Redefining Risk
in the Next Phase
of Financial
Repression
How to find new opportunities and
combat new risks in a rising-rate,
slow-growth environment
us.allianzgi.com
Redefining
Risk
Introduction to financial repression
What is financial
repression?
Why is it important to
redefine risk?
A series of government actions (lower interest
rates, increased regulations, etc.) designed to
stimulate an economy and reduce debt while
maintaining inflation.
Even as it shifts to its next phase, financial
repression means a continued environment
of low yields and slow but steady inflation that
could last for some time to come. In this world,
staying low-risk could mean the big risk of
missing your long-term goals.
It’s been used before and has been very
successful, which is a big reason why—
unbeknownst to many investors—financial
repression has been in effect all around the
world for several years now.
This flipbook will show you how to redefine
your real risks as you seek to combat financial
repression and its related headwinds.
2
Redefining
Risk
Phase I
Financial repression
(2007–2013)
Phase II
Financial repression
(2014 onward)
A new phase of financial repression
means new headwinds
Economic Outcomes
Investor Headwinds
◾ Fed and other central banks pump in massive
amounts of liquidity to stave off global economic
collapse
◾ S trong investor risk aversion
◾ Highly accommodative central-bank policies cause
interest rates to fall to record lows
◾M
arket volatility spikes from time to time
Economic Outcomes
◾ Fed reduces liquidity, interest rates eventually
climb (while remaining relatively low)
◾ Economic growth improves; inflation becomes more
likely longer term
◾ Government deficits decrease, but debt
remains large
◾ “ Safest” investments become expensive and yield
little income
Investor Headwinds
◾ F ear of losses (see Headwind 1)
◾ F ear of missed opportunities (see Headwind 2)
◾C
ontinued lack of income (see Headwind 3)
◾O
n the horizon:
- Inflation (see Headwind 4)
- More volatility (see Headwind 5)
- Demographic shifts add to debt (see Headwind 6)
- Rising interest rates
3
Headwind 1: Renewed risk aversion is keeping some
investors in cash, limiting income potential
Redefining
Risk
Why This Matters
In 2007, you needed $2.9 million in cash to generate $100,000 in income.
In 2013, you needed $142 million to generate the same amount.
Change in income from 1997 to 2013
Equities
10-Year Treasuries
High-Yield Corporate Bonds
Convertibles
Cash
1997
2002
If you’re not properly
allocated to investments
that generate the income
potential you need, financial
repression's low yields and
persistent inflation could
steadily erode your wealth.
Fear of market losses
could be limiting your
potential for long-term
gains
2007
◾M
ore than 1 in 4 Americans
think cash is the best way to
invest money not needed
for more than 10 years1
2013
$0
$5,000,000
$10,000,000
$100,000,000
$150,000,000
Source: FactSet and US Treasury Department, Bloomberg and Allianz Global Investors, as of 12/31/2013.
1. abcnews.com 2. Citi Private Bank
Past performance is no guarantee of future results. Equities are represented by the S&P 500, high-yield corporate bonds
by the BofA Merrill Lynch HY Master II Index, convertibles by the BofA Merrill Lynch All Convertibles All Qualities Index and cash
by the 90-day Treasury bill. Based on yields for the indexes as of 12/31/1997, 12/31/2002, 12/31/2007 and 12/31/2013 obtained
from FactSet.
◾H
igh-net-worth investors
allocate 39% of their
portfolios to cash on
average2
4
Headwind 2: Some investors are afraid
they’ve missed the boat
Redefining
Risk
The long-term run-up in stocks might prompt fears of a correction
Growth of the S&P 500 since the financial crisis
Do you expect a significant correction for US
stocks in 2014?
2,000
6.7%
1,500
Index (price)
Why This Matters
33.3%
If you’re afraid opportunity
has passed you by, or if you
fear a significant correction
in the markets, you could
be at risk of not maintaining
adequate long-term exposure
to stocks.
1,000
40%
500
0
2008
2009
2010
2011
2012
2013
20%
No, only minor selloffs
Yes, 10% or more
Yes, a bear-market correction of 20% or more
Don’t know/unsure
Source: FactSet as of 12/31/2013 and CNBC Investor Poll as of 12/5/2013.
5
Headwind 3: Traditional income sources
still may not cut it
Redefining
Risk
Even if rates rise, many investments may still generate less income
than they did five years ago
Income generated from a hypothetical $100,000 investment
12/31/2006
$6,000
$5,000
$5,007
12/31/2013
$4,790
Why This Matters
Projected 75 bps increase in rates
$4,690
$3,790
$4,000
$3,040
$3,000
Financial repression has
redefined some notions of
risk and reward, causing
a big income shortfall in
traditionally “safe” asset
classes and forcing investors
to hunt for alternative income
sources.
Rising rates won’t change
the need to search for new
income streams.
$2,000
$0
$1,130
$820
$1,000
$70
3-month T-bill
$380
2-year
Treasury note
10-year
Treasury note
Source: Bloomberg and FactSet as of 12/31/2013. Past performance is no guarantee of future results. Based on yields for the indices as of 12/31/06 and 3/31/14,
obtained from Bloomberg,and FactSet.
6
Redefining
Risk
Headwind 4: “Real-feel inflation”
is eroding purchasing power
Although traditional inflation yardsticks have stayed relatively low,
everyday costs have been rising much more quickly than wages
Increase in cumulative per person expenditures and earnings (2000–2014)
Why This Matters
Earnings
Expenditures
200
162%
Percentage increase
150
130%
100
72%
63%
50
50%
-50
Gasoline
Higher
(and Other Education
Motor Fuels)
Health
Insurance
Services
Electricity
What will happen when
inflation spikes—which,
historically, has happened
suddenly and without
much warning?
41%
0
Wages
Groceries
(Average Hourly
Earnings)
Source: Bureau of Economic Analysis, wages data are from the Labor Department, as of 1/31/2014.
The prices we pay for goods
and services—particularly
health care and college, two
of the biggest expenses for
high-net-worth investors—
have been trending higher.
-5%
-8%
Phone
Services
Clothing
7
Redefining
Risk
Headwind 5: As tapering continues,
volatility may rise
The “fear index” moved lower as the Fed bought more bonds
Why This Matters
Monetary policy vs. the VIX
Quantitative easing has
had a calming effect on the
stock market.
Federal Reserve balance sheet
(right)
60
4.2
50
3.6
40
3.0
30
2.4
20
1.8
10
2009
2010
2011
2012
Source: FactSet and Congressional Budget Office, weekly data as of 12/27/2013.
2013
Trillions of dollars
Index (price)
CBOE Market Volatility Index—Index Price Level
(left)
Tapering—the “winding
down” of the Fed’s bond
purchases—is likely to
result in greater volatility as
stocks transition from being
supported by monetary
policy to being supported by
fundamentals.
1.2
8
Redefining
Risk
Headwind 6: Demographics are skewing older
Our aging population is adding to our fiscal woes
Why This Matters
Number of workers to support Social Security
The demographic picture is
worsening in the US.
●●●●●●●●●●●●●●●
1950: 16.5 workers to …
●●●●
2005: 3.3 workers to …
●●●
2025: 2.3 workers to …
●
1 beneficiary
●
1 beneficiary
●
1 beneficiary
Source: “The 2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance
Trust Funds” as of 5/12/2009. Past performance is not a guarantee of future results.
Entitlement spending has
risen from 31% of the federal
budget in 1982 to 62% in
2012—and is projected to
grow larger.
More retirees and more
spending will make it harder
to grow our way out of debt.
9
Redefining
Risk
Why we believe financial repression
is here to stay
The Evidence
Our Analysis
Debt levels remain high globally
Keeping interest rates low—a key element of financial repression—
helps lower debt-servicing costs and reduce debt
The economic recovery is still lackluster
In the absence of strong economic growth, governments need
to implement financially repressive policies to stimulate their
economies
Central banks are the key drivers of global markets
With such a long way to go to restore growth and reduce debt, the
financially repressive policies that have been driving markets are
likely to continue in some form for years
10
Redefining
Risk
Getting out of debt takes time
As long as the world remains in a debt crisis, financial repression isn’t going away
Why This Matters
Government debt-to-GDP ratios (actual and projected)
Japan
United States
Actual data
Projected
Greece
Spain
Italy
Emerging markets
300
For many countries, it will
be difficult to lower debt as
a percentage of GDP to a
sustainable level.
250
Gross debt levels vs. GDP
The debt crisis in the
developed world was years
in the making and is historic
in scale.
200
It could all add up to many
more years of financial
repression.
150
100
50
0
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Source: IMF as of October 2013. Forecasts are inherently limited and should not be relied upon as a guarantee of future results.
11
History has shown financial repression
to be an effective tool
Redefining
Risk
Percentage of gross domestic product
Thanks to financial repression, we reduced our post-WWII debt level …
but then we ran it back up again
Debt/GDP since 1940
140
Why This Matters
Actual data
Projected
World War II
120
100
Policymakers hope financial
repression will work again
today—but that means
investors must be prepared to
deal with its effects.
80
60
40
Financial Repression
20
0
1940
After WWII, US debt rose
to nearly 122% of GDP—an
unsustainably high level.
Financial repression helped
lower that number to almost
30% by the mid-1970s.
1950
1960
1970
1980
1990
2000
2010
2018
estimate
Source: Congressional Budget Office. For details about the sources of data used for past debt held by the public, see Congressional Budget Office, Historical Data on Federal
Debt Held by the Public (July 2010).
Notes: The extended baseline generally adheres closely to current law, following CBO’s 10-year baseline budget projections through 2018 and then extending the
baseline concept for the rest of the long-term projection period. The long-term projections of debt do not reflect the economic effects of the policies underlying the
extended baseline.
Data from 1929 onward reflect the recent revisions by the Bureau of Economic Analysis to the estimates of gross domestic product (GDP) in past years and CBO's
extrapolation of those revisions to projected future GDP.
12
Redefining
Risk
The Fed will use its tools
to do what must be done
The low rates associated with financial repression have reduced
debt-servicing costs, but the overall public debt level is still high
Federal interest outlays and debt since 1940
Net federal debt held by
the public (right)
300,000
12,000
250,000
10,000
200,000
8,000
150,000
6,000
4,000
100,000
Financial Repression
Because the US economy
is growing slower than
expected, the Fed needs to
keep rates low. If not, debtservicing costs will increase,
raising debt levels and
hurting economic growth
even more.
With limited choices for the
Fed, investors need to be
realistic about the likelihood
of seeing historically low rates
continue.
2,000
50,000
0
1940
Billions of dollars
Millions of dollars
Federal outlays: Interest
(left)
Why This Matters
1950
1960
1970
Source: US Treasury data as of fiscal year ending 9/30/2013.
1980
1990
2000
0
2010 2013
13
Redefining
Risk
What’s different about financial repression
in the Great Recession?
Financial repression, then and now
1945–1979
Monetary Policy
Post-WWII policies favored
growth over price stability
Why This Matters
2007–Present
Financial crisis, Great Recession push
discretionary economic policies toward growth
in a low-inflation period
Stimulative monetary policies suppressing
interest rates reduce Treasury financing costs
Economy & Debt
Inflation, persistent economic
growth reduced debt/GDP ratio
Slow economic recovery, low inflation,
structurally unbalanced budget raise
debt/GDP
Politics
“Great Society” began amid
reluctance to raise taxes in era of
social unrest, housing expansion,
accelerating inflation
Congress deadlocked over budget reform,
debt financing in era of housing-market distress,
elevated unemployment
Growth Outlook
Favorable demographics,
global industrial leadership
boosted sustained long-term
economic growth
Less-favorable demographics, new laws and
regulations, growing foreign competition point
to modest long-term economic growth
Source: Allianz Global Investors.
We’ve lived through financial
repression before, but it’s
a bit different now. Today,
fiscal policy is less closely
aligned with monetary
policy, unconventional
monetary policy tools are
being used more frequently
and demographics are less
favorable.
14
Redefining
Risk
Take a new look at old risks:
Focus on the financial repression risk zone
Use the “Smart-Risk Spectrum” to assess how financial repression is affecting your portfolio
Alternatives
Potential Reward
Stocks
“Moving out on the risk/reward spectrum” has always meant taking
on greater risk to principal in return for greater reward potential.
Financial repression hasn’t changed that. Investors with sufficient risktolerance levels should consider allocating a portion of their portfolios
to risk assets in a time of financial repression.
Bonds
Cash
What has changed are traditional notions of low-risk investing.
Financial repression may have put new risks into play.
Financial
Repression
Risk Zone
Potential Risk
Important considerations: Optimal allocations relative to the Smart-Risk Spectrum will vary over time depending on macroeconomic conditions and an individual's
investment time horizon, financial status and risk-tolerance level. Investors should consult with a financial advisor when determining an asset allocation suitable for their
investment needs. Unlike cash and fixed-income securities, equity securities do not offer a fixed rate of return and entail a greater risk to principal.
15
Redefining
Risk
How to prepare for the next phase
of financial repression
5 ideas to help you move out of the financial repression risk zone (continued on next page)
1
Investing Idea
Diversify bond
allocations
Investment Opportunity
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Income Fund
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2
Explore multi-asset
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3
Add dividends for
significant income
potential
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Seeks superior risk-adjusted performance by investing in shortduration, higher-quality high-yield bonds using a unique top-down,
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Its seasoned investment team employs a proven process that seeks
to minimize credit risk and target the higher income and growth
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Pursues risk management, long-term growth, income and real
return by investing in a wide spectrum of global asset classes and
acutely focusing on risk management.
High-yield bonds, convertibles and equities with covered-call
options provides income and growth while helping to moderate
downside risk.
Focuses exclusively on dividend-paying stocks trading at attractive
valuations, offering potential for income and capital appreciation.
There is no guarantee that any of these strategies will be successful or result in a profit.
16
Redefining
Risk
How to prepare for the next phase
of financial repression
Ideas to help you move out of the financial repression risk zone (continued from previous page)
4
5
Investing Idea
Investment Opportunity
Look beyond the US for
attractive valuations
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AllianzGI NFJ International Value Fund
Seek organic growth
in stocks
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AllianzGI Global Water Fund
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Key Differentiator
Invests in undervalued, dividend-paying international stocks
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There is no guarantee that any of these strategies will be successful or result in a profit.
Investors should consider the investment objectives, risks, charges and expenses of any mutual fund carefully before investing. This and other information is contained
in the fund’s prospectus or summary prospectus, which may be obtained by contacting your financial advisor. Please read the prospectus carefully before you invest.
A Word About Risk: Equities have tended to be volatile, and unlike bonds, do not offer a fixed rate of return. Bond prices will normally decline as interest rates rise. High-yield, or
“junk,” bonds have lower credit ratings and involve a greater risk to principal. Convertible securities involve the added risk that securities must be converted before it is optimal.
Below-investment-grade convertible and fixed-income securities involve a greater risk to principal than investment-grade securities. Derivative prices depend on the performance
of an underlying asset; derivatives carry market, credit and liquidity risk. A security in the value portfolios may not perform as anticipated if the market does not agree with the
portfolio manager’s value assessment. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Foreign markets may be
more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
Investing in a limited number of issuers or sectors may increase risk and volatility. Securities purchased in initial public offerings have no trading history, limited issuer information
and increased volatility. Investing in the water-related resource sector may be significantly affected by events relating to international political and economic developments, water
conservation, the success of exploration projects, commodity prices and tax and other government regulations. Investments in commodities may be affected by overall market
movements, changes in interest rates and other factors such as weather, disease, embargoes and international economic and political developments. Leverage can magnify losses
during adverse market conditions. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that
payments on the underlying assets are delayed, prepaid, subordinated or defaulted on.
17
Redefining
Risk
Glossary, chart information and
index definitions
Fed: US Federal Reserve.
QE: Quantitative easing.
S&P 500 Index is an unmanaged market index of large capitalization common stocks.
PCE inflation is inflation measured by the personal consumption expenditures NASDAQ Composite Index is a market-value weighted, technology-oriented
index composed of approximately 5,000 domestic and foreign securities.
price index.
MSCI All Country World Index (MSCI ACWI) is a free float-adjusted market
Gross domestic product (GDP) is the value of all final goods and services
produced in a specific country. It is the broadest measure of economic activity capitalization weighted index that is designed to measure the equity market
and the principal indicator of economic performance. Forecasts and estimates performance of developed and emerging markets. As of May 2010 the MSCI
ACWI consisted of 45 country indices comprising 24 developed and 21 emerghave certain inherent limitations, and are not intended to be relied upon as
ing market country indices.
advice or interpreted as a recommendation.
Consumer price index (CPI) measures changes in the price level of consumer goods purchased by households.
BofA Merrill Lynch US Treasury Current 10-year Index is a one-security
index comprised of the most recently issued 10-year US Treasury note. The
index is rebalanced monthly. In order to qualify for inclusion, a 10-year note
must be auctioned on or before the third business day before the last business
day of the month.
Barclays US Aggregate Index is composed of securities from the Barclays
Government/Credit Bond Index, Mortgage-Backed Securities Index, and
Asset- Backed Securities Index. It is generally considered to be representative
of the domestic, investment-grade, fixed rate, taxable bond market.
Dow Jones Industrial Average (DJIA) is a price-weighted average of 30
actively traded blue chip stocks, primarily industrials, but including financials
and other service oriented companies. The components, which change from
time to time, represent between 15% and 20% of the market value of NYSE stocks.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the
global emerging markets.
Citigroup 3-Month T-Bill Index, an index of three-month Treasury bills.
BofA Merrill Lynch All Convertibles Index, which measures the performance of US dollar-denominated convertible securities not currently in bankruptcy with a total market value greater than $50 million at issuance.
BofA Merrill Lynch US High Yield Master II Total Return Index, which
tracks the performance of below investment grade (BBB), but not in default, US
dollar-denominated corporate bonds publicly issued in the domestic market.
CBOE Volatility Index® (VIX®) is a key measure of market expectations of
near-term volatility conveyed by S&P 500 stock index option prices. Since its
introduction in 1993, VIX has been considered by many to be the world’s
premier barometer of investor sentiment and market volatility.
18
Redefining
Risk
Important information
Past performance is no guarantee of future
results. This is not an offer or solicitation for the
purchase or sale of any financial instrument. It is
presented only to provide information on investment strategies and opportunities. The material
contains the current opinions of the author,
which are subject to change without notice.
Statements concerning financial market trends
are based on current market conditions, which
will fluctuate. References to specific securities
and issuers are for illustrative purposes only and
are not intended to be, and should not be interpreted as, recommendations to purchase or sell
such securities.
A Word About Risk: Equities have tended to be
volatile, and unlike bonds do not offer a fixed
rate of return. Dividend-paying stocks are not
guaranteed to continue to pay dividends. Bond
prices will normally decline as interest rates rise.
High-yield or “junk” bonds have lower credit
ratings and involve a greater risk to principal.
Convertible securities involve the added risk that
securities must be converted before it is optimal.
Foreign markets may be more volatile, less
liquid, less transparent and subject to less oversight, and values may fluctuate with currency
exchange rates; these risks may be greater in
emerging markets. Investments in commodities
may be affected by overall market movements,
changes in interest rates, and other factors such
as weather, disease, embargoes and international economic and political developments.
©2014 Allianz Global Investors Distributors LLC, 1633 Broadway, New York, NY 10019
AGI-2014-04-28-9596
VA-RR-20-PRES-1213
Derivatives can lose substantially more than the
original amount invested and can also limit
upside potential. REITs are subject to risk, such as
poor performance by the manager, adverse
changes to tax laws or failure to qualify for
tax-free pass-through of income. Treasury
inflation-protected securities (TIPS), issued by
the US government, are Treasury securities
indexed to inflation whose principal value is periodically adjusted according to the rate of inflation. Repayment upon maturity of the adjusted
principal value of TIPS is guaranteed by the US
government. TIPS decline in value when real
interest rates rise.
19