Core Fixed Income Strategies

FMA's fixed income objective is to construct a diversified portfolio of investment grade securities designed to outperform its benchmark index over a market cycle while controlling risk. We believe this can be accomplished on a consistent basis by differentiating our portfolios from the index by combining an appropriate level of interest rate, credit and option risk. Portfolio construction is an ongoing process at FMA. We employ a traditional methodology whereby both top-down and bottom-up analysis is utilized to maximize performance. The top-down macroeconomic fundamental analysis is combined with an ongoing review of market valuations to assess the current and expected financial and economic trends. A relative value methodology is employed across market sectors and within market segments and industries.

The top-down macroeconomic forecast provides a fundamental evaluation of where the economy is in the business cycle today and where we expect it to be over the next six to 18 months. This analysis incorporates current and expected levels of growth (including broad sectors), inflationary pressures, fiscal and monetary policy, and factors impacting the domestic and international economic markets. This forecast incorporates a macro projection for the future levels of interest rates, the slope of the yield curve and the performance of broad sectors of the market. The top-down forecast is then compared to various bottom-up market valuations to confirm forecast estimates. These evaluations incorporate current, historical and forward-looking trends in both the financial and non-financial markets. Any divergence is noted and additional analyses and reviews are undertaken. We combine both approaches to establish a risk/reward perspective relative to the indices regarding duration, credit and option risk. The portfolio reflects our opinion of these risk characteristics from a fundamental and market perspective and incorporates appropriate levels of duration, positioning on the yield curve and sector/issue weightings.

FMA's investment staff is composed of two teams - small cap equity and large cap/fixed income. FMA's fixed income product is managed by the large cap/fixed income team. A formal meeting of the entire FMA research team is held each week to review the latest economic and financial trends. This weekly meeting serves as the basis for assessing FMA's macro outlook and broad risk parameters. This meeting is led by FMA's chief investment officer and attended by all equity and fixed income portfolio managers and analysts. The large cap/fixed income team meets weekly to ensure the latest top-down outlook is consistent with the portfolio's characteristics. A more detailed review of the fixed income markets is addressed and the portfolio may be adjusted to reflect the current outlook. Various quantitative tools combined with fundamental analysis are utilized to drive our relative value approach to manage overall duration, credit and option risk.

Portfolio duration is driven by our assessment of the current and expected economic and interest rate conditions in the business cycle. Within a traditional business cycle, the portfolio's weighted average maturity will range between 3.75 and 5.25 years. The duration will range from 90% to 110%, relative to the benchmark. Our credit risk is driven by the business cycle and by investing in a diversified mix of U.S.-based investment grade securities with varying maturities. Industries are reviewed on an ongoing basis to determine attractiveness, including macro factors such as barriers to entry, regulatory issues, and competitive forces (both domestic and international). Credit worthiness is evaluated through a fundamental analysis of the industry/issuer utilizing both internal and external sources. Sector diversification is maintained by limiting major sector allocations to 50% to 200% of the benchmark. The maximum position for each issue is 2.0% with initial positions of 0.5% to 1.5%. Marketability and liquidity of issues are emphasized and are generally driven by index membership guidelines.

Company specific fundamentals, such as management depth and product strengths, are further evaluated from industry conferences and journals as well as periodic meetings with senior management. Initial purchase decisions include price/spread targets relative to its industry/segment. Sell decisions include both nominal and relative credit spread performance.

Option risk is driven by the stage of the business cycle, the volatility of the markets, and the slope of the yield curve. FMA manages this component of risk through coupon selection, cash flow structure and yield curve analysis. We utilize an option-adjusted spread methodology to evaluate the attractiveness of this component of return.

Portfolios are managed to meet the objective of generating risk-adjusted returns that exceed the appropriate benchmark. In addition portfolios maintain a high quality bias, excellent liquidity, and appropriate diversification and are composed of U.S.-dollar-based securities. Lastly, the portfolios are managed to limit turnover.