CAPTRUST Strategic Research Report Q1 2013 Wealth Management Edition

WEALTH MANAGEMENT | Q1 13

Strategic research report BUYING HIGH AND SELLING LOW Mark Paccione, CFA, CFP® Director, CAPTRUST Consulting Research Group

In 2012, the average equity mutual fund investor earned 15.56% — just short of the S&P 500’s 15.98% return.1 The average fixed income mutual fund investor earned 4.68%, while the benchmark Barclays Aggregate Bond Index returned 4.21%.2 Unfortunately, average investor outperformance over common market benchmarks is a rare occurrence. For example, in 2011 the S&P 500 Index returned 2.12%, while the average equity mutual fund investor lost 5.73%.3 Admittedly, global equity markets experienced a particularly volatile year as Standard & Poor’s downgraded the U.S. federal government credit rating in August 2011, and the European Sovereign debt crisis sent many equity investors to the sidelines. The Barclays Aggregate Bond Index, which tends to react well in volatile equity markets, had a much better year, up 7.84%. The average fixed income mutual fund investor received a meager 1.34% return,4 which is better than the average equity investor did, but significantly worse than the Barclays Aggregate benchmark.

More importantly, 2011 is not an isolated incident. Findings by financial research firm DALBAR indicate that the average mutual fund investor consistently underperforms the market. In its annual Quantitative Analysis of Investor Behavior study, DALBAR notes, “One of the most startling and ongoing facts is that at no point in time have average investors remained invested for sufficiently long periods to derive the benefits of the investment markets.”5 Figure One captures the average investor’s plight — which is especially obvious over longer periods:

Letter from the Editor

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Wealth Management Planning

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Portfolio Strategy

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Index Returns

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Discretionary Research Highlights 18 Investment Asset Classes

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CAPTRUST News

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Figure One: Annualized Investor Returns vs. Benchmark as of 12.31.2012

1 YR

Avg. Equity Investor

S&P 500

Difference

Avg. Fixed Income Investor

Barclays Aggregate Bond Index

Difference

15.56%

15.98%

-0.42%

4.68%

4.21%

0.47%

3 YRS

7.63%

10.87%

-3.24%

2.85%

6.19%

-3.34%

5 YRS

-0.84%

1.66%

-2.50%

1.64%

5.95%

-4.31%

10 YRS

6.05%

7.10%

-1.05%

1.17%

5.18%

-4.01%

20 YRS

4.25%

8.21%

-3.96%

0.98%

6.34%

-5.36%

Timing is a key contributing factor to the average investor’s underperformance.

The same DALBAR study also shows mutual fund flows tend to lag market movements, causing investors to unintentionally buy high and sell low. Equity continued on page 3

Source: DALBAR

In This Issue

letter from the editor

IN LIKE A LION, OUT LIKE A LION? Dear Readers, While the title above is an intended riff on an idiom normally affixed to this time of year, it certainly feels like 2013 has begun with much pomp and circumstance. Put simply, a lot is going on across the wealth industry and the financial markets. This publication’s goal is to both ascertain the proverbial hand we have been dealt with respect to capital market, legislative, and wealth-specific developments, and also to share best practices across the domains in which our clients engage us. So far, 2013 has provided many opportunities for us to weigh in.

In this quarter’s centerpiece article, Mark Paccione provides some practical insight on behavioral finance, how it can adversely impact investors, and how we try to avoid psychological pitfalls that could otherwise hurt investment outcomes. Mark also wrote a second article; this one focused on opportunities within incomefocused investment vehicles following a substantial move higher in seemingly all things yield-related, given very low global interest rates.

John Curry, our head of marketing, linked up with a former colleague from Putnam Investments to address a series of questions related to recent tax legislation and its potential implications for client portfolio and tax management. With respect to the investing climate, Hunter Brackett weighs in on whether global stocks can deliver investors’ expected returns after a decade of frustrating results. Our central thesis is that global growth will remain subdued relative to “potential” growth.

Finally, I offer thoughts on global central bank policy, with a more globally interconnected world finding itself disconnected on what monetary effects we may see going forward.

The first quarter roared like a lion on many fronts, and as always, we strive to keep you updated on our thoughts across topics like the ones outlined above. If you were hoping we would address other issues, please don’t hesitate to growl. We want to hear from you.

Onward,

Eric J. Freedman CAPTRUST Chief Investment Officer

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continued from page 1

Figure Two: Investor Fund Flows and Market Performance for Calendar Year 2012 0.4%

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-0.1%

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-0.2% -4 -0.3% Fund Flows S&P 500

-0.4%

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-0.5%

-8 Jan

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fund inflows tend to increase after run-ups in the S&P 500.

Meanwhile, outflows tend to pick up after market sell-offs. For example, fund outflows in the first six months of 2012 were greatest at the S&P 500’s bottom, and fund inflows were greatest in December when the S&P was trading near year-highs.

Figure Two, which plots investor fund flows versus market performance for calendar year 2012, illustrates this point.

These trends seem illogical, yet they are explainable. Several behavioral biases play a role in contributing to the ill-timed investment decisions, including what psychologists call herding, confirmation bias, and loss aversion.

• Herding

is the tendency of individuals to follow the group’s actions. If everyone is buying and equity markets are going up, the individual investor is compelled to go along with the crowd. People tend to conform to the group because individuals believe it is unlikely the group is wrong.

The dot-com bubble in the late 90s and the more recent housing bubble are perfect examples.

• Confirmation

bias is the tendency to accept data that confirms existing beliefs — while rejecting data that contradicts them. With every market rally or decline, market participants (assisted by financial news outlets)

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Source: DALBAR

2 0.1%

Monthly Market Returns

0.2%

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Fund Flows as % of Total Assets

0.3%

Dec

assign a reason behind the latest capital market move, whether that reason is a recent economic data release, comments from an influential source, a corporate earnings release, or even the time of year. When equity indices are rising, individuals have a tendency to overemphasize the positive data points, while ignoring the negatives; when equity markets decline, individuals do just the opposite.

• Finally,

loss aversion is particularly detrimental to investors in market downturns. Research has shown that individuals prefer avoiding losses much more than experiencing gains.7 When equity markets correct, many individual investors reduce equity holdings in order to avoid further losses. In the long run, however, investors would be better served increasing equity holdings in a market downturn.

While the average mutual fund investor’s underperformance is understandable, there is a cure. Asset allocation — while not trendy and certainly not a new concept — can help overcome these behaviors. Asset allocation allows an investor to reduce overall portfolio risk by combining asset classes that do not move together in lockstep. CAPTRUST asset allocation models, for example, consist of a mix of U.S. equities, international equities, fixed income, commodities, real estate, and hedge fund strategies. The result is a continued on page 4

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portfolio that is not overly dependent on a single factor such as rising equity markets. In a decelerating economy where corporate earnings are suffering, equities may perform poorly. Meanwhile, traditionally safe investments like fixed income securities would likely do well and offset some of equities’ declines. If nothing happens and the financial markets move sideways, the investor collects interest and dividends. More importantly, an investor with a welldiversified portfolio can maintain a steady course, knowing that, even in volatile markets, some portion of his portfolio is doing well.

CAPTRUST has developed an investment process that helps compensate for these behavioral biases. The process

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starts with development of a strategic, long-term asset allocation plan. This strategic asset allocation acts as our compass, pointing us in the direction we have determined to go. However, we realize that the road is not always straight; our strategic asset allocation also includes predefined bands — like guard rails — that allow us some flexibility to shift portfolios when we see opportunity.

attempt to eliminate confirmation bias.

We want to make certain that investment decisions are based on all available data, not just data that confirms our initial views. Further, we hope to avoid any herding behavior and eliminate emotions from playing a key role in decision making by maintaining a spirited debate where all members are expected to contribute to the discussion, and take their turn playing devil’s advocate.

We accomplish several goals by changing the asset allocation within these bands. In severe equity market corrections, like the ones experienced in October 2008 or September 2011, it seemed like stocks would continue to fall without end. However, history has shown time and again that markets bottom, and all trends come to an end — all without warning. The bands ensure that we never deviate too far from our long-term heading. Second, by adjusting the asset allocation based on prevailing market conditions, we hope to avoid situations where we are forced to make emotional decisions.

The basic takeaway from the DALBAR study is clear. Without assistance, the average individual investor is fighting an uphill battle; however, with the help of asset allocation and a wellthought-out investment process, one can dampen or even eliminate many of the biases that contribute to long-term underperformance.

Our Capital Markets Committee is another part of CAPTRUST’s investment process that helps us avoid common behavioral biases. A group of committee members comprised of senior CAPTRUST investment professionals meets regularly to discuss markets, portfolio construction, and investment performance. Their lively discussions are fueled by primary research and empirical data in an

Sources: 1

DALBAR, Inc. Research & Communications Division. 2013 Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. March 2013, page 17.

2

Ibid.

3

DALBAR, Inc. Research & Communications Division. 2012 Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. April 2012, page 9.

4

Ibid.

5

Ibid, page 5.

6

DALBAR, Inc. Research & Communications Division. 2013 Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. March 2013, page 19.

7

Kahneman, D. and Tversky, A. (1984). “Choices, Values, and Frames.” American Psychologist 39 (4), pages 341–350.

WEALTH MANAGEMENT | Q1 13

wealth management planning

CAN EQUITIES GENERATE ACCEPTABLE RETURNS IN A SLOWER GROWTH ENVIRONMENT? Hunter Brackett, CFA Senior Manager, CAPTRUST Consulting Research Group

In recent years, financial publications ran ominous headlines such as “The Worst Economic Recovery in History” and “U.S. Hit by Weakest Postwar Rebound.”

While the headlines may appear sensationalist at first glance, the current U.S. recovery is, in fact, significantly weaker than prior ones. According to the Congressional Budget Office (CBO), since 2009, U.S. economic growth is less than half of the rate exhibited, on average, during other recoveries in the post-World War II era.1 As shown in Figure One, the current recovery is now in its fourth year since 2009, but U.S. Gross Domestic Product (GDP) growth is still below its long-term average. Likewise, the unemployment rate remains well above the Federal Reserve’s 6.5% target, although recent signs of improvement are encouraging.

Figure One: U.S. Real GDP Growth 1948-2018 10%

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Average=3.2%

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2%

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Source: Federal Reserve, Congressional Budget Office

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Figure Two: U.S. GDP and Potential GDP 2000–2023 $20 U.S. GDP Potential GDP

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$17 $16 Source: Congressional Budget Office

In Trillions of 2005 Dollars

$18

$15 $14 $13 $12 $11 $10 2000

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As illustrated in Figure Two, the CBO reports that U.S. GDP has been below its potential level (the CBO’s estimate of the maximum sustainable level of economic output) since 2008, and the gap is expected to persist until 2017.

If this phenomenon occurs, it would mark roughly a decade of U.S. output operating below its potential level.

The late economist Victor Zarnowitz, a leading scholar on business cycles, described the historical pattern in which deep recessions are usually followed by sharp recoveries. The current recovery has not followed this precedent due to both long-term demographic trends and cyclical factors.

A number of trends unrelated to the financial crisis could provide a headwind for long-term economic growth in the U.S. In particular, the U.S. working age population (typically ages 20 to 65) growth rate

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2008

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is declining as baby boomers retire, and cyclical factors related to the financial and housing crisis will likely dissipate as the recovery progresses.

Deleveraging is a drag on economic growth, but the household and financial sectors made considerable strides in reducing their debt-to-GDP ratios in recent years. In contrast, the government debt-to-GDP ratio continues to increase at a rapid pace and is currently at historic highs. The fiscal tightening that is necessary to address this issue, likely tax increases and spending cuts, could be a drag on U.S. economic growth. Meanwhile, the housing market normally plays an important role in economic recoveries by increasing consumer spending and net worth. Given the severe housing market decline, consumer net worth fell sharply and grew unusually slowly in recent years. In addition, the economy has been less responsive to

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2022

historically low interest rates due to the deleveraging process and tighter bank lending standards.

Despite the sluggish recovery, we see encouraging signs in coming years.

Referring back to Figure One, the CBO forecasts U.S. GDP growth to remain subdued in 2013 as the economy adjusts to fiscal tightening, but expects improvement in 2014 and beyond thanks to dissipating effects from the housing and financial crises.

Market observers expect housing to be a tailwind for the U.S. economy this year as housing starts and sales activity increase. Recent equity market gains provide another boost to consumer net worth, although this impact is more pronounced in higherincome households.

Despite the subdued economic recovery, we remain constructive on the capital market opportunity set and

WEALTH MANAGEMENT | Q1 13

believe traditionally riskier assets such as equities can still provide reasonable returns. Conventional wisdom states that stronger economic growth should lead to higher corporate profits and, therefore, better equity returns. However, this relationship does not always hold true. Although U.S. GDP growth remains below its long-term trend, equities posted solid returns in recent years, including a 16% total return for the S&P 500 in 2012 and a strong start to 2013.

and investors’ increased appetite for traditionally riskier asset classes. The Fed’s accommodative monetary policy provides investors an incentive to move away from lower-yielding asset classes. This incentive provides a further tailwind for equity returns, although we caution that it may not be sustainable over the longer term.

In our view, the combination of modest growth, contained inflation, and accommodative monetary policy provides a favorable environment for riskier asset classes. Some observers consider the current environment to be near the “sweet spot” for equity returns; the economy is growing fast enough to avoid another recession but not strong enough to spark inflation concerns and tighter monetary policy. If U.S. GDP growth follows the CBO’s projected path as in Figure One and the unemployment rate continues to improve, the Fed could begin to withdraw its accommodative monetary policy in the coming years. In that scenario, investors will have to weigh a more favorable economic outlook against tighter monetary policy, with an uncertain impact on equity returns.

Our capital market assumptions, which are based on a period of five to seven years, utilize the three building blocks to forecast equity market returns. We forecast a 7% return for U.S. large-cap equity and modestly higher returns for U.S. mid-, small-cap, and international equity. These return forecasts are mainly driven by earnings growth and dividend yields; we do not assume much benefit from valuation1 changes. Our 7% return assumption for U.S. large-cap equity, while reasonable relative to historical returns, is less than half of the 16% return posted last year. This further underscores the favorable backdrop that we are currently experiencing.

For more detail on our capital market assumptions, we invite you to read our newly published position paper, Capital Market Assumptions — Opportunities in a More Challenging Environment.

Equity returns are comprised of three building blocks: (1) expected earnings growth, (2) dividend yield, and (3) the impact from valuation changes. Many investors tend to focus on the first factor, but we believe that all three play an important role. While a sluggish recovery hampers revenue growth, earnings have proven resilient as companies reduced their cost structures during the recession. We expect earnings growth to gradually accelerate over the next few years, in line with our expectation for the trend in GDP growth. Dividend yield is an increasingly important component of equity total returns. In a slower-growth environment, companies tend to be more focused on returning capital to shareholders by way of increases and share buybacks supported by a high level of cash on corporate balance sheets. Finally, equities benefit from a positive valuation impact primarily due to monetary policy

Although we believe equities can continue to provide reasonable returns, we stress the importance of diversification, both within and among asset classes. Over the five- to seven-year period of our capital market assumptions, we expect equities to generate higher returns than other asset classes such as fixed income, but also exhibit higher volatility. Within equities, we see the strongest returns in U.S. mid- and small-caps as well as international equities, but with the trade-off of higher volatility relative to U.S. large-caps. Investors should consider their return objectives and risk tolerance when determining the amount and composition of equity exposure in their portfolios.

While the current environment is quite favorable for equities, we remain mindful of global macroeconomic risks that could reemerge such as the European sovereign debt crisis or an unexpected shift in U.S. monetary policy.

Source: 1

Congressional Budget Office. What Accounts for the Slow Growth of the Economy after the Recession? November 2012, pp. 1-4.

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SO NOW WHAT? INVESTMENT PLANNING IN THE NEW TAX ENVIRONMENT John D. Curry Senior Director, CAPTRUST Marketing

The fiscal cliff debate resolution may have averted an acute crisis at the beginning of 2013, but it didn’t provide a long-term fix for the United States’ chronic imbalance of revenues and spending.

The conversation has now shifted to the debt ceiling and how the mandatory spending cuts (known as the sequester) will be administered. Without a doubt, the country’s fiscal future remains cloudy and uncertain; however, the American Taxpayer Relief Act of 2012 (ATRA) does provide some fresh insight into the potential direction of future tax policy (see Figure One). While its impact will not be fully felt until this time next year, as taxpayers file their 2013 taxes, the time to plan is now. Our hope is that priming you with a few specific ideas will help you start conversations with your tax advisors. These are conversations you should have as soon as possible to help manage your income and, therefore, your 2013 tax picture.

This quarter we asked tax expert Chris Hennessey to provide his perspective on these recent developments. Chris is a tax attorney, certified public accountant, associate professor of law at Babson College, and advisor to Putnam Investments on wealth management topics such as tax, estate, retirement, and education planning. Chris recently joined us to answer questions and provide his thoughts on how CAPTRUST clients may want to adjust their thinking on a few topics to help manage their tax liability.

Figure One: Summary of Key Tax Developments

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Details

Who is Affected?

Social Security Payroll Tax

Increase from 4.2% to 6.2% (applies to wages and salary up to $113,700)

All taxpayers earning salary or wages

Ordinary Income Taxes

Highest marginal tax rate increases from 35% to 39.6%

Taxpayers with taxable income over $400,000 ($450,000 for couples)

Long-Term Capital Gains and Dividend Taxes

Maximum tax rate increases from 15% to 20%

Taxpayers with taxable income over $400,000 ($450,000 for couples)

Phaseout of Itemized Deductions and Personal Exemptions

Tax benefit of itemized deductions (mortgage interest, charitable donations, property taxes, state/local income taxes, etc.) and personal exemptions (e.g., dependent children) are reduced as income increases; itemized deductions are reduced as much as 80%; personal exemptions may be fully eliminated

Taxpayers with adjusted gross income (AGI) above $250,000 ($300,000 for couples)

Medicare Surtax

3.8% tax on investment income, including taxable interest, dividends, capital gains, rental income, royalties, the taxable portion of income from nonqualified annuities, and income from business activity where the taxpayer is not considered an “active” participant

Taxpayers with over $200,000 of modified adjusted gross income (MAGI), couples with more than $250,000 of MAGI; for trusts and estate, the income threshold is $11,950

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Source: Putnam Investments

Tax Area

WEALTH MANAGEMENT | Q1 13

Q: In general, how would you describe the impact of the tax provisions that go into effect this year?

Hennessey: The vast majority of taxpayers will notice little to no change in their 2013 taxes. The big changes will primarily impact taxpayers at the higher end of the income scale — which the administration defines as more than $400,000 of taxable income for individuals or $450,000 for couples filing jointly. Without thought and planning, those taxpayers may see some fairly significantly increases.

To put some numbers around the potential tax impact, taxpayers with investment income in the new highest federal income tax bracket go from paying 35% to 43.4% with the Medicare surtax included. But that’s not the whole story.

With the phaseout of itemized deductions, you should anticipate another 1 to 2%, so the spread is more like 35% to 45% — about a 10-percentage-point increase. The potential increase for these people means that the cost of failing to plan has gone up.

Q: It sounds like reducing taxable income becomes a priority. Can you offer a couple of tax planning strategies for our readers to discuss with their tax advisors?

Hennessey: Taking advantage of pre-tax savings accounts is probably the best place to start. 401(k)s, 403(b)s, individual retirement accounts (IRAs), nonqualified deferred compensation, flexible spending accounts (FSAs), and health savings accounts (HSAs) all become more important in a higher-tax-rate environment. I suggest higher-income families take a look at how they might use these accounts to reduce their taxable income, ideally to get it below the thresholds for the Medicare surtax, itemized deduction phaseout, or new top-end tax bracket. The tax savings could be significant.

For example, let’s take a look at a married couple with three children where both spouses work. The parents can max out their 401(k) plans for a total of $35,000. Then, they’ve got dependent care spending accounts for another $5,000, an HSA plan for $6,450 each, and, finally, FSA plans for another $2,500 each. That’s a lot of pre-tax savings, which will directly reduce their taxable income.

Another strategy involves managing the timing of gains and losses. I am not a fan of “rules of thumb” but, in the past, most tax advice suggested taking losses and deferring income and gains in an attempt to reduce current-year taxes.

Today, it’s a slightly different and somewhat more complex challenge. It will be more important to time the recognition of gains and losses to try to manage income below these thresholds. Taxpayers will want to match gains and losses, if possible. They may even want to take gains sooner — to “fill up” a lower bracket — if they anticipate their income will be higher in future tax years. This might be due to the pending sale of a business, expected stock option exercise, or required minimum distributions. This isn’t radically different thinking, but it is something to be mindful of.

Speaking of required minimum distributions, there is a provision in ATRA that allows individual retirement account owners over the age of 70½ to avoid taxes on their IRA distributions by making a direct transfer from the IRA to a qualified public charity. There is an annual limit of $100,000 on these transfers. continued on page 10

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Q: Changes like this always seem to affect some asset classes or investment vehicles more than others. Who are the winners this time?

Q: I know you don’t have a crystal ball, but I’m sure you have an opinion. What is your outlook for taxes and tax reform?

Hennessey: There are some pretty clear winners.

Municipal bonds are obvious ones. Their taxable equivalent yields go up with the higher tax rates.

Additionally, the 3.8% Medicare surtax doesn’t apply to income from municipal bonds. Growth stocks and growth-oriented mutual funds may also be winners since they are not intended to generate a lot of income.

Dividend-paying stocks may be somewhat negatively affected since the top tax rate for dividends is 23.8% compared to 15% previously, but I think many investors are simply relieved that dividends won’t be taxed as ordinary income.

Hennessey: It is very hard to predict these things, but a couple of things seem clear. Although this new law makes many formerly temporary tax rates and provisions permanent, it is still prudent for investors to prepare for a rising tax environment. Taxes are still relatively low by historical standards. Revenue as a percent of GDP is currently about 15.3%. Historically, that number has been around 18.5% — which might suggest that tax rates can go higher.

Annuities and life insurance potentially become more attractive under these new tax rules. Despite being funded with after-tax money, they offer tax advantages that might come in handy for investors who are looking to reduce their future taxable income.

Lastly, there are a number of strategies involving Roth accounts that may be worth exploring. Younger investors may want to set up a Roth account as a hedge against future higher tax rates. Others may want to consider a Roth conversion — or series of partial Roth conversions — to create a tax-free income source in retirement. Roths have some interesting features that make them fairly flexible for tax planning purposes.

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Second, given fiscal pressures in the U.S., it is very conceivable that additional legislation to address the federal budget deficit will be considered until we address mandatory spending on entitlement programs like Social Security, Medicare, and Medicaid. Against this backdrop, tax diversification, and tactical, tax-smart planning strategies and investment solutions will be critical.

WEALTH MANAGEMENT | Q1 13

LOOKING FOR YIELD IN ALL THE RIGHT PLACES Mark Paccione, CFA, CFP® Director, CAPTRUST Consulting Research Group

Figure One: 10-Year Treasury Yield 18% 16% 14% 12% 10% 8%

Source: Bloomberg

6% 4% 2% 0% 1955

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1965

Today, three things are certain: death, taxes, and rising interest rates. While this is said somewhat tongue in cheek, interest rates’ future path is presently a key topic in meetings with investment professionals and clients alike. The topic is especially pertinent for those investors reliant on fixed income and other yield-generating investments for income. Understandably, their common fear is that — with interest rates near all-time lows — rates will rise in the future causing bond investments to suffer, resulting in losses.

When investors refer to historically low interest rates, they are referring first and foremost to U.S. Treasury yields.

As Figure One demonstrates, interest rates are near historically low levels as measured by the 10-year U.S. Treasury.

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The 10-year yield reached a low of 1.39% last July before rebounding to its current level of just under 2%, as equity markets rallied over that same time period. CAPTRUST believes the trend will continue, and interest rates will move higher over time; however, some perspective is in order.

First, we expect interest rates to gradually move higher going forward.

In this scenario, yield may offset the decline in underlying bond prices, meaning that fixed income investments can still deliver positive total returns.

CAPTRUST research has shown that fixed income total returns were, in fact, positive over past gradual rising rate environments. Second, at the security level, the only way to lose money on a bond purchased at issue and held to

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maturity is via default. This fact is often forgotten when discussing fixed income in the current environment. If, for example, a client buys a bond at issue and interest rates spike right after the bond purchase, the bond’s price may immediately drop; however, if the client holds the bond to maturity and does not default, the investor will continue to collect yield for the bond’s life and earn a positive total return, regardless of interest rate moves after the purchase. While this example neglects any negative impact from trading or inflation and ignores the opportunity cost of not investing in a bond at a higher interest rate, it does highlight fixed income investments’ lower risk of permanent capital loss.

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Figure Two: BBB Corporate Spread

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Sources: Bank of America, Merrill Lynch, 2013 research.stlouisfed.org

9% Shaded areas of the graph indicate

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a time of recession

6% 5% 4% 3% 2% 1% 0% 1997

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More relevant to investors seeking portfolio income are non-Treasury fixed income instruments such as municipal securities, investment-grade corporate bonds, high-yield fixed income, and mortgage bonds. Municipal bonds remain attractive today with 10-year, AAA-rated general obligation bonds hovering around 2%. Historically, municipal bonds have traded at a premium to Treasurys due to their tax treatment; however, since 2008, they have traded at a discount and continue to do so, albeit at a smaller discount than several years ago. Further, recent increases in federal tax rates, combined with tax increases in some states, make the favorable tax treatment municipal bonds receive more valuable today than several months ago.

Corporate bonds, both investment grade and high yield, trade at spreads over Treasurys as investors demand more compensation for bearing higher default risk. While spreads have come down over time, many remain above pre-2008 levels as indicated by the BBB corporate bond chart (Figure Two) above. If the economy continues to grow as expected, corporate balance sheets should continue to improve and spreads should contract further, which would help offset the expected concurrent rise in interest rates.

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However, a word of caution is in order. Investors should pay attention to duration — a measure of interest rate sensitivity.

Duration reveals the sensitivity of the value of a fixed income investment, like a bond or bond portfolio, to a change in interest rates. The higher the duration, the greater the sensitivity to rate changes, and vice versa. For example, if a bond has a duration of five years, a 1% increase in rates would cause the value of the bond to decline by approximately 5%.

Conversely, a 1% decline in interest rates would cause the bond’s value to go up by about 5%. With interest rates grinding higher, we have taken steps to reduce duration in clients’ portfolios in an effort to decrease interest rate sensitivity. As a reference, the Barclays Aggregate Bond Index — a broad measure of the fixed income market — has a duration of 5.30 years. For CAPTRUST discretionary relationships, we are presently targeting portfolio duration below four years.

Another area of the fixed income market that has done well is the non-agency mortgage market, which consists of mortgages not insured by the federal government. After the housing bubble burst in 2008, non-agency mortgage bonds sold off to trade at discounts. As the housing market and economy have improved, the price of mortgage bonds has also improved,

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banks can borrow funds from other banks. As prevailing market interest rates fluctuate, floating rate bonds’ coupon payments change as well. Because the coupon payment fluctuates, floating rate bond prices exhibit low sensitivity to interest rate changes, making them attractive in a rising-rate environment.

Non-fixed income investments, including dividend-paying stocks, Master Limited Partnerships (MLPs), and Real Estate Investment Trusts (REITs) continue to perform well, trading more in line with equity markets than fixed income markets.

For example, the Dow Jones Select Dividend Index — an index of dividend-paying stocks — was up 11.78% in the first quarter of 2013, compared to 10.61% for the S&P 500.

Given the index’s exposure to utilities, it is surprising to see such outperformance over the S&P 500, which includes traditionally higher-beta sectors such as technology. The Alerian MLP Index returned an impressive 19.74% in the first quarter. With low interest-rate sensitivity and the possibility of capital appreciation, non-fixed income yield investments may be of interest to investors seeking yield, while mitigating overall interest rate sensitivity. although many still trade at a discount. Should the economy and housing market continue their rebounds, non-agency mortgage bonds should do well, although not as well as the past few years. One added benefit of non-agency mortgages is the fact that most non-agency mortgages trade at a discount, so the risk of an individual bond being called away is low.

Going forward, floating rate bonds will be an interesting fixed income market subset to watch. Floating rate bonds are comprised of bundles of bank loans made to corporations usually with below-investment-grade credit ratings. These loans typically have seniority in a firm’s capital structure and the highest claims to a borrower’s assets in the event of default. Unlike traditional bonds with a fixed coupon rate, floating rate bonds’ interest payments are based on an underlying floating reference rate such as the London Interbank Offered Rate (LIBOR), the interest rate at which

Investors are flocking to investments in these categories, perhaps indicating that money is moving from traditional fixed income into non-fixed income yield investments. While this may make long-term sense given yields near historical lows and equity markets near all-time highs, investors should exercise caution as many of these instruments trade like traditional equities in declining markets and with significantly more volatility than core fixed income.

While concerns about rising interest rates are not entirely unfounded, we expect interest rates to move higher only gradually. In this kind of environment, fixed income investments can still deliver positive total returns. Further, by creating a portfolio with a variety of income-generating securities that respond to varying factors and market conditions, investors can enjoy a portfolio that generates income, while minimizing exposure to risk.

13

portfolio Strategy

THE COUNTERFACTUAL Eric J. Freedman CAPTRUST Chief Investment Officer

Early in my business school tenure, the recently retired Dr. David Crawford began the first day of our Managerial Economics class by asserting that the world consisted of three groups of people, and these three phyla were mutually exclusive and collectively exhaustive. The first group included engineers, physical scientists, and general numerate and facile individuals Crawford affectionately dubbed “gearheads.”

Crawford assigned accountants and controllers to a second order titled “bean counters,” prompting smiles among several of my classmates with corporate treasury roles. “The rest of you,” exclaimed Crawford, “are poets.” Raising his voice for effect, Dr. Crawford boomed: “And poets do not do well in my class!” Unsure of how to react, 130 classmates simultaneously self-assessed their newly anointed labels. While some nervous laughter followed, Crawford’s intense-yet-stoic face made it clear the man meant business.

14

that my jeans would be looser each November if I didn’t help my children eat their Halloween candy is a counterfactual; perhaps my waist expanded due to some other reason (or, as the optimist in me hopes, maybe the jeans themselves shrank!). The philosopher and professor Nassim Nicholas Taleb calls these events “potential histories” and argues that when thinking about potential histories before an outcome occurs (in my case before the Snickers bar passed my lips), one must take into account that the actual outcome is likely to be a lot different than one expects.1 Said another way, forecasting is subject to large deviations from perception.

The most significant counterfactual in today’s capital market environment surrounds global monetary and central bank policy, with investors thinking about potential histories that may evolve should the Federal Reserve or other central banks scale back their recent pro-growth policies. Put more simply, do we need the Fed and its global peers to keep printing money and buying assets in order for riskier asset classes to deliver returns?

Applying data-driven thinking about what the world will look like after easy-money policies is a challenge for professional investors; we simply haven’t been here before on a global scale.

My classmates and I now joke that even our Leadership and Public Communications courses were highly quantitative.

Our alma mater emphasized the need for evidence-based, data-driven conclusions; half-baked hypotheses and unconfirmed solutions were anathema. We were trained to use data whenever possible to confirm or refute claims that are too often evaluated through loose associations. As my marketing professor Dr. Eric Bradlow frequently reminded us as we sifted through analyses, “The math does not lie.”

Since 2007-08, central banks have implemented several policies designed to offset anemic consumer trends, reducing key interest rates and purchasing assets in the open market (via programs like quantitative easing) to help stimulate borrowing. Figure One shows five major central banks’ respective balance sheets, with each moving from the “lower left to the upper right” as banks have purchased sovereign bonds, mortgages, and other assets to try to keep rates down and spur economic output. Six years later, the world is in a very uneven place from a growth perspective, and differing regional responses highlight these variations.

Across disciplines, we spent considerable time pondering what psychologists call the “counterfactual” — loosely defined as what series of events would have transpired had a certain action occurred or not occurred. For example, me stating

In some regions, central bank activity can be characterized as consistent with recent policymaker activity. A centrally planned economy enduring growing pains in the form of property price volatility and high disparities between rich

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WEALTH MANAGEMENT | Q1 13

Figure One: Select Central Bank Assets (in millions) 2007–2012 $6,000,000 U.K. Monetary Policy Committee

$5,000,000

European Central Bank Bank of Japan U.S. Federal Reserve

$4,000,000

People's Bank of China

Source: St. Louis Fed, Bloomberg

$3,000,000

$2,000,000

$1,000,000

$0 2007

2008

and poor, China continues to offer the market mixed signals about its monetary policy intentions, thus retaining a somewhat neutral positioning relative to some of its peers. The European Central Bank (ECB) has also been in a holding pattern despite weak economic growth; Europe’s GDP dropped by 0.6% in the fourth quarter of 2012, with even the venerable Germany seeing its economy contract by the same amount, yet ECB President Mario Draghi has not budged on stimulus measures.

Two major economies that appear to be in transition are the U.S. and the U.K., although they are seemingly heading in opposite directions. The latest U.K. Monetary Policy Committee (MPC) meeting revealed that the MPC, which is currently engaged in a stimulus program where the Bank

2009

2010

2011

2012

of England maintains a stock of £375 billion in asset purchases, was split on maintaining that asset purchase level with three of nine committee members (including outgoing leader Mervyn King) requesting even more asset purchases.2 In the U.S., where central bankers have committed to purchasing $85 billion per month in mortgage and Treasury bonds until the labor market improves, recent Fed-watch chatter has centered on when the Fed may start to scale back its purchases. While Fed Chairman Ben Bernanke has been adamant about a “full steam ahead” orientation, other Fed officials have been more tempered in their public appearances.

Abe campaigned on a platform of bold new action, and his newly installed Bank of Japan Governor Haruhiko Kuroda said he would do “whatever is needed” to combat persistent deflation.3 The central bank surprised markets in early April, communicating a two-year plan to reverse deflation with asset purchases on a large scale (the total size was nearly twice what prognosticators thought) and scope (asset purchases will not be limited to the bond market). Markets anticipated Abe’s accommodative policies, helping push the Nikkei stock index up more than 40% from mid-November 2012 to early April as the yen plummeted.

Japan recently switched to “full steam ahead” to the third power, committing to an aggressive monetary policy path after a decades-long economic malaise.

Newly elected Prime Minister Shinzo

While central bankers cite economic growth as the end stimulus goal, it is important to make the distinction between economic growth and asset price returns (e.g., equity market

continued on page 16

15

continued from page 15

returns); several studies have analyzed long-run capital market and economic growth statistics and found very little relationship between GDP growth and stock market returns over time.4 The recent Japanese experience reflects these findings.

Japanese economic fundamentals did not improve by more than 40% in the last four and a half months, and the Japanese equity market began its ascent long before Abe and Kuroda communicated their plan. Instead, market perceptions about future easy-money policies took over, driving riskier asset classes higher before their efficacy is even proven. Similarly in the U.S., since 1994, “there has been a large and statistically significant excess return on equities on days of scheduled FOMC (Federal Open Market Committee) announcements,” according to a 2012 New York Fed staff report conducted

by David Lucca and Emanuel Moench, providing empirical evidence that central bank policy moves markets.5 Seemingly, understanding the linkage between central bank policy and asset class returns is more important than what bearing central bank policy may have on broad economic growth. Or is it?

Since central bank policy and economic growth are linked in the eyes of policy makers, and central bank policy and riskier asset class returns are empirically linked, by implication we may be in a period where economic growth and riskier asset class returns demonstrate a relationship, although they could move in opposite directions.

If economic growth returns in earnest, central banks like China and the U.S. may be reticent

to push forward with or continue stimulative policies, which could hurt stock prices if investors view policy makers’ easy-money departure as premature. If growth is weaker than expected or desired, central banks may step up asset purchases and other easy-money policies, supporting riskier asset classes. In other words, seemingly good economic news may be interpreted as bad for equity prices if markets don’t perceive it to be good enough. This, of course, assumes reasonable expectations for corporate profits and riskier asset class valuation doesn’t get out of hand.

So, what is our investment strategy in a world with a few too many potential histories? What counterfactuals should we focus on to benefit client outcomes, and will markets be driven by perceptions about future actions or more focused on the present? In addition to an intense focus on valuation, we continue to center on central bank policy, leading economic indicators, and market psychology. We see the glass as half full for asset classes to ascend higher, and we do not share the consensus view that interest rates will be on a potentially quick upward trajectory, hurting bondholders as they rise. Given how uneven the world is — and potential histories subject to central banks treading where the data has not yet traveled — gearing for more growth, while being respectful of downside potential, particularly after such strength across many asset classes since late 2012, is our baseline mindset heading into the second quarter, a mindset we deem appropriate for gearheads, bean counters, and poets alike.

Sources: 1

Taleb, Nassim Nicholas. The Future Has Thicker Tails than the Past: Model Error as Branching Counterfactuals (May 23, 2011). NYU Poly Research Paper. Available at SSRN: http://ssrn.com/abstract=1850428 or http://dx.doi.org/10.2139/ssrn.1850428

16

2

http://www.bankofengland.co.uk/publications/minutes/Documents/mpc/pdf/2013/mpc1303.pdf

3

http://www.nytimes.com/2013/03/05/business/global/05iht-yen05.html

4

See for example Inker, Ben. Reports of the Death of Equities Have Been Greatly Exaggerated (GMO White Paper, August 2012).

5

http://libertystreeteconomics.newyorkfed.org/2012/07/the-puzzling-pre-fomc-announcement-drift.html

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WEALTH MANAGEMENT | Q1 13

index returns

2000 1996

2001 1997

2002 1998

2003 1999

2000 2004

2005 2001

2006 2002

2003 2007

2004 2008

2009 2005

2006 2010

2007 2011

2008 2012

YTD YTD 2013

Commodities

Real Estate

Commodities

Small Cap Stocks

Real Estate

Commodities

Real Estate

International Equities

Fixed Income

International Equities

Real Estate

Real Estate

Real Estate

Mid Cap Stocks

35.92%

17.12%

5.24%

42.14%

28.48%

8.69%

17.77%

12.96%

Cash

Mid Cap Stocks

Small Cap Stocks

Fixed Income

International Equities

Small Cap Stocks

40.48%

26.85%

7.84%

17.39%

12.39%

31.84%

12.83%

Real Estate

Fixed Income

26.81% Fixed Income

25.90%

Fixed Income

Mid Cap Stocks

Real Estate

Mid Cap Stocks

Mid Cap Stocks

Mid Cap Stocks

Small Cap Stocks

Fund of Funds

Fund of Funds

Real Estate

Mid Cap Stocks

Large Cap Stocks

Mid Cap Stocks

Large Cap Stocks

3.64%

40.06%

20.22%

12.65%

18.37%

10.26%

-21.34%

28.61%

25.48%

1.50%

17.28%

10.96%

Cash

Real Estate

Small Cap Stocks

Real Estate

Large Cap Stocks

Fixed Income

Small Cap Stocks

Cash

Large Cap Stocks

Real Estate

16.42%

8.07%

2.79%

Cash

Small Cap Stocks 2.49%

Fund of Funds

Mid Cap Stocks

4.08%

-5.62%

Small Cap Stocks

Large Cap Stocks -12.45%

Large Cap International Stocks Equities -7.79%

1.51%

Cash

8.25%

-3.02%

International International International International Commodities Equities Equities Equities Equities 16.23% 27.16% 41.41% 17.11% 21.36%

10.25%

Fund of Funds

6.36%

31.49%

8.44%

3.64%

11.63%

47.25%

21.36%

-19.50%

1.68%

36.74%

18.33%

12.13%

15.46%

Fund of Funds

Large Cap Stocks

Large Cap Stocks

Fund of Funds

Mid Cap Stocks

1.01%

29.89%

11.40%

7.45%

15.26%

International Large Cap Commodities Commodities Equities Stocks 9.15% 23.93% -14.67% 6.27% Mid Cap Stocks

Fund of Funds

Fund of Funds

-16.19%

11.62%

6.79%

Small Cap Stocks

Fixed Income

Fixed Income

-20.48%

International Large Cap Commodities Equities Stocks -19.51% -15.11% -21.65%

4.10%

Small Cap Stocks

4.34%

4.55%

Cash 3.35%

Fixed Income

Cash

Cash

1.05%

1.44%

6.97%

-33.79%

Large Cap Small Cap Commodities Stocks Stocks -35.65% 5.77% 27.17%

Fund of Funds

Mid Cap Stocks

10.34%

5.60%

Cash

Cash

5.08%

4.71%

Fixed Income

Small Cap Stocks

Mid Cap Stocks

Small Cap Stocks

Fund of Funds

16.10%

-1.55%

16.35%

3.46%

Small Cap Stocks

Fund of Funds

International Equities

-4.18%

4.79%

3.27%

Real Estate

Fund of Funds

Fixed Income

Fund of Funds

Fixed Income

-37.97%

11.16%

6.54%

-5.51%

4.22%

Mid Cap Stocks

Fixed Income

Fund of Funds

Commodities

Cash

-13.32%

0.11%

-1.57%

-41.46%

Commodities

Real Estate

International Equities

2.07%

-16.82%

0.10%

Large Cap Stocks

International Large Cap Commodities Equities Stocks 18.91% 11.60% -37.60%

4.33%

2.43%

Large Cap Commodities Stocks 16.83% 28.43%

-45.25%

5.93%

5.46%

Cash

Cash

0.21%

0.13%

Cash 0.02%

Fixed Income -0.12%

International Commodities Commodities Equities -1.06% -1.13% -13.33%

Small-Cap Stocks (Russell 2000 Index)

Real Estate (MSCI U.S. REIT Index)

International Equities (ACWI Ex-U.S. Index)

Large-Cap Stocks (Russell 1000 Index)

Fund of Funds (HFRI FoF Composite Index)

Fixed Income (Barclays Capital U.S. Aggregate Index)

Commodities (Dow Jones UBS Commodity Index)

Mid-Cap Stocks (Russell Mid-Cap Index)

Cash (Merrill Lynch 3-Month Treasury Bill)

Sources: Markov Processes Inc., Bloomberg, Mobius

2013 1ST QUARTER ASSET CLASS RETURNS

2013 1ST QUARTER INDEX PERFORMANCE Q1 ’13

YTD ’13

2012

2011

2010

2009

2008

1-YEAR

3-YEAR

5-YEAR

S&P 500

10.61%

10.61%

16.00%

2.11%

15.06%

26.46%

-37.00%

13.96%

12.67%

5.81%

10-YEAR 8.53%

Dow Jones Industrial Average

11.93%

11.93%

10.24%

8.38%

14.06%

22.68%

-31.93%

13.37%

13.32%

6.50%

8.94%

8.21%

8.21%

15.91%

-1.80%

16.91%

43.89%

-40.54%

5.69%

10.86%

7.47%

9.31%

10.96%

10.96%

16.42%

1.50%

16.10%

28.43%

-37.60%

14.43%

12.93%

6.15%

8.97%

Russell 1000 Growth

9.54%

9.54%

15.26%

2.64%

16.71%

37.21%

-38.44%

10.09%

13.06%

7.30%

8.62%

Russell 1000 Value

12.31%

12.31%

17.51%

0.39%

15.51%

19.69%

-36.85%

18.77%

12.74%

4.85%

9.18%

Russell Mid-Cap Index

12.96%

12.96%

17.28%

-1.55%

25.48%

40.48%

-41.46%

17.30%

14.62%

8.37%

12.27%

Russell 2000

12.39%

12.39%

16.35%

-4.18%

26.85%

27.17%

-33.79%

16.30%

13.45%

8.24%

11.52%

Russell 2000 Growth

13.21%

13.21%

14.59%

-2.91%

29.09%

34.47%

-38.54%

14.52%

14.75%

9.04%

11.61%

Russell 2000 Value

11.63%

11.63%

18.05%

-5.50%

24.50%

20.58%

-28.92%

18.09%

12.12%

7.29%

11.29%

NASDAQ Composite Russell 1000

AC World Index Free Ex-U.S.

3.27%

3.27%

17.39%

-13.33%

11.60%

42.14%

-45.24%

8.87%

4.87%

0.07%

11.41%

HFRI Fund of Funds

3.46%

3.46%

4.79%

-5.72%

5.70%

11.47%

-21.37%

4.88%

2.13%

-0.22%

3.86%

Wilshire REIT Index

7.43%

7.43%

17.59%

9.24%

28.60%

28.60%

-39.20%

14.02%

17.35%

6.32%

12.23%

Barclays Govt. Intermediate Bond

0.14%

0.14%

1.73%

6.08%

4.98%

-0.32%

10.43%

2.26%

3.91%

3.70%

4.02%

Barclays Corporate IG Bond

-0.11%

-0.11%

9.82%

8.15%

9.00%

18.68%

-4.94%

7.47%

8.12%

7.88%

6.05%

Barclays Aggregate Bond

-0.12%

-0.12%

4.22%

7.84%

6.54%

5.93%

5.24%

3.77%

5.52%

5.47%

5.02%

Barclays Intermediate Govt./Credit

0.26%

0.26%

3.89%

5.80%

5.89%

5.24%

5.08%

3.53%

4.75%

4.61%

4.49%

Barclays Muni Bond

0.29%

0.29%

6.78%

10.70%

2.38%

12.91%

-2.47%

5.25%

6.23%

6.10%

5.01%

Barclays High Yield

2.89%

2.89%

15.81%

4.98%

15.12%

58.21%

-26.16%

13.13%

11.24%

11.65%

10.12%

90-Day U.S. Treasury

0.02%

0.02%

0.11%

0.10%

0.13%

0.21%

2.06%

0.12%

0.11%

0.34%

1.75%

1.25%

1.25%

1.74%

2.96%

1.50%

2.72%

0.09%

1.34%

2.22%

1.71%

2.35%

Consumer Price Index (Inflation)

Sources: Morningstar, Mobius, MPI

INDICES

The information contained in this report is from sources believed to be reliable, but are not warranted by CAPTRUST Financial Advisors to be accurate or complete. Index performance depicts historical performance and is not meant to predict future results.

17

CAPTRUST Discretionary research highlights

U.S. EQUITIES • We have carried a bullish posture on U.S. stocks over the

• We continue to view the U.S. as the most attractive global

past year, emphasizing growth-focused sectors and a bias

equity market and will likely deploy more capital there

toward large- over mid-cap and small-cap based on more

should we see some spring weakness similar to the last

attractive fundamental attributes, particularly valuation.

• Our bias has been to avoid rebalancing our stock exposure through the recent upturn in equities, but we

few years. Our attention remains on Federal Reserve policy as well as corporate earnings momentum, two key equity market factors that could oscillate in coming months.

have recently shored up our sector exposures, deploying a more balanced orientation but still favoring large-cap and high quality.

INTERNATIONAL EQUITIES • Growth prospects have improved across several regions

or additional financial system stress unhinge the potential

relative to this time last year, but we remain concerned

for a “muddle through” type of recovery. Recent concerns

about Southern Europe as well as more sluggish

about whether Spain or Italy will submit to more stringent

performance in emerging market equities, which are

fiscal measures could continue to cast a shadow over

down on the year through the end of Q1 thanks to an

European stocks, and Cyprus serves as a stark reminder

unflattering combination of higher inflation prospects but

that the banking sector is fragile.

less economic growth magnitude.

• We see the emerging market opportunity as potentially • Valuation is somewhat attractive from a historical

compelling on a relative basis versus Europe, and recent

standpoint; however, valuation metrics could prove

Japanese monetary policy activity has sparked a sharp

irrelevant should the European Union’s structure unravel

rally that could endure beyond the recent reaction.

FIXED INCOME • We de-emphasized fixed income in the second half of 2010,

• Active management continues to be our preferred

despite anticipating further federal stimulus in the form of

access method, although we have decreased our overall

quantitative easing and open market bond purchases.

fixed income weighting within portfolios, feeling better opportunities lie elsewhere. We do not anticipate a

• We increased our weighting to fixed income during mid-2011, incorporating a diversified approach by sector and geography using a combination of active and passive management. We expected a few persistent themes to endure within the space that are accessible via highly skilled managers and were pleased with those results.

18

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sudden and persistent move higher in interest rates, but we remain wary of a more gradual grind upward. By no means are we abandoning the asset class but instead are taking on a more global perspective with our exposure.

WEALTH MANAGEMENT | Q1 13

HEDGE FUNDS / PRIVATE EQUITY • Hedge fund strategies have had a challenging backdrop in

the start of this year, we opted for more directional hedge

which to operate over the past three years given market

fund strategies that would capture more potential upside

oscillations, yet we see investment merit in certain hedge

in riskier asset classes.

fund sub-strategies, particularly those that are less reliant on overall market direction.

• One of the challenges in a “risk on, risk off” investment environment is finding hedge fund solutions that display

• We had emphasized a more conservative hedge fund orientation recently with a goal of preserving capital

low correlation to other asset classes, and we are currently gauging the existing opportunity set in light of that need.

during large down periods in riskier asset classes, but at

COMMODITIES • We remain long-term bullish on commodities due not

• We have recently de-emphasized actively managed

only to the demand story but also because of a lack of

strategies with the view that commodities present

infrastructure investment across many key commodities,

considerable challenges for most active managers to

but we acknowledge that recent price weakness has

successfully navigate. Correlations between commodities

been disappointing.

and more “crowded” active manager positions leave us happy to invest in broad commodity mandates and

• Given the challenging macroeconomic environment and the potential for further growth scares, we expect to see considerable volatility within commodities. We would like

control the overall exposure levels versus leaving that to an active manager. Commodities remain a small portfolio component for us right now.

to see commodities decouple from equity returns and give investors more of a correlation boost than we have experienced since the financial crisis.

REAL ESTATE • We added to real estate positions in mid-2010 based on

• Recent capital-raising success across the REIT complex in

improved fundamentals as well as attractive yields given

late 2011 through 2012 and in early 2013 leaves operators

subdued interest rates.

poised for opportunistic purchases and increased flexibility, but we remain watchful of investors chasing

• In a low-yield world, REITs retain a strong distribution profile while offering some growth potential, an attractive combination for a variety of investors that should provide

what has been a strong asset class since the financial crisis. Liquidity is clearly better, but we retain a watchful eye on valuation and loan quality.

an underlying bid to the space. However, valuation metrics appear to be on the richer side, with REITs delivering a strong 2012 total return.

The foregoing comments demonstrate our firm’s strategic and forward-looking views as they are implemented in cases where clients have contractually granted CAPTRUST sole tactical discretion over portfolio decisions.

19

investment asset classes

U.S. EQUITIES Market Performance, 1st Quarter 2013

• U.S. stocks closed at record levels in the first quarter. U.S. large-cap stocks rose 10.6%, shrugging off calendar 2012 Q1-13

2012

Large Value (R1000 Value)

12.31%

17.51%

Large Blend (S&P 500)

10.61%

16.00%

2012 momentum, once again leading their small- and

Large Growth (R1000 Growth)

9.54%

15.26%

large-cap peers in total returns.

Mid Value (Russell)

14.21%

18.51%

Mid Blend (Russell)

12.96%

17.28%

Mid Growth (Russell)

11.51%

15.81%

Small Value (R2000 Value)

11.63%

18.05%

Small Blend (R2000 Blend)

12.39%

16.35%

Small Growth (R2000 Growth)

13.21%

14.59%

year-end fiscal cliff concerns. Mid- and small-caps were up 13% and 12.4%, respectively. Mid-caps continued their

• All 10 major S&P 500 sectors were positive in the first Source: MPI Stylus Pro

quarter, but surprisingly the best sectors were historically defensive in nature. Health care (+15.8%), consumer staples (+14.6%), and utilities (+13%) were sector leaders, while traditionally higher beta sectors like technology (+4.6%) and materials (+4.8%) lagged.

• Since the U.S. equity market touched its March 2009 low, large-caps, mid-caps, and small-caps are up 153%, 204%, and 193%, respectively, including reinvested dividends.

INTERNATIONAL EQUITIES Market Performance, 1st Quarter 2013

• Developed and emerging international equities had mixed performance to start the year, with developed up 5.23% in Q1-13

2012

International Equities (MSCI EAFE)

5.23%

17.90%

The developed-equity-focused MSCI EAFE Index has

Pacific Stocks (MSCI Pacific Ex-Japan)

7.05%

24.74%

been higher 13 out of the last 16 quarters, while the MSCI

European Stocks (MSCI Europe Ex-UK)

3.01%

22.54%

Japanese Stocks (MSCI Japan)

11.70%

8.36%

UK Stocks (MSCI UK)

2.49%

15.30%

Emerging Markets (MSCI EME)

-1.57%

18.63%

Source: MPI Stylus Pro

U.S. dollar terms but emerging market stocks down 1.6%.

Emerging Markets Index has been higher 12 out of the last 17 quarters.

• Japan was a significant outlier within developed equities, closing up 11.7% in dollar terms but almost twice that percentage in yen terms. Market participants anticipated aggressive monetary policy from new Japanese central bank leadership, which arrived after the quarter ended. European performance was mixed in the quarter with Cyprus-driven fears subsiding toward the quarter’s conclusion.

• Emerging markets were noticeably weak for the quarter with China (-4.5%), Russia (-3.2%), India (-2.6%), and Brazil (-0.8%) all posting negative returns as investors questioned growth trajectory after the sharp equity market run-ups in 2012 for most emerging market indices.

20

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WEALTH MANAGEMENT | Q1 13

FIXED INCOME Market Performance, 1st Quarter 2013

• The Barclays Aggregate Bond Index fell for only the second quarter out of the past 18, shedding a mere 0.1%.

2012

Broad Market (Barclays Capital U.S. Aggregate)

-0.12%

4.22%

Barclays Capital U.S. Treasurys

-0.19%

1.99%

Barclays Capital Mortgage Backed Securities -0.05%

2.59%

Barclays Capital Municipals

0.29%

6.78%

Barclays Capital Intermediate Corporates

0.57%

8.84%

Barclays Capital High Yield

2.89%

15.81%

The index has not had a negative annual return in 13 years.

• Within the broad fixed income space, historically riskier Source: MPI Stylus Pro

Q1-13

parts of the bond market were mixed this past quarter, despite the run-up in global stocks, with emerging market debt falling 1.5% but high yield rising almost 3%.

Treasurys, investment-grade corporates, and mortgages were mostly flat.

• Despite relentless calls for interest rates to rise and a “great rotation” out of bonds following a nearly 40-year bull market, early 2013 fund flow data suggests that bond flows remain sticky with investors continuing to allocate net new capital into the asset class.

HEDGE FUNDS / PRIVATE EQUITY Market Performance, 1st Quarter 2013

• Hedge fund strategies posted a solid start to 2013, with the HFRX Global Hedge Fund Index posting a 3.3% return 2012

HFRI Fund Weighted Composite Index

2.86%

6.38%

HFRI Equity Hedge Index

3.47%

7.42%

HFRI Relative Value Index

3.68%

10.59%

HFRI Fund of Funds Composite Index

2.34%

4.79%

HFRI Fund of Funds Conservative Index

1.65%

4.21%

through the end of March.

• Global macro remained a challenging subcategory after losing 1% for 2012 and registering weak 2010 and 2011 Source: HFRI

Q1-13

calendar years as global central bank policy and unstable trends plagued managers. Equity-hedged strategies were strong in the first quarter with returns comparable to long-only global equity indices.

• Alternatives research firm Prequin highlights that private equity fundraising was strong for the first quarter, with total capital raised expected to be similar to 2012’s first quarter. Based on survey data, it appears interest in large- to mega-market deals is increasing, as is interest in secondary funds.

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COMMODITIES Market Performance, 1st Quarter 2013 Q1-13

2012

Dow Jones UBS Commodity Index

-1.13%

-1.06%

S&P GSCI Commodity Index

0.55%

0.08%

-4.62%

6.33%

Natural Gas (U.S. Spot Henry Hub)

11.67%

14.95%

Crude Oil (U.S. Spot, WTI Cushing)

5.89%

-7.09%

Gold (Spot, $/oz)

Sources: MPI Stylus Pro, Bloomberg

• The Dow Jones UBS Commodity Index fell 1.1% in the first quarter after a disappointing 2011 and 2012. Dollar strength did not help the broad index to start 2013.

• At the sub-index level, energy was strong thanks to a mid-quarter rally in oil and natural gas strength. Industrial metals fell 7.8%, agriculture dropped 3.2%, and livestock fell 6.4%.

• Precious metals were also hit by dollar strength with the index falling 5.5% after posting a 6% return in 2012.

Individually, silver and gold flirted with bear territory as both metals have fallen close to 20% from all-time highs.

Market Performance, 1st Quarter 2013 Q1-13

2012

MSCI U.S. REIT Index

8.07%

17.77%

Wilshire REIT Index

7.43%

17.59%

Source: MPI Stylus Pro

REAL ESTATE • Public real estate, as measured by the NAREIT Equity REIT index, increased 8.1% in the first quarter after returning 3.1% in Q4 2012. REITs underperformed U.S. equities for only the third quarter out of the last eight.

REITs are up a staggering 204.6% cumulatively over the past 10 years.

• Capital raising continues to be robust for REITs, with NAREIT data showing that REITs raised $22.6 billion of total capital thus far in 2013, with $16.1 billion in equity.

This total exceeds the capital amounts raised in the fourth quarter of 2012 as well as the first quarter of last year.

• Several REIT subsectors exhibit attractive fundamentals based on changes in buyer behavior, but cap rates and other valuation metrics reflect strong REIT performance coming out of 2012 and into the new year.

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WEALTH MANAGEMENT | Q1 13

captrust news

CAPTRUST GROWTH CAPTRUST started 2013 with a new addition to our advisory team in Clarkston, Michigan.

Mary Draayer joined CAPTRUST as a Financial Advisor, Relationship Manager, and is responsible for building relationships and meeting existing client needs in the institutional retirement market. Prior to joining our firm, she worked at the Principal Financial Group as senior relationship manager for over 30 years. Mary studied accounting at Iowa State University.

RECOGNITION

GIVING BACK

Ronald McDonald House, February 2013

We are honored to have helped support these charities throughout the first quarter of 2013: • Junior Achievement of Eastern North Carolina

Todd Jones, CAPTRUST Senior Vice President and Financial Advisor, was recently named one of the Triangle Business Journal’s “40 Under 40,” a list of professionals from the Raleigh, NC, area under the age of 40 who are recognized for their outstanding contributions to their organizations and the community.

• Autism Society of Ohio • Special Olympics of North Carolina • American Liver Foundation • NC Coalition Against Sexual Assault • Boys and Girls Club of Las Vegas • Starfish Family Services • Big Brothers Big Sisters of the Triangle • Lucy Daniels Center • Seedlings Braille Books • St. Baldrick’s Foundation

CONGRATULATIONS

• John Owen’s Adventure • Muscular Dystrophy Association • East Coast Migrant Head Start Project • MeFine Foundation • Myco • Assistance League of the Triangle

On January 30, 2013, LipoScience, Inc., a medical diagnostics company pioneering a new field of personalized diagnostics based on nuclear magnetic resonance technology, closed a successful initial public offering of 5,000,000 shares of common stock at a price to the public of $9 per share.

Headquartered in Raleigh, NC, LipoScience employs approximately 200 employees in the United States. The company’s common stock is listed on the NASDAQ Global Market under the trading symbol LPDX.

• Frankie Lemmon School • 200 Club of Wake County • West Johnson High School Band Program • The Miracles of Mitch Foundation • Junior Achievement of Central Virginia • Ronald McDonald House of Chapel Hill • Duke Children’s Hospital

continued on page 24

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WEALTH MANAGEMENT | Q1 13

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UPCOMING INDUSTRY INVOLVEMENT The following is a list of topical discussions to

May 15, 2013 | Bedford, VA

be led or attended by CAPTRUST at upcoming

Council of Independent Colleges in Virginia Spring Conference

industry events in the second quarter of 2013.

May 2, 2013 | San Francisco, CA Western Pension Benefits Council Spring Conference Participant Engagement Moderator: Karen Casillas, Financial Advisor

Enhancing Retirement Readiness through a Focus on Total Retirement Speaker: Beryl Ball, Financial Advisor June 4, 2013 | Chicago, IL PLANSPONSOR National Conference

May 7, 2013 | Greensboro, NC North Carolina Association of CPAs Enhancing Retirement Readiness through a Focus on Total Retirement Speaker: Shaun Eskamani, Financial Advisor

Retirement Income Speaker: John Pickett, Financial Advisor 401(k) Boot Camp Speaker: Phyllis Klein, Senior Director Target Date Fund Environment Speaker: Pam Popp, Financial Advisor

May 8, 2013 | New Orleans, LA SouthWest Benefits Association Annual Meeting

June 4, 2013 | Chicago, IL

Stable Value and Cash Equivalent Landscape Speaker: Marshall Cobb, Financial Advisor

Mid-Sized Retirement & Healthcare Plan Management Conference

Quantifying Success for Your 401(k) Plan Moderator: Marshall Cobb, Financial Advisor

Enhancing Retirement Readiness through a Focus on Total Retirement Speaker: Jason Stanicek, Financial Advisor

All Publication Rights Reserved. None of the

The opinions expressed in this report are subject to change without notice. This material has

material in this publication may be reproduced

been prepared or is distributed solely for informational purposes and is not a solicitation

in any form without the express written

or an offer to buy any security or instrument or to participate in any trading strategy. The

permission of CAPTRUST: 919.870.6822.

information and statistics in this report are from sources believed to be reliable but are not warranted by CAPTRUST Financial Advisors to be accurate or complete. Performance

©2013 CAPTRUST Financial Advisors

data depicts historical performance and is not meant to predict future results. CAPTRUST Financial Advisors, Member FINRA/SIPC.

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