the core conundrum: dealing with fixed-income market realities

1 | PORTFOLIO STRATEGY RESEARCH GUGGENHEIM PARTNERS

THE CORE CONUNDRUMPORTFOLIO STRATEGY RESEARCH | FEBRUARY 2013

As U.S. monetary policy continues to artificially depress yields on government-related securities, traditional core fixed-income strategies have proven less effective in achieving total return objectives. Compounding this issue is the flagship fixed-income benchmark, which has become heavily concentrated in government and agency debt. As benchmark yields languish around 1.9 percent, the chasm between investors’ return targets and current market realities deepens.

Bridging this gap, without assuming undue credit or duration risk, requires a shift away from the traditional view of core fixed-income management in favor of a more diversified, multi-sector approach. An increased tolerance for tracking error provides the flexibility to increase allocations to undervalued yet high-quality credits across sectors. We believe this approach offers a more sustainable way to improve total risk-adjusted returns in today’s low-rate environment.


• The combined impact of U.S. monetary and fiscal policy has created the core conundrum: How can core fixed-income investors meet their yield objectives while maintaining low tracking error to the Index, which has become approxi-mately 75 percent concentrated in low-yielding government-related debt?

• The benign credit environment is encouraging investors to take investment shortcuts, such as increasing credit and duration risk, to generate yield. History has shown that the market has a tendency to underestimate these risks, particularly during periods of monetary policy accommodation.

• In the current environment, we believe the surest path to underperformance is to remain anchored to the past. Investors must develop a new, sustainable, long-term strategy to generate yield without assuming excessive credit or duration risk.

• Accessing short-duration, investment-grade quality securities with consider-able yield pickup relative to government and corporate bonds may be the investment blueprint needed to navigate the current low-rate environment and hedge against interest rate risk.

Report Highlights

INVESTMENT PROFESSIONALS

B. SCOTT MINERD Chief Investment Officer

ERIC S. SILVERGOLD Senior Managing Director, Portfolio Manager

KELECHI C. OGBUNAMIRI Associate, Investment Research

ANNE B. WALSH, CFA Assistant Chief Investment Officer, Fixed Income

JAMES W. MICHAL Director, Portfolio Manager

OVERVIEW

CONTENTS

SECTION 1 3 The Core Conundrum

SECTION 2 7 Coping with New Market Realities

SECTION 3 10 Future Investment Blueprint

3 | THE CORE CONUNDRUM GUGGENHEIM PARTNERS

Monetary Policy Distorting

Government and Agency Markets

Having reached the limits of conventional monetary

policy, quantitative easing (QE) has become the

preferred tool for U.S. central bankers to keep interest

rates artificially low in hopes of stimulating the

economy. Over the past five years, the total aggre-

gate assets on the Federal Reserve’s balance sheet

increased by a staggering 225 percent (compared

to 22 percent over the previous five-year period).

Recognizing that the Fed’s asset purchases are

entirely policy-driven and contrary to natural

market dynamics, investors should pause to fully

appreciate the attendant implications. Whenever

there is an uneconomic buyer making large-scale

investment decisions irrespective of price, market

distortions are inevitable.

Artificially low yields have long been the case with

Treasuries, and this distortion is increasingly true

for agency mortgage-backed securities (MBS),

which have been purchased at the rate of $40 billion

per month since the start of QE3 in September

2012. With the start of an additional $45 billion per

month Treasury purchase program beginning in

January 2013, and the Fed’s statement that highly

accommodative monetary policy will continue

at least until specific unemployment or inflation

targets are reached, Treasury and agency MBS

markets are likely to remain distorted throughout

the next several years. Today, these overbought

asset classes currently represent nearly 75 percent

of the Barclays U.S. Aggregate Bond Index.

In an environment where the benchmark index is heavily concentrated

in low-yielding government and agency securities, maintaining low

tracking error and pursuing total return targets have seemingly become

contradictory objectives. In the following section, we will discuss how

recent monetary and fiscal policy has created this conundrum for

core fixed-income investors.

The Core ConundrumSECTION 1


As the U.S. government’s fiscal deficit soared from 1.3 percent of GDP in 2007 to 10.4 percent of GDP by 2009, the resulting impact was a significant rise in Treasury issuance. Treasury debt outstanding grew from $4.5 trillion in 2007 to $11.3 trillion by the end of 2012. The Congressional Budget Office (CBO) projects an additional 68 percent increase to $18.9 trillion over the next ten years. Source: SIFMA, Congressional Budget Office. Data as of 12/31/2012.

$20Tn

$15Tn

$10Tn

$5Tn

19881984 1992 1996 2000 2004 2008 2012 2016 2020 2022

162%46%2001 – 2006 2007 – 2012

68%projected

$0Tn1980

The Impact of the Financial Crisis Rise in U.S. Treasury Debt Outstanding since the Financial Crisis

The Evolution of the Core Fixed-Income Universe Reweighting of the Universe toward Risk-Free Assets

The massive increase in Treasury debt has reshaped the core fixed-income universe. Since bottoming in 2007 at 19 percent of core bonds outstanding, Treasuries nearly doubled to 35 percent of the universe by 2012. Combined with agency debt, U.S. government assets now comprise almost two-thirds of the core fixed-income universe, and nearly 75 percent of the Barclays Agg. Source: SIFMA, Credit Suisse. Data as of 12/31/2012.

Treasuries Agency MBS Agency Bonds Investment-Grade Bonds Non-Agency MBS Taxable Municipals ABS

2012

34.5%

2007

19.0%


Fiscal Policy Reconfiguring

Composition of Barclays Agg

Since its creation in 1986, the Barclays U.S.

Aggregate Bond Index (the “Index” or the “Agg”)

has become the most widely used proxy for the U.S.

bond market with over $2 trillion in fixed-income

assets managed to it. Inclusion in the Agg requires

that securities be U.S. dollar-denominated,

investment-grade rated, fixed-rate, taxable, and

meet minimum par amounts outstanding. In 1986,

the fixed-income landscape primarily consisted of

U.S. Treasuries, agency bonds, agency MBS, and

corporate bonds – all of which met these inclusion

criteria. Therefore the Agg was a useful proxy for

the universe of fixed-income assets. However,

the fixed-income universe has evolved over the

past twenty years with the growth of sectors

such as asset-backed securities and municipals.

Over the past five years, the composition of the

Barclays Agg has been altered by the massive

volume of Treasuries issued in response to the

U.S. financial crisis.

The sheer glut of Treasuries and their increasingly

dominant representation in the Index is a trend

unlikely to reverse anytime soon. The need

to fund government shortfalls – present and

future – is astonishing. The U.S. Treasury debt

Currently, the Barclays Agg is the least attractive it has ever been as measured by yield per unit of duration. Given the Fed’s recent pledge to keep rates low at least until specific unemployment or inflation targets are reached, the Index’s unattractiveness from an investment standpoint is likely to continue in the near term. Source: Barclays. Data as of 12/31/2012.

Assessing the Relative Value of the Barclays Agg Historical Yield per Unit of Duration

1%

2%

3%

4%

1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

0%

1976

0.3%12/31/2012


balance totaled $4.5 trillion in 2007. By the end

of 2012, it had skyrocketed to $11.3 trillion. Yet,

it is projected to go even higher – hitting $18.9

trillion by 2022, according to estimates from the

Congressional Budget Office. As Treasuries climbed

from 19 percent of the core fixed-income universe

to 35 percent over the last five years, the market-

capitalization weighted Agg has followed suit.

Treasuries currently comprise 37 percent of the

Agg, and combined with agency debt, total U.S.

government-related debt comprises nearly 75

percent of the Index with a weighted-average yield

of 1.6 percent, as of January 31, 2013.

Anchored to a benchmark heavily allocated to

sectors yielding negative real rates of return

has forced investors to reassess the traditional,

benchmark-driven approach to core fixed-income

management. While historically, core strategies

have had negligible exposure to leveraged credit,

emerging-market debt, and non-agency structured

credit – all of which are typically higher yielding

and commensurately, higher risk segments of the

fixed-income universe – this aversion to riskier

assets appears to be waning given the need for

yield. In the next section, we will analyze the

strategies being employed to generate yield, as

investors adjust to new market realities.

SectorWeight

0%

9%

6%

3%

18%

15%

12%

Barclays Agg 100.0%

Historical High

1.9%

7.3%

ABS 0.4%

Municipals 1.4%

CMBS 1.8%

Agency Bonds8.9%

Corporates 21.6%

Agency MBS 29.4%

Treasuries 36.6%

Historical Low Historical AverageCurrent

2.8%

1.0%

3.3%

1.8% 1.1%

2.5%

0.9%

5.0% 5.5% 5.5%

4.5%

8.0% 7.9%

6.6%

With the average yield of the Barclays Agg at 1.9 percent, and 75 percent of the Index allocated to Treasuries, agency MBS, and agency bonds, investors with minimum yield targets have nowhere to hide within the Index and benchmark-driven strategies may continue to fall short of the yield requirements for most institutional investors. Source: Barclays. Data as of 01/31/2013.

Scarcity of Yield across Fixed-Income Landscape Historically Low Yields across Traditional Core Sectors

7 | COPING WITH NEW MARKET REALITIES GUGGENHEIM PARTNERS

Prioritizing Yield Targets

For investors who service their cash liabilities

through the income stream generated from their

bond portfolios, relative performance to an Index,

that finished 2012 with a total return of 4.2 percent

and a yield of 1.7 percent, is of secondary impor-

tance, and in some cases, inconsequential. For

institutional investors, such as insurance companies,

pension funds, and endowments, absolute yields

and returns are preeminently important. While

several prominent pension funds recently lowered

portfolio return estimates by 25 to 50 basis points,

these diminutive cuts appear largely symbolic

in nature as they fail to address the investment

shortfall concerns emanating from this persistent,

low-rate environment. Despite historically low yields,

materially lowering investment return targets is

simply not a viable option for particular investor

classes. As portfolio return targets remain unhinged

from current market yields, many investors have

begun assuming increased investment risks.

Demand for yield has precipitated a relaxation

in underwriting standards and eased the avail-

ability of credit. For example, during 2012, the

investment-grade and high-yield bond markets

set records for issuance. Particularly in the high-

yield market, there was a significant increase in

deals lacking covenant protection; volume from

lower-rated, first-time issuers; and aggressive deal

structures. The negative, long-term impact of

As institutional investors evaluate their need to generate yield, a softening

stance toward tracking error appears to be emerging, industry-wide.

Traditional yield enhancement techniques, such as increasing duration

and lowering credit quality, may boost total returns in the near term,

but at what cost? Currently, benign credit conditions may be over-

shadowing the potentially deleterious, long-term effects of higher

credit and interest rate risk.

Coping with New Market Realities

SECTION 2


these worsening trends in new issuance is currently

being obscured by the benign credit environment,

a by-product of the Fed’s unprecedented monetary

accommodation. As the Fed begins the fifth year of

its zero-bound monetary policy, continued expec-

tations for low rates would appear to mitigate the

risk of extending duration in pursuit of incremental

yield. However, using historical precedent as our

guide, the market sometimes fails to effectively

discount the potential for sudden monetary

policy shifts.

Asymmetric Risk in Treasuries

During the 1940s, the Fed, acting in concert with

the Treasury Department, fixed interest rates on

short-term Treasury bills while committing to buy

long-term Treasury bonds in order to ensure cheap,

adequate financing for World War II and the

attendant recovery. The end of this practice, under

the Treasury Accord of 1951, led to a tumultuous

sell-off in longer-duration bonds as the market

failed to anticipate the shift in monetary policy.

Once the Fed inevitably begins removing excess

The removal of Fed support of bond prices at the long end of the curve in 1951 set off a bear market in bonds that lasted thirty years. Could history repeat itself once the current period of low rates ends? While we do not think this is imminently possible, future policy change is increasingly a concern. Source: Bloomberg. Data as of 12/31/2012.

Historically, the End of Fed Intervention is Bad News for Bonds U.S. 10-Year Treasury Yields since 1800

1%

3%

5%

7%

9%

11%

13%

15%

1800 1815 1830 1845 1860 1875 1890 1905 1920 1935 1950 1965 1980 1995 2010

10-Y

ear

Trea

sury

Yie

ld

1 2

Rate Stability

Bear Market in Bonds

Treasury Accord


liquidity from the financial system, could a repeat

of the 1950s occur? While we do not envision any

sudden monetary policy shifts or a meaningful

rise in rates in the near term, given where rates

are today and how grossly overvalued Treasury

securities have become, the risk to rates is clearly

to the upside. At current coupon rates, a 20 basis

point rise in rates would result in a negative total

return on 10-year Treasuries over a one-year holding

period. Based on the asymmetrical risk-return

profile, we believe Treasuries have gone from

offering “risk-free returns” to now effectively

becoming “return-free risk.”

The dearth of yield within traditional core fixed-

income sectors has resulted in an uptick in tracking

error as investors increase allocations to riskier

investments, such as emerging-market bonds and

high-yield debt. According to eVestment Alliance,

the average tracking error for core fixed-income

strategies rose to 1.09 percent over the past three

years ending December 2012, compared to 0.66

percent in the three-year period from 2005 to 2007.

Given investors’ increased willingness to venture

outside the traditional confines of core fixed-income,

in the following section, we propose a more optimal

method to generate attractive yields without

sacrificing credit quality or extending duration.

Purchasing 10-year Treasuries at current yields comes with considerable duration risk. Today’s low coupon rates mean a 20 basis point rise in rates would lead to a negative total return over a one-year holding period. With the risk in Treasuries heavily skewed to the downside, we believe Treasuries have gone from offering “risk-free returns” to now effectively becoming “return-free risk.” Source: Bloomberg.

Data as 12/31/2012. The total return scenario is calculated based on the coupon rate of 1.625% and an effective duration of 9.1.

Era of “Return-Free Risk” U.S. 10-Year Treasury One-Year Holding Period Returns

U.S. 10-Year Treasury One-Year Holding Period Total Returns

Change in Interest Rates (Basis Points)

Nom

inal

Tot

al R

etur

n

15%

10%

5%

0%

-5%

-10%

-15%

-20%

-150 -100 -50 0 100 150 200

A 20 basis point move in rates wipes away the total return in 10-year Treasuries

10 | FUTURE INVESTMENT BLUEPRINT GUGGENHEIM PARTNERS

Short-Duration Strategy

Predicated on our view that the risk to interest rates

is to the upside, we would advise investors to

shorten portfolio duration and look for innovative

ways to approach core fixed-income investing.

Shortening duration offers a buffer against rising

rates, but this generally comes at the expense

of yield, particularly in corporate credit securities.

The presumed positive correlation between yield

and duration in the investment-grade universe has

driven demand down the credit spectrum into

lower-rated, high-yield bonds. A broader investment

focus beyond the traditional core fixed-income

framework demonstrates that lowering duration

and producing attractive portfolio yields do

not necessarily have to be mutually exclusive

investment objectives.

Within the investment-grade universe, floating-rate

collateralized loan obligations (CLO) and short-

duration asset-backed securities (ABS) offer similar

yields to longer-dated corporate bonds with signific-

antly less interest rate risk. While traditional

securitizations of credit card receivables, student

loans, and auto loans represent the majority of the

ABS market, the sector has diversified into more

specialized, niche segments of securities backed

by various types of collateral, such as aircraft

and shipping container leases, timeshare vacation

ownership interests, and franchise fees. Largely

owing to its association with the subprime crisis,

these types of lesser-known, “orphan” credits suffer

from a lingering negative connotation. The illiquidity

and complexity of these non-traditional, “off-the-

run” sectors provide opportunities to generate yield

in excess of comparably rated corporate credits.

While corporate bond investors are exposed to the

credit risk of a specific issuer or entity, idiosyncratic

risks are mitigated in CLOs and ABS through large,

diversified collateral pools. Additionally, these

securities offer significant downside structural

protection during stressed economic environments

While it may seem that increased credit and duration risk have become

prerequisites to generate yield, there is a more sustainable, long-term

strategy that relies on the ability to uncover quality, investment-grade

opportunities outside of the traditional benchmark-driven framework.

Future Investment BlueprintSECTION 3


through overcollateralization, excess spread,

reserve accounts, and triggers that cut off cash

flows to subordinated tranches. Lastly, the

amortizing structures of many asset-backed

securities reduce credit exposure over time,

while risks remain constant in corporate bonds

due to their bullet maturities.

Monetizing Complexity

Despite the generally positive credit fundamentals

in traditional ABS sectors, low nominal yields

decrease the attractiveness of these segments.

These traditional sectors, which represent the

lion’s share of the ABS exposure in the Barclays

Agg, have a weighted-average yield of 1.0 percent.

Yields on credit card ABS are currently below

1 percent, while yields on auto loans are between

1 and 2 percent. Although student loans offer

slightly higher yields of 2 to 4 percent, the

regulatory risk coupled with our belief that loan

prepayments will be low, which would extend

the average life of the securities to 10 to 15 years,

significantly reduce their relative attractiveness.

Relative Value of ABS and CLOs vs. Corporate Bonds Spread Comparison between BBB-AA-rated ABS, A-rated CLOs, and BBB-A-rated Corporates

CLO

ABS

Corporate

0bps

600bps

1,200bps

2002 2004 2006 2008 2010

1,500bps

1,800bps

2,100bps

900bps

300bps

2012

Largely owing to their association with the subprime crisis, CLOs and ABS frequently offer excess yield over corporate bonds given their increased complexity and illiquidity. Source: JP Morgan, Bank of America Merrill Lynch. Data as of 12/31/2012.

Spread High: Low: Avg: Last:

CLO 2,070 68 460 315

ABS 1,983 104 431 200

Corporate 710 87 199 163


We believe CLOs and ABS backed by aircraft leases

are the two sectors currently offering the most

attractive relative value. CLOs are benefitting from

low bank loan default rates, healthier corporate

balance sheets, and robust new loan issuance

(nearly $300 billion in 2012). In the aircraft ABS

space, the recent wave of restructurings and

recapitalizations of U.S. airlines have resulted

in improved profitability and lower fixed costs.

Leasing rates have been supported through the

increased demand from airlines that have chosen

to lease rather than buy aircraft. In addition to

our favorable view on the underlying collateral,

aircraft ABS securities tend to be amortizing,

have shorter durations, and offer yields in excess

of 6 percent on senior BBB tranches – a premium

of almost 300 basis points over corporate bonds.

Due to the immense diversity and complexity

of CLOs and ABS, however, ascertaining relative

value requires in-depth analysis of both deal

structure and the underlying collateral.

Long-Duration Strategy

For investors who need to maintain longer asset

duration in order to match their liabilities, floating-

rate CLOs or short-duration ABS can be combined

with longer-duration, fixed-rate securities as part

of a barbell strategy. (“Barbell” means to structure

In the investment-grade complex, ABS is one sector offering leveraged credit-type yields without the commensurate credit risk. Additionally, the shorter duration of ABS securities relative to comparably rated corporate bonds offers greater protection against rising rates. Source: Bloomberg, Bank of America Merrill Lynch, Barclays. Data as of 12/31/2012. Willis Lease is a U.S. public company and a major lessor of spare aircraft engines. BCP is a leading commercial bank in Peru.

Discovering Yield in the Investment-Grade Universe New Issue, Esoteric ABS Provide Yield without Increased Credit and Rate Risk

0%

2%

4%

6%

8%

2 3 4 5 6 7 8

Yiel

d to

Wor

st

Duration

BofA ML ABSMaster BBB-AA Index

Barclays BBBCorporate Index

Barclays BCorporate Index

Barclays BBCorporate Index

Barclays U.S. Aggregate Bond Index (AA)

Barclays ACorporate Index

(A S&P / A Fitch)

Barclays AA Corporate Index

(A S&P / A Fitch)


a portfolio with both short- and long-duration

securities in order to achieve a desired duration

target.) Utilizing this approach provides investors

with yield advantages while still meeting portfolio

duration objectives. With a barbell strategy, the

negative impact of rising rates on the longer-

duration, fixed-rate assets is partially offset by

the positive benefit of higher interest coupons

on floating-rate CLOs. In the case of ABS, shorter

maturities and principal amortizations allow

investors to reinvest proceeds at higher yields

if rates were to rise over an extended period.

To complement the short duration of ABS in the

barbell strategy, we prefer select, longer-dated,

taxable municipal bonds that offer yield premium

to Treasuries and agency debt. The political

uncertainty over the past several years, namely

the debt ceiling debate and the Fiscal Cliff, has

created attractive valuations in the municipal

market. As investors begin focusing on the real

economy and not the political economy, we believe

municipals are primed to benefit. According to

the Rockefeller Institute, state tax revenues have

grown for 10 consecutive quarters as employment

at the state and local government level has stabilized.

California, once the poster child for fiscal ineptitude,

is projecting an $850 million budget surplus for

full year 2014. A longer-term tailwind for municipal

credit fundamentals will be the continued

momentum of the housing sector. Home price

appreciation will eventually translate into higher

property tax assessments realized by local govern-

ments over the next several years.

Aside from these improving fundamental factors,

the municipal sector may also benefit from technical

catalysts. Building upon the record $50 billion in

mutual fund inflows in 2012, continued demand

for municipals will likely be aided by the expected

growth of the U.S. economy throughout 2013.

Increased Federal revenues may lead to a decline

in Treasury bond issuance, forcing investors into

other government-related alternatives such as

municipals and military housing. Our focus remains

on A-rated revenue bonds maturing within 20 years

that finance essential services, public universities

and transportation.

Active Management in Practice

With nominal coupons across the fixed-income

universe near historical lows, the opportunity cost

from employing a benchmark-driven, passively

managed strategy has increased dramatically. An

actively managed strategy provides the opportunity

to generate returns through targeted weightings

to attractively valued sectors. The volatility of sector

performance over the past few years, quantified

in the following table, underscores the importance

of active management.

Barbell means to structure a portfolio with both short- and long-duration securities in order to achieve a desired duration target. With a barbell strategy, the negative impact of rising rates on the longer-duration, fixed-rate assets is partially offset by the positive benefit of higher interest coupons on floating-rate securities.


The Future of Core Fixed-Income

The traditional view of core fixed-income did not

include active duration management, increased

tolerance for tracking error, or significant allocations

to non-indexed sectors such as floating-rate CLOs

and “off-the-run” ABS. As the chasm between

investors’ return targets and current market yields

deepens, it is apparent that the traditional view of

core fixed-income management requires innovation.

The historically low-rate environment has intensified

the demand for absolute yield, antiquating investors’

historical focus on relative performance.

In pursuing yield targets, investors must not allow

short-term pursuits to derail long-term investment

objectives. We believe the global easing cycle will

continue to support a benign credit environment

over the next two to three years; however, the current

accommodative conditions are likely masking a

comprehensive appreciation of investment risks.

With nominal yields near historical lows, price performance is likely to become a larger component of total returns in the near term. Active asset allocation provides the opportunity for a portfolio to generate returns through increased weightings to attractively valued sectors and decreased weightings to overvalued asset classes. Source: Barclays, Credit Suisse. Data as of 12/31/2012.

Asset Allocation Matters, Particularly in Today’s Low Yield Environment Historical Annual Fixed-Income Sector Returns

2006 2007 2008 2009 2010 2011 2012

High Yield

11.8%Treasuries

9.0%Treasuries

13.7%High Yield

58.2%High Yield

15.1%Municipals

18.1%High Yield

15.8%

Leveraged Loans

7.3%Municipals

7.6%Municipals

7.0%Leveraged Loans

44.9%Leveraged Loans

10.0%Treasuries

9.8%IG Corporates

9.8%

ABS

4.7%IG Corporates

4.6%IG Corporates

-4.9%ABS

24.7%IG Corporates

9.0%IG Corporates

8.1%Municipals

9.6%

IG Corporates

4.3%ABS

2.2%ABS

-12.7%IG Corporates

18.7%Municipals

7.2%ABS

5.1%Leveraged Loans

9.4%

Municipals

3.2%Leveraged Loans

1.9%High Yield

-26.2%Municipals

0.7%Treasuries

5.9%High Yield

5.0%ABS

3.7%

Treasuries

3.1%High Yield

1.9%Leveraged Loans

-28.8%Treasuries

-3.6%ABS

5.9%Leveraged Loans

1.8%Treasuries

2.0%


Given the overwhelming emphasis on total return,

investors must be vigilant in identifying the risks

involved in reaching for incremental yield, since

“not all yield is created equal.” Employing investment

shortcuts, such as increased credit or interest

rate risk, solely to generate yield may come at the

expense of future performance. Achieving yield

targets without assuming undue risk has proven

extremely difficult under the traditional framework.

We believe it is achievable under a broadened

investment framework.

By remaining tightly aligned to the Barclays Agg,

which is currently bloated with low-yielding

government-related debt, investors are giving up

the flexibility to take advantage of undervalued

sectors and underweight unattractive ones. In

a market coping with unprecedented monetary

conditions, we believe the surest path to underper-

formance is to remain anchored to outdated core

fixed-income conventions of the past.

U.S. Treasuries

Agency MBS

Agency Bonds

Corporates

RMBS

CMBS

Taxable Municipals

ABS

Weighted-Average Yield

0%

U.S. Treasuries

Agency MBS

Agency Bonds

Corporates

RMBS

CMBS

Taxable Municipals

ABS


0%1% 2% 3% 4% 5% 1% 2% 3% 4% 5%

0.9% 1.0%

2.2% 2.3%

1.3% 2.3%

2.7% 4.2%

4.2%

n/a 5.0%

1.7%

1.7%

4.7%

3.2%

4.8%

0.9%

4.9%

With the traditional view of core fixed-income management quickly becoming antiquated in today’s low-yield environment, investors must begin looking forward towards the future of core fixed-income management. Source: Barclays, Guggenheim Investments. Data as of 12/31/2012. Sector allocations are based on the representative

account of the Guggenheim Core Fixed-Income Strategy and excludes cash.

The Changing of the Guard The Future of Core Fixed-Income Management

Traditional View: Barclays Agg

WEIGHT

U.S. Treasuries

Agency MBS

Agency Bonds

Corporates

RMBS

CMBS

Taxable Municipals

ABS


0%

U.S. Treasuries

Agency MBS

Agency Bonds

Corporates

RMBS

CMBS

Taxable Municipals

ABS


0%1% 2% 3% 4% 5% 1% 2% 3% 4% 5%

0.9% 1.0%

2.2% 2.3%

1.3% 2.3%

2.7% 4.2%

4.2%

n/a 5.0%

1.7%

1.7%

4.7%

3.2%

4.8%

0.9%

4.9%

74.7% gov.-related debt

YIELD

U.S. Treasuries

Agency MBS

Agency Bonds

Corporates

RMBS

CMBS

Taxable Municipals

ABS


0%

U.S. Treasuries

Agency MBS

Agency Bonds

Corporates

RMBS

CMBS

Taxable Municipals

ABS


0%1% 2% 3% 4% 5% 1% 2% 3% 4% 5%

0.9% 1.0%

2.2% 2.3%

1.3% 2.3%

2.7% 4.2%

4.2%

n/a 5.0%

1.7%

1.7%

4.7%

3.2%

4.8%

0.9%

4.9%

Future View: Guggenheim Core Fixed-Income

U.S. Treasuries

Agency MBS

Agency Bonds

Corporates

RMBS

CMBS

Taxable Municipals

ABS


0%

U.S. Treasuries

Agency MBS

Agency Bonds

Corporates

RMBS

CMBS

Taxable Municipals

ABS


0%1% 2% 3% 4% 5% 1% 2% 3% 4% 5%

0.9% 1.0%

2.2% 2.3%

1.3% 2.3%

2.7% 4.2%

4.2%

n/a 5.0%

1.7%

1.7%

4.7%

3.2%

4.8%

0.9%

4.9%

16.6% gov.-related debt

WEIGHT YIELD


1 Assets Under Management(AUM) is as of 12.31.2012 and includes $10.71B of leverage. AUM includes assets from Security Investors, Guggenheim Partners Investment Management, LLC (“GPIM”, formerly known as Guggenheim Partners Asset Management, LLC; GPIM assets also include all assets from Guggenheim Investment Management, LLC which were transferred as of 06.30.2012), Guggenheim Funds Investment Advisors and its affiliated entities, and some business units including Guggenheim Real Estate, Guggenheim Aviation, GS GAMMA Advisors, Guggenheim Partners Europe, Transparent Value Advisors, and Guggenheim Partners India Management. Values from some funds are based upon prior periods.

Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC (“GP”): GS GAMMA Advisors, LLC, Guggenheim Aviation, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Investment Management, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners India Management, Guggenheim Real Estate, LLC, Security Investors, LLC and Transparent Value Advisors, LLC. Guggenheim Partners Investment Management, LLC (GPIM) is a registered investment adviser and serves as the adviser to the Core Fixed Income Strategy. GPIM is included in the GIPS compliant firm, Guggenheim Investments Asset Management, and is also a part of Guggenheim Investments. This material is intended to inform you of services available through Guggenheim Investments’ affiliate businesses.

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy.

Past performance of indices of asset classes does not represent actual returns or volatility of actual accounts or investment managers, and should not be viewed as indicative of future results. The benchmarks used are for purposes of comparison and should not be understood to mean that there will necessarily be a correlation between the portrayed returns herein and these benchmarks.

Past performance is not indicative of comparable future results. Given the inherent volatility of the securities markets, it should not be assumed that investors will experience returns comparable to those shown here. Market and economic conditions may change in the future producing materially different results than those shown here. All investments have inherent risks.

No representation or warranty is made to the sufficiency, relevance, importance, appropriateness, completeness, or comprehensiveness of the market data, information or summaries contained herein for any specific purpose.

© 2013 Guggenheim Partners LLC. All Rights Reserved. No part of this document may be reproduced, stored, or transmitted by any means without the express written consent of Guggenheim Partners LLC.

Guggenheim Partners is a privately held financial services firm that provides asset management, investment

banking, and insurance solutions. At Guggenheim Partners, we combine innovative thinking and experienced

advice to sophisticated clients. Our primary businesses include:

INVESTMENTS

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About Guggenheim Partners

About Guggenheim Investments

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Guggenheim Investments represents the investment management division of Guggenheim Partners, which

consist of investment managers with approximately $143 billion in combined total assets.1 Collectively,

Guggenheim Investments has a long, distinguished history of serving institutional investors, ultra-high-net-

worth individuals, family offices, and financial intermediaries. Guggenheim Investments offers clients a wide

range of differentiated capabilities built on a proven commitment to investment excellence. Guggenheim

Investments has offices in Chicago, New York City, and Santa Monica, along with a global network of offices

throughout the United States, Europe, and Asia.

the core conundrum: dealing with fixed-income market realities

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