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LMM Compass EDITION 2 / 1ST QUARTER 2017

We hope, you had a good start into the new Year 2017! This year as well we will assist you with regard to the management of your assets and to keep you on track. How do bond-portfolios react on a sudden rise in inflation expectations? Do inflation-linked bonds offer protection? If yes, under which circumstances? More details as well as some important comments you will find in this issue.

Jürg Meier Jürg Meier

Partner, CEO

Markus Häni Markus Häni

Member of the Management Board

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MARKETS AND STRATEGIES

The 4th quarter 2016 has led to a number of shifts within the asset classes. Primarily share prices increased further and the US markets and Emerging markets closed the year with an increase of more than 10%. On the other hand, interest rates went up towards the end of the year after having reached a low in July. This resulted in price falls on bonds
and other income-producing investments (such as real estate). Along with the increased investor confidence, the demand for gold has waned and the price dropped in the 4th quarter.

The investment year 2016 closed on a positive note. Investment strategies with high weightings in US- and Emerging markets equities were the most compelling ones. The investment environment was generally positive as well on the interest-rate side,
especially in the case of riskier high yield- and emerging markets bonds.

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BONDS WITH PROTECTION AGAINST INFLATION

During the months November and December 2016 interest rates have started to point upward and commodity prices had a strong upward trend as well. Many investors were surprised by the fast movement and they ask themselves whether this is a change
in trend in interest rate markets and whether inflation, expected by the central banks, returns.

The past has shown, that with a high probability, stocks, real estate and commodities can provide a hedge against inflation in the long-term. Bonds, however, would become under pressure in an environment of rising inflation and interest rates. Bonds protected against inflation (“Inflation-Linked-Bonds” or “ILB’s”) contain a price index clause, with which one tries to hedge the inflation risk. The face value of these bonds will be adjusted periodically according to the development of a price index (mostly consumer prices). This means that the repayment amount is aligned to the change of inflation rates, i.e. rising inflation leads as well to a higher repayment amount. In return, ILB’s pay a lower coupon.

The following example illustrates the payout profile:

It is obvious, that the price index clause protects the investor from (real) losses in times with strongly increasing prices. In the reverse case, i.e. during a period of negative inflation, bonds with a nominal value should be preferred.

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practical tips

What speaks in favour of this asset class?
ILB’s can contribute an important part, when it comes to preserving the purchasing power and to be protected against an unexpected rise in inflation.

What is the best economic environment?
The best environment is stagflation, this means inflation and falling interest rates.

What is the worst economic environment?
In a rising interest rate environment without inflation, the inflation protection is not effective.

How can this asset class being implemented?
Due to the complexity the use of investment funds is recommended. It is important to make sure, that the indirect costs of the funds chosen are in relation with respect to the added-value of the asset class.

What are the challenges with ILB’s?
Quite often it is difficult to understand the pricing together with a lack of transparency. For the protection against inflation, the investor pays a premium in the form of a lower coupon. The indirect costs of the bond have to be checked before the purchase.

Are those bonds having an interest rate risk?
Yes, ILB’s as well can suffer losses if interest rates rise. They are however diminished by the indexing of the coupons and the nominal value.

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LMM WINS AWARD IN DUBAI

On 1 November 2016, LMM has won the Award in the category “Wealth Management – Innovative client solution”. The Award was presented on the occasion of the Wealth Briefing GCC Region Awards, which was held by ClearView Financial Medit., London.
We are delighted to receive this award and we are convinced that this will strengthen further our brand in the middle east region.

INSTITUTIONAL PENSION PROVISION DIALOGUE FALL 2016

Barbara Bertolini staged the Institutional Pension Provision Fall Dialogue with the friendly support of LMM Investment Controlling under the motto “Pension Provision at the Turning Point”. Around 60 experts from Austria, Germany, Switzerland and Norway, managing assets of more than EUR 320 Billion, followed the invitation to come to Vienna in order to discuss with economists and high-ranking representatives of the EU, as well as with the supervisory authority. Industry experts such as Dr. Wolfgang Huber, Board member of BONUS Pensions kasse and Vorsorgekasse, agreed that there will be an increased
focus again on the costs for the asset management.

Cost transparency at all levels of the management, is in our experience, one of the prerequisites for an efficient implementation of the investment strategy.

Not only the cost structure of pension funds can be optimised with an independent cost audit, but it can also be demonstrated externally with the “LMM cost transparency seal of approval.”

Publications

In the current issue 6/2016 of the magazine “Aufsichtsrat aktuell” (Linde Verlag), our branch managers Switzerland and Austria, Markus Häni and Stefan Kargl, are highlighting the requirements for the internal control system of a foundation. Their conclusion is, that the functions of the Investment Controlling cover the most important areas of the internal control system of a foundation.

The entire article is available for download on our homepage.

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LMM Investment Controlling Ltd. is an independent provider of Investment Controlling services and represents the interests of private and institutional clients towards banks and asset managers. Apart from the head office in Vaduz, LMM has branches in Zurich, Dubai and Vienna..

Disclaimer: LMM takes the utmost care in compiling the information. We don’t grant any warranty, including liability towards third parties, with respect to the accuracy, relevance and completeness of the information and opinions published in this newsletter.