Factors That Affect Bond Yields These Characteristics And These Higher Credit Quality Lower Credit Quality Shorter Duration Low Inflation Expectations Increasing Demand Y I E L D Longer Duration High Inflation Expectations Decreasing Demand Y I E L D put downward pressure on Yields put upward pressure on Yields Investors should determine the level of risk, and thus volatility, they are willing to accept in exchange for higher yields. Risks such as credit quality, maturity/duration, and inflation expectations among others, must be fully understood before Higher allocating Risk to bonds rather than making decisions solely on the amount of yield received. The direction of interest rates and bond prices are inversely related when one increases, the other decreases.
The Relationship Between Bond Price and Yield Total Return Depends on Price Changes and Income Return 16 115 14 110 Yield to Worst (%) 12 10 8 6 4 2 105 100 95 90 Average Price ($) 0 Jun-83 Apr-84 Feb-85 Dec-85 Oct-86 Aug-87 Jun-88 Apr-89 Feb-90 Dec-90 Oct-91 Aug-92 Jun-93 Apr-94 Feb-95 Dec-95 Oct-96 Aug-97 Jun-98 Apr-99 Feb-00 Dec-00 Oct-01 Aug-02 Jun-03 Apr-04 Feb-05 Dec-05 Oct-06 Aug-07 Jun-08 Apr-09 Feb-10 Dec-10 Oct-11 Aug-12 Jun-13 85 Yield to Worst Price Source: Barclays; Baird analysis. For the 30-year period ending 5/31/13. Represented by the Barclays Aggregate Bond Index. The shaded sections represent periods that experienced a significant yield increase and/or price decline. An investment cannot be made directly in an index. Past performance is not a guarantee of future results.
Thinking About Real (Inflation-Adjusted) Yields Nominal and Real Yields Across Bond Types Traditional Bond Types Non-Traditional Bond Types 7 Yield to Worst (%) 6 5 4 3 2 1 0 0.1 Nominal Yield Real Yield 1.3 1.1 2.3 0.8 2.9 2.9 1.4 1.4 1.8 1.8 0.3 0.3 2.2 0.7 4.6 3.1 4.9 3.4 5.4 3.9 5.7 4.2-1 -0.4-0.2-2 -1.4 Source: Citigroup, Barclays benchmarks. Nominal rates are as of 5/31/13; Real rates assume an annualized inflation rate of 1.5%. For illustrative purposes only and subject to change.
Understanding Risk-Adjusted Yields The Relationship between Yield and Volatility 6 5 Yield is offered as compensation for various risks and higher yielding asset classes are often accompanied by higher volatility. Investors can benefit from thinking about how much risk is it worth taking for additional yield. Bank Loans Emerging Market 4 Yield (%) 3 Mortgage-Backed 2 Aggregate Bond Global Inflation-Protected 1 Agency Treasury 0 0 2 4 6 8 10 12 10-Year Standard Deviation (%) Source: Barclays Capital. Barclays EM USD ( EM Debt ), Barclays Global Aggregate ( Global ), Barclays ( ), Barclays IG ( ), Barclays Loans ( Bank Loans ), Barclays ( ), Barclays US Agency ( Agency ), Barclays US Treasury( Treasury ), Barclays TIPS( TIPS), Barclays ( ), Barclays MBS ( Mortgage-Backed ). For the 10-year periods ending 5/31/13. An investment cannot be made directly in an index.
Not All Bonds Act the Same 5 Year Correlation Among Bond Types EM Debt Global Bank Loans Agency Treasury TIPS Mortgage- Backed EM Debt 1.00 Global 0.66 1.00 0.44 0.07 1.00 0.80 0.70 0.30 1.00 Low correlation across different bond sectors and maturities can provide long term diversification benefits in a bond portfolio, attempting to maximize total return for a given level of volatility. Legend High Correlation (0.70-0.99) 0.81 0.42 0.52 0.65 1.00 Moderate Correlation (0.30-0.69) Bank Loans 0.64 0.13 0.69 0.45 0.88 1.00 Low Correlation (less than 0.30) Agency 0.34 0.65-0.25 0.52-0.08-0.35 1.00 Treasury 0.08 0.46-0.25 0.30-0.35-0.52 0.90 1.00 TIPS 0.71 0.64 0.34 0.64 0.49 0.35 0.49 0.42 1.00 0.42 0.28 0.60 0.57 0.40 0.34 0.22 0.16 0.39 1.00 Mortgage- Backed 0.39 0.52-0.06 0.46-0.05-0.18 0.83 0.77 0.50 0.21 1.00 Source: Barclays EM USD ( EM Debt ), Barclays Global Aggregate ( Global ), Barclays ( ), Barclays IG ( ), Barclays Loans ( Bank Loans ), Barclays ( ), Barclays US Agency ( Agency ), Barclays US Treasury( Treasury ), Barclays TIPS( TIPS), Barclays ( ), Barclays MBS ( Mortgage-Backed ). For the 5-year periods ending 5/31/13. Diversification does not ensure a profit or protect against loss.
Important Disclosures and Benchmark Definitions Important Disclosure Indices are unmanaged and are used to measure and report performance of various sectors of the market. Past performance is not a guarantee of future results and diversification does not ensure a profit or protect against loss. Direct investment in indices is not available. Benchmark Definitions Barclays Aggregate Bond Index ( Aggregate Bond ): Comprised of approximately 6,000 publicly traded bonds, including U.S. Government, mortgagebacked, corporate, and Yankee bonds with an average maturity of approximately 10 years. Barclays Muni Bond Index ( ): Bonds must have a minimum credit rating of at least Baa, an outstanding par value of at least $3 million, part of a transaction of at least $50 million, issued after December 31, 1990 and have a year or longer remaining maturity. Barclays Muni Bond Index ( ): A subset of the Barclays Muni Bond Index that have a credit rating of less than Baa, an outstanding par value of at least $3 million, part of a transaction of at least $50 million, issued after December 31, 1990 and have a year or longer remaining maturity. Barclays U.S. Treasury Index ( Treasury ): Public obligations of the U.S. Treasury with a remaining maturity of one year or more. Barclays Agency Bond Index ( Agencies ): A sub-set of the Aggregate Bond Index that includes U.S. agency issued bonds, including the Federal National Mortgage Association (Fannie Mae). Barclays U.S. Credit Index ( ): Includes publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered. Barclays MBS Index ( Mortgage-Backed ): U.S. agency mortgage-backed bonds, including Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) and Freddie Mac (FHLMC) securities. Barclays U.S. ( ): Covers the universe of fixed rate, non-investment grade debt. Eurobonds and debt issues from countries designated as emerging markets (sovereign rating of Baa1/BBB+/BBB+ and below using the middle of Moody s, S&P, and Fitch) are excluded, but Canadian and global bonds (SEC registered) of issuers in non-emg countries are included. Original issue zeroes, step-up coupon structures, 144-As and pay-in-kind bonds (PIKs, as of October 1, 2009) are also included. Barclays Global Aggregate ( Global ): Provides a broad-based measure of the global investment-grade fixed income markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The index also includes Eurodollar and Euro-Yen corporate bonds, Canadian government, agency and corporate securities, and USD investment grade 144A securities. Barclays EM USD Aggregate ( Emerging Markets ): Includes USD denominated debt from sovereign, quasi-sovereign, and corporate EM issuers. Country eligibility and classification as an Emerging Market is rules-based and reviewed on an annual basis using World Bank income group and International Monetary Fund (IMF) country classifications. Barclays US Gov t Inflation Linked ( Inflation Linked ): Measures the performance of the US Treasury Inflation Protected Securities ( TIPS ) market. The index includes TIPS with one or more years remaining maturity with total outstanding issue size of $500m or more. Market Risk: The risk that the bond market as a whole would decline, bringing the value of individual securities down with it regardless of their fundamental characteristics. Costs and Fees: The risk that the costs and fees associated with an investment are excessive and detract too much from an investor s return. Liquidity Risk: The risk that investors may have difficulty finding a buyer when they want to sell and may be forced to sell at a significant discount to market value. Credit Risk: The risk that the borrower will be unable to make interest or principal payments when they are due and therefore default. Beta: A measure of a portfolio s sensitivity to the performance of its benchmark. A beta greater than 1 suggests higher volatility and vice versa. Standard Deviation: A statistical measure of performance dispersion. The higher the measure, the more volatile the historical return pattern. Maximum Drawdown: Over a specific period, the greatest peak to trough decline. Correlation: A statistical measure of how securities move in relation to each other.