GARCIA HAMILTON ASSOCIATES Presented By Jeffrey D Detwiler

GARCIA HAMILTON & ASSOCIATES Presented By: Jeffrey D. Detwiler, CFA, AAMS Partner/Portfolio Manager Fixed Income Fundamentals of Inve$ting 5 Houston Center 1401 Mc. Kinney, Suite 1600 Houston, TX 77010 Tel: (713) 853 -2359 Fax: (713) 853 -2300 Ruby@Garcia. Hamilton. Associate s. com Awards/rankings may not represent client experiences and are not indicative of future performance. Go to www. garciahamiltonassociates. com/awards/ for additional information on

Table of Contents I. Fixed Income Basics II. Interest Rate Risk III. Credit Risk IV. Market Environment V. Conclusion

What are Bonds? Bonds 101: What are bonds and why do they exist? • • • A bond is a debt security, similar to an I. O. U. When you purchase a bond, you are lending money to an issuer. In return for that money, the issuer provides you with a promise to pay a specified rate of interest during the life of the bond and to repay the principal when it comes due. Sources: US Bond Market Outstanding: www. sifma. org/research/statistics. aspx, www. investinginbonds. com, www. treasurydirect. gov 1

Types of Bonds Corporate Securitized Treasury Agency Sources: www. theinvestorsnews. com, www. dailykos. com, istockphoto/Richard. Cano, www. forbes. com 2

Types of Bonds 1976 2018 $456 Billion $20. 3 Trillion Bloomberg Barclays U. S. Aggregate Index Source: Bloomberg Barclays Live Chart Data as of 12/31/80 and 9/30/18 3

Features: Coupon: A feature of a bond that denotes the amount of interest due, and the date payment will be made. • A bond is normally an interest-only loan, meaning the borrower pays the interest every period, but none of the principal is repaid until the end of the loan. Source: www. investinginbonds. com 4

Features: Maturity: The date when the principal amount of a security is due to be repaid. • Generally, bond terms range from one year to 30 years. • Short-term bonds generally offer lower yields. • Long-term bonds generally offer higher yields. Source: www. investinginbonds. com 5

Features: Rating: Designations used by credit rating agencies to give relative indications as to opinions of credit quality. • Generally speaking, a higher rating means less risk but a lower potential return and vise-versa. Source: www. investinginbonds. com 6

Understanding Risks • All investments carry some degree of risk, which is linked to the return that investment will provide. • A good rule of thumb is the higher the risk, the higher the return. • Two types of Risk related to fixed income: § § Interest Rate Risk Credit Risk 7

Interest Rate Risk • Interest rates and bond prices are like a see-saw – when interest rates rise, bond prices fall (and vice versa). • How much interest risk a bond has depends on how sensitive its price is to interest rate changes. • Duration is a measure of the sensitivity of price change to interest rate changes. 8

Interest Rate Risk Duration Example Duration Portfolio A 5 Portfolio B 2 Interest rates, in general, RISE by 100 BPS (1. 0%). Which portfolio LOSES value the most? Portfolio A would lose approximately 5% Portfolio B would lose approximately 2% Interest rates, in general, FALL by 100 BPS (1. 0%). Which portfolio GAINS value the most? Portfolio A would gain approximately 5% Portfolio B would gain approximately 2% Dates and data used are for illustration purposes only and may not reflect actual data as of the dates shown. 9

Interest Rate Risk Less HIGHER Interest Rate Risk If the Coupon Rate More LOWER is If the Maturity SHORTER Less Source: www. web-books. com is Interest Rate Risk LONGER More 10

Credit Risk • The risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do. Credit risks are calculated based on the borrower’s overall ability to repay. • • Ratings agencies such as S&P, Moody's, and Fitch evaluate the credit risks of thousands of issuers on an ongoing basis. 11

Credit Risk Why quality matters… • A bond’s yield is calculated assuming that all the promised payments will be made. • As a result, it is really a promised yield, and it may or may not be what you will earn. • If the issuer does not make the promise payment, your actual yield will be much lower. Source: www. theguardian. com 12

NON-INVESTMENT GRADE Credit Ratings* Strongest Weakest MOODY’s STANDARD & POOR’S DESCRIPTION Aaa AAA Highest Rating Aa AA Very Strong A A Upper Medium Grade Baa BBB Lower Medium Grade Ba BB Non-Investment Grade B B Highly Speculative CCC Caa Substantial Risk CC Ca Substantial Risk C C Substantial Risk D D Issuer is in Default *These credit ratings are reflective of obligations with long-term maturities. Source: www. investinginbonds. com 13

Credit Risk 198 0 2018 $178 Billion $5. 1 Trillion Bloomberg Barclays U. S. Corporate Index Source: Bloomberg Barclays Live Chart Data as of 12/31/80 and 9/30/18 14

Credit Spreads Ratings Examples % of Index* AAA Microsoft, Johnson & Johnson 1. 9% AA Berkshire Hathaway, Apple, Wal-Mart 8. 4% A JP Morgan, Wells Fargo, Pepsi, Pfizer 40. 6% BBB AT&T, Xerox, Mc. Donalds, General Electric 49. 1% *Percentage of Bloomberg Barclays Investment Grade Corporate Index **Option Adjusted Spread Source: Bloomberg, Barclays Live Last Update: 9/30/2018 15

Market Environment • The Federal Reserve has begun the process of Monetary Policy “Normalization” • As a result the yield curve has “Flattened” • Corporate bond spreads have recovered to “pre-crisis” levels 16

Yield Curve Changes Dec 2013 Sept 2018 § US Treasury Actives Curve 12/31/2013 § US Treasury Actives Curve 9/30/2018 3 m 6 m 30 yr 2 yr 5 yr 10 yr 3 Month 6 Month 2 Year 5 Year 10 Year 30 Year 12/31/13 0. 07 0. 09 0. 38 1. 74 3. 03 3. 97 9/30/18 2. 19 2. 36 2. 82 2. 95 3. 06 3. 20 Difference 2. 12 2. 27 2. 44 1. 21 0. 03 -0. 77 Source: Bloomberg Last Update: 9/30/2018 17

Average Option Adjusted Spreads (OAS) U. S. Credit Downgrade Greece Gulf War Source: Barclays Live Last Update 9/30/2018 18

Conclusions • It is important to understand how both interest rate risk and credit risk might impact your portfolio. • The importance of having an investment manager who can successfully navigate both types of risks has risen as the market dynamics have changed. • Looking forward, expect short term rates to continue to gradually move higher as the Fed continues on the path of monetary policy “normalization” 19