Investment Analysis Scorecard: Passive Methodology Overview

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1 Investment Analysis Scorecard: Passive Methodology Overview Basic Premise Designed to help you and your advisor determine and monitor passive fund selections Can assist in helping you fulfill your fiduciary responsibilities as set forth under ERISA Review data from the past 3 years and analyze 12 factors in a pass-fail system and equally weight the factors Maximum total score = 12 o 10 or greater the investment earns Blue Ribbon status o 7 through 9 the investment is acceptable o 6 or below the investment falls onto the Watch List While this score is intended to help you evaluate plan investments, it does not constitute a specific recommendation or advice and should not be the sole factor in selecting investments for your plan We believe Investments should be evaluated on more than just historical returns The process should be consistent, simplistic yet sophisticated, and repeatable 1

2 Investment Analysis Scorecard: Passive Methodology Snapshot Factors of Passive Scoring Methodology Quantitative Factors 83.3% of total Qualitative Factors 16.7% of total Style/Index Related 25% of total Return Based 16.67% of total Risk Based 41.67% of total Expense Ratio 8.33% of total Net Assets 8.33% of total 1-Year Tracking Error: 1 point if the tracking error is less than or equal to the peer group median 3-Year Return: 1 point if the return was equal to or greater than the peer group median 1-Year Standard Deviation: 1 point if the Standard Deviation is equal to or less than the peer group median Net Expense Ratio: 1 point if the ratio is less than or equal to the peer group average Net Assets: 1 point if the Net Assets are greater than $100 Million 3-Year Tracking Error: 1 point if the tracking error is less than or equal to the peer group median 3-Year R 2: : 1 point if the R 2 is greater than 95% 3-Year Up/Down Capture: 1 point if this ratio between.95 and Year Standard Deviation: 1 point if the Standard Deviation is equal to or less than the peer group median 3-Year Beta: 1 point if the beta is in between 0.95 and 1.05 Peer groups consist of passive funds only. Actively managed funds are not included in the peer group data and calculations. 1-Year Sharpe Ratio: 1 point if the Sharpe Ratio is equal to or greater than the peer group median Benchmarks used for the passive methodology are Prospectus Primary Benchmarks, which are defined in the prospectus of each investment. 3-Year Sharpe Ratio: 1 point if the Sharpe Ratio is equal to or greater than the peer group median 2

3 Style/Index-Related Factors (25% of total score) 1, 3-Year Tracking Error <= Passive peer group median o Tracking error measures the consistency of excess returns, or the difference between the returns of the investment and the target index. o A tracking error less than or equal to the peer group median indicates volatility of the investment s excess returns (difference between the investment s returns and the index returns) is equal to or less than half its peer group. The lower the tracking error, the closer the investment follows the index. R 2 > 95% o When selecting an investment, you want to know how correlated the investment s returns are with its benchmark index o This value of R 2 implies that the investment s return moves in the same direction as the index more than 95% of the time 3

4 Return-Based Factors (16.7% of total score) 3-year return => Passive peer group median o Measuring a passive investment s performance helps to understand how well a fund replicates its index without suffering losses due to its structure or other inefficiencies. o A total return greater than or equal to the peer group median implies the investment has similar or greater performance then more than half of other investments in its same category. 3-year Up/Down capture between 0.95 and 1.05 o Passive investments are intended to track the performance of its index. o An Up/Down capture ratio between.95 and 1.05 implies the investment s performance in up and down markets is similar to that of its benchmark. 4

5 Risk-Based Factors (41.7% of total score) 1- and 3-year Standard Deviation <= Passive peer group median o Standard Deviation is a measure of the volatility of an investment s return. The standard deviation of an investment that intends to replicate a specific index should be similar to the target index. o A standard deviation less than or equal to the peer group median indicates the volatility of the investment s returns are similar or less than those of half of its peers. 3-year Beta between 0.95 and 1.05 o A Beta between.95 and 1.05 indicates the passive investment is taking similar risk as the index that it intends to replicate. o A Beta outside of this range may indicate the investment s risk does not resemble its index. 5

6 Risk-Based Factors (cont d) (41.7% of total score) 1- and 3-year Sharpe Ratio => Passive peer group median o Sharpe Ratio is a measure of an investment s risk-adjusted performance. The Sharpe Ratio, or risk adjusted-performance, of an investment should be similar to or greater than its peers. o A Sharpe Ratio less than its peers indicates the investment experiences lower relative returns and/or higher relative risk than its peers. 6

7 Qualitative Factors (16.7% of total score) Net expense ratio =< Passive Peer group average* o When selecting an investment, you want to know how much it costs as total fees reduce the total return captured by the investor. o An expense ratio less than the category average implies the investment charges no more than the average of all others that fall into the same category. Net Assets > $100 Million o An investment with higher assets may exhibit higher liquidity and is potentially less likely to close. In certain cases, the demand (or lack thereof) for a passively managed ETF can cause it to trade at a price premium or price discount relative to its underlying net asset value (NAV). *For Separate Accounts and Collective Investment Trusts (CITs), the 1 st Management Fee/CAC (%) is used instead of Net Expense ratio due to their unique expense structure. These investments are scored against the Separate Account/CIT peer group, not the open end mutual fund peer group. 7

8 Glossary of Selected Statistics Beta A measure of volatility, or systematic risk, of a security or a portfolio comparison to the market as a whole. A Beta of 1.00 means that a portfolio s risk is at parity with the market benchmark associated with that portfolio. A Beta less than 1.00 means that a portfolio is less volatile than the market, a Beta over 1.00 means a portfolio is more volatile/risky than the market. A Beta range of will earn a point within the scoring system. Tracking Error Measures the consistency of excess returns of the investment relative to the index. The lower the tracking error, the closer the investment follows the index. R-Squared A statistic that measures how well the investment tracks the benchmark index. For example, an R-Squared statistic of 90% indicates that 90% of the movement in the investment can be explained by the movement in the underlying benchmark index. Sharpe Ratio A measure of risk-adjusted return. Sharpe Ratio uses Standard Deviation as the risk statistic. Standard Deviation - A measure of the dispersion of a set of performance data from its mean. The greater the range of returns, the higher the standard deviation. Standard deviation is calculated to measure the volatility of a fund s returns which is an indicator of a fund s performance consistency and is also used as a measurement of a portfolio s risk. Up Capture, Down Capture - The Up Capture reflects how the investment has historically performed relative to the benchmark index in an Up market. For example, an investment with an Up Capture of 110 has returned 110% of the benchmark index return in Up market cycles. Similarly, the Down Capture statistic measures the investments historical relative performance in Down markets. 8

9 Important Disclosures This material is for informational purposes only and is not intended to provide specific advice or recommendations. This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation. Indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results. Investing in mutual funds involves risk, including loss of principal. No strategy assures success or protects against loss. An investment in Exchange Traded Funds (ETF), structured as a mutual fund or unit investment trust, involves the risk of losing money and should be considered as part of an overall program, not a complete investment program. An investment in ETFs involves additional risks such as not diversified, price volatility, competitive industry pressure, international political and economic developments, possible trading halts, and index tracking errors. Peer groups based on Morningstar category. Not FDIC or NCUA Insured No Bank or Credit Union Guarantee May Lose Value Not Insured by any Federal Government Agency Not a Bank or Credit Union Deposit