MUTUAL FUND DUE DILIGENCE Presented to FIRMA By

MUTUAL FUND DUE DILIGENCE Presented to FIRMA By

MUTUAL FUND DUE DILIGENCE Presented to FIRMA By R. James Hrabak, CFA March 28, 2012 About the Presenter 2 R. James Jim Hrabak is Chief Investment Officer for MB Financial Banks Asset Management & Trust Group, where he is responsible for over $3 billion in assets under administration and nearly $1.8 billion in assets under management. His team of three Portfolio Managers and five Securities Analysts specialize in asset allocation, portfolio construction, and security selection for individual and institutional clients. Jim received a BBA., double majoring in Finance and Economics, from New Mexico State University, an MBA with a concentration in Financial Management from the University of New Mexico, and is also a Chartered Financial Analyst. Jim is a member of the CFA Institute as well as the CFA Society of Chicago. General Items to Consider (Before Designing a Due Diligence Program) 3 What is Our Investment Philosophy? In-House Management vs. Outside Expertise Active vs. Passive Management Mutual Funds vs. ETFs How Much Style Drift is Tolerable? Special Note: All of the above should be greatly influenced by your firms investment management resources. The Importance of an Investment Philosophy 4 Is your philosophy a known commodity? Why is philosophy important? Due Diligence Program (and all investment functions) should reflect your firms investment philosophy Dont have a clearly articulated philosophy? The items to consider on the previous slide can serve as a guide for creating one. In-House Management vs. Outside Expertise 5

The 1992 restatement of the Prudent Investor Act: Allows delegation of investment management States that investments should be viewed in the context of the total portfolio Risk/return tradeoff is the central consideration Firms are essentially required to seek out expertise in investment areas that improve the risk/return tradeoff in their clients portfolios Firms should carefully evaluate what they can do in-house versus what they should hire outside expertise to perform Investing in a mutual fund (or an ETF ) is a form of hiring outside expertise Firms should balance what they can competently and effectively perform inhouse with using outside managers to complete a diversified portfolio 6 Alpha Virtually Generation guaranteed to ActiveLabor vs. Passive Management Intensive underperform Cons benchmarks Pros Pros Tracking error Less ability to Differentiate differentiate IM Active through Management Passive Management process investment Low Labor performance Commitment Higher cost Cons The decision Differentiate between active and passive is not a zeroLess emphasis sum through game. A combination of the two may be optimal. on performance manager

Barbell risk in lower-alpha categories Low such as LC Equity Cost selection Using index funds for high-volatility asset classes such as commodities 7 Growing management market Redemption Selecting Types of Management Vehicles Drawing fees are positive media possible attention Large Universe Cons Cons Tactical trading Higher expense Exchange Traded Mutual Funds may be costly ratios Funds Potential tax Access to many pitfalls (K-1s) wellPros established Low Costthe Much like the active versus passive discussion, managers Actively decision between Desired fundMutual Funds and ETFs is not all-ormanaged nothing. may be closed options limited A firm to new can dramatically reduce their clients expense through ETFs, if passive management is preferred investors Pros Attention should be paid to the tax implications of Share ETFs classas well as the potential trading costs individual confusion How Much Style Drift is Tolerable? 8 Example of Style Categories, Domestic Equities

Large Value Mid Value Small Value Large Blend Mid Blend Small Blend Large Growth Mid Growth Small Growth Large Value Mid Value Small Value Large Growth Mid Growth Small Growth Large Value SMID Value Large Growth SMID Growth Large Blend SMID Blend Style box complexity should be scaled to the IM resources of the firm Regardless of the chosen style-box complexity, each category should be evaluated with equal rigor and frequency Style box complexity intensifies with international equities (Developed Markets vs. Emerging + Large, Mid, Small; Growth, Blend, Value) Selecting appropriate benchmarks is very important A

less complex style-box should lead to a shift away from category averages to the use of broad benchmarks Designing a Program Around Your Firms Resources 9 Necessary resources To run a fund due diligence program effectively, it should be scaled to the firms IM resources Manager Database/Analytics Software Investment Management Staffing Investment Committee to vet manager selection Active Management over Passive = More Analysis More Complex Style-Box = More Analysis Active vs. Passive decision is the key driver An Example Due Diligence Program w/Examples 10 The due diligence process described in the next slides focuses on following categories Quantitative Analysis: Returns; Risk; Cost Qualitative Analysis: Performance attribution; Fund Manager Investment Philosophy Final Review Ongoing Monitoring/Review The program is designed to be consistently employed across all asset classes/investment styles Mutual Fund Due Diligence Process 11 Are there under-performing funds in the portfolio? What are the best funds in the asset class universe based on our metrics? Is this underperformance more cyclical or structural (STYLE DRIFT)? If STYLE DRIFT is present, is

it organic or synthetic? SUPERIOR RISKADJUSTED RETURNS How do the best funds differ from each other? What factors explain the best funds outperformance? What are the insights/concerns of our group regarding the fund under review? Is the fund managers philosophy aligned with the firms? M T T E E R R M M Mutual Fund Due Diligence Process: QUANTITATIVE ANALYSIS 12 Operato r Command Field Name Morningstar Category = Large Value And Total Ret % Rank Cat 1 Yr <= 50th percentile And Total Ret % Rank Cat 3 Yr <= 50th percentile And Total Ret % Rank Cat 5 Yr <= 50 percentile And And And Max Front Load Deferred Load Std Dev 3 Yr (Mo-End) = = <= NA NA CAT AVG And Annual Report Net Expense Ratio <= CAT AVG And And Turnover Ratio % Manager Tenure (Longest) <= >= CAT AVG 5 years TOP SCREENED FUNDS Best funds in category universe based on our metrics Value Mutual Fund Due Diligence Process: QUANTITATIVE ANALYSIS 13 Name Ticker MFS International Value I MINIX Morningstar Category

GMO International Core Equity VI GCEFX US OE Value US OE Value US OE Value US OE Value US OE Value US OE Value US OE Value DFA International Value I DFIVX Tweedy, Browne Global Value Thomas White International Manning & Napier International S JHancock3 International Value Eq I Templeton Instl Foreign Eq Ser Primary US OE Foreign Large Value TBGVX TWWDX EXITX JIEEX TFEQX Foreign Large Foreign Large Foreign Large Foreign Large Foreign Large Foreign Large Foreign Large Total Ret Total Total Total Prospectu Std YTD: Total Ret Ret Ret Manager Turnover s Net Dev 3 JANUARY Ret 1 Yr Annlzd Annlzd Annlzd Tenure Ratio % Expense Yr 2012 3 Yr 5 Yr 10 Yr

Ratio Exceeds Group Avg. 1.82 -1.10 15.52 -0.12 9.28 18.38 8.33 24.00 1.03 7 1.78 -3.03 16.72 -0.12 6.37 14.26 18.67 12.00 1.40 7 41.00 1.38 6 6.38 -6.72 16.22 -1.27 8.89 22.26 17.67

5.13 -9.99 14.66 0.69 7.90 20.61 19.17 13.00 1.11 5 12.00 1.18 4 6.65 -9.71 17.52 -2.68 7.15 21.68 13.92 5.22 -9.45 14.18 -1.95 7.37 22.75 15.58 13.63 0.81 4 40.00 0.44

1 5 4.02 -7.72 12.95 -3.52 7.10 21.46 10.08 US OE Foreign Large Value 6.72 -14.88 16.64 -4.49 8.50 26.88 13.17 9.00 0.45 SCREEN GROUP AVERAGE 4.72 -7.82 15.55 -1.68 7.82 21.03 14.57 20.58 0.98 Foreign Large Value 5.66 -10.41 13.13

-4.51 5.76 22.85 45.95 1.41 QUANTITATIVE QUALITITATIVE ANALYSIS ANALYSIS WILL INFORM the next phase Mutual Fund Analytics and Selection Process: QUALITATIVE ANALYSIS 14 Mutual Fund Analytics and Selection Process: QUALITATIVE ANALYSIS 15 We identified a period of sustained underperformance combined with above average risk in our Foreign LC Growth fund (BIGIX). After reviewing the data, we linked this period of outlier underperformance to the funds significant OW in EM. Once we identified this style drift into the EM space of our Foreign Large Cap Growth manager, the questions we asked ourselves: CONSISTENT or TRANSITORY? ALIGNED WITH OUR EXPECTATIONS FOR OUR MANAGERS? Mutual Fund Due Diligence Process: QUALITATIVE ANALYSIS 16 We verified that BIGIXs EM style drift could be expected to be consistent going forward, after a series of live and conference call portfolio updates with the lead PM. Our next step was to identify replacement candidates in the asset class/style box under review. (UMBWX and HLMIX)

These candidates have to had made through our screen as detailed in slides 2 and 3. We then compared the candidate funds historical EM weightings and current EM caps to ensure that these funds were being managed in alignment with our expectations for our Foreign Large Cap Growth manager. Q U E S T I O N S a n d INTERNAL GROUP DISCUSSIO N Q&A with Candidate Fund PM team s w a p : p r o s p e c t i v e o f T I M E L I N E S

S M I S C E L L A N E O U S : u s a g e ? S e l l P O T E N T I A L D e r i v a t e s K N O W L E D G E : t h e Mutual Fund Due Diligence Process: FINAL REVIEW

s w a p ? P r e v i o 17 o m m i t t e e G R O U P C o m p a n y u n d o C O M P A R A T I V S t r u c t u r a l ? C

A S H A L L O C A T I O N T a c t i c a l P M ? o r 18 a c t u a l A t t r i b u t i o n ? C y c l i c a l / U W s

Mutual Fund Analytics and Selection Process: FINAL REVIEW R E S P O N S I V E N E S S o f P M Q&A WITH CANDIDA TE FUND PM TEAM IMPLEMENTATION of INVESTMENT DECISION R E Q U E S T R i s k R e t u r n s , 19 rel re Mutual FundRE Analytics and ati Selection Process: CU NE ve ONGOING MONITORING/REVIEW

Mont RR W un hly IN rel Revi der ew G ati per of rel ve Scre for en ati un ma Metr ve Asset Management & Trust Group der ic nc data un per e der for im per ma pro for nc vin ma e? g nc or e? wo rse nin g? Featured Mutual Funds (Extract) 1/31/2012 Page 1 of 2 Name Ticker YTD Return 1-year Return

3-year Return 5-year Return 10-year Return Std Dev 3yr Manager Tenure Turnover Ratio Expense Ratio FINSX 4.91 3.53 18.37 2.82 6.31 1.83 19.73 1.60 3.14 15.67 19.09 8.58 47.00 0.89 73.65 1.32 90.00 0.60 61.14 1.25 30.10 0.80

87.94 1.40 41.00 0.76 58.10 1.34 Large Cap Equity Fidelity Advisor New Insights Category Average: Large Growth American Beacon Lg Cap Value Inst 4.95 -0.16 18.19 -1.55 5.42 20.22 Category Average: Large Value AADEX 4.27 1.23 17.06 -1.46 3.87 18.96 S&P 500 4.48 4.22 19.24 0.33 3.52 18.16 6.20

2.47 26.56 6.23 8.54 19.86 6.79 1.19 23.33 2.73 5.40 20.93 24.58 Mid Cap Equity T. Rowe Price Mid-Cap Growth RPMGX Category Average: Mid-Cap Growth JPMorgan Mid Cap Value Instl 4.04 5.39 22.07 2.42 9.17 18.69 Category Average: Mid-Cap Value FLMVX 5.74 -0.46 22.27 0.41 6.52 21.63 S&P MidCap 400 6.61

2.71 25.26 3.90 7.78 21.68 19.67 14.25 Mutual Fund Analytics and Selection Process: ONGOING MONITORING/REVIEW 20 Do we see RECURRING relative under-performance? Do we understand the under-performance as cyclical and expected for what we selected the manager to do? NO? YES? Fund put on watch list In-depth review tabled SUPERIOR RISKADJUSTED RETURNS Final Thoughts 21 Mutual Fund due diligence is critical to the role of fiduciary The process, and the overall investment program itself, should be tailored to fit the level of resource committed to the investment function A well documented and consistent review process can be a major selling point to prospective clients Altering the perception of outsourcing to one where the firm is actively managing its managers MUTUAL FUND DUE DILIGENCE Presented to FIRMA By R. James Hrabak, CFA March 28, 2012

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