Sectors: How to Do More for the Core

Marketing Communication

For Investment Professional use only. Do not reproduce or reprint without the written permission of State Street Global Advisors. All the information contained in this presentation is as of date indicated unless otherwise noted.

2388197.3.1.GBL.INST 1 Table of Contents

1. The Case for Sector Investing

2. Sector Portfolio Construction Top-Down Thematic Bottom-Up/Fundamental Technical

3. Considerations for Sector Portfolio Implementation

2388197.3.1.GBL.INST 2 The Case for Sector Investing

For Institutional Use Only

2388197.3.1.GBL.INST 3 Diversification: Variable Correlations Among Sectors Correlations between sectors vary markedly, potentially providing another source of diversification to an equity portfolio Sector Rolling 90-Day Pair-wise Correlation (January 2016 – December 2018) 1.1 Average Sector Pair-wise 90-Day Correlation The shaded area indicates differences among sector pair-wise correlations

0.9

0.7

0.5

0.3

0.1 +/- 1 Stdv

-0.1 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18

Source: FactSet, as of December 31, 2018. Diversification does not ensure a profit or guarantee against loss. It is not possible to invest in an index. Sectors are represented by the corresponding S&P Select Sector Indices.

2388197.3.1.GBL.INST 4 Diversification: Variable Correlations to the Broad Market Sector correlations to the broad market are different and change over time

Sector 90-Day Correlation to the S&P 500 Index ( January 2016 – December 2018) Average 1.20 Max Min 1.00

0.80

0.60

0.40

0.20

0.00

-0.20

-0.40 Utilities Telecom Real Estate Cons. Energy Health Care Financials Materials Industrials Cons. Disc. Tech Staples

Source: FactSet, as of December 31, 2018. Diversification does not ensure a profit or guarantee against loss. It is not possible to invest in an index. Sectors are represented by the corresponding S&P Select Sector Indices.

2388197.3.1.GBL.INST 5 Wide Dispersion and Changing Winners and Losers Among sectors, there are wide dispersions of returns, providing investors opportunities to add value by overweighting winners and underweighting losers Sector Calendar Year Price Returns 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Cons. Disc. -17.7 59.9 28.0 14.8 26.3 41.0 26.1 8.4 23.7 36.9 4.7 Cons. Staples -24.5 45.2 25.7 10.5 21.9 38.7 24.3 5.2 20.1 21.4 0.5 Energy -31.6 38.8 23.9 10.2 16.2 37.6 23.3 4.3 17.8 21.2 -0.5 Financials -33.6 23.5 19.9 7.9 15.2 33.2 18.2 3.8 16.1 20.0 -1.6 Health Care -34.7 20.8 17.9 4.4 13.4 29.6 13.1 1.2 14.1 20.0 -5.6 Industrials -35.9 17.3 12.8 2.8 13.2 26.2 12.9 -0.7 12.2 19.4 -6.24 Tech. -38.5 17.1 12.3 1.3 12.5 22.7 11.4 -1.7 12.0 18.5 -8.0 Materials -41.5 14.8 10.8 0.8 12.5 22.7 8.1 -3.5 9.5 10.5 -11.2 Real Estate -43.7 11.3 10.7 0.0 12.2 22.3 7.5 -4.7 4.3 8.3 -14.7 Telecom -45.0 11.2 9.1 -2.9 7.5 8.8 4.7 -8.4 2.6 7.2 -15.0 Utilities -47.1 6.8 0.9 -11.6 2.3 6.5 -1.9 -10.4 0.0 -3.8 -16.4 S&P 500 -57.0 2.6 0.7 -18.4 -2.9 -1.5 -10.0 -23.6 -4.4 -6.0 -20.5

Sector Dispersion 29.4 53.1 27.2 26.5 23.9 34.5 28.1 18.8 23.6 40.7 25.2

Size & Style Dispersion 7.2 10.4 12.2 5.1 4.3 10.1 10.5 8.9 17.9 15.7 9.9

Wider dispersions among sectors than among traditional size & styles

Source: FactSet, as of December 31, 2018. Past performance is not a guarantee of future results. Index returns reflect capital gains and losses, income, and the reinvestment of dividends. Diversification does not ensure a profit or guarantee against loss. Sector dispersions are calculated using the max returns minus min returns among S&P 500 sector indices. Size & style performance is represented by the S&P 500 Value Index, S&P 500 Growth Index and S&P SmallCap 600 Index.

2388197.3.1.GBL.INST 6 For Thematic Plays, Sectors May be Better than Stocks An investor may get the sector call right, but the stock call wrong, as the odds are historically not in the stock picker's favor Percentage of S&P 500 Stocks That Outperformed or Underperformed the Sector Average by More Than 10%

More stocks underperformed the sector average significantly than the ones outperforming Underperform 10% Outperform 10% 49 43

35 35 36 36 34 34 32 31 32 31 30 30 30 30 30 30 30 29 30 31 29 30 28 27 27 27 28 28 25 25 23 24

2003 - 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2018 Average

Source: State Street Global Advisors, FactSet, January 2003 – December 2018. Performance quoted represents past performance, which is no guarantee of future results. The index returns are unmanaged and do not reflect the deduction of any fees or expenses. The index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. It is not possible to invest in an index.

2388197.3.1.GBL.INST 7 Sector Portfolio Construction

For Institutional Use Only.

2388197.3.1.GBL.INST 8 Sector Strategy Implementation Approaches

Top-Down Thematic Bottom-Up Technical • Survey macro • Position according • Evaluate sector • Overweight/ economic to changes in fundamentals, underweight environment and certain macro- such as valuations sectors based analyze business economic variables and earnings on recent cycles • Identify secular trends performance industry trends and • Position towards harness a long- sectors that show term growth trend attractive within a particular valuations and/or segment of the strong sentiment economy

Source: State Street Global Advisors

2388197.3.1.GBL.INST 9 Research on Sector Performance in Business Cycles Investment Belief: Business cycles exhibit characteristics that impact sectors or industries differently Research methodology 1. Divide the economic cycle based on the direction and magnitude of changes of the Conference Board Leading Economic Indicator (LEI) Index 2. Leverage Kenneth French 48 SIC-based (Standard Industrial Classification) industry portfolios to create sector performance history back to 1961, which covers 7 recessions and recoveries, 12 expansions and 11 slowdowns 3. Assess sector performance and performance consistency

20 1

15 1

10 1 5 1 1 0 1 -5 0 -10 0 -15

LEI YoYChange (%) 0 -20 0 -25 0 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 Recession Recovery Expansion Slowdown Conference Board LEI YoY %

Source: FactSet, as of December 31, 2018. Diversification does not ensure a profit or guarantee against loss. It is not possible to invest in an index. Sectors are represented by the corresponding S&P Select Sector Indices.

2388197.3.1.GBL.INST 10 Sector Performance in Business Cycles

Recession: Declining economic Avg excess return during the business cycle Market Return % of Times Outperforming

outputs and aggregate demand; 5.0% 100% increasing unemployment; low 1.0% 0.0% 80% consumer expectations; easing -1.6% -5.0% -2.9% monetary policy 60% -10.0% 40% -15.0% market

-20.0% -14.8% 20% Avg Return over the Cycle the over Return Avg -20.3%

-25.0% -21.6% 0% % of times outperforming the the outperforming times of % Cons. Staples Utilities Health Care Industrials Tech Real Estate Top 3 Bottom 3

Recovery: Economy rebounds from Avg excess return during the business cycle Market Return % of Times Outperforming the bottom but below the trend.

50.0% 100% Consumer expectations and consumer 39.2% 40.0% 80% spending pick up. Interest rate 33.1% 29.3% remains low. 30.0% 60% 21.4% 18.0% 20.0% 40%

14.7% market

10.0% 20% Avg Cycle the over Return Avg

0.0% 0% % of times outperforming the the outperforming times of % Real Estate Cons. Disc. Materials Health Care Cons. Staples Utilities Top 3 Bottom 3

Source: State Street Global Advisors, as of November 30, 2018. Past performance is not a reliable indicator of future performance. This information should not be considered a recommendation to invest in a particular sector shown. It is not known whether the sectors shown will be profitable in the future

2388197.3.1.GBL.INST 11 Sector Performance in Business Cycles

Expansion: Economic growth Average Period Return Market Return % of Times Outperforming

reaches the cycle peak. Business 25.0% 100% confidence improves and business 21.0% 18.7% spending expands. Interest rate starts 20.0% 17.8% 80% increasing from a relatively low level. 15.0% 60% 10.8% 10.6%

10.0% 7.6% 40%

market Return over the Cycle the over Return

5.0% 20% Avg

0.0% 0% % of times outperforming the the outperforming times of % Tech Financials Real Estate Health Care Cons. Staples Utilities Top 3 Bottom 3

Slowdown: Economic growth starts Average Period Return Market Return % of Times Outperforming decelerating but remains positive. 16.0% 15.0% 14.6% 80% The economy is running beyond 13.7% its full capacity. Monetary policy 12.0% 60% becomes restrictive. 8.0% 6.5% 40% 5.5%

4.0% 2.4% 20% Avg Cycle the over Return Avg

0.0% 0%

Health Care Cons. Staples Financials Materials Cons. Disc. Real Estate % of times outperforming the market the outperforming times of % Top 3 Bottom 3

Source: State Street Global Advisors, as of November 30, 2018. Past performance is not a reliable indicator of future performance. This information should not be considered a recommendation to invest in a particular sector shown. It is not known whether the sectors shown will be profitable in the future

2388197.3.1.GBL.INST 12 Position the Portfolio to Capture Shifts in Business Cycles As sector performance varies in each phase of the business cycle, investors may tilt towards sectors which are beneficiaries of the economic environment to position for economic shifts

Expansion Slowdown Recession Recovery

++ ++ ++ ++ Financials, Technology Consumer Staples, Health Care Consumer Staples, Utilities Consumer Discretionary, Real Estate + + + + Communication Industrials Health Care Materials Services - - - - Consumer Staples Materials Communication Services Health Care ------Health Care, Utilities Consumer Discretionary, Real Estate, Technology Consumer Staples, Utilities Real Estate Energy: Given the fungibility of the sector outputs and highly connected global commodity market, energy firms’ profits are more driven by oil supply and demand worldwide. Geopolitical tensions also introduce more idiosyncratic risks to the sector

Source: State Street Global Advisors, as of December 31, 2018. Double ++/-- signs indicate the top/bottom best performing sectors. Single +/- sign indicate the third best/worst performing sectors. The information contained above is for illustrative purposes only. It should not be construed as investment advice.

2388197.3.1.GBL.INST 13 Top-Down Example: Economic Recession Scenario Analysis Equally allocate to Utilities, Staples and Health Care that historically performed well during a recession to help navigate market downturns

Hypothetical Profit & Loss % For Scenario Analysis based on Holdings and Market Levels A Recession Sector Portfolio Weight As of March 31, 2019 Recession Sector Portfolio S&P 500 Index

-1.39

-8.29 -8.35

-10.39 33.3% 33.3% Utilities Cons. Staples

33.3% Health Care -18.08

-22.3

Bear Market: SPX Down 20%, Oil down 10-Year Treasury Yield Down 100bps US 10-Year Breakeven Inflation down 20% and VIX Up 150% 100bps Source: Bloomberg Finance, L.P. As of March 31, 2019. All Risk measures are derived from Bloomberg US Equity Risk Model and are expected risk measures forecast over the next calendar year. Forward looking risk factors are generated by means of a mathematical formula using the Bloomberg Multi-Asset Global Risk Model which includes historical volatilities, correlations and sensitivities to interest rates, credit spreads and risk factors and assumes a time horizon of 1 year. It does not reflect actual trading and does not reflect the impact that material economic and market factors may have on a Portfolio.

2388197.3.1.GBL.INST 14 Thematic: Changes in Economic Variables

Where are oil prices headed? Because sectors are closely aligned to specific economic Beta Sensitivity to Brent Crude Oil Prices (36M) variables, they can help investors harness macro trends or 0.78 shifts in economic fundamentals 0.70

0.38 Industry Sector Broad 0.12 0.05 0.02

-0.01 O&G Eqmt O&G Exp & Energy Cons. Health Care Utilities & Svs Prod Staples S&P 500 Top 3 Bottom 3

What are the inflation expectations? Where are we in the rate hike cycle? Beta Sensitivity to 10 Year Breakeven Inflation Rate (36M) Beta Sensitivity to the US 10 Year Yield (36M) 0.59 0.50 0.50 0.52 0.48 0.44

0.06 0.15

-0.12 0.00 -0.05 -0.07 -0.21 -0.22 O&G Eqmt O&G Exp & Metals & Cons. Real Estate Utilities Regiongal O&G Eqmt Bank Cons. Utilities Real Estate & Svs Prod Mining Staples Banks & Svs. Staples

S&P 500 Top 3 Bottom 3 S&P 500 Top 3 Bottom 3

Source: State Street Global Advisors, FactSet, as of March 31, 2019. Beta sensitivity is calculated using weighted average beta of underlying constituents of Select Sector Indices and S&P Select Industry Indice. Past performance is not a guarantee of future results.

2388197.3.1.GBL.INST 15 Thematic: Capture Secular Trends within Industries Long-term secular trends emerge as economy evolves and may benefit certain industries The Boom in Biotech Innovations Novel Drug Approval S&P Biotech Select Index S&P 500 Index Level S&P 500 Health Care Index

6000 70

5000 60

50 4000

Level 40 3000

Index 30

2000 of # Novel Drug Approval 20

1000 10

0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Source: FDA, Bloomberg Finance,L.P., as of December 31, 2018. Past performance is not a guarantee of future results.

2388197.3.1.GBL.INST 16 Thematic Example: Enhance Growth Potential for Sectors

Identify a secular industry trend 100%

Biotechnology Conventional/Unclassified

80% Biotech-based products increasingly 60% contribute to overall drug sales 40%

Prescription Prescription 20% & OTC & Sales Market ofShare 0% 2010 2012 2014 2016 2018 2020 2022 2024

Complement an existing portfolio with a Enhance the growth potential of a more targeted exposure Sector Exposure

9 Stocks Overlap Est. 3–5 Year Growth 16.4% of S&P 500 Health Care 13% of the Biotechnology Index 50% S&P Biotechnology Select Index + 50% S&P 500 20.45% Health Care Index

S&P 500 S&P Health Biotechnology Care Select Industry Sector Index S&P 500 Health Care Index 11.60% 62 Holdings 121 Holdings

Source: Bloomberg Finance,L.P., as of November 28, 2018. World Preview 2018, Outlook to 2012, Evaluate, May 2018 Characteristics are as of the date indicated and should not be relied upon as current thereafter.

2388197.3.1.GBL.INST 17 Bottom-Up: Sector Fundamental Scorecard 1. Aggregate fundamental data of individual securities within the same sector 2. Evaluate sector valuation and earnings sentiment using multiple metrics 3. Calculate a composite score by equally weighting each metric z-score in the same category 4. Sectors with cheaper valuation and higher earnings sentiment are given higher z-scores 5. Overweight sectors with the highest score in one or multiple categories

Valuation Earnings Sentiment • Absolute valuation: Percentile ranking of • Earnings revision: 3-month % change in the sector current Price to Earnings, Next next twelve month (NTM) EPS Estimates Twelve Month Price to Earnings, Price to • Earnings upgrade-to-downgrade ratio Book and Price to Sales over the past 15 years • % of companies with earnings beats • Relative valuation: Percentile ranking of • The magnitude of earnings surprise the current premium/discount relative to the S&P 500 based on Price to Earnings, Forward Price to Earnings, Price to Book and Price relative over the past 15 years

2388197.3.1.GBL.INST 18 Bottom-Up Example: Sector Scorecard For a strategy that looks for sectors that trade at cheap valuations with improving earnings, one consideration would be to overweight the top 3

Valuation Composite Earnings Sentiment Communication Services Score topped earnings sentiment Consumer Discretionary -1.15 0.36 in March, while valuations Consumer Staples 0.03 -0.08 remain attractive for Energy 0.37 -0.32 Financials relative to historic Financials 1.37 -0.53 levels and also relative to Health Care -0.02 0.33 the S&P 500 Industrials 0.26 0.45 Information Technology -0.72 0.34 Materials 0.65 -0.78 Communication 0.27 1.26 Real Estate -0.10 -0.80 Utilities -0.97 -0.22

Source: State Street Global Advisors, as of March 31, 2019. S&P 500 Sector Indices are used to calculate fundamental metrics of each sector. Top 3 sectors with least expensive valuations or highest earnings sentiment are highlighted in blue. Bottom 3 sectors with most expensive valuations or lowest earnings sentiment are highlighted in red.

2388197.3.1.GBL.INST 19 Technical Example: Capture Strong Performance Trends A momentum strategy seeks to capture the strongest performance trends among sectors. One of commonly used momentum strategies is to look at cross-sectional price momentum of different time horizons. 푷 풏 − 푴풐풏풕풉 푷풓풊풄풆 푴풐풎풆풏풕풖풎 = 푻−ퟏ − ퟏ 푷푻−풏−ퟏ Sector Price Momentum as of March 31, 2019 Top and Bottom Momentum Sectors 120 3M Price 6M Price 12M Price Composite Index Price Level (base = 100) Momentum Momentum Momentum Momentum 115 Z-score 110 Cons. Disc. 1.57 -6.69 4.80 -0.11 105 Cons. Staples -2.93 1.46 1.93 -0.24 Communication 2.76 0.01 N/A N/A 100 Energy -1.33 -12.35 -2.19 -1.05 95 Financials -1.75 -6.41 -8.27 -0.98 90 Health Care -3.47 -1.18 8.94 -0.19 85 Industrials 5.34 -0.84 -0.38 0.47 Tech 4.23 -6.55 4.35 0.19 80 Apr-18 Jun-18 Aug-18 Oct-18 Dec-18 Feb-19 Materials 0.86 -7.41 -7.74 -0.72 Real Estate 2.81 3.01 15.47 1.03 S&P 500 Real Estate Index S&P 500 Utilities Index Utilities 2.43 6.61 16.08 1.23 S&P 500 Energy Index S&P 500 Financials Index High Momentum Low Momentum

Source: Bloomberg Finance L.P., S&P 500 Sector Indices price return, data as of March 31, 2019. All other data annual data. Past performance is not a guarantee of future results. Index returns reflect capital gains and losses, income, and the reinvestment of dividends.

2388197.3.1.GBL.INST 20 Do More for the Core With Sectors • Carve out a quarter of the US equity exposure to allocate to the top three sectors based on fundamentals, macro trends or/and technical analysis • With an allocation to the highest momentum sectors, the portfolio exhibited similar expected risks as the benchmark, but with certain sector and style tilts

Portfolio Weight (%) Total Expected Risk (Standard Deviation %) Core + Momentum Sector Portfolio 5.83 Benchmark* 6.17  S&P 500 Industrial Index Active Risk 0.72 25 2.00 40 Active Risk Contribution (%)  S&P 500 Real Estate Index 6 81.2 2.00

 S&P 500 Utilities Index 29 2.00

Russell 3000 Index 14.2 US Sectors 4.7 S&P Developed ex US BMI Index Sector Style Non-factor Bloomberg Barclays US Aggregated Bond Index

Source: Bloomberg Finance L.P. as of March 31, 2019. * Benchmark consists of 40% of the Bloomberg Barclays US Aggregated Bond Index, 31% of the Russell 3000 Index, 29% of the S&P Developed ex-US BMI Index. All Risk measures are derived from Bloomberg US Equity Risk Model and are expected risk measures forecast over the next calendar year. Forward looking risk factors are generated by means of a mathematical formula using the Bloomberg Multi-Asset Global Risk Model which includes historical volatilities, correlations and sensitivities to interest rates, credit spreads and risk factors and assumes a time horizon of 1 year. It does not reflect actual trading and does not reflect the impact that material economic and market factors may have on a Portfolio.

2388197.3.1.GBL.INST 21 Considerations for Sector Portfolio Implementation

• Examine • For a frequent/ • Not all industry • Be cautious of embedded factor tactical sector funds offer the stock concentration exposures within strategy, evaluate same industry risk in market-cap the sector and total cost of coverage, due to weighted indices review factor ownership of different weighting for a narrowly exposures in the sector funds, methodologies defined industry, context of a total instead of focusing as well as security portfolio only on a fund total overlaps between expense ratio, as sector and industry trading costs may exposures increase significantly on less liquid ETFs such that they could potentially offset any savings from low expense ratio

2388197.3.1.GBL.INST 22 Important Disclosures

For Investment Professionals Only. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All asset allocation scenarios are for hypothetical purposes only and are not intended to represent a specific asset allocation strategy or recommend a particular allocation. Each investor’s situation is unique and asset allocation decisions should be based on an investor’s risk tolerance, time horizon and financial situation. Non-diversified funds that focus on a relatively small number of securities tend to be more volatile than diversified funds and the market as a whole. All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment. Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions. Investments in mid/small-sized companies may involve greater risks than in those of larger, better known companies. Diversification does not ensure a profit or guarantee against loss. Value stocks can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time. Growth stocks may underperform stocks in other broad style categories (and the stock market as a whole) over any period of time and may shift in and out of favor with investors generally, sometimes rapidly. Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations. Because of their narrow focus, sector funds tend to be more volatile than funds that diversify across many sectors and companies. Select Sector SPDR Funds bear higher level of risk than more broadly diversified funds. All ETFs are subject to risk, including the possible loss of principal. Sector ETFs products are also subject to sector risk and non-diversification risk, which generally results in greater price fluctuations than the overall market. Index-based ETFs are passively managed and seek to track an index of securities. Expenses may cause the ETF’s returns to deviate from the returns of the index. All ETFs are subject to risk, including possible loss of principal. Sector ETF products are also subject to sector risk and non-diversification risk, which generally result in greater price fluctuations than the overall market. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.

2388197.3.1.GBL.INST 23 Important Disclosures

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2388197.3.1.GBL.INST 24 Important Disclosures

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