For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Why Commodities? When? How Much? How? February 22, 2010 This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational 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 material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA ©2010, PIMCO.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Biographical Robert J. Greer At PIMCO Mr. Greer is an Executive Vice President and Manager of Real Return Products which embraces commodities, inflation-linked bonds, real estate and active asset allocation. Mr. Greer spent eight years managing commodity index business first for Daiwa Securities and then for both Chase Manhattan Bank and JP Morgan. Prior to this, he spent ten years in the investment real estate business. He is regarded as the first person to define an investable commodity index and is a pioneer in explaining why commodity indexes are an asset class distinct from stocks and bonds. He developed one of the two common methods of explaining sources of commodity index returns and has spoken on this asset class at universities, industry conferences, and trade meetings globally. He has also published articles on the subject in The Journal of Portfolio Management, The Journal of Derivatives, The Journal of Alternative Investments and Pensions & Investments. He has consulted on the subject of commodities to governmental entities such as the CIA, CFTC, and Bank of England. Mr. Greer wrote The Handbook of Inflation Hedging Investments, oriented to the institutional investment community, which was published by McGraw Hill in December Mr. Greer received a bachelors degree in mathematics and economics from Southern Methodist University. He earned an MBA from the Stanford Graduate School of Business.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Economic forces are not understood well enough for predictions to be beyond doubt or error... We are expecting too much if we require the security analyst to predict with certainty... Portfolio Selection – Harry Markowitz

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Historical Benefits of a Commodity Index Diversification Negatively correlated to stocks Negatively correlated to bonds Inflation Hedging Positively correlated to inflation Positively correlated to changes in rate of inflation Return Potential Magnitude of returns comparable to equities ( ) Volatility comparable to equities Question: Why have commodities provided these returns?

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Owning actual commodities –Not practical Owning shares (equity) in commodity producers –Return affected by factors other than commodity price Traditional active commodity trading (Managed Futures) –Loses inherent return of the asset class Commodity index investment –Systematic approach to the asset class –Inherent return driven by economic factors Choices for Commodity Investment

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Refers to exchange-traded futures contracts Considers only true commodities (stuff) Assumes only long positions Fully collateralizes each position Has completely specified calculation method (passive) Return is affected by changes in EXPECTED FUTURE PRICES A Commodity Index

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) SOURCE: UBS Refer to Appendix for additional index information As of December 31, 2009 Components of Dow Jones–UBS Commodity Index

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Commodity Futures Pricing Model October Risk Premium 2¢ 65¢ Producers Break-even 70¢ Acceptable Profit 72¢ Expected Cash Price 84¢ 60¢ Potential Range of Cash Price February Current Cash Price 67¢ commRR_phil_10 Sample for illustrative purposes only.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Current Cash Price 67¢ 72¢ Expected Cash Price Commodity Futures Pricing Model February October 84¢ 60¢ Positive Expectational Variance Negative Expectational Variance Potential Range of Cash Price commRR_phil_11 Sample for illustrative purposes only.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Long-only investor rolls from higher priced nearby to lower priced distant contract Low Inventory / Tight Supply More Normal Inventory Price Forward Month J F M A M J J A S O N D SOURCE: PIMCO Sample for illustrative purposes only. Examples of a Forward Curve

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Unexpected General Inflation; Plus... Individual market surprises Expectational Variance Components of Return: Causes of Return: T-Bill Rate Expected Inflation (plus real rate of return) Risk Premium Price Uncertainty (producers vs. processors) Uncorrelated Volatility (mean reversion) Rebalancing Low Inventory Relative to Demand Convenience Yield Unleveraged Commodity Indexes: Basis For Returns

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Commodities Have Provided Diversification From Equities (And From Nominal Bonds) Correlation of Commodity Futures With Other Financial Assets (2006) SOURCE: CFA Institute, 2006; (Financial Analyst Journal, Volume 62) Stocks are represented by the S&P 500; Bonds are represented by the Ibbotson Corporate Bond Total Return Index; Inflation is represented by the Consumer Price Index Overlapping return data from July 1959 to December Refer to Appendix for additional correlation and index information.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Commodities Have Provided Protection From Inflation Correlation of Asset Classes With Inflation (2006) SOURCE: CFA Institute, 2006 (Financial Analyst Journal, Volume 62) Stocks are represented by the S&P 500; Bonds are represented by the Ibbotson Corporate Bond Total Return Index; Commodity Futures is represented by the equally- weighted collateralized futures index is constructed using data from the Commodity Research Bureau and the London Metals Exchange. Overlapping return data from July 1959 to December Refer to Appendix for additional correlation and index information.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Commodity Index Returns SOURCE: Goldman Sachs, AIG Trading Refer to Appendix for additional index information.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) SOURCE: Goldman Sachs, Bloomberg Refer to Appendix for additional index information Diversification During a Political Crisis

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Diversification During a Financial Crisis SOURCE: Goldman Sachs, Bloomberg Refer to Appendix for additional index information

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Things Can Also Go Badly for Commodities SOURCE: Goldman Sachs, Bloomberg Refer to Appendix for additional index information Growth of a $1 - DJUBSCI vs. S&P 500 (From 05/31/97 through 12/31/98) $0.50 $0.75 $1.00 $1.25 $1.50 May-97Aug-97Nov-97Feb-98May-98Aug-98Nov-98 Cumulative Return = 48.55% Cumulative Return = % S&P 500 DJUBSCI

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) 2008 – Where Was Diversification When We Needed it? SOURCE: Goldman Sachs, Bloomberg Financial Markets Refer to Appendix for additional index information.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Issues to Consider Commodity capacity utilization Planned capital expenditures Demand from emerging economies Impact of dollar valuation Expected correlation with stocks, bonds, and inflation Potential rebalancing opportunities Remember, predictions can not be beyond doubt or error Commodities: When?

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( )

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Modest Commodity Allocations May Reduce Portfolio Risk (2006) Stocks 1 Bonds 2 TIPS 3 Comm. 4 Stocks Bonds TIPS Cmdty Return8.04%5.46%5.41%7.01% Risk19.81%7.28%5.53%19.40% Correlations/Capital Markets Assumptions* SOURCE: PIMCO *Hypothetical example for illustrative purposes only. Based on annual returns from 1976 to 2006 for all statistics versus commodities. The remaining statistics are based on data from 1900 to Stocks: Return - S&P 500 Div. Yield as of 12/31/ % GDP Growth + 3% Inflation Volatility & Correlations - S&P 500 ® Total Return Index (w/Global Financial Data extension) 2 Bonds: Return – Lehman Brothers Aggregate Index Yield to Maturity as of 12/31/2006 Volatility & Correlations - Lehman Brothers Aggregate Index Returns since TIPS: Returns – Real Yield of Generic 10 year US TIPS as of 12/31/ % Inflation Volatility & Correlations - For years ended 1900 through 1997, TIPS Total Returns were calculated by estimating price returns and real coupons along with inflation data. Price returns were estimated from the monthly change in 10 year constant maturity treasury yield and an assumed yield beta of 0.6. Real coupons were based on average nominal yield less trailing three-year inflation, from , which averaged 1.25%. Monthly inflation accruals were based on monthly changes in the CPI index. From Feb, 1997 through 2006, TIPS Total Returns are represented by the Lehman TIPS Index. 4 Commodities: Returns – 3 month T-Bill Yield + 2% Volatility & Correlations Ibbotson Commodity Composite Refer to Appendix for additional correlation, chart, efficient frontier model, hypothetical example, index, and risk information.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Commodities: How? What index will we track? What will be our choice of collateral? Active / Passive Commodity exposure Collateral management Fund vs. Separate Account Futures vs. Swaps ETFs – Index or Individual Commodity

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) commRR_phil_59 Return of commodity futures (non-collateralized) Return of collateral (assumed T-Bills) Return of collateral (assumed T-Bills) Commodity indexes are comprised of two components: This provides two areas to add value (Double Alpha): Total Return of Index Total Return of Portfolio ++ Return of commodity futures (non-collateralized) Commodity Structured Alpha Strategies Commodity Structured Alpha Strategies Return of collateral (assumed T-Bills) Return of collateral (assumed T-Bills) Selection of Collateral Active Management of Collateral Active Management of Collateral Sample for illustrative purposes only. Refer to Appendix for additional Double Alpha information. Double Alpha Approach to Commodity Index Mandates

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Only the clairvoyant could hope to predict with certainty. Clairvoyant analysts have no need for the techniques of this monograph. Portfolio Selection – Harry Markowitz

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Commodity References Erb, Claude B. and Campbell R. Harvey. The Strategic and Tactical Value of Commodity Futures. Financial Analysts Journal, Vol 62, No. 2. (2006) Fernholz, Robert, and Brian Shay. Stochastic Portfolio Theory and Stock Market Equilibrium. Journal of Finance, Vof 37 (1982), pp Gorton, Gary and K. Geert Rouwenhorst. Fact and Fantasies about Commodity Futures, Financial Analysts Journal, Vol 62, No. 2. (2006) Greer, Robert. Conservative Commodities: A Key Inflation Hedge. Journal of Portfolio Management, (Summer 1978). Greer, Robert. What is an Asset Class, Anyway? Journal of Portfolio Management, (Winter 1997). Greer, Robert. Handbook of Inflation Hedging Investments (Chapter 5). McGraw-Hill Kaldor, Nicholas. Speculation and Economic Stability. The Review of Economic Studies, Vol. 7, No. 1. (October 1939), pp Keynes, John Maynard. A Treatise on Money, Volume II. New York: Macmillan & Co., Working, Holbrook. The Theory of Price of Storage. The American Economic Review, Vol. 39, No. 6. (December 1949), pp

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Appendix Past performance is not a guarantee or a reliable indicator of future results. Chart Performance results for certain charts and graphs may be limited by date ranges specified on those charts and graphs; different time periods may produce different results. Correlation The statements contained in this presentation regarding the correlation of various indices or securities against one another or against inflation are based upon data over a long time period. These correlations may vary substantially in the future or over shorter time periods, resulting in greater volatility. Double Alpha The Double Alpha refers to a strategy that should provide excess return under the active management of collateral backing the commodity index. In addition, this strategy derives alpha from the structural commodity relative to the index. Hypothetical Example Hypothetical and simulated examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated results and the actual results. There are numerous factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved. Risk Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Appendix Efficient Frontier Models The Efficient frontier models represented in this report are bound by the data sets and date ranges used in those models. This model illustrates performance from 1976 to Different time periods or data sets may produce different results. Past performance is no guarantee of future results. Certain assumptions were made in this analysis, which have resulted in the returns detailed herein, changes to the assumptions may have an impact on any returns detailed. Transaction costs (such as commissions or other fees) are not included in the calculation of returns reflected, and changes to the assumptions may have an impact on any returns detailed in this document. If these fees and charges were included the performance results would be lower. Index Definitions The Citigroup 3 Month Treasury Bill Index is an average of the last 3-month treasury bill issues (excluding the current month-end bill). The CPI is an unmanaged index representing the rate of inflation of the US consumer prices as determined by the US Department of Labor Statistics. There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at any given time. The Dow Jones UBS Commodity Total Return Index is an unmanaged index composed of futures contracts on 19 physical commodities. The index is designed to be a highly liquid and diversified benchmark for commodities as an asset class. Prior to May 7, 2009, this index was known as the Dow Jones AIG Commodity Total Return Index. Dow Jones UBS Commodity Excess Return Index is the return of the Dow Jones UBS Commoity Total Return Index less the return from T-Bills assumed to collateralize the futures positions. Prior to May 7, 2009, this index was known as the Dow Jones AIGCI Excess Return Index. Dow Jones UBS Commodity Excess Return Index + TIPS is comprised of the Dow Jones UBS Commodity Excess Return Index plus the Barclays Capital Global Real: U.S. TIPS Index less annual transaction costs. Prior to May 7, 2009, this index was known as the Dow Jones AIGCI Excess Return Index + TIPS. The Goldman Sachs Commodity Index (GSCI) is an unmanaged index composed of futures contracts on 25 physical commodities, designed to be a highly liquid and diversified benchmark for commodities as an asset class. The Goldman Sachs Commodity Index Total Return (GSCITR) is an unmanaged index composed of futures contracts on 25 physical commodities, designed to be a highly liquid and diversified benchmark for commodities as an asset class. The Total Return index includes an implied T-Bill rate on the notional value of the futures contracts. The Ibbotson Corporate Bond Total Return Index is an managed index composed of long dated corporate bonds with maturities greater than 20 years. The S&P Goldman Sachs Commodity Index (S&P GSCI) is a composite index of commodity sector returns, representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. Inception Date: 12/31/69

For Educational Use Only !edu_Why_Commodities For Educational Use Only Yale_Univ( ) Appendix The Goldman Sachs Commodity Index Excess Return (GSCIER) is identical to the GSICTR except that it excludes the implied T-Bill rate on the notional value of the futures contracts. The Goldman Sachs Commodity Index Excess Return + TIPS (GSCIER + TIPS) equals the return of the GSCIER plus the return of the Lehman Brothers U.S. TIPS Index. Lehman Brother Indices are published by Barclays Capital as of November 1, The Lehman Brothers U.S. TIPS Index is an unmanaged market index comprised of all U.S. Treasury Inflation Protected Securities rated investment grade (Baa3 or better), have at least one year to final maturity, and at least $250 million par amount outstanding. Performance data for this index prior to 10/97 represents returns of the Lehman Inflation Notes Index. The Lehman Brothers Aggregate Bond 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. The Lehman Brothers U.S. TIPS Index is an unmanaged market index comprised of all U.S. Treasury Inflation Protected Securities rated investment grade (Baa3 or better), have at least one year to final maturity, and at least $250 million par amount outstanding. Performance data for this index prior to 10/97 represents returns of the Lehman Inflation Notes Index. The Standard & Poors 500 Stock Price Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on the Large-Cap segment of the U.S. equities market. The GSCI is a composite index of commodity sector returns, representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The Barclays Global Inflation-Linked Bond Index measures the performance of the major government inflation-linked bond markets. The index is designed to include only those markets in which a global government linker fund is likely to invest and includes Government domestic debt only, i.e., debt issued by a government in the domestic currency of that country. Bonds in the index must have a minimum remaining life of one year on the rebalancing date. It is not possible to invest directly in an unmanaged index.