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High Yield

What are High Yield Bonds?

High yield bonds are corporate securities with credit ratings below investment grade. Since non-investment-grade companies usually pay higher interest rates than more creditworthy borrowers, their bonds are called “high yield.” High yield bonds can be used to diversify an investment portfolio because their performance has a low correlation with investment-grade bonds such as Treasuries. Like stocks, high yield bond prices are more sensitive to the economic outlook and corporate earnings than to day-to-day interest rate fluctuations. While high yield bonds share some behavioral characteristics with stocks, their overall returns should be less volatile because their income is normally much higher.

Credit analysis is central to high yield bond investing. It focuses on individual characteristics and fundamentals of issuers as well as the downside risk of default. Portfolios of high yield bonds are diversified by industry group and issue type. Today’s vast high yield market enables portfolio managers to achieve extensive diversification by industry, issuer, as well as by the individual issue within a credit’s capital structure. By actively managing portfolios, PIMCO seeks to lower portfolio volatility while enhancing returns.

PIMCO’s High Yield Bond Experience

PIMCO started using high yield bonds as a key component in our sector rotation process in the 1980s. We introduced our first high yield mutual fund in 1992 and opened a separate account portfolio in 1994. We have an experienced team of high yield portfolio managers and credit analysts, each of whom focuses on credit analysis for certain industries. Together this dynamic team is constantly searching for ways to add value in high yield portfolios.

The principal reasons for investing in high yield bonds are diversification and the potential for superior risk-adjusted returns over a full market cycle. High yield bonds have typically had a low correlation with most other fixed income sectors, enhancing the risk return profile of a broader core fixed income portfolio over the long term. Additionally, high yield bonds have been used as a substitute for equities, given a similar return profile to the asset class and generally lower volatility.

Investment Philosophy for High Yield

PIMCO’s philosophy and approach to the high yield market is consistent with our conservative, yet innovative, approach toward the fixed income markets in general. Specifically, our high yield, fixed income philosophy embodies four key principles:

1) Bottom-up credit research incorporating top-down economic framework

2) Total return approach, not just yield focused

3) Focus on credits with best risk/return profile

4) Seek to limit risk through issuer and industry diversification

Sources of Added Value

Credit Research
PIMCO’s experienced team of credit analysts, located around the globe, is responsible for evaluating corporate credit. We place a great deal of importance on independent analysis when evaluating corporate credits. We never rely on rating agencies alone. Our staff of seasoned credit analysts rates every credit that we hold. Our research is focused on issues with improving credit profiles and prospects for rating upgrades and, therefore, greater capital appreciation potential. A prerequisite to our evaluating an issuer is access to management. We concentrate on issuers with strong underlying businesses and competitive positions.

Our credit research framework focuses on business and financial risk at the issuer level, as well as security specific risk with the structure of the issue. With respect to business risk, we evaluate the overall industry dynamics, the company’s competitive position within the industry, the quality of the business plan and the quality of management and their ability to execute on the business plan. In terms of financial risk, we evaluate a variety of financial ratios measuring leverage, cash flow, interest coverage and liquidity.

Default and spread widening risk are the dominant potential risks in purchasing corporate debt securities. Our focus on higher quality corporates, combined with our comprehensive evaluation of credits, both at purchase and on an ongoing basis, reduces the risk of downgrade or default.

There are four common criteria that each analyst will focus on: 1) business model 2) cash flow 3) balance sheet, and 4) security structure. The specific metrics and financial ratios will vary based on the industry and as a result the format of reporting the analysis will also vary. In addition, emphasis on the four factors listed above will also depend on the industry, however the general criteria applied to the analysis is consistent across our Global Credit Research team.

Macroeconomic Focus
PIMCO’s robust, top-down macroeconomic analysis of the world’s major economies sets the tone for the structure of our credit portfolios. The assessment of the direction of global economic growth and interest rates provides important insight in choosing the optimal portfolio structure and sector allocation within this strategy.

Risk Management / Controls

High yield securities are subject to greater levels of credit, and liquidity risk than other securities. High yield bonds are considered predominately speculative with respect to the issuer’s continuing ability to make principal payments. An economic downturn or period of risk aversion could adversely affect the market for high yield debt and reduce an investor’s ability to sell its securities.

In addition to PIMCO’s disciplined approach to fundamental credit research, extensive analytical tools are used to measure and monitor the risk characteristics of the portfolio. PIMCO has invested considerable resources in developing proprietary models and analytical tools that enable a robust approach to risk management. These tools are important in managing credit strategies as their flexibility facilitates analysis at the regional, sector and security level. These models include our Bonds Under Management report, which provides an extensive summary of portfolio holdings and portfolio level risk characteristics. Additionally, the PIMCO Position Blotter system provides risk and portfolio structure information, allowing for the aggregation of detailed security-level information into a variety of risk matrices including sector and issuer exposure by quality and duration bucket.

Extensive use of analytical tools allows us to maximize the value of our investment professionals and provides a dispassionate check on our investment decisions. These systems also augment our understanding of the strategies that have consistently added value to our clients’ portfolios.

How To Invest

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. PIMCO strategies utilize derivatives which may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Diversification does not ensure against loss.

This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.

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