The Asset Allocation Advisor - October 2015

•Eric J. Weigel, Managing DirectorOctober 2015

► Research Goals and Motivation

► Review of Asset Class Performance

► Assessing Current Investor Sentiment

► Our Asset Class Views – Return Potential and Risks

► Multi-Asset Class Portfolio Implications

► Summary Recommendations

► Key Issues Facing Investors over the next Year

Outline

Help Investors with their asset allocation decisions by providing a research-based perspective on

prospective asset class returns and risks as well as thoroughly examining the associated portfolio

positioning implications

► Focus on broad asset classes and multi-asset class portfolios

► Assess the dynamic nature of capital market behavior and investor risk aversion

► Provide a breakdown of the risk profile of multi-asset portfolios as well as their key macro-economic exposures

► Evaluate the long-term return and wealth creation distribution of multi-asset class portfolios

Research Goals and Motivation

3

► Slowing global economic growth

► US remains robust, China is slowing and EM is flat-lining (but with significant across country variation)

► No inflation in sight (except if you are paying college tuition or medical bills)

► Greatest fear by policymakers is actually deflation

► Commodity bust and global labor excess supply dampen future price rises (good for corporate margins)

► Loose but divergent monetary policy with the Fed threating to tighten and the BOJ, ECB and Bank of China providing further stimulus

► Currency market turmoil created by a rapidly strengthening USD and sinking EM currencies

► The floating of the renminbi (within bands) took the market by surprise

► The strength of the USD is exacerbating trade imbalances (hot political topic for 2016)

► Commodity bust causing serious fiscal problems in many emerging markets and tarnishing the emerging market growth story

► Political tension - Iran nuclear deal, Russia involvement in Libya, migrant issue in Europe, US elections in 2016, Stimulus versus Austerity

► Investor apathy to risk replaced by hyper sensitivity during the last few months as investors become concerned about asset bubbles

Macro-Economic Backdrop

4

Major Asset Class Performance

► After several years of above-average returns, major asset classes remain under duress in 2015

► No asset class has remained unscathed YTD with emerging market equities and commodities taking the biggest hits

► US bonds have not helped much as rates keep fluctuating without clear direction and YTD returns are barely positive

► Currency losses have exacerbated the poor performance of international assets

-20

-16

-12

-8

-4

0

4

US LCAP US SCAP INTL EQ EM EQ COMM RE US BD INTL BD EM BD CASH

Asset Class Perfor mance

1 MONTH YTD

-24

-18

-12

-6

0

6

12

18

24

30

36

42


Asset Class Perfor mance

2014 2013 2012

► The numbers don’t lie – its been ugly this year but long term investors have enjoyed some pretty generous capital market returns post-Financial crisis

► 2015 is feeling very much like 2011 in terms of investor sentiment which we expect to revert back to more normal levels in the next few months

► The root causes for the global equity downdraft this year relate more to slowing growth, higher starting valuations which lower investor’s margin of error, and fear of living in a world without the paternalistic oversight of the US Federal Reserve

► The rise of the US dollar in conjunction with the commodity bust have created additional uncertainty which has destabilized global capital markets in the short term

Asset Class Performance Summary

6

Global Focus Capital US LCAP US SCAP INTL EQ EM EQ COMM RE US BD INTL BD EM BD CASH

RETURN 1 WK 1.10 -0.69 0.69 1.93 -0.68 1.53 0.68 1.61 0.05 0.01

RETURN 1 MO -2.47 -4.91 -5.04 -2.97 -3.42 3.03 0.68 0.98 -0.86 0.04

RETURN YTD -5.29 -7.73 -4.91 -15.22 -15.80 -4.26 1.13 -3.32 0.10 0.10

RETURN 2014 13.69 4.89 -4.48 -1.82 -17.01 30.38 5.97 -2.97 7.12 0.06

RETURN 2013 32.39 38.82 23.29 -2.27 -9.52 2.47 -2.02 -5.57 -6.34 0.10

RETURN 2012 16.00 16.35 17.90 18.63 -1.06 17.77 4.21 0.46 18.32 0.12

RETURN 2011 2.11 -4.18 -11.73 -18.17 -13.32 8.69 7.84 5.98 8.80 0.15

RETURN 2010 15.06 26.85 8.21 19.20 16.83 28.48 6.54 7.02 12.12 0.22

CURRENT VOLATILITY 11.60 13.82 12.08 14.60 10.39 13.34 3.17 6.91 4.72 0.03

RELATIVE STRENGTH 49.20 41.22 44.31 49.74 46.60 55.78 60.44 64.04 44.48 76.95

TECHNICAL STAGE

DOWN

TREND

DOWN

TREND

DOWN

TREND

DOWN

TREND

DOWN

TREND IMPROVING IMPROVING BREAK OUT

DOWN

TREND BREAK OUT

INCOME (YIELD) 2.11 1.50 3.30 2.80 0.00 0.04 2.31 0.77 5.86 0.04

LONG-TERM RETURN 7.00% 8.00% 8.00% 8.00% 2.00% 6.00% 4.00% 3.50% 6.50% 1.50%

LONG-TERM VOLATILITY 16.00% 19.00% 17.00% 20.00% 18.00% 14.00% 6.00% 7.00% 9.00% 0.50%

Equity Performance – Region and Sector

Influences

7

► Regional/country and sector performance are key dimensions of equity market behavior

► Emerging markets and commodity sensitive sectors have taken the biggest hit YTD

► Growth sectors such as health care and tech have weathered the storm better

► Emerging and Developed Europe have held up relatively well despite the perception of high risk

► Low valuations are supportive

► Expectations for growth were low to begin with

-24

-20

-16

-12

-8

-4

0

4

8

CD CS EN FN HC IN IT MA TS UT

S&P 500 Sector Perfor mance

1 MONTH YTD

-32

-30

-28

-26

-24

-22

-20

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

NA EU ASIA EM EM LA EM EU EM ASIA WORLD

Global Region Perfor mance

1 MONTH YTD

-28

-24

-20

-16

-12

-8

-4

0

4

8

12

Global Sector Perfor mance

1 MONTH YTD

Fixed Income Performance

8

► Higher quality, shorter maturity bonds outperformed last month as well providing superior returns YTD

► With no clear sign of re-emerging inflation TIPS globally have offered disappointing returns

► As expected the worst fixed income sector has been YTD high yield

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

CREDIT GOV MBS HYLD TIPS MUNI

US Fixed Income Perfor mance

1 MONTH YTD

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

GLOBAL G1-3 G3-5 G5-7 G7-10 G10+ CREDIT GOV

Global Fixed Income Perfor mance

1 MONTH YTD

-13

-12

-11

-10

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

GLOBAL CA EU FR GE SW UK US

Global TIPS Perfor mance

1 MONTH YTD

Alternative Asset Class Performance

9

► While Reits in Germany have been standout performers this year, the rest of the liquid real estate market has suffered along with risky assets

► The commodity bust continues unabated with no relief in sight even for more risk-sensitive sectors such as gold and silver

► The US dollar and the Swiss Franc have been the standout winners this year. Resource sensitive currencies have experienced the largest depreciation

► EM currencies have in a significant down trend despite interest rate hikes in several of the key markets -24

-20

-16

-12

-8

-4

0

4

8

12

16

20

24

28

AU CA FR GE HK JP LATAM UK US WORLD

Global Real Estate Perfor mance

1 MONTH YTD

-24

-22

-20

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

BROAD AG ENE X-ENE GRAINS IND MET LIVE OIL PREC

MET

Commodity Perfor mance

1 MONTH YTD

-20

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

Cur rency (USD) Perfor mance

1 MONTH YTD

Asset Class Volatility

10

► While market participants lament the recent spike in volatility, all asset classes except for real estate and international bonds currently exhibit lower than normal levels of volatility

► Capital market volatility has been suppressed by expansionary monetary policies around the globe, but the low levels of volatility are, in our opinion, transitory and likely to revert as policy rates are gradually hiked

► Investors have become overly sensitized to short-term capital market volatility and risk as a concept has been significantly under-prized in the last few years

► Investors will need to extend their time horizons and accept more normalized levels of asset class volatility over the next decade

► A greater focus on proper portfolio “balance” (risk/return tradeoffs over short, intermediate and long-term horizons) will necessitate a complete asset allocation perspective and less of an emphasis on return expectations exclusively

0%

5%

10%

15%

20%

25%

30%


Asset Class Volatility

Current Normalized

Key Asset Class Correlations

11

► The biggest problem faced currently by investors is the lack of adequate diversification opportunities

► At the moment only high quality bonds offer significant diversification potential to equity investors

► Real estate has recently become more correlated with interest rates offering potential diversification relief to equity holders

► The role of fixed income in a multi-asset class portfolio has shifted almost entirely to volatility reduction as opposed to income generation

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0


Asset Class Cor relation to US Stocks

Current Normalized

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1


Asset Class Cor relation to US Bonds

Current Normalized

► Our investor risk aversion is currently firmly in the Extreme Aversion (Fear) Zone

► Investors remain petrified but, in our view, the fundamental picture does not merit such levels of fear and we would expect to revert back to our Normal Zone in the fourth quarter

► Valuations are above average for all major asset classes, but growth remains positive and monetary stimulus and a lack of inflation are likely to keep the cost of money low

► While the debacle in commodity prices is clearly detrimental to exporting nations (many in emerging markets) global economic activity in the developed world should benefit from this form of cost reduction

Investor Risk Aversion

12

► Investor risk aversion readings show a form of complacency in late

2014 with a slight re-awakening to potential capital market risks thus

far in 2015

► The implicit “put” option engineered by central banks around the

world may not be as firm of a commitment as once believed

► As the US Federal Reserve starts moving away from “rescue” mode to

operating procedures more in line with its mandate of price stability,

maximum employment and moderate long-term rates investors will

need to accept more normal (and higher) rates of capital market

volatility

► Offsetting the actions of the Fed are the ECB, BOJ and the People’s

Bank of China who remain in “rescue” mode thus providing excess

global liquidity

► We believe that while capital liquidity will remain abundant, the

implicit “put” story has lost credibility and investors are no longer

betting on the ability of central banks to protect capital markets

Investor Risk Aversion

13

Asset Class Views

Potential Returns and Risks

14

► Multi-Asset Class Models covering 10 asset classes

► Equities (US Large Caps, US Small Caps, Developed International,

Emerging Markets)

► Fixed Income (US Bonds, Developed Market Bonds, Emerging Market

Bonds)

► Alternatives (US Real Estate, Commodities)

► Cash

► Intermediate (6-12 month out) expected returns driven by Valuation,

Income Generation and Investor Sentiment/Momentum factors

► Long-term (10 years out) expected returns given as a function of

assumed asset class Income Potential, Growth and Valuation

changes

Asset Allocation Methodology – Assessing

Return Potential

Asset Allocation Model Current Breakdown

by Conceptual Category

16

-1.8

-1.5

-1.2

-0.9

-0.6

-0.3

0.0

0.3

0.6

0.9

1.2

1.5

1.8

CURRENT PROFILE - VALUATION

-1.8

-1.5

-1.2

-0.9

-0.6

-0.3

0.0

0.3

0.6

0.9

1.2

1.5

1.8

CURRENT PROFILE - INCOME

-1.8

-1.5

-1.2

-0.9

-0.6

-0.3

0.0

0.3

0.6

0.9

1.2

1.5

CURRENT PROFILE - ST REVERSAL

-1.8

-1.5

-1.2

-0.9

-0.6

-0.3

0.0

0.3

0.6

0.9

1.2

1.5

1.8

CURRENT PROFILE - RISK ADJUSTED MOMENTUM

Higher factor readings correspond to higher return potential

► Our intermediate term multi-asset class model currently favors riskier assets such as equities over short-term safer assets such as bonds

► Within equities the model rates US small cap and Developed Markets best in terms of return potential

► Within fixed income, the lack of any significant income potential for Developed Market bonds detracts from their return potential

► Emerging Market Debt (sovereign debt denominated in USD) has enough of a yield advantage to enjoy favorable return prospects despite clear macro-economic headwinds

Forward Looking Return Model Summary

17

-1.5

-1.2

-0.9

-0.6

-0.3

0.0

0.3

0.6

0.9

1.2

1.5

CURRENT PROFILE - MODEL ALPHA

► Our Multi-Asset Class Volatility and Correlation Models covering 10

asset classes complement our expected return models

► The intermediate-term expected volatility and correlation structure of

asset class returns is modelled as a function of the current reading of

our proprietary Risk Aversion Index and the likely near-term change in

investor sentiment

► Additional risk perspectives are gained by estimating the exposure of

asset classes to a variety of macro-economic factors

► Conceptually, our macro-economic factors correspond to growth, cost of

money, economic and financial distress, and inflation

► The long-term (10 years out) expected volatility and correlation

structure assumes a reversion to long-term historical norms

Asset Allocation Methodology – Assessing

Potential Risks

► We estimate the volatility and correlation structure of key asset classes using a combination of methods weighting alternative capital market risk scenarios and macro-economic risk factors

► We use our Risk Aversion Index to identify three distinct zones – Extreme Risk Aversion (Fear), Normal and Extreme Apathy (Greed)

► Each risk zone has very distinct volatility and correlation implications

► Based on the current risk zone classification we assign different weights to each risk zone scenario

► We are currently in the Extreme Risk Aversion Zone associated with higher risky asset volatilities and higher within-asset class correlations

Classifying Asset Class Risk by Investor Risk

Aversion Zone

19

VOL (ANN) 23.1% 28.3% 24.3% 28.7% 20.1% 33.8% 4.0% 9.2% 11.5% 0.4%


US LCAP 1 0.91 0.81 0.69 0.35 0.68 -0.21 -0.14 0.40 -0.17

US SCAP 0.91 1 0.76 0.70 0.36 0.75 -0.22 -0.11 0.41 -0.15

INTL EQ 0.81 0.76 1 0.84 0.50 0.57 -0.06 0.13 0.50 -0.15

EM EQ 0.69 0.70 0.84 1 0.52 0.54 -0.07 0.03 0.61 -0.12

COMM 0.35 0.36 0.50 0.52 1 0.27 -0.06 0.17 0.34 -0.04

RE 0.68 0.75 0.57 0.54 0.27 1 -0.08 -0.04 0.40 -0.03

US BD -0.21 -0.22 -0.06 -0.07 -0.06 -0.08 1 0.51 0.21 0.17

INTL BD -0.14 -0.11 0.13 0.03 0.17 -0.04 0.51 1 0.10 0.13

EM BD 0.40 0.41 0.50 0.61 0.34 0.40 0.21 0.10 1 -0.02

CASH -0.17 -0.15 -0.15 -0.12 -0.04 -0.03 0.17 0.13 -0.02 1

Current Short-Term Volatility and Correlation Forecasts

Macro-Economic Risk Exposures – Major

Asset Class Factors

20

► Equities exhibit minimal sensitivity to the global bond market

► Correspondingly, the beta of fixed income to the global equity factor is close to zero

► Commodities and International Debt exhibit the highest exposure to the FX (USD) factor

► All equity categories exhibit betas to the equity factor close to zero highlighting very similar behavior

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

USLCAP

US SCAP INTLEQ

EM EQ COMM RE US BD INTLBD

EM BD CASH

Beta to Equity Market Factor

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to Bond Market Factor

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to USD FX Factor

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to USD FX Factor

Macro-Economic Risk Exposures – Growth

Factors

21

► Equity asset classes are significantly positively exposed to “growth” factors

► Commodities, in particular, have high betas to our growth factors

► Our estimates indicate that higher inflationary expectations would be beneficial to all asset classes except high quality bonds-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to Term Spread Factor

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to Industrial Metals

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to Inf lationary Expectations

Macro-Economic Risk Exposures –

Uncertainty Factors

22

► The beta of equity-like

assets to “uncertainty”

factors is large and

negative

► Clearly fixed income acts

as a distress

counterbalance to equities

-0.2

-0.2

-0.1

-0.1

0.0

0.1

0.1

0.2

0.2

0.3

0.3

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to Precious Metals

-1.6

-1.4

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to US Default Factor

-0.8

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

USLCAP

US SCAP INTLEQ


EM BD CASH

Beta to TED Spread

► Based on conceptual building blocks of income potential, growth and valuation changes -10 year time horizon

► Current expected returns are below historical averages for all asset classes

► Primarily a function of starting point valuations

► The volatility of individual asset classes is expected to revert back to historical norms

► Within-asset class correlations are expected to remain close to historical averages

► The greatest diversification potential will continue to be between equity and long-maturity government debt

Long-Term Expected Returns, Volatility and

Correlations

23

GF Capital SP500 R2000 EAFE EME COM RE US BD INTL BD EM BD CASH

SP500 1 0.9 0.95 0.85 0.2 0.6 0.2 0.2 0.3 0.01

R2000 0.9 1 0.8 0.8 0.2 0.6 0.2 0.1 0.3 0.01

EAFE 0.95 0.8 1 0.85 0.3 0.4 0.2 0.3 0.3 0.01

EME 0.85 0.8 0.85 1 0.5 0.4 0.2 0.3 0.6 0.01

COM 0.2 0.2 0.3 0.5 1 0.2 0.1 0.1 0.3 0.01

RE 0.6 0.6 0.4 0.4 0.2 1 0.2 0.2 0.4 0.01

US BD 0.2 0.2 0.2 0.2 0.1 0.2 1 0.6 0.2 0.01

INTL BD 0.2 0.1 0.3 0.3 0.1 0.2 0.6 1 0.2 0.01

EM BD 0.3 0.3 0.3 0.6 0.3 0.4 0.2 0.2 1 0.01

CASH 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 1

GF Capital SP500 R2000 EAFE EME COM RE US BD INTL BD EM BD CASH

LT EXPT RETURNS 7.00% 8.00% 8.00% 8.00% 2.00% 6.00% 4.00% 3.50% 6.50% 1.50%

LT EXPT VOLAT 16.00% 19.00% 17.00% 20.00% 18.00% 14.00% 6.00% 7.00% 9.00% 0.50%

The Historical Value Add of our Active Asset

Allocation Methodology

24

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

SUMMARY STATS2002-2015

ACTIVE RETURN TRACKING ERROR VOLATILITY

0

50

100

150

200

250

300

350

20011

2

200206

200212

200306

200312

200406

200412

200506

200512

200606

200612

200706

200712

200806

200812

200906

200912

2010

06

2010

12

2011

06

2011

12

2012

06

2012

12

2013

06

2013

12

2014

06

2014

12

2015

06

WEALTH CREATION

BENCHMARK

PORTFOLIO

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

CALENDAR YEAR PERFORMANCE

BENCHMARK PORTFOLIO

Benchmark is 60% S&P500, 40% Barclays Aggregate

Note: Gross Returns

Portfolio Positioning

Implications

► Three Multi-Asset Strategies with distinct risk/return tradeoffs

► Traditional 60/40 (S&P 500 / Barclays Aggregate)

► One All Global Equity Strategy

► One All Global Fixed Income Strategy

Menu of Constant Mix Asset Allocation

Strategies

26

SP50040%

R200015%

EAFE30%

EME15%

All Equity Portfolio

SP500 R2000 EAFE EME COM

RE US BD INTL BD EM BD CASH

US BD65%

INTL BD20%

EM BD10%

CASH5%

All Fixed Income Portfolio



All Strategies are

rebalanced monthly to a

pre-determined mix of asset

class weights

Constant Mix Allocation Strategies

27

SP50030%

R200015%

EAFE20%

EME10%

COM5%

RE5%

US BD10%INTL BD

2%

EM BD3%

Portfolio 1



SP50025%

R200012%

EAFE15%

EME8%

COM3%

RE7%

US BD18%

INTL BD7%

EM BD5%

Portfolio 2



SP50022%

R20005%

EAFE10%EME

3%

COM2%

RE8%

US BD25%

INTL BD10%

EM BD10%

CASH

Portfolio 3



SP50060%

US BD40%

60/40 Portfolio



All Strategies are

rebalanced monthly to a

pre-determined mix of

asset class weights

Our Constant Mix Portfolios on the Efficient

Frontier

28

Expected Return

Expected

Risk

All Fixed

Income

Portfolio

All Equities

Portfolio

Portfolio 3

Portfolio 2

60/40

Portfolio

Portfolio 1

The Constant Mix Strategies – Current

Performance Summary

29

Global Focus Capital PORT 1 PORT 2 PORT 3 60/40

ALL

EQUITY

ALL FIXED

INC

LAST MONTH 0.92% 1.11% 1.23% 1.31% 0.81% 0.71%

LAST 3 MONTHS -6.86% -5.02% -2.66% -2.56% -8.60% 1.83%

LAST 12 MONTHS -3.32% -2.26% -1.02% 0.85% -3.81% 0.25%

YEAR TO DATE -5.51% -4.58% -3.01% -1.95% -6.02% -0.13%

RETURN 2014 6.03% 6.72% 7.22% 11.83% 5.78% 3.74%

RETURN 2013 18.89% 14.45% 9.16% 18.36% 25.62% -3.21%

RETURN 2012 13.75% 12.45% 10.57% 10.30% 16.09% 4.71%

RETURN 2011 -2.90% -0.22% 3.01% 5.07% -6.02% 7.24%

RETURN 2010 15.90% 15.03% 12.71% 12.03% 15.50% 6.94%

INCOME - CURRENT 2.22% 2.19% 2.20% 2.19% 2.48% 2.24%

VOLATILITY - CURRENT 8.89% 7.33% 5.38% 6.72% 11.16% 3.26%

VOL - 3 MO AGO 8.07% 6.74% 5.11% 6.12% 10.09% 3.42%

VOL - 12 MO AGO 8.39% 7.09% 5.43% 6.07% 10.24% 3.39%

EXPOSURES (BETAS)

GLOBAL EQUITY 0.79 0.64 0.44 0.57 1.00 -0.04

GLOBAL BOND -0.06 0.11 0.25 -0.12 -0.27 0.64

DEFAULT SPREAD US -0.74 -0.59 -0.40 -0.53 -0.90 0.05

TED SPREAD -0.45 -0.37 -0.27 -0.31 -0.52 -0.04

PRECIOUS METALS -0.02 0.01 0.04 -0.05 -0.07 0.10

INDUSTRIAL METALS 0.22 0.17 0.12 0.12 0.27 -0.01

TERM HORIZON SPREAD 0.32 0.31 0.31 0.33 0.28 0.20

INFLATIONARY 0.46 0.38 0.29 0.41 0.55 0.03

USD FX 0.05 0.14 0.21 -0.11 -0.07 0.43

60/40 PORTFOLIO 1.25 1.03 0.73 1.00 1.56 -0.03

LONG-TERM RETURN 6.77% 6.32% 5.58% 5.80% 7.60% 4.03%

LONG-TERM VOLATILITY 13.41% 11.31% 8.45% 10.35% 16.57% 5.14%

► All constant mix strategies currently reside in negative territory for 2015

► Greater exposure to equities this year has hurt performance but equity heavy strategies have had above-average performance since the end of the Financial crisis

► The volatility of all strategies is currently below our ten-year forward expectations, but we would expect overall capital market volatility to revert back to higher levels as the paternalistic hand of the Fed is withdrawn

► More equity oriented portfolios (1 and 2) exhibit a clear growth bias and aversion to further market and economic uncertainty

► The income potential of the All Fixed Income Strategy lags that of some of our more equity heavy multi-asset class portfolios

► International Equity offers attractive yield opportunities at the moment

The Constant Mix Strategies – Further Risk &

Return Thoughts

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► These estimates are a function of our 10 year-ahead fundamentally-based asset class projections

► Returns for all portfolios are expected to fall short of historical norms

► Starting valuations will be a long-term drag on performance

► The low rates of yield on fixed income are a huge headwind for risk averse multi-asset class investors

► Investors will need to get out of their comfort zone and extend holding periods in order to achieve target returns in the 6-8% range

► The current low volatility environment is not expected to last with asset class volatility reverting back to more normalized conditions

Long-Term Risk and Return Expectations for

the Constant Mix Asset Allocation Strategies

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3%

5%

7%

9%

11%

13%

15%

17%

19%

PORT 1 PORT 2 PORT 3 60/40 ALLEQUITIES

ALL BONDS

Portfolio Expected Volatility - Long Term Projections

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

PORT 1 PORT 2 PORT 3 60/40 ALLEQUITIES

ALL BONDS

Portfolio Expected Returns - Long Term Projections

► The traditional 60/40 portfolio is inherently a lot riskier than previously presumed with all of its volatility emanating from its equity exposure

► Given the current slight negative correlation between stocks and bonds, adding fixed income significantly lowers overall portfolio volatility

► The 60/40 portfolio is positively exposed to the equity market and growth expectations (inflation and the business cycle) and negatively influenced by factors generally associated with distress

► The long-term return to the 60/40 portfolio is expected to lie south of 6% with a yearly volatility of about 10%

The 60/40 Portfolio – Still the Standard Bearer

32

Return and Wealth Patterns of the 60/40

Portfolio

33

► The expected distribution of annualized compounded strategy returns implies a fairly wide range of potential returns over the short holding periods

► In year 1 we would, for example, expect returns to lie between 24 and -10% given the assumed 10% volatility of the strategy

► Over longer holding periods the expectation would be for compound returns to average out within the range of potential outcomes shown in the chart

► Assuming returns in the lower 5th percentile the cumulative wealth generated by this strategy over 10 years would fall between $1.01 and $2.78 (with a $1investment)

Equivalent charts for our other multi-asset class strategies are available upon

request

Asset Class Risk Contributions of the

Constant Mix Strategies

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► For all of these strategies the proportion of total portfolio risk originating from equity exposures is significant.

► As the allocation to bonds increases (from Port 1 to 3) the contribution to risk from equities diminishes to some extent

► From a total risk perspective and given the high correlations among asset classes it is likely that most multi-asset portfolios will remain heavily exposed to equities

Asset Class Risk Contributions of the

Constant Mix Strategies

35

► The 60/40 portfolio risk profile is emanating exclusively from its equity exposure. In fact, bond exposure reduces portfolio volatility

► While within-asset class correlations are high, there is a diversification benefit from spreading allocations to “similar” investments

► Despite the recent spike in capital market volatility our research still favors holding riskier assets such as equities and real estate

► Investors have grown too accustomed to low levels of volatility which are unsustainable and likely to revert back to more normal levels

► The greatest concern to equity holders should be slowing growth

► While valuations are on the expensive side we do not see valuations being the catalyst for a market correction

► In the short-term fixed income investments provide less downside, but tilting toward safer assets is unlikely to provide enough comfort to offset the lack of sufficient long-term return potential

► As long as the cost of money is low, riskier assets are expected to offer more compelling benefits over intermediate and especially longer-term time horizons

► Within equities we prefer developed markets in large part due to lower commodity exposure and diminished currency risk

► The competitive benefits of currency devaluation will not be felt immediately and many commodities remain in net excess supply

► In the US we prefer large caps over small caps due to lower valuations, higher levels of firm profitability and the most important reason lower volatility

► Among fixed income investments, we prefer (with some trepidation) emerging market debt (priced in USD) over high quality US and developed market fixed income alternatives

► Removing the currency risk from the equation leaves us with a bet on the credit worthiness of emerging market issuers which we believe is worth taking

Global Focus Capital Summary Views

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► Will the USD keep appreciating at this rate?

► NO and non-USD denominated investments will receive some relief along with commodities

► Will bonds continue to be superior diversifiers to equity risk?

► YES, but the effect will diminish as the US yield curve starts normalizing

► Will global earnings keep growing?

► YES, but slowly and various regions will be impacted differently. A strong USD will dampen the growth of many US domiciled export-driven companies. Corporate margins will likely drift lower but we do not see an implosion given the low cost of money, excess labor and cratering commodity markets

► Is the commodity rout finally over?

► NO. Markets are still saturated with excess supply and slowing global growth is making matters worse. Excess supply conditions are expected to remain in force for the foreseeable future

► Will we continue to see risk on/off markets?

► YES. In fact the biggest surprise over the last few years has been the almost uninterrupted low level of volatility until August of this year. But investors should view periods of market stress as attractive tactical rebalancing opportunities but must be willing to also trim winners as investors as a whole become too complacent about risk

► Will the Federal Reserve raise rates in 2015?

► NO, but they will do next year. But, whatever negative effects are seen initially will soon dissipate as global liquidity remains abundant.

► Investors obsessed with Fed actions are focused on the wrong metric – raising rates is an admission that the global economy is better able to handle the inevitable random shocks to growth and should be interpreted as a vote of confidence for growth-oriented assets

Key Questions Facing Global Capital Market

Investors

37

For further information on our research

subscriptions or asset management products

please contact us at:

[email protected]

Phone 617-529-2913

or visit our website at http:\\gf-cap.com

38

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The Asset Allocation Advisor - October 2015

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