An Introduction to the MetWest Total Return Bond Fund
June 29, 2010
MetWest is a wholly-owned subsidiary of The TCW Group, Inc. Presented by: Tad Rivelle Chief Investment Officer High Grade Fixed Income Agenda 1 MKTcc347 6/28/10 I. Organizational Update/Team History II. MetWest Total Return Bond Fund Overview III. Investment Thesis IV. Portfolio Opportunities V. Q & A The information contained herein may include estimates, projections, and other forward-looking statements. Actual events may differ substantially from those presented herein. TCW assumes no duty to update any such statements. Any opinions expressed are current only as of the time made and are subject to change without notice. The views expressed herein are solely those of the author and do not represent the views of TCW as a firm or of any other portfolio manager or employee of TCW. You should consider the investment objectives, risks, charges and expenses of the Metropolitan West Funds carefully before investing. A prospectus with this and other information about the funds may be obtained by calling (800) 241-4671 or download one at www.mwamllc.com. It should be read carefully before investing. Shares of the Metropolitan West Funds are distributed by PFPC Distributors, Inc., 760 Moore Road, King of Prussia, PA 19406. I. Organizational Update/Team History 3 MKTcc347 6/28/10 TCW Overview Established in 1971 in Los Angeles, California The TCW Group (TCW
) entities principally include:
The TCW Group, Inc. Holding company Trust Company of the West An independent trust company chartered by the State of California TCW Asset Management Company (TAMCO)* Institutional and private client separate accounts TCW Investment Management Company (TIMCO)* Mutual funds and retail managed accounts Metropolitan West Asset Management, LLC (MetWest)* Mutual funds, institutional separate accounts and private client separate accounts Approximately $115 billion under management or committed to management as of March 31, 2010 Approximately 1,400 institutional and private clients Over 558,000 retail accounts** TCW staff of approximately 735 individuals, including over 440 investment and administrative professionals*** The TCW Group, Inc. is an indirect majority-owned subsidiary of Socit Gnrale, S.A. TCW offers strategies that invest in major world equity, fixed income and alternative markets, with offices in Los Angeles, New York and Houston * Investment advisors registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Other registered investment advisor entities are also included in the TCW Group. ** Number reported semi-annually, as of December 31, 2009. ***Assistant Vice President and above. 4 MKTcc347 6/28/10 TCW Assets Under Management or Committed to Management as of March 31, 2010 Total Assets: $114.8 Billion U.S. Fixed Income Assets: $71.1 Billion Equities ($23.7) Fixed Income ($71.1) International ($5.3) Alternative Investments ($14.2) Core Balanced ($0.5) Mortgage-Backed Securities ($31.3) Core Fixed Income ($23.3) Short/Long Duration ($7.2) Bank Loans ($3.3) Government/Corporate Investments ($2.7) High Yield Bonds ($2.7) Alpha Trak ($0.6) 5 MKTcc347 6/28/10 TCW Asset Breakdown By Product As of March 31, 2010 Product Categories $ Billions U.S. Fixed Income $71.1 Mortgage-Backed Securities 31.3 Core Fixed Income 23.3 Short/Long Duration 7.2 Bank Loans 3.3 Government/Corporate Investments 2.7 High Yield Bonds 2.7 Alpha Trak 0.6 U.S. Equities $23.7 Relative Value 6.0 Large Cap Value 5.7 Concentrated Core 3.4 Large Cap Growth 3.2 Small/Mid Growth 2.7 Small/Mid Value 1.7 Comprehensive Asset Allocation 0.8 Convertibles 0.1 Other 0.1 Product Categories $ Billions Alternative Investments $14.2 Energy 6.2 Mezzanine 4.9 Real Estate 1.1 Private Equities/Other Alternatives 0.9 Distressed Debt 0.7 Commodities 0.4 Core Balanced $0.5 Balanced 0.3 Strategic Income Fund 0.2 International $5.3 Joint Ventures 2.8 International/Emerging Markets Securities 1.6 Worldwide Opportunities 0.9 Total Assets Under Management or Committed to Management $114.8 Team History & Evolution 6 MKTcc347 6/28/10 The Team of generalist portfolio managers, Tad Rivelle, Laird Landmann, and Steve Kane, have conjunctively managed fixed income assets for over 20 years TCW/MetWest is responsible for the management of all high grade fixed income assets at TCW Source: MetWest, PIMCO PIMCO AUM figures refer to the entire firm; other AUM references relate solely to the fixed income assets managed by the MetWest Investment Team. PIMCO 1990-1992 $20 Billion AUM Approx. 100 Total Employees 29 Investment Professionals Hotchkis & Wiley 1992-1996 $200 Million - $2 Billion AUM 6 Total Employees 5 Investment Professionals MetWest 1996-2009 $2 Billion - $30 Billion AUM 7 Total Employees 5 Investment Professionals TCW/MetWest Today As of 5/31/2010 $71 Billion AUM (Fixed Income) 737 Total Employees 212 Investment Professionals 7 MKTcc347 6/28/10 High-Grade Fixed Income Expertise As of June 2010 Portfolio Investment Team Eric Arentsen Pat Doyle Mitch Flack John Friedman Bryan Whalen, CFA Analysts/Traders Pat Ahn Scott Austin, CFA Elissar Boujaoud Helen Chen, CFA Harrison Choi Jae Choi Beth Clarke Melissa Conn David Doan Philip Dominquez Daniel Dy Michael Hsu Tony Lee Lifen Li Brian Loo, CFA Sonia Mangelsdorf Jonathan Marcus Sagar Parikh Palak Pathak, CFA Brian Rosenlund, CFA Brett Roth, CFA Charles Tu Nanlan Ye Zhao Zhao Portfolio Investment Team Claude Erb Jay Gerard Matthijs Randsdorp Portfolio Investment Team Bret Barker Lawrence Rhee Analysts/Traders Richard Eldred Jeannie Fong Jeffrey Lee Dolores Talamantes Katherine Wu Stephen Burns, PhD Marcos Gutierrez Erik Huynh Daniel Kale Joseph Lopez Melicia Shen Andy Wu Bing Bing Yu Christina Bau Julie Cooper Tracy Gibson Christine Hendrickson Irene Mapua Patrick Moore Marie Thomasson David Vick Portfolio Investment Team Penny Foley David Robbins Javier Segovia Analysts/Traders Blaise Antin Stephen Keck Evelyn Leyva Marcela Meirelles, PhD Brett Rowley Jean-Charles Sambor Jason Shamaly Alex Stanojevic Government/Rates Mortgage-Backed Securities Corporate/High Yield Commodities Investment Risk Management Product Management Emerging Markets Portfolio Investment Team Jamie Farnham Tammy Karp Thomas Lyon Gino Nucci, CFA Analysts/Traders Rahul Bapna, CFA Sinjin Bowron Mike Carrion Marie Choi RJ Cruz, CFA Joel Shpall Kenneth Toshima Jen Raye Adams Brian Cone Michael Frazier Ritsuko Hertrich Alex Jenkins John MacNeil John Mendell Chris Scibelli Conor Shalloe Kimberly Yamamoto Marketing Generalist Portfolio Team Stephen Kane, CFA Laird Landmann Barr Segal, CFA, CIC Ruben Hovhannisyan, CPA Analyst Chief Investment Officer Tad Rivelle II. MetWest Total Return Bond Fund Overview 9 MKTcc347 6/28/10 MetWest Funds and MetWest Total Return AUM and Fund Flows 1 YTD Net Flows MetWest Funds AUM YTD Net Flows MetWest Total Return Bond Fund AUM $1.7 $12.5 $1.3 $9.4 1 1 Billion Billion Billion Billion 1 Through June 17, 2010. MetWest Total Return Bond Fund MWTIX (I-Class) as of March 31, 2010 10 MKTcc347 6/28/10 Net Performance Total Returns The performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher. Performance data current to the most recent month-end may be obtained at www.mwamllc.com. The investment return and principal value of an investment will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Without fee waivers, returns would have been lower. The Fund offers another class, the performance for which will vary due to fees and expenses. You should consider the investment objectives, risks, charges, and expenses of the Metropolitan West Funds carefully before investing. A prospectus with this and other information about the Funds may be obtained by calling (800) 241-4671 or you can download one at www.mwamllc.com. It should be read carefully before investing. As of the year ending March 31, 2009, for MWTIX the total expense ratio is 0.44%. Expenses reflect a contractual agreement by the Adviser to reduce its fees and/or absorb expenses to limit the funds total annual operating expenses until March 31, 2011. For more information about fees and expenses, please read the prospectus. 1 Total return figures assume reinvestment of all distributions. Total returns reflect fee waivers in effect. Without fee waivers returns would have been lower. 2 The Barclays Capital Aggregate Index is an unmanaged index of investment grade fixed-rate debt issues with maturities of at least one year. Unlike a mutual fund, the performance of an index assumes no taxes, transaction costs, management fees, or other expenses, and is not available for direct investment. Bond Funds have the same interest rate, high yield, and credit risks associated with the underlying bonds in the portfolio, all of which could reduce the Funds value. As interest rates rise, the value of the Fund can decline and an investor can lose principal. Shares of the Metropolitan West Funds are distributed by PFPC Distributors, Inc., 760 Moore Road, King of Prussia, PA 19406 11 MKTcc347 6/28/10 MetWest Total Return Bond Fund Class I Performance As of May 31, 2010 YTD 1 Year 3 Year (annualized) 5 Year (annualized) 7 Year (annualized) 10 Year (annualized) Since Inception (annualized) 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 6.03% 3.71% 19.87% 8.42% 8.86% 6.88% 7.31% 5.32% 7.20% 4.69% 7.42% 6.52% 7.27% 6.37% MetWest Total Return Performance (Net of fees) Barclays Aggregate 1 1 Class I inception date was March 31, 2000. The performance data quoted represents past performance and does not guarantee future results. Current performance may be lower or higher. Performance data current to the most recent month-end may be obtained at www.mwamllc.com. The investment return and principal value of an investment will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Without fee waivers, returns would have been lower. The Fund offers another class, the performance for which will vary due to fees and expenses. For MWTRX the total expense ratio is 0.65%. Expenses reflect a contractual agreement by the Adviser to reduce its fees and/or absorb expenses to limit the funds total annual operating expenses until March 31, 2011. For more information about fees and expenses, please read the prospectus. Bond Funds have the same interest rate, yield and credit risks associated with the underlying bonds in the portfolio, all of which could reduce the Funds value. As interest rates rise, the value of the Fund can decline and an investor can lose principal. MetWest Total Return Summary Characteristics 1 12 MKTcc347 6/28/10 Sector Composition MetWest Barclays Total Return Fund Aggregate Agency MBS 27.2% 34.7% Non-Agency MBS/ABS 17.4% 0.3% CMBS 10.1% 3.1% U.S. Treasuries/Agencies 21.1% 43.8% 2 IG Corporates 18.8% 18.1% High Yield/Bank Loans 4.8% 0.0% Cash/Money Markets/Other 0.6% 0.0% Quality Composition 3 MetWest Barclays Total Return Fund Aggregate UST/Agency 4 48.6% 74.3% AAA 10.9% 4.1% AA 8.7% 4.3% A 9.2% 9.3% BBB 9.0% 8.0% BB 4.1% 0.0% B & below 9.5% 0.0% MetWest Barclays Total Return Fund Aggregate Portfolio Duration 4.1 Years 4.5 Years SEC Yield 4.54% N/A Average Maturity 7.2 Years 6.8 Years Yield-to-Maturity 5.39% 3.19% 1 As of May 31, 2010. 2 Barclays Aggregate Index includes supranationals, sovereign bonds, and local authorities. 3 Quality ratings by Moody's, Standard & Poor's and Fitch, such as "AAA" refer to portfolio securities and not to the fund itself. When ratings vary, the highest rating is used. Securities rated below BBB are considered more speculative and are subject to greater risks than higher rated bonds. Portfolio composition may change at any time. Holdings rated below B were purchased at B or better. 4 UST/Agency % includes U.S. Treasury securities, U.S. Agency debentures, and mortgage- and asset-backed securities that are issued by the U.S. Government and government agencies. U.S. Fixed Income Investment Philosophy 13 MKTcc347 6/28/10 Consistent Outperformance Can Be Achieved Through: Implementation of multiple fixed income strategies Focus on sector management and issue selection Application of fundamental value-driven research process Philosophical Tenets Fixed income markets/securities are mean reverting Technical factors can temporarily drive pricing away from fundamentals Persistent inefficiencies in fixed income market can be exploited through disciplined research and bottom-up issue selection Investment Process 14 MKTcc347 6/28/10 QUARTERLY DAILY MONTHLY Portfolio Structure Diversified Optimized Controlled Risk Mean reversion Patience Discipline Understanding of macro risks Intensive search for value Understanding of micro risks Duration Management Yield Curve Management Sector Management Long-Term Economic Outlook Security Selection Buy / Sell Execution Client Objectives & Guidelines III. Investment Thesis Illusion of Wealth Effect: Consumer Behavior 16 MKTcc347 6/28/10 Asset price bubbles create an illusion of wealth Consumers wake up rich, consume excessively Inaccurate self-perception of wealth led to: Unsustainable elevation in consumption Massive trade deficits Overleveraged consumer U.S. Economy Has Suffered An Immense Loss of Wealth 17 MKTcc347 6/28/10 While an illusion, the net-worth estimates of consumers had been unduly elevated in the bubble years This loss of net worth translates into: Less private sector consumption Increase in savings rate D e c - 1 9 5 1 D e c - 1 9 5 4 D e c - 1 9 5 7 D e c - 1 9 6 0 D e c - 1 9 6 3 D e c - 1 9 6 6 D e c - 1 9 6 9 D e c - 1 9 7 2 D e c - 1 9 7 5 D e c - 1 9 7 8 D e c - 1 9 8 1 D e c - 1 9 8 4 D e c - 1 9 8 7 D e c - 1 9 9 0 D e c - 1 9 9 3 D e c - 1 9 9 6 D e c - 1 9 9 9 D e c - 2 0 0 2 D e c - 2 0 0 5 D e c - 2 0 0 8 0 5 10 15 20 25 30 T r i l l i o n s
( $ ) U.S. Residential Real Estate (Households and Nonprofits) Savings Rate A p r - 2 0 0 0 A p r - 2 0 0 1 A p r - 2 0 0 2 A p r - 2 0 0 3 A p r - 2 0 0 4 A p r - 2 0 0 5 A p r - 2 0 0 6 A p r - 2 0 0 7 A p r - 2 0 0 8 A p r - 2 0 0 9 A p r - 2 0 1 0 0% 1% 2% 3% 4% 5% Source: Federal Reserve Source: Bloomberg Economic Retrenchment Has Been Severe 18 MKTcc347 6/28/10 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 0 2 4 6 8 10 G r o s s
D o m e s t i c
P r o d u c t ( A n n u a l i z e d ) 2.1 -0.7 1.5 -2.7 -5.4 -6.4 -0.7 2.2 5.6 2.7 While The Great Recession has technically ended... (economic growth a flow variable has turned positive) ...Measures of recessionary conditions (stock variables) say otherwise Labor market in worst condition since World War II Housing markets remain challenged Private sector continues to de-lever Source: Bloomberg 4.0 6.0 8.0 10.0 12.0 U n e m p l o y m e n t
( % ) Both Narrow and Broad Measures of Unemployment are Very High 19 MKTcc347 6/28/10 Historical Unemployment (U-3) Historical Unemployment and Underemployment Rate (U-6) 10.0 12.0 14.0 16.0 18.0 U n e m p l o y m e n t
( % ) 18 16 14 12 10 8 6 Other Labor Market Metrics Remain Dismal 20 MKTcc347 6/28/10 Private sector is challenged from the standpoint of re-allocating U.S. labor force Average Unemployment Duration (SA) Jobless Benefit Exhaustion Rate (12 Month Average) J a n - 1 9 4 8 J a n - 1 9 5 1 J a n - 1 9 5 4 J a n - 1 9 5 7 J a n - 1 9 6 0 J a n - 1 9 6 3 J a n - 1 9 6 6 J a n - 1 9 6 9 J a n - 1 9 7 2 J a n - 1 9 7 5 J a n - 1 9 7 8 J a n - 1 9 8 1 J a n - 1 9 8 4 J a n - 1 9 8 7 J a n - 1 9 9 0 J a n - 1 9 9 3 J a n - 1 9 9 6 J a n - 1 9 9 9 J a n - 2 0 0 2 J a n - 2 0 0 5 J a n - 2 0 0 8 5 10 15 20 25 30 35 40 A v g .
U n e m p l o y m e n t
D u r .
( W e e k s ) J u n - 1 9 7 2 J u n - 1 9 7 4 J u n - 1 9 7 6 J u n - 1 9 7 8 J u n - 1 9 8 0 J u n - 1 9 8 2 J u n - 1 9 8 4 J u n - 1 9 8 6 J u n - 1 9 8 8 J u n - 1 9 9 0 J u n - 1 9 9 2 J u n - 1 9 9 4 J u n - 1 9 9 6 J u n - 1 9 9 8 J u n - 2 0 0 0 J u n - 2 0 0 2 J u n - 2 0 0 4 J u n - 2 0 0 6 J u n - 2 0 0 8 25 30 35 40 45 50 55 60 E x h a u s t i o n
( M i l l i o n s ) Source: Bloomberg Source: Bloomberg Source: Bloomberg Federal Government Has Provided Vast Assistance to Housing Sector 21 MKTcc347 6/28/10 Fed has purchased $1.25 Trillion in agency MBS U.S. Treasury bought an additional $250 Billion FNMA, FHLMC unofficial wards of the state Tax credits for first time home buyers Probable arm twisting to limit foreclosures Fed Balance Sheet J a n - 2 0 0 3 M a y - 2 0 0 3 S e p - 2 0 0 3 J a n - 2 0 0 4 M a y - 2 0 0 4 S e p - 2 0 0 4 J a n - 2 0 0 5 M a y - 2 0 0 5 S e p - 2 0 0 5 J a n - 2 0 0 6 M a y - 2 0 0 6 S e p - 2 0 0 6 J a n - 2 0 0 7 M a y - 2 0 0 7 S e p - 2 0 0 7 J a n - 2 0 0 8 M a y - 2 0 0 8 S e p - 2 0 0 8 J a n - 2 0 0 9 M a y - 2 0 0 9 S e p - 2 0 0 9 J a n - 2 0 1 0 M a y - 2 0 1 0 4 6 8 10 12 14 16 18 T i m e l i n e
( B i l l i o n s ) UST Agency MBS Repos Term Auction Credit (TAF) Primary, Secondary and Seasonal Credit Primary Dealer Credit Facility (PDCF) AMLF Credit to AIG TALF Other Credit Extensions CPFF ML I,II,III Liquidity Swaps Gold SDRs Treasury Currency Other Source: Bloomberg Source: TCW ...Yet Pricing and Credit Trends in Housing Have Not Recovered 22 MKTcc347 6/28/10 3 / 3 1 / 1 9 9 8 9 / 3 0 / 1 9 9 9 3 / 3 1 / 2 0 0 1 9 / 3 0 / 2 0 0 2 3 / 3 1 / 2 0 0 4 9 / 3 0 / 2 0 0 5 3 / 3 1 / 2 0 0 7 9 / 3 0 / 2 0 0 8 3 / 3 1 / 2 0 1 0 0 2 4 6 8 10 12 14 16 F o r e c l o s u r e
R a t e
( % ) Prime Foreclosures (%) Subprime Foreclosures (%) 1 / 3 1 / 2 0 0 0 4 / 3 0 / 2 0 0 1 7 / 3 1 / 2 0 0 2 1 0 / 3 1 / 2 0 0 3 1 / 3 1 / 2 0 0 5 4 / 3 0 / 2 0 0 6 7 / 3 1 / 2 0 0 7 1 0 / 3 1 / 2 0 0 8 1 / 3 1 / 2 0 1 0 80 100 120 140 160 180 200 220 1 / 1 / 2 0 0 0 4 / 1 / 2 0 0 1 7 / 1 / 2 0 0 2 1 0 / 1 / 2 0 0 3 1 / 1 / 2 0 0 5 4 / 1 / 2 0 0 6 7 / 1 / 2 0 0 7 1 0 / 1 / 2 0 0 8 1 / 1 / 2 0 1 0 80 100 120 140 160 180 200 220 240 Prime & Subprime Foreclosure Rates S&P/Case-Shiller Composite-20 Home Price Index OFHEO U.S. Purchase Only Index (SA) Constant Default Rate (CDR) Trends J a n - 2 0 0 3 M a y - 2 0 0 3 S e p - 2 0 0 3 J a n - 2 0 0 4 M a y - 2 0 0 4 S e p - 2 0 0 4 J a n - 2 0 0 5 M a y - 2 0 0 5 S e p - 2 0 0 5 J a n - 2 0 0 6 M a y - 2 0 0 6 S e p - 2 0 0 6 J a n - 2 0 0 7 M a y - 2 0 0 7 S e p - 2 0 0 7 J a n - 2 0 0 8 M a y - 2 0 0 8 S e p - 2 0 0 8 J a n - 2 0 0 9 M a y - 2 0 0 9 S e p - 2 0 0 9 J a n - 2 0 1 0 M a y - 2 0 1 0 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% C D R
( % ) Prime AltA OptArm Subprime Down 29% from peak Down 13% from peak Source: Bloomberg Source: Office of Federal Housing Enterprise Oversight Source: TCW Source: Bloomberg Private Sector Continues to De-Lever 23 MKTcc347 6/28/10 Commercial and Industrial Loans Outstanding Commercial Paper Outstanding: Financial and Asset-Backed J a n - 2 0 8 8 A u g - 2 0 8 9 M a r - 1 9 9 1 O c t - 1 9 9 2 M a y - 1 9 9 4 D e c - 1 9 9 5 J u l - 1 9 9 7 F e b - 1 9 9 9 S e p - 2 0 0 0 A p r - 2 0 0 2 N o v - 2 0 0 3 J u n - 2 0 0 5 J a n - 2 0 0 7 A u g - 2 0 0 8 M a r - 2 0 1 0 200 400 600 800 1000 1200 1400 1600 B i l l i o n s
( $ ) Financial Commercial Paper Outstanding (SA) Asset-backed Commercial Paper Outstanding (SA) Banking Sector Shadow Banking System Source: Federal Reserve Bank of St. Louis Source: Federal Reserve Bank of St. Louis America Goes for Broke: Government Levers Up as Private Sector Levers Down 24 MKTcc347 6/28/10 GDP = C + I + G + (X M) In classic fashion, government is replacing the loss of consumption from the private sector by implementing borrow and spend stimulative programs U.S. Public Debt Outstanding U.S. Total Public Debt Outstanding as a % of GDP M a r - 1 9 9 6 M a r - 1 9 9 7 M a r - 1 9 9 8 M a r - 1 9 9 9 M a r - 2 0 0 0 M a r - 2 0 0 1 M a r - 2 0 0 2 M a r - 2 0 0 3 M a r - 2 0 0 4 M a r - 2 0 0 5 M a r - 2 0 0 6 M a r - 2 0 0 7 M a r - 2 0 0 8 M a r - 2 0 0 9 M a r - 2 0 1 0 50% 55% 60% 65% 70% 75% 80% 85% 90% T o t a l
P u b l i c
D e b t
a s
a
%
o f
G D P Jan-2000 Jan-2007 Dec-2009 3.2 2.5 4.3 4.4 7.3 5.0 Marketable Non-Marketable $5.7 Trillion $12.3 Trillion $8.7 Trillion Source: Bloomberg, U.S. Treasury Source: Bloomberg, U.S. Treasury Benefit: Government Spending Providing Bridge Financing 25 MKTcc347 6/28/10 Do the Feds have the willingness and the ability to sustain the stimulus until private sector balance sheets recover and growth resumes? Transfer Payments as a Share of Personal Income 8% 10% 12% 14% 16% 18% 20% 4% 6% 8% 10% 12% 14% 16% 18% 20% Source: Bloomberg Cost: Federal Debt Interest Payments 26 MKTcc347 6/28/10 Interest-Bearing Debt Rate* T-bills 0.24% Treasury Notes 2.74% Treasury Bonds 6.23% TIPS 2.24% Other 4.63% Non-Marketable 4.37% Total 3.21% Interest service over $400 Billion per annum * As of May 31, 2010. Source: U.S. Treasury Central Conundrum 27 MKTcc347 6/28/10 Public debt/GDP has risen from 55% to nearly 90% over the 00s Trend is not sustainable unless private sector begins to grow substantially more rapidly Private sector must replenish the demand that will be lost when deficit spending moderates Once debt/GDP equals 100%... GDP must grow as fast as debt service rate or debt/GDP worsens (forever) Interest-bearing debt rate of 3.2% suggests that nominal GDP growth rate must sustain itself over this figure $14.6 Trillion National Economy (GDP) $13.0 Trillion Public and Non-Marketable Federal Debt 28 MKTcc347 6/28/10 YTD 1 Performance In Context ABX 2007-2 AAA Gold ABX 2006-1 AAA IG Corporates Treasuries/ Agencies Barclays Aggregate Agency MBS High Yield Case-Shiller Home Price Index Cash S&P 500 (CRB) -15% -10% -5% 0% 5% 10% 15% 20% 16.00% 10.50% 5.84% 3.95% 3.69% 3.68% 3.49% 3.39% 0.08% 0.04% -1.45% -10.10% 2 Commodities 1 Through May 31, 2010. 2 Q1 2010. Interestingly, gold is up but commodities are down Commodity pricing signaling global economic weakness Higher gold prices a vote of no confidence on currencies? Fundamentally: How Do You Solve a Problem Like a Debt Burden? 29 MKTcc347 6/28/10 1. Depression: Cancel debt via forgiveness/bankruptcy Creates vicious cycle of foreclosure and bankruptcy forcing asset sales and still more bankruptcies Democratic systems do not voluntarily choose this as the primary solution 2. Inflation: Reduce the debt burden over time via expansion of money and credit Allow the real adjustment to be masked by a nominal change in price level Socializes the costs of adjustment 3. Prosperity: Grow your way out: Fix private sector balance sheets Re-allocate labor/capital facilitating real GDP growth Not directly determined by policy makers in Washington Conclusions 30 MKTcc347 6/28/10 Fundamental economic imbalances resulting from housing bubble remain Stock of U.S. residential real-estate still excessive given price level of homes Long arm of Federal intervention will continue to: Impede the price adjustment of the U.S. housing stock Slow the re-allocation of labor and capital resources Keynesian stimulus will be pulled back Endogenously: by deficit hawks pre-emptively cutting the budget or raising taxes Exogenously: by global financial markets reducing its preference for U.S. Treasuries Hence, growth will remain very muted Think early 1990s Secular headwinds, jobless recovery IV. Portfolio Opportunities Key Alpha Drivers 32 MKTcc347 6/28/10 Senior Non-Agency MBS Super-Senior, 30% enhanced CMBS Systemically critical financial corporate bonds Aircraft EETCs Bank Loans Taxable Munis 33 MKTcc347 6/28/10 Non-Agency MBS Investing 3 rd Party Data Provider Trustee Alternative TCW Loan Level Database Over 33 million loans Investments in Non-Agency MBS are supported by a comprehensive proprietary mortgage loan database 34 MKTcc347 6/28/10 Raw Data: Zip Code Documentation Purpose FICO Original LTV Mark-to-Market LTV Modification Activity Interest Rate Loss Amount Property Type Loan Balance Maturity Date Origination Date Occupancy Origination Date Principal and Interest Payment Servicer Originator Negative Amortization Cap Original Appraisal Value Debt to Income Ratio Margin Index Cap Information Lien Prepayment Penalty Information Term Amortization Term Interest Only Period Rate Reset Period Mortgage Insurance Information Delinquency Status 60++ Delinquency Severities Prepayments Defaults Weighted average Mark-to-Market LTV Distributions Servicer metrics Recidivism Cash Flow Velocity Advancing Behavior Modification Amount Modification Type Cure Rates State Specific Severities State-Specific Liquidation Timelines Negative Amortization Recast Details Always Current Percentages Reperforming Statistics % loans with equity in the home Cashflow Modeling Outputs Cohort level statistics to gauge securitys relative performance Generates over three hundred analytical fields available to each cusip 35 MKTcc347 6/28/10 Finding loans whose borrowers have equity in the property is a primary objective in security analysis. For deal A we take its 3,000 loans and find the distribution of mark-to-market LTVs using two approaches: Index-Based Approach Zip code level index is used to map monthly changes in index values to the loans original appraisal amount attempting to approximate the propertys value over time. Distressed Sales Approach We use zip code level severities to back into local distressed sale home prices to avoid many of the pitfalls of an index-based approach. Mark-to-Market LTV Non-Agency Mortgages: Credit Trends Loss Severity Trends 60+ Delinquency Trends 36 MKTcc347 6/28/10 J a n - 2 0 0 5 M a y - 2 0 0 5 S e p - 2 0 0 5 J a n - 2 0 0 6 M a y - 2 0 0 6 S e p - 2 0 0 6 J a n - 2 0 0 7 M a y - 2 0 0 7 S e p - 2 0 0 7 J a n - 2 0 0 8 M a y - 2 0 0 8 S e p - 2 0 0 8 J a n - 2 0 0 9 M a y - 2 0 0 9 S e p - 2 0 0 9 J a n - 2 0 1 0 M a y - 2 0 1 0 0% 10% 20% 30% 40% 50% 60% 70% 3 - M o n t h
R o l l i n g
A v g .
L o s s
S e v e r i t y
( % ) Prime AltA OptArm Subprime J a n - 2 0 0 5 A p r - 2 0 0 5 J u l - 2 0 0 5 O c t - 2 0 0 5 J a n - 2 0 0 6 A p r - 2 0 0 6 J u l - 2 0 0 6 O c t - 2 0 0 6 J a n - 2 0 0 7 A p r - 2 0 0 7 J u l - 2 0 0 7 O c t - 2 0 0 7 J a n - 2 0 0 8 A p r - 2 0 0 8 J u l - 2 0 0 8 O c t - 2 0 0 8 J a n - 2 0 0 9 A p r - 2 0 0 9 J u l - 2 0 0 9 O c t - 2 0 0 9 J a n - 2 0 1 0 A p r - 2 0 1 0 0% 10% 20% 30% 40% 50% 60% A v e r a g e
6 0 +
D e l i n q u e n c y
( % ) Prime AltA OptArm Subprime Source: TCW Source: TCW Example: Senior Non-Agency MBS 37 MKTcc347 6/28/10 Opportunity: Subprime, Sequential 3rd Pay Current Collateral Characteristics: Credit Enhancement: 37% 60+ Delinquent: 42% (down from 46%) Cumulative Defaults: 19% Always Current: 23% (of current pool) Average Loan Balance: $185,000 (at time of origination) Base Case Scenario (Go Forward Assumptions): Loss Severities: 75% Cumulative Defaults: 90% CPR: 0.5% Commercial Mortgage Market: Pricing Trends 38 MKTcc347 6/28/10 Moodys/REAL Commercial Property Price Index (CPPI) While commercial real estate has not performed well as an asset class, we believe heavily credit enhanced and well diversified securitizations (AAA super seniors) will likely perform very well D e c - 2 0 0 0 J u n - 2 0 0 1 D e c - 2 0 0 1 J u n - 2 0 0 2 D e c - 2 0 0 2 J u n - 2 0 0 3 D e c - 2 0 0 3 J u n - 2 0 0 4 D e c - 2 0 0 4 J u n - 2 0 0 5 D e c - 2 0 0 5 J u n - 2 0 0 6 D e c - 2 0 0 6 J u n - 2 0 0 7 D e c - 2 0 0 7 J u n - 2 0 0 8 D e c - 2 0 0 8 J u n - 2 0 0 9 D e c - 2 0 0 9 80 100 120 140 160 180 200 220 Source: Bloomberg 39 MKTcc347 6/28/10 Example: Super Senior Commercial Mortgages Opportunity: 2006 CMBS Securitization Rated Aaa/AA- Description: Credit Enhancement: 31% 60+ Delinquent: 6% Special Serviced: 9% (Includes REO, foreclosures, as well as some performing loans) Watchlist: 17% Cumulative Losses: 0.1% DSCR: 1.45x Collateral Overview: 100% 1st liens on 329 properties Well diversified by property type: Retail 33.9% Office 17.3% Multi-Family 15.7% Lodging 10.8% Industrial 4.5% Other 4.0% Largest 50 loans comprise 2/3rds of total notional 40 MKTcc347 6/28/10 Example: Super Senior Commercial Mortgages (contd) Opportunity: 2006 CMBS Securitization Rated Aaa/AA- Analysis: Bond begins receiving principal in 2014 Same 40% of the pool defaulting at 75% loss severity is necessary to lose first dollar of principal 41 MKTcc347 6/28/10 Example: Airline EETCs Opportunity: DAL 2002 Transaction (Ba2/BB+) Description: Bond wrapped by MBIA Collateral package is 32 aircraft 17 737-800 (98 - 02) 8 767-300 ER (95 - 97) 6 767-400 ER (00) 1 757-200 (01) Bond downgraded by ratings agencies due to MBIA Wrap Analysis: DAL has a strong balance sheet, including $6+ Billion in unrestricted liquidity Bonds stressed LTV approximates 95% (high) but on track to de-lever to 75% by July 2012 Why Regulatory Forbearance Remains the Order of the Day 42 MKTcc347 6/28/10 Banking is an inherently unstable enterprise Depositors can call their money back at par with few limitations Bank has committed long-term real-estate, consumer and commercial loans Loss of confidence results in a banking panic Forced liquidation of assets by banks experiencing a run Bank failures Economic depression As lender of last resort, Fed must credibly demonstrate that it is able and willing to preserve, protect and defend the banking system Banks will continue to be given the opportunity to play through, earn their way to a better capital position Systemically Critical Financials 43 MKTcc347 6/28/10 Consolidation of major banking/brokerage franchises have continued JP Morgan acquired Bear Stearns and WAMU B of A acquired Merrill Lynch, Countrywide Regulatory forbearance enables these franchises to play through to a highly profitable future B of A JP Morgan Citicorp Wells Fargo Goldman Sachs Morgan Stanley $2.03 Trillion $1.70 Trillion $2.22 Trillion $1.13 Trillion $849 Billion $771 Billion Balance Sheet Barclays U.S. Corporate Index OAS 1 / 2 9 / 1 9 9 9 1 0 / 2 9 / 1 9 9 9 7 / 3 1 / 2 0 0 0 4 / 3 0 / 2 0 0 1 1 / 3 1 / 2 0 0 2 1 0 / 3 1 / 2 0 0 2 7 / 3 1 / 2 0 0 3 4 / 3 0 / 2 0 0 4 1 / 3 1 / 2 0 0 5 1 0 / 3 1 / 2 0 0 5 7 / 3 1 / 2 0 0 6 4 / 3 0 / 2 0 0 7 1 / 3 1 / 2 0 0 8 1 0 / 3 1 / 2 0 0 8 7 / 3 1 / 2 0 0 9 4 / 3 0 / 2 0 1 0 0 100 200 300 400 500 600 700 800 O A S
( b p s ) Barclays U.S. Corporate Index Barclays U.S. Corporate Index - Financials Source: Barclays Capital Source: SEC Website Additional Fixed Income Opportunities 44 MKTcc347 6/28/10 Taxable munis Illinois GO (A1/A+) 4 1/2% to 2014 vs. 1 1/2% U.S. Treasuries Bank Loans First lien loans from health care, energy, etc. Loans priced $75-$95 Fed Funds, FRNs Agency credit Spread +40 over comparable money-market securities V. Q & A 46 MKTcc347 6/28/10 A Word About Risk The primary risks affecting this Fund are interest rate risk (including extension risk and prepayment risk), liquidity risk, market risk, and credit risk. Interest rate risk refers to the possibility that the value of the Funds portfolio investments may fall since fixed income securities generally fall in value when interest rates rise. Extension risk is the possibility that rising interest rates may cause owners of the underlying mortgages to pay off their mortgages at a slower than expected rate. This particular risk may effectively change a security which was considered short or intermediate term into a long-term security. Long-term securities generally drop in value more dramatically in response to rising interest rates than short or intermediate-term securities. Prepayment risk refers to the possibility that falling interest rates may cause owners of the underlying mortgages to pay off their mortgages at a faster than expected rate. This tends to reduce returns since the funds prepaid will have to be reinvested at the then lower prevailing rates. Liquidity risk refers to the possibility that the Fund may lose money or be prevented from earning capital gains if it cannot sell a security at the time and price that is most beneficial to the Fund. Market risk is the possibility that the returns from the types of securities that the Fund invests in will underperform returns from the various general securities markets or different asset classes. Credit risk refers to the loss in the value of a security based on a default in the payment of principle and/or interest of the security, or the perception of the market of such default. The value of the Funds share price will fluctuate up or down based on the value of the portfolio holdings, which can be affected by these risks.