POOL INVESTMENT STRATEGIES IN THE CURRENT MARKET 2015 NLC RISC TRUSTEES CONFERENCE MAY 7, 2015 MIKE NORMAN, PARTNER

Transcription

1 POOL INVESTMENT STRATEGIES IN THE CURRENT MARKET 2015 NLC RISC TRUSTEES CONFERENCE MAY 7, 2015 MIKE NORMAN, PARTNER

2 GOALS Explore current investment trends and likely future return environment What to do in a low-yield investment return environment AGENDA What can we invest in? What have we experienced and where are we now? What might we expect? What can we do? 1

3 The information contained herein reflects the views of Galliard Capital Management, Inc. and sources believed to be reliable by Galliard as of the date of publication. No representation or warranty is made concerning the accuracy of any data and there is no guarantee that any projection, opinion, or forecast herein will be realized. The views expressed may change at any time subsequent to the date of publication. This publication is for information purposes only; it is not investment advice or a recommendation for a particular security strategy or investment product. Graphs and tables are for illustrative purposes only. 2

4 WHO AM I? Partner, Galliard Capital Management, located in Minneapolis, MN We focus exclusively on fixed income solutions for institutional investors Currently manage more than $84 billion, including 5 Public Risk Insurance Pools WHO AM I NOT? No PhD in Economics Definitely NOT Janet Yellen 3

5 PUBLIC RISK POOLS WHAT ARE THE ELIGIBLE INVESTMENTS? INVESTMENTS DICTATED BY Statutes / legislation Insurance industry regulations Investment policies Investment guidance from committee / board / staff / others RESULTS Not all pools can invest in the same assets Investment horizon / goals may be different Common theme # 1: principal preservation Common theme #2: fixed income investments common across all 4

6 PUBLIC RISK POOLS INVESTMENT OPTIONS FIXED INCOME SECURITIES U.S. Government Corporate Municipals Structured Products - Mortgage Backed - Asset Backed Sovereign/Supranational RISK ASSETS Equity High yield securities Derivatives Not a laundry list there are other instruments available 5

7 FIXED INCOME OPTIONS U.S. TREASURIES THERE ARE DIFFERENT TYPES OF U.S. TREASURY DEBT U.S. TREASURIES FIXED-PRINCIPAL TREASURIES INFLATION-INDEXED TREASURIES (TIPS) TREASURY STRIPS (created by private sector) Treasury Bills Treasury Notes Treasury Bonds Coupon Strips Principal Strips 6

8 FIXED INCOME OPTIONS U.S. GOVERNMENT AGENCIES THERE ARE DIFFERENT TYPES OF U.S. GOVERNMENT AGENCY DEBT DIFFERENT TYPES OF DEBT Direct debentures Structured products NOT ALL AGENCIES ARE CREATED EQUAL Federally related institutions GSEs GSEs FHLB FHLMC FNMA FFCB REFCORP USPS FICO GTC FAMC SLMA Federally Related Institutions TVA CCC FHA GSA GNMA MA PEFCO REA RTB SBA WMATA HUD OPIC 7

9 WHAT CAN WE INVEST IN? THE FIXED INCOME YIELD CURVE RELATIONSHIP OF YIELD AND MATURITY Yield 10 % C B A 0 % 3 Months 1 Year 5 Years 20 Years Time to Maturity 8

10 WHAT CAN WE INVEST IN? THE U.S. TREASURY YIELD CURVE THE YIELD CURVE TAKES ON DIFFERENT SHAPES 6.0 U.S. Treasury Yield Curve Yield (%) /29/06 3/31/08 3/31/ Month 6 Month 1 Year 2 Year 3 Year 5 Year 7 Year 10 Year 30 Year Source: Bloomberg 9

11 WHAT CAN WE INVEST IN? MOVEMENT OF THE U.S. TREASURY YIELD CURVE THE CURVE MOVES 03/31/14 03/31/15 Change 3 Month (0.02) 6 Month Year Year Year Year (0.35) 7 Year (0.59) 10 Year (0.80) 30 Year (1.02) Yield (%) Month 6 Month 1 Year 2 Year 3 Year 5 Year 7 Year U.S. Treasury Yield Curve 10 Year 30 Year 3/31/14 3/31/15 Source: Bloomberg 10

12 WHAT CAN WE INVEST IN? MOVEMENT OF THE U.S. TREASURY YIELD CURVE FED FUNDS RATE EXPECTATIONS (%) 11

13 WHAT HAVE WE EXPERIENCED AND WHERE ARE WE NOW?

14 WHERE ARE WE NOW? THE YIELD CURVE CONTINUES MAIN DRIVERS OF THE YIELD CURVE No one factor or entity sets the yield curve Main drivers - Economic environment Both domestic and global - Monetary policy Expansionary Contractionary Quantitative easing / the twist 12

15 WHERE ARE WE NOW? IS THERE MORE THAN ONE YIELD CURVE? TREASURY YIELD CURVE DRIVES OTHER YIELD CURVES 10% Hypothetical Yield Curves Yield to Maturity 8% 6% 4% 2% Credit Spread for High Yield (Junk) Bond Rated CC Credit Spread for Investment Grade Bond Rated AA 0% Maturity (Years) Source: Bloomberg Corporate CC (High Yield) Corporate AA (Investment Grade) U.S. Treasury Treasuries: historically viewed as risk-free rate Corporate bonds require risk premium 13

16 WHAT HAVE WE SEEN? ALL SECURITIES RESPOND DIFFERENTLY DIFFERENT TYPES OF SECURITIES REACT DIFFERENTLY DUE TO MARKET CONDITIONS 900 CORPORATE CREDIT 1800 STRUCTURED PRODUCT Invest. Grade: Industrial -- Intermediate - OAS Intermediate Utility - OAS Invest. Grade: Financial Institutions -- Intermediate - OAS Source: BarclaysLive U.S. MBS: Agency Fixed Rate MBS - OAS Agency Hybrid ARM: U.S. Aggregate - OAS Asset-Backed Securities - OAS CMBS: Erisa Eligible - OAS 14

17 WHAT HAVE WE SEEN? WELCOME TO THE LOW RATE ENVIRONMENT YIELDS OF U.S. TREASURY SECURITIES HAVE BEEN IN A LONG TREND DOWNWARD Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Yield U.S. Treasury Fed Funds Source: Bloomberg, Federal Reserve 15

18 WHAT HAVE WE SEEN? GLOBAL DEMAND We need to remember we re not investing in a U.S. Domestic bubble 10 Year Government Bond Yield 4% 3% 2% 1% 0% US GERMANY JAPAN Source: BarclaysLive 16

19 WHAT HAVE WE SEEN? HISTORICAL CONTRIBUTORS TO PERFORMANCE GALLIARD INTERMEDIATE CORE COMPOSITE CALENDAR YEAR INVESTMENT PERFORMANCE* PERFORMANCE ATTRIBUTION OF EXCESS RETURNS RELATIVE TO BARCLAYS U.S. INTERMEDIATE GOVERNMENT/CREDIT BOND INDEX Just one example of active portfolio management Investment choices by different managers/funds will impact performance over time Past performance (market environments) may not be a good indicator for future results *Net returns are gross returns less the maximum investment management fee and include the effect of compounding. Past performance is not an indication of how the investment will perform in the future. See appendix for additional disclosure information. This if for information purposes only; it is not investment advice or a recommendation for a particular security strategy or investment product. 17

20 WHAT HAVE WE EXPERIENCED? A BROAD LOOK AT ASSET CLASSES ASSET CLASS RETURNS Reporting period as of December 31, Real Estate 33.16% Emerging Markets 34.00% Real Estate 35.97% Emerging Markets 39.39% Government Treasury 24.03% Emerging Markets 78.51% Real Estate 28.60% Government Treasury 29.93% Emerging Markets 18.22% Small Cap 38.82% Real Estate 31.78% Emerging Markets 25.55% Intl Stocks 20.25% Small Cap 18.33% Intl Bonds 12.04% Large Cap 10.88% High Yield 10.76% Commodities 9.15% Asset Allocation 8.30% Government Treasury 7.70% Intermediate Bond 4.34% Cash 1.24% Commodities 21.36% Real Estate 13.82% Intl Stocks 13.54% Government Treasury 6.50% Large Cap 4.91% Small Cap 4.55% Asset Allocation 4.00% Cash 3.00% High Yield 2.83% Intermediate Bond 2.43% Intl Bonds -9.24% Emerging Markets 32.17% Intl Stocks 26.34% Small Cap 18.37% Large Cap 15.79% High Yield 11.64% Asset Allocation 11.12% Intl Bonds 6.84% Cash 4.76% Intermediate Bond 4.33% Commodities 2.07% Government Treasury 1.85% Commodities 16.23% Intl Bonds 11.30% Intl Stocks 11.17% Government Treasury 9.81% Intermediate Bond 6.97% Asset Allocation 6.22% Large Cap 5.49% Cash 4.74% High Yield 2.17% Small Cap -1.57% Real Estate % Intl Bonds 11.40% Intermediate Bond 5.24% Cash 1.80% Asset Allocation % High Yield % Small Cap % Commodities % Large Cap % Real Estate % Intl Stocks % Emerging Markets % High Yield 56.28% Intl Stocks 31.78% Real Estate 28.60% Small Cap 27.17% Large Cap 26.46% Commodities 18.91% Asset Allocation 18.40% Intermediate Bond 5.93% Intl Bonds 3.94% Cash 0.16% Government Treasury % Small Cap 26.86% Emerging Markets 18.88% Commodities 16.83% High Yield 15.24% Large Cap 15.06% Asset Allocation 12.13% Government Treasury 9.38% Intl Stocks 7.75% Intl Bonds 6.78% Intermediate Bond 6.54% Cash 0.13% Emerging Markets % Real Estate 9.24% Intermediate Bond 7.84% Intl Bonds 5.91% Asset Allocation 4.69% High Yield 4.50% Large Cap 2.11% Cash 0.08% Small Cap -4.18% Intl Stocks % Commodities % Real Estate 17.59% Intl Stocks 17.32% Small Cap 16.35% Large Cap 16.00% High Yield 15.44% Asset Allocation 11.31% Intermediate Bond 4.21% Government Treasury 3.56% Intl Bonds 0.71% Cash 0.07% Commodities -1.06% Large Cap 32.39% Intl Stocks 22.78% Asset Allocation 17.56% High Yield 7.38% Real Estate 1.86% Cash 0.05% Intermediate Bond -2.02% Emerging Markets -2.60% Intl Bonds -5.08% Commodities -9.52% Government Treasury % Government Treasury 25.07% Large Cap 13.69% Asset Allocation 10.62% Intermediate Bond 5.97% Small Cap 4.89% High Yield 2.44% Cash 0.03% Emerging Markets -2.19% Intl Bonds -2.53% Intl Stocks -4.90% Commodities % Source: Zephyr Associates, Inc. Cash- Citigroup 3 month T-bill,Government Treasury-Barclays Capital Long Treasury, Commodities-Dow UBS Commodity Index, Intermediate Bond- Barclays Capital US Aggregate Bond Index, High Yield Bond-Merrill Lynch High Yield Index, Intl Bonds-JPMorgan GBI Global ex U.S., Asset Allocation-portfolio assumes the following weights: 60% S&P 500 and 40% Barclays Capital Aggregate, Large Cap-S&P 500, Small Cap-Russell 2000, Intl Stocks-MSCI EAFE (net), Emerging Markets- MSCI EM (net), Real Estate-Wilshire U.S. REIT. 18

21 WHAT MIGHT WE EXPECT?

22 WHAT MIGHT WE EXPECT? U.S. FEDERAL RESERVE ACTION All eyes on Janet Yellen and the Federal Reserve Consensus is rates will rise at some point 1.0% 2 Year Treasury Benchmark 0.5% Source: BarclaysLive 0.0%

23 WHAT MIGHT WE EXPECT? WHERE DOES THE FED GO FROM HERE? TIMELINE OF KEY FED POLICY MOVES Policy Step Galliard Estimated Actual Time Frame Start to taper quantitative easing Complete tapering of quantitative easing Adjust disclosure for Fed Funds rate Fed Funds rate increase Supplementary normalization tools: Term Deposit Facility, Term/Overnight Reverse Repurchase Agreements 4Q 2013 January Q 2014 October st Half 2015 December 2014 Mid to late 2015 Currently testing, potential to use as needed 6 Fed pauses at neutral rate 1.5% - 2% End 2017 FED METRICS GOING FORWARD Moderately expanding economic activity is leading to an underlying desire to start normalizing monetary policy in 2015, and timing and pace of rate hikes will be a focus As the unemployment rate nears the Fed s target, attention can turn to other facts such as wage growth, which remains muted Inflation is another key metric which will be monitored closely, expectations are for a gradual rise toward the Fed s 2% target over time as labor markets continue to strengthen and transitory factors (i.e. low oil prices) wane Global deflationary pressures are a concern but we believe the domestic economic landscape would have to deteriorate sharply from forecasts for the Fed to change their plans 20

24 1 2 WHAT MIGHT WE EXPECT? CAN A SOFT LANDING BE ENGINEERED BY THE FED? Effective Fed Funds rate hits 20% April 83 August 84 Target Fed Funds rate increased from 8.5% to 11% ECONOMY/ IMPACT Double Dip Recession, but inflation is beaten Soft Landing BROAD MARKET IMPACT/EVENT Excessive Negative Returns Soft Landing 3 April 87 May 89 Target Fed Funds rate increased from 6% to 9% 1990 Recession S&L, High yield, Real Estate and Insurance Crisis, Stock Market Crash Sept. of Feb 94 Feb 95 Target Fed Fund rate increased from 3% to 6% Soft Landing The Great Bond Massacre (Orange County Default; CMOs) 5 July 99 to May 00 Target Fed Funds rate increased from 4.75% to 6.5% 2001 Recession Bust of Tech Bubble 6 July 04 July 06 Target Fed Fund rates increased from 1% to 5.25% The Great Recession Bond Market Collapse (Except U.S. Treasuries) 21

25 WHAT MIGHT WE EXPECT? MAKING A SOFT LANDING BY THE FED PROS Longer U.S. Treasuries maturities held by investors increases potency of rate moves Investors in U.S. Treasuries are more stable (i.e. the Fed, foreign central banks) which means volatility should be reduced Increased policy tools allow for smoother transitions, decreasing chances of abrupt jumps therefore reducing volatility CONS History, history, history The experts couldn t predict the crises and don t agree on effectiveness of monetary or fiscal policy. How can they engineer a soft landing? The laws of unintended consequences 22

26 WHAT MIGHT WE EXPECT? MAKING A SOFT LANDING BY THE FED EXAMINING FIXED INCOME SECTOR RETURNS PRE- AND POST- CRISIS DURATION-MATCHED TREASURY AND EXCESS RETURNS^ January 1990 December % 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 10 Yr Tsy* Int Agg Index Duration-Matched Treasury ABS Sector** Excess MBS Sector Agency Sector Duration-Matched Treasury IG Corp Sector Excess HY Corp Sector Annualized Return Annualized Return (9/30) ^Source: Barclays Live *U.S. Treasury Bellwethers: 10 Year Index **ABS Sector return data starts 12/31/1991 Over the 17 years ended December 2007, falling Treasury yields boosted returns on fixed income assets Spread component of returns was generally a small portion of overall total return Since the end of 2007, returns on most bonds have been lower than the period as lower yields result in lower returns Spreads have fallen back to precrisis levels, leading to large gains from spread tightening Is the bull market in bonds finally over? 23

27 WHAT MIGHT WE EXPECT? MAKING A SOFT LANDING BY THE FED BARCLAYS U.S. 1 YEAR EXCESS RETURNS AS OF MARCH 31, 2015 U.S. Agg U.S. Agg - Int Gov/Credit Gov/Credit - Int Gov/Credit - Long Corp Corp - Int Corp - Long Industrial Industrial - Int Industrial - Long Utility Utility - Int Utility - Long Financials Financials - Int Financials - Long Corp AAA Corp AA Corp A Corp BBB High Yield High Yield - Int High Yield - Long MBS MBS - 15 Year MBS - 20 Year MBS - 30 Year CMBS ABS Source: Barclays Live (7.00) (6.00) (5.00) (4.00) (3.00) (2.00) (1.00)

28 WHAT MIGHT WE EXPECT? STOCK-BOND RETURN CORRELATION Annual Returns on S&P 500 and 10-yr U.S. Treasury Bond since 1990 Source: Aswath Damodaran, NYU Stern, u/~adamodar/pc/datase ts/histretsp.xls Stock and Bond returns are negatively correlated over time (quarterly since 1988 = -0.35) The two asset classes can move upwards together over short intervals (2-3 years) Interestingly, stocks and bonds almost never fall together over a full year (last time was 1969) 25

29 WHAT MIGHT WE EXPECT? A LOOK AHEAD Looking ahead to a likely shift in Fed policy in August/September 2015, navigating a ratcheting up of short rates without a strong pickup in growth in the meantime could present a stumbling block for equities. That said, if the Fed goes slowly and growth holds firm, it is certainly possible that bonds re-price before stocks. Either way, it seems a stretch to think that both asset classes will continue to risk together for long. Percent Total Return Annual Returns on S&P 500 and 10-yr US Treasury Bond Future period returns are average annual returns since Sources: LehmanLive, evestment and Aswath Damodaran, NYU Stern, Stocks Bonds 26

30 WHAT MIGHT WE EXPECT? IS HISTORY A GOOD INDICATOR? Since 1980, the Fed has increased rates 59 times on a month over month basis 12 Months Following Rate Hike 24 Months Following Rate Hike Asset Class # Positive Return Periods # Negative Return Periods Average Return (% Annualized) # Positive Return Periods # Negative Return Periods Average Return (% Annualized) U.S. EQUITY % % INTERNATIONAL EQUITY % % CORE FIXED INCOME % % LONG DURATION FIXED INCOME % % REITS % % Source: Bloomberg, BNY Mellon 27

31 WHAT CAN WE DO?

32 MARKET REVIEW FIRST QUARTER 2015 REAL GDP GROWTH U.S. DOLLAR STRENGTH Source: Bloomberg Source: Bloomberg The information contained herein reflects the views of Galliard Capital Management, Inc. & sources believed to be reliable by Galliard as of the date of publication. The views expressed here may change at any time subsequent to the date of publication. This publication is for informational purposes only. For institutional investor use only. 28

33 MARKET REVIEW FIRST QUARTER 2015 UNEMPLOYMENT RATE VS. INFLATION RATE U.S. TREASURY YIELD CURVE Source: Bloomberg Source: Bloomberg The information contained herein reflects the views of Galliard Capital Management, Inc. & sources believed to be reliable by Galliard as of the date of publication. The views expressed here may change at any time subsequent to the date of publication. This publication is for informational purposes only. For institutional investor use only. 29

34 MARKET REVIEW FIRST QUARTER 2015 Bond Total Returns Strong Across the Board, Driven by Falling Rates The U.S. Treasury yield curve rallied during the first quarter as yields on intermediate and longer dated maturities moved lower. For the trailing year, the 10-year U.S. Treasury yield declined 80 bps as the 30-year U.S. Treasury yield fell over 100 bps. Despite falling yields, the yield curve remains relatively steep as the market anticipates the Fed beginning to raise its policy rate in the second half of The 3-7 year part of the yield curve remains relatively attractive. Galliard is maintaining an overall neutral duration position versus benchmarks. Corporate credit posted positive excess returns for the quarter. From a trailing year perspective, intermediate corporates outperformed U.S. Treasuries, while longer corporates couldn t keep pace with the strong rally in long U.S. Treasuries, underperforming by over 4%. Q Year Source: Barclays Within structured products, Agency MBS posted negative excess returns for the quarter as mortgage rates declined approximately 20 bps vs year-end 2014 and refinancing activities picked up. The Fed ended its net purchase program in the fourth quarter of 2014 and has maintained its principal reinvestment program. ABS and CMBS continued to produce excess returns in the first quarter amidst healthy investor demand. Within the CMBS market, property fundamentals are strong and supportive of current valuations. However, we believe the market could come under pressure as underwriting standards continue to loosen and $300B in maturing CMBS (underwritten in ) needs to be refinanced over the next couple of years. The information contained herein reflects the views of Galliard Capital Management, Inc. & sources believed to be reliable by Galliard as of the date of publication. The views expressed here may change at any time subsequent to the date of publication. This publication is for informational purposes only. For institutional investor use only. 30

35 WHAT CAN WE DO? INVESTMENT OUTLOOK OUTLOOK GALLIARD VIEW GALLIARD POSITIONING DURATION U.S. economy slowed below trend in Q1, but labor market remains a bright spot Global developed economy ex-u.s. remains mixed, though currency adjustments are making Europe and Japan more competitive Strong dollar driving higher imports and crimping export demand Inflation remains low and little sign of any near-term price pressures Global QE keeping U.S. interest rates lower in the near term Greece default threat remains a wildcard for the Eurozone and global risk appetites Maintain neutral duration positioning TIPS have bounced back strongly on ECB QE and reflation theme: maintain position Continue to favor spread assets instead of Treasuries YIELD CURVE Fed being very transparent, will hike rates this year if economy remains resilient Own long Treasuries as a hedge against deflation Yield curve remains steep, despite a recent dampening of rate hike expectations 3-7 year part of the curve looks attractive Flatter curve seems likely; long rates seem fair for low growth, low inflation environment Position for a flatter curve, make sure 3-7 year holdings have cushion of spread to offset potential rate rise Curve roll-down strategies still likely positive in 2015 SECTOR Corporate Spreads remain tight for high quality corporate issuers New issue spread concessions have eroded; very selective participation in new issue calendar biased towards shorter end of the curve Strong dollar, global slowdown and dividend/share-buybacks have weakened corporate credit metrics more negative credit surprises coming in 2015 Maintaining our overweight in Credit Maintain underwriting discipline and avoid LBO/activist investor risks to the extent possible Continue to emphasize best-of-breed issuers well positioned to withstand potential credit headwinds Taxable Municipal Issuance has remained steady and high quality paper remains attractive relative to other credit alternatives University and Healthcare sub-sectors bringing more taxable issuance offers good diversification from traditional state/local issuers Continue to source quality paper and add to overweight in a disciplined fashion emphasizing highest quality names MBS/ Structured Government With rates new recent lows, MBS valuations have cheapened as investors are wary of a new refinancing wave Fed continued reinvestment in MBS should keep net new supply scarce Slowly improving housing market slowly increasing new supply Continue to add agency multifamily and SBA securitizations Within passthroughs, maintain focus on specified pools with more stable cashflows CMBS/ABS Consumer ABS supply remains strong, particularly in autos and equipment finance CMBS new issuance remains robust, but underwriting standards have deteriorated and are back to pre-crisis stretched levels Continue to add short high-quality consumer ABS Maintain CMBS position, selectively adding in seasoned paper with strong collateral performance 31

36 WHAT CAN WE DO? THE CHASE FOR YIELD Chasing yield or return can be challenging Over 90% of investment returns are determined by asset allocation* Higher risk assets have potential for higher return Timing is tough Implications on surplus impact Guideline limitations *D. Smereck, Strategic Asset Alliance 32

37 WHAT CAN WE DO? THE BALANCED PORTFOLIO HYPOTHETICAL PERFORMANCE OF ASSET ALLOCATION PORTFOLIOS 12/31/94 12/31/14 Growth of a $10,000 Investment 1-YEAR CUMULATIVE RETURNS % Average Annual Total Return Best Worst 100% Stocks $51, % % Stocks / 20% Bonds $50, % % Stocks / 40% Bonds $47, % % Stocks / 40% Bonds / 20% Cash $38, % % Stocks / 60% Bonds / 20% Cash $34, % The hypothetical asset allocation portfolios shown above are for illustrative purposes only. They do not represent the past or future portfolio composition or performance of any investable portfolio and are not intended as investment advice. Source: 2015 Morningstar, Inc, 12/31/14. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance does not guarantee future results. Stock investments are represented by equal investments in the S&P 500 Index, Russell 2000 Index, and MSCI EAFE Index, representing large U.S. stocks, small U.S. stocks, and foreign stocks, respectively. Bonds are represented by the Barclays U.S. Aggregate Index. Cash equivalents are represented by the Payden & Rygel 90-Day U.S. Treasury Bill Index. Portfolios are rebalanced annually. Indexes are unmanaged, and one cannot invest directly in an index. 33

38 WHAT CAN WE DO? SOME FINAL THOUGHTS Individual bonds vs. bond funds Prudent diversification Going longer, lower credit, more risk all has tradeoffs You don t know what you don t know Have yet to find a firm/person with all of the right answers Look at the hedge fund vs. Warren Buffet bet Interest rates will rise at some point - Will likely lead to negative total returns in your fixed income portfolio - Short term pain can lead to longer term gain (higher yields) 34

39 GALLIARD CAPITAL MANAGEMENT, INC. GALLIARD INTERMEDIATE CORE COMPOSITE JANUARY 1, 1996 THROUGH DECEMBER 31, 2014 Gross Return (%) Net Return (%) Barclays U.S. Int. Govt/Credit Index Internal Dispersion (%) Number of Accounts As of December 31 Composite Assets ($ millions) Percentage of Firm Assets (%) Total Firm Assets ($ millions) Year , , , , , , , , , , , , , , , , n/m , , , , , , n/m , n/m < , n/m < ,195.6 Galliard Capital Management, Inc. claims compliance with the Global Investment Performance Standards (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. Galliard Capital Management, Inc. has been independently verified for the period from October 1, 1995 through December 31, Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The Intermediate Core Composite has been examined for the period from January 1, 2007 through December 31, The verification and performance examination reports are available upon request. 1. Galliard Capital Management, Inc. ( Galliard ) is a registered investment adviser and a wholly owned subsidiary of Wells Fargo Bank, N.A. Registration with the U.S. Securities and Exchange Commission does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information for you to determine whether to hire or retain an adviser. Since it began operations on July 1, 1995, Galliard has provided fixed income and stable value investment portfolio management for institutional clients. Prior to January 1, 2011 certain stable value assets were excluded from firm assets because they were valued at book value and were not compliant with the marked-to-market valuation criteria of the GIPS standards. A list of composite descriptions and policies for valuing portfolios, calculating performance and preparing compliant presentations are available upon request. 35

40 GALLIARD CAPITAL MANAGEMENT, INC. GALLIARD INTERMEDIATE CORE COMPOSITE JANUARY 1, 1996 THROUGH DECEMBER 31, The Intermediate Core Composite is a sub composite of the Intermediate Core Total Composite. It consists of all discretionary separate accounts invested in fixed income securities managed against the Barclays U.S. Intermediate Government/Credit Bond Index or similar indices which do not use derivatives or certain more complex securities and/or strategies. These accounts allow the purchase of BBB and/or A rated securities, but do not allow the purchase of high yield bonds. Accounts are included in the composite at the beginning of the quarter following the first full quarter of management to assure the composite strategy is fully implemented in each account. The composite is an asset-weighted average of each account s monthly time-weighted total return calculated on an accrual basis, and includes reinvestment of income and capital gains. Trade date valuation is used to calculate composite returns. The composite was created on March 31, Gross composite returns include all income, realized and unrealized gains and losses, and all brokerage and other transactional costs. Model net composite returns are calculated by subtracting the highest applicable fee on a monthly basis from the gross composite returns. The standard fee schedule in effect is as follows:.30% on the first $50 million,.25% on the next $50 million,.20% on the next $100 million, with a negotiable fee on the balance. Actual client fees may vary depending on the size of the assets, competitive discounts, etc. The composite may contain accounts with performance based fees. Galliard s advisory fees are disclosed in the firm s SEC Form ADV Part 2A, which is available upon request. All returns are expressed in U.S. dollars. 4. From January 1, 2003 to December 31, 2007, an account would be temporarily removed from the composite if it experienced a cash inflow or outflow greater than or equal to 10% of the account s beginning market value. 5. The internal dispersion of annual returns is calculated from the equal-weighted variance of annual account returns from the equal-weighted mean annual return of all accounts included in the composite for the full year. For periods with 5 or less accounts included for the entire year, internal dispersion is not presented as it is not considered meaningful (n/m). 6. The three-year annualized ex-post standard deviation measures the variability of the composite (using gross returns) and the benchmark for the 36-month period ended at the following dates: 3-Yr Annualized Standard Deviation (%) December 31 Composite Benchmark The Barclays U.S. Intermediate Government/Credit Bond Index returns are provided to represent the investment environment existing during the time periods shown. For comparison purposes, the index is fully invested and includes the reinvestment of income. The returns for the index do not include any transaction costs, management fees, or other costs, and are not covered by the report of the independent verifiers. Source: Barclays. 8. Individual account performance results may differ from composite returns depending on the size of the account, investment guidelines and/or restrictions, inception date, and other factors. Past performance is not indicative of future results. As with any other investment vehicle, there is always the potential for gains as well as the possibility of losses. 36