State Universities Retirement System of Illinois (SURS) Traditional Overlay Update & Option Selling Programs. September 18, 2014.

Transcription

1 State Universities Retirement System of Illinois (SURS) September 18, 2014 Traditional Overlay Update & Option Selling Programs

2 Disclosure About Parametric Portfolio Associates LLC (Parametric): Parametric, headquartered in Seattle, WA, is a leading global asset management firm, providing investment strategies and implementation services to institutions and individual investors around the world. Parametric offers a variety of rules-based, risk-controlled investment strategies, including alpha-seeking equity, alternative and options strategies, as well as implementation services, including customized equity, traditional overlay and centralized portfolio management. is the institutional business unit of Parametric, comprised of applicable sales and client services personnel across all of Parametric s investment centers. Parametric is a majority-owned subsidiary of Eaton Vance Corp. and currently offers these institutional strategies through investment centers in Seattle, WA, Minneapolis, MN and Westport, CT (home to Parametric subsidiary Parametric Risk Advisors LLC, an SEC-registered investment adviser). Parametric s Minneapolis Investment Center will be referred to as Parametric Minneapolis herein. Parametric is divided into two segments: Parametric Investment & Overlay Strategies and Parametric Custom Tax-Managed & Centralized Portfolio Management. For compliance with the Global Investment Performance Standards (GIPS ), the Firm is defined and held out to the public as Parametric Investment & Overlay Strategies. Parametric Investment & Overlay Strategies provides rules-based investment management services to institutional investors, individual clients and registered investment vehicles, including Engineered Alpha Strategies, Specialty Index, and Policy Implementation Overlay Service (PIOS). The Firm has complied with the GIPS standards retroactive to January 1, Information provided in this presentation is the view of Parametric and is subject to change based on market and other conditions. The use of derivative instruments may differ from client to client, based on different investment philosophies and restrictions. The use of derivative instruments may be precluded by investment policies and restrictions. The information provided is general information, even as it pertains to you and does not take into account any investor s particular investment objectives, strategies, tax status, or investment horizon. Derivatives such as futures, swaps, and other investment strategies have certain disadvantages and risks. Futures require the posting of initial and variation margin. Therefore, a portion of risk capital must be preserved for this purpose rather than being allocated to a manager. Liquid futures may not exist for published benchmarks which may result in tracking error. Also, some intra-period mispricing may occur. Swaps require periodic payments, may be less liquid than futures, and may have counterparty/credit risk. Some investment strategies require a cash investment equal to the desired amount of exposure. The use of certain derivatives may increase a portfolio s overall risk exposure and thus negatively impact performance. Clients should use caution whenever considering derivatives and fully understand the investments prior to addition this asset class to a portfolio. Additional documentation and certification may be required in order to invest in these securities. We encourage you to consult with your legal and tax advisors regarding derivative instruments and their possible legal and tax issues. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on this information. Past performance is no guarantee of future results. 2 SURS: Traditional Overlay Update & Option Selling Programs

3 Table of Contents and Parametric Contacts Parametric Contacts: Jack Hansen, CFA Chief Investment Officer Minneapolis Investment Center P: F: Greg Baranivsky, CFA Director, Institutional Relationships P: F: Traditional Overlay Update 4 Index Options 23 Appendices 40 3 SURS: Traditional Overlay Update & Option Selling Programs

4 Traditional Overlay PIOS Update (Policy Implementation Overlay Service) 4

5 Traditional Overlay Onboarding Update Notified of mandate on March 21, 2014 Onboarding kick-off call held on March 27, 2014 Ongoing dialogue with SURS staff and Parametric IMA remains in legal review From investment management perspective, SURS is ready for trading pending the completion of legal documents: Overlay Strategy Procedures drafted Custodial bank link to Northern Trust established Parametric is running a comprehensive daily tracking report posted each day for SURS staff viewing Futures account documentation is with FCM (sent June 9, 2014). Account will be active approximately 10 days after FCM receives signed IMA. 5 SURS: Traditional Overlay Update & Option Selling Programs

6 Fund Sponsor Policy Implementation Challenges Fund Sponsors face many policy performance headwinds including: Potential Overlay Solution? Staying fully invested consistent with policy Efficient management of exposure on all cash flows Comprehensive and updated portfolio exposure on a daily basis Ability to carry more on demand liquidity Efficient rebalancing when policy rebalancing bands are breached Maintaining asset class exposure during a transition 6 SURS: Traditional Overlay Update & Option Selling Programs

7 Performance Enhancement and Risk Control POLICY SHORTFALL OVERLAY VALUE ADDED O V E R SURS Target Policy Mix L A Y SURS Target Policy Mix SURS has selected each of the overlay components above 7 SURS: Traditional Overlay Update & Option Selling Programs

8 Securitize Liquidity Needs CHALLENGE POTENTIAL SOLUTION EXPECTED BENEFITS Holding cash to facilitate liquidity needs results in tracking error relative to the investment policy and creates long-term expected performance drag Efficiently eliminate unwanted cash exposure through the use of an overlay program Increase expected return Increase day-to-day liquidity Reduced transaction costs Simplify the management of inflows and outflows resulting in time savings for staff 8 SURS: Traditional Overlay Update & Option Selling Programs

9 Securitize Residual Manager Cash CHALLENGE POTENTIAL SOLUTION EXPECTED BENEFITS Residual or transactional manager cash exposure (e.g. 1-3% of portfolio) creates an expected long-term performance drag In non disruptive manner, efficiently eliminate unwanted manager cash exposure through the use of an overlay program Increase expected return Maintain exposure across multiple asset classes Ability to customize cash overlay for each manager 9 SURS: Traditional Overlay Update & Option Selling Programs

10 PIOS Neutralizing Policy Performance Shortfalls 2% Residual Cash Impact Over Last Decade 1.00% Cash is your Friend SURS Policy Mix: Domestic Equity (Dow Jones U.S. Total Stock Market Index) 41.56% Non-U.S. Equity (MSCI ACWI Ex-U.S.) 23.33% Fixed Income (Barclays Capital Aggregate) Total 8.89% 26.22% 100% Impact on Fund Performance Global Equity (MSCI ACWI) 0.50% 0.00% 10 Year Average (0.17)% -0.50% Policy Performance Slippage -1.00% Source: Parametric Minneapolis Date created: August 18, 2014 Holding 2% residual cash, at first view, does not sound significant. However, when your policy goals target 0% cash exposure, you may experience performance slippage. Over the last 10 years, that slippage was estimated to be 0.17% on the total portfolio, on average Note: The analysis utilizes index total returns. Realized results would reflect transaction costs, management fees and contract financing costs. For illustrative purposes only. Individuals may not invest directly in indexes. Investments are subject to loss. Please refer to disclosures on the last page. 10 SURS: Traditional Overlay Update & Option Selling Programs

11 Rebalancing DISCIPLINED APPROACH Description Fund exposures are rebalanced when pre-determined thresholds are exceeded (+/- 7.0% proportional rebalancing bands) Example, if target weight is 10%, 7% proportional band = +/- 0.70% Parametric Minneapolis Role Portfolio exposures are monitored daily If a rebalancing band for any asset class is exceeded, Parametric Minneapolis will contact SURS and discuss rebalance position for SURS consideration No rebalancing transactions will be implemented absent SURS giving written permission to Parametric Minneapolis Offsetting long/short futures positions will be employed to bring all marketable asset classes back to adjusted targets 11 SURS: Traditional Overlay Update & Option Selling Programs

12 Overlay Transition Exposure Management* CHALLENGE POTENTIAL SOLUTION EXPECTED BENEFITS Manager changes, manager reallocations, liquidation of illiquid holdings (e.g. hedge funds), change to target allocations, etc. which cause the fund to meaningfully deviate from target exposures Reduce or eliminate exposure gaps using index overlays or ETF s Mitigation of exposure gaps which reduces performance risk The manager termination point can be accelerated or new manager search period can be extended as long as needed without losing targeted market exposure * works closely with transition service providers but does not transition physical portfolio holdings 12 SURS: Traditional Overlay Update & Option Selling Programs

13 Overlay Transition Exposure Management Example SURS approves a new 2% allocation to commodities in June SURS desire to move to new commodities allocation prior to the hiring and funding of new manager(s) Parametric Minneapolis gains new commodities exposure via a futures overlay by seeking to trade a standard index for example, the Bloomberg Commodity Index (see next page for details). New allocation can be achieved at one point in time or over multiple time periods based on staff/committee preferences As SURS funds new commodity manager(s), Parametric unwinds its futures positions Parametric Minneapolis coordinates all purchases and sales with SURS staff and investment managers with the goal of achieving target commodities exposure 13 SURS: Traditional Overlay Update & Option Selling Programs

14 Overlay Transition Exposure Management Example (continued) Bloomberg Commodity Index Softs 7.72% Precious Metals 15.89% Energy 31.48% Industiral Metals 16.58% Livestock 5.28% Grains 23.05% *Weights are as of 1/14/2014 to reflect most recent index rebalance. Source: Dow Jones and Bloomberg Date created: 1/29/ SURS: Traditional Overlay Update & Option Selling Programs

15 Process Daily Tracking Report Provides Key Information SURS receives a daily tracking report containing: Fund cash levels Manager values Asset class exposures and imbalance Margin summary Custom portfolio metrics All information updated through previous night s close 15 SURS: Traditional Overlay Update & Option Selling Programs

16 PIOS (Policy Implementation Overlay Service) SURS Account Number: Base Currency: USD Position Summary Margin Summary Close Of: 8/29/2014 Portfolio Value Daily Change 17,225,279, % Overlay Index Exposure Total Long Index Exposure 0 Total Short index Exposure 0 Net Index Exposure 0 Gross Index Exposure 0 Value % of Overlay Account Value 0.00 % Required Initial Margin 0.00 % Variation Margin Available 0.00 % Gain/Loss Summary Daily Gain/Loss Month to Date Gain/Loss Year to Date Gain/Loss Inception to Date Gain/Loss Total Fund Exposure Summary Actual Target Adjusted Target Physical Exposure Physical Deviation From Adjusted Target Overlay Exposure Total Exposure Total Exposure Deviation From Adjusted Target Rebalance Trigger Domestic Equity 5,512,089,534 5,541,684,389 5,739,009, ,325, ,739,009, ,325, ,896,076 Non-US Equity 3,617,308,757 3,638,769,217 3,631,637,727-7,131, ,631,637,727-7,131, ,658,536 Global Equity 1,378,022,384 1,386,197,797 1,403,861,739 17,663, ,403,861,739 17,663,942 97,064,452 Fixed Income 3,445,055,959 3,480,456,951 3,100,538, ,918, ,100,538, ,918, ,686,033 Private Equity 1,033,516,788 1,036,623,587 1,036,623, ,036,623,587 0 TIPS 689,011, ,048, ,048, ,048,734 0 Real Estate 689,011, ,471, ,471, ,471,784 0 Public Real Assets - REITs 689,011, ,034, ,034, ,034,665 0 Opportunity Fund 172,252,798 68,992,671 68,992, ,992,671 0 Cash ,061, ,061, ,061, ,061,069 17,225,279,794 17,225,279,794 17,225,279, ,225,279,794 0 Account Number: Page 16

17 PIOS (Policy Implementation Overlay Service) SURS Account Number: Base Currency: USD Asset Summary Close Of: 8/29/2014 Security Total Cash Total Market Value Domestic Equity - DJTSM US TR MTD % Change 0.39 % 4.19 % Cash % CastleArk Management 102,800,642 2,712, ,513, % 3.99 % 2.57 % Channing Capital Management 114,224,772 2,740, ,965, % 3.93 % 2.34 % EARNEST Partners 100,553,655 2,701, ,255, % 4.40 % 2.62 % Fiduciary Management Associates 98,163,325 2,723, ,887, % 5.02 % 2.70 % Holland Capital Management 95,662,386 4,301,643 99,964, % 4.68 % 4.30 % Jacobs Levy Equity Management 383,789,323 1,361, ,150, % 4.45 % 0.35 % Lombardia Capital Partners 100,273,417 4,528, ,802, % 3.36 % 4.32 % Northern Trust Asset Management 2,015,217, ,015,217, % 4.14 % 0.00 % Piedmont Investment Advisors 384,109,766 2,800, ,910, % 4.29 % 0.72 % PIMCO StocksPlus 379,105, ,105, % 3.10 % 0.00 % Progress Investment Domestic 379,369, ,369, % 4.51 % 0.00 % RhumbLine Advisers 1,207,483, ,826 1,208,124, % 4.09 % 0.05 % T. Rowe Price 378,256,158 2,639, ,895, % 3.87 % 0.69 % Total 5,739,009,740 27,150,559 5,766,160, % 4.11 % 0.47 % 0.13 % 0.55 % Ativo Capital Management 106,654,445 1,981, ,636, % 1.55 % 1.82 % BTC Alpha Tilts 459,677, ,677, % % 0.00 % BTC Emerging Markets 191,596, ,596, % 2.12 % 0.00 % BTC International 1,551,692, ,551,692, % % 0.00 % GlobeFlex Capital 218,772,158 4,896, ,668, % 0.17 % 2.19 % Herndon Capital Management 160,952,201 4,575, ,527, % % 2.76 % Martin Currie 190,177,682 5,596, ,773, % 0.17 % 2.86 % Progress Investment Int'l 152,111, ,111, % % 0.00 % Pyramis Global Advisors 500,771,737 9,639, ,410, % 0.18 % 1.89 % Strategic Global Advisors 99,231, ,432 99,929, % 1.33 % 0.70 % Total 3,631,637,727 27,387,819 3,659,025, % % 0.75 % 0.24 % 2.21 % Calamos Investments 316,619,020 19,096, ,715, % 2.07 % 5.69 % Mondrian Investment Partners 376,671,300 5,687, ,358, % 1.35 % 1.49 % T. Rowe Price Global Focused Growth 356,679,418 4,977, ,657, % 3.50 % 1.38 % Wellington Management 353,892,002 3,147, ,039, % % 0.88 % Total 1,403,861,739 32,909,352 1,436,771, % % 2.29 % 0.00 % 1.10 % Chicago Equity Partners 315,893, ,893, % 1.14 % 0.00 % Garcia Hamilton & Associates 98,514, ,514, % 1.28 % 0.00 % LM Capital Group 150,330, ,330, % 1.16 % 0.00 % Neuberger Berman 317,181, ,181, % 0.80 % 0.00 % PIMCO Total Return 436,262, ,262, % 0.81 % 0.00 % PIMCO Unconstrained 435,774, ,774, % % 0.00 % Progress Investment FI 94,389, ,389, % 1.13 % 0.00 % Pugh Capital Management 151,439, ,439, % 1.07 % 0.00 % Smith Graham & Company 97,035, ,035, % 1.11 % 0.00 % State Street Global Advisors 398,889, ,889, % 0.19 % 0.00 % Taplin, Canida & Habacht 129,839, ,839, % 1.37 % Non-US Equity - MSCI ACWI ex. US Total Return Index Global Equity - MSCI ACWI Total Return Index Fixed Income - Barclays Capital Aggregate Account Number: One Day % Change 0.00 % Page 17

18 PIOS (Policy Implementation Overlay Service) SURS Account Number: Base Currency: USD Private Equity TIPS Real Estate Public Real Assets - REITs Opportunity Fund Cash Close Of: 8/29/2014 TCW MetWest 474,989, ,989, % 0.94 % 0.00 % Total 3,100,538, ,100,538, % 0.75 % 0.00 % Adams Street Partners 493,445, ,445, % % 0.00 % Fairview Capital 1,672, ,672, % % 0.00 % M2 MPEFF 16,215, ,215, % 0.00 % 0.00 % Muller and Monroe 11,542, ,542, % % 0.00 % Pantheon Ventures, Inc. 512,805, ,805, % % 0.00 % Private Opportunities 546, , % 0.00 % 0.00 % Progress Venture Capital 394, , % % 0.00 % Total 1,036,623, ,036,623, % % 0.00 % Longfellow Investment Management 168,376, ,376, % 0.33 % 0.00 % New Century Advisors 166,395, ,395, % 0.39 % 0.00 % PIMCO US TIPS 339,276, ,276, % 0.35 % 0.00 % Total 674,048, ,048, % 0.35 % 0.00 % Core RE Fund - Heitman 82,559, ,559, % 0.00 % 0.00 % Dune Real Estate Fund III 46,607, ,607, % 0.00 % 0.00 % Dune Real Estate Parallel Fund II 28,169, ,169, % 0.00 % 0.00 % Franklin Templeton EMREFF 46,876, ,876, % 2.79 % 0.00 % Franklin Templeton FTPREF 20,969, ,969, % 1.89 % 0.00 % JP Morgan Strategic Property 152,515, ,515, % 0.50 % 0.00 % Mesirow MFIRE II 34,686, ,686, % 0.00 % 0.00 % RREEF America III Fund 10,791, ,791, % % 0.00 % UBS Trumbull Property Fund 290,298, ,298, % 0.00 % 0.00 % Total 713,471, ,471, % 0.10 % 0.00 % BTC Global REIT Fund 317,095, ,095, % 1.38 % 0.00 % BTC REIT Fund 120,423, ,423, % 2.82 % 0.00 % CBRE Clarion Global REIT 105,163, ,163, % 1.53 % 0.00 % CBRE Clarion Real Estate Securities 142,351, ,351, % 2.94 % 0.00 % Total 685,034, ,034, % 1.98 % 0.00 % Alinda Capital Partners 38,898, ,898, % 0.00 % 0.00 % Macquarie Capital 30,094, ,094, % % 0.00 % Total 68,992, ,992, % % 0.00 % Cash Flow 0 84,613,339 84,613, % % % % 0.00 % 0.00 % Total 0 84,613,339 84,613, % % % Security Total Cash Total Market Value One Day % Change MTD % Change Cash % Fund Total 17,053,218, ,061,069 17,225,279, % 0.19 % 1.00 % Account Number: Page 18

19 PIOS (Policy Implementation Overlay Service) SURS Account Number: Base Currency: USD Exposure Summary Actual Target Adjusted Target Physical Exposure Physical Deviation From Adjusted Target Overlay Exposure Total Exposure Total Exposure Deviation From Adjusted Target Rebalance Trigger Domestic Equity 5,512,089,534 5,541,684,389 5,739,009, ,325, ,739,009, ,325, ,896,076 Non-US Equity 3,617,308,757 3,638,769,217 3,631,637,727-7,131, ,631,637,727-7,131, ,658,536 Global Equity 1,378,022,384 1,386,197,797 1,403,861,739 17,663, ,403,861,739 17,663,942 97,064,452 Fixed Income 3,445,055,959 3,480,456,951 3,100,538, ,918, ,100,538, ,918, ,686,033 Private Equity 1,033,516,788 1,036,623,587 1,036,623, ,036,623,587 0 TIPS 689,011, ,048, ,048, ,048,734 0 Real Estate 689,011, ,471, ,471, ,471,784 0 Public Real Assets - REITs 689,011, ,034, ,034, ,034,665 0 Opportunity Fund 172,252,798 68,992,671 68,992, ,992,671 0 Cash ,061, ,061, ,061, ,061,069 17,225,279,794 17,225,279,794 17,225,279, ,225,279,794 0 Actual Target Adjusted Target Physical Exposure Physical Deviation From Adjusted Target Overlay Exposure Total Exposure Total Exposure Deviation From Adjusted Target Rebalance Trigger Domestic Equity % % % 1.15 % 0.00 % % 1.15 % 2.25 % Non-US Equity % % % % 0.00 % % % % Global Equity 8.00 % 8.05 % 8.15 % 0.10 % 0.00 % 8.15 % 0.10 % 0.56 % Fixed Income % % % % 0.00 % % % % Private Equity 6.00 % 6.02 % 6.02 % 0.00 % 0.00 % 6.02 % 0.00 % 0.00 % TIPS 4.00 % 3.91 % 3.91 % 0.00 % 0.00 % 3.91 % 0.00 % 0.00 % Real Estate 4.00 % 4.14 % 4.14 % 0.00 % 0.00 % 4.14 % 0.00 % 0.00 % Public Real Assets - REITs 4.00 % 3.98 % 3.98 % 0.00 % 0.00 % 3.98 % 0.00 % 0.00 % Opportunity Fund 1.00 % 0.40 % 0.40 % 0.00 % 0.00 % 0.40 % 0.00 % 0.00 % Cash 0.00 % 0.00 % 1.00 % 1.00 % 0.00 % 1.00 % 1.00 % 0.00 % % % % 0.00 % 0.00 % % 0.00 % Close Of: 8/29/2014 Account Number: Page 19

20 Risk Controls Parametric SURS NEPC Overlay Strategy Procedures (Guidelines) Portfolio Management Team Approach Electronic Trade Confirmation Portfolio Monitoring Investment Personnel Proprietary Data Accessed through Web Safeguards Daily Mark-to-Market Segregated Margin Account Risk controls seek to minimize the risks, but risks are not eliminated by such controls and are often outside of the influence or control of Parametric. See Risks section. 20 SURS: Traditional Overlay Update & Option Selling Programs

21 Overlay Services: What are the Risks? Risk Description How Parametric Mitigates Market Market performs in a way that was not anticipated. For example, cash outperforms capital markets. Systematic market risk is an inherent part of the PIOS program and can neither be diversified away nor mitigated. Client specific policy guidelines are established to clearly define desired market risk based on client asset allocation targets. Communication/ Information Overlay index exposures are maintained based on underlying investment values provided by one or more third parties. There are often delays in the receipt of updated information which can lead to exposure imbalance risks. Inadequate communication regarding cash flow moves into and out of fund and manager changes can lead to unwanted asset class exposures and loss. Parametric establishes communication links with custodial, manager, and other sources to obtain and verify positions and cash flow data as soon as it is available. Suspect data may be researched and staff notified. Leverage Creation of market exposure in excess of underlying collateral value may lead to significant capital losses and result in position liquidation. Parametric obtains daily collateral pool values and adjusts beta overlay positions to maintain the ratio of total exposure to collateral within a predefined client determined band. Potential that the market moves in a manner adverse to the overlay position causing a mark-to-market loss of capital to the fund and a resulting need to raise liquidity or to close positions; this situation could happen at a time when underlying fund or positions are also declining in value. Parametric strives to be aware of potential collateral and cash requirements to reduce the risk of needing to remove positions. Additional margin requirements are communicated via electronic mail and margin adequacy is available to the client daily. Futures (synthetic) index returns do not perfectly track benchmark index returns. This divergence between the price behavior of a position or portfolio and the price behavior of a benchmark is tracking error and impacts performance. Parametric seeks to minimize tracking error by utilizing liquid futures contracts with sufficient daily trading volume and open interest. All derivative contracts will have some tracking error that cannot be mitigated by an overlay manager. The implied financing levels change over time which may make certain synthetic long or short positions costly to maintain. Parametric carefully monitors implied financing costs on an ongoing basis. Significant changes in estimated costs are factored into the contracts utilized or suggested for use within client overlay programs. Counterparty credit risk on OTC trading. Parametric can facilitate the negotiation of ISDA documentation that seeks to reduce the potential credit risk associated with OTC counterparties. monitors credit ratings and credit default swap spreads for all counterparties used and will inform staff of developments which may negatively impact credit risk. The program may experience losses on the underlying designated assets in addition to potential losses on the index market exposure overlaying these assets. This risk cannot be mitigated by an overlay manager. Parametric discusses the potential for negative performance in the collateral used for the overlay prior to alpha transport applications with client. Margin/Liquidity Tracking Error Implied Financing Counterparty Collateral 21 SURS: Traditional Overlay Update & Option Selling Programs

22 Expected Benefits Information Daily report that provides an up to date snapshot of holdings by asset class and manager security and cash positions Liquidity Access to more cash on-demand for fund needs and investment opportunities Efficiency Ability to put cash inflows to work immediately and eliminate transition exposure gaps Flexibility Ability to efficiently rebalance or tactically overweight/underweight specific asset classes Service Access to derivative implementation information and personnel to discuss management applications 22 SURS: Traditional Overlay Update & Option Selling Programs

23 Index Options A Tool to Enhance Returns, Dampen Risk, or Gain Alternative Beta Exposure 23

24 The Basics Options Options are derivative contracts used by investors to create asymmetric return profiles. In essence, option contracts may be viewed as insurance contracts where investors can buy (hedge) or sell (underwrite) financial insurance. 24 SURS: Traditional Overlay Update & Option Selling Programs

25 Options as Financial Insurance Instruments Option Buyers Option Sellers Buyer pays premium Seller collects premium Limited risk / large potential gain Limited return / large potential loss Similar to buying homeowner s insurance Similar to selling homeowner s insurance Risk/return profile appears to favor buyers yet insurance industry is very profitable 25 SURS: Traditional Overlay Update & Option Selling Programs

26 The Allure of the Lottery Style Payoff Put (Insurance) Buyer Profits Insurance Buying vs. Insurance Selling Maximum Profit for Seller 0 Maximum Loss for Buyer Insurance buying is appealing but not free Insurance sellers demand compensation for underwriting risk Losses Put (Insurance) Seller Sell-off Burned Down Index Price Your Home? Rally Didn t Burn So why would insurance sellers accept risk/return profile that looks unattractive? For illustrative purposes only. All investments subject to loss. 26 SURS: Traditional Overlay Update & Option Selling Programs

27 Why Would Option Sellers Accept This Payoff Profile? because of the Insurance Risk Premium (IRP) Put (Insurance) Buyer Profits Implied-Realized Gap Represents IRP Maximum Profit for Seller 0 Maximum Loss for Buyer IRP Received IRP Paid Options buyers less price sensitive and demand is often inelastic Option sellers very price sensitive Losses Put (Insurance) Seller Sell-off Burned Down Index Price Your Home? Rally Didn t Burn We believe index options contain an embedded risk premium that compensates sellers for underwriting financial risk For illustrative purposes only. All investments subject to loss. 27 SURS: Traditional Overlay Update & Option Selling Programs

28 Option Selling Programs Investment Thesis Investment Thesis S&P 500 Index options have historically traded above theoretical fair value, and we expect this to continue Options may be thought of as financial insurance contracts insurance is not free Option prices contain an Insurance Risk Premium (IRP) paid by option buyers to option sellers The IRP is meaningful (averaging about 4% annually) and likely to persist A defensively structured portfolio can capture the IRP by selling fully-covered options without introducing leverage 28 SURS: Traditional Overlay Update & Option Selling Programs

29 Empirical Data Supports Our Investment Thesis S&P 500 index options have traded above theoretical fair value over 85% of the time since 1990 Implied Minus Realized Volatility % 60.0% Positive Insurance Risk Premium1 40.0% 20.0% Portfolio Opportunity Rich historic1 option valuation has translated to average IRP of about 380 bp/yr since % -20.0% Negative Insurance Risk Premium1-40.0% 1/1/90 6/30/ % Embedded risk premium creates opportunity to enhance return through option selling 1 S&P 500 Index options relative valuation measured by taking daily observations of Implied Volatility (as measured by VIX Index) and subtracting the subsequent Realized Volatility of the S&P 500 over the following 30 days. If options were priced at their fair theoretical value, the volatility embedded in options prices (expected or implied volatility) should, on average, be very close to the subsequent realized volatility of the S&P 500. However, options have historically traded about 4.4 volatility points above subsequent realized volatility. Said another way, the option market tends to overestimate future volatility, which means that options prices tend to trade expensive. VIX is the Chicago Board Options Exchange volatility index. VIX is calculated constantly throughout each trading day by observing the implied volatility derived from actual market prices of a wide array of put and call options with an average maturity of 30 days to expiration. 2 IRP opportunity based on observed difference between Defensive Equity Simulation gross returns and return of the base 50% S&P 500/50% T-Bill portfolio. Simulated presentations are for illustrative purposes only, do not represent actual returns of any investor, and may not be considered for investing purposes. It is not possible to invest directly in an index. Investments are subject to loss. Past performance is not indicative of future results. Material provided is supplemental to the GIPS compliant presentation. Please refer to the GIPS compliant presentation and other disclosures at the end of this presentation. Source: Parametric Minneapolis, Bloomberg Date created: July 11, SURS: Traditional Overlay Update & Option Selling Programs

30 Possible Factors Driving Option Pricing Short-Term Factors Current headlines Potential headlines Regulatory changes Demographics crisis memory 30 SURS: Traditional Overlay Update & Option Selling Programs

31 Explanations for Long-Term Observed Option Pricing Long-Term Factors Insurance underwriters should expect to earn an economic profit as contingent owners of equity downside risk Utility function of investors loss avoidance preference Barriers to option supply collateral requirements, regulations and committees Demand for limited risk capital efficient strategies speculators Health, Home and Life Why not investor use of insurance covering financial risk? 31 SURS: Traditional Overlay Update & Option Selling Programs

32 Capturing the IRP in an Institutional Portfolio Insurance Risk Premium Harvesting Strategy Call Selling Put Selling Strangle Selling (sell put and call) Investor Objective Portfolio Fit Sold against long equity exposure. Contingently removes Incremental return and lower risk portion of underlying equity exposure. Tethered to cash, treasury, absolute return or other "lower Incremental return risk, collateral. Contingently adds equity risk to underlying cash. Create defensive equity holding, Incremental return and favorable liquid alternative, or risk adjusted performance monetize rebalancing preferences. For illustrative purposes only. Investor objectives may not be achieved with options strategies. Uncovered options carry greater risks. Please see options risk on page SURS: Traditional Overlay Update & Option Selling Programs

33 Dynamic Strike Price Selection The strike price selection alternatives Fixed Strikes Most approaches, including CBOE indexes (BXM, BXY, PUT), sell the same strike prices in all market environments No recognition given to changing magnitude of likely market moves Frequency of option exercises will vary widely Premium income likely to be more variable Dynamic Strikes Approach targets fixed probability of options expiring worthless Observed implied volatility drives determination of strike price Strike prices move further out-of-the-money in higher volatility environments Seeks to provide more upside potential and larger downside buffer in more volatile markets A dynamic, volatility-based strike methodology may produce* more consistent and more attractive long-term risk/return characteristics * Hill, Joanne M., Venkatesh Balasubramanian, Krag (Buzz) Gregory, and Ingrid Tierens. "Finding Alpha via Covered Index Writing." Financial Analysts Journal 62.5 (2006): Print. 33 SURS: Traditional Overlay Update & Option Selling Programs

34 We View Index Option-Based IRP as a Distinct Risk Premium Insurance Risk Premium - Covered Strangle (Option Only) Annual Profit1 20% 15% 10% 5% 0% -5% -10% Avg. Excess Return Standard Deviation Maximum Minimum Correlation to IRP % % Insurance Risk Premium S&P 500 MSCI EAFE GSCI Barclays Long Barclays High Treasury Barclays Credit Yield 3.8% 7.8% 3.5% 3.8% 5.3% 4.0% 6.9% 2.6% 17.9% 20.9% 24.6% 11.1% 6.5% 17.8% 10.9% 31.7% 37.6% 43.7% 29.9% 16.4% 58.1% -0.3% -38.8% -45.2% -48.3% -13.5% -8.1% -27.9% Covered strangle simulation for options only, no returns included for underlying collateral. Simulated presentations are for illustrative purposes only, do not represent actual returns of any investor, and may not be considered for investing purposes. Please refer to the Disclosure in the Appendices for further information. Investments are subject to loss. Past performance is not indicative of future returns. Individuals are not able to invest directly in indexes. Source: Parametric, Bloomberg Date created: January 14, SURS: Traditional Overlay Update & Option Selling Programs

35 Defensive Equity Unfunded: Actual Performance* (6/30/14) 1.00% 0.80% Defensive Equity Unfunded (Net) 0.77% 0.72% 0.56% 0.60% 0.51% 0.36% 0.40% 0.26% 0.20% 0.21% 0.21% 0.15% 0.07% 0.05% 0.00% 0.27% 0.20% 0.13% 0.04% 0.31% 0.31% 0.30% 0.28% 0.21% 0.16% -0.01% -0.07% -0.20% 0.24% -0.06% -0.10% -0.20% -0.40% -0.23% -0.17% -0.42% -0.60% -0.67% -0.80% Returns DE Unfunded Composite Assets: Approximately $495.9 million Total DE Strategy Assets: Approximately $2.07 billion Defensive Equity Unfunded (Net) 2Q 2014 Year-to-Date 1 Year Since Inception (Sept. 2011) 0.46% 1.36% 1.42% 2.56% Note: Returns stated above are net of actual management fees. The inception date for Parametric's Defensive Equity Unfunded strategy was September * Results shown are based on options gain-loss. No return is assumed for the underlying Treasury Bill collateral pool. Material provided is supplemental to GIPS compliance composites. Please refer to the last page for the GIPS Performance Presentation and Disclosure Statement. The use of Parametric s Defensive Equity Unfunded strategy program involves certain risks. See Risks on page 52. Source: Parametric Date created: July 25, SURS: Traditional Overlay Update & Option Selling Programs

36 Fully Funded versus an Unfunded Mandate An option selling program can be implemented in fully-funded1 or unfunded mandates. Fully Funded Unfunded IMA and guidelines executed IMA and guidelines executed Index options brokerage account established Client establishes account at custodian Cash deposited in custodial account Futures options brokerage account established Equity exposure and Treasury Bills purchased Funded with 5-10% of targeted option notional Index options sold Client identifies collateral anchoring each option position Custodian provides evidence of collateral to OCC Client assets remain in custodial account 1Fully Index options sold Parametric Minneapolis directs margin/collateral flows between custodian and broker funded investments can also be made via a commingled vehicle. Contact Parametric for more information. 36 SURS: Traditional Overlay Update & Option Selling Programs

37 Key Option Program Risks Risks Black Swan The extreme market move not yet observed Path Risk Interim moves can adversely impact long term results Structural change in the pricing of financial insurance Committee Risk Early program termination 37 SURS: Traditional Overlay Update & Option Selling Programs

38 Where does it fit? Where does An option selling program fit in Institutional Portfolios? Unfunded Mandate Source of expected incremental return on existing collateral Public Market Equity Allocation (fully funded mandate) Complement to higher risk strategies Alternative to a traditional hedged equity or balanced portfolio Marketable Alternatives Allocation (fully funded mandate) Additional component within an alternative assets allocation highly liquid and complete transparency of holdings Expected Benefits Enhanced performance and attractive risk-adjusted returns Access to a distinct, persistent and diversifying risk premium Please refer to the general disclosures in the Appendices. 38 SURS: Traditional Overlay Update & Option Selling Programs

39 Summary Investors in search of ways to dampen risk, enhance returns and capture truly different beta exposures may be well served to look at options through a different lens. Recognize that options usually contain an embedded insurance risk premium The IRP is meaningful and persistent arguably a distinct market-based risk premium Investors with long-term horizons are well positioned to sell (underwrite) financial insurance Straightforward portfolios can be constructed to capture this risk premium without introducing leverage The IRP may provide diversification benefits and a source of incremental return on existing portfolios when implemented as an overlay 39 SURS: Traditional Overlay Update & Option Selling Programs

40 Appendices 40

41 Definitions Call Option Provides the owner of the option the right but not the obligation to purchase an asset at a specific price on, or in some cases before, a certain date. Cash Securitization Using exchange traded futures contracts to maintain index (passive) exposure while having the benefits of on-demand cash at Northern Trust. Duration Duration is a measure of the sensitivity of a bond's price to interest rate movements. It is approximately proportional to the percentage change in price for a given change in yield. For example, a bond with a duration of 7 would fall approximately 7% in value if interest rates increase by 1%. Expiration Date The day on which the option value is determined or underlying exchanged. 41 SURS: Traditional Overlay Update & Option Selling Programs

42 Definitions Futures Contract on an Index An agreement to buy or sell an underlying index on a specified date (end of each quarter), with daily changes in the index reflected as margin flows. Hedging Action taken to protect the value of a portfolio against change in market prices. Usually used to reduce or eliminate risk, although similar techniques can also be used to speculate in a market. Margin/Liquidity Potential that the market moves in a manner adverse to the futures position causing a mark-to-market loss of capital and a resulting need to raise liquidity or to close positions. Overlay Service A comprehensive program that uses information technology and exchanged traded futures contracts to enhance expected return and reduce performance risk. Over-The-Counter (OTC) Any market that does not operate through a recognized exchange (for example: foreign exchange market or any non standard option contracts). Performance Risk Risk associated with not earning clients target policy return due to administrative management and exchange traded futures relative performance. Premium An option s price. 42 SURS: Traditional Overlay Update & Option Selling Programs

43 Definitions Put Option Re-Entry Risk Premium Strike Price Synthetic Rebalancing Target Policy Return Tracking Error Provides the owner of the option the right but not the obligation to sell an asset at a specific price on, or in some cases before, a certain date. Short Put Position. Difference between the risk free return and the total return from a risky investment (target policy return). The specified purchase or sale price for the underlying asset. Using exchange traded futures contracts to get back to target allocations without incurring costs associated with moving physical assets. Return of a passive (indexed) portfolio based on your target asset allocation. The divergence between the price behavior of a position or portfolio and the price behavior of a benchmark. 43 SURS: Traditional Overlay Update & Option Selling Programs

44 Option Basics Options can be employed as a single position, or in various combinations, to help achieve the investor s overall risk objectives. Typical applications for call and put options are highlighted in the table below. Option Type Position Objective Premium Put Buyer Protect against downside loss Pays Seller Gain exposure at target level Receives Buyer Desires upside potential Pays Seller Forego upside above some level Receives Call Many investors desire downside loss protection initiated with the purchase of a put option, which provides a floor beneath which the investment gain on the put option offsets some portion of the decline in the underlying asset (a stock/etf or equity index). The investor can reduce the out-of-pocket cost (premium) required to purchase a put option by selling one or more other options (receiving premium). Adding combinations of option positions allows the investor to create customized hedge structures based on their specific needs and market views. 44 SURS: Traditional Overlay Update & Option Selling Programs

45 Synthetic Indices The most often used index benchmarks are as follows: Domestic Equity* Dow Jones US Total Stock Market Index International Equity S&P 500 Index S&P 400 Mid Cap Index MSCI USA IMI Index MSCI USA Small Cap Index Russell 1000 Index Russell 2000 Index Russell 3000 Index Wilshire 5000 Index Fixed Income Barclays Capital Aggregate Index Barclays Capital Gov t/credit Index Global Equity MSCI ACWI MSCI ACWI IMI MSCI World Commodities Goldman Sachs Commodity Index Bloomberg Commodity Index Custom Commodity Baskets Barclays Capital Intermediate Gov t/credit Index Barclays Capital Long Gov t/credit Index Barclays Capital Long Treasury Index Barclays Capital Universal Index Citigroup BIG Index Merrill 1-3 Index Various Constant Duration Benchmarks MSCI EAFE Index MSCI ACWI ex. US MSCI ACWI ex. US IMI MSCI Emerging Markets Index MSCI World ex. US Citigroup Broad Market Index Citigroup PMI EPAC International Fixed Income Currency Citigroup WGBI (ex. US) Barclays Capital Global Aggregate Index (ex. US) Indexes Individual Currency Exposure *In the case of style asset exposure needs (i.e. small cap growth), Parametric can manage ETF exposures to fulfill client needs. Customized nonstandard indexes can be replicated using swaps. Please note that only broad market (e.g. versus style) futures are available and/or liquid enough for use. Individuals may not invest directly into indexes. 45 SURS: Traditional Overlay Update & Option Selling Programs

46 Portfolio Construction Fully Funded Mandate Example Defensive Equity provides protection by de-risking base portfolio, then selling fully covered index options to generate additional portfolio income 50% S&P 500 Index S&P 500 Call Overlay Sell covered calls above current market price (out-of-money) Base Portfolio 50% US Treasury Bills Portfolio Characteristics S&P 500 Put Overlay Sell cash covered puts below current market price (out-of-money) US Treasury Bills reduce base portfolio risk by approximately 50%, but also give up Equity Risk Premium (ERP) on half of portfolio Covered options add Insurance Risk Premium (IRP) on entire portfolio, without adding any leverage1 Disciplined rebalancing back to 50/50 blend no market timing Expected Return = (50% x S&P 500) + (50% x T-Bills) + (100% x IRP ) 1Options are fully-covered (no leverage), out of the money at initiation, approximately one month term, exchange-traded, and typically cash settled. For illustrative purposes only. Individuals may not invest directly in indexes. Investments subject to loss. Information subject to change. 46 SURS: Traditional Overlay Update & Option Selling Programs

47 Dynamic Strike Prices Adapt to Market Conditions The dynamic strike process reacts to volatility changes, selling further out-of-money options when implied volatility is higher S&P 500 Index: Monthly Price Change versus Defensive Equity Model Option Strike Prices 1/1/1990 to 6/30/2014 S&P 500 Price Return Monthly Call and Put Strikes (% Out-of-Money) 20% Since 1990 the S&P 500 Index price at expiration: 15% 10% 5% Median Call Strike: +3.8% 0% Median Put Strike: -4.4% -5% -10% Declined below the put strike 10% of the time Remained between the call and put strikes 67% of the time -15% -20% 1990 Rallied above the call strike 23% of the time In 82% of the monthly periods since 1990, option sales were additive to performance* *Said another way, in 18% of the monthly periods, total premium collected was less than the loss on an option that expired in-the-money. Simulated presentations are for illustrative purposes only, do not represent actual returns of any investor, and may not be considered for investing purposes. Individuals are not able to invest directly in indexes. Investments are subject to loss. Past performance is not indicative of future results. Individual returns will be lower after management fees are deducted. Please refer to disclosures in Appendices. Source: Bloomberg, Parametric Minneapolis Date created: July 11, SURS: Traditional Overlay Update & Option Selling Programs

48 Defensive Equity Strategy Simulation* - Summary of Results Return Period: 1/1/1990 6/30/ Simulated Defensive Equity1 (Gross) Simulated Defensive Equity2 (Net) S&P % S&P 500/ 50% T-Bills Simulated Defensive Equity vs. S&P 500 (Gross) Annualized Return 10.5% 10.1% 9.6% 6.6% 0.9% Standard Deviation 8.0% 8.0% 14.7% 7.4% (6.7%) Sharpe Ratio Simulated Defensive Equity (Gross) Defensive Equity seeks to outperform in major bear markets S&P 500 Total Return 50% S&P 500 / 50% T-Bills 9.6% S&P 500 outperforms in major bull markets % Insurance Risk Premium Capture3 Equity Risk Premium Give Up % Defensive Equity (Gross) simulated returns are gross of management fees and net of expected transaction costs. Defensive Equity (Net) simulated returns are net of management fees (35bps) and net of expected transaction costs. 3 Return difference between the Base Portfolio and Defensive Equity represents the Insurance Risk Premium captured by selling fully covered options against the Base Portfolio, e.g. 10.5% - 6.6% = 3.9%. 4 Return difference between the S&P 500 and the de-risked Base Portfolio (50% S&P 500/50% T-Bills) represents the Equity Risk Premium given up in the Defensive Equity strategy, e.g. 9.6% - 6.6% = 3.0%. *Simulated presentations are for illustrative purposes only, do not represent actual returns of any investor, and may not be considered for investing purposes. Returns stated above are gross of management fees which would reduce an investor s return. It is not possible to invest directly in an index. Investments are subject to loss. Past performance is not indicative of future results. Material provided is supplemental to the GIPS compliant presentation. Please refer to the GIPS compliant presentation and other disclosures at the end of this presentation. Source: Parametric Minneapolis, CBOE Date created: July 11, SURS: Traditional Overlay Update & Option Selling Programs

49 Defensive Equity Composite Results are In-Line with Expectations in a Strong Market (6/30/14) Defensive Equity vs. S&P 500 Growth of $100: 9/1/2011-6/30/2014 Defensive Equity - $ S&P $ (Sep-Dec) 2012 Q Q Q Q Q Apr-14 May-14 Jun Q YTD-14 Inception * Sep-11 Feb-12 Aug-12 Jan-13 Jul-13 Dec-13 Jun-14 DE Funded Composite Assets: Approximately $1.22 billion Total DE Strategy Assets**: Approximately $2.07 billion Defensive Equity Composite (Net) 6.20% 9.07% 5.40% 1.67% 2.82% 5.28% 1.94% 0.68% 1.41% 0.96% Benchmark S&P % 16.00% 10.61% 2.91% 5.24% 10.51% 1.81% 0.74% 2.35% 2.07% 3.07% 5.07% 12.96% 5.23% 7.14% 20.88% Total Returns "Risk Equivalent" "Base Portfolio" 50% S&P 500 / 50% BCA 50% S&P 500 / 50% T-Bill 3.12% 2.17% 10.13% 7.91% 5.17% 5.23% 0.28% 1.46% 2.92% 2.65% 5.10% 5.18% 1.88% 0.95% 0.79% 0.37% 1.74% 1.17% 1.06% 1.04% 3.63% 5.58% 11.70% 2.60% 3.57% 10.19% Defensive Equity 6.0% Annualized Volatility (Inception) * S&P % S&P 500 / 50% BCA 11.5% 5.7% 50% S&P 500 / 50% T-Bill 5.8% Defensive Equity 2.1 Sharpe Ratio (Inception) * S&P % S&P 500 / 50% BCA % S&P 500 / 50% T-Bill 1.8 Results versus Risk Equivalent blend provide relevant short-term performance comparison versus similar risk profile/portfolio beta comprised of 50% S&P 500 and 50% Barclays Capital Aggregate Index Results versus Base Portfolio blend provide proxy for incremental return impact of options sales in Defensive Equity strategy In a strong environment since inception, DE has produced favorable risk-adjusted returns with 48% less volatility than the S&P 500 The returns are presented net of management fees (35 bps) and net of transaction costs. *The inception date for Parametric Minneapolis Defensive Equity strategy was September **Note: Returns above are representative of funded composite only. Total DE strategy assets include funded composite, overlay only, and other variations of DE with different target weight. This is for illustrative purposes only, does not represent the actual returns that any investor may achieve. Investments are always subject to loss. It is not possible to invest directly in an index. Past performance is not indicative of future results. Material provided is supplemental to the GIPS compliant composite. Please refer to the GIPS compliant presentation and other disclosures at the end of this presentation. Source: Parametric Minneapolis Date created: July 16, SURS: Traditional Overlay Update & Option Selling Programs

50 Simulated Defensive Equity Monthly Option Selling Gain/Loss (Overlay Only) as of June 30, 2014 Call Selling - Monthly Gain/Loss Put Selling - Monthly Gain/Loss 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% -8.0% 1990 Sim ulate d Put S elling Gain/Los s % 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% -8.0% 1990 DE 50% Put & 50% Call Selling - Monthly Gain/Loss 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% -8.0% 1990 Simula ted Defensive Equity - Options G/L *Returns stated above are gross of management fees and net of expected transaction costs which would reduce an investor s return. Simula ted Covered Call Selling 1994 Annualized Return 1998 Simulated Put Selling* 2002 Simulated Call Selling* Simulated Defensive Equity - Options G/L* 1yr 3yr 5yr 6.1% 7.3% 7.7% -1.5% 0.4% 0.5% 2.3% 3.8% 4.0% 10yr 6.0% 2.7% 4.4% 20yr 5.7% 2.4% 4.1% Inception 5.4% 2.0% 3.7% Annualized Standard Deviation Simulated Put Selling* Simulated Call Selling* 1yr 0.3% Defensive Equity simulated option selling model consists of 50% put selling and 50% call selling. 3yr Returns above are illustrative return attributions of the put and call selling program individually. 1.4% These returns are simulated, for illustrative purposes only, do not represent actual returns of any 5yr 1.7% investor, and may not be considered for investing purposes. Past performance is not indicative of 10yr 3.5% future returns. The deduction of fees would reduce an investor's return and there is always the 20yr 3.6% possibility of loss of the entire investment. Please refer to the Appendices for further information. Material provided is supplemental to GIPS compliance composites. Please refer to the Inception 3.4% GIPS Performance Presentation and Disclosure in the Appendices for actual results. The use of Parametric Minneapolis Defensive Equity Unfunded strategy program involves certain risks. See Risks section. Source: Parametric Minneapolis, Bloomberg Dated created: July 16, SURS: Traditional Overlay Update & Option Selling Programs 2006 Simulated Defensive Equity - Options G/L* 2.2% 2.2% 2.6% 1.0% 1.2% 1.5% 2.2% 2.0% 2.4% 2.1% 2.8% 2.2%

51 Representative Defensive Equity Overlay Account Performance Attribution* (6/30/14) Call Selling Return 2011 (Sep-Dec) Q Q Q Q Q Q Q Q Q Q CARR (Inception) Volatility 2.80% -0.95% 1.12% -0.34% -0.59% -0.86% -1.27% -1.12% -1.40% 0.26% -0.41% -0.99% 1.99% Put Selling Return 4.36% 1.72% 0.79% 0.90% 1.26% 1.59% 1.48% 1.03% 1.81% 1.62% 1.41% 6.49% 2.55% Representative Account (50% Call Selling / 50% Put Selling) 3.61% 0.38% 0.96% 0.28% 0.34% 0.36% 0.10% -0.04% 0.19% 0.95% 0.50% 2.70% 1.44% As of 6/30/14, Parametric Minneapolis manages approximately $2.0 billion in portfolios of blended Put Selling (PS) and Call Selling (CS) The table provides return attribution for the PS and CS components of a representative DE overlay account using S&P 500 index futures options Since September 2011, the annualized IRP captured by the DE overlay has been 2.70% (gross) with a 1.44% volatility level Actual results have tracked closely with simulated risk/return metrics and expectations stated above are gross of management fees and net of expected transaction costs which would reduce an investor s return. Returns are for a representative Defensive Equity account with 50% put selling and 50% call selling. 1Returns Monthly percentage gain-loss values are calculated relative to an assumed $50 million underlying portfolio ($25mm Call options and $25mm Put options). *Results shown are based on options gain-loss. No return is assumed for the underlying Treasury Bill or equity collateral pool. Please refer to the Disclosure in the appendices for further information. The information provided is based on a representative account. This account was selected on equity based on investment objectives. It is not known whether the account approves or disapproves of the advisory products. Past performance is not indicative of future results. Investments are subject to loss. Individual may not invest directly in indexes. Material provided is supplemental to GIPS compliance composites. Please refer to the GIPS Performance Presentation and Disclosure in the Appendices for actual results. The use of Parametric Minneapolis Defensive Equity Unfunded strategy program involves certain risks. See Risks on page 7. Source: Bloomberg, Parametric Minneapolis Date created: July 16, SURS: Traditional Overlay Update & Option Selling Programs

52 Potential Risks Strategies utilizing options have certain risks. One or more combinations of the following risks may be incurred: trade restrictions risk, liquidity risk, early termination risk, tracking error risk, option collateral risk, and opportunity risk. Risk Trade Restrictions Risk Liquidity Risk Early Termination Risk Tracking Error* Risk Option Collateral Risk Opportunity Risk Overlay Risk Description Like other strategies that utilize exchange-traded instruments, a trading halt or other suspension of trading, whether or not temporary in nature, may limit Parametric s ability to implement portfolio modifications During periods of heightened volatility, there may be a reduction in liquidity that impacts option pricing or bid/offer spreads. Such occurrences could impact Investment Manager s ability to establish new or liquidate existing positions and subject portfolio to losses Early termination of options positions may produce results meaningfully different from typical long-term expectations Mismatch between the Client s investment manager performance and the behavior of the option index upon which the strategy is based Changes in option collateral requirements could require positions to be modified or removed, which may produce results meaningfully different from objectives Selling call options could limit investment gains if underlying index advances beyond call strike price. Selling put options creates an obligation to buy the market at a strike price that may be higher than the market price at expiration Selling put or call options on an overall portfolio s may add or remove incremental equity risks to that portfolio potentially causing the portfolio to be over exposed to that asset class. *Tracking Error Risk applies only to an overlay application where Parametric Minneapolis does not control the underlying collateral. Please refer to the general disclosures on the last page. 52 SURS: Traditional Overlay Update & Option Selling Programs

53 Biographies Jack Hansen, CFA Chief Investment Officer, Parametric - Minneapolis Investment Center Mr. Hansen joined Parametric in 1985*. As Chief Investment Officer, his responsibilities include the management of investment operations and portfolio management. Jack has managed futures, swaps, options, and other derivative based programs since Jack earned a BS degree in finance and economics from Marquette University and a MS in finance from the University of Wisconsin, Madison. He is a CFA charterholder and member of the CFA Society of Minnesota. Jack writes and lectures on the use of derivatives in portfolio management. Gregory Baranivsky, CFA Director, Institutional Relationships Central and Southeast America Mr. Baranivsky joined the firm in 2010*. He is responsible for developing, coordinating, and executing the sales and marketing strategies for s unique family of products in the Central and Southeastern sales territory. Prior to joining, Greg spent 12 years at First American Funds/FAF Advisors (now Nuveen Asset Management) in various sales, national accounts, and product management leadership roles. Before joining First American Funds in 1998, he spent over three years at Van Kampen Investments (today INVESCO) finishing in the product management department. Greg holds a B.A. from Benedictine University and an M.B.A. from the Illinois Institute of Technology. Greg holds the Chartered Financial Analyst designation, is a member of the CFA Institute and the CFA Society of Minnesota where he previously served as a member of its board of directors. *Reflects the year employee was hired by The Clifton Group, which was acquired by Parametric Portfolio Associates LLC on December 31, SURS: Traditional Overlay Update & Option Selling Programs

54 Disclosure Parametric Portfolio Associates, LLC ( Parametric ), headquartered in Seattle, Washington, is registered as an investment adviser under the United States Securities and Exchange Commission Investment Advisers Act of This presentation may not be forwarded or reproduced in whole or in part without the written consent of Parametric. Parametric, headquartered in Seattle, WA, is a leading global asset management firm, providing investment strategies and implementation services to institutions and individual investors around the world. Parametric offers a variety of rules-based, risk-controlled investment strategies, including alpha-seeking equity, alternative and options strategies, as well as implementation services, including customized equity, traditional overlay and centralized portfolio management. is the institutional business unit of Parametric, comprised of applicable sales and client services personnel across all of Parametric s investment centers. Parametric is a majority-owned subsidiary of Eaton Vance Corp. and currently offers these institutional strategies through investment centers in Seattle, WA, Minneapolis, MN and Westport, CT (home to Parametric subsidiary Parametric Risk Advisors LLC, an SEC-registered investment adviser). Parametric is divided into two segments: Parametric Investment & Overlay Strategies and Parametric Custom Tax-Managed & Centralized Portfolio Management. For compliance with the Global Investment Performance Standards (GIPS ), the Firm is defined and held out to the public as Parametric Investment & Overlay Strategies. Parametric Investment & Overlay Strategies provides rules-based investment management services to institutional investors, individual clients and registered investment vehicles, including Engineered Alpha Strategies, Specialty Index, and Policy Implementation Overlay Service (PIOS). The Firm has complied with the GIPS standards retroactive to January 1, The PIOS Composite, Defensive Equity Composite I and Defensive Equity Composite V is offered by the Parametric Investment & Overlay Strategies segment of Parametric. Parametric Investment & Overlay Strategies AUM as of 12/31/2013 is approximately $80.9 billion. The GIPS compliant presentation is included herein along with other supplemental information that further defines or explains the strategy, investment process or composite. This information is intended solely to report on investment strategies and opportunities identified by Parametric. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Past performance does not indicate future returns. The views and strategies described may not be suitable for all investors. Parametric does not provide legal, tax and/or accounting advice or services. Clients should consult with their own tax or legal advisor prior to entering into any transaction or strategy described here. Charts, graphs and other visual presentations and text information were derived from internal, proprietary, and/or service vendor technology sources and/or may have been extracted from other firm data bases. As a result, the tabulation of certain reports may not precisely match other published data. Data may have originated from various sources including but not limited to Bloomberg, MSCI/Barra, FactSet, and/or other systems and programs. Please refer to the specific service provider s web site for complete details on all indices. Parametric makes no representation or endorsement concerning the accuracy or propriety of information received from any other third party. This presentation contains back-tested hypothetical and/or model performance data and may not be relied upon for investment decisions. This material may contain confidential and/or proprietary information and/or assumptions and may only be relied on for this report. Detailed account inclusion/exclusion policies and back-tested data are available upon request. Perspectives, opinions, and testing data may change without notice. Decisions and information were based on available research at the time and as data may contain back-tested hypothetical results, returns may not be realized and specific action or lack of action is not known for certainty. No securities, sectors, industries, or other information mentioned herein may be considered as an offer to purchase or sell a firm product or security. The information presented, including, but not limited to, objectives, allocations and portfolio characteristics, is intended to provide a general example of the implementation of the strategy and does not represent the experience of any particular client. Actual client portfolio holdings, performance, allocations and portfolio characteristics will vary for each client. Any positive comments regarding specific data may no longer be applicable and should not be relied on for investment purposes. 54 SURS: Traditional Overlay Update & Option Selling Programs

55 Disclosure (continued) Returns presented were generated using Parametric s proprietary investment methodology as described in Parametric s Form ADV Part 2A. Returns are unaudited, and may not correspond to quarterly calculated performance for any other client account in the stated discipline. Returns are calculated in U.S. dollars using the internal rate of return, reflect the reinvestment of dividends, interest, gains and other income, include transaction costs but exclude account and custodial services fees, and do not take individual investor tax categories into consideration. After-tax estimates are a best scenario provision for illustrative purposes. Specific periods of returns are not meant to imply that the portfolio would have been profitable had the client only invested in the market for this time period. All investments are subject to loss. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, simulated trading does not involve financial risk, and no simulated trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results. Because there are no actual trading results to compare to the simulated performance results, clients should be particularly wary of placing undue reliance on these simulated results. Benchmark/index information provided is for illustrative purposes only. Investors cannot invest directly in an index. Returns for indexes are calculated gross of management fees. Deviations from the benchmarks provided herein may include but are not limited to factors such as: the purchase of higher risk securities, over/under weighting specific sectors and countries, limitations in market capitalization, company revenue sources, and/or client restrictions. Parametric s proprietary investment process considers factors such as additional guidelines, restrictions, weightings, allocations, market conditions and other investment characteristics. Thus returns may at times materially differ from the stated benchmark and/or other disciplines and funds provided for comparison. Returns may be presented gross of management fees. The deduction of an advisory fee would reduce an investor s return. All returns are calculated in U.S. dollars and include the reinvestment of distributions. Advisory fees are deducted quarterly from an investor s portfolio and have an impact on performance. As an example, the effect of investment advisory fees on the total value of a portfolio assuming (a) $1,000,000 investment, (b) portfolio return of 5% per year, and (c) 1.00% annual investment advisory fee would be $10, in the first year, $56, over five years, and $129, over ten years. Actual fees charged vary by portfolio due to various conditions, including account size. Parametric s investment advisory fees are described further in Part 2 of Form ADV, which is available upon request. The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI Index ex-us is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets excluding the US. The Dow Jones Total Stock Market Index family is a clear, comprehensive mirror to the global equity market. Anchored by the Dow Jones Global Total Stock Market Index, the Dow Jones Total Stock Market Index family includes more than 12,000 securities from 77 countries providing near-exhaustive coverage of both developed and emerging markets. As its U.S. component, the family features the Dow Jones U.S. Total Stock Market Index, which comprises all U.S. equity securities with readily available prices. 55 SURS: Traditional Overlay Update & Option Selling Programs

56 Disclosures (continued) The Barclays Capital Aggregate Bond Index ( BarCap Agg ) is a market-capitalization-weighted index, maintained by Barclays Capital and is often used to represent investment grade bonds being traded in the United States. VIX is the Chicago Board Options Exchange volatility index. The S&P 500 Index represents the top 500 market capitalization publicly traded companies in the U.S. Treasury Bills are a short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks). Parametric is located at th Avenue, Suite 3100, Seattle, WA For more information regarding Parametric and its investment strategies, or to request a copy of Parametric s Form ADV, please contact us at or visit our website, Parametric - Minneapolis Investment Center is located at 3600 Minnesota Drive, Suite 325, Minneapolis, MN For more information regarding Parametric Minneapolis and its investment strategies, or to request a copy of Parametric Mineapolis Form ADV, please contact us at or visit our website, 56 SURS: Traditional Overlay Update & Option Selling Programs

57 PIOS Composite Parametric Investment & Overlay Strategies Division 57 SURS: Traditional Overlay Update & Option Selling Programs

58 PIOS Composite (continued) Parametric Investment & Overlay Strategies Division 58 SURS: Traditional Overlay Update & Option Selling Programs

59 Defensive Equity Composite I Parametric Investment & Overlay Strategies Defensive Equity Composite I Performance Presentation As of December 31, 2013 Returns Period Total Gross Total Net Return Return AWR AWR 3 Yr. Annualized Standard Deviation Index Composite Index Dispersion Assets Internal Number of Composite Total Firm Equal Wtd. Portfolios* (MM)* (MM)* 2011** 6.28% 6.20% 3.96% - - N/A , % 9.07% 16.00% - - N/A , % 16.01% 32.39% - - N/A ,896 * The composite was not included in the Firm Assets prior to 2012 as it was being managed by a prior firm. ** Represents data from 9/1/2011 through 12/31/2011. Index: S&P 500 Total Return Index N/A - Internal dispersion is not statistically meaningful for periods shorter than a y ear or for y ears in which fiv e or fewer portfolios were included in the Composite for the full y ear. Parametric Portfolio Associates LLC and Parametric Risk Advisors LLC (collectively Parametric ) are affiliated investment advisory firms separately registered with the U.S. Securities and Exchange Commission. Parametric Portfolio Associates LLC is headquartered in Seattle, Washington and has investment centers in Seattle, Washington; Minneapolis, Minnesota; and Westport, Connecticut providing investment management services. The Minneapolis investment center resulted after the purchase of Clifton Group Investment Management in December The Westport investment center, Parametric Risk Advisors LLC was formed in Parametric is divided into two segments: Parametric Investment & Overlay Strategies and Parametric Custom Tax-Managed & Centralized Portfolio Management. For compliance with the Global Investment Performance Standards (GIPS ), the Firm is defined and held out to the public as Parametric Investment & Overlay Strategies. Parametric Investment & Overlay Strategies provides rules-based investment management services to institutional investors, individual clients and registered investment vehicles, including Engineered Alpha Strategies, Specialty Index, and Policy Implementation Overlay Service (PIOS). The Firm has complied with the GIPS standards retroactive to January 1, Parametric Investment & Overlay Strategies claims compliance with the Global Investment Performance Standards (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. The Investment & Overlay Strategies segment of Parametric has not been independently verified. The Defensive Equity Composite I is comprised of all fully discretionary funded accounts that invest in a base portfolio of approximately 50% domestic equities and 50% cash equivalents and are rebalanced monthly. Short-term (maturity generally between 3-6 weeks) exchange-traded call and put options are sold against the base portfolio, with option strike prices determined dynamically based on market characteristics. Included accounts will be invested in a separate account or commingled vehicle structure. Composite creation date is September SURS: Traditional Overlay Update & Option Selling Programs

60 Defensive Equity Composite I (continued) Parametric Investment & Overlay Strategies The Composite is compared to the S&P 500 Total Return Index. The Index is a total return index that reflects both changes in the prices of stocks in the S&P 500 Index as well as the reinvestment of the dividend income from its underlying stocks. The Index is unmanaged and does not incur management fees, transaction costs or other expenses associated with separately managed accounts in this style. It is not possible to directly invest in an index. Derivative securities are used in the accounts which comprise this composite. Accounts invest in futures, exchange traded funds (ETFs) and options which are material to this composite. The firm's strategies contain derivatives such as futures, options, swaps, and other investment strategies that may involve certain advantages and risks. Futures require the posting of initial and variation margin. Therefore, a portion of risk capital must be preserved for this purpose rather than being allocated to a manager. Swaps require periodic payments, which may be less liquid than futures, and certain swaps may have counterparty/credit risk. Some investment strategies may require a collateral investment equal to the desired amount of exposure. Portfolio returns reflect the reinvestment of dividend and interest income. Performance results are expressed in U.S. dollars. Composite gross returns are after transaction costs and other direct expenses, but before management fees. Net returns reflect the deduction of actual investment management fees. The fees for the investment management services described herein are described in the fee schedule. The separate account management fee schedule is as follows: First 0.35%; Next 0.25%; next 0.20%; 0.10%. The pooled account management fee schedule is as follows: 0.35%. The dispersion of annual returns is measured by equal-weighted standard deviation of portfolio returns within the Composite for the full year. Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. A list of composite descriptions is available upon request. Performance prior to January 2013 was achieved by the Clifton Group Investment Management prior to its merger with Parametric Portfolio Associates, LLC and has been linked to the performance history of Parametric Investment & Overlay Strategies. Performance results prior to January 2013 should not be interpreted as the actual historical performance of Parametric Investment & Overlay Strategies. Parametric Investment & Overlay Strategies has adhered to the performance record portability requirements of the GIPS standards in regard to the presentation and linking of this performance track record. Past performance is not a guarantee of future results. The three-year annualized Ex-Post Standard Deviation of the Defensive Equity Composite I/S&P 500 Total Return Index for the period January, December, 2013 is not presented because 36 monthly returns are not available. 60 SURS: Traditional Overlay Update & Option Selling Programs

61 Defensive Equity Composite V 61 SURS: Traditional Overlay Update & Option Selling Programs

62 Defensive Equity Composite V (continued) 62 SURS: Traditional Overlay Update & Option Selling Programs