Quarterly SIGMA Commentary Second Quarter 2013

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2 Market Overview The world s capital markets exhibited a wide divergence in returns during the 2nd quarter of Once again the domestic equity markets led the way with modestly positive returns (in contrast to the double digit returns of the first quarter). The developed international markets were essential flat with the MSCI EAFE Index posting a -0.73% return for the quarter masking wide dispersion among individual country returns with Australia down nearly -14% during the quarter and Japan up 4.4%. Emerging Markets continued to struggle with the MSCI EM Index posting a -7.95% return in the quarter. The fixed income markets reacted negatively and forcefully to the messaging coming out of the Federal Reserve indicating that tapering of QE could begin sooner than the markets had been anticipating. Other than 3 Month T-Bills, all of the fixed income asset classes that Envestnet PMC follows were negative for the quarter (see the Envestnet PMC Capital Markets Flash Report for the period ending June 30, 2013). Hit especially hard were TIPS as real interest rates moved up and inflation expectations declined. The Barclays US TIPS Index fell -7.05% during the quarter. Commodities and REITS also declined in the quarter with the DJ UBS Commodity Index falling -9.45% and the DJ US Select REIT Index down -1.29%. Performance Review Given the above capital market returns, it should not be surprising that during the 2nd quarter the performance of the SIGMA Mutual Fund Solution portfolios reflected the impact of negative fixed income returns. Returns ranged from -2.55% for the Capital Preservation model to -0.08% for the Aggressive Model. Please refer the SIGMA Quarterly Performance Update for detailed performance and risk statistics. Top Contributors to Quarterly Performance PRIMECAP Odyssey Growth (POGRX) PRIMECAP continued to post strong returns relative to its Russell 1000 Growth benchmark by returning 4.39% during the quarter, over 230 basis points above the 2.06% return of the benchmark. Largest contribution to performance was stock selection within the technology sector. T. Rowe Price Emerging Markets (PRMSX) Although emerging markets in general fared poorly during the quarter; the MSCI Emerging Market Index returned -7.95%, T. Rowe Price outperformed by 92 basis points declining only -7.03% during the quarter. The fund also outperformed by 133 basis points over the trailing 12 months largely from strong relative performance within the Consumer Staples, Utilities, and Materials sectors. Selected American Shares (SLASX) Outperformed the Russell 1000 Index by 76 basis points during the quarter returning 3.41%. Largest contributions came from an overweight to Financials and stock selection within Technology. Top Detractors from Quarterly Performance Longleaf Partners Fund (LLPFX) Lagged behind the Russell 1000 Index by 445 basis points returning -1.80% against the benchmark s 2.65%. Poor stock selection combined with a sector overweight to Energy was the primary drag followed by stock selection within Financials. A 17% cash weighting also hurt performance in the quarter. Aston/Montag & Caldwell Growth (MCGFX) Returned 0.34% which was 172 basis points behind the Russell 1000 Growth Index return of 2.06%. Allergan, a top 10 holding was down -24.5% during the quarter and accounted for -0.92% of relative performance. Consumer Staples, many of which have sizeable dividend yields, 2

3 suffered a short term negative reaction to the spike in interest rates. PIMCO Total Return (PTTRX) Returned -3.60% for the quarter; 98 basis points behind the Barclays U.S. Aggregate Index. Exposure to TIPS and select Emerging Market Debt detracted relative to the benchmark. An emphasis on the intermediate portion of the yield curve also hurt as the longer end of the curve outperformed the intermediate portion. What to make of the recent spike in interest rates? Investors were taken by surprise by the recent and swift upward move in interest rates and resulting negative impact on their fixed income holdings. The 46 basis point rise in the 10 Year Treasury yield during May (to 2.16% on May 31st) matched the increase in yields during March of 2012 when yields moved up 46 basis points between February 15 and March 19th from 1.93% to 2.39%. A comparable rise over a 30 day period also occurred between September 26th and October 27th of 2011 when the interest rate on the Ten Year Treasury moved up a half a percent from 1.91% to 2.42%. Interest rates moved up an additional 36 basis points in June and ended the 2nd quarter 65 basis points above the level prevailing at the end of March The below graph shows the recent trend of the 10 Year Treasury yield going back to December 2008, the official launch of the Federal Reserve s Quantitative Easing programs. Source: 3

4 As the graph illustrates, the two recent periods of spiking interest rates over a short period in 2011 and 2012 were followed by a sharp reversal in yields. Time will tell whether or not the recent spike will follow the path of the two previous interest rate scares. Predicting interest rate movements in the short run has proven to be a difficult if not an impossible task. As of July 18th, the 10 Year Treasury yielded 2.5%; down from a high of 2.73% on July 5th. The consensus explanation for interest rates moving higher seems to rest on the perception that recent data on job growth and employment is supporting a generally more positive economic outlook for the U.S. In addition, Ben Bernanke, the Federal Reserve Chairman, recently testified before Congress that the Fed s current asset purchase program (QE) would be scaled back if incoming data continued to point to a strengthening economy and falling unemployment. Investors seemed to interpret the Chairman s comments as a signal that the Fed would begin removing monetary accommodation sooner than markets had anticipated; as early as September. The bond market reacted; some would say overreacted, as heavy selling put downward pressure on prices pushing interest rates higher across the yield curve. Here is a slightly different interpretation: First, it is important to note that tapering (of bond purchases) is not the same as tightening (of monetary policy). In his testimony, Bernanke emphasized that any reduction in the pace of purchases would not signal an irreversible wind down of the QE program. Even if the Fed were to initially reduce the pace of these purchases on account of stronger economic conditions, it could subsequently adjust them upward should conditions deteriorate. And indeed, Fed bond buying in any capacity, whether at the current monthly pace of $85 billion or at some lower amount, translates to incrementally more accommodative monetary conditions each month. Second, the Fed is still significantly undershooting its mandate on inflation and unemployment. Year-over-year growth in the core personal consumption expenditure (PCE) deflator, the Fed s preferred gauge of inflationary pressures, is at its lowest level on record. Monthly job growth has come in below 200,000 for the last three months. There are pockets of strength, particularly in the housing market where sales and prices are rising at an impressive rate. Yet taken together, the data indicates an economy still struggling to transition to a higher, sustainable growth trajectory. PIMCO Total Return Monthly Commentary, May It s important to emphasize that the process of developing the SIGMA asset allocation models rests on the foundation of forward looking capital market assumptions regarding the expected returns, risk, and correlations of the asset classes used in the portfolios. Specifically in terms of the fixed income asset classes, our assumptions are based on a normalization of interest rates over our forecast horizon (ten years). In other words we expect that interest rates will rise over time to reflect stronger economic growth and that the Fed will respond by raising the Fed Funds rate. Our return assumptions incorporate this anticipated rise in interest rates and inform our asset allocation decisions. We are confident that the fundamental factors that determine asset class returns (real rates, economic growth, inflation, and risk premiums) will dominate over the long haul. In the short term, however, rational, fundamental considerations are largely overwhelmed, in our view, by investor s emotional reaction to the noisy news cycle. Index Overview The Morgan Stanley EAFE Index represents 21 developed markets outside of North America. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The Barclays Capital U.S. Government/Credit Bond Index measures the performance of U.S. Dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year. The Barclays Capital U.S. Intermediate Government/Credit Bond Index measures the performance of U.S. Dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year and less than ten years. The Barclays US TIPS Index measures the performance of the US Treasury Inflation Protected Securities ( TIPS ) market. The index includes TIPS 4

5 with one or more years remaining maturity with total outstanding issue size of $500m or more. The Barclays Capital U.S. Corporate High Yield Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody s, Fitch and S&P is Ba1/BB+/ BB+ or below. The index may include emerging market debt. The FTSE NAREIT All Equity REITs Index is a free float adjusted market capitalization weighted index that includes all tax qualified REITs listed in the NYSE, AMEX, and NASDAQ National Market. The DJ-UBS Commodity Index Total ReturnSM measures the collateralized returns from a basket of 19 commodity futures contracts representing the energy, precious metals, industrial metals, grains, softs and livestock sectors. The Russell 3000 Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market. The Russell 1000 Index is a market capitalization-weighted benchmark index made up of the 1000 largest U.S. companies in the Russell 3000 Index. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell Top 200 Growth Index measures the performance of the especially large-cap segment of the U.S. equity universe represented by stocks in the largest 200 by market cap that exhibit growth characteristics. The S&P Developed Property Index is an investable index including approximately 400 stocks from 22 countries. The index is a sub-index of the S&P Global Property, which defines and measures the investable universe of publicly traded property companies. The Citi World Government Bond Index (WGBI) includes the 23 government bond markets of Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Malaysia, Mexico, the Netherlands, Norway, Poland, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States. The SIGMA MFS Capital Preservation Portfolio blended benchmark includes 75% Barclays Govt/Credit, 20% R3000, 5% EAFE (inception to 5/31/10), 80% Barclays Int Govt/Credit, 14% R3000, 6% EAFE (6/1/10 to date). The SIGMA MFS Conservative Portfolio blended benchmark includes 55% Barclays Govt/Credit, 35% R3000, 10% EAFE (inception to 5/31/10), 67% Barclays Int Govt/Credit, 24% R3000, 9% EAFE (6/1/10 to date). The SIGMA MFS Conservative Growth Portfolio blended benchmark includes 43% R3000, 40% Barclays Govt/Credit, 15% EAFE (inception to 5/31/10), 54% Barclays Int Govt/Credit, 33% R3000, 13% EAFE (6/1/10 to date). The SIGMA MFS Moderate Portfolio blended benchmark includes 50% R3000, 30% Barclays Govt/Credit, 20% EAFE (inception to 5/31/10), 43% R3000, 40% Barclays Int Govt Credit, 17% EAFE (6/1/10 to date). The SIGMA MFS Moderate Growth Portfolio blended benchmark includes 55% R3000, 25% EAFE, 20% Barclays Govt/Credit (inception 50 5/31/12), 53% R3000, 27% Barclays Int Govt/Credit, 20% EAFE (6/1/10 to date). The SIGMA MFS Growth Portfolio blended benchmark includes 65% R3000, 25% EAFE, 10% Barclays Govt/Credit (inception to 5/31/10), 62% R3000, 24% EAFE, and 14% Barclays Int Govt/Credit (6/1/10 to date). The SIGMA MFS Aggressive Growth Portfolio blended benchmark includes 70% R3000, 30% MSCI EAFE (inception to 5/31/12), 72% R3000, 28% MSCI EAFE (6/1/12 to date). Disclosure Index performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index. Past performance is not a guarantee of future results. This material is not meant as a recommendation or endorsement of any specific security or strategy. Information has been obtained from sources believed to be reliable, however, Envestnet PMC cannot guarantee the accuracy of the information provided. The information, analysis and opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. An individual s situation may vary; therefore, the information provided above should be relied upon only when coordinated with individual professional advice. Reliance upon any information is at the individual s sole discretion. Performance is shown gross of platform and advisory fees. For a complete description of all fees, costs and expenses please refer to the sponsor s Form ADV Part 2A or Form ADV Part 2A-Appendix 1 as applicable. Actual performance results will be reduced by fees including, but not limited to, investment management fees and other costs such as custodial, reporting, evaluation and advisory services. 5