navigating inflation - lyxor etf uk · linked bonds, both coupon and principal are adjusted for...

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Protect your portfolio against rising prices

Navigating inflation

Protect myselfNovember 2018

Protect myself | Inflation

Navigate rising inflation

Welcome 3

What is inflation? 4

How is inflation calculated? 5

What can you do to protect against inflation? 7

Inflation-linked bonds 8

The inflation-linked bond market 10

The breakeven inflation rate 11

Floating rate notes 13

Conclusion 14

Glossary of terms 16

Knowing your risk 18


3

Inflation has been dormant for years, but that could be set to change. When and where it might rise is hard to predict, but it’s better to be prepared.

At Lyxor we strive to give you the clearest and most relevant information for you to use with your clients, arming you with all the tools we think you’ll need in order to focus on what’s important – giving advice and making the right investment decisions.

In this guide, we’ll remind you of some of the basics of what causes inflation, why it matters, and ultimately, what you can do about it.

Arnaud Llinas, Global Head of ETFs & IndexingLyxor Asset Management

Welcome

Beating inflation is a goal for many portfolios. A rising price environment calls for protection, and investors need to take this seriously.

Demand pull inflation

Cost push inflation

DEMAND SUPPLY


RAW MATERIALS

WAGESIMPORT PRICES

What is inflation?

There are two types of inflation: demand-pull and cost-push.

Demand pull

Demand-pull inflation is when consumer demand exceeds supply, pushing prices upward. It usually takes place during times of healthy economic growth.

A number of factors can cause it:

► Increased levels of government spending, sometimes caused by a lack of fiscal discipline

► Excessive money supply – too much money chasing too few goods (often caused by central bank quantitative easing programmes)

► Rising exports, which lead to currency undervaluation

► Inflation forecasts that may lead to price increases

► Higher levels of consumer confidence, leading to more spending and investing, causing companies to then produce more to meet demand.

Cost Push

Cost-push inflation is when demand remains steady but wages and/or the cost of natural resources go up, and are often the result of higher production costs.

This can be caused by either expected or unexpected events:

► Unexpected increase in cost of raw materials and commodities such as oil, or sudden halt to production (for example if a factory is destroyed), or industrial action taking place

► Wage increases for production staff, including higher minimum wages that could push all staff costs upward

► Sudden changes to laws or government intervention might take place leading to the need to revisit costs

Z If demand is stable and production costs are higher, in order for margins to remain steady, the goods must be priced higher

In economic terms, inflation is a sustained increase in the price of goods and services over a period of time. Effectively, during inflationary periods, the same amount of money today would be able to buy less than it would at some point in the future, meaning a single unit of currency is worth less in terms of its purchasing power.

Too many dollars chasing too few goods

Increased production costs passed on to consumers

How is inflation calculated?

Suppliers such as supermarkets, service providers, manufacturers and real estate companies are polled by government statistics bureaus, usually on a monthly basis, in order to keep track of the price of this basket.

While inflation measures may vary slightly by country, the approach remains similar across the board: goods and services selected as a proxy for the overall economy are lumped into an ‘inflation basket’, the price of which is monitored over time.

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CPI All Items (12 month % change)RPI All Items (12 month % change)

Souce: ONS website. Quarterly data over period Q1 1989 to Q1 2018. Past performance is not a reliable indicator of future results.

Inflation baskets vary by country

CPI vs. RPI – 12 month % changeWhy you should check the basket

While inflation is calculated in similar ways across regions, there can be subtle points to be aware of. A case in point: in the UK, there are two main measures of inflation – the Consumer Price Index (CPI) and the Retail Price Index (RPI). Both are calculated on a large, hypothetical basket of everyday goods that includes food, alcohol, tobacco, household items, fuel, clothing, leisure goods and services among other items.

The main difference is that RPI includes housing costs such as mortgage interest payments and council tax whereas CPI does not, and therefore CPI is usually lower.

The CPI basket calculates ‘core inflation’ – i.e. it represents a normalised increase or decrease over time, rather than short, sharp corrections, such as oil and other commodities.

US CPI-U (Consumer Price Index for all Urban Consumers)

► Index excludes rural consumers

HICP (Harmonised Index of Consumer Prices) ex-Tobacco

► Weighted average of price indices of euro member states

► Excluded costs: owner-occupied housing and tobacco

HICPCPI

Retail Price Index (RPI)

► Housing costs and mortgage payments included (unlike UK CPI)

RPI

5

Regional differences between inflation indices

Issuing country Inflation index Index description/components Indexation lag

United States US CPI-U (Consumer Price Index for All Urban Consumers)

Food & beverages, Housing, Apparel, Transportation, Medical care, Recreation, Education & communication, other goods and services

3 months

United Kingdom Retail Price Index (RPI) Food, Catering, Alcoholic Drink, Tobacco, Housing, Fuel and Light, Household Goods, Household Services, Clothing & Footwear, Personal Goods & Services, Motoring Expenditure, Fares & other travel costs, Leisure Goods, Leisure Services

3 months (8 for some

earlier issues)

France France CPI ex Tobacco Nondurable goods, semi-durable goods, durable goods, services, and energy. Index excludes tobacco.

3 months

EU HICP ex Tobacco Food and non-alcoholic beverages, alcoholic beverages, clothing and footwear, housing, water, electricity, gas and other fuels, furnishings, household equipment and routine house maintenance, health, transport, communication, recreation and culture, education, restaurants and hotels, miscellaneous goods and services. Index excludes tobacco.

3 months

Germany EU HICP ex Tobacco (see above) 3 months

Italy EU HICP ex Tobacco (see above) 3 months

Sweden Swedish CPI Food and non-alcoholic beverages, alcoholic beverages and tobacco, clothing and footwear, housing, water, electricity, gas and other fuels, furnishing and household goods, health, transport, communication, recreation and culture, education, restaurants and hotels, miscellaneous goods and services.

3 months

Japan Japan CPI (nationwide, ex-fresh food)

Food (excluding fresh food), Housing, Fuel, light and water charges, Furniture and household utensils, Clothes and footwear, Medical care, Transportation and communication, Education, Culture and Recreation, Miscellaneous, and Services.

3 months

Source: US Bureau of Labor Statistics, UK Office for National Statistics, Federal Reserve Bank of St. Louis, Eurostat, Bundesrepublik Deutschland Finanzagentur GmbH, Statistics Sweden, Statistics Japan. Indexation lag refers to the lag between the publication of inflation index data, and the subsequent indexation of the ILB.


What can you do to protect against inflation?While the European inflation-linked bond market may have been around for several decades, there are new products and solutions hitting the market every day. Understanding how and when to use them is key.

While central banks have long had control of our fiscal spending, perhaps somewhat absolved from any inflationary effects, today, with the higher levels of volatility driven by core asset prices such as oil and gas, inflation expectations have become harder to estimate.

With active managers finding it harder and harder to beat their respective benchmarks once fees have been accounted for, we believe ETFs are worth considering for mitigating that inflation erosion. Products fall into three categories:

Inflation-linked bond ETFs

► ETFs that track a basket of inflation-linked bonds

► Coupon and principal are adjusted upwards as inflation rises

► Offer simple inflation protection

Inflation expectations ETFs

► ETFs that track changes in inflation expectations via a long leg of ILBs and short leg of nominal bonds

► Strategy aims to offer similar performance to the inflation breakeven rate*

► Attempts to eliminate interest rate risk

Floating rate note ETFs

► ETFs exposed to a basket of floating rate notes (FRNs)

► Because rising rates often follow a rise in inflation

► FRN coupons are adjusted upwards as interest rates rise

While it is important to note that floating rate note ETFs may not directly protect against inflation, they are designed to mitigate the effects of rising interest rates – which may have been caused by rising inflation, therefore are often considered a way of indirectly managing inflation risk. Furthermore, they may be exposed to higher credit risk when the issuer is a corporation rather than a sovereign entity.

Choosing which of these will best suit your needs requires a bit of thought as to where you think inflation and interest rates will head.

7


Inflation-linked bondsWith fixed income assets, inflation eating into your returns also means your real rate of return becomes less predictable and therefore could be seen as defeating the object of investing in a supposedly safer asset class in the first place.

One way around this is to consider inflation-linked bonds (ILBs), also referred to as index-linked bonds or ‘linkers’, whose interest and principal payments will rise and fall directly in line with RPI, in the UK, or HICP in Europe, adding a layer of investor protection.

ILBs are typically issued by governments in a bid to reduce borrowing costs and reach a wider audience. In some cases like certain emerging markets, they are also a way for governments to address concerns about their ability to keep inflation under control.

ILBs are constructed in a similar way to traditional bonds. Both pay out income via a regular coupon, and the principal is repaid at the end of the term, but in the case of inflation-linked bonds, both coupon and principal are adjusted for rising inflation.

Therefore, the coupon on the nominal bond will be higher than it would an ILB to compensate the investor for assuming inflation risk, as the market prices the inflation expectation in.

Conversely, ILBs pay a lower nominal yield with the inflation expectations discounted by the market to reflect the embedded inflation protection.

What about deflation? When prices are falling, ILBs from major issuers such as the US, France and Italy tend to provide a floor on the nominal face value of the bond. However, some issuers including the UK do not have such a deflation floor, meaning both the coupon and the principal are at risk.

Bond type Yield type Inflation expectations Realised inflation

Nominal Real + expected inflation Priced in -ve price impact

Inflation-linked Real + realised inflation Discounted +ve price impact

PRINCIPAL

COUPON

INFLATION

9

Nominal bond with 6% annual couponILB with 4% annual coupon

(100)

(50)

0

50

100

Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10

0% inflation

Nominal bond with 6% annual couponILB with 4% annual coupon

(100)

(50)

0

50

100

Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10

Inflationimpact

2.5% inflation

Source: Lyxor International Asset Management. For illustrative purposes only. This is not a recommendation.

Source: Lyxor International Asset Management. For illustrative purposes only. This is not a recommendation.

Illustrative cash flows – When ILBs underperform nominal bonds with the same maturity (0% inflation)

Illustrative cash flows – When ILBs outperform nominal bonds with the same maturity (2.5% inflation)

Time Nominal bond (6% annual coupon)

ILB (4% annual coupon)

Y0 -100 -100Y1 6 4Y2 6 4Y3 6 4Y4 6 4Y5 6 4Y6 6 4Y7 6 4Y8 6 4Y9 6 4Y10 106 104

Time Nominal bond (6% annual coupon)

ILB (4% annual coupon)

Y0 -100 -100Y1 6 4.10 2.5%Y2 6 4.20 2.5%Y3 6 4.31 2.5%Y4 6 4.42 2.5%Y5 6 4.53 2.5%Y6 6 4.64 2.5%Y7 6 4.75 2.5%Y8 6 4.87 2.5%Y9 6 5.00 2.5%Y10 106 133.13 2.5%

How do inflation-linked bonds work?Let’s examine two scenarios. In the first, we look at the illustrative cash flows of a 10 year nominal bond issued at a face value of €100 paying out an annual coupon of 6% with

an equivalent 10 year inflation-linked bond with an annual coupon of 4%, in a zero-inflation environment.

The interest accumulated at maturity would have been €60 for the nominal bond and just €40 for the inflation-linked bond. So in this case, you would have been better off buying a traditional bond, as the potential additional upside of buying an inflation-linked bond did not materialise given the zero inflation context.

Now let’s see what happens if the same two bonds are compared in an environment of rising prices, say with an inflation rate of 2.5%.

This time, it paid off to hold the inflation-linked bond over the nominal one. The ILB’s total accrued interest at maturity, including the upward adjustment of principal repayment, totalled €74, while the total for the traditional bond remained at €60.

The key thing to remember is that when realised inflation exceeds expected inflation, ILBs should outperform traditional bonds of the same maturity.


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US UK Euro

Correlation of inflation linked bonds with other asset classes(2)

The inflation-linked bond market

1 Source: Bloomberg. Based on market capitalisation of the Barclays Universal Government Inflation-Linked All Maturities Bond Index, as at 30/09/2018.2 Source: The correlation is calculated over a 3-year period using weekly observations of total return indices (euro) and EWMA methodology. For calculating the correlation, 25 financial instruments across various asset classes have been considered. Source: Datastream, Barclays, SG Cross Asset Research/Global Asset Allocation, data from 01/01/05 to 31/08/16. Past performance is not a reliable indicator of future results.

As traditional asset classes such as equities and bonds can be hard hit by persistent inflation, ILBs can introduce real returns to a portfolio that are exempt from such risk. Furthermore, Societe Generale Cross Asset Research observed the correlation between ILBs and other asset classes, such as nominal bonds, credit, cash and alternatives. They came to the conclusion that ILBs can offer attractive diversification benefits.2

At a time when markets are volatile and correlations between equities and traditional bonds are fairly high, that diversification is welcome.

$3.43tn market value, Sep 20181

The global inflation-linked bond market is worth more than $3trn1 and continues to grow. The products have become more popular in an environment where stable sources of income are harder to come by.

11

The breakeven inflation rateIf you are comparing a fixed rate bond with an inflation-linked bond of similar credit quality and maturity, the difference in the two yields is known as the breakeven rate, and will determine which will deliver a better return.

If a conventional 10-year US Treasuries bond is offering a nominal yield of 2.5%, and the 10-year TIPS (Treasury Inflation-Protected Securities) is offering a real yield of 1.0%, the breakeven inflation rate is 1.5%.

Put another way, if realised inflation stays below the breakeven rate, the fixed rate bond will outperform the inflation-linked bond. If however it exceeds the breakeven rate, the reverse is true. The clue is in the name; if inflation remained at the breakeven point for the length of the bond to maturity, you would receive (more or less) the same total return on the nominal bond as you would the ILB.

The breakeven rate is determined by the market, and is commonly used as an indicator of which way future inflation is headed, on a continual basis, and in real time.

Yie

ld

Maturity

INFLATION-LINKEDBONDS

NOMINAL BONDS

Difference in yields= breakeven rate

10-yearUS Treasuries

TIPS Breakevene.g. 2.50% – 1.00% = 1.50%

For ilustrative purposes only.

For ilustrative purposes only. This is not a recommendation.

My expected inflation = 3%

INFLATION BREAKEVEN

RATE

2%

My expected inflation = 1%

Preference for nominal bond

Preference for ILB

INVESTOR A INVESTOR B

Interpreting the breakeven rateThe breakeven inflation rate is used to measure the relative attractiveness of ILBs vs. nominal bonds. It is the rate at

which investors are indifferent to owning a traditional bond vs. an ILB from the same issuer and with the same maturity.


Inflation expectations ETFs – making the theory investable*The breakeven rate is a theoretical index, not a quoted instrument with a price. In order to make the theory investable, the ETF offers exposure to a long basket of ILBs and a short basket of nominal sovereign bonds.

► Inflation breakeven

Z Theoretical measure of inflation expectation

Z Non-investable, yield based measure

Z Driven by the variation in yield between bonds

► The Lyxor long/short ETF strategy

Z An investable proxy of breakeven inflation (subject to market related factors impacting performance)

Z Track changes in inflation expectations via long leg of ILBs and short leg of nominal bonds

Z Aims to eliminate interest rate risk

Z 100% UCITS compliant strategy

*Worth noting, the daily ETF performance will not be exactly equal to the daily change in inflation expectations. The ETF performance is driven by the daily outperformance of the long basket of inflation-linked bonds against the short basket of nominal bonds. This is in theory correlated to changes in inflation expectations, i.e. the breakeven rate. However, other market-related factors, as well as the ETF management fee, can cause some deviation from the actual breakeven rate.

Long basket of ILBs

Short basket of nominal bonds

%

Nominal bonds

Inflation-linked bonds

= inflation breakeven rate

Yiel

d

MaturityYield based index

ETF performance is approximately equal to: Performance of Long ILBs basket – Performance of Short nominal bonds basket – costs of financing & rebalancing over the investment period

Factors to be aware of ► Cost of financing in short leg can detract from performance

► Average duration may be significantly different from theoretical breakeven components

► Volatility of prices on CPI announcement dates can differ from one instrument to another

► Rebalancing costs associated with rebalancing the index monthly

Price based index

Inverse inflation expectationsInflation expectations strategy can also be reversed. The performance will be then based on

► the difference between the realised daily returns of the ILB and the Sovereign bonds legs

► adjusted for the cost of repo and rebalancing

13

Sources: Lyxor AM International, Bloomberg, data as at 31/10/2018

Floating rate notes

FRN may be an appealing alternative to cash when rates are rising. They tend to be less volatile than conventional bonds and provide additional yield.

Floating rate notes consist of investment-grade bonds issued primarily by corporates, which accrue interest based on a specific spread over a reference rate that resets periodically. The fixed spread is determined at the time of issuance, and is based on the market’s perception of the issuer’s credit risk.

The reference index is a short-term interest rate, typically the 1-month or 3 months London Interbank Offer Rate (LIBOR). LIBOR is the rate an international bank would charge another bank for a short-term loan, so it tends to be higher than the policy rates used by central banks.

Coupon = Reference Index Rate + Fixed Spread

Theoretical coupon for a Floating rate note over time

Time period3-month LIBOR

Fixed Spread

Coupon

Coupon at issuance

2 0.5 2.5

Coupon at first reset

2.2 0.5 2.7

Coupon at second reset

2.4 0.5 2.9

For illustrative purpose only

Performance of floating rate notes in a rising rate environment

► 3.00

► 2.50

► 2.00

► 1.50

► 1.00

► 0.50

► 0.00

120

118

116

114

112

110

108

Jan-15 May-15 Oct-15 Mar-16 Aug-16 Jan-17 Jun-17 Nov-17 Apr-18 Sep-18

ICE LIBOR USD 3 Month US Corporate FRN 2-7Y Unhedged USD

Past performance is not indicative of future performance


Conclusion

2Source: Bloomberg and Morningstar data from 31/12/2007 to 29/12/2017. Past performance is not a reliable indicator of future results. 2Source: Bloomberg and Morningstar data from 31/12/2007 to 29/12/2017. Past performance is not a reliable indicator of future results.

Choosing a potential inflation ETF strategy

Floatingrate note ETFs

Nominalbond ETFs

By more or less than what

the marketexpects?

Do youthink interest

rates willrise?

Inflationexpectations ETFs

Inflation-linkedbond ETFs

An alternativeinflation strategy

NO

LESS

YES

YES

MORE

NO

Do youthink inflation

will rise?

For ilustrative purposes only.

*This strategy is a proxy for the inflation breakeven rate; performance may deviate from the true breakeven rate due to market related factors.

When inflation-linked bond ETFs could workIf you believe inflation is on the rise, inflation-linked bond ETFs can offer a solid inflation hedge to help you protect your wealth in real terms.

The inflation breakeven rate can be a useful barometer to help decide whether to opt for nominal bond ETFs or inflation-linked bond ETFs.

So if you believe inflation expectations are too low, meaning market participants have potentially understated where

inflation is going, inflation linked bond ETFs could make sense.


If thenILB ETFs should outperform nominal bond ETFs

Realised inflation

Expected inflation

IfBUT thenILB ETFs should underperform nominal bond ETFs

Realised inflation

Expected inflation

15

This is where inflation expectations ETF can come in handy. They offer a hedge against both rising inflation, and interest rate hikes. The ETFs offered by Lyxor do this through an

innovative long/short strategy that keeps the products’ duration close to zero.

So if you think inflation expectations are on the rise and are concerned about rising rates, inflation expectations ETF could make sense. Traditional linker ETFs do not offer the added

benefit of interest rate protection. Worth noting, the strategy is not recommended for short term investment horizons due to inflation lags and seasonality.


If thenInterest rates

Bond prices


If and thenInflation expectations ETFs should outperform ILB ETFs

Realised inflation

Expected inflation

IfBUT and thenInflation expectations ETFs should underperform ILB ETFs

Realised inflation

Expected inflation

Rates

Rates

When inflation expectations ETFs might make senseRising inflation is often accompanied by rising interest rates, as central banks attempt to rein in growth. Interest rate hikes

have a negative impact on bond prices, both nominal and inflation-linked.

When floating rate note ETFs could helpBecause rate hikes tend to follow rising inflation, another alternative inflation strategy could be implemented using floating rate note ETFs.

Floating rate notes are a type of bond that adjust coupon rates in line with interest rates. As such, floating rate note ETFs can protect against rising rates through higher coupons.

So if you believe interest rates will go up after a rise in inflation (e.g. central bank reaction), you could protect yourself using floating rate note ETFs.


e.g. following a rise in inflation

If thenRatesFRN ETFs should protect you through a higher coupon yield


Glossary of terms

► Bond:

Z Often compared to an IOU, a bond is a debt instrument; the investor lends money to an organisation – either a company (corporate bonds) or a government body (government bonds) – for a set period of time and usually at a fixed interest rate. That fixed rate of interest will determine the return the investor receives at regular intervals during the investment period, which is known as the coupon, with the amount originally invested returned at the end of the term, or maturity date.

► Consumer Price Index (CPI):

Z A representative sample of everyday goods and services whose prices are measured at regular intervals to determine whether household costs are going up or down. A commonly used measure of inflation.

► Core inflation:

Z Core inflation only takes into account the ‘normal’ rising and falling of prices of everyday goods and services, rather than including assets where prices are more volatile, such as oil or basic materials.

► Corporate:

Z A company, usually referring to those listed on a public stock exchange

► Coupon:

Z Named so because in the early days of bond issuance the physical strip was torn off and redeemed by the issuer, the coupon is the periodic payment returned to the investor for the life of the bond.

Z Calculated as total sum of coupons (over a year) / face value of bond = coupon rate (expressed as a percentage)

► Deflation:

Z The steady decline in the price of goods and services over a cycle

► Disinflation:

Z A reduction in the rate of inflation

► Duration:

Z Not to be confused with maturity. Duration is also expressed in years, but refers to the bond’s sensitivity to interest rates. If interest rates move up, bond prices move down because the fixed interest (i.e. fixed at the outset, before the interest rate movement) is now worth less. If interest rates drop, the bond is worth more. The shorter the duration, the less sensitive the bond is to changes in interest rates.

► Expected inflation:

Z The collective wisdom of thousands of market participants on where they expect inflation rates will head. Interest rates tend to be set based on the expected rate of inflation. If the real interest rate is that set by economic forces, then the nominal interest rate = fixed real interest rate + expected inflation

► Floating rate note:

Z Bonds with a variable interest rate, or coupon, that is linked to a money market rate, such as Euribor or Libor. Rates will vary in line with the benchmark rate, as frequently as daily or as infrequently as annually. They tend to be favoured when interest rates are expected to rise, introducing a degree of protection. For this reason, they tend to pay a lower coupon than fixed rate bonds.

► High yield bond:

Z Bonds are classified by the leading ratings agencies (Moody’s, Fitch, Standard & Poor’s) along a scale of measurement ranking them from AAA (highest credit quality) to D (where it has already defaulted on a payment)

Z The ‘mid line’ is around the BB (or Ba if Moody’s) mark and those above this line are rated investment grade, while those below the line are considered high yield, or ‘junk’ bonds. Those with a higher credit quality have less likelihood of default but tend to have lower yields.

► Hyperinflation (where inflation rises very rapidly - higher than 50% in a month – and usually follows a war or times of depression. As growth and production prospects fall, people are tempted to hoard basic goods where future prices might rocket, and currencies lose their value dramatically).

► Inflation breakeven rate:

Z The difference between the yield on a fixed rate bond and an index-linked bond of similar credit quality and maturity. The breakeven rate is a common measure of the market’s expectations on inflation.

► Inflation-linked bond:

Z Also known as index-linked bonds or linkers, these are bonds where their coupon and principal payment are linked to inflation, by tracking against the Consumer Price Index (CPI) – or Retail Price Index (RPI) in the case of UK inflation-linked gilts - in order to protect your return against the effects of inflation.

► Issuer:

Z The company or government you are lending the money to when you take out a bond investment

17

► Junk bond:

Z See high yield bond

► Maturity:

Z The length of time in years from the bond first being issued and the length of time for which the debt contract is in place. These are one, two, three, five, 10, 20 or 25 years typically. You are not obliged to hold your bond investment until it matures, but you run the risk of redeeming at a lower value (see par) than if you hold it to maturity. Not to be confused with duration.

► Nominal bond:

Z A standard bond, where a fixed rate of interest is paid for a fixed term. Nominal bonds do not offer embedded inflation protection.

► Nominal return:

Z The ‘gross’ rate of return, not factoring in any taxes, fees or inflation effects.

► Par:

Z When a bond is issued and priced, its face value is known as par. However, market forces dictate that when bonds are sold, their value may rise or fall according to demand. Therefore, if they are worth less than face value, they are trading at less than par (i.e. at a discount) or if their value has risen, they are trading at a premium.

► Purchasing power:

Z The value of a currency defined in terms of the amount of goods and services one can purchase with a single unit of currency. Rising inflation erodes purchasing power over time.

► Real return:

Z Opposite of nominal return. The actual return the bond investor walks away with after inflation has been factored in.

► Realised inflation:

Z The actual inflation rate observed over time, unlike expected inflation which is purely speculative.

► Reflation:

Z Monetary or fiscal policy designed to counter the effects of deflation such as reducing taxes, lowering interest rates, and increasing money supply

► Retail Price Index (RPI):

Z As with CPI, the Retail Price Index measures the price of a large basket of identical goods and services over time to track price movements and determine changes in the rate of inflation. The main difference is that RPI includes housing costs such as mortgage interest payments and council tax whereas CPI does not. Furthermore, RPI is calculated as an arithmetic mean while CPI is calculated as a geometric mean; as a result, CPI is lower than RPI.

► Stagflation:

Z A portmanteau of stagnation and inflation, a depressing combination of low demand, high inflation, and rising levels of unemployment.

► Yield:

Z Bonds deliver more than one yield, depending on the type of security. The coupon is the bond interest rate fixed at point of issue. The current yield is the bond interest rate as a percentage of the price of the bond at that point.

Z In short, yield = coupon amount / price. If price goes up, yield goes down, and vice versa.

► Yield to maturity:

Z The yield on the bond if it is held for the entire length of the investment to its maturity date. It is expressed as an annual rate of return.


Knowing your risk It is important for potential investors to evaluate the general risks described below and in the fund prospectus on our website www.lyxoretf.com

Capital at risk ETFs are tracking instruments: Their risk profile is similar to a direct investment in the Underlying index. Investors’ capital is fully at risk and investors may not get back the amount originally invested

Replication riskThe fund objectives might not be reached due to unexpected events on the underlying markets which will impact the index calculation and the efficient fund replication.

Counterparty riskWith synthetic ETFs, investors are exposed to risks resulting from the use of an OTC swap with Societe Generale. In-line with UCITS guidelines, the exposure to Societe Generale cannot exceed 10% of the total fund assets. Physically replicated ETFs may have counterparty risk if they use a securities lending programme.

Underlying riskThe Underlying index of a Lyxor ETF may be complex and volatile. For example, when investing in commodities, the Underlying index is calculated with reference to commodity futures contracts exposing the investor to a liquidity risk linked to costs such as cost of carry and transportation. ETFs exposed to Emerging Markets carry a greater risk of potential loss than investment in Developed Markets as they are exposed to a wide range of unpredictable Emerging Market risks.

Currency riskETFs may be exposed to currency risk if the ETF is denominated in a currency different to that of the Underlying index they are tracking. This means that exchange rate fluctuations could have a negative or positive effect on returns.

Liquidity risk Liquidity is provided by registered market-makers on the respective stock exchange where the ETF is listed, including Société Générale. On exchange, liquidity may be limited as a result of a suspension in the underlying market represented by the Underlying index tracked by the ETF; a failure in the systems of one of the relevant stock exchanges, or other market-maker systems; or an abnormal trading situation or event.

19

Important information This communication is exclusively directed and available to Institutional Investors as defined by the 2014/65/EU Directive on markets in financial instruments acting for their own account and categorised as eligible counterparties or professional clients.

This communication is not directed at retail clients. This document is issued in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658.

Some of the funds described in this brochure are sub-funds of either Multi Units Luxembourg or Lyxor Index Fund, being both investment companies with Variable Capital (SICAV) incorporated under Luxembourg Law, listed on the official list of Undertakings for Collective Investment, and have been approved and authorised by the CSSF under Part I of the Luxembourg Law of 17th December 2010 (the “2010 Law”) on Undertakings for Collective Investment in accordance with provisions of the Directive 2009/65/EC (the “2009 Directive”) and subject to the supervision of the Commission de Surveillance du Secteur Financier (CSSF).

Alternatively, some of the funds described in this document are either (i) French FCPs (fonds commun de placement) or (ii) sub-funds of Multi Units France a French SICAV, both the French FCPs and sub-funds of Multi Units France are incorporated under the French Law and approved by the French Autorité des marchés financiers. Each fund complies with the UCITS Directive (2009/65/CE), and has been approved by the French Autorité des marchés financiers.

Société Générale and Lyxor AM recommend that investors read carefully the “risk factors” section of the product’s prospectus and Key Investor Information Document (KIID). The prospectus and the KIID are available in French on the website of the AMF (www.amf-france.org). The prospectus in English and the KIID in the relevant local language (for all the countries referred to, in this document as a country in which a public offer of the product is authorised) are available free of charge on lyxoretf. com or upon request to client-services-etf@ lyxor.com.

The products are the object of market-making contracts, the purpose of which is to ensure the liquidity of the products on NYSE Euronext Paris, Deutsche Boerse (Xetra) and the London Stock Exchange, assuming normal market conditions and normally functioning computer systems. Units of a specific UCITS ETF managed by an asset manager and purchased on the secondary market cannot usually be sold directly back to the asset manager itself. Investors must buy and sell units on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units and may receive less than the current net asset value when selling them.

Updated composition of the product’s investment portfolio is available on www. lyxoretf.com. In addition, the indicative net asset value is published on the Reuters and Bloomberg pages of the product, and might also be mentioned on the websites of the stock exchanges where the product is listed.

Prior to investing in the product, investors should seek independent financial, tax, accounting and legal advice. It is each investor’s responsibility to ascertain that it is authorised to subscribe, or invest into this product.

This document together with the prospectus and/or more generally any information or documents with respect to or in connection with the Fund does not constitute an offer for sale or solicitation of an offer for sale in any jurisdiction (i) in which such offer or solicitation is not authorized, (ii) in which the person making such offer or solicitation is not qualified to do so, or (iii) to any person to whom it is unlawful to make such offer or solicitation. In addition, the shares are not registered under the U.S Securities Act of 1933 and may not be directly or indirectly offered or sold in the United States (including its territories or possessions) or to or for the benefit of a U.S Person (being a “United State Person” within the meaning of Regulation S under the Securities Act of 1933 of the United States, as amended, and/or any person not included in the definition of “Non-United States Person” within the meaning of Section 4.7 (a) (1) (iv) of the rules of the U.S. Commodity Futures Trading Commission.). No U.S federal or state securities commission has reviewed or approved this document and more generally any documents with respect to or in connection with the fund. Any representation to the contrary is a criminal offence.

This document is of a commercial nature and not of a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor Asset Management (together with its affiliates, Lyxor AM) or any of their respective subsidiaries to purchase or sell the product referred to herein.

These funds include a risk of capital loss. The redemption value of this fund may be less than the amount initially invested. The value of this fund can go down as well as up and the return upon the investment will therefore necessarily be variable. In a worst case scenario, investors could sustain the loss of their entire investment.

This document is confidential and may be neither communicated to any third party (with the exception of external advisors on the condition that they themselves respect this confidentiality undertaking) nor copied in whole or in part, without the prior written consent of Lyxor AM or Société Générale. The obtaining of the tax advantages or treatments defined in this document (as the case may be) depends on each investor’s particular tax status, the jurisdiction from which it invests as well as applicable laws. This tax treatment can be modified at any time. We recommend to investors who wish to obtain further information on their tax status that they seek assistance from their tax advisor. The attention of the investor is drawn to the fact that the net asset value stated in this document (as the case may be) cannot be used as a basis for subscriptions and/or redemptions.

The market information displayed in this document is based on data at a given moment and may change from time to time.

Authorizations: Lyxor International Asset Management (Lyxor AM) is a French management company authorized by the Autorité des marchés financiers and placed under the regulations of the UCITS (2009/65/EC) and AIFM (2011/61/EU) Directives.

Société Générale is a French credit institution (bank) authorised by the Autorité de contrôle prudentiel et de résolution (the French Prudential Control Authority

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