MUTUAL FUND DUE DILIGENCE Presented to FIRMA By

MUTUAL FUND DUE DILIGENCE Presented to FIRMA By R. James Hrabak, CFA March 28, 2012

About the Presenter 2 R. James “Jim” Hrabak is Chief Investment Officer for MB Financial Bank’s Asset Management & Trust Group, where he is responsible for over $3 billion in assets under administration and nearly $1. 8 billion in assets under management. His team of three Portfolio Managers and five Securities Analysts specialize in asset allocation, portfolio construction, and security selection for individual and institutional clients. Jim received a BBA. , double majoring in Finance and Economics, from New Mexico State University, an MBA with a concentration in Financial Management from the University of New Mexico, and is also a Chartered Financial Analyst. Jim is a member of the CFA Institute as well as the CFA Society of Chicago.

General Items to Consider (Before Designing a Due Diligence Program) 3 What is Our Investment Philosophy? In-House Management vs. Outside Expertise Active vs. Passive Management Mutual Funds vs. ETFs How Much Style Drift is Tolerable? � Special Note: All of the above should be greatly influenced by your firm’s investment management resources.

The Importance of an Investment Philosophy 4 Is your philosophy a known commodity? Why is philosophy important? � Due Diligence Program (and all investment functions) should reflect your firm’s investment philosophy Don’t have a clearly articulated philosophy? The items to consider on the previous slide can serve as a guide for creating one.

In-House Management vs. Outside Expertise 5 The 1992 restatement of the Prudent Investor Act: � � � Allows delegation of investment management States that investments should be viewed in the context of the total portfolio Risk/return tradeoff is the central consideration Firms are essentially required to seek out expertise in investment areas that improve the risk/return tradeoff in their client’s portfolios Firms should carefully evaluate what they can do “in-house” versus what they should hire outside expertise to perform Investing in a mutual fund (or an ETF ) is a form of hiring outside expertise Firms should balance what they can competently and effectively perform in-house with using outside managers to complete a diversified portfolio

Active vs. Passive Management 6 Active Management Passive Management • Pros • Alpha Generation • Differentiate through investment performance • Differentiate through manager selection • Pros • Low Cost • Low Labor Commitment • Less emphasis on performance • Cons • Tracking error • Higher cost • Labor Intensive • Cons • Virtually guaranteed to underperform benchmarks • Less ability to differentiate IM process The decision between active and passive is not a zero-sum game. A combination of the two may be optimal. � “Barbell” risk in lower-alpha categories such as LC Equity � Using index funds for high-volatility asset classes such as commodities

Selecting Types of Management Vehicles 7 Mutual Funds Exchange Traded Funds • Pros • Large Universe • Access to many well-established managers • Still best avenue to pursue specialized active management • Pros • Low Cost • Growing market • Drawing positive media attention • Cons • Higher expense ratios • Redemption fees are possible • Share class confusion • Desired fund may be closed to new investors • Cons • Actively managed options limited • Potential tax pitfalls (K-1 s) • Tactical trading may be costly Much like the active versus passive discussion, the decision between Mutual Funds and ETFs is not allor-nothing. �A firm can dramatically reduce their client’s expense through ETFs, if passive management is preferred � Attention should be paid to the tax implications of individual ETFs as well as the potential trading costs

How Much Style Drift is Tolerable? 8 Style box complexity should be scaled to the IM resources of the firm Regardless of the chosen style-box complexity, each category should be evaluated with equal rigor and frequency � Style box complexity intensifies with international equities (Developed Markets vs. Emerging + Large, Mid, Small; Growth, Blend, Value) � Selecting appropriate benchmarks is very important � A less complex style-box should lead to a shift away from category averages to the use of broad benchmarks

Designing a Program Around Your Firm’s Resources 9 Necessary resources � Manager Database/Analytics Software � Investment Management Staffing � Investment Committee to vet manager selection To run a fund due diligence program effectively, it should be scaled to the firm’s IM resources � Active Management over Passive = More Analysis � More Complex Style-Box = More Analysis Active vs. Passive decision is the key driver

An Example Due Diligence Program w/Examples 10 The due diligence process described in the next slides focuses on following categories Quantitative Analysis: Returns; Risk; Cost Qualitative Analysis: Performance attribution; Fund Manager Investment Philosophy Final Review Ongoing Monitoring/Review The program is designed to be consistently employed across all asset classes/investment styles

Mutual Fund Due Diligence Process 11 QUANTITATIVE ANALYSIS Asset Class Screening Are there under-performing funds in the portfolio? What are the best funds in the asset class universe based on our metrics? Is this underperformance more cyclical or structural (STYLE DRIFT)? If STYLE DRIFT is present, is it organic or synthetic? BI-ANNUAL REVIEW Under. Performanc e Style Drift What are the insights/concerns of our group regarding the fund under review? SUPERIOR RISKADJUSTED RETURNS STYLE CONSISTENCY LOW COST LONG-TERM TRENDS FINAL ANALYSIS Q&A with Fund portfolio team Internal Group Discussion QUALITATI VE ANALYSIS Performance Attribution Analysis How do the best funds differ from each other? What factors explain the best funds’ outperformance? Is the fund manager’s philosophy aligned with the firm’s?

Mutual Fund Due Diligence Process: QUANTITATIVE ANALYSIS 12 Risk Returns Cost NEAR TERM: 1 yr returns above Category Average 3 yr annualized Standard Deviation of returns above Category Average NO FRONT END LOAD FEES MEDIUM TERM: 3 yr annualized returns above Category Average Annual turnover of portfolio below Category Average NO DEFERRED SALES FEES LONG TERM: 5 yr annualized returns above category average Portfolio Manager tenure greater than 5 years Net Expense Ratio below Category Average Command Field Name Morningstar Category = Large Value And Total Ret % Rank Cat 1 Yr <= 50 th percentile And Total Ret % Rank Cat 3 Yr <= 50 th percentile And Total Ret % Rank Cat 5 Yr <= 50 percentile And And Max Front Load Deferred Load Std Dev 3 Yr (Mo-End) = = <= NA NA CAT AVG And Annual Report Net Expense Ratio <= CAT AVG And Turnover Ratio % Manager Tenure (Longest) <= >= CAT AVG 5 years TOP SCREENED FUNDS Best funds in category universe based on our metrics Operator Value

Mutual Fund Due Diligence Process: QUANTITATIVE ANALYSIS 13 Name Ticker MFS International Value I MINIX Morningstar Category GMO International Core Equity VI GCEFX US OE Value US OE Value DFA International Value I DFIVX Tweedy, Browne Global Value Thomas White International Manning & Napier International S JHancock 3 International Value Eq I TBGVX TWWDX EXITX JIEEX Templeton Instl Foreign Eq Ser Primary TFEQX US OE Foreign Large Value QUANTITATIVE ANALYSIS Screen Group created Foreign Large Foreign Large Total Ret Total Prospectus Std Exceeds YTD: Total Ret Ret Manager Turnover Net Dev 3 Group Avg. JANUARY Ret 1 Yr Annlzd 3 Annlzd Tenure Ratio % Expense Yr 2012 Yr 5 Yr 10 Yr Ratio 1. 82 -1. 10 15. 52 -0. 12 9. 28 18. 38 8. 33 24. 00 1. 03 7 12. 00 1. 40 7 1. 78 -3. 03 16. 72 -0. 12 6. 37 14. 26 18. 67 6. 38 -6. 72 16. 22 -1. 27 8. 89 22. 26 17. 67 41. 00 1. 38 6 13. 00 1. 11 5 5. 13 -9. 99 14. 66 0. 69 7. 90 20. 61 19. 17 6. 65 -9. 71 17. 52 -2. 68 7. 15 21. 68 13. 92 12. 00 1. 18 4 5. 22 -9. 45 14. 18 -1. 95 7. 37 22. 75 15. 58 13. 63 0. 81 4 40. 00 0. 44 1 5 4. 02 -7. 72 12. 95 -3. 52 7. 10 21. 46 10. 08 US OE Foreign Large Value 6. 72 -14. 88 16. 64 -4. 49 8. 50 26. 88 13. 17 9. 00 0. 45 SCREEN GROUP AVERAGE 4. 72 -7. 82 15. 55 -1. 68 7. 82 21. 03 14. 57 20. 58 0. 98 Foreign Large Value 5. 66 -10. 41 13. 13 -4. 51 5. 76 22. 85 45. 95 1. 41 WILL INFORM the next phase QUALITITATIVE ANALYSIS Screen group parsed Attribution investigated

Mutual Fund Analytics and Selection Process: QUALITATIVE ANALYSIS 14 SCREEN GROUP RELATIVE PERFORMANCE: Do we see OUTLIER PERFORMANCE PERIODS for any of the top screen group funds? Could this be driven by… Overweights/Underweights by SECTOR or REGION? STYLE tilt or MARKET CAP tilt? If we identify any significant OW/UW’s and or tilts… Do these attributes appear to be CONSISTENT or TRANSITORY? Are these attributes aligned with our expectations for how a manager should manage a portfolio in that asset class? Does it all make sense? Can we explain to ourselves what a manager has done to be successful relative to her peer group? Could we explain this to our clients? If not, we need to request insight and guidance directly from the PM team at the fund.

Mutual Fund Analytics and Selection Process: QUALITATIVE ANALYSIS 15 We identified a period of sustained underperformance combined with above average risk in our Foreign LC Growth fund (BIGIX). After reviewing the data, we linked this period of outlier underperformance to the fund’s significant OW in EM. Once we identified this style drift into the EM space of our Foreign Large Cap Growth manager, the questions we asked ourselves: CONSISTENT or TRANSITORY? ALIGNED WITH OUR EXPECTATIONS FOR OUR MANAGERS?

Mutual Fund Due Diligence Process: QUALITATIVE ANALYSIS 16 We verified that BIGIX’s EM style drift could be expected to be consistent going forward, after a series of live and conference call portfolio updates with the lead PM. Our next step was to identify replacement candidates in the asset class/style box under review. (UMBWX and HLMIX) These candidates have to had made through our screen as detailed in slides 2 and 3. We then compared the candidate funds’ historical EM weightings and current EM caps to ensure that these funds were being managed in alignment with our expectations for our Foreign Large Cap Growth manager.

Mutual Fund Due Diligence Process: FINAL REVIEW 17 TIMELINESS of prospective swap: • Whipsaw risk? POTENTIAL QUESTIONS and QUALMS: • How does current Market and Sector environment affect the swap? • From Clients • From Investment Committee INTERNAL GROUP DISCUSSION GROUP KNOWLEDGE: MISCELLANEOUS: • Experience with Fund Company • Previous experience with similar swap/shift • Derivates usage? • Trading structure • Sell Discipline Q&A with Candidate Fund PM team

Mutual Fund Analytics and Selection Process: FINAL REVIEW 18 EXPLANATION OF OW/UW’s: RESPONSIVENESS of PM team • Cyclical or Structural? • Do we have direct access to actual PM? • OW/UW’s Attribution? Q&A WITH CANDIDATE FUND PM TEAM REQUEST COMPARATIVE ANALYSIS with CURRENT FUND • Sector weights, Returns, Risk CASH ALLOCATION • Tactical or Fully Invested? IMPLEMENTATIO N of INVESTMENT DECISION

Mutual Fund Analytics and Selection Process: ONGOING MONITORING/REVIEW 19 Monthly Review of Screen Metric data Is the RECURRING relative underperformance improving or worsening? Do we see RECURRING relative underperformance? Is there NEW relative underperformance? Asset Management & Trust Group Featured Mutual Funds (Extract) 1/31/2012 Page 1 of 2 Name Ticker YTD Return 1 -year Return 3 -year Return 5 -year Return 10 -year Return Std Dev 3 yr Manager Tenure Turnover Ratio Expense Ratio FINSX 4. 91 3. 53 18. 37 2. 82 6. 31 1. 83 19. 73 1. 60 3. 14 15. 67 19. 09 8. 58 47. 00 0. 89 73. 65 1. 32 90. 00 0. 60 61. 14 1. 25 30. 10 0. 80 87. 94 1. 40 41. 00 0. 76 58. 10 1. 34 Large Cap Equity Fidelity Advisor New Insights Category Average: Large Growth American Beacon Lg Cap Value Inst 4. 95 -0. 16 18. 19 -1. 55 5. 42 20. 22 Category Average: Large Value AADEX 4. 27 1. 23 17. 06 -1. 46 3. 87 18. 96 S&P 500 4. 48 4. 22 19. 24 0. 33 3. 52 18. 16 6. 20 2. 47 26. 56 6. 23 8. 54 19. 86 6. 79 1. 19 23. 33 2. 73 5. 40 20. 93 24. 58 Mid Cap Equity T. Rowe Price Mid-Cap Growth RPMGX Category Average: Mid-Cap Growth JPMorgan Mid Cap Value Instl 4. 04 5. 39 22. 07 2. 42 9. 17 18. 69 Category Average: Mid-Cap Value FLMVX 5. 74 -0. 46 22. 27 0. 41 6. 52 21. 63 S&P Mid. Cap 400 6. 61 2. 71 25. 26 3. 90 7. 78 21. 68 19. 67 14. 25

Mutual Fund Analytics and Selection Process: ONGOING MONITORING/REVIEW 20 Do we see RECURRING relative under-performance? QUANTITATIV E ANALYSIS Asset Class Screening Do we understand the under-performance as cyclical and expected for what we selected the manager to do? NO? YES? BI-ANNUAL REVIEW Under. Performance Style Drift SUPERIOR RISKADJUSTED RETURNS STYLE CONSISTENCY LOW COST LONG-TERM TRENDS FINAL ANALYSIS Fund put on watch list In-depth review tabled Q&A with Fund portfolio team Internal Group Discussion QUALITATIV E ANALYSIS Performance Attribution Analysis

Final Thoughts 21 Mutual Fund due diligence is critical to the role of fiduciary The process, and the overall investment program itself, should be tailored to fit the level of resource committed to the investment function A well documented and consistent review process can be a major selling point to prospective clients � Altering the perception of “outsourcing” to one where the firm is actively “managing” its managers

MUTUAL FUND DUE DILIGENCE Presented to FIRMA By R. James Hrabak, CFA March 28, 2012