ACTIVE MANAGEMENT REVIEW Q3 2017

Transcription

1 October 2017 ACTIVE MANAGEMENT REVIEW Q Prepared by the Strategic Investment Research Group For financial professional use only. Not for use with the public.

2 Executive Summary US Equity Active Management results are mixed for the quarter, value strategies posted stronger relative performance than growth. The Trump Trade was broadly higher for the quarter creating opportunities for active managers biased toward Financials, Infrastructure and Health care. Over the trailing 1-year, stock selection has been materially additive for value managers and has been marginally positive across the growth spectrum. Small Cap active strategies underperformed, led by persistent under exposure to Biotech; stock selection broadly weaker. International Equity Active Management results were strong for the quarter, and are competitive for the trailing 1-year. International equity markets were broadly higher for the quarter, helped in part to a weakening USD. On a trailing 1-year basis, stock selection has been a significant contributor to relative excess performance. Fixed Income High Yield and EM results improved after a difficult 2nd quarter, trailing 1-year performance is favorable for active managers. Intermediate-term bond managers continued to benefit from tighter spreads and marginally higher rates. Higher yielding spread sectors - high yield and EM continued to outperform as spreads tightened. Outperforming managers benefitted from Non-US and CCC exposures. Global fixed income again benefitted from currency moves as the US dollar broadly weakened Liquid Alternatives Most Liquid Alternative strategies outperformed bonds during the quarter. 2

3 Return (%) Volatility Index Level Return (%) Return (%) Markets continued to move higher despite elevated geopolitical risks Market Returns Q3:17 12-Month Source (as of 9/30/17): Morningstar, Bloomberg, S&P, MSCI Domestic Equity Index Performance R2000G R1000G R2000 R2000V R1000 R1000V Source (as of 9/30/17): Russell Q3:17 12-Month S&P 500 Sector Returns Volatility Index Year Historical Average 5 Source (as of 9/30/17): S&P Q3:17 12-Month - Source (as of 9/30/17): CBOE 3

4 Growth remains in favor; Value & Dividends continue to pull back Equity Factors Q3:17 Q2:17 1-Year 3-Year High E/P -1.2% -1.6% 4.8% 1.0% Value High B/P High S/P -1.5% -0.7% -2.7% -3.1% -0.4% 2.5% -2.4% -0.7% High CF/P -1.0% -2.8% -0.6% 0.1% Momentum 12M Price S/T Reversal 0.5% 3.6% -2.8% 0.6% -0.7% 0.7% -0.1% 1.3% EPS NTM 2.6% 1.4% 7.1% -0.2% Growth EPS L/T Est Sales NTM 1.6% 1.0% 1.4% 3.3% 1.7% 5.4% -3.9% 0.3% High ROE -1.1% 2.5% 2.5% 2.4% Quality High ROIC Low Debt/EQ -0.6% 2.2% 0.2% 2.9% 0.6% 3.1% 1.3% 3.9% Dividends EPS Stability Div Yield Div Growth -1.0% -2.5% -1.1% -3.1% -0.8% 3.0% -7.3% -1.3% 1.6% -0.5% 4.0% 4.2% Safety Low Price Vol Low Beta -2.7% -3.9% 2.7% 2.8% -6.2% -3.1% 3.2% 7.5% Size Small vs. Large -0.8% -3.4% -5.7% -4.2% -5.0% 0.0% 5.0% Factor Returns -10.0% -5.0% 0.0% 5.0% Factor Returns -10.0% -5.0% 0.0% 5.0% 10.0% Factor Returns -5.0% 0.0% 5.0% 10.0% Factor Returns Source (as of 9/30/17): FactSet, SIRG. Factor definitions included in the disclosures. Using the largest 1000 stocks by market capitalization, stocks are grouped into quintiles by each respective characteristic. The factor returns represent the return spread between the top and bottom quintiles. 4

5 Investors are most bullish Quality, Value and Small Cap factors Investors favor higher quality stocks, and continue to be bearish on low volatility and high dividend yield Favorable outlook for value factors as valuations are reasonable and earnings recovery is expected to continue Value Momentum Growth Dividends Quality Safety Size Current Valuations vs. L/T Averages High E/P High B/P High S/P High CF/P EXPENSIVE 12 Month Price EPS NTM EPS L/T Est Sales NTM High Div Yield High Div Growth High ROE High ROIC CHEAP Low Debt/EQ EPS Stability Low Price Vol Low Beta Small Size Z-Score Which styles will outperform the broad equity market over the next 12 months? Small Cap Quality 35% Large Cap 41% Value Small Caps Growth Div Growth Momentum Div Yield Low Volatility Growth 32% Low Quality 23% High Vol 30% Low Dividend Yield 41% Low Mom. 29% 100% 50% 0% 50% 100% % Underperform % Outperform Source (as of 9/30/17): FactSet Research Systems, Inc., SIRG. Factor definitions included in the disclosures Source: SIRG Investment Manager Survey, October 2017 Equity Factor: Using the largest 1000 stocks by market capitalization, stocks are grouped into quintiles by each respective characteristic. The factor valuations represent the P/E spread between the median stock in the top and bottom quintiles. Z-Scores are a standard score indicating how many standard deviations an observation is above or below its historical mean. 5

6 Trump policy continues to materially impact specific markets 40.0% Infrastructure vs. Russell 3000 Index November 8, September 30, % Financials vs. Russell 3000 Index November 8, September 30, % 30.0% 20.0% 10.0% 0.0% Infrastructure Russell % +18.5% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Financials Russell % 40.0% 30.0% 20.0% 10.0% 0.0% Obama Care Repeal vs. Russell 3000 Index November 8, September 30, 2017 Obamacare Repeal Russell % +18.5% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Drug Pricing Regulations vs. Russell 3000 Index November 8, September 30, 2017 Drug Pricing Regulations Russell % +18.5% Source (as of 9/30/17): Factset, Russell. See Disclosures for more information on Trump Trade Companies 6

7 Correlation Active Management Hit Rate Intra-stock correlation remains supportive for Active Management 70 Stock Picking Opportunity Set Intra-Stock Correlation (Blue) & Active Management Hit Rate (Gold) 80% 60 70% Average 6 Month Rolling Correlation 60% 50% 40% 30% 20% 10 10% 0 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 0% Source (as of September 30, 2017): FactSet, S&P, Morningstar Month Rolling Correlation (Left Axis) Large Cap Home Run/Strike Out Ratio Russell 1000 Growth Russell 1000 Russell 1000 Value Russell 3000 Russell Top 200 Source (as of September 30, 2017): FactSet, Russel Home Run/Strikeout Ratio: ratio of stocks that out/underperform mean by 1 std. deviation 3Q-17 HR=SO AMR Hit Rate (Right Axis)

8 PGIM INVESTMENTS Active Management Review: Domestic Equity 8

9 Value Active Managers continue to outperform, Growth Managers struggled Q3:17 VALUE CORE GROWTH VALUE GROWTH DEEP TRADITIONAL RELATIVE CORE GARP TRADITIONAL HIGH GROWTH LARGE MID SMALL Year VALUE CORE GROWTH VALUE GROWTH DEEP TRADITIONAL RELATIVE CORE GARP TRADITIONAL HIGH GROWTH LARGE MID SMALL LEGEND > 75% of Managers Beat Index 51% - 75% of Managers Beat Index 26% - 50% of Managers Beat Index 0% - 25% of Managers Beat Index Numbers = Index Percentile Rank Source (as of September 30, 2017): Morningstar, Russell, BlackRock See Disclosures for descriptions of referenced benchmark. Investable ETFs used to measure active manager results. 9

10 Skill (Alpha) Skill (Alpha) For Value, strong selection and favorable style exposure drove excess performance; Growth managers performed differently Large Cap VALUE CORE GROWTH Q3: Year Style Vs. Alpha Generation Large Cap Q3:17 Large Cap 1-Year Style out of favor (+) Alpha Generation 2.00 Style in of favor (+) Alpha Generation Style out of favor (+) Alpha Generation 2.00 Style in of favor (+) Alpha Generation Traditional Value Deep Value Relative Value 0.50 Deep Value Relative Value Traditional Value High Growth GARP High Growth GARP Traditional Growth Traditional Growth Style out of favor (-) Alpha Generation Style Effect Style in of favor (-) Alpha Generation Style out of favor (-) Alpha Generation Style Effect Style in of favor (-) Alpha Generation Source (as of 9/30/17): MSCI Barra, Lipper Source (as of 9/30/17): MSCI Barra, Lipper 10

11 Attribution Strong stock selection driving relative outperformance of Value strategies Large Value DEEP TRADITIONAL RELATIVE Q3: Year Style Factor Exposures Current & Historical 0.1 Divs Large Cap Value Selection & Notable Styles Impact on Active Management Results Quality 0 Small Cap 1.5 % of Managers Outperforming Growth (Est) Value Market Current Avg Source (as of 9/30/17): FactSet, SIRG Style Factor Returns (%) Momentum Growth Small Cap Div Yield F a c t o r E x p o s u r e s QTD 1 Yr 3 Yr Small Cap Value Growth Quality Div Yield Momentum Source (as of 9/30/17): FactSet, SIRG Source (as of 9/30/17): FactSet, SIRG, Lipper, Morningstar Excess Selection 11

12 12/28/2012 3/28/2013 6/28/2013 9/27/ /27/2013 3/28/2014 6/27/2014 9/26/ /26/2014 3/27/2015 6/26/2015 9/28/ /28/2015 3/28/2016 6/28/2016 9/28/ /28/2016 3/28/2017 6/28/2017 9/28/2017 Attribution (% ) 12/28/2012 3/28/2013 6/28/2013 9/27/ /27/2013 3/28/2014 6/27/2014 9/26/ /26/2014 3/27/2015 6/26/2015 9/28/ /28/2015 3/28/2016 6/28/2016 9/28/ /28/2016 3/28/2017 6/28/2017 9/28/2017 Attribution (% ) 12/28/2012 3/28/2013 6/28/2013 9/27/ /27/2013 3/28/2014 6/27/2014 9/26/ /26/2014 3/27/2015 6/26/2015 9/28/ /28/2015 3/28/2016 6/28/2016 9/28/ /28/2016 3/28/2017 6/28/2017 9/28/2017 Attribution (% ) Overtime, security selection has been additive for LCV active managers Large Value DEEP TRADITIONAL RELATIVE Q3: Year Total / Selection Effect Large Cap Value Exposure & Attribution Q3: Tech - Security Selection 12/31/12-9/30/17 Financials Consumer Consumer Sector: Tech Industrials Energy Health Care Real Estate Utilities Telecom Materials Staples Discretionary Over/Underweight: Source (as of 9/30/2017): FactSet HR SO Large Cap Value - HR/SO Notable Sectors Tech Industrials Energy Health Care Materials Financials Consumer Disc Source (as of 9/30/17): FactSet, Russell Total Effect Selection Industrials - Security Selection 12/31/12-9/30/17 Health Care - Security Selection 12/31/12-9/30/17 Source (as of 9/30/2017): FactSet, Lipper Source (as of 9/30/2017): FactSet, Lipper Source (as of 9/30/2017): FactSet, Lipper 12

13 Exposure (% ) Contribution to Return Cumulative Return (% ) Tech Exposure (%) Technology was an important driver to relative returns Large Value DEEP TRADITIONAL RELATIVE Q3: Year Tech Exposure LCV Manager Positioning Tech Exposure Contribution To Excess Returns LCV Manager Overweight Benchmark Weight Off- Benchmark Stocks Stocks in Benchmark Attribution % 47% 28% 59% Tech Selection Tech Total Excess Return 0 Q3:17 3-Years Source (as of 9/30/17): FactSet, Russell, Lipper Source (as of 9/30/17): FactSet, Russell, Lipper 2.00 Notable Off-Benchmark Positioning Microsoft & Apple Microsoft & Apple 3-Year Return & Attribution Microsoft Apple 55 Microsoft Active Weight Apple Active Weight Contribution (Left Axis) Return (Right Axis) Source (as of 9/30/17): FactSet, Lipper Source (as of 9/30/17): FactSet, Lipper 13

14 Attribution Growth managers have not fared as well GARP Large Growth TRADITIONAL HIGH GROWTH Q3: Year Growth (Est) Market Momentum Style Factor Exposures Current & Historical 0.1 Quality Source (as of 9/30/17): FactSet, SIRG Style Factor Returns (%) QTD 1 Yr 3 Yr Small Cap Value Growth Quality Div Yield Momentum Current Value Avg Divs Small Cap Large Cap Growth Selection & Notable Styles Impact on Active Management Results Source (as of 9/30/17): FactSet, Morningstar, SIRG % of Managers Outperforming Div Yield Quality Growth F a c t o r E x p o s u r e s Excess Selection Source (as of 9/30/17): FactSet, SIRG 14

15 Attribution (% ) Attribution (% ) Large Cap Growth selection has been below average in select sectors GARP Large Growth HIGH TRADITIONAL GROWTH Q3: Year Total + Selection Effect Large Cap Growth Exposure & Attribution Q3:17 Attribution (% ) Tech - Security Selection 12/31/12-9/30/ Source (as of 9/30/2017): FactSet, Lipper Total Effect Selection Consumer Sector: Tech Materials Real Estate Energy Utilities Telecom Financialsumer DiscretiIndustrials Health Care Staples Over/Underweight: Health Care - Security Selection 12/31/12-9/30/17 Source (as of 9/30/2017): FactSet HR Tech SO Consumer Disc Large Cap Growth - HR/SO Notable Sectors Industrials Health Care Materials Energy Financials Consumer Staples Industrials - Security Selection 12/31/12-9/30/17 Source (as of 9/30/2017): FactSet, Lipper Source (as of 9/30/2017): FactSet, Russell Source (as of 9/30/2017): FactSet, Lipper 15

16 Z-Score Active Share Z-Score Active Share Using Active Share, Value Managers appear more active than Growth counterparts Large Cap VALUE CORE GROWTH Q3: Year Large Cap Value - Active Share (0.50) Large Cap Active Share Growth vs. Value Z-score (0.50) (1.00) (1.50) Large Value Large Deep Value Large Trad Value Large Rel Value z-score (Left axis) Active Share (Right Axis) Active Share (1.00) 71 Source (as of 9/30/17): FactSet, Morningstar, Russell (1.50) 71 Large Cap Growth - Active Share (2.00) 70 - (0.50) (1.00) 72 (2.50) 69 (1.50) 70 (3.00) Large Growth Large Value z-score (Left axis) Active Share (Right Axis) Source (as of 9/30/17): FactSet, Morningstar, Russell 69 (2.00) (2.50) (3.00) Large Growth Large GARP Large Trad Growth Large Momentum z-score (Left axis) Active Share (Right Axis) Source (as of 9/30/17): FactSet, Morningstar, Russell Active Share is a measure of the percentage of stockholdings in a manager's portfolio that differ from the benchmark index. 16

17 FACTOR EXPOSURE FACTOR EXPOSURE Risk factors show otherwise; Value Managers becoming more defensive & Growth managers more aggressive Large Cap VALUE CORE GROWTH Q3: Year Large Value Manager Current vs. 10 Year Factor Exposure History Large Growth Manager Current vs. 10 Year Factor Exposure History 20% 20% 10% 10% 0% 0% -10% -10% -20% Max Range Min Current -20% Range Max Min Current Source (as of 9/30/17): FactSet, MPI Stylus, SIRG Source (as of 9/30/17): FactSet, MPI Stylus, SIRG 17

18 Skill (Alpha) Skill (Alpha) Small Cap managers relative underperformance driven by style not stock selection Small Cap Value Core Growth Q3: Year Style Vs. Alpha Generation Small Cap Q3:17 Small Cap 1-Year Style out of favor (+) Alpha Generation Style in of favor (+) Alpha Generation Style out of favor (+) Alpha Generation Style in of favor (+) Alpha Generation High Grow th 1.00 Traditional Value 1.00 GARP High Grow th Traditional Deep Value Value Traditional Grow th Relativ e Value Deep Value Traditional Grow th GARP Relativ e Value Style out of favor (-) Alpha Generation Style Effect Style in of favor (-) Alpha Generation Style out of favor (-) Alpha Generation Style Effect Style in of favor (-) Alpha Generation Source (as of 9/30/17): MSCI Barra, Lipper Source (as of 9/30/17): MSCI Barra, Lipper 18

19 Material underweight to Biotech has been a headwind since 2013 Biotech Exposure Growth Managers vs. Index Biotech Exposure (% ) Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Attribution (% ) Mar-15 Jun-15 Sep-15 Dec-15 Dec-12 Mar-13 Jun-13 Mar-16 Sep-13 Dec-13 Jun-16 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Attribution (% ) GARP Small Growth TRADITIONAL HIGH GROWTH Q3: Year Small Cap Growth Underweight to Biotech Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Exposure to Biotech (% ) - (1.0) (2.0) (3.0) (4.0) (5.0) (6.0) (7.0) SC GARP SCG Manager Russell 2000 Growth Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Source (as of 9/30/2017): FactSet, Lipper Source (as of 9/30/2017): FactSet, Lipper Small Cap Growth Biotech Selection Impact Small Cap Growth Biotech Industry Impact (0.1) (0.2) (0.5) (0.3) (0.4) (1.0) (0.5) Source (as of 9/30/2017): FactSet, Lipper Source (as of 9/30/2017): FactSet, Lipper 19

20 PGIM INVESTMENTS Active Management Review: International Equity 20

21 Return (%) International and Emerging Markets continue to trend higher; Active Managers adding value Q3: MSCI BRIC EAFE MSCI Frontier Markets USD VALUE CORE GROWTH LARGE SMID MSCI EM MSCI EAFE Small Growth Global Equity Index Performance As of September 30, 2017 MSCI EM LCL 23.6 MSCI EAFE Small Value MSCI ACWI Ex US Q3:17 12-Month MSCI EAFE Value Active Management Results GLOBAL 37 EMERGING MARKETS Source (as of 9/30/17): Morningstar, Russell, MSCI, Bank of America/Merrill Lynch, BlackRock 74 LEGEND 1-Year > 75% of Managers Beat Index 51% - 75% of Managers Beat Index 26% - 50% of Managers Beat Index 0% - 25% of Managers Beat Index Numbers = Index Percentile Rank See Disclosures for descriptions of referenced benchmark. Investable ETFs used to measure active manager results MSCI EAFEMSCI ACWI MSCI EAFEMSCI EAFE Growth GR LCL EAFE VALUE CORE GROWTH LARGE SMID GLOBAL 40 EMERGING MARKETS 61 21

22 Skill (Alpha) Skill (Alpha) Style factors impact categories differently, but selection is generally strong across the active management landscape Q3:17 EAFE VALUE CORE GROWTH LARGE SMID GLOBAL 37 EMERGING MARKETS 74 Style Vs. Alpha Generation International Q3:17 International 1-Year Style out of favor (+) Alpha Generation 3.0 Style in of favor (+) Alpha Generation Style out of favor (+) Alpha Generation 3.0 Style in of favor (+) Alpha Generation Int Growth Int Growth Global 1.0 Emerging Markets Int Core Int Value Int Core Global Int Value Emerging Markets Style out of favor (-) Alpha Generation Style Effect Style in of favor (-) Alpha Generation Style out of favor (-) Alpha Generation Style Effect Style in of favor (-) Alpha Generation Source (as of 9/30/17): MSCI Barra, Lipper Source (as of 9/30/17): MSCI Barra, Lipper 22

23 Attribution Attribution Style had greater impact on shorter-term results; skill evident over longer time periods Q3:17 EAFE VALUE CORE GROWTH LARGE SMID GLOBAL 37 EMERGING MARKETS 74 Attribution 1.8% 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% -0.2% International Managers Attribution Versus MSCI EAFE 3Q17 Growth Core Value 1.4% 1.2% 1.0% 0.8% Notable Style Factors Attribution (3Q17) Source (as of 9/30/2017): FactSet, Lipper Skill Style 0.6% 4.0% International Managers Attribution vs. MSCI EAFE (3-Year) 0.4% 0.2% 3.5% 3.0% 2.5% 2.0% 0.0% -0.2% Momentum Beta Market Cap 1.5% 1.0% 0.5% 0.0% Growth Core Value -0.4% Growth Core Value Skill Style Source (as of 9/30/2017): FactSet, Lipper Source (as of 9/30/2017): FactSet, Lipper 23

24 Return Return Currency has significantly impacted results Q3:17 EAFE VALUE CORE GROWTH LARGE SMID GLOBAL 37 EMERGING MARKETS 74 Return 30.0% 25.0% 20.0% 15.0% Currency Impact on International Indices 2017 USD Return 21.6% USD Return 20.5% USD Return 25.8% USD Return 13.9% 15.0% 10.0% Local Currency vs. US Dollar YTD 2017 vs % 5.0% 0.0% ACWI Ex-U.S. EAFE EAFE SC Russell 3000 Local Return Currency Return Source (as of 9/30/2017): MSCI, Bloomberg 5.0% 0.0% -5.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% Currency Impact on International Indices 2016 USD Return 5.0% USD Return 1.5% USD Return 2.6% USD Return 12.7% ACWI Ex-U.S. EAFE EAFE SC Russell % -15.0% -20.0% YTD Local Return Currency Return Source (as of 9/30/2017): MSCI, Bloomberg Source (as of 9/30/2017): MSCI, Bloomberg 24

25 PGIM INVESTMENTS Active Management Review: Fixed Income 25

26 Return (%) Fixed income returns remained positive in 3Q Fixed Income Market Returns Q3: Global HY EM High Yield Global Agg IG Corp Gov't Related Bank Loans MBS US Agg CMBS Global Agg Hedged ABS Treasuries 3Q17 Return (%) 3Q17 Excess Return (%) Source (as of 9/30/2017) : Bloomberg Barclays Higher yielding spread sectors - high yield and EM continued to outperform as spreads tightened. Global fixed income again benefitted from currency moves as the US dollar broadly weakened (DXY was lower by 2.7%). US Treasuries were the worst performing sector. US rates were marginally higher during the quarter, following September spike. For financial professional use only. Not for use with the public. Past performance is no guarantee of future results. The indices mentioned are unmanaged and are provided for informational purposes only; investors cannot directly invest in an index. 26

27 Yield (%) Yield (%) U.S. rates little changed; Yield curve continued to flatten US Yield Curve 10 Year: +2 bps 30 Year: +2 bps 4Q16 3Q17 2Q US Rates Year: +9 bps 1.5 US Election mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr 10 yr 2-10 Spread Source (as of 9/30/17): US Treasury Source (as of 9/3017): US Treasury, FactSet US rates initially moved lower on increased geopolitical concerns, before spiking in September on renewed optimism for tax reform. The US yield curve flattened by 7 bps (as measured by spread between 2 year and 10 year Treasury) as investors anticipated a likely December rate hike. For financial professional use only. Not for use with the public. Past performance is no guarantee of future results. The indices mentioned are unmanaged and are provided for informational purposes only; investors cannot directly invest in an index. 27

28 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 HY/EM Spread (bps) IG Spread (bps) Spread (bps) Spreads continued to grind tighter across all sectors 900 IG/HY/EM Spreads Securitized Spreads HY Spreads EMD IG Spreads ABS MBS CMBS Source(as of 9/30/17): Bloomberg Barclays Source (as of 9/30/17): Bloomberg Barclays Sector Current (bps) 3Q Change (bps) YTD Change (bps) Historical Average Investment Grade Q Change YTD Change Historical Sector Current (bps) (bps) (bps) Average ABS High Yield CMBS Emerging Markets MBS Source (as of 9/30/17): Bloomberg Barclays Source (as of 9/30/17) : Bloomberg Barclays Avg. spreads including credit crisis represent monthly OAS spreads for each respective index through 12/31/2016. Avg. spreads excluding credit crisis represent monthly OAS spreads for each respective index through 12/31/2016 excluding credit crisis (excludes data from 12/2007 to 6/2009), which are defined as the recession beginning & end by the National Bureau of Economic Research. For financial professional use only. Not for use with the public. Past performance is no guarantee of future results. The indices mentioned are unmanaged and are provided for informational purposes only; investors cannot directly invest in an index. 28

29 Active managers posted another strong quarter Intermediate-term bond managers continued to benefit from tighter spreads and marginally higher rates. High Yield and EM results improved after difficult 2 nd quarter. Fixed Income Intermediate High Yield EM World 3Q Fixed Income Intermediate High Yield EM World 1-Year LEGEND > 75% of Managers Beat Index 50% - 75% of Managers Beat Index 25% - 50% of Managers Beat Index < 25% of Managers Beat Index Numbers = Index Percentile Rank Source (as of 9/30/2017): Morningstar, Barclays Capital, BlackRock, Invesco, Vanguard, State Street. Investable ETFs used to measure active manager results. * World Bond: Due to limited investable ETFs that are global, manager results are versus Bloomberg Barclays Global Agg For financial professional use only. Not for use with the public. Past performance is no guarantee of future results. The indices mentioned are unmanaged and are provided for informational purposes only; investors cannot directly invest in an index. 29

30 Avg Active Weight (%) Intermediate Term Bond Managers continue to overweight spread sectors Intermediate 55 Average Active Weight vs Passive ETF IG Corporates EM CMBS ABS High Yield MBS Treasuries % 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00% % % of Managers Overweight (%) Source(as of 9/30/17): Bloomberg Barclays, Morningstar Direct Active managers have consistently been overweight higher yielding sectors in recent years. Managers remain underweight Treasuries and MBS as the Fed signals a December rate hike and plans to reduce balance sheet get underway. For financial professional use only. Not for use with the public. Past performance is no guarantee of future results. The indices mentioned are unmanaged and are provided for informational purposes only; investors cannot directly invest in an index. 30

31 Avg Active Weight (%) Avg Active Weight (%) Intermediate Term Bond Best performing managers had largest U/W to Treasuries and MBS, O/W to High Yield and EM Intermediate 55 US Treasuries and MBS High Yield and EM % of managers underweight 86% of managers underweight % of managers overweight 75% of managers overweight Treasury Agency MBS High Yield EM 1st Quartile 4th Quartile 1st Quartile 4th Quartile Source(as of 9/30/17): Bloomberg Barclays. Morningstar Direct Source(as of 9/30/17): Bloomberg Barclays. Morningstar Direct MBS posted positive excess returns, but underperformed other spread sectors. Fed will begin tapering balance sheet this month, which is likely to weigh on Treasury and MBS markets. High Yield again provided strong total and excess returns as rates remained low and default rates muted. EM has benefitted from strong investor flows amid low developed market rates and improving fundamentals. 31

32 Intermediate Term Bond Managers remain overweight spread sectors, but sentiment shifting given valuations Intermediate 55 US IG US HY Spread Levels Approaching Tights Since August 2000 Tightest Widest Growing number of managers have been reducing corporate bond exposure 50% 15% 35% Increased Decreased EM Debt MBS Source: SIRG Investment Manager Survey, October 2017 Expectations for US credit spreads over the next 12 months CMBS ABS Current Percentile Year End 2015 Source (as of 9/30/17): FactSet Source: SIRG Investment Manager Survey, October

33 Intermediate Term Bond - Median manager has historically outperformed during periods of falling high yield spreads Intermediate 55 3Q active management results were largely in-line with expectations given current high yield spread environment Median manager produced modestly better excess return in 3Q than what has been historically seen in this spread regime Median Active Fund vs. Benchmark (Median Excess Return / Hit Rate of Median Manager) Change in HY Spreads Level of HY Spreads < -49 > 17 Falling Normal Rising > 583 High 0.60 / 89% 0.06 / 33% / 0% Normal 0.21 / 86% 0.02 / 63% / 8% < 393 Low 0.11 / 100% / 41% / 11% HY Spreads and Excess Return of Median Active Manager Beg 3Q HY Spread (bps) 364 End 3Q HY Spreads (bps) 347 Spread Change QoQ (bps) -17 Excess Return of Median Manager (%) 0.03 Source (as of 9/30/16): FactSet, Morningstar Direct Source (as of 9/30/17): FactSet, Morningstar Direct 33

34 Avg Active Weight (%) Avg Active Weight (%) Intermediate Term Bond - Duration impact limited; Curve positioning helped Intermediate 55 ~60% of managers were underweight duration ~93% of managers were underweight 1-3 year maturities 0.40 Active Weight - Duration Active Weight - Maturity 0.20 Managers maintained underweight duration positioning Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 Source(as of 9/30/17): Bloomberg Barclays. Morningstar Direct Underweight positioning a modest tailwind as longer rates inched higher (10 year Treasury: +2bps) Maturity (yrs) Source(as of 9/30/17): Bloomberg Barclays. Morningstar Direct Longer dated debt outperformed during the quarter, as move higher in short rates was more pronounced than in long rates Managers anticipating December rate hike. Inflation continues to undershoot Fed s 2% target. 34

35 Yield (%) Millions of $$ Intermediate Term Bond - Managers positioned for higher rates and Fed taper Intermediate Federal Funds Rate Projections 4,500,000 Federal Reserve Balance Sheet Assets ,000, ,500,000 3,000, ,500, % 2.7% 2.1% 1.4% 2,000,000 1,500,000 1,000, , Dec-99 Dec-02 Dec-05 Dec-08 Dec-11 Dec-14 Dec-17 Dec-20 MBS Treasury Source (as of 9/30/17): FactSet, US Federal Reserve Source (as of 10/11/17): FRED Economic Research 35

36 Spread (bps) Avg Active Weight (%) Excess Return (%) Avg Active Weight (%) High Yield - Managers outperformed as CCCs led way High Yield 63 CCCs marginally outperformed during 3Q IG HY BBB BB B CCC 3Q17 Excess Return (%) YTD Excess Return (%) Source(as of 9/30/17): Bloomberg Barclays, Morningstar Direct Outperforming managers benefitted from Non-US and CCC exposures 1st Quartile 2nd Quartile 3rd Quartile 4th Quartile Non-US Source(as of 9/30/17): Morningstar Direct CCC 1, , , , CCC spread tightening less pronounced in 3Q Overweight duration helped outperforming managers, long dated HY outperformed BB-CCC Spread st Quartile 2nd Quartile 3rd Quartile 4th Quartile Source(as of 9/30/17): Morningstar Direct Source(as of 9/30/17): Morningstar Direct 36

37 Spread (bps) Brent Crude ($$) Average Active Weight (%) Excess Return (%) High Yield - Underweight to energy hurt, but impact limited High Yield 63 Energy was the best returning industry, bouncing back after negative 2Q Basic IndustryCapital Goods Consumer Cyclical 2Q17 Excess Return Source (as of 9/30/17): Bloomberg Barclays Consumer Non-Cyclical 3Q17 Excess Return Energy Energy spreads tightened 63bps as oil prices moved higher Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Technology High Yield managers have reduced underweight in recent months, limiting impact of energy 3Q17 2Q % 20.00% 40.00% 60.00% 80.00% % % of Managers Underweight (%) Source (as of 9/30/17): Bloomberg Barclays, Morningstar Direct 1Q17 1Q17 1Q16 Source (as of 9/30/17): FactSet HY Energy Brent Oil 37

38 Avg Active Weight (%) UK Yield (%) Germany/Japan Yield (%) Yen / $$$ Euro / $$$ World Bond - Hedged strategies struggled on dollar weakness World* 37 Developed market rates volatile, but little changed QoQ Dollar weaker for the quarter, but trend could be turning bps UNCH -2 bps UK 10 Yr (lhs) Germany 10 Yr (rhs) JGB 10 Yr (rhs) Yen/$$ Euro/$$$ Source(as of 9/30/17): Factset Source(as of 9/30/17): Factset Managers with less active duration bets outperformed ~25% (82 of 326) of World Bond strategies are USD Hedged Q17 2Q % Hedged Strategies Above Median (4 of 82) 4.88% 3.31% % Hedged Strategies Below Median (78 of 82) 95.12% 94.69% st Quartile 2nd Quartile 3rd Quartile 4th Quartile % Hedged Strategies Outperforming Benchmark (1 of 82) % Hedged Strategies Underperforming Benchmark (81 of 82) 1.21% 1.81% 98.79% 98.19% Source(as of 9/30/17): Bloomberg Barclays, Morningstar Direct Source(as of 9/30/17): Morningstar Direct 38

39 PGIM INVESTMENTS Active Management Review: Liquid Alternatives 39

40 Quarterly Return (% ) Most Liquid Alternative Funds outperformed bonds Liquid Alternatives Q3:17 CURRENCY DIVERSIFIED ARBITRAGE EQUITY MARKET NEUTRAL EVENT DRIVEN HEDGE FUND TRACKING LONG/SHORT EQUITY MANAGED FUTURES MULTI- ALTERNATIVE NONTRADITIONAL BOND Source (as of 9/30/2017): Morningstar, Russell, MSCI, BoAML Liquid Alternative Funds Q3:17 Net Performance Source (as of 9/30/2017): Morningstar Source (as of 9/30/2017): Morningstar, S&P, Bloomberg Barclays. 60/40: 60% S&P 500 /40% Bloomberg Barclays Aggregate Bond Index (this is a hypothetical portfolio and not representative of any investment). Funds Below Zero Above Zero Above Agg Above 60/40 Above S&P 500 Total Currency: Diversified Arbitrage: Equity Market Neutral: Event Driven: Hedge Fund Tracking: Long/Short Equity: Managed Futures: Multialternative: NTB: Total: 15.1% 9.1% 57.8% 10.0% 8.0% 100.0% 40

41 Disclosures Indices are unmanaged and an investment cannot be made directly into an index. The Russell 3000 Index (R3000) is composed of the 3,000 largest U.S. securities, as determined by total market capitalization. The Russell 3000 Growth Index (R3000G) measures the performance of those Russell 3000 Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell 3000 Value Index (R3000V) measures the performance of those Russell 3000 Index companies with lower price-to-book ratios and lower forecasted growth values. The Russell 1000 Index (R1000) consists of the 1,000 largest securities in the Russell 3000 Index. This large capitalization (market-oriented) index represents the universe of stocks from which most active money managers typically select. The Russell 1000 is highly correlated with the S&P 500 Index. The Russell 1000 Growth Index (R1000G) measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Value Index (R1000V) measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell Top 200 Index (R200) measures the performance of the 200 largest companies in the Russell 1000 Index, which represents approximately 70% of the total market capitalization of the Russell 1000 Index. The Russell Top 200 Growth Index (R200G) measures the performance of those Russell Top 200 companies with higher price-to-book ratios and higher forecasted growth values. The Russell Top 200 Value Index (R200V) measures the performance of those Russell Top 200 companies with lower price-to-book ratios and lower forecasted growth values. The Russell Midcap Index (RMid) measures the performance of the 800 smallest companies in the Russell 1000 Index. The Russell Midcap Growth Index (RMidG) measures the performance of those Russell Midcap companies with higher price-to-book ratios and higher forecasted growth values. The Russell Midcap Value Index (RMidV) measures the performance of those Russell Midcap companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Index (R2000) measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The Russell 2000 Growth Index (R2000G) measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 2000 Value Index (R2000V) measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value weighted index (stock price times number of shares outstanding), with each stock's weight in the Index proportionate to its market value. The value-weighted index represents about 75% of the NYSE market capitalization and 30% of the NYSE issues. The CBOE Volatility Index (VIX) is a measure of the implied volatility of S&P 500 Index options. Often referred to as a fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 day period. The Euro tracks moves in the exchange rate in dollar terms. The Yen tracks moves in the exchange rate in dollar terms. 41

42 Disclosures The MSCI All Country World Index (ACWI) is a market capitalization weighted index composed of companies representative of the market structure of developed and emerging market countries in the Americas, Europe/Middle East, and Asia/Pacific regions. The index is calculated without dividends or with gross or net dividends reinvested, in both U.S. Dollars and local currencies. The MSCI All Country World Ex-U.S. Index (ACWI exus) is a market capitalization weighted index composed of companies representative of the market structure of developed and emerging market countries in the Americas (less the United States), Europe/Middle East, and Asia/Pacific regions. The index is calculated without dividends or with gross or net dividends reinvested, in both U.S. Dollars and local currencies. The MSCI BRIC Index (BRIC) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the following four emerging market country indices: Brazil, Russia, India and China. The MSCI EAFE Index (EAFE) is a free-float adjusted market capitalization index that is designed to measure the equity performance of developed markets, excluding the U.S. & Canada. The MSCI EAFE Index Local Currency (EAFE LCL) is a free-float adjusted market capitalization index that is designed to measure the equity performance of developed markets, excluding the U.S. & Canada using countries local currency. The MSCI EAFE Growth Index (EAFE Growth) consists of the securities within the MSCI EAFE Index that have the highest P/BV ratios (up to 50% of the market capitalization). The MSCI EAFE Index is a market capitalization weighted index composed of companies representative of the market structure of 22 Developed Market countries in Europe, Australasia and the Far East. The MSCI EAFE Value Index (EAFE Value) consists of the securities within the MSCI EAFE Index that have the lowest P/BV ratios (up to 50% of the market capitalization). The MSCI EAFE Index is a market capitalization weighted index composed of companies representative of the market structure of 22 Developed Market countries in Europe, Australasia and the Far East. The MSCI Emerging Markets Index (EM) is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index Local Currency (EM LCL) is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets using countries local currency. The MSCI Frontier Markets Index (Frontier) is a free float-adjusted market capitalization index that is designed to measure equity market performance of frontier markets. The MSCI Frontier Markets Index consists of the following 25 frontier market country indices: Argentina, Bahrain, Bangladesh, Bulgaria, Croatia, Estonia, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Nigeria, Oman, Pakistan, Qatar, Romania, Serbia, Slovenia, Sri Lanka, Tunisia, Ukraine, United Arab Emirates, and Vietnam. 42

43 Disclosures The MSCI Global Value and Growth Indices cover the full range of MSCI Developed, Emerging and All Country Indices across large, mid and small cap size segmentations. They are also cover large and mid cap size segments for the MSCI Frontier Markets Indices. The indices are constructed using an approach that provides a precise definition of style using eight historical and forward-looking fundamental data points for every security. Each security is placed into either the Value or Growth Indices, or may be partially allocated to both (with no double counting). The objective of this index design is to divide constituents of an underlying MSCI Equity Index into respective value and growth indices, each targeting 50% of the free float adjusted market capitalization of the underlying market index. The MSCI EAFE Small Cap Growth and Value Indices (EAFE Small Growth/EAFE Small Value) cover all investable small cap securities with a market capitalization below that of the companies in the MSCI Standard Indices, targeting approximately 14% of each market s free-float adjusted market capitalization, and cover the full range of MSCI Developed, Emerging and All Country Indices. The indices are constructed using an approach that provides a precise definition of style using eight historical and forward-looking fundamental data points for every security. Each security is placed into either the Value or Growth Indices, or may be partially allocated to both (with no double counting). The objective of this index design is to divide constituents of an underlying MSCI Equity Index into respective value and growth indices, each targeting 50% of the free float adjusted market capitalization of the underlying market index. Credit Suisse ( CS ) Leveraged Loan ( LL ) is an index designed to mirror the investable universe of the $US-denominated leveraged loan market. The index inception is January The Bloomberg Barclays Aggregate Bond Index (US Agg Bond) represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage passthrough securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. The Bloomberg Barclays US Credit Index (US Credit): This index is the U.S. Credit component of the U.S. Government/Credit index. The index includes both corporate and non-corporate sectors. The corporate sectors are Industrial, Utility, and Finance, which include both U.S. and non-u.s. corporations. The non-corporate sectors are Sovereign, Supranational, Foreign Agency, and Foreign Local Government. The Bloomberg Barclays US Dollar Emerging Markets Index (EM) includes USD-denominated debt from emerging markets in the following regions: Americas, Europe, Middle East, Africa, and Asia. The Bloomberg Barclays US High Yield Index (US High Yield) covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody s, Fitch, and S&P is Ba1/BB+/BB+ or below. A small number of unrated bonds are included in the index. The index excludes emerging markets debt. The Bloomberg Barclays US Treasury Index (US Treasury) consists of public obligations of the U.S. Treasury maturities ranging from across all issues. 43

44 Disclosures The Bloomberg Barclays US ABS Index (ABS) is the ABS component of the U.S. Aggregate index and consists of securitized loans with the following collateral types: credit cards, autos, home equity loans, manufactured housing, and others. The Bloomberg Barclays US MBS Index (MBS) is the MBS component of the U.S. Aggregate index. The MBS Index covers the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The Bloomberg Barclays Aggregate Global Bond Index (Global Aggregate) provides a broad-based measure of the global investment-grade fixed income markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The index also includes Eurodollar and Euro-Yen corporate bonds, Canadian government, agency and corporate securities, and USD investment grade 144A securities. The Bloomberg Barclays Aggregate Global Bond Hedged Index (Global Agg Hdg) provides a broad-based measure of the global investmentgrade fixed income markets. Currency exposure is hedged to the US dollar. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The index also includes Eurodollar and Euro-Yen corporate bonds, Canadian government, agency and corporate securities, and USD investment grade 144A securities. The Bloomberg Barclays Global Credit Index (Global Credit) contains investment grade and high yield credit securities from the Multiverse Index. (The Multiverse Index is the merger of two index groups: the Global Aggregate Index and the Global High Yield Index.) The investment grade component of the Global Credit Index is a subset of the Global Aggregate Index, and contains credit securities from the U.S. Aggregate, Pan- European Aggregate, Asian-Pacific Aggregate, Eurodollar, 144A, and Euro-Yen indices. The high yield component is a subset of the Global High Yield Index, and contains securities from the U.S. Corporate High Yield, Pan-European High Yield, and Emerging Markets indices. The index is denominated in U.S. dollars. The Bloomberg Barclays Global High Yield Index (Global High Yield) The Global High Yield Index represents the union of the U.S. High Yield, Pan-European High Yield, U.S. Emerging Markets High-Yield, CMBS High Yield, and Pan-European Emerging Markets High Yield Indices. The Global High Yield Index provides a broad-based measure of the global high yield fixed income markets with eligible bonds denominated in USD, EUR, and GBP, as of October The Bloomberg Barclays Global Treasury Index (Global Treasury) tracks fixed-rate local currency sovereign debt of investment grade countries. The three major components of this index are the U.S. Treasury Index, the Pan-European Treasury Index, and the Asian-Pacific Treasury Index, in addition to Canadian, Chilean, Mexican, and South African government bonds. The Bloomberg Barclays CMBS ERISA-Eligible Index is the ERISA-eligible component of the Bloomberg Barclays CMBS Index. This index, which includes investment grade securities that are ERISA eligible under the underwriters exemption, is the only CMBS sector that is included in the Bloomberg Barclays U.S. Aggregate Index. 44

45 Disclosures The Bloomberg Commodity Index (Commodities) is an unmanaged index composed of futures contracts on 19 physical commodities. The index is designed to be a highly liquid and diversified benchmark for commodities as an asset class. The Bloomberg Barclays US TIPS Index (TIPS) consists of Inflation-Protection securities issued by the U.S. Treasury. The FTSE EPRA/NAREIT Global Real Estate Index (Global REIT) Series is designed to represent general trends in eligible real estate equities worldwide. Relevant real estate activities are defined as the ownership, disposure and development of income-producing real estate. The S&P Global Infrastructure Index (Global Infrastructure) is comprised of 75 of the largest publicly listed infrastructure companies that meet specific investability requirements. The index is designed to provide liquid exposure to the leading publicly listed companies in the global infrastructure industry, from both developed markets and emerging markets. The S&P Global Natural Resources Index (Global Natural Resources) is comprised of 90 of the largest publicly traded companies in natural resources and commodities businesses that meet specific investability requirements. The S&P GSCI Crude Oil Spot (Oil) measures the spot price of crude oil. The S&P GSCI Gold Spot (Gold) measures the spot price of gold. The S&P 600 Index consists of 600 domestic small capitalization stocks chosen for market size, liquidity and industry group representation. The S&P500 and S&P 600 Sectors as developed by Standard & Poor's and MSCI Barra according to the Global Industry Classification Standard. GICS consists of 10 sectors, 24 industry groups, 68 industries and 154 sub-industries. 45