1. Trends in Risk-Based Portfolio Design and Management
Quiet/Bold Headlines
The first line establishes a premise with a few well-chosen words. The second line should add meaning to the premise established by the first line. 
Peter S. Austin – Head of Multi-Asset Solutions
Presentation to Louisiana Association of Public Employees’ Retirement Systems
September 20, 2016
For Investment Professionals Only. Not for further distribution.

2. Today’s Discussion
Identify the top five challenges facing public pension plans in the U.S.
Review the return environment: past, present and future
Introduce systematic risk-based portfolio management models
Demonstrate the potential benefit of employing risk-based investing in a multi-asset framework

3. Sample Public Pension Plan Allocation
As of June 30, 2015
Equity
Alternatives
Fixed Income
Cash
Note: Reflects average allocation based on the 25 largest U.S. public pension plans as of June 30, 2015.
See page 34 for list of the asset class representative indices.
Sources: Money Market Directory and public filings.
Analysis: T. Rowe Price.

4. Public Pension Plan Challenge #1: Portfolio Returns Have Fallen Short of Discount Rates
As of June 30, Figures are Calculated in U.S. Dollars
Sample Public Pension Plan Allocation Returns Last 5 Years Annual Periods from June 30 Through June 30
16.66%
11.66%
7.58% Average Discount Rate
6.83% 5-Year Annualized Return
6.32% 10-Year Annualized Return
3.62%
1.90%
1.09%
Past performance cannot guarantee future results.
Source for Average Discount Rate: Center for Retirement Research at Boston College.
Sources: Russell, MSCI, Barclays, Cambridge Associates, Hedge Fund Research, and the National Council of Real Estate Investment Fiduciaries.
Sample Public Pension Plan Allocation returns are hypothetical, inherently limited, and should not be relied upon as indicators of future performance. Results do not reflect actual fees, charges, or expenses. See page 33 for additional information regarding this chart.

5. Public Pension Plan Challenge #2: Diversification Into Alternative Strategies Has Fallen Short of Expectations
As of June 30, Figures are Calculated in U.S. Dollars
9.07%
7.90%
2.34%
-2.40%
-4.34%
Past Performance cannot guarantee future results.
HFRI = Hedge Fund Research Index.
Source: Hedge Fund Research.

6. Growing Trend of Hedge Fund Liquidations
CalPERS
September 2014
Decision to eliminate hedge fund allocation
Illinois State Board of Investment
February 2016
Reduced hedge fund target from 10% to 3%
NYCERS April 2016
Voted to liquidate hedge funds
New Jersey State Investment Council
August 2016
Cut hedge fund allocation from 12.5% to 6%
Source: Pensions and Investments.

7. Public Pension Plan Challenge #3: Central Bank Policies Have Created a New Interest Rate Paradigm
As of June 30, Figures are Calculated in U.S. Dollars
Past Performance cannot guarantee future results.
Source: Haver Analytics.

8. Public Pension Plan Challenge #4: Equity Valuations Are Trending Above Long-Term Averages
As of June 30, Figures are Calculated in U.S. Dollars
NTM=Next Twelve Months.
P/E median calculated from 1/1/2002 through 6/30/2016.
Sources: MSCI, Russell and T. Rowe Price.

9. Public Pension Plan Challenge #5: Decline in Plan Funded Status
As of June 30, 2016
Note: The median discount rate for public pension plans was 8% from and 7.75% in 2012.
Sources Public Plan Database and PENDAT.
National data averages are weighted by plan size.

10. Investment Return Analysis
As of June 30, Figures are Calculated in U.S. Dollars
Past 20 Years
U.S. Large-Cap U.S. Small-Cap Global Equity Non-U.S. Equity EM USD Bonds U.S. Aggregate U.S. Treasury U.S. High Yield U.S. TIPS Private Equity Real Estate Hedge Funds Sample Public Pension Plan Allocation
Public Plan Average Discount Rate
Annualized Return
Annualized Volatility
Past Performance cannot guarantee future results.
Sources: Russell, MSCI, Barclays, Cambridge Associates, Hedge Fund Research, and the National Council of Real Estate Investment Fiduciaries.
Please see page 33 for additional information regarding this chart.
Please see page 34 for a list of the asset class representative indices.

11. Investment Return Analysis
As of June 30, Figures are Calculated in U.S. Dollars
Past 20 Years
Past 15 Years
U.S. Large-Cap U.S. Small-Cap Global Equity Non-U.S. Equity EM USD Bonds U.S. Aggregate U.S. Treasury U.S. High Yield U.S. TIPS Private Equity Real Estate Hedge Funds Sample Public Pension Plan Allocation
Public Plan Average Discount Rate
Annualized Return
Annualized Volatility
Past Performance cannot guarantee future results.
Sources: Russell, MSCI, Barclays, Cambridge Associates, Hedge Fund Research, and the National Council of Real Estate Investment Fiduciaries.
Please see page 33 for additional information regarding this chart.
Please see page 34 for a list of the asset class representative indices.

12. Investment Return Analysis
As of June 30, Figures are Calculated in U.S. Dollars
Past 20 Years
Past 15 Years
Past 10 Years
U.S. Large-Cap U.S. Small-Cap Global Equity Non-U.S. Equity EM USD Bonds U.S. Aggregate U.S. Treasury U.S. High Yield U.S. TIPS Private Equity Real Estate Hedge Funds Sample Public Pension Plan Allocation
Public Plan Average Discount Rate
Annualized Return
Annualized Volatility
Past Performance cannot guarantee future results.
Sources: Russell, MSCI, Barclays, Cambridge Associates, Hedge Fund Research, and the National Council of Real Estate Investment Fiduciaries.
Please see page 33 for additional information regarding this chart.
Please see page 34 for a list of the asset class representative indices.

13. Investment Return Analysis
As of June 30, Figures are Calculated in U.S. Dollars
Past 20 Years
Past 15 Years
Past 10 Years
Past 5 Years
U.S. Large-Cap U.S. Small-Cap Global Equity Non-U.S. Equity EM USD Bonds U.S. Aggregate U.S. Treasury U.S. High Yield U.S. TIPS Private Equity Real Estate Hedge Funds Sample Public Pension Plan Allocation
Public Plan Average Discount Rate
Annualized Return
Annualized Volatility
Past Performance cannot guarantee future results.
Sources: Russell, MSCI, Barclays, Cambridge Associates, Hedge Fund Research, and the National Council of Real Estate Investment Fiduciaries.
Please see page 33 for additional information regarding this chart.
Please see page 34 for a list of the asset class representative indices.

14. Forward Curves Project Lower Fixed Income Returns
As of June 30, Figures are Calculated in U.S. Dollars
Historical 20-Year Return
Yield as of 6/30/2016
Projected 5-Year Return
Projected 10-Year Return
U.S Treasury
5.42%
1.11%
0.46%
1.50%
U.S. Aggregate
5.68
2.59
1.10
2.09
U.S. Credit
6.31
2.78
3.06
U.S. High Yield
7.03
7.27
6.72
7.46
Past performance cannot guarantee future results.
Please see page 34 for a list of asset class representative indices.
Note: Yield curve shift from current to forward curve is assumed to be proportionate based on forward curve year(s). Projected return assumes spreads remain unchanged from levels.
5-year return based on equal monthly adjustment from current yield curve to 5-year forward curve. 10-year return based on equal monthly adjustment from current yield curve to 10-year forward curve.
Sources: Bloomberg Finance L.P., U.S. Treasury , Barclays and T. Rowe Price.

15. Interest Rate Normalization Impact on Sample Public Pension Plan Allocation Returns
As of June 30, 2016
Hypothetical Rolling 20-Year Returns Using 10-Year Treasury Forward Curve
Note: Returns for U.S. fixed income (Treasury, Aggregate, High Yield) starting on June 30, 2016 are based on projected 10-year returns as presented on page 14. All other asset class returns held constant at their 20-year historical averages as of June 30, 2016 (see page 13).

16. Shifting the Focus From Return to Risk
Despite investors’ best efforts, portfolio returns have fallen short of targets and may continue a downward trajectory
Forecasting return is challenging and can lead to unintended results
Forecasting risk may produce more predictable outcomes
Risk-based investing may represent an easier and more robust method for improving portfolio returns

17. The Ability to Forecast Risk is at the Heart of Risk Managed Portfolios
Correlation = -0.05
Correlation = -0.05
Correlation = 0.01
Forecast of Return
Forward 1-Day Return (%)
Forward 21-Day Return (%)
Forward 252-Day Return (%)
1-Day Return (%)
21-Day Return (%)
252-Day Return (%)
Equity Volatility, Correlation = 0.57
Treasury Volatility, Correlation = 0.65
Eq./Treas. Volatility, Correlation = 0.77
Forecast of Risk
Volatility Forecast (%)
21-Day Forward Realized Volatility (%)
Current returns give very little information about future returns, but current levels of risk can be very informative of future risk.
Data includes S&P 500 futures, 5-Year Treasury futures 05/ / In bottom plot, exponentially weighted moving average model (lambda = 0.94) covariance forecast.
This information demonstrates, in part, the firm's Risk/Return analysis. This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

18. What Is Risk-Based Investing?
The ability to forecast asset class volatility and correlation underlies risk-based portfolio construction methodologies
Portfolios are constructed with a constant risk profile by systematically adjusting asset class exposures through the use of derivative-based overlays
Over longer time frames risk-based investing can stabilize portfolio volatility and reduce tail risk
The design of risk-based portfolios can be customized to investor objectives

19. Sample Risk-Based Portfolio Analysis
As of June 30, 2016
Step One: We start with a broadly diversified global asset allocation design (“Sample Portfolio”)
Source: T. Rowe Price.
Figures may not total 100% due to rounding.
Performance from January 1, 2003 to June 30, 2016 based on following allocation with monthly rebalancing to respective target weights:
9.60% Russell 1000 Growth, 9.60% Russell 1000 Value, 4.80% CBOE S&P 500 Buywrite Index, 4.20% Russell 2000, 7.10% MSCI EAFE Hedged, 7.00% MSCI EAFE Growth, 7.00% MSCI EAFE Value, 4.20% S&P Global ex U.S. Small-Cap, 3.50% MSCI Emerging Markets Index, 1.8% S&P GSCI Total Return Index, 1.2% FTSE EPRA / NAREIT Developed Total Return Index, 1.00% Barclays U.S. Government Long Index, 4.00% Barclays U.S. Government Intermediate Index, 4.00% Barclays U.S. Intermediate Credit Index, 3.00% Barclays U.S. Long Credit Index, 4.00% Barclays Global Aggregate ex U.S. Index, 4.00% JP Morgan Emerging Markets Bond Global Diversified, 2.00% JP Morgan GBI-EM Global Diversified, 2.00% JP Morgan Global High Yield, 2.00% Barclays U.S. TIPs, 1.00% Barclays U.S. Treasury Tips 1–5 Year, 1.00% S&P/LSTA Performing Loan Index, and 10% HFRX Global Hedge Fund Index USD.
Sample Portfolio results are hypothetical, inherently limited, and should not be relied upon as indicators of future performance. Sample Portfolio results do not reflect actual fees, charges, or expenses. See page 33 for additional Important Information.


20. Sample Risk-Based Investing Analysis
Step Two: We add a managed volatility overlay framework
Managed Volatility Overlay
Targets a long-term volatility goal of 11% within a range of 10% - 14%
Daily volatility forecasting using an algorithmic, rules-based framework based on expectations of future volatility for a proxy allocation
Equity exposure can range from 20% - 75%
Highly liquid futures overlay used to manage exposures
Notional net exposure of portfolio always equals 100%
Note: Proxy allocation is composed of 30% S&P 500; 30% MSCI EAFE; 28% Bloomberg Barclays 10-Year Treasury Index; 12% Citigroup 90-Day T-Bill Index.
Futures based on S&P 500, MSCI EAFE and U.S Treasury 10-Year.
Source: T. Rowe Price.

21. Futures Overlay Trading Based on Volatility Forecast
Portfolio Volatility Expectation
Action Taken
Trade back to the volatility target
Above upper volatility band
Upper volatility band (14%)
Between volatility bands
No rebalance necessary
Forecast Volatility
Volatility target (11%)
Lower volatility band (10%)
Trade back to the volatility target but not beyond the cap on equity exposure
Below lower volatility band

22. Risk-Based Investing Can Stabilize Portfolio Risk and Reduce Drawdowns
As of June 30, 2016
Sample Portfolio
Sample Portfolio % Constrained Overlay
Annualized Volatility (%)
Years
Past performance cannot guarantee future results.
Source: T. Rowe Price.

23. Sample Portfolio Exposure Summary With Managed Volatility Overlay
As of June 30, 2016
Sample Portfolio Asset Class Net Exposure
100% Constrained Overlay
Exposure
Source: T. Rowe Price.

24. Managed Volatility Reduced Drawdown Experience
As of June 30, Figures are Calculated in U.S. Dollars
We measured the largest drawdown for the measurement period
Rolling Periods from
1/1/2003 Through 6/30/2016
Sample Portfolio
Sample Portfolio % Constrained
1-Day Maximum Drawdown
-4.64%
-1.48%
10-Day Maximum Drawdown
-18.98
-14.09
30-Day Maximum Drawdown
-29.36
-20.79
365-Day Maximum Drawdown
-40.42
-30.03
Past performance cannot predict future results.
Source: T. Rowe Price.
Sample Portfolio performance from January 1, 2003 to June 30, 2016 based on the indices and allocations identified on page 19 with monthly rebalancing to respective target weights.

25. While Preserving Risk Return Profile of Underlying Sample Portfolio
As of June 30, Figures are Calculated in U.S. Dollars
1-Year
3-Year
5-Year
7-Year
10-Year
Since January 1, 2003
Sample Portfolio Annualized Returns
-1.08%
4.58%
4.24%
7.36%
3.41%
5.60%
Sample Portfolio Annualized Volatility
9.42%
7.14%
7.92%
8.55%
11.18%
10.18%
Sample Portfolio Sharpe Ratio
-0.13
0.63
0.53
0.85
0.22
0.43
Sample Portfolio with 100% Constrained Volatility Overlay
-4.57%
4.01%
4.46%
7.22%
4.44%
6.98%
Sample Portfolio with 100% Constrained Volatility Overlay Annualized Volatility
10.42%
8.57%
8.88%
9.26%
10.22%
9.63%
Sample Portfolio with 100% Constrained Volatility Overlay Sharpe Ratio
-0.45
0.46
0.50
0.77
0.34
0.59
Past performance cannot predict future results.
Source: T. Rowe Price.
Sample Portfolio performance from January 1, 2003 to June 30, 2016 based on the indices and allocations identified on page 19 with monthly rebalancing to respective target weights.

26. Enhancing Returns Through Wider Exposure Limits
The previous example demonstrates how a 100% constrained volatility overlay preserved long-term performance while managing drawdown experience, but the exposure target limited opportunities to capture additional return
To test the impact of a more unconstrained risk-based approach, we adjusted the guidelines
Equity and fixed income exposures are unbounded – the algorithm has full latitude to determine optimal stock/bond mixes
The sample portfolio is managed to an 11% volatility target on a daily basis – we eliminated the 10% to 14% volatility range
The unconstrained managed volatility overlay is applied on 50% of the notional exposure
This unconstrained example is intended to illustrate the flexibility of the volatility forecasting model

27. Historically, Lower Volatility Environments Delivered Better Risk-Adjusted Returns
January 1975 Through August 2016
Average 60 Day Sharpe Ratio – S&P 500 Index
Lowest
Highest
Past performance cannot predict future results.
Source: S&P.
Note: Deciles defined by rolling 60-day volatility of S&P returns.

28. Equity Market Drawdowns Tended to Coincide With Higher Volatility
As of June 30, 2016
VIX and S&P
Index Level
Sources: S&P, Chicago Board Options Exchange.

29. Sample Portfolio Exposure Summary with Unconstrained Overlay
As of 30 June 2016
Sample Portfolio Asset Class Net Exposure
50% Unconstrained Overlay
Exposure
Index Level
Source: T. Rowe Price and Chicago Board Options Exchange.

30. Drawdown Profile Changed with Unconstrained Approach
As of June 30, 2016
Rolling Periods from
1/1/2003 Through 6/30/2016
Sample Portfolio
Sample Portfolio % Constrained
Sample Portfolio + 50% Unconstrained
1-Day Maximum Drawdown
-4.64%
-1.48%
-3.24%
10-Day Maximum Drawdown
-18.98
-14.09
-17.68
30-Day Maximum Drawdown
-29.36
-20.79
-26.27
365-Day Maximum Drawdown
-40.42
-30.03
-31.38
Past performance cannot predict future results.
Source: T. Rowe Price.
Sample Portfolio performance from January 1, 2003 to June 30, 2016 based on the indices and allocations identified on page 19 with monthly rebalancing to respective target weights.

31. Wider Exposure Limits Can Improve Risk-Adjusted Results
As of June 30,2016 Figures are Calculated in U.S. Dollars
1-Year
3-Year
5-Year
7-Year
10-Year
Since January 1, 2003
Sample Portfolio Annualized Returns
-1.08%
4.58%
4.24%
7.36%
3.41%
5.60%
Sample Portfolio Annualized Volatility
9.42%
7.14%
7.92%
8.55%
11.18%
10.18%
Sample Portfolio Cumulative Sharpe Ratio
-0.13
0.63
0.53
0.85
0.22
0.43
Sample Portfolio with 100% Constrained Volatility Overlay
-4.57%
4.01%
4.46%
7.22%
4.44%
6.98%
Sample Portfolio with 100% Constrained Volatility Overlay Annualized Volatility
10.42%
8.57%
8.88%
9.26%
10.22%
9.63%
Sample Portfolio with 100% Constrained Volatility Overlay Sharpe Ratio
-0.45
0.46
0.50
0.77
0.34
0.59
Sample Portfolio 50% Unconstrained Volatility Overlay
3.88%
8.87%
8.76%
12.01%
7.99%
9.29%
Sample Portfolio 50% Unconstrained Volatility Overlay Annualized Volatility
9.28%
8.53%
8.70%
8.86%
10.69%
10.19%
Sample Portfolio 50% Unconstrained Volatility Overlay Sharpe Ratio
0.40
1.03
1.00
1.35
0.66
0.79
Past performance cannot predict future results.
Source: T. Rowe Price.
Sample Portfolio performance from January 1, 2003 to June 30, 2016 based on the indices and allocations identified on page 19 with monthly rebalancing to respective target weights.

32. Conclusion
Public pension plans face a challenging investment environment
Low interest rates
High equity market multiples
Disappointing alternative asset class returns
The typical public plan asset allocation design may not deliver future returns sufficient to improve funding levels
While managed volatility strategies don’t perform well in all markets, over time they have demonstrated an ability to generate stable risk-adjusted returns with better tail risk protection
Loosening the exposure constraints of managed volatility models may represent an opportunity for public plans to realize higher investment returns while managing risk within reasonable tolerances

33. IMPORTANT INFORMATION
The information presented herein was prepared by T. Rowe Price Associates, Inc. for illustrative purposes only and should not be redistributed, in whole or in part, without prior written consent by T. Rowe Price. This information is not intended to be investment advice or a recommendation to take any particular investment action. The results shown herein for the Sample Portfolio are hypothetical and do not represent the returns of any T. Rowe Price product or strategy. Sample Portfolio results were developed with the benefit of hindsight and have inherent limitations. Sample Portfolio results do not reflect actual trading or the effect of material economic, market, or other factors on the decision-making process. It is assumed that the Sample Portfolio incepted on January 1, 2003 and remained at the same weighting during the analysis period, rebalanced to its respective target weight on a monthly basis. Sample Portfolio results are derived from the actual returns of the indices and the allocations listed on page 19 and do not include management fees, advisory fees, and other related fees. Results have not been adjusted to reflect the reinvestment of dividends and capital gains. Actual returns may differ significantly from the results shown. Source for MSCI data: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a trademark of Russell Investment Group.
2016-US-25856

34. Representative Indices
Asset Class
Representative Index
US Large Cap
Russell 1000 Index
US Small Cap
Russell 2000 Index
Global Equity
MSCI All Country World Index
Non-US Equity
MSCI All Country World ex-U.S. Index
Emerging Markets Equity
MSCI Emerging Markets  Index
Global Aggregate
Barclays Global Aggregate Index
Global Treasury
Barclays Global Treasury Index
Global High Yield
Barclays Global High Yield  Index
EM $ Bonds
Barclays EM USD Aggregate  Index
US Aggregate
Barcalys US Aggregate Index
US Credit
Barclays US Credit  Index
US Treasury
Barclays US Treasury Index
US High Yield
Barclays US High Yield  Index
US TIPS
Barcalys US TIPS Index
US Cash
Barclays US Treasury Bills 1-3 Month Index
Private Equity
Cambridge Associates US Private Equity Index
Real Estate
NCREIF Property Index
Hedge Funds
HFRI Fund Weighted Composite Index