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NZD HEDGED GLOBAL FIXED INTEREST FUND LYDIA SERAFIM DECEMBER 2016

NZD HEDGED GLOBAL FIXED INTEREST FUND | 1

FIXED INCOME RETURNS

• Going down in credit quality

was a winning trade in

2016, as the ‘junkiest’ parts

of fixed income markets

performed best

• Tight spreads / elevated

prices in these lower

quality sectors reduce the

margin for error (caution is

warranted)

.


Source: Morgan Stanley Investment Management

PERFORMANCE AS AT 31 DECEMBER 2016

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NZD HEDGED GLOBAL FIXED INTEREST FUND

1m 3m 6m 1 Year 2 Year 3 Year

NZD Hedged Global Fixed Interest Fund 0.44% -1.88% -0.74% 5.19% 4.19% 6.27%

Barclays Global Aggregate Index Hedged NZD 0.39% -2.02% -1.07% 5.82% 5.14% 7.10%

Relative 0.05% 0.14% 0.33% -0.63% -0.94% -0.83%

Colchester 0.26% -2.17% -1.46% 4.76% 3.92% 5.98%

Barclays Global Treasury GDP Weighted by Country 0.38% -2.61% -1.96% 4.95% 5.03% 6.81%

Relative -0.12% 0.44% 0.50% -0.19% -1.10% -0.83%

Morgan Stanley 1.00% -1.34% 1.10% 7.36% 5.03% 6.97%

Barclays Global Aggregate Corporate Index 0.85% -1.79% 0.46% 7.98% 5.54% 7.36%

Relative 0.15% 0.45% 0.64% -0.62% -0.51% -0.39%

Wellington 0.23% -1.56% -0.37% 4.00% 4.40% 6.38%

Barclays Global Aggregate Securitised Index 0.17% -1.49% -0.35% 4.01% 4.42% 6.17%

Relative 0.06% -0.07% -0.01% -0.01% -0.02% 0.21%

• Colchester outperformed by 44bp over the quarter. From a rates perspective, underweights in Europe, the UK and the US

contributed to returns. In currencies, overweights to the British Pound and South African Rand also contributed.

• Morgan Stanley outperformed by 45bp over Q4. An overweight to Financials, specifically Banking within the IG space, was a

positive contributor to returns over the period. Positioning within Utilities detracted over the quarter

• Wellington underperformed by 7bps. Duration and yield curve positioning detracted from performance over Q4, as did security

selection within agency pass-throughs

PERFORMANCE ANNUAL ATTRIBUTION


4

NZD Hedged Global Fixed Interest Fund: as at 31 December 2016

Q4 1 Year

NZD Hedged Global Fixed Interest Fund -1.88% 5.19%

Benchmark (Barclays Global Aggregate hedged to $NZD) -2.02% 5.82%

Relative Return 0.14% -0.63%

Decomposition of Relative Return Q4 1 Year

Benchmark differences - difference between Barclays Global

Aggregate and the weighted manager benchmarks -0.25% -0.34%

Manager alpha 0.40% -0.25%

Residual 0.00% -0.03%

Relative Return 0.14% -0.63%

Benchmark Mismatch –

negative over Q4 and the

year, as JGB’s continued to

rally (structural underweight)

Manager Alpha – MSIM &

Colchester significantly

underperformed (see

previous slide)


PORTFOLIO POSITIONING – AS AT 31 DECEMBER 2016


MARKET OUTLOOK

SOURCE: AMP CAPITAL, MANAGERS

Bond Markets:

> US rates spiked up post election on expectations of Trump enacting growth friendly fiscal policy – but rate rises to

remain capped

> Rates began drifting lower in mid January (despite better economic data) on concerns Trump may implement

restrictive trade policies (“border adjustment tax”)

> Eurozone data continues to improve, however ECB is expected to continue to provide accommodative monetary

policy through 2017

> Government bond yields therefore expected to be reasonably well behaved

> Uncertainty is elevated however, with general elections in various countries and further potential

banking crises (flowing through to the sovereign) posing risks

Credit markets:

> Despite ongoing record issuance in the corporate sector, credit continues to hold up

> Markets may not be fully pricing in the effects of lower corporate tax rate in a Trump administration

> A cut in the corporate tax rate from 35% to ~20% will be positive for corporate balance sheets all else equal,

as more cash flow becomes available to service debt

> This may lead to less issuance going forward, as the tax shield benefit of debt would be reduced at lower tax

rates, effectively increasing the after tax cost of debt

> Investors have begun to push back on aggressive covenant terms, particularly in the investment grade space

> In particular, investors are demanding ‘make whole premiums’ are re-inserted into bond indentures (to

compensate for early call backs)

> A potential one-time repatriation tax holiday for US companies holding overseas corporate cash has the potential to

reduce corporate issuance, as funds brought back are used to pay down debt

> Yields are edging below 10 year averages, but not at extreme levels – potential to tighten further given better

growth prospects and points above

| 6 NZD HEDGED GLOBAL FIXED INTEREST FUND

MARKET OUTLOOK

High Yield / Bank Loans:

> Lower quality outperformed in 2016

> CCC rated loans (25.6%) and bonds (33.1%) outperformed their BB rated counterparts by 18.7% and 21%

respectively

> On a risk adjusted basis, we anticipate going up in credit quality will be better in 2017

> Declining default rates and improving macroeconomic conditions should sustain positive returns in leveraged credit,

but tight spreads and high bond prices make the sector vulnerable to volatility

> Highly levered firms continue to lever up

> Current valuations favour Bank loans over HY

> European CLOs/ABS – lack of liquidity and unfavourable growth prospects has meant this segment remains unloved

– however valuations are better than US, so worth keeping an eye on

ABS:

> ABS issuance continues to grow whilst trading volumes fall, raising concerns about market liquidity

> FELP student loan downgrades from Moody’s have been finalised

> Approximately 8% of securities on ‘Watch’ were ultimately downgraded to sub-investment grade, far lower

than market expectations

> Prices have held up in the face of downgrades, with further spread tightening possible –good for our

mandates (Wellington and TCW)

CMBS and agency / non-agency mortgages:

> Underwriting standards appear to have morphed in the CMBS sector, with originators now ‘barbelling’ higher quality

loans with lower quality loans to hit average LTV targets (ahead of risk retention implementation that occurred in

Dec)

> This is leading to large variations across loan qualities within collateral pools – caution is needed

> Majority of non-agency MBS coupons are floating rate and indexed to Libor, providing a hedge against a potential

rising rate environment

> The sector remains attractive, as home prices continue to increase and loans amortise more quickly


APPENDIX

CORPORATE HEALTH

* SOURCE: AMP CAPITAL AS OF SEPTEMBER 30, 2016. Q4 DATA NOT AVAILABLE.

INCREASING LEVERAGE HAS NEGATIVELY IMPACTED CORPORATE

HEALTH*

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• Low interest rates

have encouraged

corporates to lever

(first week of 2017

was fourth largest

issuance week on

record)

• Whilst increased

leverage flags as

the greatest risk,

other measures of

corporate health

have also trended

down


Souce: AMP Capital. As at 30 September 2016 (Q4 data not available as yet)

MARKET OUTLOOK AS AT 31 DECEMBER 2016

| 10

Source: JP Morgan. As at 31 December 2016

Yields

continue

to hover

around

their 10

year lows

Fixed

income

may

struggle

in a

period of

sustained

rate rises

– only

High

Yield

insulated

by

duration

effects


MARKET OUTLOOK AS AT 31 DECEMBER 2016

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Source: JP Morgan.

HY Energy

spreads have

compressed

post Q1 2016

HY spread

& default

rates are

below 30

year

average


PRODUCT OVERVIEW .


Targeted returns

Suggested timeframe

Distributions

Liquidity

88bps above the Fund’s benchmark

(Barclays Global Aggregate Index, $NZ Hedged)

Three years

Hedging Foreign exposures fully hedged

Half yearly

Daily, Sell Spread

Key guidelines Tracking error of 150 - 200bps

Universe of securities

Global Government Bonds, Global Credit Securities & Securitised

SOURCE: AMP CAPITAL

FUND STRUCTURE


SOURCE: AMP CAPITAL. AS AT 30 JUNE 2016

FD NZ International

Bond Fund

Global Government

(63%)

Global Credit (22%)

Securitised (15%)

Colchester

Morgan Stanley

Wellington

KEY INVESTMENT PROFESSIONALS

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Michael Dennis

Fixed Income Analyst

BBus, CFA

Michael joined AMP Capital in July 2014 as an Analyst within the Public Market Solutions team. Michael works closely with portfolio

managers in undertaking manager research, selection and monitoring. Prior to joining AMP Capital, Michael was an Analyst at IOOF,

focusing on fixed income manager research. He holds a Bachelor of Business (Finance and Economics) from the University of

Technology, Sydney. Michael is also a CFA charterholder, and is a member of the CFA Institute and the CFA Society of Sydney.

Lydia Serafim

Senior Portfolio Manager, RIL Diversified Fixed Income Fund

BCom (Hons) (Economics)

Lydia is the Senior Portfolio Manager for the fixed interest funds within the Public Markets Solutions team within the Multi-Asset Group.

Her single sector funds form part of the Future Directions, Responsible Investment Leaders, MySuper, AMP Life, NMLA, ipac and

Experts Choice range of diversified portfolios. Asset sectors covered include Australian and global government bonds, global credit,

inflation linked bonds, bank loans and high yield credit. Lydia internally transferred to the Multi-Asset Group in 2008 from AMP Capital’s

Fixed Interest team, where she was an Investment Specialist. In this capacity, she was responsible for the planning and development

of the team’s capabilities, promoting the fixed interest product range. Here Lydia was spokesperson for the investment capabi lity,

liaising with internal and external parties. Lydia joined the Fixed Interest team in 2000, and her roles included Portfolio Controller and

Co-Head, Quantitative Analysis & Risk Management. Responsibilities in this latter role included managing portfolio positions for the

fixed interest portfolios in line with the team’s strategy, improving and developing systems, and risk management. Prior to joining AMP

Capital, Lydia held a number of positions at GIO Asset Management, including Fixed Interest Investment Analyst and Money Market

Dealer. Lydia holds a Bachelor of Commerce and Administration, with first class Honours in Economics, from Victoria University in New

Zealand.


IMPORTANT NOTE

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THE INFORMATION CONTAINED IN THIS DOCUMENT, INCLUDING ANY ATTACHMENTS (COLLECTIVELY, "INFORMATION") HAS BEEN PREPARED BY AMP CAPITAL INVESTORS LIMITED

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PROSPECTIVE INVESTORS SHOULD MAKE THEIR OWN INQUIRIES AND CONSULT PROFESSIONAL ADVISERS AS TO APPLICABLE LAWS, REGULATIONS AND DIRECTIVES (INCLUDING

ANY REQUISITE GOVERNMENTAL OR OTHER CONSENTS OR PRESCRIBED FORMALITIES) IN ANY PARTICULAR JURISDICTION (INCLUDING, WHERE THE INFORMATION IS RECEIVED)

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THE INFORMATION DOES NOT PURPORT TO BE COMPLETE, DOES NOT NECESSARILY CONTAIN ALL INFORMATION WHICH A PROSPECTIVE INVESTOR WOULD CONSIDER MATERIAL,

AND HAS BEEN PREPARED WITHOUT TAKING ACCOUNT OF ANY PARTICULAR PERSON’S OBJECTIVES, FINANCIAL SITUATION OR NEEDS. ACCORDINGLY, THE INFORMATION SHOULD

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TARGET RETURNS OR A RETURN OF INVESTED CAPITAL.

THE INFORMATION IS PROVIDED ON A CONFIDENTIAL BASIS AND MUST BE KEPT STRICTLY CONFIDENTIAL (WITH THE EXCEPTION OF PROVIDING IT TO YOUR PROFESSIONAL

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