Total Return Bond

Investment Environment:
The fourth quarter saw interest rates continue to move higher with the 10-year treasury yield moving up just over 50 basis points (0.50%); higher rates and a steeper yield curve was the primary theme for treasuries in 2009. Spread sectors performed well amidst this rate back up as investor flows into diversified bond funds created a strong technical backdrop for everything but treasuries. Investment grade corporate bond spreads tightened by over 380 basis points and agency mortgage-backed bond spreads tightened by over 125 basis points. This massive spread contraction is what enabled the broader bond market indices to post respectable positive returns in 2009.

Actions Taken:
The constant in the portfolio has been our overweight to corporate bonds. Credit spreads have tightened dramatically in 2009 but remain wide relative to their long term averages. We continue to believe corporates provide the best relative value in the fixed income market.

We continue to underweight the finance sector, but are selectively adding higher quality banks (many formerly characterized as brokers) primarily through new issuance. We added positions in solid credits across a number of businesses without compromising our long term view that the industry remains challenged. We continue to be extremely cautious on the sector. Our industrial sector exposure remains largely unchanged.

In an effort to support the housing market, the Federal Reserve and Treasury purchased over $1 trillion of mortgagebacked securities (MBS) in 2009; this was the primary catalyst for the aforementioned spread tightening in MBS. Current valuations are exceptionally rich and the Fed/Treasury intervention is scheduled to end this March. Given this backdrop we’ve elected to underweight the MBS sector; our exposure is approximately 0.7 times the sector’s index weight.

Factors Affecting Performance:
The I Shares of the Fund lagged the Barclays Capital Aggregate Index (-0.18% vs. 0.20%) in the fourth quarter of 2009, but for the full year, the Fund outperformed 7.22% versus the Index at 5.93% (I Shares). I Share returns for longer term time periods have also produced significant value relative to the benchmark. For the past three years, returns were 7.09% versus 6.04% for the Index and five-year results were 5.43% versus 4.97%. We believe our ability to generate above benchmark returns with moderate volatility is a hallmark of our stability and sets us apart from our peers.

Overweighting corporate bonds produced the biggest benefit as a result of the precipitous decline in spreads over the past year. Combined with our underweight to Treasuries (which recorded their worst annual sector performance since the inception of the Barclays Treasury Index in 1973) and void in Agencies, our bottom-up approach to security selection and top-down view of the economy was used by our investment professionals to structure a highly diversified portfolio.

Strategy and Outlook:
Recent GDP figures point to a statistical recovery, but we are not certain that the economy has truly turned the corner. We do not anticipate the Fed will increase short term rates until late 2010 at the earliest. Nor do we believe that it will step back, in total, from the multitude of stimulus programs – few of which have focused exclusively on the consumer. The economy may have seen its worst but there remains much work to be done. While we would not expect the outsized returns received in 2009, we are confident fixed income markets will provide consistent returns in the future.

Bonds offer a relatively stable level of income, although bond prices will fluctuate providing the potential for principal gain or loss. Intermediate-term, higher quality bonds generally offer less risk than longer-term bonds and a lower rate of return. Mutual fund investing involves risk, including the possible loss of principal.

Mortgage-backed investments involve risk of loss due to prepayments and, like any bond, due to default. Because of the sensitivity of mortgage-related securities to changes in interest rates, the Fund’s performance may be more volatile than if it did not hold these securities.

Credit rating is a measure of the quality and safety of a bond, based on the issuer’s financial condition. More specifically, an evaluation from a rating service indicating the likelihood that a debt issuer will be able to meet scheduled interest and principal repayments. Typically, AAA is highest (best), and D is lowest (worst).

A basis point is equal to 0.01%.

The Barclays U.S. Aggregate Index is a widely recognized index of 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. An investor cannot invest directly in an index.

The views expressed by the Fund's managers are as of the quarter-end specified. This information is subject to change without notice as market conditions change, and is not intended to predict the performance of any individual security, market sector, or RidgeWorth Fund.

Past performance does not guarantee future results.