Presentation to the PortfolioConstruction Conference 2008

Defensive Asset Allocation in I fl i E ian Inflationary Environment

Doug HodgeManaging Director, Head of PIMCO Asia Pacific

This presentation contains the current opinions of the manager and such opinions are subject to change without notice This presentation has been distributed forThis presentation contains the current opinions of the manager and such opinions are subject to change without notice. This presentation has been distributed forinformational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this presentation may be reproduced in anyform, or referred to in any other publication, without express written permission of Pacific Investment Management Company LLC. ©2006, PIMCO.

Since the 1970’s, inflation has been in persistent declinedecline

30%

20%

25%

10%

15%

0%

5%

-5%Dec-71 Dec-76 Dec-81 Dec-86 Dec-91 Dec-96 Dec-01 Dec-06

Austrialian CPI % YOY US CPI % YOY UK CPI % YOY

Europe CPI % YOY Japan CPI % YOY Canada CPI % YOY

Central bank success in its inflation targeting or were there other factors involved?

The Fall of the Iron Curtain

Agrarian Reform by the Communist Party of ChinaChina

GDP Growth Rates are on the Decline

8.7 8.89

7.4

6.86.5

6.07

8

9

)

2006 Actual

2007 Actual

2008 Projected

5.3 5.3

4.0

2.9 2.94

5

6

Y G

row

th (

%)

2.9

2.2

1.5

2.42.0

1.2

2.92.6

1.8

1

2

3Yo

Y

0Latin

AmericaEM Asia Emerging

EuropeU.S. Japan Euroland

The PIMCO view: Global growth will remain robust despite a cyclical downturnThe PIMCO view: Global growth will remain robust despite a cyclical downturn in the U.S and other developed economies

Source: PIMCO, JP Morgan, Goldman Sachs

But Emerging Markets Have Picked up the Slack

EM Share of Global GDP (At Market Exchange Rates)

28

30

24

26

rcen

t (%

)

22

24

Pe

2093 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Growth will be driven to a greater extent by emerging markets that are in the midst of a breakout development phase

Source: PIMCO, IMF

Leading to a Divergence in Current Account BalancesBalances

Global Current Account Balances

2.0

2.5

Industrialized Countries

Emerging & Other Developing Countries

1.0

1.5

d G

DP

(%

) Emerging & Other Developing Countries

0.0

0.5

ce

nt

of

Wo

rl

-1.0

-0.5

Pe

rc

-1.570 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 07

Source: PIMCO, IMF

Heeeeeere’s INFLATION!

The inflationary pressures we are witnessing inThe inflationary pressures we are witnessing in emerging markets are spilling over into developed economies.

Inflation pressures will spring from several sources;

– Commodity Price PressuresCommodity Price Pressures

– Rising wages in emerging economies

– Increased social spending in developedIncreased social spending in developed economies

– Depreciating developed currencies vs emerging currenciesemerging currencies

– Loose US monetary policy that may be inflationary globally

Why Should We Be Worried About Inflation?

Inflation has the effect of reducing the purchasing power of money, which is at odds with the long term goal of most investors

Over time, it can chip away at real savings and investment returns.

Inflation affects all aspects of the economy, from consumer spending, business investment and employment rates, to government programs, tax policies and interest rates

How can I Protect my Portfolio From Inflation?

Rather than think about an investment portfolio as a range of asset classes, investors should think about their portfolios as a set of inflation hedges.

Inflation hedges can be divided into three main buckets;

– Leading inflation hedges

– Contemporaneous inflation hedges

– Lagging inflation hedges

Effective Hedging requires a recognition of where we are in the inflation cycle, followed by an appropriate allocation to the corresponding hedge

Leading Inflation Hedges

Tend to perform in advance of inflation becoming visible in the broader economyTend to perform in advance of inflation becoming visible in the broader economy

Leading inflation hedges include commodities and equities

Over longer periods, equities have shown a negative correlation to inflation and can be especially hurt by unexpected inflation

US Equities & Inflation -0.25 Australian Equities & Inflation -0.11

Unlike equities, commodities show a positive correlation with inflation

Commodities (USD) & Inflation 0.33 Commodities (AUD) & Inflation 0.45

Australian Equities represented by the ASX 200. US Equities represented by S&P 500. Figures are based on 1 year returns compared to 1 year CPI figures for Australia and the US from 1992-2007. Commodities are represented by the DJAIG commodity index denominated in AUD and USD. Figures are based on rolling 1 year returns measured quarterly from 1992-2008.

Commodities Diversify Equity Risk and Hedge Inflationary DriversInflationary Drivers

Positively correlated to inflationPositively correlated to inflationPositively correlated to changesin rate of inflation

InflationHedging

Negatively correlated to equitiesNegatively correlated to bondsDiversification g y

Magnitude of returns comparable to equities (1970-2007)Volatility comparable to equities

ReturnPotential

Once inflation becomes visible, it is time to move assets away from leading hedges such as equities into contemporaneous inflation hedgesleading hedges, such as equities, into contemporaneous inflation hedges

Contemporaneous Inflation Hedges

C t h d t d t f i li ith i fl tiContemporaneous hedges tend to perform in-line with inflation

Examples of contemporaneous hedges include inflation Linked Bonds (ILBs) or CPI S t tCPI Swap contracts

Both strategies provide explicit inflation protection and preserve real purchasing Th diffi lt ith b th t t i i l k f l f it blpower. The difficulty with both strategies is a lack of supply of suitable

instruments and securities in Australia

Ho e er a high le el of correlation bet een A stralian and Global inflationHowever a high level of correlation between Australian and Global inflation means that investment in a portfolio of global ILBs offers a practical solution to hedging domestic inflation

ILBs Diversify the “Disinflationary Bias” of Traditional Fixed Income

Low Inflation High Inflation

Traditional Fixed Income

InflationInflationInflationInflation

Real YieldReal Yield

InflationInflation

Real YieldReal Yield

Couponpayment

CumulativeCumulative

Principal

CumulativeInflation Accruals

CumulativeInflation Accruals

I iti l P V lI iti l P V l

CumulativeInflation Accruals

CumulativeInflation Accruals

Initial Par ValueInitial Par Value Initial Par ValueInitial Par Value

Once the presence of inflation is well established, investors should look pto take advantage of government policy response

Lagging Inflation Hedges

Lagging hedges are centered in those assets that offer returns following boutsLagging hedges are centered in those assets that offer returns following bouts of inflation

In countries where the central bank uses monetary policy to combat inflationIn countries where the central bank uses monetary policy to combat inflation, cash or bank bills can offer the most basic form of inflation hedge

Other securities include Floating Rate Notes (FRNs)- where an interest marginOther securities include Floating Rate Notes (FRNs) where an interest margin is paid over the cash or bank bill rate- also offer a good, lagged, inflation hedge

In Australia this strategy is particularly effective considering that aside from oneIn Australia this strategy is particularly effective considering that aside from one brief period, the RBA have managed to maintain a real cash rate

Australia’s Inflation Experience…

Australian Inflation

14

19CPI YoY

9

14

cent

(p.a

)

4

Perc

-1

Jun-8

8

Jun-8

9

Jun-9

0

Jun-9

1

Jun-9

2

Jun-9

3

Jun-9

4

Jun-9

5

Jun-9

6

Jun-9

7

Jun-9

8

Jun-9

9

Jun-0

0

Jun-0

1

Jun-0

2

Jun-0

3

Jun-0

4

Jun-0

5

Jun-0

6

Jun-0

7

Jun-0

8

Source: PIMCO, Bloomberg

…and the RBA response

Australian Inflation

14

19 RBA Cash RateCPI YoY

9

14

cent

(p.a

)

4

Perc

-1

Jun-8

8

Jun-8

9

Jun-9

0

Jun-9

1

Jun-9

2

Jun-9

3

Jun-9

4

Jun-9

5

Jun-9

6

Jun-9

7

Jun-9

8

Jun-9

9

Jun-0

0

Jun-0

1

Jun-0

2

Jun-0

3

Jun-0

4

Jun-0

5

Jun-0

6

Jun-0

7

Jun-0

8

Add a margin for active management and cash plus strategies become compelling ways to achieve high real rates of return as well as a hedge against inflation in the current environment of elevated rates

Source: PIMCO, Bloomberg

inflation in the current environment of elevated rates.

Conclusion

ngH Best: Equities Best: CommoditiesH

igh/

Ris

in

O W

T H

q

Mixed: Commodities &Nominal Bonds

Worst: ILBs

Best: Commodities

Mixed: Equities & ILBs

Worst: Nominal Bonds

allin

gH

A L

G R

Worst: ILBs

Best: Nominal Bonds Best: ILBs & Cash Plus

Mixed: Commodities &

Low

/Fa

R E

A Mixed: Equities & ILBs

Worst: Commodities

Mixed: Commodities &Nominal Bonds

Worst: Equities

Low/Falling High/Rising

I N F L A T I O N

Questions

PIMCO Commodity Real Return Fund

The PIMCO Commodity Real Return Fund is designed forThe PIMCO Commodity Real Return Fund is designed for investors seeking commodity exposure complemented by a core fixed interest allocation

The fund uses derivatives linked to commodity indices to gain exposure to the asset classexposure to the asset class

The collateral backing the commodity index positions is g y pinvested in a wide range of fixed interest strategies

PIMCO Global Real Return Fund

The PIMCO Global Real Return Fund is designed forThe PIMCO Global Real Return Fund is designed for investors who recognise that their liabilities are often in real terms and wish to protect against a rise in inflation

The fund utilises PIMCO’s core global fixed interest strategy of seeking active investment returns whilst moderating riskof seeking active investment returns whilst moderating risk

The fund is benchmarked against the Lehman Brothers gGlobal inflation Linked Bond index and hedged into AUD

PIMCO Diversified Fixed Interest Fund

The PIMCO Diversified Fixed Interest Fund is designed forThe PIMCO Diversified Fixed Interest Fund is designed for investors who wish to have a broadly diversified exposure to both domestic and international fixed interest markets

The fund invests in a mix of government and semi government bonds, mortgages, corporate and emerginggovernment bonds, mortgages, corporate and emerging market debt

The Australian component of the fund is positioned to take advantage of the high cash rates currently on offer

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PIMCO ContactMatthew Mclenaghan

matthew.mclenaghan@au.pimco.com

Address:

Level 19, 363 George Street

Sydney, NSW 2000

Tel: 02-9279-1771

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Tel: 02 9279 1771

Fax: 02-9279-2580

The services and products provided by PIMCO Australia Pty Ltd are only available in Australia to persons who come within the category of wholesale clients as defined in the Corporations Act 2001. They are not available to persons who are retail clients, who should not rely on this communication. Investors should obtain relevant and specific professional advice before making any investment decision. The information contained herein does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision investors should consider, with or without the assistance of a securities advisor, whether the information contained herein is appropriate in light of their partic lar in estment needs objecti es and financial circ mstancesthe information contained herein is appropriate in light of their particular investment needs, objectives and financial circumstances.

Investment management products and services offered by PIMCO Australia Pty Ltd are offered only to persons within its respectivejurisdiction, and are not available to persons where provision of such products or services is unauthorised.

Past performance is no guarantee of future results This article contains the current opinions of the author but not necessarily those ofPast performance is no guarantee of future results. This article contains the current opinions of the author but not necessarily those of the PIMCO Group and does not represent a recommendation of any particular security strategy, or investment product. The author’sopinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This article is distributed for educational purposes and should not be considered as investment advice or an offer of any security for sale.

No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.

Copyright 2008, PIMCO