For professional / regulated qualified investors only BMO Global Absolute Return Bond Fund Targeting the sweet spot for absolute return bonds
Things to look for in Absolute Return Fixed Income Diversified return sources Independently-managed sub-strategies Relative value alpha generators Low correlations between alpha generators Consistent absolute returns Low volatility Active risk budgeting across return drivers Potential drawdown risks continually analysed and managed Use of derivatives For alpha generation and hedging Exchange traded futures and options Currency forwards and options Interest rate swaps Credit default swaps Absolute Return Fixed Income Disciplined risk management Precise calibration of risk budgets Risk management at sub-strategy and portfolio level Tail risk analysis, VaR models, scenario analysis, stop losses, review levels Conviction Investment teams are unconstrained and can focus on their strongest convictions Varied sources of value Duration Yield curve Inflation Asset allocation Security selection Currency Liquidity Daily dealing 2
The BMO Global Absolute Return Bond Fund The BMO Global Absolute Return Bond Fund builds on the success of our Total Return Fixed Income Strategy and our Sterling Credits Absolute Return Fixed Income Strategy. It offers a sophisticated solution to investors looking for greater certainty of outcome in today s low-yield environment. Simplicity Strategic decisions delegated to market professionals The cash plus 3% return target represents an attractive proposition in a low-yield world Liquid investment strategy with daily dealing Flexibility and downside protection The unconstrained approach allows for greater diversification across strategies and allows positioning to target where the team has the greatest conviction The unconstrained approach has strict risk limits to distinct return drivers within fixed income markets, these limits provide comfort to our clients The absolute return bias of the strategy has the flexibility and potential to create positive returns in both positive and negative market environments Greater certainty Enhanced portfolio diversification and the avoidance of unnecessary volatility are central to this strategy The use of multiple underlying strategies working together has the potential to provide a smoother overall return profile over time relative to traditional investments The focus on shorter-dated maturities to create a yield has the potential to reduce the variance of outcomes resulting from the business and credit cycle Key risks The BMO Global Absolute Return Bond Fund aims to deliver a positive return regardless of market conditions over any one-year rolling period but such a positive return is not guaranteed over this or any time period. Capital is at risk and on sale of shares in the Fund an investor may receive back less than the original investment. With government bond yields so low, the incremental yield from credit becomes even more important. 3
Combining global credit with thematic overlays to build an absolute return portfolio Diverse sources of return are assembled within a disciplined risk management framework. Each element contributes to the overall return and enhances risk diversification. Core credit Exploiting persistent anomalies in investment grade and high yield securities. Thematic overlays Contributing to return and aiding diversification through active management of credit, interest rate and currency risk through the cycle. Active portfolio construction Drawing on the insights of specialist teams, disciplined risk management is used to calibrate risk up or down as necessary. Duration Currency Rates Risk management Stock / sector Currency risk Core portfolio Yield curve Thematic overlays Absolute return portfolio Credit Core portfolio The core portfolio is focussed on targeting an attractive yield within a clearly understood range of outcomes. To ensure confidence in the outcome, the characteristics of the core portfolio are to focus on shorter-dated maturities to reduce the risk of losses due to changes in the credit cycle. The well diversified (over 150 securities) core portfolio, aims to minimise the possibility of idiosyncratic capital loss from credit weakness and default. Low turnover helps to reduce the risk of trading costs from eroding returns. The core portfolio is not benchmark constrained and therefore is able to focus on security selection where traditional guideline constraints and index composition creates anomalies, these anomalies are often observed around the BBB / BB rating bands are explained in detail on page 5. Overlays The overlay strategies are included in order to increase diversification and target additional return. These strategies complement the core portfolio. They mostly target shorter-term relative value opportunities and allow for a broader opportunity set than the core portfolio. Each strategy is managed independently by a specialist team and correlations between them are reduced. The currency and rates portfolios are unfunded and use derivatives to express investment views. The stock/sector overlay has a strong credit element, focusing on ideas and positions that fall outside the core portfolio. Given its very modest risk budget, the stock/sector overlay is able to target securities often ignored by indices and index-based strategies. Risk management The Asset Allocation committee takes responsibility for setting the risk levels of the overall portfolio and monitoring the use of the allocated risk budgets. This team of senior professionals is responsible for ensuring the strategy is appropriately positioned across the key return drivers, interest rates, credit and currency. The team takes a mediumterm cyclical approach with a key focus on minimising the potential for losses. Derivatives are used to ensure these key decisions can remain independent from the core portfolio and the thematic overlays from the currency and interest rate teams. In addition, individual positions from the thematic overlays may be resized outside of these independent strategies where such strategies offer significant benefit at a total portfolio level. 4
Core portfolio The core portfolio is essentially a buy and maintain strategy that seeks to deliver more certainty of outcome. It offers a lower duration alternative to traditional core fixed income and pure investment grade allocations, with a low correlation to government rates, for a marginal increase in credit risk. The core portfolio seeks to capture the premia available from credit markets without exposing the strategy to significant cyclical risk which may severely affect the ability to generate an absolute return. Sharpe ratios for credit rating bands in the 3-5 year sector* 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 AAA To achieve a greater certainty of outcome, the manager s focus on short duration (lower volatility) securities of issuers having relatively resilient business models. These securities are typically those that the manager would be happy to hold to maturity. Overall portfolio returns benefit from this buy-and-maintain approach because transaction costs are low, posing less of a drag on returns. Credit Rating AA A BBB BB B CCC As the strategy is not benchmark constrained, the team can focus on the area of the credit markets where traditional guideline and index constraints create anomalies. The imaginary demarcation line between investment grade and high yield credit creates such anomalies. The reason for this anomaly is largely due to investment guidelines, as many institutional investors are prohibited from owning high yield bonds and become forced sellers when issuers are downgraded to high yield. Forced selling creates value opportunities (called fallen angels ). In contrast, most high yield managers seeking to outperform a high yield index concentrate their exposure in lower quality (higher yielding) assets, paying less attention to idiosyncratic opportunities in the BB segment, which has historically delivered superior risk-adjusted returns in the high yield space. Some specific names may benefit from a rating transition from BB to BBB (called rising stars ) as they enter a much wider universe of buyers. The strategy comprises the lowest grade bonds in the investment grade sector (BBB) and the highest grade bonds in high yield sector (BB) also known as crossover bonds. This market segment has a long history of providing high yield-like returns with high grade-like volatility. Exploiting the anomalies for absolute return The horizontal bar chart (above right) illustrates the persistent premia that occurs around the BBB/BB crossover segment. The chart compares Sharpe ratios for different credit rating bands in the 3-5 year sector between December 1996 and December 2017. Anomaly Source. Bank of America Merrill Lynch (BAML). Chart data covers the following period: December 1996 to December 2017. The data is from the BAML US corporate indices 3-5 year maturity bands by rating. To calculate the Sharpe Ratio, the BAML USD 1 Month Deposit Bid Rate has been used. * A Sharpe ratio is the average return earned in excess of the risk-free rate per unit of volatility (i.e. a measure of risk-adjusted return). Taking advantage of the rating transition More sellers than buyers Over sold Value opportunity Investment grade credit market $10.8trn More buyers than sellers Ratings uplift Global high yield credit market $2.8trn Source: BofaML Index Group, corporate and emerging sovereign hard currency bonds. As at 31 March 2018. 5
Currency overlay The relatively low correlation between currency returns and those of bonds and equities means that the inclusion of a foreign exchange (FX) overlay element within a larger portfolio typically aids diversification. This tactical overlay is designed to generate performance by targeting opportunities in FX markets. Currency views are expressed via currency derivatives. All derivative positions are either liquid or have limited downside possible when buying options. Using an overlay strategy allows us to calibrate the level of return so that it reflects the strategy s risk target. As an indicator of the risk/return trade-off, we would expect volatility to be roughly double that of the expected level of return. Our currency process is underpinned by a combination of different research approaches. The relative importance attached to each research strand varies over the economic cycle. These strands are pulled together to create a relative valuation ranking of different FX pairs. The final stage in the process involves trade structuring, portfolio construction and risk management. Building the currency overlay portfolio Investment universe Sectors Majors Dollar Block Scandinavia Asia EMEA Latin America Research Currencies USD, EUR, JPY, GBP, CHF CAD, AUD, NZD NOK, SEK CNY/H, IDR, INR, KRW, MYR, PHP, SGD, TWD CZK, HUF, PLN, RON, RUB, TRY, ZAR BRL, CLP, COP, MXN, PEN Fundamental macroeconomic analysis. Analysing economic, fiscal and monetary variables to determine the future trajectory of currencies. Positioning and flow data analysis. Analysis of central bank asset purchases, anticipated cross-border merger and acquisition flows, foreign direct investment trends and investor positioning data. This strand provides information on strengthening and weakening trends across different FX markets. Technical analysis. Analysis of price action, including trend, momentum and pattern recognition, to identify short-term and longer-term trends. Valuation Different research strands are pulled together to establish which currencies we feel are overvalued or undervalued relative to their past trading history and our expectations of changes in the global economy. Deviations of spot prices from fair value allow us to rank different FX pairs in terms of their relative attractiveness. Portfolio construction Portfolio of highly liquid positions typically combines five to 10 FX crosses, expressing three to five major themes. Portfolio construction has a strong focus on diversification and the ongoing risk management. 6
Interest rate overlay This unfunded overlay is managed by a highly experienced rates team with a strong track record in adding value to mandates over both the long term and short term in a risk-controlled manner. The team has embraced innovations in fixed income instruments and is able to scale its process to meet very specific risk/ return objectives. Our unfunded, derivative-based global interest rate overlay is underpinned by fundamental and relative value analysis. Our fundamental research involves assessing the fair value of a wide range of assets, modelling potential yield paths by combining the outputs of our fair value model with scenario analysis, and quantifying the impact of changes in the many variables that can affect interest rates. Our relative value research involves idea generation via regression analysis and proprietary economic research, and identifying potential entry/exit points via analysis of historic trading patterns. Relative value analysis is used primarily for cross-market and yield curve trades. Typically, we will seek to express our relative value ideas in a manner that minimises the impact of spread directionality. The overlay has exposure to the entire opportunity set in interest rate swaps (nominal and inflation) and liquid exchange-traded derivative contracts. Both centrally cleared derivatives and overthe-counter (OTC) interest rate swaps can be used. The variety of instruments available to our team allows them to express an investment view in the most efficient manner. Specific sources of added value in this overlay include cross-market views, yield curve trades, inflation breakeven trades, swap spread trades and directional duration positioning. Typical investment guidelines for outperformance target of 0.5% Duration: -1 to +1 years Volatility: approximately <1% Approximate leverage: 3X Benefits of using an unfunded interest rate strategy Ability to transform risk profile of a domestic portfolio Ability to express long and short views, duration neutral curve trades, inflation breakeven trades and yield curve steepeners Ability to scale positions more appropriately and more efficiently More efficient use of capital Expected sources of added value over the cycle Duration 25% Yield curve 25% Inflation 5% Swap spreads 20% Country selection 25% Note: The contribution from different alpha sources will vary over the economic cycle. Swap spreads refer primarily to trades involving bond futures and interest rate swaps of the same maturity. 7
Risk management through the cycle Risk management through the cycle encompasses three key components: effective diversification of risk, tactical management of risk and explicit risk mitigation strategies. The fund embraces both market directional and non-market directional themes. Fundamental to the management of the portfolio is a focus on asset allocation and risk management through the cycle: resizing positions as necessary and avoiding unnecessary volatility. This process involves a strong emphasis on events or periods where capital is at risk. A strong focus on periods and events where capital is at risk Where in the growth cycle? 2 3 GDP growth Responsibility for the resizing of investment ideas in the portfolio lies with the Strategic Allocation team. The Strategic Allocation team makes key decisions such as how much interest rate risk and credit risk is appropriate for the portfolio at a particular point in time. They are supported by an Asset Allocation Committee, which meets regularly to set overall risk parameters. As is evident from the table below left, a long exposure to credit makes sense under most economic conditions. However, we pay particular attention to periods when capital is at risk. An example of this would be in phase 4, when GDP growth is below trend and declining. As appropriate, we will pare back long credit exposures and consider tactical hedging or deploying outright short credit positions. 1 4 Trend growth The importance of managing credit risk through the economic cycle The chart below indicates the importance of managing credit risk through the economic cycle. BBB spreads relative to US economic growth For illustrative purposes only. Source: BMO Global Asset Management. 6 0.0 Phase 1 2 3 4 Economic cycle GDP < avg and rising GDP > avg and rising GDP > avg and declining GDP < avg and declining Bonds Equities Credits Credits vs Gov. %Time -- ++ ++ ++ 35% = ++ + + 10 % + + + = 36% ++ -- -- -- 19%! 5 4 3 2 % 1 0-1 -2-3 Dec-97 GDP Consensus Forecast 2 3 1 4 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 US GDP (2 yr avg) BBB spread (2yr avg) RHS Trend growth Dec-18 1.0 2.0 3.0 4.0 5.0 6.0 Note: the above table denotes the responsiveness of the assets to market conditions in positive (+), negative (-) or neutral (=) terms. Note: For illustrative purposes only. Source: BMO Global Asset Management, data to 31 December 2017, Bloomberg since December 1996, assumes 2.5% trend growth. 8
Building an absolute return bond portfolio The combination of different strategies, each with very modest risk budgets and return targets, increases the likelihood that the overall yield target will be achieved. BMO Global Asset Management s strategic allocation team has overall responsibility for the portfolio Approx. 50% of return Approx. 50% of return Cash +3% return target Core portfolio Low turnover with strategic focus on harvesting the premia in shorter-duration credit Shorter-term independent overlay strategies Stock/sector Currency Rates Risk management (through the cycle) Asset allocation - Duration - Credit Position resizing Overall portfolio Diversified source of returns targeted with the potential for downside protection Greater confidence in expected outcome Sources of return: Aims to target an appropriate yield Designed to deliver a relatively predictable return Targets short duration A/ BBB/BB rated securities Approximately 150 holdings issued Currency overlay strategy Interest rates overlay Sector/stock overlay Seeking to deliver 100 bps A strong focus on downside protection Avoidance of unnecessary volatility Interest rate risk and credit risk managed independently Flexibility to take duration negative and implement hedges Quarterly macro scenario probability analysis Annualised volatility target 3-5% Modified duration -3 yrs / +5 yrs Spread duration -3 yrs / +5 yrs Currency (base) -30% / +20% Emerging markets max 25% High yield max 35% High yield B or less max 15% When the core portfolio is towards the lower bound of its anticipated return, we expect the asset allocation / risk management process to add more value and vice-versa. While the fund targets a return of cash +3%, there is no guarantee this will be achieved and capital is at risk. 9
BMO Global Asset Management s extensive fixed income capability At BMO Global Asset Management, we are able to offer clients a full range of fixed income solutions by leveraging an extensive mix of expertise and wealth of experience. Our capability is derived from multiple specialist teams, each structured to facilitate collaboration, idea generation and the challenging of ideas. Working with these teams is our strategic allocation team, which draws on their expertise to offer our clients outcome-orientated solutions. The strategy is underpinned by a clear investment philosophy. We believe no single strategy works all the time and that a combination of top-down and bottom-up capabilities is necessary to deliver consistent performance. We also hold that diverse sources of value can improve the risk/return profile of the portfolio over the cycle (e.g. dynamic allocation to interest rates, yield curves, inflation, credit, sectors and security selection). Further, we believe specialist capabilities and disciplined risk management are essential to long-term investment success, and that persistent pricing anomalies exist in credit markets that can most effectively be harvested by an unconstrained strategy. Global interest rates / FX Credit Global rates and money markets team Global macro team Multi-strategy fixed income team Credit team Strategic allocation team Head of Credit Head of Multi-Asset Investing Senior Credit fund manager Head of Global Rates Director, Currency fund manager Actively-managed range of fixed income solutions Emerging market debt 10
Key features of our approach to Absolute Return Fixed Income Our approach to absolute return fixed income is unconstrained and has a clear focus: the delivery of returns having a different profile to that of global bond markets. We target diverse return sources, managed by specialist teams and brought together in a sophisticated risk management framework, to deliver a narrow range of risk/return outcomes. As with all investments, your capital is at risk and on sale of shares in the Fund an investor may receive back less than the original investment. Diversified return sources Consistent absolute returns Disciplined risk management Liquidity Varied sources of value High conviction Use of derivatives for alpha generation and hedging 11
Contact us +44 (0)207 011 4444 institutional.enquiries@bmogam.com bmogam.com Telephone calls may be recorded Follow us on LinkedIn Subscribe to our BrightTALK channel 2018 BMO Global Asset Management. All rights reserved. BMO Global Asset Management is a trading name of BMO Asset Management Limited, which is authorised and regulated by the Financial Conduct Authority. CM15637 (09/18). FR, DE, IE, IT, NL, NO, PT, ES, SE, CH, UK, AT, BE, FI, LU.