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Q3 | 2012Putnam high-yield and floating-rate funds Q&A

Corporate debt posted solid gains in Q3 amid improving investor sentiment

Portfolio management team


Paul Scanlon leads a team of veteran investors responsible for day-to-day management of the funds.

Key takeaways High-yield bonds and floating-rate debt continued their streak of solid gains in the third quarter. Given recent tightening, spreads in both markets are now approaching their historical norms. Defaults have remained well below their long-term average, and we have reason to believe that trend could continue.

Paul D. Scanlon, CFA (industry since 1986)

Norman P. Boucher (industry since 1985)

Supply and demand characteristics have been positive, with most new bond issuance used to refinance existing debt. How did the high-yield bond market perform in the third quarter? High-yield bonds posted solid returns in the third quarter. Investors had moved to the sidelines in April and May amid concerns about the strength of the U.S. economy and the sovereign debt situation in Europe. Investors regained some of their appetites for risk and reentered the market in the summer months, sending prices higher and driving spreads tighter. As a reminder, the spread in the highyield market refers to the yield advantage the sector offers over Treasuries. Defaults in the high-yield market have been relatively low. How confident are you that this trend can endure in whats been a sluggish economy? Historically, after a period of heightened defaults in the high-yield market, the default rate among the remaining companies in the high-yield universe has tended to remain relatively low for anywhere from five to ten years. Today, were only three years out from the most recent peak in defaults in 2009, which was more than 15%, so we have reason to believe this trend could continue for some time. Moreover, we are not seeing significant levels of issuance for mergers and acquisitions or for leveraged buyout activity. Today, as much as two thirds of new high-yield issuance is being used to refinance existing bank debt. And as a result

Robert L. Salvin (industry since 1986)

PUTNAM INVESTM ENTS| putnam.com

Q32012 | Corporate debt posted solid gains in Q3 amid improving investor sentiment

of that trend, about 25% of the high-yield market is now secured as that bank debt collateral has been transferred to the new bonds. In addition, because economic growth has been so slow, many high-yield issuers have been very conservative with their use of capital, adding to their cash reserves, for example, instead of investing in new infrastructure or seeking to expand their businesses through acquisitions. This behavior has been favorable for bond investors, who have benefited from improving corporate balance sheets and stable revenues. How attractive does high yield appear today relative to the equity markets? Historically, high-yield bonds have offered a return potential that has approached that of equities with about half the volatility over the long term, and that can be a fairly attractive combination for investors. We believe that high-yield bonds today may be particularly attractive given the slow-growth environment that weve been experiencing. In an uncertain environment, corporations may be a little more conservative with their plans to expand, they may keep a little more cash on their balance sheets, and they may be a little more cautious with their use of leverage. Those kinds of decisions generally are supportive of fundamentals in the high-yield debt market, and thats essentially the environment were in today. Moreover, with todays exceptionally low interest rates, many investors are wary of gearing their portfolios toward a continued decline in rates. High yield is a segment of the capital markets that can benefit from an improving economy but may not be as reliant on faster growth as equities tend to be. At the same time, high-yield bonds arent reliant on declining interest rates to drive returns.

With short-term interest rates as low as theyve been, how strong has demand been in the floating-rate market? Weve seen relatively strong demand for floating-rate debt throughout 2012, which has helped create price stability. Individual investors often have used floatingrate-loan funds as a hedge against rising short-term rates. But with the Federal Reserve recently announcing that short-term rates will be locked essentially at zero until 2015, thats clearly a less compelling reason to own the asset class. More compelling is the protection floatingrate loans can offer from volatility on the long end of the yield curve. With the Federal Reserve in the United States recently launching a third round of quantitative easing, known as QE3, and Europe kicking off its own open-ended bond buying program, theres reason to believe that economic growth and inflation could both tick up, which would likely result in higher long-term rates. Floating-rate notes would be less affected than other segments of the bond markets. How much does active management matter in the kind of risk-on/risk-off environment weve been experiencing? Active management allows us to position the funds to take advantage of disparities in relative value among sectors and securities. We acknowledge that market volatility may be with us for some time, and for that reason weve been seeking to construct portfolios that have overall risk profiles that track the funds benchmarks. What is your outlook for the remainder of 2012 and into 2013? We continue to believe that high-yield corporate bonds remain attractive. Our base case calls for a slow growth recovery in the United States and, barring a significant reversal in the growth picture, that environment would be conducive to continued solid performance in the corporate debt markets. Spreads ended the quarter tighter, and are closer to their long-term average, while defaults remain low and stable. All in all, we believe high-yield and floating-rate bonds remain attractive options for investors in a low-rate world.

PUTNAM INVESTM ENTS| putnam.com

Q32012 | Corporate debt posted solid gains in Q3 amid improving investor sentiment

Putnam High Yield Trust (PHIGX)


Annualized total return performance as of September 30, 2012 Before sales charge
4.63% 19.16 11.42 7.57 9.69 8.85

Quarterly returns are cumulative.


JPMorgan Developed High Yield Index
4.56% 19.31 13.50 9.60 10.89

Class A shares (inception 2/14/78)


Last quarter 1 year 3 years 5 years 10 years Life of fund Total expense ratio: 1.00%

After sales charge


0.40% 14.45 9.92 6.70 9.25 8.72

Putnam High Yield Advantage Fund (PHYIX)


Annualized total return performance as of September 30, 2012 Before sales charge
4.29% 18.56 11.35 7.78 10.12 7.82

Class A shares (inception 3/25/86)


Last quarter 1 year 3 years 5 years 10 years Life of fund Total expense ratio: 1.04%

After sales charge


0.07% 13.81 9.84 6.90 9.67 7.66

JPMorgan Developed High Yield Index


4.56% 19.31 13.50 9.60 10.89

Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results. Share price, principal value, and return will vary, and you may have a gain or a loss when you sell your shares. Performance of class A shares assumes reinvestment of distributions and does not account for taxes. After-sales-charge returns reflect a maximum 4.00% load (1.00% for PFLRX). For a portion of the periods, these funds had expense limitations, without which returns would have been lower. A short-term trading fee of 1% may apply to redemptions or exchanges from certain funds within the time period specified in each funds prospectus. The funds expense ratios are based on the most recent prospectus and are subject to change. To obtain the most recent month-end performance, visit putnam.com. The JPMorgan Developed High Yield Index is an unmanaged index of high-yield fixed-income securities issued in developed countries. The Barclays U.S. High Yield Loan Index provides broad and comprehensive total return metrics of the universe of syndicated term loans. To be included in the index, a bank loan must be dollar denominated and have at least $150 million in funded loans, a minimum term of one year, and a minimum initial spread of LIBOR+125. You cannot invest directly in an index.

Putnam Floating Rate Income Fund (PFLRX)


Annualized total return performance as of September 30, 2012 Before sales charge
2.94% 11.49 6.89 3.38 3.70

Class A shares (inception 8/4/04)


Last quarter 1 year 3 years 5 years Life of fund Total expense ratio: 1.03%

After sales charge


1.87% 10.42 6.52 3.18 3.57

Barclays U.S. High Yield Loan Index*


3.57% 12.03 7.70 5.46

1Inception date of the index is 1/1/06.

PUTNAM INVESTM ENTS| putnam.com

Q32012 | Corporate debt posted solid gains in Q3 amid improving investor sentiment

The views and opinions expressed are those of the portfolio managers as of September 30, 2012, are subject to change with market conditions, and are not meant as investment advice. Consider these risks before investing: Lower-rated bonds may offer higher yields in return for more risk. The use of derivatives involves additional risks, such as the potential inability to terminate or sell derivatives positions and the potential failure of the other party to the instrument to meet its obligations. Bond investments are subject to interest-rate risk, which means the prices of the funds bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interestrate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. The prices of bonds may fall or fail to rise over extended periods of time for a variety of reasons, including both general financial market conditions and factors related to a specific issuer or industry. The following also applies to Putnam Floating Rate Income Fund: To the extent the fund holds floating-rate loans, interest-rate risk may be reduced but will not be eliminated. While floating-rate loans are normally secured by specific collateral or assets of the issuer (so that holders of the loan, such as the fund, will have a priority claim on those assets in the event of default or bankruptcy of the issuer), the value of collateral may be insufficient to meet the issuers obligations, and the funds access to collateral may be limited by bankruptcy or other insolvency laws. Request a prospectus or summary prospectus from your financial representative or by calling 1-800-225-1581. The prospectus includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing.
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