We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global...

21
In the United States, Aberdeen Asset Management (AAM) is the marketing name for the following affiliated, registered investment advisers: Aberdeen Asset Management Inc., Aberdeen Asset Managers Ltd, Aberdeen Asset Management Ltd and Aberdeen Asset Management Asia Ltd, each of which is wholly owned by Aberdeen Asset Management PLC. "Aberdeen" is a U.S. registered service mark of Aberdeen Asset Management PLC. For professional use only Not for Public distribution The “Third” Asset Class High Yield: An asset class with both bond and equity-like characteristics September 2015 Patrick Maldari, CFA, Senior Fixed Income Investment Specialist Aberdeen Asset Management 1 What is the “third” asset class? We at Aberdeen believe that the high yield market at times will exhibit the characteristics of both equities and high grade bonds. In our opinion, this creates an opportunity for investors to capture the majority of the upside while also protecting the downside. 2 Talks like a bond, acts like an equity U.S. high yield bonds showed higher correlation* to equities than 5-year U.S. Treasuries Sources: BofA Merrill Lynch, Barclays, 31 Aug 15 * Rolling 3-year correlations For illustrative purposes only -0.60 -0.40 -0.20 0.00 0.20 0.40 0.60 0.80 1.00 Aug-89 Aug-90 Aug-91 Aug-92 Aug-93 Aug-94 Aug-95 Aug-96 Aug-97 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Correlation with closest US Treasury by duration US HY Bonds to 5-year Treasuries US HY Bonds to Equities Index level

Transcript of We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global...

Page 1: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

In the United States, Aberdeen Asset Management (AAM) is the marketing name for the following affiliated, registered investment advisers: Aberdeen Asset Management Inc., Aberdeen Asset Managers Ltd, Aberdeen Asset Management Ltd and Aberdeen Asset Management Asia Ltd, each of which is wholly owned by Aberdeen Asset Management PLC. "Aberdeen" is a U.S. registered service mark of Aberdeen Asset Management PLC.

For professional use only – Not for Public distribution

The “Third” Asset Class High Yield: An asset class with both bond and equity-like characteristics

September 2015

Patrick Maldari, CFA, Senior Fixed Income Investment Specialist Aberdeen Asset Management

1

What is the “third” asset class?

We at Aberdeen believe that the high yield market at times will exhibit the characteristics of both equities

and high grade bonds. In our opinion, this creates an opportunity for investors to capture the majority of the

upside while also protecting the downside.

2

Talks like a bond, acts like an equity U.S. high yield bonds showed higher correlation* to equities than 5-year U.S. Treasuries

Sources: BofA Merrill Lynch, Barclays, 31 Aug 15 * Rolling 3-year correlations For illustrative purposes only

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

Aug-

89

Aug-

90

Aug-

91

Aug-

92

Aug-

93

Aug-

94

Aug-

95

Aug-

96

Aug-

97

Aug-

98

Aug-

99

Aug-

00

Aug-

01

Aug-

02

Aug-

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Aug-

04

Aug-

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Aug-

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Aug-

07

Aug-

08

Aug-

09

Aug-

10

Aug-

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Aug-

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Aug-

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14

Aug-

15

Cor

rela

tion

with

clo

sest

US

Tre

asur

y by

dur

atio

n

US HY Bonds to 5-year Treasuries US HY Bonds to EquitiesIndex level

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3

Attractive diversification dynamics Correlation of global high yield versus other asset classes 12/31/2002 – 8/31/2015

Global High Yield

US Equities US Investment Grade International Equities

Global High Yield 1.00 0.70 0.24 0.76

US Equities 0.70 1.00 0.01 0.87

US Investment Grade 0.24 0.01 1.00 0.10

International Equities 0.76 0.87 0.10 1.00

Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total Return Percentage, gross of fees, Frequency=Monthly Global HY: The BofA Merrill Lynch Global High Yield Constrained Index US Equities: S&P 500 Index US Investment Grade: The BofA Merrill Lynch US Corporate Index International Equities: MSCI AC World ex US Index Hypothetical positions are used here and actual markets conditions may have a different impact on the portfolio Diversification does not ensure a profit or protect against a loss in a declining market. For illustrative purposes only

4

-40

-20

0

20

40

60

80

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015YTD

Total Return Income Return Price Return

Income matters Global high yield has been providing positive income-driven returns over the years

Source: Source: BofA Merrill Lynch Global Research, 31 Aug 15. Past performance is not an indication of future results The above data represents: (HW0C) BofA Merrill Lynch Global High Yield Constrained Index For illustrative purposes only

%

5

What makes global high yield attractive?

Source: Bloomberg, BofA Merrill Lynch Global Research, 31 Aug 15. Past performance is not an indication of future results Cumulative Performance of Monthly Index Returns hedged to USD For illustrative purposes only

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

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15

Gro

wth

of $

10,0

00

MSCI All Country ex US S&P 500 Barclays US Aggregate BofA Merill Lynch Global High Yield

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This says it all…

Source: Jantoo

7

Lower treasury yields typically offset by higher spreads

From To 10Y Treasury Yield High-Yield Spread SPX Price

Oct ’87 Mar ’88 -1.44% – -16.8%

Mar ’89 Aug ’89 -1.49% +138 bp +19.8%

May ’90 Feb ’91 -1.02% +358 bp +4.0%

Jul ’91 Jan ’92 1.53% +3 bp +12.4%

May ’92 Oct ’92 -1.23% +45 bp +0.7%

Dec ’92 Oct ’93 -1.56% -48 bp +6.4%

Dec ’94 Jan ’96 -2.33% +64 bp +35.8%

Apr ’97 Oct ’98 -2.48% +335 bp +34.3%

Feb ’00 Mar ’01 -1.77% +240 bp -11.1%

Jul ’01 Nov ’01 -1.18% +142 bp -13.4%

Apr ’02 Oct ’02 -1.80% +379 bp -28.9%

Jul ’07 Apr ’08 -1.62% +507 bp -12.0%

Nov ’08 Jan ’09 -1.74% +122 bp -6.8%

Apr ’10 Sep ’10 -1.36% +106 bp -10.3%

Apr ’11 Oct ’11 -1.56% +309 bp -14.7%

Median -1.56% +140 bp -6.8%

Source: Citi Research, Bloomberg, 31 Mar 15 Note: All periods are month beginnings For illustrative purposes only

8

Higher treasury yields typically offset by narrower spreads

From To 10Y Treasury Yield High-Yield Spread SPX Price

Mar ’88 Mar ’89 +1.15% – +7.9%

Aug ’89 May ’90 +1.22% +1.32 bp -4.4%

Oct ’93 Dec ’94 +2.52% -66 bp -1.1%

Feb ’96 Sep ’96 +1.36% -94 bp +2.5%

Oct ’98 Feb ’00 +2.25% -122 bp +37.1%

Nov ’01 Apr ’02 +1.16% -227 bp +8.3%

Jun ’03 Jun ’04 +1.28% -228 bp +16.3%

Jul ’05 Jul ’06 +1.22% -43 bp +6.6%

Jan ’09 Jan ’10 +1.63% -962 bp +23.5%

Sep ’10 Apr ’11 +1.00% -207 bp +26.4%

May ’13 Sep ’13 +1.11% +41 bp +2.2%

Median +1.22% -108 bp +7.9%

Source: Citi Research, Bloomberg, 31 Mar 15 Note: All periods are month beginnings For illustrative purposes only

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9

Lower ouch factor Global high yield typically less sensitive to interest rate movements than other fixed income sectors

Source: Source: Morningstar, 30 Jun 15 Citi Treasury Benchmark 10 Yr USD Barclays US Agg Bond TR USD BofAML US Corps 1-3 Yr TR USD BofAML US HY Master II TR USD Credit Suisse Leveraged Loan USD BofAML All Convertible All Qualities S&P 500 TR USD For illustrative purposes only

Period 10-Year Treasury

Barclays Aggregate

Short-Term Corporates

High-Yield Bonds

Floating-Rate Loans

Convertible Bonds S&P 500

9/30/1993 - 11/30/1994 -9.5 -3.8 1.8 1.4 13.4 -2.6 1.9

1/31/1996 - 8/31/1996 -5.4 -1.6 1.8 3.2 5.4 9.1 4.9

9/30/1998 - 1/31/2000 -5.6 -0.3 5.2 5.1 6.1 58.1 35.2

6/30/2005 - 6/30/2006 -5.0 -0.6 2.2 4.9 7.4 9.0 7.9

12/31/2008 - 12/31/2009 -4.2 5.6 14.8 58.9 39.4 50.7 28.3

8/31/2010 -3/31/2011 -2.3 -0.6 1.6 10.2 7.8 19.2 27.8

7/31/2012 - 12/31/2013 -7.2 -1.5 3.3 14.0 11.1 33.7 37.7

Color gradations range from worst performing (red) to best performing (green)

10

High yield can protect from rising rates

Source: Bloomberg, Jul 14 Past performance is not an indication of future results The above data represents the BofA Merrill Lynch Current five year Index (US 5yr Gov’t), BofA Merrill Lynch US Corporate Index (US IG) and CS Leveraged Loan Index (US HY) For illustrative purposes only

Total return (periods of five year treasury rates up by > 100bps)

-8

-4

0

4

8

12

US 5yr Government US IG US HY

Sep 93 to Nov 94 Dec 95 to Aug 96 Oct 98 to Feb 00 Sep 01 to Mar 02 May 03 to Jun 06 Aug 12 to Jul 14Return (%)

… Less sensitive to rates due to higher coupon and risk premium and low

duration

11

Top performing asset classes Global high yield returns are compelling relatively to other asset classes

15 year period to 31 Aug 15

Source: Bloomberg, 31 Aug 15. Past performance is not an indication of future results Global HY: The BofA Merrill Lynch Global High Yield Constrained Index, Investment Grade: The BofA Merrill Lynch US Corporate Index, Gold: Generic 100 oz. Gold Futures Contract (ticker is GC1) Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are reflected Individuals cannot invest directly in an index.. For illustrative purposes only US treasuries are backed by the full faith and credit of the US government

Historically higher returns with lower risk compared to equities

5yr Treasury 10yr Treasury US Aggregate

Global HY

S&P 500

Wilshire 5000

Russell 2000

FTSE 2000

CAC 40

DAX

Gold

US Inflation

0%

2%

4%

6%

8%

10%

12%

0% 5% 10% 15% 20% 25% 30%

Ann

ualiz

ed R

etur

n

Annualized Volatility

Page 5: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

12

Why global high yield?

13

Exponential growth in global high yield over past 17 years Non-U.S. high yield is 48% of global markets and growing.

Source: Source: BofA Merrill Lynch Global Research, 31 Aug 15. Past performance is not an indication of future results For illustrative purposes only

0

500

1,000

1,500

2,000

2,500

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Face

Val

ue, U

S $

bn

US High Yield Constrained Index High Yield US Emerging Markets Corporate Plus Global High Yield European Issuers Constrained Index Canada High Yield

14

Bank of America Merrill Lynch Global High Yield Constrained Index

Source: BofA Merrill Lynch, 31 Aug 15 Standard & Poor’s credit ratings are expressed as letter grades that range from “AAA” to “D” to communicate the agency’s opinion of relative level of credit risk. Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. The investment grade category is a rating from AAA to BBB- Diversification does not ensure a profit or protect against a loss in a declining market. Figures may appear not to add due to rounding. For illustrative purposes only

Country breakdown Credit rating breakdown Currency breakdown

• 80 countries, 1736 issuers, 3688 issues

• Market cap: US $2,102 bn, modified duration: 3.95 yrs, YTW: 7.14%

CAD 0.4%

EUR 17.5%

GBP 3.8%

USD 78.3%

Industry breakdown

Africa 0.7%

Asia 5.1% Cash

0.4% Eastern Europe 4.9%

Europe 26.7%

Latin America

7.4% Middle East 0.4%

US/ Canada 54.5%

BB 54.2%

B 33.9%

CCC & Below 11.5%

Cash 0.4%

Basic Industry, 12.3%

Capital Goods, 5.0%

Consumer Goods, 3.2%

Energy, 13.7% Financial

Services, 3.1%

Healthcare, 6.7%

Leisure, 3.3%

Media, 7.8%

Real Estate, 2.5%

Retail, 4.6%

Services, 4.0%

Technology & Electronics,

3.4%

Telecommunications, 9.3%

Transportation, 1.7% Utility,

3.6% Automotive,

3.2% Banking, 10.7%

Insurance, 1.3%

Cash 0.4%

Page 6: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

15

Why own the “third” asset class now?

16

Negative articles continue to dominate headlines

Carl Icahn’s Warning About the High Yield Market Bubble Market Realist, May 15, 2015

Wall Street Sees Junk Bond Collapse, Prepares to Profit from it Zero Hedge, Aug 13, 2015

Junk Bond Market: Danger ahead Market Watch, Sept 8, 2015

Yet another measure of risk in junk-bond market flashing red Market Watch, Sept 8, 2015

17

“Research has shown that over the long term, going back at least to the 1960s, high-yield bonds in general have tended to produce annualized returns of about 4% a year above inflation”. Today investors are receiving a 50% premium above that long term average.

Source: Aberdeen Asset Management; Brett Arends, “Junk bond market: Danger ahead, “Market Watch”, 8 Sep 15

Real return opportunity in high yield market

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1990*: -4.34 1994*: -1.17%

2002*: -1.14% 2000*: -3.79%

2008*: -26.21%

* Positive returns for 25/29 years

0

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0%

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8%

12%

16%

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

bps High-yield default rate (LHS) High-yield spreads (Domestic) (RHS)

-10%

-5%

0%

5%

10%

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

GDP % GDP QoQ

Economic growth is the foundation for improving or deteriorating credit fundamentals Roadmap for high yield Investing

Source: Aberdeen Asset Management Inc., Bloomberg, JP Morgan, 30 Jun 15 * BofA Merrill Lynch US Cash Pay High Yield Index For illustrative purposes only

19

Coverage ratio

Aggregate credit quality – Still supportive of the high yield sector Interest coverage, maturity profile & leverage all point to low default expectations

Source: BofA Merrill Lynch Global Research, 31 Aug 15 Forecasts are offered as opinion and are not reflective of potential performance, are not guaranteed and actual events or results may differ materially. For illustrative purposes only

HY and leveraged loan maturity

Leverage by Sector

Bond and loan default rates

Source: BofA Merrill Lynch Global Research, 30 Jun 15. For illustrative purposes only

Source: JPMorgan, 31 Aug 15 Note: 2014 default rates exclude TXU’s $36.1bn default. For illustrative purposes only

Source: BofA Merrill Lynch Global Research, 30 Jun 15. For illustrative purposes only

0

50,000

100,000

150,000

200,000

250,000

2015

2016

2017

2018

2019

2020

2021

2022

2023

Mat

uriti

es ($

mm

)

Bonds Loans

1.8

2.3

2.8

3.3

3.8

4.3

1998 2000 2002 2004 2006 2008 2010 2012 2014

Cov

erag

e (L

TM

EB

ITD

A/N

et L

TM In

tere

st

Exp

ense

), x

Excluding TXU,CCU,CZR and FDC HY Coverage Ratio1.

71%

4.10

%

5.00

% 9.

10%

8.00

%

3.30

%

1.10

%

2.80

%

0.90

%

0.40

%

2.30

%

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0%

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%

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%

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%

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%

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%

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%

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%

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%

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%

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%

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%

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%

1.00

%

3.00

%

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%

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% 3.90

%

12.8

0%

1.80

%

0.40

%

1.40

%

1.70

%

1.70

%

1.51

%

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

High-yield bond default rate Loan default rate

Par-weighted default rates

0 5 10 15 20 25 30

EnergyGaming

MaterialsTelecommunications

UtilitiesMedia

TechnologyHealth CareReal Estate

Consumer ProductsCommercial Services

Hotels & LeisureRetailFood

Capital GoodsTransportation

Automotive

Leverage (Net Debt/LTM EBITDA), x

Q2 '14 Q2 '15

Average Leverage ex-Energy Q2 '14: 5.0x Q2 '15: 4.0x

20

Option adjusted spreads – At the upper end of our valuation range High yield at current valuations is at almost 2x historical averages

BofA Merrill Lynch Global High Yield Constrained Index (Option adjusted spreads – 2/01/10 to 8/31/15)

Sources: Bloomberg, 31 Aug 15 For illustrative purposes only

Shaded region represents Aberdeen’s fair valuation range

0

100

200

300

400

500

600

700

800

900

1000

2010 2011 2012 2013 2014 2015

Global HY OAS(bps)

Slowdown, Sovereign Debt, & Fiscal Mess

European Concerns

Tapering Talk Oil Decline / Global Growth Concerns

China, Fed Concerns, Emerging Markets

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21

What is priced into the high yield market Ex-energy expected default rate is expected to be 1.5%, well below what’s priced in

Global High Yield OAS 588bp

Less Premium For Liquidity 100bp

Implied Default Risk Premium 488bp

Expected Default Rate 4.88/(1- 0.40) = 8.13%

Global High Yield OAS-Ex Energy 519bp

Less Premium For Liquidity 100bp

Implied Default Risk Premium 419bp

Expected Default Rate 4.19/(1- 0.40) = 6.98%

Source: JPMorgan, Bloomberg, Aberdeen Asset Management, 3 Sep 15

22

New thoughts on liquidity and lower recovery rates

Source: JPMorgan, Bloomberg, Aberdeen Asset Management, 3 Sep 15

Global High Yield OAS 588bp

Less Premium For Liquidity 200bp

Implied Default Risk Premium 388bp

Expected Default Rate 3.88/(1- 0.38) = 6.25%

Global High Yield OAS-Ex Energy 519bp

Less Premium For Liquidity 200bp

Implied Default Risk Premium 319bp

Expected Default Rate 3.19/(1- 0.40) = 5.31%

23

High yield energy sector default rate sensitivity analysis Current valuations are consistent with lower for longer oil prices

Annual Default Rate

Case Scenario 2015 2016 2017 Average Cumulative

Modest Recovery $55 oil, $2.75 gas 4.6% 3.8% 11.6% 6.7% 20.0%

% Services 24.3% 70.3% 53.7%

% E&P 75.7% 29.7% 46.3%

Spot Market $45 oil, $2.75 gas 4.6% 6.4% 18.6% 9.9% 29.6%

% Services 24.3% 66.3% 25.0%

% E&P 75.7% 33.7% 75.0%

Unsustainably Low $35 oil, $2.75 gas 4.6% 20.0% 10.7% 11.8% 35.3%

% Services 24.3% 44.3% 11.2%

% E&P 75.7% 55.7% 88.8%

Source: J.P. Morgan, Aberdeen Asset Management, Bloomberg, 31 Aug 15 Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially

Energy OAS 1026bp

Less Premium For Liquidity 400bp

Implied Default Risk Premium 626bp

Expected Default Rate 6.26/(1 - 0.20) = 7.82%

Page 9: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

24

9% of Global high yield index trading at distressed levels

Percentage of global high yield Index trading at an option adjusted spread of above 1000

Source: BofA Merrill Lynch, 31 Aug 15 For illustrative purposes only

0

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1

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% o

f Ind

ex

Broad-based concerns

about global economic

recession

48% of recent surge is

driven by Energy and

Metals & Mining

25

High yield energy sector Proceed with caution in the E&P sector

• Midstream 5% to 8% YTW

• Services 8% to 42% YTW

– Offshore

– Onshore

• Refining 3% to 8% YTW

• Exploration & Production 5% to 78% YTW

Source: BofA Merrill Lynch, Aberdeen Asset Management 31 Aug 15 For illustrative purposes only

Ranges of Yield to Worst by Tier

Tier 1 30% of E & P 5% - 8%

Tier 2 28% of E & P 8% - 11%

Tier 3 17% of E & P 11% - 15%

Tier 4 10% of E & P 15% - 20%

Tier 5 15% of E & P > 20%

26

Not all is bad in global high yield

Source: BofA Merrill Lynch, 31 Aug 15 The above data represents the BofA Merrill Lynch Global High Yield Constrained Index For illustrative purposes only

Trailing 3-months

Trailing 12-months

Energy Basic Industry

Services Utility

Technology & Electronics Banking

Consumer Goods Leisure

Real Estate Healthcare

-12 -10 -8 -6 -4 -2 0 2Total Return (%) Hedged to USD

Energy Basic Industry

Services Utility

Technology & Electronics Banking Consumer Goods

Leisure Real Estate

Healthcare

-20 -15 -10 -5 0 5 10Total Return (%) Hedged to USD

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27

Liquidity

28

High yield mutual fund ownership over time Mutual fund ownership not that significant in historical context

Source: Morningstar, BofA Merrill Lynch Global Research, 31 Jul 15. Past performance is not indicative of future results The above data represents BofA Merrill Lynch US HY Cash Pay Index & Morningstar US Open-end High Yield Category and excludes ETFs, Money Market Funds, and Fund of Funds For illustrative purposes only

-

200

400

600

800

1,000

1,200

1,400

1,600

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Feb

93Au

g 93

Feb

94Au

g 94

Feb

95Au

g 95

Feb

96Au

g 96

Feb

97Au

g 97

Feb

98Au

g 98

Feb

99Au

g 99

Feb

00Au

g 00

Feb

01Au

g 01

Feb

02Au

g 02

Feb

03Au

g 03

Feb

04Au

g 04

Feb

05Au

g 05

Feb

06Au

g 06

Feb

07Au

g 07

Feb

08Au

g 08

Feb

09Au

g 09

Feb

10Au

g 10

Feb

11Au

g 11

Feb

12Au

g 12

Feb

13Au

g 13

Feb

14Au

g 14

Feb

15

US

Hig

h Y

ield

Mar

ket V

alue

(in

billio

ns)

Mut

ual F

und

Ow

ners

hip

as %

of I

ndex

Mutual Fund Ownership as % of Index (LHS) US High Yield Market Value (in billions) (RHS)

29

Liquidity risk exaggerated? We think so… Markets historically not very liquid in global high yield

Past performance is not indicative of future results The above data represents FINRA – BLP Active High Yield US Corporate Bond Index and the BofA Merrill Lynch US High Yield Constrained Index. For illustrative purposes only

Primary Dealer Positions in Corporate Securities (old)

Source: Federal Reserve Bank of New York, 7 May 14

High Yield US Corporate Bond Trading Volume as Percent of Index

Source: BofA Merrill Lynch Global Research, FINRA TRACE, 31 Aug 15

Primary Dealer Positions in Corporate Securities (new)

Source: Federal Reserve Bank of New York, 19 Aug 15

MarketAxess High Yield Bid-Ask Spread

Source: MarketAxess, 31 Aug 15

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1

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02

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03

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04

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05

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05

Mar

06

Oct

06

May

07

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07

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8

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0

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11

Jan

12

Aug

12

Mar

13

Dea

ler I

nven

torie

s, U

S$b

n Old Series (includes CDO)

0

5

10

15

20

25

30

Apr 1

3M

ay 1

3Ju

n 13

Jul 1

3Au

g 13

Sep

13O

ct 1

3N

ov 1

3D

ec 1

3Ja

n 14

Feb

14M

ar 1

4Ap

r 14

May

14

Jun

14Ju

l 14

Aug

14Se

p 14

Oct

14

Nov

14

Dec

14

Jan

15Fe

b 15

Mar

15

Apr 1

5M

ay 1

5Ju

n 15

Jul 1

5Au

g 15

Dea

ler I

nven

torie

s, U

S$b

n New Series (IG & HY Corporates Only) High Yield Only

0%

2%

4%

6%

8%

10%

Aug

05

Apr 0

6

Dec

06

Aug

07

Apr 0

8

Dec

08

Aug

09

Apr 1

0

Dec

10

Aug

11

Apr 1

2

Dec

12

Aug

13

Apr 1

4

Dec

14

Aug

15

Mon

thly

trad

ing

volu

me

as

perc

ent o

f US

Hig

h Y

ield

In

dex

00.5

11.5

22.5

33.5

4

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Jan

13

Jan

14

Jan

15

Bid

-Ask

Spr

ead

Page 11: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

30

What are we focusing on today?

• Where are rates headed?

• China. Will the China slowdown drag the rest of the world with it?

• Commodities and TIPS. What is the market telling us?

31

Where are rates headed?

32

Lower interest rates for longer than you might think

We at Aberdeen believe that there is a compelling case to be made that interest rates might be sticking around at historically low levels longer than most believe possible. The foundation for that view can be seen in some of the structural changes to the economy as well as some underlying trends that are not so obvious.

Page 12: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

33

There are two schools of thought

Normal cyclical recovery • Real GDP at or above long-term trend growth

• As unemployment rates move lower, wages will increase

• Inflation will accelerate

• The transmission mechanism of velocity of money, wealth creation, and animal spirits will lift us to a new glide path for growth

Lower for longer • Deteriorating demographic trends worldwide

• World inundated with debt

• More deleveraging

• Lower productivity growth

• Regulatory environment creating headwinds

34

The more obvious

• Still too much debt

• Demographics

• Declining productivity

• Regulatory overhang still creating head winds

• Potential Real GDP expected to remain well below trend

35

What happened to deleveraging?

Source: McKinsey Global Institute analysis

Page 13: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

36

Aging US population

Percentage of population younger than 15 vs. 65 and older in the U.S.

Source: United Nations, Department of Economic and Social Affairs, World Population Prospects: 2012 Revision, Jun 13 http://esa.un.org/unpd/wpp/index.htm, PEW Research Center. For illustrative purposes only Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially

37

Increasing dependency across much of the world

Number of dependents (younger than 15 and 65 and older) for every 100 people of working age (15-64)

Source: United Nations, Department of Economic and Social Affairs, World Population Prospects: 2012 Revision, Jun 13 http://esa.un.org/unpd/wpp/index.htm, PEW Research Center. For illustrative purposes only . Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially

88

82

54 54

36

49 52 52

38

47

57

69

60

48 47

63 66

83 88 88

94 96

0

20

40

60

80

100

Nigeria Kenya India South Africa China U.S. Germany Italy South Korea Spain Japan

2010 2050

Fewer Dependents More Dependents

38

Source: McKinsey Global Institute analysis Forecasts are offered as opinion and are not reflective of potential performance, are not guaranteed and actual events or results may differ materially. For illustrative purposes only

Productivity growth and labor force growth suggest sub-par growth ahead

Page 14: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

39

Productivity slump plaguing the US economy

US productivity growth

Source: The Economist Intelligence Unit, 14 Aug 15. For illustrative purposes only

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

(% change, year on year, five-year rolling average

40

Federal Regulations….a massive headwind

• Federal regulation and intervention cost American consumers and businesses an estimated $1.88 trillion in 2014 in lost economic productivity and higher prices.

• If U.S. federal regulation was a country, it would be the world’s 10th largest economy, ranking behind Russia and ahead of India.

• Economy-wide regulatory costs amount to an average of $14,976 per household – around 29 percent of an average family budget of $51,100. Although not paid directly by individuals, this “cost” of regulation exceeds the amount an average family spends on health care, food and transportation

Source: “Ten Thousand Commandments 2015”, The American Enterprise Institute, 8 May 15

41

Output gap: Real GDP compared with potential GDP Is this what a normal recovery looks like?

Output gap: Real GDP compared with potential GDP, 2000Q1–2014Q4

Source: Bureau of Economic Analysis’ National Income and Product Accounts Tables and U.S. Congressional Budget Office, 13 Apr 15 Old Potential GDP was based on data gathered in Q2 2014. The third and fourth quarters of 2014 were estimated based on this data and calculated using the slope of potential GDP since Q1 2000. New Potential GDP is based on U.S. Congressional Budget office data as of 13 Apr 15. For illustrative purposes only

Real GDP

Potential GDP (Old vs. New)

$11,500

$12,500

$13,500

$14,500

$15,500

$16,500

$17,500

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

2012

Q1

2013

Q1

2014

Q1

Bill

ions

of c

hain

ed 2

009

dolla

rs

Real GDP New Potential GDP Old Potential

$326.3 billion below new potential

$608.2 billion

Page 15: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

42

The not so obvious

• Corporate Pension Funds and Insurance Portfolios Love Higher Rates!

• Retiring Baby Boomers

• The Global Savings Glut

• Global Government Yield Curves

43

US Corporate DB plans are desperately trying to avoid the pains of 2008 when their funding ratio dropped precipitously

Source: UBS Global Asset Management, Barclays, Markit, Mar 15. For illustrative purposes only

Fund

ing

Rat

io

Funding Ratio R

eturn

Funding Ratio Return

Funding Ratio

• Corporate America is increasingly turning to Liability-Driven-Investing (LDI) to de-risk their DB pension

portfolios and immunize their pension liabilities

• As their funding status improves, more assets will be shifted towards long-duration fixed income

44

Retiring baby boomers need more fixed income

Source: S&P Capital IQ Financial Communications, 2013. For illustrative purposes only

25-year-old 45-year-old 65-year-old

85%

10%

5%

Stocks Bonds Cash

70%

20%

10%

Stocks Bonds Cash

50% 40%

10%

Stocks Bonds Cash

Page 16: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

45

Combined retirement market over $24 trillion

U.S. Total Retirement Market

Source: Investment Company Institute, Federal Reserve Board, National Association of Government Defined Contribution Administrators, American Council of Life Insurers, Internal Revenue Service Statistics of Income Division, and Government Accountability Office, 24 Jun 15 * Data are estimated For illustrative purposes only

2.6 4.7 3.7 5.9 7.0 7.1 7.3 7.3 7.4 7.6

3.0

4.6 3.6

5.3 6.2 6.3 6.5 6.5 6.7 6.8

2.0

2.6

2.0

2.7

3.1 3.1 3.2 3.2 3.2 3.2

3.0

4.4

3.6

4.4

5.0 5.0 5.1 5.1 5.1 5.1

1.0

1.7

1.4

1.8

2.0 2.0 2.1 2.0 2.1 2.1

11.6

18.0

14.2

20.1

23.3 23.5 24.2 24.2 24.6 24.9

2000 2007 2008 2012 2013 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15

IRAs DC plans Private-sector DB plans Government DB plans Annuity reserves

* * * * * * *

Trillions of dollars, end-of-period, selected periods

46

The trend to immunize continues

Asset allocation – equities Asset allocation – fixed income

Source: Milliman-Corporate Pension Funding Study, Dec 14 For illustrative purposes only

47

Global household wealth totaled $263 trillion in 2014. This global aggregate has more than doubled since 2000 creating a global savings glut that continues to look for a safe place to park money.

Total global wealth 2000 – 2014, by region

Source: James Davies, Rodrigo Lluberas and Anthony Shorrocks, Credit Suisse Global Wealth Databook, Oct 14 For illustrative purposes only

Page 17: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

48

5-Year Government Yields of G10 countries 5 of the 10 at or close to zero

Source: Bloomberg, 17 Aug 15 For illustrative purposes only

-0.25

0.25

0.75

1.25

1.75

2.25

2.75

Dec

-13

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-1

5

May

-15

Jun-

15

Jul-1

5

United States Belgium Canada France Germany Italy Japan Netherlands Sweden United Kingdom

49

Fed Funds Rate and 10-year US Treasury Yield during the last tightening cycle Expect a similar path for the 10-year US Treasury during this upcoming tightening cycle

Fed Funds Rate and 10-Year US Treasury Yield During the Last Tightening Cycle

Source: US Federal Reserve, Bloomberg, 31 Aug 15 For illustrative purposes only

0

1

2

3

4

5

6

7

Dec

-99

Apr-0

0

Aug-

00

Dec

-00

Apr-0

1

Aug-

01

Dec

-01

Apr-0

2

Aug-

02

Dec

-02

Apr-0

3

Aug-

03

Dec

-03

Apr-0

4

Aug-

04

Dec

-04

Apr-0

5

Aug-

05

Dec

-05

Apr-0

6

Aug-

06

Dec

-06

Apr-0

7

Aug-

07

Dec

-07

Apr-0

8

Aug-

08

Dec

-08

Apr-0

9

Aug-

09

Dec

-09

Apr-1

0

Aug-

10

Dec

-10

Apr-1

1

Aug-

11

Dec

-11

Apr-1

2

Aug-

12

Dec

-12

Apr-1

3

Aug-

13

Dec

-13

Apr-1

4

Aug-

14

Dec

-14

Apr-1

5

Aug-

15

US 30 Day Fed Funds Rate US 10-year Government Bond Yield

US 10-year 4.583%

US 10-year 4.981%

50

China - Can they drag down the rest of the world?

Page 18: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

51

The disconnect between the Chinese economy and equity markets

A-share market (index, 2001=100, 6mma)

Source: EM Advisors Group, 31 Jul 15, For illustrative purposes only

0

100

200

300

400

500

600

700

2000 2003 2006 2009 2012 2015

GDP Index

52

China - Can they win the currency war? Total return of various currencies between 8/11/15 and 9/8/15

Source: Bloomberg, 8 Sep 15, For illustrative purposes only

Malaysian Ringgit

Brazilian Real

Turkish Lira

South African Rand

Colombian Peso

Russian Ruble

Indonesian Rupiah

Australian Dollar

Indian Rupee

Mexican Peso

Polish Zloty

Swiss Franc

Hungarian Forint

Czech Koruna

Romanian Leu

Danish Krone

Euro

Swedish Krona

Iceland Krona

Japanese Yen

-10.00 -8.00 -6.00 -4.00 -2.00 0.00 2.00 4.00 6.00Currency Total Return (%)

Chinese Yuan has depreciated 2.54% vs. USD

53

Composition of China GDP Exports less than 5% of GDP

Source: Emerging Advisors Group, Sep 15, For illustrative purposes only

-5%

0%

5%

10%

15%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Consumption Investment Net exports Overall GDPContribution to GDP growth (% y/y 3qma)

Page 19: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

54

There are some signs of a domestic recovery

Source: NBS, Bloomberg, 30 Jun 15 For illustrative purposes only

Property sales improve Loan growth picks up following easing measures

-20

-10

0

10

20

30

40

50

0

20

40

60

80

100

120

140

160

180

Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15

Residential Floor Space Sold sqm mnResidential Floor Space Sold % yoy (RHS)

0

500

1,000

1,500

2,000

2,500

3,000

-500

0

500

1,000

1,500

2,000

2,500

3,000

Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15

RMB Bank Loans Foreign Currency Bank LoansOff Balance-Sheet Lending Corporate BondsEquity Financing Total Social Financing (RHS)

Aggregate Financing (RMB bn)

Source: PBOC, 30 Jun 15 For illustrative purposes only

55

What are the markets telling us?

• Commodities

• Break Even Inflation Rates

• Forward Rates

• We can learn a lot from the last tightening cycles

56

Declining commodity prices dampen inflationary pressure

Source: Bloomberg, 20 Aug 15, For illustrative purposes only

50

100

150

200

250

300

350

400

450

500

300

400

500

600

700

800

900

1000

Dec

-09

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec

-10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct

-11

Dec

-11

Feb-

12

Apr-1

2

Jun-

12

Aug-

12

Oct

-12

Dec

-12

Feb-

13

Apr-1

3

Jun-

13

Aug-

13

Oct

-13

Dec

-13

Feb-

14

Apr-1

4

Jun-

14

Aug-

14

Oct

-14

Dec

-14

Feb-

15

Apr-1

5

Jun-

15

Commodity Research Bureau BLS/US Spot Raw Industrials Index (LHS) S&P-Goldman Sachs Commodity Index (LHS)

Bloomberg Commodity Index (RHS) Thomson Reuters/CoreCommodity CRM Commodity Index (RHS)

Page 20: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

57

Inflation expectations back to new lows 10 yr US Treasury vs. 10 yr TIPS

Source: Bloomberg, 31 Aug 15, For illustrative purposes only

100

120

140

160

180

200

220

240

260

280

Dec

-10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct

-11

Dec

-11

Feb-

12

Apr-1

2

Jun-

12

Aug-

12

Oct

-12

Dec

-12

Feb-

13

Apr-1

3

Jun-

13

Aug-

13

Oct

-13

Dec

-13

Feb-

14

Apr-1

4

Jun-

14

Aug-

14

Oct

-14

Dec

-14

Feb-

15

Apr-1

5

Jun-

15

Aug-

15

164

58

The forward yield curve is usually too pessimistic. This suggests that five year rates will be well under 3% in five years!

Source: Bloomberg, 19 Aug 15. For illustrative purposes only Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially

0.37

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

Aug-

15

Nov

-15

Feb-

16

May

-16

Aug-

16

Nov

-16

Feb-

17

May

-17

Aug-

17

Nov

-17

Feb-

18

May

-18

Aug-

18

Nov

-18

Feb-

19

May

-19

Aug-

19

Nov

-19

Feb-

20

May

-20

Aug-

20

3 Month Eurodollar Futures Curve 5 Yr Fixed-Rate Futures Swap Curve

1.60

0.37

59

High yield performance surrounding a tightening cycle

Rising Rate Period 1: February 4, 1994 - February 1, 1995 Calendar-year returns (before, during, after full period) 1993 1994 1995 1996 Ending Fed Funds Rate 3.00% 5.50% 5.63% 7.00% US High Yield 17.18% -1.17% 19.91% 11.06% Investment Grade Corporate 12.42% -3.34% 21.55% 3.39% Five Year US Treasury 9.41% -4.26% 16.93% 2.31% S&P 500 10.06% 1.31% 37.54% 22.91%

Rising Rate Period 2: June 30, 1999 - May 16, 2000 Calendar-year returns (before, during, after full period) 1998 1999 2000 2001 Ending Fed Funds Rate 5.00% 5.25% 6.25% 1.25% US High Yield 3.66% 1.57% -3.79% 6.21% Investment Grade Corporate 8.72% -1.86% 9.14% 10.73% Five Year US Treasury 9.81% -2.54% 11.88% 7.51% S&P 500 28.55% 21.03% -9.10% -10.92%

Rising Rate Period 3: June 30, 2004 - June 29, 2006 Calendar-year returns (before, during, after full period) 2003 2004 2005 2006 2007 Ending Fed Funds Rate 0.94% 2.25% 4.00% 5.38% 3.00% US High Yield 27.23% 10.76% 2.83% 11.64% 2.17% Investment Grade Corporate 8.31% 5.41% 1.97% 4.38% 4.64% Five Year US Treasury 2.51% 2.4% 0.016% 2.81% 10.42% S&P 500 28.66% 10.88% 4.91% 15.78% 6.30%

Investment Grade Corporate Index US High Yield Index Difference Annualized Return for Cumulative Period 6.39% 8.07% 1.68%

Source: Bloomberg, 2007. Past performance does not guarantee future results Investment Grade Corporate: The BofA Merrill Lynch US Corporate Index, US High Yield: The BofA Merrill Lynch US Cash Pay High Yield Index For illustrative purposes only

Page 21: We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total

60

Disclaimer

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