1 The 7Twelve Portfolio The Benefits of Low Correlation Craig L. Israelsen, Ph.D. Brigham Young University 41 slides

2 This document is a research report presenting portfolio research and analysis. This document is neither investment advice nor an investment solicitation. 7Twelve Implementation of the 7Twelve portfolio is no guarantee of performance This is a copyrighted document, copying for redistribution is prohibited unless written permission is obtained from Craig L. Israelsen. Copyright © 2008 Craig L. Israelsen All rights reserved

Presentation Overview ► Part One provides a historical context of the benefits of a multi-asset, low correlation portfolio. ► Part Two introduces the 7Twelve Portfolio, a multi-asset, low correlation global portfolio. 3

Part One 4

5 Historical Asset Returns 38-Year Period from Annualized Return (%) Std Dev of Annual Returns Growth of $10,000 REIT ,476 Commodities ,183 US Small Stock ,684 US Large Stock ,040 International Stock ,316 Bonds (Intermediate) ,131 Cash ,701 Inflation ,618

6 Data ► Large-cap US equity represented by the S&P 500 Index. ► Small-cap US equity represented by the Ibbotson Small Companies Index from , and the Russell 2000 Index from ► Non-US equity represented by the MSCI EAFE Index. ► Real estate represented by the NAREIT Index from and the Dow Jones Wilshire REIT Index from ► Commodities represented by the Goldman Sachs Commodities Index (GSCI). As of February 6, 2007, the GSCI became the S&P GSCI Commodity Index. ► U.S. intermediate term bonds represented by the Ibbotson Intermediate Term Bond Index from and the Lehman Brothers Intermediate Term Government Bond index from ► Cash represented by 3-month Treasury Bills.

7 Historical Upside and Downside Largest One-Year Gain (%) Worst One-Year Loss (%) Worst 3-Year Cum Loss (%) Bonds 25.42(1.75)6.43 Cash Commodities 74.96(35.75)(26.06) REIT 48.99(23.44)(28.30) US Large Stock 37.58(26.47)(37.61) US Small Stock 57.40(30.90)(42.22) International Stock 69.44(23.45)(43.32)

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Benefit #1 When built correctly, multi-asset portfolios achieve low aggregate correlation among the internal assets. 9

10 Correlation of Major Asset Classes ( ) Large US Equity Small US Equity Non-US Equity US Bonds CashREIT Small US Equity.74 Non-US Equity US Bonds Cash REIT Commodities Aggregate (Average) Correlation in Equal-Weighted 7-Asset Portfolio = 0.12

11 Correlation Matters Commodities and small US stock had a similar 38-year return—but blending commodities with large US stock was far more beneficial because commodities has a lower correlation to large US stock (-0.28) than does small US stock (0.74).

12 Performance During Accumulation Phase Individual Assets vs. Typical Portfolios vs. Multi-Asset Portfolio

13 Year Large US Equity Small US Equity Non-US Equity Intermediate Term US Bonds CashReal EstateCommodities Equally Weighted Multi- Asset Portfolio (17.40)(11.66) (4.00) (14.69)(30.90)(14.92) (15.52) (26.47)(19.90)(23.16) (21.42)39.51(5.15) (17.22) (11.92) (7.16) (4.92)2.03(2.28) (23.01) (1.86) (7.30) (8.80) (6.59) (3.10)(19.48)(23.45) (23.44)29.08(3.26)

14 Year Large US Equity Small US Equity Non-US Equity Intermediate Term US Govt Bonds CashReal EstateCommodities Equally Weighted Multi- Asset Portfolio (6.13) (12.17) (12.33) (1.82)7.78(1.75) (14.07) (2.55) (17.01)(35.75) (2.58) (9.10)(3.02)(14.17) (11.89)2.49(21.44) (31.93)(5.48) 2002 (22.10)(20.48)(15.94) (1.65) (15.09) (1.57) (17.56)

Benefit #2 When built correctly, multi-asset portfolios achieve equity-like returns with bond-like risk. 15

16 Multi-Asset Portfolio vs. Single Assets Large US Equity Small US Equity Non-US Equity US Bonds Cash Real Estate Commodities Equally Weighted 7-Asset Portfolio 38-Year Average Annualized % Return Year Standard Deviation of Annual Returns Number of Years with Negative Returns Worst One-Year % Return (26.47)(30.90)(23.45)(1.75)1.05(23.44)(35.75) (5.48) Worst Three-Year Cumulative % Return (37.61)(42.22)(43.32) (28.30)(26.06) 2.43

What’s Different in 2008? Commodities and real estate are not helping as much as in prior downturns. 17 Year Large US Equity Small US Equity Non-US Equity Intermediate US Govt Bonds Cash Real Estate Commodities Equally Weighted Multi-Asset Portfolio 1973 (14.69)(30.90)(14.92) (15.52) (26.47)(19.90)(23.16) (21.42)39.51(5.15) 2000 (9.10)(3.02)(14.17) (11.89)2.49(21.44) (31.93)(5.48) 2002 (22.10)(20.48)(15.94) (1.65) YTD Oct (32.9)(29.1)(42.0)4.81.5(30.5)(28.3) (22.34)

18 Portfolio (Equity/ Fixed Income) Large US Stock Small US Stock Non-US Stock BondsCash 60/4030%15%15%30%10% 40/6020%10%10%50%10% Typical Multi-Asset Portfolios

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20 Performance in Post-Retirement Distribution Phase Various Portfolios vs. Multi-Asset Portfolio

Benefit #3 When built correctly, multi-asset portfolios are durable during the post-retirement distribution phase. Durable = Growth + Downside Resistance 21

22 1 = One-asset portfolio (100% Cash) 2 = Two-asset portfolio (50% each Bonds, Cash) 3 = Three-asset portfolio (33% each Cash, Bonds, Large US Stock) 4 = Four-asset portfolio (25% each Cash, Bonds, Large US Stock, Small US Stock) 5 = Five-asset portfolio (20% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock) 6 = Six-asset portfolio (16.7% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock, REIT) EW = Seven-asset equal-weighted portfolio (14.3% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock, REIT, Commodities) CW = Seven-asset custom-weighted portfolio (12% Large US, 8% Small US, 10% Non-US, 5% REIT, 5% Commodities, 40% Bond, 20% Cash) 60/40 = 30% Large US, 15% Small US, 15% Non-US, 30% Bond, 10% Cash 40/60 = 20% Large US, 10% Small US, 10% Non-US, 50% Bond, 10% Cash $500,000 Initial Portfolio Value 5% withdraw rate 3% inflation rate of annual withdrawal

23 ► Minimizing frequency of loss and size of portfolio loss while generating robust performance are distinct benefits of low correlation portfolios—provided that each asset is assigned a meaningful allocation. ► Recovering from large losses is more difficult in distribution portfolios--when money is being systematically withdrawn.

24 Portfolio Loss Needed Average Annual % Return to Restore Original Portfolio Balance WITHDRAWAL Portfolio First Year Withdrawal of 5% of initial balance, 3% increase of annual withdrawal Within 1 YearWithin 2 Years Within 3 Years Within 4 Years Within 5 Years -5% 16.8%11.1%9.3%8.4%8.0% -10% 23.7%14.4%11.5%10.1%9.4% -15% 31.4%18.0%13.9%12.0%10.9% -20% 40.2%22.0%16.5%14.0%12.5% -25% 50.2%26.4%19.4%16.1%14.3% Portfolio Loss BUY-and-HOLD Portfolio Within 1 Year Within 2 Years Within 3 Years Within 4 Years Within 5 Years -5% 5.3%2.6%1.7%1.3%1.0% -10% 11.1%5.4%3.6%2.7%2.1% -15% 17.6%8.5%5.6%4.1%3.3% -20% 25.0%11.8%7.7%5.7%4.6% -25% 33.3%15.5%10.1%7.5%5.9%

25 Portfolio (Equity/ Fixed Income) Large US Stock Small US Stock Non-US Stock BondsCash 60/4030%15%15%30%10% 40/6020%10%10%50%10% 20/8010%5%5%60%20% 0/1000%0%0%70%30% Example Distribution Portfolios

26 Final Outcomes Are Very Dependent on Timing of Returns DISTRIBUTION PORTFOLIO $500,000 Initial Portfolio Value 5% withdraw rate 3% inflation rate of annual withdrawal

27 Distribution Portfolio Goals Stabilize Returns to Minimize Timing Dependence Maintain Robust Performance to Increase Portfolio Longevity Ave. 3-Yr Return Ave. 3-Yr Std Dev 40 Equity/60 Fixed Income 9.8% 4.3% 7-Asset EW Portfolio 11.7% 4.4%

Part Two 28

29 Building a Multiple-Asset Low Correlation Portfolio The 7Twelve Portfolio ► 7 Core Asset Classes with ► 12 Underlying Funds

30 The Portfolio A Multiple-Asset Global Portfolio The 7Twelve Portfolio A Multiple-Asset Global Portfolio Approximately 60% of the Portfolio Allocation in Equity and Diversifying Assets Approximately 40% of the Portfolio Allocation in Bonds and Cash US Equity Non-US Equity Real Estate Resources US Bonds Non-US Bonds Cash Large Companies Developed Markets Global Real Estate Natural Resources US Aggregate Bonds International Bonds US Money Market Medium-sized Companies Emerging Markets Commodities Inflation Protected Bonds Small Companies

31 Large US Mid US Small US Non-US Developed Non-US Emerging Global Real Estate Natural Resources Commodities US Aggregate Bonds Inflation Protected Bonds Non-US Bonds Mid US 0.58 Small US Non-US Developed Non-US Emerging 0.50(0.18) Global Real Estate Natural Resources Commodities US Aggregate Bonds (0.39)0.05(0.17)(0.68)(0.83)0.05(0.61)(0.24) Inflation Protected Bonds (0.47)0.01(0.27)(0.54)(0.42)(0.02)(0.08) Non-US Bonds (0.20) (0.10)0.25(0.09)(0.11)(0.17)(0.09) US Money Market (0.13)0.29(0.24)(0.35)(0.32)(0.35)(0.15)(0.22)0.08(0.22)(0.50) Correlation 7Twelve Correlation Aggregate Correlation = 0.09 Using annual returns from

32 7Twelve Portfolio 1,979 distinct mutual funds with at least 10 years of performance as of December 31, 2007 Red dot is 7Twelve portfolio

33 Calendar Year Total % Return 7Twelve Portfolio American Funds Capital Income Builder Fidelity Global Balanced S&P 500 Index (5.97)5.60(9.06) (8.15)(2.49)(12.02) (6.15)(7.74)(22.15) Year Annualized Return Correlation to S&P 500 Index

34 Accumulation 7Twelve Portfolio

35 Distribution 7Twelve Portfolio $100,000 Initial Account Value, 5% Initial Withdrawal, 3% Annual Increase in Withdrawal

Age of Investor  Under Age 50 Age Age Over Age 70 Comparison Funds Portfolio Mix  100% 7Twelve 80% 7Twelve 10% TIPS 10% Cash 60% 7Twelve 20% TIPS 20% Cash 40% 7Twelve 30% TIPS 30% Cash American Funds Capital Income Builder A (CAIBX) Fidelity Global Balanced (FGBLX) Accumulation Portfolio (1998 – 2007) 10-Year Average Annualized Return (%) Worst One-Year % Loss (2.78)(8.15) Distribution Portfolio (1998 – 2007) ($100,000 initial value, 5% annual withdrawal, 3% annual increase in withdrawal) Internal Rate of Return (%) Worst One-Year Portfolio Loss ($4,899)($4,010)($3,122)($2,233)($8,118)($15,267) Correlation (1998 – 2007) Correlation to S&P

As of October 31, Master 7Twelve TM Portfolios Year-to-Date Total % Return as of October 31, Year Annualized % Return as of October 31, % 7Twelve(27.72) % 7Twelve, 10% TIPS, 10% Cash(22.72) % 7Twelve, 20% TIPS, 20% Cash(17.73) % 7Twelve, 30% TIPS, 30% Cash(12.74)6.39 Comparison Funds American Funds Capital Income Builder (CAIBX) (30.15)5.48 Fidelity Global Balanced (FGBLX) (24.57)5.38 T. Rowe Price Personal Strategy Balanced (TRPBX) (27.77)3.57 Vanguard Balanced (VBINX) (21.37)2.98 Vanguard 500 Index (VFINX) (32.87)0.32

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DJIA hit all-time high on Oct 9, days later…(Thursday Oct 9, 2008) Trailing 1-year Return as of Oct 9, 2008 ► ► DJIA -39.4% ► ► S&P % ► ► 100% 7Twelve -25.9% ► ► 40/30/30 7Twelve * -10.4% * 40% 7Twelve, 30% TIPS, 30% Cash 39

40 1) Portfolio logistics are very straight-forward:  Equally-weighted, annually rebalanced.  Using cash flows to accomplish rebalance increases tax efficiency. 2) No reliance upon tactical skill or timing. 3) Represents the core “module” of any portfolio pre or post retirement. Examples: 80% 7Twelve, 20% individual stocks Examples: 80% 7Twelve, 20% individual stocks 60% 7Twelve, 20% TIPS, 20% cash 60% 7Twelve, 20% TIPS, 20% cash 50% 7Twelve, 30% fixed annuity, 20% cash 50% 7Twelve, 30% fixed annuity, 20% cash 4) Can be built using actively managed funds, passively managed index funds, ETFs, ETNs, or CTFs (collective trust funds). 5) Sets upper and lower boundaries for number of portfolio holdings:  (7 asset classes employing 12 underlying funds) 7Twelve Portfolio

41 The 7Twelve Portfolio The Benefits of Low Correlation Craig L. Israelsen, Ph.D. Brigham Young University Web: