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QuarterlyCommentary

December2013
333S.GrandAve.,18thFloor||LosAngeles,CA90071||(213)6338200
2
QuarterlyCommentary12/31/13
Overview
2013 was a pivotal year for fixed income markets,
endingwithanannouncementfromtheFederalOpen
MarketCommittee(FOMC)ofamuchanticipatedcut
in its Quantitative Easing (QE) programs. One of the
topicsofconcernwastheplummetingunemployment
rateamidstafallingproportionofthepopulationwho
areeitherworking,orlookingforwork.
Also creating concern for central bankers were the
continually low levels of inflation. Both realized
measures of inflation, such as the Consumer Price
Index (CPI) and the Personal Consumption
Expenditures (PCE) Index, and anticipated future
levels of inflation by market participants, such as
forward breakeven rates on inflationindexed
securities, remain low. Ultimately, however, the
decision to contract purchases by $10 billion per
month ($5 billion each of U.S. Treasury (UST) and
AgencyMortgageBackedSecurities(MBS)purchases)
wasdeemedthemostprudentdirectionbythevoting
membersoftheFOMC.UpwardrevisionstoRealGDP
for the third quarter showing 4.1% growth received
after the decision from the FOMC would serve to at
least partially substantiate this decision. Nonfarm
QuarterlyCommentary
payroll growth of only 74,000 in December the
lowest such growth since 2011 suggests something
tothecontrary.AsJanetYellentakesthehelmofthe
Federal Reserve effective February 1, her ability to
navigate this still nascent recovery will be closely
monitored.
Domestic equity markets closed the year with
strength,justastheybegan.Aftergaining10%during
thefirstquarteroftheyear,thefinalquarterof2013
saw nearly identical growth in the S&P 500 Index.
Following the opposite trend, domestic fixed income
markets as measured by the Barclays U.S. Aggregate
Bond Index nearly mirrored the 0.12% decline
experiencedduringthefirstquarteroftheyearwitha
declineof0.14%duringthefourthquarter.Whilethe
index finished the year down 2.0% (the first yearly
0
50
100
150
200
250
300
350
Jan13 Feb13 Mar13 Apr13 May13 Jun13 Jul13 Aug13 Sep13 Oct13 Nov13 Dec13
N
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t

P
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A
d
d
i
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(
0
0
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s
)
NonfarmPrivatePayrolls NetChange
BLS ADP
Source:BureauofLaborStatistics, Bloomberg, ADP
LastBLS=74K
LastADP=238K
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
QuarteroverQuarter(QoQ)RealGDPGrowthEstimates
Advance
Second
Third
Latest
Source:BureauofEconomicAnalysis, Bloomberg
Q32013Growth =4.1%
52.0%
54.0%
56.0%
58.0%
60.0%
62.0%
64.0%
66.0%
68.0%
1
/
1
/
1
9
4
8
1
/
1
/
1
9
5
1
1
/
1
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1
9
5
4
1
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1
/
1
9
5
7
1
/
1
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1
9
6
0
1
/
1
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1
9
6
3
1
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1
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1
9
6
6
1
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1
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1
9
6
9
1
/
1
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1
9
7
2
1
/
1
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1
9
7
5
1
/
1
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1
9
7
8
1
/
1
/
1
9
8
1
1
/
1
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1
9
8
4
1
/
1
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1
9
8
7
1
/
1
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1
9
9
0
1
/
1
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1
9
9
3
1
/
1
/
1
9
9
6
1
/
1
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1
9
9
9
1
/
1
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2
0
0
2
1
/
1
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2
0
0
5
1
/
1
/
2
0
0
8
1
/
1
/
2
0
1
1
U.S.LaborForceParticipationRate
Source:BureauofLaborStatistics, Bloomberg
12/31/2013: 62.8%
3
QuarterlyCommentary12/31/13
declinesince1999),mostofthemovementhappened
during the relatively sharp rise in benchmark rates
which spooked fixed income markets broadly during
the second quarter. Tenyear UST rates increased 42
basispoints(bps)duringthequarter,andfinishedthe
month at 3.02%. The 10year rate at December
monthend is the highest such monthly close since
June2011.

QuarterlyCommentary
4
QuarterlyCommentary12/31/13
EmergingMarketsFixedIncome
In Emerging Markets Fixed Income (EMFI), all three
sectors of the markets; the external sovereign,
corporatedebtandlocalcurrencybonds,represented
bytheJPMorganEmergingMarketBondIndexGlobal
Diversified (EMBI), the JP Morgan Corporate
Emerging Markets Bond Index Broad Diversified
(CEMBI) and the JP Morgan Government Bond Index
Emerging Markets Broad Diversified (GBIEM)
respectively, posted mixed returns for the month of
Decemberandnegativereturnsfortheyear2013.
Developed markets saw uneven economic progress
over the course of 2013. The eurozone, which has
been mired in recession and stubbornly high
unemployment rates, in March 2013 saw the
European Union (EU) approve the bailout of yet
another member nation struggling with a banking
crisis,Cyprus.Thiswasthefirstinstanceofabailin
provision requiring uninsured depositors accounts
above 100,000 to partake in losses. The eurozone
continuedtostruggleduringthefirsthalfof2013:the
manufacturing sector contracted every month
through June. In contrast, the latter half of 2013 saw
moderate expansion in the sector every month.
Servicerelatedindustrieswereclosebehind,withthe
sector expanding every month from August onward.
The European CentralBank (ECB) has proven keen to
combatdeflationarypressuresinthemonetaryunion:
it made a surprise 25 bps cut to the benchmark
refinancing rate in November and said it would
support eurozonewide banks with as much liquidity
as necessary until mid2015. The ECBs hand may
have been forced by October data showing inflation
at just 0.7% in October, well below the 2% level it
targets.

Asia too, witnessed policymakers attempt to fight

deflationary pressures. China, where investors had
feared weak growth could slow the global recovery,
posted growth that was the slowest since the Asian
financial crisis of 19971998. This weak growth fed
through to commodity markets and led many assets,
such as precious metals, to post extremely weak
performance for 2013. Commoditylinked exporters,
suchasAndeannationsinLatinAmerica(LatAm),saw
exceedingly weak exports on the back of Chinas
cooling growth. Still, the new administration of
President Xi Jinping that took over in March
underlined that it would support moderate growth,
while also focusing on shrinking an excessive credit
bubble.Thegovernmentpublicallystateditwoulddo
what was necessary to support 7.5% economic
growth in 2013, and this appears to be the likely
target for 2014. The Chinese government has made
clamping down on excessive lending, especially in
property markets, a key policy out of fear of a credit
QuarterlyCommentary
Tickers December
Return
4Q2013
Return
2013
Return
YTM Spread
EMBI JPGCCOMP 0.51% 1.53% 5.25% 5.88% 308
CEMBI JBCDCOMP 0.17% 1.96% 0.60% 5.69% 311
GBIEM JGENBDUU 0.09% 0.73% 7.26% 6.79% N/A
Source:JPMorgan
(Pastperformanceisnoguaranteeoffutureresults.)
8.0%
6.0%
4.0%
2.0%
0.0%
2.0%
4.0%
6.0%
Dec12 Feb13 Apr13 Jun13 Aug13 Oct13 Dec13
JPMorganEmergingMarkets BondIndex
Performance12/31/2012through 12/31/2013
EMBI
CEMBI
GBIEM
Source:JPMorgan
5
QuarterlyCommentary12/31/13
bubble forming. Twice during the year, the central
bankallowedforovernightlendingratestoskyrocket
in order to illustrate to banks, especially smallto
medium sized ones, that it was serious about
preempting a bubble. The new administration also
made battling widespread corruption one of its top
priorities. In Japan, Prime Minister Shinzo Abe began
to implement his socalled three arrow policies to
unlock growth: explicit 2% inflation targeting, use of
monetary QE (similar to the Fed), and widespread
publicandprivatesectoreconomicreforms.Investors
welcomed Abenomics, with the countrys equities
risingover50%andtheyenfallingapproximately17%
in2013.

In EMFI, the impact of tapering was felt across the

asset class, particularly amongst those countries
running twin deficits with weak growth prospects. A
number of countries, whose debt had otherwise
enjoyed strong performance in the lowrate
environment implemented by the Fed, now saw
waning investor support due to a lack of meaningful
fiscalandeconomicreforms.CountriessuchasSouth
Africa, India, Indonesia, Ukraine, and Venezuela all
saw large spikes in volatility within foreign exchange
and debt markets, particularly over the summer as
investors braced for Septembers expected taper.
Venezuela, which had performed strongly in 2012
despite a lack of marketfriendly policies under its
populistPresidentHugoChavez,sawitsdebtmarkets
sharplyreversecoursein2013.Followingthedeathof
thecharismaticChavezinMarch,hisnarrowlyelected
successor Nicolas Maduro has pursued a hardline
policy stance, with widespread asset seizure and
command pricesetting. India struggled over the
summer with missteps by its central bank and a lack
of clear communication of its policy to combat FX
volatility, though the selection of a new central bank
governor did help calmmarkets somewhat into year
end. South Africa struggled for much of 2013 amid
fallingcommoditypricesandwidespreadstrikesinits
criticalrevenuedrivingminingsector,whilePresident
Jacob Zuma saw support ebb from breakaway
factionsofhisparty.

Sociopolitical unrest proved to be a theme across

many emerging market economies in 2013 touching,
to varying degrees: Egypt, South Africa, Brazil,
Venezuela, Turkey, Ukraine, and Thailand, among
others. Public anger at the perceived conservative,
Islamisttilt of leaders in both Egypt and Turkey saw
largescalepublicprotestsandclasheswithpolicefor
much of the spring. The protests and widespread
clashes in Egypt eventually brought down the
relatively new government of Mohammed Morsi as
the military intervened on the side of antiIslamist
protestors and imposed martial law as it wound up
outlawing Morsis Muslim Brotherhood party.
Sporadic violence between the military and Islamist
protestors/fighters continues. Turkeys protests were
sparked by the planned bulldozing of a public park,
but swelled with secular, middle classfigures coming
out in anger at perceived authoritarian tendencies of
Prime Minister Recep Erdogans Islamist ruling party.
Though dying down somewhat toward late 2013
following violent crackdowns, protests reignited in
Decemberamidamajorcorruptioninvestigationthat
continuestosweepthroughErdogansgovernment.

NotallEMmarketswitnessedturmoilin2013:Mexico
saw a series of major reforms tied to its revenue
critical state oil monopoly pass into law, as President
Enrique Pea Nieto seeks to boost flagging growth;
whileColombia,wrackedbydecadesofcivilwar,saw
crucialprogressmadeinpeacetalksbetweenMarxist
rebels and the government in November, which may
QuarterlyCommentary
6
QuarterlyCommentary12/31/13
pavethewayforthemainrebelgrouptolaydownits
armsandinsteadenterpolitics.

In conjunction with the selloff in EMFI markets
following the first news of tapering in May was the
pace of outflows from both hard and local currency
funds totaling $39.8 billion from June to December.
For the calendar year, the emerging market debt
funds saw a net inflow of $10.3 billion, down
significantly from inflows of $97.5 billion in 2012.
Retail flows were particularly susceptible to taper
related headlines, such as strong economic data
releasesincludingnonfarmpayrolls.Lookingforward
to 2014, we believe that many of these shorterterm
investors may have been flushed out of the asset
class, leaving stronger, longterm strategic buyers.
Strategic inflows from pension funds, insurance
companies, endowments, etc. totaled $26 billion in
2013, inline with prior years. Many crossover
investors, for whom emerging markets are not a
specialty,hadexposuretoonlythemostwellknown,
liquid names: when outflows spiked from May
through yearend, sovereign and local bond funds
sawcombinedoutflowsof$37billion,versusjust$1.7
billion leaving corporate debt since the end of May.
Furthermore, we feel that the selloff for much of
2013 left many fundamentally sound corporate
credits trading at attractive levels simply due to the
excessivefearoftaperingandratesrapidlyrising.

Weexpectdebtissuance,whichhadpickedupinthe
fourth quarter 2013 after trailing off in the summer,
tocontinueatleastthroughthefirstquarter2014,as
thereremainsasolidpipelineofnewissuancewaiting
tocometothemarket.

QuarterlyCommentary
7
QuarterlyCommentary12/31/13
GlobalDevelopedCredit
Although total returns for corporate credit in 2013
failed to match the spectacular results posted in
2012, the year logged respectable performance
despite a meaningful rise in UST rates. The total
returnoftheBarclaysU.S.CreditIndexwas2.01%in
2013, far short of the total returnof 9.39% posted in
2012. However, investment grade corporate bonds
posted an excess return over UST of 2.26% for the
year. Investment grade corporate bond spreads
tightened by 20 bps during 2013 led by financial
institutions which tightened by 46 bps. The Barclays
U.S. Corporate High Yield Index returned 7.44% in
2013,lessthanhalfofthe15.81%theIndexgainedin
2012. Excess returns posted by high yield corporate
bonds came in at 9.23% for 2013. High yield bond
spreads tightened by 129 bps during the year led by
industrials which tightened by 137 bps. The Barclays
U.S. High Yield Loan Index returned 5.39% in 2013
with the asset class continuing to enjoy strong levels
of demand from investors. Gross fixedrate
investment grade supply in 2013 of $1.106 trillion
essentiallymatchedthe$1.086trillionissuedin2012.
The primary high yield market priced $325 billion in
2013, slightly lower than the $345 billion priced in
2012whichstillholdstherecordforannualhighyield
issuance.
Within the investment grade universe during 2013
the greatest excess returns were posted by Gaming
(+6.94%); Airlines (+6.28%); Supermarkets (+6.01%);
Life Insurance (+5.76%); and Building Materials
(+5.55%).Theworstperformingsectorsonarelative
basis were Media/Cable (+17 bps); Foreign Agencies
(+19 bps); Wireless Telecommunications (+40 bps);
Supranationals (+43 bps); and Metals (+50 bps).
Higher quality issues (those bonds rated singleA or
better) materially underperformed their lower rated
counterparts given the continued predilection of
investors to trade down the risk curve to reach for
yield. The top performing high yield sectors in 2013
were Consumer Products (+10.35%); Technology
(+10.22%); Building Materials (+8.74%); Paper
(+8.05%); and Gaming (+7.37%). The worst
performing sectors of 2013 were Pipelines (+2.12%);
Media/Cable (+3.58%); Wireless Telecommunications
(+6.04%); Retailers (+7.55%); and NonCaptive
Finance (+9.08%). As was the case with investment
grade corporate credit, lower quality bonds
outperformed their higher rated counterparts with
Caarated credits returning 13.82% in 2013 versus a
returnof7.27%forBratedcreditsand5.05% forBa
QuarterlyCommentary
4.0%
3.0%
2.0%
1.0%
0.0%
1.0%
2.0%
3.0%
J
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PerformanceofSelectBarclaysIndices
12/31/2012through12/31/2013
U.S.HighYield
U.S.Credit
U.S.Aggregate
Source:BarclaysLive
0
20
40
60
80
100
120
140
160
180
B
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.

D
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TotalFixedRateInvestmentGradeSupply
Source:BarclaysLive
8
QuarterlyCommentary12/31/13
ratedcredits.
Overall, default activity in 2013 was benign as both
default volume and the high yield default rate
reached sixyear lows. According to JP Morgan, in
201329companiesdefaultedcomprising$18.9billion
in bonds and institutional loans. In comparison, 36
companies and $22.6 billion defaulted during 2012.
Notably, bond defaults were almost twice as
prevalent as loan defaults in 2013 with 16 bondonly
defaults versus only 9 loanonly defaults and 4
defaults in which the company had both bonds and
loansoutstanding.
Withrespecttofundflowsandinvestordemand,high
yield mutual funds experienced a net outflow of
assets of $5.6 billion in 2013 while loan fund inflows
totaled$62.9billionfortheyear.
As we move toward 2014, it is likely the markets will
experience continued interest rate volatility with
movements in the Treasury curve reflecting both
underlying economic fundamentals as well as further
expectations for Fed tapering of the QE program.
Corporate credit spreads should continue to tighten
in line with fundamental economic improvement.
However, spread movements for corporate credit
could be a bumpy ride in 2014 as well with more
spreadvolatilitythanthatwitnessedin2013ascredit
investors balance what have become the competing
forcesoffundamentalconditionsintheU.S.economy
with the challenges faced by the Fed in
communicatingfurthertaperingactions.

QuarterlyCommentary
9
QuarterlyCommentary12/31/13
further although we believe the majority of the
extension has already occurred. If rates were to rise
significantly, we would project the MBS duration to
extendabove6,butnotmuchmorethanthat.Ifthat
scenario were to play out over the next 12 months,
the MBS sector could outperform the TSY
sector. How it performs relative to the Corporate
sector will depend in large part on what happens to
U.S. InvestmentGradeCorporatespreadsduringthat
timeperiod.

One of the major reasons why MBS experience

duration extension during rising rate periods is the
expectation of decreasing prepayment speeds on a
going forward basis. Prepayment speeds went up
marginally for the month of December. This slight
increaseinspeedsbrokethestringofsixconsecutive
decliningmonthsofprepaymentspeeds.Prepayment
AgencyMortgageBackedSecurities
AgencyMBShadareturnof0.47% forthemonthof
December 2013, according to the Barclays U.S. MBS
Index.For December, 10year UST rates rose by 23
bps, and the MBS sector outperformed the U.S.
Treasury (TSY) sector but underperformed the U.S.
Investment Grade Corporate sector according to the
BarclaysU.S.AggregateBondIndex.Forthecalendar
year2013,10yearUSTratesroseby125bpsandthe
Barclays U.S. MBS Index had a return of 1.41% for
same period. This 12month performance was better
than the performances of both the U.S. TSY and U.S.
InvestmentGradeCorporatesectorsaccordingtothe
Barclays U.S. Aggregate Bond Index. This is an
example of mortgages outperforming the other
components of the Index when rates rise more than
100bps.

One of the major reasons for mortgage

outperformance in rising rate environments has
historically been due to the shorter duration of the
MBSsectorrelativetothoseoftheTSYandCorporate
sectors, according to the Barclays U.S. Aggregate
Bond Index.During the rate rise of 2013, duration of
Agency MBS extended from 3.18 years at the
beginning of the year to 5.66 yearsat the end of the
year. This is the longest duration ever reported for
the sector. Should rates rise further, we would
expect the duration of the MBS sector to extend
QuarterlyCommentary
ConditionalPrepaymentRates(CPR)
2013 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
FannieMae(FNMA) 27.8 24.4 24.4 24.0 25.1 22.7 20.5 16.2 12.2 11.5 10.4 10.6
FreddieMac(FHLMC) 28.2 26.0 25.9 25.3 25.5 23.4 21.5 17.1 13.1 12.0 10.8 11.1
GinnieMae(GNMA) 23.3 21.9 21.8 23.0 22.2 19.4 18.2 14.9 12.2 12.1 11.2 11.2
BarclaysCapitalU.S.
MBSIndex 10/31/2013 11/29/2013 12/31/2013 Change
AverageDollarPrice 104.60 103.68 102.91 0.77
Duration 5.26 5.56 5.62 0.06
BarclaysCapitalU.S.
IndexReturns 10/31/2013 11/29/2013 12/31/2013
U.S.Aggregate 0.81% 0.37% 0.57%
U.S.MBS 0.68% 0.62% 0.47%
U.S.Corporate 1.44% 0.27% 0.25%
U.S.Treasury 0.48% 0.33% 0.91%
source:eMBS,BarclaysCapital
0.00
1,000.00
2,000.00
3,000.00
4,000.00
5,000.00
6,000.00
7,000.00
1
2
/
3
1
/
1
0
2
/
2
8
/
1
1
4
/
3
0
/
1
1
6
/
3
0
/
1
1
8
/
3
1
/
1
1
1
0
/
3
1
/
1
1
1
2
/
3
1
/
1
1
2
/
2
9
/
1
2
4
/
3
0
/
1
2
6
/
3
0
/
1
2
8
/
3
1
/
1
2
1
0
/
3
1
/
1
2
1
2
/
3
1
/
1
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2
/
2
8
/
1
3
4
/
3
0
/
1
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6
/
3
0
/
1
3
8
/
3
1
/
1
3
1
0
/
3
1
/
1
3
MortgageBankersAssociationRefinanceIndex
Source:MortgageBankersAssociationviaBloomberg
10
QuarterlyCommentary12/31/13
would mean no more QE program 12months from
now.Assumingthisscenarioplaysout,wewouldnot
expect any widening of MBS. As in most markets,
MBSperformancewilldependonboththesupplyand
demand for securities. Currently, the Fed is the
biggest player on the demand side and therefore its
actions are very important; however, there are
changes on the supply side of mortgages that have
experienced even greater change than the Fed
tapering.Lastsummer,grossissuanceofAgencyMBS
was approximately $150 billion per month. As rates
have risen, this number has come down
significantly. In fact, Decembers number was $75
billion, so the gross issuance of Agency MBS is down
approximately $75 billion permonth from where it
waslastsummer.

speedsdecreasedby60%over2013andAgencyMBS
experienced their slowest speeds since December
2008, which was in the middle of the subprime
housing crisis. We are already in an environment
whereprepaymentspeedsareata5yearlow.

Future prepayment speeds will depend partly on

what happens to interest rates. A secondary factor
couldbeachangeinthegovernmentsinvolvementin
the mortgage process. Currently, the Home
Affordable Refinance Program (HARP) 2.0 is the
government program with one of the largest affects
on prepayment speeds. HARP 2.0 is experiencing
burnout,whichiswhathappensastimepassesand
the borrowers who qualify have already acted,
thereforeleavingfewereligibleborrowersthanthere
wereinthepast.Themortgagemarketisdealingwith
the confirmation of Mel Watt as the new director of
Federal Housing Finance Agency (FHFA) as well,
replacing Ed DeMarco.The markets perception is
thatWattmaybemorefriendlytowardsborrowers
than DeMarco, which could lead to policy decisions
thatcouldincreasetheprepaymentspeedsofcertain
mortgagesecurities.Thusfar,Watthasindicatedthat
he will postpone the previously announced increase
in fees across both Fannie Mae and Freddie Mac.
Watt officially takes the position on January 6, 2014
and many investment professionals are closely
watching the decisions made by Watt and their
ramificationsonthefixedincomemarkets.

OnDecember18
th
,theFedannouncedthetaperingof
$10 billion per month with half of the tapering being
inMBS.ThistakesthetotalamountofFedpurchases
to $75 billion per month, with $35 billion of that in
MBS (this doesnt include the reinvesting in MBS of
paydownsonoutstandingMBS,whichcanbeasmuch
as$1520billionpermonth).TheMBSmarketseems
to have priced in a 12month tapering process which
QuarterlyCommentary
3.00
3.50
4.00
4.50
5.00
5.50
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/
1
2
1
/
3
1
/
1
3
2
/
2
8
/
1
3
3
/
3
1
/
1
3
4
/
3
0
/
1
3
5
/
3
1
/
1
3
6
/
3
0
/
1
3
7
/
3
1
/
1
3
8
/
3
1
/
1
3
9
/
3
0
/
1
3
1
0
/
3
1
/
1
3
1
1
/
3
0
/
1
3
FreddieMacCommitment Rate 30Year
Source:Bloomberg
11
QuarterlyCommentary12/31/13
debated throughout 2013. News of the record
settlementbyJPMorgandominatedthemarketplace.
Ocwen, the largest nonbank servicer, is the latest
entity making the headlines in regards to mortgage
litigation. Ocwen will provide $2.1 billion on
foreclosure compensation and principal modification
for homeowners who are behind on their payments.
The settlement is based on regulator claims that
Ocwen abused its handling of borrowers loans. We
willcontinuetomonitortheseeventsclosely.

NonAgencyMortgageBackedSecurities
December trading volume experienced an uptick due
to the liquidation of a large segment of INGs
portfolio late in the month. The ING list consisted
largely of payoption AdjustableRate Mortgage
(ARM) bonds and thus, this sector of the market saw
an almost threefold increase from November.
Despite the size of the list and time in the year, the
list traded very well with bids coming from banks,
investment managers, hedge funds and insurance
companies.

Fundamentally, December remittance reports

showed mixed results. Prepay speeds on prime
collateral increased 0.5 Conditional Prepayment Rate
(CPR) while AltA and subprime speeds decreased a
modest 0.5 CPR and 0.4 CPR, respectively. Rising
interest rates have been pressuring the fast prepay
speeds seen during much of the second half of 2013.
Liquidationsslowedforallsectorswiththeexception
of subprime. Average Conditional Default Rates
(CDRs)decreasedby0.4forprimeand0.9CDRforAlt
A collateral while subprime, on average, saw
liquidations increase by 0.2 CDR. Loan modifications
slowed going into 2013 yearend with 1,947 loans
modified in December; 56% of all modified loans
were rate modifications, with the average mortgage
ratebeingreducedbyapproximately4%.Withsupply
still relatively low, technicals continued to put
pressure on yields and we saw a slight tightening
across all sectors. Prime finished the year trading
between 44.25%, AltA between 4.54.75%, and
subprimebetween55.5%.

On the political front, there was some concern on

whatchangeswouldbeimplementedwhenMelWatt
takes over the Directorship of the FHFA. Settlements
between mortgage issuers and investors were hotly
QuarterlyCommentary
30
35
40
45
50
55
60
65
70
75
80
6
/
3
0
/
1
1
8
/
3
1
/
1
1
1
0
/
3
1
/
1
1
1
2
/
3
1
/
1
1
2
/
2
9
/
1
2
4
/
3
0
/
1
2
6
/
3
0
/
1
2
8
/
3
1
/
1
2
1
0
/
3
1
/
1
2
1
2
/
3
1
/
1
2
2
/
2
8
/
1
3
4
/
3
0
/
1
3
6
/
3
0
/
1
3
8
/
3
1
/
1
3
1
0
/
3
1
/
1
3
1
2
/
3
1
/
1
3
ABXPrices
ABX20062AAA
ABX20071AAA
Source:MarkIt viaMorgan Stanley
86
89
92
95
98
101
104
107
110
113
6
/
3
0
/
1
1
8
/
3
1
/
1
1
1
0
/
3
1
/
1
1
1
2
/
3
1
/
1
1
2
/
2
9
/
1
2
4
/
3
0
/
1
2
6
/
3
0
/
1
2
8
/
3
1
/
1
2
1
0
/
3
1
/
1
2
1
2
/
3
1
/
1
2
2
/
2
8
/
1
3
4
/
3
0
/
1
3
6
/
3
0
/
1
3
8
/
3
1
/
1
3
1
0
/
3
1
/
1
3
1
2
/
3
1
/
1
3
PrimeXPrices
PrimeXFRM.1
PrimeXFRM.2
Source:MarkIt viaMorgan Stanley
12
QuarterlyCommentary12/31/13
Our investment focus for the sector continues to
emphasize security selection. We continue to focus
onshorterdurationassets,includingsecuritieswitha
more storied basis, as our ability to drill down to
the collateral and borrower allows us to adequately
assess risk. Looking forward, our outlook for the
sector continues to remain cautious given
uncertaintiesinthemacroenvironment.

CommercialMortgageBackedSecurities
Newissuanceactivitykeptinvestorsbusythroughout
the month of December, finishing the year with $79
billionintotalissuance,thehighestsince2008.Ofthe
total, $52 billion were from conduits, representing
less than half of the 20052007 conduit issuance
average. Overall, the market sentiment remains
cautiously optimistic as investors generally added to
positions lower down the capital stack now that the
Fed has brought some clarity to concerns with the
taper. We believe that some of the broader themes
for 2014 are the improvement in Commercial Real
Estate(CRE)fundamentals,increaseinCMBSissuance
in 2014 and concerns with the continued
deteriorationofnewissuecreditqualityduetolooser
lendingstandards.ForDecember,spreadsralliedinto
yearend with legacy AAA and junior AAA CMBS
spreads tightening versus November. In the new
issue market, AAA spreads ended the month 45 bps
tighterwhileBBBspreadsimprovedby1012bps.For
the month, the CMBS portion of the Barclays U.S.
Aggregate Bond Index returned 0.29% in December,
+0.53%forthefourthquarterandfinished+0.23%for
theyear.
The delinquency rate continued its decline in
December ending the month at 7.43% (23 bps). By
property type, the 30+ day delinquency rate for
multifamilydeclinedto10.86%(28bps),industrialto
10.46%(+2 bps),officeto8.13%(33bps),lodgingto
7.91% (+19 bps), and retail to 6.06% (26bp). During
themonthofDecember,93loanstotaling$1.3billion
weredisposedof,resultinginanaveragelossseverity
of 50.4%. We anticipate the delinquency rate to
declinefurtherin2014withthependingresolutionof
CW Capital liquidation of $2.5 billion of defaulted
loans, fewer expected delinquencies and higher
resolutionrates.
QuarterlyCommentary
13
QuarterlyCommentary12/31/13
The Barclays Capital U.S. Government Index returned
2.60%fortheyear.Itwasthefirstfullcalendaryear
negativereturnsince2009.The2013returnincludes
a return of 0.69% for the fourth quarter and 0.87%
forDecember.Thefullyearyieldrisewassharpestfor
intermediate maturities, with the 7year and 10year
points on the yield curve posting matching 127 bps
rises,followedby102bpsrisesforthe5yearand30
year maturities. Returns were more negative for
longer maturities. For the full year the 2year note
return was +0.30%, worsening to 2.47% for the 5
year note, 7.81% for the 10year note, and 15.03%
forthe30yearnote.

TheTreasurymarketselloffgarneredthelionsshare
ofinvestorsattentionin2013,butsomeotherfixed
incomesectorsespeciallythosewithlessliquidityor
longer duration suffered even larger losses.
Treasury InflationProtected Securities (TIPS)
substantially underperformed conventional
Treasuries through 2013, burdened by both long
durationandpoorliquidity,pluslowrealizedinflation
and falling inflation expectations. The Barclays U.S.
TIPS Index returned 8.61% for the year. Tax
exempt bonds fared better, boosted by improving
credit fundamentals and a strong performance in the
fourth quarter. The Barclays Municipal Bond Index
returned 2.55% for the year, including a +0.32%
returnforthefourthquarter.

The powerful fixedincome liquidation cycle that

began in early May 2013 brought most investor
positions into line with postQE Fed policy and
sustained economic growth. We expect the bond
marketwillfindbuyinginterestfromsometraditional
investorgroups,suchaspensionfundsandinsurance
U.S.GovernmentSecurities
TheUSTmarketfinishedatumultuousyearonaweak
note, as the 10year Treasury note yield rose from
late October through November and December to
finishtheyearatitshighclosingyieldof3.03%.
Asforayearinreview,theyearbeganquietlyasthe
10year yield started 2013 at 1.76%, only modestly
above the alltime low yield set in July 2012. After a
small selloff the market rallied to 1.63% on May 1
st
.
May 3
rd
proved to be a turning point, with the UST
market selling off on a strongerthanexpected
employment report. Market sentiment shifted
dramatically as a broad range of investors sought to
liquidate longheld positions and shed duration. The
changed psychology was reinforced in late May by
Fed Chairman Bernanke, who discussed for the first
time a timetable for winding down and ending the
Feds asset purchase program. In early September
the 10year note yield had risen to 2.99%. By then,
investors seemed more comfortable with their fixed
income exposure. The Fed helped calm bearish fears
by noting that financialconditions had tightened due
totheselloffandbyemphasizingthatahikeinshort
termrateswouldnotinevitablyfollowontheheelsof
the end of the asset purchase program. Weak
economic data, resolution of the federal
governments fiscal crisis and an unexpected delay in
the onset of the Feds taper all contributed to a
rally through September and October, but that rally
could retrace only 50 bps of the earlier 140 bps sell
offbeforereversing.
QuarterlyCommentary
11/29/2013 12/31/2013 Change
3month 0.06 0.07 0.01
6month 0.10 0.09 0.01
1year 0.12 0.11 0.01
2year 0.28 0.38 0.10
3year 0.55 0.77 0.22
5year 1.37 1.74 0.37
10year 2.75 3.03 0.28
30year 3.81 3.97 0.16
Source:Bl oomberg
YieldCurve
14
QuarterlyCommentary12/31/13

companies, at 10year Treasury yields above 3.00%.

Higher yields could limit domestic economic growth.
While yields may rise modestly in 2014 we do not
expectarepeatof2013.

QuarterlyCommentary
15
QuarterlyCommentary12/31/13
12.3%, respectively.The quarter was quite volatile
for precious metals prices as the market initially
ralliedduringtheU.S.debtceilingcrisis,followedbya
downward trend in the last two months of the
quarter. Chairman Bernanke announced the Feds
asset purchase program would begin a gradual data
dependent taper, leading to a sharp selloff.Investors
continue to waiver between inflationary fears via
unintended consequences of the multitrillion dollar
balance sheets of central banks and potential real
yieldprospectsofinvestmentsinbonds.Ifrealyields
on other financial assets remain elevated and levels
of inflation remain near alltime lows, gold and silver
pricescouldhaveanotherbearishyearin2014.

For2013,theenergycomplexwasupover5%,driven
by increased demand and global tension. Quarterly
energy prices were mixed with the SPGSCI Energy
Index returning 1.3%, refined products, natural gas
and Brent crude posting positive returns, and WTI
crude returning 4.4%.Increasing nonOPEC crude
production may continue to degrade the cartels
ability to control global oil supply. Over the last few
years, new U.S. extraction technologies have led to
historically high production growth with more
potential for 2014; this may lead to an increased
divergence in the price of WTI crude versus Brent
crude. The U.S. currently imports roughly 500,000
barrels per day while domestic supply is forecast to
increase over 1 million barrels per day in 2014.
Coupledwiththecurrentexportban,theU.S.market
could see falling prices in 2014. Natural gas returns
were positive on the quarter returning 12.5% on
strongerseasonaldemandforthewinterthusfar,this
strongperformanceallowednaturalgastogeneratea
positive9.1%returnin2013.
Commodities
The Standard and Poors (S&P) Goldman Sachs
Commodity Excess Return Index (SPGSCI ER) ended
the fourth quarter down 0.34%. For the year, the
Index suffered a small loss of 1.3%, though these
numbers do not tell the entire story. Of the five
sectors represented by the SPGSCI, only the energy
sector had positive returns for both the fourth
quarter and 2013. Inflationary fears waned as year
overyear(YoY)U.S.CPI hoverednear1%,alevelnot
seen since mid2010. This was exacerbated in the
fourth quarter by the Feds decision to implement a
gradual tapering of its large scale asset purchase
program, known as quantitative easing (QE). In the
developed world, preliminary forecasts showed that
Europewasfinallyekingfromthedepthsofrecession,
and the U.S. economy appeared to be gaining
momentum albeit at a slow rate. Unfortunately,
major commodity consumers such as China, Brazil
and India continue to grow at paces slower than the
previous decade, which could put a damper on
demandgrowthin2014.
Preciousmetalssufferedin2013returning29.8%for
the year. It was the first calendar year that gold
suffered a negative return since 2000. The weakness
continued throughout yearend with both gold and
silver giving back all of the positive returns they
reapedfromthethirdquarterlosing9.5%and
QuarterlyCommentary
0.34%
1.26%
9.67%
0.37%
1.31%
6.71%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
2.00%
S&PGSCIER Energy Precious
Metals
Industrials Livestock Agriculture
QuarterlyExcessReturnsofGSCSICommoditySectors
September30,2013 December31,2013
Source:Bloomberg, DoubleLine
16
QuarterlyCommentary12/31/13
stronger U.S. housing market and ameliorated
concernsregardingEMgrowth.

TheLivestocksectorsawamodestlossof1.3%inthe
fourthquarter.Withinthesector,hogsweretheonly
loser for the quarter giving back 5.8% due to the low
impactofthethirdquartersporcinevirusoutbreakin
the U.S. Fears of a supply shock due to piglet
mortality and quarantine conditions failed to
materialize leaving supply relatively unaffected. The
spread between the performance of Live Cattle and
Feeder Cattle narrowed to 65 bps on the quarter,
with both gaining in priceby 73 bps and 138 bps,
respectively.Ontheyearlivestocklost3.7%in2013,
goingforwardwatchforincreasedmeatconsumption
from emerging markets that could drive demand
higherin2014.

The agricultural sector ended 2013 with a 6.7%

return in the fourth quarter, capping off a weak year
where 18.1% was lost. Corn continued its slide down
more than 6.9% in the fourth quarter on increasing
inventory levels, stemming from larger acreage and
higher potential crop yields. Further weakness
stemmed from the Environmental Protection
Agencys (EPAs) decision to reduce the ethanol
mandate landing a particularly hard blow to corn
based suppliers contributing to a 2013 loss of
30.3%.Soybeanspostedapositive2.0%returninthe
Chinese, Brazilian and Indian economic growth was
moderated this year putting a demand side damper
on commodity prices in 2013, for the year they
returned12.9%.Onaquarterlybasis,industrialslost
0.4% on uncertainty concerning the next political
economic epoch in China. Going forward excess
inventories may lead to a demand driven market
where marginal cost of production will set prices,
potentially leading to downward price pressure over
the longer term. Copper inventory is coming off all
time highs with the Chinese physical premium
increasing to levels not seen since 2009; this should
leadtowardsautilizationofexcesssupply.Withnew
multiyear project mines coming online the supply
surplus will likely continue for at least the next
several years providing limited upside to prices
without a large demand side catalyst. Potential
positiveshockstodemandin2014couldcomefroma
QuarterlyCommentary
1.28%
5.08%
29.79%
12.92%
3.66%
18.05%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
5.00%
10.00%
S&PGSCIER Energy Precious
Metals
Industrials Livestock Agriculture
YearlyExcessReturnsofGSCSICommoditySectors
December31,2012 December31,2013
Source:Bloomberg, DoubleLine
15.00%
12.50%
10.00%
7.50%
5.00%
2.50%
0.00%
2.50%
5.00%
7.50%
10.00%
12.50%
15.00%
S
&
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W
h
e
a
t
QuarterlyExcessReturnsofGSCSICommodity Sectors
September30,2013 December31,2013
Source:Bloomberg, DoubleLine
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
S
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YearlyExcessReturnsofGSCSICommodity Sectors
December31,2012 December31,2013
Source:Bloomberg, DoubleLine
17
QuarterlyCommentary12/31/13

fourth quarter finishing out a strong 2013 campaign

in which they returned 10.5% on supply concerns in
Brazil and crop yield concerns in the United States.
Wheat and Kansas Wheat ended the year on a down
ticklosing12.3%and13.6%,respectivelyinthefourth
quarteranddown27.2%and26.2%,correspondingly,
ontheyear.

QuarterlyCommentary
18
QuarterlyCommentary12/31/13

U.S.Equities
InMayandJune,theprospectoftheFedtaperingits
QE policies helped to drive the market down 5%, its
greatestdeclineoftheyearalbeitamoderateone.By
midDecember,however,anticipationoftaperingwas
welldigested by the market and macroeconomic
fundamentals were looking stronger. By the time of
theFedsDecembermeeting,theyieldonthe10year
Treasury had already risen 1.27%, a 78% increase
from summer lows in 2013. Judging from the rise in
stock prices, the decline in unemployment, and the
overall more positive tone in macroeconomic data,
this increase in rates was easily absorbed by the
economy. Therefore, when the longanticipated
announcement of the taper occurred on December
18
th
, the stock market reacted not with the alarm of
June, but by rallying through yearend. The S&P 500
Index closed the year at an alltime high, up 32% for
theyear.Forthefourthmonthinarow,theS&P500
Index closed the month higher than it began, as the
S&P500Indexwasdowninonlytwomonthsin2013.

QuarterlyCommentary
19
QuarterlyCommentary12/31/13
pressure in the fourth quarter as investors remained
mixed on whether or not the broadbased reforms
announced by the Chinese government in November
will set the stage for positive longterm growth
trajectory or will it come at a the cost of lower short
to medium term growth, which could unravel some
overzealous sectors of the economy. The Shanghai
Composite Index was down 2.70% during the fourth
quarter.

Goingforward,globalequitymarketsshouldfocuson
U.S. growth and the pace of Fed tapering. European
and Japanese markets will be monitoring the actions
oftheECBandBOJ,asbothbanksarelikelytoremain
highlyaccommodativein2014.EmergingMarketswill
be highly contingent on U.S. rates and a smooth
transitioninChina.

GlobalEquities
Global equity markets, as measured by the Morgan
Stanley Capital International AllWorld Country Index
(MSCI ACWI), performed well in fourth quarter, as
equitiesshruggedofftheannouncementofFedtaper
inDecemberandembracedthebetterthanexpected
economicdatathatwasreleasedovertheperiod.The
MSCIACWIreturned6.93%fortheperiod.

Europeanequitieswerepositiveinthefourthquarter
with Germany, Italy, and Spain the top performing
countries with the Deutsche Borse AG German Stock
Index (DAX), Financial Times Stock Exchange Milano
Italia Borsa (FTSE MIB), and ndice Bursatil Espaol
(IBEX)up11.14%,8.79%,and7.95%,respectively.The
Cotation Assiste en Continu (CAC 40) and Financial
TimesStockExchange(FTSE100)werealsopositivein
the fourth quarter returning +3.68% and 4.44%,
respectively. European equities were supported in
part by an ECB that cut its key interest rate and
pledgedtomaintainitsaccommodativestanceforan
extendedperiod.Theeconomicdataoutoftheregion
also showed signs that the region was climbing its
wayoutofrecession.

Japanese equities performed extremely well in the

fourth quarter with the Nikkei +12.70%. Japanese
equities were supported by the weakness in the
Japanese Yen and the belief that the Bank of Japan
(BOJ) will step up its quantitative easing program to
offset drag from fiscal reform. Emerging markets, as
measured by the MSCI Emerging Market Index,
underperformed Developed Markets over the period
with the index only up 1.54%. Rising rates in the U.S.
were a headwind to Emerging Market equities as
foreign investors pulled capital out of countries with
high external financing needs; e.g., Brazil, Indonesia,
and Turkey. Chinese equities were also under
QuarterlyCommentary
20
QuarterlyCommentary12/31/13
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policiesandprocedures,ortoobtainadditionalinformationonDoubleLinesproxyvotingdecisions,pleasecontactDoubleLinesClientServices.
ImportantInformationRegardingDoubleLinesInvestmentStyle
DoubleLineseeks tomaximizeinvestmentresultsconsistentwithourinterpretationofclientguidelinesandinvestment mandate.WhileDoubleLine seeksto maximize
returnsforourclientsconsistentwithguidelines,DoubleLinecannotguaranteethatDoubleLinewilloutperformaclient'sspecifiedbenchmark.Additionally,thenature
ofportfoliodiversificationimpliesthatcertainholdingsandsectorsinaclient'sportfoliomayberisinginpricewhileothersarefalling;or,thatsomeissuesandsectors
areoutperformingwhileothersareunderperforming.Suchoutorunderperformancecanbetheresultofmanyfactors,suchasbutnotlimitedtoduration/interestrate
exposure,yieldcurveexposure,bondsectorexposure,ornewsorrumorsspecifictoasinglename.
DoubleLineisanactivemanagerandwilladjustthecompositionofclientsportfoliosconsistentwithourinvestmentteamsjudgmentconcerningmarketconditionsand
any particular security. The construction of DoubleLine portfolios may differ substantially from the construction of any of a variety of bond market indices. As such, a
DoubleLineportfoliohasthepotentialtounderperformoroutperformabondmarketindex.Sincemarketscanremaininefficientlypricedforlongperiods,DoubleLines
performanceisproperlyassessedoverafullmultiyearmarketcycle.
ImportantInformationRegardingClientResponsibilities
Clients are requested to carefully review all portfolio holdings and strategies, including by comparing the custodial statement to any statements received from
DoubleLine. Clients should promptly inform DoubleLine of any potential or perceived policy or guideline inconsistencies. In particular, DoubleLine understands that
guidelineenablinglanguageissubjecttointerpretationandDoubleLinestronglyencouragesclientstoexpressanycontrastinginterpretationassoonaspractical.Clients
are also requested to notify DoubleLine of any updates to Clients organization, such as (but not limited to) adding affiliates (including broker dealer affiliates), issuing
additionalsecurities,namechanges,mergersorotheralterationstoClientslegalstructure.
DoubleLineisaregisteredtrademarkofDoubleLineCapitalLP.

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