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Trading Ideas: 24 February 2011: Further Risk Reduction

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IDEA of the month:  Further Risk Reduction

Two weeks ago we had already  reduced the equity weight in our index portfolio from 30% to 10%. With this note we further reduce the equity weight and the risk in our index portfolio. We sell the 7.5% Utilities stake and sell the 5% stake in the …..


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LPX Major Market Private equity Total Return index. Instead, we buy Eurostoxx50 short with 5% and put the remaining 7.5% back into the EONIA benchmark. The European equity market has fallen by 4% over the last week as a reaction to the unrest in Libya and the Arab region. News of potential Saudi Arabian protests was one key catalyst for the market weakness yesterday because of the importance of Saudi Arabia for the oil price. The Brent Oil price has moved up by 23% YTD. Our commodity strategists argue that US-$120/bbl (for WTI) is the level where global growth could come under pressure. Major protests against rising Food prices have been observed in India and efforts to organize protests have been observed in China. Rising commodity prices and rising inflation are a key risk to the economy.

Many Investors have the Commodity price spike from 2008 in mind. Our economists argue that the world could relatively fast return to the 5%-6% global inflation rates of 2008. Back then, the big financial crisis and the subsequent Great Recession stopped inflation in its tracks. They also think there is good reason to expect that this time will be different.

In the current geo-political environment we see more downside risks than upside chances for equity markets in the short term and therefore reduce our equity weight from 10% to -2.5% due to our short positions. In addition, the Q4 reporting is half through and has not been a positive trigger. Sales number came in strongly, but company margins in Q4 suffered already from higher input costs. We keep our relative trade Long commodities vs. Short EM equities. The long held correlation of commodities to equity and FX markets has recently broken down as the commodity market has shifted focus to physical drivers.

TI 25022011 1

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Source: Trading Ideas ETF: Ideas and Flows – Deutsche Bank AG

rated “BB”. 13% of the basket is rated “B” and this is one issuer, Venezuela. So the country
with the biggest weight in the index is also the country with the lowest rating. While
Venezuela is clearly a high risk country with 13% weight in the index, the remaining countries
are clearly more solid (for more details on the “MSCI USA TRN” ETF see ETF: Ideas and
Flows, 25 November 2009).
“db x-trackers Currency valuation” ETF 20% weight
In currency markets the majority of the participants are “liquidity seekers”. “Profit seekers”
are a minority in currency markets and can generate returns on the expense of the “liquidity
seekers”. Profit-seekers can generate returns by buying “under-valued” currencies and
shorting “over-valued” currencies. A widely used measure to determine “under-valued” and
“over-valued” valuation for currencies is the concept of “Purchasing Power Parity” where
“fair” exchange rates are calculated by comparing the prices of a basket of goods in different
countries. The ETF “db x-trackers Currency valuation” buys each quarter the three currencies
with the “lowest” valuation out of the universe of the G10 currencies and sells the three
currencies with the “highest” valuation using the PPP concept. In addition, the correlation to
equities and bonds is very low and therefore the currency valuation index helps to diversify
our ETF portfolio. The index is currently long in the US Dollar, New Zealand Dollar, and the
British Pound whereas the index is short in the Swiss Franc, Swedish Krona and the
Norwegian Krona. Risks to the investment include that currencies movements become less
rational again. Especially increased uncertainty about the economic development could
trigger a flight back into expensive currencies like the Swiss Franc (for more details on the
“db x-trackers Currency valuation” ETF see ETF: Ideas and Flows,12 June 2009).
Trading portfolio
We have kept the portfolio unchanged this time. Earlier we bought the “Emerging Markets
Liquid Eurobond Euro Index” ETF with 10% weight and sold the “db x-trackers DJ Stoxx
Global Dividend 100 ETF”. The portfolio targets absolute return and has the EONIA index as
benchmark.

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