The 7 Twelve Portfolio The Benefits of Low

The 7 Twelve Portfolio The Benefits of Low Correlation Craig L. Israelsen, Ph. D. Brigham Young University www. 7 Twelve. Portfolio. com 41 slides 1

This document is a research report presenting portfolio research and analysis. This document is neither investment advice nor an investment solicitation. Implementation of the 7 Twelve portfolio is no guarantee of performance. ----------------------------------------------This is a copyrighted document, copying for redistribution is prohibited unless written permission is obtained from Craig L. Israelsen. Copyright © 2008 Craig L. Israelsen All rights reserved 2

Presentation Overview ► Part One provides a historical context of the benefits of a multi-asset, low correlation portfolio. Two introduces the 7 Twelve Portfolio, a multi-asset, low correlation global portfolio. ► Part 3

Part One 4

Historical Asset Returns 38 -Year Period from Annualized 1970 -2007 Return (%) Std Dev of Annual Returns Growth of $10, 000 REIT 12. 38 18. 45 843, 476 Commodities 12. 02 23. 93 747, 183 US Small Stock 11. 74 21. 68 678, 684 US Large Stock 11. 08 16. 62 542, 040 International Stock 10. 86 21. 54 503, 316 Bonds (Intermediate) 8. 10 5. 39 193, 131 Cash 6. 29 3. 07 101, 701 Inflation 4. 62 3. 08 55, 618 5

Data ► Large-cap US equity represented by the S&P 500 Index. ► Small-cap US equity represented by the Ibbotson Small Companies Index from 1970 -1978, and the Russell 2000 Index from 1979 -2007. ► Non-US equity represented by the MSCI EAFE Index. ► Real estate represented by the NAREIT Index from 1970 -1977 and the Dow Jones Wilshire REIT Index from 1978 -2007. ► Commodities represented by the Goldman Sachs Commodities Index (GSCI). As of February 6, 2007, the GSCI became the S&P GSCI Commodity Index. ► U. S. intermediate term bonds represented by the Ibbotson Intermediate Term Bond Index from 1970 -73 and the Lehman Brothers Intermediate Term Government Bond index from 1974 -2007. ► Cash represented by 3 -month Treasury Bills. 6

Historical Upside and Downside Largest One-Year Gain (%) Worst One-Year Loss (%) Worst 3 -Year Cum Loss (%) Bonds 25. 42 (1. 75) 6. 43 Cash 15. 58 1. 05 4. 22 Commodities 74. 96 (35. 75) (26. 06) REIT 48. 99 (23. 44) (28. 30) US Large Stock 37. 58 (26. 47) (37. 61) US Small Stock 57. 40 (30. 90) (42. 22) International Stock 69. 44 (23. 45) (43. 32) 1970 -2007 7

Risk and Return of Major Asset Classes 1970 -2007 13 REIT 12 Commodities Non-US Equity 11 Annualized % Return (1970 -2007) Small US Equity Large US Equity 10 9 Bonds 8 7 Cash 6 5 10 0 -10 -20 -30 Worst Three-Year Cumulative % Return (1970 -2007) -40 -50 8

Benefit #1 When built correctly, multi-asset portfolios achieve low aggregate correlation among the internal assets. 9

Correlation of Major Asset Classes (1970 -2007) Large US Equity Small US Equity Non-US Equity US Bonds Cash Small US Equity . 74 Non-US Equity . 59 . 47 US Bonds . 21 . 05 -. 11 Cash . 05 . 01 -. 12 . 42 REIT . 39 . 71 . 25 . 00 -. 05 Commodities -. 28 -. 32 -. 14 -. 20 . 00 Aggregate (Average) Correlation in Equal-Weighted 7 -Asset Portfolio = REIT -. 24 0. 12 10

Correlation Matters Commodities and small US stock had a similar 38 -year return—but blending commodities with large US stock was far more beneficial because commodities has a lower correlation to large US stock (-0. 28) than does small US stock (0. 74). 11

Performance During Accumulation Phase Individual Assets vs. Typical Portfolios vs. Multi-Asset Portfolio 12

Year Large US Equity Small US Equity Non-US Equity Intermediate Term US Bonds Cash Real Estate Commodities Equally Weighted Multi. Asset Portfolio 1970 3. 92 (17. 40) (11. 66) 16. 90 6. 80 (4. 00) 15. 17 1. 39 1971 14. 30 16. 50 29. 59 8. 70 4. 53 15. 52 21. 08 15. 75 1972 19. 00 4. 40 36. 35 5. 20 4. 24 8. 01 42. 43 17. 09 1973 (14. 69) (30. 90) (14. 92) 4. 60 7. 46 (15. 52) 74. 96 1. 57 1974 (26. 47) (19. 90) (23. 16) 7. 03 8. 35 (21. 42) 39. 51 (5. 15) 1975 37. 23 52. 80 35. 39 8. 33 6. 08 19. 29 (17. 22) 20. 27 1976 23. 93 57. 40 2. 54 11. 74 5. 23 47. 56 (11. 92) 19. 50 1977 (7. 16) 25. 40 18. 06 3. 00 5. 52 22. 43 10. 37 11. 09 1978 6. 57 23. 50 32. 62 2. 23 7. 67 10. 98 31. 61 16. 45 1979 18. 61 43. 07 4. 75 6. 59 10. 86 48. 99 33. 81 23. 81 1980 32. 50 38. 60 22. 58 6. 65 12. 71 33. 12 11. 08 22. 46 1981 (4. 92) 2. 03 (2. 28) 10. 79 15. 58 17. 88 (23. 01) 2. 30 1982 21. 55 24. 95 (1. 86) 25. 42 11. 66 20. 91 11. 56 16. 31 1983 22. 56 29. 13 23. 69 8. 22 9. 24 32. 17 16. 26 20. 18 1984 6. 27 (7. 30) 7. 38 14. 29 10. 33 21. 89 1. 05 7. 70 1985 31. 73 31. 05 56. 16 18. 00 7. 97 6. 50 10. 01 23. 06 1986 18. 67 5. 68 69. 44 13. 06 6. 29 19. 75 2. 05 19. 28 1987 5. 25 (8. 80) 24. 63 3. 61 6. 13 (6. 59) 23. 77 6. 86 1988 16. 61 25. 02 28. 27 6. 40 7. 06 17. 48 27. 94 18. 40 1989 31. 69 16. 26 10. 54 12. 68 8. 67 2. 72 38. 28 17. 26 1990 (3. 10) (19. 48) (23. 45) 9. 56 7. 99 (23. 44) 29. 08 (3. 26) 13

Year Large US Equity Small US Equity Non-US Equity Intermediate Term US Govt Bonds Cash Real Estate Commodities Equally Weighted Multi. Asset Portfolio 1991 30. 47 46. 04 12. 13 14. 11 5. 68 23. 84 (6. 13) 18. 02 1992 7. 62 18. 41 (12. 17) 6. 93 3. 59 15. 13 4. 42 6. 28 1993 10. 08 18. 88 32. 56 8. 17 3. 12 15. 14 (12. 33) 10. 80 1994 1. 32 (1. 82) 7. 78 (1. 75) 4. 45 2. 66 5. 29 2. 56 1995 37. 58 28. 45 11. 21 14. 41 5. 79 12. 24 20. 33 18. 57 1996 22. 96 16. 49 6. 05 4. 06 5. 26 37. 05 33. 92 17. 97 1997 33. 36 22. 36 1. 78 7. 72 5. 31 19. 66 (14. 07) 10. 87 1998 28. 58 (2. 55) 19. 93 8. 49 5. 02 (17. 01) (35. 75) 0. 96 1999 21. 04 21. 26 27. 03 0. 49 4. 87 (2. 58) 40. 92 16. 15 2000 (9. 10) (3. 02) (14. 17) 10. 47 6. 32 31. 04 49. 74 10. 18 2001 (11. 89) 2. 49 (21. 44) 8. 42 3. 67 12. 35 (31. 93) (5. 48) 2002 (22. 10) (20. 48) (15. 94) 9. 64 1. 68 3. 58 32. 07 (1. 65) 2003 28. 69 47. 25 38. 59 2. 29 1. 05 36. 18 20. 72 24. 97 2004 10. 88 18. 33 20. 25 2. 33 1. 43 33. 16 17. 28 14. 81 2005 4. 91 4. 55 13. 54 1. 68 3. 34 13. 82 25. 55 9. 63 2006 15. 79 18. 37 26. 34 3. 84 5. 07 35. 97 (15. 09) 12. 90 2007 5. 49 (1. 57) 11. 17 8. 47 4. 77 (17. 56) 32. 67 6. 21 14

Benefit #2 When built correctly, multi-asset portfolios achieve equity-like returns with bond-like risk. 15

Multi-Asset Portfolio vs. Single Assets 1970 -2007 Large US Equity Small US Equity Non-US Equity US Bonds Cash Real Estate Commodities Equally Weighted 7 -Asset Portfolio 38 -Year Average Annualized % Return 11. 08 11. 74 10. 86 8. 10 6. 29 12. 38 12. 02 11. 41 38 -Year Standard Deviation of Annual Returns 16. 62 21. 68 21. 54 5. 39 3. 07 18. 45 23. 93 8. 60 Number of Years with Negative Returns 8 11 10 1 0 8 9 4 Worst One-Year % Return (26. 47) (30. 90) (23. 45) (1. 75) 1. 05 (23. 44) (35. 75) (5. 48) Worst Three-Year Cumulative % Return (37. 61) (42. 22) (43. 32) 6. 43 4. 22 (28. 30) (26. 06) 2. 43 16

What’s Different in 2008? Commodities and real estate are not helping as much as in prior downturns. US Govt Bonds Cash Real Estate Commodities Equally Weighted Multi-Asset Portfolio (14. 92) 4. 60 7. 46 (15. 52) 74. 96 1. 57 (19. 90) (23. 16) 7. 03 8. 35 (21. 42) 39. 51 (5. 15) (9. 10) (3. 02) (14. 17) 10. 47 6. 32 31. 04 49. 74 10. 18 2001 (11. 89) 2. 49 (21. 44) 8. 42 3. 67 12. 35 (31. 93) (5. 48) 2002 (22. 10) (20. 48) (15. 94) 9. 64 1. 68 3. 58 32. 07 (1. 65) YTD Oct 31 2008 (32. 9) (29. 1) (42. 0) 4. 8 1. 5 (30. 5) (28. 3) (22. 34) Year Large US Equity Small US Equity Non-US Equity 1973 (14. 69) (30. 90) 1974 (26. 47) 2000 Intermediate 17

Typical Multi-Asset Portfolios Portfolio Large US Stock Small US Stock Non-US Stock Bonds Cash 60/40 30% 15% 30% 10% 40/60 20% 10% 50% 10% (Equity/ Fixed Income) 18

Accumulation Portfolio (1970 -2007) 13 REIT Equal Weighted Multi-Asset Portfolio 12 Non-US Equity 11 Annualized % Return (1970 -2007) Small US Equity Commodities Large US Equity 60 Equity/40 Fixed Inc 10 40 Equity/60 Fixed Inc 9 Bonds 8 7 Cash 6 5 10 0 -10 -20 -30 Worst Three-Year Cumulative % Return (1970 -2007) -40 -50 19

Performance in Post-Retirement Distribution Phase Various Portfolios vs. Multi-Asset Portfolio 20

Benefit #3 When built correctly, multi-asset portfolios are durable during the post-retirement distribution phase. Durable = Growth + Downside Resistance 21

$500, 000 Initial Portfolio Value 5% withdraw rate 3% inflation rate of annual withdrawal 1 = One-asset portfolio (100% Cash) 2 = Two-asset portfolio (50% each Bonds, Cash) 3 = Three-asset portfolio (33% each Cash, Bonds, Large US Stock) 4 = Four-asset portfolio (25% each Cash, Bonds, Large US Stock, Small US Stock) 5 = Five-asset portfolio (20% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock) 6 = Six-asset portfolio (16. 7% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock, REIT) EW = Seven-asset equal-weighted portfolio (14. 3% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock, REIT, Commodities) CW = Seven-asset custom-weighted portfolio (12% Large US, 8% Small US, 10% Non-US, 5% REIT, 5% Commodities, 40% Bond, 20% Cash) 60/40 = 30% Large US, 15% Small US, 15% Non-US, 30% Bond, 10% Cash 40/60 = 20% Large US, 10% Small US, 10% Non-US, 50% Bond, 10% Cash 22

► Minimizing frequency of loss and size of portfolio loss while generating robust performance are distinct benefits of low correlation portfolios—provided that each asset is assigned a meaningful allocation. ► Recovering from large losses is more difficult in distribution portfolios--when money is being systematically withdrawn. 23

Needed Average Annual % Return to Restore Original Portfolio Balance WITHDRAWAL Portfolio Loss First Year Withdrawal of 5% of initial balance, 3% increase of annual withdrawal Within 1 Year Within 2 Years Within 3 Years Within 4 Years Within 5 Years -5% 16. 8% 11. 1% 9. 3% 8. 4% 8. 0% -10% 23. 7% 14. 4% 11. 5% 10. 1% 9. 4% -15% 31. 4% 18. 0% 13. 9% 12. 0% 10. 9% -20% 40. 2% 22. 0% 16. 5% 14. 0% 12. 5% -25% 50. 2% 26. 4% 19. 4% 16. 1% 14. 3% BUY-and-HOLD Portfolio Loss Within 1 Year Within 2 Years Within 3 Years Within 4 Years Within 5 Years -5% 5. 3% 2. 6% 1. 7% 1. 3% 1. 0% -10% 11. 1% 5. 4% 3. 6% 2. 7% 2. 1% -15% 17. 6% 8. 5% 5. 6% 4. 1% 3. 3% -20% 25. 0% 11. 8% 7. 7% 5. 7% 4. 6% -25% 33. 3% 15. 5% 10. 1% 7. 5% 5. 9% 24

Example Distribution Portfolios Portfolio (Equity/ Fixed Income) Large US Stock Small US Stock Non-US Stock Bonds Cash 60/40 30% 15% 30% 10% 40/60 20% 10% 50% 10% 20/80 10% 5% 5% 60% 20% 0/100 0% 0% 0% 70% 30% 25

Final Outcomes Are Very Dependent on Timing of Returns DISTRIBUTION PORTFOLIO $500, 000 Initial Portfolio Value 5% withdraw rate 3% inflation rate of annual withdrawal 1975 -1994 26

Distribution Portfolio Goals Stabilize Returns to Minimize Timing Dependence Maintain Robust Performance to Increase Portfolio Longevity Ave. 3 -Yr Return 40 Equity/60 Fixed Income 7 -Asset EW Portfolio 9. 8% 11. 7% Ave. 3 -Yr Std Dev 4. 3% 4. 4% 27

Part Two 28

Building a Multiple-Asset Low Correlation Portfolio The 7 Twelve Portfolio ► 7 Core Asset Classes with ► 12 Underlying Funds 29

The 7 Twelve Portfolio A Multiple-Asset Global Portfolio Approximately 60% of the Portfolio Allocation in Equity and Diversifying Assets Approximately 40% of the Portfolio Allocation in Bonds and Cash US Equity Non-US Equity Real Estate Resources US Bonds Non-US Bonds Cash Large Companies Developed Markets Global Real Estate Natural Resources US Aggregate Bonds International Bonds US Money Market Medium-sized Companies Emerging Markets Commodities Inflation Protected Bonds Small Companies 30

7 Twelve Correlation Aggregate Correlation = 0. 09 Using annual returns from 1998 -2007 Large US Mid US Small US Non-US Developed Non-US Emerging Global Real Estate Natural Resources Commodities US Aggregate Bonds Inflation Protected Bonds Non-US Bonds Mid US 0. 58 Small US 0. 88 0. 38 Non-US Developed 0. 65 0. 16 0. 48 Non-US Emerging 0. 50 (0. 18) 0. 50 0. 74 Global Real Estate 0. 70 0. 46 0. 74 0. 19 0. 17 Natural Resources 0. 47 0. 37 0. 48 0. 53 0. 69 0. 35 Commodities 0. 14 0. 25 0. 12 0. 09 0. 34 0. 35 0. 59 US Aggregate Bonds (0. 39) 0. 05 (0. 17) (0. 68) (0. 83) 0. 05 (0. 61) (0. 24) Inflation Protected Bonds (0. 47) 0. 01 (0. 27) (0. 54) (0. 42) (0. 08) 0. 38 0. 63 Non-US Bonds (0. 20) (0. 10) 0. 25 (0. 09) (0. 11) (0. 17) (0. 09) 0. 36 0. 42 US Money Market (0. 13) 0. 29 (0. 24) (0. 35) (0. 32) (0. 35) (0. 15) (0. 22) 0. 08 (0. 22) (0. 50) 31

7 Twelve Portfolio Red dot is 7 Twelve portfolio 1, 979 distinct mutual funds with at least 10 years of performance as of December 31, 2007 32

American Funds Capital Income Builder Fidelity Global Balanced S&P 500 Index Calendar Year Total % Return 7 Twelve 1998 0. 10 17. 75 13. 90 28. 62 1999 15. 47 23. 03 7. 96 21. 07 2000 12. 26 (5. 97) 5. 60 (9. 06) 2001 2. 17 (8. 15) (2. 49) (12. 02) 2002 2. 31 (6. 15) (7. 74) (22. 15) 2003 28. 61 29. 90 24. 38 28. 50 2004 17. 46 13. 67 12. 55 10. 74 2005 12. 31 9. 00 6. 44 4. 77 2006 15. 13 13. 70 11. 92 15. 64 2007 12. 46 13. 77 7. 70 5. 39 10 -Year Annualized Return 11. 54 9. 35 7. 69 5. 83 Correlation to S&P 500 Index . 50 . 94 . 89 1. 00 Portfolio 33

Accumulation 7 Twelve Portfolio 10 Year Risk/Return: 1998 -2007 Accumulation Portfolio with Annual Rebalancing 13% 12% 10 -Year Annualized Return 7 Twelve 11% Amer Fds Cap Inc Bldr 10% Fidelity Global Balanced 9% Classic 7 Asset 8% T. Rowe Pers Strat Bal 7% Vanguard Balanced 6% S&P 500 Index 5% 4% 5% 0% -5% -10% -15% Worst One-Year % Return -20% -25% 34

Distribution 7 Twelve Portfolio $100, 000 Initial Account Value, 5% Initial Withdrawal, 3% Annual Increase in Withdrawal 10 Year Risk/Return: 1998 -2007 Distribution Portfolio with Annual Rebalancing 11% 7 Twelve 10 -Year Internal Rate of Return 10% Amer Fds Cap Inc Bldr 9% Fidelity Global Balanced 8% Classic 7 Asset 7% T. Rowe Pers Strat Bal 6% Vanguard Balanced Vanguard 500 Index 5% 4% $0 ($5, 000) ($10, 000) ($15, 000) ($20, 000) ($25, 000) Worst One-Year Account Value Loss ($) ($30, 000) ($35, 000) 35

Age of Investor Portfolio Mix Under Age 50 -60 100% 7 Twelve Age 60 -70 Over Age 70 80% 7 Twelve 60% 7 Twelve 40% 7 Twelve 10% TIPS 20% TIPS 30% TIPS 10% Cash 20% Cash 30% Cash Comparison Funds American Funds Capital Income Builder A (CAIBX) Fidelity Global Balanced (FGBLX) Accumulation Portfolio (1998 – 2007) 10 -Year Average Annualized Return (%) 11. 54 10. 40 9. 23 8. 03 10. 06 9. 35 Worst One-Year % Loss 0. 10 0. 99 1. 88 2. 77 (2. 78) (8. 15) Distribution Portfolio (1998 – 2007) ($100, 000 initial value, 5% annual withdrawal, 3% annual increase in withdrawal) Internal Rate of Return (%) 10. 24 9. 28 8. 30 7. 29 8. 90 8. 46 Worst One-Year Portfolio Loss ($4, 899) ($4, 010) ($3, 122) ($2, 233) ($8, 118) ($15, 267) 0. 44 0. 94 Correlation (1998 – 2007) Correlation to S&P 500 0. 50 0. 45 0. 37 0. 19 36

As of October 31, 2008 Master 7 Twelve. TM Portfolios Year-to-Date 10 -Year Total % Return as of October 31, 2008 Annualized % Return as of October 31, 2008 100% 7 Twelve (27. 72) 8. 19 80% 7 Twelve, 10% TIPS, 10% Cash (22. 72) 7. 69 60% 7 Twelve, 20% TIPS, 20% Cash (17. 73) 7. 08 40% 7 Twelve, 30% TIPS, 30% Cash (12. 74) 6. 39 (30. 15) 5. 48 (24. 57) 5. 38 (27. 77) 3. 57 (21. 37) 2. 98 (32. 87) 0. 32 Comparison Funds American Funds Capital Income Builder (CAIBX) Fidelity Global Balanced (FGBLX) T. Rowe Price Personal Strategy Balanced (TRPBX) Vanguard Balanced (VBINX) Vanguard 500 Index (VFINX) 37

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DJIA hit all-time high on Oct 9, 2007 365 days later…(Thursday Oct 9, 2008) Trailing 1 -year Return as of Oct 9, 2008 ► DJIA ► S&P 500 ► 100% 7 Twelve ► 40/30/30 7 Twelve* -39. 4% -40. 6% -25. 9% -10. 4% * 40% 7 Twelve, 30% TIPS, 30% Cash 39

7 Twelve Portfolio 1) Portfolio logistics are very straight-forward: § Equally-weighted, annually rebalanced. § Using cash flows to accomplish rebalance increases tax efficiency. 2) No reliance upon tactical skill or timing. 3) Represents the core “module” of any portfolio pre or post retirement. Examples: 80% 7 Twelve, 20% individual stocks 60% 7 Twelve, 20% TIPS, 20% cash 50% 7 Twelve, 30% fixed annuity, 20% cash 4) Can be built using actively managed funds, passively managed index funds, ETFs, ETNs, or CTFs (collective trust funds). 5) Sets upper and lower boundaries for number of portfolio holdings: § (7 asset classes employing 12 underlying funds) 40

The 7 Twelve Portfolio The Benefits of Low Correlation Craig L. Israelsen, Ph. D. Brigham Young University Email: craig@7 Twelve. Portfolio. com Web: www. 7 Twelve. Portfolio. com 41