Bigger Economic Green Shoots This Spring?

1

Bigger Economic Green Shoots This Spring?

Presented by: Dan Byrnes Senior Portfolio Manager AAM – Insurance Investment Management

Reproduction or use of these materials for any other purpose or by or for any individuals is strictly prohibited. The information contained in this presentation has been obtained from sources that AAM believes to be reliable, but AAM does not represent or warrant that it is accurate or complete. The views in this presentation are those of AAM and are subject to change, and AAM has no obligation to update its opinions or the information in this presentation. Neither AAM, nor any of their respective officers, directors, members, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this presentation or its contents. The securities discussed in this presentation may not be suitable for all investors. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information in this presentation is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results.

2

It’s Baseball Season: Trivia Question

How many hot dogs are expected to be eaten in Major League ball parks this year: ~ 3 million ~ 14 million ~ 20 million ~ 28 million

3

It’s Baseball Season: Trivia Question

How many hot dogs are expected to be eaten in Major League ball parks this year: ~ 3 million ~ 14 million ~ 20 million ~ 28 million

4

Winter Wonderland

Fond Memories (?!) From This Winter in Chicago 93% of Great Lakes

Frozen – 2nd highest 3rd coldest average

temperature Most days with low

temps at or below 0o

3rd snowiest winter

5

Recent Consumer Data Underwhelming What is driving these negative

figures?• Weather? • Weaker Consumer?

Reading Month Survey Actual ΔBuilding Permits MoM Dec -0.3% -2.6% -2.3%Building Permits MoM Jan -1.6% -5.4% -3.8%Existing Home Sales MoM Dec 0.6% 0.8% 0.2%Existing Home Sales MoM Jan -4.1% -5.1% -1.0%Retail Sales Advance MoM Dec 0.1% -0.1% -0.2%Retail Sales Advance MoM Jan 0.0% -0.4% -0.4%Total Vehicle Sales Jan 15,700,000 15,160,000 -540,000Total Vehicle Sales Feb 15,400,000 15,270,000 -130,000

Source: U.S. Census Bureau, National Association of Realtors, Bloomberg, AAM

6

Unemployment Rate Falling Fast

Unemployment rate falling dramatically The Fed is concerned about the labor market

Job Adds and Unemployment Rate

Source: Bureau of Labor Statistics as of 2/28/2014

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

YTD '14

-500-400-300-200-100

0100200300400

0

2

4

6

8

10

12

Avg Annual Payroll Change (LHS) Year End Unemployment Rate (RHS)

Thou

sand

s of

Jobs

Unem

ployment

Rate

7

Stubborn Low Employment/ Population Ratio Suggest Structural Changes

3

4

5

6

7

8

9

10

11 58

59

60

61

62

63

64

65

Unemployment rate (lhs)Employment/population ratio (rhs)

Source: Bureau of Labor Statistics; FTN Financial

Rate

(%

) Ratio (%)

8

Long Term Unemployment Still An Issue

1990

1993

1996

1999

2002

2005

2008

2011

2014

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Thou

sand

s of

Peo

ple

5 – 14 Weeks

14 -27 Weeks

27 Weeks and Over

Less Than 5 Weeks

Source: Bureau of Labor Statistics; AAM

9

Housing Still Strong Despite Higher Interest Rates

Source: Standard & Poor’s, Case-Schiller as of 12/31/13

Dec-03Oct-

04Aug-05

Jun-06Apr-0

7Feb-08

Dec-08Oct-

09Aug-10

Jun-11Apr-1

2Feb-13

Dec-13

120

140

160

180

200

220Home Prices

2002

2003

2004

2005

2007

2008

2009

2010

2012

2013

90

110

130

150

170

190

210

230Home Affordability

At 100, median-income family just qualifies for mortgage on median-priced home.

Source: National Association of Realtors as of 12/31/13

Housing has been a bright spot in the economy

Recent pace of gains likely unsustainable

10

Still Spending

Source: US Census Bureau as of 1/31/14

Capital Goods Orders Change In Consumer Spending

Source: National Association of Realtors as of 12/31/13

Spending has been good, but not robust

2006

2007

2008

2009

2010

2011

2012

2013

2014

40

45

50

55

60

65

70

75

$Bill

ion

1Q 2005

1Q 2006

1Q 2007

1Q 2008

1Q 2009

1Q 2010

1Q 2011

1Q 2012

1Q 201

3-2%

-1%

0%

1%

2%

3%

4%

5%

11

The World Stage

Eurozone United Kingdom

Japan China EMEA Latin America

-2

0

2

4

6

8

10Annual GDP Growth Expectations

2012201320142015

Source: Bloomberg as of December 2013

Russia

Crimea

Ukraine

NATO

There has been a lot of concern around China’s “slow” growth

Geopolitical concerns remain

GD

P (%

)

12

What’s All This Mean for Growth?

1Q GDP is expected to be weak – around 1.8% Growth should pick up in the second half of the year Average growth of 3% expected over the next two years

Real U.S. GDP Growth During Expansions

Source: Bureau of Economic Analysis, Bloomberg Forecast as of 2/28/2014

Jun 91

Feb 93Oct 9

4Jun 96

Feb 98Oct 9

9Jun 01

Feb 03Oct 0

4Jun 06

Feb 08Oct 0

9Jun

11Feb 13

Oct 14

-1%0%1%2%3%4%5%6%7%8%

Forecast

13

What About Inflation?

-100.0%

-50.0%

0.0%

50.0%

100.0%

150.0%

200.0%

250.0%

300.0%

350.0%

10-yr breakeven rate5-yr breakeven rate

Source: Bloomberg; FTN Financial

14

The Fed Under Yellen

Dovish reputation

Expected to maintain the course set by Bernanke if conditions meet expectations

More concerned about full employment than predecessors

15

Fed Stimulus Exit

If the economy grows as expected the Fed should have exited QE III by year end

October

Dec-12

Feb-13Apr-1

3Jun-13

Aug-13Oct-

13Dec-

13Feb-14

Apr-14

Jun-14Aug-14

Oct-14

0102030405060708090 Treasuries

Agency MBS

$ Bi

llion

Forecast

16

Work to do After QE

Balance sheet will still be large and need to be wound down

Fed Funds rate increase expected mid-2015

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000 Fed Agency MBS PurchasesLiquidity to Key Credit MarketsLending to Financial InstitutionsLong Term Treasury PurchasesTraditional Security Holdings

Fed Balance Sheet

17

Limited Correlation Between Fed Policy and Long Term Interest Rates

0

1

2

3

4

5

6

7

8

9

1019

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

0620

0720

0820

0920

1020

1120

1220

1320

14

Yield

(%)

Federal Funds Rate2 Year US Treasury10 Year US Treasury30 Year US Treasury

Source: Barclays, Federal Reserve, Data as of 3/28/14

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What About Interest Rates?

Source: Bloomberg as of February 2014

What could cause meaningful divergence• Higher

Faster growth Concerns about Fed

commitment to low inflation

Other?• Lower

Geopolitical issues Dramatic slow-down in

China Weaker consumer

2 Year 10 Year 30 Year2Q '14 0.50% 3.00% 3.92%3Q '14 0.62% 3.20% 4.05%4Q '14 0.77% 3.35% 4.21%1Q '15 0.88% 3.50% 4.30%2Q '15 1.04% 3.60% 4.40%3Q '15 1.33% 3.75% 4.50%

Expected Treasury Yields

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What Do I Do With All Of This?

20

It’s Baseball Season: Trivia Question

What MLB stadium has the most expensive small beer? Yankee Stadium Marlins Park - $8 Wrigley Field Dodger Stadium

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It’s Baseball Season: Trivia Question

What MLB stadium has the most expensive small beer? Yankee Stadium Marlins Park - $8 Wrigley Field Dodger Stadium

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Status Quo: Investment Grade Fixed Income

23

Corporate Bonds Remain Attractive

Source: AAM, Barclays

-

50

100

150

200

250

BBB-A Industrial Spread Difference

Basi

s Po

ints

2004

2006

2008

2010

2012

2014

50

100

150

200

250

300

U.S. Corporate Investment Grade Spread

Basi

s Po

ints

24

Technicals Expected To Remain Supportive

20042005

20062007

20082009

20102011

20122013

F2014-500

0

500

1,000

1,500

$755

$1,084

$1,489 $1,491

$173$329

$34$188

$700 $862$747

CLOsABSCMBSAgency MBSNon-agency MBSBuild America BondsEM SovereignEM CorporatesHY corporatesIG corporatesTotal spread product net issuance

2011 coupons = $757

2014 coupons = $668

2010 coupons = $699

Source: JP Morgan

Net Issuance

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Investable And Attractive Risk-adjusted Assets

Note: AAM is not soliciting or recommending any action based on above material. Any views presented above represent the opinion of AAM at a given time and are subject to changeSource: Barclays, Moody’s

1988

1990

1992

1995

1997

1999

2001

2003

2005

2008

2010

2012

$0 $500

$1,000 $1,500 $2,000 $2,500 $3,000 $3,500 $4,000

AAA AA A BBB

Mar

ket

Val

ue o

f Co

rpor

ate

Inde

x (B

illio

ns)

The Corporate Market Has Grown And Is Lower Quality

Moody's Credit StatisticsAAA AA A BBB BB

Historical Average Loss (1982 - 2013) 0.00% 0.03% 0.03% 0.13% 0.69%Worst Loss Experience (1982 - 2013) 0.00% 0.48% 0.36% 0.79% 3.14%

9.59%5.01%6.31%9.09%8.98%1 Year Avg Ratings Migration Down (1970 - 2013, % of category), excl. WR

26

What Other Levers Can Be Pulled?

27

No Free Lunch

Source: AAM

Add interest rate risk via more duration

Add liquidity risk – commercial loans

Add credit risk – high yield and/or convertibles

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Duration Decisions

Results greater than one year are cumulativeInterest rate changes are assumed to happen evenly over indicated time periodSource: Actual portfolios modeled in CMS BondEdge as of 8/31/2013

Common question: If interest rates are rising, should I shorten my portfolio duration?

Short Answer: No

Scenario testing shows the role income plays in returns

No Change in Interest Rates

12 Months 24 Months 36 MonthsIncome Return 2.0% 4.1% 6.3%Total Return 2.5% 4.7% 6.9%Income Return 3.2% 6.6% 10.3%Total Return 3.9% 7.8% 11.8%Income Return 1.2% 2.5% 3.9%Total Return 1.4% 3.0% 4.9%

3.1 Duration

5.4 Duration

Difference

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What If Rates Rise Substantially?200 Basis Point Rise In Interest Rates

Income is the key driver in fixed income performance

Stick to your knitting on duration

Scenario testing shows the role income plays in returns

12 Months 24 Months 36 MonthsIncome Return 2.2% 4.7% 7.6%Total Return -2.0% 1.9% 5.8%Income Return 3.3% 7.0% 11.2%Total Return -4.4% 0.9% 6.5%Income Return 1.1% 2.4% 3.6%Total Return -2.4% -1.0% 0.7%

3.1 Duration

5.4 Duration

Difference

Results greater than one year are cumulativeInterest rate changes are assumed to happen evenly over indicated time periodSource: Actual portfolios modeled in CMS BondEdge as of 8/31/2013

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High Yield

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U.S. High Yield Corporate Bond Spreads

Spread of the Credit Suisse U.S. High Yield II Index

Source: Credit Suisse

High yield spreads are slightly lower than their long-term average, while the risk-free interest rates are at historically low levels

Current spreads imply a default rate of almost 6% for the U.S. high yield market

0 bp

400 bp

800 bp

1200 bp

1600 bp

2000 bp

2/28/1997: 315 bp

10/31/2002 1080 bp

5/31/2007 271 bp

11/28/2008 1816 bp

1/9/2014 426 bpAverage

Spread:589 bp

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2014 2015 2016 2017 2018 2019 2020 2021 20220

40,000

80,000

120,000

160,000

200,000

Mat

urit

ies

($bi

llion

)

High Yield Bond Maturities

Record new issue proceeds used primarily for the purpose of repaying or refinancing existing debt.

High Yield company fundamentals remain strong. We anticipate defaults will be less than 2% for the overall market.

Refinancing Risk Remains Low

Source: BofA Merrill Lynch, Data as of December 31, 2013 (Updated quarterly)

33

Not All High Yield Is Created Equal

Source: Annual Default Study: Corporate Default and Recovery Rates, 1920-2013 Yield to Worst shown for B of A Merrill Lynch BBB, BB, B, and CCC & Below Indices as of 2/28/2014. Loss adjusted assumes 40% average recovery for senior unsecured bonds.

A focus on Ba/B ratings substantially reduces the risk of impairments

Baa Ba B Caa_C0

2

4

6

8

10

12

14

0

2

4

6

8

10

12

14

16Annualized DefaultsYieldLoss-adjusted Yield

Def

ault

Rat

e (P

erce

nt) Yield

(Percent)

34

In A Rising Rate Environment, High Yield Has Performed Well

Sources: JP Morgan and BofA ML. BofA ML U.S. 10 Year Treasury Index (GA10), BofA ML U.S. High Yield Cash Pay (J0A0) Index. Prior to the inception of J0A0 on 10/31/1984, BofA ML U.S. High Yield Master II (H0A0) was used.

12-months ending:

10-year Treasury

yield move

10-year Treasury return (GA10)

U.S. High Yield Bond Index (J0A0)

Feb-89 +BP 117 0.39% 9.88%

Dec-94 +BP 204 -8.29% -1.17%

Dec-99 +BP 179 -8.25% 1.57%

May-04 +BP 130 -5.38% 11.34%

Jun-06 +BP 120 -5.79% 4.65%

35

Convertibles

36

Convertible Securities-Equity-like Returns With Less Risk

*

Capture 70-80% of stock market advances

Participate in only 40-50% of stock market declines

Carry higher current yields as compared to common stock

Constant focus on maintaining consistent risk/return profile

37

Historical Issuance/Redemptions

96.9

62.1

40.035.9

25.221.4

48.9

70.0

48.355.6

50.0

38.3

47.1

31.8

48.1

36.0

0

20

40

60

80

100

120

2007 2008 2009 2010 2011 2012 2013 2014

Issua

nce/

Rede

mpt

ions

(USD

$ bi

llion

s)

Issuance Redemptions

Source: Barclays Research as of December 31, 2013. *Estimates for 2014

*

38

Convertible Performance Drivers for 2014

Return Component

Likely Impact Comment

Equity Prices + / -Primary driver of convertible performance; strong upside participation in rising markets and attractive downside protection in a market correction

Valuation 0 Valuations remain generally attractive, particularly in sub-IG and short-dated space

Volatility 0 / + Volatility expectations remain low despite near-term market concerns

Credit Spreads 0 / - Improved corporate balance sheets and easy refinancing help support bond floors

Interest Rates 0 / - Exposure to rising rates is cushioned by low duration of portfolio and embedded equity option

39

Performance During Rising Rates

Zazove Convertibles

Note: Portfolio returns are reflected before management fees. Benchmark returns include reinvestment of interest/dividends. Past results are not a guarantee of future performance. See "Notes to Performance Summaries" for additional information that is an integral part of this presentation.

Zazove Institutional Investment Grade

Composite

10-Year Treasury Barclays Capital U.S. Corporate Bond Index

Barclays Capital U.S. Aggregate Bond Index

S&P 500-10%

-5%

0%

5%

10%

15%

8.61%

-7.69%

-0.60%-1.35%

12.47%

Rising rate periods included are: 10/31/93-11/30/94, 1/31/96-5/31/96, 9/30/98-1/31/00, 10/31/01-3/31/02, 5/31/03-7/31/03, 6/30/05-6/30/06,12/31/08-12/31/09, 8/31/10-3/31/11, 4/30/13-8/31/13.

40

Commercial Loans

41

Overview

Commercial mortgages have been a staple of U.S. insurance company portfolios for over 100 years due to:

Liability Matching: Asset / liability duration matching with fixed credit spreads mitigating interest rate risk

Competitive Risk Adjusted Returns: Relative to public market alternatives, including corporate bonds

Superior Call Protection: Relative to corporate bonds, due to lock out periods and pre-payment penalties

Lower Delinquency and Severity Rates: versus corporate bonds and CMBS

Lower Volatility

Structural Benefits Versus CMBS: More lender control in loan structuring; realizing a recovery in the event of a default

Improved Risk Based Capital Treatment – Effective 2013

42

Yield Comparison

U.S. Fixed Income Yields(Approximately 7-7.5 year Modified Duration)

Asset Yield (1/14)

Credit Spread (bps)

(1/31/14)U.S. Treasury Notes(Barclays UST, 7-10 Yrs Index) 2.45% N/A

A Rated Corporate Bonds(Barclays A Corporate Bond Index)

3.09% 118

BBB Rated Corporate Bonds(Barclays BBB Corporate Bond Index)

3.61% 154

Commercial Mortgage Loans (2) 4.79% 234

Source: Barclays, Quadrant Real Estate Advisors

Note: Commercial Mortgage Loans represent privately placed whole loans (first mortgages). Total return and standard deviation calculations sourced from the Giliberto-Levy index as of 9/30/2013. Commercial mortgage yields and spreads are based on market opportunities seen by Quadrant Real Estate Advisors. The Yield represents the bond equivalent weighted spread across property types for 75% LTV loans and DSCR ranging from 1.25-1.45x.

Commercial Mortgages provide attractive yields relative to public market alternatives.

43

Capital Treatment Has Become More Favorable

RBC Group Commercial Mortgages

Corporate Bond

1 0.90% 0.40%2 1.75% 1.30%3 3.00% 4.60%4 5.00% 10.0%5 7.50% 23.0%

Life Insurance Company Risk Based Capital Charges

Commercial Mortgage RBC Charge Description

RBC Group RBC Charge Description1 0.90% DSC=>1.50X and LTV<85%2 1.75% 0.95 <= DSC < 1.50X / LTV<75%3 3.00% DSC<0.95X and LTV<85%4 5.00% DSC<1.15X and LTV=>100%5 7.50% DSC<0.95X and LTV=>105%

Source: NAIC, AAM

44

Widely Used

Percent of Companies with CML Holdings

Source: SNL, data as of 9/30/13

Size of Company

$100-$500 million

$500MM – $1.5 billion

$1.5 – $5 billion

Life 44.6% 56.3% 47.5%

P&C 10.0% 11.4% 23.1%

45

Any Questions?