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“Smart Beta” Strategies

What are they and When Did

Beta Get Smart?

2017 PAPERS Forum

May 24, 2017 Geoffrey Gerber, Ph.D.

President & Chief Investment Officer

2

PLEASE READ IMPORTANT DISCLOSURES AT THE END OF THIS PRESENTATION

Geoffrey Gerber, Ph.D.

Having founded TWIN in 1990, Geoff is the Chief Investment Officer overseeing the quantitative investment

process and general management of the firm. Recognized as a specialist in institutional quantitative

investment management, he is often quoted in the financial press. Two of his publications appear in Market

Neutral: State-of-the-Art Strategies for Every Market Environment as a chapter entitled “Using a

Nonparametric Approach to Market Neutral Investing” and in Global Asset Allocation as a chapter entitled

“Equity Style Allocations: Timing Between Growth & Value”. His most recent publication is entitled

“Dividend Growth as a Defensive Equity Strategy”, published in the Journal of Investment Consulting.

Outside of TWIN, Geoff is a faculty member for the Aresty Institute’s Wharton Executive Education Program

on Investment Strategies and Portfolio Management. He participates in a number of foundations’

investment committees and boards including the Burroughs Wellcome Foundation, the Jewish Federation of

Greater Pittsburgh and the Jewish Healthcare Foundation. Geoff is also a member of the Editorial Advisory

Board of the Journal of Investment Consulting and is a former member of the Investment Advisory

Committee for NY State Teachers Retirement System (NYSTRS).

Geoff holds a Ph.D. in Finance and Economics from the University of Pennsylvania, and a B.A. in Economics

from the State University of New York at Buffalo where he graduated summa cum laude and was elected to

Phi Beta Kappa.

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Outline

• Definition of Beta

• Active vs. Passive Management

• Market Index Weighting Methodologies

• Alternative or “Smart Beta” Strategies

− Value

− Momentum

− Quality

− Low Volatility

• Dividend-Related Examples

• Key Takeaways

4


What is Beta?

CAPM – Capital Asset Pricing Model

RP – RF = AP + BP * (RM – RF)

With:

RP = Return to Portfolio (or Stock)

RF = Return to T-Bill Investment

AP = Portfolio (or Stock) Alpha

BP = Portfolio (or Stock) Beta

RM = Return to Market Index (S&P 500)

5


What is Beta?

• Beta measures a stock or portfolio’s

variability relative to the market index

− High Beta stocks are more volatile than the

market

• Beta exposure can be captured through

either Active or Passive Management

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Active Vs. Passive Management

• Passive Management provides a Beta of

One (equal to the market index) and an

Alpha of Zero

• Active Management provides Beta

exposure that could be equal to, higher

or lower than the market with the hope

of adding positive Alpha.

− While Beta is a positive number, Alpha can

be positive or negative

7


Why Has Passive Beaten Active?

After a jump at the start of the year, S&P

500 Dispersion moved lower in February and

again in March (4.8%). Breadth declined

during the first quarter, ending below 50%

(at 45.8%). Pair-wise correlations rose in

March following drops in the first two

months of the quarter.

AVERAGE PAIRWISE STOCK CORRELATIONSTWIN EQUITY UNIVERSE (LARGE/MID CAP)

MONTHLY CROSS-SECTIONS of DAILY RETURNS

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Correlation

12 Month Moving Average

DISPERSION

Standard Deviation of Monthly Residual Returns

S&P 500 Constituents

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BREADTH

Outperformance Percentage (Rolling 12-Month Basis)

S&P 500 Constituents

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• Active Investment Management:

‒ Most managers trail benchmarks over time

‒ Performance is often inconsistent

‒ Portfolios tend to be concentrated, downplaying

risk considerations

• Passive Management:

− At best match the benchmark before fees

− Offer relatively low fees

• Enhanced Indexing Offers a “Middle Ground”

• “Smart Beta” offers Rules-Based but still Active

Strategies

Active, Passive, Enhanced Indexing &

Smart Beta

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Enhanced Index Overview

• Definition: An enhanced index portfolio aims to “track” an index, but also attempts to outperform it (modestly) with similar or less risk.

• Active management can be measured in terms of “tracking error” or range of returns around the benchmark.

− Higher tracking error – implies wide quarterly and annual variance from the index.

− Lower tracking error – implies closer to index-like risk and returns.

• Tracking Error: The annualized standard deviation of value-added, it measures the variation of a portfolio’s returns relative to the benchmark. Managers with larger active bets tend to have return streams exhibiting higher tracking error.

− A manager with a 5% tracking error can be expected to produce positive & negative value-added in excess of 5% in 1 out of every 3 years.

• Enhanced indexing can increase the odds of success, and can reduce the odds of a large negative surprise

10


Weighting Stocks in Market Indices

• Capitalization - Most widely used method of index

construction

− Standard & Poors (S&P 500)

− Russell Indices (Russell 1000, 2000, 3000)

• Price - Are simple to create but place too much

emphasis on high-priced stocks

− Dow Jones (Dow 30)

• Equal - Gives more (less) weight to smaller (larger)

capitalization stocks

• Fundamental – Weights reflect non-price elements such

as $ dividend payments, scale of operations, valuation

multiples

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The Impact of Portfolio Weighting is Significant Trailing 12-Month Equal-Weight minus Cap Weight Return

S&P 500

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What is “Smart Beta”?

Expanded CAPM

RPe = AP + BP * (RMe)

RPe = aP + ∑bJ*FJ + BP * (RMe)

With:

RPe = Excess Return to Portfolio (or Stock)

AP = Portfolio (or Stock) Traditional Alpha

aP = Residual Portfolio (or Stock) Alpha

bJ = Return to Factor J (“Smart Beta”)

FJ = Factor J Exposure

BP = Portfolio (or Stock) Traditional Beta

RMe = Excess Return to Market Index (S&P 500)

13


Alternative or “Smart Beta”

• Market beta (provided by market capitalization-weighted

indices) is not the only source of equity risk premia available

when purchasing a stock portfolio

• There are additional “factors” or fundamental characteristics

that provide investors with attractive risk-return trade-offs

that can complement and, in some cases, compete with the

traditional market capitalization-weighted benchmark indices

• Alternative Beta: Factor-based investing provides

passive/rules-based exposure to alternative risk premia or

return factors in the equity market

• Well-known “factors”:

− Value

− Momentum

− Quality

− Low Volatility

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Smart Beta Factors

• Value: Forecast Earnings/Price ratio, with forecasted earnings

over next 12-months calculated using weighted combination of

IBES consensus fiscal year EPS forecasts. Top/Bottom Quartile

Return Difference.

• Momentum: 12-month trailing cumulative price change,

corrected for short-term reversal impulse by subtracting most

recent monthly price change from the cumulative return.

Top/Bottom Quartile Return Difference.

• Quality: Rating (A+ to C- spanning 9 levels) assigned quarterly

by Ford Equity Research indicating financial strength and

earnings predictability, with Above B ranks defined as High-

Quality & Below B ranks denoted as Low-Quality. High/Low

Group Return Difference.

• Low-Volatility: Realized 3-Year Volatility, defined as standard

deviation of latest 36 monthly price changes. Bottom/Top

Quartile Return Difference.

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Value

• One of the most widely recognized risk premia in the

equity space

• Stocks with low ratios of price to book value, price to

earnings or price to cash flows are generally classified

as Value stocks

• Behavioral argument is that investors consistently

undervalue value stocks and overvalue growth stocks

due to overconfidence and the extrapolation of past

returns

• Value premium is an additional source of risk for stocks

as value-oriented strategies have outperformed but

have exhibited higher standard deviation of returns and

bigger drawdowns compared to the (capitalization-

weighted) market indices

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Value (High Forecast E/P) Trailing 12-Month Target Group Return Minus Market Return

S&P 500 Stocks

Value stocks have out-performed the market over the past year.

Returns are hypothetical. See

“HYPOTHETICAL RETURNS &

PERFORMANCE” in the Disclosures for details.

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Momentum • Momentum is typically defined in terms of price and does

not consider any other company specific characteristic –

i.e., it is a technical measure as compared to a fundamental

factor

• Stocks which have performed well are positive momentum

stocks while underperforming stocks have negative

momentum

• Behavioral finance argues that Momentum exists due to

investor under-reaction to information, which implies that

stock prices take time to incorporate new information,

creating a trend

• Momentum premium is an additional source of risk for

stocks as trend-following strategies have outperformed but

have exhibited higher standard deviation of returns

compared to (capitalization-weighted) market indices

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Momentum (Recent Winners) Trailing 12-Month Target Group Return Minus Market Return

S&P 500 Stocks

Momentum stocks have under-performed the market over the past year.




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Quality • Quality is the most controversial “Smart Beta” factor as

there is no universal agreement on how to define it

− Quantitative profitability metrics such as ROE or ROIC

− Growth and/or stability of earnings & dividends

− Leverage measures such as the level of debt in the balance

sheet

− Subjective measures such as market positioning, barriers to

entry of the business or the recurring nature of a company’s

earnings

• Regardless of the definition used, from a fundamental

standpoint, quality businesses are expected to be

consistent performers in the long run with the ability to

protect value better in economic downturns

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High Quality (Size & Earnings Predictability) Trailing 12-Month Target Group Return Minus Market Return

S&P 500 Stocks

High Quality stocks have performed in line with the market over the past

year.




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Low Volatility

• Is something you’ve heard from me and from TWIN for

over 5 years

• Low Volatility is an alternative beta not based on a

formal equity return factor (like Value, Momentum or

Quality), rather it is defined as an anomaly that has

been found empirically

• Volatility anomaly is evident over the long-term as

portfolios of low volatility stocks (measured using

market beta or historical returns variability) have

outperformed portfolios of higher volatility stocks

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Low Volatility (36-Month Return Variability) Trailing 12-Month Target Group Return Minus Market Return

S&P 500 Stocks

Low Volatility stocks have recently lost the advantage over the market.




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“Smart Beta” Statistics Price-Only Basis Jan 1980 – March 2017




Smart Beta Factor

Annualized

Return (%)

Annualized

Risk (%)

Return/Risk

Ratio

Value (High Forecast E/P) 12.5 17.1 0.73

Momentum (Recent Winners) 13.3 19.3 0.69

High Quality (Size & Earnings Predictability) 10.4 15.0 0.70

Low Volatility (Realized Return Variability) 9.5 12.4 0.77

S&P 500 Stocks 10.9 16.8 0.65

Monthly Relative Return CorrelationsSmart Beta Factor

Value Momentum High Quality Low Volatility

Value 1.00 -0.46 -0.16 -0.26

Momentum -0.46 1.00 0.11 0.18

High Quality -0.16 0.11 1.00 0.82

Low Volatility -0.26 0.18 0.82 1.00

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Low-Volatility Anomaly Facts

• Modern portfolio theory (CAP-M) states that investors who take on greater risk can expect to earn greater rewards

• An ever-growing collection of research disputes this fundamental relationship between expected risk and reward – Least-volatile stocks in the US and other global markets

have produced higher average returns (+17%) historically compared to the highest-risk stocks (Baker & Haugen 2012)

– Advantage of lower-volatility stocks exists using different measures of risk, sub-periods and capitalization tiers (Baker, Bradley & Wurgler 2011)

• Evidence suggests effect is stronger in more recent periods

25


Low-Volatility Anomaly Facts

Low-risk stocks

have out-

performed high-

risk stocks over

the past 20 years

across all

developed equity

markets.

Source: N. Baker & R. Haugen, “Low Risk Stocks Outperform Within

All Observable Markets of the World”, 2012 (LowVolatilityStocks.com)

26


Low Volatility

Low-volatility trails the market over the past year.

Trailing 12-Month Low-Volatility Minus Market Return

S&P 500

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Performance of Sub-Groups of Stocks

Depends on Market Environment

The S&P Low-Volatility Index stocks have historically performed better than the S&P 500

index in negative markets. The Equal-Weight S&P 500 really shines in the biggest up-

market months.

Largest 50 returns are hypothetical. See



S&P 500 Monthly Returns & Dispersion AnalysisJanuary 1991 - March 2017

Biggest Negative Smaller Negative Smaller Positive Biggest Positive All

Months Months Months Months Months

Counts (#) 54 54 104 103 315

Average Returns (%)

S&P 500 -5.60 -1.40 1.30 5.06 0.89

S&P 500 Low-Vol Index -2.81 -0.56 1.22 3.36 0.92

S&P 500 Eq-Wt -5.63 -1.39 1.52 5.40 1.06

S&P 500 Largest 50 -5.53 -1.36 1.17 4.95 0.83

Hit Rates

S&P 500 Low-Vol Index 0.87 0.78 0.46 0.18 0.50

S&P 500 Eq-Wt 0.41 0.44 0.56 0.56 0.51

S&P 500 Largest 50 0.46 0.57 0.43 0.45 0.47

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Low-Volatility Anomaly Implementation

• Managed volatility strategies

– Minimum-variance

– Blended equity & fixed income approach

(i.e., Risk Parity)

• Passive exposure via ETFs

– LGLV (SPDR Russell 1000)

– SPLV (PowerShares S&P 500)

• Reduced-volatility active equity

strategies

− Isolating less-volatile stocks

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• Stocks in the S&P 500 with at least 10 years of history are screened to insure the latest indicated annual dividend is at least as large as the level one year ago, and strictly progressively increasing over intervals of prior 10, 5, 3 and 1 years.

• Stocks satisfying the dividend growth screen must also have a current indicated annual dividend less than the most-recently reported trailing 12-month operating earnings and the 12-month forward consensus analyst earnings estimate.

• Stocks passing these screens are assigned to the Dividend Select Club. Membership in the “Club” is re-evaluated at each quarter-end based on current dividend & earnings trends.

TWIN’s Approach

Isolating Less Volatile Stocks

The Dividend Select Club is a custom collection of companies with a rising dividend stream thought to be less at-risk than the stream from typical dividend-paying stocks.

30


• Assign every stock in the S&P 500 Index into one of three non-overlapping subset groups:

1. Companies that are Dividend Select Club members

2. Companies that currently pay dividends but are not members of the Club (“Weak Payers”)

3. Companies that do not currently pay dividends (“Non-Payers”)

• Reconstitute each group on a quarterly basis; calculate monthly returns for the three portfolio groups starting in 1981

Dividends and Stock Research Analysis

Key Research Finding:

While there are different excess return patterns (relative to the

S&P 500), the Dividend Select Club members have consistently

displayed the lowest returns variability among the three groups.

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As of March 31 (2017), the Dividend Select Club includes 2 of

the largest 10 stocks as ranked by market capitalization in

the S&P 500.

Top Holdings Comparison Alternative Dividend Groups v. S&P 500

Dividend Select

Club

Weak Dividend

Payers

Non-Dividend

Payers S&P 500

MICROSOFT APPLE ALPHABET APPLE

JOHNSON JOHNSON EXXON MOBIL AMAZON.COM ALPHABET

AT&T INC J P MORGAN CHASE BERKSHIRE HATHAW MICROSOFT

PROCTER & GAMBLE WELLS FARGO & CO FACEBOOK AMAZON.COM

WAL-MART STORES GEN ELECTRIC CELGENE CORP BERKSHIRE HATHAW

VERIZON COMMUNIC BANK OF AMERICA CHARTER COMM INC FACEBOOK

COCA-COLA VISA PRICELINE GROUP EXXON MOBIL

DISNEY WALT PFIZER ADOBE SYSTEMS JOHNSON JOHNSON

HOME DEPOT CHEVRON NETFLIX J P MORGAN CHASE

MERCK ORACLE CORP BIOGEN WELLS FARGO & CO

TOP 10 COMPANIES

Largest 10 Companies in S&P 500 Index (Ranked by Capitalization) Appear in Black

32


Isolating Stocks With Less Volatile Earnings

S&P 500 Groups

The TWIN

Dividend

Select Club

has had the

most stable

long-term

reported

earnings

growth rates

of the four

S&P 500

groups.

Portfolio 5-YR Reported Earnings Growth

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120

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Pe

rce

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(%)

Pe

r Y

ea

r

TWIN Dividend Select Club Stocks

Other Dividend-Paying Stocks

Non-Dividend-Paying Stocks

S&P 500 Stocks

33


Dividend

Select Club

Stocks

Other

Dividend-

Paying

Stocks

Non-

Dividend-

Paying

Stocks

S&P 500

Stocks

Annualized Returns

Through Latest Period

Jan-1981 -- 11.65 10.78 10.18 11.14

Annualized Risk

Through Latest Period

Jan-1981 -- 13.65 15.71 22.43 14.74

Annualized Returns

Selected Periods

1-YR 13.74 19.77 15.39 17.01

3-YR 9.06 10.46 11.43 10.38

5-YR 12.14 13.17 16.68 13.37

10-YR 7.19 6.42 10.58 7.64

Annualized Risk

Selected Periods

1-YR 6.19 6.81 10.60 6.01

3-YR 9.22 11.43 13.16 10.24

5-YR 9.21 11.12 13.42 10.10

10-YR 12.97 17.62 17.94 15.14

Breaking the S&P 500 into

3 non-overlapping groups

(Dividend Select Club,

Other Dividend-paying

Stocks & Non-Paying

Stocks) shows dramatically

different performance.

A portfolio of Dividend

Select Club stocks has

consistently had lower risk

at longer-term horizons

than portfolios built from

the other groups and the

S&P 500 as a whole.

Isolating the Impact of Dividends S&P 500 Group Risk & Return (%)

Periods Ending March 2017




34


Including the effect of

dividends, a hypothetical

Dividend Select Club portfolio

has out-performed portfolios of

other dividend paying stocks

and non-paying stocks among

S&P 500 constituents on

average over the past 30+

years.

Returns are monthly buy &

hold, cap-weighted measures

with large individual positions

constrained to a 6% target

maximum weight.

Best-performing segment each

period is highlighted.

Relative Excess

Returns (%)

< YTD Through March




YEAR

TWIN

Dividend

Select Club

Stocks

Other

Dividend-

Paying

Stocks

Non-

Dividend-

Paying

Stocks

1981 -3.29 5.53 -7.33

1982 -2.65 0.63 10.93

1983 -0.74 1.28 7.42

1984 2.26 -0.67 -16.98

1985 1.12 0.09 -9.99

1986 3.71 1.37 -18.78

1987 -1.99 0.98 6.97

1988 -0.28 -0.21 -0.56

1989 5.20 -2.68 -7.37

1990 4.12 -1.41 -19.21

1991 7.81 -9.17 1.43

1992 -4.05 4.73 9.43

1993 -7.22 7.56 7.08

1994 0.88 -1.05 1.03

1995 3.69 -3.42 -5.06

1996 -0.61 1.67 -5.87

1997 4.96 -7.09 -3.95

1998 -3.76 -5.98 30.42

1999 -11.42 -9.87 57.09

2000 21.64 1.19 -26.38

2001 4.61 1.65 -12.92

2002 5.38 0.76 -13.77

2003 -4.35 -0.18 17.19

2004 -2.08 2.74 0.88

2005 -2.03 4.72 -3.85

2006 2.01 -0.19 -6.62

2007 -2.63 1.18 3.13

2008 6.62 -5.75 -3.90

2009 -12.64 4.77 25.73

2010 -0.03 -0.37 2.18

2011 8.85 -5.66 -8.82

2012 -5.69 1.18 8.10

2013 -2.48 -0.77 13.19

2014 -1.11 0.82 3.28

2015 -3.31 -1.07 9.03

2016 1.78 1.88 -12.71

2017 -0.92 -1.01 4.19

35


Performance of Less-Risky Stocks

Depends on Market Environment




The Dividend Select Club stocks have historically performed better than

the S&P 500 index in negative markets. The non-paying stocks really

shine in only the biggest up-market months.

S&P 500 Sub-Groups Monthly Returns AnalysisJanuary 1981 - March 2017



Counts (#) 80 79 138 138 435

Averages (%)

S&P 500 -5.35 -1.12 1.42 5.39 0.97

Dividend Select Club -4.43 -0.84 1.34 4.86 0.99

Other Dividend-Paying Stocks -5.65 -1.19 1.46 5.52 0.95

Non-Dividend-Paying Stocks -7.16 -1.89 1.42 7.03 1.03

Hit Rates

Dividend Select Club 0.69 0.62 0.43 0.30 0.47

Other Dividend-Paying Stocks 0.46 0.44 0.55 0.54 0.51

Non-Dividend-Paying Stocks 0.29 0.29 0.47 0.70 0.48

36


Up and Down Market Capture January 1981 – March 2017

The Dividend Select

Club has historically

captured 89% of the

market’s upside return

and 84% of the

downside return. Over

435 months (January

1981 – March 2017) the

Club Portfolio has

outpaced the S&P 500

Index by 0.5% annually.




-40

-30

-20

-10

0

10

20

30

40

50

60

All S&P 500 Index Up S&P 500 Index Down

Months (435) Months (279) Months (156)

An

nu

ali

ze

d A

ve

rag

e R

etu

rn (

%)

TWIN DIVIDEND SELECT CLUB

S&P 500 Index

37


Implications of Less-Risky Stocks

Differential Market Performance

• Negative Relationship (Correlation) Exists

Between Dividend Select Club Excess Returns

and Excess Returns of Portfolios of Both Non-

Payers (-0.71) & Weak-Payers (-0.48)

• Non-Payers’ Excess Returns are Modestly

Related to Weak-Payers’ Excess Returns (0.05

Correlation)

Adding Dividend Select Club exposure to a multi-manager

investment program will likely lower overall plan

volatility as the “Club” is a very diversifying subset of

the S&P 500 (based on historical excess return

correlations).

38


Two Dimensions of Smart Beta

• Isolating return premia involves rules-based

exposure to sources of Smart Beta

− Some strategies involve significant sector bets

relative to cap-weighted market benchmarks

• Portfolio weighting schemes are important

consideration in the efficiency of Smart Beta

strategies

− Weighting schemes also typically impact sector and

stock-level diversification

Regular rebalancing (re-screening & re-weighting) is

required to maximize Smart Beta rewards.

39


“Club” Weighting Schemes Comparison March 31 2017

Inverse-Volatility weights are based on trailing 36-month standard deviation

of realized monthly price changes. Aggregate Dividend weights are based on

the total dollar value of current company dividends. Portfolio concentration

and sector distribution vary significantly for different weighting schemes.

Dividend Select

Club

Capitalization

Basis

Cap

WT

Dividend Select Club

Aggregate Dividend

Basis

Div $

WT

Dividend Select

Club

Inverse Volatility

Basis

I-Vol

WT

S&P 500 Stocks

Capitalization

Basis

Cap

WT

MICROSOFT 5.9% MICROSOFT 5.5% REPUBLIC SERVICE 0.9% APPLE 3.5%

JOHNSON JOHNSON 3.9% AT&T INC 5.5% PEPSICO 0.9% ALPHABET 2.7%

AT&T INC 2.9% VERIZON COMMUNIC 4.3% HONEYWELL INTL 0.8% MICROSOFT 2.4%

PROCTER & GAMBLE 2.6% JOHNSON JOHNSON 4.0% JOHNSON JOHNSON 0.8% BERKSHIRE HATHAW 2.0%

VERIZON COMMUNIC 2.5% PROCTER & GAMBLE 3.1% CLOROX 0.8% EXXON MOBIL 1.9%

WAL-MART STORES 2.3% WAL-MART STORES 2.9% COLGATE-PALMOLIV 0.8% AMAZON.COM 1.9%

COCA-COLA 2.1% COCA-COLA 2.9% PROCTER & GAMBLE 0.8% FACEBOOK 1.6%

INTEL 2.1% IBM 2.4% LOCKHEED MARTIN 0.8% JOHNSON JOHNSON 1.6%

DISNEY WALT 2.0% MERCK 2.4% SEMPRA ENERGY 0.7% J P MORGAN CHASE 1.5%

HOME DEPOT 2.0% INTEL 2.3% CHURCH DWIGHT 0.7% GEN ELECTRIC 1.3%

TOP 10 Companies

Cumulative Weight>28.3% 35.3% 8.0% 20.4%

TOP 10 COMPANIES

Largest 10 Companies in S&P 500 Index (Ranked by Capitalization) Appear in Bold Black

40


Sector weights tend to be more stable in the S&P 500 as

compared to the Dividend Select Club. Constituent

weights based on market capitalization.

Sector Composition S&P 500 Sector Weights

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

20

15

20

17

PE

RC

EN

T (

Sta

cke

d)

Utilities

TelecommunicationServices

Materials

Information Technology

Industrials

Health Care

Financials

Energy

Consumer Staples

Consumer Discretionary

41


Constituent weights based on market capitalization. The weight

of the Energy sector has declined in the Dividend Select Club as

the weight of the Financial sector has recently risen.

Capitalization Weighting Scheme Dividend Select Club Sector Weights

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

20

15

20

17

PE

RC

EN

T (

Sta

cke

d)

Utilities


Materials


Industrials

Health Care

Financials

Energy

Consumer Staples


42


Constituent weights based on aggregate dollar dividends. The relative

size of the Technology sector is larger when Dividend Select Club stocks

are weighted on this basis as compared to Inverse-Volatility weights.

Dividend Weighting Scheme Dividend Select Club Sector Weights

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

20

15

20

17

PE

RC

EN

T (

Sta

cke

d)

Utilities


Materials


Industrials

Health Care

Financials

Energy

Consumer Staples


43


Constituent weights based on Inverse-Volatility. The relative size of the

Utilities & Industrials sectors are larger when Dividend Select Club stocks

are weighted on this basis as compared to market capitalization weights.

Sector composition also tends to be more stable.

Volatility Weighting Scheme Dividend Select Club Sector Weights

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

20

15

20

17

PE

RC

EN

T (

Sta

cke

d)

Utilities


Materials


Industrials

Health Care

Financials

Energy

Consumer Staples


44


Dividend Select Club Performance

Impacted by Weighting Scheme

An Inverse-Volatility weighted portfolio of Dividend Select Club stocks

delivers better performance than a market-cap weighted version of the

portfolio in both up & down markets. While a Dividend weighting scheme for

the Club does offer some advantage over Inverse-Volatility weighting in

negative markets, the Inverse-Volatility methodology out-performs it in the

more frequently observed up markets, delivering better overall results.




S&P 500 Dividend Select Club Monthly Returns AnalysisJanuary 1981 - March 2017



Month Counts (#) 80 79 138 138 435

Averages (%)

S&P 500 -5.35 -1.12 1.42 5.39 0.98


Cap WT -4.43 -0.84 1.34 4.86 1.00

Div $ WT -4.09 -0.62 1.34 4.74 1.06

IVol WT -4.22 -0.72 1.45 5.01 1.14

Hit Rates


Cap WT 0.69 0.62 0.43 0.30 0.47

Div $ WT 0.73 0.66 0.45 0.32 0.50

IVol WT 0.78 0.65 0.49 0.41 0.54

45


Investment Mandates

& Risk Levels

Manager Mandate Total Volatility Active Risk

Passive Equals Market 0.1% - 0.5%

Enhanced Index Close to Market 1% - 2%

Active At or Above Market 2% - 8%

Low-Volatility Below Market 4% - 7%

While adding a lower-volatility strategy will likely reduce total plan risk,

the trade-off is that the plan will have to accept the higher active risk

(tracking error) of the lower-volatility strategy, and likely under-

performance in strongly upward markets.

46


Key Takeaways

• Smart Beta premia exist historically

• Screening rules and weighting schemes are important

considerations, as is re-balancing schedule

• Low-volatility anomaly is Smart Beta

• Stocks with consistent dividend growth offer one way to

capture benefits of lower returns volatility, with returns

negatively correlated to the excess returns of stocks that

don’t pay dividends or do not exhibit consistent dividend

growth

• Adding a lower volatility strategy could be an excellent

diversifier to a plan’s investment performance,

especially in higher-risk or declining market

environments.

47


Important Disclosures PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. INVESTMENTS ARE NOT GUARANTEED AND MAY

LOSE VALUE.

TWIN Capital Management, Inc. (TWIN) is a registered investment advisor founded in April 1990 and headquartered in McMurray,

Pennsylvania.

This material is intended as an aid in the education of investors about various topics including the effects of volatility and the inclusion of

dividend paying stocks in a diversified portfolio. It is not to be considered an advertisement for any services or specific investment product

offered by TWIN. Although not specifically provided herein, it should be disclosed that TWIN manages an investment strategy which begins with

all of the stocks in the Dividend Select Club, and is further narrowed to those TWIN believes are most attractive using its proprietary quantitative

valuation process and model. The process is augmented with TWIN’s unique Fundamental Tilt®, providing dynamic tracking error and active

size/style targeting. The strategy is named Dividend Select, and it has an actual inception date of 6/1/2010. The returns to Dividend Select vary

from, and over certain periods trail, those of the Dividend Select Club presented herein. One of the risks associated with an investment strategy

such as that discussed in this presentation is the possibility that returns from dividend-paying stocks (including those in the Dividend Select

Club) will trail returns from the overall stock market during any given period. However, an investor with a well-balanced, long-term portfolio who

seeks some income and exposure to dividend-focused companies and is interested in risk-adjusted returns may wish to speak with their

investment professionals about this type of investment approach.

MARKET DATA

Where market and/or index data is presented, it has been obtained from a variety of sources deemed reliable. These sources may include

some or all of the following: Russell Investments, FactSet Research Systems, and Ford Equity Research. TCM assumes no responsibility for

the accuracy of this data.

INDEX INFORMATION

The S&P 500 Index is a representative measure of 500 leading companies from leading industries; the index is a benchmark for the large-cap

segment of U.S. equity market. Company weights in the index are proportional to firms' available market capitalization (price times available

shares outstanding). A Committee at Standard and Poor’s maintains the index with a focus on liquidity and investability. Style category

breakpoints based on an objective scoring algorithm are used to assign fractions of the S&P 500 Index constituents’ capitalization to value &

growth sub-indices. . The S&P 500 Low-Volatility Index consists of the 100 least-volatile stocks in the S&P 500 at each quarterly reconstitution

date as measured by daily realized returns variability over the 12 months prior to reconstitution, weighted in proportion to the inverse of the

realized volatility score. The S&P 500 Top 50 is a custom portfolio managed by TWIN consisting of the 50 largest stocks in the S&P 500 by

index weight, reconstituted each quarter.

48


Important Disclosures INDEX INFORMATION (Continued)

The Dividend Select Club is a custom collection of companies with a rising dividend stream thought to be less at-risk than the stream from typical

dividend-paying stocks. Stocks in the S&P 500 with at least 10 years of history are screened to insure the latest indicated annual dividend is at

least as large as the level one year ago, and strictly progressively increasing over intervals of prior 10, 5, 3 and 1 years. In addition, the indicated

annual dividend must be less than recent reported trailing 12-month operating earnings and the 12-month forward consensus analyst earnings

estimate. The S&P 500 Index is a float-capitalization-weighted representative measure of leading large-cap companies created and maintained

by Standard & Poor’s. The Dividend Select Club is constructed and maintained by TCM as a hypothetical portfolio and is not a publicly available

index. TCM reconstitutes the stocks in the Dividend Select Club at each quarter-end based on current dividend & earnings trends. Stock weights

reflect market capitalization. Overly large weights are capped at a threshold for diversification purposes. While the stocks remain the same

throughout the subsequent calendar quarter, the weight of each company in the benchmark is reset monthly based on the latest data at each

month-end. Returns are computed using a bottom-up, buy and hold computation, based on prior month-end holdings in the Dividend Select Club

portfolio. Stocks in the S&P 500 not in the Dividend Select Club at reconstitution are assigned to one of two distinct alternative group portfolios:

Other Dividend Paying Stocks (provided the latest indicated annual dividend is strictly positive) or Non-Dividend Paying Stocks. Group weights

and returns are constructed in an analogous manner to those of the Dividend Select Club.

HYPOTHETICAL RETURNS & PERFORMANCE

The long-run performance presented by TCM for the Dividend Select Club, other dividend-related groupings of stocks and other custom portfolios

of stocks is hypothetical. Prospective investors are advised to consider a number of important factors when reviewing this type of back-tested

information. The reported performance was derived from the retroactive application of sets of rules with the benefit of hindsight. There are

inherent limitations with this type of data (e.g., performance results do not represent actual trading) and results are sensitive to the period of

analysis chosen. TCM did not offer the trading strategies throughout the entire periods presented and different economic conditions might have

impacted the adviser’s decision-making when using the rules to manage actual client accounts. While the sets of rules have been applied

consistently to generate the latest results, these rules and associated trading strategies have evolved over time. The performance presented

does not reflect the deduction of advisory fees, brokerage or other commissions, mutual fund exchange fees, and other expenses

a client would have paid. Investors are reminded of the potential for loss as well as profit.

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