Trends & Long-Term Outlook for & gFixed and Stable Value Funds

CPPC Conference

C th T h CFA S i Vi P id t

CPPC ConferenceAugust 2013

Cathe Tocher CFA, Senior Vice President

AGENDA Introduction: Short-term noise – pay p y

attention

Preparing for the future: A Challenge

Economic Review: Working with trends

Capital Markets: Framework for fixed income pinvesting

Outlook: Positioning for the long-term 2

Short-term NoiseShort term Noise

STOCKS

Bond

BONDSBond

MarketRide

3

Stocks Stocks S&P 500 +19% return

1670

1720 ytd to 8/7

1620

1520

1570

6/18 – 6/24: Taper Talk

1470

1520 - 4.8%alk

1420Jan‐13 Feb‐13Mar‐13 Apr‐13 May‐ Jun‐13 Jul‐13 Aug‐13

4Source: Bloomberg

13

Bonds

Yield%

10 year UST  Yields -5.6% return ytd to 8/7

2.7

Yield % ytd to 8/7

2 3

2.5

2.1

2.3

Taper Talk

1 7

1.9

alk

1.5

1.7

D 12 F b 13 M 13 A 13 M 13 J 13 J l 13

5Source: Bloomberg

Dec‐12 Feb‐13 Mar‐13 Apr‐13 May‐13 Jun‐13 Jul‐13

PREPARING FOR THE FUTURE

6

There are always challengesThere are always challenges…..

sequestergrowth

7

And responses to those challenges This cycle: Fiscal & Monetary Policy Intervention

Fiscal policy: TARP, bailouts, increased spending, tax

cuts emergency benefits sequester cuts, emergency benefits sequester,

austerity

Monetary policy: Fed Funds rate cut to 0%, use of

Fed’s balance sheet for security purchases to ‘push’ F f y p p

rates down = quantitative easing QE 1 – QE4,

Operation Twist8

U.S. ECONOMY: CHANGE IN TREND

9

State of the Economy

Real GDP Growth 3.0%Real GDP Growth qoq annualized

3.0

Ann % Chg

2.0%

3.0%qoq annualized

0 0

1.0

2.0

1.0%Gaining t ti

2 0

-1.0

0.0

0.0%/ / / / / / / /

traction

-3.0

-2.0

2009 2010 2011 2012 2013E

12/31/2012 3/31/2013 6/30/2013 9/30/13 E

1st half growth: 1 4%

Source: Bloomberg10

growth: 1.4%

State of the Consumer

HOUSEHOLD NET WORTH

INCOME HOME PRICES

TAXES

Consumer STOCK PRICES

EMPLOYMENT

SpendingPRICES

The consumer accounts for approximately 70% of

11

pp ytotal expenditures based GDP!!

State of the Consumer Household Net Worth

Recoveryy

20.0%$75,000yoy % change in net worth ‐ right 

Peak to trough (07‐09): ‐ 26%2007 Peak to current: +6.6% Key to

confidence

10.0%$65,000

$70,000

g

and spending

0.0%

$50 000

$55,000

$60,000

20 0%

‐10.0%

$40,000

$45,000

$50,000

Net worth in billi f US$

‐30.0%

‐20.0%

$30,000

$35,000

$40,000 billions of US$left scale

Source: Federal Reserve

12

1q05 1q07 1q09 1q11 1q13

Housing Market Recoveryl / d d

Case Shiller 20 City Home Price Index

Supply / demand imbalance

15.0%200Index Level

y- inventories down

demand up

5.0%

10.0%

175 +12.5%- demand up

- Homebuilders m ptimisti

-5.0%

0.0%150

more optimistic

- traffic up

t t

-15.0%

-10.0%125 - mtge rates remain relatively low

-20.0%100May-08 May-09 May-10 May-11 May-12 May-13

Index Level ‐ left axis  YOY % Change ‐ rt axis

-yield curve steep, bank lending picking

13

lending picking up

Source: Bloomberg

Secondary Impacts Consumer d ddemand

+ business Consumer

spending & lending

confidence & sentiment

responseConsumer

+ business

Housing market recovery = growth

home prices

recovery = growth engine for the

economyhiring

prising

business

economy

growth

business

g

economy14

Personal Income

Real Personal Income5.0

Real Personal Income

3.0yoy

1.0

y % chge

‐1.0

‐3.0Jun‐08 Jun‐09 Jun‐10 Jun‐11 Jun‐12 Jun‐13

15

Jun 08 Jun 09 Jun 10 Jun 11 Jun 12 Jun 13

Source: Bloomberg

Job Market

700 000Labor Market Trends

Outlook improving

# of jobs created since 550 000

700,000

14 0%

17.0%

created since 2010:

6 4 milli

550,000

11.0%

14.0%

14.0%

7.4%

6.4 million

# of jobs lost th h th

400,000

8.0%

through the crisis:

ll

250,0005.0% 7.4%

8.7 million100,0002.0%Jul-03 Jul-05 Jul-07 Jul-09 Jul-11 Jul-13

Unemployment Rate Underemployment Rate Claims  ‐ rt axis

Source: Bloomberg# of unemployed: 11.5 million

16

Consumer Behavior

Confidence & Spending100

2.5

4.0

75

1.0

2.5

oy 50‐0.5

% chge yo

25‐2.0

%

0‐3.5Jul-09 Jul-10 Jul-11 Jul-12 Jul-13

l d l f f d h

Source: Bloomberg 17

Real Consumer Spending left axis Confidence right axis

Business Behavior

%Spending&ConfidenceCompanies are

sitting on a lot of

10 0

20.010Spending & Confidence g

cash

0.0

10.0

6

8

‐10.04

6

Corporate

‐30.0

‐20.0

2

Corporate balance sheets are in good shape

‐40.002Q08 2Q09 2Q10 2Q11 2Q12 2Q13 E

ar n goo shap

Source: Bloomberg18

Confidence ‐ left axis Spending qoq  ‐ right axis

Inflation

3 0

3.5

Employment Cost Index & Ave Hourly Earnings(% chge yoy)

Wage deflation a Federal

2.0

2.5

3.0 Reserve concern

C PCE

1.0

1.5

Dec 08 Jun 10 Dec 11 Jun 13 2 50

3.00

(% chge yoy)

Core PCE Core inflation persistently

weakDec‐08 Jun‐10 Dec‐11 Jun‐13

Ave. Hourly Earnings Employment Cost Index

Inflation Expectations 1.50

2.00

2.50 weakSource: Bloomberg

4.0

5.0

6.0

0.00

0.50

1.00

Dec 07 Sep 08 Jun 09 Mar 10 Dec 10 Sep 11 Jun 12 Mar 13

1 0

2.0

3.0

Dec‐07 Sep‐08 Jun‐09 Mar‐10 Dec‐10 Sep‐11 Jun‐12 Mar‐13

Inflation expectations ll h d

19

0.0

1.0

J‐08 S‐08 M‐09 J‐10 S‐10 M‐11 J‐12 S‐12 M‐13

well-anchored

Source: Bloomberg

the pieces are SLOWLY moving into placethe pieces are SLOWLY moving into place…

20

BUT the FED is Still Present

OBJECT VEAnn % Chg

Real GDP Growth GROWTH

OBJECTIVES:

1) Foster growth 0 0

1.0

2.0

3.0

1) Foster growth

3 0

-2.0

-1.0

0.0

(% chge yoy)

Core PCE

-3.02009 2010 2011 2012 2013E

INFLATION2) increase inflation

2.00

2.50

3.00 INFLATION

0 50

1.00

1.50

21

0.00

0.50

Dec‐07 Sep‐08 Jun‐09 Mar‐10 Dec‐10 Sep‐11 Jun‐12 Mar‐13Source: Bloomberg

QE TAPERING: will it stall the recovery??

1. The FED is NOT tightening policyg g p y

2 Question: is the economic recovery 2. Question: is the economic recovery sustainable without the FED?

22

FED POLICY: IMPACT ON CAPITAL MARKETS

U.S. Treasury Curve / YieldsFed Policy: Impact on Capital Markets

10 Year U S Treasury Yields 500

600bps

Corporate Spreads

3.8

Percent10 Year U.S. Treasury Yields

300

400

3.3 QE1QE2 100

200

Dec‐08 Sep‐09 Jun‐10 Mar‐11 Dec‐11 Sep‐12 Jun‐13

2 3

2.8Q

QE3T T lk

QE4

Dec 08 Sep 09 Jun 10 Mar 11 Dec 11 Sep 12 Jun 13

1.8

2.3Operation

Twist

Taper Talk

1.3Dec‐08 Sep‐09 Jun‐10 Mar‐11 Dec‐11 Sep‐12 Jun‐13

Twist

24Source: Bloomberg and Barclays Live

p p

Post Crisis Flows into Bonds

25Source: Deutsche Bank

Post Crisis Flows into Equities

26Source: Deutsche Bank

OUTLOOK FOR FIXED INCOME

Where Should UST Yields Be??

%

Real Treasury Yields: 5 & 10 Year

2.0

3.0 10 YR

5 YR

10 year just

0.0

1.0

10 year just turned positive

‐2.0

‐1.0

7/29/03 7/29/05 7/29/07 7/29/09 7/29/11 7/29/13

Forward Curve 7/29/13 Current 3months 6months 1 year

Nominal yield expectations one year out7/29/13 Current 3 months 6 months 1 year

5 year 1.38% 1.70% 1.87% 2.22%10 year 2.60% 2.89% 2.85% 3.22%

one year out

28

Source: Bloomberg

Treasury Yields: Looking forward

%10 year UST Historical Yields

13 0

15.0%

11.0

13.0

Secular decline in

7 0

9.0decl ne n interest rates

5.0

7.0

Change

1.0

3.0Change in trend

29

1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013Source: Bloomberg

10 year Corporate Bond Yields: Looking forwardy p g

10 A L C B d Hi i l Yi ld

16 0

18.010 year A.L. Corporate Bond Historical Yields

14.0

16.0

Yi

Secular decline in corporate bond i ld

10.0

12.0iel

d

yields

6.0

8.0d

%Change in trend

2.0

4.0in trend

30

Jul-77 Jul-83 Jul-89 Jul-95 Jul-01 Jul-07 Jul-13

Source: Barclays Live

Short Term Corporate Bond Yields: HoldingShort Term Corporate Bond Yields Holding

18.0

Short Duration Corporate Bond Historical Yields

14.0

16.0

Yi

Secular decline in corporate bond i ld

8 0

10.0

12.0iel

yields

4 0

6.0

8.0d

%

0.0

2.0

4.0%Consolidation

31

0 0Jul‐77 Jul‐81 Jul‐85 Jul‐89 Jul‐93 Jul‐97 Jul‐01 Jul‐05 Jul‐09 Jul‐13

Source: Barclays Live

Managing Fixed Income Funds in a Low Rate Environment

maintain or increase yield = add duration add alternative

g g

maintain or increase yield add duration, add alternative asset classes, increase/decrease diversification / issuer concentration, decrease Portfolio quality

increased risk

short duration consistently lower portfolio yields; money market funds yielding 0 – 10 basis points y y g p

10 year U.S. Treasury yields are 130 basis points higher th n th t th l s st blish d J l 2012than they were at the lows established July,2012

Still a low rate environment32

Still a low rate environment

Strategy: Positioning for higher yields

Why will rates rise?? Increased economic

gy g g y

activity = good

Portfolio positioning: contributions and portfolio cash flows participate in rising rate environment = l dd i ld ti i h flladder yield curve, amortizing cash flows

Disciplined and consistent processes t k d t f h t t di d l k t - take advantage of short-term disorderly market

responses within the framework of a long-term outlook e g following Bernanke’s taper talkoutlook e.g. following Bernanke s taper talk

Diversify between and within asset classes

33

The Power of Diversification on Performance

26.4% 23 5%30%

40%

. 23.5%

17.0% 19.8%20%

30%

0%

10%

0.0%

-6.4%

21 7%‐20%

‐10%

0.0%

-23.4%-21.7%

‐30%

20%S&P 500

Barclay's Credit (Bonds)

50%S&P / 50% C di-38.5%

‐50%

‐40%

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

50% S&P / 50% Credit

34

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Source: Barclays Live