Active vs. Passive Management A Panel Discussion

September 9, 2020

1 Matt Caire joined Houston Trust Company in 2014. As Senior Vice President of Investments, he is responsible for managing the firm’s fixed income investments, performing equity manager due diligence and constructing the asset allocation for client accounts.

Matt holds a Bachelor of Business Administration in Marketing, Cum Laude, from Texas State University and a Masters of Finance from the Tulane University Freeman School of Business. He is also a Chartered Matthew E. Caire Financial Analyst (CFA®) charterholder, CERTIFIED FINANCIAL PLANNER™ (CFP®) professional and a Chartered Market Technician Senior Vice (CMT). He serves as an Arbitrator for Financial Industry Regulatory President, Authority (FINRA) and teaches as an investments instructor for the CFP® Investments Program at Rice University’s Glasscock School of Continuing Studies.

He previously served on the Board of Directors of the Financial Planning Association of Houston, for which he was also the Symposium Director for 2014 and 2015, and was the Education Director in 2012. He has also served as the Co-Chair for the Houston CMT Association and he is a member of the CFA Institute and the CFA Society of Houston. Today’s Presentation

Explore the pros and cons of active and passive management

How to synthesize each approach

How to choose the best approach for your goals and objectives

1. Our Approach: Matt Caire, Houston Trust Company 2. The Passive Approach: Martin Kleppe, Vanguard 3. The Active Approach: Catherine Crain, Fayez Sarofim & Co. 4. Q&A

3 Defining Passive and Active

PASSIVE

• Investing assets to strictly mirror, in both style and holdings, a pre-defined index

• Also referred to as “indexing”

ACTIVE

• Basically, doing something different than the approach above

• An active manager will incorporate deviations from the underlying index, or “benchmark,” when constructing a portfolio

4 Houston Trust Company’s Investment Philosophy

We take a hands-on, holistic approach to portfolio management:

• One size does not fit all: consider Custom Objective individual goals, objectives and Portfolios Advice

risk tolerance Tenets of our Investment • Also consider taxes, asset location Management Approach (i.e. trust, agency), and fees

Open Tax • Unbeholden to any one approach Architecture Conscious between active and passive investing – focus on individual needs, often incorporating both

5 Factors that lead to Passive Management

FEES TAXES PERFORMANCE CAPACITY CONSTAINTS

6 Fees

Year-after-year fee compression in the investment space means active managers simply can’t compete with indexing when looking at fees alone. Ta x e s

When embedded gains are not present and/or if the client is a non- taxable investor, the choice between indexing and active management comes down to client preference.

7 Performance

With an index fund, you give up any opportunity for significant excess returns over and above the market’s rate of return, also known as “alpha”.

In exchange, an investor is confident that the particular index fund will closely track the performance of the underlying index that the fund is designed to track.

This tracking applies to the upside and downside performance of the index.

8 Capacity Constraints

STOCK A: $750 MILLION HYPOTHETICAL MKT. CAP HYPOTHETICAL $100B AUM SMALL $2B AUM SMALL CAP MANAGER CAP MANAGER

If the small cap manager becomes too large in terms of AUM, they will limit the size of the fund to avoid “trading against themselves.”

For asset classes where capacity constraints exist, or if we are unable to identify a superior active manager, we look to passively managed investments instead.

9 Capacity Constraints

Example: Actual Small Cap Fund Holdings

10 Factors that lead to Active Management

Asset Downside Transfer Protection Process

Custom Staying Portfolios Power

11 Security Unrealized Gain The Asset Transfer Apple Inc. $1,300,301 Process Microsoft Corp. $1,127,002 Amazon.com Inc. $948,750

Facebook Inc. $778,122 . “In-kind” versus liquidating: avoiding taxable gains Holdings % of Funds Apple Inc. 6.36% . Repositioning holdings Microsoft Corp. 5.71% into a more efficient portfolio Amazon.com Inc. 4.87% . Highly appreciated Facebook Inc. 2.24% equity holdings . Large asset Alphabet Inc. 1.63% concentrations Alphabet Inc. 1.60%

. More tax efficient than Johnson & Johnson 1.41%

selling securities and Berkshire Hathaway Inc. 1.37% reinvesting into an index fund Procter & Gamble Co. 1.19%

Visa Inc. 1.17%

12 Downside Protection

• A smaller reduction in market value compared to the market’s decline • Achieve lower relative volatility while producing index-like returns: give up little in the way of returns for their reduction in risk

13 Custom-tailored Portfolios

Active management allows for a degree of customization not generally accessible when investing in a passively managed index fund.

• Tailored for income needs • Tailored for holdings/sectors

14 Companies known for their “staying power” due Staying Power to sustainable business models, fortress balance sheets, and experienced management teams: Holding positions that allow an investor to ride through the • Apple proverbial storm without Johnson & Johnson selling out of equities during a • market low when the pain • Amazon.com from market volatility is at a • Microsoft maximum. • Facebook 15 Martin Kleppe, CFA, is the head of the Index Strategies Team in the Vanguard Portfolio Review Department. His team is responsible for researching equity and fixed income indexing and multi-asset topics (including Target Retirement Funds), conducting competitor analysis, creating positioning for Vanguard’s indexing and multiasset capabilities, meeting with clients and prospects, publishing on noteworthy developments, and supporting index and multi-asset Martin Kleppe education initiatives. Head of Equity Mr. Kleppe earned a B.S. from The Pennsylvania State Index Product Management, University and an M.B.A. from Saint Joseph’s University. In Planning, and addition, he holds the Chartered Financial Analyst® Development designation and is a member of the CFA Society of Philadelphia. The case for low cost index investing

For financial advisors only. Not for public distribution. 1 Agenda

• Zero-sum game theory • The effect of costs • Persistent outperformance is scarce

For financial advisors only. Not for public distribution. 2 Zero-sum game theory Investing as a zero-sum game

Market benchmark

• At any time, the holdings and investment processes of all investors aggregate to form a market • If one investor’s dollars outperform the market, another investor’s dollars must underperform

For financial advisors only. Not for public distribution. 3 Zero-sum game theory Market participant returns after adjusting for costs

Market benchmark Underperforming funds Outperforming funds

Costs

High-cost investment Low-cost investment

• At any time, the holdings and investment processes of all investors aggregate to form a market • If one investor’s dollars outperform the market, another investor’s dollars must underperform • Investment costs shift the distribution to the left, leaving fewer dollars to the right of the market return

For financial advisors only. Not for public distribution. 4 Zero-sum game theory 15 year excess return distribution of US equity funds

7000 1400 Prospectus benchmark 6000 1200

5000 1000

4000 800

3000 600

Number funds of 2000 400

1000 200

0 0 Less thanLess -7% Greater than 7% than Greater Merged/Liquidated Between0% and 1% Between1% and 2% Between2% and 3% Between3% and 4% Between4% and 5% Between5% and 6% Between6% and 7% Between-1% and 0% Between -7% and -6% -7% Between and -5% -6% Between and -4% -5% Between and -3% -4% Between and -2% -3% Between and -1% -2% Between Active funds Excess return Index funds

Sources: Vanguard calculations, using data from Morningstar, Inc. Displays the distribution of excess returns, relative to their prospectus benchmark for the 15-year period ending December 31, 2019. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

For financial advisors only. Not for public distribution. 5 Zero-sum game theory 15 year excess return distribution of US fixed income funds

1600 Prospectus benchmark 1400

1200

1000

800

600 Number funds of 400

200

0 Merged/Liquidated Between0% and 1% Between1% and 2% Between2% and 3% Between-1% and 0% Between -3% and -2% -3% Between and -1% -2% Between Excess return Active funds Index funds

Sources: Vanguard calculations, using data from Morningstar, Inc. Displays the distribution of excess returns, relative to their prospectus benchmark for the 15-year period ending December 31, 2019. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment as you cannot invest directly in an index.

For financial advisors only. Not for public distribution. 6 Over time, higher costs have correlated with lower returns

U.S. equity styles U.S. fixed income styles

Value Blend Growth Government Credit High-yield 15% cap 5% term - – Large Short Scale cap – Scale term Mid - –5% Intermediate

cap 0% Scale 3% – Cost for each style (Expense ratio) year year return) excess annualized Small

- –15%

(10 0% Scale 3% Cost for each style (Expense ratio) Style outperformance and underperformance outperformance Style

Sources: Vanguard calculations, using data from Morningstar, Inc. All data as of December 31, 2019. Notes: Index funds noted in red. Each plotted point represents a U.S. equity mutual fund within the specific size, style, and asset group. Each fund is plotted to represent the relationship of its expense ratio (x-axis) versus its ten year annualized excess return relative to its stated benchmark (y-axis). The straight line represents the linear regression, or the best-fit trend line—that is, the general relationship of expenses to returns within each asset group. The scales are standardized to show the slopes’ relationship to each other, with expenses ranging from 0% to 3% and returns ranging from –15% to 15% for equities and from –5% to 5% for fixed income. Some funds’ expense ratios and returns go beyond the scales and are not shown.

For financial advisors only. Not for public distribution. 7 Past success is not an indicator of future success for active funds

Quintile rank in subsequent non-overlapping five-year period (% of funds)

Quintile rank in subsequent non-overlapping five-year period (% of funds) ending December 2019 Initial excess return Highest High Medium Low Lowest Merged/ Total Quintile, 5-years quintile quintile Liquidated ending December 2014

Highest quintile (1) 20.8% 16.1% 11.0% 14.3% 13.7% 24.1% 100.0%

High (2) 15.7 13.2 18.1 12.7 11.1 29.2 100.0

Medium (3) 8.6 16.4 16.0 15.3 11.9 31.8 100.0

Low (4) 10.2 12.0 13.7 14.5 12.8 36.7 100.0

Lowest quintile (5) 10.3 8.4 6.9 9.0 16.4 49.0 100.0

Source: Vanguard and Morningstar. Notes: The far left column ranks all active U.S. equity funds based on their returns relative to their peer group (Morningstar category) during the five year period as of the date listed. Each quintile includes the funds within that quintile from each of the 9-style Morningstar categories. The remaining columns show how these quintiles performed over the next five years. Past performance is no guarantee of future returns. For financial advisors only. Not for public distribution. 8 Active management is a difficult proposition: Comparison to self selected benchmark

The record of actively managed funds versus their prospectus benchmark (15-year evaluation)

100%

90%

80%

70%

60%

50%

40%

30% Percentage underperforming Percentage 20%

10%

0% -0.89 -0.66 -0.76 -1.72 -0.66 -1.11 -0.22 0.39 -0.12 -0.20 -0.10 -0.02 -0.10 -0.35 -0.25 -0.58 -0.17 -1.12 yield - GNMA Global Emerging Midblend Midvalue Developed High Mid growth Mid Large blend Large value Large Smallblend Smallvalue Smallgrowth Large growth Large Shortcorporate

Survivors only Survivors plus "dead" funds Shortgovernment Intermediatecorporate

x.xx Median surviving fund excess return (%) Intermediategovernment

Sources: Vanguard calculations, using data from Morningstar, Inc. Note: Data reflects the 15-year period ended December 31, 2019. Benchmarks reflect those identified in each fund’s prospectus. “Dead” funds are those that were merged or liquidated during the period. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

For financial advisors only. Not for public distribution. 9 Important information

For more information about Vanguard funds or ETF Shares, contact your financial advisor to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Mutual funds and all investments are subject to risk, which may result in loss of principal. Prices of mid- and small-cap stocks often fluctuate more than those of large- company stocks. Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets. Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility. It is possible that tax- managed funds will not meet their objective of being tax-efficient. Because company stock funds concentrate on a single stock they are considered riskier than diversified stock funds.

Investments in bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments. High-yield bonds generally have medium- and lower-range credit-quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit-quality ratings. Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund's trading or through your own redemption of shares. For some investors, a portion of the fund's income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax. Diversification does not ensure a profit or protect against a loss.

Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the Fund name refers to the approximate year (the target date) when an investor in the Fund would retire and leave the workforce. The Fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in the Target Retirement Fund is not guaranteed at any time, including on or after the target date.

The information contained herein does not constitute tax advice, and cannot be used by any person to avoid tax penalties that may be imposed under the Internal Revenue Code. Each person should consult an independent tax advisor about his/her individual situation before investing in any fund or ETF.

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For financial advisors only. Not for public distribution. 10 Important information

"Dividend Achievers" is a trademark of The NASDAQ OMX Group, Inc. (collectively, with its affiliates, "NASDAQ OMX") and has been licensed for use by The Vanguard Group, Inc. Vanguard mutual funds are not sponsored, endorsed, sold, or promoted by NASDAQ OMX and NASDAQ OMX makes no representation regarding the advisability of investing in the funds. NASDAQ OMX MAKES NO WARRANTIES AND BEARS NO LIABILITY WITH RESPECT TO THE VANGUARD MUTUAL FUNDS.

The index is a product of S&P Dow Jones Indices LLC (“SPDJI”), and has been licensed for use by Vanguard. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); S&P® and S&P 500® are trademarks of S&P; and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Vanguard. Vanguard product(s) are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, or their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the index. London Stock Exchange Group companies includes FTSE International Limited ("FTSE"), Frank Russell Company ("Russell"), MTS Next Limited ("MTS"), and FTSE TMX Global Debt Capital Markets Inc. ("FTSE TMX"). All rights reserved. "FTSE®", "Russell®", "MTS®", "FTSE TMX®" and "FTSE Russell" and other service marks and trademarks related to the FTSE or Russell indexes are trademarks of the London Stock Exchange Group companies and are used by FTSE, MTS, FTSE TMX and Russell under license. All information is provided for information purposes only. No responsibility or liability can be accepted by the London Stock Exchange Group companies nor its licensors for any errors or for any loss from use of this publication. Neither the London Stock Exchange Group companies nor any of its licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Indexes or the fitness or suitability of the Indexes for any particular purpose to which they might be put. The Russell Indexes and Russell® are registered trademarks of Russell Investments and have been licensed for use by The Vanguard Group, Inc. The Products are not sponsored, endorsed, sold or promoted by Russell Investments and Russell Investments makes no representation regarding the advisability of investing in the Products. The funds or securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such funds or securities. The prospectus or the Statement of Additional Information contains a more detailed description of the limited relationship MSCI has with Vanguard and any related funds. The Vanguard ETFs are not sponsored, endorsed, sold or promoted by Barclays Risk Analytics and Index Solutions Limited or its affiliates ("Barclays"). Barclays does not make any representation regarding the advisability of Vanguard ETFs or the advisability of investing in securities generally. Barclays' only relationship with Vanguard is the licensing of the Index which is determined, composed and calculated by Barclays without regard to Vanguard or the Vanguard ETFs. Barclays has no obligation to take the needs of Vanguard or the owners of the Vanguard ETFs into consideration in determining, composing or calculating the Index. Barclays has no obligation or liability in connection with administration, marketing or trading of the Vanguard ETFs. © 2020 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; (3) does not constitute investment advice offered by Morningstar; and (4) 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. Past performance is no guarantee of future results. © 2020 The Vanguard Group, Inc. All rights reserved. U.S. Patent Nos. 6,879,964; 7,337,138; 7,720,749; 7,925,573; 8,090,646; 8,417,623; and 8,626,636. Vanguard Marketing Corporation, Distributor of the Vanguard Funds.

Investment Products: Not a Deposit • Not FDIC Insured • Not Guaranteed by the Bank • May Lose Value • Not Insured by Any Federal Government Agency

PID1315226(1302492)_DOLU02/16/2022 For financial advisors only. Not for public distribution. 11 Catherine P. Crain, CFA, is a Vice President at Fayez Sarofim & Co. and a co-portfolio manager of the mutual funds that Fayez Sarofim & Co. manages for The Bank of New York Mellon Corporation. She also serves as a portfolio manager for a variety of institutional and high net worth clients. Ms. Crain joined the Firm in 1993 in Equity Research. Over the years, areas of research responsibility have included transportation, media and entertainment, and consumer products.

Ms. Crain received a M.B.A. from the University of Texas in 1993 and a B.A. with Highest Honors in the Plan II Liberal Arts Honors Catherine P. Crain Program at the University of Texas at Austin in 1989, where she was elected to Phi Beta Kappa. Prior to joining Fayez Sarofim & Vice President Co., she was employed at Merrill Lynch & Co. as a Financial Analyst in the Investment Banking Division in New York and Houston. Ms. Crain is a life member of the University of Texas McCombs School of Business Advisory Council. She has also served on the Board of Trustees for The Joy School and Presbyterian School of Houston. Domestic and Global Equity Management Houston Trust Company Next Gen Webinar Active vs. Passive Management

Catherine P. Crain, CFA Vice President Portfolio Management

Confidential. Not for distribution or reproduction. 1 Active Management and Importance of Long-Term Perspective

. Look beyond the 12-month horse race

. Maintain discipline to withstand periods of underperformance

. Importance of Buy-and-Hold

Confidential. Not for distribution or reproduction. 2 Outperformance of Active Fund Managers Over Longer Periods

As of 12/31/2019 10 Years 15 Years 20 Years Total Funds 738 601 445 Outperform Benchmark 155 196 248 % Outperform 21% 33% 56%

Median Outperformance 0.73 0.78 1.20 Highest Outperformance 4.03 4.48 5.47 Lowest Outperformance 0.03 0.01 0.01

Note: Active U.S. Large Cap Equity funds in Morningstar.

* Measuring active managers over the long-term is the best way to discover true stock picking skills.

Confidential. Not for distribution or reproduction. 3 Six Key Characteristics of Quality Active Managers*

. High Active Share

. Low Fees and Expenses Portfolio Attributes . Low Turnover

. Risk Avoidance

Firm . Focus on Core Competency Attributes . Alignment of Interests Between Manager and Investor

*Source: Dodge & Cox, “Understanding the Case for Active Management”, October 2016.

Confidential. Not for distribution or reproduction. 4 Active Share

. Definition: Active share measures how much a portfolio’s holdings differ from benchmark index member constituents at a point of time.

. Numerous studies show managers with high active share beat “closet indexers”.

Confidential. Not for distribution or reproduction. 5 Portfolio Sector Composition As of 06/30/20

35%

29.5% 30% 27.5%

25%

20%

15% 14.6% 13.0% 11.5% 11.5% 12.0% 10.8% 10.8% 10.1% 10% 9.3% 8.0% 7.0% 6.0% 6.0% 5% 3.5% 3.1% 2.8% 2.5% 2.8% 1.8%

0% Comm Consumer Consumer Energy Financials Health Care Industrials Technology Materials Real Estate Utilities Cash Services Disc. Staples Fayez Sarofim & Co. Model Portfolio S&P 500 Index

Source: Fayez Sarofim & Co. Based on a Fayez Sarofim & Co. SMA model portfolio and subject to change; actual individual accounts may vary. Sectors are defined according to Global Industry Classification (GICS).

Confidential. Not for distribution or reproduction. 6 Lower Turnover and High Active Share

Excess Returns of U.S. Equity Mutual Funds 2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

-0.5%

-1.0%

-1.5% Longest Duration Shortest Duration Longest Duration Shortest Duration

High Active Share Low Active Share

Source: Martijn Cremers, Financial Analyst Journal, December 2016. Data through 1990-2015

Confidential. Not for distribution or reproduction. 7 Compound Annual Rate of Returns 12/31/75 – 06/30/20 Last Quarter Last Year Last 3 Years Last 5 Years Last 10 Years Since Inception Russell:1000 Growth Russell:1000 Growth Russell:1000 Growth Russell:1000 Growth Russell:1000 Growth FS & Co. 27.8% 23.3% 19.0% 15.9% 17.2% 11.9% Russell 2000 Index FS & Co. FS & Co. FS & Co. S&P 500 Index S&P 500 Index 25.4% 13.6% 13.3% 11.8% 14.0% 11.4% FS & Co. Barclays Aggregate S&P 500 Index S&P 500 Index FS & Co. MSCI World 21.3% 8.7% 10.7% 10.7% 13.4% 9.4% S&P 500 Index S&P 500 Index S&P Index Fund S&P Index Fund S&P Index Fund MSCI:EAFE 20.5% 7.5% 10.3% 10.2% 13.4% 8.7% S&P Index Fund S&P Index Fund MSCI World MSCI World Russell 2000 Index Barclays Aggregate 20.4% 7.1% 6.7% 6.9% 10.5% 7.4% MSCI World MSCI World Barclays Aggregate Russell:1000 Value Russell:1000 Value Russell: 1000 Growth 19.4% 2.8% 5.3% 4.6% 10.4% NA MSCI:EAFE MSCI:EAFE Russell 2000 Index Barclays Aggregate MSCI World Russell: 2000 Index 14.9% (5.1%) 2.0% 4.3% 10.0% NA Russell:1000 Value Russell 2000 Index Russell:1000 Value Russell 2000 Index MSCI:EAFE Russell: 1000 Value 14.3% (6.6%) 1.8% 4.3% 5.7% NA Barclays Aggregate Russell:1000 Value MSCI:EAFE MSCI:EAFE Barclays Aggregate S&P Index Fund 2.9% (8.8%) 0.8% 2.1% 3.8% NA

* FS & Co.’s returns reflected above represent the returns of the Equity Fund Composite during the time period(s) referenced. The returns reflected in this report are not presented in accordance with the GIPS Performance Presentation Standards unless accompanied by the NOTES TO INVESTMENT RESULTS. The rates of return are not adjusted for the impact of fees. Additional information regarding these calculations may be obtained from the Firm’s GIPS compliant presentations. Past performance is not an indicator of future results. Estimated and unaudited.

Confidential. Not for distribution or reproduction. 8 Q&A