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Objective After the US market closed on August 31st 2016, Real Estate was separated from the GICS Financial sector into a sector of its own. The goal of this white paper is to explore the following topics: • What are the implemented changes to the Global Industry Classification

Standard (GICS), and how did market capitalization growth and sector correlations impact the decision?

• Why have active funds managers generally underweighted real estate and will that likely change?

• How well does SGA’s stock selection model perform within Real Estate? Introduction The Global Industry Classification Standard (GICS) was co-developed in 1999 by Standard & Poor’s and MSCI. Together their goal was to create a systematic and well-defined classification system that allows investors to compare company fundamentals to global peers within the same corresponding sector, industry group, industry, and sub-industry group. The GICS methodology reflects a view that revenues are a strong representation of operating activities but also considers earnings and market perception. When it comes to perception, the committee uncovered that most market participants consider real estate companies to be fundamentally different from financial companies.1 Since 1999, GICS has experienced ongoing structural changes resulting in the net new addition of one industry group, nine industries, and thirty-four sub-industries. For the first time, on September 1, 2016 a new sector was created which separates real estate from financials. Companies moving forward may now be classified in one of the following sectors: • Consumer Discretionary • Consumer Staples • Energy

1 S&P Dow Jones Indices And MSCI Announce Further Revisions To The global Industry Classification Standard (GICS®) STRUCTURE IN 2016. N.P., 02 Nov. 2015.

Global Equity Research Real Estate Relocated

October 2016

This is the first sector level change in the GICS structure since it was established in 1999.

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• Financials • Health Care • Industrials • Information Technology • Materials • Real Estate • Telecommunication Services • Utilities GICS is an important classification standard in capital markets which enables participants to easily compare companies to their global peers based on sector, industry, or sub-industry. The standards are especially important to firms such as Strategic Global Advisors (SGA) when looking to rank stocks across markets as well as manage risk across regions, countries, sectors, and industries relative to strategy benchmarks. The newly implemented Real Estate GICS sector comprises two industries: Equity Real Estate Investment Trusts (Equity REITs) and Real Estate Management and Development companies (RE M&D). Equity REITs make up approximately 50% of the new sector by market cap. An Equity REIT is a company that buys and sells residential and commercial properties such as apartment buildings, office buildings, and shopping centers. Although global standards vary, most countries require Equity REITs to distribute at least 90% of their income to maintain tax-free status. Their high dividend yield has historically made them attractive for investors seeking income, especially in low interest rate environments. The Equity REITs vs RE M&D The first REIT structure was created in the United States. In 1960, President Eisenhower signed the REIT Act, which was meant to give investors the opportunity to invest in liquid securities that provide exposure to diversified large-scale real estate portfolios. Today, more than thirty-five countries have REIT structures, many of which were established just in the past 10 years, including Germany, Finland, and the United Kingdom. Real estate companies such as Equity REITs require access to liquid capital markets because they generally rely on external financing for growth. As global interest rates continue to persist at record lows, real estate companies have benefited as their cost of capital has fallen. Conversely, RE M&D companies are service providers and generate a larger portion of their profits from capital gains as a result of more focus on the development of real estate and they are not subject to dividend pay-out requirements.

The first REIT structure was created in the 1960’s by President Eisenhower. Today, more than 35 countries have listed REITs.

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It is important to note that not all REITs are in the business of owning and operating real estate. In fact, GICS continues to classify Mortgage REITs as part of the Financials sector because they generally do not own property but rather make money providing financing services by borrowing at short-term rates in order to buy long-term mortgage backed securities and other types of credit securities. Implemented Changes: Before and After In Figure 1 below, we highlight in green the portion that was carved out to its own stand-alone sector, called “Real Estate”. Notice however that the Mortgage REITs sub-industry, highlighted in yellow, remained in the Financial Sector and was promoted from sub-industry to industry level classification under Diversified Financials. Intuitively, this makes sense as mortgage REITs do not own underlying property and their earnings are driven by interest and credit spreads in their portfolio of mortgage-backed securities. Figure 1: Old GICS Financial Sector

Sector Industry Group Industry Sub Industry

DIVERSIFIED BANKS

REGIONAL BANKS

THRIFTS &

MORTGAGE FINANCETHRIFTS & MORTGAGE FINANCE

OTHER DIVERSIFIED FINANCIAL SERVICES

MULTI-SECTOR HOLDINGS

SPECIALIZED FINANCE

CONSUMER FINANCE CONSUMER FINANCE

ASSET MANAGEMENT & CUSTODY BANKS

INVESTMENT BANKING & BROKERAGE

DIVERSIFIED CAPITAL MARKETS

INSURANCE BROKERS

LIFE & HEALTH INSURANCE

MULTI-LINE INSURANCE

PROPERTY & CASUALTY INSURANCE

REINSURANCE

DIVERSIFIED REITS

INDUSTRIAL REITS

MORTGAGE REITS

HOTEL & RESORT REITS

OFFICE REITS

HEALTH CARE REITS

RESIDENTIAL REITS

RETAIL REITS

SPECIALIZED REITS

DIVERSIFIED REAL ESTATE ACTIVITIES

REAL ESTATE OPERATING COMPANIES

REAL ESTATE DEVELOPMENT

REAL ESTATE SERVICES

FIN

AN

CIA

LS

BANKS

DIVERSIFIED

FINANCIALS

INSURANCE

REAL ESTATE

REAL ESTATE

MANAGEMENT &

DEVELOPMENT

INSURANCE

CAPITAL MARKETS

BANKS

DIVERSIFIED

FINANCIAL SERVICES

Old GICS Financial Sector

REAL ESTATE

INVESTMENT TRUSTS

(REITS)

Source: MSCI, Factset

Other than the change to Mortgage REITs, there are no additional impacts to sub-industries within Equity Real Estate Investment Trusts or Real Estate Management & Development.

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In Figure 2 below, the new GICS Real Estate Sector, detailed in green, has only one industry group, two industries, and twelve sub-industry groups. Mortgage REITs, highlighted in yellow, remain in the Financials Sector as its own industry and sub-industry within the Diversified Financials Industry Group. Figure 2: New GICS Financial Sector

Sector Industry Group Industry Sub Industry

DIVERSIFIED BANKS

REGIONAL BANKS

THRIFTS &

MORTGAGE FINANCETHRIFTS & MORTGAGE FINANCE

OTHER DIVERSIFIED FINANCIAL SERVICES

MULTI-SECTOR HOLDINGS

SPECIALIZED FINANCE

CONSUMER FINANCE CONSUMER FINANCE

ASSET MANAGEMENT & CUSTODY BANKS

INVESTMENT BANKING & BROKERAGE

DIVERSIFIED CAPITAL MARKETS

FINANCIAL EXCHANGES & DATA

MORTGAGE REITS MORTGAGE REITS

INSURANCE BROKERS

LIFE & HEALTH INSURANCE

MULTI-LINE INSURANCE

PROPERTY & CASUALTY INSURANCE

REINSURANCE

DIVERSIFIED REITS

INDUSTRIAL REITS

HOTEL & RESORT REITS

OFFICE REITS

HEALTH CARE REITS

RESIDENTIAL REITS

RETAIL REITS

SPECIALIZED REITS

DIVERSIFIED REAL ESTATE ACTIVITIES

REAL ESTATE OPERATING COMPANIES

REAL ESTATE DEVELOPMENT

REAL ESTATE SERVICES

DIVERSIFIED

FINANCIALS

FIN

AN

CIA

LS

CAPITAL MARKETS

New GICS Financial and Real Estate Sector

BANKS

DIVERSIFIED

FINANCIAL SERVICES

EQUITY REAL

ESTATE INVESTMENT

TRUSTS (REITS)

INSURANCE

REAL ESTATE

MANAGEMENT &

DEVELOPMENT

RE

AL E

ST

AT

E

REAL ESTATE

INSURANCE

BANKS

The Real Estate GICS sector is now the eleventh sector with approximately 2,600 companies in the MSCI ACWI index. By market cap the Equity REITs industry and RE M&D industry each represent approximately 50% of the $3 trillion Real Estate sector. Additionally, a minor tweak to the previous naming convention results in the industry “Equity Real Estate Investment Trusts” or Equity REITs which was previously defined as REITs, to distinguish it from the Mortgage REITs Industry that remains in Financials.

Mortgage REITs remain within Financials as their earnings are driven by the interest rate and credit spreads in their portfolio of mortgage-backed securities.

Source: MSCI, Factset

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The Growth of Real Estate As illustrated in the Figure 3, in 2000, the Real Estate Industry Group made up less than 1% of the market capitalization in the MSCI ACWI index. Today, that weight approaches close to 3.4%. Figure 3: Evolving Weight of the Real Estate Industry Group

A combination of both more countries adopting REIT regimes, and more private real estate moving to the public market has resulted in the Real Estate sector ranking as the 10th and 8th largest sector in the MSCI ACWI (Ex-US) and Russell 1000 indices respectively as shown by the green arrows in Figure 4 and Figure 5. Figure 4: GICS Sector weights for ACWI Ex-US

Source: Factset, SGA

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Figure 5: GICS Sector weights for Russell 1000

Sector Correlations It was determined by the creators of GICS that historical real estate industry returns were least correlated with several industries within the the Financials Sector including Banks, Diversified Financials, and Insurance. SGA’s analysis confirms that historical return correlations between real estate and financials (ex-real estate) fall in the bottom half of industries. This can be partially explained by different fundamental drivers behind real estate and financials. Real estate companies generally use external financing to develop and purchase new properties, and lower interest rates reduce their cost of capital and help creates value for shareholders. Banks, on the other hand, are negatively impacted by low interest rates as their net interest margin, or the spread between what they borrow and pay, narrows. In the 20 year regression on returns shown in Table 1, Real Estate industry returns are historically most correlated with sectors such as Utilities (0.89), Health Care (0.85), Industrials (0.85), and Consumer Staples (0.78), ahead of Financials (0.74). Most of these sectors can be considered defensive and have high dividend yields.

Source: Factset, SGA

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Table 1: GICS Sector Correlation

Energy Materials Industrials Cons. Disc

Cons.

Staples Health Care

Financials

(Excl. RE) Technology Telecom Utilities Real Estate

Energy 1.00

Materials 0.81 1.00

Industrials 0.82 0.86 1.00

Cons. Discretionary 0.71 0.77 0.88 1.00

Cons. Staples 0.72 0.67 0.79 0.75 1.00

Health Care 0.65 0.63 0.81 0.78 0.80 1.00

Financials (Excl. RE) 0.72 0.78 0.85 0.78 0.75 0.78 1.00

Technology 0.60 0.66 0.78 0.89 0.52 0.66 0.57 1.00

Telecom 0.63 0.71 0.79 0.87 0.71 0.76 0.72 0.83 1.00

Utilities 0.73 0.62 0.79 0.67 0.80 0.81 0.71 0.55 0.69 1.00

Real Estate 0.68 0.73 0.85 0.75 0.78 0.85 0.74 0.67 0.74 0.89 1.00

CORRELATIONS OF RETURNS UNDER NEW GICS STRUCTURE (ACWI INDEX) 04/30/96 - 7/31/16

Figure 6 also suggests that prior to the split, real estate as an industry group was by far the least correlated with Financials as a sector group. There are other industry groups that have low correlation with their respective sectors, but they lack sufficient weight in the index to become their own sector group. For example, we see below that the Healthcare Service And Providers Industry Group is much less correlated with the Healthcare Sector but it only represents 0.66% of the benchmark, while Real Estate is 3.55% of the MSCI ACWI index. Figure 6: GICS Industry correlation with corresponding sector

Real estate returns are historically most correlated with returns of defensive sectors such as utilities, health care, and consumer staples

Source: Factset, SGA

Source: Factset, SGA

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It is difficult to predict when there might be a change to a GICS classification, but watching these correlations in relation to market cap representation in the benchmark can point to possible future changes. Real Estate is Under-Owned Moving Real Estate to its own sector highlights the importance of managing risk exposure and may lead to changes in portfolio construction. As recently as December of 2015, Fidelity provided a comparison of allocations to REITs in US mutual funds as compared to their benchmarks in Figure 7 below. When grouped by Morningstar style, US mutual fund managers were underweight REITs across the board.2 Figure 7: Weight of REIT in Different Indices and Mutual Funds

Multiple sources including Fidelity Investments and Goldman Sachs have used Morningstar data to conclude that both Real Estate and REITs are under-owned by domestic active fund managers.3 Information on international managers is more limited; however, we view the principal reasons for underweighting the sector to apply to most investors.

2 Buller, Steven, and Sam Wald. REIT Stocks: An Underutilized Portfolio Diversifier. Rep. Fidelity Investments, Sept. 2013 3 Kostin, David. And Then There Were 11: Real Estate Becomes Its Own GICS Sector. Rep. Goldman Sachs, 23 May 2016.

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Real estate has chronically been under weighted by active investors, because as a group real estate companies generally do not screen well.4 For example, Table 2 shows that the sector has continued to trade at a significant premium to the broad market on a forward earnings basis. The sector has traded at a premium at the beginning of every year, for the past 10 years. Valuations were on average 50% above the broad market. Additionally, it is well known that analyzing companies based on revenue growth is not a strong indicator of improving fundamentals since companies can easily grow revenues by raising more capital and making acquisitions. Likewise, revenue declines could indicate a company is selling properties and improving fundamentals by deleveraging. Table 2: Sector Valuation Across MSCI ACWI

12/30/05 12/29/06 12/31/07 12/31/08 12/31/09 12/31/10 12/30/11 12/31/12 12/31/13 12/31/14 12/31/15

P/E FY1 P/E FY1 P/E FY1 P/E FY1 P/E FY1 P/E FY1 P/E FY1 P/E FY1 P/E FY1 P/E FY1 P/E FY1

CONSUMER DISC. 16.7 16.6 14.4 11.7 19.0 15.2 12.5 14.1 17.0 17.2 17.4

CONSUMER ST. 17.8 18.7 19.2 13.6 15.9 15.7 15.7 16.8 18.6 20.2 21.5

ENERGY 11.1 11.0 13.3 6.3 15.1 12.6 9.4 10.4 12.4 11.4 15.8

FINANCIALS 13.5 13.2 11.6 9.2 14.4 12.1 9.4 11.3 12.7 12.8 11.5

HEALTH CARE 19.1 18.3 16.4 12.2 12.9 12.0 11.9 13.5 17.3 18.8 18.1

INDUSTRIALS 17.2 17.0 15.9 9.3 17.1 15.3 12.0 13.9 17.2 16.9 16.3

TECHNOLOGY 21.2 20.1 19.5 11.6 18.2 14.0 12.3 13.0 15.6 16.5 16.9

MATERIALS 13.2 12.4 14.0 7.0 21.4 14.9 9.9 14.8 15.4 15.7 16.7

REAL ESTATE 22.5 28.3 22.6 12.8 20.3 19.7 17.2 22.1 21.5 24.1 22.1

TELECOM 7.3 15.4 16.5 10.5 11.9 11.7 11.8 12.2 14.9 15.4 14.8

UTILITIES 15.1 17.0 17.9 12.1 12.8 12.4 12.6 12.1 13.1 15.3 13.8

Total 14.7 15.3 14.9 9.7 15.7 13.6 11.4 13.0 15.2 15.7 15.8

MSCI Al l Country World Index Forward P/E

In fact, using quantitative measures can be a challenge when important analysis for real estate companies is often qualitative. The location of properties is of primary importance, and prudent capital allocation is essential, as well as management’s ability to raise and deploy capital through booms and busts. These challenging quantitative and qualitative factors help explain why generalist investors have drastically underweighted the sector. Investment managers will need to rethink their allocations as more attention will be directed towards managers who avoid real estate. SGA’s Exposure to Real Estate In Figure 8 we show our exposure to Real Estate as well as the exposure of the corresponding index as of December 31st 2015 which is the same time period as the study published by Fidelity in Figure 7. This shows that SGA has almost neutral active exposure in Real Estate.

4 Spector, Jeffrey. Countdown to the REITs Breakout - Expanded Scenarios around Potential Inflows. Rep. Bank of America Merrill Lynch, 27 Apr. 2016

Fundamental metrics such as price-to-earnings and revenue growth are not necessarily strong indicators of improving business conditions in real estate companies. Source: SGA, Factset, MSCI

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Figure 8: Real Estate Weight in SGA’s Composites and Corresponding Benchmark

In fact, SGA’s portfolios have remained relatively neutral to the Real Estate Industry Group over time, generally within + or – 5%. By this neutrality, SGA maintains a focus on adding value through stock selection. Backtest results We performed a backtest of SGA’s stock selection model (SGA Alpha Model) on the Real Estate sector, to confirm our ability to select outperperforming stocks within this sector. Results of this backtest are displayed in Table 3. Quintile returns are equal weighted. The table includes:

Backtest period (12/31/88 – 12/31/15)

T-Stat for equal weighted long-short (Quintile5 1 minus Quintile 5) portfolio returns.

T-Stat6 for the information coefficient7.

Security universe on which these tests are performed.

Holding and Rebalancing period of 3 months.

5 Quintile is a statistical value of a data set that represents 20% of a given population. 6 A significant IC T-Stat indicates that one can reject the null hypothesis that the IC equals zero for a particular significance level. 7 Information Co-efficient measures the relationship between the model’s predicted return and actual realized return.

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Table 3: Back-Test results

Our back tests indicate that we have confidence there is opportunity for the SGA Alpha Model to identify stocks in real estate with potential for outperformance. More specifically, our back test shows that the Model performs best in small- and mid-cap strategies where real estate makes up a larger proportion of the benchmark index. Conclusion The creation of a new sector for the first time in GICS history marks an important time for real estate. The GICS committee continues to improve their classification structure to better meet investor demands. The unique business drivers and valuation characteristics of Real Estate companies contribute to significant differences from other segments of the Financial Sector, such as banks, diversified financials, and insurance. The long-term outperformance of real estate and the response by the GICS creators highlight a real danger of ignoring risk exposures at the industry group, industry and even sub industry levels. About Strategic Global Advisors, LLC Founded in 2005, Strategic Global Advisors, LLC (SGA) is an SEC Registered Investment Advisor, managing international, domestic and global equity portfolios for institutions and individuals. SGA is headquartered in Newport Beach, California. Our team of investment professionals has an average of 17 years of investment experience in quantitative methods, fundamental research and global investing. SGA’s investment management team has developed investment strategies within a collaborative environment, while maintaining a focus on a bottom-up decision making process. Through our disciplined investment process that integrates quantitative and fundamental methods, we construct portfolios focused on stock selection, rather than country and sector market timing. We have been dedicated to integrating quantitative and fundamental methods since the firm’s inception. For more information on SGA please contact our Director of Marketing, Sam King, CFA, at sking@sgadvisors.com or 949.706.2640 ext 605.

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Bibliography Avgeriou, Anastasios. Global REITs: True Love or Stockholm Syndrome? Rep. BCA Research, 19 Aug. 2016. Avgeriou, Anastasios. The Price Is "REIT" Rep. BCA Research, 13 May 2016. Buller, Steven, and Sam Wald. REIT Stocks: An Underutilized Portfolio Diversifier. Rep. Fidelity Investments, Sept. 2013. Chisholm, Denise. The New GICS Framework: The Impact of Adding Real Estate as the 11th Equity Sector. Rep. Fidelity Investments, June 2016. Consultation On Potential Changes To The Global Industry Classification Standard Structure In 2015. Rep. S&P Dow Jones Indices/ MSCI, 2 June 2014. GICS Mapbook Brochure. Rep. S&P Dow Jones Indices/ MSCI, 2015. Kostin, David. And Then There Were 11: Real Estate Becomes Its Own GICS Sector. Rep. Goldman Sachs, 23 May 2016. Luo, Yin. A Quant Handbook On REIT Investing. Rep. Deutsche Bank, 2 May 2011. REIT Primer, 7th Edition: A Comprehensive Handbook for a New GICS Sector. Rep. Bank of America Merrill Lynch, 02 May 2016. Real Estate to Receive a Dedicated Sector Classification. Rep. Cohen & Steers, Apr. 2015. Real Estate GICS Sector. Rep. AEW Capital Management, Sept. 2015. S&P Dow Jones Indices And MSCI Announce Further Revisions To The global Industry Classification Standard (GICS®) STRUCTURE IN 2016. N.p., 02 Nov. 2015. Spector, Jeffrey. Countdown To The REITs Breakout - Expanded Scenarios Around Potential Inflows. Rep. Bank of America Merrill Lynch, 27 Apr. 2016. Teuben, Bert, and Brent McElreath. The Road Toward A Seamless Global Real Estate Portfolio. Rep. MSCI, June 2016.

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Important Disclosures Alpha Model backtests Alpha Model backtests are hypothetical and do not reflect actual returns of SGA portfolios. There is no guarantee that SGA’s live strategies will capture fully or in part the excess returns estimated here. Furthermore, SGA does not guarantee the accuracy of these estimates or methodology. There are limitations inherent in backtested model results, particularly the fact that such results do not represent actual trading and that they may not reflect the impact that material economic and market factors might have had on portfolio decision-making in a live client account. SGA did not manage any live accounts during the entire backtest period. The results portrayed reflect the reinvestment of dividends and other earnings. International equity investing includes the possibility of loss. Equal-weighted quintile returns by SGA Alpha are compared to each applicable equal-weighted universe. The volatility of the index may be materially different from that of all quintile returns by SGA Alpha. Results presented here do not represent the results of actual trading but were achieved by means of the retroactive application of a model designed with the benefit of hindsight. SGA believes the backtest analysis provides important insights for SGA in thinking about and designing the firm’s investment process. SGA applies both quantitative and qualitative approaches to portfolio management which may vary depending on market conditions and impact the firm’s ability to capture the alpha indicated by these backtests. SGA encourages clients and prospects to seek independent sources of analysis in assessing SGA’s returns and process. For additional information on the calculation methodology, please contact Strategic Global Advisors, LLC at 949.706.2640. Time period: December 1988 – December 2015 Formed equal weighted quintiles based on SGA Alphas Quarterly rebalancing with no transaction costs Sector definitions used are Global Industry Classification Standard (GICS®) Source: FactSet, and Strategic Global Advisors Past performance is not indicative of future results. Returns are presented gross of fees.

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Systematic or Quantitative Process Risk

There is potential for shortfall in any investment process due to a variety of

factors including, but not limited to, data and system imperfections, analyst

judgment, and the complex nature of designing and implementing portfolio

construction systems and other quantitative models. Such shortfalls in

systematic or quantitative processes in particular pose broader risk because

they may be more pervasive in nature. Furthermore, the Advisor’s SGA’s

systems may not necessarily perform in a manner in which they have historically

performed or were intended to perform. The Advisor recognizes that such

shortfalls are inherent to both fundamental and systematic or quantitative

processes, and believes that combining both approaches improves the

opportunity to reduce these shortfalls. However these efforts may not

necessarily result in the identification of profitable investments or the

management of risk.