Traded on January 27, 2015 For Financial Advisor and Current Client Use Only Morningstar Investment Services, Inc. Contrarian ETF Portfolios Affected Portfolios Contrarian ETF Contrarian & Growth ETF Contrarian & Income ETF We have reallocated the Contrarian ETF portfolios as part of the annual reconstitution of these strategies. To review, the Contrarian ETF portfolios invest in ETFs that mirror the five mostunloved market segments (defined as Morningstar, Inc. categories that have suffered the heaviest outflows of mutual-fund assets) of the past five calendar years. In January of each year, we reconstitute the portfolios to reflect the latest asset-flow data, a process that typically entails adjusting nearly every position that the strategies hold. The reconstitution process is formulaic it involves selling the ETFs representing the mostunloved categories of five years ago (2009 in the case of this reconstitution), buying ETFs mirroring the most-unloved areas of the last calendar year (2014), and adjusting the weightings of the remaining ETFs (2010, 2011, 2012, and 2013). The following table is color-coded to show which categories we sold from (red), added to (green), or adjusted within (blue) the Contrarian portfolio as part of the just-completed reconstitution. 2009 2010 2011 2012 2013 2014 Most- Large Europe Pacific/Asia Mid-Cap Int. Unloved Growth Stock ex-japan Growth Government Bank Loan 2 nd -Most Financial Large Mid-Cap Large Commodities High-Yield Growth Growth Growth Prec. Metals Bond 3 rd -Most Large World Large Small Lat. American Natural Value Stock Growth Growth Stock Resources 4 th -Most Div. World Short Inflation-Prot. Small Health Pacific/Asia Stock Government Bond Growth 5 th -Most Health Large China Interm-Term Mid-Cap Convertibles Blend Region Bond Growth Legend: Positions Sold Weightings Adjusted Positions Added (The Contrarian portfolio invests all of its assets in unloved categories, in the manner shown in the table immediately above. The Contrarian & Growth portfolio splits its assets 50/50 between a sleeve that invests in unloved categories as shown and a second sleeve that invests in widely-
diversified, core stock ETFs. The Contrarian & Income portfolio follows the same approach, but invests its second sleeve in diversified bond, rather than stock, ETFs.) As mentioned, for this reallocation, we exited our positions in the five ETFs representing the most unloved categories of 2009 and added positions in ETFs representing the most unloved of 2014. The five most-unloved categories of 2014 which we define based on the dollar value of outflows (60% of ranking) as well as outflows as a percentage of average net assets (40% of ranking) are as follows: Rank Category Outflows ($B) Outflows as % of Avg. Net Assets Most-Unloved Bank Loan $20,676 14.5% 2 nd -Most High-Yield Bond $15,681 4.8% 3 rd -Most Natural Resources $5,284 10.1% 4 th -Most Small Growth $11,769 6.1% 5 th -Most Mid-Cap Growth $13,443 4.4% Net-net, the reconstitution slightly raised the Contrarian portfolios bond stake, lowered their weightings in U.S. stocks, and slightly boosted their exposure to precious metals and other assets. To illustrate, the table below presents the change in the Contrarian portfolio s stock, bond, and commodities/other weightings before and after the reconstitution. Before* After** Change U.S. Stocks 61.2% 50.5% -10.7% Foreign Stocks 26.5% 26.3% - 0.2% Bonds/Cash 9.8% 19.5% + 9.7% Commodities/Other 2.5% 3.7% +1.2% * Amounts represent target weightings as of January 2014 ** Amounts represent target weightings as of January 2015
To better illustrate the mechanics of this reconstitution, we further decompose the Contrarian ETF portfolio by category to show the weightings changes by unloved year. Again, these changes are purely rules-driven, not based on subjective judgments that we are making. Removing Changing Weightings Adding Category 2009 2010 2011 2012 2013 2014 Tot. Bef. Tot. Aft. Bank Loan - - - - - 3.00% 0.00% 3.00% China - - 1.00% - - - 2.00% 3.00% Comm. Prec. Metals - - - - 1.25% - 2.50% 3.75% Convertible Bond - - - 0.50% - - 1.50% 2.00% Div. Pac-Asia -3.75% - - - - - 3.75% 0.00% Europe Stock - -1.50% - - - - 9.00% 7.50% Financials -6.25% - - - - - 6.25% 0.00% Healthcare -2.50% -0.75% - - - - 7.00% 3.75% High-Yield Bond - - - - - 2.50% 0.00% 2.50% Inflation-Prot. Bond - - - - 1.00% - 2.00% 3.00% Interm.-Term Bond - - - - 0.50% - 1.00% 1.50% Intermediate Govt. - - - - 1.50% - 3.00% 4.50% Large Blend - -0.50% - - - - 3.00% 2.50% Large Growth -7.50% -1.25% 2.00% 1.25% - - 22.75% 17.25% Large Value -5.00% - - - - - 5.00% 0.00% Latin America Stock - - - - 0.75% - 1.50% 2.25% Mid-Cap Growth - - 2.50% 1.50% - 1.00% 9.50% 14.50% Natural Resources - - - - - 2.00% 0.00% 2.00% Pacific Asia ex- Japan - - 3.00% - - - 6.00% 9.00% Short Government - - - 0.75% - - 2.25% 3.00% Small Growth - - - 1.00% - 1.50% 3.00% 5.50% World Stock - -1.00% 1.50% - - - 9.00% 9.50% As shown in the chart above, the reconstitution removes the positions associated with the most-unloved categories of 2009, adds positions for the most-unloved categories of 2014, and alters the weightings of the positions associated with the most-unloved categories of 2010, 2011, 2012, and 2013. These weightings changes are purely formulaic, as spelled-out in the methodology document that we published in launching the portfolios in 2010. (That methodology document can be found on our website.)
The following section details the net change to each position in the Contrarian portfolios: Contrarian Series Changes N New ishares iboxx $ High Yield Corporate Bd Unloved Class of 2014 N New Powershares Senior Loan Unloved Class of 2014 N New ishares Global Materials Unloved Class of 2014 ] Increase Vanguard Mid-Cap Growth ETF Unloved Class of 2011-2012, 2014 ] Increase Vanguard Small-Cap Growth ETF Unloved Class of 2012, 2014 ] Increase ishares Agency Bond Unloved Class of 2013 ] Increase ishares Gold Trust Unloved Class of 2013 ] Increase ishares TIPS Bond Unloved Class of 2013 ] Increase ishares MSCI Brazil Capped Unloved Class of 2013 ] Increase ishares Vanguard Total Bond Market ETF Unloved Class of 2013 ] Increase PIMCO 1-3 Year U.S. Treasury ETF Unloved Class of 2012 ] Increase SPDR Barclays Convertible Securities Unloved Class of 2012 ] Increase Vanguard Total World Stock ETF Unloved Class of 2010-2011 ] Increase ishares MSCI All-Country Asia ex-japan Unloved Class of 2011 ] Increase SPDR S&P China Unloved Class of 2011 [ Decrease Vanguard Growth ETF Unloved Class of 2009-2012 [ Decrease Vanguard Healthcare ETF Unloved Class of 2009-2010 [ Decrease Vanguard FTSE Europe ETF Unloved Class of 2010 [ Decrease Vanguard S&P 500 ETF Unloved Class of 2010 M Replace Vanguard Financials ETF Unloved class of 2009 M Replace Vanguard Value ETF Unloved class of 2009 M Replace Vanguard FTSE Pacific ETF Unloved class of 2009
For Financial Advisor and Current Client Use Only This communication is for Morningstar Investment Services clients ONLY. It contains important information about their investment advisory account. Opinions expressed are as of the current date; such opinions are subject to change without notice. Morningstar Investment Services shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. Neither diversification nor asset allocation ensure a profit or guarantee against a loss.