Parametric Emerging Markets: A Third Way of Emerging Markets Investing

March 2018 Tim Atwill, Ph.D., CFA Head of Investment Strategy Parametric Emerging Markets: A Third Way of Emerging Markets Investing There s an alternative. There s always a third way, and it s not a combination of the other two ways. It s a different way. -David Carradine The emerging markets equity asset class has experienced great growth over the last 25 years, as perceptions of these developing economies has moved from skepticism to a well-established appreciation for their contribution to global economic growth. Accordingly, an asset class that was once considered the realm of the courageous (or foolhardy) is now considered a key part of many investors portfolios. However, investors have learned that they are put between a rock-and-a-hard place. Active strategies are challenged by high transaction costs and low liquidity, while passive solutions create poorly constructed portfolios that are concentrated in the most developed of the emerging market countries. Parametric 1918 Eighth Avenue Suite 3100 Seattle, WA 98101 T 206 694 5575 F 206 694 5581 www.parametricportfolio.com The Parametric Emerging Markets strategy, outlined in this paper, is designed to efficiently and consistently capture the long-term growth of this asset class, avoiding both the return risks inherent in active management and the concentration risks of the mainstream emerging markets indexes. With nearly $12 billion in assets under management, this strategy has enjoyed great success over the past 19 years, and has demonstrated higher returns with lower volatility than the mainstream emerging market indices.

Introduction Emerging market equities are now firmly established as a dedicated asset class. Portfolio flows have increased as investors continue to respond to the attractive opportunities presented by the relatively immature economies comprising this asset class. A large portion of these flows has been directed to traditional active investment styles. These strategies rely upon in-depth research of countries and securities in order to identify tactical or short-term opportunities. Conventional wisdom states that because these are the world s most inefficient equity markets, quality research should create information advantages and enhance performance. However, investors in such strategies incur higher implementation costs while bearing significantly greater risks (as measured by higher portfolio volatility or as active risk versus a benchmark). In addition, active managers tend to concentrate their holdings in the larger, more established emerging market countries due to their improved liquidity profile. These country concentrations add further to tracking error considerations, and to the extent such countries are less emerging in nature, may leave investors short of their strategic goals. On the other end of the spectrum, there are substantial assets held in indexed portfolios that are designed to track the capitalization-weighted indexes compiled by MSCI and other index providers. Although management fees and implementation costs tend to be lower in this approach, investors must fully embrace both the positive and negative aspects of passive-index investing. In particular, similar to the active solutions, indexes based upon market capitalization tend to exhibit sizeable concentrations in the largest countries. For example, more than half of the MSCI Emerging Markets Index is currently held within its largest three country constituents (China, Taiwan, and Korea). While these concentrations are troubling enough, further consideration reveals that these countries are among the most developed of the emerging markets. For an investor seeking exposure to truly emerging economies, these passive solutions may run counter to their investment rationale. Because of these concentration issues, passive solutions are viewed by many as less than optimal. In this paper, we argue for a long-term core holding to the emerging markets asset class employing a third investment approach, distinct from both passive and active: a disciplined, rulesbased, engineered approach. Our strategy emphasizes diversification and rebalancing, while avoiding active country or security bets, and the use of return forecasts. Unlike many active strategies, this approach seeks to provide the strategic benefits investors desire, by maintaining a consistent, broad exposure to a wide range of emerging and frontier market countries, while minimizing trading in the high-cost environments inherent in these markets. Further, unlike numerous passive strategies, this approach avoids the consequences of concentration, and it holds material weights in many of the lesser-known emerging market countries, as well as a large number of the even less developed frontier market countries. Parametric s research and experience indicate that such an approach improves upon, and serves as a complement to, both active and passive strategies. Below, we present arguments to support the thesis that the emerging markets asset class is well suited to an engineered portfolio management approach. This technique incorporates ideas such as target country weights, systematic rebalancing and a diversified exposure at the sector and security level. We first examine the key characteristics of the asset class. Then we show how our approach seeks to address the associated challenges posed by these characteristics, in order to provide a more powerful core exposure to emerging markets equities. 02

Characteristics of the Emerging Markets Equity Asset Class Concentrated Benchmarks: The most striking aspect of the MSCI Emerging Markets Index is its high level of concentration and variability in country weights. Over the past 20 years, eight different countries have at one point risen to occupy more than 10% of the index weight. Though concentration has fallen since 1988, when Malaysia alone accounted for more than half of the index, the level of concentration remains quite high. In December 2017, the top three countries accounted for more than 55% of the MSCI Emerging Markets Index, and the top eight countries accounted for more than 85%, as shown in Figure 1. Figure 1: Emerging Market Capitalization Weights, December 2017 Mexico 2.9% Russia 3.3% Indonesia 2.2% Thailand 2.3% Malaysia 2.4% Brazil 6.8% Poland 1.3% Chile 1.3% Philippines 1.1% Other 4.1% China 29.7% South Africa 7.1% India 8.8% Taiwan 11.3% South Korea 15.4% Source: MSCI as of 12/31/2017. High Volatility: Emerging and frontier market investments have a well-earned reputation for being risky, experiencing high levels of volatility even over very short time periods. This volatility results from such factors as political risk, global central bank actions, and inconsistent levels of information quality. All of these factors can cause rapid re-evaluations of the opportunities presented by an emerging market security, sector or country. Combined, these factors result in much higher volatility than that observed in the capital markets of most developed nations. For example, as shown in Figure 2, for the five years ending December 2017, the volatility of the MSCI Emerging Markets Index was 14.40%; over the same period, the S&P 500 Index and MSCI EAFE Index volatilities were 9.49% and 11.67%, respectively. 03

Figure 2: Annualized Standard Deviations: 5 Years Ending December 2017 Greece Brazil Egypt Turkey Colombia Russia Hungary Qatar Peru Pakistan South Africa Indonesia Poland Czech Republic Chile China India Philippines South Korea Mexico Thailand Malaysia Taiwan MSCI EM Argentina Nigeria Kazakhstan Vietnam Kenya Sri Lanka Slovenia Romania Bangladesh Bahrain Jordan Croatia Kuwait Morocco Oman Mauritius MSCI Frontier 20.75 20.39 19.77 19.66 19.26 18.16 17.20 16.27 15.58 15.37 14.01 13.49 11.89 11.46 Source: Parametric, MSCI, S&P as of 12/31/2017. 41.96 32.23 29.53 27.53 26.14 25.61 23.72 21.94 21.61 20.90 20.75 20.74 20.39 19.60 Emerging Market Countries 19.22 18.54 17.97 16.39 16.33 16.27 16.10 14.83 12.31 14.40 28.80 27.14 Low correlations: Emerging markets exhibit meaningful diversification due to relatively low correlations between emerging market countries. The individual emerging market countries represent a set of disparate domestic economies that share very little in terms of return drivers with other emerging market countries. Indeed, their lack of integration into the global economy accounts for part of their lack of correlation with other countries, both emerging and developed. Unlike the equity markets of developed countries, in which global economic variables create a commonality to return patterns across countries, there is little that connects the economy of, say, Peru and Hungary. The factors that lower correlation in the emerging markets tend to be even more pronounced within frontier market countries, given their relatively domestically-focused companies and lower economic integration into the global marketplace. Because of this, emerging markets overall exhibit very low cross-correlations, as shown in Figure 3. 39.17 Frontier Countries 0 10 20 30 40 50 04

Figure 3: Average Cross Correlations, 5 years ending December 2017 0.7 0.6 0.58 0.5 0.4 0.3 0.2 0.24 0.1 0 EM & Frontier Source: Parametric, MSCI as of 12/31/2017. Developed Inconsistent Data Quality: The quality of data and information in emerging market countries is often lacking or inconsistent by developed market standards. For example, in developed equity markets, accounting transparency, regulatory conditions and established public exchanges allow a clear picture of a company s economic condition, ensures such information is shared with all market participants, and historical price movements are readily available, and reliable. Often, this is not the case in emerging equity markets. Accounting standards are lax and not well enforced, critical company information may not be well distributed, and exchange price histories are neither available nor reliable. In addition, recent history has shown that even many official government statistics are open to manipulation and political influence. Because of this, investors may find it impossible to verify individual company metrics, or to have confidence that projections based on this information are valid. In this uncertain data environment, many traditional security and market selection models become noisy and less effective. High Transaction Costs: The cost to execute transactions in emerging markets is high and liquidity is often challenged. On average, trading costs for emerging market equities are approximately three times those of developed international markets and five times those of the United States. Total agency costs range between 15 and 75 basis points and bid/ask spreads can be as high as two percent. The magnitude of these transaction costs can create a significant hurdle for an active management process to generate and deliver value. That is, an alpha signal must generate outperformance net of trading costs in the range of 100-150 basis points. Parametric Emerging Markets: A Disciplined Approach to Emerging Markets Investing As the prior section describes, investors who seek to actively participate in emerging markets investing must navigate a world of high individual country volatility, relatively poor information, and extreme transaction costs. Furthermore, while emerging market cap-weighted indexes offer some cost relief, they present concentration risks that may run counter to many investors interests. As an alternative, we developed the Parametric Emerging Markets strategy as an approach that applies common-sense heuristics to address the aforementioned issues. What results is an exposure that is more thoughtfully constructed than many broad-based indexes designed 05

to capture systematic returns, while generating an alpha that does not rely on forward looking estimates of relative value or market timing. The Parametric Emerging Markets strategy is informed by the following foundational elements. Diversify at the Country Level & Include Frontier Markets: Because the systematic risk of each country is the dominant factor in explaining security returns, selecting and weighting countries (as opposed to selecting specific securities) is the most crucial determinant of investment success in any diversified emerging market strategy. While individual country returns can be highly volatile, a portfolio built to emphasize diversification can dampen this volatility at the portfolio level. In this pursuit, the Parametric Emerging Markets strategy employs a broad selection of emerging market countries, each with an associated target weight that enforces diversification at the portfolio level. We further diversify the portfolio by adding non-index, frontier market countries. The distinction between frontier and emerging is somewhat arbitrary, and the investment thesis for investing in both is quite similar: to tap the growth potential of developing economies. We do not add frontier market countries because of a belief that they will outperform emerging market countries. Rather, we observe that the addition to the portfolio of lowly correlated countries, with similar return characteristics, results in a lower volatility portfolio with higher expected long-term returns. Absent an active view regarding the future prospects for an individual country, the most diversified portfolio is one comprised of an equally-weighted basket of all countries. As these countries exhibit a wide range of liquidity conditions, ranging from the large, liquid countries (e.g. Brazil and China) down to the small, less liquid frontier market countries (e.g. Kazakhstan), we employ a tier system to group together those countries with similar liquidity conditions (assigned by market size and liquidity). Figure 4 shows the current country membership and target weight of each tier. By reflecting the lower liquidity condition of smaller, less-liquid countries with lower target weights, we balance real-world implementation concerns with the theoretical benefits achieved by holding a more diversified portfolio. As a result, our portfolio will have greater exposure to the medium- and small-sized countries in the emerging and frontier markets, and less exposure to the largest countries, relative to the index. Figure 4 also lists the current transition countries for the strategy, those countries for which we are not currently able to consistently maintain a Tier 4 target weight. These include countries recently added to the portfolio, but still in the process of having their positions built out to a full Tier 4 weight, as well as those previously fully investable countries where liquidity conditions have deteriorated. As these latter countries still act to diversify the portfolio, they are maintained in those portfolios in which they exist, but they may not be included in any newly funded portfolios. Figure 4: Parametric Emerging Markets Strategy Country Tiers Membership Target Weights Tier 1+ China 10.53% Tier 1 Brazil, India, Mexico, Russia, South Africa, South Korea, Taiwan 6.02% Tier 2 Chile, Indonesia, Malaysia, Philippines, Poland, Thailand, Turkey 3.01% Tier 3 Colombia, Greece, Kuwait, Pakistan, Peru, Qatar, U.A.E. 1.50% Tier 4 Transition Countries Argentina, Bahrain, Bangladesh, China - Shanghai, China - Shenzhen, Croatia, Czech Republic, Egypt, Hungary, Jordan, Kazakhstan, Kenya, Mauritius, Morocco, Nigeria, Oman, Romania, Saudi Arabia, Slovenia, Sri Lanka, Vietnam Botswana, Bulgaria, Estonia, Ghana, Latvia, Lebanon, Lithuania, Panama, Tunisia Source: Parametric as of 12/31/2017. 0.75% No fixed targets 06

Regarding the tier assignment for China, this is based on tracking error considerations relative to the MSCI Emerging Markets Index. Due to its large underweight, China would contribute a material part of the tracking error of the strategy if it was assigned its natural tier target weight. While we wish to reduce this tracking error concentration, we attempt to balance this desire with our primary goal of absolute diversification. We do this by creating a specific tier for China, which allows a 100% increase to the weight it would normally be assigned in our model, thus reducing its contribution to active risk. This is currently spread across three countries listed in Figure 4 (China, China-Shanghai, China-Shenzhen). This allocation further diversifies our China exposure between the mainland exchanges and those securities available for investment on offshore exchanges (e.g. Hong Kong, New York, London). Diversify at the Sector Level: Once we have specified a set of country target weights, the majority of the strategy s expected tracking error is determined, due to the importance of country in the risk profile of a diversified emerging markets portfolio. However, within each country, we also utilize a systematic approach to emphasize economic sector diversification. Our process sets sector-level target weights in each country in an attempt to move closer to an equal representation from each economic sector, while taking into account practical liquidity considerations. As an example, Figure 5 depicts the target sector weights for the Philippines versus the current market-cap weights (as represented by the S&P Emerging Plus BMI Index). Figure 5: Example of Within Country Sector Diversification: Philippines Sector S&P Emerging Plus BMI Strategy Model Weight Industrials 27.2% 16.6% Financials 25.7% 15.7% Real Estate 19.9% 13.6% Consumer Staples 6.9% 13.6% Utilities 6.0% 12.0% Consumer Discretionary 5.0% 10.0% Telecommunication Services 4.1% 8.2% Materials 2.6% 5.2% Energy 2.1% 4.1% Information Technology 0.5% 1.0% Health Care 0.0% 0.0% Sector constraints for Philippines: Minimum:.5x index weight Maximum: 2x index weight Source: Parametric as of 12/31/2017. Similar to our process of selecting country target weights, we note that this systematic sector approach ensures a more balanced position across all major economic sectors within a given country, which can further enhance performance and reduce concentration risk. Diversify at the Stock Level: Once the country and sector weight have been determined, we set security-level targets within each country/sector combination via the market capitalization weights of the S&P Emerging Plus BMI Index. That is, once we have determined the target weight for the country, and then further determined the sector weights within the country, we populate this country/sector allocation by setting security targets equal to the market capitalization weights of the securities within this country/sector. Note that these will differ from the pure market capitalization weights of the index, due to our country and sector reweighting decision. 07

1 For example, Volatility Harvesting: Why Does Diversifying and Rebalancing Create Portfolio Growth? Paul Bouchey, Vassilii Nemtchinov, Alex Paulsen, and David Stein. Journal of Wealth Management (Fall 2012). We have determined that these security targets are appropriate, as they provide a proxy for the liquidity of the individual stocks. We view individual stocks simply as exposure units. If an indicated stock within a country/sector combination is unavailable, we move on to the next available security in the same country/sector combination. Overall, our goal is to represent the country s sector exposure in a relatively diversified security portfolio and, because of this, the choice of which specific securities are used to achieve this goal is not critical to our investment process. In our quest for security diversification, we employ the amalgamation of three S&P indexes as our universe for stock selection: S&P Emerging Plus BMI, S&P BMI Frontier, and S&P BMI Saudi Arabia. This results in the strategy holding stocks that are further down the market capitalization structure than those represented by the MSCI Emerging Markets Index. That is, the index represents larger market capitalization stocks, while the S&P indexes reflect an all capitalization universe. Similar to our addition of frontier markets at the country level, this expansion of the security universe is not driven by any belief that small- and mid-cap stocks will outperform over the long term. Instead, this is motivated by our belief that tempering the impact of idiosyncratic risk within the portfolio allows the benefits of country- and sector-level diversification to accrue more prominently at the total portfolio level. Because of this, the Parametric Emerging Markets strategy tends to hold 1000-1600 separate securities, with few positions accounting for more than 50 basis points of the total portfolio. Diversify, Diversify, Diversify: To reiterate, all of the above diversification decisions serve two purposes. First, they seek to lower overall portfolio volatility, which, in turn, increases the expected value of compounded portfolio returns. Second, they align with the growth-seeking goal of many emerging market allocations. By maintaining target exposures across a broad range of countries and sectors, we ensure that the portfolio participates in an emerging market country s rapid growth, regardless of where this growth arises. Additionally, downside risk is mitigated by not allowing concentrations to build within the portfolio at the country, sector, or stock level. Systematic Rebalancing: The academic literature is rich with examinations of incremental portfolio return that can be harvested through the use of target weights and disciplined rebalancing. 1 Theoretically, this rebalancing alpha is a function of the volatility and correlation of asset class constituents; and the amount of rebalancing opportunities increasing directly with the volatility, and inversely with the correlation, of the asset class members. By systematically selling when prices rise and buying when they fall, rebalancing can be viewed as simply exploiting the volatility of an asset class. However, volatility alone will not drive rebalancing returns. If all assets in a portfolio are both highly volatile and highly correlated, few rebalancing opportunities will arise, as all positions would tend to move in concert. As correlation decreases, the volatility characteristics become more intrinsic to each member of the portfolio, thus creating more rebalancing opportunities. That is, the potential for a rebalancing alpha depends on both the volatility and correlation characteristics of an asset class. As noted above, the emerging markets asset class is characterized by both relatively high levels of volatility and low levels of correlation at the country level. Because of this, the expected rebalancing alpha achieved through establishing fixed target weights and a welldefined rebalancing mechanism at the country level should be meaningful. Importantly, this potential return enhancement is achieved without forward-looking, relative-value views of the various countries. Instead, it relies on a sensible set of diversifying target weights paired with a disciplined rebalancing process to exploit the natural volatility and correlation properties of the emerging markets equity asset class. In this way, the underlying volatility of the asset class is transformed from a source of risk into a potential additional source of return. 08

In the Parametric Emerging Markets strategy, our rebalancing process incorporates a system of rebalancing triggers. Rebalancing trades are only initiated once a country s portfolio position exceeds a predetermined deviation from its target weight. When this occurs, the entire portfolio is not traded. Instead, only the country exceeding its trigger is pared back to its target weight, and the resulting capital is deployed to the most underweighted positions, so as to bring them closer to their target weights, as illustrated in Figure 6. Figure 6: Trigger-Based Rebalancing Example Rebalancing Trigger % Weight in Portfolio Source: Parametric. Our rebalancing triggers are set on a country-level basis, and reflect the implementation realities of the particular markets. While we seek a rebalancing alpha, this benefit could be diluted if country-level trading costs are not recognized. Accordingly, we group countries by their level of trading costs, setting larger thresholds for those countries with higher trading costs. That is, for those countries with high transaction costs, we wish to defer rebalancing until the benefit from a rebalancing trade is materially higher than the costs required to implement it. Figure 7 shows the current assignment of rebalancing triggers by country, expressed as a percentage of each country s target weight. Figure 7: Parametric Emerging Markets Strategy Rebalancing Triggers Trigger 20% Trigger 30% Trigger Membership Argentina, Brazil, China, China - Shanghai, China - Shenzhen, India, Mexico, Russia, South Africa, South Korea, Taiwan Czech Republic, Hungary, Indonesia, Malaysia, Peru, Philippines, Poland, Saudi Arabia, Thailand, Turkey 40% Trigger Chile, Colombia, Egypt, Greece, Kuwait, Pakistan, Qatar, U.A.E. 50% Trigger 50% Downside Trigger All Countries Source: Parametric as of 12/31/2017. Countries Bahrain, Bangladesh, Croatia, Jordan, Kazakhstan, Kenya, Mauritius, Morocco, Nigeria, Oman, Romania, Slovenia, Sri Lanka, Vietnam Minimize Trading Costs: To the extent we can maintain a diversified portfolio without incurring the relatively high transaction costs present in this asset class, we would prefer to do so. That is, we find that a strategy with a low turnover has an inherent advantage in alpha generation, due to the fierce headwinds that trading costs present in this space. 09

Accordingly, we limit trading to those events where such transaction costs can be justified. This belief in minimizing transaction costs informs the setting of the above rebalancing triggers, but is also embedded in many of our implementation decisions. For example, if there are flows into and out of the portfolio, we will use them to rebalance the portfolio by buying exposures that are below target, or selling exposures that are above target. By doing so, we potentially forestall an expensive future rebalancing trade. Because of this attention to trading costs, our strategy has historically enjoyed turnover rates in the 5-15% range, compared with many active managers that can have turnover rates in the 40-60% range. Implementation: In the above discussion, we have laid out many of the rules and construction techniques used in the Parametric Emerging Markets strategy. While these provide a perspective on how we intellectually approach investing in the emerging markets asset class, we would also like to highlight the importance of the implementation component to our strategy. Parametric has a long history of trading in the emerging markets, with almost twenty years dealing with the various idiosyncrasies encountered in developing countries. This history has given us unparalleled experience with the liquidity-challenged marketplaces of emerging and frontier countries. We have learned how to work orders so that they do not overly impact prices, and to transact in a way that does not exacerbate the unique liquidity conditions we encounter on a day-to-day basis. In addition, we have built out a complex set of trading and portfolio management systems and processes to help us smoothly manage and trade in over 1500 securities across 50 emerging and frontier countries. Without this implementation expertise, much of the benefits springing from our portfolio construction would be lost to excessive trading costs and price impacts. Historical Results for Parametric Emerging Markets To empirically demonstrate the effectiveness of the above approach, we present in Figure 8 the historical results for the Parametric Emerging Markets strategy for the eighteen years ending December 31, 2017. The strategy is notable for its consistency in outperforming the benchmark (the MSCI Emerging Markets Index). Figure 8: Parametric Emerging Markets Strategy Historical Results, by Calendar Year 2017 2016 2015 2014 2013 2012 2011 2010 2009 Emerging Markets Composite (Net) 27.60% 12.80% -16.08% -3.66% 1.87% 19.72% -18.66% 23.32% 68.88% Emerging Markets Composite (Gross) MSCI Emerging Markets Index (Net Dividends) 28.50% 13.68% -15.42% -2.91% 2.67% 20.63% -18.06% 24.21% 70.07% 37.28% 11.19% -14.92% -2.19% -2.60% 18.22% -18.42% 18.88% 78.51% Excess Returns (Gross) -8.78% 2.49% -0.51% -0.72% 5.27% 2.41% 0.36% 5.33% -8.44% 2008 2007 2006 2005 2004 2003 2002 2001 2000 Emerging Markets Composite (Net) -51.01% 40.56% 38.60% 34.44% 32.28% 63.65% 2.05% 0.44% -28.75% Emerging Markets Composite (Gross) -50.69% 41.29% 39.23% 35.05% 32.87% 64.39% 2.51% 0.89% -28.43% MSCI Emerging Markets Index (Net Dividends) -53.33% 39.42% 32.14% 34.00% 25.55% 55.82% -6.17% -2.62% -30.83% Excess Returns (Gross) 2.64% 1.87% 7.09% 1.05% 7.32% 8.57% 8.68% 3.51% 2.40% Source: Parametric, MSCI as of 12/31/2017. 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. Please refer to the Disclosure included on page 12 for important additional performance information. Composite performance presented for periods prior to January 1, 2000 does not comply with the GIPS standards. It is not possible to directly invest in an index. Indexes are unmanaged and do not reflect the deduction of fees or expenses. Past performance is not indicative of future returns. 10

The strategy s outperformance versus the benchmark is noteworthy; of equal interest is the fact that the Parametric Emerging Markets strategy accomplishes this while consistently demonstrating lower volatility than the MSCI Emerging Markets Index, as shown in Figure 9. Figure 9: Rolling 36-Month Volatility (Annualized), MSCI Emerging Markets Index Versus Parametric Emerging Markets Strategy 35% 30% 25% 20% 15% 10% Jun-01 Dec- 01 Jun-02 Dec- 02 Jun-03 Dec- 03 Jun-04 Dec- 04 Jun-05 Dec- 05 Jun-06 Dec- 06 Jun-07 Dec- 07 Jun-08 Dec- 08 Jun-09 Dec- 09 Jun-10 Dec- 10 Jun-11 Dec- 11 Jun-12 Dec- 12 Jun-13 Dec- 13 Jun-14 Dec- 14 Jun-15 Dec- 15 Jun-16 Dec- 16 Jun-17 Dec- 17 EM Composite MSCI EM Source: Parametric, MSCI as of 12/31/2017. Our experience to date provides confirmation that the tenets of diversification and rebalancing are applicable to the emerging markets asset class. The strategy s outperformance is not driven by being smarter than the market, it is a result of building a better exposure to the emerging markets equity asset class. This is due not simply to the portfolio construction rules, but also to the high level of discipline and consistency surrounding implementation. The strategy has been engineered to broadly capture the outsized growth potential of developing economies, while seeking to generate additional returns by exploiting the volatility and correlation properties of the emerging markets equity asset class. Conclusion This strategy has enjoyed great success for more than 18 years, demonstrating higher returns with lower volatility than most mainstream emerging market indices. Importantly, this investment success has not been the result of episodic occurrences of exceptional performance. Instead, the outperformance has been relatively consistent, persisting across a variety of market environments. An interpretive analysis of performance affirms this investment thesis: systematic emphasis on smaller emerging markets and under-represented economic sectors realizes greater portfolio diversification; a highly controlled rebalancing discipline captures profits from volatility and low correlations; and low portfolio turnover protects against significant trading costs and taxes. The systematic strategy outlined in this paper is designed to allow an investor to efficiently participate in the positive attributes and long-term growth potential of the emerging markets equity asset class in a consistent and replicable basis without incurring the return risk that comes with an active fundamental approach or the concentration risk of mainstream capitalization-weighted indexes. 11

Disclosure Parametric Portfolio Associates LLC ( Parametric ), headquartered in Seattle, Washington, is registered as an investment adviser with the U.S. Securities and Exchange Commission under the Investment Advisers Act of 1940. Parametric is a leading global asset management firm, providing investment strategies and customized exposure management directly to institutional investors and indirectly to individual investors through financial intermediaries. Parametric offers a variety of rules-based investment strategies, including alpha-seeking equity, alternative and options strategies, as well as implementation services, including customized equity, traditional overlay and centralized portfolio management. Parametric is a majority-owned subsidiary of Eaton Vance Corp. and offers these capabilities through investment centers in Seattle, WA, Minneapolis, MN and Westport, CT. This material may not be forwarded or reproduced, in whole or in part, without the written consent of Parametric Compliance. Parametric and its affiliates are not responsible for its use by other parties. Parametric is divided into two divisions: 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, 2000. To receive a copy of a GIPS compliant presentation and/or a list of composite descriptions, please contact the Firm at 206.694.5575. The Emerging Markets Composite is comprised of all fully discretionary accounts that seek long-term capital appreciation by primarily investing in equity securities of companies located in emerging and frontier market countries. The investment process emphasizes broad exposure and diversification across countries, economic sectors and issuers. The Emerging Markets Equity Composite was created in December, 2013 and the inception date is July, 1998. The Composite is compared to the MSCI Emerging Markets Index (the Index ). The Index is broad-based and is commonly used as a measure portfolios managed in this style. The Index uses withholding tax rates applicable to a Luxembourg-domiciled investor. 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. For the period 7/1/98-12/31/98, the Index was calculated using gross dividends without consideration of taxes. Thereafter the Index is calculated using dividends net of taxes. Performance results are expressed in U.S. dollars. Portfolio returns reflect the reinvestment of dividend and interest income. Composite gross returns are after transaction costs, any foreign withholding taxes and other direct expenses, but before management fees, custody charges and other indirect expenses. Composite net returns are calculated by using the actual management fees when known. For portfolios within the composite that actual fees are not known or available then the highest standard composite fee schedule is used. The current management fee schedule for Composite portfolios is as follows: Separate Account: First $150M: 0.80%; Next $150M: 0.70%; Thereafter: 0.65%. Performance presented prior to January 1, 2000 has been linked to compliant performance and is shown as supplemental information. 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 is not indicative of 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 herein. 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 website 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. Benchmark/index information provided is for illustrative purposes only. Investors cannot invest directly in an index. Indexes are unmanaged and do not reflect the deduction of management fees or other expenses. 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. MSCI is a registered trademark of MSCI Inc. Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. Please refer to the specific service provider s website for complete details on all indices. Global market investing, (including developed, emerging and frontier markets) carries additional risks and/or costs including but not limited to: political, economic, financial market, currency exchange, liquidity, accounting, and trading capability risks. Future investments may be made under different economic conditions, in different securities and using different investment strategies. The currency used in all calculations is the U.S. dollar. Currency exchange may negatively impact performance. Parametric is headquartered at 1918 8th Avenue, Suite 3100, Seattle, WA 98101. For more information regarding Parametric and its investment strategies, or to request a copy of Parametric s Form ADV, please contact us at 206.694.5575 or visit our website, www.parametricportfolio.com 17991 3.7.18 12