WESTERN ASSET GSM AND GOV/CORP PORTFOLIOS

Transcription

1 4Q 2017 Separately Managed Accounts Product Commentary WESTERN ASSET GSM AND GOV/CORP PORTFOLIOS Market overview As was the case for the year as a whole, the U.S. Treasury yield curve flattened during the fourth quarter. Over the last three months of the year, short-term yields rose more than their longer-term yields counterparts (yields and prices move in the opposite direction). During the fourth quarter, the overall U.S. bond market posted a small positive return and spread sectors (non-u.s. Treasuries) produced mixed results versus equalduration Treasuries. Looking at the U.S. economy, the Commerce Department reported that third quarter 2017 gross domestic product (GDP) 1 growth was 3.2% the strongest pace since the first quarter of In contrast, the economy expanded 3.1% during the second quarter. The modest upturn in growth during the third quarter was attributed to a number of factors, including positive contributions from private inventory investment and upturns in state and local government spending. The preliminary estimate for fourth quarter GDP will be released on January 26, The labor market was a tailwind for the economy during the fourth quarter. The unemployment rate fell from 4.2% in September to 4.1% in October. This represented the lowest level in nearly 17 years. The unemployment rate then remained unchanged in November and December. Meanwhile, the workforce participation rate held steady at 62.7% during the quarter. Finally, the number of longer-term unemployed moved lower over the last three months of the year. In December, 22.9% of the 6.6 million Americans looking for jobs 1 Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. 2 Source of data in this paragraph: Bloomberg, 1/18. had been out of work for more than six months, versus 24.8% in October. 3 The manufacturing sector continued to expand, and its pace accelerated late in the year. According to the Institute for Supply Management s Purchasing Managers Index (PMI), 4 the manufacturing sector expanded for a fourteenth consecutive month in October, with a reading of (A reading below 50 indicates a contraction, while a reading above 50 indicates an expansion.) After dipping to 58.2 in November, the PMI rose to 59.7 in December, with 16 of the 18 industries measured by the PMI expanding during the month. 5 Data in the housing market were positive overall during the fourth quarter. According to the National Association of Realtors (NAR), existing-home sales rose 2.0% on a seasonally adjusted basis in October versus the previous month's sales. Existing-home sales then increased 5.6% in November the strongest reading in nearly 11 years. The NAR also reported that the median existing-home price for all housing types was $248,000 in November 2017, an increase of 5.8% versus November Finally, the inventory of homes available for sale in November was a 3.4-month supply at the current sales pace, 9.7% lower than a year ago. 6 3 Source of data in this paragraph: Bloomberg, 1/18. 4 The Institute for Supply Management's composite PMI Index (formerly the National Association of Purchasing Managers Index) is based on a survey of purchasing executives who buy the raw materials for manufacturing at more than 350 companies. It offers an early reading on the health of the manufacturing sector. Please note that an investor cannot invest directly in an index. 5 Source of data in this paragraph: Bloomberg, 1/18. 6 Source of data in this paragraph: Bloomberg, 12/17. INVESTMENT PRODUCTS: NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE

2 The Federal Reserve Board ( Fed ) 7 raised rates for the third time in 2017 at its meeting in December This latest increase boosted rates to a range between 1.25% and 1.50%. The Fed also anticipates three additional rate hikes in 2018 and expects to continue paring its balance sheet throughout the year. However, the Fed s future action will be data-dependent. Also of note, in December 2017 the U.S. tax reform bill was signed into law, which could be a near-term positive for economic growth. 8 Both short-term and longer-term Treasury yields moved higher during the fourth quarter. When the quarter began, the yield on the two-year Treasury was 1.47% matching its low for the period. It rose as high as 1.92% on December 26 and ended the quarter at 1.89%. The yield on the 10-year Treasury began the quarter at 2.33%. Its low of 2.28% occurred on October 13 and its peak of 2.49% took place on December 20. The yield on the 10-year Treasury ended the quarter at 2.40%. 9 GSM and Gov/Corp Portfolios Annualized returns net and gross of fees - PRELIMINARY (%) as of December 31, 2017 QTR YTD 1-yr 3-yr 5-yr 7-yr 10-yr GSM 3-Year (net) GSM 3-Year (gross) Merrill Lynch 1-3 Year Treasury Index GSM 5-Year (net) GSM 5-Year (gross) GSM 7-Year (net) GSM 7-Year (gross) Bloomberg Barclays U.S. Int. Treasury Index Gov/Corp (net) Gov/Corp (gross) Bloomberg Barclays U.S. Int. Gov/Credit Index FTSE 3-Month U.S. Treasury Bill Index The strategy returns are preliminary composite returns, subject to future revision (downward or upward). Please visit for the latest performance figures. YTD numbers are not annualized. Quarterly and YTD numbers are not annualized. Past performance is no guarantee of future results. Please see the GIPS endnotes for important additional information regarding the portfolio performance and for effects of fees. Management and performance of individual accounts may vary for reasons that include the existence of different implementation and model requirements in different investment programs. Fees: Gross performance shown does not reflect the deduction of investment management fees and certain transaction costs, which will reduce portfolio performance shown. Net performance includes the deduction of a 1.5% annual wrap fee, which is the maximum anticipated wrap fee for fixed income portfolios. Actual fees may vary. For fee schedules, contact your financial professional or, if you enter into an agreement directly with Legg Mason Private Portfolio Group, LLC (LMPPG), refer to LMPPG s Form ADV disclosure document. Returns reflect the reinvestment of dividends and other earnings. Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. 7 The Federal Reserve Board ("Fed") is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments. 8 Source of data in this paragraph: Bloomberg, 12/17. 9 Source of data in this paragraph: Bloomberg, 1/18. 2

3 Contributors and detractors Although its absolute return was slightly negative, the GSM 3- year Portfolio (gross of fees) slightly outperformed its benchmark, the Merrill Lynch 1-3 Year Treasury Bond Index, during the quarter. GSM 5-year and 7-year portfolios (gross of fees) slightly outperformed their benchmark, the Bloomberg Barclays U.S. Intermediate Treasury Bond Index, during the quarter. For GSM 3-year, duration was additive for results, as the Portfolio s duration was slightly short that of the benchmark and short-term rates continued to move higher over the quarter, as was the case for the year as a whole. Sector allocation, overall, was neutral for performance, as shorterdated agencies spreads offered little in the way of incremental yields. For GSM 5-year and GSM 7-year, duration was a slight positive for performance, as the portfolios were slightly short that of the benchmark. A neutral allocation to the 10-year Treasury curve neither added nor detracted from results. Our out-ofbenchmark allocation to agency debentures longer than five years was slightly additive for returns, given their incremental yields. The Government/Corporate Portfolio (gross of fees) outperformed its benchmark, the Bloomberg Barclays U.S. Intermediate Government/Credit Index benchmark, during the quarter. Duration was a slight positive for performance, as the portfolios were modestly short that of the benchmark. A tactical allocation to the 10-year part of the Treasury curve was slightly additive. A modest overweight to credit was positive for results, as were allocations to the bank, finance and energy sectors. However, our higher quality focus within the energy sector was a headwind for results, as some lower-rated names in the space performed well as oil closed the year above $60 a barrel. Outlook Republicans were finally able to pass a tax reform bill shortly before the end of Generally, lower taxes should be additive to growth in 2018, perhaps on the order of a 0.25% to 0.50% impact on GDP, which is positive but not huge. However, the tax bill also includes some reform aspects and these may create some losers in addition to the winners, and the prospect of unintended consequences adds some uncertainty to the outlook. It s not clear how the housing market will be affected by the reductions of mortgage interest and property tax deductions, especially in high housing cost areas. Limiting the deductibility of corporate interest payments could have a negative impact on highly leveraged corporations and produce a deleveraging impulse. Also of note, now that the tax bill has been completed, Congress will turn immediately to the spending side of the government budget. While the shape of the eventual deal is far from clear, there is a prospect of increased spending next year. Just as has happened on the revenue side, a material change to government spending plans may cause another set of adjustments to growth and debt issuance expectations. The Fed raised rates in December, the third 0.25% increase in 2017, and we expect the process of inching up rates will continue as we go into Much will depend on the naming of Fed governor appointees in line with our more dovish hypothesis, but with growth remaining above trend, unemployment clearly at or below the Fed s goal, and the prospects of a meaningful tax cut, a continuation of very gradual rises in short-term rates seems straightforward. We think this is the correct course. We have never experienced such aggressive monetary experimentation as we have seen in much of the developed world in the aftermath of the financial crisis. Experimental policies may have unforeseen consequences. There are always long and variable lags. With inflation in both the U.S. and developed world well below policy goals (a ubiquitous standard of 2%), central banks are wise to move toward the path of policy normalization in a very cautious way. The very good news is that growth has firmed, albeit from a very low level. The inflation picture, however, remains exceptionally subdued. This has been a major surprise in this year s economic development. In fact, ex-fed Chair Yellen has called the stubbornly low inflation mysterious. We have been believers that the process of inflation bottoming and the resulting path to interest rate normalization would be very, very slow. Yet even we have been surprised with just how sluggish U.S. inflation has been in light of a pickup in global growth. We continue to believe this is inflation delayed, not aborted. Still, one should respect the evidence. In the U.S., the core PCE index has not been above the Fed s target of 2% since At its current annual rate of 1.5%, the need to more preemptively raise short-term rates does not appear to be compelling. In our view, the inflation outlook is likely to remain a sticking point for the Fed, constraining the pace of rate hikes now and the eventual level of terminal fed funds later. The U.S. economic outlook for 2018 looks to be another 2+% growth year, and with many of the new tax bill provisions taking effect almost immediately, perhaps better. Does such cyclical strength presage a meaningful pickup in longer-term 3

4 interest rates? We think not. Our view has always been that the story of long-term interest rates is little more than the story of long-term inflation. In many past recoveries, inflation has risen in line with cyclical strength, and basing longer-term rate forecasts on cyclical forecasts worked out reasonably well. But in a highly disinflationary world, which we have been in since the turn of the century, inflation dynamics have not readily followed cyclical forces. Add the burden of global debt into this picture, and a sharp rise in developed market interest rates does not seem likely. A further note of caution is exemplified by the flattening of the yield curve. Historically, the yield curve has the best predictive success of all the leading economic indicators. Indeed, the yield curve has often been called the Cassandra of leading indicators. As per the Greek myth, Cassandra s predictions were always right, yet never believed. And so it is with the flattening of the yield curve. So often this occurs as the Fed is tightening. The Fed does this based on the economic evidence it has on hand. The prevailing financial wisdom of the times is invariably supportive of this policy. When the yield curve flattens meaningfully in this process, it seems that either the Fed or the market has it wrong. So, in order to keep hiking away, the Fed and the financial community must come up with a highly plausible explanation of why this time it is different. The simple truth is that when the central bank is hiking into a seriously flattening yield curve, it must have a narrative to explain why the yield curve is wrong. Otherwise it rationally follows that the Fed should stop hiking. With every cycle, such a narrative is produced. It seems eminently plausible. After all, the concurrent evidence is that the economy is growing, so it is easy to dismiss Cassandra s warnings. Even as short-term rates have risen steadfastly, the long end of the Treasury curve has remained anchored. Clearly, the yield curve is starting to signal caution. Yes, there are thoughtful arguments about why the long end is giving off an errant signal. These rates have been artificially suppressed by central bank buying. Or, the yield spread versus other developed markets keep these rates artificially low. Maybe. But to our minds, the rates the central bank controls are more reliably short-term rates whereas long-maturity bond investors have a free choice. We take the warning sign of the yield curve at face value. With global growth picking up, emerging markets in particular healing readily, and European optimism growing, there should be few headwinds from abroad to impede U.S. growth. We believe that in this environment spread products should still continue to outperform government bonds. While we may not get the meaningful benefit from spread compression that we did in 2016 and 2017, this environment remains supportive of successfully clipping coupons. That is the challenge of a lowgrowth, low-inflation environment. Returns in high-quality fixed income products should be expected to be modest. The demand for income and yield with diminishing prospects for an imminent, significant rise in interest rates provides the possibility of spreads tightening further. Important information Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, a forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional. Past performance is no guarantee of future results. There is no guarantee that investment objectives will be met. An investor cannot invest directly in an index. Investments are not FDIC insured or guaranteed by any government agency. Values may fluctuate due to market conditions and other factors. Diversification does not assure a profit or protect against market loss. Risks All investments involve risk, including the loss of principal, and there is no guarantee that investment objectives will be met. Fixed income securities are subject to interest rate and credit risk, which is a possibility that the issuer of a security will be unable to make interest payments and repay the principal on its debt. As interest rates rise, the price of fixed income securities falls. Foreign securities, where permitted, are subject to the additional risks of fluctuations in foreign exchange rates, changes in political and economic conditions, foreign taxation, and differences in auditing and financial standards. These risks are magnified in the case of investments in emerging markets. 4

5 U.S. Treasuries are direct debt obligations issued by the U.S. government and backed by its full faith and credit. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities. Gov/Corp investments may also be made in taxable municipal securities and investment-grade, U.S. dollar-denominated fixed income securities of non-u.s. developed and emerging market sovereign and corporate issuers. Tapering of the Federal Reserve Board's quantitative easing program and a general rise in interest rates may lead to increased portfolio volatility. Important tax information Legg Mason, Inc., its affiliates and its employees are not in the business of providing tax or legal advice to taxpayers. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties or complying with any applicable tax laws or regulations. Taxrelated statements, if any, may have been written in connection with the promotion or marketing of the transaction(s) or matter(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer s particular circumstances from an independent tax advisor. Investments are not FDIC insured or guaranteed by any government agency. Values may fluctuate due to market conditions and other factors. Separately managed accounts (SMAs) are investment services provided by Legg Mason Private Portfolio Group, LLC (LMPPG), a federally registered investment advisor. Client portfolios are managed based on investment instructions or advice provided by one or more of the following Legg Masonaffiliated subadvisors: ClearBridge Investments, LLC and Western Asset Management Company. Management is implemented by LMPPG, the designated subadvisor or, in the case of certain programs, the program sponsor or its designee. all or some of LMPPG's implementation services. LMPPG and Western Asset are subsidiaries of Legg Mason, Inc. Definitions and additional information Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. An agency debenture is debt issued by a federal agency or a government-sponsored enterprise (GSE) for financing purposes. These types of debentures are not backed by collateral, but by the integrity and creditworthiness of the issuer. Officially, agency debentures issued by a federal agency, such as the Tennessee Valley Authority, are backed by the full faith and credit of the United States government. Agency debentures issued by a GSE are backed only by that GSE's ability to pay. The Bloomberg Barclays U.S. Intermediate Government/Credit Index is a market value-weighted performance benchmark for government and corporate fixed-rate debt issues (rated Baa/BBB or higher) with maturities between one and 10 years. The Bloomberg Barclays U.S. Intermediate Treasury Index is composed of all public obligations of the U.S. Treasury. This index has an average current maturity of 3.69 years (average maturity may vary over time). The FTSE 3-Month U.S. Treasury Bill Index is an index based on the average monthly yield of the 90-day Treasury bills. U.S. Treasury bills are secured by the "full faith and credit" of the U.S. government and offer a fixed rate of return. The Portfolio composition typically varies from that of the above-noted, unmanaged indices. Federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. The Federal Reserve Board ("Fed") is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments. Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. Institute for Supply Management (ISM), formerly known as the National Association for Purchasing Management, is an association representing more than 48,000 purchasing and supply management professionals. It conducts regular surveys of purchasing and supply managers to determine industry trends. The Merrill Lynch 1-3 Year U.S. Treasury Bond Index is a market capitalizationweighted index including all U.S. Treasury notes and bonds with maturities greater than or equal to one year and less than three years. National Association of Realtors (NAR) is a national organization of real estate brokers. It was created to promote the real estate profession and foster professional behavior in its members. Personal consumption expenditures (PCE), or the PCE Index, measure price changes of consumer goods and services. PMI is the Institute for Supply Management's composite PMI Index (formerly the National Association of Purchasing Managers Index), which is based on a survey of purchasing executives who buy the raw materials for manufacturing at more than 350 companies. It offers an early reading on the health of the manufacturing sector. Professional money management may not be suitable for all investors. Where LMPPG implements, Western Asset selects broker/dealers to execute trades; and certain Western Asset employees, acting as dual employees of LMPPG, may perform 5

6 Western Asset GSM 3-Year GIPS endnotes ($USD) Schedule of investment performance results December 31, 2016 Year Net Pure 1 gross total return Gross total 3 Yr. total 3 Yr. Number of portfolios % of bundled fee portfolios in the composite Internal dispersion Composite ($mm) % of firm % 7.22% 7.32% % % % 6.69% 6.61% % % % 1.92% 0.78% % % % 2.30% 2.35% % % % 1.43% 1.55% 0.99% 1.03% % % % 0.62% 0.43% 0.67% 0.74% % % % 0.35% 0.36% 0.45% 0.51% % % % 0.67% 0.62% 0.38% 0.44% % % % 0.55% 0.54% 0.50% 0.57% % % % 0.86% 0.88% 0.68% 0.77% % % Western Asset claims compliance with the Global Investment Performance s (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. Western Asset has been independently verified for the periods from January 1, 1993 to December 31, The verification report is available upon request. 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 verification does not ensure the accuracy of any specific composite presentation. For GIPS purposes, the Firm is defined as Western Asset, a primarily fixed-income investment manager comprised of Western Asset Management Company, Western Asset Management Company Limited, Western Asset Management Company Pte. Ltd., Western Asset Management Company Ltd, Western Asset Management Company Pty Ltd, and Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários (DTVM) Limitada, with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Dubai. Each Western Asset company is a wholly owned subsidiary of Legg Mason, Inc. ( Legg Mason ) but operates autonomously, and Western Asset, as a firm, is held out to the public as a separate entity. Western Asset Management Company was founded in The Firm is comprised of several entities as a result of various historical acquisitions made by Western Asset and their respective performance has been integrated into the Firm in line with the portability requirements set forth by GIPS. Effective April 2007, Western Asset manages these portfolios as sub-advisor to its affiliate, Legg Mason Private Portfolio Group, LLC. From January 2006 through March 2007, Western Asset portfolio managers managed these portfolios as dual employees of ClearBridge Advisors, LLC, and ClearBridge Asset Management Inc. (each a Western Asset affiliate), following Western Asset s investment process and having access to Western Asset s investment resources, expertise and investment outlook. Western Asset GSM 3 Year Portfolios are discretionary fixed-income portfolios that offer - to individual and taxable institutional investors - tailored management of U.S. Treasury and federal agency securities with average maturities of three years or less. These portfolios seek to produce s over complete market cycles that exceed appropriate benchmark returns. The portfolios also seek to preserve principal. The GSM 3 Year strategy has a maximum maturity of five years. The composite is comprised of accounts that are separately managed accounts (SMAs) managed in accordance with the strategy. The composite employs a 10% significant cash flow policy. The composite was created on January 1, Effective January 1, 2013, the number of portfolios reflects a change from prior periods due to an aggregation of accounts as reported by one sponsor. For periods prior to 2013, the firm excluded accounts designated by the sponsor as client-restricted. For comparison purposes, composite returns are shown against returns of the Merrill Lynch 1-3 Year U.S. Treasury Bond Index, which is a market capitalization-weighted index including all U.S. Treasury notes and bonds with maturities greater than or equal to one year and less than three years. An investor cannot invest directly in an index. 1 Pure gross returns are presented as supplemental information to the net returns. The current fee schedule is 1.50% on all. Net returns are calculated by deducting the anticipated maximum annual bundled fee applied on a monthly basis from the "pure" gross monthly return. The bundled fee includes all charges for trading costs, portfolio management, custody, and other administrative fees. Bundled fees may vary across different financial firms and across different accounts based upon account size and other factors. Returns and market values are expressed in USD. Dispersion is calculated using the asset-weighted standard deviation of annual returns of those portfolios that were included in the composite for the entire year (equal-weighted prior to 2014). Periods with five or fewer accounts are not statistically representative and are not presented. The three-year annualized ex-post standard deviation measures the variability of the composite and the benchmark returns over the preceding 36-month period. deviation is not presented for periods where 36 monthly returns are not available for the composite or the benchmark. Past investment results are not indicative of future investment results. Western Asset s list of composite descriptions and policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. Please contact Ellen Cammer at or Ellen.Cammer@westernasset.com. 6

7 Western Asset GSM 5-Year GIPS endnotes ($USD) Schedule of investment performance results December 31, 2016 Year Net Pure 1 gross total return Gross total 3 Yr. total 3 Yr. Number of portfolios % of bundled fee portfolios in the composite Internal dispersion Composite ($mm) % of firm % 8.94% 8.83% % % % 10.47% 11.35% % % % 0.28% -1.41% % % % 5.50% 5.29% % % % 6.30% 6.57% 2.98% 3.29% % % % 2.20% 1.71% 2.37% 2.53% % % % -1.30% -1.34% 2.12% 2.20% % % % 2.53% 2.57% 1.70% 1.81% % % % 1.37% 1.18% 1.93% 2.01% % % % 1.32% 1.06% 2.18% 2.35% % % Western Asset claims compliance with the Global Investment Performance s (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. Western Asset has been independently verified for the periods from January 1, 1993 to December 31, The verification report is available upon request. 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 verification does not ensure the accuracy of any specific composite presentation. For GIPS purposes, the Firm is defined as Western Asset, a primarily fixed-income investment manager comprised of Western Asset Management Company, Western Asset Management Company Limited, Western Asset Management Company Pte. Ltd., Western Asset Management Company Ltd, Western Asset Management Company Pty Ltd, and Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários (DTVM) Limitada, with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Dubai. Each Western Asset company is a wholly owned subsidiary of Legg Mason, Inc. ( Legg Mason ) but operates autonomously, and Western Asset, as a firm, is held out to the public as a separate entity. Western Asset Management Company was founded in The Firm is comprised of several entities as a result of various historical acquisitions made by Western Asset and their respective performance has been integrated into the Firm in line with the portability requirements set forth by GIPS. Effective April 2007, Western Asset manages these portfolios as sub-advisor to its affiliate, Legg Mason Private Portfolio Group, LLC. From January 2006 through March 2007, Western Asset portfolio managers managed these portfolios as dual employees of ClearBridge Advisors, LLC, and ClearBridge Asset Management Inc. (each a Western Asset affiliate), following Western Asset s investment process and having access to Western Asset s investment resources, expertise and investment outlook. Western Asset GSM 5 Year Portfolios are discretionary fixed-income portfolios that offer - to individual and taxable institutional investors - tailored management of U.S. Treasury and federal agency securities with average maturities of five years or less. These portfolios seek to produce s over complete market cycles that exceed appropriate benchmark returns. The portfolios also seek to preserve principal. The GSM 5 Year strategy has a maximum maturity of ten years. The composite is comprised of accounts that are separately managed accounts (SMAs) managed in accordance with the strategy. The composite employs a 10% significant cash flow policy. The composite was created on January 1, Effective January 1, 2013, the number of portfolios reflects a change from prior periods due to an aggregation of accounts as reported by one sponsor. For periods prior to 2013, the firm excluded accounts designated by the sponsor as client-restricted. For comparison purposes, composite returns are shown against returns of the Bloomberg Barclays U.S. Intermediate Treasury Bond Index, which is comprised of all public obligations of the U.S. Treasury. This index has an average current maturity of 3.69 years (average maturity may vary over time). An investor cannot invest directly in an index. 1 Pure gross returns are presented as supplemental information to the net returns. The current fee schedule is 1.50% on all. Net returns are calculated by deducting the anticipated maximum annual bundled fee applied on a monthly basis from the "pure" gross monthly return. The bundled fee includes all charges for trading costs, portfolio management, custody, and other administrative fees. Bundled fees may vary across different financial firms and across different accounts based upon account size and other factors. Returns and market values are expressed in USD. Dispersion is calculated using the asset-weighted standard deviation of annual returns of those portfolios that were included in the composite for the entire year (equal-weighted prior to 2014). Periods with five or fewer accounts are not statistically representative and are not presented. The three-year annualized ex-post standard deviation measures the variability of the composite and the benchmark returns over the preceding 36-month period. deviation is not presented for periods where 36 monthly returns are not available for the composite or the benchmark. Past investment results are not indicative of future investment results. Western Asset s list of composite descriptions and policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. Please contact Ellen Cammer at or Ellen.Cammer@westernasset.com. 7

8 Western Asset GSM 7-Year GIPS endnotes ($USD) Schedule of investment performance results December 31, 2016 Year Net Pure 1 gross total return Gross total 3 Yr. total 3 Yr. Number of portfolios % of bundled fee portfolios in the composite Internal dispersion Composite ($mm) % of firm % 8.63% 8.83% % % % 9.87% 11.35% % % % 0.45% -1.41% % % % 5.40% 5.29% % % % 6.44% 6.57% 2.97% 3.29% % % % 2.29% 1.71% 2.40% 2.53% % % % -1.28% -1.34% 2.15% 2.20% % % % 2.56% 2.57% 1.71% 1.81% % % % 1.32% 1.18% 1.93% 2.01% % % % 1.31% 1.06% 2.18% 2.35% % % Western Asset claims compliance with the Global Investment Performance s (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. Western Asset has been independently verified for the periods from January 1, 1993 to December 31, The verification report is available upon request. 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 verification does not ensure the accuracy of any specific composite presentation. For GIPS purposes, the Firm is defined as Western Asset, a primarily fixed-income investment manager comprised of Western Asset Management Company, Western Asset Management Company Limited, Western Asset Management Company Pte. Ltd., Western Asset Management Company Ltd, Western Asset Management Company Pty Ltd, and Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários (DTVM) Limitada, with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Dubai. Each Western Asset company is a wholly owned subsidiary of Legg Mason, Inc. ( Legg Mason ) but operates autonomously, and Western Asset, as a firm, is held out to the public as a separate entity. Western Asset Management Company was founded in The Firm is comprised of several entities as a result of various historical acquisitions made by Western Asset and their respective performance has been integrated into the Firm in line with the portability requirements set forth by GIPS. Effective April 2007, Western Asset manages these portfolios as sub-advisor to its affiliate, Legg Mason Private Portfolio Group, LLC. From January 2006 through March 2007, Western Asset portfolio managers managed these portfolios as dual employees of ClearBridge Advisors, LLC, and ClearBridge Asset Management Inc. (each a Western Asset affiliate), following Western Asset s investment process and having access to Western Asset s investment resources, expertise and investment outlook. Western Asset GSM 7 Year Portfolios are discretionary fixed-income portfolios that offer - to individual and taxable institutional investors - tailored management of U.S. Treasury and federal agency securities with average maturities of seven years or less. These portfolios seek to produce s over complete market cycles that exceed appropriate benchmark returns. The portfolios also seek to preserve principal. The composite is comprised of accounts that are separately managed accounts (SMAs) managed in accordance with the strategy. The composite employs a 10% significant cash flow policy. The composite was created on January 1, Effective January 1, 2013, the number of portfolios reflects a change from prior periods due to an aggregation of accounts as reported by one sponsor. For periods prior to 2013, the firm excluded accounts designated by the sponsor as client-restricted. For comparison purposes, composite returns are shown against returns of the Bloomberg Barclays U.S Intermediate Treasury Bond Index, which is comprised of all public obligations of the U.S. Treasury. This index has an average current maturity of 3.69 years (average maturity may vary over time). An investor cannot invest directly in an index. 1 Pure gross returns are presented as supplemental information to the net returns. The current fee schedule is 1.50% on all. Net returns are calculated by deducting the anticipated maximum annual bundled fee applied on a monthly basis from the "pure" gross monthly return. The bundled fee includes all charges for trading costs, portfolio management, custody, and other administrative fees. Bundled fees may vary across different financial firms and across different accounts based upon account size and other factors. Returns and market values are expressed in USD. Dispersion is calculated using the asset-weighted standard deviation of annual returns of those portfolios that were included in the composite for the entire year (equal-weighted prior to 2014). Periods with five or fewer accounts are not statistically representative and are not presented. The three-year annualized ex-post standard deviation measures the variability of the composite and the benchmark returns over the preceding 36-month period. deviation is not presented for periods where 36 monthly returns are not available for the composite or the benchmark. Past investment results are not indicative of future investment results. Western Asset s list of composite descriptions and policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. Please contact Ellen Cammer at or Ellen.Cammer@westernasset.com. 8

9 Western Asset Government/Corporate GIPS endnotes ($USD) Schedule of investment performance results December 31, 2016 Year Net Pure 1 gross total return Gross total 3 Yr. total 3 Yr. Number of portfolios % of bundled fee portfolios in the composite Internal dispersion Composite ($mm) % of firm % 8.26% 7.39% % % % 7.95% 5.08% % % % 5.85% 5.24% % % % 5.91% 5.89% % % % 4.94% 5.80% 2.55% 2.59% % % % 4.97% 3.89% 2.15% 2.19% 1, % % % -0.64% -0.86% 2.22% 2.14% % % % 3.15% 3.12% 1.98% 1.96% % % % 1.14% 1.07% 2.06% 2.13% % % % 2.07% 2.08% 2.04% 2.26% % % Western Asset claims compliance with the Global Investment Performance s (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. Western Asset has been independently verified for the periods from January 1, 1993 to December 31, The verification report is available upon request. 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 verification does not ensure the accuracy of any specific composite presentation. For GIPS purposes, the Firm is defined as Western Asset, a primarily fixed-income investment manager comprised of Western Asset Management Company, Western Asset Management Company Limited, Western Asset Management Company Pte. Ltd., Western Asset Management Company Ltd, Western Asset Management Company Pty Ltd, and Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários (DTVM) Limitada, with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Dubai. Each Western Asset company is a wholly owned subsidiary of Legg Mason, Inc. ( Legg Mason ) but operates autonomously, and Western Asset, as a firm, is held out to the public as a separate entity. Western Asset Management Company was founded in The Firm is comprised of several entities as a result of various historical acquisitions made by Western Asset and their respective performance has been integrated into the Firm in line with the portability requirements set forth by GIPS. Effective April 2007, Western Asset manages these portfolios as sub-advisor to its affiliate, Legg Mason Private Portfolio Group, LLC. From January 2006 through March 2007, Western Asset portfolio managers managed these portfolios as dual employees of ClearBridge Advisors, LLC, and ClearBridge Asset Management Inc. (each a Western Asset affiliate), following Western Asset s investment process and having access to Western Asset s investment resources, expertise and investment outlook. Western Asset Government/Corporate Portfolios are discretionary fixed-income portfolios that offer - to individual and taxable institutional investors - tailored management of U.S. Treasury securities, federal agency securities and investment-grade corporate bonds. These portfolios seek to produce s over complete market cycles that exceed appropriate benchmark returns. The portfolios also seek to preserve principal. The composite is comprised of accounts that are separately managed accounts (SMAs) managed in accordance with the strategy with an account minimum of US $80,000 (Prior to 7/1/2013, the composite minimum was $10,000). The composite employs a 10% significant cash flow policy. The composite was created on January 1, Effective January 1, 2013, the number of portfolios reflects a change from prior periods due to an aggregation of accounts as reported by one sponsor. For periods prior to 2013, the firm excluded accounts designated by the sponsor as client-restricted. 2 Effective January 1, 2012 the WA Intermediate Taxable Fixed Income Composite merged with the WA Government/Corporate Composite as they are the same strategy. For comparison purposes, composite returns are shown against returns of the Bloomberg Barclays U.S. Intermediate Government/Credit Bond Index, which is comprised of all publicly issued, fixed-rate, nonconvertible, domestic debt in three major classifications: industrial, utility and financial (as well as domestic debt of the U.S. government or any agency thereof). All corporate bonds have a minimum rating of Baa (Moody s) and BBB ( & Poor s). An investor cannot invest directly in an index. 1 Pure gross returns are presented as supplemental information to the net returns. The current fee schedule is 1.50% on all. Net returns are calculated by deducting the anticipated maximum annual bundled fee applied on a monthly basis from the "pure" gross monthly return. The bundled fee includes all charges for trading costs, portfolio management, custody, and other administrative fees. Bundled fees may vary across different financial firms and across different accounts based upon account size and other factors. Returns and market values are expressed in USD. Dispersion is calculated using the asset-weighted standard deviation of annual returns of those portfolios that were included in the composite for the entire year (equal-weighted prior to 2014). Periods with five or fewer accounts are not statistically representative and are not presented. The three-year annualized ex-post standard deviation measures the variability of the composite and the benchmark returns over the preceding 36-month period. deviation is not presented for periods where 36 monthly returns are not available for the composite or the benchmark. Past investment results are not indicative of future investment results. Western Asset s list of composite descriptions and policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. Please contact Ellen Cammer at or Ellen.Cammer@westernasset.com Legg Mason Investor Services, LLC, a Legg Mason, Inc. subsidiary. Member FINRA, SIPC AMXX D846 9