BANK LOANS SEARCH. Fresno County Employees Retirement Association. November SEATTLE LOS ANGELES

Transcription

1 BANK LOANS SEARCH Fresno County Employees Retirement Association November 213 SEATTLE LOS ANGELES

2 TABLE OF CONTENTS MANAGER SUMMARY COMPARISONS MANAGER PERFORMANCE MANAGER FACTOR ANALYSIS GLOSSARY OF TERMS Page 3 Page 13 Page 25 Page 3 MANAGER WRITE-UPS Page 35 2

3 MANAGER SUMMARY COMPARISONS 3

4 MANAGERS OVERVIEW ING Eaton Vance Pacific Asset Firm Ownership ING U.S. Investment Management ( ING US ) is spinning out via an Initial Public Offering from ING Group N.V. Public company with shares traded on the NYSE under ticker EV Pacific Asset Management is a subsidiary of Pacific Life, a privately owned company. Firm Name ING Investment Management Co. LLC Eaton Vance Management Pacific Asset Management, Product Name ING Senior Loan Senior Floating-Rate Bank Loans Corporate (Bank) Loan Strategy Firm Total AUM ($mm) Product Total AUM ($mm) Inception Date Portfolio Mgrs/Dual Role PMs Research Analysts/Analysts Avg Yrs Exp: PMs Avg Yrs Exp: Analysts $196,99 $165,187 $3,778 $16,266 $37,458 $1,2 4/1/21 1/1/1989 1/1/ Benchmark: CS BB Leveraged Loan Data Source: Evestment Alliance and Morningstar Monthly Database Fees: Unless otherwise indicated, all performance calculations are based on gross of fees returns including mutual fund performance 4

5 PERFORMANCE SUMMARY AS OF 9/213 ING Eaton Vance Pacific Asset CS BB Leveraged Loan Alpha (5yr) Beta (5yr) R-Squared (5yr) Sharpe Ratio (5yr) Treynor Ratio (5yr) Std Dev (5yr) Tracking Error (5yr) Information Ratio (5yr) Max Drawdown Return (5yr) Calmar Ratio (5yr) Excess Ann. Return (5yr) Significance Level (5yr) Skewness (5yr) Kurtosis (5yr) Hurst Exponent (5yr) Performance To Date 1 Year Year Year Year Year Calendar Year Return

6 PORTFOLIO CHARACTERISTICS ING Eaton Vance Pacific Asset Annual Turnover 94% 39% -- Portfolio Holdings Yield to Maturity 5.5% 4.6%* 6.1% Effective Duration Average Quality Issue B Ba3 B Minimum Quality Issue CCC Not Rated Not Rated** Preferred Benchmark Credit Suisse Leveraged Loan Index S&P LSTA Leveraged Loan Index Credit Suisse Leveraged Loan Index *Yield-to-3 (assumes three year accretion to par) **Limitations being greater than $1m EBITDA by issuer 6

7 INVESTMENT PHILOSOPHY AND PORTFOLIO CONSTRUCTION Firm Name Investment Philosophy Portfolio Construction ING Bottom-up fundamental credit analysis; some top-down approach utilized to avoid "clustered" defaults during economic downturns, although some industries avoided all together Invest in high quality issues which the team determines a low probability of default exists. Forecast each companies' cash flow for detailed understanding of investment risks. Preferred characteristics: predictable, stable cash flows, high barriers to entry, and stable asset values Believe the asymmetric profile of bank loans is a reason to invest mainly for income; minimal price appreciation possible Relative value analysis determines over and underweights and is the primary allocation driver Private market-only participant (no high yield bonds) Avoid "risky" industries and/or firms that have volatile cash flows Highly diversified: approximately holdings High turnover: 94% 5% to 6% of holdings purchased in primary market Focus on market liquidity in order to efficiently implement tactical changes Eaton Vance Bottom-up fundamental credit analysis; little to no top-down analysis utilized Long-term performance driven primarily by fundamentals rather than behavioral forces or technical; and by income rather than price appreciation Target attractive income-producing bank loans with low probability of default; allocating to lower-quality credit adds geometrically to risk without a comparable increase in return High quality cash flow forecasting Screen loan universe using two criteria: EBITDA is greater then $75 million and deal size is greater than $2 million High yield bonds occasionally used in strategy, combining public credit analyst research views Highly diversified: 5+ holdings Moderate turnover: 37% Primary and secondary market participation Emphasis on forecasting cash flows and less on backward-looking leverage ratio analysis Pacific Asset Fundamental credit analysis is the cornerstone of the investment process Utilization of top down assessment is incorporated to determine potential headwinds and tailwinds; used as framework to determine portfolio risk positioning. Sector allocations are based on team-identified secular trends in industries and periodic rotations Screen loan universe using two criteria: EBITDA is greater than $1 million and deal size is greater than $3 million Target first lien bank loans of non-investment grade companies, will hold some high yield bonds issues Typically holds between 8-12 issuers. Low turnover: 1% annualized excluding re-financing. Focus on larger, rated issuers with low probability of default and an emphasis on relative value and liquidity 7

8 QUALITATIVE EVALUATION Firm Name Differentiating Characteristics Potential Concerns ING Eaton Vance High emphasis on liquidity; over 98% of the portfolio is marked-to-market on a daily basis with multiple broker quotes. Top-down strategy can play a role in the allocation decision based on credit cycle Access to significant original issue volume offers potential for realization of original issue discount Tracking error close to the benchmark; similar drawdowns Risk exposure similar to the benchmark Consistent, incremental outperformance over various time periods Investment team has also managed over $3 billion in CLOs over the last five years Long track record and deeply experienced team Portfolio manager has been with the firm for over twenty years Majority of the portfolio is invested in higher quality credit rated BB-B; outperformance in down markets and underperformance in up markets Strategy AUM is 2% of firm assets Lack of mutual fund track record (though long composite history) Perception of organizational risk with recent initial public offering (NYSE:VOYA) Large increase in assets over the last three years ($8.7B as of 12/31/21 to $16.3B as of 9/3/213) S&P/LSTA may not be an accurate benchmark to analyze performance given the team's focus on BB-B quality issues Large number of holdings suggests the idiosyncratic risk may be diversified away Large increase in assets over the last three years; currently 6.4% of the U.S. leverage loan market ($8B more capacity stated at current market size) CFO departed Eaton Vance in Q no impact to this strategy Recent move to eliminate private market restrictions to benefit from broader credit team research Pacific Asset Low default rate:.7% for the strategy versus Moody's bank loan issuer default rate of 4% Strong relative performance in downside market capture, as indicated by outperformance in 28 Strategy has outperformed 89% of its peer group since its inception in 27 Small AUM of $1B may result in limited access to primary deals, pricing power and access to company management Two directors of credit research departed the firm in 3Q 212 Rapid growth in AUM during 213 may lead to small deterioration of historical alpha 8

9 PERFORMANCE EVALUATION Firm Name Performance Sensitivity Relative to S&P/LSTA Leveraged Explanation ING Risk profile is similar to S&P/LSTA Leverage Loan index Low tracking error and high R-squared Down market and up market alpha positive; a sign the team is able to outperform under different economic environments Historically, less dispersion in style selection suggests credit quality has not been materially changed through time Incremental excess return coming from credit selection Persistent underweight to CCC and overweight to B compared to the S&P/LSTA Leverage Loan index Eaton Vance Preferred index BB-B constrained credit quality although none exists; Credit Suisse has a BB credit quality index Down market alpha is positive while the up market alpha is negative, most likely due to the persistent allocation to higher quality credit Persistent allocation to higher quality credit Persistent underweight to CCC and overweight to BB compared to the S&P/LSTA Leverage Loan index Pacific Asset Stronger alpha / lower beta a result of higher issuer concentration. Relatively small AUM and relatively low number of holdings. As AUM has grown, correlation to other managers / index has increased as expected 9

10 TOP 1 HOLDINGS ANALYSIS 9/213 Top 1 Portfolio Holdings - ING Weights Blackboard Inc. 2.34% Fram Group Holdings Inc. 1.37% Clear Channel Communications, Inc. 1.31% RedPrairie Corporation 1.28% Asurion, LLC 1.27% Freescale Semiconductor, Inc. 1.16% Hub International Limited 1.1% Hilton Worldwide Finance, LLC 1.9% Global Tel*Link Corporation 1.9% CorpSource Finance Holdings, LLC 1.8% Total 13.9% Top 1 Portfolio Holdings - Eaton Vance Weights Valeant Pharmaceuticals International, Inc. 1.24% Dell Inc. 1.15% Asurion LLC 1.5% Intelsat Jackson Holdings S.A. 1.4% H.J. Heinz Company 1.2% HCA, Inc..99% Ineos US Finance LLC.94% Virgin Media Investment Holdings Limited.9% MEG Energy Corp..86% Biomet Inc..86% Total 1.5% Top 1 Portfolio Holdings - Pacific Life Weights Intelsat Jaskson 2.67% U.S. Foods 2.15% Petco Animal Supplies 2.11% Servicemaster 2.9% Level 3 Communications 1.91% 99 Cents Only Stores 1.88% Roofing Supply Group 1.75% Acosta Holdings 1.72% Fortescue Metals Group 1.63% Osmose Holdings 1.62% Total 19.54% 1

11 SECTOR ALLOCATION AS OF 9/213 2% 9% ING 4% 13% 2% Eaton Vance 13% 7% 7% 3% 2% 2% 39% 11% 1% 1% 29% 8% 3% 1% 24% 3% Pacific Life 3% 6% 6% 33% 16% 4% 7% 8% 16% 6% 3% S&P LSTA 11% 7% 5% 6% % 23% 9% 4% Energy Materials Industrials Consumer Discretionary Consumer Staples Health Care Financials Information Tech Telecommunication Services Utilities Other Cash 11

12 INVESTMENT VEHICLE INFORMATION Vehicles Minimum Investment Expense Ratio Fee Schedule ING 1 Separate Account $75,,.5%.45%.4%.3% First $1 Million Next $15 Million Next $25 Million Remaining balance Commingled Fund $5,, Flat.45% Flat.4% Accounts Under $25 MM Accounts Over $25 MM Mutual Fund (IFRIX) $25,.76% All Assets Separate Account $1,,.48%.4%.35% First $1 Million Next $1 Million Remaining balance Eaton Vance 2 Commingled Fund $1,,.55% All Assets Mutual Fund (EIBLX) $25,.77% All Assets Separate Account $5,,.5%.4%.3% First $1 Million Next $1 Million Remaining Balance Pacific Asset Commingled Fund N/A N/A N/A Mutual Fund (PLFRX) $5,.8% All Assets 1 For accounts under $25 million, ING offers standard reporting and quarterly call to review performance and answer questions. For accounts over $25 million, in addition to standard reporting and quarterly call, they offer annual face-to-face meeting with a member of the investment team a dedicated relationship manager. 2 Eaton Vance offers a reduced commingled fund fee of 5 bps for clients of investment consultants who will rely more heavily on their consultant for information. Under this Service Light model agreement portfolio managers will not travel for client meetings and access will be limited. There is also no ability to customize reporting under this fee option. 12

13 MANAGER PERFORMANCE 13

14 PERFORMANCE TO DATE AS OF 9/213 ING Eaton Vance Pacific Asset CS BB Leveraged Loan Total Annualized Return, % year 7 year 5 year 3 year 1 year 1 Year 7 Year 5 year 3 year 1 year ING Eaton Vance Pacific Asset CS BB Leveraged Loan

15 EXCESS PERFORMANCE TO DATE AS OF 9/213 ING Eaton Vance Pacific Asset CS BB Leveraged Loan 5 Excess Annualized Return, % Year 7 year 5 year 3 year 1 year 1 Year 7 year 5 year 3 year 1 year ING Eaton Vance Pacific Asset

16 ANNUAL PERFORMANCE ING Eaton Vance Pacific Asset CS BB Leveraged Loan Total Annualized Return, % ING Eaton Vance Pacific Asset CS BB Leveraged Loan

17 EXCESS ANNUAL PERFORMANCE ING Eaton Vance Pacific Asset CS BB Leveraged Loan Excess Annualized Return, % ING Eaton Vance Pacific Asset

18 ROLLING PERFORMANCE ING Eaton Vance Pacific Asset CS BB Leveraged Loan 2 36 Month Rolling Annualized Return Total Annualized Return, % Oct-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Dec-12 Sep Month Rolling Annualized Excess Return 8 Excess Annualized Return, % Oct-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Dec-12 Sep-13 18

19 PEER GROUP RANKING ING Eaton Vance Pacific Asset CS BB Leveraged Loan 36 Month Rolling Performance Since Inception Total Return Rank, % Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Sep-13 Calendar Year Performance Ranking Total Return Rank, % Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Dec-12 Sep-13 19

20 PERFORMANCE STATISTICS ING Eaton Vance Pacific Asset CS BB Leveraged Loan Annualiuzed StdDev, % 36 Month Rolling Risk Oct-3 Dec-5 Dec-7 Dec-9 Dec-11 Sep-13 Sharpe Ratio 36 Month Rolling Sharpe Ratio Oct 3 Dec 5 Dec 7 Dec 9 Dec 11 Sep Month Rolling Tracking Error 5 36 Month Rolling Information Ratio Annualized Tracking Error, % Oct-3 Dec-5 Dec-7 Dec-9 Dec-11 Sep-13 Information Ratio Oct 3 Dec 5 Dec 7 Dec 9 Dec 11 Sep 13 2

21 PERFORMANCE STATISTICS ING Eaton Vance Pacific Asset CS BB Leveraged Loan Max Drawdown Return, Oct-1 to Sep-13 Max Drawdown Return, Jan-7 to Sep-13 Max Drawdown Return, % Max Drawdown Return, % Alpha, % 36 Month Rolling Alpha, Oct-3 to Sep Oct-3 Dec-5 Dec-7 Dec-9 Dec-11 Sep-13 Beta 36 Month Rolling Beta, Oct-3 to Sep Oct-3 Dec-5 Dec-7 Dec-9 Dec-11 Sep-13 21

22 RISK VS. RETURN ING Eaton Vance Pacific Asset CS BB Leveraged Loan Performance vs. Risk, Jan-7 to Sep-13 Performance vs. Risk, Apr-6 to Sep-13 Total Annualized Return, % Total Annualized Return, % Standard Deviation % Standard Deviation % Performance vs. Risk, Apr-8 to Sep-13 Performance vs. Risk, Apr-1 to Sep-13 Total Annualized Return, % Total Annualized Return, % Standard Deviation % Standard Deviation % 22

23 PERFORMANCE EFFICIENCY ING Eaton Vance Pacific Asset CS BB Leveraged Loan Excess Return vs. Tracking Error, Mar-4 to Sep-13 Excess Return vs. Tracking Error, Mar-2 to Sep-13 Excess Annualized Return, % 36 Month rolling windows, Mar 4 - Sep Excess Annualized Return, % 36 Month rolling windows, Mar 2 - Sep Tracking Error % Tracking Error % Excess Return vs. Tracking Error, Dec-9 to Sep-13 Excess Annualized Return, % 36 Month rolling windows, Dec 9 - Sep Tracking Error % 23

24 UP & DOWN MARKET ANALYSIS ING Eaton Vance Pacific Asset CS BB Leveraged Loan Down Mkt Alpha Down Mkt Beta Down Market Performance, Jan-7 to Sep Up Mkt Alpha 2 1 Up Mkt Beta 2 1 Up Market Performance, Jan-7 to Sep

25 MANAGER FACTOR ANALYSIS 25

26 FACTOR ANALYSIS: ING ING Excess CS BB Leveraged Loan Calendar Year Excess Return vs. Benchmark Regression Based Asset Style Allocation ING BC US High Yield CS BB Leveraged Loan CS Leveraged Loan Cash 1 Excess Return, % Dec-3 Dec-5 Dec-7 Dec-9 Dec-11 Sep CS BB Leveraged Loan Return, % Weight, % Mar-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Sep-13 USD, 36-month trailing window; exp. weighted Excess Return, % 12 Month Rolling Excess Return vs. Benchmark ING CS BB Leveraged Loan Return, % Benchmark R-Squared ING Benchmark R-Squared, % Month Rolling R-Squared Mar-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Sep-13 26

27 FACTOR ANALYSIS: Eaton Vance Eaton Vance Excess CS BB Leveraged Loan Calendar Year Excess Return vs. Benchmark Regression Based Asset Style Allocation Eaton Vance BC US High Yield CS BB Leveraged Loan CS Leveraged Loan Cash 1 Excess Return, % Dec-3 Dec-5 Dec-7 Dec-9 Dec-11 Sep CS BB Leveraged Loan Return, % Weight, % Oct-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Sep-13 USD, 36-month trailing window; exp. weighted Excess Return, % 12 Month Rolling Excess Return vs. Benchmark Eaton Vance CS BB Leveraged Loan Return, % Benchmark R-Squared Eaton Vance Benchmark R-Squared, % Month Rolling R-Squared Oct-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Sep-13 27

28 FACTOR ANALYSIS: Pacific Asset Pacific Asset Excess CS BB Leveraged Loan Calendar Year Excess Return vs. Benchmark Regression Based Asset Style Allocation Pacific Asset BC US High Yield CS BB Leveraged Loan CS Leveraged Loan Cash 1 Excess Return, % Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Dec-12 Sep CS BB Leveraged Loan Return, % Weight, % Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Sep-13 USD, 36-month trailing window; exp. weighted Excess Return, % 12 Month Rolling Excess Return vs. Benchmark Pacific Asset CS BB Leveraged Loan Return, % Benchmark R-Squared Pacific Asset Benchmark R-Squared, % Month Rolling R-Squared Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Sep-13 28

29 EXCESS RETURNS CORRELATION ING Eaton Vance Pacific Asset CS BB Leveraged Loan Excess Correlation, Jan-7 to Sep Month Rolling Excess Correlation, Dec-9 to Sep-13 ING ING Eaton Vance Eaton Vance Excess Correlation Pacific Asset Pacific Asset Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Sep-13 * Correlation coefficients greater than.3 or lower than -.3 can be considered statistically significant (different than zero) 29

30 GLOSSARY OF TERMS 3

31 GLOSSARY OF TERMS Alpha (a): The excess return of a portfolio after adjusting for market risk. This excess return is attributable to the selection skill of the portfolio manager. Alpha is calculated as: Portfolio Excess Return (Beta x Excess Market Return). Annualized Return: Converts the Total Return to an annual basis for comparison purposes. Periods shorter than one year are not annualized. Barclays Capital Bonds Index: Measures the performance of various bonds sectors including (but not limited to): Government, Corporate Bonds (Credit), High-Yield Bonds ( Junk Bonds ), Mortgage backed securities, and Municipal bonds. Benchmark: Investment index used as a standard by which to measure the relative performance of an overall portfolio or an individual money manager. Appropriate benchmarks are selected based on their similarity to a portfolio or to the style of the individual money manager being measured. For example, a large cap core equity manager would be appropriately measured against the S&P 5 index. Alternatively, a fixed income core manager might be measured against the Barclays Capital Aggregate Bond index. Benchmark R-squared: Measures how well the Benchmark return series fits the manager's return series. The higher the Benchmark R-squared, the more appropriate the benchmark is for the manager. Beta (b): A measure of systematic, or market risk; the part of risk in a portfolio or security that is attributable to general market movements. Beta is calculated by dividing the covariance of a security by the variance of the market. Book-to-Market: The ratio of book value per share to market price per share. Growth managers typically have low book-to-market ratios while value managers typically have high book-to-market ratios. Calmar Ratio - The Calmar Ratio is a risk/return ratio that calculates return on a downside risk adjusted basis. Similar to other efficiency ratios it balances return in the numerator per unit risk in the denominator. In this case risk is characterized by the Maximum Drawdown. Capture Ratio: A statistical measure of an investment manager's overall performance in up or down markets. The capture ratio is used to evaluate how well an investment manager performed relative to an index during periods when that index has risen/fallen. The capture ratio is calculated by dividing the manager's returns by the returns of the index during the up/down market, and multiplying that factor by 1. Commingled Fund: A fund consisting of assets from several accounts that are blended together. Investors in a commingled fund investment benefit from economies of scale, which allow for lower trading costs per dollar investment, diversification and professional money management Correlation Coefficient (r): A measure of the relative movement of returns of one security or asset class relative to another over time. A correlation of 1 means the returns of two securities move in lock step, a correlation of 1 means the returns of two securities move in the exact opposite direction over time. Correlation is used as a measure to help maximize the benefits of diversification when constructing an investment portfolio. DJ UBS Commodity Index: A broadly diversified index that allows investors to track commodity futures price returns. Hurst Exponent: quantifies the relative tendency of a time series either to regress the mean. A value H in the range.5 < H < 1 indicates a time series with long-term positive autocorrelation, meaning a high value in the series will probably be followed by another high value. A value in the range < H <.5 indicates a time series with long-term switching between high and low values in adjacent pairs, meaning that a single high value will probably be followed by a low value. A value of H=.5 can indicate a completely uncorrelated series. Excess Correlation: Correlation of the excess returns (above the benchmark). Index: A passively managed portfolio of securities that remains constant from one period to the next. Indexes are used to gauge the performance of sectors of the market or the market as a whole. In addition, indexes are used as a benchmark for measuring the performance of investment managers. 31

32 GLOSSARY OF TERMS (Continued) Information Ratio: A measure of a manager's ability to earn excess return without incurring additional risk. Information ratio is calculated as: alpha divided by tracking error. Kurtosis (excess returns)- Kurtosis describes whether the series distribution is peaked or flat and how thick the tails are as compared to a normal distribution. Positive kurtosis indicates a relatively peaked distribution near the mean and tends to decline rapidly and have fat tails. Negative kurtosis indicates a relatively flat distribution near the mean. Long Term Reversal Factor: Risk premium associated with buying past losers and selling past winners (five year time horizon). Low Volatilty: Risk premium generated by picking low volatility stocks, measured by the MSCI USA Minimum Volatility Index. Momentum Factor: Risk premium associated with buying past winners and selling past losers. MSCI EAFE Index: The Morgan Stanley Capital International Europe Australia and Far East (MSCI EAFE) Index is a value-weighted index composed of equity securities traded in the countries that give the index its name. This index is a typical benchmark for international equity managers as well as the basis for many international equity index funds. MSCI Regional Indexes: Fee float-adjusted market capitalization weighted indexes that are designed to measure the equity market performance of various regions, including (but not limited to): North America, Emerging Markets, Pacific, and Europe. Mutual Fund: Pools of money that are managed by an investment company. They offer investors a variety of goals depending on the fund and its investment charter. For example, some funds seek to generate income on a regular basis; others seek to preserve an investor's money. Still others seek to invest in companies that are growing at a rapid pace. Mutual funds are investment companies regulated by the Investment Company Act of 194. Nominal Major Currencies US Dollar Index: A weighted average of the foreign exchange values of the U.S. dollar against a subset of currencies in the broad index that circulate widely outside the country of issue. The weights are derived from those in the broad index, which is a weighted average of the foreign exchange values of the U.S. dollar against the currencies of a large group of major U.S. trading partners. The index weights, which change over time, are derived from U.S. export shares and from U.S. and foreign import shares. Portfolio Turnover: The percentage of a portfolio that is sold and replaced (turned over) during a given time period. Low portfolio turnover is indicative of a buy and hold strategy while high portfolio turnover implies a more active form of management. Predicted Style R-squared: Measures how well the manager's predicted style fits the manager's return series. Adding many unnecessary indices will not improve the Predicted Style R-Squared. The methodology essentially predicts the manager's style at each point in time without the data at that point with the rationale being that if the style estimates obtained so far are good, then they can be used to predict the style at the estimation point. Price-to-Earnings Ratio: Also called the earnings multiplier, it is calculated by dividing the price of a company's stock into earnings per share. Growth managers typically hold stocks with high price-to-earnings ratios whereas value managers hold stocks with low price-to-earnings ratios. Regression Based Asset Allocation / Asset Loading: Represents the exposure period of an investment product (called a Manager, Fund, or Index in Stylus) to various explanatory variables. It is also referred to as Style Indices or Asset Classes. These Indices can be interpreted as the Manager Betas or risk factors at a given point in time. Return: A measure of the appreciation or depreciation in the price of an investment over a given time period. This is usually expressed as a percentage and may be annualized over a number of years or represent a single period. In addition, this percentage may be expressed gross or net of adjustments, such as dividends or fees. Risk Premium: An expected return in excess of the risk-free rate. The premium provides compensation for the assumption of risk. 32

33 GLOSSARY OF TERMS (Continued) Risk-Free Rate: The rate of interest that one can earn on an investment with no default risk. It is generally assumed to be the interest rate on a 91 day T-Bill. R-Squared: Also called the coefficient of determination, it measures the amount of variation in one variable explained by variations in another. In the case of investments, the term is used to explain the amount of variation in a security or portfolio explained by movements in the market or the portfolio's benchmark. Russell 2 Index: A value-weighted small-cap stock index composed of the 2 securities with the lowest market capitalization in the Russell 3 index. This is one of the most common benchmarks for small-cap equity managers and is compiled by the Frank Russell Company. Russell 6 style map: Combination of 6 Russell Indices to identify a manager investment style in terms of size/value/growth factors. Russell Mid-Cap Index: A value-weighted index composed of the 8 smallest companies by market capitalization in the Russell 1 index. This index is compiled by the Frank Russell Company and is used as a benchmark for mid-cap portfolios. S&P 5 Index: A value-weighted index compiled by Standard and Poor's that is comprised of 5 of the largest companies traded on the NYSE and NASDAQ exchanges. This is the most common proxy for the equity market as a whole and is the typical benchmark for large-cap portfolios. Sector Indices:The S&P North American Sector Indices provide investors with a suite of equity benchmarks that represent U.S. traded securities across seven broadly defined economic sectors: Consumer, Cyclical, Financial Services, Health Care, Natural Resources, Technology, and Utilities. S&P Indices uses GICS to determine a company's sector classification. Each index is modified-capitalization weighted, which is where a stock's weight is capped at a level determined on a sector basis. Selection return: The difference between the Manager and the Manager's Style Return. Sharpe Ratio: A measure of portfolio efficiency. The Sharpe Ratio indicates excess portfolio return for each unit of risk associated with achieving the excess return. The higher the Sharpe Ratio, the more efficient the portfolio. Sharpe ratio is calculated as: Portfolio Excess Return / Portfolio Standard Deviation. Short Term Reversal Factor: Risk premium associated with buying past losers and selling past winners (two month time horizon). Significance Level (Excess Returns) - The Significance Level of a test is the probability that the test statistic will reject the null hypothesis when the hypothesis is true. Significance is a property of the distribution of a test statistic, not of any particular draw of the statistic. Size Factor: Risk premium associated with buying small companies. Skewness (Excess Returns)- Skewness describes the degree of asymmetry of a distribution around its mean. A distribution is said to be symmetric if has the same shape to both the left and right of the mean. A perfectly symmetrical distribution has a Skewness of. A positively skewed distribution has larger gains than losses, while a negatively skewed distribution has a longer tail of losses. Small Capitalization Stocks: Also referred to as small-cap stocks, these are securities of companies whose overall market capitalization is roughly less than $1.5 billion. Standard Deviation (s): A measure of volatility, or risk, inherent in a security or portfolio. The standard deviation of a series is a measure of the extent to which observations in the series differ from the arithmetic mean of the series. For example, if a security has an average annual rate of return of 1% and a standard deviation of 5%, then two-thirds of the time, one would expect to receive an annual rate of return between 5% and 15%. Style Analysis: A return based analysis designed to identify combinations of passive investments to closely replicate the performance of funds. 33

34 GLOSSARY OF TERMS (Continued) Style Dispersion: Style dispersion measures the deviation around a managers average asset weights. For example, if a manager maintains constant asset exposures over the time period being analyzed then the dispersion will be zero. The more the manager varies in asset exposure over time the higher the style dispersion result will be. Style dispersion will tend to increase in times of increased market volatility and may seem to be random at times when analyzing over long periods (possibly due to change in management style or investment policy). The resulting numbers are best used when comparing to another manager and are difficult to independently interpret. Style Map: A specialized form or scatter plot chart typically used to show where a Manager lies in relation to a set of style indices on a two-dimensional plane. This is simply a way of viewing the asset loadings in a different context. The coordinates are calculated by rescaling the asset loadings to range from -1 to 1 on each axis and are dependent on the Style Indices comprising the Map. Style Returns: The sum of the Return of each Style Asset multiplied by its weight for the time period. Style R-squared: Measures how well the estimated Manager's style return series fits the manager's return series. The higher the Style R-squared, the better the fit between the manager's style and return series. Timing return: The Manager's Style Returns in excess of the Benchmark's Style Returns. Total Return: Total Return geometrically compounds the Returns in the series from one period to the next. Tracking Error/Excess Standard Deviation: The standard deviation of the difference between the rate of return of a portfolio and its benchmark. Treynor Ratio - The Treynor Ratio is defined as the ratio of the manager's excess geometrically annualized return over the portfolio Beta. Excess returns are computed versus the cash index. Universe: Also called a peer group, a universe is a large number of portfolios of a similar style. These portfolios can be divided into deciles or quartiles and then used for performance measurement and comparative purposes. Portfolios are ranked within the universe, which tells the investor how well a manager has done relative to his or her peers. US BLS CPI All Urban SA : Changes in the prices paid by urban consumers for a representative basket of goods and services, seasonally adjusted. Value: Refers to the style of an equity manager. A value manager seeks to create returns by purchasing stocks selling at a discount to their true or intrinsic value. Typical portfolio characteristics of this strategy include a low price-to-earnings ratio, high book-to-market ratio, and high dividend yield. Vaulation Factor: Risk premium associated with buying companies trading at a low price/book multiple. VIX : VIX is a trademark ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 5 index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 3 day period. 34

35 Manager Evaluation: ING Investment Management Co. LLC Senior Loan Strategy Last Updated: September 213 Strategy Basics Asset Class: Senior Bank Loans Firm Inception: 1973 Firm Assets: $196 Billion Strategy Inception: 21 Strategy Assets: $16.3 Billion Min. Size, MF (IFRIX*): $25, Fee, Mutual Fund:.76% All Assets Min. Comm. Fund $5 Million Fee, Comm. Fund:.45% < $25 Million.4% > $25 Million Min. Size, Sep. Acct: $1 Million Fee, Separate Account:.5% First $1 Million.45% Next $15 Million.4% Next $25 Million.3% Remaining Balance * Institutional mutual fund assets total $671.2 million; 21 inception. Firm Background and History ING Group N.V. ( ING Group ), a globally diversified financial services company based in the Netherlands began in 1973, when a predecessor firm registered as an investment adviser with the U.S. Securities and Exchange Commission. ING Group formed in 1991 with a merger of the largest Dutch insurance company and NMB Postbank Group. ING Group then made a number of investment adviser acquisitions in the 199 s including Aeltus Investment Management, Inc., Furman Selz Capital Management LLC and ING Advisers. These firms were combined in June 24 along with other affiliates to form an asset management division, ING Investment Management Co. LLC. Today, this business manages approximately $2 billion in assets across equity, fixed income, and multi-asset strategies. ING U.S. Investment Management ( ING US ) recently spun out from the parent ING Group in an Initial Public Offering (NYSE: VOYA). Under terms of abailout agreement between ING Group and the Netherlands government, the bank is required to divest its remaining stake in VOYA by the end of 216. The ING Senior Loan Group was originally organized in April 1995 as Pilgrim Investments, Inc. an investment adviser to the NYSE-listed, closed-end fund Pilgrim Prime Rate Trust. The team was acquired by ReliaStar Insurance Company in 1999; ReliaStar was purchased by ING Group in 2. Despite name changes to ING Prime Rate Trust, the senior loan investment team remained intact throughout this period. Dan Norman and Jeff Bakalar were appointed as co-heads in January 2 and continue to lead the group today. Headquartered in Scottsdale, Arizona, the Senior Loan Group manages senior loan portfolios and also creates Collateralized Loan Obligation (CLO) vehicles. Over the last five years, the team has launched eight CLOs, totaling over $3 billion. Strategy Background The investment team s emphasis is on finding attractively priced senior loan bonds while avoiding losses through defaults. In an effort to avoid those sectors they believe could experience a large percentage of defaults due to macroeconomic conditions, they utilize a top-down investment approach, whereas bottom-up, fundamental credit analysis determines those issues that are attractively valued relative to default probabilities. They believe that top-tier quality, non-investment grade loans with high liquidity in the B to BB+ range offer superior long-term risk-adjusted performance. Investing in highly liquid issues is key a component to the investment team s ability to successfully implement tactical changes in the portfolio, in that it allows for enhanced trade execution in times of substantially reduced market liquidity. As part of the team s philosophy, consistent implementation of their investment process is maintained through central decision-making by a small Investment Committee consisting of co-heads Dan Norman and Jeff Bakalar; and Ralph Bucher, Senior Credit Officer. They feel the potential for error arising from a single portfolio manager decision process or a decentralized multiple manager arrangement is mitigated through Investment Committee approval of every investment decision. Bureaucratic disadvantages are precluded by limiting membership to senior investment professionals actively involved in the day-to-day work. Page 1

36 The investment team attempts to outperform the S&P/LSTA Leveraged Loan Index by building a broad basket of exclusively senior loans no high yield bonds highly liquid, which trade at attractive yields compared to similar issues, and which reflect low probabilities of default loss according to the team s research. Key Investment Professionals The ING Senior Loan Group is located in Scottsdale, Arizona with an additional office in London. The 24- member Senior Loan investment team is comprised of eight portfolio managers/team leaders (including Group co-heads, Jeff Bakalar and Dan Norman), one senior credit officer (Ralph Bucher), ten investment managers/analysts, three research analysts and two traders. There are five portfolio management teams in Scottsdale responsible for particular industries, and a European team that sources overseas loans. All buy/sell decisions are made by the three-person Investment Committee. Dan Norman, Senior Vice President and Group Head Mr. Norman co-manages the Group with Mr. Bakalar, and he is co-chairman of the Group s Investment Committee and the Loan Pricing and Valuation Committee. He has over twenty years of investment experience. He began managing senior bank debt portfolios in 1995 when ING s predecessor acquired the management rights to ING Prime Rate Trust. Mr. Norman became the co-head of ING s senior bank loan business in January of 2 and with Mr. Bakalar created and implemented the ING Senior Loan Strategy and the ING Senior Loan Group in January of 21. He began his career at Arthur Andersen & Co. in 1981 and joined ING s predecessor in Mr. Norman received his B.A. degree in 198 from the University of Nebraska and completed the University of Nebraska M.B.A. program in He maintains several NASD securities licenses including: Financial and Operations Principal (Series 27), General Securities Principal (Series 24), Registered Options Principal (Series 4), and General Securities Representative (Series 7). Jeff Bakalar, Senior Vice President and Group Head Mr. Bakalar co-manages the Senior Loan Group with Mr. Norman, and he is co-chairman of the Group's Investment Committee and the Loan Pricing and Valuation Committee. He has over twenty years of investment and banking experience and joined ING's predecessor in 1998 and became part of the investment team for what is now ING Prime Rate Trust. He became the co-head of ING's senior bank loan business in January of 2 and with Mr. Norman created and implemented the ING Senior Loan Strategy and the ING Senior Loan Group in January of 21. Mr. Bakalar began his career as an associate with Continental Bank in 1987, serving in various credit and corporate finance roles, including establishing and managing derivatives trading lines with international bank counterparties, and structuring and monitoring various classes of asset-backed transactions. In 1994, he joined the Communications Division within The First National Bank of Chicago, ultimately serving as a senior underwriter responsible for structuring and managing leveraged transactions for issuers in the broadcasting and media sectors. Mr. Bakalar received his B.S. degree with honors in finance from the University of Illinois Chicago, and his M.B.A. in finance with highest distinction from DePaul University. Ralph Bucher, Senior Vice President and Senior Credit Officer Mr. Bucher joined the ING Investment Management Group in November 21. He serves as a voting member of the Group s Investment Committee and also assists in the approval of senior loan credit limits, problem loan management and loan valuations. Prior to joining ING, he was the North American Head of Special Assets for Standard Chartered Bank and has held other senior credit risk management positions with Standard Chartered and Societé Generale, as well as credit structuring and analysis positions with Commerzbank and National Australia Bank. Mr. Bucher earned a Masters of International Management at The American Graduate School of International Management in 1985 and a B.A. degree from the University of Arizona in He is also fluent in German. Process The ING Senior Loan Group s investment process combines top-down views with bottom-up credit analysis. Although top-down macro strategy is the start to the investment process, the investment team is primarily focused on adding value through fundamental credit and relative-value analysis. Given the asymmetric payoff of owning senior loans, i.e., limited upside with more downside risk, top-down strategy is used to avoid what the investment team calls clustering of defaults, which is a reference to those sectors or industries that typically experience higher defaults during a downturn in the business cycle. By avoiding defaults and investing in attractively valued senior loans with strong company fundamentals, the team attempts to protect portfolios on the downside and position the portfolio to pick up Page 2

37 incremental yield with the possibility of capital appreciation as loans prices converge to the team s assessment of fair value. Macro Strategy/Sector Analysis: The investment team will purposefully avoid those sector/industries they deem to a have a risk of increasing defaults. Although the investment team attempts to determine where the market is within the business and credit cycle, they typically choose to altogether avoid certain industries and sectors that are highly sensitive to changing business conditions and as a result have unpredictable cash flows. This investment philosophy leads the group to seek companies in mature industries with high barriers to entry and stable asset values, where there may be less variability in forecasting a company s cash flow and their ability to service debt. As a consequence, health care, cable television, printing and publishing, and utilities are the majority industries represented in the portfolio. In contrast, they avoid industries with commodity-like products, unproven cash flows, and that are highly sensitive to the business cycle. The investment team has identified the apparel and fashion industries, for example, that exemplify the characteristics they avoid. Deal Screening: The investment team manages senior loan portfolios from the private side of the market, which allows them high level access to deals entering the market. As part of this, they receive material non-public information about borrowers that they can use when evaluating secondary market opportunities. Every Monday morning the investment team meets to discuss proposed transactions. Each industry team member discusses current trends and opportunities, and all existing transactions in the secondary market are analyzed to determine which are being mispriced, if any. Screening deals leads the investment team to then focus on fundamental credit analysis, which they feel is the foundation of their portfolio construction process. Fundamental Credit Analysis/ Company Analysis: Financial statement analysis is the team s key focus in evaluating a company s financial health. Historical operations as well as financial projections provided by the company are considered to determine the amount of free cash flow generation. A sensitivity analysis is applied to a company s free cash flow projection in order to determine the likely change in free cash flow given assumed changes to the economic environment. Again, the team focuses on industries that are highly likely to meet debt obligations under stressful economic scenarios. In addition to scenario analysis, the investment team also analyzes the company s current cost- and capital structure and the impact additional borrowing will have on each. Secondary to the financial analysis, the company s management, competitive position, market share, and its strength and weaknesses of business segments are evaluated to supplement the quantitative analysis. Quantitative credit analysis and qualitative company analysis are combined to find those companies with diversified sources of revenue, experienced management and a sufficient level of assets, all in an attempt to increase the probability of investing in loans with companies that will be able to service debt in various economic scenarios. Although an issue may be attractively priced compared to alternative opportunities, deal structure is an important consideration in this asset class and adds another layer of complexity to be analyzed. Senior loans typically have varying degrees of protection within the capital structure and are issued with covenants to protect investors. Currently, over 98% of the senior loans in the strategy s portfolio are secured by first lien on all of the assets of the borrower and are considered senior in the capital structure. Given the more conservative approach to investing in this asset class, the team typically maintains an intentional underweight to the lowest-rated and second lien issues within the universe despite the higher yield these issues may offer. Properly analyzing the quality of pledged collateral assets and strength of financial covenants to ensure they are investor friendly is another way the investment team believes they add value, in addition to the aforementioned financial statement and relative value analysis. Buy/Sell Analysis: Before investments are considered for inclusion into the portfolio, a thoroughly written credit analysis is presented to the three-person investment committee. The largest, most liquid names in the market typical comprise the bulk of the portfolio. Those issues that are attractively priced and which trade at a discount relative to other opportunities are considered first. As mentioned, all buy/sell investment decisions require approval by the committee. Although there are no restrictions on the minimum credit ratings of loans that may be purchased, the team targets credit quality in the B to BB range and they typically avoid purchasing credit below a rating of B-. The team Page 3

38 maintains a dollar-weighted average time to the next interest rate adjustment on its floating rate investments of 6 days or less. The portfolio weight to floating-rate, non-investment grade senior loans is typically over 95%, although the portfolio guidelines impose a lower threshold of at least 8%. To provide consistent diversification through time, the investment team limits portfolio industry exposure to an average of not more than 3% over 35 industries and limits issuer exposure to an average of not more than ½ to 1% per issuer. An independent pricing service can marketto-market a majority of the portfolio, which is evidence that the team does focus on including highly liquid names in the portfolio. The typical portfolio consists of over 25 positions. Overall, 5% to 6% of the loans in the portfolio are originally purchased in the primary market; this percentage varies based on the fund s monthly cash availability and investment needs, as well as opportunities within primary versus secondary markets. Sell discipline is primarily driven by changes in the team s internally derived and managed credit scores. The investment team believes managing default risk has been paramount to the success of the strategy s performance. Consequently, the team states they take prompt action upon changes in their credit outlook of an issuer. Risk Management Default risk is the greatest risk the investment team attempts to mitigate. Proper diversification and a consistently applied investment process is the primary means by which they attempt to limit defaults and is assisted by their overall philosophy: focus on high quality senior loans with the highest relative value within the asset class. To ensure issues are being assigned proper credit ratings, the investment team continuously monitors and places on watch those issues with deteriorating credit fundamentals in an attempt to stay ahead of potential market downgrades. Focused credit meetings are held regularly to discuss pertinent changes in market- or company conditions that may warrant a change in credit score. To assist the investment team s effort in monitoring portfolio risk they use a proprietary portfolio management system, named RDS System, with key portfolio data accessible to real-time primary and secondary transaction information. As part of monitoring the credit underwriting process, RDS provides detailed transaction information, relevant documentation, portfolio manager s recommendation, and in-depth quantitative and qualitative analysis originated by research analysts. Prior to all primary and secondary trades being placed, the system also tests for portfolio eligibility. No trades can be executed without prior approval by the Investment Compliance Team. Over the last ten years, the average yearly default rate for the strategy has been approximately half of the S&P/LSTA Index default rate, which shows the investment team is able to mitigate some default risk. In the event an issue defaults, the investment team is experienced with the restructuring process, having chosen not to utilize a separate team to handle workouts. Instead, the original research analyst assigned to a loan transaction continues to monitor the company through bankruptcy and workout, with the Senior Credit Officer overseeing the process. The team does employ internal counsel who provides as-needed advice on bankruptcy and workout processes; however, since they are only one investor of many, the process is seldom controlled by the team. Still, when they can take a leadership role to influence the workout process, they attempt to maximize returns for all members represented by the senior lending group. Leverage is used on a case-by-case basis only in separate account vehicles and is not used in the collective trust version of this strategy. The ING Prime Rate Trust and ING Senior Income mutual funds does use leverage for investment purposes. The typical leverage is 25% and has been as high as 45%. Periods of highly volatile loan prices magnify the performance impact to those strategies that use leverage. Risk Factors and Potential Red Flags ING U.S. Investment Management was part of ING Insurance U.S. and an indirect subsidiary of ING Group N.V. ( ING Group ) a global, diversified financial services company. The corporate structure is currently in transition as ING Group spins-off ING U.S., including ING U.S. Investment Management, as a new, standalone publicly traded entity, Voya. THe parent now owns approximately 5% of the company and expects to fully divest its interest by the end of 216 as mandated by the Netherlands government. While these are positive developments toward a more independent investment manager, we prefer firms with a sole business focus on investment management and in which the portfolio managers and employees have majority ownership. We feel that the risk of the strategy or the organization materially changing is lessened when the company is Page 4