0 understanding fixed income investment products: not fdic insured no bank guarantee may lose value
TRANSCRIPT
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Understanding Fixed Income
INVESTMENT PRODUCTS: NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE
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A few words before we begin…
This presentation is designed to provide general background information for investors and is not a solicitation for any Legg Mason investment product.
While we mention “tax-exempt” securities in this presentation, this is solely to acknowledge that such securities do exist and may be available to certain investors. Legg Mason is not an authority on taxes or tax preparation, is not in the business of providing tax advice to investors, and makes no claim as to the impact of such securities on the tax liabilities of any individual investor.
Investors should recognize that all investments involve some degree of risk, including loss of principal, and that the past performance of specific investments or classes of investments is no guarantee of future results.
U.S. Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the U.S. Government. High-yield bonds are subject to additional risks such as the increased risk of default and greater volatility because of the lower credit quality of the issues. Foreign securities are subject to certain risks of overseas investing including currency fluctuations and changes in political and economic conditions, which could result in significant market fluctuations. These risks are magnified in emerging or developing markets.
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Fixed income: important and diverse
Includes:
• Corporate bonds
• Treasury bonds
• Muni bonds
• High-yield bonds
• Commercial paper
• …and much more
Fixed IncomeEquities
Cash Alternatives
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Widely held…often misunderstood
What is fixed income?
• For investors, investments that generate a regular series of interest payments…
- …with the timing and value of the payments “fixed” in advance
• For corporations and governments, a way to borrow money
- Securities that represent a share of debt, not a share of ownership
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Widely held…often misunderstood
Potential benefits:
• Regular stream of interest income
• Tax-exempt income
• Portfolio diversification
• Capital gains through price appreciation
Diversification does not assure a profit or protect against market loss. Certain investors may be subject to the federal Alternative Minimum Tax (AMT) and state and local taxes will apply. Capital gains, if any, are fully taxable. The exact impact depends on individual tax situations.
What is fixed income?
• For investors, investments that generate a regular series of interest payments…
- …with the timing and value of the payments “fixed” in advance
• For corporations and governments, a way to borrow money
- Securities that represent a share of debt, not a share of ownership
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Types of fixed income
Tax Exempt
• U.S. Treasury
- T-Notes
- T-Bills
- TIPS (Treasury Inflation Protected Securities)
• Municipal
- State
- Local
Taxable
• Corporate
- Investment Grade
- High Yield
- Commercial paper
• U.S. Agency
• Foreign
- Sovereign
- Emerging market
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Basics of bonds
A few important definitions…
When first offered:
• Issuer
• Face (“par”) value
• Coupon rate
• Maturity
When sold:
• Yield – the % return generated by the cash flow from the bond, based on the purchase price
Bond from
XYZ Incorporated
$1,000
@ 4.5%
Due: August 4, 2017
Maturity refers to the date on which the principal is required to paid on the bond. Coupon is the periodic interest payment made to the bondholders during the life of the bond.
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Interest rates and the bond market
When interest rates rise,
the value of bonds declines (and vice versa)
Value of bonds
Interestrates
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Alphabet soup:deciphering credit ratings
To guide investors, several firms
rate the creditworthiness of individual bonds
Example:
• “Investment Grade”
- AAA, AA, A, BBB
• “High Yield”
- BB, B, CCC, CC, C, D
• Ratings expressed in groups of letters
• Different bonds from same issuer may have different ratings
A credit rating is a measure of an issuer's ability to repay interest and principal in a timely manner. The credit ratings provided by Standard and Poor's, Moody's Investors Service and/or Fitch Ratings, Ltd. typically range from AAA (highest) to D (lowest) or an equivalent and/or similar rating. Please see www.standardandpoors.com, www.moodys.com, or www.fitchratings.com for details.
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Assessing the risks
FIXED INCOME
Interest
Rate RiskCredit Risk
Prepayment Risk Currency Risk
Liquidity Risk
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Bonds have followed a different pattern of returns than stocks
33.4
21.0
23.0
37.6
28.7
10.9
4.9
5.5
-37.0
26.5
15.8
-22.1
-11.9
-9.1
28.6
-3.1
10.1
30.5
7.6 1.3
18.59.0
16.0
7.4
9.8
8.7 -0.8
5.25.27.04.32.44.1
4.3
3.6
9.7-2.9
11.6 8.4 10.3
-50%
0%
50%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Stocks: S&P 500 Bonds: Barclays U.S. Aggregate
Legg Mason. Data shown covers annual returns for period 1/1/1993 through 12/31/2012. Stocks are represented by the S&P 500; bonds are represented by the Barclays U.S. Aggregate Bond Index. Data is for general illustration of the relative historical returns of stocks and bonds and does not represent a specific investment or a recommendation for specific action; Investors cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. Past performance is no guarantee of future returns. The S&P 500 is a market-capitalization weighted index of 500 large-cap US stocks designed to reflect the performance of the broad domestic economy. The Barclays U.S. Aggregate Bond Index is a broad-based, capitalization-weighted index designed to measure the performance of investment-grade bonds traded in the U.S.
Annual returns (%), 1993 through 2012
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The role of fixed income in a portfolio
The potential for:
•Diversification
•Regular stream of income
•Tax-exempt income
•Price appreciation
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How can you invest in fixed income?
Buy individual issues…
• Direct control
• Lower fees
…OR professionally managed vehicles such as mutual funds or separately managed accounts (SMAs)
• Access to issues
• Access to expertise
• Concentrated purchasing power
• Reduced minimum investment
Mutual funds are sold by prospectus only. You should consider the fund’s investment objectives, risks, charges and expenses carefully before investing. The prospectus, and summary prospectus, if available, which can be obtained through your financial advisor contain this and other important information about the fund. You should read the prospectus carefully before investing.
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Active vs. passive management
Passive: Select basket of securities and leave unchanged
• Seeks to simulate returns of target benchmark
Active: Adjust security selection in response to changes in market conditions
• Typically seeks to outperform “benchmarks” through astute security selection
- “Top down” analysis
- “Bottom up” analysis
- Sector, term and/or duration analysis
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Fixed income…
• …is an important and diverse asset class
• …can provide both taxable and tax exempt income
• …can help to moderate the risk of a portfolio
• …can be acquired through a variety of investment vehicles
Yields and dividends represent past performance and there is no guarantee they will continue to be paid. While dividends may cushion returns in down markets, investments are still subject to loss of the principal amount invested.
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© 2013 Legg Mason Investor Services, LLC. Member FINRA, SIPC. Legg Mason Investor Services, LLC and Western Asset Management Company are subsidiaries of Legg Mason, Inc.FN1311531
Legg Mason, Inc., its affiliates, and its employees are not in the business of providing tax or legal advice to taxpayers. These materials and any tax-related statements are not intended or written to be used or replied upon, by any such taxpayer for the purpose of avoiding tax penalties. Tax-related statements, if any, may have been written in connection with the “promotion or marketing” of the transaction(s) or matter(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.
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