u.s. economy, bond market, and the challenge of thincome ® dave mazza senior national account...

U.S. Economy, Bond Market, and the challenge of Thincome ®Dave MazzaSenior National Account Manager, Calvert Investment Distributors, Inc.

Steve Van OrderFixed Income Strategist, Calvert Investment Management, Inc.

Jon SeiterRegional Vice President – Central, Calvert Investment Distributors, Inc.

FOR BROKER/DEALER AND INSTITUTIONAL USE ONLY. NOT FOR PUBLIC DISTRIBUTION.

© 2014 CALVERT INVESTMENTS, INC.

U.S. ECONOMY, BOND MARKET, AND THE CHALLENGE OF THINCOME ®


SEPT 2014


AGENDA1. Economic and Bond Market Outlook

2. Challenge of Thincome

3. Opportunity in Corporate Bonds

4. Corporate Bonds and Thincome

5. Summary and Conclusions

3FOR BROKER/DEALER AND INSTITUTIONAL USE ONLY. NOT FOR PUBLIC DISTRIBUTION.


ECONOMIC AND BOND MARKET OUTLOOK



SUMMARY OUTLOOK: 22603 INTO 2015

5

≈ 2% — GDP growth of 2% for 2014 requires 3% growth in second half

of year

≈ 2% — Consumer inflation approaching the Fed target rate

≈ 6% — Unemployment rate around 6%

≈ 0% — Money market rates near 0%

≤ 3% — 10-year Treasury yield ceiling around 3%



POLITICS AND POLICYMAKERS REMAIN KEY

U.S. Monetary Policy: No rate increase until sometime in 2015 Bond purchases (QE) completed by the end of this October Fed “policy normalization” strategy updated between Sep-Jan

U.S. Fiscal Policy: Federal policy drag nearly gone this year States contributing a few ticks to GDP Budget and debt ceiling issues come back in 2015

Other: Major central banks guide for low policy rates for a long time ECB/BOJ on easing track, US/UK on tightening track Higher tensions between old WWII adversaries in the west and east



U.S. BOND MARKET OUTLOOK

Long-maturity Treasury yields to remain broadly range-bound

Shorter-coupons under pressure to rise in advance of Fed “liftoff”

Yield curve shape less unnatural past the three-year point

Central bank policies work to dampen volatility

But investors more jittery as Fed liftoff signaling approaches

With money market rates near 0% the search for yield will continue

Corporate bond (credit) spreads achieved pre-crisis levels, stable

Sub-par growth, low inflation, and the policy mix:



TREASURY YIELD CURVE RE-SHAPINGStill a steep slope and low front-end yields. But Fed will guide for much lower-than-average, end-of-tightening cycle policy rate.


8


YIELD CURVESFed forward guidance keeps short interest rates locked down. From there, however, the curves are relatively steep but with less unnatural shapes.



BANG FOR THE MATURITY-EXTENSION BUCKTreasury curve now offers pre-crisis bang for the buck extending into 5-10 year maturities. IG offers bit less bang due to persistent demand for extra yield



THE CHALLENGE OF THINCOME®


© 2014 CALVERT INVESTMENTS, INC. 12

Thincome®

Interest payments from high-quality bonds are very small, offering a thin income (i.e., thincome) stream.



THINCOME® AND INTEREST-RATE RISK

Deep CB Footprints

Powerful, unorthodoxmonetary policies:

Suppressed bear-market cycles

Lowered net supply

Forced investors to search for yield

Thincome®

Thin coupons/yields:

On the most liquid high-grade bonds

Some yields near record lows

Very low income to bond investors

Manage Interest-Rate Risk

Bond math:

Thin coupons/yields:

Result in longer durations, thus

Greater potential price volatility



METHODS TO ADDRESS THE CHALLENGE OF THINCOME®

Move out the yield curve – careful extension given long durations

Move down in credit quality – reasonable value but not cheap

Move up in complexity – opportunities at this point in cycle

Move down in liquidity – but aware of lower structural liquidity now

Move up in leverage – careful here

Methods may be combined – flexible investment vehicles

Focus on total return potential, not just yield



CORPORATE BONDSAND THINCOME®



INVESTMENT GRADE (IG) CORPORATE BONDS: REASONABLE VALUE

U.S. corporate balance sheets remain in strong condition

Record $1.5 trillion in liquidity

Debt levels and leverage have increased but are not yet unhealthy

Corporate treasurers extended liability portfolio fixed-rate debt maturities

As a result IG market duration is long (7 years)

IG default rates should remain quite low

Spreads at pre-crisis levels, should be generally stable pending “liftoff”

signaling, yet vulnerable to liftoff-related scares and outflows



BAA SPREAD: 2007 AREA, -0.2 LONG-RUN Z-SCORE

Sources: Moody's, Fed, Robert Shiller



HIGH YIELD (HY): IMPROVED VALUE AFTER 2014 SUMMER OUTFLOWS

HY remains vulnerable to risk-off “liftoff” scares and outflows – buying opportunities

Recent yield on the BAML HY index 2.0 times the BAML IG index, above the 1.8x average since index inception (12/1997)

Low forecast default rate for 2014 of ± 3%

Awareness of weakened investor protections (e.g., calls, covenants)

Diversification benefit: high-yield asset class fairly uncorrelated with Treasuries over long periods of time

Expect returns in the area of HY index yields, around 5% to 6%



HY AT BETTER VALUE NOW FOR FUND FLOWS

Source: St. Louis FRED

19

BofA Merrill Lynch High Yield Master II Option-Adjusted Spreads and Effective Yield and S&P 500 Index


US Near-Default and Euro Crisis Scares

Euro Crisis Contagion Fear

Taper Tantrum


IDEAS TO ADDRESS THINCOME®



SOME IDEAS TO ADDRESS THINCOME®

Increase Allocation to High Yield (move down in credit to HY) Add yield via a straight boost in allocation to high-yield bonds

IG/HY Credit Blend (move down in credit but less so than above) Blend shorter-duration, investment-grade (SIG) bonds with high-yield (HY) allocations to boost yield and manage expected volatility

IG Yield Curve Barbell (move down in credit the least, but out the yield curve) Blend SIG and longer-duration investment-grade (LIG) allocations to boost yield and manage expected volatility

Allocate to an “Alternative” Category Fixed Income Fund For example, an “unconstrained” bond fund

Objective: pick up yield/return potential but manage expected risk compared to an intermediate-maturity bond allocation.



A BLEND OF SHORT-DURATION IG AND HY BONDSOver 36 months ended 12/31/2013, blending SIG and HY bonds provided better returns and higher yields than the Aggregate bond index. This position took more credit risk to gain yield.

Short-duration bonds are represented by the Barclays 1–5 Year U.S. Credit Index, intermediate bonds by the Barclays Aggregate Index, and high-yield bonds by the BofA Merrill Lynch High Yield Master II Index.

Indices are unmanaged and do not reflect the payment of advisory fees and other expenses associated with an investment in a mutual fund. It is not possible to invest directly in an index. The index-based performance is for illustrative purposes only and is not indicative of any actual investment. Past performance does not guarantee future results.

Source: Calvert Investments, Inc.



BARBELL OF SHORT AND LONG IG BONDSOver 36 months ended 12/31/2013, a blend of SIG and LIG bonds provided better returns and yields than the Aggregate bond index. This “barbell” strategy used more credit and interest-rate risk to gain yield.

Short-duration bonds are represented by the Barclays 1–5 Year U.S. Credit Index, intermediate-term bonds by the Barclays Aggregate Index, and long-term bonds by the Barclays Long U.S. Credit Index.

Indices are unmanaged and do not reflect the payment of advisory fees and other expenses associated with an investment in a mutual fund. It is not possible to invest directly in an index. The index-based performance is for illustrative purposes only and is not indicative of any actual investment. Past performance does not guarantee future results.

Source: Calvert Investments, Inc.



ALTERNATIVE FIXED-INCOME CATEGORY

Benchmark-aligned products are designed to adhere to an index and constrain manager flexibility. However, flexibility is often a strength during unusual market periods.

Alternative-category products give managers the flexibility to use all strategies to tackle the challenge of Thincome for investors.

This category is experiencing rapid growth, will have some shakeout eventually, but will become a staple for investors.

Category tends to be cycle-based, with global reach if needed.

FOR INSTITUTIONAL USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 24


EXAMPLE: CALVERT UNCONSTRAINED BOND FUND

Objective: Positive absolute return over a full market (interest rate) cycle regardless of market conditions

Same overall CIM philosophy toward FI investing: relative value Outlook horizon: weeks, months, quarters, typically Return benchmark: 1-3 month T-bills Strategy: best ideas from a broad group, led by a core team Cycle-based approach: will change at times Rate-rise risk mitigation at this point in cycle Complexity and novelty in structured offer opportunity, at this point Stopped-out, alpha-adding strategies: i.e., yield curve and basis

trading

A (pending) new offering in the alternative fixed-income space

FOR INSTITUTIONAL USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 25


SUMMARY

The challenge of Thincome® will be with us for some years

Evaluate the various tradeoffs when reaching for yield and return

Credit remains a better tradeoff than duration to add yield

We remain positive on U.S. investment-grade and high-yield sectors

Consider methods to boost yield using IG and HY corporate bonds

Consider some allocation to alternative category fixed-income products


what’s next

Market View: Fixed Income, July 25, 2014, “How Divergent Data Trends create differing expectations for central bank policies.”

It’s a Low, Low Yield World:http://www.calvert.com/nrc/literature/documents/el2/ffi-20140519.pdf?article=21318

Integrating ESG and High Yield Debt Analysis: http://www.calvert.com/nrc/literature/documents/el2/ffi-20140512.pdf?article=21311e=20446

To learn more, visit: www.calvert.com.


http://www.calvert.com/nrc/literature/documents/el2/ffi-20140519.pdf?article=21318

http://www.calvert.com/nrc/literature/documents/el2/ffi-20140519.pdf?article=21318

http://www.calvert.com/nrc/literature/documents/el2/ffi-20140512.pdf?article=21311e=20446

http://www.calvert.com/nrc/literature/documents/el2/ffi-20140512.pdf?article=21311e=20446


DISCLOSURE

This commentary represents the opinions of its author as of August 15, 2014 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any losses or damages arising from any use of this information.

This material is provided for informational purposes only. The opinions expressed herein are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Any statistics contained in this presentation have been obtained from sources to be reliable, but the accuracy of those statistics cannot be guaranteed.

www.calvert.com

Copyright, 2014. Calvert Investments, Inc. All rights reserved.

PT10110-201408


For financial advisors:800.368.2750

For institutional investors:800.327.2109www.calvert.com

© 2014 CALVERT INVESTMENTS, INC. 29FOR BROKER/DEALER AND INSTITUTIONAL USE ONLY. NOT FOR PUBLIC DISTRIBUTION.

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