ACTIVE MANAGEMENTOutperforming the low-yield environment06STRATEGYTransformation stories are investment opportunities in European equity14RISK MANAGEMENTDynamic risk management22

I / 2015

Update

OutperformanceSeize the opportunities of active investing in the low interest rate environment

Allianz Global Investors’ Magazine for Institutional Clients

14

22

06

0604

14

2232ACTIVE MANAGEMENT

Outperforming the low-yield environment

SPOTLIGHTSNews from the world of Allianz Global Investors

STRATEGYTransformation stories are investment opportunities in European equity

RISK MANAGEMENTDynamic risk management

RISK WISENine Everyday Adventures

CONTENTS

34 INTERVIEW“Quo vadis Europe, Professor Dr Heise?”

Dear Reader,

Here at Allianz Global Investors, we believe that active management will continue to play a pivotal role in investing during times of financial repression.

In view of lower trend growth and continued low interest rates, investors need to be prepared for lower market returns (beta) for the foreseeable future. That is why achieving results that go beyond market returns (alpha) must become an even more important component of overall return. Investment concepts that take a more active approach – such as portfolios with a higher active share – and strategies aimed at taking advantage of risk premiums are reliable sources of alpha.

As a result, active investing is the main challenge and, more importantly, an opportunity for the years ahead.

The greatest risk is not wanting to take any risk at all.

On that note, I wish you fascinating reading!

Sincerely,

Tobias C. ProssHead of Distribution Europe

EDITORIAL

A C T I V E I N V E S T I N GA critical difference in an environment of low market returns

y,

Tobias C. ProssH d f Di ib i E

4

Spotlights

O U T LO O K

Global Strategic Outlook for the first quarter of 2015The only way is up – but only slightly. The global economy probably grew moderately in the first quarter of 2015, with the main stimulus coming from the low oil price, which is benefiting both consumption and the economy in general. Investors are more likely to see positive returns from higher-risk asset classes, although setbacks are also possible. The US Federal Reserve might raise its key interest rates earlier than currently expected, which would likely lead to an increase in returns on US bonds. In contrast, monetary policy in Japan and the Eurozone is likely to remain growth-friendly, which will probably allow equity prices to continue rising in 2015.

O P I N I O N

Allianz Global Investors Investment ForumAllianz Global Investors’ capital markets experts and investment strategists met in January at the Investment Forum in Hong Kong to talk about the situation in capital markets.

The main questions they discussed were: does the scenario of financial repression continue to exist even though the central banks in leading economies have started pursuing different monetary policy courses? Will Asia see reforms that change the region’s decades-old development model? What effect is demographic change having on global growth prospects? And what are the consequences of all this for active investment managers and clients?

In the end, the Investment Forum came to the conclusion for investment strategy that active investing will continue to be the main challenge and opportunity this year and beyond.

MORE AT

www.updatemagazineonline.com/InvestmentForum

MORE AT

www.updatemagazineonline.com/GSO

5

U P D A T E I / 2 0 1 5 SPOTLIGHTS

AWA R D

AllianzGI wins four infrastructure debt awards AllianzGI was named as winner in the three categories for which it was shortlisted at the “Infrastructure Investor 2014” awards, highlighting the broad capability and deep experience of AllianzGI’s infrastructure debt team.

Allianz GI won:· Europe PPP deal of the year for the A11 road transaction in

Belgium· Europe transport investor of the year for its investments in the

A11, DBFO2 in Northern Ireland and the M8 in Scotland· Global debt provider of the year for the launch of its pioneering

UK infrastructure debt fund

At the “I J Global Europe & Africa” awards held on 19 February 2015, at the National History Museum in London, AllianzGI also won Europe and Africa Fund of the Year, for its UK infrastructure debt fund, launched in the summer of 2014.

STUDY

“QE” – A starting signal for euro area investments?The European Central Bank has launched a massive bond purchasing programme – and the attention of investors seems increasingly to be directed towards the “old” continent. Is a renaissance of Eurozone equities on the cards? There seems to be increasing evidence for this. Time for a voyage of discovery to Europe.

MORE AT

www.updatemagazineonline.com/QE

6

Outperforming the low-yield environment

Active Management

AUTHOR: ANDREAS UTERMANN

U P D A T E I / 2 0 1 5 ACTIVE MANAGEMENT

8

It was at our 2012 Investment Forum in Hong Kong that we identified financial repression as the dominant issue affecting economies and markets for the foreseeable future. Three years later, our chief investment officers and economic strategists were once again in this dynamic city to discuss how our long-term view on capital markets has evolved. Is financial repression still at work with G4 monetary policies beginning to diverge? Will reform efforts help Asia finally change its decades-old development model? How are shifting demographics affecting the outlook for global growth? And what are the investment implications for us as active investment managers and, above all, for our clients?

Financial repression is still in effectOur medium- and long-term macroeconomic and market outlook remains rooted in our understanding of central bank policy in the G4. With the global economy continuing to suffer from high levels of leverage and slow growth, we fully expect monetary policy globally to remain accommodative, if not expansionary. At the same time, monetary policy measures in developed markets must be accompanied by fiscal- and supply-side reforms to be effective; one cannot exist without the other.

In this context, we believe the diverging approaches in G4 nations – with the European Central Bank and the Bank of Japan in one camp, and the US Federal Reserve and Bank of England in the other – can continue to pursue their separate paths without

contradicting our overall forecast of financially repressive monetary policies. Even with an impending interest rate hike by the Fed, the US central bank has a long way to go to return rates to their historic levels, and it will remain willingly “behind the curve” to make sure it achieves its dual mandate. But being ahead of the others, we expect the US dollar to continue to gain strength.

Growth is slow, but generalised, global deflation isn’t likelyAt every Investment Forum, inflation, or the lack thereof, has been a key topic. This year, we discussed extensively how shifting demographics and an ageing development model in Asia are contributing significantly to deflationary pressures. Nevertheless, we see supportive signs for our view that while inflation will stay subdued, deflation – in the sense of a long economic downswing accompanied by shrinking consumer prices – is not on the cards.

While the pronounced fall in the price of oil is on the surface deflationary, the fact that it is driven by excess supply rather than subdued demand should mean that it acts as a stimulus – alongside accommodative monetary policy – which supports economic growth. In addition, the US has resumed its place as the world’s strongest economy, and is continuing its post-financial-crisis recovery, moving from healing to healed to healthy. Re-industrialisation is ongoing, and we are seeing encouraging job growth among the higher-wage segments of the US labour market. In Europe, we are seeing signs of stabilisation, although data from Japan continue to disappoint.

UNDERSTAND.

9

U P D A T E I / 2 0 1 5 ACTIVE MANAGEMENT

10

Structural reform holds the key to Asia’s transformationWith Hong Kong as our backdrop, a large part of our agenda was, fittingly, dedicated to the many opportunities and challenges within the region. Given shrinking current account surpluses, we evaluated the continued viability of the “North Asian Development Model” – a set of policies based on heavy import substitutions and the promotion of exports, while low real yields facilitate easy access to credit for companies.

In this context, it was encouraging to reflect on just how much China, led by Premier Xi Jinping, has been progressing with financial-market liberalisation and service-sector reforms as it transitions towards a more consumption-led economy. In fact, reform is in the air all around the region, with India starting labour-market reforms, Thailand proclaiming its “Thailand Plus One” investment policy and Indonesia increasing its infrastructure spending, to name a few. The message is clear: the old model appears to have run its course.

Global demographic change is dramaticElsewhere in Asia, we considered the extent to which Japan’s struggles with an ageing population may be a harbinger of demographic trends1 and challenges in other economies. Most developed and emerging nations are set to experience a significant increase in the number of retirees in the next 20 years, whereas dependency ratios will go down. Indeed, 2013 was the first year in history with a shrinking working population in developed regions, excluding Japan2. A dwindling labour force and

a growing number of retirees with lower consumption will both hurt economic growth, with the potential for capital markets to be affected as older investors shift their allocations to less risky assets.

Of course, assessing how capital markets will actually be influenced by such factors is much more difficult. Indeed, while demography is a megatrend of our age, it is not destiny. Some economies may dabble in encouraging net immigration, though a sustainable and effective response would be to promote an increased birth rate, as has been achieved in Sweden. Short of increasing the active labour force, there is still room to manoeuvre to at least dampen the effects of ageing populations. Structural rigidities in labour markets can be addressed, and pension reforms can pave the way to a more flexible – or even a delayed – retirement age. For example, if between now and 2020 reforms in the Eurozone (excluding Germany) were to push labour-force participation rates toward those currently seen in Germany, then the Eurozone workforce would grow by almost 7% – a net addition of 9 million people to the labour market. Furthermore, as observed at one of our earlier Investment Forums, technology-driven innovations have the potential to drive up productivity and output over the long term.

ACT.

[1] See the latest United Nations “World Populations Prospect” and our white paper “Demographic Turning Point” for more on demography.

[2] UN Population Division, “World Population Prospects – The 2012 Revision”.

11

For individual investors, the effects of changing demographics could not be more dramatic. We live in times of ultra-low bond yields, while life expectancies are on the rise and the workforce is shrinking 3. As a result, the modern world’s risk of dying too soon will continue to give way to the risk of “not dying soon enough”, in Peter Drucker’s memorable words, heightening the need for more creative income-replacement solutions.

The benefits of active management The challenges we discussed at this and other Investment Forums continue to point to the value we can add as an active investment manager that is able to turn its insights and capabilities into clear solutions for its clients:

· In a world of lower-trend growth and persistently low yields, investors should expect lower market returns (“beta”) for the foreseeable future. As a result, generating outperformance (“alpha”) should become an even more important aspect of overall investment returns. More active investment approaches – e.g. portfolios with a higher “active share” 4 and strategies that help harvest risk premia 5 – can help deliver reliable alpha.

· With geopolitical risks set to have a more significant impact on market returns and volatility, and with increased expectations for liquidity-induced volatility, investors should consider highly diversified, multi-asset, risk-managed solutions.

· Traditional approaches to bridging the pension gap are not working any more, with public pension income already at low levels and set to decrease further, and with real bond yields in negative territory and unable to play their traditional role as a source of retirement income. As a result, we continue to expand our range of solutions designed to help investors to decumulate wealth after retirement.

Investment conclusions In assessing which investments offer value for us and our clients, we reached several clear conclusions:

· With financial repression still in effect and US Treasuries and German Bunds overvalued, our core conviction remains valid: the biggest risk is not to take risk at all.

· Financial markets should still deliver promising investment opportunities, though investors will need to be selective.

· The outlook for emerging market bonds and currencies is still positive for long-term investors. Nominal yields are inviting, and many currencies are undervalued in terms of their purchasing power.

“ The biggest risk is not to take risk at all.”

U P D A T E I / 2 0 1 5 ACTIVE MANAGEMENT

[3] UN Population Division, “World Population Prospects – The 2012 Revision”. [4] For further reading: “Active Share: The Parts Are Worth More Than The Whole”.[5] See also: “Harvesting risk premium in equity investing”.

12

“ Active investing – this is themain challenge and opportunityfor the year ahead and the years to come.”

13

· Eurozone assets should benefit structurally from a tighter monetary union, corporate restructuring and low yields.

· In a world of lower growth and ultra-low yields, dividends remain an important driver of equity returns6.

· Dividends, corporate high-yield issues and emerging market debt can also generate much-needed income.

· Strategies with proven long-term superior risk premia, such as international small caps, are expected to deliver additional return.

· Institutional investors with a long time horizon should consider harvesting illiquidity premia.

· Liquid alternatives – e.g. long/short and market-neutral strategies – and illiquid alternatives can both offer positive return opportunities, as they are not, or are less, exposed to market beta.

Active investing – this is the main challenge and opportunity for the year ahead and the years to come.

Andreas Utermann is Global Chief Investment Officer (CIO) and Co-Head of Allianz Global Investors. He joined Allianz Global Investors and its Executive Committee as Global CIO Equities in 2002. From then until the end of 2011 he was Global CIO and Co-Head of RCM, the equities investment platform of Allianz Global Investors. Prior to joining us, Mr Utermann worked for 12 years at Merrill Lynch Investment Managers, London (formerly Mercury Asset Management), where he was the Global Head and CIO Equities. Before joining MLIM, he worked for two years at Deutsche Bank AG. Mr Utermann holds a number of non-executive positions in the industry, including Board memberships at the CFA Society of England, as well as memberships of the AMIC Council of the ICMA and the Advisory Council of the DVFA. He holds a BSc in Economics from the London School of Economics, and an MA in Economics from Katholieke Universiteit Leuven in Belgium. He is an Associate at the Institute of Investment Management and Research.

U P D A T E I / 2 0 1 5 ACTIVE MANAGEMENT

[6] See also: “Dividend strategies in times of financial repression”.

Strategy

15

U P D A T E I / 2 0 1 5 STRATEGY

Transformation stories are investment opportunities in European equity

AUTHORS: CATHERINE GARRIGUES & OLIVIER GASQUET

The continual transformation of the world calls for transforming stories, and constantly creates investment opportunities for equity investors who have the necessary analytical tools at their disposal. The quality of an investment process is reflected in the reliable assessment of a company’s fundamental situation, specific risks and the price potential from restructuring.

16

Challenging capital market environmentUnlike the 1980 to 2007 period and previous decades, future years will probably be characterised by slow growth and very low inflation. We identify three reasons for this.

· As with any developed economy, the Eurozone still has to adapt to “globalisation”. Its members are not only challenged by emerging powers on the low added-value goods they manufacture, but on more sophisticated goods and services. They are thus compelled to steadily reduce their administrative, economic and social overheads, in order to improve their competitiveness.

· New technologies have structural impacts on tele-communications, IT and other activities, which are gradually unfolding and irrigating the economy. Networks are being developed which enable consumers and suppliers to connect themselves more and more directly, and to

bypass intermediaries. Prices for goods and services are therefore getting cheaper, and involve significant deflationary trends.

· In the Eurozone, the economy is currently inhibited by public indebtedness and fiscal consolidation. Nations’ eagerness to defend their sovereignty within the Union prevents them from agreeing on common solutions for a recovery. The absence of an common economic policy is a weakness in comparison with the United States, the United Kingdom and even Japan.

If low growth and very low inflation dominate the long-term environment, candidates for investment could prove hard to identify. However, there are still attractive companies – in particular those which are undergoing a transformation process. On successful restructuring, they are able to improve earnings from their own resources with less dependence on the general economic situation.

01 ANALYSIS OF TRANSFORMATION STORIES

Source: Allianz Global Investors Equity Conviction Team, as at March 2015.

Transformation Stories

Consistent Value Creators1 2Thematics· Promising themes or positive phase

of the cycle

· Debt level under control

· Sudden and impressive surge in the value creation profile

56 %

30 %

14 %

· Disposal of non-performing assets

· Internal shake-up led by a convincing new management

· A better company in approx. three years · Prolonged durability of the franchise i.e. protected and low-volatility cash generation

· Very focused management

· Ability to generate long-term economic returns

3

17

U P D A T E I / 2 0 1 5 STRATEGY

Transforming stories are submitted to a risk wise approachThe AllianzGI Equity Conviction Strategy has selected transforming stories (1) as one of its three investment profiles, along with consistent value creators (2) and long term thematic investments (3) . Consistent value creators are companies that regularly grow their asset base, and steadily create value through economic cycles. They usually stay in a portfolio over a long period of time. Long-term thematic investments play on dynamic sectorial trends which are structural for economic growth. But a transforming story is fundamentally transitional. If transformation is successful, over time a company becomes a consistent value creator or a pure cyclical.

Once a company is identified as a transforming story, Conviction Strategy portfolio managers assess its risk-reward ratio. This work is supported by 25 buy-side analysts who contribute to identifying short and medium-term trends, and potential threats, within each sector. The second step is to evaluate the investment candidate’s

strategy over three to five years; its consistency, and its capacity to take benefit from its environment and to obviate dangers that are identified. The next step is to measure its financial strength, i.e. how forecasted cashflows can meet financial commitments to bankers, and to shareholders through dividends and internal or external growth. The last step is price assessment: we look for a minimal 50% capital gain, even if our target selling price can be revised upwards over time.

Transforming stories impel a new strategyWhen a company puts its strategy under review, it is looking towards its survival, its independence and if possible a superior competitive position. A change of capital allocation is often the first step, ahead of restructuring. The following example illustrates this.

After a period of excessively expensive, dynamic and diversified external growth, Veolia, a French environment and transport

18

“ A change of capital allocation makessense if it improves medium-term earnings visibility, and helps raise the share price: the more expensive a company is, the more difficult it is to take over.”

19

U P D A T E I / 2 0 1 5 STRATEGY

group, was squeezed by rising debt, poor cashflows, and numerous contract renewals in France, as competition was growing fiercer. Financial performance deteriorated sharply, especially in comparison with their main competitor, Suez Environnement (Graph 02). The new management decided to prioritise the most profitable contracts, in particular those with industrial customers and with local authorities in developing countries, in order to develop the less capital-intensive and most promising contracting activities. This will, eventually, lead to the sale of marginal assets once the company is deleveraged and profitability improved, to resume expansion. Capital will therefore be refocused on a new group of selected attractive markets.

A well conducted strategy transforms companies’ financial structure and performanceA change of capital allocation makes sense if it improves medium-term earnings visibility, and helps raise the share price: the more

expensive a company is, the more difficult it is to take over. Strategy and visibility are what investors buy first. Restructuring and ratio improvements are only the translation of strategy into the balance sheet and accounts.

Delhaize accounts for ¼ of the Belgian food retailing market, but 70% of its sales are located in the U.S.A. A new management, that pursues a two-pronged strategy, has been appointed to enhance group value. In Belgium, restructuring and modernisation are being implemented in order to withstand fierce competition and pressure on margin. In the U.S.A., they aim at increasing market share and profitability: activities are being developed on selected brands, the product range is being rejuvenated, prices are being cut and stores converted from casual purchase to mass market distribution (Graph 03). Various divisions are being sold to reduce leverage and to buy back shares. The operational profit is planned to increase from 2.3 to 3.3% (2013–2016). The earnings

02 VEOLIA ENVIRONNEMENT AND SUEZ ENVIRONNEMENT ROCE – COMPARISON AND EVOLUTION

11 %

12 %

9 %

10 %

4 %

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

5 %

6 %

7 %

8 %

In 2011 and 2012, Veolia Env. ROCE dropped well below Suez. The group’s new strategy should enable it to catch up with its competitor.

Source: company data, J.P. Morgan estimates. Veolia post-tax ROCE excluding Operating Financial Assets. Data figures starting 2014 are estimated. This is no recommendation or solicitation to buy or sell any particular security.

Veolia excl. JVs and associatesVeolia incl. JVs and associates

SEV 2019 indication Sues Env incl. JVs and associates

ROCE

20

In Belgium, Delhaize strives to curb EBIT margin erosion. In the USA, it plans to improve its EBIT by refocusing its activities.

03 DELHAIZE: UNDERLYING OPERATING MARGIN - 200 TO 2018

6 %

5 %

4 %

3 %

2 %

1 %

0 %

20012000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

USA Belgium

Source: company data, Morgan Stanley Research. Data figures starting 2014 are estimated. This is no recommendation or solicitation to buy or sell any particular security.

21

U P D A T E I / 2 0 1 5 STRATEGY

momentum, the absence of synergies between the U.S.A. and Belgium, and the fading family commitment could ignite speculation on the stock.

Conclusion: transformation companies boast particularly good prospectsLow GDP growth and very low inflation are likely to slow added-value expansion over future years, but will not greatly reduce investment opportunities in the equity market. Once they understand the global evolution of technology and competition in their environment, companies modify their strategy and adapt accordingly in order to survive and expand. For investors, these restructuring candidates are especially attractive, because successful transformation often goes hand in hand with price gains that are well above average.

Olivier Gasquet joined the Convictions strategy team in 2013 as Investment and Communication Support. His previous appointment was Head of the Financial Training and Information Department. Before joining the company in 2005, he had been working in fund management as a financial analyst, equity fund manager and Head of the Asset Management team of a French bank (later Dexia group). He studied at Sciences-Po (Institut d’Etudes Politiques de Paris). He graduated with a master of Business Administration delivered by HEC-MBA, and is a member of SFAF (Société Française des Analystes Financiers).

Catherine Garrigues is Senior Portfolio Manager European Equities, and leader of the Conviction strategy. She has managed Allianz Actions Euro Convictions as lead portfolio manager since she joined the company in 2004. Prior to her current position, Catherine was deputy head of the Crédit Agricole AM European equity team. She was the lead portfolio manager of the equity Predica account. She worked for five years at Crédit Agricole AM, and four years for Fimagest as an equity portfolio manager. She graduated with a master’s degree in economics from the University of Paris X-Nanterre, and is a member of SFAF (Société Française des Analystes Financiers).

22

Dynamic RiskManagement

Risk Management

23

U P D A T E I / 2 0 1 5 RISK MANAGEMENT

Many institutional investors are searching for adequate risk premiums, as this is something most bond markets no longer offer. A strategic asset allocation that includes a significant proportion of risky asset classes such as equities makes it possible to achieve typical institutional return targets, even in today’s market environment. However, this sort of strategic orientation can only be recommended in combination with intelligent risk management. And intelligent risk management is synonymous with strategic yield management.

24

announced on 22 January will pour over a trillion Euros of central bank money into the bond markets, where returns on German government bonds with maturities of up to five years and beyond already had negative yields at the end of February. US equities, in contrast, are profiting from very solid economic growth, but valuation levels are sky-high: based on our preferred valuation measure – the cyclically-adjusted price-earnings ratio – the value of the US equity market is currently about 58% above its long-term average. Our expectations of a divergence in central bank policies by the Fed, the ECB and the Bank of Japan in 2015 has the potential to reinforce the already visible distortions in the currency and bond markets. Geopolitical hotspots, especially the situation in Ukraine, may flare up into major fires.

The simplest risk management strategy – avoiding risks – is no solution given that in many cases money market and government bond interest rates are in negative territory: at

Current challenges for risk and return management The risks on the capital markets have not disappeared – they were just on their summer holidays. This is the conclusion one reaches when looking at the performance of the VSTOXX (Graph 01) risk barometer in 2014 and 2015. While the implied volatility for equities in the Eurozone was still less than 15% last summer, it rose to twice that figure in autumn and at the beginning of this year.

Even a cursory fundamental analysis confirms that strong and sometimes diametrically opposed forces are at work in the main markets: in macroeconomic terms, the growth and recovery trend in Europe has been anaemic thus far. Whether this will be enough to limit the political risks resulting from the massive gains by radical parties with a clear anti-Euro agenda (in addition to Syriza, mainly Podemos in Spain), remains an open question. Starting in March, the ECB’s massive bond purchase programme

01 VSTOXX INDEX OVER TIME

30

35

25

10

Jan.

14

Feb.

14

Mar

. 14

Apr.

14

May

201

4

Jun.

201

4

Jul. 2

014

Aug.

201

4

Sep.

201

4

Oct.

2014

Nov.

2014

Dec.

2014

Jan.

201

5

Feb.

201

5

15

20

Source: Bloomberg; VSTOXX measures the implied volatility based on option prices on the Euro Stoxx 50 over 30 days in percentage points.

AUTHORS: DR WOLFGANG MADER & DR THOMAS G. STEPHAN

In percentage points

25

U P D A T E I / 2 0 1 5 RISK MANAGEMENT

the beginning of February, bonds with a value of USD 3.6 trillion, or 16% of the JP Morgan Global Government Bond Index, had negative yields. The fact is, the greatest risk is avoiding risk entirely. Institutional investors, who had traditionally used low-risk bonds as their anchor investment, will not be able to sustainably meet their medium-term yield targets with this portfolio structure. The strategic challenge in the coming years is therefore to take advantage of the risk premiums on equities and other risky asset classes for investments, while simultaneously protecting the usually modest risk budgets.

Strategic return and risk managementGiven the market environment described above, return and risk management should be of particular importance to investors. Our 4-point plan (Graph 02), which we presented in Update 2013 Edition IV, takes a holistic view of the sources of income, and the risk-reducing components in a portfolio context. In order to

harmonise the earnings targets, risk budgets and other constraints, such as liquidity requirements, the strategic asset allocation (SAA) and the allocation of alpha sources must be given a tactical orientation, and make use of sensible risk management which sustainably supports, rather than hampers, the generation of long-term returns.

Broad diversification of the strategic asset allocation reduces portfolio risk, and thus makes the first significant contribution in the context of risk management. However, in order to ensure compliance with a defined risk budget with a high level of confidence, beta risks should also be controlled dynamically over time, especially if there needs to be a higher allocation of risky investments in the portfolio to achieve the required rates of return. This dynamic element of the investment concept (dynamic asset allocation, DAA), which is usually implemented in the form of a derivative overlay, is already standard at many

02 THE 4-POINT PLAN

Source: Allianz Global Investors, March 2015.

DiversificationThe allocation should be broadly and globally

diversified to reduce risk. To protect against

future inflation, real assets should be included.

Dynamic Risk ManagementDynamically manage risk to reduce losses

while keeping the upside potential.

AlphaAdd uncorrelated sources of sustainable

alpha to increase the return potential for

low risk budget consumption.

Return EnhancementIncrease the average allocation to risky assets

to have the return potential to achieve the

desired target returns.

2 4

1 3

Return Focus Risk Focus

26

27

U P D A T E I / 2 0 1 5 RISK MANAGEMENT

institutional investors, and uses the defined SAA to reallocate assets to provide the desired asymmetry of the results.(Graph 03)

This means that losses due to the dynamic allocation are generally reduced, while the return potential in positive market phases is retained. This sort of asymmetry cannot be achieved via purely forecast-based tactical approaches to asset allocation (TAA); a systematic dynamic strategy (DAA) is also required to reduce unfavourable investment results or downside risks independently of short-term return forecasts.

Dynamic asset allocation The Dynamic Risk Management Solution of Allianz Global Investors was developed in order to effectively generate the desired asymmetric return profile. This approach addresses, among other things, the weaknesses of well-known portfolio insurance strategies (such as constant proportion portfolio

03 DYNAMIC RISK MANAGEMENT COMBINES LONG-TERM RETURN TARGETS AND SHORT-TERM RISK TARGETS

OVERALL RETURN

MARKET RETURN ADDITIONAL RETURN

Strategic Market Return Participation in long-term risk premiums while taking advantage of diversification potential

Risk Protection and Additional Earnings Limiting loss risk while maintaining as much upside potential as possible

DYNAMIC RISK MANAGEMENTSTRATEGIC ASSET ALLOCATION (SAA)

Additional Uncorrelated Earnings Additional earnings from• Underlying Alpha• Tactical Asset Allocation (TAA)

ALPHA ALLOCATION

Using dynamic risk management to reduce loss risks by up to 50% for 12 months

RESPONSIBILITY OF THE OVERLAY MANAGER

+

insurance, CPPI). CPPI offers protection in bear markets, but often does not permit attractive participation in a market recovery. CPPI strategies act purely pro-cyclically, which creates value in clear trends, but lacks correction mechanisms in market exaggerations. The pro-cyclicality of such simple risk management approaches results from fully linking the allocation decision to the available risk budget. However, as capital markets have scientifically proven trends, and a tendency to revert to the mean after positive and negative exaggerations (mean reversion), the dynamic allocation strategy should take these properties into account.

For this reason our proprietary strategy combines pro- and anti-cyclical allocation components at both portfolio and asset class level.

· The pro-cyclical component gives the portfolio a more opportunity-oriented focus when more risk budget is

28

available, and reduces the risks when the risk budget is low. This involves an increase in the weighting of the risky asset classes in the event of a positive performance, and a reduction in their weighting in the event of a negative performance.

· The countercyclical component takes effect in more extreme market movements. It thus ensures re-entry into the market after a rapid drop in prices, and at the same time it means that at least some gains can be taken when prices rise sharply.

· These pro- and anti-cyclical elements also act at the level of the individual asset classes, so our risk and return management also takes into account the “special economic cycles” of individual markets (e.g. emerging markets, commodities).

The conditions in each case are individually coordinated in detail when this strategy is defined. This includes customising the strategic asset allocation, including the permissible allocation bandwidths, as well as the mandate-specific return and risk objectives.

The following composites document the sustainable success of our investment approach. These include firstly the

Dynamic Composite Risk Management (since April 2008, exclusively overlay mandates) and secondly the Dynamic Multi Asset Plus Composite (since February 2005, exclusively underlying mandates) (Graph 04). Since both types of mandate follow the same basic process for active asset allocation and risk management, we see both composites as representative of the risk/return profile of our dynamic investment approach.

The Dynamic Risk Management Composite initially consisted of very defensive portfolios, with the result that only a moderate amount of risk reduction was required in comparison to the already very low-risk benchmark. The mandates of the Dynamic Multi Asset Plus Composite date back to 2005, and on aggregate have significantly higher weightings of risky asset classes in the benchmark. The risk protection offered by our approach can thus be more clearly seen in these mandates in 2008. Apart from the hedging effect in weak markets, in both composites the SAA yield was achieved without high hedging costs in positive market phases. (Graph 05)

The asymmetry can thus be clearly seen in the return profile, i. e. the significant reduction in downside risks in the composite, as well as the improvement in average returns.

29

U P D A T E I / 2 0 1 5 RISK MANAGEMENT

Source: IDS/Allianz Global Investors, as at 31 December 2014. Risk Management Overlay Asset Only composite performance and Dynamic Multi Asset Plus composite gross of fees in Euros. Past performance is not an indicator of future performance. Gross returns were calculated on a total return basis, including all dividends and interest, accrued income, realised and unrealised gains and losses, after broker commissions and trading costs, and not taking account of asset management costs, which would reduce this income. We will be happy to provide you with the detailed GIPS disclaimer upon request.

04 DYNAMIC RISK MANAGEMENT COMPOSITE

05 DYNAMIC MULTI ASSET PLUS COMPOSITE

10

8

6

4

2

0

– 2

20

15

10

5

0

– 5

– 10

– 15

2008

2008200720062005

since launch (04/08)2009

2009

2010

2010

2011

2011

2012

2012

2013

2013

2014

2014 since launch p. a.

since launch p. a.

Performance in percentage points

Performance in percentage points

Composite SAA

Composite SAA

30

“ The current market environment presents institutional investors with major challenges, and more than ever requires the very conscious and active management of risks.”

31

Dr Thomas Stephan is CIO Overlay & Protection at Allianz Global Investors, responsible for mandates with more than 47 bn EUR assets under management/assets under overlay managed (as of 2014). The range of investment solutions in his team includes overlay, LDI and protection solutions for equity; fixed income and multi asset portfolios; as well as liquid alternative solutions, which include commodity and volatility strategies. Prior to joining Allianz Global Investors, Thomas worked as a research assistant at Mannheim University, where he did his doctorate with an award-winning dissertation on “Strategic Asset Allocation for Life Insurance Companies.” He has written articles about strategic and dynamic asset allocation, including option strategies and multi-factor equity risk models. At Allianz Global Investors, Thomas played a decisive role in setting up its systematic portfolio management. In addition to his management job, Thomas has a teaching assignment at the University of Frankfurt.

Dr Wolfgang Mader is Managing Director at Allianz Global Solutions, and Head of Investment and Risk Strategy at risklab. He is responsible for strategic and dynamic asset allocation/ALM, DC/retirement investments, fiduciary investments and risk management. He has more than 13 years of experience in the consultancy and securities business. Before joining risklab, Dr Mader was a consultant for insurance and investment advisory companies. He also worked as a researcher and lecturer at the Department of Banking and Finance at Augsburg University. He completed his degree in Business Administration, and gained a PhD with his thesis on “Hedge Funds – Alternative Investment Strategies and Portfolio Models”. He is author of diverse articles on alternative assets, and supervisor of the German versions of the textbooks “Options, Futures and other Derivatives” and “Risk Management and Financial Institutions” by John C. Hull.

SummaryThe current market environment presents institutional investors with major challenges, and more than ever requires the very conscious and active management of risks. For this reason, we advise institutional investors to analyse all components of their investment concept, and to review them to ensure that they are a good fit.

In our opinion, the importance of dynamic allocation management has increased noticeably, as it allows the active management of allocations in the overlay through different market phases, and between the adjustment dates of the respective strategic asset allocation. Our many years of experience in the dynamic management of a variety of international risk management mandates for a wide range of different customer requirements shows that the desired long-term asymmetric return profile can, in fact, be achieved. We  are also convinced that, in the current market environment, the added value provided by systematic dynamism in the portfolio is an indispensable component of institutional investors’ future-proof investment concepts.

U P D A T E I / 2 0 1 5 RISK MANAGEMENT

Dealing with risk – managing it and harnessing it according to clients’ needs – is at the heart of what an investment manager does. Risk per se is neither good nor bad; rather it is an expression of probability – the likelihood of a particular outcome, positive or negative. By definition, the professional investor takes risks in the capital markets every day – to buy, to sell or indeed to hold. The successful investment manager is a successful risk-taker, someone who sustains a record of good decisions.

Risk is not confined to the world of finance, of course; a society or an economy without it is unimaginable. It’s something we all face daily, whether consciously or otherwise. And yet, in everyday usage, the word ‘risk’ has become laden with negative overtones. Indeed, when we speak of risk, it conjures notions of anxiety, hazard, even fear. In turn, profound risk aversion becomes a habit, one that can undermine good decision-making, tainting our institutional organisation and social mores, as well as our individual actions and wider public discourse.

Studies of risk are nothing new. Disciplines ranging from sociology and psychology through to behavioural finance have all produced significant insights into how human

beings confront risk and uncertainty. But sometimes a purely theoretical approach can feel remote from our ordinary day to day experiences.

Working with The School of Life, Allianz Global Investors wanted to explore what might help us to reconnect intellectually and emotionally with the concept of risk. We invited Polly Morland to take up an artistic residency, not within a particular physical space, but within a real world of everyday risks and rewards. The result is this series of compelling and engaging human stories which help us to reflect on the nature of risk from a variety of fresh perspectives, and to explore what it means to be truly risk wise.

This book is an inspiring journey, one that reminds us how learning to walk wisely hand-in-hand with risk can be positive and enabling.

Each of us is a risk-taker, and we have the capacity to become more risk wise as we learn to hone and trust our judgements.

We hope that this book will spark a rich public dialogue, and open up new conversations about the meaning and role of risk in a fulfilled life.

Risk Wise Nine Everyday AdventuresWhy should an investment manager support a book about risk, in particular a book that looks at risk in everyday life, outside the financial sector?

32

“Risk Wise. Nine Everyday Adventures”, a book by Polly Morland

If you are interested in getting a copy of this book, please contact:update-redaktion@allianzgi.com

U P D A T E I / 2 0 1 5 ESSAY

33

P O L L Y M O R L A N D

[…] Guiseppe Mastrolorenzo is, he says, so used to talking about Vesuvius, reading about Vesuvius, thinking and writing about Vesuvius, watching it, climbing it, photographing it, measuring it, smelling and touching it, quarrelling and dreaming about it, that he has neither the energy nor the head-space to be actively scared about it. Which is not to say it is not frightening. […]

A volcanologist with the Osservatorio Vesuviano, the oldest such institute in the world, Guiseppe has spent over thirty years studying the volcano that annihilated Pompeii and Herculaneum, and which looms today over modern Naples. […]

‘It’s difficult,’ says Guiseppe, ‘for ordinary people to accept that this is the most dangerous volcano, because generation after generation has lived here with no problems. Eruptions are rare compared with the length of a human life, but in geological time, they are very frequent. Entire generations completely forget the risk, but scientists and government, they must remember.’ […]

Just before he leaves to meet the French TV crew, Guiseppe Mastrolorenzo lets slip where he himself lives. And all at

once, you glimpse the reality of the risk dilemma that has vexed Neapolitans for centuries.

‘Where do I live? OK, well, I live in the presently considered Yellow Zone that I suggest be changed to Red Zone. And so I guess, according to my own research, I live in the Red Zone, too.’ Guiseppe grins, shrugs and he is gone. […]

Update will be presenting a selection of the book’s stories in no particular order. In this edition, we take a trip to Italy and spend

a little time “Under the Volcano”…

34

“Quo vadis Europe, Professor Dr Heise?”

Interview

35

U P D A T E I / 2 0 1 5 INTERVIEW

Professor Heise, the European Central Bank has decided to buy about EUR 1.1 trillion in European government bonds by September 2016, as part of an asset purchase programme. This is intended to stimulate both inflation and the economy in the Eurozone. Do you agree with this decision to introduce quantitative easing (QE) based on the Fed model, or does this mean that the ECB is out of ideas?

Prof. Michael Heise: I still think major government bond purchases are inappropriate, as is the resulting massive expansion of the ECB’s balance sheet, because the decline in oil prices is only temporarily pushing inflation in the Eurozone into negative territory, and it provides a boost to the EMU economy. The current Euro devaluation is also creating growth momentum, but the risk of overshooting the exchange rate movement via QE is increasing. In addition, the already low level of yields makes it questionable whether QE can have a significant inflation-driving effect. Bank liquidity is already very high, and liquidity constraints are certainly not the reason for sluggish lending. In fact, I see the potential for extensive government bond purchases to have serious negative side-effects, including financial market bubbles, expropriation from savers, delays in cleaning up bank balance sheets, and reduced incentives for the necessary reforms and

ABOUT PROFESSOR HEISE

Professor Michael Heise is chief economist of the Allianz Group. He advises the boards of the Allianz Group on economic and strategic issues. This includes analyses of and forecasts for German and international economic and financial-market developments, as well as risk analyses.

Prof. Heise completed his undergraduate degree and doctoral studies at the University of Cologne, and has taught at the European Business School in Oestrich-Winkel and at Johann Wolfgang Goethe University in Frankfurt. He is an honorary professor at Johann Wolfgang Goethe University.

Before joining the Allianz Group, Mr Heise was the Secretary General of the German Council of Economic Experts, Chief Economist at DG BANK and Chief Economist and Head of Research at DZ BANK.

Editor-in-chief Marty-Jörn Klein speaks with Professor Dr Michael Heise, Chief Economist of the Allianz Group

36

However, in view of the steady devaluation of the Euro, the SNB recently had to buy more and more Euros in order to counter the growing upward pressure on the Franc. This had already led to a substantial expansion of the SNB’s balance sheet, and it was foreseeable that the intervention volumes would increase significantly again with the beginning of the ECB’s bond purchase programme this month. It was thus perfectly understandable that the Swiss National Bank would take this step to detach itself from the monetary policy of the ECB. However, one can imagine a gentler way of doing this, such as the gradual reduction of the lower limit, or a definition of the limit based on a basket of currencies including the US Dollar.

The election results in Greece have revived the discussions on debt relief and an exit from the Euro by Greece and other Euro countries. Can the Eurozone survive without Greece and co.?In my opinion, a Greek exit from the Euro is still unlikely. The cost would be too great for Greece. I expect that Greek politics will take a pragmatic approach. It is true that for the Eurozone a Greek exit would be associated with negative effects and risks, but contagion effects as in the 2011/2012 crisis are unlikely, given the protective mechanisms now in place and the market confidence in the ECB’s readiness to take action. Similarly, I think

budgetary consolidation at the EMU country level. Let us hope that the QE measures will be reviewed each time conditions change. It must be possible, depending on how inflation develops, to reduce the monthly purchases early, or suspend purchases altogether. I say this because I now see an increasing likelihood that the strength of the economic upturn in the Eurozone is being underestimated, and that the ECB is “behind the curve”.

The Swiss National Bank (SNB) recently abandoned its exchange rate target of 1.20 Francs per Euro, resulting in a Franc shock after the Franc appreciated sharply. Export-dependent companies are now responding by cutting working hours. And the SNB is making massive Euro purchases to prevent an even greater appreciation of the Franc. What would you have recommended the SNB do?The Swiss economy is being hit hard by the SNB’s abrupt change of course. Negative inflation rates, a much gloomier economic outlook and rising unemployment are expected in 2015. The tourism sector and the export industry in particular face major challenges in the short term. In recent years, the minimum exchange rate has generally helped companies to do their manufacturing with certainty about their budgets.

“ In my opinion, a Greek exit from the Euro is still unlikely. The cost would be too great for Greece. I expect that Greek politics will take a pragmatic approach.”

37

U P D A T E I / 2 0 1 5 INTERVIEW

Given this backdrop, what is your financial market and economic outlook for Europe in 2015?Last year, the Eurozone economy was hampered mainly by a slowdown in key emerging markets, and major political uncertainties. However, concerns about another economic crash – a so-called triple-dip recession – turned out to be exaggerated. After a GDP increase of 0.9% in 2014, the Eurozone’s recovery should move forward with a growth rate of about 1.5%. Former programme countries such as Ireland and Portugal, but also Spain and – depending on the course taken by the new government – Greece, will recover significantly after years of weakness. However, countries that have inadequately implemented reforms thus far – such as France and Italy – will continue to see relatively weak performance, and will remain vulnerable. In addition to the reforms, the main drivers for the Eurozone will be the decline in oil prices, and the Euro devaluation. The gains in purchasing power and price competitiveness, which should have a positive impact on corporate profits, give the European equity markets potential in 2015. Given the price level reached, occasional but probably limited setbacks can be expected. The ECB’s government bond purchase programme is also a strong supporting factor for the equity markets. It ensures sufficient liquidity, and the key interest

it is unlikely that other countries would follow a Greek exit from the Euro, especially as the implications this would have for the Greek economy would be clear very quickly. Greece has been an isolated case since the return of Ireland and Portugal to the capital markets. The Euro is not in danger.

The winners of the BRIC boom in recent years have been China and India, while Russia and Brazil have disappointed. Is that enough to support Europe, or is the comeback of the US more vital in this regard?After the slight acceleration of growth in the fourth quarter of 2014, the economic recovery in the Eurozone will continue in the current year. Private consumption will benefit greatly from the decline in oil prices, and from the slightly negative inflation in the Eurozone. In addition, the depreciation of the Euro against the currencies of the major trading partners should stimulate exports. It is generally true that the economic performance of a number of emerging markets, including Brazil and Russia, has been on the disappointing side for some time. Overall, however, there are signs that global trade will see more dynamic growth this year than in recent years – not least due to higher growth in the US, and some Asian emerging markets. This should also benefit the European economy, which is broadly positioned in terms of its export markets.

38

Marty-Jörn Klein, Editor-in-chief was talking toProf. Dr Michael Heise.

rate remains anchored at a record low of 0.05%. Yields on fixed-income securities are likely to fall even further as a result of QE, and will see a slight recovery only towards the end of 2015, when the economy improves and the inflation rate increases. Despite the expansionary monetary policy, I expect the Eurozone inflation rate to be slightly negative on average for 2015, as inflation in most Eurozone countries was negative in early 2015 due to the decline in commodity prices.

Where do you see Europe in 2020? And how will our problem child, the Euro, be doing then?To me, the most likely scenario for the future of the Euro is that pro-European forces in politics gain the upper hand, and we see closer coordination in the monetary union and the EU. The policy leading to “true” economic and monetary union, which consists of four building blocks of fiscal union, banking union, economic union and political union, is based on evolution, not abrupt change. Increasingly, rules, institutions and enforcement mechanisms are being strengthened at European level, in order to make the Euro more functional and more resilient to crises in the future. It is not impossible that we will see a change in the process of EU integration, from the predetermined path of an ever-closer union to a more variable geometry. Despite the criticism of a multi-speed Europe, this should ultimately

be regarded as an acceptable way; it seems preferable to the imminent threat of the disintegration of the community. In addition, I am also convinced that the Eurozone will not have fewer members in 2020. On the contrary, I firmly expect additional accessions to the monetary union – and that Greece will continue to be a part of it.

Professor Heise, thank you very much for sharing your thoughts.

“ I am also convinced that the Eurozone will not have fewer members in 2020. On the contrary, I firmly expect additional accessions to the monetary union – and that Greece will continue to be a part of it.”

39

U P D A T E I / 2 0 1 5

39

A ranking, a rating or an award provides no indicator of future performance and is not constant over time. Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors may not get back the full amount invested.

The volatility of fund unit prices may be increased or even strongly increased. Past performance is not a reliable indicator of future results. If the currency in which the past performance is displayed differs from the currency of the country in which the investor resides, then the investor should be aware that due to the exchange rate fluctuations the performance shown may be higher or lower if converted into the investor’s local currency.

This is for information only and not to be construed as a solicitation or an invitation to make an offer, to conclude a contract, or to buy or sell any securities. The products or securities described herein may not be available for sale in all jurisdictions or to certain categories of investors. This is for distribution only as permitted by applicable law and in particular not available to residents and/or nationals of the USA. The investment opportunities described herein do not take into account the specific investment objectives, financial situation, knowledge, experience or particular needs of any particular person and are not guaranteed. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer and/or its affiliated companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or willful misconduct. The conditions of any underlying offer or contract that may have been, or will be, made or concluded, shall prevail.

Contact the issuer electronically or via mail at the address indicated below for a free copy of the sales prospectus, the incorporation documents, the latest annual and semi-annual financial reports and the key investor information document in English. Please read these documents – which are solely binding – carefully before investing.

This is a marketing communication. Issued by Allianz Global Investors Europe GmbH, www.allianzgi-regulatory.eu, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42–44, D-60323 Frankfurt/Main, authorized by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted.

Masthead

Update I / 2015The magazine for institutional investors from Allianz Global Investors

Publisher: Allianz Global Investors GmbHBockenheimer Landstr. 42–44 60323 Frankfurt www.allianzglobalinvestors.dewww.updatemagazineonline.com/de

Editor in Chief:Marty-Jörn Klein

Project Manager:Caroline Wagner, Lina Masri (deputy)

Editorial Team:Peter Berg, Marty-Jörn Klein, Hans-Joachim Kollmannsperger, Lina Masri, Hans-Jörg Naumer, Klaus Papenbrock, Oliver Schütz, Christian Subbe, Caroline Tschesche, Caroline Wagner

Contact the Editorial Team:update-redaktion@allianzgi.com

Design: 3st kommunikation GmbH, Mainz

Layout:Brückner & Neuner GmbH, Obertshausen

Printing: Brückner & Neuner GmbH, Obertshausen

Photographs: Allianz Global Investors, getty images, shutterstock

Stand: March 2015

Investing involves risk. The value of an investment and the income from it could fall as well as rise and investors might not get back the full amount invested. Past performance is not indicative of future performance. This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzglobalinvestors.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42–44, 60323 Frankfurt/Main, registered with the local court Frankfurt/Main under HRB 9340, authorised by Bundesanstalt für Finanzdienst leistungs aufsicht (www.bafin.de). As at November 2014.

Manuel Neuer, Bayern Munich goalkeeper

Reacting quickly, warding off problems reliably and acting when the situation demands it. Those are the hallmarks of modern goalkeeping, as demonstrated by Manuel Neuer.

But risk awareness and quick reactions are not just a principle of success in football. Our Dynamic Multi Asset Plus investment strategy proves that the right combination of flexible strategies and forward-looking risk management works.

For more detailed information, speak to your customer advisor!