War Room 28 March 2012

Fixed Income in 2012:Are Bonds Still En Vogue?

War Room

•Monthly macro discussion

•Using tools in context

•Update on HiddenLevers Features

•Your feedback welcome

Fixed Income in 2012 – Are Bonds Still En Vogue?

•Market Snapshot

•Fixed Income Fundamentals

•Outlook + Scenarios

•Fixed Income Functionality

FIXED INCOME IN 2012:MARKET SNAPSHOT

HiddenLevers

Market Snapshot: US Benchmark Rate

US Interest Rates at all time low, and pledge from Fed extended – rates will remain here until mid 2014.

The New Normal

Market Snapshot – Fixed Income good stories

Treasuries + Emerging Markets Debt Funds have trounced the S&P 500, without the volatility

Market Snapshot – Fixed Income good stories

Less volatility since the crisis helps folks sleep better

Many still haunted by Meredith Whitney comments in October 2010 for no reason

FIXED INCOME FUNDAMENTALSHiddenLevers

Fixed Income: Credit Risk Profiles

Even through financial crisis, credit risk not an issue for investment grade – but CCC and below has 57% lifetime default rate.

Credit Risk: HY Credit Spreads

Credit spreads much narrower than crisis levels

Still above 30 yr average Further narrowing =

upside for HY, Munis, EM debt

Widening = flight back to treasuries

Sources: Citigroup + BofA Merrill Lynch

Interest Rate Risk - DurationHow to control duration?

Shorten maturities Increase yield Hold to maturity Floating rate issues

Higher yield considerations Increased credit risk Higher correlation to

stocks

Sources: National Associations of Realtors, Home Builders, and Wells Fargo

Interest Rate Risk: Yield Curve

The current yield curve is significantly lower than historical averages, with seemingly little precedent to drop further.

1980 – High Inflation 2003 – Last Recovery

2006 - Last Cycle Peak 2011- What's Next?

Avg Yield Curve 1977-2011

Source: Fidelity

FIXED INCOME IN 2012:OUTLOOK + SCENARIOS

HiddenLevers

Interest Rates Stay Low – Deflation Worry

US Interest rates going nowhere

Bernanke’s worst fear, and the reason for QE

Consequences - Inflation:

1. Fed forced to tighten to contain inflation

2. 2014 pledge goes bye bye – Fed eats crow

3. Commodities keep rising – push cost of everything

4. Negative impact for equities and bond markets

Interest Rates Rise – What is the Driver?

Consequences - Growth:

1. Fed tightens as we get back to normalcy

2. Borrowing costs rise for financial firms, REITs

3. Bullish for equities as bonds lose luster

4. Precious metals not as shiny either

FIXED INCOME – NEW FEATURESHiddenLevers

HiddenLevers - New Features

• Fixed Income Support

• Cusips + Options now uploadable

• Macro Profile for Portfolio – need feedback

Coming soon:

• Scenario Hedging Wizard

• Excel-type pasting for Add Portfolio

Fixed Income Functionality

CUSIPs now supported in edit portfolio or via portfolio upload

You can also manually enter custom fixed-income or cash-flow investments (including real estate)

How it works:– Interest Rate Risk Modeling: Calculates duration

and convexity to model interest rate risk – Credit Risk Modeling: Uses industry/sector or

proxy symbol to determine correlations, and uses ratings to determine volatility