Quarterly Investment Report June 30, 2015 PIMCO 650 Newport Center Drive Newport Beach California 92660 (888) 87-PIMCO www.pimco.com/investments
High Yield Fund Second Quarter 2015 Market Commentary Federal Reserve officials reiterated their desire to hike rates sometime this year as a healthy labor market and an increasingly confident consumer kept the focus on policy normalization Eurozone bond and equity rallies reversed course following a strong first quarter as uncertainty surrounding Greece overshadowed improvement in the underlying economy Sovereign yield curves steepened across the globe as fears of global deflation receded in the face of stabilizing oil prices and an improved growth outlook U.S. high yield corporate bonds were flat in the second quarter, due to heightened volatility from macro headlines including a potential Greece default, rising rates, and volatile technicals in the way of exchange traded fund flows Fund Recap The Fund underperformed its benchmark for the quarter The following strategies were positive for the quarter: An underweight to the metals & mining sector, which underperformed the broader high yield market due to declining commodity prices and industrial metal demand An overweight to the healthcare sector, which outperformed alongside risk aversion Security selection in the telecommunications sector, where wireless providers significantly outperformed wirelines The following strategies were negative for the quarter: Security selection in the energy sector, due to an emphasis on pipelines and integrated energy, which underperformed relative to independent exploration and production firms and oilfield services An underweight to the energy sector, which outperformed the broader high yield market on rising oil prices Security selection in the media, entertainment & publishing sector, where select advertising firms underperformed Market Outlook PIMCO expects global growth to accelerate modestly to 2.5-3.0% over the next 12-months The U.S. is on track for above-trend growth, supported by robust personal consumption and a healthy pace of job gains An accommodative European Central Bank (ECB) should support modest growth in the eurozone but uncertainty around Greece remains Growth in Japan will continue to recover, although the Bank of Japan may find it difficult to meet inflation targets soon Although recent pressure in June has opened the door to potentially better total return opportunities with prices now below par, we expect performance to be dominated by income Fund Strategy Broadly, plan to continue to maintain a defensive approach with sufficient liquidity due to potential macroeconomic headwinds In the European high yield market, with the support of ECB policy, focus on multinational companies that are not dependent on any single economy Focus on owning better convexity bonds through exposure to sectors and credits with favorable industry dynamics and positive event risk from merger and acquisition or equity offerings Favor industrials, healthcare/pharmaceuticals, and cable/wireless, which have higher barriers to entry, favorable asset quality, and potential downside risk protection Maintain exposure to the banking sector, specifically subordinated debt issued by banks with sufficient liquidity and high capital ratios Remain cautious against metals & mining, which generally have longer-term demand challenges and are dependent on volatile commodity prices Remain underweight to the long-end of the market and focused on intermediate-term and select short-dated bonds 1 Risk Disclosures and Index Descriptions are located in the Important Information section of the Appendix
Summary of Performance Data and Portfolio Statistics Institutional Class Performance Since Periods Ended 6/30/2015 Inception 10 yrs 5 yrs 3 yrs 1 yr 6 mos 3 mos Total Portfolio 1 Before Fees (%) 8.55 7.43 8.34 6.83 1.47 2.48-0.12 After Fees (%) 8.00 6.86 7.75 6.25 0.92 2.20-0.26 (Inception 12/15/92) BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index (%) 7.60 7.21 8.32 6.75 0.70 2.69 0.02 Expense Ratio The Fund's Total Annual Operating Expenses 0.55% Performance quoted represents past performance. Past performance is not a guarantee or a reliable indicator of future results. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed. Current performance may be lower or higher than performance shown. For performance current to the most recent month-end, visit www.pimco.com/investments or call (888) 87-PIMCO. The minimum initial investment for Institutional class shares is $1 million; however, it may be modified for certain financial intermediaries who submit trades on behalf of eligible investors. Annualized Return (%) 14 12 10 8 6 4 2 10-Year Return vs. Standard Deviation BofA ML 1-3 Yr. Treasury Index Portfolio Citigroup 10-Yr. Strip 0 0 2 4 6 8 10 12 14 Standard Deviation of Return 2 (%) Summary Information 3/31/2015 6/30/2015 Total Net Assets (USD in millions) 10,592.3 9,933.7 SEC 30-Day Ann. Yield (%) 4.46 4.81 Distribution Yield (%) 3 5.42 5.69 Effective Duration (yrs) 4.0 4.1 Benchmark Duration - Provider* (yrs) 4.6 4.7 Benchmark Duration - PIMCO** (yrs) 4.1 4.1 Effective Maturity (yrs) 5.8 5.9 Average Coupon (%) 6.5 6.4 Net Currency Exposure (%) 0.1 0.1 Tracking Error (10 yrs, %) 4 2.4 2.4 Information Ratio (10 yrs) 4-0.1-0.1 See example of tracking error / information ratio in Important Information section of the Appendix. *The benchmark duration as provided by Benchmark Provider **Benchmark duration as calculated by PIMCO % of Market Value 15 10 5 0 Top 5 Industry Holdings - Current Quarter Portfolio Benchmark 9 7 6 6 6 6 5 5 4 3 Healthcare Wireless Media Cable Pharmaceuticals Independent E&P 2
Additional Share Class Performance June 30, 2015 Net of Fees Performance Gross Net NAV Inception Since 10 5 3 1 6 3 Expense Expense Currency Date Inception Year Year Year Year Month Month Ratio Ratio ADMINISTRATIVE Class: High Yield Fund, Administrative 0.80 - USD Jan-16-95 7.74 6.60 7.48 5.99 0.66 2.07-0.32 BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index - 7.60 7.21 8.32 6.75 0.70 2.69 0.02 Class D: High Yield Fund, Class D 0.90 - USD Apr-08-98 7.59 6.47 7.37 5.88 0.56 2.02-0.35 BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index - 7.60 7.21 8.32 6.75 0.70 2.69 0.02 Class P: High Yield Fund, Class P 0.65 - USD Apr-30-08 7.89 6.75 7.64 6.15 0.82 2.15-0.28 BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index - 7.60 7.21 8.32 6.75 0.70 2.69 0.02 Performance quoted represents past performance. Past performance is not a guarantee or a reliable indicator of future results. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed. Current performance may be lower or higher than performance shown. For performance current to the most recent month-end, visit www.pimco.com/investments or call (888) 87-PIMCO. The minimum initial investment for Institutional class shares is $1 million; however, it may be modified for certain financial intermediaries who submit trades on behalf of eligible investors. 3
Market Commentary Second Quarter 2015 During the second quarter, global deflation fears gradually receded as oil prices firmed and the outlook for growth brightened, particularly for developed economies. Markets were captivated by events in Greece, where the debt crisis worsened sharply, and China, where equity markets had a tumultuous quarter and policymakers expanded their easing efforts. Global interest rates rose and yield curves steepened, while risk assets such as equities, high yield and emerging markets (EM) ended the quarter on a weaker note. The U.S. economy continued to show signs of strength. First quarter gross domestic product (GDP) was revised up to show a more modest -0.2% decline, while more timely data also suggested the economy is improving after a brief winter downturn. Nearly every labor market indicator pointed to sustainable growth, including a healthy pace of payroll gains, a rising backlog of job vacancies and a multi-decade low for unemployment claims. While earnings growth remained tepid, the employment cost index suggested wage pressures may be slowly building. High levels of consumer confidence provided a lift to consumer spending including a 10-year high for vehicle sales and a post-crisis high for home sales. The healthier labor market, improving outlook for spending, and modest rebound in oil prices led to a sell-off in the back-end of Treasuries as the 10-year yield rose 43 basis points (bps) and that on the 30-year jumped nearly 60 bps. That said, short-dated Treasuries were well anchored as the market continued to debate when the Federal Reserve (Fed) would begin raising interest rates. Lingering uncertainty about the start and pace of rate hikes also led to softness in the U.S. dollar, which dropped nearly 3% after its seemingly unstoppable 25% rally over the prior nine months. Volatility in eurozone markets grabbed headlines despite gradual improvement in the underlying economy. After falling to an all-time low of just 0.07% on April 17, the 10-year German bund yield backed up nearly 100 bps before settling at 0.76%. While fundamental factors played a role economic activity improved, credit conditions eased and a modest uptick in prices 4 led to a reduction in deflationary fears technical factors exacerbated the size and speed of the move. If the sharp correction in the bund was not enough to get the market s attention, the course of events in Greece certainly was. While most assumed that negotiations between Greece and its creditors would go down to the wire, no one expected Greek PM Tsipras to call a national referendum on the bailout proposal default on the country s June payment to the International Monetary Fund (IMF), impose capital controls or close banks nation-wide. With the vote scheduled for July 5 and polls leaving little guidance on the outcome, risk assets came under pressure; high yield spreads jumped and the S&P 500 Index quickly erased its year-to-date gains. That said, these moves and the modest 10-15 bps flight-to-quality across core bonds suggested events in Greece were more noise than news for global financial markets. Unfortunately, market volatility was not confined to Europe last quarter as economic conditions and policy choices led to equity volatility in Asia. Weak industrial production and falling inflation prompted the People s Bank of China to cut interest rates multiple times, while ongoing challenges in the banking sector and property market led the government to recapitalize local government financing entities. Chinese equities had one of their most volatile quarters on record, as thousands of newly opened stock trading accounts first sent the Shanghai Composite soaring to a year-to-date gain of 60% on June 12, before the index corrected 20% by month end. Stock market gyrations reflected the difficult tightrope Chinese policymakers have to walk as they transition toward a more liberalized financial system while also trying to avoid new credit bubbles. Conversely, Japan s Nikkei proved a more one-way bet last quarter, rising more than 5%, as optimism for corporate governance reform grew and Q1 GDP was revised up to 3.9% quarter-on-quarter.
Market Commentary, (cont d) Second Quarter 2015 High Yield Returns were flat in the second quarter U.S. high yield corporate bonds posted a negligible return of 0.0% in the second quarter, amid rising interest rates, large retail outflows, and heightened volatility in the equity markets as a result of growing concerns with a potential Greece default. The energy sector, which witnessed significant volatility in the second half of 2014, was the best performing sector in the quarter despite June weakness. European high yield underperformed U.S. high yield in the second quarter with a return of -0.9%, despite accommodative European Central Bank policy. Returns by quality during the quarter were mixed, as single-b s were the best performer, returning 0.5%, followed by double-b s and triple-c s both returning -0.4%. Despite mediocre performance from an absolute perspective, U.S. high yield outperformed most other asset classes including 10-year Treasuries, U.S. investment grade corporates, and EM bonds for the quarter, returning - 3.0%, -2.9%, and -0.9%, respectively. Spreads over Treasuries widened by 18 basis points over the quarter to end the period at 500 basis points. In similar fashion, U.S. high yield bond yields rose by 43 basis points and ended the quarter at 6.7%. Despite coming under pressure in June, energy was the top performer for the quarter as oil prices rose from a 6-year low. The worst performing sector was telecommunications, as the fixed-line sub-sector lagged the broader high yield market. Specifically, the top performers were energy (2.0%), insurance (1.4%), and healthcare (0.7%). The worst performing sectors were telecommunications (-2.0%), basic industry (-1.4%), and media (-1.2%). Default volume picked up over the quarter as there were nine high yield issuer defaults totaling $5.5 billion, which compares to six high yield issuers totaling $3.3 billion in the first quarter. It s worth noting that given the significant pressure energy and coal companies have experienced the last few months, it s no 5 surprise that ~70% of defaulted issuers are in the energy and metals and mining sectors. However, discounting these two sectors, default rates still underscore a relatively benign outlook. Both global defaults by issuer count and by total volume are well-below their long-term averages and stand today at 2.3% and 1.6%, respectively. While low oil prices may put additional stress on energy companies, we expect default rates to remain low for the foreseeable future, given the high level of refinancing activity that has taken place over the last few years and low levels of principal maturing through 2017. High yield primary issuance stood at $110 billion in the second quarter and was almost identical to first quarter s $111 billion. After witnessing robust inflows in the first quarter, high yield experienced net outflows of -$8.5 billion during the quarter, but still remain slight in positive territory year-to-date. The breakdown of actively managed mutual fund and exchange traded fund flows was -$3.8 billion and -$4.7 billion, respectively. This compares to $1.6 billion of net inflows over the same time period last year, when the outflows were most prominent in the third quarter beginning in July. Source: High yield statistics and performance represented by the BofA-Merrill Lynch U.S. High Yield Index and its respective sub-indices. Investment grade returns represented by the Barclays U.S. Credit Index. Equities represented by the S&P 500.Default rate represented by Moody s. High Yield issuance and flows represented by Lipper FMI.
Market Outlook Third Quarter 2015 PIMCO Expects Global Growth to Accelerate Modestly to 2.5-3.0% Over the Next 12-months The cumulative benefits of global monetary policy accommodation and a near cessation of fiscal austerity will allow the step-wise healing of global economic growth to continue. While economic slack will gradually be reduced, inflationary pressures are expected to remain contained. The roughly 40% oil price cut will further buoy these trends by transferring wealth from producers to consumers and keeping headline inflation subdued. We expect U.S. growth to reach 2.5%-3.0% with inflation gradually approaching the Federal Reserve s (Fed) 2% target. A robust outlook for personal consumption growth forms the foundation of our outlook. Consumer spending will be supported by a healthy pace of job gains, low energy prices and gradual improvement in wages and salaries. Housing and business investment will be buoyed by still low interest rates and pent-up demand. We expect home prices to rise gradually and sales trends to continue, but housing will remain a small portion of economic growth. Business investment should continue to expand as demand improves and capacity utilization rates rise, though capital expenditure (capex) plans in the energy sector are likely to be scaled back. Importantly, our expectations for moderate growth, low energy prices and a still strong U.S. dollar suggest inflationary pressures will build only gradually, allowing the Fed to begin reducing its policy accommodation at a very measured pace. While headline risks are likely to persist, we retain our forecast of 1.25%-1.75% eurozone growth, with little inflationary pressure. Low oil prices, a weaker euro, and the financial backing of the European Central Bank s (ECB s) quantitative easing (QE) program support the outlook for European growth. The benefit of a weaker euro is already evident in trade accounts with imports weaker and exports stronger, while the terms of trade for energy is also showing marked improvement. 6 Going forward, the ECB s QE program will be a substantial source of liquidity and will also serve to anchor expectations. Yet despite these supports, growth will remain modest and headline risks are substantial. While the actual contagion risks emanating from a default in Greece have diminished over time, there could be substantial implications if confidence is undermined. Given this backdrop, we expect the ECB to continue its asset purchase program in the year ahead. Japan will continue to recover from last year s technical recession, but the pace of growth in China will slow even further. The decisions late last year to delay the next value-added tax (VAT) hike and increase the size of the Bank of Japan s easing program helped boost Q1 GDP to 3.9%. Going forward, Japan will continue to benefit from low oil prices and past depreciation of the yen, but growth will likely remain modest (1.25%-1.75%). In China, we maintain our below-consensus forecast, expecting growth in the 5.75%-6.75% range. Recent equity market volatility along with further slowing in the property sector will likely require ongoing support from the People s Bank of China including additional rate cuts and reduced reserve requirements. We expect dispersion across emerging markets (EM) to continue, especially given the recent downturn in commodity markets. Differences across EM countries in initial conditions, commodity reliance and sensitivity to Fed and U.S. dollar moves suggest we are likely to see further divergence in economic outcomes over the next few quarters. Our 1.5%-2.5% forecast for the BRIM economies reflects improving growth prospects in Mexico and India offset by expected recessions in both Russia and Brazil. Benign Fundamentals and Fair-to-Attractive Valuations Bode Well for High Yield, while Technicals are Likely to Remain Mixed While high yield bonds have posted a positive 2.5% for the first half of the year of 2015 (BofA Merrill Lynch U.S. High Yield Index), performance for the rest of the year will remain
Market Outlook, (cont d) Third Quarter 2015 predominantly influenced by top-down themes, such as sovereign uncertainty in the eurozone and level of growth in EM countries, specifically China as well as volatile technicals in the way of net flows. On the balance, we believe fundamentals of high yield issuers that make up the asset class remain in decent shape and relatively supportive. We believe corporate credit fundamentals broadly are likely to remain positive as we head into the third quarter, in large part due to the high level of refinancing activity that has taken place over the last few years. To put this into perspective, only 8.4% of debt maturities ($96 billion) are due through the end of 2017 for high yield issuers. This has wiped out the once-discussed wall of maturities, allowing companies to extend their maturity profile, increase their liquidity, and limit default risk over the near-to-medium term. Furthermore, corporate balance sheets remain resilient, as many companies have delevered and maintain high cash balances. While leverage ratios are now above historical averages due to a pick-up in strategic merger and acquisition activity, interest coverage ratios are adequate given the low cost of debt. Realized global default rates through June stand at 1.6% by volume and 2.3% by issuer, well-below the historical average. Moreover, recovery rates are running above 50% today, versus the historical average of roughly 40%, which bodes well for subdued losses associated with defaults. From a valuation perspective, high yield looks fair-to-attractive as yields are now at 6.7%, and exceed most other fixed income opportunities. Spreads over Treasuries also remain attractive and currently stand at 500 basis points. Given the positive fundamentals backdrop, we do think that investors seeking higher yields are being fairly compensated for the risk they take by allocating to high yield bonds. It s worth noting that we believe the energy sector, which has been one of the main catalysts for high yield performance as witnessed in the second quarter, will continue to play an important role given its significant weight in the index. It s important to note that PIMCO s high yield investment decisions are typically based on a longer-term outlook and we believe periods of market corrections provide opportunity to capture long-term gains, particularly among issuers we have high conviction in through bottom-up fundamental research. On a macro level, we plan to maintain ample liquidity from a defensive perspective. We plan to continue to emphasize credits that are likely to benefit from global growth. In the European high yield market, we will continue to look to selectively add to multinational companies with a global footprint that are not overly dependent on any single economy. On a broad level, we plan to remain positioned on the intermediate end of the curve and underweight the long end of the market. Additionally, we plan to continue to maintain a tactical allocation among select lower-rated issuers, where rating agencies lag improved credit situations or where we see fundamental improvement in the near-to-medium term. By sector, we plan to favor industrials, healthcare (including pharmaceuticals), and cable/wireless, which are sectors that have high quality underlying assets and high barriers to entry. We also plan to maintain an allocation to the banking sector, particularly to subordinated debt issued by banks with sufficient liquidity and high capital ratios. We remain cautious on the energy and mining sectors, which generally have longer-term demand challenges and are dependent on volatile commodity prices. Moreover, we plan to focus on owning better convexity, in the form of exposure to sectors and credits with favorable industry dynamics and positive event risk from potential merger and acquisition activity or equity offerings. Source: High yield statistics and performance represented by the BofA-Merrill Lynch U.S. High Yield Index and its respective sub-indices 7
Portfolio Characteristics and Benchmark Variance Curve Exposure % of Market Value 80 70 60 50 40 30 20 10 0 Portfolio (%) 5 3/31/2015 6/30/2015 59 54 24 20 12 11 7 7 2 2 1 1 0-1 yrs 1-3 yrs 3-5 yrs 5-10 yrs 10-20 yrs 20+ yrs 15 10 5 0-5 -10-15 Portfolio vs. Benchmark (%) 5 3/31/2015 8 6/30/2015 7 1 0 2-1 -3-2 -2-2 -1-7 0-1 yrs 1-3 yrs 3-5 yrs 5-10 yrs 10-20 yrs 20+ yrs 8
Direct Country and Currency Exposure Country Exposure (by currency of settlement) * Portfolio Portfolio 03/31/2015 06/30/2015 % of Currency % of Currency (settlement currency) Duration Exposure ** (%) Duration Exposure ** (%) North America 98.7 0.1 98.8 0.1 Canada 0.0 0.1 0.0 0.1 United States 98.7 0.0 98.8 0.0 Europe - EMU 0.8 0.0 0.8 0.0 France 0.0-0.0 - Germany 0.1-0.1 - Luxembourg 0.0-0.0 - Netherlands 0.2-0.2 - Spain 0.2-0.2 - Other 6 0.3-0.3 - United Kingdom 0.5 0.0 0.4 0.0 Europe - Non-EMU 0.0 0.0 0.0 0.0 Switzerland 0.0 0.0 0.0 0.0 Japan 0.0 0.0 0.0 0.0 Asia Pacific ex-japan 0.0 0.0 0.0 0.0 Emerging Markets 0.0 0.0 0.0 0.0 Total Direct Exposure 100.0 0.1 100.0 0.1 Small allocations may round to zero. *Country exposures reflect the portfolio's effective exposure to non-u.s. markets, inclusive of forward settled holdings. **Includes currency exposure due to non-u.s. holdings, hedging transactions and outright currency transactions. Positive numbers reflect long currency positions relative to base currency. Allocations may not add to totals due to rounding. 9
Direct Emerging Markets Bond Exposure Emerging Markets Exposure (by country of risk*) 3/31/2015 6/30/2015 % of MV % of MV % of % of MV % of MV % of Short Duration Bonds Duration Short Duration Bonds Duration Instruments** Instruments** Brazil 0.00 0.07 0.11 0.00 0.04 0.08 Jamaica 0.00 0.47 0.46 0.00 0.51 0.45 Mexico 0.00 0.00 0.00 0.00 0.00 0.00 Russia 0.00 0.20 0.25 0.00 0.22 0.28 Total Direct Emerging Markets 0.00 0.74 0.82 0.00 0.77 0.81 Small allocations may round to zero. *Country of risk reflects the country of incorporation of the ultimate parent company. **Short duration Instruments includes an emerging market security or other instrument economically tied to an emerging market country by country of risk with an effective duration less than one year and rated investment grade or higher or if unrated, determined to be similar quality by PIMCO. 10
PIMCO Proprietary Portfolio Level Risk Measures Risk Measures (yrs) 3/31/2015 6/30/2015 Definitions of Risk Measures: Interest Rate Exposures: Effective Duration Portfolio 4.0 4.1 Benchmark** 4.1 4.1 Bull Market Duration Portfolio 3.7 4.0 Benchmark** 3.9 4.0 Bear Market Duration Portfolio 4.1 4.2 Benchmark** 4.3 4.2 A portfolio's price sensitivity to changes in interest rates. An accurate predictor of price changes only for small, parallel shifts of the yield curve. For every 1 basis point fall (rise) in interest rates, a portfolio with duration of 1 year will rise (fall) in price by 1 bp. A portfolio's effective duration after a 50 bp decline in rates. The extent to which a portfolio's duration exceeds its bull market duration is a gauge of contraction risk. A portfolio's effective duration after a 50 bp rise in rates. The extent to which a portfolio's bear market duration exceeds its duration is a gauge of extension risk. Sector Exposures*: Mortgage Spread Duration Portfolio 0.0 0.0 Benchmark 0.0 0.0 Corporate Spread Duration Portfolio 4.2 4.3 Benchmark 4.2 4.3 Emerging Markets Spread Duration Portfolio 0.1 0.1 Benchmark 0.0 0.0 Swap Spread Duration Portfolio 0.0 0.0 Benchmark 0.0 0.0 Covered Bond Spread Duration Portfolio 0.0 0.0 Benchmark 0.0 0.0 The contribution of mortgages to spread duration. For every 1 bp of mortgage spread tightening (widening), a portfolio with mortgage spread duration of 1 year will rise (fall) in price by 1 bp. The contribution of corporate bonds to spread duration. For every 1 bp of corporate spread tightening (widening), a portfolio with corporate spread duration of 1 year will rise (fall) in price by 1 bp. The contribution of emerging market bonds to spread duration. For every 1 bp of emerging market spread tightening (widening), a portfolio with an emerging market spread duration of 1 year will rise (fall) in price by 1 bp. The contribution of swaps to spread duration. For every 1 bp of swap spread tightening (widening), a portfolio with swap spread duration of 1 year will rise (fall) in price by 1 bp. A negative swap spread duration indicates that the portfolio will benefit from widening swap spreads. The contribution of covered bonds to spread duration. For every 1 bp of covered bond spread tightening (widening), a portfolio with a covered bond spread duration of 1 year will rise (fall) in price by 1 bp. Sovereign Related Spread Duration Portfolio 0.0 0.0 Benchmark 0.0 0.0 The contribution of sovereign related bonds to spread duration. For every 1 bp of sovereign related spread tightening (widening), a portfolio with a sovereign related spread duration of 1 year will rise (fall) in price by 1 bp. * As measured by spread duration, which represents a portfolio's price sensitivity to changes in spreads, or yield premiums, that affect the value of bonds that trade at a spread to Governments. These include mortgage-backed, corporate and emerging market bonds, as well as swaps. **Benchmark duration is calculated by PIMCO. 11
Summary of Derivatives Derivatives 7 (% of Duration) 3/31/2015 6/30/2015 Characteristics of Derivatives: Control Measures Government Futures 0.0 0.0 Used to adjust interest rate exposures and to replicate government bond positions. Frequently offers the opportunity to outperform government securities due to cheapness of futures contracts and active management Bond-equivalent exposure included in portfolio duration. Back long futures positions with high grade, liquid debt securities. of the liquid, short duration securities backing the futures. Other Futures 0.0 0.0 Includes municipal, mortgage-backed and interest rate swap futures. See Government Futures. Interest Rate Swaps 0.0 0.0 Includes swaps with duration greater than 1 year. Used to adjust interest rate and yield curve exposures and substitute for physical securities. Long swap positions ("receive fixed") increase exposure to long-term Bond-equivalent exposure included in portfolio duration. Back long swaps positions with high grade, liquid debt securities. interest rates; short positions ("pay fixed") decrease exposure. Credit Default Swaps* 4.0 2.9 Written 4.0 2.9 Purchased 0.0 0.0 Options 0.0 0.0 Written 0.0 0.0 Purchased 0.0 0.0 Credit default swaps are used to manage credit exposure without buying or selling securities outright. Written CDS increase credit exposure ("selling protection"), obligating the portfolio to buy bonds from counterparties in the event of a default. Purchased CDS decrease exposure ("buying protection"), providing the right to "put" bonds to the counterparty in the event of a default. Written options generate income in expected rate scenarios and may generate capital losses if unexpected interest rate environments are realized. Purchased options are used to manage interest rate and volatility exposures. Both written and purchased options will become worthless at expiration if the underlying instrument does not reach the strike price of the option. Bond-equivalent exposure included in portfolio credit risk measures. Back long exposures with high grade, liquid debt securities. Continually monitor underlying credit exposure. Bond-equivalent exposure (weighted by probability of exercise) included in portfolio duration. Back underlying exposure with high grade, liquid debt securities. Mortgage Derivatives 0.0 0.0 Used to manage portfolio duration and/or enhance yield. Includes securities determined by PIMCO to have potentially less stable duration characteristics, such as Interest Only strips (IOs), Principal Only strips (POs), Support Class CMOs and Inverse Floaters. Value will fluctuate as Bond exposure included in portfolio duration, convexity, and prepayment risk measures. Use IO's and PO's in moderation and in an overall portfolio context. prepayment speeds respond to rising and falling interest rates. Money Market Derivatives 0.0 0.0 Futures 0.0 0.0 Interest Rate Swaps 0.0 0.0 Used to manage exposures at the short end of the yield curve and express PIMCO's expectations for future short-term rates. Includes swaps with duration of 1 year or less, and Eurodollar, Euribor and other futures based on short-term interest rates. Bond-equivalent exposure included in portfolio duration. MM derivatives are not backed by other assets as they represent short-maturity exposures and have no deliverable at expiration. * Credit default swaps are shown as percentage of market value to reflect potential default risk. 12
Appendix Risk Disclosures 1 June 30, 2015 Past performance is no guarantee of future results. Forecasts are based on proprietary research and should not be interpreted as investment advice or as an offer or solicitation for the purchase or sale of any financial instrument. The performance figures presented reflect the total return performance for the stated share class (after fees) and reflect changes in share price and reinvestment of dividend and capital gain distributions. All periods longer than one year are annualized. The Before Fees performance figures presented herein do not reflect the deduction of the Fund s total annual operating expenses, which includes, but is not necessarily limited to, advisory fees, administrative fees, and 12b-1 fees (where applicable). The After Fees performance figures reflect the deduction of all such fees. Neither Before nor After Fees performance figures reflect any applicable redemption fees, the performance figures would be lower if the fee was applied. Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the longer term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice. Duration is a measure used to determine the sensitivity of a security s price to changes in interest rates. The longer a security s duration, the more sensitive it will be to changes in interest rates. By way of example, the price of a security with an average duration of eight years would be expected to fall approximately 8% if interest rates rose by one percentage point. The maturity of a security, another commonly used measure of price sensitivity, measures only the time until final payment is due, whereas duration takes into account the pattern of all payments of interest and principal on a security over time, including how these payments are affected by prepayments and by changes in interest rates, as well as the time until an interest rate is reset (in the case of variable-rate securities). PIMCO uses an internal model for calculating effective duration, which may result in a different value for the duration of an index compared to the duration calculated by the index provider or another third party. Portfolio allocations and other information in the charts in this Quarterly Investment Report are based on the fund's net assets. These percentages may differ from those used for the fund's compliance calculations, including the fund's prospectus, regulatory, and other investment limitations and policies, which may be based on total assets of the fund or other measurements, may include or exclude various categories of investments from those covered in the portfolio allocation categories shown in this report, and may be based on different classifications and measurements of the fund s investments and other criteria. All time periods longer than one year are annualized and returns include reinvestment of dividends, income and capital gains, if any. The Fund can invest a portion of its assets in non- U.S. securities, which can entail greater risks due to non-u.s. economic and political developments. This risk may be enhanced when investing in Emerging Markets. Investment in a Fund that invests in high-yield, lower-rated securities, will generally involve greater volatility and risk to principal than investments in higher-rated securities. In an environment where interest rates may trend upward, rising rates will negatively impact the performance of most bond funds, and fixed income securities held by a fund are likely to decrease in value. Bond funds and individual bonds with a longer duration (a measure of the sensitivity of a security's price to changes in interest rates) are more sensitive to changes in interest rates, usually making them more volatile than securities with shorter durations. 2 Standard deviation is a statistical measure of dispersion about an average, which for a mutual fund, depicts how widely the returns varied over a certain period of time. 3 Distribution yield is calculated by annualizing actual dividends for the month ended on the date shown and dividing by net asset value per share on the last business day of the same period. 4 Tracking error, a measure of risk, is defined as the standard deviation of the portfolio's excess return vs.the benchmark expressed in percent. The information ratio is defined as the portfolio's excess return per unit of risk, or tracking error. For example, an information ratio of 1 means that a portfolio manager generates 100 basis points, or one percent of excess return for every 100 basis points of risk taken. 5 Portfolio allocations and other information in the charts in this Quarterly Investment Report are based on the fund's net assets. These percentages may differ from those used for the fund's compliance calculations, including the fund's prospectus, regulatory, and other investment limitations and policies, which may be based on total assets of the fund or other measurements, may include or exclude various categories of investments from those covered in the portfolio allocation categories shown in this report, and may be based on different classifications and measurements of the fund s investments and other criteria. All funds are separately monitored for compliance with prospectus and regulatory requirements. Other includes Yankee/Euro bonds, convertibles and municipal bonds. 6 Other includes swaps and securities issued in euros. 7 This Fund may use derivative instruments for hedging purposes or as part of its investment strategy. Use of these instruments may involve certain costs and risks such as liquidity risk, interest rate risk, market risk, credit risk, management risk and the risk that a fund could not close out a position when it would be most advantageous to do so. Portfolios investing in derivatives could lose more than the principal amount invested. 13
Appendix June 30, 2015 Market Commentary and Market Outlook Mortgage bonds are susceptible to risks such as default and prepayment of principal, and taxable at the state and federal levels, while Treasuries are guaranteed by the United States government and are only taxable at the Federal level. Guarantee does not eliminate market risk. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. Investment grade corporate bonds are considered among the higher rated in the corporate bond sector. These securities are not guaranteed by the federal government and are thus more susceptible to default risk. Generally most corporate bonds are taxable at the state and federal level. Treasuries are guaranteed by the United States government and are only taxable at the Federal level. Guarantee does not eliminate market risk. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. Real Return bonds, more commonly known as Treasury Inflation Protected Securities or TIPS, are issued and guaranteed by the U.S. government at a fixed rate that is adjusted based on the change of the Non-Seasonally Adjusted Consumer Price Index. Guarantee does not eliminate market risk. TIPS sacrifice some yield for the benefit of inflation protection. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. TIPS are only taxable at the Federal level. Nominal Bonds are any security issued, both domestic and foreign, that do not have inflation protection. The risks of nominal bonds fluctuate with the characteristics and credit rating of the issuing entity or government. Municipal bonds are guaranteed by the states in which they are issued. Guarantee does not eliminate market risk. Municipal bonds are not taxable at the Federal level and the issuing state has the right to demand tax; however, many states forgo tax on municipal bonds to entice investment. Treasuries are guaranteed by the United States government and are only taxable at the Federal level. Guarantee does not eliminate market risk. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. Corporate bonds are debt securities issued by a corporation. These securities are not guaranteed by the federal government and are thus more susceptible to default risk. Generally most corporate bonds are taxable at the state and federal level. Treasuries are guaranteed by the United States government and are only taxable at the Federal level. Guarantee does not eliminate market risk. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. Asset backed securities are financial securities backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. These securities can be an alternative to investing in corporate debt. Treasuries are guaranteed by the United States government and are only taxable at the Federal level. Guarantee does not eliminate market risk. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. Bonds issued by a government outside of the United States that are guaranteed by the issuing government. Guarantee does not eliminate market risk. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. Also, governments outside of the United States have different credit ratings which directly correlate to the risks associated with securities. Emerging Market bonds are susceptible to market, credit, currency, liquidity, legal, political, technical and other risks different from, or greater than, the risks of investing in developed foreign countries. Bonds issued by a government outside of the United States that are guaranteed by the issuing government. Guarantee does not eliminate market risk. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. Also, governments outside of the United States have different credit ratings which directly correlate to the risks associated with securities. High Yield bonds involve greater volatility and risk to principal than investments in higher-rated securities as the issuing entity has a lower credit rating possibly making the security more susceptible to default. Generally these types of bonds are taxable at the state and federal level. Index Descriptions Citigroup 1-10 Year Treasury STRIPS Index represents a composition of outstanding Treasury Bond and Notes with a maturity of at least one year but less than ten years. The index is rebalanced each month in accordance with underlying Treasury figures and profiles provided as of the previous month- end. The included STRIPS are derived only from bonds in the Citigroup U. S. Treasury Bond Index, which include coupon strips with less than one year remaining to maturity. It is not possible to invest directly in an unmanaged index. Barclays Universal Bond Index represents the union of the U. S. Aggregate Index, the U. S. High- Yield Corporate Index, the 144A Index, the Eurodollar Index, the Emerging Markets Index, the non- ERISA portion of the CMBS Index, and the CMBS High- Yield Index. Municipal debt, private placements, and non- dollar- denominated issues are exclude from the Universal Index. The only constituent of the index that includes floating- rate debt is the Emerging Markets Index. It is not possible to invest directly in an unmanaged index. 14
Appendix June 30, 2015 Index Descriptions (cont'd) Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. It is not possible to invest directly in an unmanaged index. BofA Merrill Lynch 1-3 Year U.S. Treasury Index is a subset of The BofA Merrill Lynch US Treasury Index including all securities with a remaining term to final maturity less than 3 years. The BofA Merrill Lynch US Treasury Index tracks the performance of US dollar denominated sovereign debt publicly issued by the US government in its domestic market. Qualifying securities must have at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of $1 billion. Bills, inflation-linked debt and strips are excluded from the Index; however, original issue zero coupon bonds are included in the index and the amounts outstanding of qualifying coupon securities are not reduced by any portions that have been stripped. Prior to September 25th, 2009, the BofA Merrill Lynch Indices were known as the Merrill Lynch Indices BofA Merrill Lynch U.S. High Yield, BB-B Rated Index is comprised of fixed income securities rated BB and B. The index tracks the performance of below investment grade U.S. Dollardenominated corporate bonds publicly issued in the U.S. domestic market. Prior to 1/97, data represents that of BofA Merrill Lynch High Yield Cash Pay, BB-B rated. BofA Merrill Lynch High Yield Cash Pay, BB-B rated. is comprised of fixed income securities rated BB and B. The index tracks the performance of below investment grade U.S. Dollardenominated corporate bonds publicly issued in the U.S. domestic market. Excludes pay-in-kind bonds and deferred interest bonds that are not yet accruing a coupon. It is not possible to invest directly in an unmanaged index. Prior to September 25th, 2009, the BofA Merrill Lynch Indices were known as the Merrill Lynch Indices. BofA Merrill Lynch U.S. High Yield Master II Index tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market. Qualifying bonds must have at least one year remaining term to maturity, a fixed coupon schedule and a minimum amount outstanding of USD 100 million. Bonds must be rated below investment grade based on a composite of Moody s and S&P. It is not possible to invest directly in an unmanaged index. Prior to September 25th, 2009, the BofA Merrill Lynch Indices were known as the Merrill Lynch Indices. The S&P/Case-Shiller Home Price Index measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States. The index uses the repeat sales pricing technique to measure housing markets. First developed by Karl Case and Robert Shiller, this methodology collects data on single-family home re-sales, capturing re-sold sale prices to form sale pairs. This index family consists of 20 regional indices and two composite indices as aggregates of the regions. 15
This material is authorized for use only when preceded or accompanied by the current PIMCO funds prospectus. This report includes information as of 06/30/2015 and contains the current opinions of the manager and such opinions are subject to change. This report is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. The fund offers different share classes, which are subject to different fees & expenses (which may affect performance), have different minimum investment requirements and are entitled to different services. PIMCO is a trademark or registered trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. THE NEW NEUTRAL and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Pacific Investment Management Company LLC in the United States and throughout the world. PIMCO Investments LLC, distributor, 1633 Broadway, New York, NY, 10019 is a company of PIMCO. No part of this report may be reproduced in any form, or referred to in any other publication, without express written permission. 2015, PIMCO.