 bps (12/18/08 6/10/09) Rates fall 160 bps (4/5/10 10/08/10) Rates rise 131 bps (10/12/10 2/8/11) Rates fall 221 bps (2/9/11 7/24/12) Rates rise 155 bps (7/25/12 9/5/13) Rates fall 136 bps (1/1/14 2/2/15) Rates rise 48 bps (2/3/15 12/31/15) Rates fall 87 bps (1/1/16 7/8/16) Rates rise 131 bps (7/9/16 3/31/18) Dec-08 Jul-09 Feb-10 Oct-10 May-11 Jan-12 Aug-12 Apr-13 Nov-13 Jul-14 Feb-15 Oct-15 May-16 Dec-16 Aug-17 Mar-18 While the U.S. Federal Reserve Board has held the federal funds rate steady since 12/18/08, market rates have shown high volatility Name Returns during rising rates Returns during falling rates U.S. Treasuries 4.18% 7.99% Floating-rate loans 11.19% 3.06% Short-term bonds 0.51% 1.74% Intermediate-term bonds 3.25% 10.58% High-yield bonds 12.98% 7.11% Ultra-short duration bonds 1.41% 1.06% Source: Morningstar as of 3/31/18. Performance is historical and does not guarantee future results. This chart is for illustrative purposes only. Asset-class representation is as follows: U.S. Treasuries, Bloomberg Barclays U.S. Treasury Index; floating-rate loans, S&P/LSTA Leveraged Loan Index; short-term bonds, Bloomberg Barclays 1 3 Year U.S. Aggregate Index; intermediate-term bonds, Bloomberg Barclays 7-10 Year U.S. Aggregate Index; high-yield bonds, Bloomberg Barclays U.S. Corporate High Yield Index; ultrashort duration bonds, Bloomberg Barclays Corporate 1-Year Duration Index. Index returns do not reflect fees or expenses, and it is not possible to invest directly in an index. Fixed-income investments are subject to interest-rate risk, and their value will decline as interest rates rise. See pages 3 and 4 for definitions of technical terms used on this page. 18

19 Taxes: Municipal bonds are relatively cheap vs. taxable bonds Municipal bonds should yield less than taxable bonds because of their tax-advantaged income Currently A-rated municipal bonds are yielding 90% of A-rated taxable corporate bonds, which represents a possible dislocation Bond yields (as of 3/31/18) Municipal bonds currently offer investors comparable pre-tax yields to taxable corporate bonds 4.98% 3.76% 2.95% Municipal bond yield Corporate bond yield Municipal bond tax-adjusted yield Source: Morningstar as of 3/31/18. Performance is historical and does not guarantee future results. This data is for illustrative purposes and does not represent any DWS product. Asset class representation is as follows: municipal bonds, Bloomberg Barclays Municipal Bond Index; corporate bonds, Bloomberg Barclays U.S. Credit Index. Yield ratio is the municipal bond yield divided by the corporate bond yield. Tax-adjusted municipal bond yield is the muni bond total return divided by the maximum (40.8%, including the 3.8% Medicare surtax) federal tax bracket. Income from municipal bonds is generally free from federal income tax; income from corporate bonds is subject to taxation. Index returns do not reflect fees or expenses, and it is not possible to invest directly in an index. See slides 3 and 4 for index definitions and definitions of technical terms used on this page. Performance for other time periods may not be as favorable. 19

20 Fixed-income sectors: volatility/return (10-year period as of 3/31/18) 10.00% 9.00% Municipal bonds have historically provided attractive risk/return characteristics, particularly when tax benefits are considered High-yield corporates Return 8.00% 7.00% 6.00% 5.00% 4.00% Tax-exempt munis (unadjusted) Investment-grade bonds Tax-exempt munis (tax-adjusted*) Credit (A-rated) Taxable munis Long muni Emerging markets 10-year U.S. Treasuries Long U.S. corporate 30-year U.S. Treasuries 3.00% Mortgage-backed 5-year U.S. securities Treasuries 2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00% Standard deviation Source: Morningstar as of 3/31/18. Performance is historical and does not guarantee future results. Volatility is measured by standard deviation, which depicts how widely an investment s returns vary from the investment s average return over a certain period. Tax-equivalent yield is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of a tax-free municipal bond. Asset-class representation is as follows: mortgage-backed securities, Bloomberg Barclays U.S. Mortgage Backed Securities Index; municipal bonds, Bloomberg Barclays Municipal Bond Index; investment-grade bonds, Bloomberg Barclays U.S. Aggregate Bond Index; high-yield corporates, Bloomberg Barclays U.S. Corporate High Yield Index; 10-year U.S. Treasury, Citi Treasury Benchmark 10-Year Index; 5-year U.S. Treasury, Citi Treasury Benchmark 5-Year Index; emerging markets, Bloomberg Barclays Emerging Market Aggregate Bond Index; credit (A-rated), Bloomberg Barclays U.S. Credit A-Rated Index; long muni, Bloomberg Barclays Municipal Long 22+ Year Index; long U.S. corporates, Bloomberg Barclays Long U.S. Corporate Index; 30-Year U.S. Treasuries, Bloomberg Barclays U.S. Treasury Bellwether 30-Year Index; Taxable munis, Bloomberg Barclays Taxable Municipal index. *Bloomberg Barclays Municipal Bond Index s return was adjusted for the 39.6% federal income tax rate and 3.8% Medicare surtax. See pages 3 and 4 for index definitions and definitions of technical terms used on this page. This illustration does not represent the performance of any DWS product, is for informational purposes only and should not be considered tax advice. 20

21 Duration is not necessarily a good predictor of volatility U.S.- investment grade and emerging-market indices have similar durations (orange bars) but very different volatility levels (blue bars). High-yield corporate bonds have little duration but relatively high volatility levels. 10-year volatility (%) and duration ( as of 3/31/18) High-yield corporate Emerging-market 10-year U.S. Treasury U.S. credit Municipal 5-year U.S. Treasury U.S. investment grade Mortgage-backed Volatility Duration Source: Morningstar and Bloomberg as of 3/31/18. Performance is historical and does not guarantee future results. This data is for illustrative purposes and does not represent any DWS product. Asset-class representation is as follows: emerging-market, Bloomberg Barclays Emerging Market Index; municipal, Bloomberg Barclays Municipal Bond Index; U.S. investment-grade, Bloomberg Barclays U.S. Aggregate Index; U.S. credit, Bloomberg Barclays U.S. Credit Index; mortgage-backed, Bloomberg Barclays Mortgage Backed Securities Index; 10-year U.S. Treasury, Bloomberg Barclays 10-Year Treasury Bellwethers Index ; 5-year U.S. Treasury, Bloomberg Barclays 5-Year Treasury Bellwethers Index; high-yield corporate, Bloomberg Barclays U.S. Corporate High-Yield Bond Index. Volatility is represented by standard deviation as is expressed in percentage. Duration is in years. See pages 3 and 4 for index definitions and definitions of technical terms used on this page. 21

22 Municipal spreads Muni credit spreads: 10-year AAA vs. 10-year A (in basis points) When credit spreads are wide, lower-quality bonds offer significantly higher yields than higher-quality bonds This scenario has implications for active managers of bond portfolios Managers must decide how much credit risk is appropriate for their shareholders Average 0 Jan-08 Jan-09 Jan-10 Jan-11 Feb-12 Feb-13 Feb-14 Feb-15 Mar-16 Mar-17 Mar-18 Muni yield spreads: 30-year AAA vs. 2-year AAA (in basis points) When the yield curve is steep, long-maturity bonds offer significantly higher yields than short-maturity bonds This has implications for active managers of bond portfolios Managers must decide how much interest-rate risk is appropriate for their shareholders Average 0 Jan-08 Jan-09 Jan-10 Jan-11 Feb-12 Feb-13 Feb-14 Feb-15 Mar-16 Mar-17 Mar-18 Sources: Municipal Market Data and DWS as of 3/31/18. Period shows 01/01/08 to 3/31/18. Performance is historical and does not guarantee future results. This data is for illustrative purposes and does not represent any DWS product. See pages 3 and 4 for definitions of technical terms used on this page. 22

23 Managing potential risks Foreign-currency risks

24 Managing currency risks Risk factors of foreign currency Country risk Total return Currency cycles Potential solutions for foreign currency risk U.S.-dollar-hedged Investments See pages 3 and 4 for definitions of technical terms used on this page. 24

25 Do you know what risks lurk inside your international equity allocation? International equity investing Even when investing in U.S. dollars, an international equity investor is exposed to fluctuations in local currencies of underlying holdings. Currency risk Typically, investors are unaware of this risk and how to control it. Country risk Typically, investors manage this through portfolio diversification. International equity investors are also exposed to the economic and/or political risks of individual countries. Hedged products are designed to minimize the effects of currency fluctuations and allow purer exposure to equity markets. See pages 3 and 4 for definitions of technical terms used on this page. 25

26 What is your currency risk exposure? MSCI EAFE index: Country and currency exposure Euro, EUR, 32.70% Austria Belgium Finland France Germany Ireland Italy Portugal Spain The Netherlands British pound, GBP, 17.26% United Kingdom Yen, JPY, 24.57% Japan Australian dollar, AUD, 6.57% Australia Franc, CHF, 7.79% Switzerland Krona, SEK, 2.65% Sweden Hong Kong dollar, HKD, 3.34% Hong Kong Singapore dollar, SGD, 1.34% Singapore Krone, DKK, 1.82% Denmark Krone, NOK, 0.69% Norway Shekel, ILS, 0.26% Israel New Zealand dollar, NZD, 0.17% New Zealand U.S. dollar, USD, 0.83% United States Europe Asia/Pacific Middle East 15 countries/6 currencies 5 countries/5 currencies 1 country/1 currency Source: MSCI as of 3/31/18. Numbers may not equal 100% due to rounding. See pages 3 and 4 for definitions of technical terms used on this page. 26

27 Contribution to MSCI EAFE Index return from currency ( ) As shown below, negative orange bars represents U.S. dollar strength and a loss from currency movements while positive orange bars represent U.S. dollar weakness and currency gains Annual currency contribution to MSCI EAFE Index return (percent return, ) U.S. dollar weakness currency gain U.S. dollar strength currency loss 1/1/1983 1/1/1984 1/1/1985 1/1/1986 1/1/1987 1/1/1988 1/1/1989 1/1/1990 1/1/1991 1/1/1992 1/1/1993 1/1/1994 1/1/1995 1/1/1996 1/1/1997 1/1/1998 1/1/1999 1/1/2000 1/1/2001 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014 1/1/2015 1/1/2016 1/1/2017 Equity return in local currency Proxy Currency effect (effect of translation from local currency to USD) Equity return in USD Potential return impact: Since 1983, a significant portion of international equity return has come from currency moves, which can be positive or negative. Source: MSCI and Morningstar as of 12/31/17. Performance is historical and does not guarantee future results. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. See pages 3 and 4 for definitions of technical terms used on this page. 27

28 Identifying trends in the U.S. dollar Since 1973, the U.S. dollar cycle has averaged 8 years (excluding current cycle) The current cycle of U.S. dollar strength began in 2011 during the European sovereign debt crisis U.S. Dollar Index (2/28/73 3/31/18) 6 yrs. 6 yrs. 10 yrs. 7 yrs. 10 yrs. 7 yrs. +101% (+11.6% annualized) Collapse of Bretton Woods Early 1973 Plaza Accord September 1985 Black Wednesday September 1992 September 11, % (6.1% annualized) Ben Bernanke s Jackson Hole Speech August % (3.0% annualized) % ( 3.4% annualized) 51% ( 6.8% annualized) 39% ( 5% annualized) Source: Bloomberg and Deutsche Bank as of 3/31/18. Vertical axis represents index levels for the U.S. Dollar Index. The shaded box covers the period from late November 2008 (when the U.S. Federal Reserve Board initiated quantitative easing, QE1) through October 2014, when purchases ended. The yellow line indicates the current level. 28

29 Hedging currency risk: Returns Hedged indices represent equity returns excluding currency returns. Unhedged indices combine equity and currency returns. Since fund inception of five of our Deutsche X-trackers currency-hedged ETFs, all MSCI currency hedged indexes listed below have outperformed their unhedged counterparts. Annualized returns (as of 3/31/18) Hedged vs. unhedged returns (% as of 3/31/18) 3-year Since 6/9/11 Hedged Unhedged Hedged Unhedged MSCI EAFE Index 4.26% 5.55% 8.76% 5.42% MSCI Emerging Markets Index MSCI Europe Index 7.05% 8.81% 4.17% 2.75% 4.15% 4.79% 8.02% 4.73% MSCI Japan Index 4.53% 8.36% 12.02% 8.24% MSCI ACWI ex-usa Index 4.85% 6.18% 7.40% 4.50% Jun-11 Oct-12 Feb-14 Jul-15 Nov-16 Mar-18 MSCI EAFE US Dollar Hedged Index MSCI EAFE Index Source: Morningstar as 3/31/18. Performance is historical and does not guarantee future results. Performance for other time periods may not have been as favorable. Index returns do not reflect fees or expenses and it is not possible to invest directly in an index. Current performance may differ from the results above. In the chart, for comparison purposes, we start each index with a value of 100. Lines show percentage movements in the index. See pages 3 and 4 for definitions of technical terms used on this page. 29

30 Hedging currency risk: Volatility Currency fluctuations may also have a significant impact on portfolio volatility. In general, hedged indices have had lower volatility than unhedged indices. Currency hedged investments may also serve as volatility risk management tools in addition to their roles as currency risk reducers Annualized volatility (as of 3/31/18) Hedged vs. unhedged volatility (% as of 3/31/18) 3-year Since 6/9/11 Hedged Unhedged Hedged Unhedged 30% 25% MSCI EAFE Index 11.14% 12.25% 16.23% 18.19% 20% MSCI Emerging Markets Index MSCI Europe Index 11.91% 16.46% 14.46% 18.69% 10.86% 12.89% 19.32% 22.65% 15% 10% 5% MSCI Japan Index 16.34% 12.47% 23.98% 22.47% MSCI ACWI ex-usa Index 10.12% 12.47% 14.65% 17.26% 0% Jun-11 Nov-12 Mar-14 Jul-15 Nov-16 Mar-18 MSCI EAFE U.S Dollar Hedged Index MSCI EAFE Index Source: Morningstar as of 3/31/18. Performance is historical and does not guarantee future results. Performance for other time periods may not have been as favorable. It is not possible to invest directly in an index. Current performance may differ from the data shown. Indexes assume reinvestment of dividends & do not show fees that would have been paid on a fund. See pages 3 and 4 for definitions of technical terms used on this page. 30

31 Managing potential risks Equity risks

32 Managing equity risks Risk factors facing equity investors Market participation Beta exposure Valuation risk Potential solutions for equity investors Dividend income and growth Companies with stable cash flows See pages 3 and 4 for definitions of technical terms used on this page. 32

33 Investor returns are not the same as investment returns: Buying and selling at the wrong times Average annual total returns, % 8.0% 7.8% 4.0% 3.5% 2.6% 0.0% S&P 500 Index DALBAR average equity fund investor Inflation Average holding period of equity mutual fund investors: 3.3 years Source: UBS and Quantitative Investor Behavior, 2012, DALBAR, Inc. Performance is historical and does not guarantee future results. The average equity fund investor is comprised of the cash flow of 4,585 funds as classified by the Investment Company Institute (ICI). Returns are represented by the change in total equity mutual fund assets after excluding sales, redemptions and exchanges. This method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses, and any other costs. After calculating investor returns in dollar terms. Two percentages are calculated for the period examined. Performance calculated assumes reinvestment of all dividends and capital gains. Total return rate is determined by calculating the investor return dollars as a percentage of the net of sales, redemptions and exchanges for the period. Holding period reflects the length of time the average investor holds a fund is the current redemption rate persists. It is the time to fully redeem the account. See pages 3 and 4 for index definitions and definitions of technical terms used on this page. 33

34 Navigating the ups and downs of the equity markets S&P 500 Index calendar year returns and market corrections (in percentages, ) Return 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40% -45% -50% -55% -60% 33% 22% 23% 6% 32% 19% -3% -5% -7% -4% -10% -9% -8% -12% 12/31/ /31/ /31/ /31/ /31/ /31/ /31/1986 5% -30% 12/31/ % 32% 30% 8% 10% 1% 38% 23% 33% 29% -3% -3% -7% -7% -6% -6% -5% -8% -7% -9% -7% -7% -7% -11% -10% -12% -12% -14% -17% -19% -19% -22% 12/31/ /31/ /31/ /31/ /31/ /31/ /31/1994 Calendar-year returns 12/31/ /31/ /31/ /31/ % 12/31/ % -33% 29% Intra-year drops 12/31/ /31/ /31/ /31/ % 12/31/2004 5% 12/31/ % 12/31/2006 5% 12/31/ % -48% 12/31/ % -27% 12/31/ % 2% 16% 32% 14% 1% 12% 22% -3% -6% -7% -10% -12% -10% -16% -19% 12/31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/2017 Calendar year returns were positive 32 of 38 years Intra-year drops were often substantial 1 Source: Morningstar as of 12/31/17. Performance is historical and does not guarantee future results. This data is for illustrative purposes and does not represent any DWS product. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. See pages 3 and 4 for index definitions and definitions of technical terms used on this page. 1) Intra-year drop Is max-year drawdown and has been computed on a daily basis through Morningstar 34

35 Staying invested via low-beta stocks Attributes of low-beta stocks Lower potential volatility Better potential for less downside capture. Leads to the potential for more capital to compound during market rallies Characteristics of low-beta stocks Companies that tend to produce reliable and consistent cash flows Companies that tend to have wide economic moats Dividend-paying stocks Dividend-growing stocks See pages 3 and 4 for definitions of technical terms used on this page. 35

36 Dividends have been a valuable part of total returns U.S. dividend-growers and dividend-payers have generated long-term value (growth of $100 in S&P 500 Equal Weight Index stocks, 9/30/97 9/30/17) U.S. dividend-growing stocks have generated value, returning a cumulative 384% from 9/30/97 to 9/30/17. growth of $ Sep-97 Jan-99 May-00 Sep-01 Jan-03 May-04 Sep-05 Jan-07 May-08 Sep-09 Jan-11 May-12 Sep-13 Jan-15 May-16 Sep-17 Dividend Non-Payers Dividend Growers Dividend Cutters Dividend Payers w/ No Change in Dividends Source for chart: Ned Davis Research as of 9/30/17. Performance is historical and does not guarantee future results. Returns are based on the monthly equal-weighted geometric average of total returns of S&P 500 Equal Weight Index component stocks with components reconstituted monthly. The S&P 500 Equal Weight Index is the equally weighted version of the S&P 500 Index, which is capitalization-weighted. The index has the same constituents as the S&P 500 Index, but each company is allocated a fixed weight of 0.20%, rebalanced quarterly. The index returned a cumulative 210% and an average annual 3.8% from 9/30/97 to 9/30/17. Index returns assume reinvestment of all distributions and do not reflect any fees or expenses. It is not possible to invest directly in an index. Dividends are not guaranteed. 36

37 Why infrastructure is a compelling investment Asset characteristics Essential services High barriers to entry Capital intensive + Historical economic characteristics Little to no pricing risk Inelastic demand profiles High and stable operating margins As a result of asset characteristics, offers the opportunity to produce stable and predictable cash flows Results in premium risk-adjusted return potential for investors Via diversification, improves risk/return potential when added to a portfolio Diversification cannot protect against a loss. See pages 3 and 4 for definitions of technical terms used on this page. 37

38 Infrastructure cash flows have been resilient Median EBITDA growth (local currency), Global Infrastructure Equities Global Equities 16.1% 15.9% 15.0% 14.5% 14.6% 15.2% 12.7% 12.3% 12.5% 12.3% 8.2% 7.6% 8.6% 8.1% 7.9% 4.6% 17.1% 11.2% 10.6% 7.7% 8.2% 7.7% 7.8% 7.0% 7.2% 6.6% 6.6% 6.2% 5.5% 6.3% 5.3% 5.5% -1.4% -6.3% Through periods of both economic expansion and contraction, the cash flows of listed infrastructure securities have been more stable than those of global equities. Source: Bank of America Merrill Lynch as of 12/31/17. Performance is historical and does not guarantee future results. Gray bar indicates a recession, which took place from December 2007 to June Global equities are represented by the MSCI World Index. Global infrastructure equities are represented by the Dow Jones Brookfield Global Infrastructure Index. Index returns do not reflect fees or expenses, and it is not possible to invest directly in an index. See pages 3-4 for index definitions and definitions of technical terms used on this page. 38

39 Global infrastructure index vs. equities Total return 13.99% 2.87% 5.15% 3.07% 4.44% 10.78% 6.54% 6.88% 13.31% Standard deviation (volatility) 8.75% 9.73% 8.47% 11.31% 11.25% 10.26% 10.88% 10.82% 9.87% Sharpe ratio Year 3 Year 5 Year Dow Jones Brook field Global Infrastructure Index MSCI AC (All Country) World Index S&P 500 Index Source: Morningstar and Bloomberg as of 3/31/18. Performance is historical and does not guarantee future results. This information is for illustrative purposes and does not represent any DWS product. Volatility is represented by standard deviation. Index returns do not reflect fees or expenses, and it is not possible to invest directly in an index. Stocks may decline in value. Investing in foreign securities, particularly those of emerging markets, presents certain risks, such as currency fluctuations, political and economic changes, and market risks. Infrastructure should be considered part of a diversified portfolio; market-price movements, regulatory changes and adverse political or financial factors could have a significant impact of performance. Index returns do not reflect fees or expenses. See pages 3 and 4 for index definitions and definitions of technical terms used on this page. 39

40 Introducing the CROCI methodology When evaluating a stock, investors often look at its traditional (accounting) price-to-earnings (P/E) ratio. In theory, that should work; in practice, it doesn t. That s because varying accounting standards make it difficult to compare the valuations of companies in different sectors or countries. Cash return on Capital Invested (CROCI ) seeks to provide an intelligent alternative by evaluating the stocks the way a CFO evaluating a potential acquisition would by leveling the playing field. Traditional evaluation: P/E ratio compares a company s current share price to its per-share accounting earnings Recognize all liabilities Liabilities should include off-balance-sheet items such as operational leases, pension underfunding, warranties and future provisions. Adjust for economic value Similar assets that are located in different countries should be depreciated over the same economic lives irrespective of the accounting and tax depreciation methodology used in those countries. The CROCI alternative Adjust for inflation Book value is typically represented at original cost, which means depreciation is understated by the impact of inflation. Account for intangibles Investments in unreported assets such as branding and research and development (R&D) should be capitalized and depreciated. Economic P/E ratio Revised economic data feeds into a valuation metric called Economic P/E ratio, which enables intelligent comparisons between markets and sectors and is the primary metric in building CROCI indices and investment strategies. 40

41 The CROCI valuation process Main differences between accounting and economic data Accounting data Book value Economic data Net capital invested (NCI) Historical cost accounted; ignores intangible economic assets, such as research and development, and advertising of brands. Adjusted for inflation, and also includes capitalized intangibles, such as R&D and advertising of brands. Return on equity (ROE) CROCI ROE does not represent a real return. For example, depreciation is not charged economically, and asset life is inconsistent. The cash return over the life of the assets. Depreciation is charged economically, with similar assets having similar lives. Market capitalization Enterprise value (EV) Only includes the value of the equity, but ignores debt and other calls on shareholders. Includes not only financial debt but other liabilities, such as leases, warranties, pension under-funding. Accounting P/E Economic P/E Easily distorted and not comparable across industries and sectors, or over time Price / book value Accounting P/E = Return on equity Seeks true consistency and comparability between stocks, sectors and countries EV / NCI Economic P/E = CROCI See pages 3 and 4 for definitions of technical terms used on this page. 41

42 Using CROCI data instead of Accounting Data has historically resulted in markedly different portfolios The overlap between portfolios seeking out the lowest accounting P/E and lowest Economic P/E is close to half 1 MSCI World Index S&P 500 Index lowest accounting P/E stocks 46 same stocks lowest Economic P/E stocks CROCI lowest accounting P/E stocks 18 same stocks lowest Economic P/E stocks CROCI 100 stocks from MSCI World Index with lowest accounting P/E compared to 100 stocks with lowest Economic P/E 40 stocks from S&P 500 Index with lowest accounting P/E compared to 40 stocks with lowest Economic P/E CROCI seeks to provide exposure to real value based on economically adjusted data Low-Economic-P/E portfolios are qualitatively distinct from traditional value portfolios in terms of operational and financial characteristics 2 (1) A comparison of the companies that are in more than one of the 100 global and 40 U.S. stock strategy baskets using data as of 12/31/17. U.S. baskets are composed of the 40 cheapest stocks as measured by Economic P/E and the 40 cheapest stocks as measured by accounting P/E. Global baskets are composed of the 100 cheapest stocks as measured by Economic P/E and the 100 cheapest stocks as measured by accounting P/E. 12 years of annual data from shows that the overlap ranges between 38% and 53%, with a mean of 45%. (2) Refer to slide 13 for a comparison between Economic P/E and traditional accounting based value portfolios. 42

43 Managing potential risks Alternative risks