ETF Review 2012 by Vishaal Sharma

PI P R E V I E W S prOFESSIONAL & institutional portfolio

2012 ETF Review

ETF Review 2012 A snapshot of current views, facts and ideas from professionals in the ETF industry. We sincerely hope you enjoy reading this edition as it has been a pleasure to compile for a wider audience. Sunil Maya Managing Director PIP Reviews IBPC 153 Fenchurch Street London EC3M 6BB info@ibpcmedia.com Tel: +44 207 220 0440 Fax: +44 207 220 0445 Although every effort has been made to ensure the accuracy of the information contained in this book the publishers can accept no liability for inaccuracies that may appear. All rights reserved. No part of this publication may be reproduced in any material form by any means whether graphic, electronic, mechanical or means including photocopying, or information storage and retrieval systems without the written permission of the publisher and where necessary any relevant other copyright owner. This publication – in whole or in part – may not be used to prepare or compile other directories or mailing lists, without written permission from the publisher. The use of cuttings taken from this directory in connection with the solicitation of insertions or advertisements in other publications is expressly prohibited. Measures have been adopted during the preparation of this publication which will assist the publisher to protect its copyright. Any unauthorised use of this data will result in immediate proceedings. © Copyright rests with the publishers, ibpc, England. The material in this publication has been prepared solely for the distribution to professional and qualified investors. The information in this publication you are about to read is intended for Professional and Qualified Investors. Including regulated financial intermediaries such as banks and securities brokers, regulated insurance companies, government or public authorities, corporate treasurers and financial advisers. The information contained in this publication should not be considered as an offer, or solicitation, to deal in any of the investments or funds mentioned herein, by anyone in any jurisdiction in which such offer or solicitation would be unlawful or in which the person making such offer or solicitation is not qualified to do so or to anyone to whom it is unlawful to make such offer or solicitation. The market commentaries represent an assessment of the market environment at a specific point in time and are not intended to be a forecast of future events, or a guarantee of future results. This publication is not prepared for any particular investment objectives, financial situation or requirements of any specific investor and does not constitute a representation that any investment strategy is suitable or appropriate to an investor’s individual circumstances or otherwise constitute a personal recommendation. The information in this publication is being provided strictly for informational purposes only and does not constitute an advertisement. The commentaries should not be regarded by investors as a substitute for independent financial advice or the exercise of their own judgment. IBPC does not warrant the accuracy, adequacy or completeness of the information and materials contained in the publication and expressly disclaims liability for errors or omissions in such information and materials. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader, the investor, any person or group of persons acting on any information, opinion or estimate contained in the website. IBPC reserves the right to make changes and corrections to any information on this publication at any time, without notice. Past performance is not a guide to the future. Market and exchange rate movements may cause the capital value of investments and the income from them, to go down as well as up and the investor may not get back the amount originally invested. Investments involve risks. Before making any investment decision, you should read the relevant offering documents and in particular the investment policies and the risk factors. You should ensure you fully understand the risks associated with the investment and should also consider your own investment objective and risk tolerance level. Remember, you are responsible for your investment decision. If in doubt, please get independent financial professional advice.

ETF Review

Contents

01 02 03 04 05

Deutsche Bank - What does 2012 hold for the European ETF Industry? Claymore Investments - The Basics of Fundamental Index速 Investing Commerzbank - Lucrative Component for Investments iShares Switzerland - Friend or Foe? The Impact of Inflation on Local Currency Emerging Market Bonds UBS - Index Investments that Shine

06 07

14 16

Natixis - Focus on Enhanced Beta Strategies Detlef Glow, Head of Lipper EMEA Research, Lipper Are ETFs in Trouble? Amundi ETF - How to Implement Hedging Strategies using ETFs Worldtrack - Managing ETF Portfolios

BlackRock - European ETP NNA

7 08 8 9 12

17 19

ETF Review

Deutsche Bank

What does 2012 hold for the European ETF Industry? Rebalancing Act 2011 was a good year overall for the ETF industry. Amid challenging market conditions the global ETF industry grew by 3.2%. Comparing this to prior year growth rates, often over 30%, could provide an unfavorable picture and be perceived as a slowing down of the industry. However, this observation on the surface masks the fall in asset prices over the year, which contributed a decline of 9.3% to global ETF assets. Some of the most positive news came from the fact that new money flowing into the global ETF industry [cash flows] for 2011 totalled $163.8 billion. This was marginally higher than the prior year’s [$162.3 billion] cash flows, when the industry had grown by 27.4%. Market prices shaved off an average of 9.3% of global ETF asset levels over the 2011, but investors interest, as expressed by new money, outpaced asset price falls and contributing 12.5%, making it a positive year for ETFs. Figure 1: European ETF in 250,000

1,400 1,200

200,000

€m illion

800 600

100,000

400 50,000

200 2003

Other

Comm odity

Fixed Income

2004

2005

2006

2007 96

1681

,078

1,9871

,867

2,089

,402

2,3203

,596

10,664

19,483

23,219

24,841

--3401

2008

2009

2010

20112

012* *

8012

,034

4,0029

,370

13,743

29,857

35,871

42,343

43,354

43,787

Equity

15,532

21,815

37,907

57,029

70,771

65,489 1

10,657 1

47,766 1

39,463 1

45,391

Total

16,332

23,849

42,249

67,801

86,930

99,110 1

58,270 2

11,579 2

07,902 2

16,108

1001

1632

4186

Number of ETFs*

Numb er of ETFs

1,000 150,000

8191

,072

1,2371

,247

Source: Deutsche Bank ETF Research, Weekly European ETF Market Monitor ** As of 13/01/11

The growth story for European ETF market however was a bit different. European ETF assets shrunk by 4.9% over 2011. Cash flows for Europe were positive, totalling $22.1 billion, however they were half of those experienced in 2010 [$45.0 billion]. There are mainly two reasons for the reduction in European ETF cash flows. Firstly, 2012 was a year of two minds in terms of investors’ risk appetite. The first half brought healthy flows to the equity market, including the ETF market, however, starting in August, the risk-off trade prevailed and cash flows started trending negative. Market uncertainty, primarily caused by the Euro sovereign debt crisis, also kept investors away from sovereign benchmarked ETFs, Europe’s largest fixed income ETF market component. In addition, in 2011, ETFs received much attention from regulators, a lot of which was fuelled by general credit concerns in the market. These two factors contributed to a slower year, than other global territories, for European ETFs. However, there are hopeful signs that things are turning around and that the European industry is overcoming some of these hurdles. In the first two weeks of 2012, European ETFs received strong cash flows totalling €2.2billion of new inflows and saw their assets rise by 3.9% to reach €216.1 billion. Furthermore, a lot of the regulator discussions have gone through a full review cycle and the European Markets and Securities Authority [ESMA], the European asset management industry regulator, is undergoing a second, and perhaps final consultation before issuing guidance. A lot of what materializes in terms of growth in ETF industry asset growth is affected by equity market conditions. In a good equity market year, ETF cash flows tend to be higher, especially as equities are by far the industry’s largest component [close to 70%]. Therefore, depending on how the European sovereign crisis evolves, we expect the ETF industry to continue growing. If 2011 was a year during which regulators digested the issues raised about ETFs, 2012 should be a year during which resolution materializes. With increased education and follow-

ETF Review

ing comprehensive discussions, many of the issues initially raised by regulators have been dropped. We anticipate that regulators will come out with additional ETF specific guidance but will otherwise refrain from making drastic changes, for the time being, that are more relevant to the entire asset management industry and not just ETFs. One important realization that has transpired from the ETF regulatory discussion, is that ETFs are the golden standard when it comes to disclosure and transparency across the fund industry. These developments should boost ETF usage as now with the regulatory reviews reaching a conclusion, the industry will likely benefit and continue to attract investors at rates seen prior the middle of 2011. We therefore expect asset level growth rates in the European ETF industry to range between 10% and 20%, the majority of this growth coming from new money flowing into the industry. The actual growth will largely depend over equity market conditions over 2012 and how asset prices evolve. If market uncertainty declines, growth could be closer to 20%, however, if European government debt woes continue the growth is more likely to be closer to 10%.

ETF launches, which direction are they going? The ETF industry is fairly concentrated in terms of providers, at the industry’s top echelon. In Europe, the top 5 ETF providers manage close to 80% of the industry’s assets, while the comparable number in the US is closer to 90%. However, a closer look at the very strong ETF product launch calendar over 2011 can shed more light about industry competitive dynamics as well as product launch trends. The European ETF industry experienced 165 new product launches over 2011, while the global total reached 554 new launches. Due to increasingly challenging market conditions, investors have become more inquisitive about benchmarking that can deliver consistently positive returns. As a result, ETF providers have responded by building on the currently strong ETF industry traditional beta base. This trend has also provided a viable entry point for new entrants in the industry. Over 2011, there were three new entrants in the US industry and an equivalent number in the European industry. Out of these six new entrants, four launched products that are benchmarked to noncapitalization weighted indices. A trend that was started by RAFI in 2006 in the US, seems to be gathering pace. In addition to alternative index weighting techniques, many of the new products are tracking more active strategies that aim for positive returns irrespective of market conditions. Such products range from strategies driven on purely quantitative models to fully discretionary strategies such as hedge funds. Figure 2 gives a mapping of investment strategies followed by products currently in the European ETF market. Products range from beta, which offer diversified capitalization weighted indices, to alpha, which offer manager discretionary market access. Semi-active products include ETFs that track leveraged, double long and short indices, aiming to deliver superior returns. Semi-active products include non capitalization weighted indexed products. While 97% of ETF products are beta benchmarked, it is important to note that many investment managers are increasingly using these products as building blocks for more active strategies in their portfolios.

Deutsche Bank

What does 2012 hold for the European ETF Industry? Figure 2:

sets benchmarked to these same indices, are on the rise.

nt strategy type

$2.2 bil. $0.6 bil.

Passive, $262.7 bil. Passive plus, $4.4 bil.

97% Tracker

Leverage

Source: Deutsche Bank ETF Research, 2011 ETF Market Review & 2012 Outlook, data as of 31/12/11

The increased use of ETFs as building blocks in portfolios is precisely what is driving the launch of more niche products by both existing as well as new market entrants. The rate of entry of smaller providers through the ‘niche channel’ is increasing the pressure on existing providers to diversify their product ranges in order to avoid losing assets. Over 2011, the larger five ETF providers lost a collective 2.2% of market share, this was gained by smaller providers and rising stars. Some of the growth was also absorbed by however established providers beefing up their product ranges by launching beta products.

How are ETF usage patterns changing? ETFs became more widely used over 2011 and this is captured by two key market metrics: The percentage of ETF flows and assets when compared to the relevant mutual fund statistics and the percentage of ETF turnover as compared to that of cash equities in general. A comparison with the mutual fund industry yields important information about the comparative use of different type of fund products, often termed by many as the ETF adoption rate. ETF turnover comparisons with cash equities turnover give a good insight about how actively ETFs are traded compared to other cash equity instruments, including single stocks and basket products. ETFs are now almost a third [29.6%] of the cash equities turnover in the US as of the end of 2011, up from 24.0% in December 2011. The comparable number for Europe registered at 8.7%, up from 6.9% over December 2010. Furthermore, ETFs continue to advance against mutual funds, registering at 9.0% in the US and 2.8% in Europe, up from 8.4% and 2.7% last year respectively. Perhaps most impressive is the comparison of new money that listed [ETFs] and unlisted [mutual] funds have received over 2011. US ETFs received 2.8x higher flows than the ten-fold larger mutual fund industry. European ETFs received 2.2x higher flows than the thirty-plus-fold larger UCITS mutual fund industry. The numbers in Europe point to the conclusion that the weakness in the local ETF market is not specific to ETFs but more likely due to uncertain market conditions. There are a number of developments to watch out for in terms of ETF usage over the coming year. Currently ETFs in Europe are more popular with institutional investors. While there are no official statistics, we estimate that upwards of 90% of investors in the ETF industry are institutional. On the institutional usage component, ETF gains will come by increased usage for ETFs that are benchmarked to indices for which no other wrapper – such as futures contracts – is available. Furthermore, due to heightened risk oversight with many investment managers, ETFs are favoured over derivative products such as futures, options and swaps. The challenge for ETFs, in capturing more of these institutional users, lies in increasing usage and turnover levels in these ETF unique products. It is a bit of a chicken and egg dilemma, however, there are signs that open interest in futures usage, especially on mainstream equity indices, is on the decline, while ETF as-

Beyond institutional investors, the next big piece in the ETF industry participant puzzle is the retail investor. There is currently retail money invested in ETFs, however, the majority of these are found in mandates managed by pension funds and asset managers. Direct retail investor participation is still very low, even though some early adopters, in the form of discount brokerage clients, are frequent ETF users. The high level of regulatory scrutiny that we have witnessed over 2011 is a sign that there is now consensus among policy makers that ETFs are about to get closer to the retail investor in Europe. Structural changes, primarily through MiFiD, have made the overall asset management product distribution process more efficient and for the first time, ETFs have a real shot at competing on a level ground with other types of funds. This is a medium to long term goal though as it will take time for ETF awareness to built up with retail investors directly. In addition, intermediaries that look after retail money, such as Independent Financial Advisors in the UK, will take time to get to know the product and alter their current instrument selection practices.

Direction forward for ETFs: Where to? Much of Europe’s ETF market fortunes in the coming year will depend on what happens outside the ETF market over 2011. The resolution, or at least softening, of the Euro Sovereign crisis, and the impact it will have on market mood will be crucial in forming asset allocation patterns. However, other forces are beginning to shift in Europe. At the moment, the European market is dominated by US asset managers and European investment banks. The large European asset management houses remain largely absent from the ETF market. Currently, ETF providers in Europe are comprised of US based asset managers and European investment banks. Changing competitive dynamics on how mutual funds are sold across the European market are creating more incentives for European asset managers to engage in the ETF industry. Increased scrutiny by regulators in Europe also signals the belief that more retail and smaller investors are beginning to embrace the ETF product. We expect ETFs to continue growing in 2012 and while much of the growth will be determined by general market mood, ETFs are at a stage where they it is exhibiting signs of functioning as an independent – portfolio building - market. In the US market, fixed income ETFs over 2011 have reflected broader economic risk themes, proving that ETFs grow not only when the equity market is rising. Gold exchange-traded products [ETPs] also played an important role in filling the risk off trade both in the US and Europe. A balancing of asset class sizes in the ETP industry can also help growth prospects going forward. The European fixed income ETF market has not been the beneficiary of the same high level of interest as its US counterpart over 2011. The sector’s large sovereign benchmarked component, together with the Euro sovereign crisis did not do much to help. However, 2012 might just hold the key to reversing sovereign benchmarked product dominance in the European fixed income ETF market. As the European ETF market is largely populated by equity-driven investors, continued turbulence in the equity market and an elevation of credit to an equity equivalent return source, could just entice equity-driven investors to increase usage of fixed income ETFs. This increased usage is likely to come from products offering various types of credit related exposure, such as those ETFs that track iTraxx indices, rather than from the more traditional duration oriented fixed income benchmarks. Given the low interest rate environment, credit is likely to play a much larger role in portfolio construction in the year ahead, and the European ETF industry is very well positioned with a total number of ETF products that reached 245 as of the end of 2011, as compared to 166 in the US and 20 in Asia. But the industry is at a turning point in its evolution as growth rates in both the US and Europe appear to be normalizing. Failure to proceed with a swift resolution in the regulatory investigations could negatively impact European ETF growth in 2012. In the last three months of 2011, increased regulatory scrutiny

ETF Review

Deutsche Bank

What does 2012 hold for the European ETF Industry? and general credit concerns clearly played a significant impact on how investors chose products. Additionally, prolonged uncertainty in the equity markets, both in the US and Europe, could slow down allocations in the industry’s larger compartment, equity. Gold ETPs, a major beneficiary of the credit crisis accounting for 8.1% of the global ETP industry, could see big outflows if the outlook for the price of gold changes. Much of the investment in gold ETPs is concentrated in a handful of products in the US and Europe. These are all factors to watch out for in the first half of 2012. We don’t believe they pose a vital threat to the general health of the global industry, they could however generate shocks which could drag ETFs to reflect conditions prevalent in the rest of the wider – confidence stricken –market and thus push growth in the slower lane, especially in Europe. The author is an employee of Deutsche Bank, views expressed here may have been previously published in research by Deutsche Bank.

Christos Costandinides christos.costandinides@db.com +44(20)754-71975

Disclaimer The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively “Deutsche Bank”). The information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Deutsche Bank makes no representation as to the accuracy orcompleteness of such information. Deutsche Bank may engage in securities transactions, on a proprietary basis or otherwise, in a manner inconsistent with the view taken in this research report. In addition, others within Deutsche Bank, including strategists and sales staff, may take a view that is inconsistent with that taken in this research report. Deutsche Bank may be an issuer, advisor, manager, distributor or administrator of, or provide other services to, an ETF included in this report, for which it receives compensation. Opinions, estimates and projections in this report constitute the current judgement of the author as of the date of this report. They do not necessarily reflect the opinions of Deutsche Bank and are subject to change without notice. Deutsche Bank has no obligation to update, modify or amend this report or to otherwise notify a recipient thereof in the event that any opinion, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. Prices and availability of financial instruments are subject to change without notice. This report is provided for informational purposes only. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy. Target prices are inherently imprecise and a product of the analyst judgement. As a result of Deutsche Bank’s March 2010 acquisition of BHF-Bank AG, a security may be covered by more than one analyst within the Deutsche Bank group. Each of these analysts may use differing methodologies to value the security; as a result, the recommendations may differ and the price targets and estimates of each may vary widely. In August 2009, Deutsche Bank instituted a new policy whereby analysts may choose not to set or maintain a target price of certain issuers under coverage with a Hold rating. In particular, this will typically occur for “Hold” rated stocks having a market cap smaller than most other companies in its sector or region. We believe that such policy will allow us to make best use

ETF Review

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Claymore Investments

The Basics of Fundamental Index® Investing Indexing has demonstrated its worth as a great investment idea and has provided the essential building block for developing ETFs. However, traditional market capitalization-weighted indexes, such as the S&P/TSX 60 Index and S&P 500 Index, have one structural flaw—they link market price with the weighting of a security, therefore systematically overweight overvalued securities and underweight undervalued securities. Traditional indexing can create periods of extreme volatility and lead to a drag in performance. For this reason, institutional and retail investors around the world are becoming increasingly interested in alternative indexes designed to counter the flaws of market capitalization. Most notably, investors are turning to Claymore and our lineup of Fundamental Index® ETFs, a methodology designed by Research Affiliates in Newport Beach, California, to overcome the basic shortcomings of the traditional index structure. The trend towards alternative indexes is demonstrated in Canada by the increasing popularity of the Claymore Canadian Fundamental Index® ETF. The Research Affiliates Fundamental Index® (RAFI®) methodology selects and allots index security weights based on four key financial measures of a company. These measures are indifferent to its stock price and consequently to its market cap or weighting in an index. The methodology, which is designed to work in inefficient markets, limits exposure to pricing errors and fads.

Award Winning Methodology The concept of fundamental-indexing was first developed in 2005 by Robert Arnott, the chairman of Research Affiliates. In the research published by Research Affiliates in 2005, Rob Arnott demonstrated that the RAFI® methodology produced a 2 per cent greater return than the S&P 500 performance from 1962-2004 with very little to no extra risk. The RAFI® methodology determines index weights of a company based on the following four financial measures to avoid overvaluing or undervaluing stocks: 1. 2. 3. 4. butions)

stock price and index weighting is critical—it eliminates the return drag built into cap-weighted indexes. This change in weighting methodology can add up substantially over time.

The Fundamental Index® concept works globally. It’s more than luck – it’s the intelligence and discipline of the process. The Fundamental Index® methodology is based on the theory that day-to-day, markets and stock prices are not perfectly efficient (individual stocks are overvalued and undervalued from time to time), and that prices revert to their “fair value” over time. Weighting using fundamentals creates a stable anchor to trade against the market’s constantly shifting expectations, fads and bubbles. In fact, this “contra rebalancing” provides a significant source of added value over time.

The Claymore Canadian Fundamental Index ETF Claymore ETFs is the exclusive provider of ETFs based on the FTSE RAFI® Fundamental Index Series in Canada. In March 2011, the Claymore Canadian Fundamental Index® ETF (CRQ) celebrated its 5 year anniversary with impressive results. CRQ offers investors the highlights of a passive investment: low cost, lower turnover, and transparency. Fundamental-weighting decreases exposure to high P/E stocks during episodes of unsustainable P/E expansion, thus avoiding overexposure to the more overvalued stocks. Over the past five years (February 2006-December 2011), CRQ has outperformed the benchmark S&P/TSX 60 Index and the majority of mutual funds in the Canadian equity category. CRQ is the #4 ranked fund (out of 93 funds with 5 year track records) in the Canadian Equity fund category to the end of December 2011 and received a Five-Star rating from Morningstar.

Total Sales—(five-year average total sales) Book Equity Value—(current period book equity value) Cash Flow—(five-year average cash flow) Gross Dividends—(five-year average of all regular and special distri-

By using fundamental factors rather than prices to weight stocks, fundamentalindexing takes advantage of price movements and at rebalance date, reduces the index’s constituents whose prices have risen relative to other constituents, and increases holdings in companies whose prices has fallen behind. When a company’s stock goes up and appreciates faster than its fundamentals do, it’s rebalanced downward. This is effectively a buy-low, sell-high strategy.

“In the past five years, the RAFI® methodology has generated superior performance, even during a period of market turmoil.” Rob Arnott Chairman & CEO, Research Affiliates, LLC. March 2011

3 Year 12.78% 10.31%

Source: Bloomberg as of 12/31/11

5 Year 2.38% 1.57%

In addition to CRQ, Claymore offers Canadian investors four additional ETFs that utilize the RAFI methodology, including

A Fundamental Difference A capitalization-weighted index, such as the S&P 500 Index, weights its components (or companies included in the index) by the total market value of their outstanding shares. The math is simple: number of shares outstanding multiplied by current market price. The impact of each component stock’s price change on the index is proportional to its overall market value, not the fundamental value of the stock itself. In other words, the more a stock increases in price, the higher its weighting in the portfolio.

Claymore Fundamental Index ETF S&P/TSX 60 Index

ETF Name Claymore US Fundamental Index ETF -‐ C$ Hedged Claymore US Fundamental Index ETF -‐ Non-‐Hedged Claymore International Fundamental Index ETF Claymore Japan Fundamental Index ETF -‐ C$ Hedged

Ticker CLU CLU.C CIE CJP

Som Seif President & CEO Claymore Investments, Inc. sseif@claymoreinvestments.ca

On the other hand, in a Fundamental Index® portfolio, stocks are weighted by their fundamental accounting factors rather than market value—these factors include sales, book value, cash flow and dividends. Breaking the link between

ETF Review

Commerzbank

Lucrative Component for Investments In psychology, passive means an experience without doing anything oneself. And this is something that stock market players are increasingly coming to like. A certain degree of passivity can be advantageous in many cases. We are talking about passive investments. Tests have shown that only around one in five actively managed equity funds manages to outperform the benchmark over the long term. So why not just invest in the benchmark in the first place? John C. Bogle is a pioneer in this area - he founded the first index fund in the USA. His investment strategy is both simple and efficient: He aims to acquire all of the listed companies in a country in a package. This allows investors to participate in the performance of the entire market. Nowadays, putting theory into practice just takes a single order. Exchange traded funds (ETFs) allow passive investments to be implemented cheaply. ETFs are enjoying a strong increase in popularity with both retail and institutional investors These financial instruments participate one-to-one in the performance of the underlying, and have a very low cost ratio. As each investor has their own personal preferences, ETFs now offer a wide range of index products and underlyings. In spite of this, however, the aim is to test each index exactly in order to exclude a cluster risk. Weighting a few shares too strongly would negatively impact diversification. ETFs have an open-ended structure. This allows investors to invest in the markets they have selected without a limited duration. A key criterion, which John C. Bogle also describes in his best-seller “Common sense on mutual funds”: “The longer the investment horizon, the lower the deviations in the average annual income are.” That is why investors should not underestimate the timespan for their investment, according to the investment expert. For example, S&P 500 has yielded impressive returns in the past two years. Since the start of the 1990s, the index has brought a total return of 335 per cent or a respectable 7.6 present per year. Our own SPI has even performed slightly better, with annual returns of almost 8 per cent. That means that the capital employed has increased more than five-fold during this investment period. The Swiss “Gesamtmarktindex” (total market index) has 217 members, and a very broad investment base, as is the case for the S&P 500. This is not the case for the DAX which comprises just 30 blue chips. However, in terms of performance (6.4% p.a.), the DAX has no reason to hide itself away. In addition, the key German index also has a high dividend return of 4.6 per cent. This is benefits shareholders if the product selected is based on “total return”, which is generally the case for ETFs, even for price indices. Investors who want to invest in a specific barometer should have a well-founded opinion of the markets. If this is the case, index products are an optimum instrument for retail investors to participate in the markets. They allow risks to be spread rea-

ETF Review

sonably and they are also low priced. Well-established markets in Europe are available with low annual fees of 0.12 per cent and less. “Performance from costs that have not arisen” is an excellent way to summarize ETFs compared to active funds. Investors pay a management fee of 1.5 per cent and more on average for actively managed portfolios - not to mention possible performance-related fees. An important factor: investors should always keep an eye on their own risk management. If the underlying political or economic conditions change - which would not be surprising given the current insecure phase - investors may have to reshuffle.

Dominique Boehler Phone +41 (0) 44 563 69 82 mailto:dominique.boehler@commerzbank.com www.zertifikate.commerzbank.ch www.comstage-etf.ch

iShares Switzerland

Friend or Foe? The Impact of Inflation on Local Currency Emerging Market Bonds Post the 2008 global credit crisis the success of the emerging markets story has been the focus of much commentary. With economic growth rates in these countries continuing to be above that of the developed world, it is entirely understandable that investors continue to look towards these markets in increasing numbers. The noticeably higher yields offered by these bonds is the key feature that attracts investors, but in light of the fact that the cash flows are denominated in the local currency, this exposes the investor to currency risk.

while performing not too badly in their local currencies, did not perform very well in the second half of 2008 when converted into dollars. Since the beginning of 2009, all but one of the local currencies in the index have appreciated against the dollar. Figure 1 – Comparison of cumulative returns in USD and FX appreciation of the local currencies against the dollar

We examine the historical relationship between the local currency exchange rates as measured against the dollar and the level of inflation prevalent in the countries issuing the government debt. We find there is a significant relationship between these FX rates and the level of inflation, which can be loosely explained by the rate setting policies of the local central banks. While the onset of inflation can unduly affect the FX cross-rate against the dollar, the impact is not onedirectional, and for a long-term investor offers the possibility that the impact on returns could cancel out. With the continuing growth of the ETF market, more corners of the investment world are now accessible via a single security. In particular with the recent launch of the iShares Barclays Capital Emerging Markets Local Government Bond ETF, one can gain access to the eight largest and most liquid emerging market local government bond markets. This ETF directly invests in the physical bonds, and aims to track the Barclays Capital Emerging Markets Local Currency Core Government Index. The index comprises approximately 100 fixed-rate local currency government bonds across eight countries and three regions.

Potential Currency Appreciation

When looking at the fundamentals of emerging market countries compared to developed countries, there is potential for the emerging currencies to appreciate against the dollar. This is one of the benefits of the emerging market local currency bond market.

What Makes This Product Attractive?

Firstly, most of the emerging market countries have a very strong balance sheet. Lower debt levels mean that a more flexible monetary policy can be applied in response to the global financial crisis. For many of the developed countries, with relatively high levels of debt, this is not so easily the case. A second reason for emerging currencies to appreciate against the dollar is their higher purchasing power in dollars. As emerging countries grow in productivity, the purchasing power of the dollar in those countries is likely to decline, resulting in an appreciation of their local currencies against the dollar.

Attractive yields

Compared to the yields in other fixed income areas, be it developed market government or investment-grade corporate bonds, the yields of the emerging markets local currency bonds seem very attractive. The only comparative yields in developed markets are those of high-yield bonds. On top of that, there is the potential of further economic growth in emerging markets which could lead to an increase in bond prices in local currency and to the currencies appreciating against the dollar. These factors combined make this a very attractive market as a conservative allocation to the ETF should provide enhanced returns and diversification within a portfolio.

Strong performance historically The performance in emerging market local currency bonds has been quite high in recent years. While one may not expect the very high returns of the year 2009 of more than 21% in the future, the market seems still attractive. The returns will depend on two main factors: 1) the returns of bond prices in the local market and 2) the appreciation/depreciation of the local currency compared to the dollar. With the flight to quality during the global financial crisis, the dollar appreciated significantly compared to most other currencies. The local currency bonds,

A third reason for a potential currency appreciation lies in the favourable demographics of emerging market countries. Working age adults are at a relatively high proportion and many young people are entering the workforce in the coming years. With a growing workforce and a growing number of consumers, emerging countries should achieve additional GDP growth.

Woe Betide Inflation One should of course not forget that currency appreciation or depreciation can – to some extent – be controlled by central banks. Some of the emerging countries have already started in tackling high capital inflows. This can be done in various different ways. Brazil, at the time of writing, has increased its so-called IOF-tax on foreign investments of fixed income products to 6%, thus trying to prevent an increase in capital inflow which can appreciate the currency against the dollar. This is offset by a very high yield to maturity at currently 12.3% and an investor with a 1-year investment horizon will still earn a yield of around 6.3%. Indonesia is imposing capital gains and withholding tax of 20% and Poland has introduced a withholding tax of 10%. In controlling capital inflows all three countries are trying to combat inflation. Historically inflation has been one of the major concerns for investors in the emerging market bond sector. In the past, hyper-inflation has had the capacity to destroy an economy and its ability to meet its debt repayments. Excluding the periods where hyper-inflation was the order of the day, the level of the local exchange rate against the dollar appears to loosely mean-revert around the level of inflation. For active managers, the exact nature of this relationship

ETF Review

iShares Switzerland

Friend or Foe? The Impact of Inflation on Local Currency Emerging Market Bonds is almost certainly a source of alpha, where one would look to exploit the lead/ lag effect of the central bank’s rate setting policy. Whereas for a long-term buy and hold investor this propensity for the exchange rate to over- or undershoot means that this effect may cancel out. The last decade has seen structural changes in both the macro economic policies of the central banks and the stability of a number of the core countries contributing to the Barclays Capital index. This improved landscape is also evident in the strong GDP figures that have been a feature of the last few years. The case study that provides the best backdrop from which to understand the extent of the political and economic reform is Brazil. When Luiz Inácio Lula da Silva was the leading candidate for the presidential election the markets were concerned about how Lula’s policies would impact Brazil’s economy. Having been seen as very left wing in his ideologies, the currency very rapidly depreciated. Successfully winning the bid for presidency, Lula then had the challenge of winning over the confidence of the markets. He renewed the agreement with the IMF and within two to three years Brazil’s poor reputation as a country which was unable to meet its debt obligations to one that was in budget surplus was restored.

debt. For debt issued in dollars, this is not possible. After the defaults of some of the emerging countries, there is now a growing trend in issuing more debt in local currencies rather than in USD. The percentage of domestic debt as part of the overall debt issued has recently increased to around 80% . This leaves the countries less vulnerable to a sudden dollar appreciation, which can increase the cost of servicing its debt quite substantially. The servicing cost is foreseeable and can be much easier matched with debt issued in local currency. To see this one simply needs to look at the different credit ratings that Standard & Poor’s assigns to domestic and foreign debt of emerging countries. The domestic credit rating is either higher or the same as the foreign credit rating.

Interest rate risk

Table 2 - Domestic and foreign country credit ratings

Looking at the relationship between Brazil’s central bank target rate, the level of inflation and the USD/Brazilian Real exchange rate over the last ten years reveals the extent to which the Brazilian authorities have succeeded in their aims during the last decade. emerging countries should achieve additional GDP growth. Figure 2 - Brazilian central bank target rate compared with CPI and the USD-BRL exchange rate

As the price of a bond is inversely correlated to changes in interest rates, we need to ask ourselves what drives the yield curve in emerging market countries. Similarly to developed countries, interest rates change due to actual and perceived changes in inflation and monetary policy intervention. The central banks of emerging market countries will need to weigh the same factors as for developed countries when deciding whether to change the policy rate. These factors are economic growth, inflation and currency appreciation/depreciation. The difference is that growth and inflation rates are usually higher in emerging countries. The start of the appreciation of the Real against the dollar was underway and Brazil was to end the decade as the poster child of the emerging markets sector.

getIt is this conversion from an economy with the historical threat of inflation ting out of control, to one based on orthodox policies and a sustainable central banking infrastructure that offers the most promise for a long-term investor in the iShares Barclays Capital Emerging Markets Local Government Bond ETF.

Main Drivers of Returns The local currency emerging markets bond market behaves somewhat differently from its USD-denominated counterpart. In this section, we highlight the main drivers of returns of the local currency bond market and where the risk factors lie.

Credit risk According to the study in “This time is different” by the economists Reinhard and Rogoff, governments have historically been slightly more likely to default on USD-denominated debt than on debt issued in their local currency. If a government has difficulty repaying its local debt, it will, to some extent, be able to increase local tax and/or depreciate its currency such that it is easier to repay the

ETF Review

FX risk Similar to changes in interest rates, the FX rates fluctuate due to actual and perceived changes in the values of economic growth and inflation. If the growth in a country is low, the currency tends to depreciate. A certain level of growth is seen as healthy, which means that the economy is getting stronger, which in turn leads to currency appreciation. With strong growth often comes high inflation, which is usually higher in emerging market countries than in the developed world. Therefore, a certain level of “acceptable” inflation can often be coupled with currency appreciation and not depreciation. If inflation gets too high on the other hand, a country is usually in trouble and the currency will depreciate. Inflation may spike quickly and is often coupled with a depreciation of the currency. One can observe that in general the rate of currency appreciation/depreciation is mean-reverting around the inflation rate. The FX rate is also affected by interest rate changes. If the interest rate in a country rises, more investors will move their money into bonds in that country to benefit from the higher rates. This leads to currency appreciation and vice versa. The expectation of a future interest rate hike can therefore drive changes in exchange rates.

iShares Switzerland

Friend or Foe? The Impact of Inflation on Local Currency Emerging Market Bonds This is a shortened version of the original paper that can be found at www.iShares.ch. To read the entire paper “Friend or Foe? – The Impact of Inflation on Local Currency Emerging Markets Bonds” contact your iShares Switzerland team (0800 33 66 88), email info@iShares.ch or visit www.iShares.ch.

iShares Switzerland Dr Andreas Zingg andreas.zingg@blackrock.com +4144 2977340 Mathieu Vinson Mathieu.vinson@blackrock.com +41 44 297 73 44

Regulatory Information: BlackRock Advisors (UK) Limited, which is authorised and regulated by the Financial Services Authority (‘FSA’), has issued this document for access in Switzerland only and no other person should rely upon the information contained within it. iShares plc, iShares II plc and iShares III plc (together ‘the Companies’) are open-ended investment companies with variable capital having segregated liability between their funds organised under the laws of Ireland and authorised by the Financial Regulator. For investors in Switzerland: This document is directed at ‘qualified investors’ only, as defined by Clause 10 (3) of the Swiss Act on Collective Investment Schemes (‘CISA’) and Clause 6 of the Swiss Ordinance on Collective Investment Schemes (‘CISO’). Certain of the funds are not registered with the Swiss Financial Supervisory Authority FINMA which acts as supervisory authority in investment fund matters. In respect of these funds, the shares or units of these funds may not be offered or distributed in or from Switzerland unless they are placed without ‘public solicitation’ as such term is defined under the practice of the FINMA from time to time. With respect to those funds that are registered, the FINMA has authorised BlackRock Asset Management Schweiz AG, Claridenstrasse 25, 8002 Zurich, to act as Swiss Representative and JPMorgan Chase Bank, National Association, Columbus, Zurich branch, Dreikönigstrasse 21, 8002 Zurich, to act as Swiss Paying Agent of the Companies. The prospectus, complete and simplified, the Articles of Incorporation, the latest and any previous annual and semi-annual reports of the Companies as well as a list of purchases and sales undertaken on behalf of the Companies are available free of charge from the Swiss representative. Before investing please read the prospectus, complete and simplified, copies of which can be obtained from the Swiss representative. Restricted Investors: This document is not, and under no circumstances is to be construed as, an advertisement, or any other step in furtherance of a public offering of shares in the United States or Canada. This document is not aimed at persons who are resident in the United States, Canada or any province or territory thereof, where the Companies are not authorised or registered for distribution and where no prospectus for the Companies has been filed with any securities commission or regulatory authority. The Companies may not be acquired or owned by, or acquired with the assets of, an ERISA Plan. Risk Warnings: Shares in the Companies may or may not be suitable for all investors. BlackRock Advisors (UK) Limited does not guarantee the performance of the shares or funds. The price of the investments (which may trade in limited markets) may go up or down and the investor may not get back the amount invested. Your income is not fixed and may fluctuate. Past performance is not a reliable indicator of future results. The value of the investment involving exposure to foreign currencies can be affected by exchange rate movements. We remind you that the levels and bases of, and reliefs from, taxation can change. Affiliated companies of BlackRock Advisors (UK) Limited may make markets in the securities mentioned in this document. Further, BlackRock Advisors (UK) Limited and/or its affiliated companies and/or their employees from time to time may hold shares or holdings in the underlying shares of, or options on, any security included in this document and may as principal or agent buy or sell securities. Index Disclaimers: Barclays Capital’ is a trade mark of Barclays Capital, the investment banking division of Barclays Bank PLC (‘Barclays Capital’), and is used by BlackRock Advisors (UK) Limited under licence. With a distinctive business model, Barclays Capital provides corporates, financial institutions, governments and supranational organisations with solutions to their financing and risk management needs. Barclays Capital compiles, maintains and owns rights in and to the iShares Barclays Capital Emerging Markets Local Govt Bond (the ‘index’). iShares Barclays Capital Emerging Markets Local Govt Bond (‘the fund’) is not sponsored, endorsed, sold or promoted by Barclays Capital and Barclays Capital makes no representation regarding the advisability of investing in the funds. iShares is a registered trademark of BlackRock Institutional Trust Company, N.A. All other trademarks, servicemarks or registered trademarks are the property of their respective owners. © 2011 BlackRock Advisors (UK) Limited. Registered Company No. 00796793. All rights reserved. Calls may be monitored or recorded.

ETF Review

UBS

Index Investments that Shine In view of ongoing debt problems, precious metals are attracting increasing investor attention‫‏‬. Index products such as ETFs not only offer low-cost and efficient access to this asset class but can also help to improve portfolio diversification

Risk spreading: Gold exhibits only a low correlation with most standard asset classes -0.3

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The confidence of many investors in the stability of the global financial system has been shattered. The period of recovery from the crisis that shook the financial world in 2008 proved to be short-lived. The subprime crisis that emanated from the US has been succeeded over the past two years by the debt problems experienced by a number of European countries. The debt crisis has left most major financial markets in turmoil. Share prices fell and bond yields for many eurozone countries skyrocketed as currencies perceived as safe havens – the Swiss franc and the Japanese yen, for example – appreciated so much in value that central banks saw themselves forced to intervene. And all the while the gold price hit a series of record highs in rapid succession. This is not the only reason why precious metal investments have started to play a key role for institutional investors and the public sector too. According to the World Gold Council (WGC), for example, central banks’ demand for gold reached just short of 150 tonnes in the third quarter of 2011 alone. During the preceding decades they had tended largely to act as net sellers of it. That precious metals are currently in such high demand is evidence of the fact that the twofold crisis of recent years has marked a sea change. The investment world has undergone a transformation – although the major catastrophe that had been predicted by a number of forecasters did not materialize. This has to do as much with the crises themselves as with the measures chosen by central banks and policymakers in order to deal with them. Rather than opting for debt reduction on a grand scale, they shifted debt mainly from the private to the public sector – this pushed the sustainability of national budgets to the limit, and, in some cases, over it. The US Fed’s innovative response to the crisis and to persistent weak economic growth included buying up government bonds and expanding its balance sheet to an unprecedented extent; the European Central Bank is increasingly having recourse to similar measures. This scenario is favorable to investment in precious metals, and for a variety of reasons. For one, the overall low level of interest rates in connection with central bank bond purchases in many cases results in negative real interest rates on investments perceived as default-free, such as government bonds issued by the US or Germany. The opportunity cost of investing in precious metals has fallen to a lower level than has been seen in years. For another, a number of factors indicate that the strong money supply expansion could lead to higher inflation in the medium to long term. It is inevitable that investors will turn to precious metals and other commodities for protection against unexpected rises in inflation. Gold in particular, having a real value, lends itself to use as a hedge against inflation. With the right type of investment, physical gold, thanks to its low correlation with other asset classes, offers diversification benefits and can potentially improve the risk/return profile of portfolios. The price of gold tends for the most part to move independently of stock prices. For that reason, it has continued to shine even during the most recent stock market turmoil. While many major stock indices plummeted within the span of a few days and the value of the US dollar fell against other currencies, the price of gold has soared from one record high to the next. This shows that precious metals such as gold can help to enrich and stabilize a portfolio. The World Gold Council arrived at the same conclusion in a study covering the period from December 1987 to July 2010. In 18 out of 24 crises and extreme events analyzed, i.e. in 75 percent of the cases, portfolios that included gold outperformed those that did not.

S&P 500 CA C40 D A X 30 FTSE 100 SMI Barclays G lobal Treasury Index Barclays U S Credit Index

Even more than other investors, however, institutional investors are faced with the question of how to make a commodity investment as cost-efficient and effective as possible. Physical precious metals provide a high level of security without any counterparty risk but at the same time also present major problems – for instance, in terms of safekeeping and tradability, as well as trade currency. Moreover, the purchase of physical precious metals such as silver or platinum is subject to value-added tax in many countries. In addition, laws and regulations prohibit many organizations from directly buying physical precious metals. There are various investment instruments available to institutional investors that offer them the opportunity to invest in precious metals, thus enabling them to improve their risk/return profile while providing them with access to this attractive asset class. The available instruments will differ substantially, however, depending on whether a given precious metal investment is implemented using futures, structured products (certificates), physically backed ETCs or ETFs.

Futures: liquid but complex Futures have the advantage of being liquidly tradable. As their maturity is limited, however, expiring contracts must be regularly replaced by contracts with longer maturities. This complicates an investment. On the one hand, this feature of futures markets offers investors the opportunity not only to participate in spot price increases but also to additionally earn a positive roll return if longer term contracts are cheaper than expiring ones (backwardation); on the other, there is the risk of roll loss if the situation is the other way around and the futures are trading in contango. The problem of rolls means also that precious metal investments using futures may not correlate exactly with the spot price. Changes in the futures curve are difficult to predict. Moreover, in order to carry out futures transactions investors must first open a margin account with a bank. For these reasons, investors interested in participating as fully as possible in the spot price appreciation of gold, silver, platinum or palladium should consider other investment options.

Structured products: a wide range of investments, but with issuer risk Investment certificates are one such option. A wide range of structured products allow investors to participate in the spot price performance and also in the performance of precious metal futures, as well as in diversified precious metal and commodity indices. Certificates offer a wide variety of opportunities in this respect. However, as they are – as a rule unsecured – bearer bonds, they always entail an issuer risk. Exchange-traded commodities (ETCs) are meant to offer a way out of this dilemma. These exchange-traded products allow investors to participate in the performance of individual commodities exactly as they would using certificates. ETCs track the performance either of the spot price or of futures. They are, as a

ETF Review

UBS

Index Investments that Shine rule, secured or unsecured debt securities issued by a bank, with government bonds or physical precious metals serving as collateral, depending on the product version. Collateral is used to mitigate the default risk associated with debt securities in the event of issuer bankruptcy. Investors are well advised to pay particular attention to the type of collateral used.

ETFs: the best of both worlds Exchange-traded funds (ETFs) offer even greater security. They combine various advantages of the investment opportunities mentioned above. As ETFs represent special assets, they meet stringent regulatory requirements and provide investors with a particularly high level of security. They are approved by at least one regulatory agency. There is absolutely no issuer risk. ETFs on precious metals invest in them almost exclusively in physical form. ETF investors accordingly participate in the precious metal spot price performance. As a rule, the precious metal bars are physically segregated and stored in a designated high-security vault in Switzerland. Hence, there is no risk of theft, and custody and insurance costs can be kept low. For ETFs on precious metals domiciled in Switzerland, a number of providers offer an in-kind redemption option in Switzerland – that is, the delivery of physical precious metals in exchange for ETF units. This is an additional option available to investors for a fee – alongside selling their units on the stock exchange – should they wish to take it upon themselves to sell their ETF units. However, physical delivery is recommended in extreme situations only. Most providers forego the use of gold derivatives and invest exclusively in physically held gold. To meet the special needs of institutional and high-net-worth private clients, a number of providers offer special unit classes for this investor group in your precious metal ETFs. In addition, currency-hedged versions are also available. By investing in a unit class that features currency hedging, you can eliminate the exchange rate risk of the US dollar – the currency in which gold is traded – versus the Swiss franc or euro. This is not possible when investing in purely physical precious metals. Clients with the EUR as their base currency gain an advantage from currency hedging when the USD is weaker -> the hedged unit class is the better investment choice. In an environment with a strong USD, currency hedging results in a loss -> EUR unit class (without currency hedging) or USD unit class is the better choice. These ETFs in fact combine the advantages of physical investments and securities: They are as secure as genuine precious metals and may be traded as flexibly as equities. They may be traded in multiple trading currencies on SIX Swiss Exchange. Multiple market makers provide good intraday liquidity. In view of the ongoing debt problems, the addition of gold, silver, platinum or palladium should prove to be a sensible approach for many investors – because precious metals can significantly improve a portfolio’s risk/return profile owing to their favorable correlation properties. Thanks to their easy tradability and transparency, as well as the possibility of currency hedging, exchange-traded index products, in particular ETFs on precious metals, provide a good opportunity to participate in the performance of precious metals and to incorporate them into the asset allocation mix.

Clemens Reuter

Tel: +41-44-234 75 19 clemens.reuter@ubs.com

ETF Review

Natixis

Focus on Enhanced Beta Strategies The new passive investing Index strategies that deliver passive market exposure – or beta – have long attracted investors. In response to the systematic rise in volatility across global asset classes, along with weaknesses of market capitalisation indices, a growing number of investors are now exploring new passive approaches. Often called “enhanced beta” or “smart beta” strategies, this innovative indexing is helping investors address today’s need to build more resilient portfolios. Smart beta indices harness the power of technology to deliver repeatable sources of returns that are often based on well-established investment theory. The development of new approaches has led to new betas which even replicate strategies employed by active managers. Investors can often benefit from implementing these strategies at significantly lower costs, reduced governance requirements, high levels of transparency and liquidity, and an improved efficiency of their risk budget. Ossiam, a research-led asset management firm based in Paris, specialises in delivering enhanced beta solutions notably through ETF, including minimum variance and equal weight strategies. Ossiam recently listed the first Minimum Variance ETF on the Swiss Stock Exchange. This offering is designed to reduce portfolio volatility and minimise drawdowns while generating performance above the market capitalisation index over the economic cycle. “A natural question investors ask is: is it possible to maintain a full exposure to the equity market while mitigating its risk? The approach initiated by Ossiam’s research and investment management team intends to obtain an optimized portfolio that includes a selection of stocks where volatility is among the lowest in the investment universe, and historical correlations are moderate enough to allow for risk reduction.” says Isabelle Bourcier, director of development at Ossiam. “Empirical studies show that low volatility stocks have had very attractive performance.” Bourcier also points out the enhanced beta attributes of equally weighted strategies. “The concept aims to provide investors with a more diversified exposure to a given stock market, avoiding the dominance of a small group of stocks.”

The mean-variance framework suggests another definition of passive equity investing: an investment process aimed at providing access to the equity market or one of its segments that does not require return forecasts for the stocks inside the chosen universe. The objective of a “new passive” approach is to shape the portfolio in such a way that the equity exposure gives the best possible riskadjusted performance. Mathematically, the Minimum Variance Portfolio is an optimal portfolio constructed by minimising portfolio variance. The only input that is used by the minimum variance construction is the covariance matrix of the stocks, which generally is estimated on the historical data. Once the covariance matrix is built, various constraints allow the technique to incorporate ex-ante risk management features in the portfolio (e.g., limiting exposure to single names at 4.5%) and specific investor requirements (e.g., long only). Minimum variance strategies are largely shaped by the constraints used in the optimisation, and the right balance should be found between volatility reduction and portfolio diversification. Overall, we believe that a well-designed minimum variance investment approach can be relevant for investors seeking risk-efficient passive equity allocation.

Ossiam investment line-up Ossiam offers the following range of specialty ETFs. • OSSIAM ETF iSTOXX™ EUROPE MINIMUM VARIANCE Reference investment universe: STOXX® Europe 600 • OSSIAM ETF US MINIMUM VARIANCE NR Reference investment universe: S&P 500 • OSSIAM ETF EURO STOXX 50® EQUAL WEIGHT NR • OSSIAM ETF STOXX® EUROPE 600 EQUAL WEIGHT NR

Ossiam’s research team has written a number of research papers on enhanced beta topics which can be found on www.ossiam.com Below we have included a brief summary of their minimum variance piece: Maximising risk efficiency with a minimum variance approach market that serves offshore corporates for trade settlements. By design and through regulation, all these markets trade separately from each other.

Maximising risk efficiency with a minimum variance approach Quote: “A properly designed minimum variance investment approach can be relevant for investors seeking risk-efficient passive equity allocation.” Ksenya Rulik, PhD, Ossiam’s head of Quantitative Research Since Harry Markowitz’s seminal work in 1952, the investment community has embraced the concept of an optimal portfolio. While simple in its objective, building an optimal portfolio is a daunting task requiring implicit or explicit assumptions about future risk and returns. As a consequence, the resulting allocation remains optimal on an ex-ante basis whilst its ex-post performance may be compromised by forecasting errors. The Capital Asset Pricing Model (CAPM) brought an elegant solution to the optimisation problem in the 1960s arguing that the most efficient portfolio is a broad market portfolio using mean-variance optimisation with market-implied forecasts of risk and returns. This idea gained enormous influence and reshaped equity investing over the past 35 years.

ETF Review

Ossiam Research Analysts

Natixis Global Asset Management Switzerland Ksenya Rulik, Bruno Monnier Ossiam Research Analysts

Further information including the fund prospectus can be downloaded from www.ossiam.com.

Natixis

Focus on Enhanced Beta Strategies

The fund’s representative and paying agent in Switzerland is RBC Dexia Investor Services Bank S.A., Zurich Branch, Badenerstrasse 567, 8048 Zurich. The full prospectus, the Key Investor Information, and the annual / semi-annual reports of Ossiam Lux, a Luxembourg-domiciled SICAV, can be obtained free of charge from the Representative together with the initial articles of association of the fund and any subsequent changes to such articles. Investments decision should only be made on the basis of the above mentioned documents. Past performance is no guarantee for future returns and does not take into consideration any commissions charged for purchase, redemption or conversion of shares. The iStoxx Europe Minimum Variance Index is an index initiated by Ossiam and calculated and maintained by STOXX. “The STOXX® Indices and the data comprised therein (the “Index Data”) are the intellectual property (including registered trademarks) of STOXX Limited, Zurich, Switzerland (“STOXX”) and/or its licensors (the “STOXX Licensors”). The use of the Index Data requires a license from STOXX. STOXX and the STOXX Licensors do not make any warranties or representations, express or implied with respect to the timeliness, sequency, accuracy, completness, currentness, merchantability, quality or fitness for any particular purpose of the Index Data. In particular, the inclusion of a company in a STOXX® Index does not in any way reflect an opinion of STOXX or the STOXX Licensors on the merits of that company. STOXX and the STOXX Licensors are not providing investment, tax or other professional advice through the publication of the STOXX® Indices or in connection therewith.

in France. Natixis Global Asset Management’s affiliated investment management firms and distribution and service groups include: Absolute Asia Asset Management; AEW Capital Management; AEW Europe; AlphaSimplex Group; Aurora Investment Management; Capital Growth Management; Caspian Capital Management; Darius Capital Partners; Gateway Investment Advisers; H2O Asset Management; Hansberger Global Investors; Harris Associates; Loomis, Sayles & Company; Natixis Asset Management; Natixis Multimanager; Ossiam; Reich & Tang Asset Management; Snyder Capital Management; and Vaughan Nelson Investment Management. Natixis Global Asset Management also includes business development units located across the globe, including NGAM S.A., a Luxembourg management company that is authorized by the CSSF, and a distribution office in Switzerland (NGAM, Switzerland Sàrl). http://ngam.natixis.com

Natixis Global Asset Management Switzerland Switzerland@ngam.natixis.com 022 817 80 20

Ossiam US Minimum Variance Nr Index is the exclusive property of Ossiam, which has contracted with Standard & Poor’s Financial Services LLC (“S&P”) to maintain and calculate the Index. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC “Calculated by S&P Custom Indices” and its related stylized mark(s) are service marks of Standard & Poor’s Financial Services LLC and have been licensed for use by Ossiam. S&P and its affiliates shall have no liability for any errors or omissions in calculating the Index. The Ossiam ETF US Minimum Variance based on the Ossiam US Minimum Variance NR Index is in no way sponsored, endorsed, sold or promoted by S&P. About Ossiam Ossiam is an affiliate of Natixis Global Asset Management. Headquartered in Paris, France, Ossiam is the first ETF company in Europe to offer access to multiple financial asset classes via a diverse range of specialty ETFs and funds, based on quantitative and fundamental analysis. Its team has extensive experience in fund management, ETF structuring, fundamental and quantitative research and trading. www.ossiam.com About Natixis Global Asset Management Natixis Global Asset Management is one of the 15 largest asset managers in the world based on assets under management. Its affiliated asset management companies provide investment products that seek to enhance and protect the wealth and retirement assets of both institutional and individual investor clients. Its proprietary distribution network helps package and deliver its affiliates’ products around the world. Natixis Global Asset Management brings together the expertise of multiple specialized investment managers based in Europe, the United States and Asia to offer a wide spectrum of equity, fixed-income and alternative investment strategies. Headquartered in Paris and Boston, Natixis Global Asset Management’s assets under management were €525 billion as of September 30, 2011. Natixis Global Asset Management is part of Natixis. Listed on the Paris Stock Exchange, Natixis is a subsidiary of BPCE, the second-largest banking group

ETF Review

Detlef Glow, Head of Lipper EMEA Research, Lipper

Are ETFs in Trouble?

Exchange traded funds (ETFs) have found themselves under ever more scrutiny from regulators and market participants this year and expectations are that new rules for the sector are just a matter of time. It’s tempting to think of ETFs as unwilling victims of new regulation, but to my mind, ETFs have much to gain. The point is that it isn’t just regulators who are seeking improved transparency on fund holdings and on the use of derivatives by mutual funds, crucially it is end-investors too. And once the fog has cleared, they might come to see ETFs — with daily published portfolios and clearer statements on the use of derivatives in general — as a role model for all kinds of mutual funds. The discussion surrounding ETFs could leave you with the feeling that they are unregulated products; that fund promoters can go wild when creating new products and with the use of derivatives in the portfolios. In reality though, ETFs follow the same local and/or international legislation of any other mutual fund; the EU UCITS regime for example. So, why all the fuss around ETFs? In my opinion, there is nothing uniquely wrong with these products as they are using the same tools and techniques used by other funds under the UCITS regime. Some authorities, however, have raised questions as ETFs grow in popularity among professional investors. A deeper look into the questions posed shows that the points made by the critics are not only applicable to ETFs, but to any mutual fund.

Concern I wonder if the popularity of ETFs, which have sold well in tough market conditions, has made them a useful conduit to raise more general concerns about the mutual fund industry as a whole. Of course, some of the concerns mentioned by market authorities are reasonable points to make, but they apply far more broadly; derivatives in general and swaps in particular are nothing new, and alongside stock lending, are widely used within the asset management industry. Yes, ETFs have been a sales success, but for all the fanfare, they still account for less than 10 percent of assets under management in the global fund industry. In what is a well diversified range of products, to my mind this does not constitute a structural risk. So perhaps ETFs have become a victim of their own success, as regulators jump on the most popular fund products in recent times to highlight concerns about the complexity of some fund types and about the use of derivatives and stock lending in the investment industry more widely. I think there can be no doubt all this attention will lead to new regulations for the all mutual funds. But contrary to the expectations of most market observers, I think this new regulation will change the landscape for “regular” mutual funds much more than the environment for ETFs. After all, relatively speaking, ETFs have a useful head-start on transparency. The sector won’t escape unscathed. Some asset classes like commodities are only investable via the use of swaps under the UCITS directive and investment here is likely to face a shake-up. The ETF sector is also likely to find itself subject to a redefinition of funds into complex and non-complex products as regulators seek to better safeguard retail investors; the performance dynamics of products like short or leveraged long ETFs, after all, are beyond the understanding of the average private investor.

ETF Review

Detleft Glow - Head of Lipper EMEA Research -Lipper detlef.glow@thomsonreuters.com

Worldtrack

Managing ETF Portfolios Worldtrack

Multi-Asset ETF Portfolios

Following newly drafted rules and guidance by ESMA, the European ETF market will now enter a new ‘applications-growth’ phase. This will be driven by improved education, professional advice and ever more sophisticated tools and users. This stage represents a significant opportunity for product development, which is likely to result in the emergence of many types of actively-managed ETF solutions.

We expect that high net worth investors will be empowered with personalised and segregated ETF portfolios managed directly by experts. For the retail or self-directed investor, we are likely to see the introduction of out-of-the-box solutions such as multi-asset ETFs or Funds of ETFs, which will be easy to access and distribute. The benefits of all these products will include improved cost efficiency, performance and liquidity when compared to traditional methods. These innovations and developments will be a timely blessing for investors who, having lost faith in financial products, face the future prospect of low and unstable returns. The diagram below illustrates ranges of ETF solutions we expect in the future.

Risk management in 3D ETF providers’ ever-increasing commitment to transparency and reporting is setting new standards for the industry. It is now possible to virtually look through fund holdings in almost real-time. This enables portfolio managers to obtain a complete 360 degree view of fund structures. For example, they are able to access related information on underlying indices, counterparties, collateral and custodians and thereby have a comprehensive measure of investor safeguards. At a portfolio level, this provides an unprecedented degree of clarity which we would describe as “Risk management in 3D”. The table below illustrates example of features that require professional due diligence.

Anthony Christodoulou, Founder anthony.christodoulou@world-trackers.com +44 203 402 2200

Investing in HD Equally powerful in the evolution of ETFs are technical advances which allow replication across ever more systematically weighted or rule-based indices covering a wider range of markets. This is having a profound effect on asset allocation techniques and, as a result, portfolios can now be constructed with ever increasing precision within pre-defined targets of risk and return. Without wanting to overstretch the analogy, this is what we see as “Investing in HD.” The diagram below illustrates the process of designing and stress testing ETF portfolios.

ETF Review

Amundi ETF

How to Implement Hedging Strategies using Equity and Fixed Income ETFs This Document may only be addressed to qualified investors as such term is defined by the Swiss Collective Investment Schemes Act of 23 June 2006, its implementing ordinances and the FINMA Circular on public offering of funds. It is not to be distributed to the general public, private customers or retail investors in any jurisdiction whatsoever.

Today, investors can implement a number of asset allocation strategies to help them to navigate through increasingly challenging market conditions, and may use ETFs as effective tools to mitigate portfolio risks. In this article, we examine how ETFs can offer solutions to help investors manage risk in fixed income, taking into account inflationary and interest rate risk. On the equity side, we examine recent innovation which helps to reduce currency risk.

Using Fixed Income ETFs for Hedging Purposes Recent developments in the fixed income market have been a major driver of innovation in ETF products as demand for these exposures has accelerated. Developments in ETF products in the fixed income asset class have really taken off in the last four years. Assets under management, invested in over 200 products, have tripled from just under EUR 14bn at the end of 2007 to around EUR 43bn at year end 20111. Investors can now choose from exposures to a wide range of maturities in government bonds, long or short indices in the US or the Euro Zone, corporate bonds, and different ratings awarded by the main rating agencies (Fitch, Standard & Poor’s and Moody’s), etc.

Addressing inflationary risk A number of inflation-linked bond ETFs are available to investors anticipating a scenario in which inflationary pressure is rising. A variety of products, covering geographic areas including the US, the Euro Zone and the UK, can be accessed. In the case where an investor’s expectations on inflation are higher than those of the market, positions can be taken in inflation-linked ETFs to mitigate this risk.

Using fixed income ETFs to reduce interest rate risk Among the more recent innovations in this asset class, short fixed income ETFs have opened up opportunities for investors who are exposed to long indices but expect a fall in interest rates and, therefore, negative returns. For example, an investor exposed to a Eurozone government bond index can seek protection against a potential fall by purchasing an ETF exposed to the corresponding short index, which provides the daily inverse performance (positive or negative). The combination of the two ETFs can allow the investor to offset a loss if the long index falls.

Performances

106

EuroMTS Investment Grade Broad All MaturiCes Index Short EuroMTS Investment Grade Broad All MaturiCes Index Yield to Maturity (right axis)

4.40

104

4.20

102

4.00 3.80

100

3.60 98 3.40 96

3.20

3.00

2.80

Source: Bloomberg, Amundi IS This hypothetical example is for illustration purposes only. This document does not in any way constitute an offer, investment advice, recommendation (personal or otherwise) or a solicitation to purchase, invest or convert AMUNDI ETF fund shares or units, nor should it be interpreted as such under any circumstances. Past performance is not a guarantee or a reliable indication for future returns. Returns may increase or decrease as a result of currency fluctuations.

Example of Short index methodology Daily performance Short index = 2 x Effective Central Bank rate – Daily performance Long index – Repo rate Level T Index Short strategy index

100 100

Performance T+1/T -5% +5%

104.5 94.5

Performance T+2/T +4.5% -5.5%

For instance, investors can seek protection and even draw benefit from a widening of the core and peripheral spreads. Combining an ETF on ex-AAA countries with a short exposure on Eurozone government bonds can provide hedging when spreads widen.

Amundi ETF Institutional Sales Amundi Switzerland benoit.garcia@amundi.com +41 22 316 01 51

ETF Review

Level T+2

As seen over the last months in the Euro Zone, the spread between what are commonly referred to as “Core” and “Peripheral” countries has become pronounced. Some ETFs offer exposure to country rating indices, enabling investors to choose to invest in highly-rated (for instance, AAA countries) or on the contrary, in lower-rated Eurozone member states. This kind of product has gained recognition by investors, and is now used to implement sophisticated hedging strategies.

Amundi ETF Institutional Sales Crédit Agricole Cheuvreux lrochehintzy@cheuvreux.com +33(0)1 41 89 76 68

95 105

Performance T+2/T+1 +10% -10%

Hedging against spread widening

Benoit Garcia

Deutsche Bank, 2011 ETF Market Review & 2012 Outlook, at 30 December 2011

Level T+1

The inverse performance effect is daily. The performance of the short index over a period longer than 1 day can therefore differ by -1 times the performance of the long index over the same period. This illustrative and theoretical example is not in any way a prediction of future scenarios and does not guarantee future output. It is deliberately simplified and does not take into account the cost of short selling relating to (for one day) the underlying index’s basket of securities (costs measured by the variable “repo”).

Laetitia Roche-Hintzy

4.60

Yield to maturity (%)

108

30 /1 2/ 30 200 9 /0 1 28 /201 /0 2/ 0 31 201 0 /0 3/ 30 201 /0 0 4/ 31 201 0 /0 5/ 30 201 /0 0 6/ 2 0 31 /0 10 7/ 31 201 0 /0 8/ 30 201 /0 0 9/ 2 0 31 /1 10 0/ 30 201 /1 0 1/ 31 201 0 /1 2/ 2 0 31 /0 10 1/ 28 20 /0 11 2/ 31 201 1 /0 3/ 30 201 /0 1 4/ 2 0 31 /0 11 5/ 30 201 /0 1 6/ 31 201 1 /0 7/ 2 0 31 /0 11 8/ 30 201 /0 1 9/ 31 201 1 /1 0/ 30 201 /1 1 1/ 2 0 31 /1 11 2/ 20 11

The use of ETFs in Europe has become more widespread and sophisticated thanks to rapid product development over the past 10 years. In 2000, from a handful of products offering access to mainly developed country equity markets, ETFs have now become a major industry in their own right representing the main asset classes, geographic regions, sectors, investment themes and strategies.

Example of hedging strategy on the Euro Zone (31/12/2009 – 31/12/2011)

Amundi ETF

How to Implement Hedging Strategies using Equity and Fixed Income ETFs Example of S & P 500 EUR Daily Hdg strategy index compared to the S & P 500 index in USD. (31/12/2009-31/12/2011)

Example of widening strategy on the Euro Zone (30/12/2009-30/12/2011)

Comparison of index performance 31/12/2009 -‐30/12/2011

125.00 EuroMTS Lowest-‐Rated Investment Grade Government All-‐Maturity Index

Short EuroMTS Broad Index

CumulaLve PnL Strategy (right axis)

106

3.00%

120.00

2.50%

105

S&P 500 NTR (USD) Index S&P 500 Daily Hedged Euro Net TR Index

2.00% 104

115.00

1.50% 103 1.00% 102

110.00

0.50%

101

0.00% -‐0.50%

100

105.00

-‐1.00% 99 -‐1.50%

100.00

98 -‐2.00% 97

-‐2.50%

95.00 96 30/12/2009

30/01/2010

28/02/2010

31/03/2010

30/04/2010

31/05/2010

30/06/2010

31/07/2010

31/08/2010

30/09/2010

31/10/2010

30/11/2010

-‐3.00% 31/12/2010

90.00 Dec-‐09

A closer look at the widening strategy on the Euro Zone over one month (29/06/2010-29/07/2010)

1.20%

104 EuroMTS Lowest-‐Rated Investment Grade Government All-‐Maturity Index Short EuroMTS Broad Index CumulaLve PnL Strategy (right axis)

103

1.00%

10 20

7/ /0

10 20

7/ /0

20 7/

10 20

/0 26

10 20

/0 25

10 20

7/ /0

20 7/

10 20

/0 20

10 20

/0 19

10 20

7/ /0

10 20 16

10 20

/0 15

10 20

/0 14

10 20

/0 10

10 20

7/ /0

10 20

20 7/

20 04

10 20

/0 03

10 /0 02

0.00%

0.20%

0.40%

100

0.60%

101

0.80%

102

Protection Against Currency Risk in Equity Investments Holding exposures with the aim of benefiting from the growth potential in stock markets across the globe requires investors to take into account the impact that different currencies in their underlying investments may have on returns. Investors may wish to manage the currency risk themselves through the use, for example, of future contracts, but this strategy can incur costly margin calls and provide less efficient hedging.

Mar-‐10

Jun-‐10

Sep-‐10

Dec-‐10

Mar-‐11

Jun-‐11

Sep-‐11

Dec-‐11

There are now over 1000 ETFs available in Europe2 providing investors with a complete tool box for meeting long-term objectives, such as portfolio diversification, as well as short-term objectives, including tactical allocation, cash management and, as we have seen here, more sophisticated hedging strategies to protect a portfolio in challenging market conditions. The ETF offering has become so rich that they can provide a cost efficient alternative to other types of products traditionally used for implementing such strategies.

About Amundi ETF Amundi ETF designates the ETF business of Amundi Investment Solutions (the management company of Amundi ETF Funds), part of Amundi, one of the world’s leading asset managers. This wide ETF range is based on three main principles: product quality, innovation and cost efficiency. Amundi ETF offers a wide range of products on the main European stock exchanges (NYSE Euronext Paris, Deutsche Börse, Borsa Italiana, SIX Swiss Exchange and the London Stock Exchange). As of 31 December 2011, the Amundi ETF range offers over 100* products with over 400 cross-listings and registrations, representing assets under management of EUR 6.5 billion3. * The Funds taken into account for this number may not be authorized for distribution in all countries. It is the investor’s responsibility to ensure that he is authorized to invest in a Fund. For the AMUNDI ETF Funds that have been authorized for public distribution by FINMA : Swiss Representative: CACEIS (Switzerland) SA, 7-9 chemin de Précossy, Nyon. Paying Agent in Switzerland: Crédit Agricole (Suisse) SA, 4 quai Général Guisan, Genève. The Key Investor Information Document (“KIID”) and the prospectus, or the funds regulation as well as the annual and semi-annual financial reports are available from the Swiss Representative free of charge.

ETFs can offer a packaged solution to mitigate this risk through the use of indices combining exposure to a given equity market and the currency hedging. In general, these ETFs offer monthly currency hedging but recent innovation has now introduced more finely tuned daily currency hedging which can reduce this risk to close to zero. For example, through the use of USD forward contracts due on a rolling basis at the end of the month, the hedging is adjusted daily to reflect movements in the relevant index in USD. Through this daily adjustment, the hedging ratio thus obtained can be said to be near perfect as the risk of over- or under-hedging remains very limited.

For the Amundi ETF Funds that have not been approved by the Swiss Financial Supervisory Market Authority (FINMA) as a foreign collective investment scheme pursuant to article 120 of the Swiss Collective Investment Schemes Act of 23 June 2006 (the “CISA”) : Accordingly, the Amundi ETF Funds may not be publicly offered in or from Switzerland and neither this Document nor any other offering materials relating to the Amundi ETF Funds may be made available through a public offering in or from Switzerland.

Source : Deutsche Bank, 2011 ETF Market Review & 2012 Outlook, at 30 December 2011

Source : Amundi Investment Solutions

ETF Review

BlackRock

European ETP NNA

ETF Review

BlackRock

European ETP NNA

ETF Review

BlackRock

European ETP NNA

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