Pacific Investment Management Company LLC’s (PIMCO's) Short-Term strategy is designed for investors who seek to improve on the return potential provided by a typical money-market vehicle for incremental risk. Emphasizing active management of high-quality, fixed income securities with an average interest rate sensitivity comparable to between a one to two-year U.S. Treasury note, PIMCO's Short-Term portfolios have historically achieved a high level of current income consistent with consistent with preservation of capital and daily liquidity. While PIMCO has always managed cash equivalent holdings, which we define as those securities having a duration, or weighted average maturity, of one year or less, we began managing dedicated Short-Term accounts in 1986. Of course, past performance is no guarantee of future results and unlike a mutual Fund, money market funds strive to maintain a steady net asset value.

This strategy is ideal for defined contribution, pension and operating cash, insurance reserves and other liquid asset pools.

The spectrum is not based on any statistical risk and reward data, but is instead a graphic depiction of the portfolios relative potential risk and reward compared to other PIMCO portfolios and does not represent the past or future performance of any product.

Short-Term Fixed Income: Philosophy and Process Relative to a money-market fund index, the excess return of PIMCO's Short-Term strategy has been derived from three main sources:

• Exploiting the term premium at the short end of the yield curve through duration management
• Extracting a yield premium for managing varying levels of transaction liquidity of the fixed income securities in the portfolio
• Actively managing duration, yield curve exposure and relative value allocations to short-duration mortgage, corporate and currency-hedged, non-dollar securities.

Adding Value Through Active Duration Management We believe that the most efficient duration management strategy involves a modest investment in maturities beyond three-months, but limiting volatility by maintaining an average portfolio duration of one year or less. Over 30 years of empirical evidence demonstrates that slightly extending duration will, over time, produce higher returns compared to money markets, without materially increasing the frequency of negative returns, in a normal positively sloped yield curve environment. The yield curve pictured below depicts the average yield relationship for U.S. Treasury securities over the last 15 years. Clearly, the majority of the yield can be captured in the 3-month to 5-year part of the curve.

By restricting the portfolio duration to one year or less, the price risk to increasing interest rates is significantly reduced. The higher yield obtained through duration extension and active management should more than offset any potential decline in the price of the fixed income portfolio due to rising interest rates. We will, occasionally, maintain a duration strategy similar to a more traditional money-market instrument when we expect a rise in interest rates and price declines that would eliminate the yield advantage of duration extension. In sum, for short-term strategies, a greater flexibility in duration management can enhance returns.

Liquidity Management: Extracting a Yield Premium
Liquidity management has been another important source of excess returns. Securities which are considered less likely to be readily bought and sold in a secondary market must provide their investors with a higher yield, or liquidity premium. By expanding the opportunity set of securities to include floating-rate securities, high coupon mortgage-backed securities, Collateralized Mortgage Obligations (CMOs), Adjustable Rate Mortgages (ARMs), derivatives and callable corporate securities, we gain the liquidity premium offered by these securities. PIMCO's analytical capabilities assist in the selection of these more complex securities.

Security Selection: Non-Traditional Money Market Securities
Another powerful tool for adding value in PIMCO's Short-Term portfolios has been managing the yield advantage normally present in corporate, mortgage and international securities relative to U.S. Treasuries. Effective use of these securities creates additional return with little incremental risk from spread widening given their modest duration. While the Short-Term strategy generally holds investment grade securities in the portfolio, we have selectively invested up to 10% of the portfolio in BB-rated securities for those clients who have granted PIMCO such authority.

While PIMCO mitigates basis risk by focusing on short-duration, high credit quality assets, the modest corporate risk in a Short-Term portfolio acts to diversify the additional duration, or interest rate risk. This is best demonstrated in a rising interest rate environment as a result of a strong economy, where the costs of extended duration due to higher interest rates can be offset by the benefit of corporate yield spreads narrowing. Thus, the use of short duration corporate securities offsets some of the exposure to rising interest rates and serves to diversify overall portfolio risk.

In recent years, there have been excellent opportunities to purchase short-duration foreign bonds, hedge the currency risk, and earn a yield premium over like maturity U.S. debt securities. Such foreign exposure, typically permitted by clients to the extent of approximately 5% of a Short-Term assignment, serves as a useful means of further diversifying the portfolio, particularly during periods when the short-end of the yield curve is inverted, or no longer positively sloped.

Overall, exploiting these modest areas of risk exposure add up to a variety of active management opportunities, which allows us to best demonstrate our security selection and proven analytical technology. In the process, PIMCO's Short-Term portfolios diversify risk across a compliment of bond market sectors without substantially increasing the variability of returns.

Summary
PIMCO's Short-Term strategy historically has been successful due to the multiple sources of performance; duration, liquidity and security selection. PIMCO employs the same investment philosophy for its Short-Term strategy as it does with its flagship, intermediate maturity Total Return portfolios. For over 10 years, PIMCO's Short-Term strategy has offered an enhanced money market product which has added value for our clients.