Upward Bound PRIVATE EQUITY

Private equity activ-ity gained momentum in the second quar-

ter. Fundraising was particularly strong, even though high prices made the buyout investment envi-ronment challenging. Venture financing increased and exit activ-ity remained healthy.

Soccer and Stocks Soar NON-U.S. EQUITY

Global markets settled into a steady rhythm, and at the final whistle most

indices ended in the black. The MSCI ACWI ex USA Index tallied a 5.25% gain, with all sectors scoring positive results. The developed MSCI EAFE Index came in low (+4.09%) versus the MSCI Emerging Markets Index (+6.71%).

Finding Profits in Cognitive Dissonance HEDGE FUNDS

Positive credit and equity markets supported long-biased hedge funds, but

hedge funds generally trailed the capital markets. The Credit Suisse Hedge Fund Index climbed 1.89%. The median manager in the Callan Hedge Fund-of-Funds Database earned 1.58%, net of all fees.

DC Ekes Out Modest GainDEFINED CONTRIBUTION

During the first quar-ter of 2014, the Callan DC Index™ eked out a

1.50% gain in choppy market con-ditions. After extremely strong rela-tive performance in 2013, DC plans trailed DB plans by 57 basis points (bps). Since the Index’s 2006 incep-tion, DB plans have outperformed DC plans by an annualized 78 bps.

REITs Keep It Real REAL ESTATE

Global real estate securi-ties, as measured by the FTSE EPRA/NAREIT

Developed REIT Index, advanced 7.88%. Domestic REITs, tracked by the FTSE NAREIT Equity REITs Index, gained 6.98%. The NCREIF Property Index advanced 2.91%.

Gains GaloreFUND SPONSOR

According to the Callan Fund Sponsor Database, all fund types

enjoyed solid returns. Median per-formance ranged between 3.26% and 3.52%. Recent positive returns have contributed to healthy gains for the trailing 3-, 5-, and 10-year periods for every fund type.

Knowledge. Experience. Integrity.

Broad Market Quarterly Returns

Second Quarter 2014

Cash (90-Day T-Bills)

U.S. Equity (Russell 3000)Non-U.S. Equity (MSCI EAFE)

Emerging Equity (MSCI Em. Mkts.)U.S. Fixed (Barclays Aggregate)

Non-U.S. Fixed (Citi Non-U.S.)Real Estate (NCREIF Property)

Hedge Funds (CS HFI)Commodities (Bloomberg)

Sources: Barclays, Bloomberg, Citigroup, Credit Suisse Hedge Index LLC, Merrill Lynch, MSCI, NCREIF, Russell Investment Group,

2.04%2.64%

2.91%1.89%

0.01%0.08%

4.87%4.09%

6.71%

Are New Highs Too High? U.S. EQUITY

Despite a slow start to the second quarter, the S&P 500 Index ended

the quarter up 5.23%. Large cap stocks led the way (Russell 1000 Index, +5.12%), though there was little distinction between value and growth styles this quarter.

Back in Black U.S. ECONOMY

GDP growth came in at a robust 4%. The growth was driven by strong

gains in consumption, inventory growth, exports, building activity, and even state and local govern-ment spending. The decline in the first quarter was reduced from -2.9% to -2.1%.

6P A G E

2P A G E

19P A G E

Bond Market Continues to SurpriseU.S. FIXED INCOME

The U.S. bond market posted solid returns as the yield curve continued

to flatten. The Barclays Aggregate Index increased 2.04%, despite mixed economic data. The Barclays Corporate High Yield Index gained 2.41%, driven by ongoing demand for yield.

9P A G E

4P A G E

More Yield, Please?NON-U.S. FIXED INCOME

The global bond market continued its climb in the second quarter as the

Citi Non-U.S. World Government Bond Index-Unhedged gained 2.64%. Emerging markets out-performed developed markets as attractive yields and stabilizing economies lifted investor sentiment.

15P A G E

12P A G E

20P A G E

21P A G E

17P A G E

CALLAN INVESTMENTS INSTITUTE Capital

Market Review

2

Back in Black U.S. ECONOMY | Jay Kloepfer

The basic health of the U.S. economy and the official economic data as reported in the GDP releases have been at great odds with one another for the past year. First quarter GDP growth surprised all with a meager 0.1% gain in the initial report, only to be revised downward to -2.9%. The drop was the greatest downward revision since 2002, the largest contraction in GDP since the Great Recession, and the worst contraction in the midst of an economic expansion since World War II. The Fed-eral Reserve (and most other forecasters) immediately cut its GDP growth estimates for calendar 2014 by 1%, with consen-sus projections at 2% for the year. However, the GDP reports appeared to fly in the face of most other sector-specific indica-tors of economic activity, such as the ISM Purchasing Manag-ers’ Index, investment activity, housing, construction, exports, and particularly employment. With June’s payroll growth of 288,000, we have logged five straight months with more than 200,000 new jobs added to the economy, and unemployment has now slipped to 6.1%.

Now adding to the potential confusion, the initial reading of GDP growth for the second quarter was back in the black, coming in at a robust 4%. The growth was driven by strong gains in con-sumption, inventory growth, exports, building activity, and even state and local government spending. The decline in the first quarter was reduced from -2.9% to -2.1%, but the 6.1% swing in growth between quarters is remarkable. Clearly, some of the gains in the second quarter made up for weather-related losses suffered in the first quarter. The two largest contributors to GDP growth were consumption, where durable goods added 1.4% to total growth, and private investment, where contributions to inventories added 1.7% and fixed investment (including equip-ment, non-residential structures, and housing) added another 0.9% to total GDP. Exports contributed 1.2% to GDP growth, but imports rose faster, subtracting 1.9%. Overall, the gains to GDP were much more in line with the measures of growth reported in specific industries than during the previous three quarters, and suggest a U.S. economy that is continuing to broaden in its expansion across industries and regions. Auto sales reached an

annual rate of 17 million in June, the highest in more than eight years, and housing-related spending (both sales and home improvements) rose as the second quarter drew to a close.

The U.S. employment picture, a key component to sustainable growth, continues to improve. However, median household incomes remain 4% lower than levels reported before the Great Recession, while asset prices are broadly higher. The labor force participation rate sits at a generational low, but its down-ward trend appears to have been arrested. The participation

02 0394 95 96 97 98 99 00 01 04 05 06 07 08 09 10 11 12 13 14-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Source: Bureau of Economic Analysis

Quarterly Real GDP Growth (20 Years)

-15%

-10%

-5%

0%

5%

10%

15%

20%PPI (All Commodities)CPI (All Urban Consumers)

02 0394 95 96 97 98 99 00 01 04 05 06 07 08 09 10 11 12 1314

Source: Bureau of Labor Statistics

Inflation Year-Over-Year

3Knowledge. Experience. Integrity.

U.S. ECONOMY (Continued)

rate stabilized at about 63%. Therefore, recent improvements in the unemployment rate (defined as the number of people seeking work that do not have jobs divided by all those who would like to work) have been due more to job creation than to declines in the participation rate. The unemployment rate has been the subject of heightened attention, as the Fed articulated improvement in the rate as a key trigger for potential changes to monetary policy. As the participation rate dropped, the unem-ployment rate fell, but for the wrong reason— the denominator fell, rather than the number of those unable to find work. A floor on the participation rate is a welcome development. The quality of jobs and slow wage growth have been targeted by Fed chair Janet Yellen as reasons for continued monetary support despite the drop in unemployment below the articulated 6.5% target.

Economic indicators around the globe also showed signs of vital-ity in the second quarter. Japan made considerable progress toward its goal of generating domestic inflation after decades of deflation or extremely low inflation. Recent inflation readings in Japan jumped to more than 3.5%, well above the Bank of Japan’s 2% target; however, a 3% increase in the sales tax insti-tuted in April likely had a large impact. Inflation readings had been in the 1.0-1.5% range during the months preceding the tax increase. In Europe, inflation was very low at 0.5% despite the ECB’s target of 2%. European GDP remained positive with a 0.4% estimate. Results in Europe varied on a country-by-coun-try basis, with German GDP at 0.7% while France continued to struggle and suffered a mild contraction. Unemployment in the euro zone also varied widely by country. Region-wide unem-ployment stands at 11.6%, with Germany (+5.1%) at the low end while Greece and Spain (+27.4% and +25.1%, respec-tively) continue to suffer with very elevated levels. Of even greater concern in Europe is the level of youth unemployment. Currently, nearly 25% of young people are jobless in Europe.

The Long-Term ViewThe table above depicts long-term historical capital market performance across a range of asset classes. While an inves-tor’s focus is understandably drawn to the most recent peri-ods, the long-term investor is well-served to keep the long term in mind. Strong equity results over the recent one- and five-year periods should be considered in the context of 10- and 25-year results.

The Long-Term View

20142nd Qtr

Ending December 31, 2013Index Year 5 Yrs 10 Yrs 25 Yrs

U.S. EquityRussell 3000 4.87 33.55 18.71 7.88 10.39

S&P 500 5.23 32.39 17.94 7.41 10.27

Russell 2000 2.05 38.82 20.08 9.07 10.20

Non-U.S. EquityMSCI EAFE 4.09 22.78 12.44 6.91 4.94

MSCI EM 6.71 -2.27 15.15 11.52 11.11

S&P Ex-U.S. Small Cap 3.40 26.06 17.72 9.96 --

Fixed IncomeBarclays Aggregate 2.04 -2.02 4.44 4.55 6.82

3-Month T-Bill 0.01 0.07 0.12 1.68 3.59

Barclays Long G/C 4.93 -8.83 6.40 6.36 8.43

Citi Non-U.S. Govt 2.64 -4.56 2.27 4.10 6.18

Real EstateNCREIF Property 2.91 10.98 5.68 8.64 7.45

FTSE NAREIT Equity 6.98 2.47 16.50 8.42 10.45

AlternativesCS Hedge Fund 1.89 9.73 8.66 6.37 --

VE Private Equity -- 20.84 15.51 13.11 14.67

Bloomberg Comm. 0.08 -9.52 1.51 0.87 --

Gold Spot Price 2.98 -28.26 6.34 11.19 4.37

Inflation – CPI-U 0.87 1.50 2.08 2.37 2.67

Sources: Barclays, Bloomberg, Citigroup, Credit Suisse, FTSE, MSCI, NCREIF, Russell Investment Group, Standard & Poor’s.

Recent Quarterly Indicators

Economic Indicators 2Q14 1Q14 4Q13 3Q13 2Q13 1Q13 4Q12 3Q12Employment Cost–Total Compensation Growth 2.0% 1.8% 2.0% 1.9% 1.9% 1.9% 1.9% 1.9%

Nonfarm Business–Productivity Growth 1.1% -3.2% 2.3% 3.5% 1.8% -1.8% -1.5% 2.1%

GDP Growth 4.0% -2.1% 3.5% 4.5% 1.8% 2.7% 0.1% 2.5%

Manufacturing Capacity Utilization 77.1% 76.2% 76.4% 76.0% 75.9% 76.0% 75.5% 75.4%Consumer Sentiment Index (1966=100) 82.8 80.9 76.9 81.6 81.7 76.7 79.4 75.0

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve, Reuters/University of Michigan

4

Gains GaloreFUND SPONSOR | Irina Sushch

Capital markets advanced steadily into the second quarter, capturing solid gains across the board. Emerging markets (EM) surpassed all equities, boosting non-U.S. equity returns above U.S. stocks (MSCI ACWI ex USA Index: +5.25%, Russell 3000 Index: +4.87%). Fixed income markets also fared well. How-ever, renewed confidence in stabilizing emerging market econo-mies gave foreign bonds a leg up on their U.S. counterparts (Citi Non-U.S. World Government Bond Index-Unhedged: +2.64%, Barclays Aggregate: +2.04%).

The Callan Fund Sponsor Quarterly Returns chart illustrates the range of returns for public, corporate, and Taft-Hartley pension plans as well as endowments and foundations. All fund types enjoyed solid gains; median performance ranged between 3.26% and 3.52%. Performance among the top performers (10th percentile) displayed wider dispersion, with corporates coming in first place (+4.59%) and Taft-Hartley funds in last (+3.75%). Along the bottom (90th percentile), all funds performed within 14 basis points of each other, with corporates bringing up the rear at 2.71%.

Asset allocation decisions help explain the difference in perfor-mance among the fund types. Due to their lower average expo-sure to EM equity, Taft-Hartley plans trailed behind the more-EM

heavy corporate and public funds and endowments and founda-tions. Corporate performance continued to have the widest dis-tribution. Corporate funds that employ liability-driven investment (LDI) programs experienced robust gains as interest rates fell further and the yield curve continued to flatten.

The fund sponsor performance table compares the effect of asset allocation decisions over longer time periods. Strong aver-age performance for corporates this quarter pushed them to the top across every time period on the board (up 10.07%, 12.89%, and 7.37% for the trailing 3-, 5-, and 10-year time periods,

Database Median and Index Returns* for Periods ended June 30, 2014

Fund Sponsor Quarter YTD Year 3 Years 5 Years 10 YearsPublic Database 3.52 5.30 16.11 9.70 12.54 7.29Corporate Database 3.51 5.76 16.18 10.07 12.89 7.37Endowments/Foundations Database 3.45 5.11 15.63 8.78 11.81 7.10Taft-Hartley Database 3.26 5.05 16.10 10.03 12.19 6.74

Diversified Manager Quarter YTD Year 3 Years 5 Years 10 YearsAsset Allocator Style 3.66 4.89 15.71 9.66 11.87 7.20U.S. Balanced Database 3.98 5.88 17.86 10.33 13.79 7.52

Global Balanced Database 3.75 4.78 13.76 7.46 11.25 7.91

60% Russell 3000 + 40% Barclays Agg 3.74 5.73 16.61 11.60 13.76 7.34

60% MSCI World + 40% Barclays Glbl Agg 3.90 5.69 17.17 8.21 10.94 6.65

*Returns less than one year are not annualized.

Sources: Callan, Barclays, MSCI Inc., Russell Investment Group

0%

1%

2%

3%

4%

5%

Public Corporate Endow/Fndn Taft-Hartley Database Database Database Database 10th Percentile 4.09 4.59 4.17 3.75 25th Percentile 3.76 4.00 3.79 3.50 Median 3.52 3.51 3.45 3.26 75th Percentile 3.18 3.16 3.17 3.01 90th Percentile 2.85 2.71 2.80 2.74

Source: Callan

Callan Fund Sponsor Quarterly Returns

5Knowledge. Experience. Integrity.

FUND SPONSOR (Continued)

respectively). With relatively high allocations to both U.S. and non-U.S. equity (35% and 16% respectively), public funds also contin-ued to fare well, slightly trailing corporates. Recent positive returns have contributed to healthy gains for the trailing 3-, 5-, and 10-year periods for every fund type. Callan’s balanced manager groups generally maintain well-diversified portfolios and attempt to add value by underweight-ing or overweighting asset classes, as well as through stock

selection. Although the 60% MSCI World + 40% Barclays Global Aggregate benchmark produced higher returns than the 60% Russell 3000 + 40% Barclays Aggregate this quarter, Callan’s U.S. balanced manager groups (+3.98%) managed to slightly outperform the global balanced group (+3.75%). Steady, strong performance of the U.S. broad markets in recent history has led U.S. balanced managers to surpass their global counter-parts in all but the trailing 10-year time period, when their perfor-mance was within 40 basis points of each other (U.S. balanced: +7.52%, global balanced: +7.91%).

4.5%1.9%5.4%

3.3%0.6%0.8%

Source: Callan

U.S. Fixed Non-U.S. Fixed

Global BalancedReal EstateHedge Funds

Other AlternativesCash

Endowment/Foundation

3.45%

33.1%

16.7%18.7%

0.9%

4.2%

6.5%

1.7%

2.2%

3.7%

3.8%

4.0%

11.3%

1.2%

Taft-Hartley3.26%

38.6%

8.8%23.9%

3.3%

2.3%0.3%

10.3%

4.4%5.4%

0.7%Public3.52%

15.5%

1.2%

35.2%

27.5%

1.2%2.8%3.5%

2.3%0.7%1.7%

1.7%

1.2%

U.S. Balanced

U.S. EquityNon-U.S. EquityGlobal Equity

Corporate3.51%

31.7%

37.5%

13.6%

0%

20%

40%

60%

80%

100%

04 05 06 07 08 09 10 11 12 13

U.S. Fixed

Non-U.S. Fixed

Global Balanced

Real Estate

Hedge Funds

Other Alternatives

Cash

U.S. Balanced

U.S. Equity

Non-U.S. Equity

Global Equity

14

Callan Fund Sponsor Average Asset Allocation

Callan Public Fund Database Average Asset Allocation (10 Years)

Source: Callan

6

Are New Highs Too High? U.S. EQUITY | Lauren Mathias, CFA

Despite a slow start to the second quarter, U.S. equities as rep-resented by the S&P 500 Index (+5.20%) ended at 1,960.23, just two points shy of its record close of 1,962.87 set June 20. The market environment reacted favorably to economic improvements, including: 44 consecutive months of positive job growth (the unemployment rate declined from 10.2% in October 2009 to 6.1% in June 2014); a moderate rise in house-hold spending; home prices that were up 8.8% year-over-year in May; and continued subdued inflation.

Despite slowing its quantitative easing program, the Fed cut its 2014 growth outlook to a range of 2.1% to 2.3% (versus the March forecast of 2.8% to 3.0%). Other concerns remain, such as real GDP’s decline (-2.1%) in the first quarter and slow wage growth, as well as geopolitical issues including the civil war in Iraq and continued angst between Russia and Ukraine.

Large cap stocks led the way (Russell 1000 Index, +5.12%), though there was little distinction between value and growth styles this quarter; the Russell 1000 Value Index (+5.10%)

and Russell 1000 Growth Index (+5.13%) were almost exactly even. Small (Russell 2000 Index, +2.05%) and mid cap (Russell Mid-Cap Index, +4.97%) stocks trailed larger indices, while value maintained its lead over growth in both capitalizations. From a style perspective, value characteris-tics such as low prices were rewarded, while projected and historical earnings growth were not. Micro cap was the lag-gard (Russell Microcap Index, -1.41%), but remains in posi-tive territory year-to-date (+1.56%). Active managers strug-gled to keep pace with market indexes; only the Small Cap Value Style median manager outperformed its benchmark.

Within large cap, all sectors posted positive results. In small cap, the Telecommunications sector was negative for the quar-ter. Energy and Utilities led other sectors. Oil prices increased as troubles in the Middle East provided a tailwind to energy stocks. Investors continue to seek yield as quantitative easing slows, so dividend-paying equity remains an important source of income. Utilities benefited from this phenomenon, as well as from a preference for lower volatility. Consumer Discretionary

Russell 1000 Russell 2000

-5%

0%

5%

10%

15%

FinancialConsumerDiscretionary

IndustrialsTelecommHealth CareConsumerStaples

MaterialsInformationTechnology

UtilitiesEnergy

12.3%11.4%

7.7%8.9%

5.5%

1.8%

4.9%

0.8%

4.6%

1.0%

4.1%

-3.1%

3.8%

0.0%

3.3%

1.2%2.5%

1.7%

6.0%

1.9%

Source: Russell Investment Group

Economic Sector Performance

7Knowledge. Experience. Integrity.

U.S. EQUITY (Continued)

was a disappointing sector for both small and large caps, as industries like retailers were punished for weather-related poor results during the first quarter.

Mergers and acquisitions were prevalent, with levels not seen since 2007. Technology, media, and large cap telecommunica-tion companies benefited as these industries continue to evolve and innovate. Although the full quarter showed a market pref-

erence for risk reduction, in June an uptick in risk appetite led to low quality and high beta outperformance. At quarter end, S&P 500 Index stock correlations reduced to their historical long-term average, and the CBOE Market Volatility Index (VIX) moved even further below its average. The S&P 500’s forward P/E continued to increase beyond its historical average, caus-ing investors to question whether the new highs are too high.

Large Cap Large Cap Small Cap Small Cap Growth Style Value Style Growth Style Value Style 10th Percentile 6.00 5.66 2.86 4.94 25th Percentile 5.40 5.45 1.43 4.36 Median 4.69 4.71 0.18 3.21 75th Percentile 4.24 4.20 -1.56 2.40 90th Percentile 3.13 3.43 -2.58 1.80 R1000 Growth R1000 Value R2000 Growth R2000 Value Benchmark 5.13 5.10 1.72 2.38

Sources: Callan, Russell Investment Group

-4%

-2%

0%

2%

4%

6%

Callan Style Group Quarterly Returns

02 039495 96 97 98 99 00 01-30%

-20%

-10%

0%

10%

20%

30%

04 05 06 07 08 09 10 11 12 13 14

Russell 1000 Growth Russell 1000Russell 1000 Value

Source: Russell Investment Group

Rolling One-Year Relative Returns (vs. Russell 1000)

U.S. Equity Index Characteristics as of June 30, 2014

S&P 500 Rus 3000 Rus 1000 Rus Midcap Rus 2500 Rus 2000Cap Range Min ($mm) 3,137 36 345 345 36 36

Cap Range Max ($bn) 560.34 560.34 560.34 27.94 9.92 4.37

Number of Issues 501 3,000 1,027 833 2,499 1,973

% of Russell 3000 79% 100% 92% 29% 19% 8%

Wtd Avg Mkt Cap ($bn) 118.25 96.11 104.26 11.83 3.89 1.77

Price/Book Ratio 2.6 2.6 2.7 2.6 2.3 2.2

Forward P/E Ratio 15.7 16.5 16.2 18.6 19.4 20.8

Dividend Yield 2.0% 1.8% 1.9% 1.5% 1.3% 1.2%

5-Yr Earnings (forecasted) 11.1% 11.9% 11.6% 12.8% 14.3% 16.7%

Sources: Russell Investment Group, Standard & Poor’s.

8

Style Median and Index Returns* for Periods ended June 30, 2014

Large Cap Equity Quarter YTD Year 3 Years 5 Years 10 YearsLarge Cap Core Style 5.11 7.44 25.84 16.83 19.04 8.60Large Cap Growth Style 4.69 4.96 27.94 15.40 18.90 8.57Large Cap Value Style 4.71 7.76 24.51 17.05 18.99 8.56Aggressive Growth Style 0.89 0.39 26.41 12.34 19.33 9.49Contrarian Style 4.90 8.27 24.18 16.72 19.61 8.67Yield-Oriented Style 4.70 7.76 23.56 16.02 18.40 9.02Russell 3000 4.87 6.94 25.22 16.46 19.33 8.23

Russell 1000 5.12 7.27 25.35 16.63 19.25 8.19

Russell 1000 Growth 5.13 6.31 26.92 16.26 19.24 8.20

Russell 1000 Value 5.10 8.28 23.81 16.92 19.23 8.03

S&P Composite 1500 5.05 7.03 24.70 16.42 19.14 8.07

S&P 500 5.23 7.14 24.61 16.58 18.83 7.78

NYSE 4.98 6.91 23.43 15.63 17.99 8.76Dow Jones Industrials 2.83 2.68 15.56 13.57 17.83 7.63

Mid Cap Equity Quarter YTD Year 3 Years 5 Years 10 YearsMid Cap Core Style 4.92 8.21 28.24 16.84 23.16 11.24Mid Cap Growth Style 2.39 5.07 26.41 13.86 20.47 10.47Mid Cap Value Style 4.66 8.56 26.62 17.21 22.15 11.09Russell Midcap 4.97 8.67 26.85 16.09 22.07 10.43S&P MidCap 400 4.33 7.50 25.24 15.26 21.67 10.50

Small Cap Equity Quarter YTD Year 3 Years 5 Years 10 YearsSmall Cap Core Style 2.61 4.43 26.11 16.39 22.13 10.16Small Cap Growth Style 0.18 1.62 24.28 14.57 21.92 10.03Small Cap Value Style 3.21 5.10 25.33 16.50 21.56 10.27Russell 2000 2.05 3.19 23.64 14.57 20.21 8.70

S&P SmallCap 600 2.07 3.22 25.54 16.81 21.98 9.95

NASDAQ 5.31 6.18 31.17 18.28 20.59 9.06

Smid Cap Equity Quarter YTD Year 3 Years 5 Years 10 YearsSmid Cap Broad Style 2.82 4.54 25.30 14.95 21.25 10.46Smid Cap Growth Style 1.70 2.55 25.11 14.30 20.94 10.24Smid Cap Value Style 4.66 6.14 26.20 15.78 22.34 11.19Russell 2500 3.57 5.95 25.58 15.51 21.63 9.78

S&P 1000 3.65 6.18 25.36 15.74 21.77 10.31

Russell 3000 Sectors Quarter YTD Year 3 Years 5 Years 10 YearsConsumer Discretionary 3.17 0.98 21.17 20.28 26.20 9.34

Consumer Staples 4.72 5.37 16.17 15.98 17.84 10.19

Energy 12.24 13.97 30.84 11.58 17.27 13.20

Financials 2.40 5.26 18.60 15.57 15.96 1.38

Health Care 4.31 10.24 30.73 22.15 21.29 9.94

Industrials 3.41 3.93 28.89 16.48 22.50 9.14

Information Technology 5.69 7.96 32.12 16.28 18.79 8.26

Materials 5.13 8.26 31.33 11.20 19.04 10.30

Telecommunications 3.93 4.37 8.23 11.52 15.05 8.27Utilities 7.84 18.03 22.24 14.63 15.06 10.79*Returns less than one year are not annualized.Sources: Callan, Dow Jones & Company Inc., Russell Investment Group, Standard & Poor’s, The NASDAQ Stock Market Inc.

U.S. EQUITY (Continued)

9Knowledge. Experience. Integrity.

Soccer and Stocks Soar NON-U.S. EQUITY | Matt Lai

After a weak first quarter, the second quarter strengthened as investors regained some conviction in the global economy. Heartening data from emerging economies and renewed recov-ery efforts in Europe helped accelerate international returns in May and June.

A second-quarter boost of 5.25% elevated the MSCI ACWI ex USA Index to a 5.89% return for the year thus far. Middle East unrest drove the quarter’s Energy (+11.63%) stocks to the fore, though all sectors enjoyed gains. Industrials (+3.43%) and Consumer Discretionary (+3.89%) lagged. Most major curren-cies gained on the dollar save for the euro, which shed 0.6% to the greenback.

Developed countries (MSCI EAFE Index: +4.09%) fell short of their emerging counterparts (MSCI Emerging Markets Index: +6.71%), the latter holding a 154 basis point lead for 2014. MSCI EAFE Value (+4.73%) outperformed MSCI EAFE Growth (+3.45%) for the fifth straight quarter. In a reverse from last quarter, MSCI EAFE Small Cap (+2.08%) underperformed the broader index.

European Central Bank action invigorated the continent’s devel-oped markets, with the MSCI Europe Index gaining 3.30% (quar-terly) and 5.48% year-to-date (YTD). Sectors largely mirrored global trends: Energy (+11.32%) and Utilities (+6.68%) counter-balanced Industrials (+2.34%) and IT (+1.00%). Mario Draghi unveiled an interest rate cut to a record 0.15% (from 0.25%), and European unemployment decreased to 11.6%. Norway led Europe with a 9.86% jump. Second-place Spain (+7.17%) drew headlines as King Juan Carlos I abdicated the throne to his son Felipe VI, ending a 39-year reign. Ireland (-8.98%) and Portugal (-2.58%) flopped, but remained positive for the first six months.

The MSCI Pacific Index (+5.77%) finished strong, hoisting its YTD return to 3.12%. Energy (+9.19%) and IT (+9.08%) were the top sectors, though underdogs Consumer Discretionary

Global Eq Non-U.S. Eq Emg Mkts Small Cap Style Style Style Style 10th Percentile 5.70 5.40 10.21 4.30 25th Percentile 5.08 4.88 8.36 3.58 Median 4.56 4.05 7.30 2.21 75th Percentile 3.95 3.10 6.64 0.98 90th Percentile 2.67 2.36 6.02 -0.05 MSCI MSCI MSCI MSCI EAFE World EAFE Emg Mkts Small Cap Benchmark 4.86 4.09 6.71 2.08

Sources: Callan, MSCI

-3%

0%

3%

6%

9%

12%

Callan Style Group Quarterly Returns

(+3.26%) and Health Care (+3.37%) contributed. Hong Kong (+8.26%) and Japan (+6.66%) benefited most. Annualized Japanese GDP—driven by capital expenditures and sound consumer confidence—was revised up to a surprising 6.7% for the first quarter (estimates were at 5.6%). Elsewhere in the

-40%

-32%

-24%

-16%

-8%

0%8%

16%

24%

32%

40%

02 0394 95 96 97 98 99 00 01 04 05 06 07 08 09 10 11 12 13 14

*euro returns from 1Q99Source: MSCI

German markJapanese yen U.K. sterling euro*

Major Currencies’ Cumulative Returns (vs. U.S. Dollar)

10

NON-U.S. EQUITY (Continued)

region, New Zealand clocked the only negative return, with a drop of 1.19%, though its YTD gain of 14.98% remains the region’s best. Australia (+2.77%) held its 2.5% key rate.

Emerging markets prevailed over all rival regions (MSCI Emerging Markets Index: +6.71%; +6.32% YTD). IT (+11.18%) and Utilities (+10.48%) led universally black sectors, with Materials (+3.88%) and Consumer Staples (+4.12%) at the bottom. China (+5.70%) was bolstered by Energy (+13.01%) and Utilities (+11.42%); Materials dragged heavily (-6.05%), as reports emerged of an oversupply in Chinese real estate. The democratic election of pro-business Narendra Modi lifted India (+12.67%), eclipsed solely by Turkey, which saw a 15.36% gain and first-quarter GDP growth of 4.3%. Volatile Greece (-10.74%) bore the brunt of investor ire. Qatar (-5.40%) and the UAE (-5.49%) joined the MSCI Emerging Markets Index in June. Brazil (+7.66%) welcomed World Cup passion, and

Peru (+8.49%) led the MSCI Emerging Market Latin America Index (+6.99%). A time-out in Ukraine’s crisis helped elevate the MSCI Frontier Markets to a quarterly 12.10% gain and an astounding 20.54% rise YTD.

EM EAFE

Quarter Year

ACWI ex USA

0%

3%

6%

9%

12%

IndustrialsConsumerDiscretionary

UtilitiesEnergy

United ArabEmirates

Greece

Portugal

Ireland

India

Turkey

Hong Kong

Norway

Source: MSCI

Source: MSCI

10.2%

11.3%11.6%

10.5%

6.7%

7.7%

4.2%3.3%

15.4%-3.1%

12.7%

27.4%

35.0%

-9.0%

-2.6%

19.9%

55.1%

-5.5%

57.9%

-10.7%

3.9%

4.9%

17.7%8.3%

2.3%

3.4%

9.9%

29.8%

EAFE

EMEA

FEEM

Bes

t Per

form

ers

Wor

st P

erfo

rmer

s

Best Performers Worst Performers

Quarterly Country Performance Snapshot

Quarterly Returns: Strong and Struggling Sectors

Quarterly Return Attribution for EAFE (U.S. Dollar)

Country Total Local Currency WtgAustralia 2.77% 0.92% 1.83% 7.73%

Austria -0.60% 0.06% -0.66% 0.27%

Belgium 5.05% 5.74% -0.66% 1.22%

Denmark 3.18% 3.72% -0.52% 1.50%

Finland 4.36% 5.05% -0.66% 0.85%

France 1.70% 2.37% -0.66% 10.13%

Germany 1.65% 2.32% -0.66% 9.30%

Hong Kong 8.26% 8.16% 0.09% 2.84%

Ireland -8.98% -8.38% -0.66% 0.30%

Israel 2.41% 0.40% 1.79% 0.52%

Italy -0.12% 0.54% -0.66% 2.61%

Japan 6.66% 4.92% 1.66% 20.25%

Netherlands 0.50% 1.17% -0.66% 2.69%

New Zealand -1.19% -2.07% 0.90% 0.14%

Norway 9.86% 12.60% -2.43% 0.87%

Portugal -2.58% -1.93% -0.66% 0.18%

Singapore 5.71% 4.81% 0.87% 1.43%

Spain 7.17% 7.88% -0.66% 3.68%

Sweden -0.89% 2.20% -3.02% 3.04%

Switzerland 2.09% 2.49% -0.39% 9.04%

U.K. 6.05% 3.40% 2.56% 21.44%

Sources: MSCI, Russell Investment Group, Standard & Poor’s.

11Knowledge. Experience. Integrity.

Style Median and Index Returns* for Periods ended June 30, 2014

Non-U.S. Equity Quarter YTD Year 3 Years 5 Years 10 YearsNon-U.S. Equity Style 4.05 4.45 22.88 8.58 13.07 8.09MSCI EAFE 4.09 4.78 23.57 8.10 11.77 6.93

MSCI EAFE (local) 3.41 3.12 17.91 10.42 10.90 5.64MSCI EAFE Growth 3.45 3.56 20.33 7.68 12.22 7.09

MSCI EAFE Value 4.73 6.01 26.86 8.46 11.24 6.71

MSCI ACWI ex USA 5.25 5.89 22.27 6.21 11.59 8.22

Global Equity Quarter YTD Year 3 Years 5 Years 10 YearsGlobal Equity Style 4.56 5.84 24.90 12.37 15.53 8.58MSCI World 4.86 6.18 24.05 11.81 14.99 7.25

MSCI World (local) 4.42 5.48 21.70 13.04 14.44 6.52

MSCI ACWI 5.23 6.50 23.58 10.85 14.88 8.02

Regional Equity Quarter YTD Year 3 Years 5 Years 10 YearsMSCI Europe 3.30 5.48 29.28 8.67 13.03 7.54

MSCI Europe (local) 3.04 4.92 20.19 9.30 12.28 6.54

MSCI Japan 6.66 0.68 9.85 7.60 7.24 3.25

MSCI Japan (local) 4.92 -2.96 12.03 16.04 8.29 2.48

MSCI Pacific ex Japan 4.31 7.40 18.83 6.29 14.03 11.90

MSCI Pacific ex Japan (local) 2.96 3.52 16.05 9.08 11.10 9.16

Emerging/Frontier Markets Quarter YTD Year 3 Years 5 Years 10 YearsEmerging Market Style 7.30 6.47 14.62 0.85 10.25 12.90MSCI Emerging Markets 6.71 6.32 14.68 -0.06 9.58 12.30

MSCI Emerging Markets (local) 5.25 4.75 14.10 4.43 9.89 12.01

Frontier Markets 11.92 20.21 36.17 12.41 10.65 8.58

Non-U.S. Small Cap Equity Quarter YTD Year 3 Years 5 Years 10 YearsNon-U.S. Small Cap Style 2.21 5.82 28.70 11.30 18.19 10.88MSCI EAFE Small Cap 2.08 5.50 29.08 9.84 15.21 8.73

MSCI ACWI ex USA Small Cap 3.64 7.24 26.09 6.90 14.50 9.80*Returns less than one year are not annualized.Sources: Callan, MSCI

NON-U.S. EQUITY (Continued)

MSCI Europe

MSCI EAFE

MSCI Pacific ex Japan

MSCI ACWI ex USA

MSCI Japan

MSCI Emerging Markets 6.71%

4.09%

6.66%

5.25%

4.31%

3.30%

Source: MSCI

Rolling One-year Relative Returns (vs. MSCI EAFE U.S. Dollar)

02 039495 96 97 98 99 00 01-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

04 05 06 07 08 09 10 11 12 13 14

MSCI Pacific MSCI EAFEMSCI Europe

Source: MSCI

Regional Quarterly Performance (U.S. Dollar)

12

Bond Market Continues to Surprise U.S. FIXED INCOME | Steven Center, CFA

Amid mixed economic data and global volatility, the yield curve flattened for the second consecutive quarter. Yield spreads pulled tighter across all non-Treasury sectors as investors remained comfortable accepting spread risk in exchange for yield. The Barclays Aggregate Index rose 2.04%. The Fed has continued to chart a path toward eliminating its quantitative easing (QE) program by year-end, and in June announced additional tapering of the monthly asset purchase level. July’s purchase will total $35 billion, down from $45 bil-lion in June. Signs of inflation have begun to percolate, but the Consumer Price Index still sits below the Fed’s long-term 2% objective. Despite the downward GDP revision for the first quarter (from +0.1% to -2.1%), general market consen-sus points to an upward trajectory for future interest rates. Short-term rates remained anchored, as the Fed once again pegged the federal funds and discount rates at 0.00%–0.25% and 0.75%, respectively. Three-month yields slipped one basis point (bp), and six-month yields edged up by one bp. Two-year yields improved four bps, and 30-year yields dropped 20 bps, resulting in a continuation of last quarter’s flattening trend. The spread between two-year and 30-year Treasuries weakened

by 24 bps to 290 bps. Five- and 10-year yields fell nine and 19 bps, respectively. The breakeven rate (the difference between nominal and real yields) on the 10-year Treasury grew 13 bps to 2.27%.

With Treasury yields continuing their downward path, inves-tors had no choice but to turn to spread sectors as a source

Interm Core Bond Core Plus Ext Maturity High Yld Style Style Style Style Style 10th Percentile 1.65 2.44 2.84 5.50 2.98 25th Percentile 1.49 2.26 2.51 5.15 2.67 Median 1.33 2.16 2.39 5.03 2.53 75th Percentile 1.27 2.03 2.22 4.73 2.22 90th Percentile 1.16 1.77 2.05 3.95 2.08 Barclays Barclays Barclays Barclays Barclays Interm Agg Agg Agg Long G/C High Yld Benchmark 1.62 2.04 2.04 4.93 2.41

Sources: Barclays, Callan

0%

2%

4%

6%

Callan Style Group Quarterly ReturnsU.S. Treasury Yield Curves

-1%

0%

1%

2%

3%

4%

5%

6%

U.S. 10-Year Treasury Yield 10-Year TIPS Yield Breakeven Inflation Rate

07 08 09 10 11 12 13 14060504

Source: Bloomberg

Historical 10-Year Yields

0%

1%

2%

3%

4%

5%

Maturity (Years)Source: Bloomberg

June 30, 2014 March 31, 2014 June 30, 2013

302520151050

13Knowledge. Experience. Integrity.

U.S. FIXED INCOME (Continued)

of income. This environment resulted in all non-Treasury sec-tors outperforming like-duration Treasuries for the quarter. Agency mortgage-backed securities (MBS) added 0.90% over Treasuries, improving on their lackluster first quarter. Commer-cial mortgage-backed securities (CMBS) and asset-backed securities (ABS) added 0.55% and 0.30%, respectively. Cor-porate spreads again tightened, driven largely by demand for BBB-rated paper. During the quarter, Utilities, Financials, and Industrials outperformed like-duration Treasuries by 0.82%, 0.75%, and 0.68%, respectively.

High yield corporate bonds remain a bright spot in the U.S. fixed income market, powered by continued demand and relative issuer strength. The Barclays Corporate High Yield Index rallied 2.41%. New issue activity is on pace to exceed the record issuance of 2013. During the quarter, 211 high yield bonds totaling approximately $121 billion were issued.

U.S. Fixed Income Index Characteristics as of June 30, 2014

Barclays Indices Yield to Worst Mod Adj Duration Avg Maturity % of Barclays G/C % of Barclays Agg

Barclays Aggregate 2.22 5.60 7.69 - 100.00%

Barclays Govt/Credit 1.99 5.91 8.05 100.00% 68.42%

Intermediate 1.49 3.89 4.21 80.84% 55.31%

Long-Term 4.08 14.44 24.20 19.16% 13.11%

Barclays Govt 1.35 5.11 6.25 56.86% 38.91%

Barclays Credit 2.83 6.97 10.41 43.14% 29.51%

Barclays MBS 2.79 5.06 7.19 - 28.92%

Barclays ABS 1.16 2.42 2.71 - 0.48%

Barclays CMBS 2.07 3.90 4.38 - 2.13%

Barclays Corp High Yield 4.91 4.04 6.58 - -

Source: Barclays

0% 1% 2%

Excess Return versus Like-Duration Treasuries

0.00%0.52%

0.29%

0.55%

0.30%

0.90%

0.81%

1.37%

Source: Barclays

Absolute Return

0% 1% 2% 3% 4%

1.35%

2.04%

1.18%

1.31%

0.77%

2.41%

2.71%

2.41%

Barclays Treasury

Barclays Aggregate

Barclays Agencies

Barclays MBS

Barclays CMBS

Barclays ABS

Barclays Credit

Barclays Corp. High Yield

-5%

0%

5%

10%

15%

20%

U.S. Credit Bellwether 10-Year SwapBarclays High YieldMBS

ABSCMBS ERISA

07 08 09 10 11 12 13 14060504

Source: Barclays

Fixed Income Index Quarterly Returns

Effective Yield Over Treasuries

14

Style Median and Index Returns* for Periods ended June 30, 2014

Broad Fixed Income Quarter YTD Year 3 Years 5 Years 10 YearsCore Bond Style 2.16 4.25 5.09 4.46 5.87 5.44Core Bond Plus Style 2.39 4.67 6.19 5.38 7.76 6.04Barclays Aggregate 2.04 3.93 4.37 3.66 4.85 4.93

Barclays Govt/Credit 1.92 3.94 4.28 4.08 5.09 4.94

Barclays Govt 1.34 2.66 2.08 2.88 3.46 4.43

Barclays Credit 2.71 5.70 7.44 5.88 7.65 5.85

Citi Broad Investment Grade 2.04 3.90 4.34 3.68 4.72 5.05

Long-Term Quarter YTD Year 3 Years 5 Years 10 YearsExtended Maturity Style 5.03 11.89 11.77 10.23 10.74 7.98Barclays Long Govt/Credit 4.93 11.81 10.77 9.57 9.60 7.60

Barclays Long Govt 4.73 12.08 6.44 8.70 7.41 7.17

Barclays Long Credit 5.04 11.66 13.34 9.81 11.11 7.70

Citi Pension Discount Curve 5.00 14.24 14.38 13.28 12.14 9.33

Intermediate-Term Quarter YTD Year 3 Years 5 Years 10 YearsIntermediate Style 1.33 2.50 3.42 3.32 4.67 4.88Barclays Intermediate Aggregate 1.62 2.85 3.48 2.86 4.23 4.57

Barclays Intermediate Govt/Credit 1.23 2.25 2.86 2.83 4.09 4.33

Barclays Intermediate Govt 0.91 1.55 1.53 1.96 2.83 3.91

Barclays Intermediate Credit 1.79 3.45 5.21 4.45 6.44 5.23

Short-Term Quarter YTD Year 3 Years 5 Years 10 YearsDefensive Style 0.47 0.81 1.56 1.33 2.08 3.24Active Duration Style 1.53 3.28 4.06 4.08 4.94 5.10Money Market Funds (net of fees) 0.00 0.00 0.01 0.01 0.01 1.49

ML Treasury 1–3-Year 0.27 0.26 0.62 0.58 1.15 2.60

90-Day Treasury Bills 0.01 0.02 0.05 0.07 0.11 1.63

High Yield Quarter YTD Year 3 Years 5 Years 10 YearsHigh Yield Style 2.53 5.66 11.70 9.58 13.65 8.90Barclays Corporate High Yield 2.41 5.46 11.73 9.48 13.98 9.05

ML High Yield Master 2.49 5.55 11.71 9.24 13.80 8.82

Mortgage/Asset-Backed Quarter YTD Year 3 Years 5 Years 10 YearsMortgage Style 2.41 4.17 4.93 3.61 4.95 5.20Barclays MBS 2.41 4.03 4.66 2.80 3.92 4.95

Barclays ABS 0.77 1.31 1.80 2.44 4.66 3.58

Barclays CMBS 1.31 2.62 4.22 4.86 10.88 5.61

Municipal Quarter YTD Year 3 Years 5 Years 10 YearsBarclays Muni 2.59 6.00 6.14 5.35 5.81 4.97

Barclays Muni 1–10-Year 1.57 3.20 4.27 3.56 4.19 4.22

Barclays Muni 3-Year 0.71 1.04 2.42 1.83 2.45 3.17

TIPS Quarter YTD Year 3 Years 5 Years 10 YearsTIPS Full Duration 3.81 5.83 4.44 3.55 5.55 5.25

TIPS 1-10 Year 2.94 4.00 3.59 2.16 4.45 4.57

*Returns of less than one year are not annualized.

Sources: Barclays, Callan, Citigroup, Merrill Lynch

U.S. FIXED INCOME (Continued)

15Knowledge. Experience. Integrity.

More Yield, Please?

NON-U.S. FIXED INCOME | Kyle Fekete

Global investors were hungry for yield in the second quarter. Peripheral euro zone 10-year notes surged in Italy, Spain, and Ireland, while Australian debt led the developed markets. Emerging market debt outperformed its developed market counterparts, as attractive yields and stabilizing economies lifted investor sentiment. The global bond market edged on as the Citi Non-U.S. World Government Bond Index- Unhedged gained 2.64%. The U.S. dollar weakened modestly against a basket of major currencies, leaving the hedged return of this Index at 2.01%.

After months of anticipation, on June 5 the European Central Bank took aggressive action to encourage growth and fight off deflation in the euro zone. Yields declined across the board. The yield on the 10-year German bund approached record lows ver-sus Treasuries, declining 32 basis points to finish the quarter at 1.25%. Signs were positive for European peripheries, as the

Quarterly Return Attribution for Non-U.S. Gov’t Indices (U.S. Dollar)

Country Total Local Currency WtgAustralia 5.49% 3.59% 1.83% 1.77%

Austria 2.25% 2.93% -0.66% 1.88%

Belgium 2.85% 3.53% -0.66% 2.95%

Canada 5.26% 1.58% 3.62% 2.38%

Denmark 1.61% 2.14% -0.52% 0.86%

Finland 1.83% 2.51% -0.66% 0.74%

France 2.40% 3.08% -0.66% 11.15%

Germany 1.54% 2.21% -0.66% 9.17%

Ireland 3.55% 4.24% -0.66% 0.91%

Italy 2.84% 3.52% -0.66% 11.10%

Japan 2.48% 0.80% 1.66% 34.94%

Malaysia 1.95% 1.32% 1.70% 0.57%

Mexico 3.04% 4.53% 0.58% 1.13%

Netherlands 5.14% 2.63% -0.66% 2.99%

Norway 0.11% 2.60% -2.43% 0.30%

Poland 3.23% 3.75% -0.50% 0.75%

Singapore 2.31% 1.43% 0.87% 0.39%

South Africa 1.29% 2.46% -1.14% 0.00%

Spain 2.64% 3.32% -0.66% 6.05%

Sweden -0.40% 2.70% -3.02% 0.61%

Switzerland 0.47% 0.86% -0.39% 0.38%

U.K. 3.77% 1.17% 2.56% 8.45%Source: Citigroup

yield on Italy’s and Ireland’s 10-year notes fell 45 bps to 2.85% and 66 bps to 2.36%, respectively. Spanish debt rose, push-ing the yield down 57 bps to 2.66%. The Spanish 10-year note briefly traded below Treasuries in June, a vast improvement given that the spread was 600 bps over Treasuries two years ago. Italian, Irish, and Spanish debt led European bonds year-to-date (YTD), returning 8.30%, 7.92%, and 8.82%, respectively.

Australian debt posted the most gains globally as its higher yield attracted international investors and the “Aussie” rallied against the U.S. dollar (+6.5% YTD). Gains were also boosted by data pointing to stability in China, Australia’s largest mining customer. Australian 10-year notes gained 5.49% for the quar-ter and 10.70% YTD.

0%

1%

2%

3%

4%

5%

6%

GermanyU.S. Treasury U.K. Canada Japan

07 08 09 10 11 12 13 14060504

Change in 10-Year Yields from 1Q14 to 2Q14

-40 bps -30 bps -20 bps -10 bps 0 bps

-19 bps

-32 bps

-7 bps

-22 bps

-8 bps

Source: Bloomberg

Germany

U.S. Treasury

U.K.

Canada

Japan

10-Year Global Government Bond Yields

16

NON-U.S. FIXED INCOME (Continued)

Emerging market bonds continued their rally in the second quarter. The U.S. dollar-denominated J.P. Morgan Emerg-ing Market Bond Index–Global Diversified gained 4.76%. Local currency returns trailed due to weakening emerging mar-ket currencies; the J.P. Morgan Government Bond Index–Emerging Markets (Local) climbed 4.02%. Yield on Argentin-ean dollar-denominated debt dropped 92 bps to 9.88%, putting

yields at a three-year low, as the country began negotiating with creditors in June over missed interest payments. At the time, investors were hopeful that Argentina could avoid what it said could be as much as $15 billion in additional claims, put-ting the country on the brink of default. Yield on Turkish dollar-denominated debt declined 72 bps to 4.59% amid the growing risk in Iraq. Turkey’s central bank lowered its key interest rate in both May and June following rate hikes earlier in the year.

Global Fixed Non-U.S. Fixed Emerging Emerging Style Style Debt DB Debt Local 10th Percentile 3.62 4.19 5.97 5.31 25th Percentile 2.78 3.76 5.65 4.94 Median 2.54 2.78 5.29 4.43 75th Percentile 2.30 2.64 4.95 3.80 90th Percentile 2.19 0.84 4.57 2.40

Citi World Citi Non-U.S. JPM EMBI JPM GBI-EM Gov World Gov Gl Div Gl Div Benchmark 2.27 2.64 4.76 4.02

Sources: Callan, Citigroup

0%

1%

2%

3%

4%

5%

6%

Callan Style Group Quarterly Returns

Style Median and Index Returns* for Periods ended June 30, 2014

Global Fixed Income Quarter YTD Year 3 Years 5 Years 10 YearsGlobal Style 2.54 5.14 7.65 2.78 5.30 5.57Citi World Govt 2.27 5.00 6.85 1.57 3.59 4.82

Citi World Govt (Local) 1.84 3.99 4.87 4.44 3.90 3.98

Barclays Global Aggregate 2.47 4.93 7.39 2.57 4.60 5.06

Non-U.S. Fixed Quarter YTD Year 3 Years 5 Years 10 YearsNon-U.S. Style 2.78 6.07 9.81 1.84 5.08 5.76Citi Non-U.S. World Govt 2.64 5.95 8.88 1.03 3.59 4.90

Citi Non-U.S. World Govt (Local) 2.05 4.53 6.06 5.15 4.12 3.91

European Fixed Quarter YTD Year 3 Years 5 Years 10 Years

Citi Euro Govt Bond 2.37 6.31 15.06 5.73 4.88 6.24Citi Euro Govt Bond (Local) 1.38 2.81 4.97 6.34 4.55 4.57

Emerging Markets Fixed Quarter YTD Year 3 Years 5 Years 10 Years

JPM EMBI Global Diversified 4.76 8.66 11.64 7.41 10.33 9.28JPM GBI-EM Global Diversified (Local) 4.02 5.99 3.91 1.16 7.42 10.01*Returns less than one year are not annualized. Sources: Callan, Citigroup, JPMorgan Chase & Co.

Emerging Spreads Over Developed (By Region)

0 bps

200 bps

400 bps

600 bps

09 10 11 12 13 14

Emerging Americas Emerging EMEA (Europe, Middle East, Africa)

Source: Barclays

Emerging Asia

Sources: Callan, Citigroup, JPMorgan Chase & Co.

17Knowledge. Experience. Integrity.

REITs Keep It RealREAL ESTATE | Jay Nayak

Within institutional real estate accounts and funds, the National Council of Real Estate Investment Fiduciaries (NCREIF) Index tracked 164 asset trades representing $5.9 billion of trans-actional volume during the second quarter. This surpasses the $4.84 billion 10-year quarterly average, but represents a 14.4% decline in transaction activity from the same quarter a year ago. Second-quarter trades over the prior 10 years aver-aged $5.0 billion.

In the second quarter, the NCREIF Property Index advanced 2.91% thanks to a 1.35% income return and a 1.55% apprecia-tion return. On a trailing four-quarter basis, NCREIF produced a 5.47% income return and a 5.67% appreciation return for an 11.37% total return. Transaction capitalization rates, queried through NCREIF data, increased to 5.78% (up from 5.36% in the first quarter), while the Index appraisal capitalization rate bumped up to 5.18% from 5.00%. During the prior market peak, transaction capitalization rates dropped to a low of 5.00% and appraisal capitalization rates fell to 4.89%.

Global real estate securities, as measured by the FTSE EPRA/NAREIT Developed REIT Index (USD), advanced 7.88% and domestic REITs, tracked by the FTSE NAREIT Equity REITs Index, gained 6.98%.

Activist investors focused on the domestic REIT sector—both equity and mortgage REITs—during the quarter. They tar-geted Anworth Mortgage Asset Management for poor perfor-mance in navigating the prevailing interest rate environment; hedge fund investors have made calls for liquidation. Sepa-rately, American Realty Capital Properties was targeted for aggressive expansion, including plans for $4.5 billion of incre-mental acquisitions this year. Domestic REIT capital offerings more than doubled compared to the prior quarter: 78 offerings raised $24.0 billion, primarily through secondary equity and unsecured debt offerings.

Internationally, U.K.-focused stocks lagged their continental European counterparts as the Bank of England’s guidance on interest rate movement was unclear. European retail and office platforms drove regional performance as European real estate stocks generated a 7.61% quarterly return according to the FTSE EPRA/NAREIT Developed Europe Index (USD). In Asia, developers focused on China lagged considerably in the midst of slowing growth in that nation.

Commercial mortgage-backed securities (CMBS) issuance reached $20.2 billion in the second quarter, in line with figures reached in the first quarter of 2014 and the second quarter of 2013. CMBS issuance totaled $92.8 billion in 2013, repre-senting an increase of more than 100% from 2012. Investors and observers broadly anticipated that $100 billion of issuance activity would occur in 2014; the $40.6 billion of issuance activ-ity in the first half of this year falls just behind this forecast.

Rolling One-Year Returns

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

REIT Database Global REIT Database*Private Real Estate Database

02 039594 96 97 98 99 00 01 04 05 06 07 08 09 10 11 12 13 14

*Global REIT returns from 3Q96Source: Callan

18

REAL ESTATE (Continued)

Callan Database Median and Index Returns* for Periods ended June 30, 2014

Private Real Estate Quarter YTD Year 3 Years 5 Years 10 YearsReal Estate Database (net of fees) 2.05 4.53 11.12 11.20 7.45 5.71NCREIF Property** 2.91 5.73 11.21 11.32 9.67 8.63

NFI-ODCE (value wtd. net) 2.69 5.04 11.74 11.38 8.97 6.15

Public Real Estate Quarter YTD Year 3 Years 5 Years 10 YearsREIT Database 7.25 17.91 14.80 12.30 24.20 10.72FTSE NAREIT Equity 6.98 17.66 13.21 11.84 23.52 9.61

Global Real Estate Quarter YTD Year 3 Years 5 Years 10 YearsGlobal REIT Database 7.94 12.03 15.26 10.50 17.91 10.06FTSE EPRA/NAREIT Developed REIT 7.88 12.21 14.43 10.21 17.42 9.12

*Returns less than one year are not annualized.**Represents data available as of publication date.All REIT returns are reported gross in USD. Sources: Callan, NAREIT, NCREIF, The FTSE Group

NCREIF Transaction and Appraisal Capitalization Rates NCREIF Capitalization Rates by Property Type

0%

3%

6%

9%

Appraisal Capitalization RatesTransaction Capitalization Rates

04 05 06 07 08 09 10 11 12 13 14

Source: NCREIFNote: Transaction capitalization rate is equal-weighted.

0%

3%

6%

9%

IndustrialApartment RetailOffice

04 05 06 07 08 09 10 11 12 13 14

Source: NCREIFNote: Capitalization rates are appraisal-based.

19Knowledge. Experience. Integrity.

Private Equity Performance Database (%) (Pooled Horizon IRRs through December 31, 2013*)

Strategy 3 Months Year 3 Years 5 Years 10 Years 20 YearsAll Venture 6.0 15.6 4.6 4.5 5.1 15.1

All Buyouts 7.6 22.4 11.1 11.9 10.4 10.5

Mezzanine 3.4 14.0 6.4 5.9 6.6 7.4

All Private Equity 7.1 20.7 9.7 10.6 9.4 11.2 S&P 500 10.5 32.4 16.2 17.9 7.4 9.2

Private equity returns are net of fees. Sources: Thomson ONE, Standard & Poor’s* Latest quarterly data available.

Upward Bound PRIVATE EQUITY | Gary Robertson

In fundraising, Private Equity Analyst reports that new second quarter commitments totaled $78.6 billion with 229 new part-nerships formed. This represents an increase from the first quarter’s $40.0 billion and 173 new partnerships. The first half of 2014 is outpacing the first half of 2013, which produced $110 billion of new commitments and 328 new funds. Total dollar commitments represent an 8% year-over-year increase.

According to Buyouts newsletter, the investment pace by funds into companies in the second quarter totaled 343 transactions, with a subset of those deals announcing an aggregate dollar volume of $29.1 billion. The transaction count was down from 413 deals in the first quarter, but was up from 309 transac-tions in the second quarter of 2013. Six deals with announced values of $1 billion or more closed in the quarter. S&P Capital IQ reported that the average buyout purchase price for all U.S. deals climbed to 9.6x EBITDA from 7.8x a year ago.

According to the National Venture Capital Association, new investments in venture capital companies totaled $13.0 billion in 1,114 rounds of financing. The dollar volume and number of rounds both increased compared to the first quarter’s $9.7 bil-lion and 985 rounds.

Regarding exits, Buyouts reports that 146 private M&A exits of buyout-backed companies occurred during the second quarter of 2014, with 59 deals disclosing values totaling $28.3 billion.

Funds Closed January 1 to June 30, 2014

Strategy No. of Funds Amt ($MM) PercentVenture Capital 152 17,350 15%

Buyouts 167 65,418 55%

Subordinated Debt 22 3,844 3%

Distressed Debt 9 15,616 13%

Secondary and Other 10 10,314 9%

Fund-of-funds 42 6,031 5%

Totals 402 118,573 100%

Source: Private Equity Analyst

There were also 15 buyout-backed IPOs that floated $9.8 bil-lion, a significant increase from the eight IPOs totaling $3.7 billion in the first quarter.

Venture-backed M&A exits totaled 97 transactions, with 33 dis-closing a total dollar volume of $3.3 billion. Exits declined from the first quarter, which had 111 deals with 30 announcing dollar values totaling $7.5 billion. There were 28 VC-backed IPOs in the second quarter with a combined float of $4.9 billion. For comparison, the first quarter had 37 IPOs and total issuance of $3.4 billion.

Please see our upcoming issue of Private Markets Trends for more in-depth coverage.

Note: Transaction count and dollar volume figures across all private equity measures are preliminary figures and are subject to update in subsequent versions of Capital Market Review and other Callan publications.

20

Database Median and Index Returns* for Periods ended June 30, 2014

Diversified Hedge Fund Strategies Quarter YTD Year 3 Years 5 Years 10 YearsHedge Fund-of-Funds Database 1.58 2.70 8.77 5.35 6.84 5.13CS Hedge Fund Index 1.89 2.84 8.84 5.23 7.77 6.36

CS AllHedge Index 1.73 1.39 5.94 2.19 5.67 -

Credit Suisse Subindices Quarter YTD Year 3 Years 5 Years 10 YearsEquity Market Neutral -0.28 -0.53 5.80 2.77 3.17 -0.54Convertible Arbitrage -0.14 2.32 4.51 4.50 9.30 4.63

Fixed Income Arbitrage 1.29 3.40 5.89 6.41 9.85 4.00

Multi-Strategy 0.91 2.89 10.22 7.48 9.47 6.71

Distressed 3.27 6.43 14.34 8.62 10.63 7.90

Risk Arbitrage 2.39 3.14 6.14 2.90 4.04 4.61

Event Driven Multi-Strategy 2.54 5.44 14.03 5.55 8.65 7.95

Long/Short Equity 1.47 3.08 13.41 6.50 7.99 7.03

Dedicated Short Bias -2.31 -6.39 -19.83 -15.15 -17.77 -8.46

Global Macro 1.57 0.94 3.92 4.97 7.49 7.91

Managed Futures 5.12 0.60 1.68 -1.91 0.64 3.59

*Returns less than one year are not annualized. Sources: Callan, Credit Suisse Hedge Index LLC

Finding Profits in Cognitive Dissonance HEDGE FUNDS | Jim McKee

Global events and market reactions presented a picture of conflicting signals. Although job growth in the U.S. regained strength in the second quarter, economic and productiv-ity growth reported for the first quarter slumped more than expected. While the Federal Reserve continued reducing its QE program of liquidity injections during the second quarter, 10-Year Treasuries unexpectedly rallied (+2.66%) while the MSCI ACWI Index gained 5.23%.

These positive credit and equity markets supported long-biased hedge funds, but hedge funds generally trailed the capital mar-kets. Illustrating raw hedge fund performance without imple-mentation costs, the Credit Suisse Hedge Fund Index (CS HFI) climbed 1.89% in the second quarter. As a proxy for actual hedge fund portfolios, the median manager in the Callan Hedge Fund-of-Funds Database earned 1.58%, net of all fees. Within CS HFI, Managed Futures (+5.12%) was the best-performing strategy, particularly supported by short-term, trend-following styles. Another solid performer was Distressed (+3.27%), fol-lowed by Event-Driven Multi-Strategy (+2.54%).

Within Callan’s Hedge Fund-of-Funds Database, the presence or absence of market exposures barely differentiated performance in the second quarter. The median Callan Long/Short Equity FOF (+1.97%) closely matched the Callan Absolute Return FOF (+1.57%). Allocating broadly to both non-directional and direc-tional styles, the Core Diversified FOF also gained 1.47%.

Absolute Return Core Diversified Long/Short Eq FOF Style FOF Style FOF Style 10th Percentile 2.17 2.50 4.36 25th Percentile 1.96 2.01 2.74 Median 1.57 1.47 1.97 75th Percentile 1.01 0.97 1.55 90th Percentile 0.42 0.68 0.31

T-Bills + 5% 1.24 1.24 1.24

Sources: Callan, Merrill Lynch

0%

1%

2%

3%

4%

5%

Callan Style Group Quarterly Returns

21Knowledge. Experience. Integrity.

The Callan DC Index™ is an equally weighted index tracking the cash flows and performance of nearly 90 plans, representing more than one million DC participants and over $140 billion in assets. The Index is updated quarterly and is available to clients at http://www.callan.com/research/dcindex/. Read the quarterly DC Observer newsletter for additional com-mentary and data.

During the first quarter of 2014, the Callan DC Index™ eked out a modest 1.50% gain in choppy market conditions. After extremely strong relative performance in 2013, DC plans trailed DB plans by 57 basis points in the first quarter of 2014. Since the 2006 inception of the Index, DB plans have outperformed DC plans by an annualized 78 basis points. For the quarter and since inception, the average 2035 target date fund has performed in line with DC plans.

The average DC plan balance increased 1.82%. Market returns accounted for most of the total growth (82%), with plan sponsor and participant contributions accounting for just under 20%, combined. Over time, however, plan sponsor and participant contributions have had a greater impact on balances and are responsible for a third of the total growth in balances (2.79% annualized) since the Index’s inception.

Target date funds have been attracting substantial asset flows over the past several quarters. Nearly 90 cents of every dollar that moved within DC plans headed for target date funds in the first quarter, which is the highest proportion since the Index’s inception. Conversely, stable value has been shedding assets, with nearly 40% of outflows coming from this asset class dur-ing the quarter. Overall turnover (i.e., net transfer activity levels within DC plans) was modest at 0.48%, and well below the historical average (0.69%).

DC Ekes Out Modest GainDEFINED CONTRIBUTION | James O’Connor

Net Cash Flow Analysis (First Quarter 2014)* (Top Two and Bottom Two Asset Gatherers)

Asset ClassFlows as % of

Total Net FlowsTarget Date Funds 88.93%

Non-U.S. Equity 6.91%

U.S. Fixed Income -16.13%

Stable Value -38.45%

Total Turnover1 0.48%

1 Total Index “turnover” measures the percentage of total invested assets (transfers only, excluding contributions and withdrawals) that moved between asset classes.

Source: Callan DC Index

*Notes: DC Index inception date is January 2006. DB plan performance is gross of fees. Data provided here is the most recent available at time of publication.

Average 2035 Fund Average Corporate DB Plan

0%

2%

4%

6%

8%

5.70%

1.45%

Total DC Index

5.56%

1.50%

First Quarter 2014 Annualized Since Inception

2.07%

6.48%

Investment Performance*

% Net Flows % Return Growth

First Quarter 2014 Annualized Since Inception

0%

2%

4%

6%

8%

10%

% Total Growth

1.50%

8.50%

5.70%

0.31%

2.79%1.82%

Growth Sources*

22

Steven Center, CFA, is a fixed income con-sultant in Callan’s Global Manager Research group. He is responsible for research and analysis of fixed income investment managers and assists plan sponsor clients with manager searches.

Kyle Fekete is an analyst in Callan’s Global Manager Research group. He conducts thor-ough analysis of investment managers and compiles detailed research reports for clients and the Manager Search Committee.

Jay Kloepfer is director of Capital Markets and Alternatives Research. He oversees Callan’s Capital Markets, Hedge Fund, and Private Markets research groups. Jay is author of the “Callan Periodic Table of Investment Returns.”

Matt Lai is an analyst in Callan’s Global Man-ager Research group. Matt’s role within GMR includes the quantitative and qualitative anal-ysis of investment managers, as well as the compilation of detailed research reports for clients and the Manager Search Committee.

Lauren Mathias, CFA, is a domestic equity con-sultant in Callan’s Global Manager Research group. She is responsible for research and analysis of domestic equity managers and assists plan sponsor clients with manager searches. Lauren also oversees the Callan Connects program.

Authors

Jim McKee is director of Callan’s Hedge Fund Research group. Jim specializes in hedge fund research addressing related issues of asset allocation, manager structure, manager search, and performance evaluation for Callan’s institutional clients.

Jay Nayak is a consultant in Callan’s Real Assets Consulting group. He evaluates manag-ers and their respective real estate products for plan sponsor clients. He also heads research coverage for global real estate securities and commercial real estate debt strategies.

James O’Connor is a defined contribution consultant in Callan’s Fund Sponsor Consult-ing group. He provides analytical support in areas including client proposals, manager research, and performance evaluation. James also conducts DC investment structure evalu-ations, fee analyses, and industry research.

Gary Robertson is the manager of Callan’s Private Equity Research group. Gary is responsible for the firm’s Alternative Invest-ments consulting services. He is currently secretary of Callan’s Client Policy Review Committee.

Irina Sushch is an analyst in Callan’s Global Manager Research group. Irina’s role within GMR includes the quantitative and qualita-tive analysis of investment managers and the compilation of detailed research reports for clients and the Manager Search Committee.

23Knowledge. Experience. Integrity.

Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to be reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational pur-poses only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of this report is your sole responsibility. You should consult with legal and tax advisers before applying any of this information to your particular situation. Reference in this report to any product, service or entity should not be construed as a recommendation, approval, affiliation or endorsement of such product, service or entity by Callan. Past performance is no guarantee of future results. This report may consist of statements of opinion, which are made as of the date they are expressed and are not statements of fact. The Callan Investments Institute (the “Institute”) is, and will be, the sole owner and copyright holder of all material prepared or developed by the Institute. No party has the right to reproduce, revise, resell, disseminate externally, disseminate to subsidiaries or parents, or post on internal web sites any part of any material prepared or developed by the Institute, without the Institute’s permission. Institute clients only have the right to utilize such material internally in their business.

The Capital Market Review is a quarterly macroeconomic indicator newsletter that provides thoughtful

insights on the economy and recent performance in the equity, fixed income, alternatives, international,

real estate, and other capital markets.

Authored by Callan Associates Inc.

If you have any questions or comments, please email institute@callan.com.

Editor-in-Chief – Karen Witham

Performance Data – Alpay Soyoguz, CFA; Adam Mills

Publication Layout – Jacki Hoagland; Nicole Silva

About CallanCallan was founded as an employee-owned investment consulting firm in 1973. Ever since, we have

empowered institutional clients with creative, customized investment solutions that are uniquely backed

by proprietary research, exclusive data, ongoing education and decision support. Today, Callan advises

on more than $1.8 trillion in total assets, which makes us among the largest independently owned invest-

ment consulting firms in the U.S. We use a client-focused consulting model to serve public and private

pension plan sponsors, endowments, foundations, operating funds, smaller investment consulting firms,

investment managers, and financial intermediaries. For more information, please visit www.callan.com.

About the Callan Investments InstituteThe Callan Investments Institute, established in 1980, is a source of continuing education for those in

the institutional investment community. The Institute conducts conferences and workshops and provides

published research, surveys, and newsletters. The Institute strives to present the most timely and relevant

research and education available so our clients and our associates stay abreast of important trends in the

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