ibf - updates - 2010 (q1 v1.2)

Copyright © 2010 by Institute of Business & Finance. All rights reserved. v1.1

QUARTERLY UPDATES

Q1 2010

Quarterly Updates

Table of Contents

MUTUAL FUNDS

DETERMINING ACTUAL FUND COSTS 1.1

FUND MANAGEMENT CHANGES 1.1

12B-1 FEES 1.1

WORLD STOCK FUNDS 1.2

BUFFET TRACK RECORD 7.17

PAST IS NOT A PREDICTOR 7.17

MUTUAL FUND SINS 1.2

SUPERIOR ACTIVE MANAGEMENT 1.3

PORTFOLIO CONCENTRATION 1.3

ACTIVE VS. PASSIVE 1.4

POPULAR VS. UNPOPULAR FUNDS 1.4

INDEXING 1.5

WHY INVESTORS DO NOT INDEX 1.5

JENSEN‟S ALPHA, TREYNOR INDEX AND SHARPE INDEX 1.5

USING PASSIVE AND ACTIVE MANAGEMENT 1.7

MORNINGSTAR STAR RATINGS 1.8

ACTIVE VS. PASSIVE RETURNS 1.8

U.S. EQUITY FUNDS 1.10

EXCHANGE-TRADED FUNDS

LARGEST ETFS 2.1

HISTORY OF ETFS 2.1

EXCHANGE-TRADED NOTES

ETNS 3.1

STOCKS

JANUARY EFFECT 4.1

DIVIDEND ARISTOCRATS 4.1

STOCKS (CONT.)

INVESTOR EXPECTATIONS 4.2

GLOBAL STOCK RECOVERY 4.2

FUNDAMENTAL AND TECHNICAL ANALYSIS 4.3

MARKET TIMING 4.3

ECONOMIC AND MARKET INDICATORS 4.3

MARKET ANOMALIES 4.4

GROWTH VS. VALUE 4.4

SMALL FIRM EFFECT 4.5

DOMESTIC AND FOREIGN 4.6

BONDS

MUNICIPAL BOND DEFAULTS 5.1

BOND ISSUANCE 5.1

JUNK BONDS 5.1

INTERMEDIATE-TERM BONDS 5.1

REAL ESTATE

HOME PRICES 6.1

REVERSE MORTGAGES 6.1

GLOBAL HOMEOWNERSHIP RATES 6.2

REITS 6.2

MARKET INDEXES

BARCLAYS CAPITAL U.S. AGGREGATE BOND 7.1

BARCLAYS CAPITAL U.S. TREASURY TIPS 7.2

MSCI EAFE INDEX 7.3

MSCI EMERGING MARKETS INDEX 7.4

S&P 500 INDEX 7.5

S&P 500 GROWTH INDEX 7.6

S&P 500 VALUE INDEX 7.7

RUSSELL 2000 VALUE INDEX 7.8

RUSSELL 2000 GROWTH INDEX 7.9

RUSSELL 2000 INDEX 7.10

S&P 400 MIDCAP INDEX 7.11

DOW JONES U.S. UTILITIES SECTOR INDEX 7.12

MARKET INDEXES (CONT.)

DOW JONES U.S. REAL ESTATE INDEX 7.13

MSCI ALL COUNTRY WORLD INDEX 7.14

MSCI EAFE VALUE INDEX 7.15

THE CASE FOR MID CAPS 7.16

DECADE RETURNS FOR U.S. STOCKS [1830S-2000S] 7.16

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MUTUAL FUNDS

Mutual Funds 1.1

QUARTERLY UPDATES

IBF | GRADUATE SERIES

1.DETERMINING ACTUAL FUND COSTS ADDED TO CFS 5/2010

A mutual fund‟s total costs are measured differently, depending upon the study or expert

cited. For example, Kopcke‟s study reviewed the 100 largest domestic stock funds owned

by defined contribution plans as of December 2007. Kopcke found trading costs averaged

0.11% of assets annually in the quintile with the lowest costs and 1.99% of assets in the

quintile with the highest cost, with a median of 0.66%.

A different study, updated in 2009, looked at thousands of U.S. stock funds and

concluded the average trading costs to be 1.44% of total assets, with an average of 0.14%

in the bottom quintile and 2.9% in the top. According to study co-author Richard Evans

of the University of Virginia‟s Darden School, “While some trading actually adds value,

high trading costs overall tend to have a negative impact on performance. On average $1

in trading costs decreased net assets by 46 cents.”

Market impact costs, and the resulting opportunity costs, are often the largest component

of trading costs—as much as 1 ½ times brokerage (trading) commissions. These costs

occur when a large trade changes the price of a security before the trade is completed.

Similarly, opportunity costs occur when the impact of a trade inhibits a fund manager

from filling an order on her terms, resulting in either a less-favorable price or fewer

shares traded.

FUND MANAGEMENT CHANGES ADDED TO CFS 5/2010

In 2007, 397 open-end mutual funds experienced management changes (source:

Morningstar). In 2008, the number was 391; it was roughly 280 for 2009. As of 2010,

there were 6,710 open-end mutual funds.

12B-1 FEES ADDED TO CFS 5/2010

Since 1990, investors have paid $140 billion in 12b-1 fees (source: Lipper, 2010). Back

in 1980, when 12b-1 fees were born, stock and bond mutual funds held less money than

they had in 1971; almost a third of all accounts opened in 1971 were closed by 1980.

Mutual Funds 1.2

QUARTERLY UPDATES


WORLD STOCK FUNDS ADDED TO CFS 5/2010

Often times, small stocks are not adequately represented in a world stock fund. In the

case of Vanguard Total World Stock Index Fund (VFINX), small stocks represent less

than 1% of the fund‟s portfolio, rather than the approximate 15% they make up of the

global market.

MUTUAL FUND SINS ADDED TO CFS 5/2010

A fund analyst and observer noted the seven “sins” of mutual funds (source: Burton,

1997):

[1] “hugging the index”—charging active management fees but seeking safety being part of the

herd by “closet indexing;”

[2] “racing the clock”—year-end trades to beef up a portfolio and keep management bonuses by

taking on short-term risk;

[3] “stalling the clock”—near-end-of-the-year moves to clean up a portfolio to reduce risk and

increase returns;

[4] “chasing performance”—higher than normal turnover coupled with inconsistent strategies in

an effort to “get on the hot performance bandwagon;”

Mutual Funds 1.3

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[5] “chasing yield”—increasing high-yield bond holdings to detriment of total returns;

[6] “baiting and switching”—fund names and/or objectives that do not correlate with the actual

portfolio and

[7] “getting cold feet”—having excess cash when nervous about the market.

SUPERIOR ACTIVE MANAGEMENT ADDED TO CFS 5/2010

A 1995 study reviewed 17 large cap funds that outperformed the S&P 500 at least 37 out

of 49 rolling 5-year periods. Common traits among these top-performing funds were: [1]

seasoned managers, [2] consistent rather than headline returns, [3] independent thinkers,

[4] using fundamental analysis for predominantly value funds, [5] contrarian investing,

[6] conviction in judgment, as reflected in concentrated portfolios, [7] long-term

investment horizon and low turnover and [8] managers listed by name instead of by

management team or a long list of managers (source: Arnott, 1995).

Qualifying portfolio management is difficult. Each year, Morningstar selects a “Portfolio

Manager of the Year.” A 2000 study looked at the subsequent performance of these star

managers: only slightly more than 50% of them outperformed their peers and those who

tried to time the market had the least reliable returns (source: Bryant, 2000).

Mutual fund portfolio managers who have returns higher than their peers tend to: [1] be

individually identified to shareholders, [2] be known for their investment style, [3] are

younger than average and well educated and [4] have longer-than-average tenure with the

fund they oversee (source: Chevalier and Ellison, Journal of Finance, June 1999).

Mutual funds with superior peer returns generally have the following characteristics: [a]

below-average asset size and above-average stability, [b] below-average systematic risk,

[c] high tax efficiency, [d] below-average expense ratios and [e] comparatively steady

returns over time (note: these qualities are consistent with value investing).

PORTFOLIO CONCENTRATION ADDED TO CFS 5/2010

A study of over 12,000 portfolios for 10- and 18-year periods shows the fewer the

number of stocks in a fund, the greater the likelihood it will outperform the market. For

example, the chances of a 250-stock portfolio outperforming the market is 1-in-50, but

1-in-4 for a 15-stock portfolio (source: Hester, 2001). One author notes, “You

concentrate to create wealth; you diversify to preserve it.” Warren Buffet once said,

“Diversification is a protection against ignorance.”

Mutual Funds 1.4

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ACTIVE VS. PASSIVE ADDED TO CFS 5/2010

A study covering the 20-year period 1975-1994 looked at 1,788 funds and concluded the

average fund outperformed the S&P 500 by 130 basis points on a gross return basis; once

all costs were factored in (net return before taxes), these same funds averaged 100 basis

points less than the index. The 230 basis point difference was explained as: 70 basis

points due to lower returns on non-stock holdings in the funds and 160 basis points

roughly split between expense ratios and trading costs (source: Wermers, 2000). These

findings indicate fund managers have good stock selection abilities—it is cash holdings,

securities transactions, fund profitability and overhead (all things an index does not incur)

that bring returns down below an index. This is somewhat consistent with Bogle‟s 1999

findings that 92% of the shortfall of active funds (vs. index funds) was due to expenses.

Wermers went on to point out the gross return advantage was completely lost if adjusted

for their higher risk (compared to the index).

Over a 25-year period, returns for the top-performing 30 funds were compared to their

subsequent 5-year periods for five subsequent periods. In each case, the S&P 500 out-

performed the top 30 funds from the previous 5-year period. One observer wrote: “The 5-

year „alpha man‟ became „ape man‟ over the next five years” (source: Bernstein, 1995).

POPULAR VS. UNPOPULAR FUNDS

Funds over the period 1987-1996 were divided into two broad categories: popular (funds

with highest percentage net cash inflows) and unpopular (funds not widely held). Study

results showed 78% of the unpopular funds for any given year outperformed the typical

equity fund over the next one, two and three years; results were consistent for 24 of 27

periods studied (source: Paluch and Kelly, 1996).

In a sequel study using the same criteria, unpopular and popular funds for the period

1987-1999 were compared. Again, unpopular equity funds did better than popular equity

funds 78% of the time. Furthermore, 89% of unpopular funds outperformed the then

currently most popular fund (source: Barbee, 1999). The study‟s author concluded, “This

(contrarian) strategy is the closest investing gets to a sure thing.” This strategy was

reconfirmed by a 2000 study (source: DiTeresa, 2000).

Mutual Funds 1.5

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INDEXING ADDED TO CFS 5/2010

Bogle wrote that 79% of all surviving equity funds failed to beat the S&P 500 during the

first 20 years of index funds. When the first retail domestic index fund was launched in

1976 (Vanguard 500 Index Fund), it was called “Bogle‟s Folly” and attracted just $11

million its first year. The fund did not manage $10 billion in assets until 1995.

WHY INVESTORS DO NOT INDEX ADDED TO CFS 5/2010

There are a number of investor beliefs and attitudes that make it hard for them to invest

their own money in index funds. First, investors think they can beat the market. Second,

investors feel there is no order in the market and if they knew “the key,” they could

outperform it. Third, they like to use investor newsletters and be told what to do.

Fourth, investors have a hard time believing the market is random. Fifth, people like to

take credit when there are good returns and blame someone else for poor returns (source:

Clements, 1998).

JENSEN’S ALPHA, TREYNOR INDEX AND SHARPE INDEX

ADDED TO CFS 5/2010

Jensen’s Alpha, also known as Jensen coefficient, or simply alpha, evaluates a portfolio‟s

actual return compared to expected return, given its systematic risk and the CAPM. Any

positive number is good; the greater the positive number, the better. It should be noted a

positive number may be the result of security selection, low expenses and/or market

timing. Security selection may be due to management skill or simply luck (source:

Jensen, 1968).

The Treynor Index, also known as Treynor ratio, relates a portfolio‟s return to its risk.

The measurement assumes portfolios are well diversified. The Treynor Index (or ratio) is

calculated by taking the risk-free rate of return (usually T-bill rate) and subtracting it

from the portfolio‟s mean return; the resulting number is then divided by the portfolio‟s

beta. As you can see from the formula, the risk component is systematic risk (source:

Treynor, 1965).

The Sharpe Index, also known as the Sharpe ratio, describes portfolio returns based on

standard deviation. Specifically, the risk-free rate of return is subtracted from the fund‟s

return; the resulting number is divided by the portfolio‟s standard deviation.

Mutual Funds 1.6

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Mutual Funds 1.7

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Of the three widely used measurements of risk-adjusted returns (Jensen, Treynor and

Sharpe), only Jensen Alpha calculates how a portfolio’s returns compare to its market

index. When the risk-free rate of return is low, it becomes easier for a mutual fund

(or any portfolio) to have comparatively superior returns when the Sharpe or

Treynor index is used.

USING PASSIVE AND ACTIVE MANAGEMENT ADDED

TO CFS 5/2010

Some in the academic community feel there is a place for both active and passive

management in a portfolio. Investing in large cap domestic stock funds favors

indexing while active management favors small cap funds. Indexing is the preferred

choice for foreign stocks of developed countries, active management is best for

emerging markets or specific regions (source: Dziubinski, 1998 and DiTeresa 1999).

Despite these conclusions, results of these two studies are quite varied, as reflected below

(note: time periods for each study were slightly different).

When Active Outperforms Passive Management [two studies]

Category

Active

(Dziubinksi)

Active

(DiTeresa)

Large Cap Growth 2% 6%

Large Cap Blend 0% 4%

Large Cap Value 31% 17%

Mid Cap Growth 33% n/a

Mid Cap Blend 47% 30%

Mid Cap Value 53% n/a

Small Cap Growth 47% 91%

Small Cap Blend 100% 54%

Small Cap Value 53% 81%

Mutual Funds 1.8

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MORNINGSTAR STAR RATINGS

The Morningstar (star) Rating system is comprised of two parts: longevity and risk-

adjusted returns. Funds with 10-year histories are weighted (based on risk-adjusted

returns described below): 50% for the entire 10-year period, 30% for the most recent 5-

year period and 20% for the most recent 3-year period. For funds with 5-year histories:

60% for the 5-year period and 40% for the most recent 3-years. If a fund only has three

years of returns, the entire 3-year period is given a weighting of 100%. In the case of

funds with 5- or 10-year track records, the most recent periods are “counted” 2-3 times.

The other component (risk-adjusted returns) is calculated by taking a fund‟s Morningstar

Risk measurement and subtracting it from the fund‟s Morningstar Return score.

Both Blume (1998) and Share (1998) have been critical of Morningstar performance

measurements. Sharpe felt Morningstar star ratings were of limited value when selecting

individual funds or constructing an entire portfolio. Another study concluded: [1] just one

month‟s or one year‟s returns can significantly change a funds rating, [2] funds with 10+

year track records do a better job of maintaining their star rating than a fund that has only

been around for three years, [3] ratings do a good job in predicting poor fund

performance (but not in predicting excellent performance) and [4] future performance

ends up being about the same whether the fund has a current rating of three, four or five

stars (source: Zweig, 2000).

ACTIVE VS. PASSIVE RETURNS ADDED TO CFS 5/2010

Advisors often cite three reasons active management is better than indexing: [1] indexing

did not do well last year (or some other year), [2] indexing may work for large cap

domestic stocks, but not for small cap or foreign stocks where markets are less efficient

and [3] active managers do better in down markets. Each of these three reasons is

examined below.

In 1977, 1978 and 1979, the Vanguard 500 Index Fund beat 15%, 25% and 28% of

domestic funds, respectively. However, for 15 years ending 12/31/2008, Vanguard fund

beat 73% of active managers in its class; Vanguard Total Stock Fund outperformed 68%

of its peer group.

Mutual Funds 1.9

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For the 10 years ending 12/31/2008, Vanguard Total International Fund beat 69% of

active managers. Over the past 15 years, DFA U.S. Microcap and U.S. Small Value

Funds (both index funds) beat 73% and 80% of their peers, respectively. Moreover, poor

performance of stocks over the past 10 years favors active funds that have a much higher

percentage of their assets in cash equivalents than their index fund counterparts.

During the 1973-74 recession, the average domestic stock fund lost 48%, versus 43% for

S&P 500. From September to November 1987 (includes October crash), active funds

outperformed S&P 500 by 0.8%. This advantage is not particularly impressive since

active funds generally hold 5-10% in cash. For 2008, Vanguard 500 Index Fund beat 62%

of its large blend category peers (again, surprising since cash held by actively managed

funds should have helped cushion their losses).

If an index fund dooms a client to mediocrity, then mediocrity must be defined as beating

60-80% of the competition in the long term. One author compares an index fund to a

shell game with 10 different shells. Under each shell is a dollar amount ($1,000, $2,000,

$3,000, etc.). The index fund pays a guaranteed $8,000 while the investor could choose

the shell worth $10,000 or the one worth $1,000.

The figures used to compare active and passive funds is tainted in favor of active

management. Morningstar‟s database suffers from “survivorship bias.” This means

hundreds of poorly performing funds have disappeared from their fund universe—all of

which likely underperformed its category index.

There can be little argument in the case of bond funds, with the possible exception of

some PIMCO funds. From 1999 through 2008, Vanguard Short-, Intermediate- and Long-

Term Bond Index Funds beat 99%, 96% and 92%, respectively, of their peer groups.

From 1995-2008, Vanguard Limited-, Intermediate- and Long-Term Tax-Exempt Funds

(none are indexed) beat 92%, 82% and 97% of their peers.

Mutual Funds 1.10

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U.S. EQUITY FUNDS

Even though the U.S. stock market is mostly comprised of small cap stocks, most mutual

funds are large cap. Of the 2,600 domestic equity funds at the end of 2009, 51% were

large cap, 26% mid cap and 23% small cap. For any given year, ~35% of domestic

equity funds have a negative return; about half of all U.S. stocks experience a

negative return. Most U.S. stock funds have “herd like” performance. The table below

shows the percentage of U.S. stocks and U.S. equity funds whose returns have been

negative (source: Financial Planning, April 2010).

U.S. Stocks and U.S. Equity Funds With Negative Returns

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

U.S. Stocks 60% 47% 63% 15% 33% 52% 39% 64% 89% 39%

U.S. Equity Funds 54% 77% 97% 0.3% 2% 6% 2% 27% 99.8% 0.4%

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EXCHANGE-TRADED FUNDS

Exchange-Traded Funds 2.1

QUARTERLY UPDATES


2.LARGEST ETFS

The 10 largest ETFs account for almost 40% of all ETF assets. The 10 funds with the

most trading activity account for roughly 60% of all ETF trading volume. For example,

SPDR (S&P 500) trading close to three billion shares in December 2009, with an average

bid-ask spread of just one penny.

HISTORY OF ETFS

The head of new products at the AMEX came up with the idea of “warehouse receipts”

when creating ETFs. At the time, the American Stock Exchange was desperately looking

for new revenue-generating products. Even in its early stages (the year 2000), ETFs

accounted for over 67% of total AMEX trading volume. Today, the figure is dramatically

higher.

The idea behind warehouse receipts is they may be bought and sold, but the underlying

commodity remains unmoved in warehouses. The receipts provide a separation of fund

management functions from trading. By not moving physical assets (or stock shares in

the case of ETFs), assets are secured in vaults and trading costs reduced. In the case of

iShares ETF index shares (largest ETF issuer), they are held in book entry form by the

Depository Trust Company, as owner of record. The link between this form of

commodity trading and securities is evidenced in the names given to shares of index

funds: depository receipts, receipts or deposit shares.

Early ETFs were organized as UITs, an inexpensive structure easy to oversee. Today,

almost all ETFs are hybrid mutual funds including features of closed- and open-end

funds.

ETF shares are formed by participants who “create” (buy) creation units; specific

securities that match the composition of a particular market index. These securities are

then delivered to custodian banks that, in turn, deliver index shares to the participants

once purchase trades have settled. Such exchanges occur after the markets have closed

for the day.

Creation units are denominated in fractions of the index, ranging in price from 1/5th

to

1/100th

of the underlying price of the market index. These units typically represent 50,000

shares of the index (but range from 25,000 to 600,000 depending on issuer and specific

index).

Exchange-Traded Funds 2.2

QUARTERLY UPDATES


Creation units are sold by an authorized participant who packages the needed number of

redemption units of the index shares; transactions commonly done by market specialists.

ETFs pay for redemption units with in-kind stock portfolios that match the index‟s

composition. Custodians make these exchanges after market hours. The exchange of

index shares for in-kind stock portfolios are tax-free under the Internal Revenue Code

(IRC). Unlike mutual funds, ETFs do not realize capital gains when they redeem

redemption units. Such tax-free transactions allow large investors to unbundle in-kind

portfolios and take advantage of any tax losses by selling one or more securities in the

portfolio (and hold onto the “winners” by not realizing a gain).

The discount or premium of an ETF index share (to the net value of the underlying

securities in the index) owned by your clients is normally extremely small because of

arbitrage. Unlike mutual funds (which are only required to report holdings twice a year),

arbitrageurs know the exact portfolio being received for their redemption units (since

ETFs have continuous 100% transparency). For example, one study in 2000 showed the

difference between the cumulative securities in the S&P 500 and the $150 market price of

SPYs (an S&P 500 ETF) was about three cents per share (0.03/150.00 = 0.0002) (source:

Zigler, 2000). Another study the same year concluded premiums and discounts for ETF

shares was “narrow and fleeting.”

The first S&P 500 ETF was introduced in 1993 by State Street Global Advisors and

structured as a UIT; later offerings by State Street were organized as mutual funds. Back

in 2000, Spiders (S&P Depository Receipts) were held for an average of just 19 days.

DJIA Model New Deposit Shares (Diamonds) were first offered as a UIT in 1998 and

trade at 1/100th

of its value. NASDAQ-100 Tracking Stocks (QQQ), known as “Cubes,”

were first offered as UITs in 1998.

The NASDAQ 100 is the technology sector of the NASDAQ Index. Back in 2000, Cubes

were held for an average of four days. In 1998, Merrill Lynch created Holding Company

Depository Receipts (HOLDRs). These “grantor trusts” differ from UIT and mutual fund

ETFs. In 1996, Barclays Global Fund Investors first offered “Individual Shares” (iShares)

organized as mutual funds. Barclays‟ San Francisco-based subsidiary was formally Wells

Fargo Investment Advisors, the 1960s creators of institutional indexed portfolios. iShares

trade at 1/10th

the market value of their underlying index. The earliest Barclays series

were known as WEBS (World Equity Benchmark Shares). Vanguard sought approval for

its first ETFs in 2001 (Vipers—Vanguard Index Participation Equity Receipts).

QUARTERLY UPDATES

EXCHANGE-TRADED NOTES

Exchange-Traded Notes 3.1

QUARTERLY UPDATES


3.ETNS

As of the second quarter of 2010, ETNs have cumulatively attracted about 1% of the

dollars that have gone into ETFs. As of November 2009, there were 820 ETFs and just 90

ETNs. Yet, if someone is interested in adding a commodities-type asset, ETNs are likely

to be more tax efficient than similar commodity-based ETFs.

Most commodity-type ETFs buy futures contracts. Under tax law, taxable investors owe

tax on any appreciation each year, even if the ETF investor does not sell any shares. Any

gain is taxed 60% as long-term and 40% is taxed as short-term (ordinary income).

Furthermore, a large number are structured as limited partnerships, meaning the ETF

investor receives a K-1 instead of a 1099.

ETNs are more tax-friendly. Although the IRS has not yet ruled on how commodity

ETNs, the accepted practice, based on tax opinion letters from different law firms, is to

treat the notes as prepaid financial contracts. This means gains are only taxed upon sale

and gains on commodity ETNs held more than one year are considered long-term.

Furthermore, ETN investors do not have to worry about “tracking error,” the issuer

promises the investor an index-based return.

An ETN favored by Morningstar is Elements S&P Commodity Trends Indicator Total

Return. One of the portfolio‟s favored strategies is to buy commodities rising in price and

betting against those falling (source: The Wall Street Journal, December 2009).

Largest ETNs

Exchange-Traded Note Size

iPath Dow Jones-UBS Commodity (DJP) $2 billion

iPath MSCI India (INP) $1.2 billion

iPath S&P 500 VIX Short-Term Futures (VXX) $705 million

iPath S&P GSCI Crude Oil (OIL) $585 million

PowerShares DB Gold Double Long (DGP) $475 million

JP Morgan Alerian MLP (SAMJ) $470 million

Elements Rogers Int‟l Commodity (RJI) $420 million

Elements Rogers Int‟l Agriculture (RJA) $310 million

iPath Dow Jones-UBS Natural Gas (GAZ) $180 million

iPath Dow Jones-UBS Copper (JCJ) $140 million

QUARTERLY UPDATES

STOCKS

Stocks 4.1

QUARTERLY UPDATES


4.JANUARY EFFECT

In normal years, investors try to front-run the expected January rise in the stock market

by bidding stocks up higher in late December. Since 1900, the DJIA has risen a median

1% in the last five trading days of December; this is more than four times the median rise

for five-day periods in general.

The Dow‟s median rise for the first five trading days in January is 0.63%. In the years

when the Dow has risen in the first month of the year, the median rise for the rest of the

year has been 10.4%. In years when the Dow has fallen in January, the median for the

next 11 months has been just 0.28% (source: Ned Davis Research).

How Often Dow Has Gone Up [1900-2009]

Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. 62% 50% 61% 56% 52% 49% 62% 65% 42% 56% 62% 71%

Average Monthly Returns of Dow [1900-2009]

Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. 0.9% -0.2% 0.7% 1.2% 0.0% 0.2% 1.3% 1.1% -1.1% 0.1% 0.9% 1.5%

DIVIDEND ARISTOCRATS

During 2008, there were several S&P 500 companies that had raised their dividends

every year for at least 25 years in a row. For the 2008 calendar year, these dividend

“aristocrats” fell 21.6% versus a 37% loss for the S&P 500 as a whole.

Annuities and Long-Term Care

As of January 2010, annuities began offering products that provided traditional deferred

growth packaged with long-term care benefits. For example, a 65-year-old can buy a

$100,000 deferred annuity that earns 3% a year and provides up to $300,000 in long-term

care benefits. Your client can also buy a life insurance policy combined with long-term

care coverage in which a portion of the policy‟s death benefit is paid to cover long-term

care expenses, reducing the death benefit accordingly.

Stocks 4.2

QUARTERLY UPDATES


Other investments can also benefit under the 2010 provisions of the Pension Protection

Act of 2006. Money transferred directly from an annuity or cash value portion of a

life insurance policy can be used to pay for long-term care insurance without

triggering a tax event. The health questionnaire for these linked products typically asks

10 questions, versus 50 questions for traditional long-term care policies.

INVESTOR EXPECTATIONS

A 2009 survey shows investors expect U.S. stocks to go up 13.7% per year for the next

10 years. Since 1926, large cap stocks have averaged 9.8% a year; their long-term net

return (after inflation, taxes and costs) is under 4%.

When a handful of experts were asked what net rate of return (after inflation, taxes and

costs) they would be willing to swap their assets for, the responses were: 4% (William

Bernstein, noted MPT author), 3% (Laurence Siegel, Ford Foundation), 2.5% (John

Bogle) and 0.5% (Elroy Dimson, London Business School).

GLOBAL STOCK RECOVERY

The table below shows stock market losses from around the world, from the September

15, 2008 peak to the March 9, 2009 trough plus the resulting gain from March 9, 2009 to

December 31, 2009 (source: Charles Schwab).

9/08-3/09 3/09-12/09 9/08-3/09 3/09-12/09

Canada -48.7% 91.1% China -28.2% 83.5%

U.S. -43.3% 64.8% Japan -37.0% 38.8%

Brazil -41.1% 125.7% China -28.2% 83.5%

U.K. -48.0% 80.3% Indonesia -39.9% 161.9%

Germany -48.3% 76.1% Australia -47.8% 118.9%

Stocks 4.3

QUARTERLY UPDATES


FUNDAMENTAL AND TECHNICAL ANALYSIS

Market forecasting is generally done by fundamental or technical analysis. Fundamental

analysis considers economic indicators (e.g., GDP, inflation rate, interest rates and

corporate earnings) to make market forecasts. Technical analysis is largely based on

identifying and interpreting market trends such as moving averages. Technicians and

fundamentalists both make forecasts based on investor sentiment, although such

sentiment is more frequently used in technical analysis.

It is generally accepted an investor cannot expect to beat the market unless more

systematic risk is taken on. However, behavioral finance believes there is opportunity for

abnormal returns by taking advantage of the psychological errors made by other investors

in the marketplace.

MARKET TIMING

A 1998 study by Sherden looked at the accuracy of market forecasters and found that

almost all of them had records no better than flipping a coin. Even the Federal Reserve

predicted only three of six turning points in GDP from 1980 to 1995 plus missed both

inflation points (source: Sherden, 1998).

ECONOMIC AND MARKET INDICATORS

Although there are no “best” indicators to predict the economy or market, there are

“seven engines for prosperity” (source: Mueller 2000): [1] population demographics, [2]

lowering of tax rates, [3] trade liberalization, [4] technology advances, [5] deregulation,

[6] welfare reform and [7] monetary policy.

The indicators most frequently followed by market observers are: advance/decline

line, market index P/E ratios, dividend yields and an increase in one index while there is a

decrease in on or more other indexes (e.g., DJ Utilities Index, S&P 500 or NASDAQ).

Commonly followed sell signals are the ratio of 90-day T-bill rate to the S&P 500 Index

yield, index of leading economic indicators, divergence of advance/decline line and the

S&P 500 as well as the divergence of the DJIA and S&P 500.

Stocks 4.4

QUARTERLY UPDATES


MARKET ANOMALIES

An anomaly can represent something contrary to the theory of efficient markets. Some

believe such anomalies lose their effectiveness once embraced by enough investors. The

most written-about anomalies include P/E and P/B ratios (low numbers tend to

outperform higher ratios), small cap size (returns tend to decrease as market caps

increase), the effect of momentum trading (recent good or bad performance tends to

continue, at least for a short period) and the reversal effect (poor performers subsequently

become the better performers and vice versa).

GROWTH VS. VALUE

A study looked at the one and three year periods following market highs of 1937, 1967,

1972, 1987 and 1992. In the years after these highs, low P/E stocks appreciated an

average of 3% while high P/E stocks dropped by just under 3%. During the three years

after market highs, low P/E stocks did better than high P/E stocks by over 7% (source:

Berry, 1997). Other studies believe value trumps growth because value investors are

compensated for taking on additional risk, investors overvalue glamour (growth) stocks

and investor error in expectations of value and growth equities. The table below

compares growth and value stocks for the years 1963-1999 (source: Berstein, 1999).

Growth vs. Value [1963-1999]

Annualized

Return

Total

Risk

Largest

Annual Loss

Small Value 17% 19% 31%

Small Growth 10% 23% 51%

Large Value 15% 15% 28%

Large Growth 12% 16% 45%

Stocks 4.5

QUARTERLY UPDATES


The weight of evidence shows value stocks have historically been underpriced compared

to their actual risk and return characteristics. One reason this trend continues is because

value stocks are not well known by investors. Another reason is glamour stocks are

more widely followed. Finally, the case for value stocks was not particularly compelling

prior to quantitative analysis, portfolio construction and the use of evaluation

measurements. Value investing requires patience. Fund managers tend to have a shorter-

term investment horizon; they do not want to lose their job or bonus by underperforming

a benchmark index such as the S&P 500 even for 1-2 years. Corporate earnings surprises

for the five years after a stock is included in a portfolio are routinely positive for value

stocks and negative for glamour issues.

For the period 1974-1994, value stocks outperformed growth stocks domestically and

internationally. Based on B/P ratios, value did better than growth in 12 of the 13 major

markets studied. The difference between high and low P/Es of global stocks is over 7%

per year. The same is true with emerging markets (source: Fama and French, 1998).

Asset Size Value funds tend to outperform growth funds as asset size increases. However, growth

funds risk-adjusted returns can quickly become negative as asset size increases (source:

Barbee, 1998). One reason for this disparity may be because growth funds are competing

for popular stocks while value funds look at unloved equities.

SMALL FIRM EFFECT

The notion that small cap stocks outperform large cap stocks over time is referred to as

the small-firm effect. There are two reasons this may be true. First, beta may not capture

the actual risk of smaller securities. Second, there is less information on these types of

stocks; neglected stocks can earn abnormally high returns—something seen domestically

and overseas. A 40/60 (mid cap/S&P 500) mix has less risk and about the same return as

a 40% allocation to small caps (source: Damodaran, 1998).

One reason small stock historical returns look so appealing is such indexes do not include

subsequent failed or delisted issues. On average, stocks that leave the NASDAQ lose

more than 50% of their value. In fact, once these “phantom” stocks are added back in the

measurement, the small cap return advantage disappears. Thus, small cap index returns

are probably the biggest beneficiaries of survivorship bias. Another reason for the

higher reported returns is close to 60% of the smallest stocks rarely trade; any significant

trade in such securities could pump up their price quite a bit—perhaps as much as 20-

40% (source: Updegrave, 1999).

Stocks 4.6

QUARTERLY UPDATES


For comparison purposes, it should be pointed out about a third of the returns from the

S&P 500 are due to just 5% of the index’s stocks. Historically, small stocks have

outperformed large cap issues during the first third of bull markets that follow bear

markets; large cap stocks perform best in the late stages of bull markets and sometimes

throughout bear markets (source: Fisher, 1998).

DOMESTIC AND FOREIGN

A study looked at using foreign equities for the period 1971-1991 and found an 80/20

(U.S./foreign) equity mix provided the minimum amount of risk and was always less

risky than a domestic-only stock portfolio. The study‟s author also concluded that over

the period of 1980-1990, a global stock/bond portfolio had twice the return but the same

risk level as a U.S.-only portfolio (source: Solnik, 2000).

Currency Hedging Currency hedging is used less than most fund investors suspect. Although many world

bond funds hedge, only about a third of all foreign stock funds use currency hedging

frequently (source: Arnott, 1996). In 1996, 23% of international fund returns were due to

hedging, just 13% a year later (source: Rothschild, 1998).

QUARTERLY UPDATES

BONDS

BONDS 5.1

QUARTERLY UPDATES


5.MUNICIPAL BOND DEFAULTS

According to Municipal Market Advisors, the U.S. municipal bond market totals $2.8

trillion. From July 2009 to March 2010, 171 municipal default notices were filed,

representing just 0.19% of the muni bond market. Of the 171 defaults, 170 were from

riskier bonds, such as those backed by casinos or land.

BOND ISSUANCE

For the first quarter of 2010, U.S. corporate investment-grade issuance was around $325

billion, the most since the second quarter of 2009, but down from $345 billion during the

first quarter of 2009. Treasury securities issuance totaled $600 billion in the first quarter

of 2010, compared with $454 billion in the first quarter of 2009.

JUNK BONDS

According to Baylor University finance professor Reichenstein, junk bond returns

mirror a portfolio comprised of 2/3 investment-grade bonds, 1/6 in large cap stocks

and 1/6 in small cap stocks.

INTERMEDIATE-TERM BONDS

By investing in intermediate-term bond funds, the investor can obtain 90% of the returns

enjoyed by long-term bond funds but with just half the volatility (source: Powell, 1993).

QUARTERLY UPDATES

REAL ESTATE

Real Estate 6.1

QUARTERLY UPDATES


6.HOME PRICES

According to data collected by Robert Shiller of Yale, in the 61 years from 1945 through

2006, the maximum cumulative decline in the average price of homes was 2.8% in 1991.

From 2000 through 2006, national home prices rose 88.7%; far more than the 17.5% gain

in the CPI or the 1% rise in median household income. Never before had home prices

jumped that far ahead of prices and incomes.

The table below shows the top five gainers and losers in the S&P/Case-Shiller home price

index as of the end of January 2010.

Gainers S.F. San Diego Dallas L.A. D.C.

1/2009-1/2010 9% 6% 4% 4% 3%

Change From Peak -37% -37% -5% -36% -29%

Losers Las Vegas Detroit Tampa Miami Seattle

1/2009-1/2010 -17% -7% -7% -7% -6%

Change From Peak -56% -43% -42% -47% -23%

REVERSE MORTGAGES

One of the biggest criticisms of reverse mortgages has been fees, which can total 5% of

the home’s value. The 2010 cuts in fees mean some homeowners can save $10,000 or

more on closing costs.

Lenders are reducing fees to attract business. From October 2009 to March 2010, home

equity-conversion mortgage volume fell 22% from the same period the previous year.

One reason for the drop in activity was that HUD reduced the amount a homeowner

could receive from a reverse mortgage by 10%. This meant many owners would no

longer qualify for enough of a reverse mortgage to pay off their regular mortgage—a

requirement for getting approval for a reverse mortgage.

Origination fees can be as high as $6,000. The reverse mortgage (home-equity conversion

mortgage) backed by HUD accounts for over 60% of all such loans. HUD requires

borrowers to have mortgage insurance.

New lower closing costs on reverse mortgages could help homeowners save thousands of

dollars. For example, a 70-year-old borrower (eligible for a reverse mortgage up to

$387,500 on a $625,000 home) would incur the following costs:

Real Estate 6.2

QUARTERLY UPDATES


$387,500 Reverse Mortgage on a $625,000 home

Closing Costs Old Pricing New Pricing

Origination fee $6,000 $0

Set-aside for monthly service fee $4,997 $0

HUD insurance $12,500 $12,500

Other costs (approx.) $5,400 $5,400

What homeowner gets $358,603 $369,600

GLOBAL HOMEOWNERSHIP RATES

As of the beginning of 2010, 67% of Americans owned their homes; the rate peaked in

2004 at 69% (source: U.S. Commerce Department).

Global Homeownership [2008]

Italy (82%) France (65%)

U.K. (73%) Japan (61%)

Canada (69%) Germany (56%)

U.S. (67%)

REITS

As of the beginning of 2010, institutions owned more than 80% of all REITs; individual

investors own the remaining 20%. From the beginning of 2000 to the end of 2009, the DJ

U.S. Equity All REIT appreciated 200% versus a slightly negative cumulative return for

the S&P 500.

QUARTERLY UPDATES

MARKET INDEXES

MARKET INDEXES 7.1

QUARTERLY UPDATES


7.BARCLAYS CAPITAL U.S. AGGREGATE BOND

This index, called Lehman Brothers Aggregate Bond Index before 2008, measures

returns of U.S. investment grade bonds market, which includes investment grade U.S.

Government bonds, high quality corporate bonds, mortgage pass-through securities and

asset-backed securities publicly offered for sale in the U.S. The index‟s securities must

have at least one year remaining to maturity; they must also be denominated in U.S.

dollars and must be fixed rate, nonconvertible and taxable. The index has 8,410 holdings

with an average selling price of 103.6.

Barclays Capital U.S. Aggregate Bond Index (1995-2009)

1995 18.5% 1998 8.7% 2001 8.4% 2004 4.3% 2007 7.0%

1996 3.6% 1999 -0.8% 2002 10.3% 2005 2.4% 2008 5.2%

1997 9.6% 2000 11.6% 2003 4.1% 2006 4.3% 2009 5.9%

Barclays Aggregate Bond ETF seeks to match the index‟s performance, before expenses.

Portfolio maturity is: 25% (0-1 years), 30% (1-5 years), 18% (5-10 years) and 6% (10-15

years). Less than 1% of holdings are rated below BBB-.

Performance History (12-31-2009)

2009 3 Year 5 Year 10 Year

ETF 5.1% 5.9% 4.8% n/a

Index 5.9% 6.0% 5.0% 6.3%

Fundamentals and ETF Profile (3-2010)

Inception (symbol: AGG) 9/2003 Distribution Yield 4.1%

ETF Credit Rating (S&P) AAA 30-Day SEC Yield 1.8%

Standard Deviation (3 year) 4% Largest Sector (Treasurys) 28%

Average Weighted Maturity 6.1 years Govt. + Agency + AAA 76%

Effective Duration 4.3 years Total Holdings 305

Average Weighted Coupon 5.0% Assets $11 billion

Average Y-T-M 3.2% Expense Ratio 0.2%

MARKET INDEXES 7.2

QUARTERLY UPDATES


BARCLAYS CAPITAL U.S. TREASURY TIPS

This index measures returns of the Treasury market as defined by the Barclays Capital

U.S. Treasury Inflation Protected Securities Index. The index is comprised of just 29

holdings with an adjusted duration of 4.7 years and a weighted average maturity of nine

years.

Barclays Capital U.S. Aggregate Bond Index (2004-2009)

2004 8.5% 2007 11.6%

2005 2.8% 2008 -2.4%

2006 0.4% 2009 11.4%

Barclays Capital U.S. Treasury ETF seeks to match the index‟s performance. Portfolio

maturity is: 38% (1-5 years), 31% (5-10 years), 6% (10-15 years) and 22% (15-20 years).

The fund‟s top 10 holdings equal 46% of the total portfolio.



ETF 11.4% 6.6% 4.4% n/a

Index 11.4% 6.7% 4.6% 7.7%


Inception (symbol: TIP) 12/2003 Distribution Yield 5.0%

ETF Credit Rating (S&P) AAA 30-Day SEC Yield 0.8%

Standard Deviation (3 year) 9% Largest Sector (Treasurys) 100%

Average Weighted Maturity 9.0 years Total Holdings 30

Effective Duration 5.0 years Assets $21 billion

Average Weighted Coupon 2.2% Expense Ratio 0.2%

MARKET INDEXES 7.3

QUARTERLY UPDATES


MSCI EAFE INDEX

This market capitalization index measures returns of 21 developed market indices:

Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong,

Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain,

Sweden, Switzerland and U.K. Index total market capitalization is $13.2 trillion and there

are 960 holdings.

MSCI EAFE (Europe, Australasia, Far East) Index (1995-2009)

1995 11.2% 1998 20.0% 2001 -21.4% 2004 20.2% 2007 11.2%

1996 6.0% 1999 27.0% 2002 -15.9% 2005 13.5% 2008 -43.4%

1997 1.8% 2000 -14.2% 2003 38.6% 2006 26.3% 2009 31.8%

EFA matches returns of stocks in European, Australasian and Far Eastern markets. The

top 10 countries represent 90% of the index; its top five stock positions are: HSBC

Holdings (2.0%), Nestle (1.8%), BP (1.7%), BHP Billiton (1.3%) and TOTAL (1.2%).

Country Weightings (3-2010)

Japan 23% Switzerland 8% Italy 3%

U.K. 21% Germany 8% Netherlands 3%

France 10% Spain 4% Sweden 3%

Australia 8%



ETF 31.4% -6.1% 3.4% n/a

Index 31.8% -6.0% 3.5% 1.2%


Inception (symbol: EFA) 8/2001 Beta 1.1

Standard Deviation (3 year) 24% 30-Day SEC Yield 0.7%

P/E Ratio 22 Largest Sector (financials) 25%

P/B Ratio 2.6 Total Holdings 853

Average Market Cap $53 billion Expense Ratio 0.4%

MARKET INDEXES 7.4

QUARTERLY UPDATES


MSCI EMERGING MARKETS INDEX

This market capitalization index measures returns of 22 emerging markets indices: Brazil,

Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel,

Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa,

Taiwan, Thailand and Turkey. The index captures 85% of the publicly available total

market capitalization of emerging markets; its total market capitalization is $6.5 trillion.

The index has 770 holdings.

MSCI Emerging Markets Index (1995-2009)

1995 -5.2% 1998 -25.3% 2001 2.6% 2004 25.5% 2007 39.4%

1996 6.0% 1999 66.5% 2002 -6.2% 2005 34.0% 2008 -53.3%

1997 -11.6% 2000 -30.8% 2003 55.8% 2006 32.2% 2009 78.5%

EEM matches returns of the MSCI Emerging Markets Index. The top 10 countries equal

84% of the index; its top five holdings are: Petroleo Brasilerio (4.4%), Samsung (3.2%),

Taiwan Semiconductor (2.4%), Banco Itau (2.2%) and Posco (1.9%). Total ETF assets

are $36 billion.

Country Weightings (3-2010)

Brazil 15% South Africa 8% Russia 6%

South Korea 12% Hong Kong 7% Mexico 5%

China 11% India 6% Israel 3%

Taiwan 10%



ETF 71.8% 4.9% 15.1% n/a

Index 78.5% 5.1% 15.5% 9.8%


Inception (symbol: EEM) 4/2003 Beta 1.7





MARKET INDEXES 7.5

QUARTERLY UPDATES


S&P 500 INDEX

This market capitalization index tracks 500 of the largest U.S. stocks, representing 88

separate industries; prior to 1957, it consisted of 90 stocks.

S&P 500 Index (1995-2009)

1995 37.6% 1998 28.6% 2001 -11.9% 2004 10.9% 2007 5.5%

1996 23.0% 1999 21.0% 2002 -22.1% 2005 4.9% 2008 -37.0%

1997 33.4% 2000 -9.1% 2003 28.7% 2006 15.8% 2009 26.5%

IVV matches returns of large U.S. stocks, as measured by the S&P 500. The ETF‟s total

valuation is $23 billion; its top five stocks are: Exxon Mobil (3.0%), Microsoft (2.1%),

Apple (2.0%), GE (1.9%) and Procter & Gamble (1.7%). Its top 10 holdings represent

19% of the portfolio.

Sector Weightings (3-2010)

Information Technology 19% Energy 11% Materials 3%

Financials 16% Industrials 10% Utilities 3%

Health Care 12% Consumer Discretionary 10% Telecom 3%

Consumer Staples 11%



ETF 26.4% -5.6% 0.4% n/a

Index 26.5% -5.6% 0.4% -1.0%


Inception (symbol: IVV) 5/2000 Beta 1.0


P/E Ratio 20 Largest Sector (info tech.) 19%



MARKET INDEXES 7.6

QUARTERLY UPDATES


S&P 500 GROWTH INDEX

This market capitalization index tracks 306 of the largest U.S. growth stocks, as

measured by the S&P 500/Citigroup Growth Index, which equals 49% of the S&P 500‟s

market capitalization.

S&P 500 Growth Index (1995-2009)

1995 38.1% 1998 42.2% 2001 -12.7% 2004 6.1% 2007 9.1%

1996 24.0% 1999 28.2% 2002 -23.6% 2005 4.0% 2008 -34.9%

1997 36.5% 2000 -22.1% 2003 25.7% 2006 11.0% 2009 31.6%

IVW seeks to match returns of large U.S. growth stocks, based on the S&P 500/Citigroup

Growth Index. The ETF‟s total valuation is $4.0 billion; its top five stocks are: Microsoft

(4.3%), Apple (4.0%), IBM (3.2%), Exxon Mobile (3.2%) and Cisco (2.9%). The top 10

holdings of this ETF represent 29% of the portfolio.


Information Technology 32% Consumer Discretionary 9% Materials 4%

Health Care 13% Industrials 9% Telecom 2%

Energy 11% Financials 7% Utilities ½%

Consumer Staples 10%



ETF 31.3% -2.3% 1.3% n/a

Index 31.6% -2.2% 1.5% n/a


Inception (symbol: IVE) 5/2000 Beta 0.9


P/E Ratio 22 Largest Sector (info tech) 32%



MARKET INDEXES 7.7

QUARTERLY UPDATES


S&P 500 VALUE INDEX

This market capitalization index tracks 347 large U.S. value stocks, represented by the

S&P 500/Citigroup Value Index, which equals 51% of the S&P 500‟s market

capitalization.

S&P 500 Value Index (1995-2009)

1995 36.0% 1998 14.7% 2001 -11.7% 2004 15.7% 2007 2.0%

1996 22.0% 1999 12.7% 2002 -20.9% 2005 5.8% 2008 -39.2%

1997 28.9% 2000 6.1% 2003 31.8% 2006 20.8% 2009 21.2%

IVE matches returns of U.S. large cap value stocks, as represented by the S&P

500/Citigroup Value Index. The ETF‟s total valuation is $4.0 billion. The index‟s top five

stocks are: GE (3.7%), Bank of America (3.4%), JP Morgan Chase (3.4%), Wells Fargo

(3.0%) and Chevron (2.8%). The top 10 holdings represent 28% of the portfolio.


Financials 26% Health Care 11% Info Tech 6%

Consumer Staples 12% Energy 10% Telecom 4%

Industrials 12% Utilities 6% Materials 2%

Consumer Discretionary 11%



ETF 21.7% -9.2% -0.9% n/a

Index 21.2% -9.1% -0.8% n/a


Inception (symbol: IVE) 5/2000 Beta 1.1





MARKET INDEXES 7.8

QUARTERLY UPDATES


RUSSELL 2000 VALUE INDEX

Russell 2000 Value Index measures returns of U.S. small value stocks and it is a

subset of the Russell 2000 Index; it is capitalization weighted, comprised of 1,400 stocks

with an average market capitalization of $950 million. The index‟s total market

capitalization is 740 billion. The index represents 50% of the Russell 2000 Index‟s total

market capitalization.

Russell 2000 Value Index (1995-2009)

1995 25.7% 1998 -6.5% 2001 14.0% 2004 22.3% 2007 -9.8%

1996 21.4% 1999 -1.5% 2002 -11.4% 2005 4.7% 2008 -28.9%

1997 31.8% 2000 22.8% 2003 46.0% 2006 23.5% 2009 20.6%

IWN seeks to match returns of small cap domestic value stocks; its total valuation is $4.3

billion. Each of its top five stocks (Domtar, E*Trade, Developers Diversified Realty,

Assured Guaranty and Highwoods Properties) has a weighting in the 0.5% range.

Top 6 Sector Weightings (3-2010)

Financial Services 26% Materials & Processing 9%

Consumer Discretionary 13% Technology 9%

Producer Durables 12% Utilities 6%



ETF 20.4% -8.2% -0.1% n/a

Index 20.6% -8.2% 0.0 % 8.3%


Inception (symbol: IWN) 7/2000 Beta 1.3



P/B Ratio 1.7 Total Holdings 1,400

Average Market Cap $950 million Expense Ratio 0.33%

MARKET INDEXES 7.9

QUARTERLY UPDATES


RUSSELL 2000 GROWTH INDEX

Russell 2000 Value Index measures returns of U.S. small cap growth stocks; it is a

subset of the Russell 2000 Index. This index is comprised of 1,275 stocks with an

average market capitalization of $5.5 billion; its total market capitalization is $750

billion. The index represents 50% of Russell 2000 Index‟s market capitalization.

Russell 2000 Growth Index (1995-2009)

1995 31.0% 1998 1.2% 2001 -9.2% 2004 14.3% 2007 7.0%

1996 11.3% 1999 43.1% 2002 -30.3% 2005 4.1% 2008 -38.5%

1997 12.8% 2000 -22.4% 2003 48.5% 2006 13.3% 2009 34.5%

IWO seeks to match returns of small cap U.S. growth stocks. The ETF‟s total valuation is

$3.5 billion; its top five stocks are: Human Genome Sciences (1.1%), UAL (0.6%),

Tupperware (0.6%), Solera (0.6%) and Skyworks Solutions (0.5%).


Health Care 24% Producer Durables 9%

Technology 23% Financial Services 7%

Consumer Discretionary 19% Materials & Processing 4%



ETF 34.4% -4.0% 0.8% n/a

Index 34.5% -4.0% 0.9 % -1.4%


Inception (symbol: IWO) 7/2000 Beta 1.1




Average Market Cap $1.1 billion Expense Ratio 0.25%

MARKET INDEXES 7.10

QUARTERLY UPDATES


RUSSELL 2000 INDEX

Russell 2000 Index measures returns of U.S. small cap stocks; the index has 2,007

stocks an average market capitalization of $1.0 billion; total market capitalization is $1.1

trillion.

Russell 2000 Index (1995-2009)

1995 28.4% 1998 -2.6% 2001 2.5% 2004 14.3% 2007 -1.6%

1996 18.5% 1999 21.4% 2002 -20.5% 2005 4.5% 2008 -33.8%

1997 13.0% 2000 -3.0% 2003 47.2% 2006 18.4% 2009 27.2%

IWM seeks to match returns of small cap U.S. growth stocks. The ETF‟s total valuation

is $13.1 billion; its top five stocks are: Human Genome Sciences (0.5%), UAL (0.3%),

Tupperware (0.3%), 3Com (0.3%) and Assured Guaranty (0.3%).


Financial Services 21% Health Care 14%

Technology 16% Producer Durables 11%

Consumer Discretionary 16% Materials & Processing 7%



ETF 27.2% -6.0% 0.5% n/a

Index 27.2% -6.1% 0.5% 3.5%


Inception (symbol: IWM) 5/2000 Beta 1.2





MARKET INDEXES 7.11

QUARTERLY UPDATES


S&P 400 MIDCAP INDEX

The S&P 400 Midcap Index measures returns of U.S. mid cap stocks; it is cap

weighted. Stocks in the index are valued at $1-$4 billion. The index‟s total market

capitalization is $955 billion.

S&P 400 Midcap Index (1995-2009)

1995 31.0% 1998 19.1% 2001 -0.6% 2004 16.5% 2007 8.0%

1996 19.2% 1999 14.7% 2002 -14.5% 2005 12.6% 2008 -36.2%

1997 32.2% 2000 17.5% 2003 35.6% 2006 10.3% 2009 37.4%

IJH matches returns of U.S. mid cap stocks; its total valuation is $7.7 billion. Top five

stocks are: Vertex Pharmaceutical (0.8%), Cree (0.8%), Newfield Exploration (0.7%),

New York Community Bancorp (0.7%) and Lubrizoil (0.6%).


Financial Services 20% Industrials 14%

Information Technology 15% Health Care 13%

Consumer Discretionary 15% Materials 7%



ETF 37.2% -1.9% 3.2% n/a

Index 37.4% -1.8% 3.3% 6.4%


Inception (symbol: IJH) 5/2000 Beta 1.1





MARKET INDEXES 7.12

QUARTERLY UPDATES


DOW JONES U.S. UTILITIES SECTOR INDEX

DJ U.S. Utilities Sector Index measures returns of utilities. It is cap weighted and

represents 75 utilities; its total market capitalization is $4.7 billion.

Dow Jones U.S. Utilities Sector Index (2001-2009)

2001 -26.2% 2004 24.0% 2007 17.8%

2002 -21.2% 2005 15.3% 2008 -30.3%

2003 24.9% 2006 21.3% 2009 12.6%

IDU matches returns of the DJ U.S. Utility Index; total valuation is $460 million. The top

five holdings are: Exelon (6.5%), Southern Company (6.0%), Dominion Resources

(5.5%), Duke Energy (4.7%) and FLP Group (4.1%).


Electricity 71%

Gas, Water & Multiutilities 28%

Other 1%



ETF 12.2% -2.9% 4.8% n/a

Index 12.6% -2.6% 5.3 % n/a


Inception (symbol: IDU) 6/2000 Beta 0.4





MARKET INDEXES 7.13

QUARTERLY UPDATES


DOW JONES U.S. REAL ESTATE INDEX

DJ U.S. Real Estate Index measures real estate industry returns; it is cap weighted and

represents 75 REITs. The index‟s total market capitalization is $261 billion.

Dow Jones U.S. Real Estate Index (2001-2009)

2001 11.8% 2004 31.2% 2007 18.2%

2002 3.6% 2005 9.6% 2008 -40.1%

2003 36.9% 2006 35.5% 2009 30.8%

IYR seeks to match returns, before fees, of the U.S. real estate sector. The ETF‟s total

valuation is $2.8 billion. The top 10 holdings make up 41% of fund assets; the top five

holdings are: Simon Property Group (8.7%), Vornado Realty (4.9%), Public Storage

(4.3%), Equity Residential (3.9%) and Boston Properties (3.8%).


Industrial and Office REITs 25% Hotels & Lodging REITs 6%

Retail REITs 21% Mortgage REITs 6%

Residential REITs 13% Holding & Development REITs 3%



ETF 30.1% -13.9% -1.2% n/a

Index 30.8% -13.8% -1.0 % n/a


Inception (symbol: IYR) 6/2000 Beta 1.7

Standard Deviation (3 year) 38% 30-Day SEC Yield 25%

P/E Ratio 41 Largest Sector 19%



MARKET INDEXES 7.14

QUARTERLY UPDATES


MSCI ALL COUNTRY WORLD INDEX

The MSCI ACWI Index Fund is a benchmark for global stocks. This cap weighted

index captures 85% of the world‟s total market capitalization. It is comprised of 2,423

different securities.

MSCI ACWI Index (1996-2009)

1995 n/a 1998 22.0% 2001 -15.9% 2004 15.7% 2007 11.8%

1996 13.0% 1999 26.8% 2002 -19.0% 2005 11.4% 2008 -42.2%

1997 15.0% 2000 -13.9% 2003 34.6% 2006 21.5% 2009 34.6%

The Vanguard Global Equity Fund (VHGEX) invests in U.S. (41%) and foreign stocks

(59%); it covers well-established and still-developing markets. The mutual fund is

comprised of 790 stocks; the 10 largest holdings represent 10% of the $3.7 billion fund.

The fund is actively managed and seeks to outperform its bench-mark, the MSCI ACWI

Index. The fund‟s five largest holdings are: Royal Dutch Petroleum, Pfizer, Sanofi-

Aventis, Cablevision Systems and Exxon Mobil.


Financials 21% Industrials 10%

Information Technology 12% Health Care 10%

Energy 11% Consumer Discretionary 9%



Fund 33.0% 2.7% 1.8% 5.6%

Index 34.6% -4.6% 3.3 % 0.7%

Fundamentals and Fund Profile (3-2010)

Inception (symbol: VHGEX) 6/2008 Beta 1.1

Standard Deviation (3 year) n/a 30-Day SEC Yield n/a



Median Market Cap $15 billion Expense Ratio 0.35%

MARKET INDEXES 7.15

QUARTERLY UPDATES


MSCI EAFE VALUE INDEX

MSCI EAFE Value Index Fund is a benchmark for foreign large cap value stocks. This capitalization-weighted index is comprised of 524 securities and is designed to

capture 50% of the total market capitalization of the MSCI EAFE Index. The value index

has a total market capitalization of $7.3 trillion.

MSCI EAFE Value Index (2006-2009)

2004 n/a 2007 6.0%

2005 n/a 2008 -44.1%

2006 30.4% 2009 34.2%

EFV seeks to match returns of the Morgan Stanley EAFE Value Index. The ETF‟s total

valuation is $1.4 billion. Its top five holdings are: HSBC Holdings (4.0%), BP (3.5%),

Total (2.5%), Vodafone (2.4%) and Toyota (2.3%). The 10 largest countries represent

11% of the portfolio. The top five countries are: Japan (23%), U.K. (21%), France (13%),

Germany (9%) and Australia (9%).


Financials 36% Utilities 9%

Energy 12% Telecom Services 8%

Industrials 11% Consumer Discretionary 7%



ETF 33.8% -7.4% n/a n/a

Index 34.2% -7.4% 3.4% n/a


Inception (symbol: EFV) 8/2005 Beta 1.3

Standard Deviation (3 year) 26 30-Day SEC Yield 0.8%




MARKET INDEXES 7.16

QUARTERLY UPDATES


THE CASE FOR MID CAPS

The vast majority of advisors and planners do not include mid cap stocks in client

portfolios. Yet, the case for mid caps is strong, as shown in the table below (note: +

represents when mid caps (S&P 400) outperformed large caps (S&P 500).

S&P 500 vs. S&P 400: Total Returns [1995-2009]

S&P 500 vs.

S&P 400

5-Year

Annualized

10-Year

Annualized

15-Year

Annualized

1995 37.6 / 31.0

1996 23.0 / 19.2

1997 33.4 / 32.2 20.3 / 17.8%

1998 28.6 / 19.1 24.1 / 18.8

1999 21.0 / 14.7 + 28.6 / 23.0

2000 -9.1 / 17.5 + 18.3 / 20.4 +

2001 -11.9 / -0.6 + 10.7 / 16.1 +

2002 -22.1 / -14.5 + -0.6 / 6.1 + 9.3 / 12.0% +

2003 28.7 / 35.6 + -0.6 / 9.2 + 11.1 / 13.9 +

2004 10.9 / 16.5 + -2.3 / 9.5 + 12.1 / 16.1 +

2005 4.9 / 12.6 + 0.5 / 8.6 + 9.1 / 14.4 +

2006 15.8 / 10.3 6.2 / 10.9 + 8.4 / 13.5 +

2007 5.5 / 8.0 + 12.8 / 16.2 + 5.9 / 11.2 + 10.5 / 13.4 +

2008 -37.0 / -36.2 + -2.2 / -0.1 + -1.4 / 4.5 + 6.5 / 9.0 +

2009 26.5 / 37.4 + 0.4 / 3.3 + -1.0 / 6.5 + 8.0 / 11.7 +

DECADE RETURNS FOR U.S. STOCKS [1830S-2000S]

ADDED TO CFS 5/2010

1830s 2.8% 1880s 6.0% 1930s -0.2% 1980s 16.6%

1840s 12.8% 1890s 5.5% 1940s 9.6% 1990s 17.6%

1850s 6.6% 1900s 10.9% 1950s 18.2% 2000s -0.5%

1860s 12.5% 1910s 2.2% 1960s 8.3%

1870s 7.5% 1920s 13.3% 1970s 6.6%

source: Yale International Center for Finance

MARKET INDEXES 7.17

QUARTERLY UPDATES


Unit investment trusts (UITs) may be the least understood, and certainly least utilized, of all of the US registered

investment companies. As of December 31, 2008, according to the 2009 Investment Company Fact Book, assets in

US registered investment companies were as follows:

Open-End Funds (Mutual Funds) $9.6 trillion in 8022 funds

Exchange-Traded Funds (ETFs) $531 billion in 728 funds

Closed-End Funds (CEFs) $188 billion in 646

Unit Investment Trusts (UITs) $28.5 billion in 5,984 trusts

BUFFET TRACK RECORD

Over the past 45 years (1965-2009), Berkshire Hathaway stock had an annualized return

of 22%; the two closest mutual funds were Fidelity Magellan (16.3%) and Templeton

Growth (13.4%). A $10,000 investment made in Berkshire on October 1st, 1964 grew to

$80 million by March 2010 ($9.1 million for Magellan and $2.9 million for Templeton).

PAST IS NOT A PREDICTOR

A 2009 study by Fama (University of Chicago) and French (Dartmouth) ran 10,000

simulations as to what investors could expect from actively managed funds. The results

were that, outside the top 3% of funds, active management lags behind the results that

would be obtained due simply to chance.

http://mutualfunds.about.com/od/mutualfundbasics/a/mutualfund.htm

http://mutualfunds.about.com/od/mutualfundglossary/g/etf.htm

http://mutualfunds.about.com/od/mutualfundbasics/a/closedendfunds.htm

ibf - updates - 2010 (q1 v1.2)

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