mapping a path 021114 - financial planning...

Your Global Investment Authority

MAPPING A PATH FORWARD

A framework for bond investing today

For investment professional use only – not for public distribution

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1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013

10-year U.S.Treasury yield (%)

History has seen multi-decade periods of rising and falling interest rates

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As of 31 December 2013Source: Federal Reserve St. Louis database (FRED), Barclays, Aswath Damodaran (NYU)

3.1% annualized total return 1953 to 1981

8.6% annualized total return 1982 to present

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Three decades of diversification

Hypothetical example60/40 refers to a portfolio comprised of 60% S&P 500 and 40% Barclays U.S. Aggregate Index.Source: Bloomberg, PIMCORefer to Appendix for additional hypothetical example, index, and risk information.

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0.63

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0.8

S&P 500 60/40

Aug ‘81 – Jul ‘90

Sharp

e ratio

0.67

0.76

S&P500 60/40

Aug ‘90 – Mar ‘01

0.25

0.41

S&P 500 60/40

Apr ‘01– Dec ‘07

0.30

0.46

S&P 500 60/40

Jan ‘08 – May ‘13

S&P 500 60/40 S&P 500 60/40 S&P 500 60/40 S&P 500 60/40

Return (%) 16.45 15.94 14.28 12.05 5.38 5.71 4.25 5.11

Volatility (%) 16.59 11.28 14.16 9.11 12.72 7.26 18.49 11.29

Risk-adjusted returns over 30 years of business cycles

S&P 500

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2008

2008

2008

2008

2009

2009

2009

2009

20102010 2010

20102011

20112011

2011

20122012 2012

2012

2013

-6.6%

2013

7.4%

2013

32.4%

2013

-2.0%

-40%

-20%

0%

20%

40%

60%

Emerging Market bonds U.S. Corporate High Yield U.S. Equities Core bonds

Negative returns in select fixed income sectors in 2013

As of 31 December 2013SOURCE: Zephyr StyleADVISOREmerging Market bonds is represented by JPMorgan EMBI Global (EMD). U.S. Corporate High Yield is represented by Barclays U.S. Corporate High Yield (HY). U.S. Equities is represented by S&P 500. Core Bonds is represented by Barclays U.S. Aggregate.Refer to Appendix for additional index, and risk information.

Barclays U.S.Aggregate Index

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New worries about bonds

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“Bonds used to be a source of principal preservation and income, and now they are neither.”

“I used to earn coupon-plus in my fixed income portfolio and now I earn coupon-minus.”

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Agenda

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Putting rates in perspective

Why today's portfolios still need bonds

Mapping a path forward

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Putting rates in perspective

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What are markets pricing in?PUTTING RATES IN PERSPECTIVE

Implied 3-month LIBOR from eurodollar futures

As of 31 December 2013Source: Bloomberg

0.43%

2.36%

4.11%

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1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

2014 2016 2018

(Percent)

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0.5

2.5

4.5

6.5

8.5

10.5

0.5

1.0

1.5

2.0

2.5

3.0

2007 2008 2009 2010 2011 2012 2013

Perce

nt (%

) Percent (%

)

Inflation (LHS)* Unemployment (RHS)

The Fed's targets remain elusive, but progress is being made

2cs_TR_review_05 9

As of 31 December 2013Source: Haver Analytics, Bureau of Economic AnalysisInflation data is current as of 31 December 2013 and reflect recently released comprehensive revisions to the national income and product accounts published by the BEA every five years to more accurately portray the evolving U.S. economy, given improved methodologies and newly available data.

* Year-over-year percentage change in the core personal consumption expenditure deflatorRefer to Appendix for additional outlook and risk information.

PUTTING RATES IN PERSPECTIVE

2.0% inflation target

6.5% Fed policy target

QE1 QE2 Operation Twist and QE3

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Yields historically anchored by fed funds rate

As of 31 December 2013Source: BloombergTrailing and average spreads compared using month-end data.Refer to Appendix for additional outlook and risk information.

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-2

-1

0

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Dec '88 Dec '93 Dec '98 Dec '03 Dec '08 Dec '13

10-year Treasury yield and Fed funds

rate spread (%)

Trailing spread Average spread Current spread

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‘Rough math’ keeps spread between fed funds rate and 10-year Treasury yield range-bound

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4%

2.5-3%

Historical Max Spread

Fed Policy

Economic Conditions

Investor Demand

• Liability hedging

• Demographics

• Shortage of safe assets

10-year Treasury Yield Forecast


Source: PIMCORefer to Appendix for additional outlook and risk information.

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The upside of rising rates

Solutions_review_03

Hypothetical example for illustrative purposes onlySource: Barclays, PIMCO. As of 31 December 2013. The chart shows the cumulative return of the Barclays U.S. Aggregate Index assuming a rate rise of 1% occurring on day one and remaining constant over the time periods depicted.Refer to Appendix for additional hypothetical example, index, and risk information.

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Effect of a 100-bps spike in yields on a portfolio of bonds

-1.27%

6.92%

15.81%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1 year 3 years 5 years

Cumulativve return

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Why today’s portfolios still need bonds

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Reaffirming the role of bonds in a portfolio

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While market conditions change, the reasons for holding bonds remain constant

Potential for:

Principal preservation

Lower portfolio volatility

Increased return potential versus cash

Income potential

WHY TODAY'S PORTFOLIOS STILL NEED BONDS

Refer to Appendix for additional investment strategy and risk information.

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The drivers of bond returns

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“This may be the most important conceptual change I have ever written about.”— BILL GROSS

The compensation an investor receives for maintaining exposureto the various risks associated with an investment.

Carry:


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Beyond duration: Diversified sources of carry

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Carry

Credit

Currency

VolatilityYieldCurve

Duration

Duration

(interest rates)

A portfolio’s sensitivity to changes in prevailing interest

rates; when rates rise, bond prices typically fall and

vice versa

Credit qualityThe likelihood of a bond issuer making good on its

debt obligation and not defaulting

Volatility The way changes in expected interest rate volatility

affect the prices of callable or prepayable bonds

Yield curve How changes in the shape of the yield curve may affect

relative prices across the maturity spectrum

Currency Fluctuations in currency exchange rates and the effect

on global bonds


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3 mo

6 mo

1 yr

2 yr

3 yr

5 yr

7 yr

10 yr

20 yr

30 yr

Treasury yield (%)

The dynamics of roll down

Rolling down the yield curve

Source: treasury.gov. As of 31 January 2014.*Roll down is a form of return that is realized as a bond approaches maturity, assuming an upward sloping yield curve.Roll down calculation assumes no change in curve.Roll down calculation ; Yield of 5 yr. = 1.5%; Yield of 4 yr. =1.1%, Price appreciation one yr. from today (-0.2*9)=1.8%, total return for one year: (1.5% + 1.8%) = 3.3%. Refer to Appendix for additional investment strategy and risk information.

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Medium-term yields (5-10 years)

• Carry on 5-yr. Treasuries currently 3.3%

• Yield of 1.5%

• Price appreciation from roll down of 1.8%

The steepness of this portion offers the best potential to “roll down*” the curve.

Short-term yields (0-5 years)

Long-term yields (10-30 years)

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Dec '80–Jul '82 Sep '87–Nov '87 Feb '01–Sep '02 Nov '07–Feb '09

S&P 500 Index -16.52% -29.58% -38.87% -50.95%

Barclays U.S. Aggregate Index 21.61% 2.17% 15.82% 6.08%

60/40 portfolio -2.64% -17.42% -20.20% -32.54%

-55%

-50%

-45%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

Portfo

lio retu

rns during m

arket crises

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Principal preservation

Source: Bloomberg, PIMCO60/40 portfolio refers to a portfolio composed of 60% S&P 500 Index and 40% Barclays U.S. Aggregate Index. Refer to Appendix for additional investment strategy, index, and risk information.

Bonds have been crucial during times of market stress

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Asset Class Volatility

Core Bonds 5.5%

U.S. Equities 15.2%

Volatility is measured by the annualized standard deviation of monthly returns from 1976-2013.Maximum drawdowns measure largest peak-to-trough decline on a percentage basis from 1976-2013.Recovery period is measured by the maximum drawdown end date to the month of recovery. U.S. equities are represented by the S&P 500; Core bonds are represented by the Barclays U.S. Aggregate Index.Refer to Appendix for additional investment strategy, index, and risk information.

Core Bonds U.S. Equities

Best and worst 12-month periods for U.S. stocks and core bonds

70%

60%

50%

40%

30%

20%

10%

0%

-10%

-20%

-30%

-40%

-50%

-60%

3-mo. recovery

2-mo. recovery 49-mo.

recovery37-mo. recovery

-13%-9%

35%

-45%-51%

33%

61%

54%

Period Ending

February 1980Period Ending

September 1981Period Ending



June 1983Period Ending



February 2010


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-40

-30

-20

-10

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1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Stock decline Bond decline


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A vast difference in ‘worst-case’ scenarios

Source: Zephyr. Chart shows U.S. stock and bond declines beginning March 1987 and ending December 2013. Stocks represented by the S&P 500 index, bonds by Barclays U.S. Aggregate Index.Refer to Appendix for additional investment strategy, index, and risk information.


Worst year for stocks (2008):

-38.0%

Worst year for bonds (1994):

-2.9%

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$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

$160,000

$180,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Value of initial $100,000 investment

Bonds Cash

Higher return potential

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Hypothetical example for illustrative purposes onlySource: U.S. bonds – Barclays U.S. Aggregate Index; money market funds – Lipper Institutional Money Market Funds Average. Chart shows growth of$100,000 from 31 December 2003 to 31 December 2013. Inflation-adjusted returns are based on the Consumer Price Index (Bureau of Labor Statistics).Refer to Appendix for additional investment strategy, index, and risk information.

A smooth but flat ride from cash …


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Income potential

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As of 31 December 2013SOURCE: PIMCO, Bloomberg, Barclays, Credit Suisse, JPM Financials, Industrials, and Utilities are sub-indices of the Barclays Credit Index. Agency MBS is represented by the Barclays U.S. MBS index; ABS and CMBS are components of the Barclays U.S. Aggregate Index; EM External is represented by the Barclays Global Emerging Markets Index; EM Local is represented by JPMorgan GBI-EM Global Diversified Unhedged Index; High Yield is represented by Barclays High Yield Index; BABs is represented by the Build America Bond subsector within the Barclays Taxable Municipals Index; Bank Loans is represented by the Credit Suisse Leveraged Loan Index; Non-Agency Mortgages is based on pricing from PIMCO’s survey of the marketRefer to Appendix for additional investment strategy, index, and risk information.

Active managers have a broad income toolset to work with


Treasury yield curve

Utilities

Financials

Industrials

CMBS

ABS

Agency MBS

EM External

EM Local

High yield

BABs

Non-agency mortgages

Bank loans

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Yield to worst (%

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Duration (Yrs.)

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Why invest in bonds?

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Potential for: Consider: Investments that fit:

Principal preservationDuration, credit risk and volatility

Core fixed income

Low correlation to equities and other risk assets

Equity correlations Core fixed income

Increased return potentialversus cash

Liquidity characteristics Short-term

Income potential Yield Income

.Refer to Appendix for additional investment strategy and risk information.

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Mapping a path forward

pg 25


Asking clients the right questions

RetirementRetirement

College

TravelTravel

Vacation HomeVacation Home

• What are your goals?

• What do you want your portfolio

to do for you now?

• What will you need it to do for

you in the future?

Mortgage

PRESENT NEEDS

FUTURE WANTS

FUTURE NEEDS

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Strategies for a goal-focused approach to fixed income

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Core Fixed Income100%


Core Fixed

Income35%

Low Duration

30%

Short-Term35%

Core Fixed

Income25%

Unconstrained Bond40%

Income15%

Income45%

DiversifiedIncome 15%

Core Fixed

Income25%

Shorter-Dated High Yield 15%

Sector-Specific Absolute Return20%

Sample Portfolios*

The allocation models presented here are based on what PIMCO believes to be generally accepted investment theory. They are for illustrative purposes only and may not be suitable for allinvestors. The allocation models are not based on any particularized financial situation, or need, and are not intended to be, and should not be construed as a forecast, research, investment advice or a recommendation for any specific PIMCO or other strategy, product or service. Investors should speak to their financial advisors regarding the investment mix that may be right forthem based on their financial situations and investment objectives.

* Sample portfolios are for illustrative purposes only and are not representative of any product or service offered by PIMCO.

Traditional Core Bond Lower-duration Opportunistic Income-focused

Flexible opportunity set with similar interest rate exposure to the Barclays U.S. Aggregate Index

Structural reduction in interest rate exposure

Focus on flexible strategies with broad opportunity sets

Seeks to increase yield by allocating to credit-, global- and income-oriented managers


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Traditional Core Bond Sample Portfolio

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Traditional Core Bond

Traditional Core Bond Sample Portfolio

Barclays U.S. Aggregate Index

Yield 3.7% 2.4%

Estimated volatility 4.5% 4.1%

Equity correlation -0.13 -0.22

Duration 5.4 years 5.3 years

As of 31 December 2013Source: PIMCOHypothetical example for illustrative purposes only. Yield quoted is yield to maturity. Yield to maturity refers to the rate of return anticipated on a bond or portfolio if held until the end of its lifetime. Corporate spread duration measures the sensitivity of the portfolio's price to changes in the spread of a reference single A rated security. Portfolio is composed of 100% Total Return representative account.

Advantages

Lower volatility, potential principal preservation and lower correlation to equities

Attractive yield

Active strategies can help mitigate interest rate risk and help investors access opportunities outside of traditional benchmark sectors

Considerations

Relies on manager skill to outperform

May be best to complement with other strategies if clients are looking to achieve specific objectives, such as structurally lowering duration

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Lower-duration Sample Portfolio

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Short-Term35%


Low Duration30%

Lower-duration Advantages

Seeks to lower total portfolio volatility and equity beta

Provides “dry powder” in the event of a sell-off to opportunistically re-risk

Considerations

Cash returns are near zero

Increases contribution or portfolio volatility from equities as the diversification benefit from duration is reduced

As of 31 December 2013Source: PIMCOHypothetical example for illustrative purposes only. Yield quoted is yield to maturity. Yield to maturity refers to the rate of return anticipated on a bond or portfolio if held until the end of its lifetime. Corporate spread duration measures the sensitivity of the portfolio's price to changes in the spread of a reference single A rated security. Portfolio allocations are a weighted average of the following: 30% Low Duration representative account, 35% Short-Term representative account, 35% Total Return representative account.

Lower-duration SamplePortfolio


Yield 2.0% 2.4%


Equity correlation -0.05 -0.22


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Opportunistic Sample Portfolio

29!mk_Solutions_All_Channels_body


Opportunistic Advantages

Provides protection against rising rates

Flexibility to position in most attractive sectors/securities

Considerations

Relies on manager’s ability to protect capital and generate alpha

Reduces investor’s transparency into underlying risk exposures

As of 31 December 2013Source: PIMCOHypothetical example for illustrative purposes only. Yield quoted is yield to maturity. Yield to maturity refers to the rate of return anticipated on a bond or portfolio if held until the end of its llifetime. Corporate spread duration measures the sensitivity of the portfolio's price to changes in the spread of a reference single A rated security. Portfolio allocations are a weighted average of the following: 20% Credit Absolute Return representative account, 15% Income representative account, 40% Unconstrained Bond representative account, 25% Total Return representative account.

Opportunistic Sample Portfolio


Yield 3.4% 2.4%


Equity correlation 0.08 -0.22


Core Fixed

Income25%

Unconstrained Bond40%

Income15%

Sector-Specific Absolute Return20%

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Income-focused Sample Portfolio

30!mk_Solutions_All_Channels_body


Income-focused Advantages

Provides potential for higher income

Provides for broader risk factor diversification

Considerations

Potential to increase total portfolio volatility

Potential to increase portfolio drawdown

As of 31 December 2013Source: PIMCOHypothetical example for illustrative purposes only. Yield quoted is yield to maturity. Yield to maturity refers to the rate of return anticipated on a bond or portfolio if held until the end of its lifetime. Corporate spread duration measures the sensitivity of the portfolio's price to changes in the spread of a reference single A rated security. Portfolio allocations are a weighted average of the following: 15% Shorter-Dated High Yield representative account, 15% Diversified Income representative account, 45% Income representative account, 25% Total Return representative account.

Income-focused Sample Portfolio


Yield 4.9% 2.4%


Equity correlation 0.37 -0.22


Income45%

DiversifiedIncome 15%

Core Fixed

Income25%

Shorter-Dated High Yield 15%

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Conclusion

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Bonds offer important benefits in all market environments, including principal preservation, lower portfolio volatility, increased return potential versus cash, and steady income.

Stay the course. If rates do rise, bond investors with a long-term objective will potentially benefit.

3There is no silver bullet solution. However, a variety of paths exist for your clients depending on their situations and investment goals.

Consider:

• Maintaining a core bond allocation• Lowering overall portfolio duration• Taking an opportunistic approach• Focusing on diverse sources of income

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Appendix

Past performance is not a guarantee or a reliable indicator of future results.

RISKInvesting in the bond market is subject to certain risks including market, interest rate, issuer, credit, and inflation risk. Investing in foreign-denominated and/or –domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Investments in value securities involve the risk that the market’s value assessment may differ from the manager's, and the performance of the securities may decline. Investing in securities of smaller companies tends to be more volatile and less liquid than securities of larger companies. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.

REPRESENTATIVE ACCOUNTThe accounts were chosen because they are considered to be the largest and most representative examples of the underlying strategies. No guarantee is being made that the structure or actual account holdings of any account will be the same or that similar returns will be achieved. PIMCO may or may not own the securities referenced and, if such securities are owned, no representation is being made that such securities will continue to be held.

VOLATILITY (ESTIMATED)We employed a block bootstrap methodology to calculate volatilities. We start by computing historical factor returns that underlie each asset class proxy from January 1997 through the present date. We then draw a set of 12 monthly returns within the dataset to come up with an annual return number. This process is repeated 15,000 times to have a return series with 15,000 annualized returns. The standard deviation of these annual returns is used to model the volatility for each factor. We then use the same return series for each factor to compute covariance between factors. Finally, volatility of each asset class proxy is calculated as the sum of variances and covariance of factors that underlie that particular proxy.

This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2014, PIMCO

PIMCO Investments LLC, distributor, 1633 Broadway, New York, NY 10019, is a company of PIMCO.

It is not possible to invest directly in an unmanaged index.

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