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Trading Ideas: 13 October 2011: Reducing portfolio risk

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Reduce risk, short sovereign debt and increase cash  level We reduce equity weight by selling the Dax.

We short sovereign debt.

We reduce Euro exposure and increase currency  diversification…


In the current times of elevated risks we reduce the risk in our portfolio and focus  on principal protection over return generation for now. Our absolute return  portfolio has done well with 2.1% since the last note (in particular benefiting from  the positions in Stoxx Utilities and MSCI Emerging markets short) and with 1.6%  YTD  (see page 9).  We expect the recent rally in equities/risky assets not to be  sustainable and reduce the net equity weight to a low level of 10% by selling our  10% Dax position. Dax earnings are particularly depending on Global and Chinese

GDP growth which is likely to  come under pressure. We increase our “Short  IBOXX Euro Sovereigns Eurozone TR Index” from 10% to 15%. In our view, the  sovereign bonds of the Eurozone countries currently don’t have an attractive risk  return profile in comparison to smaller non-Euro DM bond issuing countries or  some EM countries (see page 6). We increase our cash position and reduce Euro  exposure by buying the FED Funds Effective Rate TR Index with 5% weight.  

We  reduce the portfolio risk because of the elevated risks for the economy and  financial markets, in particular in the Eurozone:  The crisis has reached a systemic  dimension  according to the ECB president  and sovereign default risks are  elevated. The Eurozone crisis has continuously escalated over the last two years  and is likely to escalate further, in our view. The contagion risk to other countries  beyond Greece remains elevated. The European banking  system is fragile and in  need of a major recapitalisation. The Eurozone financial markets strongly depend  upon political and central bank intervention. In addition, economic sentiment  indicators signal a slow down and uncertainty for 2012E GDP growth is very high.

For the coming two quarters our economists forecast a mild recession for the  Eurozone and expect Chinese GDP growth to decelerate significantly. The number  of company profit warnings in Europe may well increase over the next weeks and  companies are likely to give cautious outlook statements for 2012E.

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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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