CDX IG CDX HY S&P 500. CDX HY Daily TR

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1 Synthetic Similarity Synthetic Credit Returns Are Almost Identical To Equites, Adjusted For Vol 12 Average Daily Return, Rolling 3m, Relative To Rolling 3m Std Dev of Daily Returns 9 CDX IG CDX HY S&P CDX IG R^2 to S&P 5 =.754 CDX IG R^2 to S&P 5 = While Rolling Returns Are Well-Correlated, Daily Returns Are Another Story % % y = 1.553x - 4E-5 R² = % S&P 5 Daily TR S&P 5 Daily TR 1% 5% % -5% 5% % -5% y = x + 2E-7 R² =.587-1% -2% -1% % 1% CDX IG Daily TR -1% 2% -6% -4% -2% % 2% CDX HY Daily TR 4% Over The Long Run, Synthetic Credit Has An Elevated Risk-Adjusted Retrn Ann. Return (Left).7 Ann. Vol (Left) 1 Risk-Adjusted Return (Right) While traditional cash credit in the form of corporate bonds offer some diversification to equities via their risk free rate component, synthetic credit instruments (credit default swap indices) give pure exposure to credit spreads. As shown in the chart at left, rolling 3m returns for credit default swap indices track extremely well with total returns for equity indices like the S&P 5. Because credit is higher in the capital structure and therefore less volatile, returns and volatility are much higher for equities. After adjusting for this volatility, equities and credit are basically the same trade! Over the very short-term, that s of course not true though. As shown at left, raw daily returns over the last 1 years have a much lower Rsquared than rolling 3m riskadjusted returns. In other words, while the trend of returns relative to volatility is generally very similar between equities and synthetic credit, it s a much less dramatic relationship from one day to the next..5 In our final chart at left, we highlight that over longer periods of.4 CDX IG CDX HY S&P 5 time large differences in riskadjusted return are possible. For instance, while CDX IG has gained about 2% annualized over the past 1 years, its relatively low volatility means it trounces the S&P 5 on a risk-adjusted basis because annualized volatility is more than twice as high for the S&P 5. The real winner is high yield credit though. Despite this timeframe capturing multiple significant spread-widenings (28, 211, and 2), CDX HY has delivered nearly as much return as volatility, and about twice as much as equities. That s an impressive record Page 1 of 7.45 Copyright 218, Bespoke Investment Group, LLC. Bespoke Investment Group, LLC believes all information contained in this report to be accurate, but we do not guarantee its accuracy. None of the information in this report or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities.

2 Treasury Yields, Prices, and 3 Year Fixed Mortgage Rate 2 Year Treasury Future (Price, Roll Adjusted) 2 Year Treasury Bond (Yield, %) DMA DMA DMA 2 DMA 5 Year Treasury Future (Price, Roll Adjusted) 5 Year Treasury Bond (Yield, %) DMA DMA DMA DMA Year Treasury Future (Price, Roll Adjusted) 1 Year Treasury Bond (Yield, %) DMA 5 DMA DMA 5 DMA 3 Year Treasury Future (Price, Roll Adjusted) 3 Year Treasury Bond (Yield, %) DMA DMA DMA 2 DMA National Average 3 Year Mortgage Rate (%) Page 2 of 7

3 Money Markets, ETFs and Trade of the Week Money Market Rates Money Market Funds Key Short Term Rates Fid. Cash 1.3. Fed Funds Van. Prime O/N Libor Schwab Cash M Libor Fid. Munis M Libor Schwab Govt Wk T Bill Blkrock Prime M T Bill JPM Prime M T Bill State St Gov't Y T Bill GS MMkt Repo Key Fixed Income ETFs Yield 5 Day YTD Ticker Name Price (%) TR (%) TR (%) AGG Core US Bond Mkt BIL 1-3 MoT Bill BIV Vang. Intrmed BKLN Senior Loans BLV Vang. Long Term BND Tot Bond Mkt BOND PIMCO Tot Ret BSV Barc. Short Term CSJ 1-3 Yr Corp EDV Long Dur. Trsy EMB JPM EM Bonds FLOT Floating Rate HYG iboxx HY IEF 7-1 Yr Bonds IEI 3-7 Yr Trsy JNK Barc. High Yield LQD iboxx Invest. Grade MBB MBS PFF Preferreds PGF Financial Preferreds PGX Preferred Port SPSB Barc. Short Term SHM Short Term Munis SHV Short Term Trsy SHY 1-3 Yr Trsy SNLN iboxx Sen Loan STPZ PIMCO 1-5 Yr TIPS n/a TIP TIPS TLH 1-2 Yr Trsy TLT 2+ Yr Trsy VCLT Long Term Corp VCSH Vang. Short Term TBF Short 2+ Yr Trsy n/a TBX Short 7-1 Yr Trsy n/a Rate Hedged Cash Credit Has Undeperformed ProShares High Yield- Interest Rate Hedged ETF (HYGH) ishares iboxx $ High Yield Corporate Bond ETF (HYG) Individual investors are unable to access synthetic credit markets. While TYTE (long CDX HY) did exist for a while, it s since been liquidated. Therefore our points from the first page of this note are of relatively limited use to investors who are unable to directly access credit derivatives markets. Unfortunately, recent performance of cash credit stripped from its rates risk has been relatively disappointing. As shown in the chart above, HYG has outperformed its rates-hedged cousin HYGH since inception. HYGH has gained 2.1% annualized, versus 3.6% for HYG. Volatility has also been higher, 8.5% annualized versus 6.4% annualized for HYG. As a result, from a cash credit perspective owning credit spreads directly can be framed as a much less attractive trade than the longer-term outperformance on a riskadjusted basis we discuss on page 1. We should also note much smaller market cap and therefore less liquidity in HYGH versus HYG. Credit and short UST ETPs are the only ones in our universe to be green YTD. Page 3 of 7

4 Benchmark Yield Curves Treasury Yield Curve: Current vs 3 Months Prior, w/ BPs Change 2/28/218 11/22/ Year 2 Year 3 Year 5 Year 7 Year 1 Year 3 Year EUR sovereign risk premiums appear to have temporarily bottomed and will not make new lows without a significant positive catalyst. One possible example could be a good outcome in the Italian election coming up in a couple weeks, but a good scenario (for instance, a PD-Forza Italia coalition) is by no means a done deal. Given global activity readings for January and February, we continue to suspect that the recent uptick in yields has run its course and the tactical risk -reward is biased towards owning bonds. Recent data from China, Japan, the Eurozone, and the US has backed that up, though global Manufacturing PMIs from Markit on Thursday will be key Bunds Yield Curve: Current vs 3 Months Prior, w/ BPs Change /28/218 11/22/ Year 2 Year 3 Year 5 Year 7 Year 1 Year 3 Year Eurodollar Yield Curve: Current vs 3 Months Prior, w/ BPs Change 2/28/ /22/ Mo 6 Mo 9 Mo 12 Mo Mo 18 Mo 21 Mo 24 Mo 27 Mo 3 Mo 33 Mo Eurodollar curves continue to show lower risk premiums versus where they stood a week ago. While contracts got hammered lower in price as a result of the testimony from Fed Governor Powell yesterday, the Eurodollar curve has not materially steepened, instead ticking up in unison across the term structure. We continue to watch oil for clues on how breakevens are likely to trade. WTI appears to have made a lower low, and is eyeing a test of its 5- DMA. We ll discuss more in The Closer tonight but for now we note that EIA data showed a larger than expected build in crude and the fundamentals are weaker than they were a month ago Bespoke Global Yield Curve: Current vs 3 Months Prior, w/ BPs Change /21/218 11/22/ Year 2 Year 3 Year 5 Year 7 Year 1 Year 3 Year Inflation Curve: Current vs 3 Months Prior, w/ BPs Change /28/218 11/22/ Year 2 Year 3 Year 5 Year 7 Year 1 Year 3 Year The long, sustained push higher in global yields may be ending. A shown in the charts on the net page, nominal, GDP-weighted global interest rates bull-flattened over the past week. That down-tick in yields was one of the largest we ve seen in quite some time. If global activity indicators continue to top out here, expect further declines in our yield indicators. Page 4 of 7

5 Bespoke Global Yield Curve: 2 Year Bespoke Global Yield Curve: 5 Year Bespoke Global Yield Curve: 1 Year Bespoke Global Yield Curve: 3 Year Bespoke Global Yield Curve: 2s1s Bespoke Global Yield Curve: 5s3s Page 5 of 7

6 Curves, Spreads and Total Returns Treasury Curves (BPs) Spreads vs Treasury (BPs) Total Return Over Past Year (BPs) 2 Year vs 5 Year 1 Year German Bund Long Dated Treasuries Year vs 1 Year 1 Year Italian BTP (vs German Bund, not Treasury) Emerging Markets Year vs 1 Year Year Swap Mortgage Backed Securities Year vs 3 Year Municipal Bonds Municipal Bonds Year vs 3 Year High Yield Corporates High Yield Corporates Page 6 of 7

7 The Fixed Income Report Explained Page 2: These charts track the performance of the yield of Treasury bonds and their price in the futures market over the past year. Also presented is the National Average 3 Year Fixed Rate Mortgage according to bankrate.com s index of mortgage lending. Page 3: At upper left is a table summarizing the level and change of short term interest rates. Money market fund rates represent the highest yields available to large money market fund investors for a spectrum of funds. Next to the money market fund rates are benchmark short-term interest rates. Each change represents the change in yield over the last five days. At lower left we show a grid of major fixed income ETFs and include yield, five day change, and year to date total return for each ETF. Our Trade of the Week is intended as a starting point for further research. Page 5: Benchmark yield curves are risk free interest rates that other fixed income securities trade relative to. All yield curves are expressed in basis points. Three month changes in the curves are shown in basis points at each point on the curve. The Bespoke Global Yield Curve is a Purchasing Power Parity Gross Domestic Product-weighted average of nominal yields for the world s fifteen largest economies. It is graphed versus the yield curves for the United States and Germany, the two mostfollowed global benchmarks. Page 5: Time series charts for the yields of the Bespoke Global Yield curve, presented in basis points. Page 6: The Treasury curve charts in column one show the difference in yield between the second security listed and the first. For instance, if 2 Year Treasuries currently yield.45% and 5 Year Treasuries yield 1.45%, the curve between 2 Years and 5 Years is 1.%. Typically, a flattening yield curve (a chart of the curve moving downwards, or the difference between the two yields narrowing) is an indication of economic headwinds, but the absolute level of the curve between Treasuries can be as important as the change in that curve. The spreads column shows yield differences between Treasuries and other important sectors of the fixed income market. Each spread is expressed as the yield on the bond in question. For instance, if Italian 1 Year government bonds or BTPs yield 3.5% and 1 Year Treasuries yield 3.%, the spread between them is.5%. This spread can be negative. All else being equal, a positive spread to Treasuries indicates increased credit risk. But when spreads are measured between two different currencies (for instance, between German Bunds and Treasuries), a negative spread to Treasuries can be caused by different inflation expectations, real growth rates or other differences between the currencies in question. Finally, the total return indices in the right hand column show the total return for Bank of America Merrill Lynch bond market indices in each sector listed. Total return shows both coupon income and price appreciation for each basket of bonds. These total returns are graphed as total return over the prior year, starting from zero as of one year ago today. Page 7 of 7