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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.
1
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
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
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

4
3rd snowiest winter
Recent Consumer Data Underwhelming

What is driving these negative figures?
•
Weather?
•
Weaker Consumer?
Reading
Building Permits MoM
Building Permits MoM
Month
Dec
Jan
Survey
-0.3%
-1.6%
Actual
-2.6%
-5.4%
Δ
-2.3%
-3.8%
Existing Home Sales MoM
Existing Home Sales MoM
Dec
Jan
0.6%
-4.1%
0.8%
-5.1%
0.2%
-1.0%
Retail Sales Advance MoM
Retail Sales Advance MoM
Dec
Jan
0.1%
0.0%
-0.1%
-0.4%
-0.2%
-0.4%
Total Vehicle Sales
Total Vehicle Sales
Jan
Feb
15,700,000
15,400,000
15,160,000
15,270,000
-540,000
-130,000
Source: U.S. Census Bureau, National
Association of Realtors, Bloomberg, AAM
5
Unemployment Rate Falling Fast
Job Adds and Unemployment Rate
400
12
300
100
8
0
6
-100
-200
4
-300
2
-400
-500
0
Avg Annual Payroll Change (LHS)
Year End Unemployment Rate (RHS)

Unemployment rate falling dramatically

The Fed is concerned about the labor market
Source: Bureau of Labor Statistics as of 2/28/2014
6
Unemployment Rate
Thousands of Jobs
10
200
Stubborn Low Employment/ Population Ratio Suggest
Structural Changes
11
58
Unemployment rate (lhs)
10
Employment/population ratio (rhs)
9
59
60
61
7
62
6
63
5
4
64
3
65
Source: Bureau of Labor Statistics; FTN Financial
7
Ratio (%)
Rate (%)
8
Long Term Unemployment Still An Issue
8,000
27 Weeks and Over
7,000
Thousands of People
6,000
5,000
4,000
Less Than 5 Weeks
5 – 14 Weeks
3,000
2,000
1,000
14 -27 Weeks
0
Source: Bureau of Labor Statistics; AAM
8
Housing Still Strong Despite Higher Interest Rates
Home Prices
Home Affordability
230
220
210
200
190
180
At
100,
medianincome family just
qualifies
for
mortgage
on
median-priced home.
170
150
160
130
140
110
90
120
Source: Standard & Poor’s, Case-Schiller as of 12/31/13
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
9
Still Spending
$Billion
Capital Goods Orders
Change In Consumer Spending
75
5%
70
4%
65
3%
60
2%
55
1%
50
0%
45
-1%
40
-2%
Source: National Association of Realtors as of 12/31/13
Source: US Census Bureau as of 1/31/14

Spending has been good, but not
robust
10
The World Stage

There has been a lot of concern around China’s
“slow” growth

Geopolitical concerns remain
Russia
Annual GDP Growth Expectations
10
Crimea
2012
GDP (%)
8
6
2013
2014
2015
Ukraine
4
2
0
NATO
-2
Eurozone
United
Kingdom
Japan
China
EMEA
Latin
America
Source: Bloomberg as of December 2013
11
What’s All This Mean for Growth?
Real U.S. GDP Growth During Expansions
8%
7%
Forecast
6%
5%
4%
3%
2%
1%
0%
-1%

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
Source: Bureau of Economic Analysis, Bloomberg
Forecast as of 2/28/2014
12
What About Inflation?
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
10-yr breakeven rate
-0.5%
5-yr breakeven rate
-1.0%
Source: Bloomberg; FTN Financial
13
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
14
Fed Stimulus Exit
90
Treasuries
Agency MBS
80
70
$ Billion
60
50
Forecast
40
30
20
10
0

If the economy grows as expected the Fed should
have exited QE III by year end
15
Work to do After QE
Fed Balance Sheet
5,000
4,000
Fed Agency MBS Purchases
Liquidity to Key Credit Markets
Lending to Financial Institutions
Long Term Treasury Purchases
Traditional Security Holdings

Balance sheet will still
be large and need to be
$ Billions
wound down
3,000

Fed Funds rate
increase expected mid-
2,000
2015
1,000
0
16
Limited Correlation Between Fed Policy and Long Term
Interest Rates
10
9
Federal Funds Rate
2 Year US Treasury
8
10 Year US Treasury
7
30 Year US Treasury
Yield (%)
6
5
4
3
2
1
Source: Barclays, Federal Reserve, Data as of 3/28/14
17
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
What About Interest Rates?

Expected Treasury Yields
2Q '14
3Q '14
4Q '14
1Q '15
2Q '15
3Q '15
2 Year
0.50%
0.62%
0.77%
0.88%
1.04%
1.33%
10 Year
3.00%
3.20%
3.35%
3.50%
3.60%
3.75%
30 Year
3.92%
4.05%
4.21%
4.30%
4.40%
4.50%
Source: Bloomberg as of February 2014
18
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
What Do I Do With All Of This?
19
It’s Baseball Season: Trivia Question
What MLB stadium has the most expensive small beer?
 Yankee Stadium
 Marlins Park - $8
 Wrigley Field
 Dodger Stadium
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
Status Quo: Investment Grade Fixed Income
22
Corporate Bonds Remain Attractive
BBB-A Industrial Spread Difference
300
250
250
200
Basis Points
Basis Points
U.S. Corporate Investment Grade
Spread
200
150
150
100
100
50
50
-
Source: AAM, Barclays
23
Technicals Expected To Remain Supportive
Net Issuance
$1,489
1,500
$1,491
2011 coupons
= $757
$1,084
2010 coupons
= $699
2014 coupons
= $668
$700
1,000
$862
$747
$755
$173
CLOs
ABS
$329
$34
$188
CMBS
500
Agency MBS
Non-agency
MBS
0
Build America
Bonds
-500
Source: JP Morgan
24
Investable And Attractive Risk-adjusted Assets
Market Value of Corporate Index
(Billions)
The Corporate Market Has Grown And Is Lower Quality
$4,000
$3,500
AAA
AA
A
BBB
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
Moody's Credit Statistics
AAA
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%
1 Year Avg Ratings Migration Down
(1970 - 2013, % of category), excl. WR
8.98%
9.09%
6.31%
5.01%
9.59%
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 change
Source: Barclays, Moody’s
25
What Other Levers Can Be Pulled?
26
No Free Lunch
 Add interest rate risk via more duration
 Add liquidity risk – commercial loans
 Add credit risk – high yield and/or
convertibles
Source: AAM
27
Duration Decisions
 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
3.1
Duration
Income Return
Total Return
12 Months
2.0%
2.5%
5.4
Duration
Income Return
Total Return
3.2%
3.9%
6.6%
7.8%
10.3%
11.8%
Difference
Income Return
Total Return
1.2%
1.4%
2.5%
3.0%
3.9%
4.9%
Results greater than one year are cumulative
Interest rate changes are assumed to happen evenly over indicated time
period
Source: Actual portfolios modeled in CMS BondEdge as of 8/31/2013
28
24 Months
4.1%
4.7%
36 Months
6.3%
6.9%
What If Rates Rise Substantially?
200 Basis Point Rise In Interest Rates
3.1
Duration
Income Return
Total Return
12 Months
2.2%
-2.0%
24 Months
4.7%
1.9%
36 Months
7.6%
5.8%
5.4
Duration
Income Return
Total Return
3.3%
-4.4%
7.0%
0.9%
11.2%
6.5%
Difference
Income Return
Total Return
1.1%
-2.4%
2.4%
-1.0%
3.6%
0.7%
 Income is the key driver in fixed income performance
 Stick to your knitting on duration
 Scenario testing shows the role income plays in returns
Results greater than one year are cumulative
Interest rate changes are assumed to happen evenly over indicated time period
Source: Actual portfolios modeled in CMS BondEdge as of 8/31/2013
29
High Yield
30
U.S. High Yield Corporate Bond Spreads
 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
Spread of the Credit Suisse U.S. High Yield II Index
2000 bp
11/28/2008 1816
bp
1600 bp
10/31/2002 1080
bp
1200 bp
800 bp
1/9/2014
426 bp
Average
Spread:589 bp
400 bp
2/28/1997: 315 bp
5/31/2007 271 bp
0 bp
Source: Credit Suisse
31
Refinancing Risk Remains Low
 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.
High Yield Bond Maturities
Maturities ($billion)
200
160
120
80
40
0
2014
2015
2016
2017
2018
Source: BofA Merrill Lynch, Data as of December 31, 2013 (Updated quarterly)
32
2019
2020
2021
2022
Not All High Yield Is Created Equal
 A focus on Ba/B ratings substantially reduces the risk of
impairments
16
14
Default Rate
(Percent)
Annualized Defaults
12
Yield
Loss-adjusted Yield
10
10
8
8
6
6
4
4
2
2
0
0
Baa
Ba
B
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.
33
Caa_C
Yield (Percent)
12
14
In A Rising Rate Environment, High Yield Has
Performed Well
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%
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.
34
Convertibles
35
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
*
36
Historical Issuance/Redemptions
120
Issuance
Issuance/Redemptions (USD$ billions)
100
Redemptions
96.9
80
70.0
62.1
60
55.6
50.0
48.3
40.0
40
48.9 48.1
47.1
35.9
38.3
36.0
31.8
25.2
21.4
20
0
2007
2008
2009
2010
Source: Barclays Research as of December 31, 2013. *Estimates for 2014
37
2011
2012
2013
*
2014
Convertible Performance Drivers for 2014
Return
Component
Equity Prices
Likely
Impact
+/-
Comment
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
38
Zazove Convertibles
Performance During Rising Rates
15%
12.47%
10%
8.61%
5%
0%
-0.60%
-1.35%
-5%
-7.69%
-10%
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
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, 6/30/056/30/06,12/31/08-12/31/09, 8/31/10-3/31/11, 4/30/13-8/31/13.
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.
39
Commercial Loans
40
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 prepayment 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
41
Yield Comparison
Commercial Mortgages provide attractive yields relative to public market alternatives.
U.S. Fixed Income Yields
(Approximately 7-7.5 year Modified Duration)
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
Asset
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.
42
Capital Treatment Has Become More Favorable
Life Insurance Company Risk Based Capital Charges
RBC Group
1
2
3
4
5
Commercial
Mortgages
0.90%
1.75%
3.00%
5.00%
7.50%
Corporate Bond
0.40%
1.30%
4.60%
10.0%
23.0%
Commercial Mortgage RBC Charge Description
RBC Group
1
2
3
4
5
RBC Charge
0.90%
1.75%
3.00%
5.00%
7.50%
Source: NAIC, AAM
43
Description
DSC=>1.50X and LTV<85%
0.95 <= DSC < 1.50X / LTV<75%
DSC<0.95X and LTV<85%
DSC<1.15X and LTV=>100%
DSC<0.95X and LTV=>105%
Widely Used
Percent of Companies with CML Holdings
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%
Source: SNL, data as of 9/30/13
44
Any Questions?
45