Twelve Points Perspectives – Q3 2016

Themes

• The Markets – Traditional Asset Classes• The Markets – Diversifying Alternatives• Market Highlights – Stocks & Bonds• Market Highlights – Alternatives• Your Portfolios• Tactical Wall St. Recommendations – Major Asset Classes • Tactical Wall St. Recommendations – Bonds• Tactical Wall St. Recommendations – Stocks• Tactical Wall St. Recommendations – Alternatives & FX• Does this 2nd Longest Bull Have Legs?• Mediocre Fundamentals• Who is Propping Up the Bull?• Our “Equity Light”- Income Heavy Approach• The Market’s Rate-Hike Expectations• Credit > Duration Theme Playing Out• Gold – Both a Hedge and a Tactical Opportunity• Closed End Fund Allocations Have Been a Success

The Markets – Stocks, Bonds, & Commodities

Source: Standard & Poors Themes

The Markets – Diversifying Alternatives

Sources: Eaton Vance, Morningstar, HFRI, Bloomberg, Alerian, Cambridge Associates, Credit Suisse, JP Morgan Themes

Market Highlights:Stocks & Bonds

• Stocks – Global stock markets shook off Brexit, with a risk-on rally through most of Q3. The U.S. Market returned roughly 3.5%, with Technology (led by Apple) providing strong tail winds. Interest rate sensitive high-dividend sectors (Utilities, REITs & Telecom) sold off during the quarter on expectations of a possible December interest rate hike by the Federal Reserve. Volatility remained eerily low throughout the quarter, building up to a likely spike in Q4. Both Developed International & Emerging Markets outperformed the U.S. during the quarter, returning approximately 6.5% and 9% respectively, aided especially by strong returns in Asia. Emerging Market Equities remain the best performer YTD, helped by many EM currencies strengthening against the U.S. dollar.

• Bonds – Duration sensitive U.S. Bond asset classes (Treasuries, Munis) were flat-to-negative in the quarter, hitting the brakes on their prolonged positive momentum. With returns of 3-4%, credit sensitive Bond asset classes (High-Yield, Bank Loans) were the best U.S. performers in Q3. Emerging Market Bonds continued their recent rally returning approximately 3.5% during the quarter.

ThemesPast performance is not a guarantee of future returns

Market Highlights:Commodities, Currencies, Alternatives

• Commodities – After a strong first half of 2016, the commodity rebound stalled in Q3, with the commodity complex losing approximately 4.5%. Industrial Metals were the only bright spot, while Agriculture and Livestock commodities were the worst performers, continuing their recent weakness.

• Currencies – During the quarter, the U.S. Dollar slightly weakened vs. the Euro and the Yen, but strengthened vs. the Pound. The USD continued to weaken vs. most of the Emerging Currencies.

• Alternatives – While most of the Defensive Alternative asset classes produced positive returns during Q3, they struggled to keep-up with Stocks during the risk-on rally. Managed Futures funds were down due to some trends (especially within Commodities) reversing quickly. Return Enhancing Alternatives showed their mettle during quarter. While REITs were down during the quarter, Private Real Estate produced positive returns. Likewise, while Oil was down during the quarter, MLPs produced strong returns.

ThemesPast performance is not a guarantee of future returns

Your Portfolios

Modeled portfolios had a positive quarter, yet due to defensive positioning, they did not quite keep up with returns of 60/40 portfolios. YTD, Modeled portfolios continue to perform in line with traditional 60/40 allocations.

Due to our current preference for income, a significant portion of recent returns has come from interest and dividends. We have also benefited from our Closed End Fund (CEF) positions, as CEF discounts to underlying Net Asset Value (NAV) continued to narrow. Our Non-U.S. Stock overweight worked during the quarter, as did our preference for Credit over Duration within U.S. Bonds.

Portfolio volatility remained low, as we persisted in a cautious stance. Our Defensive Alternative holdings and cash were detractors this quarter, but they continue to play an important role as portfolio diversifiers and providers of “dry powder.”

ThemesPast performance is not a guarantee of future returns

Tactical Overweight/Underweight Recommendationsof Wall Street Investment Firms: Major Asset Classes

• The previous issue of Twelve Points Perspectives studied long-term Capital Market Risk/Return Expectations of major Wall Street Investment Firms. In this continuation study, we look at short-term tactical recommendations of these “smart-money” institutions.

• While our long-term Capital Market Assumptions inform our Strategic asset allocation decisions, our short(er)-term expectations serve as a basis for Tactical/Opportunistic allocation shifts.

• At the high-level, we agree with the Wall Street consensus recommendations from this study: underweight Bonds, slightly underweight Stocks and Cash, and Overweight Alternatives & Specialty asset classes.

• The biggest difference between our approach and that of Wall Street Investment Firms, and even most RIAs, is level of conviction. When most of these firms are “overweight” Alternatives, they may have 5-10% of the portfolio in Alternative asset classes. On the other hand, when we feel that Alternatives are the most attractive major asset class, we allocate 30-40% to our best (Alternative) ideas.

ThemesWhile study recommendations are educated forward looking assumptions, they do not guarantee future returns

Tactical Overweight/Underweight Recommendationsof Wall Street Investment Firms: Bonds

• Wall St. Investment firms recommend underweight in Developed Non-U.S. Bonds, and are neutral duration-sensitive U.S. Bonds. While we agree on Developed Non-U.S. Bonds underweight, we believe that duration-sensitive U.S. Bonds should also be underweighted. With rates close to multi-decade lows, there is not much upside left in these securities, while short-to-intermediate term downside could result in significant losses. Alternative asset classes can step in as a Stock diversifier in this market environment, instead of relying on U.S. Treasuries for this purpose – as has historically been the norm.

• The Wall St. consensus recommends an overweight to credit-sensitive fixed income asset classes. We agree, and have allocated accordingly.• While we have a small (hedged) Emerging Market Bond allocation, we are considering increasing our exposure.

ThemesWhile study recommendations are educated forward looking assumptions, they do not guarantee future returns

Tactical Overweight/Underweight Recommendationsof Wall Street Investment Firms: Stocks

• The consensus calls for an overweight to Emerging Markets and an underweight to Developed Markets. We agree, finding Emerging Markets stocks relatively attractive due to their lower valuations, higher economic growth, more attractive demographics, and recent momentum.

• Studies have shown that stocks exhibiting a “Value” Factor (cheap vs. their peer group and/or their own history) tend to outperform over a full market cycle. Similarly, stocks exhibiting a “Momentum” Factor (trending up – outperforming their peer group over a short-to-medium term) also tend to outperform over a full market cycle. Emerging Markets stocks are currently exhibiting characteristics of both Value and Momentum Factors. We are overweight Emerging and Frontier Markets stocks.

• We are more bearish about U.S. Stocks than the consensus, due to their high valuations and low (recently negative) earnings growth, and are underweight direct U.S. stock exposure, instead, getting exposure through indirect Alternative/International & “Equity Light” positions.

ThemesWhile study recommendations are educated forward looking assumptions, they do not guarantee future returns

Tactical Overweight/Underweight Recommendationsof Wall Street Investment Firms: Alternatives & FX

• Wall St. consensus recommendations showed an overweight across all Alternative asset classes other than REITs. Diversifying Hedge Fund like strategies (Long/Short, Managed Futures, etc.) received the highest conviction overweight recommendations.

• We agree, and have currently allocated to a number of Hedge Fund like liquid Alternative strategies, MLPs, and Gold.• One of our largest Alternative allocations is to Core Private Real Estate. Wall St. recommendations typically do not cover

non-publicly traded asset classes (Private Real Estate, Private Equity, and Private Credit). However, most large institutional investors (Pensions, Endowments, etc.) are overweight these Private asset classes.

• We also agree with the Wall St. consensus of being overweight the U.S. Dollar vs. major Developed currencies, while also being underweight the USD vs. Emerging Markets currencies, and have positioned accordingly.

ThemesWhile study recommendations are educated forward looking assumptions, they do not guarantee future returns

2nd Longest Bull Market, with close to 2nd Highest Bull ReturnsDoes This Bull Still Have Legs?

ThemesSources: JPMorgan, FactSet, NBER, Robert Shiller, Standard & Poors

Mediocre Fundamentals Imply that the Bull’s Legs are Shaky

ThemesSource: GMO LLC (on behalf of Wells Fargo). Past or intended performance does not guarantee future returns.

• Over the past 5 years, there has been a large disconnect between the weak U.S. economic fundamentals, and the strong U.S. Stock Market returns. Most of the major economic indicators are below their pre (Great Financial) Crisis trends, yet the market has continued to chug along.

• One of the main reasons for U.S. stock market outperformance has been “TINA” – There Is No Alternative. As many of the other traditional asset classes were also considered not-attractive, money chased U.S. stocks as the perceived “best house in the bad neighborhood” asset class. We would argue that there are, in fact, other Alternatives (pun intended). At some point in the not-so-distant future the music will stop, and we intend to not be the one “without a chair.”

So Who Is Propping Up The Last Legs of this Bull?

ThemesSources: Goldman Sachs, Federal Reserve, Business Insider

• While the “smart money” investors (i.e. - Pension Funds) have been net sellers of U.S. Stocks, the only recent net buyers of U.S. Stocks have been Retail Investors (ETFs and Households) and Corporations.

• Retail Investors have never been good at timing the market, and the fact that Corporations (when making capital allocation decisions) can’t find ways to invest in growth, and needed to resort to stock buybacks, is not encouraging.

“Equity Light” - Income HeavyTPWM “Moderate Aggressive” Model Portfolio

• While our direct allocation to U.S. Stocks is small, around 4% for most households, the total allocation to U.S. based “Equity Light” investments, which are tied to the health of the U.S. economy and typically move in the same direction as the U.S. Stock market, is significantly higher – over 30% for most households.

• The common themes behind our “Equity Light” holdings are: income over growth, and less volatility than the U.S. stock market.

• While the 12-Month yield for the S&P 500 is around 2.1%, the weighted yield of the “Equity Light” basket of investments is 5.6%.

• Based on 2016 correlations, most of the “Equity Light” holdings are highly correlated to the S&P, but the income they provide and discounts in some of the investments provide a cushion vs. traditional equity investments. Once RE is added, the entire Direct & Indirect U.S. stock and “Equity Light” basket has only a 0.56 correlation to S&P.

ThemesSource: Morningstar

While the Market Expects a 65% Probability of a Fed Rate Hike by December, Market Expectations for the Pace of Future Hikes are Subdued

ThemesSources: JPMorgan, FactSet, Federal Reserve

Within U.S. Bonds, We Have Preferred Credit to DurationOver the Last 6 Months, This Theme is Really Starting to Play Out

ThemesSource: HiddenLevers. Past Performance Does Not Guarantee Future Returns.

Your Portfolios Include “Core”, “Hedges”, and “Tactical” SleevesGold is both a Hedge and a Tactical Opportunity

ThemesSource: HiddenLevers

“Tactical” Sleeve Closed End Fund (CEF)Allocations Have Been a Success

ThemesSource: Morningstar. Past Performance Does Not Guarantee Future Returns.

• If we find a particular asset class attractive for a small tactical allocation, we often implement that allocation with a CEFtrading at a wider-than-usual discount. If we are right about the allocation, not only will the NAV of the CEF appreciate, but the discount will narrow – aiding total returns.

• Over the past year we have had allocations to 3 CEFs, all 3 of them being among the best performing portfolio holdings. These returns have been aided by discounts narrowing across the entire CEF complex.

• Equity CEFs still trade at wider than average discounts, so we recently added a Gold Miners CEF.