Overview

Our Enhanced Income strategy is designed to generate cash flow using traditional and non-traditional income vehicles, typically fixed income ETFs. This strategy is not restricted to investment grade bonds, but instead surveys a broader universe of income-producing investments and concentrates on being paid equitably for the risk assumed.

The strategy has three main objectives:

1. Generate Income
   Produce above-average income from under-valued holdings that also have potential for superior appreciation
2. Manage Risk
   Assess yield in relative rather than absolute terms, to maximize risk-adjusted returns
3. Diversify
   Maintain diverse exposure by selecting investments from a broad mix of over 30 income asset sub-classes

Our Philosophy

For this portfolio, we seek to generate much of the required return from cash flow and place less weight on price appreciation. This strategy may have appeal for investors who wish to avoid the market risk associated with an equity-income portfolio. However, to generate cash flow we use traditional and non-traditional income investments as represented by index vehicles, typically indexed Exchange Traded Funds (ETFs). These vehicles do have an equity component, and generally a much higher cash flow, and may have more volatility than corporate or government bonds.

Philosophically, we do not believe that there is “fixed” income. All income securities have variable returns. Even fixed annuities have fluctuating yields and the risk of capital losses.

Our strategy utilizes an approach to income that is not restricted to investment grade bonds, but instead concentrates on being paid for the risk assumed. We would also suggest that there may be more interest rate risk in a ten-year U.S. Government Bond than there is business risk in our Enhanced Income approach.

The Process

Many fixed income managers construct either laddered bond portfolios or a basket of standard issue securities. These methods tend to result in static portfolios that may be out of favor for long periods of time. Our Enhanced Income management style is more proactive and wider reaching.

Security Type Selection

First, we analyze the spreads of every fixed income asset sub-class relative to the U.S. 10-Year Treasury Note to quantify which types of fixed income securities are more rewarding relative to their historical norms.

Examples: Government Bonds, Corporate Bonds, Preferred Stocks, High Yield Bonds, Convertibles, Sovereign Debt, MLPs, Energy Trusts, etc...

Duration Selection

After selecting the most favorable security types, we then analyze the shape of the yield curves to determine whether the best projected returns are available in long-term or short-term issues.

Geographic Selection

Lastly, we monitor the international fixed income market and the U.S. dollar, which may lead us to invest in foreign income securities to hedge against U.S. currency.

Investment Vehicles

The following list is not definitive as we continually seek strategies that correspond with our view of economic and interest rate trends. This is also not an exhaustive discussion of the unsystematic risks in each of these strategies. Given the delineation between short-term, intermediate-term, and long-term, there are over 35 different sub-asset classes that could be listed below. However, typically, we use five to eight sub-asset classes to implement our strategy.

Corporate Bonds, Investment Grade*	Municipal Bonds
Corporate Bonds, Non-Investment Grade*	Preferred Stock
Energy Production Trusts	Preferred Stock, Floating Rate
Energy Transportation MLPs	Real Estate Investment Trusts (REITs)
Foreign Currency Denominated Bonds	Senior Collateralized Notes
Inflation Indexed Bonds, US Treasury (TIPS)	US Agency Bonds*
Inflation Indexed Bonds, Corporate	US Treasury Bonds*
Convertible Bonds	Leveraged Limited Duration Portfolios

^* Denotes issues that may also be segmented into short-term, intermediate-term, and/or long-term.

This is not a buy and hold strategy. Since the beginning of 2003, we have owned inflation-indexed bonds, mortgage derivatives, callable corporate preferred stocks, and high yield portfolios, most of which have been sold and replaced. We typically buy securities at discounts to our valuation analysis and/or closed-end funds at discounts to NAV, and sell at premiums. We will not invest where we feel there is no value. Often we will buy yield in two negatively correlated asset sub-classes and take the cash flow. This means we may buy two securities (or portfolios) that are likely to respond in opposite fashion to a given outside stimulus (systematic change) with our goal being to earn the risk-adjusted yield. We also have no qualms about capturing short term gains when they are available.