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Bigger Economic Green Shoots This Spring?. Presented by: Dan Byrnes Senior Portfolio Manager AAM – Insurance Investment Management. - PowerPoint PPT Presentation
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1
Bigger Economic Green Shoots This Spring?
Presented by: Dan Byrnes Senior Portfolio Manager AAM – Insurance Investment Management
Reproduction or use of these materials for any other purpose or by or for any individuals is strictly prohibited. The information contained in this presentation has been obtained from sources that AAM believes to be reliable, but AAM does not represent or warrant that it is accurate or complete. The views in this presentation are those of AAM and are subject to change, and AAM has no obligation to update its opinions or the information in this presentation. Neither AAM, nor any of their respective officers, directors, members, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this presentation or its contents. The securities discussed in this presentation may not be suitable for all investors. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information in this presentation is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results.
2
It’s Baseball Season: Trivia Question
How many hot dogs are expected to be eaten in Major League ball parks this year: ~ 3 million ~ 14 million ~ 20 million ~ 28 million
3
It’s Baseball Season: Trivia Question
How many hot dogs are expected to be eaten in Major League ball parks this year: ~ 3 million ~ 14 million ~ 20 million ~ 28 million
4
Winter Wonderland
Fond Memories (?!) From This Winter in Chicago 93% of Great Lakes
Frozen – 2nd highest 3rd coldest average
temperature Most days with low
temps at or below 0o
3rd snowiest winter
5
Recent Consumer Data Underwhelming What is driving these negative
figures?• Weather? • Weaker Consumer?
Reading Month Survey Actual ΔBuilding Permits MoM Dec -0.3% -2.6% -2.3%Building Permits MoM Jan -1.6% -5.4% -3.8%Existing Home Sales MoM Dec 0.6% 0.8% 0.2%Existing Home Sales MoM Jan -4.1% -5.1% -1.0%Retail Sales Advance MoM Dec 0.1% -0.1% -0.2%Retail Sales Advance MoM Jan 0.0% -0.4% -0.4%Total Vehicle Sales Jan 15,700,000 15,160,000 -540,000Total Vehicle Sales Feb 15,400,000 15,270,000 -130,000
Source: U.S. Census Bureau, National Association of Realtors, Bloomberg, AAM
6
Unemployment Rate Falling Fast
Unemployment rate falling dramatically The Fed is concerned about the labor market
Job Adds and Unemployment Rate
Source: Bureau of Labor Statistics as of 2/28/2014
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
YTD '14
-500-400-300-200-100
0100200300400
0
2
4
6
8
10
12
Avg Annual Payroll Change (LHS) Year End Unemployment Rate (RHS)
Thou
sand
s of
Jobs
Unem
ployment
Rate
7
Stubborn Low Employment/ Population Ratio Suggest Structural Changes
3
4
5
6
7
8
9
10
11 58
59
60
61
62
63
64
65
Unemployment rate (lhs)Employment/population ratio (rhs)
Source: Bureau of Labor Statistics; FTN Financial
Rate
(%
) Ratio (%)
8
Long Term Unemployment Still An Issue
1990
1993
1996
1999
2002
2005
2008
2011
2014
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Thou
sand
s of
Peo
ple
5 – 14 Weeks
14 -27 Weeks
27 Weeks and Over
Less Than 5 Weeks
Source: Bureau of Labor Statistics; AAM
9
Housing Still Strong Despite Higher Interest Rates
Source: Standard & Poor’s, Case-Schiller as of 12/31/13
Dec-03Oct-
04Aug-05
Jun-06Apr-0
7Feb-08
Dec-08Oct-
09Aug-10
Jun-11Apr-1
2Feb-13
Dec-13
120
140
160
180
200
220Home Prices
2002
2003
2004
2005
2007
2008
2009
2010
2012
2013
90
110
130
150
170
190
210
230Home Affordability
At 100, median-income family just qualifies for mortgage on median-priced home.
Source: National Association of Realtors as of 12/31/13
Housing has been a bright spot in the economy
Recent pace of gains likely unsustainable
10
Still Spending
Source: US Census Bureau as of 1/31/14
Capital Goods Orders Change In Consumer Spending
Source: National Association of Realtors as of 12/31/13
Spending has been good, but not robust
2006
2007
2008
2009
2010
2011
2012
2013
2014
40
45
50
55
60
65
70
75
$Bill
ion
1Q 2005
1Q 2006
1Q 2007
1Q 2008
1Q 2009
1Q 2010
1Q 2011
1Q 2012
1Q 201
3-2%
-1%
0%
1%
2%
3%
4%
5%
11
The World Stage
Eurozone United Kingdom
Japan China EMEA Latin America
-2
0
2
4
6
8
10Annual GDP Growth Expectations
2012201320142015
Source: Bloomberg as of December 2013
Russia
Crimea
Ukraine
NATO
There has been a lot of concern around China’s “slow” growth
Geopolitical concerns remain
GD
P (%
)
12
What’s All This Mean for Growth?
1Q GDP is expected to be weak – around 1.8% Growth should pick up in the second half of the year Average growth of 3% expected over the next two years
Real U.S. GDP Growth During Expansions
Source: Bureau of Economic Analysis, Bloomberg Forecast as of 2/28/2014
Jun 91
Feb 93Oct 9
4Jun 96
Feb 98Oct 9
9Jun 01
Feb 03Oct 0
4Jun 06
Feb 08Oct 0
9Jun
11Feb 13
Oct 14
-1%0%1%2%3%4%5%6%7%8%
Forecast
13
What About Inflation?
-100.0%
-50.0%
0.0%
50.0%
100.0%
150.0%
200.0%
250.0%
300.0%
350.0%
10-yr breakeven rate5-yr breakeven rate
Source: Bloomberg; FTN Financial
14
The Fed Under Yellen
Dovish reputation
Expected to maintain the course set by Bernanke if conditions meet expectations
More concerned about full employment than predecessors
15
Fed Stimulus Exit
If the economy grows as expected the Fed should have exited QE III by year end
October
Dec-12
Feb-13Apr-1
3Jun-13
Aug-13Oct-
13Dec-
13Feb-14
Apr-14
Jun-14Aug-14
Oct-14
0102030405060708090 Treasuries
Agency MBS
$ Bi
llion
Forecast
16
Work to do After QE
Balance sheet will still be large and need to be wound down
Fed Funds rate increase expected mid-2015
0
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000 Fed Agency MBS PurchasesLiquidity to Key Credit MarketsLending to Financial InstitutionsLong Term Treasury PurchasesTraditional Security Holdings
Fed Balance Sheet
17
Limited Correlation Between Fed Policy and Long Term Interest Rates
0
1
2
3
4
5
6
7
8
9
1019
9019
9119
9219
9319
9419
9519
9619
9719
9819
9920
0020
0120
0220
0320
0420
0520
0620
0720
0820
0920
1020
1120
1220
1320
14
Yield
(%)
Federal Funds Rate2 Year US Treasury10 Year US Treasury30 Year US Treasury
Source: Barclays, Federal Reserve, Data as of 3/28/14
18
What About Interest Rates?
Source: Bloomberg as of February 2014
What could cause meaningful divergence• Higher
Faster growth Concerns about Fed
commitment to low inflation
Other?• Lower
Geopolitical issues Dramatic slow-down in
China Weaker consumer
2 Year 10 Year 30 Year2Q '14 0.50% 3.00% 3.92%3Q '14 0.62% 3.20% 4.05%4Q '14 0.77% 3.35% 4.21%1Q '15 0.88% 3.50% 4.30%2Q '15 1.04% 3.60% 4.40%3Q '15 1.33% 3.75% 4.50%
Expected Treasury Yields
19
What Do I Do With All Of This?
20
It’s Baseball Season: Trivia Question
What MLB stadium has the most expensive small beer? Yankee Stadium Marlins Park - $8 Wrigley Field Dodger Stadium
21
It’s Baseball Season: Trivia Question
What MLB stadium has the most expensive small beer? Yankee Stadium Marlins Park - $8 Wrigley Field Dodger Stadium
22
Status Quo: Investment Grade Fixed Income
23
Corporate Bonds Remain Attractive
Source: AAM, Barclays
-
50
100
150
200
250
BBB-A Industrial Spread Difference
Basi
s Po
ints
2004
2006
2008
2010
2012
2014
50
100
150
200
250
300
U.S. Corporate Investment Grade Spread
Basi
s Po
ints
24
Technicals Expected To Remain Supportive
20042005
20062007
20082009
20102011
20122013
F2014-500
0
500
1,000
1,500
$755
$1,084
$1,489 $1,491
$173$329
$34$188
$700 $862$747
CLOsABSCMBSAgency MBSNon-agency MBSBuild America BondsEM SovereignEM CorporatesHY corporatesIG corporatesTotal spread product net issuance
2011 coupons = $757
2014 coupons = $668
2010 coupons = $699
Source: JP Morgan
Net Issuance
25
Investable And Attractive Risk-adjusted Assets
Note: AAM is not soliciting or recommending any action based on above material. Any views presented above represent the opinion of AAM at a given time and are subject to changeSource: Barclays, Moody’s
1988
1990
1992
1995
1997
1999
2001
2003
2005
2008
2010
2012
$0 $500
$1,000 $1,500 $2,000 $2,500 $3,000 $3,500 $4,000
AAA AA A BBB
Mar
ket
Val
ue o
f Co
rpor
ate
Inde
x (B
illio
ns)
The Corporate Market Has Grown And Is Lower Quality
Moody's Credit StatisticsAAA AA A BBB BB
Historical Average Loss (1982 - 2013) 0.00% 0.03% 0.03% 0.13% 0.69%Worst Loss Experience (1982 - 2013) 0.00% 0.48% 0.36% 0.79% 3.14%
9.59%5.01%6.31%9.09%8.98%1 Year Avg Ratings Migration Down (1970 - 2013, % of category), excl. WR
26
What Other Levers Can Be Pulled?
27
No Free Lunch
Source: AAM
Add interest rate risk via more duration
Add liquidity risk – commercial loans
Add credit risk – high yield and/or convertibles
28
Duration Decisions
Results greater than one year are cumulativeInterest rate changes are assumed to happen evenly over indicated time periodSource: Actual portfolios modeled in CMS BondEdge as of 8/31/2013
Common question: If interest rates are rising, should I shorten my portfolio duration?
Short Answer: No
Scenario testing shows the role income plays in returns
No Change in Interest Rates
12 Months 24 Months 36 MonthsIncome Return 2.0% 4.1% 6.3%Total Return 2.5% 4.7% 6.9%Income Return 3.2% 6.6% 10.3%Total Return 3.9% 7.8% 11.8%Income Return 1.2% 2.5% 3.9%Total Return 1.4% 3.0% 4.9%
3.1 Duration
5.4 Duration
Difference
29
What If Rates Rise Substantially?200 Basis Point Rise In Interest Rates
Income is the key driver in fixed income performance
Stick to your knitting on duration
Scenario testing shows the role income plays in returns
12 Months 24 Months 36 MonthsIncome Return 2.2% 4.7% 7.6%Total Return -2.0% 1.9% 5.8%Income Return 3.3% 7.0% 11.2%Total Return -4.4% 0.9% 6.5%Income Return 1.1% 2.4% 3.6%Total Return -2.4% -1.0% 0.7%
3.1 Duration
5.4 Duration
Difference
Results greater than one year are cumulativeInterest rate changes are assumed to happen evenly over indicated time periodSource: Actual portfolios modeled in CMS BondEdge as of 8/31/2013
30
High Yield
31
U.S. High Yield Corporate Bond Spreads
Spread of the Credit Suisse U.S. High Yield II Index
Source: Credit Suisse
High yield spreads are slightly lower than their long-term average, while the risk-free interest rates are at historically low levels
Current spreads imply a default rate of almost 6% for the U.S. high yield market
0 bp
400 bp
800 bp
1200 bp
1600 bp
2000 bp
2/28/1997: 315 bp
10/31/2002 1080 bp
5/31/2007 271 bp
11/28/2008 1816 bp
1/9/2014 426 bpAverage
Spread:589 bp
32
2014 2015 2016 2017 2018 2019 2020 2021 20220
40,000
80,000
120,000
160,000
200,000
Mat
urit
ies
($bi
llion
)
High Yield Bond Maturities
Record new issue proceeds used primarily for the purpose of repaying or refinancing existing debt.
High Yield company fundamentals remain strong. We anticipate defaults will be less than 2% for the overall market.
Refinancing Risk Remains Low
Source: BofA Merrill Lynch, Data as of December 31, 2013 (Updated quarterly)
33
Not All High Yield Is Created Equal
Source: Annual Default Study: Corporate Default and Recovery Rates, 1920-2013 Yield to Worst shown for B of A Merrill Lynch BBB, BB, B, and CCC & Below Indices as of 2/28/2014. Loss adjusted assumes 40% average recovery for senior unsecured bonds.
A focus on Ba/B ratings substantially reduces the risk of impairments
Baa Ba B Caa_C0
2
4
6
8
10
12
14
0
2
4
6
8
10
12
14
16Annualized DefaultsYieldLoss-adjusted Yield
Def
ault
Rat
e (P
erce
nt) Yield
(Percent)
34
In A Rising Rate Environment, High Yield Has Performed Well
Sources: JP Morgan and BofA ML. BofA ML U.S. 10 Year Treasury Index (GA10), BofA ML U.S. High Yield Cash Pay (J0A0) Index. Prior to the inception of J0A0 on 10/31/1984, BofA ML U.S. High Yield Master II (H0A0) was used.
12-months ending:
10-year Treasury
yield move
10-year Treasury return (GA10)
U.S. High Yield Bond Index (J0A0)
Feb-89 +BP 117 0.39% 9.88%
Dec-94 +BP 204 -8.29% -1.17%
Dec-99 +BP 179 -8.25% 1.57%
May-04 +BP 130 -5.38% 11.34%
Jun-06 +BP 120 -5.79% 4.65%
35
Convertibles
36
Convertible Securities-Equity-like Returns With Less Risk
*
Capture 70-80% of stock market advances
Participate in only 40-50% of stock market declines
Carry higher current yields as compared to common stock
Constant focus on maintaining consistent risk/return profile
37
Historical Issuance/Redemptions
96.9
62.1
40.035.9
25.221.4
48.9
70.0
48.355.6
50.0
38.3
47.1
31.8
48.1
36.0
0
20
40
60
80
100
120
2007 2008 2009 2010 2011 2012 2013 2014
Issua
nce/
Rede
mpt
ions
(USD
$ bi
llion
s)
Issuance Redemptions
Source: Barclays Research as of December 31, 2013. *Estimates for 2014
*
38
Convertible Performance Drivers for 2014
Return Component
Likely Impact Comment
Equity Prices + / -Primary driver of convertible performance; strong upside participation in rising markets and attractive downside protection in a market correction
Valuation 0 Valuations remain generally attractive, particularly in sub-IG and short-dated space
Volatility 0 / + Volatility expectations remain low despite near-term market concerns
Credit Spreads 0 / - Improved corporate balance sheets and easy refinancing help support bond floors
Interest Rates 0 / - Exposure to rising rates is cushioned by low duration of portfolio and embedded equity option
39
Performance During Rising Rates
Zazove Convertibles
Note: Portfolio returns are reflected before management fees. Benchmark returns include reinvestment of interest/dividends. Past results are not a guarantee of future performance. See "Notes to Performance Summaries" for additional information that is an integral part of this presentation.
Zazove Institutional Investment Grade
Composite
10-Year Treasury Barclays Capital U.S. Corporate Bond Index
Barclays Capital U.S. Aggregate Bond Index
S&P 500-10%
-5%
0%
5%
10%
15%
8.61%
-7.69%
-0.60%-1.35%
12.47%
Rising rate periods included are: 10/31/93-11/30/94, 1/31/96-5/31/96, 9/30/98-1/31/00, 10/31/01-3/31/02, 5/31/03-7/31/03, 6/30/05-6/30/06,12/31/08-12/31/09, 8/31/10-3/31/11, 4/30/13-8/31/13.
40
Commercial Loans
41
Overview
Commercial mortgages have been a staple of U.S. insurance company portfolios for over 100 years due to:
Liability Matching: Asset / liability duration matching with fixed credit spreads mitigating interest rate risk
Competitive Risk Adjusted Returns: Relative to public market alternatives, including corporate bonds
Superior Call Protection: Relative to corporate bonds, due to lock out periods and pre-payment penalties
Lower Delinquency and Severity Rates: versus corporate bonds and CMBS
Lower Volatility
Structural Benefits Versus CMBS: More lender control in loan structuring; realizing a recovery in the event of a default
Improved Risk Based Capital Treatment – Effective 2013
42
Yield Comparison
U.S. Fixed Income Yields(Approximately 7-7.5 year Modified Duration)
Asset Yield (1/14)
Credit Spread (bps)
(1/31/14)U.S. Treasury Notes(Barclays UST, 7-10 Yrs Index) 2.45% N/A
A Rated Corporate Bonds(Barclays A Corporate Bond Index)
3.09% 118
BBB Rated Corporate Bonds(Barclays BBB Corporate Bond Index)
3.61% 154
Commercial Mortgage Loans (2) 4.79% 234
Source: Barclays, Quadrant Real Estate Advisors
Note: Commercial Mortgage Loans represent privately placed whole loans (first mortgages). Total return and standard deviation calculations sourced from the Giliberto-Levy index as of 9/30/2013. Commercial mortgage yields and spreads are based on market opportunities seen by Quadrant Real Estate Advisors. The Yield represents the bond equivalent weighted spread across property types for 75% LTV loans and DSCR ranging from 1.25-1.45x.
Commercial Mortgages provide attractive yields relative to public market alternatives.
43
Capital Treatment Has Become More Favorable
RBC Group Commercial Mortgages
Corporate Bond
1 0.90% 0.40%2 1.75% 1.30%3 3.00% 4.60%4 5.00% 10.0%5 7.50% 23.0%
Life Insurance Company Risk Based Capital Charges
Commercial Mortgage RBC Charge Description
RBC Group RBC Charge Description1 0.90% DSC=>1.50X and LTV<85%2 1.75% 0.95 <= DSC < 1.50X / LTV<75%3 3.00% DSC<0.95X and LTV<85%4 5.00% DSC<1.15X and LTV=>100%5 7.50% DSC<0.95X and LTV=>105%
Source: NAIC, AAM
44
Widely Used
Percent of Companies with CML Holdings
Source: SNL, data as of 9/30/13
Size of Company
$100-$500 million
$500MM – $1.5 billion
$1.5 – $5 billion
Life 44.6% 56.3% 47.5%
P&C 10.0% 11.4% 23.1%
45
Any Questions?