Active bond managementYesterday’s technology?

January 2013Stephen Snowden Investment ManagerStephen Snowden – Investment Manager

Agenda1. The case for actively managed corporate bond funds

– versus index trackers

Agenda

– retail targeted bonds

2. Market view

3. The Fund

4. Q&A

2

Equities & bonds – important differencesEquities & bonds important differences

Equities Bonds

Trading mechanism Exchange CounterpartyTrading mechanism Exchange Counterparty

Pricing Exchange ?

Market size £1,774 bn £533 bn

So what does this mean?

,

1. Corporate pricing can be inconsistent and liquidity is lower

2. Corporate bonds are therefore less suitable to index tracking

Source: FTSE UK All-share Index market cap from FactSet as at 31 December 2012. iBoxx £ Non-Gilt Index from Barclays as at 31 December 2012

3

Liquidity – what the fund managers are sayingq y g y g

“daily volumes are on a par with where they were in 2007”Richard Woolnough, manager of the £6.5bn M&G Corporate Bond Fund, £5.8bn M&G Strategic Bond Fund & £10.7bn M&G Optimal Income Fundg p

Bond Vigilantes, 4 Dec 2012

“trading in the sterling corporate bond market is moreexpensive and difficult than before the financial crisis”expensive and difficult than before the financial crisis

Ian Spreadbury, manager of the £3.3bn Fidelity Moneybuilder Income FundInvestment Week, 4 Dec 2012

“anybody who says liquidity is not a problem is lying”Richard Hodges, manager of the £1.6bn Legal & General Dynamic Bond Fund

Independent on Sunday, 19 Aug 2012

“liquidity in the corporate bond market can be pretty patchy”

Paul Reed, manager of the £5.8bn Invesco Perpetual Corporate Bond Fund

4

Investment Week, 17 Dec 2012

Index -v- ActiveIndex v ActiveFallen Angels• In isolation a fallen angel is not a big issue for an index

t ki t b d f dtracking corporate bond fund

• The problem is when it is systemicSpanish & Italian corporate bonds 14.8% of theSpanish & Italian corporate bonds 14.8% of the

iBoxx € Non-Sovereign Index = €499bn

That is 2.3x the size of the European High Yield market

Th bl i h ll f th £ t b d• The problem is much smaller for the £ corporate bond market

Spanish & Italian corporate bonds 3.0% of the iBoxx £ Non Gilt Index = £16bniBoxx £ Non-Gilt Index = £16bn

• But the dislocation when it happens will be large

Source: iBoxx & BoA/Merrill Lynch

Are index tracking corporate bond funds a low risk option?

5

Index -v- ActiveIndex v Active

• Large single name risk

7 0% of the inde– 7.0% of the index

the creeping non-call• Large financial call risk

– 7.4% of the index

• Index trackers typically yield less

Source: Barclays, iBoxx & Lipper

Are index tracking corporate bond funds a low risk option?

6

Index -v- ActiveIndex v Active• Active funds have typically been

managed with less duration than th i d5 0

5.5

7 8

8.0

Gilt yields -v- Index interest rate risk

the index

• Gilt yields have fallen but interest rate risk of the index has 3.5

4.04.55.0

7 2

7.4

7.6

7.8

%

dura

tion

increased

• An interesting time in the interest rate cycle to increase duration1 5

2.02.53.0

6.6

6.8

7.0

7.2 %

Mod

ified

rate cycle to increase duration risk!1.0

1.56.4

6.6

Jun

08S

ep 0

8D

ec 0

8M

ar 0

9Ju

n 09

Sep

09

Dec

09

Mar

10

Jun

10S

ep 1

0D

ec 1

0M

ar 1

1Ju

n 11

Sep

11

Dec

11

Mar

12

Jun

12S

ep 1

2D

ec 1

2iBoxx £ Non-Gilts (LHS) 10 year gilt yield (RHS)

Source: Barclays, iBoxx & Bloomberg

Are index tracking corporate bond funds a low risk option?

7

Which index you follow can make a big difference.....Corporate bond pricing differentials

Which index you follow can make a big difference.....

450

350

400

s (b

ps)

200

250

300

cred

it sp

read

s

100

150

00

8 8 8 8 8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9 9 9 9 0

Jan

08Fe

b 08

Mar

08

Apr 0

8M

ay 0

8Ju

n 08

Jul 0

8Au

g 08

Sep

08O

ct 0

8N

ov 0

8D

ec 0

8Ja

n 09

Feb

09M

ar 0

9Ap

r 09

May

09

Jun

09Ju

l 09

Aug

09Se

p 09

Oct

09

Nov

09

Dec

09

Jan

10

Barclays Sterling Agg Ex Gilts iBoxx Sterling Non Gilts

Source: Barclays ,Markit and Bloomberg as at 31 January 2010

8

iBoxx Sterling Non-GiltsBank of America/Merrill Lynch Sterling Non-Gilts

Retail targeted corporate bondsRetail targeted corporate bonds

A good BypassBypassAheadAhead g

idea?AheadAhead

AlternativeAlternativeAlternative Alternative RouteRoute

9

Retail targeted corporate bonds

National Grid PLC 1.25% 2021(retail bond – index linked)

g p

National Grid PLC 4.1875% 2022(institutional bond – index linked)

• Regulatory protection – None

• Credit Rating

• Regulatory protection – Yes, from OFGEM

• Credit Rating g– Baa1

• Yield – RPI plus 1.25%

g– A3

• Yield – RPI plus 1.25% *

• Minimum investment – £100

• Minimum investment – £1,900 (approx) *

• Charges – Barclays bid/offer spread = 1.4%– 0.5% introduction fee– Possible nominee and or trustee fees

• Charges – Barclays bid/offer spread = 0.5%– Annual management fee

Source: Bloomberg. Barclays bid/offer spread as of 27th December 2012. *As of 13th September 2011, launch date of the retail bond. 10

Is cutting out the middle man such a good idea?

Retail targeted corporate bondsProvident Financial 7% 2017(retail bond)

Retail targeted corporate bondsProvident Financial 8% 2019(institutional bond)

• Seniority – Senior Unsecured

• Credit Rating

• Seniority – Senior Unsecured

• Credit Rating g– BBB

• Yield (as of 14th March 2012) – 7.0%

g– BBB

• Yield (as of 14th March 2012) – 8.3%

• Minimum investment – £100

• Minimum investment – £50,700 (approx)

• Total Return* – 12.6%

• Total Return* – 18.0%

Source: Bloomberg & Barclays. Total return calculated using Barclays offer prices. *Total return from 14 March 2012 to 31 December 2012

11

Is cutting out the middle man such a good idea?

There’s still a role for actively managed corporate bond funds

Retail targeted corporate bonds

There s still a role for actively managed corporate bond funds

Index trackers

You can’t have your cake and eat it

Not without their risks

12

Market viewMarket view

13

Bond bubble?Bond bubble?

14UK Gilt Yields 1729-2012

10

12

6

8

2

4

0

1729

1737

1745

1753

1761

1769

1777

1785

1793

1801

1809

1817

1825

1833

1841

1849

1857

1865

1873

1881

1889

1897

1905

1913

1921

1929

1937

1945

1953

1961

1969

1977

1985

1993

2001

2009

Source: MeasuringWorth December 2012

14

Why are Government bond yields so low?• Low economic growth backdrop

• “Lower for Longer” Central Bank Rates

Why are Government bond yields so low?

Lower for Longer Central Bank Rates

• Quantitative Easing

• Deleveragingg g

• Shrinking pool of “safe haven” assets

This does not make them a “good” long term investment...

...but they are a necessary evil

15

Government Bonds – not all are created equalq

16

European Yields

10

12

14

%

6

8

10

Yiel

d (s

.a.)

0

2

4

Jan

95

Jan

97

Jan

99

Jan

01

Jan

03

Jan

05

Jan

07

Jan

09

Jan

11

Portugal Spain Italy France Germany Ireland

Source: Bloomberg as at 30 November 2012

16

Portugal Spain Italy France Germany Ireland

Bond bubble?Bond bubble?

6

Gilt yields

4

5

2

3%

0

1

0

Dec

02

Jun

03

Dec

03

Jun

04

Dec

04

Jun

05

Dec

05

Jun

06

Dec

06

Jun

07

Dec

07

Jun

08

Dec

08

Jun

09

Dec

09

Jun

10

Dec

10

Jun

11

Dec

11

Jun

12

Dec

12

30yr 10yr 5yr

Source: Bloomberg 31 December 2012

17

30yr 10yr 5yr

It’s not just gilts that are yielding less these daysIt s not just gilts that are yielding less these days

20Credit Suisse High Yield Index - Yield to Worst

16

18

12

14%

8

10

6

8

986

987

988

988

989

990

991

992

993

994

995

996

997

998

999

999

000

001

002

003

004

005

006

007

008

009

010

010

011

012

Source: Credit Suisse & Bloomberg as at 31 December 2012

18

19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20

It’s not just gilts that are yielding less these daysIt s not just gilts that are yielding less these days

18Global Emerging Market Sovereign Plus - Yield to Worst

14

16

10

12%

6

8

4

1991

1992

1993

1993

1994

1994

1995

1996

1996

1997

1997

1998

1998

1999

2000

2000

2001

2001

2002

2003

2003

2004

2004

2005

2005

2006

2007

2007

2008

2008

2009

2010

2010

2011

2011

2012

2012

Source: Bank of America Merrill Lynch as at 31 December 2012

19

1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

Credit Spreads - iBoxx £ Non-Gilt IndexCredit Spreads iBoxx £ Non Gilt Index

350

400

250

300

350

150

200bps

50

100

0

Dec

02

Dec

03

Dec

04

Dec

05

Dec

06

Dec

07

Dec

08

Dec

09

Dec

10

Dec

11

Dec

12

Source: Markit & Barclays as at 31 December 2012

20

Investment grade not running on empty just yetInvestment grade not running on empty just yet

21

Why the Kames Investment Grade Bond Fund? y

• Significant value in investment grade bonds

• Award winning fixed income team

• Fund size offers competitive advantage in illiq id marketEuan McNeilStephen Snowden in illiquid marketEuan McNeilStephen Snowden

Kames Investment Grade Bond Fund

Fund size £497m

Number of holdings 135

Morningstar OBSR Rating Silver

Source: Kames Capital as at 30 November 2012

22

Kames Investment Grade Bond Fund performancep

23Cumulative* vs median

18.60%

15.06%13

18

owth

3

8% g

ro

-2

ug 1

1

ep 1

1

Oct

11

ov 1

1

ec 1

1

an 1

2

eb 1

2

ar 1

2

pr 1

2

ay 1

2

un 1

2

Jul 1

2

ug 1

2

ep 1

2

Oct

12

ov 1

2

ec 1

2

Ranked 8th o t of 84

Au

Se O No

De Ja Fe M A Ma Ju J Au

Se O No

De

Kames Investment Grade Bond A Acc IMA £ Corporate Bond Sector

Source: Lipper as at 31 December 2012. NAV to NAV basis; net income re-invested. Total return; tax UK net; in GBP. A Acc. Past performance is not a guide to the future. *Performance shown since Stephen Snowden became joint manager September 2011

• Ranked 8th out of 84

23

Active asset allocation

22030

Investment Grade Bond - Asset Allocation

180

200

22242628

140

160

16182022

%

bps

100

120

8101214

1008

Jun

11

Jul 1

1

Aug

11

Sep

11

Oct

11

Nov

11

Dec

11

Jan

12

Feb

12

Mar

12

Apr

12

May

12

Jun

12

Jul 1

2

Aug

12

Sep

12

Oct

12

Nov

12

Dec

12

Cash & AAA Credit Spreads (iTraxx Europe)

Source: Kames Capital & Markit as at 31 December 2012

24

Cash & AAA Credit Spreads (iTraxx Europe)

Kames Investment Grade Bond Fund performance

• Investment grade portfolio

– Global investment remit

p

– Tactical gilts and restricted high yield

– Only taking bond risk

1 year 2 years 3 years 4 years 5 years

Fund 15.89% 21.26% 30.01% 58.95% 37.87%

Median 13.40% 18.78% 27.97% 47.17% 31.46%

Quartile 1 1 2 1 2

Outperformance 2.49% 2.48% 2.04% 11.78% 6.41%

Source: Lipper as at 31 December 2012. NAV to NAV basis, net income re-invested. Total return, tax UK net, in GBP. Past performance is not a guide to the future

25

AppendicesAppendices

26

Kames UK OEIC – building blocks or blend?g

Strategic BondStrategic Bond Fund

27% 28%

Investment Grade Bond

Fund

High Yield Bond Fund

9%9%

Source: Kames Capital as at 31 August 2012

27

Competitor ACompetitor A

IMA £ Strategic Bond offering

78%73%

IMA £ Corporate Bond offering

(2)

IMA £ Corporate Bond offering

(1)92%

(2)(1)

Source: Lipper as at 31 May 2012

28

Competitor BCompetitor B

IMA £ Strategic offering

IMA £ Corporate Bond offering

76%

Source: Lipper as at 31 July 2012

29

The challenge of managing corporate bond fundsg g g p

250

70

80

Fund size up but market liquidity has disappeared

150

200

50

60

70

$ on

10030

40

billion£ bi

llio

0

50

0

10

20

Dec

01

Dec

02

Dec

03

Dec

04

Dec

05

Dec

06

Dec

07

Dec

08

Dec

09

Dec

10

Dec

11

IMA Corp Bond & Strat Bond AuM (£bn) LHS Corporate Bond Dealer Positions ($bn) RHS

Source: Federal Reserve Bank of New York and Investment Management Association as at January 2012

30

No longer able to rely on steady supply of new bond issuanceNo longer able to rely on steady supply of new bond issuance

70Net £ Investment Grade Corporate Bond Issuance

40

50

60

10

20

30

£bn

20

-10

0

10

-30

-20

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Source: Barclays as at 31 December 2012

31

2 2 2 2 2 2 2 2 2 2 2

No longer able to rely on steady supply of new bond issuanceg y y pp y

400Net € Investment Grade Corporate Bond Issuance

200

300

100

200

€bn

-100

0

-200

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

32

Source: Barclays as at 31 December 2012

Why QE isn’t leading to inflationWhy QE isn t leading to inflation

120

UK Household debt to GDP

100

110

90

100

%

70

80

60

1-19

954-

1995

3-19

962-

1997

1-19

984-

1998

3-19

992-

2000

1-20

014-

2001

3-20

022-

2003

1-20

044-

2004

3-20

052-

2006

1-20

074-

2007

3-20

082-

2009

1-20

104-

2010

3-20

11Source: Haver Analytics. UK: Household & NPISHs Outstanding as a % of SA GDP (%) March 2012

33

Q1

Q4

Q3

Q2

Q1

Q4

Q3

Q2

Q1

Q4

Q3

Q2

Q1

Q4

Q3

Q2

Q1

Q4

Q3

Q2

Q1

Q4

Q3

Gilt market bubble?Gilt market bubble?

25UK Real Yields: Long-dated Gilts - RPI

10

15

20

0

5

10

%

-10

-5

-20

-15

729

736

743

750

757

764

771

778

785

792

799

806

813

820

827

834

841

848

855

862

869

876

883

890

897

904

911

918

925

932

939

946

953

960

967

974

981

988

995

2002

2009

Source: MeasuringWorth as at 31 December 2012

34

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2

Hedged & wedgedHedged & wedged

220275

iBoxx £ Non-Gilt Index v Market iTraxx Europe Index

180

200

225

250

140

160

200

225

bps

100

120

150

175

2 2 2 2 2 2 2 2 2 2 2 2 2

May

11

Jun

11

Jul 1

1

Aug

11

Sep

11

Oct

11

Nov

11

Dec

11

Jan

12

Feb

12

Mar

12

Apr

12

May

12

May

12

Jun

12

Jul 1

2

Aug

12

Sep

12

Oct

12

Nov

12

Dec

12

Non gilt (LHS) European main (RHS)

Source: Markit, Bloomberg, iBoxx and Barclays as at 31 December 2012

35

Non-gilt (LHS) European main (RHS)

Important informationThis document is not intended for retail distribution and is directed only at investment professionals. It should not be distributed to, or relied upon by, private investors. The information in this document is based on our understanding of the current and historical positions of the markets. The views expressed should not be interpreted as recommendations or advice. All data in this presentation

p

is sourced to Kames Capital unless otherwise stated. The views expressed and information provided are accurate at the time ofwriting. Past performance is not a guide to future performance. The value of investments and the income from them may go down aswell as up and is not guaranteed.

Kames Capital is an AEGON Asset Management company and includes Kames Capital plc (Company Number SC113505) and Kames Capital Management Limited (Company Number SC212159). Both are registered in Scotland and have their registered office at Kames House, 3 Lochside Crescent, Edinburgh, EH12 9SA. Kames Capital plc is authorised and regulated by the Financial Services Authority (FSA reference no: 144267). Kames Capital plc provides segregated and retail funds and is the Authorised C t Di t f K C it l ICVC O E d d I t t C K C it l M t Li it d idCorporate Director of Kames Capital ICVC, an Open Ended Investment Company. Kames Capital Management Limited provides investment management services to AEGON, which provides pooled funds, life and pension contracts. Kames Capital Management Limited is an appointed representative of Scottish Equitable plc (Company Number SC144517), an AEGON company, whose registered office is 1 Lochside Crescent, Edinburgh Park, Edinburgh, EH12 9SE (FSA reference no: 165548).

FP ID: 2013/15003

36