2008: a year in review for credit and inflation linked-bonds The year was characterised by the financial and liquidity crisis, deleveraging of the economy, worldwide economic downturn and very high levels of volatility. The liquidity crisis that started in July 2007 turned into a credit crisis in 2008 as the risk premium continued to widen on corporate bonds due to the deteriorating economy and to the fear that companies will be significantly hurt from being cut off from the credit markets. As a result, implicit default levels rose to historic levels. In an effort to jump start the flow of credit, massive government interventions have been designed to support the economy either through the backing of the banking sector or through direct or indirect programs to assist companies in need of funding. The year was also marked by high levels of volatility in Inflation-Linked bonds. During the first three quarters of the year, inflation expectations remained high which was mainly due to rising commodity prices (especially oil). Inflation-linked bonds outperformed nominal government bonds until the third quarter. However, the last quarter experienced a sharp correction in inflation expectations after the significant drop in oil and other commodity prices that began in July. This, combined with the flight to quality (and liquidity) to nominal bonds, pushed break-evens downward and the asset class significantly underperformed nominal bonds especially in October and November. 115 110 105 100 95 JP Morgan Broad hedged EUR Barcap World Inflation hedged EUR 90 12/07 03/08 06/08 09/08 12/08 Source: Sinopia, Bloomberg Data as at end-december 2008 10.15% -0.22% What are the investment opportunities for bonds in 2009? Investment grade bonds and inflation-linked bonds have been excessively battered in 2008 and valuations have become very attractive. Below we highlight the opportunities that both asset classes currently provide: Euro Investment Grade bonds Even though it is reasonable to expect continued liquidity and volatility risks in the short term, Investment Grade bonds offer an attractive investment opportunity as shown by the two graphs: Current high level of spreads that peaked even further during the months of October and November 2008: 800 700 600 500 400 BBB Spreads vs 10-year US Treasuries (15/01/1919 28/11/2008) 300 200 100 0 1919 1929 1939 1949 1959 1969 1979 1989 1999 2008 Source : Halbis as of 28/11/08 Non contractual document. This presentation is only intended for professional investors, as defined by MiFID.
Extremely high implicit default rate for euro investment grade that more than compensates actual historic defaults: Annual default rates for the euro investment grade market in 2008 compared to 1970-2003 5.0% Implicit market default rate as of February 3rd, 2009 : 4.8% 4.5% 4.0% 3.5% 3.0% Euro Credit and Inflation-linked bond markets 2.5% Euro Credit and Inflation-linked bond markets 2.0% 1.5% 1.0% 0.5% 0.0% 1970 1975 1980 1985 1990 1995 2000 Source: Halbis Annual default rate based on 5 year cohort data Implicit market default rate calculated using the ML EMU Index Type-Senior spread and a hypothetical recovery rate of 40% Furthermore, since the beginning of the year, we have been witnessing signs of normalisation in the credit markets. For example, we have seen continued government support in the banking sector that is determined to avoid failures. Also, in the non-financial sector, companies (including BBB names) have been able to successfully issue on the primary markets. Furthermore, since beginning December 2008, spreads have begun to taper off inboth of these sectors: 1 year Euro financial sector spreads Spread vs Swap(bp) 410 Fin Senior Fin LT2 360 310 260 210 160 110 60 Feb-08 Apr-08 May-08 Jul-08 Aug-08 Oct-08 Nov-08 Jan-09 Source : Halbis as of 16-01-09 1 year Euro non-financial sector spreads Spread vs Swap(bp) Non Fin A 360 Non Fin BBB 310 260 210 160 110 60 Feb-08 Apr-08 May-08 Jul-08 Aug-08 Oct-08 Nov-08 Jan-09 Source : Halbis as of 16-01-09
Focus on HSBC Oblig Euro Court Terme (FR0010495044- I share class)*: HSBC Oblig Euro Court Terme is a euro aggregate short duration (1-3 years) fund managed by Halbis, the fundamental active manager of HSBC Global Asset Management. The average duration and credit exposure is actively managed over time and is in function of spreads compared to government bonds and the anticipated risk/return profile for each asset type and each segment of the curve. The fund is positioned to take advantage of Halbis current market view on government and corporate bonds as described above. Finally, the fund benefits from the team s 17-year average experience and from a long and established track record (the fund was launched in December 1992). Key advantages: A short duration aggregate portfolio combines the safety and liquidity of government bonds for part of the assets and takes advantage of extra yielding corporate bonds for the other part. By nature, the fund has a low duration and thus offers protection against interest rate risk. This is a suitable choice given a very low interest rate environment, even if we do not anticipate any rate hikes by the ECB in the foreseeable future. The fund s current yield is close to 5.00% compared to 1.50% for the 2-year Bund and 3.30% for the 10 year Bund. Given the high degree of protection from adverse interest rate movements, the fund s yield is practically the same as the expected yearly return. The current average rating of the portfolio s securities is A which is in-line with our management policy. Thanks to Halbis actively managed rates and credit process, the fund benefits from: Our convictions on rates through a risk controlled approach to directional positions A high degree of diversification in function of market opportunities (selection of countries in the euro zone, allocation to sub-sovereign and agencies, sectors, etc ) Our experience and extensive resources in fundamental credit research Finally, the fund s good performance in both absolute and relative terms reflects the team s experience and the robust investment process: HSBC Oblig Euro Court Terme (A) Barclays Euro Aggregate (1-3 years) Gross performance as of 31/01/09 3 months 1 year 2 years 3 years 3.51% 5.80% 10.58% 12.73% 2.79% 5.46% 10.54% 12.61% Source : HSBC Global Asset Management. Gross performance from the A share class (FR0000972473). Management fees for the I share class (FR0010495044): 40 bps. max. Past performance is not a guarantee of future results. * I share class launched on 12/06/2008.
Inflation-linked Bonds In our view, breakeven levels are excessively low given that deflation should be transitory as mechanically implied by the peak in oil prices during the summer of 2008 which was followed by a sharp sell off. Breakeven inflation rates were extremely volatile and absorbed most of the drop in nominal interest rates, implying higher or steady real interest rates. It is clear that in a recessionary scenario, current real interest rates are too high compared to their fundamental value as they are supposed to reflect a country s mediumterm real GDP growth potential. Current levels of real interest rates in the USA (>3% on the 5-year maturity), Euro zone (1.7% on the 5-year maturity) and Japan (3% on the 6-year maturity) are incompatible with expected economic scenarios. Breakeven levels are too low, even compared to the worst-case inflation scenario. Extraordinary measures taken by the Fed that reduce the risk of deflation. Furthermore, the deleveraging process has stopped since mid-december and the potential drop in oil price is now limited. We have already started to see a significant rebound for the month of December which gained +5.21% for the Barclay's World Government Inflation- Linked Bond Index Hedged EUR. We believe that the asset class will stabilise in 2009. Given the central banks initiatives and the level of real rates which already include scenarios of substantial deflation for the most exposed countries, inflation linked bonds should perform well. Focus on Oblig Inflation World by SINOPIA (FR0000993156): Oblig Inflation World by SINOPIA is managed by Sinopia, the quantitative specialist of HSBC Global Asset Management. The fund invests in high quality government ILBs in the main developed markets: Australia, Canada, Euro zone, Sweden, UK, USA and Japan and the portfolio is systematically hedged against currency risk. With the launch one of the first Euro Zone Inflation-Linked Bond open-ended funds in January 2003 followed by a 100% Global Inflation-Linked Bond fund in April 2003, Sinopia has over 10 years experience in managing and trading inflation-linked bonds. Sinopia s Inflation-Linked bond expertise is recognised internationally. Sinopia offers its worldwide clients several solutions for investing in the fund either via segregated accounts for large institutional clients or through open-ended funds. Furthermore, Sinopia publishes a quarterly review dedicated to ILBs called Tactik Inflation-Linked Bonds.
Key Features: The fund is managed according to 4 performances sources: duration, country allocation, yield curve positioning and bond selection and benefits from Sinopia s core quantitative investment process based on valuation, allocation, and implementation. Finally, Oblig Inflation World by SINOPIA has boasted good performance with respect to its benchmark and its peer group over 1, 3 and 5 years: Net Performance as of 31/12/08 1 year 3 years 5 years Oblig Inflation World by SINOPIA -2.05% 3.90% 17.40% Morningstar (category: International Inflation-linked bonds) -6.83% -6.05% 5.21% Barclays World Inflation-Linked Index -0.22% 3.12% 19.74% Morningstar rank 8/12 4/10 1/4 Sources: Morningstar, Barclays, Sinopia - * Data as at 31/12/08 in EUR. Performance net of fees (I share class). Past performance is no guarantee of future results.
Important Information This material is issued by HSBC Global Asset Management (France) in the conduct of its investment business and is intended for one-on-one use with institutional / qualified investors only. It is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by HSBC Global Asset Management (France) and/or Sinopia Asset Management. The information contained herein is subject to change without notice. All non-authorised reproduction or use, whether in whole or in part, will be the responsibility of the user and will be likely to lead to legal proceedings. This material is for information purposes only and does not by any means constitute an offer or recommendation or a solicitation, nor a recommendation to buy or sell any investment, or subscribe to any investment management or advisory service by anyone in any jurisdiction in which such an offer is not lawful. It is not, under any circumstances, intended for distribution to the general public. Recipients may pass on this document but only to others falling within those categories. The funds presented in this document may not be registered and/or authorised for sale in your country. Past performance is not a guide to future performance. Capital is not guaranteed. Simulated performance is not guide to future performance. Fluctuations in the rate of exchange of currencies may have a significant impact on fund performance. Please note that according to article 314-13, performance for periods of less than 12 months cannot be shown to non-professional investors, as defined by MiFID. Please note that the fund is authorised to invest a considerable part of its assets in Credit Default Swaps (CDS), which are less liquid than standard bond issues. Investors should refer to the fund's information memorandum / prospectus for a detailed explanation of the investment risks associated with this product, which is available upon request from HSBC Global Asset Management (France). The client service relationship is typically maintained in the country where the client is located while assets are either managed locally or distributed to another affiliated company which offers asset management capability in the area of specialty or within in the geographic region(s) closest to the market within the mandate. HSBC Global Asset management represents Halbis Capital Management and Sinopia Asset Management throughout the world; it is responsible for the business relationship and provides client services both in France and abroad, as part of a strategic partnership. Halbis Capital Management (France), Portfolio management company, authorised by the French regulatory body AMF (no. GP06000012) Immeuble Ile de France - 4 place de la Pyramide - La Défense 9-92800 Puteaux - France The term Sinopia Asset Management ("Sinopia") refers to a business engaged in fund management activities, which are ultimately owned by HSBC Holdings plc. Sinopia's registered office is in Paris: Immeuble Ile de France - 4 place de la Pyramide - La Défense 9-92800 Puteaux - France, and has subsidiaries in London and Hong Kong: Sinopia Asset Management UK Limited - Sinopia Asset Management Asia Pacific Limited - Portfolio management company - 379 837 800 RCS NANTERRE - AMF authorisation no. GP97142. HSBC Global Asset Management (France) - 421 345 489 RCS Nanterre. Portfolio management company authorised by the French regulatory authority AMF (no. GP99026) Postal address: 75419 Paris cedex 08 Offices: Immeuble Ile de France - 4 place de la Pyramide - La Défense 9-92800 Puteaux - France www.assetmanagement.hsbc.com/fr Non-contractual document, updated