Merrill Lynch's Turn (Annuities are a Red Flag)

The following analysis and recommend portfolio was prepared for HCM's newest client. Subsequent to the

analysis we learned that her now retired Broker advised against the annuities. She is 69, but looking for Capital

Appreciation to further build her estate.

We have combined the positions in your Merrill Lynch (ML) accounts into a single portfolio for analysis.

Equity (57% of portfolio)

The following table lists the Funds you are invested in with the last column showing the percentage of your ML

portfolio:

We are aware that Merrill Lynch has, or is in the process of moving from Commission to Fee based accounts in

order to meet the new "Fiduciary Rule" requirements for retirement accounts that were in the process of being

mandated before the Trump Administration's delaying actions. However, we would be remiss in not pointing

out that all of your Open-end Funds (OEF) have a Load, with 6 of the 9 being at the highest rate, 5.75%. As I

have written in a previous article (https://medium.com/@DevinLHughes/when-is-it-time-to-shop-for-a-new-

investment-advisor-f39776dbd729):

“In order to entice investment advisors and brokers to offer their vehicles to clients, mutual funds often offer a

variety of share classes, many of which have Load fees. The idea behind the Load fee is for it to serve as a sort

of sales charge, compensating the advisor and his firm for their expertise in assisting you in purchasing the fund

shares. In practice however, the sole purpose of Load fees are to further enrich the advisor at the expense of the

client.”

There is never a good reason to be in shares with a load fee, as most Funds offer share classes with no Load.

These OEFs also have relatively high Expenses, especially when compared to SPY, an Exchange Traded Fund

(ETF) that tracks the S&P 500. Three of these OEFs have a Morningstar (M*) performance rating of 2, which

should be totally unacceptable. Morningstar's performance rating system:

"Morningstar rates mutual funds and ETFs from 1 to 5 stars based on how well they've performed (after

adjusting for risk and accounting for sales charges) in comparison to similar funds and ETFs.

Within each Morningstar Category, the top 10% of funds and ETFs receive 5 stars and the bottom 10% receive

1 star. Funds and ETFs are rated for up to three time periods-three-, five-, and 10-years and these ratings are

combined to produce an overall rating. Funds and ETFs with less than three years of history are not rated."

Name Symbol Type Category Exp. Load M* ML

AB SUSTAINABLE GLBL ALTFX OEF World Large Growth 1.41% 4.25% 4 0.9%

BLACKROCK GLOBAL BABDX OEF World Large Blend 1.02% 5.25% 2 4.6%

DEUTSCHE CROCI EQUTIY KDHAX OEF Domestic Large Value 1.04% 5.75% 2 3.2%

EATON VINCE RCHRD BRSTN EARAX OEF World Tactical Allocation Large Blend 1.37% 5.75% 4 4.4%

JOHN HANCOCK REGIONAL FRBAX OEF Domestic Mid Value (Financials) 1.28% 5.00% 5 2.0%

LORD ABBETT DEVELOPING LAGWX OEF Domestic Small Growth 0.96% 5.75% 2 2.2%

MASSACHUSETTS INVESTORS MITTX OEF Domestic Large Growth 0.73% 5.75% 4 3.4%

MFS MID-CAP GROWTH OTCAX OEF Domestic Mid Growth 1.21% 5.75% 3 1.0%

PUTNAM INTERNATIONAL POVSX OEF Foreign Large Blend 1.23% 5.75% 3 2.8%

SPDR S&P 500 ETF TRUST SPY ETF Domestic Large Blend 0.09% 4 1.8%

Morningstar's Category for each Fund is provided. As investing legend John Templeton once observed, "The

only investors who shouldn't diversify are those who are right 100% of the time." However, diversifying

among categories, as though they were Asset Classes, often gives the illusion of lower risk while merely

increasing the cost and lowering the performance. When a broker adds both a Domestic Large Value (KDHAX)

OEF and a Domestic Large Growth (MITTX) OEF to a portfolio, he is often just replicating the S&P 500

(SPY), with far higher expenses. Since most actively managed Funds fail to even match their benchmark, the

client pays the price. We have added KDHAX (orange line), and MITTX (green line) to Morningstar's chart for

SPY (blue line) since inception:

As detailed on our website, there is strong academic evidence that Value beats Growth over time. However,

there is absolutely no justification for buying a bunch of Value, Growth and Blend Funds, when you can

effectively buy the market with a single index Fund at much less Exp. For example, the iShares MSCI ACWI

ETF tracks "the investment results of an index composed of large and mid-capitalization developed and

emerging market equities" with an Expense Ratio of .33%. In legendary investor Peter Lynch's first book, ‘One

Up On Wall Street’, he coined the term "diworsification". While yours isn't the worse case we've seen

(http://www.hughescapitalmanagement.com/2017/11/18/fidelitys-turn-diworsification-111817/), the resulting

underperformance is equally assured.

The S&P 500, Large and Mega (>$100 Billion) Caps, is a subset of the S&P 1500, which is also comprised of

the S&P MidCap 400 and S&P SmallCap 600. The S&P 1500 covers approximately 90% of the U.S. market

capitalization. Your allocation to Small-Caps (LAGWX) is 2.2%. As we note on our website under Factors:

"Size is one of the three original factors when Fama and French published their three-factor model in 1992 to

explain stock returns. Over the long run, small capitalization stocks tend to beat their large counterparts." This

is clearly demonstrated by the relative performance of the S&P 600 and 400 to that of the S&P 500 when using

the best ETFs. Small (IJR, blue line) beats Mid (IJH, orange line), and both clobber Large (SPY, green line):

We have provided the Market Capitalization in billions (Mkt Cap) for your individual stocks in the Sector

Analysis on the next page. While the definition of Small-Cap varies, it is generally a company with a market

capitalization of between $300 million and $2 billion according to Investopedia, which excludes all of your

stocks.

Numerous academic studies, two of which we detail on our website, have shown that EV/EBITDA is the best

valuation metric. We have provided this metric for all but 8 of your stocks and the resulting decile. The

Valuation component of our IVE Stock Selection System requires that we buy stocks in the lowest decile ("1"),

and sell them when they become fully valued ("5"). Whatever criteria were used to select these stocks, the

Value Factor does not appear to have been one of them.

While your portfolio is extremely overweight in Consumer Staples (24.2% vs. 8.6% for the Morgan Stanley

Capital International All Country World Index, the All Cap version of which is HCM's benchmark), it has

almost no exposure to Energy and even less to Real Estate. We consider Real Estate to be a separate Asset Class

and are currently recommending at least 10% exposure even for retired clients. As we wrote in December

2017's Newsletter: "Another likely winner from the Tax Bill will be equity REITs, which most of our clients are

already significantly overweight. From High Dividend Opportunities on Dec. 23rd: "Like MLPs, Property

REITs will be winners from the tax reform, and will be permitted to benefit from the new pass-through rules.

The new tax reforms include a 20% deductibility to REIT dividends which will ... encourage investors to buy

REITs in their taxable accounts instead of only in tax-advantaged accounts. This will unlock a vast source of

capital which can now flow into REITs. This is very bullish for REITs going into 2018. ...""

In our "REITs & Rates - 11/21/16" Worth Sharing we wrote: "Whether your objective is Capital Appreciation

or Income, Real Estate is an Asset Class we recommend, and publically traded REITs are the best way to gain

exposure. However, valuations matter."

As shown in a recent report from Cohen & Steers, as of September 30, 2017 REITs had underperformed stocks

over the past 5 Years, but outperformed over the past 20 Years.

AB SUSTAINABLE GLBL ALTFX 0.0% 0.0% 0.1% 0.1% 0.1% 0.2% 0.2% 0.1% 0.0% 0.0% 0.1%

BLACKROCK GLOBAL BABDX 0.0% 0.1% 0.5% 0.5% 1.5% 1.0% 0.4% 0.3% 0.0% 0.3% 0.0%

DEUTSCHE CROCI EQUTIY KDHAX 0.0% 0.1% 0.5% 0.3% 0.8% 0.5% 0.2% 0.5% 0.0% 0.0% 0.5%

EATON VINCE RCHRD BRSTN EARAX 0.1% 0.2% 0.2% 0.3% 0.1% 0.0% 0.9% 0.7% 0.0% 0.1% 0.0%

JOHN HANCOCK REGIONAL FRBAX 2.0%

LORD ABBETT DEVELOPING LAGWX 0.0% 0.1% 0.4% 0.3% 0.1% 0.4% 0.2% 0.4% 0.0% 0.0% 0.0%

MASSACHUSETTS INVESTORS MITTX 0.2% 0.1% 0.3% 0.3% 0.4% 0.5% 0.7% 0.7% 0.0% 0.2% 0.0%

MFS MID-CAP GROWTH OTCAX 0.0% 0.1% 0.2% 0.2% 0.0% 0.1% 0.1% 0.3% 0.0% 0.0% 0.0%

PUTNAM INTERNATIONAL POVSX 0.1% 0.2% 0.5% 0.3% 0.3% 0.2% 0.6% 0.4% 0.0% 0.0% 0.0%

SPDR S&P 500 ETF TRUST SPY 0.1% 0.1% 0.2% 0.2% 0.1% 0.3% 0.3% 0.4% 0.0% 0.1% 0.0%

ABBVIE INCA ABBV 183.4 17.1 7 0.7%

ALTRIA GROUP MO 124.2 13.5 6 1.4%

AMOCR LTD AUS ADR AMCRY 13.2 12.2 5 0.9%

ANHEUSER-BUSCH INBEV ADR BUD 191.5 15.5 6 0.3%

ANSELL LTD-SPON ADR ANSLY 2.6 13.7 5 0.4%

ANTA SPORTS PROD-UNSPON ANPDY 12.7 18.9 8 0.4%

ASTRAZENECA PLC SPND ADR AZN 79.6 16.1 7 0.7%

BLOCK H7R INC HRB 5.8 7.8 2 0.5%

BRITISH AMN TOBACO SPADR BTI 135.2 16.3 7 1.4%

CISCO SYSTEMS INC CSCO 217.9 12.0 4 1.1%

CITIZENS FINL GROUP INC CFG 22.6 0.3%

COCA COLA KO 190.8 19.2 8 0.8%

DBS GROUP HLDGS SPN ADR DBSDY 53.7 0.5%

DEUTSCHE POST AG DPSGY 52.6 10.5 3 0.8%

DIAGEO PLC SPSD ADR DEO 81.3 17.8 7 0.5%

GENIUINE PARTS CO GPC 14.8 12.9 5 0.9%

GIVAUDAN SA UNSP ADR GVDNY 20.4 20.6 8 0.6%

GLAXOSMITHKLINE PLC ADR GSK 83.4 7.6 2 0.6%

HEINEKEN N V ADR HEINY 57.0 12.8 5 0.5%

IMPERIAL BRANDS PLC IMBBY 32.9 9.8 3 1.1%

INTL PAPER CO IP 24.2 10.3 3 0.7%

JAPAN TOBACCO INC JAPAF 50.0 8.9 2 0.8%

JOHNSON AND JOHNSON JNJ 352.6 15.2 6 1.2%

KNOW OYJ KNYJF 27.1 15.2 6 0.7%

LLYODS BANKING GROUP LYG 63.3 0.3%

M&T BANK CORPORATION MTB 28.8 0.5%

MICROSOFT CORP MSFT 713.5 0.4%

NESTLE S A REP RG SH ADR NSRGY 242.7 15.2 6 0.8%

NOVARTIS ADR NVS 192.0 15.0 6 1.0%

NOVO NORDISK A S ADR NVO 119.1 14.0 6 0.4%

PEPSICO INC PEP 157.6 13.3 5 0.6%

PFIZER INC PFE 212.9 11.3 4 0.4%

PHILIP MORRIS INTL INC PM 161.1 15.1 6 0.9%

PROCTER & GAMBLE CO PG 207.8 12.5 5 0.6%

ROCHE HLDG LTD SPN ADR RHHBY 198.4 9.3 3 0.5%

ROGERS COMMUNICATIONS RCI 23.6 8.5 2 0.9%

SANDS CHINA LTD UNSP ADR SCHYY 44.9 20.3 8 0.3%

SANOFI ADR SNY 92.9 8.6 2 1.0%

SGS SA ADR SGSOY 18.7 15.1 6 0.3%

SONIC HEATLHCARE LTD SKHHY 7.9 15.2 6 0.5%

SVENSKA HANDELSBANKEN AB SVNLY 27.4 0.4%

TAIWAN S MANUFCTRING ADR TSM 204.8 9.2 3 0.7%

TELUS CORP TU 21.2 9.2 2 0.9%

UNILEVERNV NY REG UN 154.0 13.6 5 0.6%

UNITED PARCEL SVC CL B UPS 93.0 11.0 4 0.3%

UNITED TECHS CORP UTX 104.0 11.9 4 0.7%

US BANCORP USB 91.3 0.5%

WELLS FARGO & CO WFC 293.6 1.2%

3M COMPANY MMM 139.9 16.7 7 0.4%

% of Overall Portfolio 0.5% 2.4% 6.3% 6.2% 13.8% 10.5% 9.4% 5.9% 0.1% 1.6% 0.6%

% of Equity 0.9% 4.2% 11.0% 10.9% 24.2% 18.3% 16.4% 10.2% 0.1% 2.8% 1.1%

MSCI ACWI 6.2% 5.5% 10.8% 11.3% 8.6% 10.7% 19.6% 17.7% 3.0% 3.9% 2.8%

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EBITDA Decile

As a result, REITs are relatively undervalued when compared to stocks.

Bonds (21%)

Our negative view on Bonds, both cyclical and secular, can be found under Asset Allocation on the HCM

website:

"Over long periods of time, the returns on equities not only surpassed those on all other financial assets, but

were far safer and more predictable than bond returns when inflation was taken into account." – Princeton

professor Jeremy Siegel from the 2014 preface to his classic book, Stocks for the Long Run."

At their current yields, government bonds, as Jim Grant of Grant’s Weekly Interest Rate Observer has

noted, now offer “return-free risk.” As Gary Antonacci, the author of Dual Momentum Investing: An

Innovative Strategy for Higher Returns with Lower Risk, has written:

“The average annualized real return after inflation on U.S. long-term government bonds from 1900 through

2013 was just 1.9%, considerably less than the 6.5% average annualized real return from U.S. equities during

this same period. Bonds had negative real returns from 1940 all the way through 1981. Purchasers of long-term

government bonds in 1941 had to wait until 1991 before breaking even.”

And:

“Given the way that bond prices move inversely to interest rate changes, intermediate-term bonds could lose

half their value if their annual yield rises to their long-run average rate of 6.75%. One should keep in mind that

real Treasury bond returns were negative for the next 45 years following similar valuation levels as exist today.

Here is what Warren Buffett wrote about fixed-income investing in his 2012 annual letter to Berkshire

Hathaway, Inc., shareholders: ‘They are among the most dangerous of assets. Over the past century these

instruments have destroyed the purchasing power of investors in many countries, even as these holders

continued to receive timely payments of interest and principal… Right now, bonds should come with a warning

label.’”

While there may come a time in the future when long-term Bonds once again make sense as a part of a

diversified portfolio, currently it is an asset class best avoided."

Our cyclical concerns have increased. From BCA Research's February 16, 2018 Global Investment Strategy:

"While bond yields are due for a pause, the long-term trend remains firmly to the upside. BCA declared “The

End Of The 35-Year Bond Bull Market” on July 5, 2016.2 As luck would have it, this was the same day that the

10-year U.S. Treasury yield hit a record closing low of 1.37%. We argued at the time that both cyclical and

structural forces would conspire to put in a bottom for yields.

Since then, the global economy has continued to grow at an above-trend pace. This has caused output gaps to

shrink in every major economy. The U.S. has now reached full employment. Wage growth tends to accelerate

once the unemployment rate falls below NAIRU. Faster wage growth will give households the wherewithal to

spend more. With little spare capacity left, this will fuel inflation. The shift from fiscal austerity to largesse

across much of the world is adding to the inflationary pressures. The Trump tax cuts are starting to look like

chump change compared to the massive amount of spending coming down the pike. The Senate agreed last

week to raise the caps on spending by $153 billion in FY2018 and an additional $143 billion in FY2019. This

does not even include the $80 billion that has already been allocated to disaster relief, the still-to-be-negotiated

sum for infrastructure spending ....

Globalization, which historically has been a highly deflationary force, is on the back foot. Global trade nearly

doubled as a share of GDP from the early 1980s to 2008, but has been stagnant ever since. Donald Trump

pulled the U.S. out of the Trans-Pacific Partnership and he may very well pull it out of NAFTA. Opposition

towards open-border immigration policies is rising. More Mexicans left the U.S. over the past eight years than

entered it.

On the demographic front, the three decade long increase in the global ratio of workers-to-consumers has finally

reversed. As baby boomers leave the labor force, the amount of GDP they produce will plummet. However,

their spending on goods and services will continue to rise

once health care expenditures are included in the tally. The

combination of more consumption and less production is

inflationary. Against a backdrop of slow potential GDP

growth, policymakers will welcome rising inflation as the

only viable tool left to deflate away high debt levels. ...

Global bond yields are on a structural upward trajectory,

however the progression will be a choppy one. The rapid

rise in bond yields will flatten out, but the 10-year

Treasury yield (it closed last week at over 2.8%) will

nevertheless finish the year at about 3.25% – around 25

basis points above the forwards. Yields will continue to

rise into next year. ...

The next downturn will see inflation and bond yields dip

again. However, they will do so from higher levels than

today. As in the 1970s, bond yields and inflation will trend

higher over the coming years, reaching “higher highs” and

“higher lows” with every passing business cycle (Chart

14).

Annuities (14%)

There is a saying in the industry that "Annuities are sold,

not bought." They are a high cost, low return form of

insurance. The unedited following article can be found

here: http://abcnews.go.com/Business/annuities-sold-

bought/story?id=28120522

Why Annuities Are Often Sold, Not Bought

BY LAURA MATTIA

Jan 12, 2015

If you have substantial assets or suddenly come into money through inheritance or a divorce settlement, there’s

a good chance that someone will try to sell you an annuity.

Annuities are highly complex investments that are marketed aggressively, often to individuals for whom they

may not be appropriate. Investors usually don’t go looking for an annuity. Instead of being sought, these

investments are sold.

In an annuity, the investor hands over a substantial lump sum to an insurance company in an arrangement by

which the company is ultimately obligated to provide an income stream for life. There are various types of

annuities, many of which aren’t right for anyone. ...

The main reason you may be solicited for this product is that commissions for them are often 6 or 7 percent or

more of the total investment. At this rate, if you invest $500,000 in an annuity, the salesperson earns $35,000 —

possibly in one afternoon.

This powerful financial incentive motivates various types of financial people, especially brokers and insurance

reps, to search high and low for prospects. Because annuities require the buyer to write a large check, prime

sales targets typically include women who have recently inherited money, collected insurance proceeds or

received a divorce settlement. Prospects also include well-heeled clients of financial professionals (including

brokers), who are well aware of the money these clients could readily invest in an annuity. The less these clients

know about financial matters, the more vulnerable they may be to sales pitches for annuity products that aren’t

right for them.

Even if a person trying to sell you an annuity calls himself or herself an advisor, he or she is under no legal

obligation to serve your interests beyond determining that an annuity is “suitable” for you — a relatively low

standard. Advisors who are classified as fiduciaries (including HCM) are required by law to meet a much higher

standard: to always put clients’ interests ahead of their own. Those who may try to sell you an annuity aren’t

pure fiduciaries.

This isn’t to say that fiduciaries don’t help clients acquire an annuity if it’s an appropriate investment for them.

But anyone who stands to gain a commission for selling you an annuity isn’t acting as a pure fiduciary. At that

point, they have taken off their fiduciary hat and are operating under regulations that don’t require them to put

your interests first.

Like most sales pitches, those for annuities convey a great sense of urgency, as though a decision to buy this

product must be made quickly. And, as usual, there’s no urgency at all. Those who delay getting an annuity are

at no disadvantage. And usually, disadvantage comes to those who decide to buy them.

For women who are financially empowered and diligently and competently managing their finances situations,

any type of annuity is probably the wrong choice.

Yet some annuities can have advantages for investors who aren’t engaged enough in managing their money or

don’t have a qualified advisor. They provide a set-it-and-forget-it option that frees buyers from worrying about

what the markets are doing; they will get a minimum guaranteed amount no matter what, assuming the

insurance company stays solvent.

The downsides of annuities include:

High fees. These fees start with sales commissions, which investors ultimately pay indirectly. Atop that, there

are typically expenses stemming from optional guarantees and add-ons for increased flexibility, as well as

from mutual funds in which your money may be invested under the arrangements of some annuity products.

Low gains relative to other investments. In some cases, depending on the rate of inflation, there may be no

gains at all. Investors can often get far better returns, while keeping risk low, by maintaining a diversified

portfolio of stocks, bonds and other investments.

Lack of access to your money. Once you buy an annuity, you can no longer get access to this money for a set

period, unless you pay a huge surrender penalty. Ultimately, you have no access to your money whatsoever

because it becomes the insurance company’s money. As a result, you could end up lacking funds you might

need in an emergency, or paying dearly to get them. Stocks and bonds, on the other hand, are highly liquid, so

you always have quick access.

Irrevocability. After you trigger an annuity’s income stream, you’re locked in for life; there’s no changing the

arrangement.

A potential nightmare for your heirs. In most cases, once you trigger the income stream, your investment is

off the table for estate purposes. If you die the day after the income stream starts, your heirs will get nothing —

no income nor any part of your lump-sum investment. Insurance companies try to make some annuities more

appealing by offering riders that assure that your heirs will receive some of the money you invested. But these

arrangements are usually quite expensive for you and for your heirs, who usually receive less money than they

would if you’d never purchased the annuity. As people who buy annuities often invest a large percentage of

their assets in them, this can severely reduce the amount of their net worth that their heirs receive.

Company risk. Investing a lot of money with one company can significantly increase your risk of loss. Those

who decide to buy an annuity should limit their investment to a manageable portion of their total assets. That

way, if the company holding your annuity goes belly-up, you would have other assets. ...

For some people, a single-premium immediate annuity (a type of fixed guaranteed annuity) might make sense.

This is one where investors pay a lump sum in exchange for a guaranteed income stream that starts right away.

Yet this isn’t the kind of annuity that financial people will probably try to sell you because sales commissions

for them are relatively low.

Instead, they are more inclined to sell you a variable annuity or an index annuity. In this type, after an

accumulation phase, the insurance company guarantees a minimum payment, with the possibility for amounts

above that minimum depending on the performance of a managed portfolio of investments held by the insurance

company.

At first, variable annuities can appear quite appealing, but they are rarely a wise choice for anyone. Some

varieties include a guaranteed withdrawal benefit. This typically allows you to withdraw a set percentage (for

example, about 4 percent) of your initial account value as long as you live. Some even offer a guaranteed rate of

return before you start drawing income. And since your money remains invested in the annuity’s subaccounts,

which operate much like mutual funds, there’s a chance your account value and future income stream might

increase. Perhaps the biggest draw is that your income won’t be disrupted if the financial markets get pummeled

as they did in 2008–09.

However, the onerous fees typical of variable annuities whittle away at your account value, making these poor

investments. Unlike fixed guaranteed annuities, variable annuities may not assure a minimum amount of

income, and the heavy fees they charge can eliminate the upside that buyers purchase them to get.

But instead of using any type of annuity, you could be investing this money yourself with total flexibility and

potentially higher long-term returns with a well-thought-out diversification strategy.

The fundamental irony of annuities is that you shouldn’t buy one without understanding it. But if you could

truly understand annuities, you’d probably have enough basic financial wherewithal to maintain a market

portfolio or engage intelligently and prudently with a qualified, ethical financial advisor. For most people, this

is usually a superior option to buying an annuity, assuming that you build and properly maintain a highly

diversified portfolio so it can withstand market declines.

Regardless of what you do when you’re approached by an annuity salesperson, take your time and get all the

facts before signing on the dotted line.

Laura Mattia is a partner with Baron Financial Group, and a fee-only financial advisor. She's a Certified

Financial Planner professional (CFP®), a Chartered Retirement Plan Specialist (CRPS®) and a Certified

Divorce Financial Analyst (CDFA™) and holds an M.B.A. in accounting/finance. Her Internet radio show is

Financially Empowering Women™ with Laura Mattia. Having worked as finance professor at the Rutgers

University Business School, Mattia is doctoral candidate in financial planning at Texas Tech University. Her

research is focused on understanding why women are not as financially literate as men.

Cash (7%)

From our website: "Equities have historically returned 10% a year. Move the decimal point 2 places to the left

and you have what cash is currently yielding. That is an opportunity cost of 9.9% annually."

Our Recommended Portfolio

In the above chart, we have added columns for Factors, which are fully explained on our website, Yield and

Distribution Frequency (Note 2).

As noted on our site, Hughes Capital Management (HCM) "applies the academic findings of Behavioral

Finance to the management of Individual Investment Accounts .... A factor is something that explains stock

% Symbol Type Description Factors (1) Yield (2) M* Risk (3)

10 SFREX OEF Global Real Estate 3.5% Q 5 1.0

10 MTUM ETF US Large Growth M 1.3% Q 5 1.0

20 SMLF ETF US Small Blend S, V, M, Q 0.9% Q 1.1

20 XSLV ETF US Small Value S, Q, LV 1.9% Q 5 0.9

20 ISCF ETF Foreign Small/Mid Blend S, V, M, Q 1.9% S 1.1

20 GPIIX OEF Foreign Small/Mid Growth S, V, Q 0.3% A 4 1.3

1.1

10 SFREX OEF Global Real Estate 3.5% Q 5 1.0

10 MTUM ETF US Large Growth M 0.9% Q 5 1.0

40 IVE System & IBT (4) US I, V, E 1.4

20 ISCF ETF Foreign Small/Mid Blend S, V, M, Q 1.9% S 1.1

20 GPIIX OEF Foreign Small/Mid Growth S, V, Q 0.3% A 4 1.3

1.2

1

2

3

4

M=Momentum, S=Size, V=Value, Q=Quality, LV=Low Volatility, I=Insiders, E=Earnings

Weighted Average:

Weighted Average:

Initial

Goal

Notes

Distribution Frequency: A=Annual, S=Semi-Annual, Q=Quarterly, M=Monthly

Ratio of average historical Max. Drawdowns to S&P 500 declines greater than 10%

IBT=Insider Buying Themes

returns, ranging from Insider Buying and Value, to stock price Momentum. The concept of Factors has been

around since Eugene Fama (who won the Nobel Prize in Economics in 2013) and Ken French began developing

statistical models to explain stock returns relative to the broader market. Since their initial work, more and more

factors have been added, and just in the past few years the idea has exploded in popularity, with so called

“Smart Beta” funds (another term for Factor based investing) sprouting up everywhere one looks. Yet despite

the newfound popularity and hype for this investing approach, very few of these Factors withstand academic

scrutiny." Seven of the Factors which we consider compelling are shown in Note 1.

SFREX - This passively managed OEF primarily invests in stocks that are included in the Russell RAFI Global

Select Real Estate Index developed by Rob Arnott's Research Affiliates. The index measures the performance of

real estate companies, including real estate investment trusts (REITs), in U.S. and non-U.S. markets, including

both developed and emerging. It ranks and weights global real estate securities by three fundamental measures

of company size, adjusted sales, retained operating cash flow, and dividends plus buybacks rather than by

market capitalization.

MTUM - In an interview, Eugene Fama (the father of the Efficient Market Hypothesis) admitted that “…the

one thing that causes lots of trouble is the evidence that there’s some short-term momentum in returns…. in my

view that’s the biggest challenge to market efficiency.” The orange line in Morningstar's chart is the S&P 500.

From Morningstar:

A cost-efficient momentum strategy.

by Alex Bryan, CFA 6/23/2017

Suitability

IShares Edge MSCI USA Momentum Factor MTUM is one of the most attractive momentum funds available.

This low-cost strategy targets stocks with strong recent performance, based on the observation that recent

performance tends to persist in the short term. It effectively captures this phenomenon, while keeping costs in

check, which should set up attractive category relative performance over the long run, supporting the

Morningstar Analyst Rating of Silver.

The fund targets large- and mid-cap stocks with strong risk-adjusted price performance over the past seven and

13 months, excluding the most recent one. This focus on risk-adjusted performance should moderate the fund's

volatility and reduce the fund's exposure to stocks that struggle when the market changes direction. Stocks that

make the cut are weighted according to both their market capitalization and risk-adjusted momentum. This can

lead to some large positions in individual names, but the fund caps these weightings at 5%. The resulting

portfolio lands squarely in large-growth territory. It should effectively complement value-oriented holdings

because momentum tends to work well when value doesn't, and vice versa.

To mitigate turnover, the fund only reconstitutes twice a year and applies a wide buffer around the stocks it

targets. These adjustments reduce the fund's style purity, since momentum can shift from month to month. But

they also improve cost efficiency. The fund can still experience high turnover. In the fund's most recent fiscal

year, turnover was 129%. However, it has not yet distributed a capital gain. The exchange-traded fund structure

allows the managers to transfer holdings out of the portfolio through a nontaxable in-kind transaction with the

fund's authorized participants.

While the fund has a limited record, its approach has worked well so far. From its inception in April 2013

through May 2017, it outpaced the Russell 1000 Growth Index by 55 basis points annually, with comparable

volatility. This was largely due to its overweighting in the healthcare sector and more-favorable stock exposure

within the technology, industrial, and consumer cyclical sectors.

Fundamental View

In theory, investors should arbitrage any predictable price pattern away. Yet, simple momentum strategies have

historically worked (on paper) in nearly every market studied. A compelling explanation is that investors may

anchor their investment thesis to old information and react slowly to new information, causing prices to adjust

more slowly than they should. For instance, event studies have demonstrated that stocks beating earnings

expectations have historically tended to offer excess returns for many weeks after the announcement. Similarly,

stocks that miss expectations have tended to continue to underperform.

Investors may also be reluctant to sell losers in the hopes of breaking even and quick to sell winners in order to

lock in gains (disposition effect). This behavior could also prevent stock prices from quickly adjusting to new

information. Once a trend is established, investors may pile into a trade or extrapolate recent results too far into

the future, pushing prices away from their fair values, which may contribute to the long-term reversals

underlying the value effect (the tendency for stocks trading at low valuations to outperform).

While momentum strategies have a good long-term record, they may struggle during periods of high volatility

or market reversals, as relative performance is less likely to persist during those periods. As a result, the fund

can underperform when it is most painful. For instance, its benchmark lagged the MSCI USA Index by 3.8%

during 2008. Heading into a bear market, momentum strategies tend to have an overweighting in riskier stocks,

which may underperform during a correction. After a market downturn, they tend to load up on defensive

stocks, and they may miss out on some of the upside during a sharp recovery.

In order to improve performance when volatility spikes, the fund's benchmark rebalances in between the

scheduled reconstitution dates if market volatility significantly increases. When this rebalancing is triggered, the

index focuses on more-recent momentum to construct the portfolio. This adjustment may help, but it isn't a

panacea. There is also a risk that momentum may become less profitable as more investors attempt to take

advantage of it. That said, the momentum effect hasn't gone away even though it was first published in the

academic literature in 1993. Like any strategy, momentum can underperform for years. This risk may limit

arbitrage and allow momentum to persist.

The fund's moderate style-tilt takes some juice out of the strategy. However, it still captures the essence of the

style at a lower cost than if it pursued a more aggressive rebalancing approach. It has a good chance of beating

the market if momentum continues to pay off. But even if momentum doesn't pan out, the fund's low expense

ratio doesn't hurt performance much.

The portfolio includes around 120 names, including Boeing BA, Comcast CMCSA, and Bank of America BAC.

The composition of the portfolio and its sector weightings can change dramatically over time. Relative to the

Russell 1000 Growth Index, the fund currently has greater exposure to the financial-services sector and less

exposure to consumer (cyclical and defensive) stocks. There are no limits on the fund's sector tilts.

Portfolio Construction

The fund tracks the MSCI USA Momentum Index, which draws stocks from the large- and mid-cap-oriented

MSCI USA Index. This strategy captures momentum in a cost-efficient way, supporting the Positive Process

Pillar rating. In May and November, MSCI calculates the ratio of each stock’s price returns over the past 13 and

seven months (excluding the most recent one) to its volatility over the past three years. The one-month

exclusion addresses the tendency for performance to reverse over that horizon. The index averages these two

scores and selects the highest-scoring stocks until it reaches a fixed target number of stocks. In order to reduce

turnover, new constituents must rank in the top half of the index's target number of securities to get priority over

stocks that were previously in the index. Stocks already in the index only have to rank within 1.5 times the

target number of securities to remain in the index. Holdings are weighted according to both the strength of their

risk-adjusted momentum and their market capitalization, subject to a 5% cap. In addition to the scheduled

semiannual reconstitution, MSCI may rebalance the index when the month-over-month change in the trailing

three-month volatility of the market is larger than the 95th percentile of such monthly changes historically.

When this occurs, the index only uses each stock's seven-month risk-adjusted momentum score.

Fees

The fund's 0.15% expense ratio makes it a bargain, giving it a very low-cost hurdle to overcome. Therefore, it

earns a Positive Price Pillar rating. Over the trailing three years through May 2017, the fund has lagged its

benchmark by 22 basis points annually.

SMLF - From "For Factor Investors, It Pays to Go Small" by Morningstar's Alex Bryan, CFA on 12-6-17: "For

those who do want to profit from momentum in the small-cap arena, it would probably be best to get that

exposure through a multifactor fund, like iShares Edge MSCI Multifactor USA Small-Cap ETF (SMLF) (0.30%

expense ratio). This is because 1) it will have lower turnover than a stand-alone momentum fund, and 2) it

should better diversify risk. This fund targets small-cap stocks with strong value, momentum, quality, and small

size characteristics under constraints that mitigate sector bets and turnover. Its holistic approach and demanding

selection criteria should give it potent exposure to the factors it targets."

We have added the Russell 2000 (orange line), the most widely benchmarked index for domestic Small Caps, to

Morningstar's chart for comparison:

XSLV - We have previously shared with clients how the S&P SmallCap 600 (orange line) outperforms the

commonly quoted Small Cap Russell 2000 (green line) benchmark due to its Quality Factor screening. Adding

the Low Volatility Factor results in XSLV, which has a historical Risk ratio of .9 to the S&P 500 based on

Maximum Drawdown. Morningstar's Analyst Report, with our parenthetical notes in red:

Potent exposure to small stocks with low volatility.

by Alex Bryan, CFA 1/5/2018

Suitability

PowerShares S&P SmallCap Low Volatility ETF XSLV aggressively pursues small-cap stocks with low

volatility. It should offer a smoother ride and better risk/reward profile than the S&P SmallCap 600 and most of

its peers. But it can make concentrated industry bets at times and may require high turnover. And it has a

limited record. These considerations limit its Morningstar Analyst Rating to Bronze.

Each quarter, the fund targets the 120 least-volatile members of the S&P SmallCap 600 Index over the past 12

months and weights them by the inverse of their volatility, so that the least-volatile stocks receive the largest

weightings in the portfolio. This strategy implicitly assumes that recent relative volatility will persist in the

short term, which has historically held. It does not consider how stocks in the portfolio interact with each other.

Stocks that make the cut tend to enjoy more stable cash flows than the average small-cap firm. This should

allow the fund to weather market downturns better than most of its peers but may cause it to lag in stronger

market environments. Because there are no limits on sector weightings, the fund can end up with large sector

bets. But these tilts can shift over time. For example, at the end of December 2017, real estate stocks

represented 25% of the portfolio, up from 16% a year earlier.

While small-cap stocks tend to be more volatile than their larger counterparts, the performance advantage from

tilting toward low-volatility stocks has historically been the largest among the smallest stocks. A big part of this

edge has come from avoiding the riskiest small-cap stocks, which tend to trade at high valuations and have poor

profitability, two characteristics that have historically been associated with lackluster performance.

So far, the fund's approach has worked well. From its inception in February 2013 through January 2017, the

fund exhibited about 13% less volatility and about 20% less market sensitivity than its parent index. It also beat

the benchmark by 124 basis points annualized during that time, largely due to more-favorable stock exposure in

the financial-services industry.

Fundamental View

Low-volatility stocks have historically offered a more favorable risk/reward trade-off than the market and will

likely continue to do so, due to behaviorally induced mispricing and constraints asset managers face. Riskier

stocks tend to have greater upside potential than defensive stocks, which makes them more appealing to

investors who care about earning high returns, like mutual fund managers who are trying to beat a benchmark.

Their collective bets on these risky stocks can cause them to become overvalued, while the neglected, steady-

eddy companies could become undervalued.

If this sounds a bit like value investing, it is. The two strategies’ performance relative to the market is positively

correlated. Like value investing, low-volatility investing has tended to work the best among small-cap stocks,

which have greater room for mispricing than their larger counterparts, since they are less widely

followed. Because it does not explicitly target stocks trading at low valuations, this fund won’t necessarily fit

neatly into the value side of the Morningstar Style Box, though it currently falls in the small value category.

As an added benefit, low-volatility investment strategies effectively filter out the riskiest and least profitable

stocks in the market, which have historically offered terrible returns. Outside of this speculative segment of the

market, the relationship between volatility and returns has been weak. Although it isn’t a strong predictor of

returns for most stocks, past volatility is a good predictor of future volatility and downside performance, at least

in the short term. This risk reduction is the principal source of low-volatility stocks’ attractive risk-adjusted

performance.

It isn’t reasonable to expect this strategy to offer eye-popping returns over the long run. It will likely lag the

S&P SmallCap 600 Index during market rallies and hold up better during market downturns, but offer better

risk-adjusted performance over a full market cycle.

This fund's focus on recent volatility and frequent rebalancing allow it to effectively capture the low-volatility

effect and quickly step out of the way as risk increases in a particular segment of the market. But it ignores how

stocks in the portfolio interact with each other and affect overall portfolio volatility. The strategy can incur high

turnover. Turnover exceeded 50% in each of the past two years.

The portfolio's sector composition can significantly depart from its parent index's. The fund has greater

exposure to the financial services, utilities, and real estate sectors than the S&P SmallCap 600 Index, and less

exposure to technology, consumer cyclical, and healthcare stocks. However, these sector tilts can change

significantly over time. While the fund often takes large sector bets, it effectively diversifies firm-specific risk.

It tends to favor profitable firms with conservative asset growth, which can translate into attractive free cash

flows (this results from the S&P SmallCap 600's Quality Factor).

Portfolio Construction

The fund employs full replication to track the S&P SmallCap 600 Low Volatility Index. It earns a Positive

Process rating because it offers pure exposure to stocks with low volatility, which have historically offered

superior risk-adjusted performance and should continue to do so. Each quarter, S&P ranks the constituents in

the S&P SmallCap 600 by their volatility over the past 12 months and selects the least volatile 120 for inclusion

in the index. It then weights these constituents by the inverse of their volatility, so that less-volatile stocks

receive larger weightings in the portfolio. This approach is laudably transparent, and it offers clean exposure to

the low-volatility effect. But because there are no constraints on sector weightings or turnover, the fund can end

up with large sector tilts that change over time. And because it does not consider valuations in its selection

process, the fund can drift across the Morningstar Style Box. It currently nets out in small-blend territory but

has exhibited a greater value tilt in the past. Unlike some of its peers, the fund does not consider correlations

among stocks, which can affect how the portfolio behaves.

Fees

PowerShares charges a low 0.25% expense ratio for this offering, which is reasonable for this strategy and low

relative to the small-value category, supporting the Positive Price Pillar rating. Over the trailing three years

through December 2017, the fund lagged its benchmark by 27 basis points annualized, slightly more than the

amount of its expense ratio. This was likely due to transaction costs.

Alternatives

SPDR SSGA US Small Cap Low Volatility ETF SMLV is the cheapest alternative (0.12% expense ratio). At

the end of December 2016, this fund switched to the SSGA US Small Cap Low Volatility Index from the

Russell 2000 Low Volatility Index. It now targets stocks representing the least volatile 30% of each sector in

the eligible universe and weights its holdings by the inverse of their volatility. This sector-relative approach

keeps the fund's sector weightings more in line with the broader small-cap market. SMLV also measures

volatility over a longer period (five years) than XSLV, which means it will be slower to adjust as volatility

changes. (XSLV, which includes the Quality Factor, is better designed, and has superior performance.)

IShares Edge MSCI Minimum Volatility USA Small-Cap ETF SMMV (0.20% expense ratio) takes a more

holistic approach to reduce volatility. It attempts to construct the least volatile portfolio possible with stocks

from the MSCI USA Small Cap Index. To do this, it uses an optimizer that takes into account each stock’s

volatility, factor exposures, how stocks interact with each other, as well as several constraints. These include

limiting sector tilts and turnover. (While this relatively new ETF, 9/9/16, is on our Watch List, its lack of

liquidity, just over 25 mil. Total Assets, precludes it from consideration for now despite its superior

performance with even less volatility.)

Actively managed Royce Special Equity RYSEX (1.17% expense ratio) may also be worth considering. This

fund carries a Morningstar Analyst Rating of Silver. Managers Charlie Dreifus and Steven McBoyle target

highly profitable small-cap businesses with attractive valuations and conservatively stated financials. They hold

a compact portfolio that has exhibited lower volatility than the S&P SmallCap 600 Index over the past decade.

More importantly, the fund has distinguished itself during market downturns and will likely continue to do so in

the future. (The much cheaper XSLV has significantly outperformed since inception. RYSEX is another

example of active management not adding value.)

ISCF - The iShares Edge MSCI Multifactor Intl Small-Cap ETF seeks to track the investment results of an

index composed of global developed market small-capitalization stocks, excluding the U.S., that have favorable

exposure to the Value, Quality, and Momentum Factors. We have added EFA (orange line) as an appropriate

benchmark. EFA tracks the market-cap-weighted MSCI EAFE Index, which covers more than 900 stocks listed

in developed markets overseas, and is, at $77.8 billion, the largest non-USA developed market ETF.

A Suite of New Multifactor ETFs for Your Watchlist

By Ben Johnson, CFA 08-21-15

In late April, iShares launched a crop of new multifactor strategic-beta exchange-traded funds, unveiling its

FactorSelect suite. The five funds are the latest in a wave of increasingly complex multifactor funds being rolled

off asset managers' assembly lines. By our count, 33 of the 88 multifactor strategic-beta ETFs that exist in the

U.S. market today were launched in the past 12 months. I think these are some of the best of the bunch.

Combining stand-alone factors in a multifactor format is a sensible strategy to the extent that the factors in

consideration are 1) credible; 2) well-constructed; and 3) combined in such a way as to improve the overall

risk/reward profile of the resulting portfolio relative to owning any of the factors in a stand-alone format, a

traditional cap-weighted index fund, or an actively managed peer. At first blush, the benchmarks underlying the

iShares FactorSelect ETFs appear to meet all three criteria.

These indexes look to combine the quality, momentum, value, and low-size factors. Quality has been vetted but

remains a relative newcomer. Low size has been called into question, but if nothing else, it can serve to magnify

the value effect. Value and momentum are the classics, the peanut butter and jelly of factor investing. They

have been tested across multiple time periods, geographies, and asset classes and have proved their worth in

out-of-sample tests as well.

MSCI takes the same approach to constructing these factor exposures in the context of the FactorSelect suite as

it does for their stand-alone versions .... There is a large gap to bridge between factor theory and investment

reality. The academics who first discovered and continue to explore and measure these factors don't have to deal

with the messy reality of transaction costs and taxes; as such, they are able to isolate and examine factors in

their purest form. MSCI has made good work of delivering investable versions of these factors with an eye

toward maintaining their "purity." From there, the firm's Diversified Multi-Factor Indexes combine these four

factors in such a way as to tamp down cyclicality (as compared with owning them on a stand-alone basis) and

maintain marketlike levels of volatility.

The FactorSelect ETFs are sensibly designed and competitively priced, but are they better mousetraps? Only

time will tell. These ETFs were launched just three months after MSCI began live calculations for the

underlying indexes. I've never met a bad-looking back-test (the ugly ones never see the light of day), and I

wouldn't suggest using a good-looking one as the sole basis for an investment decision. For now, I've got these

funds on my watchlist.

GPIIX - We have been using Grandeur Peak's International Opportunities Fund for International Small Cap

exposure almost since its inception, and were responsible the getting E*Trade to offer this OEF. They (blue

line) use a similar Quantitative approach to our own, and outperform their peers (orange line), which, in turn,

outperform Morningstar's benchmark (green line), as shown below. While it is hard Closed to all investors,

HCM has been granted a waiver.

Our Best,

Devin