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MonthlyCommentary

January2012
333S.GrandAve.,18thFloor||LosAngeles,CA90071||(213)6338200
2
MonthlyCommentary1/31/12
Overview
January saw the unemployment rate fall 20 basis
points (bps) to 8.3%. This months fall means the
unemployment rate has plummeted by 80 bps since
August and now stands at a level not seen since
February of 2009. In February of 2009, however, the
labor force participation rate stood at 65.7%,
compared with only 63.7% in January. The
underemployment rate did not see as strong a
decrease as the more narrow measure of
unemploymentfailingonly10bpsto15.1%.
Forthoseworking,averageweeklyhoursworkedheld
steadyat34.5andaveragehourlyearningsdecreased
20 bps in January to a 1.9% yearoveryear (YoY)
growthrate.WhetherU.S.growthwillbestifledbya
smallerparticipationrateisyettobeseen.
MonthlyCommentary
We saw strong monthovermonth (MoM) increases
in vehicle sales, the Institute of Supply Management
(ISM) Manufacturing Index, and the ISM Non
Manufacturing Index. The ISM Manufacturing Index
readingisalsousedtoproxyGrossDomesticProduct
(GDP)growthforthecurrentquarter,andthepeople
at the ISM believe Januarys reading of 54.1 will
translateintoaroughly3.5%GDPgrowthrateforthe
firstquarterof2012.
An alternative and increasingly controversial leading
indicatorofU.S.growth,theEconomicCycleResearch
Institutes (ECRIs) Weekly Index Growth Rate,
averaged 7.0% during January. February should be a
tellingmonthtoseeifthesefactorscoalesceintotrue
recoverymode,orifthesluggishreboundcontinues.

EmergingMarkets
In Emerging Markets Fixed Income, the three sectors
of the market the external sovereign, corporate
debtandlocalcurrencybonds,representedbytheJP
Morgan Emerging Markets Bond Index Global
Diversified (EMBI), the JP Morgan Corporate
Emerging Markets Bond Index Broad Diversified
(CEMBI) and the JP Morgan Government Bond Index
Emerging Markets Broad Diversified (GBIEM),
14.0%
14.5%
15.0%
15.5%
16.0%
16.5%
7.8%
8.0%
8.2%
8.4%
8.6%
8.8%
9.0%
9.2%
Feb11 Apr11 Jun11 Aug11 Oct11 Dec11
U
n
d
e
r
e
m
p
l
o
y
m
e
n
t

R
a
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e
U
n
e
m
p
l
o
y
m
e
n
t

R
a
t
e
UnemploymentandUnderemployment
February2010 January 2012
Unemployment Rate Underemployment Rate
Source: BureauofLaborStati sti cs, Bl oomberg
1.7
1.8
1.9
2
2.1
2.2
2.3
34.20
34.25
34.30
34.35
34.40
34.45
34.50
34.55
Feb11 Apr11 Jun11 Aug11 Oct11 Dec11
A
v
e
r
a
g
e

H
o
u
r
l
y

E
a
r
n
i
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g
s

(
Y
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Y
%
)
A
v
e
r
a
g
e

W
e
e
k
l
y

H
o
u
r
s
AverageWeeklyHoursWorked
AverageWeeklyHours
AverageHourlyEarnings(YoY)
Source:BureauofLaborStati sti cs, Bl oomberg
12
10
8
6
4
2
0
2
4
6
8
10
Feb11 Apr11 Jun11 Aug11 Oct11 Dec11
G
r
o
w
t
h

R
a
t
e

%
ECRILeadingIndexofU.S.EconomicGrowth
Source:ECRIInsti tute, Bl oomberg
3
MonthlyCommentary1/31/12
respectively posted positive returns for the month
ofJanuary.
For the month of January, emerging markets (EM)
local currency bonds were the best performing
sector,returning7.08%.Emergingmarketcurrencies
rallied after the European Central Banks (ECB) Long
Term Refinancing Operations (LTRO) auction at the
endofDecember.Mexico,Hungary,andTurkeywere
the best performing subregions of the index,
returning 11.38%, 10.86% and 9.51%, respectively.
EM corporate debt was the second best performing
sectorofthemarket,returning2.51%,drivenbya41
bps spread tightening month over month. Its high
yield subindex outperformed its investment grade
counterpart by 252 bps. EM sovereign bonds, the
weakest performing sector in the month of January,
still provided a 1.58% return. Spreads on the EM
sovereign index tightened in by 9 bps, and its high
yield subindex outperformed its investment grade
counterpartby111bps.
The January Effect seems to be alive and well in
2012,asriskmarketsmovedhigherandleadingEMBI
Source:JPMorgan
(Pastperformanceisnoguaranteeoffutureresults.)
spreads were tighter by 9 bps for the month of
January. Drivers for this favorable start of the year
include the following: strong global liquidity,
continued loose monetary policy, favorable global
PMI and U.S. unemployment data, expectations of a
second round of LTRO at the end of January for the
eurozone (500 billion to 1.0 trillion) and a lack of
badnewscomingoutofEurope.Similarto2011,the
newissuemarketwasstrongtostart2012,with$55.3
billion new debt issued during the month of January,
$37.2 billion from EM corporates, and $18.1 billion
fromEMsovereignscomparedto$41.6billionissued
in January 2011 and $63.6 billion in 4Q11. New
issuance could remain strong in the nearterm, as
many credits sat on the sidelines during the second
halfof2011,waitingforbetterentrylevels.Although
not expected to reach the record setting EM debt
issuance levels in 2010 and 2011 ($288 billion and
$272billionrespectively),2012isstillexpectedtosee
solidnewdebtissuanceofaround$250billion.
While we expect positive market perception to be a
keydriverinthecomingmonths,uncertaintyremains
surrounding a Greek default, rising concerns that
Portugal may be the next in line to restructure its
debtandEuropeangrowthwillcontinuetoslowdown
under the burden of ongoing austerity measures and
bank recapitalizations. Of these issues, the one that
has the ability to derail current market sentiment is
theGreekdebtrestructuringandwhetherGreeceand
the Troika (European Central Bank, European Union
and International Monetary Fund) can complete a
negotiatedrescuepackagetotaling$170billionand
avoid missed principal and interest payments or
whetherGreeceisheadedforadisorderlydefaultdue
tomisseddebtserviceasearlyasMarch20
th
.Atthe
start of 2012, many market participants appeared to
be in one of two camps. The first group viewed
January as a peak in risk with pending sovereign
MonthlyCommentary
Tickers
Monthly
Return
Last3
Months YTD YTM Spread
S&P
Ratings
EMBI JPGCCOMP 1.58% 1.82% 1.58% 5.69% 395 BBB
CEMBI JBCDCOMP 2.51% 1.79% 2.51% 5.80% 439 BBB
GBIEM JGENBDUU 7.08% 2.65% 7.08% 6.16% N/A A

Source:JPMorgan
(Pastperformanceisnoguaranteeoffutureresults.)
Tickers
Monthly
Return
Last3
Months YTD YTM Spread
S&P
Ratings
EMBI JPGCCOMP 1.58% 1.82% 1.58% 5.69% 395 BBB
CEMBI JBCDCOMP 2.51% 1.79% 2.51% 5.80% 439 BBB
GBIEM JGENBDUU 7.08% 2.65% 7.08% 6.16% N/A A

10%
8%
6%
4%
2%
0%
2%
4%
6%
Feb11 Mar11 Apr11 May11 Jun11 Jul11 Aug11 Sep11 Oct11 Nov11 Dec11 Jan12
JPMorgan EmergingMarkets BondIndexPerformance
Last12Months
EMBI
CEMBI
GBIEM
Source:JP Morgan
(Pastperformanceisnoguaranteeoffutureresults.)
4
MonthlyCommentary1/31/12
rating downgrades (S&P 1/13/12 9 downgrades,
Fitch 1/27/12 5 downgrades), a Greek debt
restructuring, and the implications of a potential
downgradeoftheEuropeanFinancialStabilityFacility
(EFSF). Downgrades, including the EFSF, came and
went without much fanfare and Greece seems to be
the only hurdle to enticing more money into the
market at the start of the year. The second group
believesthefavorableeconomicwindbehindthesails
of the global markets at the end of 2012 would
provide market momentum throughout the first half
of 2012 before disappearing into the second half of
theyearassevereausteritymeasuresbeingtakenon
by many countries in the European periphery and
eurozonebankcapitalraisingmeasuresbegintotake
their toll on growth. We currently believe austerity
measures and raising bank capital may prove more
problematicforgrowththananticipated.

GlobalDevelopedCredit
The credit markets registered solid performance
during the month of January generating positive
excess returns for both investment grade and high
yield. The Barclays Capital U.S. Credit Index ended
themonth26bpstighterandoutperformedduration
matchedTreasuriesby1.65%.TheBarclaysHighYield
Index tightened by 56 bps during the month and
outperformeddurationmatchedTreasuriesby2.56%.
Default activity ticked up slightly in January with
seven corporate debt issuers defaulting during the
month.AccordingtoMoodys,theglobalspeculative
grade default rate was 2.0% in January, up slightly
from Decembers revised level of 1.8%. Defaults
continuetoremainwellbelowthe25yearaverageof
approximately4.0%.

Within the investment grade universe the best

performing sectors included Life Insurance (+406
bps); Banking (+362 bps); NonCaptive Consumer
Finance (+350 bps); Municipals/Build America Bonds
(+266 bps) and Oil Field Services (+243 bps). The
worst performing sectors on a relative basis included
NaturalGasDistributors(+27bps);Supermarkets(+38
bps);ConsumerProducts(+47bps);andRefiners(+51
bps). Lower rated debt outperformed higher quality
issues during the month. The top performers in high
yield were Banking (+9.10%); Home Construction
(+8.23%); Airlines (+5.91%); Property and Casualty
Insurers (+5.46%) and Transportation Services
(+5.28%). Among the underperforming sectors were
Refining (5.21%); Electric Utilities (0.62%);
Independent Energy (+0.78%); and Pipelines
(+1.43%). As was the case with investment grade
credits, higher beta outperformed although strength
in Treasuries dampened the divergence across credit
qualities somewhat. The Barated Index was up
2.52% while the Brated Index gained 2.99% and the
CaaratedIndexrose3.75%.
Fixedrate investment grade supply for January was
approximately $116 billion, down slightly from the
MonthlyCommentary
5%
3%
1%
1%
3%
5%
7%
Feb11 Mar11 Apr11 May11 Jun11 Jul 11 Aug11 Sep11 Oct11 Nov11 Dec11 Jan12
PerformanceofSelectBarclaysIndicesLast12Months
U.S.HighYield
U.S.Credit
U.S.Aggregate
Source: BarclaysLi ve
(Pastperformanceisnoguaranteeoffutureresults.)
5
MonthlyCommentary1/31/12
$120 billion brought to market in January 2011.
Financial companies were the most active issuers.
Highyieldissuerspricedatotalof$23.7billioninnew
U.S.dollardenominatedbondsinJanuary,downfrom
the $29.5 billion in high yield issuance in January
2011.
Overall,Januarywascertainlyastrongmonthforrisk
assets as a combination of improving risk sentiment
inEuropeandrelativelysolideconomicdataprovided
the catalyst for driving equity, credit and commodity
marketshigher.Meanreversionappearedtobeakey
theme given the outperformance in asset classes
which had underperformed the most in 2011. The
risk trade faded a bit towards the end of the month,
however, as heightened concern about the details of
Greeces possible settlement with bondholders and
evidence of earnings deceleration in the U.S.
conspired to temper investors enthusiasm. Despite
the mounting geopolitical risks witnessed by the
marketinJanuary,andgiventhecompressedspreads
ongovernmentissues,investorsaremaintainingtheir
pursuit of corporate debt. Corporate borrowers
continuetohavehealthybalancesheetsand,insome
instances, are laden with cash given the issuer
friendly levels of interest rates which have fueled
record levels of debt issuance over the past year.
Although the overall economy should continue to
show modest improvement, certain sectors, most
notably housing, are either expected to remain weak
orworsen.TheU.S.unemploymentrate,currentlyat
8.3%, is declining slowly which should keep income
growth contained. Our constructive view on the
investment grade market, despite the fact that it is
within striking distance of the alltime low in yields,
reflects our belief that the sector will outperform
Treasuries on a total return basis in a low yielding,
highly liquid market environment despite periodic
bouts of volatility. With respect to the high yield
space, we remain concerned about the fact that too
many market participants are on the same page
reaching for incremental yield as far down the credit
spectrumastheyareable.

MortgageBackedSecurities
Risk on was definitely still with us as 2012 began
and it is flourishing with prices and demand for non
Agency product continuing to ramp ever higher. The
first two weeks of January were relatively stable and
quiet, until four broker dealers were involved with a
large liquidation of a portion of the Maiden Lane II
portfolio. Approximately $7 billion in assets were
auctioned on January 19th, in a winnertakeall
process, to four investment banks: Goldman Sachs,
Credit Suisse, Barclays Capital, and Merrill Lynch.
CreditSuissewasawardedtheauctionandplacedthe
majority of the assets with investors who had given
bidstothedealer.Allinvestorswererequiredtosign
confidentiality agreements resulting in less
transparency, but the assets were well bid in our
opinion.
AtthebeginningofJanuary,aFederalReserveWhite
Paper came out in an effort to restore the health of
the housing market. In the letter, Federal Reserve
MonthlyCommentary
0
20
40
60
80
100
120
140
B
i
l
l
i
o
n
s

o
f

U
.
S
.

D
o
l
l
a
r
s
TotalFixedRateInvestmentGradeSupply
Source:BarclaysLi ve
6
MonthlyCommentary1/31/12
Chairman Bernanke discussed the continuing malaise
inthehousingmarketandsomepossiblesolutionsto
correct the situation. His remarks focused on who is
financing the bulk of the current housing stock and
how much negative equity is currently within the
market. Although delinquencies are starting to come
down, they are still at levels that are simply not
sustainableforahealthymortgagemarket.
Bernanke also addressed the foreclosure hangover
that has been in the news recently with a novel and
interesting solution: Rent to Own. The goal is to
turn 3 million potential foreclosures, that would
ultimately be owned by the Government Sponsored
Enterprises (GSEs), over the next two years into an
investment vehicle to attract private capital. With a
potential$2030billionofassetstoliquefyinanasset
starved marketplace, this has become a popular
topic.

AgencyMortgageBackedSecurities
The Barclays Capital U.S. MBS Fixed Rate Index hada
total return of 41 bps during the month of January.
This was the lowest return of the three major
components of the Barclays Capital U.S. Aggregate
Bond Index. January was a month where interest
rates fell and as the mortgage sector has a shorter
durationthantheothersectorsoftheIndex,itshould
not have as much price appreciation as the other
sectors. January was also a month where the risk
on trade was working, which favors the corporate
indexoverthemortgageindexasthemortgageindex
onlymeasuresgovernmentandAgencymortgages.
There are incessant rumors regarding additional
governmental action with regards to prepayments.
The HAMP 2.0 program should not have much of a
firstordereffectonAgencyprepayments.Thereason
is that the Agencies currently buy mortgages out of
the pool when they get to be 120 day delinquent, so
theloanshouldhavealreadyprepaidbeforeitgotto
the modification point. For a similar reason, the
Rent to Own program being discussed should not
have much of a first order effect. Those loans are
alreadyinforeclosureorareRealEstateOwned(REO)
status. The second order effect of both of these
issues will be dependent on how the housing market
behaves going forward and investors ability to
refinance. An additional program, HARP 2.0, has
beenineffectforoveronemonth.Whilewedidnot
observe this during January, there should be
increases in prepayment speeds on particular
collateral due to this program. These increases
shouldbeseeninfuturemonthsprepayments.
January prepayment speeds were slower in the
Fannie Mae (FNMA), Freddie Mac (FHLMC) and
Ginnie Mae (GNMA) sectors: speeds were down 13
ConditionalPrepaymentRate(CPR).Thesedecreases
were a surprise to the marketplace as a slowdown
wasnotexpected.ItisbelievedthatHARP2.0should
start showing up in Februarys prepayment speeds
and therefore prepayment speeds could increase
somewhatfromthesenumbers.
MonthlyCommentary
3.75
3.95
4.15
4.35
4.55
4.75
4.95
5.15
12/31/10 2/28/11 4/30/11 6/30/11 8/31/11 10/31/11 12/31/11
FreddieMacCommitmentRate 30Year
Source: Bl oomberg
7
MonthlyCommentary1/31/12
For the month of January, lower coupon mortgages
went up in price, but higher coupon mortgages
actually went down in price. The biggest reason for
the higher coupon mortgages underperformance for
the month is the concern that HARP 2.0 and other
potential government action would most likely affect
thesecoupons.

NonAgencyMortgageBackedSecurities
President Obamas State of the Union address in
January mentioned a new, yet not completely
outlined, refinance program for current, nonAgency,
and Federal Housing Administration (FHA)/Veterans
Affairs (VA) borrowers. Our current understanding of
thisnewprogramisthatifahomeowneriscurrenton
theirmortgage,andhasnothadalatepaymentinthe
past6months,andnomorethanonelatepaymentin
the 6 months prior, there will be a new FHA loan
madeavailableatorneara4.5%mortgagerate(even
if the current loantovalue (LTV) was as high as
140%). Of course, this type of program needs to be
approved by the U.S. Congress and have a matching
revenuestream.Therevenueseemstobeanewtype
of fee on the larger banks and mortgage originators.
We expect this to be a tough sell to Congress during
anelectionyear.
RenewedinterestintheAttorneysGeneralsuithitthe
press at the end of January. Five states (NY, CA, DE,
NE, and MA) have still not agreed to the settlement,
which is now rumored to be in excess of $25 billion.
Additionally, there are indications of some ability of
thebankstousewritedownsonsecuritybalancesas
a way to pay the settlement. We will continue to
monitorthissituationasitdevelops.
In the nonAgency market, the ABX 071 AAA closed
onDecember31stat33.88andclosedJanuary31stat
38.61.TheABX062AAAclosedonDecember31stat
43.44andclosedJanuary31stat50.46.
MonthlyCommentary
30
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ABXPrices
ABX 20062AAA
ABX 20071AAA
Source: MorganStanley
ConditionalPrepaymentRates(CPR)
2011 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan2012
FNMA 15.2 15.2 13.2 12.8 15.0 15.2 17.3 22.6 24.8 24.8 23.0 21.0
FHLMC 17.4 14.4 12.9 12.2 14.2 14.9 17.0 22.3 25.9 25.8 24.3 22.7
GNMA 12.0 10.2 9.1 8.4 9.6 9.6 11.5 13.9 16.3 16.2 16.3 16.0
BarclaysCapital
MortgageIndex 12/30/2011 1/31/2012 Change
AverageDollarPrice 107.71 107.89 0.18
Duration 2.87 2.55 0.32
BarclaysCapital Nov Dec Jan
IndexReturns 2011 2011 2012
Aggregate 0.87% 1.10% 0.88%
MBS 0.18% 0.70% 0.41%
Corporate 1.96% 2.14% 2.21%
Treasury 0.75% 0.97% 0.42%
Source:eMBS,BarclaysCapital
8
MonthlyCommentary1/31/12
The PrimeX Indices followed a similar pattern with
the PrimeX FRM 1 closing December 31st at 102.72
and closed January 31st at 104.53, while the PrimeX
FRM 2 went from closing December 31st at 90.61 to
closingJanuary31stat95.92.

CommercialMortgageBackedSecurities
The Commercial MortgageBacked Securities (CMBS)
market posted strong performance for the month of
January as risk markets across the macro landscape
started with renewed optimism. As such,
performance in CMBS was anything but lackluster as
theriskappetitecontinuedtoshiftdownwardsinthe
capital structure as spreads continue to compress.
For the month, the CMBS component of the Barclays
Capital U.S. Aggregate Bond Index was one of the
best performing sectors, posting a return of 2.05%
andoutperformingtheindexby164bps.
On the commercial real estate (CRE) fundamental
side,delinquencyratesremainedflattoslightlydown
due to a slowed down pace of deterioration and
servicer loan modifications, which effectively bring
delinquent loans current for an indefinite period.
There continues to be increasing trends of servicer
loanmodificationswhichsplitaloanintotwopieces
with an A note paying interest and a B note that is
nonpaying and largely a hope note. We view these
types of modifications as worrisome due to the fact
that the hope notes are potentially a delayed write
downforthetrustandintheinterimmayshowlower
cumulative losses on a deal level then is occurring in
reality.ForJanuary,the30dayplusdelinquencyrate
decreased14bpsto9.55%.
WecontinuetofocusonCMBSsecurityselectionand
shorter duration assets, including securities with a
more storied basis. Our ability to drill down to the
collateral/borrowerlevelallowsustogetcomfortable
andthoroughlyassessrisks.

U.S.GovernmentSecurities
January extended the pattern established in the
fourth quarter of 2011 as Treasury yields were
confined to a narrow range. The Treasury 10year
note stayed in a 27 bps range from 1.80% to 2.07%
and ended January just 8 bps off its yearend mark.
Impliedvolatilityalsomovedclosetomultiyearlows.
The Federal Reserve extended its highly
accommodative monetary policy, announcing it
expected to keep short rates near zero though late
2014 (versus the previously announced mid 2013
timeframe).Theannouncementhelpedyieldsinthe
middle of the yield curve. The 5year note was the
bestperformingbellwetherastheyieldfell12bpson
the month to an alltime low of 0.71%. The Barclays
Capital U.S. Government Index returned 0.44% in
January.The10yearnotereturned0.81%,justedging
outthe0.79%returnofthe5year.The30yearbond
returned0.70%ona4bpsriseinyield.

MonthlyCommentary
86
91
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101
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PrimeXPrices
PrimeX FRM.1
PrimeX FRM.2
Source: MorganStanley
9
MonthlyCommentary1/31/12
The Fed policy move sparked a risk on trade, with
agency debentures, Treasury InflationProtected
Securities (TIPS) and municipals all performing better
than the comparableduration conventional Treasury
notesandbonds.Opportunitiesforprofitablerelative
value trades declined through the fourth quarter,
driven by sliding volatility and the Federal Reserves
buying.Weexpecttofavorthe7to10yearmaturity
range over the nearterm as these issues offer the
best risk/return tradeoff and should benefit most if
the Federal Reserve adopts an inflation targeting or
interestratetargetingstrategy.

MonthlyCommentary
12/30/2011 1/31/2012 Change
3month 0.01 0.05 0.04
6month 0.06 0.08 0.02
1year 0.10 0.11 0.01
2year 0.24 0.22 0.02
3year 0.35 0.29 0.06
5year 0.83 0.70 0.13
10year 1.88 1.80 0.08
30year 2.89 2.94 0.05
Source:Bloomberg
YieldCurve
10
MonthlyCommentary1/31/12
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