EFTA01475132.pdf

Deutsche Asset & Wealth Management Americas Edition October 2015 CIO View Global economic landscape Coping with emerging-market tremors EFTA01475132 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Nine positions Our key forecasts Pace of global economic growth is likely to slow down for a while. Emerging markets' (EM) growth advantage has been eroded. Commodity-exporting countries hurt by low commodity prices. + 3.5 %* + 3.8 %** Global gross-domestic-product (GDP) growth 2016; Deutsche AWM forecast as of *9/21/15 and **6/16/15 U.S. Federal Reserve Board (Fed) postpones rate hike and the pace of subsequent increases will be slow. Rate hike coming soon .. Fed and low inflation may force the European Central Bank (ECB) to continue easing beyond September 2016. Oct. 2016 Private equity and hedge funds should benefit from the capitalmarket environment. Oil prices climb as slowly as output capacity contracts. Earnings forecasts revised down slightly for developed markets and significantly for emerging markets. -20% -3 to -5% Asset allocation of our balanced model portfolio: Commodities 1.0% 10.0% 10.0% 50.0% 50.0% Alternatives* Equities 39.0% EFTA01475133 39.0% Deutsche AWM forecast as of 9/21/15 for September 2016: $55 per barrel of West Texas Intermediate (WTI) 12-month earnings forecasts for developed economies cut by 3-5% and by more than 20% for EM. Deutsche AWM forecast as of 9/21/15 Fixed income * Alternatives are not suitable for all clients. Important terms are explained in our glossary. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/ or expected returns will be achieved. Investments come with risk. Investments can fall as well as rise and investors may not get back the amount originally invested at any point in time. Investors capital may be at risk. Allocations are subject to change without notice. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. Source: Deutsche Asset & Wealth Management Investment GmbH, as of 9/24/15 2 CIO View I Americas Edition I October 2015 EFTA01475134 Nine positions Focus Letter to investors Investing in binary times Nervousness pervades the markets. China's restructuring and the central banks' policy dilemmas are unprecedented. But the reality is better than it appears to be. Investors should think twice about taking an autumn break. After the rather busy months of August and September, the traditionally turbulent October is unlikely to allow investors to catch their breath. Why are markets so unsettled? Let me try to explain. This bull market has lasted for six and a half years. Some have sought and found parallels, in terms of technical chart analysis and valuations, with the years of 2000 and 2007, when stock exchanges were also at turning points. This naturally raises the question of comparability. Does history repeat itself, or does it only rhyme? has, in a sense, been one — but not wanting to be invested either should the subsequent market fall really happen. Although Maybe what makes those three periods comparable is that investors each time had to face unprecedented, thus incomparable situations: In 2000 investors, who had been happy to pay triple-digit price-to-earnings ratios for internet companies, saw these valuations collapse as concerns mounted over the real economic merits of this new technology. And at the end of 2007, investors were faced with the question whether the most recent driver of growth, credit-based consumption, could ever take up that role again. Today, the big question is whether the Chinese authorities and central banks will cope with two major new challenges. On the one hand, there is a nation of over one billion people which, in current U.S.-dollar terms, has more than quadrupled its share in the global economy within the last 15 years; but which has also rapidly built up debt and now seeks to radically change its business model. On the other hand, there are the central banks which have more than tripled their balance EFTA01475135 sheets since the financial crisis and now have to work out how to run them down again. Will both China and the world's central banks manage to meet their very different objectives? Nobody can tell. Investors are faced with the dilemma of not wanting to miss any buying opportunity — and every setback since 2009 some clouds may linger, the situation remains good. Just recently, the Fed dodged the start of its very own turnaround once again. Although its decision may have been well reasoned, the Fed might end up as the driven, not the driver. Also, how readily can we really wean ourselves off the easy money drug? The Fed postponement has at least served to create such negative market sentiment that higher interest rates might even, for once, be welcomed. Wouldn't they? Investors are currently divided on many things: Will developed economies drive emerging markets or will the latter impede the first? Will Western consumers buy enough to compensate for globally slack levels of investment? Will consumer gains from cheaper oil compensate for the energy producers' woes? And, finally: is the actual situation better than it appears to be? These questions were on the agenda of our recent quarterly strategy meeting. In our view, the global economic recovery is intact, despite a more muted outlook for some markets. This is likely to open up a number of opportunities, just in time for the traditional year-end rally. If, of course, history chooses to repeat itself, at least in this respect. Asoka Wehrmann, Chief Investment Officer of Deutsche Asset & Wealth Management (Deutsche AWM) and Member of the Deutsche AWM Executive Committee The big picture Investment traffic lights EFTA01475136 Asset-class perspectives Portfolio High-conviction ideas Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. It is not possible to invest directly in an index. F = forecast. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analyses that may prove to be incorrect. CIO View I Americas Edition I October 2015 3 EFTA01475137 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Focus Emerging markets under observation In early 2015 the Eurozone was still seen as a risk to global economic growth, but investor concerns are now focused on the emerging markets. The Eurozone dominated the headlines until recently, with Greece's problems seen as both a potential existential threat and also as emblematic of Europe's inability to find common solutions. However, equity markets and the euro suffered only little harm, the latter even recovering in the second quarter. Perhaps this was because investors had not allowed the Greek drama to distract them from the progress made by the periphery Eurozone economies: structural reforms had helped them to significantly reduce current-account and budget deficits. However, more recently, only a very modest devaluation of the Chinese renminbi managed to send international equity markets sharply down (see Macro Outlook). Investor concerns have thus shifted towards emerging markets. Real GDP trends in the developed and emerging economies give us a clue as to the reasons of this shift. Growth in the developed economies has accelerated since 2012 but has been declining in the emerging economies since 2010. This development has helped boost developed equity markets in the last four years; by contrast, emerging-market (EM) equities were trending sideways until this August, when they fell in the wake of the renminbi devaluation. Although emerging economies are still, in aggregate, growing faster than developed economies, investors are increasingly wondering about the quality of this growth. They are looking back to the outbreak of the financial crisis in 2007, which marked a structural turning point for the world economy when both consumption and capital expenditure collapsed in the developed economies, leading to a sharp recession. It was at this point that the first cracks appeared on the exportdriven growth model of many emerging markets. Many governments and companies — often controlled by the state in emerging markets — greatly expanded capital expenditure to stabilize their economies. As a result the investment rate — i.e. capital expenditure in relation to GDP — soared. And this, in turn, resulted in a positive contribution to global economic growth by emerging markets and in particular by China — even in 2009, the worst year of the crisis. 1 International Monetary Fund: World Economic Outlook, as of EFTA01475138 04/2015 Reduction in trend growth From 2010 onwards, however, emerging-market growth has decelerated despite a very high investment rate. The International Monetary Fund (IMF) has concluded that their trend growth is declining. For the period from 2008 to 2014, the IMF trend-growth estimate for emerging markets was an annual rate of 6.5%. For 2015 to 2020, the IMF forecasts only 5.2%.1 The slowdown may be exacerbated by the lack of structural reforms in many emerging markets during the last decade. The ultra-expansionary monetary policy of the developed economies prompted many investors to invest in emerging markets in part because they offered an interest-rate advantage. Investors felt reassured by the fact that these economies had also apparently weathered the financial crisis well. In reality, however, this favorable financing environment simply helped emerging markets to veil their growing economic weakness. One example is China. Companies in the steel, cement and solarenergy sectors received plenty of loans for investment, creating substantial overcapacity. Furthermore, this pattern of economic development resulted in a significant increase in the debt owed by the EM corporate sector, not just in nominal terms but also in relation to GDP. If, however, the growth generated by this leveraged investment remains meager, interest payments will become a burden. The risk of credit defaults and bankruptcy is likely to rise. The combination of high investment rates, rising debt and declining growth has made emerging markets much more vulnerable than before. Economic reforms are crucial. India and Mexico are among those emerging markets which have already set out down the reform path. China has also started trying to transform itself. Recent state intervention on the capital markets has, however, reminded us how difficult it is for the Chinese Communist Party to come to terms with market-driven economic reforms. Countries implementing structural reforms should become attractive to investors, although risks will remain. Equities and bonds from economies which have yet to face up to the necessity of reform deserve a valuation discount. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. F = forecast. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. 4 CIO View I Americas Edition I October 2015 EFTA01475139 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Real economic growth year-on-year change in % 10 8 6 4 2 0 -2 -4 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Developed markets Emerging markets Source: International Monetary Fund: World Economic Outlook, as of April 2015 Diminishing growth differential Before the financial crisis, emerging markets enjoyed impressively high growth rates. They even prevented the world economy from sliding into recession in the crisis year of 2009. Since 2010, however, the growth differential between developed and emerging markets has been shrinking. Growth in the emerging markets is simultaneously trending downwards. Development of investment rates 35 in % of GDP World (GDP growth) The world economy is growing at a moderate rate. But decelerating emerging-market growth has become a matter of concern. 30 3.5 %* (2016 F) EFTA01475140 * Deutsche AWM forecast as of 9/21/15 25 20 We expect global growth to remain moderate and likely weaker. This reflects two forces: a weaker than expected recovery in advanced economies, and a further slowdown in emerging economies. Christine Lagarde, director of the International Monetary Fund, speech on September 1, 2015. 15 2006 2007 2008 Developed markets 2009 2010 Emerging markets Source: International Monetary Fund: World Economic Outlook, as of April 2015 2011 2012 2013 2014 2015 Emerging markets (GDP growth) Productivity growth in the emerging markets has fallen sharply since 2010. This has contributed to their growth slowdown. 4.5 %* (2016 F) Low investment efficiency The combination of a high investment rate and worsening growth dynamics can indicate that capital is inefficiently invested in emerging markets. Difficult structural reforms are necessary to make investment more efficient. But these reforms are painful, making it hard for governments to win broad acceptance for them. * Deutsche AWM forecast as of 9/21/15 Past performance is not indicative of future returns. It is not possible to invest directly in an index. No assurance can be given that any forecast or target will be reached. F = forecast. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analyses that may prove to be incorrect. CIO View I Americas Edition I October 2015 5 EFTA01475141 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas The big picture Our strategic forecasts The Fed decided to postpone its first rate hike. Its decision was not focused on the U.S. economy alone but on the deceleration of growth in emerging markets. Asoka Wehrmann, Chief Investment Officer Economic data Asoka Wehrmann, Capital markets GDP growth in percent (year-on-year) 2015 (F) United States Eurozone United Kingdom Japan China World World (GDP growth) 3.2 % 3.5 % (2015F)(2016F) We revise our global growth forecast for 2016 down by 0.3 percentage points. Global growth will be particularly hampered by decelerating growth in emerging markets. Inflation in percent (year-on-year) 2015 (F) 2016 (F) 0.1 1.2 Eurozone 1.5 1.2 China 1.4 1.6 United States 0.7 0.8 Japan F refers to forecasts. Our forecasts are as of 9/21/15. 0.5 1.8 United Kingdom A continuing economic recovery and the fading effect of low oil prices should boost inflation in the Eurozone next year. 6 CIO View I Americas Edition I October 2015 Past performance is not indicative of future returns. It is not possible to invest directly in an index. No assurance can be given that any forecast or target will be reached. Forecasts are based on assumptions, estimates, opinions and hypothetical EFTA01475142 models or analyses that may prove to be incorrect. Investments come with risk. The value of an investment can fall as well as rise and your capital may be at risk. You might not get back the amount originally invested at any point in time. MSCI AC Asia ex Japan Index3 MSCI EM Latin America Index3 Germany (DAX)1 9,571 11,400 (Current*) (Sept 2016F) The recent sell-off was caused by low growth figures from China and renminbi devaluation. The DAX suffered severe losses and is now moderately valued compared to other European markets. 2.3 1.4 2.5 0.8 6.8 3.2 2016 (F) 2.4 1.6 2.2 1.2 6.0 3.5 United States (S&P 500 Index) Europe (STOXX Europe 600 Index) Eurozone (EURO STOXX 50 Index) Germany (DAX)1 United Kingdom (FTSE 100 Index) Japan (MSCI Japan Index) MSCI Emerging Markets Index3 Equity markets (index value in points) Current* 1,943 347 3,076 9,571 5,936 889 808 497 1,920 Sept 2016(F)2 2,160 390 3,600 11,400 6,500 1,020 EFTA01475143 790 510 1,700 A(96)** 13 16 21 19 13 17 1 6 -9 EFTA01475144 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Capital-market yields (sovereign bonds) in percent Current*** United States, 2-year United States, 10-year United States, 30-year Germany, 2-year Germany, 10-year United Kingdom, 10-year Japan, 2-year Japan, 10-year Germany, 10-year 0.59% 0.75% (Current***)(September 2016F) Currencies The ECB is likely to expand its quantitative-easing (QE) program due to low inflation. The 10-year German Bund yield should rise only modestly. Current*** EUR vs. USD USD vs. JPY EUR vs. CHF Commodities in U.S. dollars Current* Crude oil (WTI) Gold Silver Copper (LME) Aluminum (LME) Crude oil (WTI) 46 (Current*) 55 LME = London Metal Exchange, WTI = West Texas Intermediate (Sept 2016F) Shale-oil production and the oil-rig count in the United States have fallen due to low oil prices. At the same time, demand for oil is on the rise. The outcome: higher oil prices. Past performance is not indicative of future returns. It is not possible to invest directly in an index. No assurance can be given that any forecast or target will be reached. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analyses that may prove to be incorrect. Investments come with risk. The value of an investment can fall as well as rise and your capital may be at risk. You might not get back the EFTA01475145 amount originally invested at any point in time. F refers to forecasts. Our forecasts are as of 9/21/15. * Source: Bloomberg Finance L.P., as of 9/22/15 ** Expected total return includes interest, dividends and capital gains where applicable *** Source: Bloomberg Finance L.P., as of 9/28/15 1 Total-return index (includes dividends) 2 Our equity-market forecasts are as of 9/23/15 3 in U.S. dollars CIO View I Americas Edition I October 2015 7 46 1,125 15 5,078 1,589 Sept 2016 (F) ♦(%)** 55 1,250 19 6,700 1,800 20 11 29 32 13 GBP vs. USD USD vs. CNY USD vs. JPY 120 130 (Current***) (Sept 2016F) The inflation target of the Bank of Japan is still far off. QE should therefore be continued. The high rate differential between the United States and Japan is likely to further weaken the yen. 1.12 120 1.09 1.52 6.37 Sept 2016 (F) ♦(%)** 1.00 130 1.13 1.49 6.65 —11 9 3 EFTA01475146 -2 4 0.68 2.10 2.88 -0.26 0.59 1.77 0.01 0.36 Benchmark rates in percent Sept 2016 (F) 1.35 2.25 2.90 -0.20 0.75 2.15 0.00 0.35 United States (federal funds rate) Eurozone (refi rate) United Kingdom (repo rate) Japan (overnight call rate) United States (federal funds rate) 0 - 0.25% 0.75 - 1.00% (Current* )(Sept 2016F) The Fed postponed its first rate hike due to decelerating growth in China and volatile capital markets It might dare to take the first step in December. Current* 0-0.25 0.05 0.50 0.10 Sept 2016 (F) 0.75-1.00 0.05 0.75 0.10 EFTA01475147 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Investment traffic lights Our tactical and strategic view 1 to 3 months up to September 2016 Equities* Regions United States Europe Eurozone Germany United Kingdom Japan Emerging markets Asia ex Japan Latin America Sectors Consumer staples Healthcare Telecommunications Utilities Consumer discretionary Energy Financials Industrials Information technology Materials Style Small and mid cap *as of 9/22/15 **as of 9/28/15 Source: Deutsche Asset & Wealth Management Investment GmbH Fixed income** Rates U.S. Treasuries (2-year) U.S. Treasuries (10-year) U.S. Treasuries (30-year) U.K. Gilts (10-year) Eurozone periphery German Bunds (2-year) German Bunds (10-year) Japanese government bonds (2-year) Japanese government bonds (10-year) Corporates EFTA01475148 U.S. investment grade U.S. high yield EUR investment gradel EUR high yieldl Asia credit Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. 8 CIO View I Americas Edition I October 2015 Emerging-market credit Securitized / specialties Covered bondsl U.S. municipal bonds U.S. mortgage-backed securities Currencies EUR vs. USD USD vs. JPY EUR vs. GBP EUR vs. JPY GBP vs. USD Emerging markets Emerging-market sovereigns Alternatives* Infrastructure Commodities Real estate (listed) Real estate (non-listed) Hedge funds Private equity2 1 to 3 months up to September 2016 EFTA01475149 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Europe (equities) 07/2014 09/2015 Europe's equities are still supported by sound economic and financial data such as credit growth, business surveys and earnings dynamics. However, we continue to stay neutral on European equities and favor Eurozone equities which are set to benefit more not only from relative U.S.-dollar strength, but also from low oil prices. Japan (equities) 07/2014 09/2015 We upgrade Japanese equities to overweight. The market has now fallen by around 15% since August, probably making it a good time to take advantage of its underlying merits: the soundest regional earnings dynamics, rising dividends and investment, plus major reforms in corporate governance which have started to bear fruit. Emerging markets (equities) 07/2014 09/2015 After revising expected emerging -market 12-month earnings growth down to zero, we downgrade EM equities to underweight. Despite the sharp sell-off, there still could be further setbacks, particularly in Latin America where consensus estimates of 2016 earnings growth look unrealistic. Financials (equities) 07/2014 09/2015 We remain overweight on financials. Balance sheets continue to recover, dividend payments are rising and valuations remain moderate in historical terms. In the short run, monetary policy should also strongly affect financials. Their recent softness could be reversed if the Fed started its interest-rate turnaround before year-end. U.S. investment grade 07/2014 09/2015 We return to neutral on U.S. investment grade. Risk premiums have widened to such an extent that they may offer a sufficient buffer against defaults. The Fed's postponement of its first rate hike also argues against an underweight. Additionally, the excess supply of the summer months is now leveling off. EUR high yield EFTA01475150 07/2014 09/2015 We upgrade EUR high yield to overweight. Over the medium term, this segment should be supported by low default rates, good ratings, high demand, the low share of the energy and mining sectors and historically high market risk premiums. However, Brazil and automotive issuers could dampen sentiment temporarily. Covered bonds 07/2014 09/2015 We downgrade covered bonds to underweight. These were not left unscathed by rising volatility and, moreover, are likely to be impaired by fears that the ECB might reduce its coveredbond purchases. Short-term, the market is also suffering from substantial new issuance, which has exceeded demand. Hedge funds 07/2014 09/2015 This market environment should allow hedge funds to outperform. Nervous, sideways-trading markets are particularly suited to equity-market-neutral strategies and discretionarymacro strategies, taking advantage of regional divergences. The tactical view (one to three months) Equity indices: positive view neutral view negative view Fixed income: For sovereign bonds, unchanged yields and Fixed income and exchange rates: The fixed-income sector or the exchange rate is expected to perform well We expect to see a sideways trend We anticipate a decline in prices in the fixed-income sector or in the exchange rate The traffic lights' history is shown in the small graphs. A circled traffic light indicates that there is a commentary on the topic. The strategic view up to September 2016 Equity indices, exchange rates and alternative investments: The arrows signal whether we expect to see an upward trend ( ), a sideways trend ( ) or a downward trend ( ) for the particular equity index, exchange rate or alternative asset class. a sideways spread trend and denotes rising yields, falling yields. For corporates, securitized /specialties and emerging-market bonds, the arrows depict the option-adjusted spread over U.S. Treasuries, if not stated differently. The arrows' colors illustrate the return opportunities for EFTA01475151 long-only investors. positive return potential for long-only investors limited return opportunity as well as downside risk high downside risk for long-only investors 1 Spread over German Bunds 2 These traffic-light indicators are only meaningful for existing private-equity portfolios Further explanations can be found in the glossary. CIO View I Americas Edition I October 2015 9 depicts an expected widening of the spread, a spread reduction. EFTA01475152 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Joe Benevento and Joern Wasmund, Global Co-Heads of Fixed Income/Cash Fixed-income market perspectives In search of leadership — should we be worried about U.S. corporate bonds? Markets hate both surprises and uncertainty. The Fed's decision not to raise rates did not turn out to be a surprise. But it did not deal with the problem of uncertainty. Janet Yellen did not want to make a policy mistake but will be well aware that postponing policy decisions can have adverse consequences, too. So, as we return to contemplating the likely timing of the next Fed rate hike, should investors in U.S. corporate bonds be concerned about its implications? We believe not. Spreads for both U.S. investment-grade and U.S. high-yield bonds had moved out quite significantly before the Fed meeting. In U.S. high yield this was largely driven by the energy and basic-resource sector, where we expect to see more defaults. Outside of this sector, the outlook is much better. Companies will benefit from having previously pushed maturities further out and, in general, have very limited refinancing needs in 2016 and 2017. Interest expenses relative to earnings are low and new refinancing costs in various sectors will still be lower than maturing coupons. Empirical evidence about the performance of U.S. high-yield bonds after a federal funds target rate hike is somewhat mixed. A recent Citibank analysis found some evidence of a reduction in risk premia, particularly when U.S. Treasury rates had also risen meaningfully in a short period of time.1 Citibank also believes that the same was true for U.S. investment grade in five of the six hiking cycles since 1980, with risk premia here coming down on average by around 20 basis points (bps). The lesson from this is that investors should not remain frozen like a deer in headlights but look at possible opportunities on the basis of past experience as summarized above. To put it briefly, the macroeconomic environment is likely to be more 1 Citi Research: Credit Strategy Q3, 2015 — Buy or Sell? The state of the credit markets? As of 9/17/15 U.S. high-yield and investment-grade spreads, 2014-15* 600Spreads in basis points 500 400 EFTA01475153 300 200 100 0 1/2014 4/2014 7/2014 U.S. high-yield spreads U.S. investment-grade spreads U.S. high-yield and investment-grade spreads had already been widening in the run-up to the latest Fed meeting. But history suggests that risk premia can fall once a tightening cycle gets underway. Sources: Bloomberg Finance L. P., Thomson Reuters Datastream, Deutsche Asset & Wealth Management Investment GmbH, as of 09/2015 * Spreads are over U.S. Treasury yields 10/20141/2015 4/2015 7/2015 relevant than the timing of the next Fed rate hike — and, while we do not expect U.S. growth to go through the roof, we expect a slow process of improvement which is likely to benefit U.S. corporates. So, while Fed leadership would be welcome, investors may already want to look beyond the current impasse. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. Investments come with risk. The value of an investment can fall as well as rise and your capital may be at risk. You might not get back the amount originally invested at any point in time. 10 CIO View I Americas Edition I October 2015 EFTA01475154 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Henning Gebhardt, Global Head of Equities Equity-market perspectives Emerging markets — expensive no more, but not yet cheap enough either Courage on the stock exchange is sometimes rewarded. EM equity investments made in October 1998 — the rock bottom of the Asian crisis — had increased sixfold by 2007. China's integration into the world economy and the commodity boom in its wake had strongly boosted the stock exchanges of Brazil, Russia, India and China. Investors focusing on established markets had to live with a comparably meager return of roughly 100%.1 In mid-2010, the favorites changed. As measured by the MSCI Emerging Markets Index, EM investors could, at best, preserve their capital employed. Recent market adjustments have left the former EM star performers again far behind established markets. What's next? China's economic growth is likely to stay well below the doubledigit growth rates achieved in the past. Partly to blame is the shift from "Made in China" to "Consumed in China". This is also reflected in a reduced demand for raw materials, which in turn partly explains the significant decline in commodity prices. Since no reversal is in sight, commodity-exporting EM will continue to struggle. Many companies in the emerging markets have used the lowrate policy of major central banks to finance growth via higher leverage. This increase is worrying and raises concerns about their vulnerability, when the Fed changes track. As measured by the ratio of net debt to earnings (EBITDA), EM corporations have been running higher debts than those in the industrialized world for roughly one year: Their debt ratio has increased sevenfold to 1.4 within eight years. 1 Performance as measured by the MSCI Emerging Markets Index and MSCI World Index, total return in U.S. dollars in the period from March 1999 to October 2007, Source: FactSet Research Systems, Inc. Sources: FactSet Research Systems Inc., Deutsche Asset & Wealth Management Investment GmbH. Debt measured as net financial liabilities in relation to earnings before interest, taxes, depreciation and amortization, 2007-2015, as of 11/2015. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. Forecasts are based on assumptions, estimates, EFTA01475155 opinions and hypothetical models that may prove to be incorrect. Investments come with risk. The value of an investment can fall as well as rise and your capital may be at risk. You might not get back the amount originally invested at any point in time. CIO View I Americas Edition I October 2015 11 For 2016, analysts currently expect significant emergingmarkets earnings growth of 11%. This seems over-optimistic, particularly the 25% for Latin America. However, after the most recent sell-off, EM equities are trading at a price-to-book (P/B) ratio of only 1.2. This valuation is in line with the crisis levels of 2001 and 2008 (see chart). The potential for further EM equity losses should thus be limited. We do not expect China to drag the world economy into recession. Downwards adjustments of earnings estimates in the U.S., European and Japanese markets, which have also suffered, should therefore be markedly lower than in the EM. Over the coming year, these developed markets may therefore offer a higher recovery potential. Trading near their historic lows 0.50 1.00 1.50 2.00 2.50 3.00 3.50 P/BV Asian crisis Dot-com bubble bursts Global financial crisis Euro crisis 1.24 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 MSCI Emerging Markets Index — price-to-book value (P/BV) ratio Low price-to-book valuations should help limit future emerging -market-equities downside risk. EFTA01475156 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Americas Commodities 1.0% Portfolio Our asset-class allocation in a balanced portfolio Traditional asset classes Within the core part of our balanced portfolio, we cover traditional liquid assets such as equities, fixed income and commodities. The chart shows how we would currently design a balanced portfolio, including alternative asset classes.1 Equities We stay generally positive on developed market equities, where returns could reach low double-digit levels on a 12-month horizon. However, we are now in a mature market phase and periods of high volatility are likely as valuations return to historical levels. This means that tactical changes in allocations may be necessary. We are much more cautious on emerging markets, with Asian markets affected by their trading links with China. Latin American equities are likely to fare worse, due in part to problems surrounding Brazil. Fixed income When the Fed starts to raise rates, most likely in December, core yields will rise — if not by very much. European and Japanese bond markets will remain well-supported by accommodative policy from ECB and Bank of Japan (BOJ). We are cautious on U.S. investment grade but continue to see opportunities in high yield. Emerging-market bonds may offer high levels of carry but this will be accompanied by increased risk, at least in the short term, making a highly selective approach essential. Emerging markets' increased levels of U.S.-dollar-denominated debt are a concern. Commodities Oil prices are forecast to increase from current low levels, but only slowly — we forecast a price of $55 per barrel WTI on a 12-month horizon. Demand for oil has so far proved resilient to slower emerging-markets growth, but the market remains in oversupply, although there are already signs that U.S. shale output could moderate. Gold is likely to trade in a tight range determined by U.S.-dollar strength; its "safe haven" appeal would be boosted by a prolonged period of market turmoil. We see only limited opportunities in commodities, so keep portfolio allocations at low levels. EFTA01475157 1 Alternative investments are dealt with separately in the next chapter. Alternatives are not suitable for all clients. 12 CIO View I Americas Edition I October 2015 Sources: Regional Investment Committee (RIC), Deutsche Asset & Wealth Management Investment GmbH, Deutsche Bank Trust Company Americas, as of 9/24/15. This allocation may not be suitable for all investors. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. Fixed income Equities Developed markets United States Europe Japan Pacific ex Japan Emerging Markets Asia ex Japan Latin America Fixed income Credit Sovereigns Emerging markets Cash Commodities Commodities Alternatives Alternatives suggested weight 26.5 % 46.0 % 12.0 % 5.5 % 2.0 % 4.0 % 3.0 % 1.0 % 2.5 % 31.5 % 2.0 % 3.0 % 1.0 % 10.0 % 10.0% EFTA01475158 2.0 % 3.0 % Alternatives 50.0% 26.5% 12.0 % 5.5 % 2.0 % 31.5 % 3.0 % 1.0 % 2.5 % Equities 39.0% EFTA01475159 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Long or short, Larry Adam? Six market views from our Chief Investment Officer for Wealth Management in the Americas and Chief Investment Strategist for Deutsche AWM Americas Will equity-market investors have to learn to live with volatility? LONG We still expect modestly rising equity markets but also believe that volatility is here to stay — the events of the last few months have demonstrated how equity-market reversals can quickly erode year-to-date gains. Equity valuation multiples also tend to decline after the Fed rate hike and we think that valuations will gradually move back towards historical averages. So opportunities will exist but investors will have to learn to live with some sharp upward and downward market moves. Are emerging markets likely to remain particularly vulnerable? LONG Emerging markets were expected to suffer in the run up to any Fed rate-hike decision and they have. But less expected was how fears about Chinese growth would spill over into a more general concern about the long-term health of emerging markets — a concern compounded by the impact of low commodity prices on certain economies. The implication is that even if the future path of Fed policy becomes much clearer, emerging markets' problems will not be resolved quickly and they will remain vulnerable to reversals. Will China's impact on developed equity markets vary? LONG The U.S. has the least exposure with an estimated 3% of profits of companies in the S&P 500 Index related to China. Germany and Japan are more exposed, with around 20% of index profits linked to China. Here, some cut in earnings-pershare estimates looks prudent in response to China's troubles. But all calculations as to the impact of various Chinese growth scenarios must be speculative as we cannot anticipate the second-round effects or the possible policy responses. Will core sovereign bonds always be a safe haven? SHORT Nothing should ever be taken for granted. Consider for example how there was only a small decline in German sovereign-bond yields earlier this year in response to a sharp equity-market correction. High measures of value at risk (VaR) meant that switching into bonds did not help portfolio managers reduce risk; they may also have been put off by negative yields. Other issues may also come into play in other sovereign-bond markets — for example, concerns over Chinese sales of U.S. EFTA01475160 Treasuries in an attempt to preserve the value of the Chinese yuan Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. CIO View I Americas Edition I October 2015 13 Are you still broadly positive on U.S. high yield? LONG Global growth concerns and low oil prices have cast a shadow over U S. high yield in 2015. In particular, parallels have been drawn to the telecoms defaults of 1998/99. But the two periods are not totally comparable. Energy has a less significant weight in the index now than telecoms did then. High volumes of new issues in recent years have also helped push out near-term maturities and have decreased current refinancing risks. This is certainly one to monitor, but we remain broadly positive on U.S. high-yield debt. Will the euro's role as a funding currency continue? LONG Over the last year, markets have realized that the ECB's long-term commitment to a very dovish monetary policy makes the euro an attractive funding currency. As a result, even increased market concerns over Greece earlier this year were supportive. With ECB quantitative easing (QE) expected to continue for some time, the euro's role as a funding currency will continue. However, it is still not clear whether the euro would remain a genuine safe-haven currency through a period of deeper financial stress. The U.S. dollar would probably reassert its historical safe-haven role, helped by the depth and liquidity of the U.S. Treasury market. LONG represents a positive answer SHORT represents a negative answer EFTA01475161 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Portfolio Our view of non-traditional asset classes Alternatives portfolios Due to their distinct characteristics, we take a differentiated look at selected liquid and illiquid alternative investments. Infrastructure 30.0% Real estate Illiquid alternatives Illiquid hedge funds 20.0% 30.0% Private equity 20.0% Liquid alternatives Macro/CTA* Illiquid alternatives Real estate Most global macro managers have generated positive returns this year. They have also weathered the recent pickup in market volatility better than most other liquid-alternatives strategies. More specifically, we feel that the persistent trend towards monetary-policy divergence within developed economies and between developed and emerging economies will continue to be the primary determinant of the trading environment faced by global macro managers over the next 12-month period. U.S.dollar strength has also forced a very diverse set of adjustment paths on emerging markets. This should continue to generate a healthy pipeline of opportunities both from a directional and arbitrage standpoint through local-currency and rates trends. Liquid alternatives Event-driven/ relative value Equity 35.0% 30.0% long/short In the United States, robust rental growth, rising occupancies EFTA01475162 and the rolling-over of leases signed during the downturn to higher current market rates should provide meaningful support to cash flow and property values. With the exception of a small number of markets, this year should see a further acceleration of the office prime-rental recovery in Europe, with growth here forecast to peak at around 3.5% per year in 2016 and 2017. Finally, China's housing sector, a key factor behind slower Chinese growth, is now turning positive. Shenzhen housing prices started to recover first and the positive momentum is now spreading to Shanghai and Beijing. Private equity 12.5% Credit 22.5% Macro/CTA* Sources: Deutsche Asset & Wealth Management Investment GmbH, Deutsche Bank AG Filiale London, as of 9/24/15. This allocation may not be suitable for all investors. In our balanced model portfolio, we currently allocate 10% to alternative investments (see "Portfolio"). Please refer to the following interview for the regulatory requirements for the offer or sale of alternative investments. * Commodity Trading Advisor 14 CIO View I Americas Edition I October 2015 In the United States, fundraising conditions remain favorable for high-quality general partners. Debt availability is still good, even though increasing macro volatility has led to a slightly tighter financing market. Investment underwriting discipline however remains paramount in the current environment. The outlook for private equity is also positive in Europe with valuations similar to U.S. levels and greater potential economic upside. Uncertainty around China may however result in lower deal activity in the second half of 2015, with a significant slowdown across the wider Asian region. Higher volatility may make limited partnerships more reluctant to commit more funds. Private-equity acquisition multiples remain above their 10-year average for large deals in the United States and for all deal sizes in Europe. EFTA01475163 Nine positions Focus The big picture Investment traffic lights Asset-class perspectives Portfolio High-conviction ideas Long or short, Hamish Mackenzie? The Head of Infrastructure, Europe & Debt, looks at this interesting sector Are valuations for large unlisted infrastructure businesses rising? LONG Large, mature infrastructure businesses are currently attractive investments for institutional investors and sovereign wealth funds seeking yield. This, combined with high levels of "dry powder" (available funds) in large, global infrastructure funds and some aggressive capital deployment has pushed up valuations at the top end of the market, lowering implied returns. Investors may want instead to focus on medium-sized investments and more complex situations, where there is less competition for investment. Should Environmental, Social and Governance (ESG) issues always be considered? LONG Investment decisions that may result in environmental or other social issues pose a reputational risk to investors and ultimately to shareholder returns. The Deutsche Asset & Wealth Management Infrastructure team therefore evaluates potential ESG issues as part of risk management throughout the investment process. These may cover a wide range of topics — from energy, water, emissions, and waste management to labor and health & safety — and need to be considered across the whole investment lifecycle, so we can be confident about an investment's longevity. Will new regulations impact European life insurance companies' infrastructure investments? LONG The introduction of Solvency II in 2016 will affect how European life insurance companies consider infrastructure equity as an asset class. Recently, the European Insurance and Occupational Pension Authority (EIOPA) proposed reducing capital charges for infrastructure investment, something which could lead to insurance companies allocating more funds to infrastructure. There is still some uncertainty surrounding Solvency II, as proposed regulatory requirements are yet to be fully phased in, but we believe that the introduction of more stringent regulatory requirements is likely to further support, rather than discourage, these companies' investment in infrastructure. Can infrastructure investment be fully de-linked from political risk? SHORT Business exposure to political developments can vary significantly from one country (and sector) to another. Such risk can have a particular impact on infrastructure-investment returns, as revenue here can be dependent on a government EFTA01475164 contract or concession, or a regulatory framework. A mature regulatory framework, supported by an independent regulator — seen in some European core markets (e.g. the U.K.) — can offer a degree of protection from political events and thus greater visibility on investment returns. Full delinking of returns from political risk is not always possible but a detailed understanding of regulation, developed through experience and often active long-term relationships with regulators, as well as of the political economy of the host country, is fundamental and can help mitigate such risk. Are megatrends important in the short term for infrastructure investment? LONG Aside from technological change, several other megatrends (for example involving social and environmental change) are likely to influence infrastructure investment in the medium to long term. But investors should be thinking about these factors now, due to the present-value implications of these longer-term trends. LONG represents a positive answer SHORT represents a negative answer Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. Offers and sales of alternative investments ar