Fixed Income Challenges in a low interest rate environment Maurizio Pedrini April 2010

1. Fixed Income � Challenges in a low interest rate environmentMaurizio PedriniApril 2010

2. Contents Opportunities and Threats in 2010 Liquidity: Engineered funds Credit-Spreads: TOPS funds Inflation risk: Inflation-linked funds Appendix

4. Risk/Return Factors in the Fixed Income Asset Class

5. De-leveraging process has just started

11. Biggest Part of Budget Deficits in Europe is Structural

12. EMU Sovereigns � Indebtedness relative to GDP (%)

14. Inflation will Remain Tame in the Short Run

16. Opportunities and Threats for 2010 Interest Rates Interest rates are generally on a low level � risk of a sudden rise Very steep yield curves mean high opportunity cost of capital Considerable risks in sovereign bonds (Dubai, Greece,�) ? Flexibility of chosen strategy is important (liquidity!) Credit-Spreads Economic recovery helps � what happens when government stimulus gets withdrawn? Credit spreads are still at historically attractive levels ? Focus needs to be on issuer selection Inflation No immediate threat Expansionary monetary policy and rising sovereign debts pose significant risks in the longer term ? Inflation risk is not sufficiently discounted by the market

18. Traditional vs. Synthetic Fixed Income Funds

19. Synthetic Money Market and Portable Alpha Portable Alpha Strategy To enhance this money market return, a small part of the fund (5% to 10%) is invested in a portable alpha strategy This strategy is a mechanical equity index arbitrage strategy which invests in single stocks subject to corporate events (e.g. inclusions/exclusions from an index) and hedges the systematic equity risk with index futures This means that the fund doesn't have any systematic equity risk, only a small additional volatility coming from the excess returns of the portable alpha strategy

20. Interest Rate Risk and Credit Risk (incl. Counterparty Risk) Interest rate risk: Positioning with respect to the benchmark along the dimensions duration and curve Credit risk is implemented through index CDS (iTraxx) and single name sovereign CDS Diversification Liquidity Credit risk can be quickly eliminated with low transaction costs Counterparty risk is only a fraction of the notional exposure diversified across several counterparties (best execution) subject to limits constantly monitored actively managed

21. Performance Credit Suisse Fund (Lux) Relative Return Engineered (Euro)

22. Performance Credit Suisse Fund (Lux) Relative Return Engineered (Euro), (net)

24. Focus is on Credit Duration

27. Enhanced flexibility without higher risk

28. Key Features

29. Credit Suisse Bond Fund (Lux) TOPS US$

30. An Alternative to Reducing The Interest Rate Risk

32. How do Inflation-Linked Bonds work?

33. Impact of an inflation shock on the bond markets

34. Efficient Frontier with Inflation Linked Bonds

35. Investors are not Properly Compensated for Long Term Inflation Risk

37. We use instruments that few people know that they exist: inflation swaps. Work like plain vanilla interest rate swap: pay fixed and receive floating Pay: Fixed leg is a fixed percentage (e.g. 2% over 10 years) Receive: Floating leg is determined ex post as realised inflation If inflation is high, I receive a larger payment and vice versa. Value of swap increases with inflation; hence, the swap can be interpreted as an insurance against inflation. Note: inflation swap market is very liquid; bid-ask spread of 3-5 bps; standardized contracts as plain vanilla interest rate swaps; transferable contracts (ISDA agreements); pricing is not complicatedWe use instruments that few people know that they exist: inflation swaps. Work like plain vanilla interest rate swap: pay fixed and receive floating Pay: Fixed leg is a fixed percentage (e.g. 2% over 10 years) Receive: Floating leg is determined ex post as realised inflation If inflation is high, I receive a larger payment and vice versa. Value of swap increases with inflation; hence, the swap can be interpreted as an insurance against inflation. Note: inflation swap market is very liquid; bid-ask spread of 3-5 bps; standardized contracts as plain vanilla interest rate swaps; transferable contracts (ISDA agreements); pricing is not complicated

38. Slide shows central idea of our portfolio enhancement: Combination of traditional bonds with inflation swaps Part of nominal coupon of traditional bonds is used to pay fixed leg of swap. Floating leg has same effect as inflation adjustment in IL bond Combination: bond + inflation swap = synthetic IL bond In portfolio context: build a standard fixed-income portfolio, independent of offer of IL bonds & with ratings as we like use inflation swaps as insurance against inflation (like a swap overlay) small number of swaps used to hedge overall exposure of total portfolio (e.g. 8 swaps for 60 bonds) Slide shows central idea of our portfolio enhancement: Combination of traditional bonds with inflation swaps Part of nominal coupon of traditional bonds is used to pay fixed leg of swap. Floating leg has same effect as inflation adjustment in IL bond Combination: bond + inflation swap = synthetic IL bond In portfolio context: build a standard fixed-income portfolio, independent of offer of IL bonds & with ratings as we like use inflation swaps as insurance against inflation (like a swap overlay) small number of swaps used to hedge overall exposure of total portfolio (e.g. 8 swaps for 60 bonds)

39. An Alternative to Reducing Interest Rate Risk

40. Difference of Inflation � Switzerland, France and the USA France USA EMU (since 1998) Average -2.07% -1.17% -0.97% Standard Deviation 3.46% 2.55% 0.60% Correlation with Swiss Inflation 0.5 0.54 0.81

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