Fresno County
Employees’ Retirement
Association
February 6, 2008
Andrew Phillips, Managing Director, Co-Head of US Fixed Income
Dan McLaughlin, CFA, Managing Director
0
Table of Contents
I.
BlackRock Update
II.
Review of Fixed Income Investment Philosophy and Process
III.
Market Review and Update
IV.
Portfolio Review
Appendices
A.
1
FCERA Guidelines Summary
BlackRock Update
Acquired fund of funds business from Quellos Group, LLC on
1 October
• Adds attractive absolute return products and enhances ability to deliver
innovative solutions to clients
• Bryan White, former Quellos CIO, leads combined fund of funds
platform with more than $28 billion1 in assets under management
New Developments
• Multi-Asset Portfolio Strategies (MAPS) group
•
Focuses on portable alpha, target and relative return, global
tactical & strategic asset allocation, LDI, and fiduciary services
• Multi-Strategy Fixed Income Alpha (MSFIA) strategy
•
Alpha engine for portable alpha product; complements MultiStrategy Hedged Equity Alpha (MSHEA) strategy
• Prepared Portfolios for DC investors: Target Date and Target Risk funds
Total Assets of US$1.36 Trillion
Alternatives / Real Estate
$71 Billion
Asset Allocation / Balanced
$139 Billion
Liquidity
$313 Billion
Equity
$322 Billion
Fixed Income
$511 Billion
Risk Management
Investment Accounting
$5.75 Trillion
$100 Billion
Institutional Client Types
Corporations
36%
Insurers
20%
• Global real estate equity and debt businesses total $29 billion
Public Funds & Union / Industry
17%
• Interest in alpha extension strategies from US, UK, and Australia
Sub-Advisory
14%
• Growth in equity strategies, particularly US large cap, natural
resources, global, European, UK, and quantitative equity
Official Institutions
8%
Non-profit & Healthcare
3%
Government Authorities
2%
• Enhanced Commodity strategy for US and non-US investors
Existing Products - Investment and Growth
• Opportunities in global bond and local currency mandates
As of 31 December 2007
1BAA
2
assets as of 1 Oct 2007; assets for BAA closed end funds reflect net asset value as of the most recent valuation date plus unfunded capital commitments
As of 31 December 2007
BlackRock, Inc. Corporate Governance
Ownership Structure
Approximately 49% Merrill Lynch & Co.; 45% voting interest
34% The PNC Financial Services Group, Inc.
17% Employees and the public
BlackRock Board Members
Current Composition
Laurence Fink
William Albertini*
NYSE Listing
BLK
Mathis Cabiallavetta*
Dennis Dammerman*
Board Composition
17 Directors: 3 BlackRock, 2 Merrill, 2 PNC, 10 independents
Bill Demchak
Robert Doll
Chairman & CEO
Laurence Fink
Kenneth Dunn*
Gregory Fleming
President
Rob Kapito
Murry Gerber*
James Grosfeld*
Executive Committee (ExCo)
Laurence Fink, Paul Audet, Robert Connolly, Bob Doll, Rob Fairbairn, Peter
Fisher, Ben Golub, Charles Hallac, Robert Kapito, Barbara Novick, Quintin Price,
Susan Wagner, and Bryan White
Robert Kapito
David Komansky*
Sir Deryck Maughan*
Operating Committee (OpCo)
Rob Kapito, Scott Amero, Paul Audet, Bob Doll, Ben Golub, Peter Hayes, Michael
Huebsch, Susan Mink, Fred Lieblich, Milan Lint, Barbara Novick, and Bryan White
Thomas O’Brien*
Linda Gosden Robinson*
James Rohr
John A. Thain
– Strategic & corporate management overseen by Laurence Fink and Sue Wagner
Organizational Initiatives
– Rob Kapito oversees day-to-day operations
– Committees work with ExCo and OpCo to streamline governance process
3
*independent
BlackRock is a Global Organization
Over 5,500 employees in 19 countries, including more than 700 investment professionals
• Seventeen investment centers in US, UK, Europe, Asia and Australia
• Clients located in over 60 countries
North America:
• Atlanta
• Boston*
• Chicago
• Durham*
• Florham Park*
• Newport Beach*
• New York*
• Los Angeles
• Philadelphia*
• Pittsburgh
• Princeton*
• San Francisco*
• Seattle*
• Wilmington*
• Regional Offices
South America:
• Montevideo
Institutional clients
*Denotes investment centers
As of 31 December 2007
4
Asia:
• Hong Kong*
• Seoul
• Singapore
• Taipei
• Tokyo*
UK, Continental Europe & Middle East:
• Amsterdam
•Stockholm
• Brussels
•Vienna
• Eindhoven*
•Zurich
• Frankfurt
•United Kingdom
• Geneva
‐ Edinburgh*
• Luxembourg
‐ London*
• Madrid
‐ Peterborough
• Milan
• Isle of Man
• Munich
• St. Helier
• Paris
Australia:
• Brisbane
• Melbourne*
• Perth
• Sydney*
Clients Benefit from Pooled Expertise of BlackRock’s Resources
“One BlackRock” reflects an organizational structure with functional, regional, and product dimensions
• Ensures consistency on a global basis
• Tailors products and services to clients and to local needs
• Promotes teamwork
• Facilitates operational integrity and efficiency
BlackRock
Total AUM of US$1.36 Trillion
Over 5,500 Employees
Account
Management
Portfolio
Management
BlackRock
Solutions®
Firmwide
Infrastructure
Pension Plans
Fixed Income
Financial Modeling
Foundations · Endowments
Equity
Investment Data & Accounting
Portfolio Administration &
Operations
Financial Institutions
Official Institutions
Corporations
Consultants
Multi-Asset Portfolio Strategies
Liquidity
Regional and Country Offices
Worldwide
5
Strategy & Product Development
Real Estate
Portfolio Analytics
Facilities Management
Alternatives
Trading Systems
Legal & Compliance
Technology
Finance
Transition Management
Human Resources
Risk & Quantitative Analysis
Private Clients
New York · Boston · Chicago
Edinburgh · Florham Park · Hong Kong
London · Princeton · San Francisco
Seattle Sydney Tokyo · Wilmington
Advisory & Hedging
New York · Boston · Durham
Edinburgh · Eindhoven · Florham Park
Hong Kong · London · Melbourne
Newport Beach · Philadelphia
Princeton · San Francisco
Seattle · Sydney · Tokyo · Wilmington
New York · Edinburgh · London
Melbourne · Philadelphia · Princeton
Tokyo · Wilmington
Diverse Products in Multiple Asset Classes and Styles
Total AUM of US$1.36 Trillion
Fixed Income: $511 Billion
US Core/Core PLUS/Core Enhanced Index
Global/Regional/Non-Dollar
US Intermediate
US Municipals
Equity & Asset Allocation / Balanced: $461 Billion
130,998
85,226
65,697
37,329
26%
17%
13%
6%
US Long
32,369
6%
US Short
Mortgages/CMBS
CDOs
LIBOR
Managed Accounts
Stable Value
Enhanced Cash
High Yield
Corporates
Bank Loan
US Inflation-Linked
Emerging Markets
Absolute Return
Preferred
28,291
24,154
22,377
14,723
14,458
12,650
10,368
10,128
6,443
5,182
3,980
2,613
1,858
1,675
5%
5%
4%
3%
2%
2%
2%
2%
1%
1%
1%
1%
<1%
<1%
193,622
62%
Tax-Exempt
49,994
16%
International
25,995
8%
Government
24,461
8%
Securities Lending
19,265
6%
As of 31 December 2007
6
13,820
75,145
65,871
55,155
23,906
20,834
15,318
15,157
13,548
10,647
8,186
6,799
6,349
5,435
30%
16%
14%
12%
5%
5%
4%
3%
3%
2%
2%
2%
1%
1%
Alternatives & Real Estate: $71 Billion
Private Equity & Debt: Private Equity FoF, BlackRock Kelso Capital
Hedge Fund of Funds: Broadly Diversified Core, Focus, Custom
Real Estate Equity: Core, Core/Enhanced Core, Value-Added, UK Property,
European Property, Australian Property
Real Estate Debt: Anthracite Capital (REIT), Carbon Capital I, II, and III
Liquidity: $313 Billion
Prime
Asset Allocation / Balanced
Index/Enh Index
US Large/Multi-Cap
Sector-Specific
UK
Global
Europe
Asia Pacific
Managed Accounts
Emerging Markets
Latin America
US Mid/SMID Cap
US Small Cap
EAFE/Non-US
Single-Strategy Hedge Funds: Diversified Fixed Income, Municipal Bond,
Credit-Oriented Fixed Income, Sector-Specific Equity, Region-Specific Equity
Capital Markets: Opportunistic Credit, Opportunistic Mortgage, CDOs,
Business Development Corporation
Commodities: Active Long-Only and Hedged, Passive/Futures-Based
Multi-Asset Class Strategies: Portable Alpha, Target and Relative Return,
Global Tactical and Strategic Asset Allocation, LDI, and Fiduciary Services
Investment Philosophy Emphasizes Relative Value
Portfolio duration is controlled within a narrow band
Value is added primarily through sector and sub-sector rotation and security selection
Representative Core PLUS Portfolio as of 31 December 2007
Years
Narrow Duration Band vs. Benchmark
Active Sector Rotation
7
100%
6
80%
5
60%
4
40%
3
20%
2
0%
Quarters Ended
BlackRock Core PLUS Portfolio
7
Quarters Ended
BlackRock Duration Band
Treasury/Agency
MBS
Corporates
ABS
CMBS
Extended Sectors
Sub-Sector Rotation Adds Value
BlackRock’s relative value approach encompasses a broad range of sub-sectors within the corporate and
mortgage sectors
All securities are evaluated within our risk management framework
Representative Core PLUS Portfolio as of 31 December 2007
Corporates/Asset-Backeds
Mortgages/Commercial Mortgage-Backeds
100%
100%
80%
80%
60%
60%
40%
40%
20%
20%
0%
0%
Quarters Ended
8
Finance
Industrial
Utility
Non-US Non-Credit
ABS
High Yield
Quarters Ended
Emerging Markets
15-Yr Generic
30-Yr Generic
ARMs
CMOs
15-Yr Seasoned
30-Yr Seasoned
CMBS/Multifamily
Investment Strategy Group Sets Macro Investment Themes
Top-down determination of investment themes based upon bottom-up inputs
Investment themes establish parameters for bottom-up sub-sector and security selection
Pre-ISG Meetings
Global Governments
Team
Global Credit Team
Global Mortgage
Team
Global ABS Team
Risk & Quantitative
Analysis Team
9
ISG Meeting
Investment Strategy
Group
Co-Chairs
Scott Amero, CIO
Peter Fisher
Risk Review
Team Presentations
Discussion
Dissent
Special Topics
Minutes
Investment Themes
Interest Rate Risk
Country/Currency
Risk
Yield Curve Risk
Cash Flow Risk
Credit Risk
Liquidity Risk
Bottom-Up Portfolio Construction is a Team Effort
Senior portfolio managers oversee groups of portfolios and determine investment needs based
upon ISG themes, mandate type, and account guidelines
• Scott Amero, CIO, and Peter Fisher are co-heads of fixed income
Core Team
Andy Phillips ∙ Stuart Spodek ∙ Matthew Marra ∙ Brian Weinstein
Steve Switzky
Kelly Campbell
Joshua Friedberg
Sector specialists source opportunities and work together to address the needs of all portfolios
• Lead sector specialists facilitate idea generation
US Govt / Agency
Derivatives
Stuart Spodek1
Peter Fisher
Matthew Marra
Jeff Jacobs
Tom Musmanno
David Sayles
Brian Weinstein
Josh Friedberg
Jack Hattem
Scott Wetzel
Non-Dollar
Global
Gordon1
Andrew
Scott Thiel1
Brita Steffelin
Yudhveer Chaudhry
Yoni Saposh
Amar Bashir
Hiroyuki Nozaki
Javier Revelo
10
Corporates
New York
Europe2
Jeff Cucunato1
Paul Shuttleworth1
Scott Amero
Adam Cohen
Michael Huebsch
Daniel McKernan
John Burger
Tom Mondelaers
Andrew Yorks
Owen Murfin
Kevin Holt
Marc Rovers
Brad Perkins
Calum Smith
Stephan Bassas
Daniel Chen
Marc Dichek
Greg Cavallo
Kristina Koutrakos
Nathaniel Toothaker
EMD
Hussain1
Imran
Daniel Ruiz
Daniel Shaykevich
High Yield
Kevin Booth1
James Keenan1
Mark Williams
Jeff Gary
Tom Colwell
Mitchell Garfin
Adrian Marshall
Derek Schoenhofen
Residential
Mortgages
Commercial
Mortgages
Eric Pellicciaro1
Dave Chesney
Ron D’Vari
Michael Lustig
Glen Perillo
Andy Phillips
Laura Powers
Kishore Yalamanchili
Colm Murtagh
Ron Sion
Daron Greene
Matthew Kraeger
Sean MacDonald
Alexander Reiss
Marshall Sebring
Matthew Rodriguez
Euro
Thiel1
Scott
Michael Krautzberger1
Jason Smith
Hans Kamminga
Michel Van der Sanden
Chris Allen
Neil Weller
¹Lead sector specialist; 2European investment centers include London, Eindhoven, and Edinburgh
Steve Switzky1
Ron D’Vari
Reginald Leese
Mark Warner
Kelly Campbell
Jeanie Spano
Andrew Kaufman
Steve Kleiman
Yen
Endo1
Shigeru
Shuji Fujita
Kunihide Takeuchi
ABS / CDO
Municipals
Todd Kopstein1
Ron D’Vari1
Reginald Leese
Kishore Yalamanchili
David Carney
Michael Khankin
Steve Ruth
Sriram Sumaithangi
Xavier Goss
AUD
Miller1
Steve
Russell Maddox
Penny Chin
Cameron Garlick
Joseph Berbari
Peter Hayes1
Ted Jaeckel
James Pruskowski
Walter O’Connor
Joe Andrews
Marie Sheehan
Margaret Heymsfeld
Sterling
Andrew Belshaw1
Stuart Niman
Panos Ferendinos
David Curtin
Deep and Experienced Team of Analysts Supports Investment Process
Research analysts are embedded within the portfolio management team
• Sit with portfolio managers in New York, Edinburgh, London, Princeton, and Tokyo
High Yield
Corporates
Peter Schwartzman1
Rob Wartell1
Zach Alpern
Philip Brendel
Dave Delbos
Anthony Heyman
Atif Malik
Chirag Patel
Paul Merwin
Ryan Mollett
Amit Patel
Melvin Rosa
1Lead
Investment Grade
Corporates - US
Doug Oare1
Matt Anavy
Ned Hole
Ann Keane
Gary Low
Keven Maloney
Keith Olsen
Karina Saade
Sandra Sullivan
Ted Stevens
Dave Taerstein
Investment Grade
Corporates – Non-US
Bruce Hamilton1
Kevin Craig
Andrew Fraser
Shuji Fujita
Christian Holder
Stephen Hunnisett
Tatiana Spineanu
Kunihide Takeuchi
Non-Corporate
ABS, MBS, CMBS
David Bai
Christian Holder
Michael Khankin
Steve Kleiman
Keith Olsen
Alexander Reiss
Gabriel Rivera
Mark Schnell
Ted Stevens
Sriram Sumaithangi
Municipals
Jack Erbeck1
Jim Schwartz1
Brian DePaulo
Chris Fornal
Susan Heide
Karen Hogan
Lidia Martinez
Tim Milway
Joe Pangallozzi
Joe Plonski
Brian Pyhel
Todd Smith
analyst
Proprietarily-developed tools aid research process
• Galileo™, our global research database, allows analysts to share, store and access information and insights across
asset classes and locations
• The Matrix™, our risk monitor, enables portfolio managers to view issuer exposure across portfolios on a real-time
basis
• Mortgage prepayment modeling provides option-based valuations and scenario analysis across a wide variety of
mortgage types
Quandamental™ process for structured finance securities
• Rigorous collateral analysis and expected loss forecasting
• Advanced modeling of complex cash flow structures
• Proprietary ongoing deal surveillance using updated econometric models
11
BlackRock is a Leader in Risk Management
Risk events have increased investor awareness and sensitivity
Investment success reflects significant commitment to people and systems since inception of firm
• Global research team includes approximately 50 analysts
• BlackRock Solutions® has over 1,000 professionals and $5.75 trillion under risk management
Risk-aware culture focuses on providing consistent, risk-adjusted returns
Benefit of risk management tools is highlighted during periods of increased market uncertainty
Risk Events Impact Results
1994: Cash Flow Risk
Mortgage prepayments slowed
dramatically as the Fed
tightened
n
g
12
1994 Return
High
Median
Low
BLK MBS
LB MBS
(%)
0.44
-1.72
-8.38
0.17
-1.61
1998: Liquidity Risk
LTCM had broad market impact
n
g
n
g
1998 Return (%)
High
11.22
Median
8.68
Low
2.19
BLK Core
9.06
LB US Agg
8.67
n
2002: Credit Risk
Corporate debacles resulted
in numerous downgrades and
high profile bankruptcies
g
n
g
2002 Return (%)
High
13.08
Median
9.78
Low
2.93
BLK Core
10.18
LB US Agg
10.26
Mortgage-Broad Market and Active Sector Rotation Manager Universe. Source: (c) Frank Russell Company © Russell/Mellon Analytical Services LLC, 1999. All rights reserved.
n
g
U.S. Economy and Markets in Review
Fixed Income Market Performance
Equity Market Performance
Interest rates closed the quarter lower as uncertainties surrounding
monetary policy, housing weakness, and credit market turmoil resulted in a
massive flight to quality.
Capping off a volatile year, U.S. equities experienced severe pressure
during the final two months of trading. Uncertainty related to housing
weakness and the credit crisis resulted in a significant decline in consensus
earnings expectations, pummeling a market which was already disappointed
by the extent of Fed easing in December.
4Q07
2007
Lehman US Aggregate
3.00%
6.97%
Lehman Global Aggregate - Hedged USD
3.26%
9.48%
Lehman Universal
2.67%
6.50%
Lehman US TIPS
4.97%
11.63%
4Q07
2007
Dow Jones Industrial Average
-4.54%
6.43%
S&P 500
-3.82%
3.53%
Nasdaq Composite
-1.82%
9.76%
Economic Data
Gross Domestic Product
Core CPI and PPI
Annual Rates, Reported Quarterly
(Year-over-Year)
9.5%
3.0%
7.5%
7.0%
5.6%
2.0%
4.9%
4.0%
4.5%
3.5%
2.7%
2.0%
4.2%
3.9%
3.8%
3.4% 3.3%
3.1%
2.6%
1.8%
1.0%
2.6%
2.5%
2.0%
1.2%
0.6%
0.0%
-0.5%
-1.0%
-3.0%
2003
2004
2005
2006
2000
2007
2001
2002
2003
2004
Core CPI
2005
2006
Core PPI
2007
Source: Bloomberg
Summary
The FOMC lowered the benchmark interest rate by 75 basis points to 3.50% on January 22nd, the biggest single cut since 1982. The emergency reduction came a
week prior to their regularly scheduled meeting, as the Federal Reserve was confronted with a global stock sell-off fanned by increased fears of a recession. The
discount rate was also lowered by the same amount to 4.00%. Policymakers stated they took the action “in view of a weakening of the economic outlook and
increasing downside risks to growth.” The Fed has now cut its target rate by a sharp 1.75 percentage points since August 2007.
13
U.S. Economy and Markets in Review
Economic Data
2-Year Treasury Yields vs.
Fed Funds Target Rate
Home Sales and Prices
Y-O-Y Growth, %
6.0%
5.0%
4.0%
3.0%
2.0%
2-Year Treasury Yield
Fed Funds Target Rate
Dec-07
Oct-07
Aug-07
Jun-07
Apr-07
Feb-07
Dec-06
Oct-06
Aug-06
Jun-06
Apr-06
Feb-06
Dec-05
Oct-05
Aug-05
Jun-05
1.0%
25
20
15
10
5
0
-5
-10
-15
-20
-25
2000
2001
2002
2003
Existing Home Sales
2004
2005
2006
2007
Median Existing Home Price
Source: Bloomberg
Growth
The U.S. economy expanded at a 4.9% annual pace in the third quarter, revised from a previously estimated 3.9%. The change was caused by an
upward revision in private inventory estimates and a better trade balance. This growth compares with gains of 0.6% and 3.8% in the first and second
quarters, respectively.
U.S. employment posted its smallest increase in over four years while the jobless rate hit a two-year high, as the housing downturn continued to take
its toll in December. Payrolls grew by 18,000 after a 115,000 increase in November. The unemployment rate rose to 5.0% from 4.7% in November.
Average hourly earnings rose 0.4%, and were 3.7% higher from a year earlier.
U.S. consumer confidence unexpectedly rose in December due to an increase in consumers’ expectations for the state of economic activity in the
near future. The Conference Board’s Index of Consumer Sentiment rose to 88.6, the first gain in five months, from a revised 87.8 in November.
Orders for U.S.-made durable goods increased by 0.1% in November, following a 0.4% decline in October. Excluding transportation goods, orders fell
0.7%.
Housing starts declined 14% in December to an annual rate of 1.006 million. For all of 2007, starts were down 25%. Building permits slid to the lowest
level in 12 years, falling 8.1% to a 1.068 million annual pace. New home sales fell 4.7% in December to a seasonally adjusted annual rate of 604,000,
also a 12-year low. Year-over-year new home sales were down 26%. Existing home sales fell 2.2% in December to an annual rate of 4.89 million,
declining 13% for all of 2007.
Inflation
Headline consumer prices increased 0.3% in December, bringing the year-on-year rate to 4.1%. Excluding food and energy, CPI climbed 0.2% and is up
2.4% year-on-year. U.S. producer prices fell 0.1% in December, following a 3.2% gain in November. Headline and core PPI rates are up 6.3% and 2.0%
year-on-year, respectively.
14
Treasury and Agency Securities
Agencies
Treasuries
Treasuries sold off following the Fed’s announcement of their new
Term Auction Facility (TAF), designed to help ease liquidity
concerns over year end. The curve steepened 4 bps in December,
as the 2-year rose 5 bps while 10-year yields climbed 9 bps,
closing the year at 3.05% and 4.02%, respectively.
Agency debt posted positive excess returns in December. Though
excess returns were still negative for the year, agencies were the
best performer among spread sectors. GSE portfolios continue to
shrink which has kept long-term debt issuance light.
Duration-Adjusted Excess Returns
Total Returns
US Treasuries
4Q07
2007
3.96%
9.01%
US Agencies
-0.56%
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
30y
1993
10y
0
1992
5y
200
1991
3m 2y 3y
400
1990
06/30/2007
09/30/2007
12/31/2007
$ Billions
Yield (%)
-0.12%
600
Source: US Treasury
Source: Bloomberg
Portfolio Strategy
Short duration versus the index with a bias to position the portfolio for a yield curve steepener.
Continue to be underweight agencies, but have opportunistically added to gain swap spread exposure.
15
2007
Net Purchases of US Fixed Income Securities
by all Foreign Investors – 6-Month Rolling Sum
Yield Curve Shifts
5.3%
5.0%
4.8%
4.5%
4.3%
4.0%
3.8%
3.5%
3.3%
3.0%
2.8%
2.5%
4Q07
Investment Grade Corporate Bonds
Outlook
Investment grade credit gained 8 bps over duration-matched Treasuries in December. The 25 bps cut by the Fed in the middle of the month
disappointed market participants who were looking for a larger reduction to help stem the slowdown in economic activity. However, subsequent
steps by the Fed and other central banks to relieve short-term funding pressures helped to lead a rally in credit. Despite announcements of
further write-downs related to subprime mortgage investments, capital was still readily available to most large financial institutions as evidenced
by convertible and preferred issuance out of Fannie Mae, Freddie Mac, Citigroup, and Wachovia. Lastly, the announcement that Citigroup would
take its seven SIVs back on balance sheet was a net positive for the broader credit market and helped support credit into the quiet holiday period.
Duration-Adjusted Excess Returns
4Q07
2007
Lehman Credit Index
-2.36%
-4.64%
Corporate
-2.62%
-5.23%
-Industrial
-2.05%
-3.83%
-Utility
-2.27%
-4.81%
-Financial Institutions
-3.33%
-6.87%
-0.82%
-1.33%
Lehman Credit Index: OAS versus
Credit Quality Composition
Investment Grade Corporate Bond Gross Issuance
Baa = 22%
OAS = 97
800
588
600
500
425
400
290
126
149
150
313
431
338
326
336
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1995
0
1994
100
250
80
200
60
40
150
100
20
50
0
0
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
80
1997
200
1996
300
100
561
444
% of Index
$ Billions
700
Baa = 32%
OAS = 181
OAS in bps
Non-Corporate
Aaa
Aa
A
Baa
Credit OAS
Source: Lehman Brothers
Portfolio Strategy
Opportunistically adding exposure through attractively valued new issues. Prefer the shorter end of the curve where swap spreads are wider
and breakevens more attractive.
Favor financials over industrials and are biased towards high quality, non-cyclical credits.
16
Mortgage-Backed Securities
Outlook
Mortgages posted 11 bps of excess return versus Treasuries in December. The basis, along with most other high quality spread sectors, benefited
from tighter swap spreads and better than expected financing over year end. The underperformance across spread products in November was
primarily due to investors preparing for a wave of delevering trades at distressed levels in December, as financing over year end was expected
to be extremely difficult and at highly unattractive rates when available. These concerns were allayed with the announcement of the Fed’s
newly created Term Auction Facility program which made $40 billion in financing available over year-end to a wide array of investors, as well as
news that many large financial institutions secured new capital, eliminating the need for “fire sales” to delever balance sheets. While mortgages
outperformed Treasuries, they underperformed CMBS, investment grade corporates, and swap spreads in December.
Duration-Adjusted Excess Returns
4Q07
2007
Lehman MBS Index
-0.21%
-1.77%
30-year
-0.28%
-2.01%
15-year
0.01%
-1.28%
Hybrid ARM
-0.09%
-1.08%
All MBS Holdings by Large Banks: October 1996 - Present
800
2.5
700
$ Billions
3.0
2.0
1.5
600
500
400
Source: Bloomberg
Portfolio Strategy
Remain overweight MBS, with a bias toward premium (above par) coupons relative to discounts within pass-throughs.
Continue to look for opportunities in high quality, but less liquid assets in the CMBS, ABS, ARM and CMO markets.
17
Dec-07
Jul-07
Feb-07
Sep-06
Apr-06
Jun-05
Nov-05
Jan-05
Aug-04
Mar-04
Oct-03
Dec-02
May-03
Jul-02
Feb-02
Sep-01
Apr-01
Jun-00
Nov-00
100
Jan-00
Aug-07
Mar-07
Oct-06
May-06
Dec-05
Jul-05
Feb-05
Sep-04
Apr-04
Nov-03
Jun-03
Jan-03
200
Aug-02
0.5
Mar-02
300
Oct-01
1.0
May-01
Millions
Housing Starts
Source: Federal Reserve
Commercial Mortgage-Backed Securities (CMBS)
Outlook
Volatility continued in the Commercial Real Estate sector in December, with CMBS posting 107 bps of excess return. CMBS triple-A spreads to
benchmark swaps tightened as a number of fast money investors and dealers covered short positions in the synthetic CMBX product by using cash
bonds as a substitute as the basis was dislocated. Four deals came to market totaling $6.6 billion, down from an average monthly issuance in 2007
of $25 billion, as the origination of loans in the commercial real estate space is grinding to a halt. Limited issuance has caused thinly traded
subordinate cash spread visibility to remain weak. Underlying commercial real estate fundamentals remain sound and CMBS delinquencies are at
historically low levels.
Duration-Adjusted Excess Returns
Lehman CMBS Index
4Q07
2007
-2.17%
-4.35%
Seasoned CMBS Delinquencies
700
650
600
550
500
450
400
350
300
250
200
150
100
50
0
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
AAA Spreads
AA Spreads
A Spreads
Aug-07
Apr-06
Aug-06
Dec-06
Apr-07
Dec-04
Apr-05
Aug-05
Dec-05
Aug-03
Dec-03
Apr-04
Aug-04
Apr-02
Aug-02
Dec-02
Apr-03
Dec-00
Apr-01
Aug-01
Dec-01
Dec-99
Apr-00
Aug-00
Jan-08
Aug-07
Mar-07
Oct-06
May-06
Dec-05
Jul-05
Feb-05
Sep-04
Apr-04
Nov-03
Jun-03
0.0%
Jan-03
Basis Points
Investment Grade CMBS Spreads to Swaps
BBB Spreads
Source: Lehman Brothers
Source: Bear Stearns
Portfolio Strategy
Overweight the sector as fundamentals remain strong and short to mid-term supply technicals look positive.
Higher-rated CMBS classes, both new and old, continue to represent attractive relative value, offering stable, high credit quality cash flows and
less idiosyncratic risk than other spread sectors.
Favor stable, seasoned deals which have collateral with transparent histories. Overweight the short to intermediate and 10-year part of the curve.
18
Asset-Backed Securities (ABS)
Outlook
Volatility and lack of liquidity continued to be the dominant themes within the ABS sector during December. In terms of residential ABS, negative
housing data and continued deterioration in the subprime mortgage market caused the ABX indices to sell off early in the month, closing down
roughly 5-10pts for the month. One positive headline for the sector was the announcement of the Treasury department to enforce a rate reset
freeze on select subprime borrowers who currently have adjustable rate mortgages. Following the announcement, various tranches of the ABX
indices rallied as much as 15pts but eventually sold off as investors viewed the changes as a marginal positive for the sector. In addition, the
major rating agencies downgraded numerous subordinate home equity bonds and CDOs which caused spreads on subordinate bonds to widen even
further. On the contrary, senior AAA rated home equity bonds rallied as buyers returned to the market with the feeling that senior bonds had
been oversold. Consumer ABS spreads also began to widen early in the month due to a lack of liquidity and investors’ fear of contagion from the
subprime mortgage sector but rallied late in the month. Auto and credit card ABS sectors tightened 10-20bps.
Duration-Adjusted Excess Returns
2007
-4.08%
-6.34%
Annual Issuance of Asset-Backed Securities
3-Yr
Credit Card
3-Yr
Auto Loan
3-Yr
Home Eq.
Source: Lehman Brothers
886
792
629
529
454
368
2007
2006
2005
2004
2003
2002
287
2001
231
2000
180
201
1999
153
190
1998
108
1997
1100
1000
900
800
700
600
500
400
300
200
100
0
1995
Dec-07
Jun-07
Jun-06
Dec-06
Jun-05
Dec-05
Dec-04
Jun-04
Dec-03
Jun-03
Jun-02
Dec-02
Jun-01
Dec-01
Dec-00
Jun-00
Dec-99
Jun-99
Jun-98
Dec-98
$ billions
450
400
350
300
250
200
150
100
50
0
Dec-97
Basis Points
Spreads to Treasuries of Selected ABS Sub-sectors (AAA-Rated)
1996
Lehman ABS Index
4Q07
Credit Card
A uto
Home Equity
Student Loans
Global RMBS
Manufac tured Housing, Equipment, Other
Source: JP Morgan
Portfolio Strategy
Remain cautious on credit and valuations. Bearish on the home equity sector but are selectively purchasing bonds from issuers/servicers with
strong track records.
Favor short, high quality paper. Adding two-year auto paper from prime issuers with low concentrations of subprime borrowers. Neutral on
credit card paper at current levels and are negative on subordinated home equity bonds.
19
High Yield Corporate Bonds
Outlook
Despite a strong start to the year, subprime-related concerns caused the high yield index to return 1.87% in 2007, the smallest return since
2002. Relative to duration-neutral Treasuries, high yield lagged 777 bps. The overall flight to quality was reflected in returns by credit quality.
However, instead of double-B credits leading the way, single-B paper fared better. The best performing sectors in December were paper,
wirelines, healthcare, and utilities. The worst performing sectors were building materials, automotive and retailers. The yield spread on the
index at year-end was 569 bps, with a yield to worst of 9.64% versus 7.70% at the end of 2006.
Duration-Adjusted Excess Returns
4Q07
2007
-5.38%
-7.77%
-5.17%
-7.41%
-BB
-4.12%
-6.56%
-B
-4.46%
-6.02%
-CCC
-7.49%
-9.87%
Lehman High Yield Index
Lehman High Yield 2% Issuer
Capped Index
High Yield Corporate Bonds:
Yield Spread to 10-Year Treasuries
Spread to Worst of High Yield Index
vs. Altman’s Default Rates
12.0%
Spread
Default Rates
1000
10.0%
YTD 2007
2005
2003
2001
1999
0.0%
1997
2.0%
0
1995
4.0%
200
1993
400
1991
6.0%
1989
8.0%
600
1987
800
Source: Spreads from CSFB; Default Rates from Altman/SSB
Dec-97
Apr-98
Aug-98
Dec-98
Apr-99
Aug-99
Dec-99
Apr-00
Aug-00
Dec-00
Apr-01
Aug-01
Dec-01
Apr-02
Aug-02
Dec-02
Apr-03
Aug-03
Dec-03
Apr-04
Aug-04
Dec-04
Apr-05
Aug-05
Dec-05
Apr-06
Aug-06
Dec-06
Apr-07
Aug-07
Dec-07
1200
1200
1100
1000
900
800
700
600
500
400
300
200
100
0
Basis Points
14.0%
1985
Basis Points
1400
BB-Rated
B-Rated
Source: Lehman Brothers
Portfolio Strategy
Maintain an allocation of approximately 2% in high-yield. Emphasis on select names at the higher quality end of the credit spectrum.
Biased toward the Wireless and Media Non-Cable sectors, while underweight Gas Pipelines and Food & Beverage sectors.
20
Non-U.S. Dollar
Global Economic Summary
The market remains focused on global monetary policy prospects. Recent data in Europe confirm the existing softening trend in activity and is
presenting clearer evidence about the magnitude of the credit crunch and the extent to which it is spilling over to the European economy. The
risk from credit-market fallout has caused the ECB to shelve its tightening plans for now, and in Japan, a lackluster growth picture and
uncertainty in the global economy will likely delay the normalization of monetary policy by the BOJ.
Dollar Index (DXY)
Central Bank Rates
0.50%
0%
US
EU
12/31/06
UK
CAN
Japan
1/22/08
Source: Central Bank Websites
Central Bank Watch
ECB: Rates left unchanged at 4.00% in January
Bank of Japan: Rates left unchanged at 0.50% in January
Bank of Canada: Cut rates by 25 basis points to 4.00% in January
Reserve Bank of New Zealand: Rates left unchanged at 8.25% in December
Bank of England: Rates left unchanged at 5.50% in January
Source: Bloomberg
Performance of the U.S. dollar was broadly stronger during
December amid a major credit squeeze and another wave of risk
liquidation. Wide scale repatriation and accumulation of dollars
for balance sheet needs helped the greenback reach 8-week highs
against the Euro, Swiss Franc and Japanese Yen around midmonth. However, most of these gains were ceded towards the
end of the month, with the Yen and Swiss franc finishing mostly
unchanged, down 0.4% and 0.1% respectively against the USD.
Portfolio Strategy
Long position in European bonds.
21
Jan-08
0.25%
Sep-07
1%
May-07
2%
Jan-07
3%
Sep-06
4.00%
May-06
4.25%
4.00%
Jan-06
3.50%
Sep-05
3.50%
May-05
4%
Jan-05
5.00%
5%
95
90
85
80
75
70
Sep-04
5.50%
5.25%
May-04
6%
Jan-04
7%
Emerging Markets
Outlook
Emerging Market external debt reversed the negative return in November and gained 0.62% in December, to close 2007 up 6.28%. The negative
events in Pakistan concerning Benazir Bhutto remained mostly local with no contagion effects into other countries. Emerging market currencies
generally had positive returns across the board, but experienced some selling pressure in the middle of the period due to strength in the U.S.
dollar against other global currencies. Local rates continued to move higher in many countries albeit at a slower pace than that experienced in
November, particularly in Brazil and Turkey. Going into 2008, the main downward risks to the asset class are global episodes of risk aversion
similar to those experienced with subprime in 2007, and the materialization of a prolonged slowdown in the global economy triggered by slowing
consumption in the United States. The direction of commodity prices will remain important for balance of payments expectations. Policy makers
may allow currencies to appreciate further to mitigate the inflation shock experienced through 2007 with commodity prices.
Total Returns
JP Morgan EMBI Global Index
4Q07
2007
2.64%
6.28%
Year-to-Date Spread Performance
Year-to-Date Performance -- External Debt vs. Local Debt
550
16.0%
14.0%
450
GBI-EM (Local Debt)
10.0%
400
8.0%
350
Spread (bps)
YTD Return
12.0%
500
EM BIG (External Debt)
6.0%
4.0%
0.0%
150
-2.0%
100
-4.0%
50
M ay-07
Jul-07
Sep-07
Nov-07
M exico
Argentina
250
200
M ar-07
Brazil
300
2.0%
Jan-07
EM BIG Index
Jan-07
M ar-07
M ay-07
Jul-07
Sep-07
Nov-07
Source: JP Morgan, Bloomberg
Portfolio Strategy
Retain strong quality and liquidity biases.
Small positions in Argentina, Peru and Colombia.
22
Fixed Income Market Review: Fourth Quarter 2007
Market Review
Data released over the course of the fourth quarter suggest that some of the underlying growth momentum in the
real economy has slowed. Headwinds to growth in 2008 include mortgage-related weakness, higher energy prices
and tighter lending standards.
Yield Curve Shifts
Yield Curve
Yield (%)
5.0%
4.0%
3.5%
09/30/2007
3.0%
• The FOMC cut the fed funds target rate 25 bps at each of its scheduled
meetings over the quarter, and it now stands at 4.25%.
12/31/2007
2.5%
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
-1.2
3m 2y
6m
•
23
Q407 credit sub-sector excess returns: Industrials (-205 bps), Utilities
(-227 bps), Financials (-333 bps).
-12
-56
-21
-177
-217
-236
-270
-435
-464
-408
-457
-517
-634
4Q07
2007
EM
D*
*
HY
*
AB
S
CM
BS
-741
M
or
tg
ag
es
• Spread sectors of the Lehman Aggregate Index dramatically
underperformed Treasuries in November. With the exception of the
asset-backed sector, spreads bounced back and tightened during
December. Nonetheless, spread sector excess returns for the year were
significantly negative.
30y
Source: Bloomberg
(Basis Points)
The global fixed income markets were hostage to headlines in
the fourth quarter, as news of portfolio write-downs, ratings
downgrades and malfunctioning money markets fueled a flight
to quality.
10y
Duration-Adjusted Excess Returns vs. Treasuries
Ag
en
ci
es
Spread Sector Performance
5y
it
Spread (%)
• The benchmark 2-year note rallied 94 basis points over the quarter to
close the year at 3.05%. The yield curve steepened 55 bps as thirty-year
yields fell 38 bps, closing the quarter at 4.45%.
4.5%
Cr
ed
The year ended with lower yields, a steeper curve, and higher
implied volatility – a risk reduction theme we have witnessed
in the U.S. markets since late in the second quarter.
Source: Lehman
* Lehman High Yield 2% Issuer Capped Index
**Lehman Emerging Markets Index (US Dollar)
Broader Fixed Income Opportunities Appear To Be Ahead In 2008
Market environment changes during 2007
increased the dispersion of investment returns
across sectors.
Dispersion of Returns Across Sectors - Lehman U.S. Aggregate Index
Duration-Adjusted Excess Returns vs. Treasuries by Calendar Year*
Credit
700
+527
Factors which had supported low volatility and
reduced risk premia were:
• Complacency among investors
• High returns of lower-quality credit assets
• Perilous risk/reward profiles
300
Basis Points
• Prolonged tightening of global monetary policy
• Increased financial innovation and growth of structured
products
500
CMBS
Credit
+210
+159
100
+138
+32
-100
+11
+78
-300
MBS
Agency
-500
CMBS
ABS
-187
-85
Credit
• Housing market turmoil
• Credit market volatility
+75
Credit
-700
-634
ABS
2002
2003
2004
2005
2006
2007
*As of 31 December 2007
Source: Lehman Brothers
We believe active management and a focus on relative value opportunities should
benefit from the return of market volatility.
24
-56
Agency
-900
Factors contributing to the reemergence of
volatility:
Agency
Fresno County Employees' Retirement Association Portfolio Review and Outlook: 4Q07
BlackRock Strategy as of December 31, 2007
Deteriorating growth fundamentals likely will prompt additional rate cuts from the Fed. However, weakness in consumption may
not bring any lessening of inflationary pressure. Probable implications include a steeper yield curve, a reversal of the monetary
easing at the Fed’s earliest opportunity and the persistence of volatility.
Modestly short duration relative to the index with a slight yield curve steepening bias.
Spread risk: Overweight relative to the index. Limited exposure to “plus” sectors.
Sector biases:
• Treasuries: Underweight with a bias toward on-the-run issues. Allocation to TIPS.
• Agencies: Underweight.
• Mortgages: Remain overweight MBS, with a bias toward premium (above par) coupons relative to discounts within pass-throughs. Continue to look
for opportunities to swap out of agency MBS and into other high quality, but less liquid assets in the CMBS, ABS, ARM and CMO markets.
• Corporates: Opportunistically adding exposure through attractively valued new issues. Prefer the shorter end of the curve where swap spreads are
wider and breakevens more attractive. Favor financials over industrials and are biased towards high quality, non-cyclical credits.
• CMBS: Overweight. Favor seasoned, high quality issues.
• ABS: Small overweight with an up-in-quality, tier-1 security bias. Favor short-dated fixed rate auto ABS.
• High Yield: Modest exposure. Continued focus on higher credit quality names.
• Non-USD: Long position in European bonds. Small allocation to Japanese yen-denominated debt and Mexican peso securities.
• Emerging Markets: Small positions in Argentina, Peru and Colombia.
Sector Allocation vs. Benchmark
Performance Attribution
(% Market Value)
19%
13% 13%
12%
4% 3%
-10% -9%
-7%
3%
<1%
3% 2%
1% <1%
-4%
-18%
25
M
ar
ke
ts
Em
g
Yi
el
d
SD
ig
h
H
AB
S
CM
BS
As of 9/30/07
No
nU
Ts
y/
Ca
s
h
Ag
en
ci
es
M
or
tg
ag
es
Co
rp
or
at
es
-26%
As of 12/31/07
Positives
Negatives
Credit underweight
Non-dollar allocation
ABS security selection
CMBS overweight
Yield curve positioning
Non-agency MBS allocation
Portfolio Composition: Fresno County Employees’ Retirement Association
September 30, 2007
Emerging
Markets
0%
High Yield ABS
Corporates 4%
3%
Tsy/Cash
1%
Characteristics as of September 30, 2007
Agencies
1%
Non-Dollar
1%
Investment
Grade
Corporates
16%
Portfolio
Benchmark
Difference
Effective
Duration (Yrs.)
4.43
4.63
-0.20
Emerging
Markets
0%
Effective
Convexity
-0.45
-0.21
-0.24
Yield
6.02
4.91
1.11
Average S&P
Credit Quality
AA+
AAA
High Yield ABS
Corporates 4%
2%
Tsy/Cash Agencies
5%
1%
Non-Dollar
0%
Investment
Grade
Corporates
19%
CMBS
19%
26
Average S&P
Credit Quality
AA+
AAA
December 31, 2007
Characteristics as of December 31, 2007
Portfolio
Benchmark
Difference
Yield
6.01
5.32
0.69
Mortgages
57%
CMBS
17%
Effective
Duration (Yrs.)
4.35
4.48
-0.13
Effective
Convexity
-0.51
-0.14
-0.37
Mortgages
50%
Portfolio Characteristics: Fresno County Employees’ Retirement Association
Sector Allocation as of January 25, 2008
AAA
32%
Tsy/Cash
Agencies
9%
1%
ABS
3%
High Yield
2%
Credit Quality as of January 25, 2008
Non USD
<1%
Corporates
19%
AA
10%
Mortgages
46%
CMBS
20%
A
3%
BBB
BB 3%
Govt/Cash
50%
2%
Below BB
<1%
Estimated NAV: $231,551,450
Sector Allocation vs. Lehman Aggregate Index
Characteristics as of January 25, 2008
14%
7%
2%
2%
<1%
<1%
-3%
-9%
27
g
Mk
ts
Yi
el
d
Em
US
D
Hi
gh
AB
S
No
n
Ts
y/
Ca
sh
Ag
en
cy
M
or
tg
ag
Co
es
rp
or
at
es
CM
BS
-14%
Portfolio
Benchmark
Difference
Effective
Duration (Yrs.)
4.01
4.23
(0.22)
Effective
Convexity
(0.38)
(0.26)
(0.12)
Yield
5.30
4.43
0.87
Average S&P
Credit Quality
AA+
AAA
Portfolio Performance: FCERA
As of December 31, 2007
Gross-of-Fees Total Return in USD (Ann%)
6.55
Net-of-Fees Total Return in USD (Ann%)
6.97
6.97
6.31
5.19 5.12
4.58
2.83
0.38
4.56
3.00
2.77
Active Return
3.00
4Q07
1 Yr
3 Yr Ann
Since Incep
Ann.
(06/30/2004)
1 Month
4Q07
1 Yr
3 Yr
Since
Inception
.10
-0.17
-0.42
0.02
0.07
1 Month
Active Return
4Q07
1 Yr
3 Yr Ann
Since Incep
Ann.
(06/30/2004)
1 Month
4Q07
1 Yr
3 Yr
Since
Inception
0.08
-0.23
-0.66
-0.21
-0.16
FCERA Portfolio
Lehman US Aggregate Index
*Results do not reflect the deduction of management/advisory fees; management/advisory fees and other expenses will reduce a client's return. For example, assuming an annual
gross return of 8% and an annual management/advisory fee of 0.25%, the net annualized total return of the portfolio would be 7.74% over a 5-year period. Fees are described in Part
II of BlackRock's Form ADV. Past results are not necessarily indicative of future results.
28
4.96 5.12
0.36 0.28
0.28
1 Month
4.56
4.35
**Results reflect the deduction of management fees. The fees for the Fresno County Employees' Retirement Association are 25 basis points on the first $100 million, 20 basis points on
the next $100 million, 17.5 basis points on the next $100 million and 15 basis points on assets above $300 million. Past results are not necessarily indicative of future results.
FCERA Guideline Summary
Benchmark
Lehman Brothers US Aggregate Bond Index
Duration Band
+/- 30% of the benchmark index
Government, including agency
Mortgage, including CMO and non-agency
Credit Sector
Asset-backed
Eligible Investments
Municipal
Preferred stock
Money market
Up to 20% in a combination of non-dollar securities on a currency-hedged basis,
high yield, and emerging market debt securities
Credit Quality
Other Investments
29
Portfolio Average: investment grade
Maximum concentration of 5% per issuer
Rule 144A securities
Futures, options and/or swaps allowed for hedging purposes
