It’s a Matter of Interest

Moderated by: Miriam Cleary, Regional Director, Public Sector Groupwith presentations by members of the Cutwater Asset Management Portfolio Management, Credit Research, and Legal & Compliance teams

It’s a Matter of Interest

February 20, 2014

2

Overview

IntroductionMiriam ClearyRegional Director, Public Sector Group

Macroeconomic UpdateSamira MattinVice President, Portfolio Management

2

Short-End Market UpdateMarc McClure, CFAVice President, Portfolio Management

3

Overview

Bond BasicsInvestment Policy Dave Witthohn, CFA, CIPMDirector, Public Sector Group

Incorporating Credit Securities Into PortfoliosRobert Claiborne, CFADirector, Co-Head of Credit Research

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Investment Adviser Regulatory Update Leonard ChubinskySenior Corporate Counsel & Secretary

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MIRIAM CLEARYREGIONAL DIRECTOR, PUBLIC SECTOR GROUPMs. Cleary is a regional Director at Cutwater. She joined the firm in 2001 and has worked in the financialservices industry since 1984. Ms. Cleary’s responsibilities include marketing investment managementservices and maintaining client relationships in Florida. She has extensive experience in the publicsector investment arena. Previously, Ms. Cleary worked as a program director and senior managingconsultant for Public Financial Management. Additionally she held positions as a public financeinvestment banker and as a financial executive at several other organizations. Ms. Cleary has aBachelor of Science (BS) degree and a Master of Business Administration (MBA) degree from La SalleUniversity. She is a member of the Florida Government Finance Officers Association (GFOA), theTreasure Coast Chapter of Florida’s GFOA, the South West Chapter of the GFOA, and the South FloridaGovernment Finance Officers and City Clerks Association. Ms. Cleary holds Series 6 and 52 licensesfrom the Financial Industry Regulatory Authority (FINRA).

Moderator

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Samira Mattin Vice President, Portfolio Management

Macroeconomic Update

February 20, 2014

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2013 Review

Positive Payroll JEC Testimony Press Conf. No Taper Taper

12/31/2012 5/2/2013 5/21/2013 6/18/2013 9/17/2013 12/17/2013 12/31/2013

10 Yr Treasury Yield 1.78 1.63 1.93 2.19 2.85 2.84 3.03

IG Credit OAS 131 126 122 136 135 115 111

YTD Barclays Agg Total Return - 1.04% 0.07% -1.22% -3.06% -1.64% -2.02%

YTD Barclays High Yield Total Return - 5.15% 5.39% 3.10% 3.49% 7.06% 7.45%

YTD S&P 500 Return - 12.75% 17.94% 16.92% 21.37% 27.46% 32.38%

• Changes in FOMC policy greatly influenced investment performance• Tapering fears shouldered by Treasury securities• Risk-based assets helped diversified indexes recover• Equity returns bolstered retirement plans• Ultimately climbed the “Wall of Worry”: Eurozone, Higher Taxes, Government Shut

Down, Fed Tapering

Source: Bloomberg Finance LP, 12/31/2013.

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7

Primary engines of Global GDP, led by North America, China, Japan, and Germany are stabilizing or growing

Source: International Monetary Fund (IMF), 1/21/2014.

Note: The countries colored on the map represent 74% of Global GDP.

Global GDP Trend

3

Trend Improving

Stable

Slowing

Global Growth Forecast 2014 2013

IMF 3.7% 2.9%

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Inte

rest

Rat

e (%

)

Historical 10-Year Treasury Yield (1873–Present)

All Time LowJul 2012: 1.53%

Prior Record LowJan 1941: 1.95%

Rates are Poised to Increase Moderately Due toReal Yield Re-pricing (Less So Inflation)

Source: Shiller, Cutwater Asset Management, 12/31/2013. Note: 10-Year Treasury Constant Maturity Rate (Monthly Averaged).

What Goes Down, Must Go Up

4

Current RateDec 2013: 2.90%

9

Inflationary effects of explosive growth in money supply being suppressed by declining velocity of money

Source: Bloomberg Finance LP.

2/13/2014 3:34:13 PM

Monetary Base vs. Velocity

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─ ARDIMONY Index (Monetary Base Total NSA) ─ VELOM2 Index (Bloomberg Velocity Of Money M2 Money Supply)

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2014 Outlook: Return to Normal Before It’s Too Late

Recovery Finally Takes Root• Continued broadening of

global growth• Employment gains are firming• External balances are improving• Housing is moving onto a stable

foundation• Inflation remains subdued

Risks• Emerging market performance • Pull-forward of Fed policy

expectations• US fiscal situation• European progress• “Unknown unknowns”

6

All opinions expressed in this presentation are solely those of Cutwater and are subject to change without notice.

11

Additional Information

7

Samira Mattin Vice President, Portfolio ManagementMs. Mattin is a Vice President and Client Portfolio Manager at Cutwater. She joined the firm in 2004 andhas worked in the financial services industry since 2002. Ms. Mattin works closely with the investmentteam and builds customized portfolio solutions for clients. Her focus is portfolio strategy and businessdevelopment for Cutwater’s Total Return Strategies. Prior to her current role, Ms. Mattin was a portfoliomanager responsible for the management of several broad, multi-sector short duration portfolios. Beforejoining Cutwater, she was a surety bond underwriter for St. Paul Travelers. Ms. Mattin has a Bachelor ofScience (BS) degree (Honors) in Finance from George Mason University.

[email protected]

Presenter Information

Marc H. McClure, CFAVice President, Portfolio Management

Short-End Market Update

February 20, 2014

13

Federal Funds Target Rate vs. Two-Year Treasury

Economic Overview


Market Update

2

2013 FOMC Announcement Dates

2014 FOMC Announcement Dates

0.0

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Feb-04 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14

Rate

Fed Funds Target Rate

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US Federal Reserve Balance Sheet

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Market Update

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Source: TIC, Zero Hedge

Top Holders of US Treasuries

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Market Update

$ Bill

ions

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What is the Fed Telling Us?

Current forward guidance indicates rate increases are at least 1.5 years away

Fed’s Forecast

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Market Update

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Federal Funds Target Rate vs. US Unemployment Rate

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Market Update

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-0.200

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Rate

3mth LIBOR 3mth Tbill 3mth DN 3mth CP (A-1/P-1) 3mth Asset Backed CP (A-1/P-1)


Money Market Yields

3-Month Maturity Rate Comparison

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Market Update

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US Treasury Yield Curves

8

Market Update

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Breakeven Analysis (Four-Year vs. Two-Year)

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Market Update

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2013 2013 Average Average Average Normalized1H 2H 2014 2015 2016 Long-Term

Real GDP 1.80 3.25 2.75 3.00 3.00 3.00Consumer Price Index 1.80 1.50 1.50 1.75 2.00 2.50Unemployment Data 7.50 6.70 6.50 6.00 6.00 5.80After-Tax Profits-Year-to-Year (% change) 6.00 6.00 6.00

Period Ending:Fed Funds Rate 0.00-0.25 0.00-0.25 0.00-0.25 0.50-1.00 1.00-2.00 3.00-3.502-Yr Treasury Rate 0.36 0.38 0.60 1.50 2.75 4.0010-Yr Treasury Rate 2.49 3.03 3.38 3.75 4.25 5.0030-Yr Treasury Rate 3.50 3.97 4.13 4.35 4.75 5.5-6.0010-Year A-Rated Corporate Spreads 0.90 0.85 0.80 0.80 0.90 1.055-7 Year BB-Rated Corporate Spreads 3.58 2.69 2.50 2.40 2.60 3.25Current Coupon 30-Year MBS Spread (vs 10yr UST) 0.72 0.68 0.75 0.75 0.80 0.7530-Year Taxable Muni Spreads 1.25 1.10 1.05 1.00 1.10 1.15

3.50

Base Economy Case

Nominal rates ultimately follow real GDP and inflation


Rates – Economy 2014

Our rate path considers historical relation between real GDP and real Rates

10

Market Update


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11

Marc H. McClure, CFAVice President, Portfolio ManagementMr. McClure is a Vice President and Portfolio Manager at Cutwater. He joined the firm in 2008 and hasworked in the financial services industry since 1999. Mr. McClure’s responsibilities include evaluatingmarket conditions and trends impacting investment opportunities in the high-grade commercial paperand corporate bond markets. Additionally, he formulates active portfolio management strategies forclients, taking into account current market conditions as well as economic expectations. Mr. McCluremaintains regular contact with clients in order to maximize portfolio return while satisfying cash flowneeds and meeting investment policy objectives. His areas of expertise include US Treasury andinstrumentality markets. Mr. McClure has a Bachelor of Science (BS) degree from Metropolitan StateCollege of Denver. He holds the designation of Chartered Financial Analyst (CFA) through the CFAInstitute.

[email protected]


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David W. Witthohn, CFA, CIPMDirector, Public Sector Group

Bond BasicsA Primer on Fixed Income Securities

February 20, 2014

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The Fundamentals

Types of Investment Instruments• Treasury• Agency / Instrumentalities / GSE• Commercial Paper• Corporate Notes

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Treasury Securities

• Virtually credit risk free– Backed by full faith and credit of U.S. government– Market risk

• Excellent liquidity– Each issue $12 to $24 billion range– Primary dealers

• Standardization– Coupon and maturity– Auction schedule

• Benchmarks for fixed-income securities

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Treasury Bills

• Maturities of 1 year or less• 3- and 6-month Bills auctioned every Monday• 4-week and 1-year Bills auctioned on Tuesdays• Mature Thursdays, unless it’s a holiday • Trade at discount to par • No coupon• Actual/360 basis

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U.S. Treasury Notes and Bonds

• Notes– Original maturity of 10 years and under

• Bonds– Original maturity >10 years, up to 30 years– STRIPS: Separate Trading of Registered Interest and Principal

• Mature either the 15th or last day of the month• Semi-annual fixed coupons• Interest calculated on actual/actual basis

5

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U.S. Agency Securities

• Government National Mortgage Association (GNMA)• Farmers Home Administration (FMHA)• Small Business Association (SBA)• General Services Administration (GSA)• Federal Housing Administration (FHA)• Housing and Urban Development (HUD)

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U.S. Agency Securities

• Backed by the full faith and credit of the U.S. government• Most are not considered money-market instruments• Most are not active; therefore the quotes, except for GNMAs,

are not widely published• Some can be Fed-wired

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Instrumentality Securities

• Federal National Mortgage Association (FNMA)• Federal Farm Credit Banks (FFCB)• Federal Home Loan Banks (FHLB)• Federal Home Loan Mortgage Corporation (FHLMC)

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Instrumentality Securities

• Government sponsored corporations (GSE)• Often referred to as “Agencies”• No explicit government guarantee, (although implied

government assistance)• Most are widely-traded• Some are state tax exempt (FFCB, FHLB)

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Note: These are representative returns, returns change daily therefore these returns do not represent future returns.

Characteristics of Instrumentalities

• Spread over Treasuries• Liquidity considerations

– Issue size $10 MM to several billion

• Various structures– Discount notes, “bullets,” callables, step-up callables, floating rate

• Coupons non-standard (2.17%, 1.83%)• Unpredictable issuing schedule• 30/360 interest calculation

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Agency Discount Notes

• Discount notes issued by instrumentalities:– FNMA– FHLMC– FFCB– FHLB

• Purchased at the “Window” or secondary through dealer

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Agency Discount Notes

• T-Bill similarities– Maturity: 1 year or under– No coupon – Discount to par– Actual/360

• T-Bill differences– Yield– Liquidity– Days of week mature

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Coupon Securities

• Securities that pay periodic interest (similar to Treasury Notes or Bonds)

• Many different structures– Bullets

• Quarterly, semi-annually

– Floating rate– Callable – Step-up

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Callable Securities

• Issuer is not obligated, but has the right to redeem early• Usually called at par value• Investors are paid a higher yield to compensate for their loss

of rights• Various structures

– Protection period: non-callable– Different types of calls

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Callable Structures

• One-time (European): Callable one-time only on call date• Discrete (Bermuda): Callable on certain specified dates

(e.g. coupon payment date, monthly, quarterly, annually)• Continuous (American): Can be called at any time on or

after the first call date

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Note: These are representative returns, returns change daily therefore these returns do not represent future returns.

Different Structures = Different Yields

The yield of the callable is based on the rights that have been sold. The more rights, the higher the yield.

16

5 year, non-callable 1 year (one-time) 0.87%5 year, non-callable 1 year (discrete) 0.92%5 year, non-callable 1 year (continuous) 1.01%

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Corporate Securities

• Commercial paper• Medium-term corporate notes

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Commercial Paper

• Credit risk• Unsecured debt• Highest ratings:

– Moody’s: P-1– S & P: A-1+– Fitch: F-1+

• 270-day maximum maturity• Discount (most common) or coupon• Purchased direct or through dealers• DTC eligible

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Medium-term Corporate Notes

• Credit risk– Check rating categories

• Higher yields• Maturity of 5 years or less • Coupon securities• Usually not callable• Purchased through dealers• DTC eligible

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Corporate Securities Policy

• Compile a list of pre-approved issuers– Establish a minimum credit rating

• Limit Commercial Paper purchases to A1/P1/F1• MTN - require a long-term debt rating of at least A

– Limit purchases to issuers with at least $500 million in total assets– Monitor trends in issuer’s financial condition

• 10-K, 10-Q and rating agency reports

• Develop a strategy for negative trends– Do not purchase securities on a watch list– Review current exposure– Make hold or sell decision

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Source: www.investopedia.com

Recommended Reading: Investopedia

• “The Advantages of Bonds”• “The Basics of Bonds”• “Bond Basics: Characteristics”• “Agency Bonds: Limited Risk and Higher Returns”• “Callable Bonds: Leading a Double Life”• “Advanced Bond Concepts: Bond Type Specifics”• “How to Invest in Corporate Bonds”

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Source: www.investopedia.com

Recommended Reading: Investopedia (continued)

• “Bond Basics: Yield, Price and Other Confusion”• “How Bond Market pricing Works”• “Advanced Bond Concepts: Yield and Bond Price”• “Advanced Bond Concepts: Term Structure of Interest Rates”

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David W. Witthohn, CFA, CIPMDirector, Public Sector Group

Investment Policy and Performance Measurement

Basic Elements of an Investment Policy

February 20, 2014

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Components of an Investment Policy

Governing Authority

Scope

General Objectives

Standards of Care

Authorized Financial Institutions, Depositories and Broker/Dealers

Safekeeping and Custody

Suitable and Authorized Investments

Investment Parameters

Reporting

Policy Considerations

Approval of Policy

List of Attachments

Other Documentation

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Governing Authority

3

Legality

“The investment program shall be operated in conformance with federal, state and other legal requirements, including [insert applicable citations governing the investment of public funds].”

Note: Suggested [or sample] wording for the investment policy.

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Scope

What funds are included in the policy?• General funds• Special revenue funds• Enterprise funds• Trust funds• Any new fund, unless specifically exemptedPooling of funds• Consolidate cash and reserve balances• Allocate investment income to various funds

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General Objectives

General Objectives: Safety

5

Safety of principal and preservation of capital

“Safety of principal is the foremost objective of the investment program. Investments shall be undertaken to ensure the preservation of capital in the overall portfolio.”


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Credit risk: The risk of loss due to the failure of a security issuer or backer• Credit risk can be minimized by:

– Limiting investments to the safest types of securities– Pre-qualifying financial institutions and other business partners– Diversifying the portfolio so that potential losses on individual securities

will be minimized

6

General Objectives

51

Controlling Credit Risk

Compile a list of pre-approved issuers• Establish a minimum credit rating

– Limit purchases to A1/P1– Require long-term debt rating of A or higher– Check the outlook for the issuer

• Limit purchases to issuers with at least $500 million in total assets

• Monitor trends in issuer’s financial condition– 10-K, 10-Q and rating agency reports

7

General Objectives

52

Monitor Credit Risk

• Review holdings on a monthly basis• Document short- and long-term ratings• Check to see if issuer is on a watch list• Develop a strategy for negative trends

– Make hold or sell decision– Get upper management support– Document decision

8

General Objectives

53


Interest rate risk: The risk that the market value of securities in the portfolio will fall due to changes in market interest rates.• Interest rate risk can be minimized by:

– Structuring the portfolio so securities mature to meet cash flow requirements

– Investing operating funds in shorter-term securities, money market funds and investment pools

– Limiting the average maturity of the portfolio

9

General Objectives

54

General Objectives: Liquidity

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Liquidity• Maintain sufficient liquidity to meet operating requirements and

other cash needs

“The investment portfolio shall remain sufficiently liquid to meet all operating requirements that may be reasonably anticipated.”


General Objectives

55

General Objectives: Liquidity

Liquidity risk: The risk that an investment cannot be sold before its maturity without incurring a significant loss in price• Liquidity risk can be avoided by:

– Restricting maturities for various types of funds– Purchasing securities with an active secondary market– Preparing a cash flow forecast

11

General Objectives

56

General Objectives: Yield

Yield• Attain market rates of return• Securities shall generally be held until maturity with the

following exceptions:– Selling a security with a declining credit quality early to minimize loss of

principal– Swapping out of a security to improve the quality, yield and target

duration of a portfolio– Liquidity needs of the portfolio require that the security be sold

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General Objectives

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Isn’t It Just All About Performance?

13

Would you buy a U.S. Treasury Bond with a yield of 3.60%?

It’s about performance and riskRisk/Return Tradeoff

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Measuring Return

There are two different perspectives:Yield Approach• Pros

– Assumes held to maturity– Simplifies calculations– Smoothes earnings– Makes projections easier– Bases return on true income

• Cons– Ignores price movement– Hides risk– Approximates performance

Total Return Approach• Pros

– Industry standard– Shows all risks– Gives an accurate value– Allows comparability

• Cons– Difficult to calculate– Hard to capture return– Return can be erratic

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Yield Approach – Yield to Maturity (YTM)

Assumptions:• Looks only at the income from the bond• Yield-to-Maturity (purchase yield)• Reinvestment of interest at the YTM• Security held to maturity with no optionality (non-callable)• Annualized for comparison purposes• Approximation of true yield

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Yield to Call

Yield-to-Call and Yield-to-Worst• Adjusts the yield based on a call date• Uses the market price as an indication of which securities will

be called

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Source: Bloomberg LLP, 2/4/2014

Yield to Worst

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Source: Bloomberg LLP, 2/4/2014

Yield to Worst

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Amortized Cost

Amortized Cost Method

Return = (Interest +/- Accretion/Amortization +/- Realized G/L)Average Daily Historical Cost

• Annualize: divide by # of days in the period, then multiply by 365 • Captures sales and purchases, maturities, and called securities • Calculates actual reinvestment rate• Calculates return for period, not just a point in time

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Total Return – Industry Standard

Total Return performance combines both income and change in price

Total Return = Value End – Value StartValue Start

• Doesn’t allow for cash flows for the period (no additions or subtractions)• Assumes you will sell the security today using the current price• Changing prices varies return from period-to-period • Global Investment Performance Standards (GIPS) – These are client returns

adjusted for any cash flows

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Source: Bloomberg Finance, LP

Total Return Performance

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Price vs. CouponBofA ML 1-3 Year Treasury Index 1990 to 2013

Income Return

Price Return

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Average Income Return 4.82% Average Price Return -0.09%

Total Return 4.91%

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Standards of Care: Prudence

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Prudence• Prudent person standard

“Investments shall be made with judgment and care, under circumstances then prevailing, which persons of prudence, discretion and intelligence exercise in the management of their own affairs, not for speculation, but for investment, considering the probable safety of their capital as well as the probable income to be derived.”


Standards of Care

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Standards of Care: Ethics and Conflicts of Interest

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Ethics and conflicts of interest

“Officers and employees involved in the investment process shall refrain from personal business activity that could conflict with the proper execution and management of the investment program, or that could impair their ability to make impartial decisions.”


Standards of Care

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Standards of Care: Delegation of Authority

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Delegation of Authority• Delegated by law or ordinance• Further delegated to others

“Authority to manage the investment program is granted to (designated official) and derived from: (law or ordinance). Responsibility for the operation of the investment program is delegated to (investment officer, treasurer)…”


Standards of Care

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Authorized Broker/Dealers

Primary broker/dealers• Meet minimum financial requirements set by New York

Federal Reserve Bank• Satisfy SEC Net Capital Rule 15c3-1• Participate with Federal open market trading to provide

liquidity for government securities

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Broker/Dealers Authorization Process

• Obtain information on the firm– Financial strength indicators such as net capital adequacy and debt

credit ratings

• Obtain information on specific brokers– Qualifications and experience– Proper state registrations– History of SEC complaints

• Check references• Review approved list annually

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Source: www.finra.org; http://brokercheck.finra.org/Search/Search.aspx

For Firm History

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Source: www.finra.org; http://brokercheck.finra.org/Search/Search.aspx

For Broker History

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• Delivery versus payment– Maintain control of cash and/or securities at all times

• Safekeeping– Use third-party custodian

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Internal Controls

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Statement of requirement

“The investment officer is responsible for establishing and maintaining an internal control structure designed to ensure the assets of the [entity] are protected from loss, theft or misuse.”



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Internal Controls

• Control of collusion• Separation of transaction authority from accounting and

recordkeeping• Custodial safekeeping• Avoidance of physical delivery securities• Clear delegation of authority to subordinate staff members• Written confirmations• Dual authorizations of wire transfers• Development of wire transfer agreement

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List of allowable investment instruments• Clear definitions of investment types• Credit criteria for each type• Maturity restrictions for each type• Other requirements

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David Witthohn, CFA, CIPMDirector, Public Sector GroupMr. Witthohn is a Director at Cutwater. He joined the firm in 1997 and has worked in the financialservices industry since 1982. Mr. Witthohn’s responsibilities include client portfolio management andproduct development for the Public Sector Group’s separately managed account business. His areas ofexpertise include portfolio management and statistical performance review. Mr. Witthohn has extensiveyears of experience in working with public entities on their investment portfolios and has additionalexperience in the areas of institutional mutual funds and bank portfolio management. He is a nationallyrecognized speaker on managing public funds and is active in many public finance associations acrossthe country. Mr. Witthohn has a Bachelor of Arts (BA) degree in Business Economics from the Universityof Pittsburgh and a Master’s of Science (MSF) degree in Finance from the University of Colorado. Heholds the designation of Chartered Financial Analyst (CFA) through the CFA Institute and has theCertification for Investment Performance Measurement (CIPM).

[email protected]


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Robert Claiborne, CFADirector, Co-Head of Credit Research

Incorporating Credit Securities Into Portfolios

February 20, 2014

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Credit Securities Overview

Major Types of Credit Securities• Corporate Credit Securities

– Corporate Commercial Paper (CP)– Corporate notes and bonds

• Structured Credit Securities– Asset Backed Commercial Paper (ABCP)– Mortgage Backed Securities (MBS)– Asset Backed Securities (ABS)– Commercial Mortgage Backed Securities (CMBS)

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Benefits & Risks of Credit Securities

Portfolio Goals – Safety, Stability & Yield• Benefits

– Added diversification enhances safety and stability– Increases portfolio yield vs. US Treasury securities

• Risks– Potential negative event (activist shareholder, M&A etc.)– Potential downgrade or default

• Very low default probability for high quality corporate bonds

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Source: Moody’s Annual Default Study 1920-2012.

Moody’s Default Rate Data

4

Average Cumulative Issuer-Weighted Global Default Rates by Alphanumeric Rating, 1983-2012 (Data In Percent)

Year

1 2 3 4 5

Ratin

g

Aaa 0.000 0.017 0.017 0.049 0.087

Aa1 0.000 0.000 0.000 0.090 0.137

Aa2 0.000 0.017 0.157 0.340 0.515

Aa3 0.052 0.151 0.226 0.335 0.478

A1 0.084 0.260 0.539 0.807 1.064

A2 0.070 0.217 0.427 0.657 0.898

A3 0.062 0.224 0.478 0.703 1.044

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We Take a “Lender’s Perspective”

Credit Philosophy

• Separate credit from relative value• Perform our own fundamental credit research• Link credit research with our macro economic view• Diversified credit exposures• Bottom-up security selection across sectors and up/down

capital structure• Seeks to capture risk-adjusted yield advantage

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The credit process is a pure assessment of fundamental credit (“lender’s perspective”) separate and distinct from relative value considerations

Our credit research process reflects our sector and issuer investment views and results in a tiering of each credit

Credit Sector & Issuer Evaluation

6

Sector Level EvaluationAssess effect of macroeconomic events and long term trends on individual industries

• Global / Domestic Economy: Synthesize view on the global and domesticeconomy and determine impact on all major industries

• Industry Dynamics: Consideration is given to success factors as well ascyclicality, regulatory environment, demographics, technological change,competitive landscape, event risk, etc. in determining industry weights

• Analysis may lead to a contrarian view relative to the market

Issuer Credit EvaluationApply “lender’s perspective” when evaluating individual credits

• Financial Evaluations: Analyze recent and historical financial statements,assess liquidity, underlying asset value and company forecasts

• Due Diligence: Review externally prepared company-specific research reports, analyze research on the company’s operating competitive environment

• Quantitative Modeling: Augment fundamental analysis using quantitative models

Sector Investment Thesis Issuer Investment Thesis

Assign Credit Tier Based on Overall Analysis

84

Source: U.S. Bureau of Economic Analysis.

Macroeconomic Observations and Credit Themes

Credit Committee Meeting – January 2014

7

Macroeconomic Observation Credit Theme• Interest rates rising gradually over time, above forward curve • Positive for banks & life insurance

• GDP growth still slow (below trend) • Slow growth supportive of hard asset sectors such as utilities, cable, commercial real estate, railroads and telecom

• Recovering disposable incomes as labor market improves and households deleverage via rising asset prices

• Better growth expected in durables demand but still modest growth expectations for soft goods retailers and gaming

• Increased U.S. energy production through advances in fracking • Positive for energy-intensive domestic chemical producers who will benefit from lower input costs. Positive for most segments of the energy sector: E + P, Services, Pipelines, Refining, etc.

• Two consecutive years of home price increases with strong improvements in existing and new home sales

• Constructive on building materials, homebuilders and non-agency RMBS

• Ongoing deleveraging of financial sector • Bank and finance to benefit from repaired balance sheets and greater go-forward earnings stability

• Government spending recovering but remains weak • Negative on aerospace and defense sectors

• Healthcare reform expected to have mixed results for healthcare sectors

• Positive on hospitals due to higher coverage rate, negative on most sectors due to pressure on reimbursement rates

• Eurozone now out of recession with a consensus forecast of 1% growth for 2014.

• Improving prospects for export-oriented manufacturers such as heavy equipment and technology

• Chinese economy now targeting a 7.0% to 7.5% GDP growth for 2014 and shifting away from investment toward consumption

• Supportive of metals and mining sectors as well as Asia regional plays

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Moderate market position• Moderate-to-high degree of financial leverage and lower

degree of financial flexibility• Moderate volatility of revenue and cash flows with

stronger linkage to overall economic activity and consumer spending

• Weakened ability to withstand weakening economy• Potential for downgrade to high yield

Solid market position• Moderate leverage and financial flexibility with weaker

access to capital markets in times of stress• Moderate volatility of revenue and cash flows due to

stronger linkage to business cycle and/or commodity prices

• Adequate ability to withstand weakening economy. Moderate probability of credit deterioration

Strong market position• Significant barriers to entry• Low-to-moderate leverage• Good financial flexibility • Generally stable revenue and cash flows• Significant ability to withstand weakening economy• Low probability of credit deterioration

Market leader• Low leverage and high degree of financial flexibility• Above average access to equity and debt markets and

strong liquidity• Strong revenues and cash flow• Strong ability to withstand weakening economy• Negligible probability of credit deterioration

Our Investment Grade Credit Tiering System

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Our credit tiering methodology focuses on fundamental credit researchwith a view of credit stability through a full business cycle

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Examples for illustrative purposes only.

Example of Tear Sheet to Evaluate Industrial Credits

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ABC Company


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Robert Claiborne, CFADirector, Co-Head of Credit ResearchMr. Claiborne is Director, Co-Head of Credit Research at Cutwater and a member of the firm’sInvestment Strategy Committee. He joined the firm in 2000 and has worked in the financial servicesindustry since 1983. Mr. Claiborne’s responsibilities include focusing on Corporate Credit, covering theTelecommunications, Media, Technology, Healthcare, Pharmaceutical and Airline sectors. Previously, hemanaged various high yield portfolios for Orion Capital Corp., a specialty property and casualtyinsurance company, and Northstar Investment Management Corp., where he managed $2 billion in highyield mutual funds and $900 million in high yield CBOs. Mr. Claiborne has over 25 years of experience inthe fixed income markets and 10 years of experience in corporate banking. He is also a member of theAssociation for Investment Management and Research (AIMR) and the New York Society of SecurityAnalysts. Mr. Claiborne has a Bachelor of Arts (BA) degree (Honors) from the University of Virginia and aMaster of Business Administration (MBA) degree (Honors) from Thunderbird, The American GraduateSchool of International Management. He holds the designation of Chartered Financial Analyst (CFA)through the CFA Institute.

[email protected]


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Leonard ChubinskySenior Corporate Counsel & Secretary

Investment Adviser Regulatory Update SEC Rule on “Pay to Play” Practices

February 20, 2014

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SEC Rule on “Pay to Play” Practices

Investment Advisers Act of 1940 – Rule 206(4)-5• Regulates political contributions by Investment Advisers that

seek to manage assets of State and Local Governments

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Investment Advisers Act of 1940 – Rule 206(4)-5

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Source: US Securities & Exchange Commission

Why the SEC Adopted Rule on “Pay to Play” Practices

• Elected officials who allow political contributions to influence management of public pension funds violate the public trust

• Pay to Play undermines the fairness of the process of awarding public contracts

• Investment Advisers who try to influence the award of public contracts compromise their fiduciary duty to pension fund clients

• Pay to Play practices may harm pension funds which may pay higher fees or receive inferior service

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Investment Advisers Act of 1940 – Rule 206(4)-5 Prohibitions

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Under the Rule, an Investment Adviser May Not:

• Provide advisory services for compensation to a government entity client for two years after the adviser, or certain of its executives or employees, defined as “Covered Associates,” make a contribution to certain elected official or candidates

• Provide direct or indirect payments to any third party that solicits government entities for advisory business unless this third party is a registered broker-dealer or investment adviser or municipal adviser, itself subject to “pay-to-play” restrictions, or

• Solicit from others, or coordinate contributions to certain elected officials or candidates or payments to political parties where the adviser is providing or seeking government business

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Investment Advisers Act of 1940 – Rule 206(4)-5 Prohibitions

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De Minimus Exception only applies to individuals who are Covered Associates, not to the firm or entity

Exception to the Prohibitions of the Rule

• De Minimus Exception: Two year “time-out” will not apply• Covered Associate may make aggregate contributions of up to:

– $350 per election to an elected official or candidate for whom the individual is entitled to vote; or

– $150 per election to an elected official or candidate for whom the individual is not entitled to vote

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Investment Advisers Act of 1940 – Rule 206(4)-5 Exceptions

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Exception to the Prohibitions of the Rule

• Returned Contributions Exception:– Applies where investment adviser discovers the prohibited contribution

within four months of the date of the contribution and obtains return within 60 days after learning of the contribution

– Applies only to contributions that don’t exceed $350 to any one official per election

• New Covered Associates Exception:– The two year time-out will not apply to an investment adviser as a result

of a contribution made by an individual more than six months before that person becomes a Covered Associate of the investment adviser, unless that person, after becoming a Covered Associate, solicits clients on behalf of the adviser

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Investment Advisers Act of 1940 – Rule 206(4)-5 Exceptions

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Key Definitions Under IA Rule 206(4)-5

Official: any person who at the time of the contribution was an incumbent or a candidate for elective office if that office is responsible for or can influence the hiring of an investment adviser by a government entity, or who has the authority to appoint a person who has the responsibility or power to influence the hiring of an investment adviser by the government entity

Contribution: any gift, subscription, loan, advance or deposit of money or anything of value made for the purpose of influencing any election for federal, state or local office, or the payment of any debt incurred in connection with any such election, or of any transition or inaugural expenses of the successful candidate for state or local office

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Key Definitions Under IA Rule 206(4)-5

Covered Associate: any general partner, managing member, executive officer of the investment adviser, or other individual with similar status or function, or, any employee who solicits a government entity for the adviser or who supervises such a person. Covered Associate also includes any Political Action Committee controlled by the adviser or any Covered Associate

Government Entity: any state or political subdivision of a state, its agencies and instrumentalities, any pool of assets sponsored or established by any of the foregoing, and any participant-directed investment program or plan sponsored or established by any of the foregoing, such as a section 403(b), 457 or 529 plan

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Leonard ChubinskySenior Corporate Counsel & SecretaryMr. Chubinsky is Senior Corporate Counsel & Secretary at Cutwater. He joined the firm in 1995 asDeputy General Counsel and has worked in the financial services industry since 1972. Mr. Chubinsky’sresponsibilities include the oversight of all legal matters for Cutwater and its investment affiliates.Previously, he held positions in the legal departments of several securities firms and corporations.Mr. Chubinsky has a Bachelor of Arts (BA) degree from City College of New York and a Juris Doctor (JD)from New York University Law School. He is a member of the Bars of New York, Virginia, and the Districtof Columbia.

[email protected]


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Legal Disclaimer

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This presentation provides a summary of certain provisions of Rule 206 (4)-5 under the Investment AdvisersAct of 1940 relating to Political Contributions by Investment Advisers. It does not discuss all of the provisions ofthe Rule and does not constitute a comprehensive description of the content or applicability of the Rule.

This presentation is intended for informational and educational purposes only and represents the opinion of thepresenter. This presentation does not constitute the solicitation or provision of legal advice and should not beacted upon or relied upon as such. This presentation is not a substitute for obtaining legal advice from aqualified attorney. You should consult a qualified attorney regarding any specific legal problem or matter.


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Additional Information1. The investment adviser providing these advisory services is Cutwater Investor Services Corp. (the “Firm”), an investment

adviser registered with the SEC under the Investment Advisers Act of 1940, as amended. Registration with the SEC does not imply a certain level of skill or training.

2. This presentation is intended for use in one-on-one presentations and is not intended to be used as advertising nor should it be distributed to any other person.

3. All opinions expressed in this presentation are solely those of Cutwater and are subject to change without notice.

For more information, visit www.cutwater.com

It’s a Matter of Interest

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