PIMCO DC Dialogue - First Manage Your Risk


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In this PIMCO DC Dialogue, Professor Zvi Bodie, Norman and Adele Barron Professor of Management at Boston University, discusses with global investment managers PIMCO the difficulties people in the United States have assessing risk accurately, the attitude to risk they should adopt when it comes to retirement planning, and investment strategies for professionals and individuals alike, beginning with low-risk assets such as Treasury Inflation-Protected Securities.

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PIMCO DC Dialogue - First Manage Your Risk

  1. 1. PIMCO DC PracticePIMCO DC Dialogue ™ First manage your risk. February 2011 In this PIMCO DC Dialogue, we talk with Professor Zvi Bodie about preparing for retirement, which he believes is too difficult for the average person without help from experts. Bodie suggests that retirement investing should begin with low-risk assets, as participants need to be This issue features an interview with prepared for the worst – even while hoping for the best. He Zvi Bodie, identifies Treasury Inflation-Protected Securities (TIPS) as theThe Norman and Adele Barron Professor most prudent asset, explaining that TIPS are the only U.S. of Management, Boston University Treasury instrument which is contractually tied to inflation. Moderated by He suggests that adding risk assets to a retirement portfolio Stacy L. Schaus, CFP , ® should be done with an understanding of the potential loss. PIMCO Senior Vice President and He also comments on ways to reduce this risk, including Defined Contribution Practice Leader “tail-risk hedging,” which he notes is an old idea that makes Volume 6, Issue 2 more sense in today’s more liquid markets. As we conclude, he emphasizes the importance of providing a “soft landing” from target-date strategies as participants begin to withdraw their money. Bodie’s retirement math shows that, to invest the most prudent way, participants need to save far more or understand that they will be working to a much older age.
  2. 2. DC Dialogue D C Dialogue: These days, we know that people, not only in the U.S. but in other countries, have to be more accountable for preparing for their own retirement security. How well prepared are they for this reality? Zvi Bodie: They’re not well prepared at all. And I think that, while it’s true that there’s no substitute for a person taking responsibility for him- or herself, it’s also true that the task is way too difficult for the average person to handle without significant help from experts. DCD: What type of help do they need from the experts? Bodie: One of the most difficult type of decisions we all face, and this we know from a lot of behavioral and psychological studies, is a decision that involves risk, because most people have the tendency to make certain errors in judgment. Our brain is more or less hard-wired to make mistakes when it comes to decisions involving uncertainty. There’s even a Nobel Prize in Economics given for work in this field. In fact, Daniel Kahneman won a Nobel for his work on what’s known as “mistakes in perception” that people make. And one of the biggest “We may consider mistakes is overconfidence. People have a tendency either to beTIPS as the closest we unaware of certain risks or to underestimate many types of risk. There may be very good evolutionary reasons for that – an evolutionary can get to a risk-free advantage to ignoring certain types of risks – but it’s not necessarily aportfolio, especially for good thing when it comes to investing for retirement. retirees who need to DCD: How should people think about risk specific to saving for retirement?retain the purchasing What are some of the types of risk someone might ignore?power of their assets.” Bodie: People should hope for the best but prepare for the worst. That is to say, your future depends largely on how much of your portfolio you’re going to put into equities and other risk securities as opposed to the safest asset, which in my book is Treasury Inflation-Protected Securities (TIPS) – government bonds that hedge inflation. We may consider TIPS as the closest we can get to a risk-free portfolio, especially for retirees who need to retain the purchasing power of their assets. Their savings must keep pace with inflation. The general tendency is for people to think with certainty that, over the long run, stocks are going to outperform everything else. And that simply is not necessarily true. In many ways, the longer your time horizon until retirement, the more extreme the loss that you can suffer. So there is this tendency to ignore the possibility of extremely bad outcomes. DCD: In the past you’ve talked about the financial advice models that are available to defined-contribution participants, and how they tend to truncate the tail risk. In other words, investors are not shown the less probable yet extreme risk they may face by investing in certain asset mixes. Page 2
  3. 3. PIMCO DC Practice TIPS are Treasury bonds, backed by the U.S. government, but unlike a traditional government bond, the principal and interest payments on TIPS adjust to track changes in inflation. Specifically, the principal and interest on TIPS are indexed to the CPI-All Urban Consumers (CPI-U) so that increases in consumer prices are directly translated into higher principal and interest payments on TIPS. In the unusual event of deflation, which is a sustained fall in “Participants need prices, the U.S. government guarantees repayment of principal; to understand the at maturity, investors receive the greater of the inflation-adjusted risk of extremely bad principal or the initial par amount. Interest payments on TIPS would decrease in a deflationary environment because interest outcomes.” payments are always based on the inflation-adjusted principal amount, which could potentially be lower than the face value of the bond in a deflationary environment. Bodie: Right. And it makes a difference – a huge difference. Participants need to understand the risk of extremely bad outcomes – the left-tail risk. In many studies, researchers have found that you can present the same set of facts about risk and reward; however, depending on how you frame those facts, you can get exact opposite reactions from the people making the decisions. For example, we know that, by definition, the probability of beating your benchmark is equal to one minus the probability of a shortfall relative to your benchmark. Those two probabilities have to total to one. And yet, if you frame the decision in terms of the chances of a shortfall, you may get a completely different decision from an employee than what you would have gotten if you’d framed it in terms of beating the benchmark. DCD: Do you believe investment professionals are properly educated on investment risk? Do investment texts need to be rewritten? Bodie: If I were rewriting an old text or writing a new book now, I’d begin from what I think is the logical starting point in terms of analyzing investment choices. And that would be taking as little risk as possible. I say that because the fundamental issue in investment management and portfolio management is the trade-off between risk and reward. Ultimately, that’s the tough question: How much risk are you willing to take to attempt to earn a higher return? First, I would have to evaluate a whole set of risk-return combinations. The natural benchmark to that is starting at the point of least risk and Page 3
  4. 4. DC Dialogue asking the question, “Well, what if only want to take minimal risk?” One approach would be to invest 100% of your retirement assets in inflation-hedged bonds – that is, TIPS. And let’s even assume that all you’re going to do is keep up with inflation – not earn any real interest above inflation. So whatever you put in, that’s what you’re going to get out, no matter how many years in the future you withdraw your money. That is still a very useful place to start because, by definition, if you’re going to invest in something that’s riskier and that offers a higher rate of return, then you have to recognize that there’s a downside to taking on that risk. So, yes, you may earn a higher return, but you also may lose principal or not even keep pace with inflation. That’s the downside. And for people who want to anchor their thinking about risk versus reward, the most sensible anchor is a safe rate of return or a minimal- risk portfolio. Again, that’s TIPS. Now, unfortunately, in this country, “safe investing” is often defined as“The safest portfolio allocating to cash, which may include such short-term instruments as is one that locks in Treasury bills and certificates of deposit. The minimal-risk portfolio may be defined as a 100% cash portfolio. Yet that is not necessarily the case,an inflation-adjusted and it certainly is not true in the context of a retirement savings plan. rate of return right I believe the safest portfolio is one that locks in an inflation-adjusted through to your rate of return right through to your mortality date. And in my opinion the closest you can get to that is long-term, inflation-protected Treasury mortality date.” bonds, not cash. So the way people are thinking about the anchor or risk-free investment may be wrong. And I’m sorry to say that even my own writing in the Bodie, Kane, and Marcus investment textbook falls into that same trap of presenting cash as the lowest-risk asset. Unfortunately, like most textbooks, we started out talking about risky assets first, discussing equity investments before we talked about bonds. By presenting the material in that order, you wind up saying, “All right, so let’s treat cash as the safe asset.” That’s a bad way to start. I think cash is a safe asset only if you’ve got a three-month planning horizon, which may be the case for portfolio managers, whose performance typically is measured every three months. But it’s not the case for the ultimate investor – the retirement plan participant. DCD: So you’re suggesting that investment professionals and investors start with TIPS as the “risk-free” asset for retirement planning and asset allocation? Bodie: Yes. That’s a very, very important point because comparing risky assets with the need for a “risk-free” asset always depends on the context. People need safe investments, yes – but risk is defined as relative to achieving a certain goal. That goal is having a certain amount of purchasing power at a retirement date that’s way into the future. Page 4
  5. 5. PIMCO DC Practice The safest asset in my opinion, is going to be TIPS matched in maturity or duration to that goal. And that’s a pretty fundamental idea. DCD: How would you suggest that TIPS be added to defined- contribution plans? Bodie: TIPS should be part of both accumulation in and decumulation from a DC plan, or any retirement plan for that matter. Asset-allocation strategies such as target-date funds should have TIPS as a core asset. This follows from what I’ve just been saying, as TIPS are the safe asset. “The closer one gets A glide path should manage the TIPS allocation with consideration of the participant’s age and life expectancy. What’s more, the glide path to the retirement date, should be focused on meeting the participant’s income the more important needs in retirement – that’s a primary liability that needs to be managed for DC participants. it becomes to add It should also be said that the matching of assets to liabilities, in terms more skill to the of the cash flow matching, is much easier said than done. You just management of need to talk to skilled investment managers to get an appreciation of how hard that is to do. Successful matching of assets to liabilities those assets.” requires active management and rebalancing. Having said that, my view is that when people start saving for retirement early on in the lifecycle, when it’s a distant goal, it may be perfectly fine to just hold a portfolio of TIPS without any precise matching. But the closer one gets to the retirement date, the more important it becomes to add more skill to the management of those assets. Ideally, as participants approach retirement age, their assets typically transition from accumulation to decumulation – to provide a reliable stream of benefits in retirement. And that may take the form of, for example, a laddered TIPS portfolio or a life annuity. Either may offer a level stream of monthly income in retirement. Or there may be a combination of investments and insurance that may allow for a steady, inflation-sensitive monthly income for life. DCD: We know that more DC plans and especially target-date strategies are being managed with an “outcome” focus, which is typically defined as meeting a retirement income goal for their participants. How should plan sponsors and participants think about reaching this outcome? Bodie: If you think about the whole investment process or pick up any guide book to investing, it starts with defining goals, right? Well, goals are desired outcomes. So when you get through with the whole process, you get to come back and say, “Well, did I achieve my goals?” In the case of retirement investing, the goal is some desired standard of living in retirement. And setting that goal is part of the process that I recommend in my book Worry-Free Investing and in every other article Page 5
  6. 6. DC Dialogue I have ever written on this subject. I always start by saying, “What if I take the minimum amount of risk? How much would I then have to save?” Saving is the critical issue here. And these days, you should assume that you’re not going to earn much. Any contribution you put in may earn just enough to keep pace with inflation. That’s a pretty conservative goal. Or you can look at the TIPS yield curve and see that over the long term it’s close to 2% real return. Well, 2% is much better than zero. But recently we’ve had five-year yields that were negative. So it has become conceivable that a minimum-risk portfolio of TIPS is going to earn a very low rate of return, maybe even zero. But then, if you’ve saved enough to achieve your goals, some level of retirement income with which you’d be comfortable, you can consider taking risk on top of that. But only when you see that, in fact, you are earning a higher rate of return can you cut back on saving – maybe. So that’s the rational approach. And it always comes back to this: Are you achieving your goals and achieving your desired outcomes?“What you’re actually DCD: How do you respond to people who are concerned about the low doing is trying to or negative earnings on TIPS, especially right now? ensure some kind of Bodie: Of course, there’s got to be some consideration of what rate of returnminimum level of real you’re going to earn, right down to a zero rate of return which, as mentioned, is essentially what TIPS are paying right now. But keep inincome in retirement.” mind, they’re paying zero in real terms – that is, zero above inflation. But you know what? Money-market strategies and other low-risk alternatives may be paying negative returns as well, once you adjust for inflation. So who promised everybody that there will always be positive returns? Let me put it a different way. In fact, what you’re actually doing is trying to ensure some kind of minimum level of real income in retirement. That can be expensive, right? So if you look at it that way, you may not want to put all of your retirement money into that zero rate, that real rate of return, to ensure that. But I think it would be unwise not to put anything there. DCD: You recently responded to an article in the Financial Times in which Professor Jeremy Siegel argued that the conservative investor should invest in dividend-paying stocks rather than in TIPS (“Inflation-linked bonds face a headwind of many risks,” Market Insight, February 3, 2011). Can you share your view with us? Bodie: Yes. I wrote a response to Jeremy’s article, which shares much of what I’m sharing with you now (“Inflation-linked bonds still best option for Page 6
  7. 7. PIMCO DC Practice pension savers,” February 7, 2011). As I noted in the article and quote here, his recommendation to invest in dividend-paying stocks instead of TIPS “misrepresents the nature of inflation-linked bonds” – TIPS are the only U.S. Treasury instrument that provides a contractual link to inflation, and I believe they are crucial for pension savers. Now, he may be thinking of investors who already have sufficient inflation-sensitive income to meet their needs in retirement. That’s not the case for most people. For the majority of U.S. workers, their DC plan will need to provide the real retirement income to support their “For the majority of lifestyle in retirement. They cannot take the risk of jeopardizing the income needed to cover basic needs for the opportunity for higher U.S. workers, their returns. As I wrote in my response, “The higher expected return of DC plan will need equities over inflation-protected bonds is simply a reward for the risk to provide the real of holding equities; it is not a ‘free lunch’ or a ‘loyalty bonus’ for long-term investors.” retirement income to Investing in assets other than TIPS adds risk to a participant’s portfolio. support their lifestyle Determining the appropriate asset allocation should be determined in retirement.” by the individual, based on their own risk aversion. They need to understand the risk. DCD: For those who do want to take on the risk, what other assets should they consider beyond TIPS? Bodie: There is a variety of investments for participants to consider beyond TIPS. The simplest strategy is to hold a broadly diversified portfolio of all existing risky assets – what the theorists call the “market portfolio.” And that consists of domestic stocks, international stocks, private equity, commodities, and real estate. Or you may want to hire an investment manager who will vary that mix, based on his or her assessment of the economic conditions and relative values. Again, as you diversify away from TIPS, it’s important to understand that markets don’t give up return easily. Participants need to understand this and make sure they don’t get hurt by wishful thinking. Something that people forget, which is hard to keep in mind, is that risk, almost by definition, means that you can make a good decision and still have a lousy outcome. That’s part of what risk entails. I like to give an example from medicine where a person may understand that there’s some risk of dying if he or she undergoes a risky procedure. But that may still be the wise course of action, considering the pain and suffering associated with not going through the procedure. Then let’s say that the operation is performed by highly skilled physicians and the patient dies. That is one possible outcome. It doesn’t mean it was a bad decision. It’s a bad outcome. Page 7
  8. 8. DC Dialogue Tail-risk hedging refers to hedging against unknown financial crisis events. These crises are often referred to as “tail-risk events” because of the way they appear on the “normal” bell-shaped curve often used to illustrate market outcomes: The most likely outcomes lie at the center of the curve, whereas the unforeseen lie at either end or the “tail” of the curve. The left-tail would comprise the undesirable outcomes. DCD: Can you talk about other ways to hedge participants’ assets against risk, especially when equity securities are mixed into target-date strategies or other asset-allocation structures? For instance, what about actively managing the risk of market shocks, or what is referred to as left-tail events, by buying equity puts or other hedging strategies?“Tail-risk hedging is Bodie: In the academic community, this idea of cushioning portfolios against actually not a new market shocks goes way back to the 1970s, when the notion of dynamic hedging became an active research topic. And thatidea. It’s an old idea happened largely as a result of the discovery of option-pricingthat has always had models in the early ’70s. the support of most Then in the ’80s, there was a big flurry of activity, mostly amongacademic economists.” pension funds, in the area of so-called “portfolio insurance,” which is tail-risk hedging by another name. Portfolio insurance got a bad name because, among other reasons, when the market did decline, it was very difficult to actually implement these strategies. The strategies actually failed in some cases, for instance during the 1987 market correction. Some believe these strategies and the trading required to implement them may have actually contributed to the market crash at that time. Up until the late ’80s, portfolio insurance was a very popular idea. Now it has returned with a different name and the markets have changed quite a lot. For example, you did not have index-put options back in the ’80s. So there was no alternative but to pursue a dynamic trading strategy, which quite possibly did precipitate that market decline at that time. With put options such as on the S&P 500 today, that risk doesn’t exist, because you in theory have someone on the other side of the put options who’s the counterparty. So bottom line, tail-risk hedging is actually not a new idea. It’s an old idea that has always had the support of most academic economists like me, although we learned early on that you have to be very careful how you implement it, as is the case with many types of technological and financial engineering advances. Page 8
  9. 9. PIMCO DC Practice DCD: As you know, nearly half of DC plans now automatically enroll participants, and the majority of the plans default participant assets into target-date strategies. What’s your view of this continued trend, especially toward target-date funds? Do you have any comments on the structure of the glide path – the “through” versus “to” retirement glide paths? Bodie: Getting people to save is a positive step. No one would question that. Target-date strategies are an improvement over defaulting to company stock, which many companies did in the past. Now, determining “There’s another what the asset allocation should be is the important issue. The structure won’t be the same for all populations. For those organizations reason that you that offer a pension plan or other retirement-income program, they might want to tilt may decide to have a more aggressive glide path if their workers’ your retirement basic income needs are already covered. That won’t be true for most populations. That said, as we’ve been discussing, I would start with portfolio toward TIPS as the core asset and then add other fixed income. Adding risk TIPS and other assets, such as equities, beyond those core holdings should be done with absolute care. fixed-income There’s another reason that you might want to tilt your retirement securities, and it has portfolio toward TIPS and other fixed-income securities, and it has to to do with taxes.” do with taxes. The differing tax treatment between fixed-income and equity securities may present an advantage of holding certain securities in tax-deferred accounts and other assets outside such accounts. For instance, depending on the participant’s circumstances, they may gain tax efficiencies by holding equity securities outside of their retirement plan where these assets may be taxed at a lower rate e.g., capital gains. Of course, investors should consult with their tax advisor to determine the tax differences and to come up with a plan on which assets to hold within or outside of their retirement plan. Now, that type of tax strategy may be mostly for people in the higher income brackets. Many participants in 401(k) plans don’t have investments outside of their retirement account. But certainly, if you have someone who has, let’s say, half a million dollars in a retirement account that is tax-sheltered and half a million dollars outside the retirement account, and he wants to have a total portfolio that’s 50% in equities and 50% in fixed income, he may want to allocate the assets both inside and outside of the retirement plan with a tax strategy in mind. Again, participants should work with their tax advisor to develop an appropriate strategy for their particular situation. What’s most important in designing or selecting a glide path is that you want to make sure that you have a safe landing. A business friend exactly addresses this issue with an analogy, saying that a very high Page 9
  10. 10. DC Dialogue percentage of airplane accidents occur on takeoff and on landing, compared to a much smaller percentage than you would imagine during the flight itself. It’s terribly important to make sure you have a safe landing. And the time to start worrying about that is a good 10 years before you get there. DCD: What would provide a “safe landing” from an investment perspective? What does that suggest for a glide path as well as for retirement-income solutions? Bodie: I have always believed in what we are now characterizing as DC 2.0. Why? Because I have always thought that what should determine a portfolio’s asset allocation is the ultimate goal in terms of what you want for your outcomes. As the boomers are now approaching retirement with those trillions of dollars of assets, they are focusing much more on the final outcome, because up until now, they could kind of ignore the losses, if there were losses, along the way, since they weren’t drawing down on those assets.“What should But that means that as they approach the drawdown phase, they really should be paying very close attention to the possibility of loss and the determine a need to lock in a level of real income that will supplement their Socialportfolio’s asset Security benefits, so that they are fully inflation-protected. Again, for the glide path and retirement income, I’d look first to TIPS.allocation is the What’s good about TIPS is that they rely on the credit of the U.S.ultimate goal in Treasury rather than on the insurance companies. I mean, if the U.S. terms of what Treasury were selling Social Security benefits, in other words, life you want for annuities that are inflation-protected, I’d say buy those.your outcomes.” DCD: Would you suggest that participants buy a ladder of TIPS rather than an annuity or other guaranteed-income solution? Bodie: A TIPS ladder is attractive, but what you’re missing with this is the longevity insurance that annuities offer. You may want some of that too. There are multiple risks to consider. With TIPS, you have addressed credit risk, investing with the U.S. government rather than selecting an insurance company. You’ve also addressed inflation risk. By adding longevity insurance, you have covered the risk of your outliving your assets, but you have reintroduced credit risk for this portion of your retirement income. One way to reduce this risk is to diversify across a number of insurance providers, all of whom have very high ratings. There aren’t that many providers of longevity insurance at this time, but there are a few. DCD: What about a systematic withdrawal program that draws down assets from a diversified portfolio, combined with longevity insurance? Bodie: The only thing I can say in defense of the systematic withdrawal programs is that they are an attempt. But it makes much more sense to me to guarantee some essential level of benefit, which TIPS and Page 10
  11. 11. PIMCO DC Practice longevity insurance are designed to provide. And then if you want to take risk, take it with whatever you have left over after you’ve covered those essentials. DCD: How should people think about longevity as they save for retirement? Bodie: How long we may live is a significant factor in determining how much we need to save for retirement. While we should all want to live long lives, when it comes to retirement, a long life becomes a risk – the risk that we’ll deplete our assets too quickly and not have enough to cover “While we should our expenses. all want to live long To look at the sensitivity of saving for retirement relative to how long we might live, I suggest using a basic retirement math formula. I start lives, when it comes to with the assumption that the real interest rate on your savings will be retirement, a long life zero. This assumption minimizes the impact of investment risk and, at this time, that’s about what TIPS are paying. Given this assumption, becomes a risk.” you’ll find that one’s retirement age is a weighted average of the life expectancy and the age one starts saving. Here’s my basic formula: Saving rate × Years of saving = Income replacement rate × Years of retirement To determine the projected retirement age: R=(r/(r+s))L + (s/(r+s))B Let R be the age of retirement; L be life expectancy; B be the age one starts saving for retirement; s be the saving rate; and r the income replacement rate. If we look at an example of someone who wants to replace 50% of their income in retirement and they begin saving 10% of their pay at age 25 and expect to live to age 85, they will need to work until age 75. Given the same assumptions and the desire to retire at age 65, this individual will need to boost their savings rate to 25%. But what if they live longer than expected – to age 95? Even if they save 25% of pay for their career, they will not have enough to retire. If they only save 10% of pay, they will need to wait until age 83. DCD: Sounds like we better save. But more important, we better enjoy our work. Bodie: That’s what it’s all about. I’ve never worked a day in my life. DCD: Thank you, Zvi. Bodie: Always a pleasure. Page 11
  12. 12. DC Dialogue About the PIMCO DC Practice PIMCO DC Dialogue is prepared and distributed by the PIMCO DC Practice. Based in Newport Beach, Claifornia this practice is dedicated to promoting effective DC plan design and innovative retirement solutions. Our team is pleased to support our clients and broader community by sharing ideas and developments in DC plans, in the hopes of fostering aZvi Bodie, Ph.D. more secure financial future for employees of corporations, not-for-profits,The Norman and Adele Barron governments, and other organizations.Professor of Management,Boston University If you have questions about PIMCO DC Dialogue or you have a topic you’dwww.zvibodie.com like to discuss, please contact your PIMCO representative or email us at pimcodcpractice@pimco.com. We’re interested in your ideas and feedback!zbodie@bu.edu617.353.4160 Stacy Schaus, CFP ® John Miller, CFAPast performance is not a guarantee DC Practice Leader U.S. Retirement Leaderor a reliable indicator of future results.A word about risk: Investing in the bondmarket is subject to certain risks includingmarket, interest-rate, issuer, credit, and inflation Steve Ferber Christina Stauffer, CFArisk; investments may be worth more or less thanthe original cost when redeemed. Equities may CIT Strategist and Key Account Leaderdecline in value due to both real and perceived Account Managergeneral market, economic, and industryconditions. Certain U.S. Government securitiesare backed by the full faith of the government,obligations of U.S. Government agencies and Fiona Cole, CFA Doug Schwab, CPAauthorities are supported by varying degrees but Key Account Manager Plan Sponsor Servicesare generally not backed by the full faith of theU.S. Government; portfolios that invest in suchsecurities are not guaranteed and will fluctuate invalue. Equities may decline in value due to bothreal and perceived general market, economic, and Joseph Yeon Ying Gao, Ph.D.industry conditions. Inflation-linked bonds (ILBs) Key Account Specialist DC Analyticsissued by a government are fixed-income securi-ties whose principal value is periodically adjustedaccording to the rate of inflation; ILBs declinein value when real interest rates rise. TreasuryInflation-Protected Securities (TIPS) are ILBsissued by the U.S. Government. Commoditiescontain heightened risk including market, political,regulatory, and natural conditions, and may not besuitable for all investors. REITs are subject to risk,such as poor performance by the manager, adversechanges to tax laws or failure to qualify for tax-freepass-through of income. Diversification does notensure against loss. PIMCO does not offer insur-ance guaranteed products or products that offerinvestments containing both securities and insurance features. Derivatives and commodity-linked derivatives may involve certain costs and risks such asliquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivativeinstruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commod-ity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investingin derivatives could lose more than the amount invested. PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel forspecific tax questions and concerns.There is no guarantee that these investment strategies will work under all market conditions and each investor should evaluate their ability to invest for along-term especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely toachieve profits, losses, or results similar to those shown.The S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on theLarge-Cap segment of the U.S. equities market. 840 Newport Center DriveThis material contains the current opinions of the authors and such opinions are subject to change without notice. This material has been distributed for Newport Beach, CA 92660informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or invest-ment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be 888.845.5012reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, pimco.com©2011, PIMCO. DCD054-021011