Fixed Income Strategy Quarterly April 2015

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1 Doucet Asset Management Fixed Income Strategy Quarterly April 2015 The first quarter of 2015 was a fairly uneventful one. Across the world, the pullback in yields we witnessed in 2014 continued; however, most of the themes driving them lower were already in place going into the new year. Europe and Japan are still a mess and in full-fledged asset purchase mode; the USD is still strong, oil prices are still depressed; China is still cooling off, and so on. The Federal Reserve did finally lose patience with its zero interest rate policy, dropping the word from its most recent statement, signaling that they may be inching closer to finally raising short-term rates. Still, the question remains; how much would a bp hike by the Fed really matter at this point? The Proxy Feds we have mentioned before are still out there, and they continue to suggest that rates may remain low for some time. According to Morningstar, there is an estimated 2 trillion of European government bonds currently trading at negative yields! Germany even recently sold a new issue of 5 year Bunds at a -.08% yield, something we haven t seen before in the new issue market. The shocking thing is that yields there could actually go lower, as the ECB s bond buying program is expected to be about the same size ($1 trillion) as the Fed s QE3, and is just getting going. And that is just Europe! The fact remains that U.S. fixed income securities will likely continue to attract capital, thereby depressing rates, thanks to their 4-pronged appeal of: having higher yields, offering exposure to the appreciating dollar (or refuge from depreciating currencies from around the world), the relative stability of the U.S. economy, and remaining the worlds safe haven asset. Bond Market At-a-Glance With yields down marginally across most sectors of the domestic fixed income market as well as the yield curve, the majority of bond indexes posted modest gains for the quarter (Figure 1). Treasury yields declined roughly 10-15% (depending on part of the curve), with the 2-Year, 5-Year, 10-Year, and 30-Year finishing at.57%, 1.37%, 1.92%, and 2.54%, respectively (Figures 4 & 5). Municipals hardly budged; and as a result, their relative attractiveness improved when measured on a percentage of Treasury basis (Figure 7). The steepness of both curves finished more or less the same (Figures 6 & 7). Thanks to the decline in Treasury yields, spreads were modestly wider on the quarter, with high yield being the exception (Figure 3). After having widened roughly 200 bps in 2H14, high yield spreads attracted inflows to the sector bringing them back in by approximately 60 bp, making it the big winner of the quarter. Much of this narrowing in high yield spreads was largely attributable to a rebound in energy sector yields, as energy represents a disproportionately large percentage of the high yield sector. Figure 1: 1Q15 Market Returns Broad Market Equity Indexes DJIA 1.95% S&P % Broad Market Bond Indexes Barclays US Aggregate Bond 1.65% Bank of America Merrill High Yield 3.41% Morningstar Core Bond 1.68% Morningstar Short-Term Core Bond 0.75% Morningstar Intermediate Core Bond 1.56% Morningstar Long-Term Core Bond 2.71% Bond Indexes by Sector Morningstar Corporate Bond 2.58% Morningstar US Govt Bond 1.36% Morningstar Mortgage Bond 1.40% Morningstar TIPS 0.99% Barclays Municipal Source: Morningstar as of 04/08/ %

2 Figure 2: Total Bond Market Yields by Sector Figure 3: Total Bond Market Spreads by Sector Figure 4: US Treasury Market Snapshot US Treasury Actives 1Q 15 4Q 14 1Q 14 Qtr change (bps) Qtr Change (%) Yr Change (bps) Yr Change (%) 2-Yr 0.57% 0.67% 0.42% (10) % % 5-Yr 1.37% 1.65% 1.72% (28) % (35) % 10-Yr 1.92% 2.17% 2.72% (25) % (80) % 30-Yr 2.54% 2.75% 3.56% (21) -7.64% (102) %

3 Figure 5: UST Active Yields since Financial Crisis: Figure 6: UST Curve Steepness since Financial Crisis:

4 Figure 7: Municipal Market Snapshot Muni Yields 2-Yr 0.73% 0.90% 0.58% 0.44% 0.48% 0.55% 0.54% 5-Yr 1.87% 1.87% 0.98% 0.98% 1.57% 1.38% 1.30% 10-Yr 2.96% 3.27% 1.95% 1.84% 2.93% 2.10% 1.99% 30-Yr 4.04% 4.73% 3.61% 2.76% 4.23% 2.92% 2.95% Curve Steepness (2s-30s) 331 bps 383 bps 303 bps 232 bps 375 bps 237 bps 241 bps Muni Taxable Equivalent Yields 2-Yr 1.29% 1.59% 1.02% 0.78% 0.85% 0.97% 0.95% 5-Yr 3.30% 3.30% 1.73% 1.73% 2.77% 2.44% 2.30% 10-Yr 5.23% 5.78% 3.45% 3.25% 5.18% 3.71% 3.52% 30-Yr 7.14% 8.36% 6.38% 4.88% 7.47% 5.16% 5.21% Curve Steepness (2s-30s) 585 bps 677 bps 536 bps 410 bps 662 bps 419 bps 426 bps Muni %UST 2-Yr 64% 151% 242% 177% 126% 83% 95% 5-Yr 70% 93% 118% 135% 90% 83% 95% 10-Yr 77% 99% 104% 105% 97% 97% 103% 30-Yr 87% 109% 125% 94% 107% 106% 116% Doucet Portfolio Positioning Figure 8: Doucet Asset Management FI Strategy Composite Characteristics Portfolio Benchmark +/- % of Benchmark Target Workout Date % 50% Coupon Rate % >100% Modified Duration % 50% Yield to Worst % >125% Yield to Maturity % >200% Current Yield % >100% Convexity % 50% OAS % >200% Rating A- AA+ Corporate Debt 35.28% 25.28% 10.00% 30% Government Debt 0.14% 44.45% % 0% Preferred Shares 4.02% 0.00% 4.02% 10% Securitized Debt 6.51% 29.33% % 10% U.S. Municipal Debt 54.05% 0.93% 53.12% 50% *Note: Stated Benchmark is Barclays US Agg Bond TR Source: All characteristics calculated using Bloomberg Portfolio & Risk Analytics Compared to our positioning going into the beginning of 2015, the biggest change in the portfolio was the increased allocation to corporate bonds and the decreased allocation to municipals. Part of this was attributable to the change in constituent accounts within the Composite. Still, a concerted effort was made to add corporate exposure over the quarter, particularly within the beat-up energy sector. We did not catch the trade at its absolute widest, but did add exposure at what we feel were very attractive levels. The focus was on cuspy, investment grade companies with clean balance sheets, ample liquidity, and manageable leverage. The purchases have worked out well so far, as energy sector spreads have tightened back in as oil seemingly found a floor and stabilized. Frankly though, in our opinion, energy spreads may have snapped back a little too quickly, as yields there declined at a much faster clip than the price of oil rebounded. Still, energy, gas pipelines, and utilities represent the cheapest sectors of the corporate bond market on an OAS basis, according to Morningstar. Even so, we would

5 not be terribly surprised to see them widen back out before coming in for good. Should this happen, we might consider adding more exposure. Relative to the 1.61% return of the benchmark, the Composite posted a 1.69% return for the first quarter, for outperformance of 8 bps. While this may sound marginal, we were very pleased with this result, as the Composite is much shorter than the benchmark (49% of benchmark average life and 39% of benchmark duration) and is thereby less exposed to interest rate risk. Further, municipal debt makes up 54.05% of the Composite, compared to only.93% of the benchmark, so roughly half of the Composite return is tax-exempt. To achieve this result, we did dip a bit in credit quality (A- versus AA+), yet still remained investment grade. We also focused our efforts exclusively on the less efficient secondary market, and were able to achieve 210% of the yield-to-worst and 257% of the yield-to-maturity of the benchmark. Given our opinion that interest rates will stay low with a moderate upward bias, we are positioned right where we want to be. Admin Notes Form ADV: Please contact our office at (205) if you would like to receive a current copy of our Form ADV II or the Schedule H Brochure. Proxy Solicitations: If you receive calls regarding proxy voting, we suggest that you inform the caller that you have delegated Doucet Asset Management full authority to vote the proxy on your behalf. Please note that we are not able to prevent these calls from being placed to you directly. The above views are those of Doucet Capital and Chris Doucet, and are not necessarily the views of Institutional Securities Corporation. Doucet Asset Management, LLC is independent of Institutional Securities Corporation (ISC). Chris L. Doucet is a Registered Representative of ISC. Past performance does not guarantee future returns. REGISTERED INVESTMENT ADVISORY SERVICES PROVIDED BY DOUCET ASSET MANAGEMENT, LLC. SECURITIES OFFERED THROUGH INSTITUTIONAL SECURITIES CORPORATION, DALLAS, TEXAS, MEMBER FINRA, SIPC (214) THIS NEWSLETTER IS FOR INFORMATION PURPOSES ONLY. NOTHING IN THIS NEWSLETTER CONSTITUTES AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY INTEREST IN ANY SECURITY, OR IN ANY INVESTMENT VEHICLE MANAGED BY DOUCET CAPITAL, LLC OR DOUCET ASSET MANAGEMENT, LLC, OR ANY OF THEIR AFFILIATES. NOTHING IN THIS NEWSLETTER CONSTITUTES PROFESSIONAL OR FINANCIAL ADVICE, OR RECOMMENDATIONS TO PURCHASE OR SELL A PARTICULAR SECURITY. CERTAIN INFORMATION DISCUSSED IN THIS NEWSLETTER MAY CONSTITUTE FORWARD-LOOKING STATEMENTS WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS MAY, WILL, SHOULD, EXPECT, ANTICIPATE, TARGET, PROJECT, ESTIMATE, INTEND, CONTINUE OR BELIEVE, OR THE NEGATIVES THEREOF OR OTHER VARIATIONS THEREON OR COMPARABLE TERMINOLOGY. DUE TO VARIOUS RISKS AND UNCERTAINTIES, ACTUAL EVENTS OR RESULTS OR THE ACTUAL PERFORMANCE OF ANY OF THE INVESTMENTS DISCUSSED HEREIN MAY DIFFER MATERIALLY FROM THE EVENTS, RESULTS OR PERFORMANCE CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS. ALTHOUGH DOUCET ASSET MANAGEMENT, LLC BELIEVES THAT THE EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE BASED UPON REASONABLE ASSUMPTIONS AT THE TIME MADE, IT CAN GIVE NO ASSURANCE THAT ITS EXPECTATIONS WILL BE ACHIEVED.

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