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Transcript of Legg mason
Fixed Income Investingin a Low Growth World
Dipankar Shewaram
Citywire Newcits Retreat
1-3 December 2010
This document is for Asset Managers, Fund Distributors and Authorised Intermediaries. Not for use by Private Individuals.
Page 2
Western Asset
Source: Assets under management in USD (billions), as of 30 Sep 10.
Total AUM: $469.4
7 Countries
Singapore
$2.0
New York
$164.8
London
$50.0
Tokyo
$43.0
Melbourne
$9.0
São Paulo
$15.8
Pasadena
$184.8Hong Kong
Page 3
Western Asset
Source: Western Asset as of 20 Oct 10.
Brendan A. Bowman (5 yrs) – USInvestment-Grade Credit & High-Yield Credit/Leveraged Loans
Investment-Grade CreditRyan K. Brist, CFA (17 yrs) – USBlanton Keh, CFA (10 yrs) – USTakahiro Omura, CFA (18 yrs) – JapanDipankar Shewaram, CFA (13 yrs) – UKJeffrey Van Schaick, CFA (29 yrs) – US
Stephen A. Walsh (29 yrs)Chief Investment Officer
Michael C. Buchanan, CFA (20 yrs)Head of Credit
High-Yield Credit/Leveraged LoansMichael C. Buchanan, CFA (20 yrs) – USIan R. Edmonds (20 yrs) – UKTimothy J. Settel (17 yrs) – US
Emerging Markets CreditMatthew Duda, CFA (17 yrs) – US
Portfolio Managers
Research
Rene Ledis (17 yrs) – USBasic Industries/Utilities/Energy
DeAndre L. Parks, CFA (17 yrs) – USHealthcare / Consumer Products / Retail
Davis Smith (21 yrs) – USCommunications
Ivor Schucking (19 yrs) – USFinancial Institutions
Adrian Chee (18 yrs) – SingaporeAsian Investment-Grade & Financials
Kailash Chhaya, CFA (9 yrs) – JapanCredit Analyst
David Klein (13 yrs) – UKConsumer Products, Retail
Sean Rogan (21 yrs) – AustraliaCredit Analyst
Trading
J. Gibson Cooper, CFA (23 yrs) – USChemicals, Energy, Pipelines & Gas DistributionArvinder S. Chowdhary, CFA (15 yrs) – UKEuropean High-Yield CreditThomas R. Galloway (18 yrs) – USHealthcare, Gaming, Lodging, REITS, Pharmaceuticals
Henrietta Gourlay (11 yrs) – SingaporeAsian High-Yield
Christopher N. Jacobs, CFA (22 yrs) – USDistressed, Media, Environmental, Brokerage/Insurance/Finance
Araceli M. Sibley (18 yrs) – USConsumer Products, Entertainment, Restaurants, Consumer Services, TextilesSuzanne M. Trepp, CFA (20 yrs) – USAerospace/Defense, Transportation, Retail, Food & Beverage, Tobacco
Robert Abad (21 yrs) – USEMD Credit Analyst
Marcos Collina (25 yrs) – BrazilBanks, Financials
Daniel Araujo (26 yrs) – BrazilIndustrials
Oberto Alvarez (17 yrs) – US
Chetna Mistry (13 yrs) – UK
Walter E. Kilcullen (13 yrs) – US
Charles Shia (14 yrs) – US
Kevin Ritter, CFA (12 yrs) – US
Christopher Kilpatrick (13 yrs) – USTelecom, Cable
Portfolio Analyst
Dan Alexander, CFA (6 yrs) – US
Sophala Chhoeng (5 yrs) – US Matthew Graves, CFA (5 yrs) – US
Product Specialist Shing Chi (Charles) Poon, CFA (12 yrs) – US
Jeffrey Nuruki, CFA (13 yrs) – USCredit Analyst
Taylor Dowling (9 yrs) – Australia
Ian Justice (12 yrs) – UKWhole Business Securitization
Samira Sattarzadeh (8 yrs) – UK
Vivek K. Acharya (9 yrs) – UK
Thomas V. McMahon (31 yrs) – USInvestment-Grade Credit & High-Yield Credit/Leveraged Loans
Mark A. Hughes, CFA (12 yrs) – USAutomotive, Media Non-Cable, Industrials, Building Products, Rental Service
John M. King, CFA (13 yrs) – USUtilities, Metals & Mining, Packaging, Paper & Forest Products
Tobias Grün (22 yrs) – UKFinancial Institutions
Paul S. Olsen (27 yrs) – USGeneralist, Liquidity
Edward T. Ma, CFA (8 yrs) – US
Kurt D. Halvorson, CFA (9 yrs) – US
James Newbery (15 yrs) – UKEuropean Credit
Roderick MacPhee (7 yrs) – UK
Ruchi Gupta (12 yrs) – UKEuropean High-Yield Credit
Where is growth going to come from?
Page 4
Gross National Product
Where is growth going to come from ?
GNP = C + I + G + ( X – M )
Consumers are deleveraging
Investment is not picking up
Fiscal deficits need to be cut
C = Consumption, I = Investments, G= Government Spending, X= Exports, M = Imports
Page 6
Deleveraging Financial Sector
Banks are reducing balance sheet size and improving capital significantly
96
52 53
109
9
126
-5
22
-7 -6 -9
0
-24
-7 -4
2
3322
31
11
27
100
5
30
10
31
62
2121
281
1
-31
-10
-30
-9
-26
128
-4
-40
-20
0
20
40
60
80
100
300
280
260W
ells
Far
go
Ban
k of
Am
eric
a
Citi
grou
p
JP M
orga
n C
hase
San
tand
er
BN
P P
arib
as
Lloy
ds
UB
S
HS
BC
Bar
clay
s
Cre
dit S
uiss
e
Uni
Cre
dit
Ban
co B
ilbao
RB
S
Deu
tsch
e
Inte
sa
Soc
iete
Gen
eral
e
Cre
dit A
gric
ole
Eur
opea
n A
vera
ge
US
Ave
rage
Cha
nge
in T
angi
ble
Equ
ity (%
)Change in T angible Common Equity T otal Change in Assets
Source: Citigroup. As of 25 Jun 10
Balance sheet numbers represent the change over the period year end 2008 to year end 2009.
Page 7
Unemployment Rates Remain Extremely High
Consumption to remain soft
0
2
4
6
8
10
12
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Une
mpl
oym
ent R
ate
(%)
US UK EU
Source: Bloomberg. As of 30 Sep 10.
8
Firms Look To Rebuild Profits Before Investment
-30
-20
-10
0
10
20
30
Mar 96 Sep 97 Mar 99 Sep 00 Mar 02 Sep 03 Mar 05 Sep 06 Mar 08 Sep 09
Perc
ent (
YoY)
Private Sector Business Investment Profits
Source: ONS, Western Asset. As of 31 Mar 10
Page 9
Fiscal Deficits to Continue
Government finances need to be tightened
Page 10
Equity Market Focus
Government Bonds Look Expensive vs Equities
Risk aversion has driven investors into lower risk assets pushing up their prices
Dow Jones Dividend
Yield
UST 10yr Yield
0
1
2
3
4
5
6
7
8
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Perc
ent
Source: Bloomberg. As of 30 Sep 10.
Page 12
Historical Dow Jones P/E Ratio
Stocks are NOT cheap in isolation
Dow Jones PE Ratio
0
5
10
15
20
25
30
35
40
45
50
1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
PE R
atio
Source: http://www.econ.yale.edu/~shiller/data/ie_data.xls
Stock Market Data Used in "Irrational Exuberance" Princeton University Press, 2000, 2005, updated
Robert J. Shiller
Page 13
Japan’s 20 Year Bear Market
Equity markets can fall for prolonged periods of time
Nikkei-225
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
1985 1990 1995 2000 2005 2010
Inde
x
Source: Bloomberg. As of 29 Oct 10.
Page 14
Are We In A Severe Bear Market Rally?
Equities may have further adjustments to go through
3,000
3,500
4,000
4,500
5,000
5,500
6,000
6,500
7,000
2005 2006 2007 2008 2009 2010 2011
Inde
x
600
700
800
900
1,000
1,100
1,200
1,300
1,400
1,500
1,600
Index
FT SE-100 (LHS) S&P (RHS)
Source: Bloomberg. As of 29 Oct 10.
?
Page 15
Volatility in Bond Markets:Government vs. Credit
Page 16
10 Year Treasury Yield At Historic Lows
If yields rise then passive government bond investment can bring negative returns
10-Year Treasury Yield
(LHS)
3-Year rolling volatility
(RHS)
0
2
4
6
8
10
12
14
16
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Yiel
d (%
)
0.0
0.5
1.0
1.5
2.0
2.5
3.0Volatility (%
)
Source: Bloomberg, Western Asset. As of 30 Sep 10.
Page 17
How Risk-free Is The Risk-free Rate?
European sovereign issuers protection premiums higher than corporate issuers
Corporate vs. Sovereign Risk
iTraxx Europe Main CDS
index
iTraxx Western European
Sovereign CDS index
0
50
100
150
200
250
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10
Spre
ad (b
ps)
Source: Bloomberg As of 30 Sep 10
Page 18
The Advantage of Beta Flexibility
Premium increases can lead to capital losses
iTraxx Europe Main CDS index
0
50
100
150
200
250
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10
Spre
ad (b
ps)
Source: Bloomberg, Western Asset. As of 30 Sep 10. Returns for shaded regions shown in bold.
1.13
-3.186.44
-2.89
3.26
-6.91
4.35
-5.87
1.65
-2.07
0.14
Page 19
Return Dispersion in Credit
2005/06 was about alpha - we expect similar themes for 2010/11
3.02.3
-2.4
-1.2
-4
-2
0
2
4
2005 2006
Exce
ss R
etur
n (%
)
Top Decile Bottom Decile
0.0 -1.8
59.4
-11.2
-86.4
2.6
-100
-50
0
50
100
2007 2008 2009
Exce
ss R
etur
n (%
)
Top Decile Bottom Decile
Source: Deutsche Bank. As of 31 Dec 09
Excess Returns in European Corporates
Page 20
Conclusions
• We are in a period of extreme uncertainty. Having more tools to manage portfolios is key
• Absolute government bond yields are at historically low levels against a backdrop of heightened volatility
• 2010/11 will see a large divergence between positive and negative performance of individual issuers
These are the views of Western Asset as at 30 September 2010. These are subject to change.
Page 21
Legg Mason Western Asset Global Credit Absolute Return Fund
Page 22
Why a Credit Absolute Return Fund?
• Credit sector and security selection are key to positive returns as market moves to alpha from beta; credit dispersion has been the key theme in 2010/2011
• Broad opportunity set – ability to invest in all credit sectors (investment grade and high yield)
• Increased volatility in sovereign markets therefore active interest rate management is the key to positive returns from global fixed income going forward
• Credit is a core strength of Western Asset
The above reflects current opinions of Western Asset Management.
Page 23
Legg Mason Western Asset Global Credit Absolute Return Fund
Expected sources of gross total return for target 8-10%* per annum over a market cycle
• Focused credit alpha generation
• Medium-term and opportunistic credit beta generation
• Active interest rate management
Global Credit Absolute Return and Risk Target
• Absolute return focus, with a target of 8-10% p.a. over a market cycle*
• Target 8-10% volatility*
• Target sharpe ratio of at least 1*
* This is a target and there is no guarantee that it will be met.
Some key strategy limits•Seek to invest at least 50% in investment grade securities •Duration range of +/- 10yrs•Maximum 20% foreign currency exposure•Maximum VaR limit of 20%
Other features•Daily Liquidity•Takes advantage of alpha opportunities in global credit
markets•Invests in a diverse portfolio of investment grade and high
yield credit (including emerging market credit) •Active interest rate management (can be long or short
duration)•Maximum flexibility allowing the generation of positive
returns through the credit cycle•Ability to use single name CDS (long and short) to
express views on specific issuers•Ability to use index CDS (long and short) to manage beta•UCITS III vehicle utilising VaR to measure and control
global exposure
Page 24
Portfolio Characteristics
As of 30 September 2010
Source: * Cash Bonds & Single Name CDS
Delta Adj Wht (%) Spread Duration (yrs)Duration (yrs)
Effective Duration -0.37
Spread Duration -4.63
Number of Holdings* 84
VaR 6.4%
Average Rating AA
Other Statistics
CashCash EquivalentsCurrency Forwards
US GovernmentsEuro GovernmentsUK GovernmentsNorway Governments
IG Financials*IG Non-financials*High Yield*
iTraxx MainiTraxx CrossoveriTraxx Main OptionsiTraxx Crossover OptionsiTraxx SOVXWE Options
756
-2
5
31-24
2
-127-19
010
24
0.100.13
0.35
2.02
-0.39-2.25
-0.41
0.08
0.99
0.09-1.09
-0.84
0.390
-6.22
2.04
Page 25
Legg Mason Western Asset Global Credit Absolute Return Fund
• Long: Long Financials across the capital structure
• Short: Short Non-Financials using CDS indices and single name CDS
• Interest Rate Risk: Tactical approach to duration management
• Currency: Short Australian Dollar and Euro versus long in US Dollar
Source: Western Asset as at 30 September 2010
Page 26
Legg Mason Western Asset Global Credit Absolute Return Fund
Performance since launch
Source: Legg Mason at at 30 September 2010
2.05
0.23 0.29
3.32
0.29
-2.03
-3
-2
-1
0
1
2
3
4
Since Inception 20 May 2010 May June July August September
To
tal R
etu
rn (%
)
Source: Legg Mason as of 30 September 2010. Performance shown is net of investment management fees.
Page 27
Legg Mason Western Asset Global Credit Absolute Return Fund
Net Asset Value (NAV) Since Launch
Source: Western Asset as of 12th November 2010
Val
ue
Date
Page 28
Important Information
This information has been prepared from sources believed reliable but is not guaranteed by Legg Mason Investments and is not a complete summary or statement of all available data. Individual securities mentioned are intended as examples of portfolio holdings and are not intended as buy or sell recommendations. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors.
Western Asset Management is affiliated with Legg Mason through common control and ownership by Legg Mason, Inc.. Legg Mason provides its clients with access to Western Asset Management primarily through its range of Irish and UK authorised funds in which Western Asset Management serves as investment manager or sub-investment manager. Some of the affiliates are not authorised to offer their investment advisory services in all European jurisdictions.
The Legg Mason Western Asset Global Credit Absolute Return Fund is a sub-fund of Legg Mason Global Funds plc, an umbrella fund with segregated liability between sub-funds, established as an open-ended investment company with variable capital and incorporated with limited liability under the laws of Ireland with registered number 278601. It qualifies and is authorised in Ireland by the Financial Regulator as an undertaking for collective investment in transferable securities and is a section 264 Scheme as recognised by the FSA. This Fund is offered solely to non-US investors under the terms and conditions of the Fund’s current prospectus - please refer to the Simplified Prospectus and Prospectus documentation, which describe the full risk factors associated with this Fund.
This document does not constitute an invitation to invest. The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested. Fluctuations in exchange rates can affect the value of the Fund and the income from it.
The fund may invest in ‘non-investment grade’ bonds, which carry a higher degree of default risk than ‘investment grade’ bonds.
The Legg Mason Western Asset Global Credit Absolute Return Fund may invest in emerging markets that may be less liquid and may have less reliable custody arrangements than mature markets and may involve a higher degree of risk. Unlike a bank or building society account, your money is at risk.
This Fund may invest extensively in certain types of financial derivative instruments (FDIs) for efficient portfolio management or investment purposes. These instruments involve additional and higher levels of risk including but not limited to market risk, liquidity risk, counterparty risk and operations risk.
This Fund may use eligible derivatives to hedge their foreign currency exposure back to the class currency. Hedging transactions can reduce the effects of currency and asset fluctuations but can expose additional risks, e.g. counterparty default.
Due to its investment policies, this Fund may have particularly volatile performance.
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 75 King William Street, London, EC4N 7BE. Registered in England and Wales, Company No. 1732037. Authorised and regulated by the Financial Services Authority. Client Services 0207 070 7400.
This document is for use by asset managers, fund distributors and authorised intermediaries. Not for use by private individuals.
Issued November 2010 Ref: 6168