ASSET ALLOCATION QUARTERLY Second Quarter 2015

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1 ASSET ALLOCATION QUARTERLY Second Quarter 2015 Asset allocation is a portfolio management process where various asset classes (stocks, bonds, commodities, etc.) are combined in one portfolio. Diversification helps to avoid having all eggs in one basket. Risk and return are considered for the entire portfolio, as opposed to evaluating individual securities or investments. 16% 14% 12% 10% 8% 6% 4% 2% 0% 0.2% Cash Three-Year Volatility as of 3/31/ % 5.96% Bonds Income With Growth 7.96% Growth & Income 9.76% 11.05% 11.75% Growth Stocks Aggressive Growth Source: Bloomberg, CIM. Cash is the ML 0-3 Month T-Bill Index; Bonds are the ML Domestic Master Index; Stocks are the S&P 500 Index. See disclosures on page 6* for important details. The Confluence asset allocation process is centered upon risk management. Our portfolios offer a broad spectrum of risk profiles, ranging from a fairly conservative posture in Income with Growth (green) to a more risk tolerant profile in Aggressive Growth (orange). The primary asset classes of cash, bonds and stocks are illustrated in the black bars for reference in the above chart. We recognize that risk levels and return potential rise and fall over market and economic cycles. Therefore, we apply a dynamic process, one that evaluates the economy, interest rates, regulation, valuations and other investment variables in a forward-looking context. Although we seek return opportunities, we do so with a consideration for the amount of risk taken to pursue these returns. For many investors, income is an important objective and we make it a priority in our incomeoriented portfolios. However, we balance the income objective relative to our outlook for various asset classes. Often times, higher yields may not translate into attractive return/risk tradeoffs. This chart shows the recent gross yields of our portfolios, relative to several asset classes. Portfolio and Asset Class Yields as of 3/31/15 High Yield Bonds Real Estate 3.6% Long-Term Bonds 3.4% Foreign Stocks 3.0% Income with Growth 2.9% Growth & Income 2.1% U.S. Stocks 2.0% Growth 1.7% Intermediate Bonds 1.5% Aggressive Growth 1.4% Short-Term Bonds 0.8% Cash 0.1% 6.5% Source: Bloomberg, CIM. Portfolio yields are before fees. See disclosures on page 6* for asset class composition and other important details. Commodities 0.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% Please see page 6 for performance and disclosures 1

2 Source: Bloomberg, CIM, using monthly data and gross returns. See disclosures on page 6* for asset class benchmark details. PORTFOLIO AND ASSET CLASS COMMENTARY This chart illustrates the return and volatility for a variety of asset classes as well as the composite performance for our asset allocation portfolios. Over time, the various asset classes can move around quite a bit. Return and volatility tend to be fairly stable for most of the fixed income asset classes, while those with equity-like characteristics experience swings in both return and volatility. In recent quarters, many equity asset classes are moving closer to one another on the chart. But this convergence comes through a variety of pathways. For example, U.S. large caps were at the top of the stack for quite a while, delivering higher returns than other asset classes with higher volatility. However, smaller companies have more recently gained ground and the overall universe of asset classes is forming a more traditional-looking efficient frontier of return and risk. Looking at this graph, it appears that asset allocation can be a fairly straightforward process. To achieve higher returns, one simply increases the exposure to riskier asset classes, and vice versa for investors looking to lower risk. This approach may work over long periods of time; however, the results over shorter cycles are likely to vary. Higher returns do not always accompany higher risk, which has certainly been the case with commodities and emerging markets over the past three years. It is for this reason we focus on business, economic, monetary and market cycles. By taking this approach, we strive to improve the return/risk exposure at the asset class level, as well as across an entire portfolio. It is a dynamic process, one that recognizes changing fundamentals, valuations and growth environments. Our work generally positions portfolios along an attractive portion of the return and risk spectrum. By offering portfolios with discrete risk profiles, we are able to accommodate a broad array of investors, ranging from the conservative to the more aggressive. Please see page 6 for performance and disclosures 2

3 SECOND QUARTER 2015 ASSET ALLOCATION OUTLOOK The U.S. economy is likely to continue along a slow-growth path, with very little inflation. The Fed is moving closer to raising rates, but we expect the hikes to be slow. We believe domestic long-term bond fundamentals are favorable. Although U.S. interest rates are low, they are much higher than many foreign rates. We believe foreign investors will continue to buy U.S. bonds. We continue to favor domestic equities to pursue growth objectives. However, we expect returns to moderate as earnings growth slows. We continue to favor mid and small caps. Our style guidance(growth/value) remains overweight growth(70/30). Real estate fundamentals are strong and this asset class should continue to benefit from low long-term rates and foreign capital investments. ECONOMIC VIEWPOINTS The U.S. economy continues along its slow-growth trajectory, making the current expansion one of the longest in modern history. The mild nature of the growth, along with globalized trade, has resulted in low inflation. At the same time, the proportion of the U.S. population in the workforce remains low, indicating that the labor markets are far from robust. Against this backdrop, it s reasonable to question the Fed s intention to begin raising short-term interest rates. Its explicit mandates are related to price stability and employment. Benign inflation and tepid labor markets hardly seem to necessitate tighter monetary policy. Since we re not Fed insiders, it s difficult to know its specific motives. But we suspect the answer isn t exactly crystal clear on the inside, either. The Fed s various voting members have a spectrum of different viewpoints and when they speak publicly their comments are nuanced, although seemingly coordinated. One possibility is the Fed may be attempting to normalize short-term rates, moving them up from the current, near-zero level. Doing so might eliminate some distortions and limitations that come with very low interest rates. It s also possible the Fed might reduce the likelihood of speculative market bubbles. So, there may be some validity to this theory. The problem is that the pursuit of these kinds of objectives is outside the Fed s stated mandate. Additionally, what exactly are normalized interest rates? It s potentially quite arbitrary, even as the Fed will have to be precise with its targeted interest rate. Furthermore, some economic models (including some of our own) indicate that normal may actually be right at zero, given the economy s mild growth and low inflation. Regardless of the Fed s specific motivations, it s likely that the economy is not strong enough to weather tightening that takes place too fast or goes too far. For this reason, we expect the Fed to move slowly, with a definition of normal that turns out to be pretty low perhaps less than 1% for quite some time. Following this path, we believe the Fed can avoid creating a recession. A low-growth, low inflation economy accompanied by gradually tightening monetary policy is a rather strange combination, but this oddity is now on the horizon. We expect its arrival to keep long-term rates low. This outcome is likely because if the Fed tightens too much, longer rates will decline due to rising recession risk; on the other hand, a gradual tightening policy would provide a measure of comfort to buy longer maturities because bond investors wouldn t be fighting an aggressive Fed. We believe these very different scenarios would probably create the same interest rate outcome. We realize this view is contrary to how many investors feel about long-term rates. These investors aren t alone the consensus among professional forecasters is also for higher rates. Consider our nearby chart. We show the annual consensus forecast for the 10-year treasury in red (circles indicate when the forecast was generally correct; squares show when the forecast was generally wrong). The blue line is the actual yield of the 10-year Treasury. The chart reveals two noteworthy outcomes. First, there is a fairly consistent bias to 3

4 forecast higher rates, and second, most of the time professional forecasters are wrong! We believe the bias forms because forecasters are steadfast in their expectation that rates will rise, based mostly on recent history. Our process recognizes the importance of history, but also incorporates current conditions as well as our forward forecasts. Right now, our work takes us against the consensus. Other important factors building the case for low interest rates include low global rates, the appeal of the U.S. dollar and rising geopolitical risks. Given these conditions, we favor asset classes that may benefit from low or declining long-term interest rates. STOCK MARKET OUTLOOK A primary risk for equity investors is a recession, which we do not currently expect. On the other hand, rising profits and valuations are the primary sources of return for equity investors and we don t expect big escalations for either of these. Accordingly, we anticipate a middle ground, one characterized by reasonable returns without excessive risk. Large caps continue to be attractive where growth is an objective. For more risk tolerant investors, we continue to favor larger proportions of small and mid caps, which offer higher growth potential, albeit with greater risk. Our style guidance remains in favor of growth over value (70/30). For large cap allocations, our sector exposure favors technology and consumer discretionary, while we underweight the energy, utilities and materials sectors. Our foreign developed country allocations remain at zero. We believe both Western Europe and Japan are unlikely to experience significant improvements in their economies, while the strong U.S. dollar will diminish foreign returns to U.S. investors. We also remain entirely out of emerging markets. China is a noteworthy risk to the asset class because of its size, its impact on other emerging markets and the rapid escalation of valuations in certain sectors. When appropriate, we include emerging markets to participate in growth and development. However, China s extraordinary market performance year-to-date appears to be less about growth and more about governmental tinkering. BOND MARKET OUTLOOK Given our view about Fed policy and interest rates, we expect tighter Fed policy to affect shorter maturity bond yields more than longer maturity yields (we expect the yield curve will flatten). Therefore, we continue to focus the bond allocation more on intermediate and long maturities. We expect defaults to remain relatively low, making corporate bonds (investment grade and speculative) attractive for bond investors. We also include a limited exposure to Treasuries. OTHER MARKETS We believe low, long-term interest rates create an attractive environment for real estate. Although real estate has performed well over the past several quarters, we continue to include this asset class across all of the portfolios. Fundamentals related to occupancy and rentals are favorable and capital costs are low. Furthermore, we believe U.S. real estate continues to have special appeal to foreign investors, particularly those seeking yield and exposure to the U.S. dollar. Commodities remain out of the portfolios as we believe demand from both developed and emerging economies is likely to remain somewhat muted. Still, we actively monitor the asset class and recognize the utility that oil and gold could bring at some point in the cycle. 4

5 Second Quarter 2015 Income Growth Aggressive With Growth & Income Growth Growth Current Change Current Change Current Change Current Change Cash 2% - 2% - 2% - 2% - Short Term Bonds Intermediate Term Bonds 27% - 2% (9%) Long Term Bonds 18% 5% 20% 9% 5% Speculative Grade Bonds 6% (8%) 5% Real Estate 18% 3% 8% - 10% - 10% - U.S. Large Cap Stocks 7% (3%) 20% - 45% - 15% - U.S. Mid Cap Stocks 7% - 33% - 23% - 15% - U.S. Small Cap Stocks 15% 3% 10% - 15% - 58% - Foreign Developed Country Stocks Emerging Market Stocks Commodities Total 100% 100% 100% 100% INCOME WITH GROWTH Intermediate and long-term investment grade bonds continue to form the base of the Income With Growth portfolio. Tighter monetary policy from the Fed is usually not paired with mild economic growth, but this appears to be a likely combination in coming quarters. We believe this environment should be constructive for intermediate and longer maturity bonds. We continue to trim back the exposure to speculative grade bonds, which have provided income and attractive returns in the portfolio for the past few years. However, valuations are now higher and we believe it is appropriate to reduce more of the speculative grade bond exposure and shift into longer maturity bonds. We also believe real estate should continue to perform well and increase the allocation, which contributes to portfolio yield. The equity allocation continues to shift more toward small caps. However, large and mid caps are also included to help maintain diversification and limit overall volatility. GROWTH & INCOME The bond allocation for the Growth & Income portfolio has been focused on intermediate and longer maturity bonds. This quarter, we shift the focus to emphasize a longer maturity profile. We believe that when the Fed begins raising short-term rates it will move slowly. Therefore, we don t expect that Fed policy will pressure longer rates higher. We also note that while U.S. rates are low relative to their own history, they remain significantly higher than other foreign developed countries. This increases the appeal of U.S. bonds to foreign investors and helps limit the risk of rising interest rates. To pursue growth objectives, the portfolio utilizes domestic equities, including large, mid and small caps. We favor domestic equities over foreign ones because we expect better growth potential. We also expect the U.S. dollar is likely to remain strong, diminishing foreign returns to U.S. investors. Real estate and speculative grade bonds contribute to portfolio yield and we believe these asset classes should perform well in a low interest rate environment. GROWTH As we move toward a period when the Fed may begin increasing short-term rates, we will closely monitor how rapidly the Fed implements its policy. The U.S. economy is growing, but not at a robust pace. If the Fed were to tighten too quickly, it could tip the economy into a recession, which tends to create a riskier environment for equities. At this point, we believe the Fed s policies are likely to avoid a recession. We also expect longer term rates to remain low. In this environment, equities can deliver reasonable returns, although they are likely to be lower than the levels from recent years. The Growth portfolio equity allocation is diversified across large, mid and small caps. We also include real estate and a small allocation to longer maturity bonds. We believe these asset classes may perform well in a low-growth, low interest rate environment. We continue to avoid foreign equities as we believe growth prospects are more attractive in domestic equities. Furthermore, we believe a strong U.S. dollar is likely to diminish foreign returns for U.S. investors. AGGRESSIVE GROWTH The Aggressive Growth portfolio remains centered on small cap stocks. We believe this asset class offers higher growth potential relative to other equity asset classes, and we believe the return/risk profile is attractive to risk tolerant investors. Yet we also include smaller allocations to mid and large caps, which should perform reasonably well as long as the Fed doesn t tighten monetary policy too quickly. Recessions are a primary source of risk for equity investors, so we will pay close attention to how the economy responds to the Fed s higher short-term rates. Real estate is somewhat unusual in this portfolio, but we believe this asset class should continue to perform well as longer term interest rates remain low. Furthermore, U.S. real estate continues to draw interest from many foreign investors, who are often seeking current income and exposure to the U.S. dollar. We believe foreign capital is likely to continue flowing into this asset class. We continue to avoid foreign equities because we believe the return potential should be higher for domestic equities. We recognize that we missed an opportunity to participate in Chinese equities, which have appreciated in an extraordinary manner. However, the escalation appears to us to be driven mostly by government stimulus, which may not continue. 5

6 Performance & Disclosures As of 3/31/15 Strategy Quarter YTD 1 - Year 3 - Year 5- Year ITD Aggressive Growth - Gross of Fees 3.2% 3.2% 10.8% 12.9% 10.7% 7.57% Aggressive Growth - Net of Fees 2.5% 2.5% 7.5% 9.5% 7.4% 4.29% Benchmark - S&P % 1.0% 12.7% 16.1% 14.5% 10.28% Growth - Gross of Fees 3.2% 3.2% 13.9% 12.8% 10.9% 7.19% Growth - Net of Fees 2.4% 2.4% 10.5% 9.5% 7.6% 4.01% Benchmark - S&P % 1.0% 12.7% 16.1% 14.5% 9.90% Growth and Income Taxable - Gross of Fees 3.7% 3.7% 13.0% 11.2% 10.2% 7.54% Growth and Income Taxable - Net of Fees 2.9% 2.9% 9.6% 7.9% 6.9% 4.35% Benchmark - 70% S&P 500 and 30% ML Bond Index 1.2% 1.2% 10.8% 12.2% 11.6% 8.77% Income Taxable with Growth - Gross of Fees 3.2% 3.2% 11.7% 9.8% 9.7% 12.41% Income Taxable with Growth - Net of Fees 2.5% 2.5% 8.4% 6.6% 6.4% 9.07% Benchmark - 40% S&P 500 and 60% ML Bond Index 1.5% 1.5% 8.8% 8.4% 8.6% 9.92% ITD: Inception-to-Date. Inception: Income with Growth (12/1/08), Growth & Income (9/1/08), Growth (9/1/08), Aggressive Growth (8/1/08). Confluence Investment Management LLC is an independent registered investment adviser. Past performance is not indicative of future results. The U.S. Dollar is the currency used to express performance. Returns are presented gross and net of all fees and include the reinvestment of all income. 1 Net of fee performance was calculated using the highest applicable annual bundled fee of 3.00% applied quarterly. This fee includes brokerage commissions, portfolio management, consulting services and custodial services. The Confluence fee schedule for this composite is as follows: 0.40% on the first $500,000; 0.35% on the next $500,000; and 0.30% over $1,000,000. There are no incentive fees. Clients pay an all-inclusive fee based on a percentage of assets under management. The collection of fees produces a compounding effect on the total rate of return net of fees. Bundled fee accounts make up 100% of the composite for all periods. Actual investment advisory fees incurred by clients may vary. Wrap fee schedules are provided by independent wrap sponsors and are available upon request from the respective wrap sponsor. Each strategy is implemented using Exchange Traded Funds (ETFs) and the investment objective is the pursuit of nominal returns (yield and growth) in excess of inflation, subject to the limitations of the risk constraint for each strategy. The targeted risk constraint and appropriate investor risk tolerance for each strategy is as follows; Aggressive Growth (High), Growth (Average), Growth and Income Taxable (Moderate), and Income with Growth (Conservative). ML Bond Index consist of Merrill Lynch US Corporate, Government, and Mortgage Bond Index. Confluence claims compliance with the Global Investment Performance Standards (GIPS ). A complete list of composite descriptions and/or a GIPS compliant presentation is available by contacting Marketing@confluenceim.com or calling There are investment risks in investing in these strategies. Each asset class has specific risks associated with it and no specific asset class can prevent a loss of capital in market downturns. In a rising interest rate environment, the value of fixed income securities generally declines. Speculative grade bonds are subject to greater risk of loss of principal and interest, including default risk, than higher-rated securities. Investments in international and emerging market securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. The real estate asset class is a portfolio containing Real Estate Investment Trust (REIT) securities. Confluence utilizes fixed income ETFs for the bond asset classes to deliver the income and lower volatility traditionally available from a diversified bond portfolio. Fixed income ETFs are not bonds, but are pro-rata interests in publicly traded bond funds. Investors should be aware there are limitations in utilizing fixed income ETFs, which are subject to market risk, including the possible loss of principal. There may be times when an ETF s performance may vary relative to its targeted benchmark. And while ETFs generally trade very close to their net asset values, during times of market disruption they can trade at discounts or premiums, directly affecting performance. Liquidity can vary depending upon market conditions. ETFs trade like a stock, and there will be brokerage commissions associated with buying and selling exchange traded funds unless trading occurs in a fee-based account. Investors should consider an ETF s investment objective, risks, charges, and expenses carefully before investing. Information provided in this report is for educational and illustrative purposes only and should not be construed as individualized investment advice or a recommendation. The investment or strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. Opinions expressed are current as of the date shown and are subject to change. *Benchmark return and volatility calculations utilize monthly data through 3/31/15. Investors cannot invest directly in an index. Past performance does not guarantee future performance. Asset class and benchmark index representation: cash (ML T-Bill); short-term bonds (ML 0-3 Year C/G); intermediate bonds (ML 3-5 Year C/G); long-term bonds (ML 10+ C/G); speculative grade or high yield bonds (ML High Yield Master); real estate (FTSE NAREIT Equity); large cap (S&P 500); mid cap (S&P MidCap 400); small cap (Russell 2000); foreign developed country (MSCI EAFE); emerging markets (MSCI Emerging Market); commodities (Dow Jones UBS Commodity). Yield chart data as of March Representations: U.S. stocks are the S&P 500; foreign stocks are the average of developed country and emerging markets. The Asset Allocation Team Mark Keller Bill O Grady David Miyazaki Patty Dahl Kaisa Stucke For more information contact one of our sales team members: Wayne Knowles Northeast John Pierucki Southeast Ron Pond Southwest Steve Mikez Northwest (314) (314) (314) (314) wknowles@confluenceim.com jpierucki@confluenceim.com rpond@confluenceim.com smikez@confluenceim.com Confluence Investment Management LLC is an independent, SEC Registered Investment Advisor located in St. Louis, Missouri. We provide professional portfolio management and advisory services to institutional and individual clients. Our investment philosophy is based upon independent, fundamental research that evaluates global markets and economies, and continues all the way down to specific companies. Our portfolio management philosophy begins by addressing risk, and follows through by positioning clients to achieve income and growth objectives. 20 Allen Avenue, Suite 300 Saint Louis, MO