DeMarche Associates, Inc. Tactical Asset Allocation in Bull/Bear Markets Timothy J. Marchesi, CFA President, CEO & Co-CIO DeMarche Associates, Inc.

2 Agenda Importance of Asset Allocation Tactical vs. Conventional Approach Economic & Market Environment Supercycles Dynamic Investment Strategies

DeMarche Associates, Inc. 3 Importance of Asset Allocation Studies estimate that asset allocation decision accounts for 91.5% of the variation between returns of different funds 1 Asset mix optimization models mathematically seek maximum expected rate of return for a given level of risk (or minimization of risk for a given expected return) 2 1 Financial Analysts Journal, May/June 1991 – Brinson, Singer & Beebower 2 Global Asset Allocation Techniques for Optimizing Portfolio Management, 1994 – Lummer & Riepe

DeMarche Associates, Inc. 4 Review of Conventional Approach Inputs based upon history Typical models assume “average” future outcomes Often ignore starting /ending market levels

DeMarche Associates, Inc. 5 Review of Conventional Approach Typical models assume “average” future outcomes (sample chart below) Today % 10% 8% 6% 4% 2% Small Cap Equities Large Cap Equities Emerging Equities Hedge Fds Bonds

DeMarche Associates, Inc. 6 One-Year Returns Are Volatile Models incorporate standard deviation to manage risk

DeMarche Associates, Inc. 7 Model Optimization: The Efficient Frontier

DeMarche Associates, Inc. 8 What is Tactical? Webster’s: “Small-scale action to serving a larger purpose” In Investment Management: Method of modifying asset allocation based upon valuation estimates and judgments of the future return of markets or sectors

DeMarche Associates, Inc. 9 Time Horizon for Investment Objectives Short Term Long Term Investment Horizon Market Timing Tactical Asset Allocation Strategic Asset Allocation Secular Asset Allocation One Year Or Less Current Market Phase Cycle Several Market Phase Cycles Multiple Market Supercycles Asset Allocation Study has both a strategic perspective and a long-term secular perspective

DeMarche Associates, Inc. 10 DeMarche Market Phases A typical market cycle has four distinct phases: * Annualized cumulative returns of S&P 500 Index. Study based upon monthly data from 1/31/63- 9/30/11. The annualized cumulative return for the full study period was +9.5%. Source: DeMarche Research  Phase IV–Bear Market  Phase III–Late Bull/Early Bear  Phase II–Bull Market  Phase I–Early Bull Total Return* Corporate Earnings Stock PricesTactical Market Phase  Phase IV–Bear Market  Phase III–Late Bull/Early Bear  Phase II–Bull Market 62.0% 20.8% 0.5% -27.0%  Phase I–Early Bull Total Return* Corporate Earnings Stock PricesTactical Market Phase

DeMarche Associates, Inc. 11 Markets Change Markets change over long periods of time As markets change, relative value between asset classes changes DeMarche research has acknowledged and identified these long wave markets as “Supercycles” Multiple bull and bear markets exist within each “Supercycle”

DeMarche Associates, Inc. 12 SupercycleYears Bank Panics/ Recessions Market Cycles (Bull/Bear Cycles) A. High Growth1900 – B. Moderate Growth1929 – C. High Growth1942 – D. Moderate Growth1966 – E. High Growth1980 – F. Moderate Growth Present23 DeMarche Supercycle Study

DeMarche Associates, Inc. 13 SupercycleBeginningEndDJIA Price Return* A % B C D E ,444 F2000Present*-5 DeMarche Supercycle Study *As of 3/31/2011. Cumulative returns are shown for each cycle (non-annualized).

DeMarche Associates, Inc. 14 SupercyclesEnvironment A1900 – 1929 High population growth B1929 – 1942 High unemployment C1942 – 1966 Baby boom / income growth D1966 – 1980 Inflation E1980 – 2000 Expansion of consumer credit F2000 – ? Demographics & debt The Consumer in Supercycles

DeMarche Associates, Inc. 15 New Normal Macroeconomic Environment Demographics  “Boomers” retire or shift emphasis from consumption to saving Consumers gradually improve their finances  Paying down debt / increase savings

DeMarche Associates, Inc. 16 New Normal Macroeconomic Environment (cont’d) Unemployment Wage growth remains slow Less help from asset gains (wealth effect) Higher taxes

DeMarche Associates, Inc. 17 Strategic Implications of Current Supercycles Stock returns likely to underperform mean Bond returns likely to underperform mean Policies need other strategies to improve expected risk/return outcomes

DeMarche Associates, Inc. 18 Asset Allocation – Expected Returns Next 5 Year “Strategic” Period versus Long-Term “Secular” Time Horizon Source: DeMarche Associates. See notes on next slide.

DeMarche Associates, Inc. 19 Asset Allocation – Expected Returns (cont.) Notes for chart on prior page: Represents geometric return estimates for the 5 years beginning January 2012, compared to long-term average geometric returns over multiple Supercycles (no specific beginning point). 5-year horizon utilizes an assumption of a moderate economic growth environment within the current Supercycle, as defined by DeMarche. U.S. Fixed Income has poor E.R. over the strategic period. Such assets presently have very low current income yield and are at risk of principal value losses as interest rates rise. Other asset classes are shown for comparison.

DeMarche Associates, Inc. 20 Dynamic Investment Strategies Hedge Funds Global Tactical Asset Allocation (GTAA) Funds Lifecycle or Target Date Fund (TDFs) Intro to some assets used by dynamic strategies  Commodities  High Yield Bonds  Emerging Market Bonds

DeMarche Associates, Inc. 21 Brief Intro to Hedge Funds and GTAA Strategies Different HF Fund of Funds approaches for clients  Conservative – emphasis on diversification, lower volatility  Strategic – more use of directional market bets, leverage GTAA is long-only, relative valuation-based Fees higher with HF Limited transparency with HF GTAA correlation is high (vs. stocks/bonds) Wide variance across manager/strategies

DeMarche Associates, Inc. 22 Sample Range of GTAA Fund Approaches ClassicMore ComplexComprehensive Asset Classes Used CashXXX Domestic EquityXXX International Equity XX Emerging Markets Equity XX Domestic BondsXXX International Bonds XX Emerging Markets Bonds XX High Yield Bonds X Inflation Protected (TIPS) XX Convertibles X Commodities XX Real Estate (REITs) X Listed Private Equity X Currency XX Typical Investments Mutual FundsXXX Closed-End Funds XX Exchange-Traded (ETFs)XXX Individual SecuritiesXXX Derivatives XX

DeMarche Associates, Inc. 23 What is a Target-Date Fund? Description of TDF (or Lifecycle Fund):  Diversified investment option  Target a specific retirement year (2020, 2030, etc.)  Professionally managed – Stock allocation reduced as retirement year nears – Disciplined rebalancing of underlying funds  May use less-traditional investments

DeMarche Associates, Inc. 24 Example of TDF Asset Allocation Source: PIMCO, compiled by MarketGlide. Fewer equities as participant retire date nears

DeMarche Associates, Inc. 25 TDF Glidepaths Programs reduce equities over time; some have tactical range

DeMarche Associates, Inc. 26 Total return from commodities comes from combination of: rolling futures contracts (roll yield), yield from the cash collateral, and the spot price gain or loss. Derivatives use is widespread (active or passive). Brief Intro: Commodities Energy, Metals, Agriculture, Livestock Weights differ among several indexes  S&P has 65-75% Energy: others cap at 33% Portfolio diversifier  Hedge against unexpected inflation  Slight negative correlation to stocks & bonds in past Liquidity varies; fund choices very distinct Key concerns: China, oil, gold

DeMarche Associates, Inc. 27 Brief Intro: High Yield & Emerging Market Bonds Both have low correlations to U.S. Bonds U.S. High Yield Bonds  Quality ratings of “BB” or lower (below investment grade)  Average maturities 3-10 years  High level of current income payments  Default risk rises in recessionary periods  Higher volatility and potential losses than other fixed income Emerging Market Bonds are investment grade  Obligations of foreign government or corporation  Average maturities 3-10 years  Higher fees (management, transaction, custodial)  Political, liquidity, and other risks differ from U.S. bonds  Currency risk (some issued in U.S. dollars)

DeMarche Associates, Inc. 28 Recommendations Adjust asset allocation more frequently Incorporate Supercycles Emphasize liquidity Diversify Increase allocation to dynamic strategies

DeMarche Associates, Inc. 29 Questions? Thank you!