BALANCING INCOME GENERATION IN A WORLD OF VUCA April 2017 FPA - PowerPoint PPT Presentation

BALANCING INCOME GENERATION IN A WORLD OF VUCA April 2017 FPA Arne Espe, CFA, Mutual Funds Portfolio Manager USAA Mutual Funds 1

About our Presenter from USAA Arne Espe, CFA Mutual Funds Portfolio Manager USAA Mutual Funds • Portfolio Manager of Flexible Income Fund. Bond portion of Cornerstone Strategy Funds, First Start Growth, and Real Return. • 30+ Years of investment management experience; has been at USAA since 2000 • Education: MBA University of Oregon and B.S. Willamette University 2

About USAA Proudly serving the military community and their families for 93 years • Founded in 1922 by 25 U.S. Army Officers in San Antonio, Texas • A privately-held reciprocal company with over 11 million members • One of only a few financial companies with the highest possible financial strength ratings from Moody’s & AM Best USAA’s Investment Solutions are Available to the General Public 3

USAA Investments Since 1970 E3./0%!''$.'%FG#$1%/#1%,/#/6$1H%<B?I@ <=>?@% 34&5%U"00.5\"C@C <=>A@ 260H 9:; ?A; <=>=@ T6>U/>.B#5'D8-70 @-05%545%8-6& 34546&'+4-70 W'"99%&%65.' YZ^RD[ YZ*RD[ <B9>C@% T6>6?&.'+%>.7'@-A8B. <D?>D@ /]4%5%.0 As of 12/31/16 X

Agenda • Defining VUCA • USAA’s Investment Outlook • Strategies for Income Generation 5

DEFINING VUCA 6

Defining VUCA It’s Crazy Out There! • V olatility • U ncertainty • C omplexity • A mbiguity 7

Volatility Stock Market *@F&%PJQ R J#1$S R)C)' b)C)' *)C)' ^)C)' S)C)' X)C)' J)C)' ()C)' !)C)' ! " #$%&#%'(" #$%&#%')" #$%&#%'*" #$%&#%#'" #$%&#%##" #$%&#%#$" #$%&#%#&" #$%&#%#+" #$%&#%#," #$%&#%#-" VIX Index (Chicago Board Options Exchange SPX Volatility Index) Source: Bloomberg as of 3/31/17 b

Volatility Economic Growth Real GDP YoY 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 2.0 - (2.00) (4.00) (6.00) 1950 1960 1970 1980 1990 2000 2010 GDP CYOY Index (GDP US Chained 2009 Dollars YoY SA) Real GDP YoY Quarterly 31DE Source: Bloomberg as of 3/31/17 9

Uncertainty Interest Rates Rising Soon? Fed vs Market Expectations 3% FUTURE FED FUNDS TARGET RATE • Fed Projection • Market Expectation • Current Rate 2% 1% 0% 2016 2017 2018 2019 Source: Bloomberg Fed projection is the median of the FOMC Members' Dot projections. The Market Expectation is the implied Fed Funds Target Rate. 10

Complexity Overwhelming Regulatory Rules Source: SEC 11

Ambiguity Earnings and Prices Have Diverged Earnings vs. Prices 170 160 150 140 130 Large gap between earnings and prices 120 110 100 90 80 11-2011 05-2012 11-2012 05-2013 11-2013 05-2014 11-2014 05-2015 11-2015 05-2016 11-2016 MSCI World Prices MSCI World Earnings Source: Bloomberg as of 11/01/16 12

Dealing with VUCA, the New Normal “VUCA environments thus become invitations for inaction — people are befuddled by the turmoil and don’t act. And to succeed, you must act!” General George Casey, Army Chief of Staff and Commanding General of the Multinational Force in Iraq 13

USAA’S INVESTMENT OUTLOOK 14

Total Nonfinancial Debt as a % of GDP Excluding Off Balance Sheet Liabilities Source: Federal Reserve through Q4 2016 !S

Global Government Debt Developed Market Debt Weighs on Global Growth Government Debt/GDP Eurozone United States 110% 100% 90% 80% 70% 60% 50% Source: Bloomberg as of 9/30/16 16

GDP Growth Remains Sluggish US Real GDP Growth 6 5 4 % GROWTH — QoQ 3 2 1 0 -1 -2 2010 2011 2012 2013 2014 2015 2016 Source: Thomson Reuters Datastream as of 9/30/2016 17

“Lower for Longer” Interest Rates Will Likely Persist BXaW$/"%E"$/'-"M%W5$01%4"3b%BIABaDXBC <H67.7'"$.60'I.#$.0.-5'5H.'i.-:5HE',.$%870'89'i8G'I65.0'+8&&8G%-:'D6&6-A.'<H..5'I.A.00%8-0 Source: Robert Shiller of Yale University as of 9/30/2016 !b

Equities A Cyclical Pattern to Global Outperformance U03_/0%&S(3'-"$%!11'%V5Y$"'545[/.53#%.3%78%8.3[Z%23".43053 !R

Value Stocks vs. Expensive Stocks “Cheap” stocks have historically produced higher returns than “expensive” stocks Historic Cheap vs. Expensive U.S. Stock Returns Annualized Return (%) 100000 Cheap 14.84% Stocks 10000 Growth of $1 (log scale) 1000 Expensive 10.02% Stocks 100 Average 12.05% 10 Stocks 1 0.1 1940 1944 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 Source: Fama French database, data as of 3/31/2016 “Cheap” defined as top 30% of stocks in the S&P500 sorted on book to market, “Expensive” defined as lowest 30% of stocks in the S%P500 sorted on book to "Cheap" Stocks "Expensive" Stocks market, average stocks defined as middle 40% of stocks in S&P500 sorted on book to market. 20 20 Past performance is no guarantee of future results

High Yield Bonds are Currently Offering Attractive Yields Relative to Other Fixed Income Asset Classes Multi Asset Class Yields 7.00% 6.00% 5.00% 4.00% 6.21% 3.00% 5.47% 2.00% 3.37% 3.09% 3.01% 2.40% 2.36% 0.78% 1.00% 0.15% 0.00% High Yield EM Debt IG Corporate Municipal CMBS 10 Yr S&P 500 T-Bills Tips Treasury Source: Barclays Capital as of 4/17/17 21 Past performance is no guarantee of future results.

Corporate Bonds and Credit Instruments Can Lead to Outperformance Corporate Bonds Generally Outperform Treasuries Over Time Relative Cumulative Performance 1.5 When slope on chart is going up, Credit is outperforming Treasuries 1.4 1.3 1.2 1.1 1 0.9 When slope on chart is going down, Treasuries are outperforming Credit 0.8 1979 1989 1999 2009 Source: Datastream and Morningstar Direct as of 3/31/17 22

Muni Yields Remain Attractive on Relative Basis Bond Yields as of 3/31/2017 8.00 Treasuries Corporates Municipals Tax-Adjusted Muni* 6.84 7.00 6.00 4.94 5.00 4.00 2.95 3.00 2.18 3.01 2.00 2.39 1.00 1.49 1.00 0.00 1 Year 3 Year 10 Year 30 Year Treasury Corporate Municipal Tax Adjusted Muni * 1 Year 1.00 1.45 1.32 2.18 3 Year 1.49 2.06 1.78 2.95 10 Year 2.39 3.28 2.98 4.94 30 Year 3.01 4.41 4.13 6.84 Note: Corporate based on A-rated industrial curve. Municipal based on Municipal Market Data A-Rated GO Scale. * Municipal yields are on a 39.6% tax bracket Source: Bloomberg/Municipal Market Data Past performance is no guarantee of future results. 23

STRATEGIES FOR INCOME GENERATION 24

Strategies for Income Generation Economy • We project modest economic growth and interest rates staying “lower-for-longer Stocks • Expected returns may be greater in International & Emerging Markets • US “value” stocks appear more attractive at current levels Fixed Income • Seek skilled actively-managed corporate bonds strategies over treasuries – Investment-grade corporate bonds – High-yield bonds – Municipal bonds 25

USAA’s Fixed Income Philosophy We believe a yield focused portfolio, Built bond-by-bond, through fundamental bottom-up analysis, Will generate total returns that can potentially outperform our peers over the long run. 26

USAA Fixed Income Capabilities Available to the General Public – Membership not Required g56N$"%W5$01%j%T5'Z 78!!%+0$S5_0$%J#[3b$% E/S/_0$%% 78!!%g56N%J#[3b$% 78!!%J#.$"b$15/.$aE$"b%@3#1 78!!%E/S%&S$b(.%^3#6aE$"b 78!!%J#[3b$ 78!!%U3Y$"#b$#.%8$[-"5.5$' 78!!%E/S%&S$b(.%J#.$"b$15/.$aE$"b% 78!!%8N3".aE$"b%@3#1 78!!%E/S%&S$b(.%8N3".aE$"b% 78!!%70."/% 8N3".aE$"b% @3#1% E/S%&S$b(.% ^3G$"%W5$01%j%T5'Z (*

USAA Fixed Income Funds with 4 & 5 Star Overall Ratings by Morningstar Morningstar Overall Rating/ 3 Year/Funds 5 Year/Funds 10 Year/Funds Taxable Bonds Category Funds in Category in Category In Category in Category ★★★★ ★★★★ ★★★★ ★★★★ USAA Short-Term Bond Short Term Bond 444 359 257 444 ★★★★ ★★★ ★★★★ ★★★★ USAA Intermediate-Term Corporate Bond 175 142 80 175 ★★★★ Intermediate-Term ★★★★ ★★★★ ★★★★ USAA Income Bond 851 750 538 851 Morningstar Overall Rating/ 3 Year/Funds 5 Year/Funds 10 Year/Funds Municipal Bonds Category Funds in Category in Category In Category in Category ★★★★ USAA Tax Exempt ★★★ ★★★★ ★★★★ Muni National Short Short-Term 181 153 96 181 ★★★★ USAA Tax Exempt Muni National ★★★★ ★★★★ ★★★★ Intermediate-Term Intermediate 256 224 150 256 ★★★★ USAA Tax Exempt ★★★★ ★★★★ ★★★★ Muni National Long Long-Term 145 132 102 145 Morningstar gives its best ratings of five or four stars to the top 32.5% of all funds (of the 32.5%, 10% get five stars and 22.5% get four stars) based on their risk-adjusted returns. The Overall Morningstar Rating is derived from a weighted average of the performance figures associated with a fund's three-, five-, and 10-year (if applicable) Morningstar Rating metrics. Morningstar ratings as of 3/31/17. 28