Institutional INSIGHT FOR INSTITUTIONAL INVESTORS

JULY 2016

MARKET CHILL Volatility in equity markets has persisted as investors run from risk and search for yield. In times like these, we stay true to bottom-up, long-term orientation.

4 PINNING DOWN THE CLOUD Sector Spotlight: Titans Emerge in Cloud Computing

6 DIVING DEEP Sustainability: Looking beyond standard measures of sustainability

8 COURAGE AMID DISRUPTION NOW 2016: Brown Advisory’s Fifth Biennial Forum

10 UP PERISCOPE FIXED INCOME: The Risks from Subzero Interest Rates EQUITY STRATEGY

Market Chill: Holding Fast to Fundamentals Volatility in equity markets has persisted as investors run from risk and search for yield. In times like these, we stay true to a bottom-up, long-term orientation.

pril is the cruelest month”—the will rise from near-record lows. In the near sentiment of poet T.S. Eliot— term, managers who take a long view may rang especially true for managers lag passive investments, which are often Aof large-cap mutual funds this tied to an index and do not overweight a spring when they learned that during the particular sector. A passive approach may BY SID AHL, CFA first quarter, only one out of five of them outperform the average active manager Chief Investment Officer of ISG beat the Standard & Poor’s 500® Index. simply because of lower management fees, NICOLE NESBITT Bottom-up stock pickers are underper- underscoring the importance of finding Head of Institutional forming this year as yield-hungry investors managers with the strongest stock selection Relationship Management snap up high-dividend stocks. Meanwhile, process. The popularity of passive investing many large, leveraged hedge funds, focused is self-reinforcing, as capital shifted from on near-term performance, quickly jettison stocks excluded from an index pushes up Maintain patience and stick to our any underperforming shares, magnifying stocks included in the index. We expect the philosophy, process and long-term volatility. pendulum to eventually swing back in favor mindset. We look for durable and resilient Investors remain on edge while coping of talented active managers as stocks listed business models that hold a sustainable with numerous challenges, including near- in indexes decline to their intrinsic value. competitive advantage and show promise for zero interest rates, reduced market liquidity Overall, we believe the market’s unusual long-term growth and profitability. We do and the U.K. vote to pull out of the European short-term preoccupation with the perceived so through extensive fundamental research, Union. (Please see article on page 7.) safety of high-yield stocks and passive invest- speaking to the company, its competitors, Prolonging a two-year trend, investors ing, as well as the indirect consequences of customers, suppliers and experts in the seeking both limited risk and high yields Brexit, offers opportunities for meaningful industry. We remain vigilant in monitoring pushed up the S&P 500® Utilities Index long-term gains as long as investors focus on our portfolios, as current market conditions this year by 23% through June 30, com- fundamentals and disregard the fads of the of uncertainty-led volatility can create pared with a nearly 4% gain in the S&P 500 moment. Given these circumstances, we are moments when fear trumps greed. As Index. During the same period, consumer taking the following approach: long-term investors, we can use these staples, also deemed a defensive sector, rose 10%, based on the S&P 500® Consumer Staples Index. Investors are also speeding up Paying a Premium for Yield a multiyear shift into passive management, including exchange-traded funds (ETFs). Investors are paying a premium to buy companies that, while not growing, offer an above- During the first five months of 2016, pas- market 3% yield. Meanwhile, some fast-growing companies sell at lower valuations. sive management gained $90 billion, while active managers saw an outflow of $40 bil- FIVE-YEAR AVG. DIVIDEND FORWARD COMPANY EPS GROWTH YIELD P/E lion, according to Morningstar. Some active managers with a long-term Wal-Mart -2% 3% 16x focus have lagged in performance in recent Coca-Cola -4% 3% 23x years after investing in sectors that they Unilever 2% 3% 21x expect will recover from a slump. For exam- Google 19% 0 21x ple, they have invested in energy companies, Priceline 30% 0 19x anticipating a rebound in the oil price, which has yet to occur. Others have invested SOURCE: BLOOMBERG AS OF 5/23/2016. in financial stocks, expecting interest rates

2 INSTITUTIONAL ADVISORY JULY 2016 EQUITY STRATEGY

opportunities to buy strong companies at yields and valuations gradually climbed Alphabet) fell 10% intraquarter and has good prices and improve our portfolios’ to premium levels. Today, many of those risen nearly 4% from that low. (Estimates risk/reward balance. This may mean adding companies have stopped growing and sell for the broader market have decreased as to or initiating positions in companies with at higher multiples than both the broader well.) Broadly speaking, we believe that superior business models and trimming market and some of the most rapidly the market’s chill is likely to persist, and positions in holdings with valuations that growing companies you can find.(Please see that investors may face a challenging and are more fully discounting a company’s the chart on page 6.) trying time ahead. Over the long term, we intrinsic value. During the first quarter, a number of our believe that by pursuing a fundamental, Take advantage of opportunistic managers seized on the opportunity to buy long-term oriented approach with the above investments and avoid overvalued areas. Google and Priceline at prices well below characteristics, we will generate attractive Recall when equities with high dividend their estimates of intrinsic value. Priceline returns regardless of any seasonal shifts in yields fell during a market panic in 2011. in February plunged 23% from the start the market’s mood. Investors later recognized that these solid of 2016 and has since rebounded by 28% companies offered above-market 3%through June 30. Google (whose parent is

Buffering Against Brexit For investors, the U.K. vote to leave the European Union raised more As part of our bottom-up analysis, we seek to take advantage of questions than it answered. Most pointedly, will the U.K. completely indiscriminate selling by “upgrading” the portfolio. We initiate new break from the continent’s political-economic union or retain some of positions—or add to existing holdings—in companies whose business its current benefits and obligations? Also, what will be the impact from models we believe are superior to those we already own. Given that we are Brexit on economic growth in the U.K., Europe and worldwide? typically fully invested, we have to make tough choices about what to sell. These high-stakes uncertainties have triggered unusual market volatility Although the questions provoked by Brexit may not be answered for since the June 23 referendum and, we believe, it would be imprudent several months, the performance of U.S. stocks as of June 30 provides to realign investments based on any predicted outcome. Consequently, some reassurance amid the uncertainty. The chart below shows that we are sticking to our longstanding investment strategy of fundamental, the U.K. referendum has not pushed the S&P 500 outside its range bottom-up analysis. We consider both adverse and benign scenarios, of the past year. Indeed, the Index’s price and forward-looking price- and patiently look for opportunities with an attractive balance of risk earnings ratio are far above their mid-February low and similar to where and return over the long term. they began the second quarter.

S&P 500 INDEX PRICE LEVEL AND FORWARD-LOOKING PRICE-EARNINGS RATIO (6/30/2015—6/30/2016)

2,150 18.5

2,100 18.0 S&P 500 P/E (x) 500 Ratio S&P 2,050 17.5

2,000 17.0

1,950 16.5

S&P 500 Index (Price) 1,900 16.0

1,850 15.5 S&P 500 S&P 500 P/E Ratio 1,800 15.0 6/15 7/15 8/15 9/15 10/15 11/15 12/15 1/16 2/16 3/16 4/16 5/16 6/16

SOURCE: BLOOMBERG

INSTITUTIONAL ADVISORY JULY 2016 3 INF0-TECH INDUSTRY

Profits, Not Vapor: Titans Emerge in Cloud Computing Three companies have brought down to earth the long-elusive goal of selling corporate customers computing power through the Internet.

or years, cloud computing’s prom- said, allowing for the emergence of a fourth ise of unmatched efficiency,cloud giant. “That’s where we’re headed.” unprecedented scale and rising The companies have gained a first- Frevenues proved out of reach for mover advantage by hiring legions of top business. Not anymore—three companies software and engineering talent, commit- are pinning down the cloud in ting billions of dollars to servers and other BY MANEESH BAJAJ, CFA enterprise computing. Internet-focused capital investment, and Portfolio Manager Amazon.com, Microsoft and Google demonstrating that cloud computing can EMMY MATHEWS, CFA have each staked out a competitive advan- be reliable and secure. For the foreseeable Equity Research Analyst tage in the booming, $70 billion business of future, they have clinched the position as selling computing power and data storage via the main engines for computing and man- AWS and other cloud providers. Netflix in the Internet. aging the world’s rising flood of data. January announced that it had completed These companies are leading a “violent” To many firms, the savings and efficiency the move of all of its streaming to AWS. shift to cloud computing that, by the end of from cloud computing are irresistible. Promising similar savings, Microsoft has this year, will probably account for one-third Companies can immediately ramp up announced it is providing cloud services to of the world’s $300 billion annual spending or reduce computing power based on 3M and Boeing, while Google has said it is on software, according to Harry Weller, their needs while shutting down costly working with Coca-Cola and Best Buy. a general partner at NEA, a leading ven- in-house data centers. They can also AWS, Microsoft and Google have ben- ture capital firm. Amazon, Microsoft and be confident of always using the new- efited as virtually every firm seeks to meet Google (whose parent company is Alphabet) est version of software. Amazon’s cloud consumer expectations for a digital expe- so dominate the market that, if current division, Amazon Web Services (AWS), rience. Even traditional businesses, in trends hold, they may handle nearly all of says that it can slash many customers’ industries such as insurance and banking, worldwide computing in 10 years, Weller information technology expenses during a have, in a sense, become software compa- predicted at Brown Advisory’s Navigating three-year period by about 60%. nies. Growth in the “Internet of Things” Our World (NOW) conference in April. General Electric Co. said in October is also fueling demand for more efficient “Three or four computers in the world,” he it plans to close most of its data centers computing and data storage. Businesses and and shift all but its most sensitive data to consumers are connecting myriad objects on

QUARTERLY REVENUES FOR AMAZON WEB SERVICES Thunderhead (3/31/2010–3/31/2016) Amazon Web Services has 3,000 Pre-2013, AWS revenue was included in Amazon’s “Other” revenue bucket. taken the lead in cloud 2,500 computing by leveraging the lessons from building the 2,000 largest e-commerce website. 1,500 During the first quarter of 2016, its sales swelled 1,000 64% to nearly $2.6 billion 500

compared with the first Quarterly Revenue AWS ($M) quarter of 2015. 0 1Q 2010 1Q 2011 1Q 2012 1Q 2013 1Q 2014 1Q 2015 1Q 2016 SOURCE: DATA FROM AMAZON’S COMPANY FILINGS

4 INSTITUTIONAL ADVISORY JULY 2016 INFO-TECH INDUSTRY

Looming Larger INTERNET RAINMAKERS Although Google arguably dominates the Internet through its search engine and other Estimated Annual Revenues (in millions) features, its Google Cloud Platform (GCP) is a distant third to Amazon Web Services and Microsoft Azure in estimated revenues. Still, GCP is making inroads among high-profile $9,620 companies:

AUDI: Uses GCP to support OFFICE DEPOT: Uses GCP to its development of digitally operate its online and in-store connected cars. printing services at more than 2,000 locations.

BEST BUY: Rewrote Giftag, a U.S. CELLULAR: Calculates and social app, as the first of several forecasts sales through applications that now run on GCP analytics.

MICROSOFT AZURE GOOGLE CLOUD PLATFORM GCP. COSTCO: Hosts its e-commerce SPOTIFY: Adopting GCP for data $1,544 $400 website for Mexico on GCP. storage and management. AMAZON WEB SERVICES

DOMINO’S PIZZA: Deploys GCP digital analytics to gain Total $11,564 insights into customer behavior.

SOURCE: DEUTSCHE BANK, 3/21/2016 SOURCE: DEUTSCHE BANK, 3/21/2016 the Internet for real-time monitoring and the risk of dependence on a single cloud pro- Google Cloud Platform is leveraging measuring—from light bulbs, heating sys- vider. AWS, Microsoft and Google seek to Google’s dominance of the Internet, spe- tems, baby monitors, factory machinery and overcome such hesitation and gain market cifically the engineering know-how and dishwashers to office equipment, bulldozers, share by leveraging their core strengths: vast computing network required to handle vending machines and jet engines. Amazon Web Services jumped to the oceans of data from its search engine, maps By 2020, the number of connected things lead in cloud computing thanks to its early and other services. Its reputation for inno- will increase to 21 billion from 4.9 billion start—in 2006—and the lessons from vation and emphasis on offering developers in 2015, according to Gartner.* Advances a decade of building the world’s largest free open-source software makes it espe- in artificial intelligence and machine learn- e-commerce platform. Its sales are about cially appealing to startups and smaller ing software will further boost the volume six times larger than its closest competitor, companies. By 2020, Google may gen- and complexity of digital information. Microsoft Azure. AWS can blunt concerns erate more revenue from the cloud than Companies will need help in processing and about security by noting that the CIA is from any other source, including advertis- storing the surge of Big Data and, by 2019, using a system designed by AWS to run the ing, Urs Hölzle, the company’s senior vice their worldwide spending on cloud comput- internal cloud for U.S. intelligence agen- president for technical infrastructure, said ing will more than double to $141 billion, cies. AWS sales ballooned 64% during the in November. according to International Data Corp.** first quarter of 2016 to nearly $2.6 billion All three companies have benefited as For decades, the concept of cloud comput- compared with the same period of last year, software developers—seeking greater speed ing dazzled info-tech executives, sometimes generating about 56% of Amazon’s operat- and efficiency—”rent” the companies’ cloud at huge cost. Following the burst of the dot- ing profit. computing power while adopting their open- com bubble in 2000, Sun Microsystems Microsoft Azure is building on cred- source code, according to Weller. Often, faltered after making a premature bet on ibility from decades of Microsoft sales to developers act without explicit approval from data processing and storage via the Internet. the information technology departments their chief information officer. Consequently, Oracle bought Sun in 2010. of large businesses. It is especially attrac- when it comes to the decision over whether Since then, technological gains have tive among customers seeking a hybrid of to embrace the cloud, traditional corporate dramatically cut costs and boosted both con- on-site data centers and external cloud com- gatekeepers for deployment of new technol- nectivity and computing power. Storing and puting. Microsoft CEO Satya Nadella led ogy are losing clout, he said. (Brown Advisory crunching data via the Internet is much eas- Azure before rising to the company’s top is invested in all three companies.) ier, cheaper and faster than just five years ago. slot in 2014. Since then, he has redoubled “There’s nothing more powerful than To be sure, regulation and concern about the company’s focus on the cloud. Azure’s when you have a combination of technology privacy have slowed adoption of cloud com- sales during the first quarter grew 120% in change and decision-maker change at the puting. Many companies have held back constant currency terms, which eliminate same time,” Weller said. “Because there is from the cloud because of worries about exchange rate fluctuations. no gatekeeper—the gatekeeper is gone.” cybersecurity, loss of control over data or

* Gartner, 11/10/2015, http//wwww.gartner.com/newsroom/id/3165317 ** IDC, Worldwide Semiannual Public Cloud Services Spending Guide, January 2016

INSTITUTIONAL ADVISORY JULY 2016 5 SUSTAINABILITY

Diving Deep: Sustainable investing offers opportunities for gains in industries ranging from manufacturing to transportation to online services. To succeed, however, investors need to look well beyond standard measures of sustainability.

acebook saved more than $2 billion The Brown Advisory Large-Cap Sustainable in operating and capital expenses Growth composite returned 13.4% over the by streamlining data center design five-year annualized period ending March Fand shifting to low-power servers 31, gross of fees, in part because we seek out and alternative energy. American Tower companies with environmental strategies that trimmed costs and improved reliability in have the potential to strengthen financial per- India by building 4,500 wireless towers that formance and increase shareholder value. We run on renewable energy. Red Hat, a pro- also look for attractive valuations and solid vider of open-source software, offers clients business models. one of the most energy-efficient operating systems available, using less power than com- DEEPER DISCLOSURE peting systems on identical hardware. One of the first steps in our approach is to All three companies, while reducing their comb the database of MSCI, a New York- BY KARINA FUNK, CFA negative environmental impact, staked out based research firm, to identify companies Head of Sustainable Investing and Large-Cap a competitive advantage and boosted share- that are vulnerable to ESG risks, such as Sustainable Growth Co-Portfolio Manager holder returns. Yet for months, their gains excessive vulnerability to commodity prices DAVID POWELL, CFA were not apparent in standard company or the energy cycle, labor management ten- Large-Cap Sustainable Growth reports. To identify these opportunities, sions or inappropriate incentives for executive Co-Portfolio Manager what we call an Environmental Business compensation. We also review company EMILY DWYER Advantage (EBATM), we usually need to dive reports detailing efforts to promote sustain- Research Analyst deep beneath the surface of corporate disclo- ability in operations, including reductions in sures, regulatory filings and investor releases. the use of water, energy or materials used in We plunge into original sustainability production. Such disclosure is surging, with is constructing a model for financial risk research—including government databases, the proportion of companies in the S&P reports that will be geared to the needs of company transcripts and interviews with 500 Index that publish sustainability reports investors, lenders, insurers and other stake- executives—to gain conviction on the funda- increasing to 81% last year from less than holders. Former SEC Chairwoman Mary mental prospects for promising companies. 20% in 2011. Schapiro serves as an adviser. “A lot of the disclosure by companies today Still, a company may expand its reporting “In the big picture, this is about institu- is backward looking,” according to Curtis on sustainability without actually curtailing tionalizing climate-related impact within Ravenel, global head of sustainable busi- its environmental risk. With that in mind, corporations and among investors,” said ness and finance at Bloomberg LP. “There the Financial Stability Board—created in Ravenel, a member of the secretariat to the is less emphasis on opportunities and for- 2009 by the G20, a group of leading devel- task force. “We want it to be on their agenda.” ward-looking indicators,” such as whether oped and developing nations—mobilized We have found that the impact of a compa- a company is investing in low-carbon tech- a task force of executives last year to build ny’s environmental strategy on its competitive nologies or spending money for research into a framework for climate-related disclosures position is not obvious at first glance. So we mitigation of carbon emissions, Ravenel said applicable across myriad industries. rely on our own digging to identify compa- in an interview. Led by former New York City Mayor nies with EBA. Investment strategies focused on sus- Michael Bloomberg and made up of execu- For example, in March 2015, we began tainability range widely in performance, tives from companies ranging from JPMorgan seeking out a possible investment in a com- primarily because of the variety of approaches Chase to Unilever to Tata Steel, the task force pany that builds and maintains wireless to research into sustainability and environ- mental, social, and governance (ESG) risk, along with differences in investing philoso- phies. For the five-year period ending March 31, the median return for U.S. managers focused on ESG was 9.6% annually, which trailed the S&P 500® Index 11.6% annual- ized return, according to eVestment.

6 INSTITUTIONAL ADVISORY JULY 2016 SUSTAINABILITY towers, attracted by the business model’s prospect of recurring Full Immersion revenue and rising demand from mobile phones and other digi- While pursuing fundamental research into a company’s business model tal devices. and valuation, the Large-Cap Sustainable Growth strategy takes a three- While we identified three companies that met the fundamen- level approach to identifying and monitoring Environmental Business tal business criteria, only one—American Tower—appeared Advantage (EBA), or strategies that boost financial performance and to hold an Environmental Business Advantage based on its increase shareholder value: responses to a questionnaire drawn up by CDP, a London- based research firm formerly known as the Carbon Disclosure Project. Subsequent interviews with American Tower manage- Level 1: Strategic Risk Assessment ment, including senior executives in some emerging markets, After identifying an attractive company, we look for signs that it is revealed that the company exceeded environmental compliance vulnerable to an ESG risk, such as excessive exposure to commodity measures and invested in environmental strategies to bolster its prices, labor management tensions or inappropriate incentives competitive advantages. for executive pay. We comb the database of MSCI, a research firm focused on sustainability, to gauge a company’s ESG risk exposure A CUT ABOVE and how it manages such risks, and to identify controversies it has In an example, American Tower provides shared backup power faced in the past or may face in the future. We also review government generators for about 12% of its 27,200 towers in the U.S. This databases for any information on environmental fines, and analyze enables customers to avoid the disruption and risks from the a company’s code of conduct and sustainability reports describing construction and maintenance of their own generators, which management systems related to the use of water, energy and other tend to be energy inefficient. Through the service, American resources. We compile our findings in a proprietary strategic risk Tower seeks to help customers trim the losses from power out- assessment report. ages and generator depreciation, which cost the industry about $15 billion each year. In addition, by seeking to improve its environmental performance, we believe that American Tower Level 2: EBA Research is well positioned to speed regulatory approvals and mini- mize environmental risk to itself and its customers. Also, the To identify sustainability-driven opportunities, we plunge into original company outside the U.S. may be a preferred vendor where its research to measure a company’s EBA, gathering information reputation on environmental practices helps win more business. at industry conferences and poring over public filings, investor Having identified American Tower’s EBA, we purchased presentations, sustainability reports, CDP responses, academic shares in September 2015. Since then, its stock has risen 24.1% research and case studies written by a company, supplier or as of June 30. customer. We interview industry thought leaders and the company’s Similarly, Facebook in December 2014 provided a limited chief sustainability officer and other management. We also leverage report on sustainability. In our deeper dive during interviews the fundamental research of Brown Advisory equity research with executives, we learned that Facebook achieved a $2 bil- analysts. lion cost reduction over three years, a number equivalent to about 15% of operating income during that time frame. Today, Facebook’s streamlined data center in Prineville, Oregon, uses Level 3: Updates 38% less energy and costs 24% less to operate than its older After buying shares in a company, we continuously freshen our EBA facilities. research reports with both quantitative and qualitative information to After ferreting out a company’s EBA and making an ensure the thesis underlying the investment remains solid and tracks investment, we track its sustainability programs and overall our expectations. We look for warning signs among several sources, performance through research that goes off the beaten path including academic reports, industry studies, press releases and of equity analysis. In 2011, we invested in Clean Harbors, company presentations. attracted by its competitive advantage in hazardous waste dis- posal and its range of services in environmental protection for energy and industrial companies. Several months after our stock purchase, Clean Harbors began a series of acquisitions of companies beyond its core busi- ness, including treating wastewater from the Alberta oil sands and re-refining used motor oil. Company revenues were increasingly tied to forces outside its control, including rig counts and the price of oil and gas. This impaired the ability of Clean Harbors to forecast its business outlook and set investor expectations. While one could argue that a business of re-refining motor oil is good for the environment, it did not provide an Environmental Business Advantage. Such cyclical end markets eroded, rather than strength- ened, the company’s business model. In 2013, we began selling shares in Clean Harbors, concerned that it had diversified away from its core business in environmental, energy and industrial services with clear EBA. We eliminated the stock from the portfolio in December 2013. Since then, Clean Harbors has fallen about 7.3% as of June 30. A company’s attention to sustainability can create competitive advantages that help it avoid risk, grow revenue, reduce costs or expand market share. By digging deep through original research, investors can find these underappreciated opportunities.

INSTITUTIONAL ADVISORY JULY 2016 7 NOW CONFERENCE

Moral Courage Amid Disruption Brown Advisory colleagues recently gathered with clients in Washington to explore how disruption in technology and other fields calls for bold, even-handed decision-making and what we call moral courage.

he idea that great power demands • Advances in communications, trade, can be better prepared both as citizens and great responsibility seems espe- finance and transport have made the world’s as investors. cially valid today. Consider the regions more interdependent, but cultural The advances that our NOW speakers Timplications of these advances: misperceptions persist in public attitudes described are enthralling. Neurologists, for • Bioengineers can pinpoint genetic toward vital global actors, including China example, are making strides in aiding recov- abnormalities to curb disease, but such and many Arab nations. ery from stroke by outfitting patients with a capabilities, when misused, could alter We invited our clients to explore these device conceived with the help of animators genetic traits of future generations and put compelling contradictions with us in April and computer gamers. Using an exoskeletal individual autonomy at risk. at Navigating Our World (NOW) 2016, our robotic arm, patients simulate the move- • The military currently deploys drone fifth biennial forum in the U.S. The confer- ments of a dolphin, thereby strengthening aircraft and is developing robots to aid in ence, subtitled Moral Courage in a Time of the brain through exercise. combat, but questions remain unanswered Disruption, focused on emerging trends in Another example is driverless cars, which, that are essential to ensuring public trust, technology, resources and geopolitics that linked to the Internet, could reduce costs including who would be accountable if these pose global challenges and therefore influ- to the consumer and prove 10 times more systems go awry. ence our investment thinking. We brought energy efficient than vehicles on the road • Digital technology has made launching our clients together with bright, provoca- today. Such “autonomous vehicles” may be a business increasingly “frictionless,” but in tive thought leaders to learn in depth about rolled out on a large scale as early as 2018. some cases, such unprecedented efficiency tough political, social and national security In public policy, U.S. schools in impov- will disrupt companies that are no longer issues, aiming to understand the implica- erished areas—while not always successful needed in an industry’s supply chain. tions from various possible outcomes so we in adopting the best teaching methods of

“I don’t believe that with powerful “You cannot undo the individualism “We are in an era of strategic anxiety tools like this it can only rest in the among Arab youth … The citizenry is with China… It’s not at all clear what hands of scientists… It has to be a completely different from what the the intentions of each side is with societal discussion and one that has regimes want to control.” respect to the other” and “there both thoughtful governance as well will almost certainly be much more as controls within the system.” ~Nadia Oweidat, Fellow, friction to come in the next few International Security Program, years.” ~Edison Liu, CEO, New America, on Arab youth The Jackson Laboratory, ~Evan Osnos, on genetic engineering a China specialist and correspondent with The New Yorker

8 INSTITUTIONAL ADVISORY JULY 2016 NOW CONFERENCE

BY BRIEN WHITE Head of Washington Office Portfolio Manager wealthier school systems—have made gains the sun. Yet we believe that never before has by ensuring that instruction takes into technological advancement burst forth at account the trauma suffered by students and such a rapid pace across so many disciplines by conveying a constant message of hope. while touching so many lives. In short, Some NOW speakers balanced their the extent and stakes of this progress are descriptions of progress by cautioning that unprecedented. institutions created to safeguard equality Our NOW forums are intended to expose and societal well-being need to keep up with our clients to stimulating speakers on top- the pace and extent of change. Indeed, we ics that expand our thinking and point the believe that the capacity to adapt decisively way to new opportunities. Please see the and equitably to change requires moral special report with summaries on the NOW courage. We think that trait is essential 2016 presentations at http://www.brown for people in a position to influence policy, advisory.com/node/16226 and share your public opinion and the direction of capital thoughts with us. investment. The idea that advancement brings risks and requires greater responsibility is nearly as old as our written history—Icarus of Greek mythology perished when he ignored his father’s warnings and flew too close to

U.S. data on post-traumatic stress “I would predict that in terms of disorder “have shown that soldiers general computing in the world, returning from live combat are only there will be four computers 10 half as likely to have the symptoms years from now: Amazon, Google, of the disorder as a young person Microsoft and one of my startups… growing up in poverty.” Three or four computers in the world… That’s where we’re headed.” ~Jeff Duncan-Andrade, Associate Professor of Raza Studies and ~Harry Weller, Education at San Francisco State General Partner, NEA University, on inequality

INSTITUTIONAL ADVISORY JULY 2016 9 FIXED INCOME

In Too Deep? The Risks from Subzero Rates Six central banks try to spur growth by introducing negative rates despite potential hazards from the unprecedented policy.

entral bankers in Europe and So far, negative rates do not show clear Japan are embarking on the mon- signs of spurring growth or speeding etary policy equivalent of the inflation. The International Monetary Fund Cfirst-ever dive by a submarine. (IMF) forecast in April that the eurozone and While pushing interest rates below zero for Japan will grow this year by 1.5% and 0.5%, the first time, they are unsure whether their respectively, or 0.2 percentage points and BY TOM GRAFF, CFA Head of Fixed Income plunge into uncharted depths will bring 0.5 percentage points less than its forecasts QUINTIN INGS-CHAMBERS progress or adversity. in January. Portfolio Manager, London The Bank of Japan, European Central The ECB’s introduction of a negative rate Bank (ECB) and four of Europe’s other in June 2014 has had no obvious impact central banks are charging a fee, rather on banks’ excess reserve accumulation. than paying interest, on money held in Nevertheless, the IMF supports such a needed. In response, investors will probably their reserves. They want banks to shift policy “given the significant risks we see to turn to income-producing assets, like real money away from central banks and into the outlook for growth and inflation,” José estate and high-yield debt, along with longer-term assets, thereby reducing rates Viñals, director of the IMF’s monetary and high-quality U.K. and U.S. bonds. They on a broad range of securities, including capital markets department, said in a blog in should exercise caution when reaching for mortgage bonds and corporate debt. In April. While saying the policy has provided yield—valuations of some high-dividend, theory, the move could spur borrowing and some stimulus, Viñals conceded that rates low-growth stocks already look excessive in stimulate economic growth. too low may trigger cash hoarding, with our view. (Please see the story on page 6.) But there is a risk of backfire. If rates are the possible “tipping point” ranging from We cannot predict with certainty the cut too far, businesses and citizens may hoard -0.75% to -2%. ultimate impact of negative rates on physical cash to avoid losses from negative Even without an outbreak of hoarding, the economy or financial markets. But interest rates, disrupting the banking system negative rates may hurt retirees and other identifying assets with an attractive balance and hobbling growth. Especially at risk are savers who will need to set aside more money of downside risk and upside potential should banks, insurers and other companies whose to generate the same amount of income. yield good long-term results, regardless profits shrink when long-term interest rates Indeed, a slump in retail sales in Europe of how long central bankers hold rates fall more than short-term rates. Lower profits suggests that negative rates are crimping underwater. could prompt banks to curtail lending. spending. Moreover, investors reaching for yield may take on more risk with less-liquid FOGGY OUTLOOK assets, fueling the emergence of asset price The unclear impact from negative interest bubbles. For example, negative rates could rates underscores the importance for prompt excessive real estate investment by investors of holding adequate liquidity— pushing mortgage rates to record lows. including cash—to meet day-to-day Negative interest rates may persist for operating expenses, buffer against market some time as policymakers try to cure severe volatility and have ready capital for any economic ills in Europe and Japan. The U.K. future investment opportunities. Over time, vote to exit the European Union may slow subzero rates will probably boost demand regional economic growth and intensify for U.K. gilts, U.S. Treasuries and other pressure for additional monetary easing. bonds with positive yields that are issued Bank of England Governor Mark Carney by governments with comparatively steady indicated after the June 23 referendum that inflation and economic growth. fiscal as well as central bank stimulus is

10 INSTITUTIONAL ADVISORY JULY 2016 DISCLOSURE

Brown Advisory Large-Cap Sustainable Growth Composite

Composite 3-Yr Benchmark 3-Yr Portfolios in Composite Assets Firm Composite Total Composite Total Benchmark Re- Composite Disper- Year Annualized Standard Annualized Standard Composite at End ($USD Assets Gross Returns (%) Net Returns (%) turns (%) sion (%) Deviation (%) Deviation (%) of Year Millions) ($USD Millions)

2015 13.7 13.1 5.7 11.1 10.7 23 0.3 405 43,746

2014 7.1 6.5 13.1 9.9 9.6 25 0.1 303 44,799

2013 34.5 33.7 33.5 12.1 15.5 24 0.2 288 40,739

2012 16.5 15.9 15.3 15.7 15.7 22 0.3 211 26,794

2011 5.4 5.0 2.6 NA NA 21 0.3 37 19,989

2010 23.5 23.1 16.7 NA NA 18 N/A 13 16,859

Brown Advisory claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with GIPS. Brown Advisory has been independently verified for the periods from January 1, 1993, through December 31, 2004, and January 1, 2006, through December 31, 2009. The verification reports are available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of GIPS on a firmwide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with GIPS. Verification does not ensure the accuracy of any specific composite presentation.

1. Brown Advisory, an independent investment management firm is defined as: 1) Brown Investment Advisory and Trust Company (“BIATC”), 2) its subsidiary Brown Investment Advisory Incorporated (“BIAI”) and selected affiliated investment advisors, including from July 2008, 3) Alex. Brown Investment Management LLC (“ABIM”) from July 2010, 4) Winslow Management Company LLC (“Winslow”) and 5) Brown Advisory Cavanaugh LLC (“BAC”) and from May 2013, 6) Brown Advisory Ltd. Effective January 2012, all of the above entities except BIATC and Brown Advisory Ltd. combined into Brown Advisory LLC, a registered investment adviser. Registration does not imply a certain level of skill or training. 2. The Large-Cap Sustainable Growth Composite includes all discretionary portfolios invested in the Sustainable Large-Cap Strategy. The strategy invests primarily in large market capitalization companies with financially and environmentally sustainable business models. The minimum account market value required for composite inclusion is $1.5 million. Prior to 2012, the minimum was $100,000. 3. This composite was created in 2010. Prior to March 31, 2013, the strategy was named Large-Cap Sustainability. Prior to December 31, 2011, the strategy was named Winslow Green Large Cap. No changes have been made to the strategy since inception. 4. The benchmark is the Russell 1000® Growth Index. The Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000® Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000® Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The Index is completely reconstituted annually to ensure that new and growing equities are included and that the represented companies continue to reflect growth characteristics. The Russell 1000® Growth Index is a trademark/service mark of the Frank Russell Company. Russell® when related to the Russell indexes is a trademark of the London Stock Exchange Group of companies. An investor cannot invest directly into an index. Benchmark returns are not covered by the report of the independent verifiers. 5. The dispersion of annual returns is measured by the equal-weighted standard deviation of portfolio returns. The composite dispersion is not applicable (N/A) for periods where there were five or fewer accounts in the composite for the entire period. 6. Gross-of-fees performance returns are presented before management fees but after all trading commissions. Net-of-fee performance returns reflect the deduction of actual management fees and all trading commissions. Other expenses can reduce returns to investors. The standard management fee schedule is as follows: 0.80% on the first $10 million; 0.65% on the next $15 million; 0.50% on the next $25 million; and 0.40% on the balance over $50 million. Further information regarding investment advisory fees is described in Part II A of the firm’s form ADV. Actual fees paid by accounts in the composite may differ from the current fee schedule. 7. The three-year annualized ex-post standard deviation measures the variability of the composite (using gross returns) and the benchmark for the 36-month period ended on December 31. The three-year annualized standard deviation is not presented as of December 31, 2010, and December 31, 2011, because 36 monthly returns for the composite were not available (N/A). 8. Valuations and performance returns are computed and stated in U.S. dollars. All returns reflect the reinvestment of income and other earnings. 9. A complete list of composite descriptions, policies for valuing portfolios, calculating performance and preparing compliant presentations is available upon request. 10. Past performance does not indicate future results. 11. This piece is provided for informational purposes only and should not be construed as a research report, a recommendation or an offer to buy or sell a security, including any mutual fund managed by Brown Advisory.

INSTITUTIONAL ADVISORY JULY 2016 11 INVESTMENT ENQUIRIES

WALTER BECKETT Tel: +44 (0)20 3301 8742 Email: [email protected]

KERYN BROCK Tel: +44 (0)20 3301 8136 Email: [email protected]

CHARLIE VAN STRAUBENZEE Tel: +44 (0)20 3301 8134 Email: [email protected] brownadvisory.com brownadvisoryfunds.com

BALTIMORE | WASHINGTON, DC | NEW YORK | BOSTON | LONDON | CHAPEL HILL, NC | WILMINGTON, DE

The views expressed are those of the author and Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested. The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. This piece is intended solely for our clients and prospective clients, is for informational purposes only, and is not individually tailored for or directed to any particular client or prospective client. The Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000® Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000® Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The Index is completely reconstituted annually to ensure that new and growing equities are included and that the represented companies continue to reflect growth characteristics. Russell® when related to the Russell indexes is a trademark of the London Stock Exchange Group of companies. An investor cannot invest directly into an index. FactSet® is a registered trademark of FactSet Research Systems, Inc. GICS® is a registered trademark of MSCI and Standard & Poor’s Financial Services LLC. The Standard & Poor’s 500® Index represents the large-cap segment of the U.S. equity markets and consists of approximately 500 leading com­panies in leading industries of the U.S. economy. Criteria evaluated include: market capitalization, financial viability, liquidity, public float, sector representation, and corporate structure. An index constituent must also be considered a U.S. company. The S&P 500® Utilities Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classifica­tion Standard (GICS) utilities sector. The S&P 500® Consumer Staples Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) consumer staples sector. S&P® - Standard & Poor’s, S&P, and S&P 500 are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”), a subsidiary of S&P Global Inc. ©2016 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. This communication and any accompanying documents are confidential and privileged. They are intended for the sole use of the addressee. Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. The portfolio information provided on pages 1-3 is based on a representative U.S. Large-Cap Sustainable Growth account and is provided as supplemental information. Environmental Business Advantage and EBA are trademarks of Brown Advisory. Sectors are based on the Global Industry Classification Standard (GICS) classification system. GICS “GICS” is a trademark of MSCI and Standard & Poor’s. Terms and definitions: Price-Earnings Ratio (P/E Ratio) is the ratio of the price per share of a company’s stock compared to its per-share earings. The Dividend Yield is the amount a company annually pays out in dividends per share of common stock divided by its share price. Earnings Per Share (EPS) Growth measures the annualized rate of growth in a company’s net income per share of common stock. Alternative investments, such as hedge funds, may only be available to qualified purchasers and accredited investors.