2013: opportunities and challenges in fixed income investing

Madrid Perspectives Event17 January 2013

Andrew WellsGlobal CIO Fixed Income, Investment Solutions and Real Estate

This presentation is for investment professionals only and should not be relied upon by private investors.

Agenda

2

Macro outlook

Inflation, rates and sovereigns

Credit, high yield and emerging debt

Conclusion

Fixed income fund types for various market scenarios

Fixed income asset class returns in 2012

3

Total returns in 2012 (Euro-hedged)

Source: BoA Merrill Lynch, 31/12/2012. Total returns of market indices in Euro-hedged terms

2.1

4.5

6.0

7.0

10.5

13.0

15.0

21.5

26.6

0.0 5.0 10.0 15.0 20.0 25.0 30.0

US Treasuries

German Bunds

Spanish Government Bonds

Global Inf lation-linked Government

Global Corporates

Euro Corporates

US High Yield

Global Emerging Market Debt

European High Yield

Total return (%)

4

More positive macro economic news

Leading economic indicatorsEconomic surprise indices

Source: FIL Fixed Income Quantitative Research, 03/01/2013.

Massive debt burdens are likely to slow the recovery

5

Source: Haver Analytics, 31/12/2011; ONS, Citigroup, 31/03/2012

UK gross debt / GDP (excluding Bank debt)US debt / GDP by sector %

0

50

100

150

200

250

300

350

400

450

500% of GDP

Households

UKGovernment

Non-bankfinancialcompanies

Non-financialcompanies

88 90 92 94 96 98 00 02 04 06 08 10 12

US:Positive but low growth, with housing recovering

6

Source: Bloomberg, National Multi Housing Council, 30/06/2012

US National Multi Housing Council quarterly housing surveyApartment Market Conditions:Sales Volume Index (Above 50 = Increasing)

Apartment Market Conditions:Debt Financing Index (Above 50 = Improving)

Europe:A downward spiral of structural problems and austerity

7

Sources: Sources: Haver Analytics, Bloomberg, RBC Capital Markets, 31/10/ 2012

Manufacturing PMIsLong-term unemployment across the Euro area (m/m change, 000s)

Historic real GDP growth per annum (%)

China:Slower growth but the trend is bottoming

8

Source: Haver Analytics, NBS, Datastream, 30/11/2012.

Chinese manufacturing PMIsChinese industrial production growth

Summary: macro outlook

Signs of better growth coming through in US but Europe still under a cloud

Deleveraging across government and personal sectors will slow the pace of economic recovery

Emerging market growth being reset at a lower but still healthy level

9

Source: FIL Limited, 03/01/2013

QE driving an inflationary tail-risk

10

0

50

100

150

200

250

300

350

400

450

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jul 07 Jul 08 Jul 09 Jul 10 Jul 11 Jul 12

US Fed: Total Assets (US$ trillion)

ECB: Total Eurosystem liabilities (EUR trillion)

Bank of England: Holdings of government securities (£ billion, R.H.S)

1.5

2.0

2.5

3.0

3.5

4.0

06 07 08 09 10 11 12

% Fed's 5 year forward breakeven inflation rate

QE1QE2

Operation Twist

Ongoing QE

Source: Bloomberg. 05/11/2012.

US Federal Reserve’s preferred measure of inflation expectations

Central Bank balance sheets

This presentation is for Investment Professionals only and should not be relied upon by private investors11

Further monetary stimulus is likely

Source: Bloomberg, Deutsche Bank (31/07/2012)

US Core Personal Consumption Expenditure (PCE)

Money velocity: Japan and US

NOMINAL GDP/MONEY SUPPLY (M2) INDEXED TO 100 AT START OF RECESSION. US RECESSION STARTED Q2 2008.

JAPAN RECESSIN STARTED Q2 1991

DM sovereign credit fundamentals are deteriorating

12

Source: Datastream, IMF World Economic Outlook. 31/08/2012.

- 9%

- 8%

- 7%

- 6%

- 5%

- 4%

- 3%

- 2%

- 1%

0%

Gov

t. de

ficit

(% G

DP)

40% 65% 90% 115% 120% 220% 320%

Govt. Gross Debt (% GDP)

US UK

Euro Area Japan

2007

20072007

2007 2011

2011

20112011

Core government bonds yields are artificially low

13

Difference between market level and model fair value

US 1.25%

UK 1.04%

Euro 0.71%

Source: Bloomberg, FIL Fixed Income Quantitative Research, 03/01/2013

US Treasury yields UK Gilt yields

Bund yields Fidelity duration models

Value in Spanish sovereign debt

14

0

100

200

300

400

500

600

700

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13

Spr

ead

(bas

is p

oint

s)

Source: Bloomberg, 09/01/2013.

Yield spread of 10 year Spanish Government Bonds over 10 year German Bunds

Summary: inflation, rates and sovereigns

15

Inflationary tail risks exist, driven by ultra-easy monetary policy

Developed market sovereign credit quality is deteriorating

Core government bond yields offer little value but may remain depressed

Spanish government debt is supported by an accommodative ECB and the OMT backstop

Source: FIL Limited, 03/01/2013

Credit fundamentals are sound but turning

16

Source: FIL Ltd, Moody’s. 31/10/2012. Ratings Drift = (Issuer upgrades – Issuer downgrades) / Rated Issuers

Trailing 12 Month Rating Drift

Moody's Europe DirectionMoody's Global DirectionFidelity Fundamental RatingFidelity Fundamental Rating: CorporateFidelity Fundamental Rating: Financials + Government + Structured

- 40%

- 30%

- 20%

- 10%

0%

10%

Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12Dec- 07

This presentation is for Investment Professionals only and should not be relied upon by private investors

Spreads are attractive, even if yields are at lows

17

Yield (%)

Spread (bp)

Yield (%)

Spread (bp)

Source: FIL Limited, Bloomberg (31/10/2012)

Global high yield Global investment grade corporates

Opportunities in European credit

18 18

Source: Morgan Stanley Research, BoA Merrill Lynch Euro Corporate Bond index (ER00), January 2013

European non-financial spread to Bunds European spread dispersion by quality

0

200

400

600

800

1000

06/2007 06/2008 06/2009 06/2010 06/2011 06/2012

AA

ABBB

Some signs of releveraging, especially in cyclicals

19

Source: Morgan Stanley – Leverage Finance Chartbook, 13/11/2012.

US Corporate Gross Leverage US Corporate Cash / Debt

4.06% 10%

High yield:Low default rates but high prices

20

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

0

200

400

600

800

1000

1200

1400

1600

1800

2000

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Basis points

US High Yield Spread

Avg Spread: 566

US Speculative Grade Default Rate (RHS)

Baseline Forecast

Pessimistic Forecast

US high yield spread (LHS)

US high yield default rate (RHS)

Pessimistic forecast

Optimistic forecast

Source: FIL Ltd, Moodys US and Europe Speculative Grade Default Rates (issuer weighted). Bloomberg, BofA Merrill Lynch US High Yield Index (to 31/10/2012)

High yield default rates and spreads

EM debt:Improving sentiment should be good for currencies

21

Source: FIL Limited, Bloomberg, J.P. Morgan, 31/12/2012

EM PMIs and new orders/inventories ratio

Summary: Credit, high yield and emerging debt

22

Credit fundamentals are strong and investment grade spreads attractive

Early signs of releveraging must be taken seriously

Low levels of default continue to support high yield investment

Persistent improvement in global business sentiment will benefit local currency emerging market debt

Source: FIL Limited, 03/01/2013

Conclusions

Macro outlook for 2013 and beyond may disappoint as deleveraging across government and personal sectors slows economic recovery

Inflationary tail risks exist, driven by ultra-easy monetary policy

Developed market sovereign credit quality is deteriorating; core government bond yields offer little value but may remain depressed

Credit fundamentals are strong and investment grade spreads attractive, but early signs of releveraging must be taken seriously

Low levels of default support high yield investment

Persistent improvement in global business sentiment will benefit emerging market debt

23

Source: FIL Limited. 03/01/2013.

Opportunities in corporate credit, challenges in government yields

24

Fixed income fund types for various market scenariosMacroeconomic Scenario Most attractive bond

asset classesFidelity Funds that will benefit

Appropriate new Fidelity products

1) Our base Case: low growth/low rates (highest probability)

• Low growth, low interest rates, more QE• Low default rates• Continued search for yield favouring spread product• Total returns lower than 2012 as headroom for spread

compression is now lower• HY, IG credit and EMD to outperform government bonds

• High yield • EMD (especially local

currency and corporate)• Investment grade credit• Inflation-linked bonds (in

anticipation of longer term QE effects)

• FF Euro High Yield• FF US High Yield• FF Asian High Yield• FF Global High Yield Focus• FF EM Debt• FF Euro Bond• FF Euro Corporate Bond• FF Sterling Bond• FF Asian Bond• FF Global Strategic Bond

• FF EM Local Currency Debt (due Q1 2013)

• FF EM Corporate Debt (due Q1 2013)

• Brazil Strategic Bond (pilot due Q1 2013)

• FF Global Income 50% IG / 35% HY / 15% EMD (due Q1 2013)

2) Tail risk: better macro conditions (low probability)• Material solutions to Eurozone crisis take effect• DM growth and investor sentiment recover sharply• Rising government bond yields in anticipation of rate

rises and a cessation of QE• Fears of rising inflation• EM growth accelerates further• Longer duration bonds underperform; credit partly

protected by spread compression; inflation-protection becomes attractive

Rising interest rates

•Shorter duration•Absolute return

• FF Global High Grade Income• FF China RMB Bond• FF Euro Short Term Bond• FF high yield range • FIF MoneyBuilder Income

Reduced Duration• FAST FI Diversified Alpha• FF Global Strategic Bond

Rising inflation•Inflation-linked bonds

• FF Global Inflation-linked Bond• FF EM Inflation-linked Bond

3) Tail risk: worse macro conditions (lowest probability)

• DM economies lurch back into bad recession• EM growth slows further• Economic contraction delays recovery in sovereign

debt levels, leading to more sovereign credit downgrades

• Default rates rise dramatically• Risk assets underperform, particularly high yield and

financials; high quality, liquid sovereigns outperform

Bad recession•Strategic bonds •High quality sovereigns

• FF Global Strategic Bond• FF Global High Grade Income

Increasing sovereign risk•Strategic bonds•High quality sovereigns

• FF Global Strategic Bond• FF Global High Grade Income

Source: FIL Limited, 31/12/2012.

25

3 Year SICAV Performance to 31 December 2012

25Fidelity Internal Information

Source: FIL Limited, Morningstar Workstation, 31/12/2012. Performance is net of fees and in fund base currency. Calculation basis is NAV-NAV with gross income reinvested. Quartile rankings are based on 3 year performance. Excludes institutional and money market funds. Past performance is not a reliable indicator of future results. The value of investments can go down as well as up and investors may not get back the amount invested. * FF Global Inflation-linked Bond Fund’s benchmark is 1-10 years whereas the peer group uses longer all maturities inflation-linked benchmarks* * FF Asian High Yield Fund's Morningstar sector is the Fixed Income Asia Pacific sector composed of 9 other funds only, none of which is a high yield bond fund.

2

1

4

2

3

2

1

1

1

1

2

1 12.9

12.1

6.2

5.5

6.5

3.1

11.5

12.9

4.9

5.0

6.7

9.1

9.7

10.4

7.2

6.5

7.5

3.9

10.2

10.7

5.2

4.5

8.0

8.5

0 5 10 15

FF Asian High Yield FundBofA ML Asian $ HY Corp Constrained

FF European High Yield FundBofA ML Euro High Yield Constrained

FF MoneyBuilder European Bond Fund10.0% BofA ML Euro HY Const; 90.0% BofA ML Euro Large Cap

FF Euro Bond FundBofA ML EMU Large Cap Inv Grade

FF Euro Corporate Bond FundBofA ML Euro EMU Corporate

FF Euro Short Term Bond FundBofA Merrill Lynch 1-3 EMU Broad Market

FF US High Yield FundBofA Merrill Lynch US High Yield Blended Index

FF Emerging Market Debt FundJPM EMBI Global

FF International Bond FundBarclays Global Agg G5 x MBS

*FF Global Inflation-Linked Bond FundBarCap World Government IL Bonds 1 to 10 year Index

FF US Dollar Bond FundBofA ML US Corp & Govt Master Large Cap

FF Sterling Bond FundBofA ML Sterling Large Cap

%

Fund (Net, three year %)

Comparative index (%)

25

Important information

26

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