continued on page 3

The One-Two Punch: Explaining Diversifi cation and Active Management Performance ShortfallsDiversifi ed investors, which we will defi ne as investors whose portfolios include several different asset categories, such as global stocks, bonds, hedge fund strategies, commodities, and real estate, have not enjoyed diversifi cation’s benefi ts over the past three to four years, compared to more narrowly allocated portfolios focused on U.S. stock and bond markets. To add insult to injury, active management, defi ned as a portfolio management style in which the manager makes individual security choices designed to beat a market benchmark, delivered poor performance across most asset classes relative to indexes and passive managers who try to replicate index returns.

To explore this “one-two punch” of underwhelming returns for diversifi ed portfolios and active managers, we interviewed CAPTRUST Chief Investment Offi cer Eric Freedman and CAPTRUST Head of Manager Due Diligence David Hood to get their insights. Eric manages asset allocation research across CAPTRUST’s business lines, and David oversees active and passive manager research. Eric and David are co-authoring a position paper on these combined issues, which we will publish later this quarter.

Eric, can you explain the basics of diversifi cation and how those principles translate to clients?

Doing my best impersonation of my mother, who was an English teacher, the term invest comes from the Latin word investire, which translates into the English “clothe in, cover, or surround.” I like those last two words when thinking about asset allocation; our goal is to try to surround and cover our clients’ investment objectives with tools that can help them increase their odds of reaching their objectives. Most investors have a goal of more than just retaining purchasing power, so they should invest in assets that will grow their capital beyond infl ation’s historical 2–3 percent growth rate.

Because no one, including professional investors, knows what the future holds, we believe in maintaining a portfolio with a variety of asset classes that respond differently to various potential economic conditions and market-driving outcomes. Examples include infl ation-protected securities, which are bonds whose principal amounts rise when infl ation increases. These securities should act differently than high-quality corporate bonds, which tend to fall in value when expected infl ation increases. Recognizing that infl ation is not the only factor driving bond returns helps us to think about how they may react in isolation, as well as in tandem with other assets for, a given market scenario.

Our goal is to make sure that clients are not overly diversifi ed, such that each portfolio component cancels out another, but instead that we have created portfolios that will increase the likelihood they can achieve what they want with their

INSTITUTIONAL | Q1 15

Strategic research reportStrategic research report

2 WWW.CAPTRUSTADVISORS.COM

LETTER FROM THE CEO

DEAR READER,

Our goal has always been to use our publications as a

way to provide you with timely, relevant, and actionable

information and perspective. We are making a few

changes to help us better accomplish this task.

• We are replacing the Strategic Research Report, which

has been delivered to you on a quarterly basis, with

a series of monthly emails. These emails will address

topics including fi duciary best practices, our thoughts

on the capital markets, and developments in the

retirement planning arena. We will supplement these

regular monthly updates with more topical pieces as

circumstances warrant.

• We are also introducing VESTED, CAPTRUST’s own

magazine that focuses on the issues, interests, and

concerns of our wealth management clients who are

largely in their retirement planning homestretch. We

would love to add you to our VESTED mailing list. If

you’re interested in receiving the magazine, just email

us at VESTEDmagazine@captrustadvisors.com.

• Finally, we will be re-launching CAPTRUST’s website

in late February. The site will feature an updated look

and feel, better navigation, and a searchable library

containing position papers, articles, market updates, and

other topical pieces we have published in recent years.

We look forward to your feedback.

All the best,

J. Fielding MillerCAPTRUST Cofounder and Chief Executive Offi cer

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INSTITUTIONAL | Q1 15

continued on page 4

capital. Over longer periods of time, diversifi cation into many dissimilar asset classes has led to good outcomes.

So what has happened more recently?

Above we show how a hypothetical diversifi ed portfolio, which is composed of global stocks, a variety of bond types, commodities, real estate, and hedge fund strategies, has performed against a less diversifi ed hypothetical portfolio consisting of 60 percent U.S. large-capitalization stocks and 40 percent U.S. investment grade corporate, mortgage, and government bonds over the past 15 years. The chart shows that the diversifi ed portfolio outperformed the 60/40 portfolio early in the 2000s but has traded leadership in more recent years. Notable market events are highlighted.

As you can see, the performance differences between the diversifi ed and 60/40 portfolios shows some persistent “clustering” but appears to be cyclical. However, over the full time period, the diversifi ed portfolio delivered higher total returns — almost 20 percentage points more. You can see certain time periods in which the diversifi ed portfolio performed better (from 2001 through August 2008, just before the fi nancial crisis), then the 60/40 portfolio performed better for a few years. The diversifi ed portfolio regained the relative lead from 2010 through mid-2011, and then the 60/40 portfolio demonstrated some consistent outperformance for the next two and a half years. Again, relative performance ebbs and fl ows over time.

continued from page 1

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

10%

-10%

8%

-8%

6%

-6%

4%

-4%

2%

-2%

0%

9/11 Terrorist Attack

Iraq War Begins Great Recession Begins

U.S. Debt Downgrade

European Debt Crisis Peak

U.S. Quantitative Easing Ends

U.S. Equity Market Trough

Lehman Brothers Fails

Source: Zephyr, CAPTRUST Research

Diff erences in Return Between a Diversifi ed Portfolio and a 60/40 PortfolioJanuary 2001�–�December 2014

DIVERSIFIED PORTFOLIO OUTPERFORMED

60/40 PORTFOLIO OUTPERFORMED

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continued from page 3

to those of non-U.S. companies, so we favor the U.S. with a conscious home-country bias. However, markets and economic growth can diverge. I wish it were as easy as picking the countries or regions that will grow the fastest.

So is diversifi cation no longer relevant?

We think diversifi cation is highly relevant. Different regions of the world are in very different economic situations right now. Central banks are taking on divergent strategies; in some regions interest rates are low and falling, and in other places they are high and rising. Energy price declines help some regions while hurting others. Many scenarios could play out this year, and in a highly correlated global marketplace, having differentiated return sources in a portfolio should help weather the varied outcomes.

While many clients wished they owned nothing but U.S. stocks over the past two years, we didn’t have a single client with the same wish in early 2009 after stocks were cut in half. Over 15 years, diversifi cation has benefi ted our clients, but over the past four, it hasn’t. As Figure One shows, these things tend to be cyclical.

We continue to look for the right asset classes for our clients. Those asset classes can change over time, but we do not expect to materially narrow the range of assets we think clients should own in their portfolios. Again, we want to cover and surround client goals. More asset classes helps accomplish that goal.

Is it fair to say that a push toward dollar-denominated assets, which the 60/40 portfolio owns more of, is the reason why the diversifi ed portfolio typically underperforms the 60/40 portfolio?

Not entirely. U.S. stocks fell within 3 percentage points of international stocks during the fi nancial crisis, so currency alone does not explain the performance differential. The “40” in the 60/40 seems to be what investors demand most emphatically during stressful time periods: government and quasi-government bonds. The bias toward U.S. stocks over international stocks has been especially persistent over the past four years, largely due to the U.S. Federal Reserve’s easy money policies, which have hurt more diversifi ed portfolios. Also, hedge funds and commodities have held back portfolio total returns. Hedge fund strategies, broadly, have made money consistently, just not a lot of it, and commodities have produced negative returns for four straight years.

With the U.S. economy on fi rmer footing than many international economies, do you think U.S. assets will perform better in the foreseeable future?

That is a possibility, but again, no one is absolute on the future. If U.S. assets perform better, our clients will benefi t; the portfolios and allocations we build tend to tilt toward the U.S. despite the fact that the rest of the world’s stocks represent a larger market capitalization. We see U.S. public companies’ accounting standards, governance, transparency, and corporate attitudes toward shareholders as superior

5

INSTITUTIONAL | Q1 15

David, what has been going on with active managers?

Active management in areas most widely followed by investors, like large-cap U.S. stocks, has been poor. In other areas, active managers have done well. Fixed income managers, for example, have outperformed their indexes and passively managed funds consistently over the past fi ve years. The diffi culty for investors, though, has been that poor active equity manager performance has overwhelmed positive performance in other asset classes. Because of this, active management as a whole has come under scrutiny by clients and advisors alike.

How has CAPTRUST scrutinized active managers?

As a way to cut through the rhetoric and passion and to provide empirical facts about the value of active managers, we studied manager performance over the past 30 years, dating back to the creation of many of the indexes we use today and the beginnings of the mutual funds themselves. We wanted to remove as much bias as possible from our analysis. To do this, we studied large-cap managers’ performance versus their benchmarks and peers and small-cap managers’ performance versus their benchmarks and peers. We also separated growth and value managers to measure them against their respective benchmarks to eliminate any factor biases that may exist in the data.

Rounding out the major asset classes, we evaluated international equity managers and fi xed income managers.

Finally, we analyzed manager performance in rolling three-year increments. Our belief was that reviewing manager returns over a one-year period was too short, and studying manager performance over fi ve-year periods was too long.

What were your fi ndings?

Large-cap U.S. equity manager performance was meager. In the short run, on a rolling three-year basis, 77 percent of large-cap growth managers underperformed their indexes, and 64 percent of large-cap value managers underperformed over the past fi ve years. Small-cap manager results were mixed. During the same period, 61 percent of small-cap value managers outperformed their indexes, but only 39 percent of small-cap growth managers outperformed their indexes. As a result, broadly diversifi ed U.S. equity portfolios underperformed.

continued on page 6

We think diversifi cation is highly

relevant. Diff erent regions of the world

are in very diff erent economic situations

right now. Central banks are taking on

divergent strategies; in some regions

interest rates are low and falling, and in

other places they are high and rising.

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continued from page 5

International equity manager performance was similar to large-cap U.S. equity manager performance. Overseas, 60 percent of active managers underperformed their benchmarks on a rolling three-year basis over the past fi ve years.

Switching from equities to fi xed income, we observed opposite results. Over the past fi ve years, 72 percent of “core” or broadly diversifi ed active managers outperformed their corresponding indexes and passive managers on a rolling three-year basis.

The issue for investors continues to be that, while active fi xed income managers have outperformed, it has not been enough to offset widespread active equity underperformance. As a result, diversifi ed portfolios with large active components across asset classes have underperformed benchmarks.

What do you look for with passive funds?

There are a number of index funds to choose from that range from global markets to sub-industries within individual countries. The fi rst step in choosing an index fund is to make sure the index it tracks aligns with your investment objectives. In an ideal world, the most important consideration for selecting an index fund would be fees. Your expected return is going to be the return of the index minus fees, so minimizing the

fee you pay to the manager maximizes your potential return. However, because even the best index funds do not perfectly track their benchmarks, we must also consider tracking error, or the volatility of the fund relative to its benchmark. An index fund that struggles to match the return of its target benchmark on a consistent basis — a characteristic of higher tracking error — creates undesired risk for a portfolio.

What about the future? Is active management doomed, and is it easier just to invest passively?

The data we analyzed suggests that the average active manager loses to passive management. However, the data is by no means smooth; there appear to be prolonged periods of time during which

active managers can add value relative to indexes. Plus, investors need to keep in mind that not all asset classes or strategies can be accessed through passive funds.

Our view remains that this is not an “either/or” choice, and that active and passive strategies can coexist in a portfolio. It is clear from our work that a high hurdle exists for active managers in general, especially in certain asset classes, but our research efforts centered on process and governance can help unearth managers we believe can add value for clients.

If you are interested in receiving the position paper on these issues when it is published, please let your fi nancial advisor know.

7

DRESS FOR SUCCESS

Todd Jones, senior vice president and fi nancial advisor, was recently recognized by Activate Good, an organization that links willing volunteers to organizations in need of help, as a Pro Hero for his commitment to using his photography talents to give back to his community. As a frequent photographer

for charities and nonprofi ts, having done twelve photo shoots in 2014, Jones was recognized by Activate Good for his work with the organization Dress for Success. Dress for Success promotes the economic independence of disadvantaged women by providing professional attire, a network of support, and career development tools. He admires the organization for its mission, and believes the images he captures show “true success stories.”

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continued on page 8

captrust newscaptrust news

GIVING BACK

Todd Jones volunteers his time and photography talents for local nonprofi t organizations.

RACQUETS FOR RESEARCH TENNIS EVENT

Shaun Eskamani, vice president and fi nancial advisor, and Mike Hudson, senior director of institutional consulting, are sponsors and committee members of the Jimmy V Foundation’s Racquets for Research tennis event. Eskamani calls it “a phenomenal cause” that combines the joy and competition of tennis with the fi ght for fi nding a cure for cancer through research. With the recent passing of Stuart Scott, sportscaster and 2014 recipient of the Jimmy V Award, Eskamani and Hudson feel even more devoted to the Jimmy V Foundation and its eff orts to cure cancer.

THE HOLLY RUN

On December 6, 2014, CAPTRUST sponsored The Holly Run in Akron, Ohio. Through the nonprofi t organization Life Is Good No Matter What, The Holly Run raises funds to provide adults with advanced cancer a break and escape from their battle and diagnosis through a cherished experience. Akron native and CAPTRUST senior vice president and fi nancial advisor Steve Wilt spearheaded the fi rm’s participation in and support of the run as a way to give back to his community. The Holly Run includes a 5K race and a 1-mile Fun Run, in which Wilt and his family participated to show their continued support.

Steve Wilt poses with his family at The Holly Run in Akron, Ohio.

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INSTITUTIONAL | Q1 15

continued from page 7

We invite you to “Like” the CAPCommunity Foundation on Facebook.

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material in this publication may be reproduced

in any form without the express written

permission of CAPTRUST: 919.870.6822.

©2015 CAPTRUST Financial Advisors

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

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

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

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 data

depicts historical performance and is not meant to predict future results.

In 2014, the CAPCommunity Foundation (CCF) made

73 fi nancial contributions totaling nearly $80,000 to

charitable organizations, all of which were made at the

request of CAPTRUST employees. Along with charitable

requests, the CCF organizes fundraising eff orts

throughout the year to benefi t a chosen organization.

In 2014, our big fundraiser benefi ted Ronald McDonald

House Charities. A total of $100,000 was contributed

to Ronald McDonald House locations in the areas where

we live and work as a CAPTRUST community.

GIVING BACK

CAPTRUST employees pose for a photo after serving dinner at the Ronald McDonald House in Chapel Hill, North Carolina.

RECOGNITION

Ellen Crowley, vice president and fi nancial advisor, was recently elected president of the Notre Dame Alumni Club of Eastern North Carolina for a two-year term beginning January 2015.

Mike Gray, senior vice president and fi nancial advisor, was recently named to the national board of directors of the University of Kentucky Alumni Association.