There are three variables we consider in constructing our World Bond fixed income portfolio:

• The shape of the yield curve
• The yield spread across the quality spectrum
• The trend of the US dollar

There are two extremes that are seen repeatedly in the US bond market. The first structure is the one we have right now. The yield curve is relatively steep – there is a wide difference in yield between short term and long term yields – and there is a large spread between high and low quality bonds. The second structure is the one that prevailed at the end of 2007. The yield curve was very flat (at times inverted) and the spread between high and low quality was minimal. The bond market moves from one structure to the other as the economy goes through cycles of growth and recession.

When the yield curve is steep, as it is now, we will reduce the maturity of our investments. The assumption is that over time, as the economy recovers, the yield curve will flatten as the Fed raises short term interest rates. At the same time, with a wide spread between high and low quality bonds, we will increase our exposure to lower quality bonds. That means reducing Treasury exposure in favor of corporate, high yield (junk) and emerging market bonds. As the economy recovers, the spread between high and low quality bonds will tend to narrow.

When the yield curve is flat or inverted, we will increase the maturity and quality of our portfolio. The shape of the yield curve is a leading indicator for the economy. A flat or inverted yield curve almost always precedes a recession. During a recession yields of long term Treasuries will fall more rapidly than short term Treasuries and generate more total return. The spread between low and high quality bonds will also rise as investors fear the loss of principal in low quality bonds.

Lastly, we consider the trend of the US Dollar in constructing our portfolio. Foreign currency denominated bonds will outperform US dollar bonds when the dollar is falling. We generally only invest in foreign currency government bonds.