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Strategic Focus:Transformation of the High Yield Asset Class

August 2012

KEY ATTRIBUTES OF HIGH YIELD

Since the Financial crisis of 2007 – 2008, the global high yield bond market has transformed itself from a tactical asset class to a more strategic allocation for pension funds, insurance companies and private clients. The fundamentals of the market are better today than they have been in decades.

Size of the asset class: The global high yield market has grown from $500 billion at the end of 2008 to $1.5 Trillion. The growth and maturation of the market has been nothing less than stunning as many new and growing corporations have used this market to issue new bonds at very attractive rates.

THE GLOBAL HIGH YIELD MARKET

HIGH-YIELD NEW-ISSUE ACTIVITY

Source: JPMorgan

HIGH YIELD MARKET GROWTH

TRANSFORMATION OF THE HIGH YIELD ASSET CLASS

» Global asset class (issuers based in U.S., Europe, Asia and Latin America; over 30% of the market is outside the U.S. and growing).

» Critical Mass ($1.5 trillion in size) and growing rapidly. Over $750 billion of new issuance during 2009-2011.

» Good Diversifi er: low correlation with many other asset classes.

» Attractive return profi le: higher Sharpe ratio and lower volatility than Equities. Solid absolute and relative returns over past 1-, 3-, 5- and 10-year periods.

THE GLOBAL HIGHYIELD CONTINUUM

$1.5 TRILLION

Emerging MarketHigh Yield Corporates

USD $200 billion

High Yield CorporatesUSD $1.1 trillion

Global Non-dollarHigh Yield Corporates

$200 billion

207

649

1392

0

200

1988 1992 1996 2000 2004 2008 2011

400

600

800

1000

1200

1400

1600

($ B

illio

ns)

Equity monetization 4%

2009 2010

2011

2009 2010

2011

2009 2010

2011

The new bonds have lower rates and longer maturities than the debt they refi nanced, with the result that the average high yield issuer has reduced its interest expense signifi cantly and does not have any debt coming due prior to 2016. The fi nancial fl exibility of these companies now is far superior to pre-2008 thanks to the massive new issuance in the high yield market over the past three years.

Source: JPMorgan* GCP = General Corporate Purposes

TRANSFORMATION OF THE HIGH YIELD ASSET CLASS

Equity monetization 3% Equity

monetization 6%Acquisitions/LBOs 4%Acquisitions/LBOs

13% Acquisitions/LBOs 4%

Capex 2% Capex 4% Capex 5%

Refinancings64%

Refinancings61%

Refinancings55%

GCP24%

GCP18% GCP

22%

USE OF PROCEEDS

WHO OWNS HIGH YIELD BONDS?

USE OF NEW ISSUE PROCEEDS

Growing Buyer base of high yield bonds: Whereas prior to 2009, investing in high yield rated companies was considered more tactical than strategic, more and more institutional investors are making 5 – 10% strategic allocations to the asset class. These investors are clearly attracted by the solid 6 – 7% yields in the asset class but, more importantly, they are attracted by the transformation of the asset class since early 2009. The $1.5 trillion size of the market with over 1,200 issuers is very attractive to institutional investors.

Strong performance: Since the end of 2008 major high yield indices are up 18% annualized with less than half the volatility of equity indices, such as the S&P 500. This strong performance has generated heavy infl ows into the asset class as both institutional and retail investors have become investors in the high yield bond market. (Since the end of 1999, the high market yield has generated an annualized return of 7% per annum versus a paltry return of 1.3% per annum for the S&P 500.)

2012

Insurance Companies25%

Pension Funds22%

High Yield Mutual Funds18%

Foreign 10%

Investment Grade Funds 9%

Equity and Income Funds 9%

Hedge Funds and Others 5%

The growing size, depth and maturity of the high yield market have made this a market that institutional investors can no longer overlook.The growing size, depth and maturity of the high yield market have made this a market that institutional The growing size, depth and maturity of the high yield market have made this a market that institutional investors can no longer overlook.investors can no longer overlook.

The high yield market is more diversifi ed by industries than the investment grade corporate bond market, which is dominated by the exposure to the volatile fi nancial sector—banks, brokerage and insurance companies. We believe this sectoral diversifi cation is a strong positive for the high yield bond market and will help to limit volatility.

GREATER DIVERSIFICATION IN THE HIGH YIELD MARKET

TRANSFORMATION OF THE HIGH YIELD ASSET CLASS

High Yield

InvestmentGrade

Basics 18%Basics 10%

Telecom 19%

Telecom 14%

Energy/Utility17%

Energy/Utility21%

Financials 16%

Financials 31%

Consumer 24%

Consumer 17%

Healthcare 6% Healthcare 7%

Sector Breakdown

Numerous well known companies are part of this diversifi ed high yield bond market. Prominent automotive companies such as Avis and Hertz to Chrysler and, until recently, Ford Motor, to airlines such as Delta and United Airlines, to such consumer product companies such as Elizabeth Arden, Levi’s and Revlon, to the two largest U.S. hospital companies, HCA and Community Health, and such restaurant companies as Burger King, Carls Jr. and IHOP. The market is comprised of over 1,200 distinct companies, many of them growth companies with attractive prospects.

Source: Bank of America

Heavy exposure to the volatile fi nancial sector