Endowment Investment Philosophy® White Paper

Investor Use

ENDOWMENT INVESTMENT PHILOSOPHY® WHITE PAPER

Abstract

The purpose of this white paper is to explain why the Endowment Investment Philosophy ® is a better option to manage your wealth. The Endowment Investment Philosophy is rooted in the basic idea that financial markets as defined by 2-dimensional stock and bond portfolios are inherently efficient and to exploit inefficiencies investors have to extend their investment universe to include alternative investments.

The Endowment Investment Philosophy seeks to replicate the 3-dimensional asset allocations built by Yale, Harvard, and over 800 other university endowments across the nation. Why? Because these institutions have historically exhibited an ability to beat an equity -only index. By separating their long-term capital appreciation goals from their short -term liquidity needs, University Endowments expand their time horizons to reduce volatility concerns. This allows them to exhibit behavioral characteristics that make them more disciplined and less susceptible to emotional biases, and more heavily weight ed to the highest-expected return asset classes.

Prateek Mehrotra, MBA, CFA, CAIA

White Paper: Endowment Investment Philosophy®

WHAT IS THE ENDOWMENT INVESTMENT PHILOSOPHY?

The Endowment Investment Philosophy builds 3-dimensional portfolios using an asset allocation methodology pursued by major universities like Yale and Harvard as it offers the potential for superior risk-adjusted returns and lower volatility across a complete market cycle. This investment philosophy expands the number of asset classes and strategies used to create a 3-D portfolio by including alternative investments such as hedge funds, private equity, and real assets, in addition to traditional stocks and bonds. The addition of alternative investments provides an expanded universe of strategies that can be employed to enhance returns and/or reduce risk We like to refer to this third dimension as the “Risk Managed” segment, augmenting the Growth and Income buckets in an overall asset allocation framework.

3-D ENDOWMENT: STOCKS, BONDS & ALTERNATIVES

Stocks (Growth) 36% 52% Bonds (Income) 12% Alternatives (Risk Managed)

2-D TRADITIONAL: STOCKS AND BONDS

STOCKS 40% (Growth) 60% BONDS (Income)

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White Paper: Endowment Investment Philosophy®

HISTORICAL ILLUSTRATION: Adding Asset Classes To A Portfolio Can Help Improve Returns 3-D Endowment Portfolio

More Diversified Portfolio

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Annualized Returns By Asset Class (July 2000 – December 2019)

12.00

10.00

8.00

Return (%) Return 6.00 10.77 9.46 8.83 8.65 4.00 8.03 7.65 7.63 7.56 7.38 6.24 5.93 5.45 4.55

2.00 4.33 Annualized

0.00

For illustrative purposes only. Returns are annualized, (and Asset Class Representative Index total return is presented where applicable) and represent period 07/01/2000 – 12/31/2019. Results of 3 Asset Class US Large-Cap Equity: S&P 500 TR portfolio and 12 Asset Class portfolio calculated by means of US Small-Cap Equity: Russell 2000 a backtest using the targeted asset class weights and annualized rebalancing. Returns assume reinvestment of International Developed Equity: MSCI EAFE Investable Market dividends, and do not account for the impact of taxes.

Emerging Markets Equity: MSCI Emerging Markets Past performance is no guarantee of future results. Backtests have certain limitations, including the benefit of hindsight. Global Bonds: Barclays Global Aggregate Bond You typically cannot invest directly in an index. Indexes don't Global High Yield: Barclays Global High Yield have fees. See back pages for index descriptions and backtest disclosure. Emerging Markets Bond: JP Morgan EMBI Global Diversified Hedge Strategies: Credit Suisse Hedge Fund Index Private Equity: Red Rocks Global Listed Private Equity US REITs: MSCI US REIT International REITs: S&P Global Ex US Property TR Commodities: SummerHaven Dynamic Commodity

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HOW DOES THE ENDOWMENT INVESTMENT PHILOSOPHY LOWER PORTFOLIO RISK?

Before we answer this question, we need to define and quantify “risk”. Risk can be thought of in the following different ways:

1. In the traditional statistical sense, risk is quantified as an annualized volatility number, often represented as standard deviation. The higher the volatility number, the higher the risk. However, one needs to also distinguish between upside and downside volatility, as any upside volatility is considered to be generally good.

2. In another traditional statistical sense, risk can also be quantified as the “maximum draw down” or the maximum decline in value from peak-to-trough. The larger this decline, the higher the portfolio has to increase in value to break-even. For example, if a portfolio declines by 50% in value from peak-to-trough, it has to increase by 100% to break-even. The 75% plus decline in the value of the Nasdaq index since peaking in March-2000, required a 300% increase to just break-even. This took 15 years, as the index finally breached a new high in 2015.

3. A third consideration is permanent loss of capital, whether due to fraud or complete loss of an investment’s value from bankruptcy or re-structuring, where the entire initial capital is wiped out with no ability to recoup value.

Generally speaking, adding lower correlated asset classes to a portfolio helps to lower the overall volatility and maximum drawdowns of a portfolio. For example, for the 20 years ended December 31, 2019, a two-dimensional global stock bond portfolio experienced a maximum drawdown of 34.7% from peak-to-trough, which occurred from Nov’07 to Feb’09. Keep in mind that this recent time period has had two cyclical bull and bear markets, each within the context of an overall secular bear market that started after the equity markets peaked in March of 2000 and which in our opinion still continues. A three-dimensional endowment styled portfolio which includes a risk- managed segment (represented by Credit Suisse Hedge Fund Index) with equal allocation to the three broad asset classes declined 23.2%, substantially less than a two-dimensional stock bond portfolio. Moreover, the annualized volatility of the three-dimensional portfolio was 5.9% as compared to the two-dimensional portfolio at 9.7%.

Another way to illustrate the above risk reduction concept is through the following diagram referred to as an Efficient Frontier. As you can see below, adding just one element of the risk managed bucket, namely hedge funds, helps reduce the annualized standard deviation while maintaining returns at the same level as a 60-40 stock bond portfolio.

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White Paper: Endowment Investment Philosophy®

Source: Efficient Frontier - Including Allocation to Alternatives (Jul 2000 - Dec 2019) Allocating to alternatives may decrease risk

7.0%

6.5% S&P 500

6.0% Credit Suisse Hedge Fund 3 Asset Class 5.5% Index Portfolio

5.0% Returns (Annualized) Returns 4.5% BBgBarc Global 4.0% Aggregate Bond Index 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% Standard Deviation (Annualized)

Past performance is not an indication of future results. Index returns are provided for illustrative purposes only to demonstrate the use of diversification among asset classes using broad-based indices of securities. Returns do not represent an actual investment. Actual investment returns would vary. Indices do not have costs, fees, or other expenses associated with their performance. Therefore, actual investment returns would be lower. In addition, securities held in an index may not be similar to securities held in an actual account. It is not possible to invest directly in an index.

DOES THE ENDOWMENT INVESTMENT PHILOSOPHY INCREASE RETURNS?

While the risk-managed bucket is used to mainly reduce the risk of a portfolio, it can also be used to enhance returns, through the use of private equity and real assets. Primarily, if these asset classes are implemented through private investment partnerships, it can help capture the illiquidity premium, which enhances the returns from liquid securities.

As an example, Yale University’s endowment, as of its fiscal year ended June 2019, was valued at $30.3 billion, making it the second largest university endowment. Its long-term performance over the last 10 and 20-year periods, ending June 2019, was 11.1% and 11.4% per year as compared to a two dimensional 60:40 global stock-bond portfolio which returned 7.8% and 5.5% per year, respectively.

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White Paper: Endowment Investment Philosophy®

DOES THE ENDOWMENT INVESTMENT PHILOSOPHY INCREASE RISK-ADJUSTED RETURNS?

We like to measure risk-adjusted returns in terms of the Sharpe Ratio. This ratio was developed by Nobel laureate William F. Sharpe to measure risk-adjusted performance. The Sharpe ratio is calculated by subtracting the risk-free rate - such as that of the US Treasury T-Bill Auction Average 3-month - from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns. The Sharpe ratio formula is:

The Sharpe ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been. A negative Sharpe ratio indicates that a riskless asset would perform better than the security being analyzed.

Given that adding alternative investments helps reduce risk and may increase returns, it implies, that risk-adjusted returns or Sharpe Ratios of an endowment portfolio will be superior to a two- dimensional stock bond portfolio. For example, adding hedge funds to a portfolio of stock and bonds in an equal proportion produced a Sharpe Ratio of 0.73 over the time period July 2000 to December 2019. This compares to a Sharpe Ratio of 0.44 for a portfolio allocated 60% to US Stocks and 40% to US Bonds.

HOW DOES THE ENDOWMENT INVESTMENT PHILOSOPHY LOWER TOTAL PORTFOLIO MANAGEMENT COSTS AND INCREASE AFTER TAX RETURNS?

The Endowment Investment Philosophy can help lower total portfolio management costs through the utilization of liquid alternative investments that are invested through traditional investment structures like Exchange Traded Funds (ETFs), Exchange Traded Notes (ETNs), Closed End Funds, and Mutual Funds. The costs of these investment vehicles are generally lower than the classical private partnerships that have primarily been utilized by institutional investors and high net worth families. These private partnerships generally have a 1-2% annual management fee along with a back-end profit sharing fee of 10-20%, with or without a high watermark. Moreover,

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White Paper: Endowment Investment Philosophy®

if these private partnerships are fund of funds, there is another 1% annual management fee and a 5-10% incentive fee. The proliferation of liquid alternative investments has allowed us to reduce some of the upfront management fees as well as the back-end fees.

Generally speaking, the illiquid alternative investments that are held through private partnerships have longer term investment horizons that generate the bulk of their returns through long-term capital gains, which have lower tax rates than short-term capital gains and/or income. Moreover, some of the liquid alternative investment vehicles like Exchange Traded Funds are inherently more tax efficient in the way they are built which minimizes trading activity.

WHAT ARE THE DIFFERENT WAYS OF IMPLEMENTING THE ENDOWMENT INVESTMENT PHILOSOPHY?

We utilize the Endowment Investment Philosophy in building client portfolios in two distinct ways, along with a third approach which combines the two: 1) The first implementation strategy utilizes illiquid alternative investments like private equity, hedge funds, and real assets. This is the preferred methodology for the larger college endowments like Harvard and Yale Universities as well as Ultra High Net Worth clients to implement their investment portfolios. This allows the investor to capture the significant illiquidity premium that has historically been in excess of 5% annually for these investments. Investors need to be “accredited” to be able to invest in these portfolios.

2) The second methodology utilizes liquid alternative investments. The recent proliferation of Exchange Traded Products, primarily Exchange Traded Funds and Exchange Traded Notes, has allowed us to build portfolios using liquid alternative investments. Asset styles and strategies that are not presently available in Exchange Traded Funds/Notes are implemented using mutual funds and/or closed end funds. Investors do not need to be “accredited” to invest in these portfolios.

3) The third methodology is a hybrid model that utilizes a combination of illiquid and liquid alternative investments. Investors need to be “accredited” for this portfolio.

Endowment Index® calculated by Nasdaq OMX®

In 2014, we endeavored to create an objective, rules-based index as a performance measurement tool for institutions, endowments, advisors, and individual investors that embrace the Endowment Investment Philosophy. The result of this project was the Endowment Index® calculated by Nasdaq OMX® symbol “ENDOW”. Using data collected from over 700 college and university endowment funds and using investable indexes to represent the historical asset allocations, the Endowment Index allows investors to track, in real time, the performance of an average university endowment allocation. In a backtest, the Endowment Index’s long-term average annual performance exceeded that of other major indexes, including the S&P 500, Dow Jones Moderate,

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a global 60-40, and the Morningstar U.S. Open End Tactical Allocation Index on both an absolute and risk adjusted basis (as measured by Sharpe ratio). Since all components of the Endowment Index are investable, meaning they are represented by a tradeable security, we are able to create a passive, institutional-level investible allocation.

Endowment Index Performance

Total return/Stats for period ended Dow 60-40 US OE Dow 12/31/2019 (unless Endowment Jones Global Tactical Jones S&P noted by year) Index™ Moderate Balanced Alloc Indus 500 CROR Annualized* 6.99 6.20 5.56 3.43 7.86 6.24 3 Mo 6.71 5.41 5.82 4.25 6.67 9.07 1 Yr 20.19 18.60 19.11 14.61 25.34 31.49 3 Yr 8.72 8.99 9.71 6.46 15.73 15.27 5 Yr 5.93 6.61 6.43 4.03 12.59 11.70 10 Yr 7.03 7.76 6.75 5.57 13.40 13.56

2019 20.19 18.60 19.11 14.61 25.34 31.49 2018 -9.09 -5.21 -5.84 -7.70 -3.48 -4.38 2017 17.61 15.15 17.73 12.82 28.11 21.83 2016 7.19 7.67 5.93 5.92 16.50 11.96 2015 -3.17 -1.21 -2.37 -5.93 0.21 1.38 2014 5.02 5.35 3.06 2.41 10.04 13.69 2013 15.66 14.46 13.02 8.62 29.65 32.39 2012 14.92 11.24 11.81 9.45 10.24 16.00 2011 -6.29 0.28 -1.86 -3.36 8.38 2.11 2010 13.10 13.95 10.15 10.53 14.06 15.06 2009 30.53 23.79 24.02 20.30 22.68 26.46

Standard Deviation* 11.53 9.50 9.73 8.55 13.92 14.44 Sharpe Ratio* 0.51 0.51 0.44 0.25 0.50 0.38 Alpha* 1.89 1.47 0.93 -0.93 1.86 0.00

*Compound rate of return since inception (07/01/2000), periods. Returns for periods over 1 yr. are annualized. Results include backtest period from 07/01/2000 through 05/18/2014. Since indexes do not have fees, all data is based upon gross returns. Index data source: Morningstar. Past performance is no guarantee of future results. You cannot invest directly in an index. Indexes do not have fees.

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About the Author:

Prateek Mehrotra, MBA, CFA, CAIA

Chief Investment Officer [email protected] Tel: 920-785-6010

Prateek Mehrotra, MBA, CFA, CAIA is the Chief Investment Officer of Endowment Wealth Management® and its affiliate ETF Model Solutions, LLC. Prateek has over 30 years of experience in the financial services industry involved in areas as diverse as sell-side investment banking, leasing, portfolio management, and buy-side alternative assets investing. He has lived and worked in India and the Middle East and brings a wealth of global experience and perspective to the Company.

Prateek earned his bachelor’s Degree in Technology from the Indian Institute of Technology, Kanpur, India. He earned his MBA from Lehigh University in Bethlehem, Pennsylvania and was a Rotary International Scholar while attending Lehigh. He is both a Chartered Financial Analyst (CFA®) Charter Holder and a Chartered Alternative Investment Analyst (CAIA®).

Prateek has appeared on CNBC and has authored or been quoted in articles in the financial media, including the HuffingtonPost.com, the Wall Street Journal, MarketWatch, Institutional Investor, Plan Sponsor, Think Advisor, Fund Industry Intelligence, and others. He was named to the Investopedia Top 100 Financial Advisers list for 2018.

About the Firm:

In 2013, the author and his partner (Robert Riedl, CPA, CFP, AWMA) formed Endowment Wealth Management, Inc. with the vision of providing multi-family office services to High and Ultra High Net Worth families throughout the country. The firm is named after their Endowment Investment Philosophy® which serves as a solid investment foundation seeking to assist their entire client base with achieving sustainable family wealth, values and legacy.

Endowment Wealth Management, Inc. is half owned by employees and half by high net worth families. The firm now has nine employees with the following credentials: 3 MBAs, 2 CPAs, 2 CFAs, 1 CAIA, 3 CFPs, and 1 AWMA. Endowment Wealth Management, Inc. is an independent Private Wealth Management firm whose sole mission is to provide wealth sustainability for families & individuals, endowments, foundations and other institutions, and retirement plans through the utilization of the Endowment Investment Philosophy. Endowment Wealth Management is co-creator of the Endowment Index calculated by Nasdaq OMX.

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DEFINITIONS:

Annualized Return: Annualized return, or “average annual return,” describes the return gained, on average, each year of a multi-year period rather than a cumulative return.

Annualized Standard Deviation: Risk as measured by the variability of performance. The higher the standard deviation, the greater the variability (and therefore the risk) of the fund or index.

60/40 Portfolio: Hypothetical investment where 60% of the portfolio is invested in S&P 500 and 40% is invested in the Barclays Capital Aggregate Bond Index.

Accredited Investor: In the United States, for an individual to be considered an accredited investor, he or she must have a net worth of at least one million US dollars, not including the value of one's primary residence or have income of at least $200,000 each year for the last two years (or $300,000 together with his or her spouse if married) and have the expectation to make the same amount this year. Data Sources: Morningstar Direct and Pertrac

INDEX DESCRIPTIONS Barclays Capital US Aggregate Bond Index is a broad bond index covering most U.S. traded bonds and some foreign bonds traded in the U.S. having maturities greater than one year. Barclays Global Aggregate Bond Index is a broad-based measure of the global investment-grade fixed-rate markets, comprised of U.S. Aggregate, Pan-European Aggregate and the Asian-Pacific Aggregate Bond Indices. It also includes a wide range of standard and customized sub-indices by liquidity constraint, sector, quality and maturity. Credit Suisse Hedge Fund Index is an is asset-weighted and fully diversified across ten style-based sectors including: Convertible Arbitrage, Dedicated Short Bias, Emerging Markets, Equity Market Neutral, Event Driven, Fixed Income Arbitrage, Global Macro, Managed Futures, Long/Short Equity, Multi-Strategy. Dow Jones Industrial Average (total return) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. It is the second oldest U.S. stock market index and remains among the most closely watched U.S. benchmark indices tracking targeted stock market activity. Dow Jones Moderate Total Return Each Dow Jones Relative Risk Index is made up of composite indices representing the three major asset classes: stocks, bonds, and cash. The asset class indices are weighted differently within each relative risk index to achieve the targeted risk level. The weightings are rebalanced monthly to maintain these levels. Global 60-40 Stock-Bond is an index comprised of 60% MSCI All-Country World Index + 40% Barclays Global Aggregate Bond Index. The HFRI Fund of Funds Composite Index is an equal weighted index of over 650 constituent hedge fund of funds that invest over a broad range of strategies. JP Morgan EMBI Global Diversified TR USD measures the emerging market debt markets as an unmanaged, market-capitalization weighted, total-return index tracking the traded market for U.S.-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities.

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MSCI All Country World Index is a capitalization-weighted index designed to provide a broad measure of global equity-market performance. The MSCI ACWI is maintained by Morgan Stanley Capital International and is comprised of stocks from both developed and emerging markets. MSCI EAFE Investable Market Index (IMI) is an equity index which captures large, mid and small cap representation across Developed Markets countries* around the world, excluding the US and Canada. With 3,077 constituents, the index is comprehensive, covering approximately 99% of the free float-adjusted market capitalization in each country. *Developed Markets countries include Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the UK. MSCI Emerging Markets Investable Market Index (IMI) captures large, mid and small cap representation across 23 Emerging Markets (EM) countries which covers approximately 99% of the free float-adjusted market capitalization in each country. EM countries include: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Russia, Qatar, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates. MSCI US REIT GR USD is a free float-adjusted market capitalization index, consists of equity REITs that are included in the MSCI US Investable Market 2500 Index, except for specialty equity REITs that do not generate a majority of their revenue and income from real estate rental and leasing operations. Red Rocks Capital Global Listed Private Equity Index is designed to track the performance of private equity firms which are publicly traded on any nationally recognized exchange worldwide. These companies invest in, lend capital to, or provide services to privately held businesses. The Index is comprised of 40 to 75 public companies representing a means of diversified exposure to private equity firms. The securities of the Index are selected and rebalanced quarterly per modified market capitalization weights. Russell 2000 measures the performance of the small-cap segment of the U.S. equity universe. The Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. S&P Global Ex US Property TR USD contains more than 530 property companies trading in 36 countries and is market-capitalization weighted. S&P 500 TR (Total Return) is a capitalization-weighted index of 500 large companies having common stock listed on the NYSE or NASDAQ. Russell 2000 TR measures the performance of the small-cap segment of the U.S. equity universe. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. SummerHaven Dynamic Commodity TR is comprised of 14 Futures Contracts that will be selected on a monthly basis from a list of 27 possible Futures Contracts. The Index is rules-based and rebalanced monthly based on observable price signals. (US OE) U.S. Open-End Tactical Allocation Index To qualify for the Tactical Allocation category, a fund must first historically demonstrate material shifts within the primary asset classes either through a gradual shift over three years or through a series of material shifts on a quarterly basis. The cumulative asset class exposure changes must exceed 10% over the measurement period.

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DISCLAIMER AND BACKTEST DISCLOSURE

This document is for informational use only. Not intended as personalized investment advice. You should not consider this as a recommendation to buy or sell a particular security. All investments involve risk. Past performance is not an indication of future results. Index returns are provided for illustrative purposes only to demonstrate the use of diversification among asset classes using broad-based indices of securities. Returns do not represent an actual investment. Actual investment returns would vary. Indices do not have costs, fees, or other expenses associated with their performance. Therefore, actual investment returns would be lower. In addition, securities held in an index may not be similar to securities held in an actual account. It is not possible to invest directly in an index.

Endowment Index Backtest Disclosure

NASDAQ OMX provides either actual historical index values or backtested histories for certain indexes. All backtested index values for periods prior to the launch date of an index are merely indicative, and they are provided “AS IS” for informational and educational purposes only. NASDAQ OMX makes no guarantee as to the accuracy, timeliness, completeness, or fitness for any particular purpose of or for any index values, either historical or backtested. Nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Past performance is not indicative of future results.

Endowment Index historical backtest was constructed based upon reported the actual reported historical asset allocations of reporting fund managers, with those allocations held constant for one year. Underlying index price data based upon monthly prices.

Backtest Disclosure

Backtested performance is NOT an indicator of future actual results. There are limitations inherent in hypothetical results particularly that the performance results do not represent the results of actual trading using client assets but were achieved by means of retroactive application of a backtested model that was designed with the benefit of hindsight.

The results reflect performance of a strategy not historically offered to investors and do NOT represent returns that any investor actually attained. Backtested results are calculated by the retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses.

Specifically, backtested results do not reflect actual trading, or the effect of material economic and market factors on the decision-making process, or the skill of the adviser. Since trades have not actually been executed, results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity, and may not reflect the impact that certain economic or market factors may have had on the decision-making process. Further, backtesting allows the security selection methodology to be adjusted until past returns are maximized. Actual performance may differ significantly from backtested performance.

Endowment Investment Philosophy, Endowment Index, ETF Model Solutions and Endowment Wealth Management are registered trademarks owned by Endowment Wealth Management, Inc.

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