© 2013 Morningstar. All Rights Reserved.

Investing in a Rising-Interest-Rate Environment

Markets Research TeamMorningstar

History of Interest RatesJanuary 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

0

12

16

20%

30-day Treasury billsIntermediate-termgovernment bonds

Long-termgovernment bonds

8

4

Average: 5.2%

Current: 3.4%

4.6%

1.1%

0.0%

3.6%

Long-Term Government Bonds’ Downturns and RecoveriesJanuary 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

1

10

$100

1996 20061986197619661956194619361926

Growth of $1

0

6

8

10

12

14

16% Yield

4

2

• Long-term government-bond yield• Recoveries• Downturns• Expansions

Downturns of 10% and more

Long-Term Government Bonds’ Downturns and RecoveriesJanuary 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

–18.8%

–10.4%

–21.0%

–10.3%

–13.4%

–12.1%

–10.4%

–11.2%

–14.9%

–11.4%

% Loss

–13.2%

40 months

21 months

27 months

13 months

7 months

9 months

15 months

2 months

12 months

5 months

Downturn

13 months

10 months

4 months

10 months

4 months

4 months

7 months

7 months

14 months

8 months

7 months

TBD

Recovery

TBD

Jan 1960–Dec 1960

Jun 1970–Mar 1971

Sep 1974–Dec 1974

Oct 1981–Jul 1982

Jun 1984–Sep 1984

Oct 1987–Jan 1988

Nov 1994–May 1995

Jan 2000–Jul 2000

Aug 2003–Sep 2004

Jan 2010–Aug 2010

Aug 2012–Aug 2013

Jun 1958–Dec 1959

Feb 1967–May 1970

Dec 1972–Aug 1974

Jul 1979–Sep 1981

May 1983–May 1984

Mar 1987–Sep 1987

Feb 1994–Oct 1994

Oct 1998–Dec 1999

Jun 2003–Jul 2003

Jan 2009–Dec 2009

Sep 2010–Jan 2011 Feb 2011–Aug 2011

–10.9%19 months 12 months

Average 7.9 months–13.2%15.3 months

Intermediate-Term Government Bonds’ Downturns and RecoveriesJanuary 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

1

10

$100

1996 20061986197619661956194619361926

Growth of $1

0

6

8

10

12

16

18% Yield

4

2

14

• Intermediate-term government-bond yield• Recoveries• Downturns• Expansions

Downturns of 5% and more

Intermediate-Term Government Bonds’ Downturns and RecoveriesJanuary 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

–5.7%

–8.9%

–8.5%

% Loss

–6.9%

15 months

8 months

15 months

Downturn

10 months

7 months

2 months

3 months

6 months

Recovery

Dec 1994–May 1995

Feb 1932–Aug 1932

Sep 1959–Mar 1960

Mar 1980–Apr 1980

Feb 1994–Nov 1994

Jun 1931–Jan 1932

Jun 1958–Aug 1959

Jul 1979–Feb 1980

Jun 1980–Aug 1981 Sep 1981–Nov 1981

–5.3%8 months 7 months

Average 5 months–7.1%11.2 months

Investors Have Most of Their Money in Intermediate BondsAs of August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

23%

13%

64%

• Short-term bonds• Intermediate-term bonds• Long-term bonds

Bond Prices Decline for Longer Periods in Low-Interest-Rate Environments Downturns of Long-Term Government Bonds, January 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

Below 3%

Starting bond yields in the beginning of each of the past 25 biggest bond-market declines

3%–5% 5%–7% Over 7%

25 Average decline (months)

20

15

10

5

0

Fund Flows and Asset-Class PerformanceJanuary 1994–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

Asset-Class Performance

Annual Net Asset Fund Flows

–200

–100

200

$300 billion

–40

–20

0

20

40% Return

100

0

94 95 96 97 08 09 Jan–Aug 13

10 1104 05 06 0798 99 00 01 02 03

• U.S. stocks • International stocks • Bonds

12

20

10

0

–20

$50 bil

40

30

Annual Net Flows of Noncore-Bond FundsJanuary 2007–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

• Bank loan

• Emerging markets bond

• High-yield corporate bond

• Nontraditional bond

2007 2008 2010 2011 2012 2013 YTD2009

–10

20

10

0

–20

30%

Average Performance of Bonds Based on Monthly Interest-Rate ChangesJanuary 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

Rising interest rates Falling interest rates Full period returnNeutral interest rates

–10

• 30-day Treasury bills

• Intermediate-term government bonds

• Long-term government bonds

• Long-term corporate bonds

• High-yield corporate bonds

Bond Performance in Times of Rising and Falling Interest RatesJanuary 1960–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

0

–15

–15

5-year government-bond yield

Long-term government bonds

High-yield corporate bonds

20%

15

30

45%

–15

Long-term corporate bonds

10

5

15

0

30

45%

15

0

30

45%

15

0

74.6%

87.9%

60.7%

Shaded areas represent rising interest rates

Corporate Credit Spread and Treasury YieldJanuary 1973–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

2

4

6

8

10

14

16

–1

0

1

2

3

4

5

6

7% Credit spread

20082003199819931988198319781973

• Intermediate-term corporate A credit spread

• Barclays US Government yield index

18% Yield

12

0

2013

QE1

QE3

QE2

15

10

0

–5

20%

Average Performance of Equities Based on Monthly Interest-Rate ChangesJuly 1927–December 2012

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

Rising interest rates Falling interest rates Full period returnNeutral interest rates

5

Dividend size

• No dividend

• Lowest 30%

• Medium 40%

• Highest 30%

0

2

4

6

16

18%

1871 1881 1891 1961 1971 1981 1991 2001 2011

Large Stock Dividend Yield Versus 10-Year Treasury YieldJanuary 1871–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

• 10-year Treasury yield

• Large stock dividend yield

8

10

12

14

1901 1911 1921 1931 1941 1951

Inflation, Not Rising Rates, Biggest Bond Threat in the Long TermIntermediate-Term Government Bonds, January 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

1

10

$100

2001 20111956195119461941193619311926

• Nominal performance

197119661961 198619811976 1991 1996 2006

• Inflation-adjusted performance

1970 1972 1974 19781976 1980

100

120%

0

80

60

40

20

–20

Bonds Can Deliver Negative Returns onInflation-Adjusted Basis, 1970–1980

Nominal

Inflation-adjusted

5.3%

2.3%

Annualized return

Rolling Period Risk and ReturnJanuary 1926–August 2013

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2013 Morningstar. All Rights Reserved.

1-year periods (1,041) 5-year periods (993) 10-year periods (933) 20-year periods (813)

–20

–10

0

10

20

30

40

60%

74.0% 77.8% 78.5% 81.3% 86.9% 94.3% 94.6% 96.2% 94.3% 100.0% 99.9% 100.0% 100.0% 100.0% 100.0% 100.0%

50

162.9% 108.7%

–67.6% –48.0%• Large stocks • Portfolio • Long-term government bonds • Long-term corporate bonds

Understanding the Graph

Best 5%

Other 90%

Worst 5%Most Recent Return

Median Return

Positivereturns