BALANCING INCOME GENERATION IN A WORLD OF VUCA

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1 BALANCING INCOME GENERATION IN A WORLD OF VUCA April 2017 FPA Arne Espe, CFA, Mutual Funds Portfolio Manager USAA Mutual Funds 1

2 About our Presenter from USAA Arne Espe, CFA Mutual Funds Portfolio Manager USAA Mutual Funds Portfolio Manager of Flexible Income Fund. Bond portion of Cornerstone Strategy Funds, First Start Growth, and Real Return. 30+ Years of investment management experience; has been at USAA since 2000 Education: MBA University of Oregon and B.S. Willamette University 2

3 About USAA Proudly serving the military community and their families for 93 years Founded in 1922 by 25 U.S. Army Officers in San Antonio, Texas A privately-held reciprocal company with over 11 million members One of only a few financial companies with the highest possible financial strength ratings from Moody s & AM Best USAA s Investment Solutions are Available to the General Public 3

4 USAA Investments Since 1970 W'"99%&%65.' YZ*RD[?A; 34546&'+4-70 YZ^RD[ 260H T6>U/>.B#5'D8-70 /]4%5%.0 As of 12/31/16 X

5 Agenda Defining VUCA USAA s Investment Outlook Strategies for Income Generation 5

6 DEFINING VUCA 6

7 Defining VUCA It s Crazy Out There! Volatility Uncertainty Complexity Ambiguity 7

8 Volatility Stock Market R J#1$S R)C)' b)c)' *)C)' ^)C)' S)C)' X)C)' J)C)' ()C)'!)C)'! " #$%&#%'(" #$%&#%')" #$%&#%'*" #$%&#%#'" #$%&#%##" #$%&#%#$" #$%&#%#&" #$%&#%#+" #$%&#%#," #$%&#%#-" VIX Index (Chicago Board Options Exchange SPX Volatility Index) Source: Bloomberg as of 3/31/17 b

9 Volatility Economic Growth Real GDP YoY (2.00) (4.00) (6.00) GDP CYOY Index (GDP US Chained 2009 Dollars YoY SA) Real GDP YoY Quarterly 31DE Source: Bloomberg as of 3/31/17 9

10 Uncertainty Interest Rates Rising Soon? Fed vs Market Expectations 3% FUTURE FED FUNDS TARGET RATE Fed Projection Market Expectation Current Rate 2% 1% 0% Source: Bloomberg Fed projection is the median of the FOMC Members' Dot projections. The Market Expectation is the implied Fed Funds Target Rate. 10

11 Complexity Overwhelming Regulatory Rules Source: SEC 11

12 Ambiguity Earnings and Prices Have Diverged Earnings vs. Prices Large gap between earnings and prices MSCI World Prices MSCI World Earnings Source: Bloomberg as of 11/01/16 12

13 Dealing with VUCA, the New Normal VUCA environments thus become invitations for inaction people are befuddled by the turmoil and don t act. And to succeed, you must act! General George Casey, Army Chief of Staff and Commanding General of the Multinational Force in Iraq 13

14 USAA S INVESTMENT OUTLOOK 14

15 Total Nonfinancial Debt as a % of GDP Excluding Off Balance Sheet Liabilities Source: Federal Reserve through Q4 2016!S

16 Global Government Debt Developed Market Debt Weighs on Global Growth Government Debt/GDP 110% Eurozone United States 100% 90% 80% 70% 60% 50% Source: Bloomberg as of 9/30/16 16

17 GDP Growth Remains Sluggish US Real GDP Growth % GROWTH QoQ Source: Thomson Reuters Datastream as of 9/30/

18 Lower for Longer Interest Rates Will Likely Persist BXaW$/"%E"$/'-"M%W5$01%4"3b%BIABaDXBC <H67.7'"$.60'I.#$.0.-5'5H.'i.-:5HE',.$%870'89'i8G'I65.0'+8&&8G%-:'D6&6-A.'<H..5'I.A.00%8-0 Source: Robert Shiller of Yale University as of 9/30/2016!b

19 Equities A Cyclical Pattern to Global Outperformance U03_/0%&S(3'-"$%!11'%V5Y$"'545[/.53#%.3%78%8.3[Z%23".43053!R

20 Value Stocks vs. Expensive Stocks Cheap stocks have historically produced higher returns than expensive stocks Cheap vs. Expensive U.S. Stock Returns Cheap Stocks Historic Annualized Return (%) 14.84% Growth of $1 (log scale) Expensive Stocks Average Stocks 10.02% 12.05% "Cheap" Stocks "Expensive" Stocks Past performance is no guarantee of future results Source: Fama French database, data as of 3/31/2016 Cheap defined as top 30% of stocks in the S&P500 sorted on book to market, Expensive defined as lowest 30% of stocks in the S%P500 sorted on book to market, average stocks defined as middle 40% of stocks in S&P500 sorted on book to market. 20

21 High Yield Bonds are Currently Offering Attractive Yields Relative to Other Fixed Income Asset Classes 7.00% Multi Asset Class Yields 6.00% 5.00% 4.00% 3.00% 6.21% 5.47% 2.00% 1.00% 3.37% 3.09% 3.01% 2.40% 2.36% 0.78% 0.00% High Yield EM Debt IG Corporate Municipal CMBS 10 Yr Treasury 0.15% S&P 500 T-Bills Tips Source: Barclays Capital as of 4/17/17 Past performance is no guarantee of future results. 21

22 Corporate Bonds and Credit Instruments Can Lead to Outperformance Corporate Bonds Generally Outperform Treasuries Over Time Relative Cumulative Performance 1.5 When slope on chart is going up, Credit is outperforming Treasuries When slope on chart is going down, Treasuries are outperforming Credit Source: Datastream and Morningstar Direct as of 3/31/17 22

23 Muni Yields Remain Attractive on Relative Basis Bond Yields as of 3/31/ Treasuries Corporates Municipals Tax-Adjusted Muni* Year 3 Year 10 Year 30 Year Treasury Corporate Municipal Tax Adjusted Muni * 1 Year Year Year Year Note: Corporate based on A-rated industrial curve. Municipal based on Municipal Market Data A-Rated GO Scale. * Municipal yields are on a 39.6% tax bracket Source: Bloomberg/Municipal Market Data Past performance is no guarantee of future results. 23

24 STRATEGIES FOR INCOME GENERATION 24

25 Strategies for Income Generation Economy We project modest economic growth and interest rates staying lower-for-longer Stocks Expected returns may be greater in International & Emerging Markets US value stocks appear more attractive at current levels Fixed Income Seek skilled actively-managed corporate bonds strategies over treasuries Investment-grade corporate bonds High-yield bonds Municipal bonds 25

26 USAA s Fixed Income Philosophy We believe a yield focused portfolio, Built bond-by-bond, through fundamental bottom-up analysis, Will generate total returns that can potentially outperform our peers over the long run. 26

27 USAA Fixed Income Capabilities Available to the General Public Membership not Required g56n$"%w5$01%j%t5'z E/S/_0$%% 78!!%+0$S5_0$%J#[3b$% 78!!%g56N%J#[3b$% 78!!%J#[3b$ 78!!%E/S%&S$b(.%^3#6aE$"b 78!!%U3Y$"#b$#.%8$[-"5.5$' 78!!%E/S%&S$b(.%J#.$"b$15/.$aE$"b% 78!!%70."/% ^3G$"%W5$01%j%T5'Z 78!!%E/S%&S$b(.%8N3".aE$"b% E/S%&S$b(.% (*

28 USAA Fixed Income Funds with 4 & 5 Star Overall Ratings by Morningstar Taxable Bonds Morningstar Category Overall Rating/ Funds in Category 3 Year/Funds in Category 5 Year/Funds In Category 10 Year/Funds in Category USAA Short-Term Bond Short Term Bond USAA Intermediate-Term Corporate Bond USAA Income Intermediate-Term Bond Municipal Bonds Morningstar Category Overall Rating/ Funds in Category 3 Year/Funds in Category 5 Year/Funds In Category 10 Year/Funds in Category USAA Tax Exempt Short-Term Muni National Short USAA Tax Exempt Intermediate-Term Muni National Intermediate USAA Tax Exempt Long-Term Muni National Long Morningstar gives its best ratings of five or four stars to the top 32.5% of all funds (of the 32.5%, 10% get five stars and 22.5% get four stars) based on their risk-adjusted returns. The Overall Morningstar Rating is derived from a weighted average of the performance figures associated with a fund's three-, five-, and 10-year (if applicable) Morningstar Rating metrics. Morningstar ratings as of 3/31/17. 28

29 Disclosures Consider the investment objectives, risks, charges, and expenses of the USAA mutual funds carefully before investing. Contact us at for a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing. Investing in securities products involves risk, including possible loss of principal. Past performance is no guarantee of future results. This material is provided for informational purposes only by USAA Asset Management Company (AMCO) and/or USAA Investment Management Company (IMCO), both registered investment advisers. The material is not investment advice and is not a recommendation, an offer, or a solicitation of an offer, to buy or sell any security, strategy, or investment product. The views and opinions expressed in the material solely reflect the judgment of the authors, but not necessarily those of AMCO, IMCO or any affiliates as of the date provided and are subject to change at any time. All information and data presented herein has been obtained from sources believed to be reliable and is believed to be accurate as of the time presented, but AMCO/IMCO do not guarantee its accuracy. The information presented should not be regarded as a complete analysis of the subjects discussed. Any past results provided do not predict or indicate future performance, which may be negative. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of AMCO/IMCO and USAA. The fixed income securities are subject to price volatility and a number of risks, including interest rate risk. Interest rates and bond prices move in opposite directions so that as interest rates rise, bond prices usually fall, and vice versa. Interest rates are currently at historically low levels. Fixed income securities also carry other risks, such as inflation risk, liquidity risk, call risk, and credit and default risks. Lower-quality fixed income securities involve greater risk of default or price changes. Securities of non-u.s. issuers generally involve greater risks than U.S. investments, and can decline significantly in response to adverse issuer, political, regulatory, market, and economic risks. Fixed-income securities sold or redeemed prior to maturity may be subject to loss. Images and content used in this presentation do not represent any endorsement, expressed or implied, by the Department of Defense or any other United States government agency. Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers, and affiliates. SOURCES 1 Credit vs. Treasuries: BofA Merrill Lynch BBB Index vs. BofA Merrill Lynch Treasury Index (relative cumulative performance) 2 Global Diversification: MSCI World TX-USA TR vs. MSCI USA TR (rolling 3-year relative return) 29

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