CAPTRUST Strategic Research Report Q3 2012 Wealth Management Edition

WEALTH MANAGEMENT | Q3 12

Strategic research reportStrategic research report

In This Issue

Letter from the Editor 2

Wealth Management Planning 4

Portfolio Strategy 12

Index Returns 15

Asset Allocation Research 16

Discretionary Research Highlights 18

Investment Asset Classes 20

CAPTRUST in the News 23

continued on page 3

Proactive Year-End Discussions for 2013’s Uncertain Tax Environment

Mark Paccione, CFA, CFP® Director, CAPTRUST Investment Research

R. Michael Gray, CPA, PFSSenior Vice President, CAPTRUST Financial Advisor

Given the looming “fi scal cliff” and potential rollback of the Bush-era tax cuts, many investors are concerned about future tax rates and may be unsure about what to do as they consider year-end tax planning opportunities. While many of the obvious questions cannot be answered with certainty just yet, proactively discussing the following topics with your tax advisor may help provide clarity around potential outcomes — and possible steps to consider in advance of year-end.

Should I sell concentrated, low-basis stock positions before year-end?

Considerations: The 15% tax rate on long-term capital gains could increase to 23.8% for those individuals also subject to the 3.8% Medicare surcharge on investment income. For individuals planning to sell a long-term holding in the near future, it could make sense to sell before year-end, rather than wait until next year. Use caution, however, since selling for tax reasons alone may negatively affect returns for long-term investors.

Should I sell my dividend-focused stocks and funds?

Considerations: If the Bush-era tax cuts expire, the tax rate for qualifi ed dividends could shift from 15% to as high as 43.4%. As a result, high dividend-paying stocks and funds could face short-term selling pressure toward the end of the year as taxable investors conclude that after-tax returns will be less attractive for those stocks and funds in the future. While keeping this in mind, we feel investment decisions should be based on underlying fundamentals such as future growth prospects—rather than tax considerations alone. Additionally, if the concept of linking the dividend tax rate to that of long-term capital gains is continued, any increase in tax rates may be limited.

Should I look at accelerating ordinary income into 2012 to avoid a higher rate in 2013?

Considerations: The highest marginal tax rate on ordinary income may rise from 35% to 39.6% or more, depending on the source, so generating

2 WWW.CAPTRUSTADVISORS.COM

letter from the editorletter from the editor

All Publication Rights Reserved. None of the

material in this publication may be reproduced

in any form without the express written

permission of CAPTRUST: 919.870.6822.

©2012 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. CAPTRUST

Financial Advisors, Member FINRA/SIPC.

“ALL THE NEWS THAT’S FIT TO PRINT”

That very tagline fi rst appeared 115 years ago in the New York Times’ upper-left corner. While the proverbial content “bar” is always high, we found this quarter especially challenging given the fourth quarter’s pending events with far-reaching implications.

The U.S. election season, change in Chinese leadership, ongoing European issues, and a volatile economic picture leave us with plenty of eligible contemporary topics. We try to avoid the “news” aspect given how much fi nancial narration has permeated mainstream media since the onset of the fi nancial crisis, but this quarter we felt we would be remiss if we did not cover what we see as the most important issue over the next 18 months: the U.S. “fi scal cliff ” and its implications for wealth clients.

Feature articles this quarter provide perspective on planning decisions one can make in light of an uncertain year-end, plus a piece on behavioral fi nance, a continued area of interest for us — and author Mark Paccione personally. Expect more on this topic in coming publications.

On the capital markets front, we share some of our thinking on bond investing in the wake of recent Federal Reserve and European Central Bank policy changes, and the team and I spent some time with JP Morgan’s Dr. David Kelly, who provides an insightful look at the fi scal cliff and various potential scenarios that could emerge in coming weeks. To close, I summarize our thoughts across asset classes in my regular investment strategy piece.

A client once told me that we are all drowning in information but thirsting for knowledge. That quote has stuck with me, and comes to mind particularly when thinking about topics to cover in this publication. As a long-time student of the global economy, I am well aware of the opportunity cost of you spending time reading this. We want to reach our readers with pieces that are understandable, actionable, and, ultimately, interesting, so if you decide any part of this quarter’s content was not “fi t for print,” please don’t be bashful; my comment box is always open.

Have a great fi nish to 2012 — it promises to be action-packed.

Onward—

Eric J. FreedmanCAPTRUST Chief Investment Offi cer


3

continued from page 1

ordinary income in 2012 may make sense. Remember, however, that the possibility of legislative activity after the presidential election and prior to year-end exists, so taking action now may be a risk. Two areas ripe for last-minute activity include Roth conversions and stock option exercises. Roth conversions have the additional advantage of having the ability to be “undone” by October 15, 2013, in the event a negative tax scenario does not occur.

Should I defer making tax-deductible payments like charitable contributions?

Considerations: Marginal tax rates could be much higher next year if the Bush-era tax cuts expire—which will affect the tax benefi t from tax-deductible payments. Once again, year-end legislative activity may pose a risk. However, many tax-deductible outlays can be made on short notice and right at year-end. Another issue is the return of the phase-out rules for itemized deductions in 2013.

Should I change my approach to municipal bonds currently in my portfolio?

Considerations: While higher tax rates would seem to benefi t municipal bond holdings, there is some speculation about potentially altering the tax-exempt treatment of interest from municipal

bonds. Currently, if no action is taken, the favorable tax treatment of municipal bond income will remain intact, so no immediate action may be necessary. However, several proposals, most notably the Simpson-Bowles Defi cit Reduction Plan, recommend eliminating the tax-exempt status of new municipal bond issues. Given the high level of uncertainty surrounding this topic, we feel investors would be wise to closely monitor the issue and protect themselves by diversifying across fi xed income subsectors beyond municipal bonds.

Should I realize gains this year to offset capital losses, or should I harvest unrealized losses as I typically do at the end of each year?

Considerations: With the potential for higher rates on capital gains (both long- and short-term), the value of realized and unrealized capital losses may be greater in 2013. If rates are higher next year, a good case can be made for not harvesting losses this year; however, selling positions with unrealized gains solely for the sake of capturing losses may not be a good solution either, since tax expense is just one component of an investor’s net returns. This is another circumstance where post-election legislation could change the recommended course of action and may call for last minute transactions in a portfolio.

Should I move assets into vehicles that are not affected by higher or new taxes?

Considerations: While they provide tax protection, it is not possible to move large sums quickly into Individual Retirement Accounts. Variable annuities may be another tax-favored option to consider since they allow unlimited contributions and tax-deferred growth. Earnings are taxed as ordinary income at the time they are withdrawn—presumably well into the future. However, investors should be cautious since annuities can be expensive and withdrawals prior to age 59½ may be subject to tax penalties.

In conclusion, the fi scal cliff presents an unusually high level of uncertainty for individual investors heading into 2012’s year-end. At a high level, our recommended approach for clients involves proactively discussing and preparing for multiple potential scenarios with your tax advisor, while keeping up to date on the latest developments, and positioning yourself to be able to move quickly. While CAPTRUST does not provide tax advice, we are certainly available for further discussions on these topics and more as we work toward our shared goal of achieving your ideal outcomes.


wealth management planningwealth management planning

As active participants in the capital markets, we at CAPTRUST are well aware that economic theory and reality are often two very different things. Traditional economic theory assumes that humans are rational wealth maximizers who make logical decisions with their capital. However, basic life experience tells us this is not always the case. Experiments have shown, for example, that individuals will drive farther to save $5 on a $15 item than a $100 item.1 Theory would dictate that a rational individual would drive the same amount of time regardless of the price. However, humans don’t always act rationally when it comes to money, and our behavioral quirks create risks, challenges, and opportunities for us as investors.

Enter behavioral fi nance, a discipline that tries to bridge this gap between theory and reality. Behavioral fi nance studies the effect of social, cognitive, and emotional forces on economic and investment decisions made by individuals — and how those decisions often contradict the rational behavior assumed by classical economic models. It is an exciting and relatively new fi eld of study based on the work of three key fi gures: Amos Tversky, Daniel Kahneman, and Richard Thaler. Starting in the 1960s, cognitive psychologists Kahneman and Tversky researched and published many of the psychological concepts that behavioral fi nance explores, including popular works on prospect theory and loss aversion which investigate an individual’s tendency to view gains differently from losses. Research has shown that individuals prefer avoiding losses much more than experiencing gains. In 2002, Kahneman received the Nobel Prize in economics for his groundbreaking work with Tversky.

The third major fi gure in behavioral fi nance is Richard Thaler, a professor at the University of Chicago. Building on the work of Tversky and Kahneman, he published a paper titled “Mental Accounting Matters” in 1999. Mental accounting, which was discussed in our fi rst quarter Strategic Research Report, is a concept that explores how individuals perceive and experience fi nancial outcomes, how decisions are made and subsequently evaluated, and how fi nancial activities are assigned to specifi c accounts or “buckets.” Anyone who has ever set aside money for a specifi c purpose—such as saving for a child’s college tuition, creating a vacation fund, or socking money away for an engagement ring—has employed mental accounting.

PERCEPTION VERSUS REALITYMark Paccione, CFA, CFP® Director, CAPTRUST Investment Research


5

Three themes central to behavioral fi nance are: heuristics, framing, and market ineffi ciencies. Heuristics refers to the use of “rules of thumb” in decision making in situations when detailed analysis and exhaustive searches are not practical. One common heuristic is anchoring and adjustment, where estimates are based on an adjustment from an implicit reference point (or anchor). For example, if you ask a general question such as “What will the S&P 500 return next year?” you will get a wide range of answers. If you ask, “How much higher or lower than +10% will the S&P 500 return next year?,” the range of estimates will be in a band that clusters around +10%. That’s a heuristic at work. Changing the

way a choice is presented can impact what choice is eventually made. This phenomenon is referred to as framing. For example, when asked if they prefer meat that is 90% lean or 10% fat, most people will say they prefer the former—even though they’re exactly the same thing. Finally, market ineffi ciencies refer to anomalies that exist due to the behavioral biases of market participants. Many biases have been uncovered and examined. A few of them are: status quo bias (sticking with what you know), recency bias (assigning a heavier weight to events that just occurred in decision making), fear of losses, and confi rmation bias (the tendency to accept data that confi rms existing beliefs while rejecting data that contradicts them).

While studying the quirks of human behavior may sound interesting, readers may question the relevance of such information. Knowledge of behavioral fi nance is important to CAPTRUST and our clients as it enables us to make better fi nancial decisions. By understanding natural mental processes and human decision-making tendencies, we can avoid common mistakes, set up portfolios that are more congruent with how an individual thinks, and make investment decisions that help generate higher returns over the long run. In short, understanding behavioral fi nance theory increases our chances of success for achieving our main mission, meeting our clients’ fi nancial goals.

Source:1 Kahneman, D. and Tversky, A. (1984) “Choices, Values, and Frames,” The American Psychologist, 39, 341-350


JUST A SPOONFUL OF SUGAREric J. FreedmanCAPTRUST Chief Investment Offi cer

It is always dangerous to write about a topic that could go in a different direction before your content reaches readers. While we endeavor to get this publication out to readers as soon as possible, paper-and-ink publishing necessarily drives a “time wedge” between when we write and when your eyes hit this page. I recall a period early in my CAPTRUST career when I dutifully penned a 1,500-word article a week before deadline, only to have the Federal Reserve announce an unexpected policy change that rendered my missive, as they say in the business, old hat. “Rookie move,” as the kids say.

The topic of the fi scal cliff presents a similar authorship risk. As I write in early October to a readership that will see this article in late October at the earliest about an event that will occur on December 31, I risk that said “time wedge” may include critical developments that render this article old hat. However, my editorial staff and I agreed that the probability of this

event being resolved before publication was extremely limited, and since resolution would likely be a positive development, we rolled the dice.

Before we delve into specifi cs, let’s start with what the fi scal cliff actually is. While the mainstream media has affi xed this catchphrase onto potential year-end events, we do not want to presuppose that what the phrase embodies has been well-explained. The fi scal cliff represents tax cut expirations, Medicare tax increases, unemployment benefi t program extension terminations, and two rounds of discretionary spending cuts resulting from the 2011 Budget Control Act that are all slated to become effective on December 31, 2012. These various programs clearly represent some political sensitivities, with parties deeply entrenched as we approach year-end.

The fi scal cliff has clear economic implications from a directional standpoint. Economic textbooks

suggest that U.S. government spending as a percentage of Gross Domestic Product (GDP) is normalized in the 15-20% range (while more skeptical sources say the range is highly volatile, more like 10% to 40% over time), so any government spending decreases would impact growth in the very near term. Effective tax increases also impact growth, as less discretionary spending means less available consumption dollars. This year, National Bureau of Economic Research economist Valerie Ramey concluded that — even if higher taxes translate into more government spending — the government spending GDP “multiplier effect” (how a dollar of increased spending reverberates in the economy) has a very wide range of potential outcomes and most likely decreases private (non-governmental) spending.1 In aggregate, the fi scal cliff ’s directional economic impact is clearly negative. The order of negative magnitude, however, is unclear and a major point of debate among economists.


7

continued on page 8

So why do we need to go through this? The answer rests on America’s increased reliance on debt fi nancing, within both the public and the private sectors. In prior Strategic Research Reports, we have analyzed consumer debt growth and how that has correlated with economic output. Government debt, however, has become a more topical discussion, particularly given the political climate.

Cumulative defi cits (when government expenditures exceed revenues) have brought our debt picture to untenable long-term levels, and both political parties agree that high debt levels are not conducive to economic growth. In a comprehensive analysis that included both developed and developing countries, economists Carmen Reinhart and Kenneth Rogoff noted that median growth rates fall by 1% and average growth rates fall more than that for countries saddled with debt-to-GDP ratios above 90%.2 We have to go through it because, just as Mary Poppins prescribed to Jane and Michael Banks, we need to take our collective medicine, and investors are trying to see how much “sugar” will be included, as the list of policy changes could come all at once (representing sugarless castor oil in the form of a potential downward GDP shock) or in a more piecemeal fashion

(attenuated castor oil that the economy could more easily stomach) should Washington decide to compromise.

Figure 1 shows the non-partisan Congressional Budget Offi ce’s (CBO’s) late August estimates of federal debt held by the public over time (a slightly different debt measure than that cited by Reinhart and Rogoff, but instructive nonetheless) as well as forecasts from fi scal year 2013 (which started on October 1) through 2020.3 As Figure 1 displays, the dotted line represents a fi gurative fork in the road for the U.S. debt-to-GDP ratio. If the full fi scal cliff occurs in early 2013, the CBO projects a drop in debt to GDP to more favorable long-term levels under its baseline scenario. However, should a spoonful of sugar dilute this tough medicine, the “alternative” fi scal scenario shows debt to GDP drift higher and into the 90% of GDP red zone. So the tradeoff is clear when assessing the CBO’s projections: Should the economy endure the “full” fi scal cliff, our debt-to-GDP ratio improves, but the economy likely suffers. If instead Washington compromises and we delay parts of the tax increases or sequestration (a term that encompasses the budget cuts), the economy may experience some short-term relief at the expense of longer-term debt considerations.

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Figure 1: Federal Debt Held by Public, Actual and Projected (CBO)

100%

80%

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Per

cent

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of

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P (

%)

If current laws governing taxes and spending remain in effect (CBO's baseline projection), debt held by the public will fall from 73% of GDP in fiscal year 2012 to 58% of GDP in 2022. If policymakers altered those laws to maintain many policies that have been in effect in recent years (CBO's alternative fiscal scenario), debt would climb to 90% of GDP by 2022. In either case, debt would be relatively high by historical standards.

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Years

Actual Projected

AlternativeFiscal Scenario

CBO's BaselineProjection



Given a wide range of potential outcomes and pending the political horse trading in coming weeks, we caught up with Dr. David Kelly, JP Morgan Asset Management’s chief global strategist and head of the Global Market Insights Strategy Team. David and his colleagues penned a lucid piece, describing several scenarios that may play out, and we wanted to share a few takeaways from our conversation with Dr. Kelly.

Dr. Kelly and team do not anticipate any legislation prior to the election, but instead anticipate the balance of power after presidential and congressional elections to drive further action.4 Based on election outcomes, Kelly sees one of four scenarios playing out: a Democratic sweep of Congress where the Bush-era tax cuts end for wealthy households, a Republican sweep with a focus on spending cuts, a divided government that induces the fi scal “ledge,” or a divided government that results in a fi scal “ladder.” Let’s look at each potential scenario and JP Morgan Asset Management’s investment conclusions for each scenario.

THE REPUBLICAN SWEEPAssumptions for this scenario include:

• extension of all Bush-era tax cuts, along with

a fi x for the Alternative Minimum Tax,

• expiration of the payroll tax cut and extended

unemployment benefi ts on schedule, and

• no increase in Medicare taxes.

Similar to the Democratic sweep scenario, only

the fi rst round of spending cuts takes place and

the second does not take eff ect.7

THE DEMOCRATIC SWEEPIf this scenario occurs, Kelly assumes that:

• the Bush-era tax cuts would be extended

only for those households earning less than

$250,000/year,

• top dividend and capital gains tax rates rise

from 15% to 20%,

• the payroll tax cut is phased down and

eventually eliminated,

• extended unemployment benefi ts expire on

schedule, and

• higher Medicare taxes ensue.

In terms of sequestration, he assumes that only

the fi rst round of spending cuts takes eff ect.5

Investment implications include a positive impact on equities but the opposite for municipal bonds. Kelly and team note further that, in this scenario, a Romney administration may seek additional tax and entitlement reform.8

Kelly sees this scenario as a negative for equities given their diminished after-tax cash fl ows but potentially positive for municipal bonds. The overall GDP impact would be a one percentage point drop in GDP from current levels if no tax increases or sequestration events happened.6


9

In our follow-up conversation with Dr. Kelly, we asked him what he was seeing investors do to prepare for this range of outcomes, and David responded that retail investors appear to be voting with their feet, as mutual fund fl ows out of stocks and into bonds have occurred at the fastest rate in the last fi ve years, a curious development in light of recent equity market performance. He was also seeing some taxable investors take steps to realize some gains this year across asset classes in light of higher anticipated taxes. In summary, though, Dr. Kelly argued that investors who are properly diversifi ed do not need to take action ahead of the uncertain outcomes that await us this year-end. Our view — a solid asset allocation, and a spoonful of sugar, may be the best combination for investors heading into 2013.

Sources:1 Ramey, Valerie A., and NBER (2012). “Government Spending and Private Activity.”

http://econ.ucsd.edu/~vramey/research/NBER_Fiscal.pdf2 Reinhart, Carmen M. and Kenneth S. Rogoff (2010). “Growth in a Time of

Debt,” American Economic Review, May. (Revised from NBER working paper

15639, January 2010.)3 http://www.cbo.gov/publication/435394 Kelly, David et al. “The Fiscal Choice: Cliff, Ledge or Ladder.” JP Morgan Asset

Management Market Insights, 2012, page 5.5 Kelly, David et al. “The Fiscal Choice: Cliff, Ledge or Ladder.” JP Morgan Asset

Management Market Insights, 2012, page 66 Ibid7 Ibid, page 88 Ibid9 Kelly, David et al. “The Fiscal Choice: Cliff, Ledge or Ladder.” JP Morgan Asset

Management Market Insights, 2012, page 1010 Ibid11 Ibid, page 1212 Ibid

DIVIDED GOVERNMENT�—�THE FISCAL LADDERThis would be a better economic scenario with a

more gradual defi cit reduction, with:

• full extension of the Bush-era tax cuts in 2013

and for households earning less than $250,000

from 2014 onwards,


from 15% to 20%,

• the payroll tax cut is maintained in 2012, phased

down in 2013, and eliminated in 2014,

• unemployment benefi ts expire on schedule,

• higher Medicare taxes to pay for President

Obama’s healthcare plan, and

• only the fi rst set of spending cuts is

implemented.11

DIVIDED GOVERNMENT�—�THE FISCAL LEDGEIf we see some split at the executive and

legislative branches of government, JP Morgan

anticipates a combination of spending cut

compromises and some higher tax rates that

could include the following:

• extension of the Bush-era tax cuts only for

households earning less than $250,000/year,


from 15% to 20%,

• expiration of the payroll tax cut on schedule,

• higher Medicare taxes to pay for President

Obama’s healthcare plan, and

• both sets of spending cuts are implemented.9

Kelly and team see this as a potential positive for equities. Even though tax rates would move higher, GDP would expand and the fi scal defi cit would simultaneously decline, potentially boosting investor confi dence.12

Kelly and team expect that outside of a full fi scal cliff realization, this scenario would have the worst impact on the economy and stocks and would have an uncertain impact on Treasury bonds.10


Nearly four years ago, the Federal Reserve cut its target interest rate to the lower bounds of its policy, where the rate remains today. While low interest rates are not a new phenomenon, two recent events have brought this issue back to the forefront of investors’ minds. First, the 10-Year U.S. Treasury — a useful proxy for interest rates — hit an all-time-low yield of 1.39% on July 24 amidst concerns about Europe’s debt crisis. Second, in September the Federal Reserve stated that it was willing to keep short-term interest rates at the present low levels through at least mid-2015 compared with the previous timeframe of 2014.

Under these circumstances, it may be an appropriate time for investors to reassess their portfolios and return expectations, particularly for fi xed income assets. Going forward, we expect subdued returns in lower-yielding assets such as certifi cates of deposit, money market accounts, and fi xed income securities for a number of reasons. The Fed actions discussed provide an incentive for investors to move away from lower-yielding assets and toward traditionally riskier areas such as equities. This is one of the reasons why the S&P 500 has rebounded so strongly off its March 2009 lows, recently approaching the all-time-high index level set in October 2007. In addition, many investors are concerned that interest rates can only go higher from today’s historically low levels. While the Fed will likely keep short-term rates anchored in the near term, it has less direct control over longer-term rates.

The biggest risk for bond returns is a sharp rise in interest rates, but several factors could prevent this scenario. Despite accommodative monetary policy from both the Fed and European Central Bank in recent months, economic fundamentals still appear weak and risks to global growth remain a concern.

In addition, demographic factors in the United States and a lack of viable substitutes for U.S. Treasurys as a safe haven asset could provide support even as rates rise. The forward curve, which represents market participants’ expectations for future interest rates, suggests a gradual rise in interest rates over the coming years. We also note that interest rates — which move in the opposite direction of bond prices — have staged short-lived rallies over the past few years, but in each instance have fallen as global

NAVIGATING BONDS IN TODAY’S LOW-RATE ENVIRONMENTHunter Brackett, CFASenior Manager, CAPTRUST Investment Research


11

growth concerns reemerged. For example, the yield on the 10-Year U.S. Treasury rose to 2.38% in March on stronger economic data, only to fall sharply and reach the previously cited all-time low in July.

We continue to encourage investors to diversify their allocations across subsectors of the bond market. Our research has shown that fi xed income returns can remain positive, even during periods of gradually rising rates, although subsectors may behave slightly differently. Given the prospect of higher long-term rates, investors may want to reduce interest rate risk while taking on a modest amount of credit risk. Credit-sensitive areas such as high-yield and emerging market debt may perform better than rate-sensitive subsectors such as Treasurys and investment-grade corporate bonds that tend to be more vulnerable to rising rates.

While credit-sensitive subsectors tend to be more volatile, we believe that their

fundamentals are supportive. Corporate balance sheets are much improved, as companies reduced costs during the recession and took advantage of low rates to refi nance their debt. Thus, default rates on high-yield debt are currently below their historical averages and are expected to rise at a modest pace going forward. It may also be useful to look outside of the U.S. market for bond exposure. Emerging market debt benefi ts from a stronger fi scal position relative to developed economies and favorable demographics, so exposure to this subsector may be appropriate depending on investor risk tolerance.

Another fi xed income subsector that has received attention recently is mortgage-backed securities (MBS). The Fed recently announced another round of quantitative easing in which it will purchase $40 billion of MBS in the open market every month. Importantly, this program is open-ended and will continue until the labor market shows sustained improvement. Although

this action is supportive of the MBS market, we note that some of the impact may have been priced into the market before the Fed announcement. While the housing market remains at a depressed level, fundamentals have started to improve, which could also aid the MBS market.

Following a multi-decade bull market in bonds and facing the prospect of rising interest rates, it may be tempting for investors to abandon this asset class. However, we continue to believe that bonds have an important role to play in client portfolios. They have historically been a less-volatile asset and provided a cushion during times of economic stress. Nevertheless, we expect subdued returns for fi xed income going forward, so investors will need to be more selective with their asset allocation decisions. We also stress the value that active management can play in a more challenging fi xed income backdrop. Having skilled portfolio managers who can profi tably source the subsectors mentioned earlier can be additive.

We are constantly reviewing and assessing bond portfolios and money manager talent. If you have specifi c questions we can answer given these historic times, please do not hesitate to let us know.


portfolio Strategyportfolio Strategy

This summer, I was fortunate enough to travel to Scotland with my dad, brother, and a good family friend, Neal Greenfi eld. It was a trip I had delayed for too long — new babies, business school, and the fi nancial crisis all contributed to its postponement, each with good reason. At last, on August 18, I found myself in Ayrshire, weary from a redeye fl ight and devoid of sleep (compliments of a fellow passenger’s cackle at every line from the recent movie version of The Three Stooges; my dad — affectionately referred to as the “Commish” for his selfl ess event planning — and I marveling at Curly’s enduring comedic prowess at 30,000 feet) but happily teeing up a new and soon-to-be-lost Titleist alongside the Ailsa Craig on Scotland’s southwest shore. I could only hope that the trip would match my long-built expectations and was determined to live every moment to the fullest. Especially considering that my honey-do account would be at an all-time surplus upon returning home. Our day at the Turnberry Golf Resort inaugurated a journey across the beautiful Scottish countryside, with my brother skillfully maneuvering a standard-shift passenger van to eight different links courses.

Leaving Turnberry and refl ecting on my par on 18 not being good enough to bring the youngsters (my brother and me) a victory over the seasoned veterans (thanks to Neal’s clutch birdie), we passed a sign with the message “Haste Ye Back,” which the Beverly Hillbillies may loosely translate into “Ya’ll come back now, ya hear?” It left us with a warm feeling every time we saw signs donning those three words, succinctly capturing the genuine Scottish hospitality no matter where we went. Caddies, waitresses, passers-by on the street; it didn’t matter whom we encountered, the Scots made us feel at home, except, of course, when an errant golf shot landed in the rough — a rough thickened by the second-wettest quarter in the United Kingdom since recorded history began in 1910.1 While we enjoyed excellent weather, the record spring rains lengthened what was already brutally high grass, causing us to export more golf balls than we would have liked.

The U.S. witnessed its own record in the third quarter, with the 10-Year Treasury hitting an all-time low in late July, touching 1.39% intraday. Uncertainty over Europe, the

Chinese slowdown’s extent, as well as a consistent thirst for yield in any form, drove up bond prices and, by defi nition, drove down bond yields. My colleague Hunter Brackett covers this development’s implications for fi xed income in this Strategic Research Report, but low bond yields also carry a signifi cant impact across portfolios.

The most important consideration is total return expectations; since most asset allocations, ranging from insurance companies, pension funds, and individual investors to sovereign countries, have notable bond allocations, all else equal, lower nominal (or non-infl ation-adjusted) interest rates imply lower total returns. We don’t rule out a rise in bond prices given major events unfolding over coming months — U.S. election season, the fi scal cliff, a more subdued corporate profi t tone, and ongoing European deliberations — but should the global economy “muddle through” or even surprise with growth exceeding expectations, bonds will not enjoy much of a yield cushion.

Figure 1 compares 10-Year U.S. Treasury yields to their equivalents in Germany, Japan, and Switzerland, demonstrating two important points. First, one can see that the yield cushion for all four sovereign countries’ bonds has contracted materially in recent years, with only the U.S. 10-Year above 1.50% at September’s end. Second, precedent exists wherein bond prices could move higher despite historically low yields. However, since nominal bond yields are bound by zero, at some point, total return expectations must come down as bond yields approach this absolute zero boundary.

While no one can know defi nitively when bond yields will bottom, the closer we approach zero, the faster investors need to “haste back” their total portfolio return expectations. If bonds move lower in yield (and higher in price), investment theory suggests that a more muted total return expectation should be applied to all asset classes. The theory is best explained by the great Warren Buffett in a 1999 Fortunemagazine article, which 13 years later remains one of the most popular media investing interviews of all time. (Please realize how clichéd it is to quote Mr. Buffett in this industry, so you know it’s gotta be good.) Mr. Buffett said that “interest

HASTE YE BACKEric J. FreedmanCAPTRUST Chief Investment Offi cer


13

continued on page 14

rates… act on fi nancial valuations the way gravity acts on matter. The higher the rate, the greater the downward pull… so if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return in line.”2

Of course, investment theory and reality can diverge over time, so it is not a given that all other asset classes will sell off if interest rates move higher. We have been adamant — in these pages and other client communications — that bond yields will remain low and sticky for some time. While we hear periodic

infl ationary cries (and have for fi ve years), we continue to see the global economy as being too weak in the short term to stoke sustainable infl ationary pressures, although we do see it as a potential risk should central banks continue accommodative monetary policy in the form of ongoing bond buying. Even given recent central bank activity, infl ation expectations remain subdued.

Figure 2 shows infl ation expectations as measured by breakeven infl ation rates, calculated as the difference between nominal and real (infl ation-adjusted) yields for bonds from the same issuer and

the same maturity. This difference, by defi nition, provides investors with a real-time gauge of infl ation expectations. The rates are for 5- and 10-year breakeven rates; in other words, where the market sees infl ation 5 and 10 years from now.

As Figure 2 details, infl ationary expectations have risen from the depths of the fi nancial crisis in 2008 and 2009, but current rates are well within the long-term average of 2.5 to 3.0% and are still below pre-crisis levels. Also, while it’s hard to see on the chart, infl ation expectations have reversed from the period immediately preceding the Fed’s September policy announcement of open-ended bond purchases. So while infl ation could cause bond yields to move higher in a more rapid fashion, for now, we retain our view that infl ation is a “high class problem.” We will be watching developments that may cause us to shift this long-standing belief.

We see bond yields as being sticky at current levels, with downside risk to yields in the form of a market-unfriendly election, a failure to reach compromise on the fi scal cliff, a sharp global slowdown, and a variety of other negative catalysts and upside in the form of unforeseen infl ation, quicker-than-expected growth, or asset allocation trends reversing from prior years’ bond-market dominance over stocks (see Figure 3 on the next page). Given consistent demand for fi xed income assets, the potential for an asset allocation shift out of bonds is real, although U.S. demographics and memories of 2008’s woes would suggest that such a shift would be gradual.

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Figure 1: Select 10-Year Government Bond Yields, Sept 2007�–�Sept 2012

12/1

/20

07

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8

6/1

/20

08

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/20

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/20

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/20

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Figure 2: Weekly U.S. Breakdown Inflation Expectations, 5 and 10 Years Forward, Jan 2002�–�Oct 2012

1/11

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12

1.0%

4.0%

0.0%

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)

3.0%

2.0%

5.0%

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1.5%

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United StatesJapan

SwitzerlandGermany

5-Year Breakevens10-Year Breakevens



Sources:1 http://www.bbc.co.uk/news/uk-186532742 http://money.cnn.com/magazines/fortune/fortune_archive/1999/11/22/269071/3 https://doc.research-and-analytics.csfb.com/docView?sourceid=em&document_id=x430358&serialid=4SZAPm5ppWs68p7uGa6zSSuWzTQo2UkuZfyb20q%2F9pk%3D, page 9

Given three possible scenarios, 1) a “muddle through” economy where bond yields hover at current levels with a bias for moving higher, 2) a “risk off” scenario where bond yields fall further, approaching the zero bound as investors seek safety, or 3) a “risk on” scenario where bonds are shunned in favor of stocks and traditionally riskier asset classes, portfolio returns could follow very different patterns, depending on their relative allocations. Regardless, only the second scenario would see bond prices head higher, which — despite economic and Buffett theory — may not result in all other asset classes moving higher as well based on recent relationships. While fixed income portfolios may get one last hurrah higher, they get closer and closer to the zero bound.

Please do not read this as me writing the bond market’s epitaph; quite the opposite. We still see a lot of risks in the global economy, including some in the very near term that cause us to recommend and retain a healthy exposure to parts of the bond market that run counter to current consensus views. My main message is that return expectations, for both bond-heavy and bond-light investors, need to be more subdued, given a lower nominal return world. Credit Suisse’s David Zion noted earlier this year that S&P 500 companies’

median pension return expectation was 7.79% at the end of 2011, in an environment where U.S. nominal bond yields stood at historically low rates.3 While we don’t think this is an unchallenging return assumption over a long period of time, shorter term it may be difficult to achieve depending on asset allocation and liquidity needs.

Our last round fittingly took place at St. Andrews’ majestic Old Course, golf ’s birthplace. After a memorable day, Neal once again birdied 18 in front of a small crowd to give the old-timers a much-deserved multi-round, carry-over win following a solid finish from the Commish that morning — leaving the youngsters to ponder what could have been (and pick up the evening’s check). On top of the epic loss, I developed elbow tendonitis from having played too many rounds in too short a period (read: I am getting old), but that injury has neither garnered sympathy from my wife, Jamie, nor shortened the honey-do list. Still, the feeling standing on the Old Course’s first tee, playing Muirfield before the Open Championship next year, birdieing 18 at Troon, the jokes, the blinding rain, the non-conceded putts, eccentric caddies, driving on the wrong side of the road, the Scotts’ warm smiles, and a nip or two on the 19th hole will stay with me: Haste Us Back, indeed. n

$20,000

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Figure 3: Investment Company Institute: Monthly Net New Flows into Stock and Bond Funds, Jan 2007 – Aug 2012

-$20,000

-$60,000

$60,000

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200

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200

8

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200

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9/1/

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5/1/

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5/1/

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$0

-$40,000

-$80,000

$40,000

Total EquityTotal Bond


15

index returnsindex returns

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2012 3RD QUARTER INDEX PERFORMANCE

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

Small Cap Stocks (Russell 2000 Index)

Large Cap Stocks (Russell 1000 Index)

Commodities (Dow Jones UBS Commodity Index)

Real Estate (MSCI U.S. REIT Index)

Fund of Funds (HFRI FoF Composite Index)

Mid Cap Stocks (Russell Mid Cap Index)

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

Fixed Income (Barclay’s Capital U.S. Aggregate Index)

Cash (Merrill Lynch 3-Month Treasury Bill)

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 YTD

S&P 500 6.35% 16.44% 2.11% 15.06% 26.46% -37.00% 5.49% 30.20% 13.20% 1.05% 8.01%

Dow Jones Industrial Average 5.02% 12.19% 8.38% 14.06% 22.68% -31.93% 8.88% 26.52% 14.45% 2.16% 8.60%

NASDAQ Composite 6.17% 19.62% -1.80% 16.91% 43.89% -40.54% 9.81% 29.02% 13.66% 2.90% 10.27%

Russell 1000 6.31% 16.28% 1.50% 16.10% 28.43% -37.60% 5.77% 30.06% 13.27% 1.22% 8.35%

Russell 1000 Growth 6.11% 16.80% 2.64% 16.71% 37.21% -38.44% 11.81% 29.19% 14.73% 3.24% 8.41%

Russell 1000 Value 6.51% 15.75% 0.39% 15.51% 19.69% -36.85% -0.17% 30.92% 11.84% -0.90% 8.17%

Russell Mid Cap Index 5.59% 14.00% -1.55% 25.48% 40.48% -41.46% 5.60% 28.03% 14.26% 2.24% 11.18%

Russell 2000 5.25% 14.23% -4.18% 26.85% 27.17% -33.79% -1.57% 31.91% 12.99% 2.21% 10.17%

Russell 2000 Growth 4.84% 14.08% -2.91% 29.09% 34.47% -38.54% 7.05% 31.18% 14.19% 2.96% 10.55%

Russell 2000 Value 5.67% 14.37% -5.50% 24.50% 20.58% -28.92% -9.78% 32.63% 11.72% 1.35% 9.68%

AC World Index Free Ex-U.S. 7.49% 10.86% -13.33% 11.60% 42.14% -45.24% 17.12% 15.04% 3.63% -3.67% 10.32%

HFRI Fund of Funds 2.34% 3.33% -5.72% 5.70% 11.47% -21.37% 10.25% 2.84% 1.48% -1.65% 3.62%

Wilshire REIT Index -0.15% 14.74% 9.24% 28.60% 28.60% -39.20% -17.55% 32.43% 20.72% 1.73% 11.35%

Barclays Govt. Intermediate Bond 0.62% 1.70% 6.08% 4.98% -0.32% 10.43% 8.47% 2.39% 4.09% 5.20% 4.20%

Barclays Corporate IG Bond 3.83% 8.66% 8.15% 9.00% 18.68% -4.94% 4.56% 10.76% 9.09% 8.06% 6.56%

Barclays Aggregate Bond 1.59% 3.99% 7.84% 6.54% 5.93% 5.24% 6.97% 5.16% 6.19% 6.53% 5.32%

Barclays Intermediate Govt./Credit 1.40% 3.53% 5.80% 5.89% 5.24% 5.08% 7.39% 4.40% 5.18% 5.71% 4.76%

Barclays Muni Bond 2.31% 6.06% 10.70% 2.38% 12.91% -2.47% 3.36% 8.32% 5.99% 6.06% 5.03%

Barclays High Yield 4.53% 12.13% 4.98% 15.12% 58.21% -26.16% 1.87% 19.37% 12.90% 9.34% 10.98%

90-Day U.S. Treasury 0.03% 0.07% 0.10% 0.13% 0.21% 2.06% 5.00% 0.07% 0.11% 0.72% 1.82%

Consumer Price Index (Infl ation) 0.59% 2.29% 2.96% 1.50% 2.72% 0.09% 4.08% 1.74% 2.24% 2.06% 2.46%

INDICES Q3 12 2012 2011 2010 2009 2008 2007 1-YEAR 3-YEAR 5-YEAR 10-YEAR

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 YTD

Commodities

24.35%

Fund of Funds

7.45%

RealEstate

-37.97%

Commodities

-35.65%

International Equities

-45.25%

Fund of Funds

-21.34%

Large CapStocks

-37.60%

Small CapStocks

-33.79%

Cash

1.51%

Fixed Income

5.24%

Mid CapStocks

-41.46%

Large CapStocks

6.27%


17.12%

Fund of Funds

10.26%

Large CapStocks

5.77%

Commodities

16.23%

Small CapStocks

-1.57%

Cash

4.71%

Fixed Income

6.97%

Large CapStocks

16.28%


10.86%

Fixed Income

3.99%

Cash

0.07%

Fund of Funds

3.33%

Small CapStocks

14.23%

RealEstate

14.89%

Commodities

5.63%


30.98%

Fund of Funds

26.47%

Small CapStocks

21.26%

Large CapStocks

20.91%

Cash

5.01%

Fixed Income

-0.82%

RealEstate

-4.55%

Commodities

31.84%

RealEstate

26.81%

Fixed Income

11.63%

Cash

6.36%

Fund of Funds

4.08%

Small CapStocks

-3.02%

Large CapStocks

-7.79%


-15.11%

RealEstate

12.83%

Fixed Income

8.44%

Cash

3.64%

Fund of Funds

2.79%

Small CapStocks

2.49%

Large CapStocks

-12.45%


-19.50%

Commodities

-19.51%

Commodities

25.90%

Fixed Income

10.25%

RealEstate

3.64%

Cash

1.68%

Fund of Funds

1.01%


-14.67%

Small CapStocks

-20.48%

Large CapStocks

-21.65%

Small CapStocks

47.25%


41.41%

RealEstate

36.74%

Large CapStocks

29.89%

Commodities

23.93%

Fund of Funds

11.62%

Fixed Income

4.10%

Cash

1.05%

Commodities

9.15%

RealEstate

31.49%


21.36%

Small CapStocks

18.33%

Large CapStocks

11.40%

Fund of Funds

6.79%

Fixed Income

4.34%

Cash

1.44%

Commodities

21.36%


17.11%

RealEstate

12.13%

Small CapStocks

4.55%

Cash

3.35%

Fixed Income

2.43%

RealEstate

35.92%


27.16%

Small CapStocks

18.37%

Large CapStocks

15.46%

Fund of Funds

10.34%

Cash

5.08%

Fixed Income

4.33%

Commodities

2.07%

RealEstate

-16.82%

Mid CapStocks

14.00%

Mid CapStocks

18.23%

Mid CapStocks

8.25%

Mid CapStocks

-5.62%

Mid CapStocks

-16.19%

Mid CapStocks

40.06%

Mid CapStocks

20.22%

Mid CapStocks

12.65%

Mid CapStocks

15.26%

Mid CapStocks

5.60%

RealEstate

28.61%

Small CapStocks

27.17%


42.14%

Large CapStocks

28.43%

Mid CapStocks

40.48%

Commodities

18.91%

Cash

0.21%

Fixed Income

5.93%

Fund of Funds

11.16%

RealEstate

28.48%

Small CapStocks

26.85%


11.60%

Large CapStocks

16.10%

Mid CapStocks

25.48%

Commodities

16.83%

Cash

0.13%

Fixed Income

6.54%

Fund of Funds

5.46%

RealEstate

8.69%

Small CapStocks

-4.18%


-13.33%

Large CapStocks

1.50%

Mid CapStocks

-1.55%

Commodities

-13.32%

Cash

0.10%

Fixed Income

7.84%

Fund of Funds

-5.51%

2012 3RD QUARTER ASSET CLASS RETURNS

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We include our asset allocation research for illustrative purposes

only. These recommendations are being implemented only

in instances where CAPTRUST has been granted full trading

discretion on asset allocation decisions within client portfolios.

asset allocation researchasset allocation research

90.0%

10.0%

65.0%

20.0%

3.0% 3.0% 6.0%3.0%

50.0%

16.0%

17.0%

10.0%

3.0%4.0%

STRATEGY 1

MIN TARGET MAX

U.S. Equities 0.0% 0.0% 0.0%

International Equities 0.0% 0.0% 0.0%

Fixed Income 75.0% 90.0% 100.0%

Hedge Funds�/�Private Equity 0.0% 10.0% 20.0%

Commodities 0.0% 0.0% 0.0%

Real Estate 0.0% 0.0% 0.0%


Fixed Income

Hedge Funds / Private Equity

Commodities

U.S. Equities

Real Estate

STRATEGY 2

MIN TARGET MAX

U.S. Equities 0.0% 6.0% 10.0%


Fixed Income 50.0% 65.0% 75.0%



Real Estate 0.0% 3.0% 6.0%


Fixed Income


Commodities

U.S. Equities

Real Estate

STRATEGY 3

MIN TARGET MAX

U.S. Equities 10.0% 17.0% 21.0%


Fixed Income 30.0% 50.0% 60.0%



Real Estate 0.0% 3.0% 6.0%


Fixed Income


Commodities

U.S. Equities

Real Estate


17

32.0%

21.0%

24.0%

16.0%

3.0%4.0%

21.0%

21.5%

28.5%

20.0%

4.0%5.0%

11.0%

23.5%

32.5%

24.0%

4.0%5.0%

4.5%

20.0%

36.5%

28.0%

5.0%6.0%

STRATEGY 4

MIN TARGET MAX

U.S. Equities 15.0% 24.0% 29.0%


Fixed Income 20.0% 32.0% 38.0%



Real Estate 0.0% 3.0% 6.0%


Fixed Income


Commodities

U.S. Equities

Real Estate

STRATEGY 5

MIN TARGET MAX

U.S. Equities 20.0% 28.5% 35.0%


Fixed Income 15.0% 21.0% 25.0%



Real Estate 0.0% 4.0% 8.0%


Fixed Income


Commodities

U.S. Equities

Real Estate

STRATEGY 6

MIN TARGET MAX

U.S. Equities 25.0% 32.5% 40.0%


Fixed Income 0.0% 11.0% 20.0%



Real Estate 0.0% 4.0% 8.0%


Fixed Income


Commodities

U.S. Equities

Real Estate

STRATEGY 7

MIN TARGET MAX

U.S. Equities 26.0% 36.5% 44.0%


Fixed Income 0.0% 4.5% 7.0%



Real Estate 0.0% 5.0% 10.0%


Fixed Income


Commodities

U.S. Equities

Real Estate


CAPTRUST Discretionary research highlightsCAPTRUST Discretionary research highlights

• We switched from a more defensive posturing early in the

second quarter of 2010 to a more optimistic orientation

in August 2010 and then an even more optimistic view in

early October 2010, feeling that the market had overshot

to the downside.

• In mid-May 2011, we ratcheted back to a more neutral

posturing, anticipating a potential growth slowdown as

well as taking profi ts on our previously held constructive

positioning.

• After the initial sharp sell-off in August 2011, we deployed

some more capital into small- and mid-capitalization

stocks in a contrarian fashion but reversed that positioning

a month later fearing more potential downside. While we

have not deployed fresh capital into the U.S., we have not

rebalanced portfolios in the recent equity market rally,

deploying a slightly bullish tilt to our portfolios.

• We continue to have a footing in international equities

yet remain concerned about the overhang surrounding

the European Union as well as the potential for Chinese

growth deceleration. We have seen some progress on the

former but the latter remains an open-ended question.

• Valuation is very attractive from a historical standpoint;

however, valuation metrics could prove irrelevant should

the European Union’s structure unravel or additional

fi nancial system stress unhinge the potential for a

“muddle through” type of recovery. Recent concerns

about whether Spain or Italy will submit to more stringent

fi scal measures could continue to cast a shadow over

European stocks.

• Given demographic factors, international equities remain

an important part of our long-term asset allocation

strategies, but it is challenging to be tactical in such a

reactionary market environment. Therefore, we continue

to retain a quality bias and await better risk/reward setups.

• We deemphasized fi xed income in the second half of 2010

despite anticipating further Federal Reserve stimulus in

the form of quantitative easing and open-market bond

purchases.

• We have since increased our weighting to fi xed income,

incorporating a diversifi ed approach by sector and

geography, using a combination of active and passive

management. We expect a few persistent themes to

endure within the space that are accessible via highly

skilled managers.

• The consensus view is for higher interest rates, and we

have been contrarian in our thinking that bond yields are

unlikely to rise quickly as capital markets will likely remain

uneasy as 2012 unfolds. Unease regarding European

policymaker decisions, the fi scal cliff and the U.S. election

all factor into our thinking that bonds should retain a

prominent place in portfolios.

U.S. EQUITIES

INTERNATIONAL EQUITIES

FIXED INCOME


19

• Hedge fund strategies have had a challenging backdrop in

which to operate over the past three years given market

oscillations, yet we see investment merit in certain hedge

fund sub-categories, particularly those that are less reliant

on overall market direction.

• We have emphasized more conservative hedge fund

strategies recently with a goal of preserving capital

during large down periods in riskier asset classes versus

strategies that have higher equity market gearing or

economic sensitivity.

• Should risk assets overshoot to the downside following

our expectation for additional macroeconomic headline

concerns and the potential for more subdued earnings-

season guidance from global companies, we may look to

deploy capital into more market directional strategies as we

have found some strong manager fi ts after a recent search.

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

to the demand story but also to a lack of infrastructure

investment across many key commodities.

• Given the challenging macroeconomic environment and

the potential for further growth scares, we expect to see

considerable volatility within commodities. We would like

to see commodities decouple from equity returns and

give investors more of a correlation boost than we have

experienced since the fi nancial crisis.

• We have recently deemphasized actively managed

strategies with the view that commodities present

considerable challenges for most active managers to

successfully navigate. Correlations between commodities

and more “crowded” active manager positions leave

us happy to invest in broad commodity mandates and

control the overall exposure levels versus leaving that to

an active manager.

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

improved fundamentals as well as attractive yields given

subdued interest rates.

• In a low-yield world, REITs retain a strong distribution

profi le while off ering some growth potential, an attractive

combination for a variety of investors that should provide

an underlying bid to the space.

• Recent capital-raising success across the REIT complex

in late 2011 and thus far in 2012 leave operators poised

for opportunistic purchases and increased fl exibility, but

we remain watchful of investors chasing what has been

a strong asset class since the fi nancial crisis; we did see

REITs trail public equities in the third quarter, which could

be healthy pending developments later this year.

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.

HEDGE FUNDS�/�PRIVATE EQUITY

COMMODITIES

REAL ESTATE


investment asset classesinvestment asset classes

U.S. EQUITIES

INTERNATIONAL EQUITIES

• U.S. equities recorded their third positive quarter in the

last four with the S&P 500 rising 6.4%, outpacing both

small- and mid-cap stocks in the third quarter.

• Nine of the ten major S&P 500 sectors were positive in

the third quarter with utilities being the sole negative

performer, falling a modest 0.5%. Energy (+10.1%) and

telecom (+8.1%) were the strongest sectors, with the

latter leading all S&P 500 sectors year-to-date with an

impressive 26% gain.

• Since the U.S. equity market peaked in October 2007, the

only style that has not fully recovered from the two-and-

a-half-year market malaise (after incorporating reinvested

dividends) is large cap value, due to its large weighting in

the fi nancial sector.

• Developed and emerging international equities both

rallied in the third quarter and have been higher 11 out of

the last 14, and 11 out of the last 15 quarters, respectively.

• Developed international equities rose 7% in dollar terms

and 4.7% in local currency terms, led by Germany (+13.9%

in dollars). Japan was a laggard, falling 3.2% in local

currency terms but down just 0.8% in dollar terms thanks

to yen appreciation.

• Emerging markets fi nished up 6% in local terms and up

7.9% in dollars due to relative currency strength. China

and Brazil were up 4.7 and 4.8% respectively, but recently

weak India posted a +15.4% dollar return after a strong

rally in both stocks and the rupee.

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Q3 12 2012

Q3 12 2012

Market Performance, 3rd Quarter 2012


Large Value (R1000 Value) 6.51% 15.75%

Large Blend (S&P 500) 6.35% 16.44%

Large Growth (R1000 Growth) 6.11% 16.80%

Mid Value (Russell) 5.80% 14.03%

Mid Blend (Russell) 5.59% 14.00%

Mid Growth (Russell) 5.35% 13.88%

Small Value (R2000 Value) 5.67% 14.37%

Small Blend (R2000 Blend) 5.25% 14.23%

Small Growth (R2000 Growth) 4.84% 14.08%

International Equities (MSCI EAFE) 6.98% 10.59%

Pacifi c Stocks (MSCI Pacifi c Ex-Japan) 11.03% 17.58%

European Stocks (MSCI Europe Ex-UK) 9.73% 12.79%

Japanese Stocks (MSCI Japan) -0.77% 2.43%

UK Stocks (MSCI UK) 7.06% 10.67%

Emerging Markets (MSCI EME) 7.89% 12.33%


21

FIXED INCOME

HEDGE FUNDS�/�PRIVATE EQUITY

• The Barclays Aggregate Bond Index had its 15th positive

quarter in its past 16, closing up 1.6% in the third quarter

of 2012. The index was up every quarter in 2011.

• Within the broad fi xed income space, historically riskier

parts of the bond market were stronger this past quarter,

with emerging market debt (+6.8%), high yield (+4.5%), and

investment grade corporates (+3.8%) all marking strong

returns. Mortgages and Treasurys lagged in the quarter.

• Despite relentless calls for interest rates to rise, 10-Year

Treasury rates hit an all-time intraday low on July 24,

touching 1.39% and closing at 1.64% for the quarter.

• Hedge fund strategies continue to post lackluster returns

and the third quarter was no exception. The HFRX Global

Hedge Fund index was up 0.39% in September after a

+0.51% August, bringing the index to just over 2.6% for

the year.

• The weakest sub-categories include global macro and

relative value strategies, while event driven is up close

to 5% through September and equity hedged strategies

have meaningfully underperformed their long-only peers.

• Alternatives research fi rm Prequin reported that, based

on preliminary data for the quarter, private equity had a

slow sequential quarter capital-raising season (but better

than the comparable quarter in 2011), as did infrastructure

and venture capital despite an otherwise strong year.

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Broad Market (Barclays Capital U.S. Aggregate) 1.59% 3.99%

Barclays Capital U.S. Treasurys 0.57% 2.08%

Barclays Capital Mortgage Backed Securities 1.13% 2.80%

Barclays Capital Municipals 2.31% 6.06%

Barclays Capital Intermediate Corporates 3.18% 7.69%

Barclays Capital High Yield 4.53% 12.13%

HFRI Fund Weighted Composite Index 2.86% 4.65%

HFRI Equity Hedge Index 3.47% 5.51%

HFRI Relative Value Index 3.68% 8.08%

HFRI Fund of Funds Composite Index 2.34% 3.33%

HFRI Fund of Funds Conservative Index 1.65% 2.36%


COMMODITIES

REAL ESTATE

• The Dow Jones UBS Commodity index rallied 9.7% in

the third quarter after falling 4.6% in the second quarter,

moving to positive territory for the year-to-date period.

• Several subsectors demonstrated considerable strength.

Metals were strong across the board, with lead up 28.1%

and silver +25.4%. Sugar and cotton were the only

weak agricultural components and the energy complex

demonstrated its typical volatility; WTI and Brent Crude

returns were both positive yet highly divergent, and

gasoline was up for the quarter.

• Commodities continue to show more elevated

correlations to other asset classes than in most periods

before the fi nancial crisis, and those correlations did not

abate in the third quarter.

• Public real estate, as measured by the NAREIT Equity

REIT index, increased a modest 1% in the third quarter

but REITs have still outperformed U.S. equities four out

of the last six quarters. REITs were up a whopping 164.2%

cumulative over the past 10 years, ending September 30.

• Capital raising continues to be easy for REITs, with

NAREIT data showing that REITs have raised just shy of

$45 billion as of the end of August 2012, which is 88% of

what the industry raised in a record-setting 2011.

• Several REIT subsectors sport attractive fundamentals

based on changes in buyer behavior. NAREIT research

suggests that apartment REIT supply lags demand by

some four million units despite early signs of stabilizing

housing demand.

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Dow Jones UBS Index 9.69% 5.63%

S&P GSCI Commodity Index 11.54% 3.47%

Gold (Spot, $/oz) 10.94% 13.33%

Natural Gas (U.S. Spot Henry Hub) 11.68% 2.68%

Crude Oil (U.S. Spot, WTI Cushing) 8.51% -6.72%

MSCI U.S. REIT Index 0.01% 14.89%

Wilshire REIT Index -0.15% 14.74%


23

captrust in the newscaptrust in the news

CAPTRUST GROWTHThe CAPTRUST team grew in the third quarter with the addition of four new fi nancial advisorsand new offi ces in Boston and New York City.

New York City Offi ce

John Davenport joined CAPTRUST in 2012 from Barclays Capital, where he was responsible for analysis and approval of over $11 billion of the bank’s balance sheet exposure to U.S. industrial, healthcare, consumer, and retail companies. He

currently provides investment advisory services to fi duciaries of corporate retirement plans. John received top honors from the University of North Carolina Wilmington’s Cameron School of Business, where he graduated summa cum laude with a Bachelor of Science degree in fi nance and economics and was awarded the 2008 E.M. West Award for most outstanding graduate. John is a CFA charter holder.

Boston Offi ce

Bob Auditore joined the fi rm in August 2012 as Vice President, Financial Advisor with over 24 years of experience in design, implementation, and administration of qualifi ed retirement plans for corporate fi duciaries. Previously, Bob was one of

the founding principals of Bay Colony Partners, a group of specialists focused on qualifi ed and nonqualifi ed corporate retirement plans and individual wealth management, located in Boston, Massachusetts. There, Bob served as managing partner of the fi rm’s retirement plan practice. Prior to the formation of Bay Colony Partners, Bob was a principal of L&M Securities, Inc. A recognized leader in the industry, Bob frequently serves as a speaker to professional groups and was named to 401k Wire’s “300 Most Infl uential DC Plan Advisors” in 2010. Bob is a graduate of Tufts University with a bachelor’s degree in economics.

Gary Cowles joined our team in August 2012 as Vice President, Financial Advisor with over 21 years of experience in retirement investment advisory services in the area of nonqualifi ed deferred compensation plans. Previously, Gary was

one of the founding principals of Bay Colony Partners and served as managing partner of the fi rm’s executive benefi ts practice. Gary also previously held executive-level positions with a large benefi ts consulting fi rm, John Hancock and Scudder, Stevens & Clark. Gary is a graduate of the University of New Hampshire with a bachelor’s degree in mathematics and performed graduate studies in taxation at Bentley College. He has obtained the Chartered Life Underwriter (CLU®) and Chartered Financial Consultant (ChFC®) designations from the American College and is a member of the Association for Advanced Life Underwriting in Washington D.C., and the Society of Financial Services Professionals.

Los Angeles Offi ce

Debbie Basch joined us as a Financial Advisor Relationship Manager and will be responsible for providing investment management and consulting services to institutional investors and corporate retirement plan fi duciaries. Debbie joins

CAPTRUST from Diversifi ed Investment Advisors, where she managed a diverse client base of corporate and not-for-profi t retirement plans. Prior to that, she was a vice president, relationship manager at Union Bank of California and director of institutional retirement consulting at Fidelity Investments. Debbie is a graduate of the University of Massachusetts with a bachelor’s degree in communication studies.

continued on page 24


CAPTRUST continued its charitable efforts this past quarter through the CAPCommunity Foundation’s involvement with the following organizations and causes:

• North Carolina Food Bank

• The Salvation Army

• Raleigh Rescue Mission

• 519 Heart Haiti

• Ronald McDonald House

• Variety—The Children’s Charity

• JOA, Inc.

• Habitat for Humanity of Summit County

• Jonathan Brookins Memorial Scholarship

• Special Olympics NC

• Foundation of Hope

• Super Cooper’s Little Red Wagon

GIVING BACK

In the third quarter of 2012, CAPTRUST launched captrustnonqualifi ed.com, a website that offers an objective and holistic perspective on best practices for nonqualifi ed deferred compensation plans. The website offers a concise overview of what CAPTRUST calls the “Five Components of a Successful Nonqualifi ed Plan Strategy.” In addition to providing a rare unbiased perspective, the site offers nonqualifi ed plan sponsors a number of interactive tools.

One highlight of the website is the Benchmark My Plan feature, an interactive tool that allows nonqualifi ed plan sponsors to see how their plan stacks up against others. Built using a combination of CAPTRUST proprietary and non-proprietary databases, this tool provides valuable insight not easily available elsewhere. The website also offers the NQIQuiz, a test to gauge a plan sponsor’s knowledge of nonqualifi ed plans, and a Plan Review tool that allows plan sponsors to upload plan-related documents and receive a complimentary nonqualifi ed plan due diligence review.

INDUSTRY INVOLVEMENTThe following is a list of topical discussions led by CAPTRUST at

industry events in the fourth quarter.

UNDERSTANDING THE FIVE COMPONENTS OF A SUCCESSFUL NONQUALIFIED DEFERRED COMPENSATION PLAN

October 3, 2012 | Portland, ME (Cumberland Club)

October 10, 2012 | Chicago, IL (University Club of Chicago)

October 11, 2012 | Des Moines, IA (Sheraton West Des Moines)

November 28, 2012 | Washington, D.C. (National Press Club)

Presented by Mike Curran, SVP,

CAPTRUST Nonqualifi ed Executive Benefi ts

“ASK THE EXPERTS” WORKSHOPOctober 2, 2012 | Atlanta, GA

Southern Employee Benefi ts Conference

Presented by Vic Bell, SVP, CAPTRUST Financial Advisor

FIDUCIARY OVERVIEW November 12, 2012 | Troy, NY (Emma Willard School)

Association of Business Offi cers of Private Schools (ABOPS)

Presented by Patrick Marlatt, VP, CAPTRUST Financial Advisor, and

Phyllis Klein, Senior Director, CAPTRUST Consulting Research Group


For the ninth time in the past 11 years, Site Selection magazine has named

FirstEnergy Corp. one of the top utilities in the country for promoting

economic development. FirstEnergy is a diversifi ed energy company

dedicated to safety, reliability, and operational excellence. In 2011, the

company helped attract more than $1.7 billion in capital investment to

its Ohio, Pennsylvania, New Jersey, West Virginia, and Maryland service

areas that is expected to create more than 7,400 new jobs.

The designation recognizes utility companies that complement

reliable power delivery to their customers with a hands-on approach

to encouraging business development in their operational areas. Using

2011 data, the award is based on a mix of objective and subjective

criteria, including what the utility does to help create jobs and facilitate

investment in its area, available website tools and data that can be used

to help business development, and survey input from corporate end users

and site consultants.

CONGRATULATIONS

RECENT NEWS

FirstEnergy Repeats

Honor of Top Utility for

Economic Development


Documents

CAPTRUST Strategic Research Report Q3 2012 Wealth Management Edition