Investment Workshop Series:
“The Expanding Credit Universe –
Avoiding Black Holes and Supernovas”
August 2004
!mk_Emerging_Markets
Presenters
Mark T. Hudoff
Mr. Hudoff is an Executive Vice President and portfolio manager. Mr. Hudoff joined the firm in 1996, previously having been associated with Bank
Credit Analyst Research Group where he worked as a fixed income strategist. He also has been associated with International City Managers
Association, Quantitative Risk Management Group and Martin Marietta Corporation as a financial analyst. He has 16 years of investment
experience and holds a bachelor’s degree in economics from Arizona State University, and an MBA in finance from the University of Chicago
School of Business.
Curtis A. Mewbourne
Mr. Mewbourne is an Executive Vice President, portfolio manager and a senior member of PIMCO’s portfolio management and strategy groups. He
is an Emerging Market and Investment Grade Credit specialist. He joined the firm in 1999, having spent the previous seven years trading fixed
income securities at Salomon Brothers and Lehman Brothers. Mr. Mewbourne has 12 years of investment experience, and holds a degree in
Computer Science Engineering from the University of Pennsylvania.
Charles Wyman
Mr. Wyman is an Executive Vice President and head of global credit research. Mr. Wyman joined the firm in 2001 from Morgan Stanley, where he
was a principal and the senior telecom analyst in high yield. He previously covered the energy sector in high yield at Morgan Stanley and was
ranked second in Institutional Investor's annual poll for 1999 and 2000. Prior to Morgan Stanley, Mr. Wyman spent ten years at Lehman Brothers in
mergers and acquisitions, corporate finance, and equity capital markets, and as an analyst for oil exploration and production companies. He has 18
years of investment experience and holds a bachelor’s degree from Harvard University and an MBA from Harvard Business School.
.
1
Agenda
 Credit Research Process
 Global Credit
 Global High Yield
2
Credit Research Objectives
 Identify and communicate investment actions that generate measurable excess return
through specific investments made or investments avoided.
 Identify, quantify, and manage credit risk in specialist and generalist portfolios.
3
Credit Research Functions
Objective
Description
Measurement
 Avoid black holes
 Avoidance of defaults
Tracked and included in year-end evaluation
 Review of new issues and new
idea generation
New issue calendar dictates pace of review
Quantitative performance of recommendations
Every addition to the portfolio requires note
from the analyst
Qualitative review of responsiveness to PM
requests and clarity of recommendations
Cooperative effort between PM‘s &
analysts
 Credit monitoring
Monitor issuer performance with written
responses to earnings reports & headline
events
Quantitative measurement of productivity by
number of notes written
Qualitative review of note content and clarity
Regular company visits and meetings
with management
 Model portfolio alpha
Analyst prepare quarterly model
portfolios for their sectors with
recommendations for sector
weightings, issuer weights, and security
selection
Alpha generated versus benchmark
Focus on accountability, investment performance, and productivity.
4
Coverage Universe
 Coverage universe represents roughly €3 trillion of corporate assets: 2/3 U.S., 1/3 Europe; 80%
investment grade, 20% high yield.
 Pimco has rated over 40% of issuers in the coverage universe, which accounts for 60% of
market value and 66% of risk dollars.
Coverage Universe
($millions except for issuer data, € at 31-Mar-04)
Lehman
investment grade
corporates
Merrill Lynch
high yield
master
Merrill Lynch
euro investment
grade
corporates
Merrill Lynch
euro 3% high
yield
corporates
total
Market Value
$1,241,234
$404,564
$912,626
$58,872
$2,617,296
Risk Dollars
$1,455,273
$958,153
$495,793
$89,244
$2,998,463
Parent Issuers
621
909
393
134
1,914
Market Value
Risk Dollars 1.
47%
49%
15%
32%
35%
17%
2%
3%
100%
100%
32%
47%
21%
7%
107%
Parent Issuers
2.
1. Risk dollars = (bond exposure x beta corp)/ (beta corp for total holdings)
2. 7% of issuers in the universe have both USD and Euro issues outstanding.
Source: PIMCO, Lehman & Merrill Lynch index data
5
PIMCO’s Internal Rating System
Fundamental Credit Analysis
 No bond may be purchased for
client portfolios prior to research
from our credit analysts
Criteria
Rating System
Implications for Analysts
Green Light
 Credit selection a two-stage
process
 Fundamental analysis
 Relative value
 Credit opinions include five
elements
 Independent credit rating
(BBB, BB, etc.)
 View on company outlook
(positive, neutral, negative)
 Risk rating (red, yellow,
green)
 Analysis of relative value
 Buy/sell recommendation
 Color system used to assess
credit risk, not relative value
risk relative to rating is
stable to improving or
where any credit
deterioration is unlikely
to have any significant
impact on price
Ongoing review
Initial warning if exposures
become too large
Yellow Light
presence of significant
current or prospective
risk
Close monitoring of
up/downgrade potential
Positive
Red Light
viability of the issuer as
a going concern in
serious question
Investigate & communicate the
firmwide risk position in the
credit
Estimate recovery rates
Goal: Select the best credits and avoid defaults
6
credit_phil_06 red green light
Issuer and Security Selection
Start with the definition of credit: what is credit?
 Credit is the risk associated with an issuer’s ability to repay obligations as they come due.
 Credit is not asset coverage, credit is not relative value, but both play an important role in
the analysis of credit.
Risk profile of credit differs markedly from other fixed income asset classes
 Linkages between credit risk and broad macroeconomic trends are indirect and complex
 Granularity of different types of credit risk is high and the relationships between those risks
are complex and unpredictable
 Risk at the level of individual credits is virtually unhedgable
7
Issuer and Security Selection
Principals of Credit Analysis
 Articulate assumptions that support our judgments on which outcomes are most likely for
an individual credit.
 Marry granular analysis of individual credit with broader secular industry view to develop
investment action.
 Seek credits with the strongest foundations of balance sheet, cash flow, management, and
industry position.
Three tests for an investment recommendation
 Does the investment thesis make sense?
 Do we as an investor have an edge and what is that edge?
 Can we control our risk through collateral value and structure?
8
Issuer and Security Selection
 Identify and prioritize by relevance the 4-5 factors tha determine success of an investment.
 Factors are different for every credit, every industry, and every phase of the industry cycle.
Key Factors in Credit Selection
Business Model
Cash Flow
Balance Sheet
Structure
• Strength &
profitability of
competitive position
• Size
 Leverage
• Seniority
• Pace of
technological
innovation
• Stability
 Liquidity
• Covenants
• Visibility
 Financial flexibility
• Growth
 Asset coverage
• Access of capital
through the cycle
• Return on assets
• Management track
record and
accessibility
• Transparency of
financial reports
9
Credit_phil_16a
Issuer and Security Selection: balance sheet
Analysis of Telecom Italia Net Balance Sheet
(Є millions)
Net Assets
30-Jun-03
Accounts Receivables
Net Capital
17,405
31%
636
1%
1,891
3%
Accounts payables
(5,436)
(10%)
Other payables
Accrued expenses and deferred income
(7,427)
(2,344)
(13%)
Inventories
Accrued income and prepaid expenses
Advances
non financial working capital
30-Jun-03
Short-term debt
4,378
8%
(4%)
Current portion of LT debt
2,969
5%
(454)
(1%)
Due to banks
6,857
12%
4,271
8%
25,970
46%
5,677
10%
Cash and Cash Equivalents
(5,957)
(11%)
ST Financial Assets
(3,430)
(6%)
Debentures
Convertible debentures
PPE, net
18,737
33%
Investments
2,864
5%
Intangible assets
6,511
12%
Goodwill
31,666
56%
Other
Reserves
4
(7,473)
0%
Net Assets
56,580
(13%)
100%
net debt
Minority interests
Shareholders' equity
Net Capital
36,464
64%
4,098
7%
16,018
56,580
28%
100%
Source: PIMCO, Company reports
PIMCO may or may not own the securities referenced and, if such securities are owned, no representation is being made that such securities will continue to be held.
10
Issuer and Security Selection: cash flow
Analysis of Tyco Cash Flow
($millions)
Sep-98
EBITDA
Electronics
969
Telecommunications
297
Healthcare & Specialty Products
703
Fire & Security Services
863
Financial Services
Flow Control Products
560
19%
subtotal
3,392
General & Administrative Expense
(49.4)
Interest Income
62.6
EBITDA
$3,405
0.3
Cash Interest
(251)
Cash Taxes
(346)
Other
(55)
Working Capital
(272)
Capital Expenditures, net
(5,646)
Capital Stock Issuance
1,310
Dividends
(303)
Debt assumed in acquisitions
(260)
Acquisition adjustments & other
843
Free Cash Flow
(1,822)
Net Debt
4,183
Sep-99
1,213
356
1,614
1,268
Sep-00
2,918
589
1,762
1,470
709
20%
5,160
(114.9)
61.5
$5,106
834
21%
7,574
(179.9)
75.2
$7,469
(509)
(210)
37
(7)
(5,844)
235
(188)
(1,629)
(902)
(4,178)
8,360
(814)
(455)
41
263
(6,938)
601
(86)
(244)
(227)
(1,374)
9,734
Dec-00
935
108
489
480
-
Mar-01
1,030
101
513
477
reclassified
2,012
(54.8)
$1,957
2,121
(25.3)
$2,096
(168)
(332.2)
87.6
(630)
(3,214)
(442)
(22)
(1,358)
59
(4,062)
13,797
(227)
(478.8)
322.5
(93)
(3,355)
(344)
(22)
(257)
124
(2,235)
16,032
Source: PIMCO, Company reports
PIMCO may or may not own the securities referenced and, if such securities are owned, `no representation is being made that such securities will continue to be held.
11
Issuer and Security Selection: comparable security analysis
Analysis of Dynegy Inc. Relative Value
($millions)
2002
credit
Market 16-Apr-03
EBV
debt
ebit
ebitda
ebit
cvg
ebitda
lev
cfo/
debt
debt/
cap
px
3,829
4,863
1,171
1,600
3.92x
3.0x
17.7%
56%
7.625% Sr Nts '11
52
1,392
299
411
3.11x
3.4x
15.4%
8.125% Sr Nts '12
5,049
12,979
790
1,565
0.64x
8.3x
Caa2/CCC+ 8.75% Sr Nts '12
2,590
6,681
531
1,096
1.16x
Calpine Corp.
B1/B+
8.5% Sr Nts '11
3,851
14,099
781
Mirant
Caa2/BB
8.3% Sr Nts '11
5,231
9,569
NRG Corp.
Ca/CC
7.75% Sr Nts '11
2,237
9,176
company
rating
issue
TXU Energy
Baa2/BBB
7% Sr. Nts. '13
IPALCO (AES)
Ba1/BB-
Williams Cos
Caa1/B
Dynegy Inc.
ytw
oas
103.88
6.46%
249
96%
104.50
6.92%
323
(4.2%)
72%
95.63
9.59%
573
6.1x
9.0%
72%
83.00
11.91%
818
1,241
1.89x 11.4x
7.6%
79%
65.63
16.47%
1,296
1,085
1,450
2.50x
6.6x
9.4%
65%
55.63
19.43%
1,585
570
840
0.92x 10.9x
6.0%
80%
37.63
23.00%
1,814
Dynegy 2003E pro forma new bank line
Source: PIMCO, Company reports
PIMCO may or may not own the securities referenced and, if such securities are owned, no representation is being made that such securities will continue to be held.
12
Issuer and Security Selection: asset valuation
Analysis of Invensys plc Collateral Value
(million sterling)
ltm 30-sep 03
EBITDA
£51
22
41
64
92
76
23
subtotal
369
Process Systems
Eurotherm
APV
Rail Systems
Climate Controls
Appliance Controls
Powerware & LHB
add/deduct
multiple
low
high
7.8x
8.8x
8.0x
9.1x
7.9x
9.1x
11.7x
13.3x
7.9x
9.0x
6.9x
7.9x
5.4x
6.5x
Pensions
Tax
Litigation/environmental
Factoring
Minority Interests, Earnouts
Escrow
Cash
Enterprise Value
debt
coverage
low
high
184%
214%
184%
214%
184%
214%
184%
214%
815%
1098%
165%
230%
Term A
Term B
Revolving Credit Facility
Bonding Facility
2nd Lien Facility
Senior Notes
total debt
Equity Value
net value
low
high
£400
£450
175
200
325
375
750
850
725
825
525
600
125
150
£3,025
£3,450
(786)
(126)
(111)
(180)
(225)
586
489
2,672
(786)
(126)
(111)
(180)
(225)
586
489
3,097
(350)
(450)
(250)
(400)
(150)
(650)
(2,250)
£422
(350)
(450)
(250)
(400)
(150)
(650)
(2,250)
£847
Source: PIMCO, Company reports
PIMCO may or may not own the securities referenced and, if such securities are owned, no representation is being made that such securities will continue to be held.
13
Agenda
 Credit Research Process
 Global Credit
 Global High Yield
14
Benefits of PIMCO’s Global Credit Process

Our global resources and expertise – portfolio managers and research

Unique credit philosophy, multiple sources of added value in portfolio construction

Consistent outperformance – with a focus on risk-adjusted returns
Global resources, multiple sources of alpha, and risk controls lead to consistency of performance
15
Global_credit_orga_01a
Global Credit Portfolio Management
Drawing on Regional Expertise
 Defines global themes
Global Credit Portfolio Management Team
 Serves as risk regulator
Hinman/Kiesel/Mewbourne
 Portfolio construction and
monitoring
Continental
Europe
Lead Portfolio
Manager:
Mead
U.K.
Bentley
U.S.
Australia
Asia
Kiesel
Palghat
Masanao
Sovereign &
Supranationals
Emerging
Market
High Yield
Mariappa
/ El-Erian
El-Erian
Kennedy
 Focus on credits within region/sector
 Handle local execution
 Monitor daily credit developments
16
Global_credit_orga_02
Global Credit Research Team Organizational Structure
Charles Wyman
Executive Vice President
Director of Global Credit Research
Ivor Schucking
Oversees global credit research effort
Senior Vice President
Director of European Credit Research
Oversees European research
Reports to Director of Global Credit Research
Credit Analysts
U.S. 14
U.K. 2
Germany (dit)* 5
Australia 1
Financials
Utilities
Consumer Non-Cyclical
Consumer Cyclical
Auto
Michael Chang
Greg Gore
Brian Kim
Rolando Rodrigues
Bob Sahota
Ivor Schucking
Elissa Johnson
Murphy McCann
Tim Shaler
Sofia Ramos
Bob Sahota
Greg Gore
Brian Kim
Murphy McCann
Monika Nemeth
Rolando Rodrigues
Marion Scherzinger
Adam Borneleit1.
Dhruv Mallick
Greg Gore
Brian Kim
Rolando Rodrigues
Marion Scherzinger
David Andrews
Michael Chang
Industrials
Energy
Communications
Basic Industry
Workouts
David Andrews
Michael Chang
Juergen Dahlhoff
Elissa Johnson
Bob Sahota
Juergen Dahlhoff
Donna Riley
Adam Borneleit1
Cyrille Conseil
Greg Gore
Brian Kim
Richard Mak
Dhruv Mallick
Christian Wild
Monika Nemeth
Elissa Johnson
Juergen Dahlhoff
Donna Riley
David Behenna
Charles Wyman
* Deutscher Investment-Trust Gesellschaft für Wertpapieranlagen mbH
1 Adam Borneleit covers emerging market corporates with the support of the industry specialists in addition to gaming, lodging, broadcasting as the primary analyst.
17
Global_HY_Orga_01
Portfolio Managers and Credit Research Interaction
Daily
Weekly
Quarterly
 Daily credit market e-mails
 Global credit team meetings
 Portfolio strategy meetings
 Informal discussion of market
conditions and company news
 Determine research priorities
 Investment committee input
 Review portfolio construction
issues relative to client guidelines
and objectives
 Review of model portfolio
 Establish broad portfolio targets
for maximizing return relative to
risk
 Construction and distribution of
GIGC model portfolio
The importance of good and timely communication
18
Global credit phil 05
PIMCO’s Alpha Generation Process
Relative
Value
Portfolio
Construction
 Active trading
 Investment Committee
alpha
 Other credit markets:
 PIMCO’s Risk Controls
– European High
Yield
 Cyclical / Secular
Forum
– Bank Loans
– High Grade
Credit Selection
– Convertibles
– Emerging Markets
 Bottom-up research
 Onsite visits
 Financial modeling and
forecasts
19
global_credit_phil_06
Global Investment Grade Credit Portfolio Construction
BB /
CrossoverCorporates,
EM,
Sovereigns
Higher Yielding Sectors
 Modest exposure in a diversified fashion
Bank Loans,
Convertible
Bonds, Asset-Backed
and Credit Derivatives
Non-traditional instruments/sectors
 Use tactically (relative value) versus
comparably rated corporates/sovereigns
Middle tier
Middle Tier Corporates/Sovereigns
 Improving credit fundamentals with
compelling a structure and good
yields
Core holdings
Upper Tier Corporates/Sovereigns/Agencies
 Strong credit profiles
 Liquid instruments
Our focus is on upper and middle tier – most clients permit us to use, tactically, other
areas of the credit spectrum
20
Global credit phil 03
Portfolio Construction Taps Multiple Sources of Added Value
Top Down Strategies

Diversified industry and issuer exposure
constitute the core risk position
Duration/Curve

Quality
Only moderate risk is taken in
each area
Industry
Correlation with
Quality

Sector
No one or two positions will drive overall
portfolio returns
US
US Treasuries
% of Index
AAA
0.93
19.71%
AA
0.93
14.75%
A
0.88
36.02%
BBB
0.78
30.12%
Credit
Industry
Issuer
Capital Structure
Bottom Up Strategies
21
Global credit phil 02
Legal & Covenant
Investment Grade Corporate Fundamentals
Positives
Negatives/Risks
 Accommodative monetary policy has improved
economic fundamentals
 Current valuations of corporate bonds have factored in
most of the positives with current yields in certain
sectors not compensating for risk taken
 Risk appetite has been high, reducing risk premium
demanded by investors, driving prices higher
 Whilst corporates have done much to strengthen
balance sheets, leverage remains high
 Foreign demand for US corporate bonds has been
high
 Corporate credit spreads set to underperform in a
rising interest rate environment due to corporates
maintaining higher leverage
 Corporate default rates have fallen to historical lows
after the highs of 2002 and corporate earnings have
been meeting or exceeding expectations
 Corporate bond supply has been muted given focus of
companies to strengthen balance sheets and reduce
debt – capital spending has also been subdued
22
How Would We Construct A Global Credit Portfolio Today?
 Duration
– US: Under
– Euroland: Over
– UK: Neutral
– Asia: Under
 Sector
– Underweight Mortgages
– Underweight Corporates
%
Index
Sector
Quality
% DWE
AAA
18
AA / A
32
Governments/Swaps
AAA
40
20
Agencies
AAA
1
1
High Yield
BB
.5
2.5
Emerging Markets
BB
4
.5
Munis
AAA
1
1
Net Cash
A1+
3.5
AA+
100
27
Mortgage Securities
(GNMA, FNMA, FHLMC)
48
Corporates
-
– Overweight International
– Overweight Emerging Markets
 Quality
100%
– AA / A
* Average weighted as of May 31, 2004.
The structure of the portfolio is subject to change.
The credit quality of the investment in the portfolio does not apply to the stability or safety of the fund.
23
Stru_1270_01
Agenda
 Credit Research Process
 Global Credit
 Global High Yield
24
PIMCO High Yield Background
As of June 30, 2004
Firm History and
Assets
 Founded in 1971
 Formed PIMCO Advisors in 1994
 Majority interest acquired by Allianz in 2000
Assets
Fixed Income
$367.0 B
High Yield Mandates*
Equity
24.9 B
Total
High Yield
Experience
16.4 B
$391.9 B
 Global high yield portfolio management team in Newport Beach, London, and
Munich (Deutscher Investment-Trust Gesellschaft für Wertpapieranlagen mbH)
with extensive experience
 22 dedicated credit research analysts
Past performance is no guarantee of future results.
* Does not include CDO business assets.
25
high_yield_asst_09d
PIMCO’s High Yield Product Breadth
As of June 30, 2004
Ray Kennedy
Head of High Yield Products
Charles Wyman
Director of Credit Research
Mark Hudoff
Portfolio Manager
High Yield Mandates
Specialty Products
Euro High Yield
$ 1.25 B*
U.S. High Yield
$ 16.2 B*
Global High Yield
$ 0.5 B*
Bank Debt
$ 5.1B*
Convertibles
$ 0.2 B*
Yuri Garbuzov
Portfolio Manager
Ray Kennedy
Portfolio Manager
Mark Hudoff
Portfolio Manager
Jason Rosiak
Portfolio Manager
Mark Hudoff
Portfolio Manager
Axel Potthof
Portfolio Manager
Mark Hudoff
Portfolio Manager
Yuri Garbuzov
Portfolio Manager
Greg Miller
Trader
Yuri Garbuzov
Portfolio Manager
Alex Struc
Assistant Trader
Jason Rosiak
Trader
Alex Struc
Assistant Trader
Bob Boyd
Assistant Trader
Jason Williams
Assistant Trader
U.S. Credit Team
European Credit Team
Product Management
Charles Wyman
Ivor Schucking
Craig Dawson
Director of Global Credit Research
Director of European Credit Research
David Andrews
Richard Mak
Jurgen Dahlhoff
David Behenna
Dhruv Mallik
Elissa Johnson
Murphy McCann
Sofia Ramos
Monika Nemeth
Rolando Rodrigues
Donna Riley
Marion Scherzinger
Tim Shaler
Christian Wild
Workout Consultant
Adam Borneleit
Michael Chang
Cyrille Conseil
Nicolette Beyer
Greg Gore
Australia/Asia Credit Team
Brian Kim
Bob Sahota
* Based on strategic mandates.
High_yield_products_aum
26
Benefits of PIMCO’s Global High Yield Process
 Focus on risk adjusted returns
 Credit selection process that emphasizes credit fundamentals, but which incorporates
PIMCO’s macro views
 Extensive experience in credit analysis and portfolio management
– Ray Kennedy has more than 17 years experience in credit research and portfolio
management*
– Mark Hudoff has more than15 years experience in credit research and portfolio
management, including 4 years of experience focused exclusively on European high
yield *
– Global research team in the U.S. Europe and Asia with 24 analysts
 Resources and experience to migrate among multiple sectors
 High yield track record
– Consistent outperformance relative to the benchmark of the broad high yield universe
– Low tracking error / high information ratio
 Focus on risk controls and processes that help to limit downside risk and reduce volatility
 Unparalleled global platform
* Years of experience include firms other than PIMCO.
27
Global_HY_phil_01
Global High Yield Outpaces U.S. & Non-U.S. Equity In Performance Per Risk
 Over the long run, high yield provides attractive risk-reward versus most asset classes
 Globalization of the high yield market should reinforce these results
Annualized Returns Versus Volatility of Return (1982-2003)
15
S&P/BARRA 500 Value
S&P 500
High Yield Bonds
12
Annualized Return (%)
S&P/BARRA
500 Grow th
(182 bps Outperform ance)
Wilshire 5000
MSCI EAFE
ML Corp
U.S. LT Govt
U.S. IT Govt
9
LB AAA Corp
ML Mortgage
U.S. 30 day T-Bill
6
U.S. Inflation
3
0
0
3
6
9
12
15
18
21
Standard Deviation of Return (%)*
Diversification does not ensure against loss.
28
Global_HY_Review_11
24
Global High Yield Has a Low Long-term Correlation With Other Asset Classes
Issuance of Non-U.S. Countries
25
Percentage (%)
20
 Non-U.S. High Yield
issuance is the fastest
growing segment of the
Global High Yield market
15
10
5
0
1998
 Global High Yield provides
compelling correlation
advantage when combined
with other asset classes
Global High Yield
U.S. Stocks
Non-U.S. Stocks
Mortgages
Global Bonds
Global Investment Grade
1999
2000
2001
2003
Global
NonGlobal
U.S.
Global
High
U.S. Mortgages
Investment
Stocks
Bonds
Yield
Stocks
Grade
1.00
0.48
1.00
0.33
0.66
1.00
0.22
0.13 -0.03
1.00
0.14
0.06 -0.11
0.78
1.00
0.38
0.22 -0.02
0.87
0.86
1.00
SOURCE: Merrill Lynch & Co., J.P. Morgan, Morgan Stanley, Lehman Brothers
Past performance is no guarantee of future results. The chart does not reflect any PIMCO product.
29
2002
Global_HY_review_09a
Upper Tier Spreads Are More-Than-Compensating Investors for Defaults
As of June 30, 2004
1985-2004* PIMCO Default Study
800
Breakeven Annual Spread over Treasuries
10-Year Average Spread
600
Basis Points
 The “breakeven spread
over treasuries” is the
spread needed to offset a
given level of default
losses*
 Actual spreads** over
treasuries have exceeded
breakeven levels on
average over the entire
period
569
540
400
341
167
200
96
14
0
Baa
Ba
B
 Higher quality segments,
within high yield, offer the
most compelling risk
versus reward
SOURCE: Moody's Investors Service, Salomon Smith Barney and PIMCO.
*
Breakeven spread =
1 + average 10-Yr. Treasury YTM
1 - (average price – recovery rate) (default rate) + (average coupon x 0.5) (default rate)
- (1 + average 10-Yr. Treasury YTM)
Assumed Recovery Rate = 35%
**
Average month-end absolute spread over 10-Year Treasury according to Salomon Smith Barney.
Past performance is no guarantee of future results.
30
Global_HY_Review_14
UPDATE ANNUALLY (Hinman updates)
Qualitative Improvements in European High Yield Markets
As of June 30, 2004
 Bankruptcy regimes have matured and been preliminarily tested in most countries
 Structural subordination have been reduced through industry moves to improve
unsecured creditor positions
 Transparency has improved as issuers provided investors with more information and
maintained ratings
 Cross-border M&A has yet to develop, but we’ve seen a strong surge in solid industrial
and other first time issuers that adds to diversity and depth of market
However, European high yield remains too heavily concentrated on a stand-alone basis.
As such, we like the global high yield alternative.
Sector
Percentage
Weight
Issuer
Percentage Weight in
Broad Index
Capital Goods
17.4%
FIAT
10.2%
Consumer Cyclicals
15.2%
AHOLD
5.8%
Basic Industries
12.9%
ALCATEL
5.4%
Technology & Electronics
12.0%
ERICSSON
4.2%
SOURCE: Merrill Lynch
INDEX: Merrill Lynch European Currency High Yield Index (HP00)
31
Global_HY_Review_07
PIMCO’s High Yield Philosophy – “Buy the Best High Yield Bonds”
 Bottom-up credit research incorporating top-down economic framework
 Core high yield approach with a total return orientation
 Upper tier quality focus
 Limit risk through issuer and sector diversification
 Broad opportunity set resulting from expertise in all global credit fixed income sectors
The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.
Strategy subject to change without notice. Diversification does not ensure against loss.
32
high_yield_phil_01
PIMCO Operates in a Unique Market Niche
Capital Structure
Senior Secured
Investment Grade
Focus is Here
 Upper / Middle tier of the high
yield market
 Higher quality than typical high
yield manager
PIMCO Operates Here
Issue
Rating BBB
BB
B
Most High Yield
Managers
Operate Here
 Result: Better
risk / return trade off potential
Junior Subordinated
Rating Tier
Upper/Middle
Tiers
(BB and B)*
Lower Tier
(B- and below)
1
2
Annualized
Return (%)(1)
Return
per Unit of
Volatility(2)
Correlation with
10-Yr Treasury
Returns
Correlation with
S&P 500
11.0%
1.79%
0.16
0.50
3.6%
0.30%
-0.06
0.38
January 1986 – June 2004. The chart does not reflect any PIMCO product.
Return per unit of volatility is calculated by dividing annualized return by annualized monthly volatility of return.
* Upper / middle tier is a market weighted blend that is rebalanced annually.
Past performance is no guarantee of future results.
SOURCE:
Credit
Suisse
First
Boston
Corporation,
Salomon
Smith
Barney,
PIMCO.
As defined by CSFB, Upper Tier includes split BBB, BB and split BB; Middle Tier includes B and split B; Lower Tier includes B-, CCC, split CCC and defaulted as
rated by Moody's and/or S&P. The S&P 500 Index is an unmanaged index of U.S. companies with market capitalizations in excess of $4 billion. It is generally
representative of the U.S. stock market.
The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.
Strategy subject to change without notice. Diversification does not ensure against loss.
33
high_yield_phil_07
PIMCO’s High Yield Portfolio Construction Process
5-15%
25-35%
50-70%
Out of
Sector
Strategies
Tactical
Overweights
Emerging Markets
Bank Loans
Convertibles
Attractively priced,
improving credits with
0.5%-2.5% overweight
Core Holdings
Stable credits with neutral
to modest overweight
Goal: Enhance return with less volatility
The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.
Global_HY_Phil_03
34
Outlook - Yield Will Be The Primary Driver of Returns For Remainder of 2004
Fundamentals
Positive – Continuing
to improve
+
Continued slowdown in fallen angels and a peak in default rates
+
Modest economic growth driven by fiscal and monetary stimulus
+
Emphasis on improving corporate balance sheets and raising liquidity
+/–
M & A activity is resulting in increased event risk
Valuation
Neutral – Intermediate
maturities offer best
value with less treasury
risk
Neutral – Market
technicals likely to
remain supportive
+/–
Spreads are wider than 2004 tights, but yields are still near
historical low levels
Middle and lower quality tiers offer less treasury rate sensitivity
+
Technical
+/–
Mutual fund outflows likely to slow; Institutional flows have been
slightly positive
+/–
Refinancing cycle has slowed down with treasury sell-off
35
2cs_HY_outlook_01
Appendix
Current Global Credit Sector Views
lehman credit index
sector
consumer
aggregate industry
consumer cyclical
consumer non-cyclical
% dur$
12.0%
yield
5.4%
8.9%
4.9%
oas
oas dur
146
5.7
84
6.3
strategy
beta cp rating
M
arket
weight
autos given recent
10.3 BAA+
7.3 A-
on Tobacco, Supermarkets and
Healthcare.
financial
industrial
Credits
Prefer GM to Ford. Take advantage
spread compression - balance sheet of CDS market which trades wider
improvements (+ve) vs. earnings
than cash market.
pressures
(-ve)
Underweight. Within sector focus
Buy lower rated supermarkets such
as Kroger and Albertsons
13.7%
4.3%
67
4.5
4.4 A+
Underweight. Decent fundamentals Overweight higher quality names
more than offset by rich valuations. such as Citigroup, BoA and Wells
Fargo
brokerage
6.9%
4.6%
83
5.2
5.6 A
finance companies
4.5%
4.3%
69
4.8
5.7 AA
Underweight in brokers due to rich
valuations; otherwise,
M arketweight due to stable
Underweight
insurance
3.5%
4.9%
91
6.1
6.8 A
basic industry
3.4%
5.1%
97
6.4
8.4 BAA+ M arket weight Paper which has
banking
Underweight Life P&C. Valuations
are rich for Life and fair for P&C.
improving fundamentals and
attractive valuations. Underweight
Chemicals.
capital goods
4.8%
4.8%
80
6.1
37
GS, BRK
7.6 BAA+ M arketweight stable industrials
Overweight Weyerhauser.
Underweight commodity chemicals
such as Dow.
Overweight out of index bet on
such as Environmental Services and Tyco and D.R. Horton.
underweight interest rate sensitive
sectors such as Home Builders
Current Global Credit Sector Views
lehman credit index
sector
industrial
aggregate industry
communications
% dur$
11.8%
yield
5.3%
oas
oas dur
122
6.5
strategy
beta cp rating
Overweight
high
beta telecom and
11.5 BAA+
cable/media. Underweight low beta
wirelines.
energy
5.0%
5.2%
92
7.3
Credits
Overweight Sprint, Newscorp and
Comcast. Underwieght BLS, SBC.
9.4 BAA+ Underweight E&P, Integrated Oils, COP, KM G, AHC
Oil Field Services and Refining due
to rich valuations.
technology
1.6%
4.7%
84
5.8
transportation
2.3%
5.5%
126
7.0
6.6 A-
Underweight due to rich valuations. Underweight HP. IBM . M OT.
10.0 BAA+ Slight overweight on airlines and
underweight on rails.
non corp
credit non-corporate
13.9%
4.4%
65
5.3
5.0 AA-
utilities
natural gas
2.0%
5.2%
107
6.4
9.1 BAA+
utilities
5.6%
5.0%
93
6.2
8.9 BAA+ Overweight. Focus on pipelines,
operating companies, nuclear deals,
crossovers and improving low
BBBs.
Grand Total
100.0%
4.8%
91
5.7
38
7.3 A
Focus on A class tranches of EETC
for stronger carriers such as AM R
and CAL. Underweight DAL due to
headline risk.
NRUC, EP, WM B
Sample Credit Write-up
39
credit_phil_25
Sample Risk Reports
40
global_credit_phil_07
External Research Supplements Internal Research
Short Sellers Views:
Behind the Numbers
Qualitative Models:
KMV/Moody’s Risk Metric
Independent Credit Shops:
KDP and CreditSights
Credit
Research
Process
Industry Experts:
J.S. Herold
Industry Publications &
Associations: Modern
Healthcare, Chemical
Week, EEI
Web Based Tools:
Multex
41
credit_phil_23
Risk Monitoring Tools and Approach
Spreads/Yields
vs.
Index
Industry
Overexposure &
Underexposure
Worst
Performers
Risk Control Goals
-Actively monitor credit bets
-Reduce volatility & tracking error
-Reduce account dispersion
Issuer
Overexposure &
Underexposure
Duration
Outliers
Quality vs.
Index
42
credit_phil_24