1) April 2015 THE INVESTOR NAVIGATING THE CREDIT MARKETS Preparing for Liftoff Nearly a decade has passed since the Federal Reserve last embarked on a tightening cycle, and the potential implications of the next cycle are a focus for capital markets. In this commentary, we reflect on Rate Guideposts previous cycles, and discuss the potential path on the next round of Taylor rule currently suggests a target rate of approximately 2% given weakness in growth and inflation expectations The Fed’s forward guidance has made clear their intent to move away 17 risks that followed. Given the length of the current economic expan- 7 policy tightening. Off the zero bound from the Zero Interest Rate Policy (ZIRP), potentially in September or December. Maintaining zero policy rates was considered a necessary condition following the 2008-2009 crisis and financial and economic sion and reduction in systemic risks, policymakers now view the long term potential costs of ZIRP as outweighing the benefits. Aug 84 Days Jun 99 May 00 321 Start Dec 86 Mar 88 Feb 94 Jun 04 End Sep 87 Feb 89 Feb 95 Jun 06 Source: St. Louis Federal Reserve 477 262 332 362 729 Taylor Rule Effective Fed Funds Rate 12 2 -3 1974 1977 1980 1983 1986 1989 1993 1996 1999 2002 2005 2008 2012 2015 Source: St. Louis Federal Reserve, as of April 1, 2015 Table 1: Recent Fed tightening cycles May 83 22 Fed Funds Rate (%) 8.50 11.75 4.75 6.50 Start 5.87 6.50 3.00 1.00 End 7.25 9.75 6.00 5.25 Conventional thought suggests that a Fed tightening cycle will gener- ally led to higher U.S. Treasury yields across the maturity spectrum. As a result, this would lead to the underperformance of longer duration securities, and thus, investor preference to shorten portfolio duration in anticipation. If one were to reflect on the past six tightening cycles, all but one cycle has seen short duration corporate bonds outperform intermediate and longer duration corporates (table 2). It is also worthwhile to note that in the more recent cycles, all credit maturities produced positive total returns across the curve despite many doomsday warnings of capital losses surrounding bonds. Higher U.S. yields need higher growth 16 Nominal GDP 10-Year Treasury Yield 14 12 10 8 6 4 2 0 -2 -4 1960 1966 1972 1978 1984 1990 1996 Source: St. Louis Federal Reserve, as of April 1, 2015 2002 2008 2014 

2) Preparing for liftoff april 2015 Table 2: Total returns of credit indices in tightening cycles May 83-Aug 84 1-3yr Credit 1.10 Int Corporate -0.94 Corporate Jun 99-May 00 4.25 1.18 0.69 Tightening cycle Dec 86-Sep 87 3.58 Mar 88-Feb 89 6.02 Feb 94-Feb 95 -2.76 4.46 3.88 Jun 04-Jun 06 0.15 -4.62 4.62 2.20 2.29 -0.91 2.64 2.94 Source: Barclays indices, periods in excess of twelve months annualized The 2004-2006 tightening cycle saw a unique environment, one in Chart 2: Curve flattening - longer term Treasury yields were anchored as the Fed raised in ‘04-’06 6 5 Fed Funds Rate 10-Year Treasury Yield 4 3 2 The ‘04-‘06 cycle - Greenspan’s Conundrum 1 30 years (table 2). Many may remember this period categorized in 0 2003 2003 2003 2004 2004 2004 2005 2005 2005 2006 2006 2006 2007 which longer duration securities outperformed for the first time in 2005 by Chairman Greenspan as a “conundrum”, referring to the fact that longer duration U.S. Treasury yields had failed to increase in the face of a 150 basis point increase in the Fed Funds target rate. Despite the ‘04-’06 cycle being the longest in thirty years (over 2 years) as well as the largest increase in the Fed Funds rate (+4.25%), short duration securities underperformed. There were two primary factors; First, the low absolute yield levels of short duration bonds in 2004 meant lower coupons to offset higher short term rates. 1-3 year U.S. Treasury yields doubled during the two year period, from 2.61% to 5.23%. Second, U.S. real GDP growth was around 3-4%, despite a booming housing market. This seemed to anchor intermediate and long maturity Treasury yields (Chart 1). Ultimately, there was limited negative impact from duration exposure in fixed income portfolios. Chart 1: The ‘04-’06 cycle saw limited movement in longer maturity Treasury yields 4.00 3.50 Average change during tightening cycle since 1980 Change during 04-06 tightening cycle 3.00 2.50 In determining the speed and size of the upcoming tightening cyWhat could ‘15-’17 look like? cle, we look at two factors that are likely to influence policy. First, U.S. growth and inflation outlooks do not warrant a substantial or rapid increase in the Fed Funds rate. While reduced systemic risks warrant a removal of ZIRP, the current expansion has been stuck at 2% real GDP for the past few years with inflation levels below target. A tightening of monetary policy to a historically neutral 4% level would have a significant contractionary effect given the economic and structural challenges of the post Great-Recession environment. One common yardstick for Fed Funds is the Taylor Rule, which provides an estimate of a neutral rate based on the output gap and current inflation. The Taylor Rule currently estimates neutral Fed Funds rate to be approximately 2% (Chart 3). This is evidence of the slack in U.S. economic output and should prevent the Fed from materially hiking rates. Chart 3: While a historically neutral Fed Funds rate may have been 4%, today’s environment may make that closer to 2% 2.61 14 2.32 1.88 2.00 Source: Barclays, St. Louis Fed 12 1.62 1.50 1.63 1.39 10 1.41 0.82 1.00 Taylor Rule Effective Fed Funds Rate 1.00 8 6 0.50 0.17 0.00 1-3 3-5 5-7 Treasury Maturity 7-10 10+ Source: Barclays, average based on change in Treasury yields during Fed tightening cycles since 1980. 4 2 0 -2 -4 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 Source: St. Louis Federal Reserve, as of April 1, 2015 2 

3) Preparing for liftoff april 2015 Second, global central bank policy, disinflation pressures, and eco- Bottom-line: The ability for the Fed to hike policy rates or for (Chart 4). This weighs down U.S. Treasury yields by driving capi- a focus on intermediate credit, in particular BBB rated bonds, re- nomic risks abroad may constrain the Fed and Treasury yields. With global central bankers engaging in aggressive QE, sovereign yields have plunged to levels not seen in modern economic history tal flows to more attractive sovereign securities. Further, the U.S. economy is not an island, and low global growth rates may weigh on U.S. GDP. The world is pushing down the U.S. yield curve, pro- viding incentive to a slower pace of policy from Fed officials. Given these factors, we may very well see a repeat of the last cycle, where intermediate and longer duration securities outperform. Chart 4: U.S. Treasury yields are among the highest in the developed world 8 10-Year Sovereign yield (%) 7 6 5 4 3 2 Italy 2012 are not advocating for an extension in duration. Instead, we believe mains our preferred investment grade area. There is a considerable amount of intellectual energy focused on U.S. monetary policy and the actions of the Federal Reserve. However, this tightening cycle may have other influences and help determine things just as important as driving bond returns over the next few years. Can the U.S. economy finally be able to stand on its own? Is our financial system stronger today than prior to the cri- sis? Are risk assets valued appropriately? As the current Chair of the Fed would say, these questions are “data dependent”. April 2015 France 2012 by growth, disinflation pressures, and global monetary policy. We Pacific Asset Management Spain U.S. Germany 1 0 2012 Treasury yields to move to previously seen levels will be limited 2013 2013 2013 2013 Japan 2014 2014 2014 2014 2015 Source: Barclays, as of April 31, 2015 ABOUT PACIFIC ASSET MANAGEMENT Founded in 2007, Pacific Asset Management specializes in credit oriented fixed income strategies. Pacific Asset Management is a division of Pacific Life Fund Advisors LLC, an SEC registered investment adviser and a wholly owned subsidiary of Pacific Life Insurance Company (Pacific Life). As of March 31, 2015 Pacific Asset Management managed approximately $4.8bn. Assets managed by Pacific Asset Management includes assets managed at Pacific Life by the investment professionals of Pacific Asset Management. IMPORTANT NOTES AND DISCLOSURES Bank loan, corporate securities, and high yield bonds involve risk of default on interest and principal payments or price changes due to changes in credit quality of the borrower, among other risks. Pacific Asset Management is an investment advisor; it provides investment advisory services to institutional clients and does not sell securities. Pacific Select Distributors, Inc. is the distributor for Pacific Life’s retail products. Pacific Asset Management and Pacific Select Distributors, Inc. are each a wholly owned subsidiary of Pacific Life. This information is presented for informational purposes only. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole investment making decision. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. The opinions expressed herein are based on current market conditions, are subject to change without notice. Investors should consider the investment objectives, risks, charges and expenses carefully before investing. Please read the applicable prospectus or other offering documents carefully before investing. For this and more complete information about the available investment vehicles, investors should contact their financial advisor, consultant or visit www.pacificlife.com or www.pam.pacificlife.com. FOR MORE INFORMATION Pacific Asset Management • 700 Newport Center Drive • Newport Beach, CA 92660 • www.pam.pacificlife.com 3