Rethinking Bond Investing Steve Shaw Founder & President, BondSavvy steve@bondsavvy

1. Rethinking Bond Investing Steve Shaw Founder & President, BondSavvy steve@bondsavvy.com September 21, 2019

2. BondSavvy Disclaimer • InvestorG2 LLC d/b/a BondSavvy is not registered as an investment adviser under the Investment Advisers Act of 1940, as amended (“Advisers Act”), or the securities laws of any state or other jurisdiction, nor is such registration contemplated.  • Any screenshots, charts, or company trading symbols mentioned are provided for illustrative purposes only and should not be considered an offer to sell, a solicitation of an offer to buy, or a recommendation for the security. • As BondSavvy operates under the publishers’ exemption of the Advisers Act, the investments and strategies discussed in this presentation do not take into account an investor’s particular investment objectives, financial situation or needs.  In making an investment decision, each investor must rely on its own examination of the investment, including the merits and risks involved, and should consult with its investment, legal, tax, accounting and other advisors and consultants. • The information in this presentation is based on data currently available to Shaw, as well as various expectations, estimates, projections, opinions and beliefs with respect to future developments, and is subject to change.  Neither Shaw nor any other person or entity undertakes or otherwise assumes any obligation to update this information. • There are risks inherent in investing in bonds, which may adversely affect the bonds’ investment returns.  These risks include, for example, market decline, interest rate fluctuations, inflation, default, liquidity, and asset class risks.  There is no guarantee that investors will be able to meet their investment objectives.  Past performance does not guarantee future results.  Investors could lose all or part of their investment in a bond, particularly when investing in a high yield bond.  Investing in bonds could also produce lower returns than investing in other securities.  Investing in bonds does not constitute a complete investment program.

3. Let’s Challenge Long-Held Bond-Investing Beliefs • Best to ‘leave it to the fund experts’ – bond investing is too hard • Investors can’t beat the index • Always hold bonds to maturity • Build a laddered bond portfolio • Focus on a bond’s yield not the price at which you buy • Bonds only return 2-4% • If ‘interest rates’ rise, bond prices ALWAYS fall • A credit rating and a yield is all you need to evaluate a bond

4. Three Things You Need To Know Before Making an Investment • The price • How investment’s ‘value’ compares to similar investments • The ongoing costs of the investment

5. With Bond Funds, You Know “None of the Above” • Impossible to compare value of fund vs. fund • Thousands of securities owned and always changing • Funds priced to NAV not par value • Few ‘pure-play’ bond funds make it difficult to compare relative performance • High fund turnover drives high, undisclosed fees

6. Bond Funds: Impossible-to-assess prices and high turnover *As of, or for the trailing twelve months ending, 12/31/18 for Vanguard, 2/28/19 for iShares AGG, 3/31/19 for PIMCO and 6/30/19 for MetWest

7. Advantage #1: Bonds vs. Bond Funds Individual corporate bonds are all quoted as a percentage of their face value, enabling investors to begin assessing a bond’s relative value “Discount” “Premium” “Par” How quoted 80.00 90.00 70.00 100.00 130.00 140.00 110.00 120.00 Value per bond $700 $800 $1,300 $1,400 $900 $1,000 $1,100 $1,200

8. Other Advantages of Bonds vs. Bond Funds • Increase returns by owning ‘All-Star’ bonds and not bond-fund benchwarmers • Know exactly what you are investing in and invest based on your risk-return objectives • Limited trading costs since you control turnover • Greater opportunity for capital appreciation and improved tax efficiency Bond funds also take the “fixed” out of “fixed income” with no set interest payments and maturity dates

9. The Benefits of Being Selective ‘Buy low and sell high’ can apply to bonds and generate returns higher than a bond’s YTM Risk Investment Date YTM Annualized Return Through Sale Interest Rate Bond Price: Investment Date vs. Sell Date Bond Credit Highest 6.4% 4.8% Apple 3.850% ’43 Low 10/28/13 5/9/18 Higher Low Cablevision 5.875% ’22 10.1% 17.6% 12/8/15 1/9/18 None Highest 54.2% Toys R Us 10.375% ’17 24.6% 2/12/16 9/29/16 Please note: Selling bonds prior to maturity will not always result in returns in excess of the bond’s Yield To Maturity.  Selling prior to maturity may result in lower returns than if the bond was held through to maturity. For Illustrative purposes only

10. Attributes of Individual Corporate Bonds Corporate bonds are issued by the same companies as stocks, but make up <1% of US investor portfolios in spite of their attributes: • Contractual interest payments and return of principal • Financial covenants that protect investors • Senior to common and preferred stock • Wide variety of risk/reward opportunities • Many areas of corporate bond market performed well when stocks collapsed in Q4 2018

11. Individual corporate bonds can help to balance stock market volatility JANUARY 3, 2019 PRICE PERFORMANCE Apple Stock Apple 3.45% ’45 Bonds Falls 10% from $158.34 to $142.09 Unchanged at 88.50* Images licensed from Getty Images. * Source: FINRA TRACE market data

12. How Not To Invest in Bonds

13. Advisors placing clients into bond funds… Investor Financial Advisor Bond Funds & ETFs 1% Fee 0.1-1% Fee …works well for everyone BUT the investor

14. Investing in large index funds – especially through an advisor – is a bad investment % Returns for Vanguard Total Bond Market Index Fund Admiral Shares and Advisor Fee Impact 0.63% Average Annual Return

15. After investing $100k over four years in VBTLX, the investor made $1,531 less than his advisor ‘15-’18 Returns Annual Investor Returns vs. Fees Paid to Advisor and Vanguard* $4,040 $202 $2,509 * Reflects returns of Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX)

16. The status quo rewards service providers at the expense of the investor

17. It’s the “Advisor to Vanguard Road to Nowhere”

18. Corporate Bonds 101

19. Corporate Bonds 101 – Coupon and Maturity Verizon 3.85% 11/1/42 • Coupon: • Paid semi-annually until maturity date • $38.50 in interest received annually for each bond owned • $385 per year if owned 10 bonds • Maturity Date: • Date at which company returns face value (“par”) to investor ($1,000 per bond) • Price you pay for a bond could be higher (‘premium’) or lower (‘discount’) than par value

20. How Bonds Are Quoted & What You Pay Bid / Offer Quote Sell 1 Bond for: Buy 1 Bond for: 87.50 / 88.00 $880.00 $875.00 • How bonds are quoted: • Percentage of face value • Face value of one bond is $1,000 • Online quotes before 0.1 pts markup/down Plus Interest Accrued Since Last Coupon

21. Current Yield vs. Yield to Maturity Verizon 3.85% 11/1/42 Yield to Maturity Current Yield Bid-Offer Quote 3.85% 3.85% If Bought at Par 87.50 / 88.00 4.70% 4.38% If Bought at 88.00 $880.00 to buy one bond $38.50 ÷ $880.00 Current Yield at 88.00 =

22. Technology Has Put Individual Investors on a More Level Playing Field with Institutional Investors 25 Years Ago Today Investing online enables investors to see broad inventory at competitive prices

23. Liquid Market That Enables Active Investing Corporate bonds trade in a competitive, two-sided market with generally reasonable bid-offer spreads Verizon 3.85% 11/1/42 – Depth of Book* Offers Bids Bid-Offer Spread 0.65 points 0.047% or 4.7 bps * Depth of book shown on Fidelity at 1:55pm EDT on March 13, 2019.

24. How Treasury Yields & Credit Spreads Impact Bond Prices Benchmark Treasury YTM + Credit Spread = Corporate Bond’s YTM YTM Building Blocks

25. Deciding When To Sell a Bond Marriott Int’l 3.125% 6/15/26 Bond December 12, 2018 Investment Date May 15, 2019 Update • Since December 12, Treasurys rallied AND the bond’s credit spread fell to a level below that of comparable bonds • No credit rating change during the five-month period • We saw little upside remaining in the bond on May 15 Benchmark Treasury YTM + Credit Spread = Corporate Bond YTM Ask Price: Benchmark Treasury YTM + Credit Spread = Corporate Bond YTM Ask Price: 2.80% 2.31% 1.78% 1.09% 4.58% 3.40% 90.83 98.29 Source: YTM, pricing, and credit spread data from Fidelity.com. Example is for illustrative purposes only.

26. The Par Value Scale Informs Buying and Selling Decisions • The par-value scale is a big advantage individual bonds have over funds • Bonds trading at a discount generally have greater upside and less downside than premium bonds • In a taxable account, $1 of capital gain is worth more than $1 of interest income • Bond prices have ceilings, which often requires selling prior to maturity to maximize returns Investment-Grade Bond Offer Prices – 1,587 Bonds – June 13, 2019 * Investment-grade corporate bond search conducted June 13, 2019 on Fidelity.com for bonds with yields to worst of at least 4.00%. Bonds are quoted as a percentage of their face value.

27. How We Make Initial Investment Decisions

28. Overlaying Credit Spreads with Financial Metrics INTEREST COVERAGE RATIO LEVERAGE RATIO EBITDA Long-Term Debt ÷ EBITDA Earnings before interest, taxes, depreciation & amortization EBITDA ÷ Interest Expense Lower = lower default risk Higher = lower default risk “Purer” of the two ratios

29. Corporate Bond ‘Sweat Meter’ Higher credit risk Lower credit risk <=3.0x >=5.5x LEVERAGE RATIO INTEREST COVERAGE RATIO >=10x <=2.5x INVESTOR STATE OF MIND Credits: Beach chair image licensed from Canva. Sweating man image licensed from Shutterstock.

30. Credit Ratings Can Be Helpful But Have Shortcomings Bond rating shortcomings • Can often go years without changing • Don’t speak to the value of a bond • “Fuzzy metrics” often weighted more heavily than traditional credit ratios BUT…Understanding ratings is still important: • Rating impacts bond’s Treasury-yield sensitivity • Upgrades and downgrades can impact corporate bond prices Investment Grade Non-Investment Grade or “High Yield”

31. Finding Value by Comparing Credit Spreads* and Financials Leverage Ratio (1) 3.6x 1.8x 2.4x 1.4x $2.3 Cash (1) $0.9 $4.6 $225.4 Debt (1) $9.8 $3.7 $113.7 $112.6 Ba1 / BBB Rating WD** / CCC+ Baa1 / BBB+ Aa1 / AA+ 31 *Bond quotes taken on Fidelity.com between 10:38am and 11:00am EDT on May 23, 2019. **Moody’s withdrew its rating 3/28/13 due to ‘insufficient’ information to support rating. (1) $ in billions. Figures calculated based on financial information as of, or for the 12 months ending March 31, 2019, except Albertsons, which is as of Feb 23, 2019.

32. Understanding ‘credit value’ is key; however, investors must also understand how different bonds can react to changes in Treasury yields

33. How Credit Quality Impacts Interest Rate Risk Corporate bonds of higher credit quality tend to have greater interest rate risk due to their: • Longer initial maturities • Lower coupons • Institutional trading being indexed to the benchmark US Treasury 3 5 2 4 1 6 Interest Rate Risk Ranked 1-6 (1=highest) Source: Bond quotes taken on Fidelity.com between 10:38am and 11:00am EDT on May 23, 2019. Expedia, on this date, was ‘split rated,’ as it was rated below investment grade by Moody’s (Ba1) and investment grade by S&P (BBB).

34. Corporate Bonds Don’t Move in Lockstep with Treasurys Investment-grade and high-yield corporate bonds react differently to changes in Treasury yields Verizon 3.85% 11/1/42 vs. Benchmark Treasury – Sep 25, 2017-Apr 30, 2019 US Treasury 2.75% 11/15/42 Verizon 3.85% 11/1/42 Total Return* Total Return* +1.9% +13.3% -2.4 pts +6 pts Source: Historical Verizon ‘42 and US Treasury prices are from FINRA market data. Treasury CUSIP is 912810QY7. * Verizon return based on market price on September 25, 2017 on Fidelity.com and Fidelity statement price on April 30, 2019. Total returns include interest income and capital gains or losses.

35. Not All Bonds Go Down When Treasurys Fall Even as the comparable Treasury fell 7 points, this Albertsons ’29 bond returned 33.6%* due to strong performance and reduced concern around the Amazon / Whole Foods merger Albertsons 7.45% 8/1/29 vs. Benchmark Treasury Price Performance – Sep 25, 2017-Apr 30, 2019 Albertsons 7.45% 8/1/29 US Treasury 6.125% 8/15/29 Total Return* Total Return* +33.6% +1.7% Albertsons Leverage Ratio: 6/17/17: 4.3x 2/23/19: 3.6x 1/22/19: S&P downgrades to CCC+ -7.4 pts June ’17: Amazon buys Whole Foods July ‘17: Albertsons cancels IPO 9/25/17 +15 pts * Albertsons return based on 9/25/17 offer price from Fidelity.com and 4/30/19 price from Fidelity brokerage statement. Treasury CUSIP: 912810FJ2. All other historical prices are from FINRA market data. Total returns include interest income and capital gains or losses.

36. How To Invest Actively in Corporate Bonds

37. Active Corporate Bond Investing vs. Bond Laddering Active bond investing has a number of advantages vs. traditional bond ladders Illustrative $100k Bond Ladder Illustrative Active Corporate Bond Investing Legend: • Reduce timing risk by investing over time • Potentially increase returns by selling pre-maturity to enhance capital appreciation • Modify approach as environment changes • Bond selection based on value and not just a maturity date • ‘Big bang’ initial investment with high timing risk • Return capped at YTM • Unable to exploit market opportunities • Maturity-based investment criteria Initial Investment Bond Maturities Additional Buys Sells $100k $40k $40k $40k $30k $30k $30k $30k 2026 $40k matures & re-invest 2028 $30k matures & re-invest 2023 $30k matures & re-invest Initial Investment Year 1 Year 5 Year 3 Year 4 Year 2 For illustrative and educational purposes only.

38. What Active Corporate Bond Investing Is and Is Not Active Corporate Bond Investing IS Active Corporate Bond Investing IS NOT • Generally 1- to 4-year holding period • Day trading • Maximize returns over 1- to 4-year periods • Selling as soon as a bond goes up 10 points Sell! • Add to positions over time, including when prices fall • Selling as soon as a bond goes down 10 points Sell!

39. My Bond Investing “Commandments” • Own bonds directly to improve transparency, lower fees, and increase returns • Own a select portfolio of bonds with compelling relative values • Make buy / sell decisions based entirely on investment criteria and NOT to create a bond ladder • Vigorously protect every dollar of capital appreciation by selling prior to maturity when upside wanes • Invest over time to capitalize on opportunities • ‘High-yield’ bonds often have less overall risk than higher-rated bonds

40. Investors in individual bonds keep learning and can improve performance over time

41. Founded company to empower investors and increase returns • 28 current bond recommendations • Both investment grade and high yield • Updating prior picks early October

42. Thank youSteve Shawsteve@bondsavvy.com(201) 748-9862 www.bondsavvy.com