DOMESTIC

& FOREIGN CASH

Methodology Overview
 TABLE OF CONTENTS
OVERVIEW.....................................................................1
What is This Document?...................................................1
Time Horizon.......................................................................2
DOMESTIC & FOREIGN CASH................................. 3
Asset Class Overview........................................................ 3
Expected Return Methodology.......................................4
Yield....................................................................................5
Growth...............................................................................7
Valuation Change ...........................................................7
Results...................................................................................9
REFERENCES...............................................................................................................11

REVISION DATE: 7/1/2015

 OVERVIEW
What is This Document?

“We understand that some of our insights

will never find their way into products, but we
provide them in support of investors and the
finance community.”
— ROB ARNOTT
CHAIRMAN & CEO

This is one in a series of plain-language white papers setting forth Research Affiliates’ building block approach
to developing long-term capital market expectations by asset class. (For information about the objectives and
guiding principles of our asset allocation initiative, please refer to “Capital Market Expectations: Methodology
Overview,” the first of these white papers.) In working out our risk and return forecasts and making them publicly
available, we keep three criteria in mind: transparency, robustness, and timeliness. By describing the conceptual
framework and calculations behind the projected asset class risks, returns, and correlations in these papers, we
hope to achieve a meaningful level of transparency without excessive details. By constructing simple, economically
sound models for major asset classes, we strive to achieve a fitting standard of robustness for forecasting to a
10-year horizon. By initially refreshing our expectations on a quarterly basis, we seek to provide information that
is updated with useful frequency. We will continue to refine our methods, extend the scope of our capital market
expectations, and improve this documentation over time.The remainder of this document addresses how we think
about domestic and foreign cash asset class returns from a building block perspective, and provides transparency
into the methods employed to develop these return expectations.

DOMESTIC & FOREIGN CASH | 1

 Time Horizon
O ne of the major considerations when embarking on the journey to generate asset class return expectations is
the issue of time horizon. Because the focus here is on generating capital market expectations for strategic
asset allocation, and not tactical overlays, a significantly long time horizon of 10 years was selected.

The 10-year time horizon is not meant to imply a 10-year buy-and-hold strategy, but instead incorporates a strategy
consisting of asset classes with constant duration targets. Said another way, asset classes with shorter durations
(e.g., fixed income) need to be periodically rebalanced to maintain the constant duration. The rebalance period
chosen here is one year which means that a two-year bond, for example, will be held for one year, at which time the
bond with one year remaining to maturity would be sold and the proceeds used to purchase a new two-year bond.
Asset classes with significantly long duration (e.g., equities) can be considered buy-and-hold because the change
in duration from the passage of 1, 2, or even 10 years on these types of assets is minimal.

2 | DOMESTIC & FOREIGN CASH

Domestic & Foreign Cash
Asset Class Overview
T he discussion of expected returns begins with a very short duration asset, cash. Investing in domestic cash
is simply purchasing short-term (30–90 day) bills denominated in the investor’s home currency whereas
investing in foreign cash means selling one’s domestic currency to purchase the currency of another country. That
foreign currency is then invested in the foreign economy’s short-term (30-90 day) bills to earn, for argument’s
sake, the foreign cash rate. Upon repatriation, the return on foreign cash consists of both the cash rate earned on
the short-term investment and the return due to any change in the foreign exchange rate over the holding period.

In the context of our work in the domain of asset allocation, we treat the U.S. dollar as the domestic (base) currency
and include 22 foreign currencies (see Table 1). The choice of the U.S. dollar as the domestic currency is arbitrary;
we could have selected any currency to illustrate the concepts in this white paper.

TABLE 1
Developed and Emerging Market Currencies

Developed Markets

1 United States USD Dollar

2 Australia AUD Dollar

3 Canada CAD Dollar

4 Eurozone EUR Euro

5 Hong Kong HKD Dollar

6 Japan JPY Yen

7 Sweden SEK Krona

8 Switzerland CHF Franc

9 United Kingdom GBP Pound

Source: Research Affiliates, LLC

DOMESTIC & FOREIGN CASH | 3

 Emerging Markets

1 Brazil BRL Real

2 China CNY Yuan
3 India INR Rupee
4 Indonesia IDR Rupiah
5 Malaysia MYR Ringgit
6 Mexico MXN Peso
7 Poland PLN Zloty
8 Russia RUB Ruble
9 South Africa ZAR Rand
10 South Korea KRW Won
11 Taiwan TWD Dollar
12 Thailand THB Baht
13 Turkey TRY Lira

Source: Research Affiliates, LLC

For currency baskets, cash returns are first modeled by country, and then combined as weighted averages to create
aggregate currency return forecasts.1

Expected Return Methodology

T he goal of the modeling framework is to provide a set of cumulatively exhaustive components with which to
capture drivers of return. This is particularly important when it comes to forecasting cash returns because they
become either a direct component of or an adjustment to nearly every other asset class forecast. Cash forecasts
are created utilizing a derivation of the component framework outlined in the methodology background whitepaper.

Real Cash Return = Local Real Cash Rate + ∆Real Exchange Rate

The first component, the local real cash rate, represents the real yield received from an investment in short-term
local currency bills. Given the exceedingly short duration of such an investment, it would be unwise to assume
a prevailing cash rate represents the average cash rate over the next 10 years. Instead, a 10-year average real
cash rate is forecasted by first recognizing that equilibrium cash rates can vary almost one-for-one with real GDP
(Laubach and Williams, 2001). This insight leads to creating a country-by-country GDP forecast by modeling the
various components of GDP growth: productivity growth, labor force growth, and capital accumulation, all of which
are affected by demographic trends. (The components are explained in further detail in the section on yield).
The GDP growth forecasts are then mapped into year-by-year cash rate forecasts after accounting for savings
preferences and the speed at which central banks move toward their respective equilibrium cash rates. The second
phase is creating long-term real foreign currency exchange rate forecasts, which can change due to movements
associated with international productivity differentials and reversion toward relative purchasing power parity. The
base currency is assumed to be the U.S. dollar throughout this document.

1
Depending on the context, equity market capitalization, country GDP or a variety of other metrics could be used as the basis for
weights in a composite.

4 | DOMESTIC & FOREIGN CASH

YIELD

T he yield component of foreign currency returns represents the real yield received from an investment of cash
into short-duration bills (sovereign instruments denominated in the local currency). The bills pay a specified
“cash rate” (i.e., short-term interest rate) over a 30- to 90-day period. Maintaining constant exposure to these
investments over a 10-year horizon inherently means rolling into another bill at the then prevailing (and likely
different) short-term interest rate dozens of times. Accordingly, using the simplifying assumption that current
cash rates represent what average cash rates will be over a 10-year investment horizon is unacceptable. Instead,
the implicit determinants of real cash rates are used to generate year-by-year cash rate forecasts that ultimately
provide average 10-year cash rate forecasts by country.

Economic theory suggests that two factors influence the dynamics of real cash rates. First and foremost, the
fundamentals of an economy should drive real interest rates over long horizons. Second, monetary policy influences
short-term interest rates at the frequency of business cycles.

Over long horizons, growth theory predicts that short-term interest rates are heavily influenced by the fundamentals
of an economy. This starting point is grounded in the neoclassical growth models of Ramsey (1928) and Solow
(1956), which provide the foundations for modern macroeconomics.2 These general equilibrium models show that
cash rates are a function of productivity growth, labor-force growth, and a time-preference factor, which captures
people’s appetite for saving over consumption. Because productivity and labor force growth are also the main
drivers of trend GDP growth, equilibrium cash rates can be explained as follows:

Equilibrum Cash Rate = Trend GDP Growth + Time Preference Factor

The above expression denotes that the equilibrium cash rate is positively related to the rates of trend growth
and time preference (Laubach and Williams, 2001). This is intuitively clear because investors enjoy higher cash
rate returns when they allocate capital to faster-growing economies, which produce more goods and services for
each dollar borrowed. Furthermore, investors enjoy a higher cash return when they lend to countries that have
a relatively low supply of funds available for investment (reflected in the time-preference factor). Essentially,
countries that tend to save less, whether due to higher levels of consumption or lower levels of discretionary
income, are characterized as having a lower supply of funds for investment. All else equal, this leads to higher
equilibrium cash rates.

Monetary authorities may drive actual short-term interest rates above or below the equilibrium level implied by
the equation above. Conventional monetary policy influences economic activity by controlling the cost of funding
and, therefore, the liquidity in the economy. For instance, Taylor (1993) estimated a policy rule that appears to
approximate the behavior of the U.S. Federal Reserve:

1
Actual Cash Rate Equilibrium Cash Rate +
= ( Output Gap + Inflation Gap )
2

The output and inflation gaps represent deviations from the Fed’s long-run desired output and inflation targets.
This relation is known as the Taylor rule and its variants are widely used as a benchmark for the behavior of central
banks around the world (e.g., Clarida, Gali, and Gertler, 2000; Nechio, 2011).

This methodology marries long and short-term drivers of real cash rates, whose relationship can be summarized by
a co-integrated process and estimated as a dynamic heterogeneous panel. A co-integrated process is characterized
by two stochastic variables that may appear unrelated in the short run but tend to converge over long timeframes.

For an introduction to neoclassical growth models, see Romer (2011).

2

DOMESTIC & FOREIGN CASH | 5

 The two variables are the actual cash rate, which is calibrated by monetary authorities, and its implied equilibrium
cash rate, which is driven by slow-moving macroeconomic fundamentals. In practice, these short- and long-run
relations are estimated by using the pooled mean group technique of Pesaran, Shin, and Smith (1999) for dynamic
error correction models. This approach allows heterogeneous monetary policies across a large set of developed
and emerging markets but maintains common long-run relationships between fundamentals. The model translates
into the following simplified specification:

−Speed × ( Cash Ratet −1 − GDP Growth t −1 − Time Preferencet −1 ) + ShortRun Effects

∆Cash Rate =

Cash rates are mainly determined by an adjustment process from current levels. Over long horizons, the cash rate
should be equal to trend GDP growth plus a time preference factor. However, in order to influence real growth over
the business cycle, the central bank can push the actual cash rate above or below its equilibrium level. The central
bank then gradually corrects this deviation, represented by the parenthesized terms, and moves the cash rate back
to its equilibrium. The rapidity at which the bank does so is captured by the term “speed.”

Most of the parameters above can be estimated using historical data, but forecasting changes in real cash rates
further than one period into the future requires long-run forecasts for both time-preferences and GDP growth.

To address time preferences by country, forecasted population-by-age-group data must be acquired. Here data
from the United Nations3 is utilized. Fortunately, demography is one of the rare social sciences in which forecasts
have surprisingly little uncertainty. Looking 10 years into the future, there is some uncertainty in the number of
people under 10 and in the number of people over 70, but surprisingly little uncertainty in the number of people
aged 10-70, barring war, pestilence, or other catastrophes (Arnott and Chaves, 2012).

Using this data, a proxy for a country’s representative time preference is constructed as the ratio of two
demographic cohorts: the number of people aged 40-49 and the number of people aged 20-29. These age cadres
are chosen for two reasons. First, middle-aged workers represent positive contributions to the supply of funds
available for investment as they tend to save more for their retirement and families. Young adults, however, detract
from the supply of funds available for investment as they tend to borrow against their future income for housing,
education, or other consumption needs. Taking the ratio of the two groups provides a means to appropriately
capture a country’s changing preference for savings over consumption. Second, this ratio sidesteps productivity
growth, which is modeled separately as a component of the GDP forecasts detailed below. Because these two
demographic cohorts have approximately the same contribution to productivity growth, they are good candidates
to capture the savings channel exclusively.

To obtain long-term GDP forecasts, we adopted a well-known approach set forth in the growth-accounting literature,
going back to the seminal works of Solow (1957) and Jorgenson and Griliches (1967). This approach is broadly
consistent with other institutions’ models, such as the OECD (Johansson et al., 2013). Using historical data from
the Penn World Table,4 forecasts are generated for each of the main components of real GDP: productivity growth,
capital accumulation, capital share of national income, labor force growth, and human capital accumulation. Each
of these components is aggregated to derive year-by-year changes in GDP forecasts by country. The model can be
expressed in the form of an equation, where α stands for the capital share of national income:

∆GDP = Productivity + α∆Capital + (1 − α ) × ( ∆Human Capital + ∆Labor Force )

3
http://esa.un.org/unpd/wpp/Excel-Data/population.htm.
4
Feenstra, Inklaar, and Timmer (2013) describe the Penn World Table (PWT), which presents real GDP comparisons across countries
and over time. They also describe certain technical enhancements implemented in Version 8 of the PWT.

6 | DOMESTIC & FOREIGN CASH

The first component of the GDP forecast is productivity growth. To create forecasts, historical data was used to
estimate the relationship between productivity, per-capita income, and demographics. The relationship between
productivity and per-capita income is part of a well-known conditional convergence hypothesis, which stipulates
that, depending on global technological progress and country-specific factors, each country should converge to
its own long-run equilibrium growth path. The relationship between productivity and demographics was explored
by Arnott and Chaves (2012), who estimate how various age cohorts impact productivity growth. Arnott and
Chaves obtain results consistent with intuition. Children, for example, are not immediately helpful to GDP. They
do not contribute to economic growth, and their parents are likely dissaving to pay for their support. Young adults,
however, are the driving force behind GDP growth. Not only are they the primary sources of innovation and
entrepreneurship, but they also become progressively more productive as they acquire experience. Older adults
make the highest per capita contribution to total output, but their contribution to growth in output starts to decline
once they acquire the experience needed to reach peak productivity. Finally, senior citizens seem to erode GDP
growth as their declining contribution to output goes to zero upon retirement. Forecasts for productivity growth
are obtained by inputting the U.N.’s predictions of demographic shares and per-capita income data to our model
and iterating the model forward.

The second component of the GDP forecast is capital accumulation. Similar to the process for forecasting
productivity growth, panel data techniques are employed to model capital accumulation across countries. Here
again, demographic variables, such as the ratio of middle-aged to young people (MY Ratio), have meaningful
explanatory power because middle-aged people tend to save more than young people. Intuitively, an increasing
MY Ratio is consistent with depressed real returns. Furthermore, both productivity growth and population growth
are significantly related to capital accumulation. This is not surprising because fast growing economies tend to
attract more capital than slow growing economies. These historical relationships, together with the productivity
forecasts and U.N. population forecasts, are used to generate capital growth forecasts.

The remaining components of the GDP forecast are capital share of national income, labor force growth, and
human capital accumulation. Capital share of national income is gathered from the Penn World Table under the
assumption that recently observed proportions will remain constant. Labor force growth is estimated utilizing
the U.N. forecasts for total population and working-age population by country. We assume that growth of human
capital accumulation gradually decreases over time; this dynamic is modeled through a simple time-dependent
process.

GROWTH
The yield on cash does not “grow” because each short-term bill is a separate investment. During the length of the
investment (30-90 days), the yield does not change; therefore, the growth component of returns to cash is always
zero.

VALUATION CHANGE
Valuation changes from a foreign cash investment are the result of movements in the real exchange rate between
countries.5 For modelling purposes, changes in the exchange rate are decomposed into: (a) reversion toward
relative purchasing power parity, and (b) adjustments associated with productivity differentials between countries.

∆Real Exchange Rate = Relative PPP Reversion + Productivity Differential

5
Because the real exchange rate of a currency with itself is always 1, there is no real currency valuation change of the base currency
(USD in this document). Therefore this section only applies to foreign currency investments and their change in real exchange rate to
USD.
DOMESTIC & FOREIGN CASH | 7
 The first component, Purchasing Power Parity (PPP), is derived from a simple theory holding that the nominal
exchange rate between two currencies should be equal to the ratio of aggregate price levels between the two
countries, so that a unit of currency from one country will have the same purchasing power in another. Most
economists instinctively believe in some variant of PPP as a long-run anchor for real exchange rates (Taylor and
Taylor, 2004).

The strongest form of this theory, Absolute PPP, stipulates that the purchasing power of a unit of currency is exactly
equal in both economies and implies that no deviations from this relationship should exist. Empirically, however,
Absolute PPP does not hold true. Instead, a less stringent form, Relative PPP, is followed, which holds that the
foreign exchange rate reverts to its equilibrium level over time because the percentage change in the exchange
rate in a given period offsets the difference in the countries’ inflation rates. Relative PPP reversion is a theoretically
sound and empirically sufficient methodology to aid in the determination of long-run real exchange rate targets.

1  Real ( CPI adjusted ) Exchange Rate10YrAvg 

Relative PPP Reversion
= × ln  
20  Real ( CPI adjusted ) Exchange RateCurrent 

In forecasting PPP reversion, one must determine both an equilibrium level of real exchange rates and the speed of
reversion to equilibrium. Our model employs a rolling 10-year average real exchange rate as the equilibrium level in
recognition that, over time, a nation’s exchange rate is subject to different exchange rate regimes. Using a 10-year
average allows the model to capture the current exchange rate regime over the last two business cycles without
going too deeply into the distant past. The assumed speed of reversion toward equilibrium is based on evidence
of a higher correlation between relative inflation and exchange rate depreciation over periods of 10 years or more.
Accordingly, a 10-year half-life in reversion toward real exchange-rate equilibrium is assumed (Taylor and Taylor,
2004).

The second component, the productivity differential, is based on the Harrod-Balassa-Samuelson effect, which
suggests a relationship between relative productivity and real exchange rates. Essentially, countries with higher
rates of productivity growth will have higher wage growth leading to higher price inflation in non-tradeable goods
and a corresponding increase in their consumption basket relative to the less-productive country. These dynamics
tend to result in a rising real exchange rate (Shepherd, 2014). In fact, the long-run expected increase in the real
exchange rate between two countries can be approximated by the difference in productivity growth rates, modeled
as follows:

Productivity Differential Productivity Foreign Country − Productivity Domestic Country

=

Where:
Productivity = ( GDP Growth Avg10Yr Fcst − Population Growth Avg10Yr Fcst )

In determining productivity differentials, we utilize the same GDP forecasts and population growth estimates that
we used in creating the average cash rate forecasts (see the yield section above). The average yearly productivity
advantage (or disadvantage) in the foreign country versus the domestic country is a percentage adjustment to the
capital returns associated with changes in the real exchange rate, and denotes movement in the equilibrium real
exchange rate over time.

A country's ability to deliver long-term productivity gains is related to the maturity of its institutions and standards
of governance. For example, a country with very high productivity, but poor rule of law, has a lower probability of
delivering the benefits of surplus productivity growth to an investor, whereas a country with high productivity and
strong rule of law has a higher probability.

8 | DOMESTIC & FOREIGN CASH

This idea is incorporated into the model as a probability-weighted result of two independent states that affect
both the expected return and the expected volatility of the currency. The first state captures a country that allows
the benefit of excess productivity growth to be shared with investors. The second state captures outcomes whose
benefits, if realized, are channeled away from investors to those well connected to decision makers in the country.
As the outcomes are probabilistic, countries that find themselves in this second, less investor-friendly state are
expected to miss out on currency appreciation related to excess productivity growth.

We do not claim to be experts at grading the quality of institutions in countries across the globe; instead, a
number of organizations provide this data. Given the subjectivity in grading countries, we do not rely on a single
organization’s rankings, but average together the rankings of, at present, two different organizations, the World
Bank and The Heritage Foundation. These organizations rank countries on a variety of metrics. Based on these
scores, we calculate a percentage rank for each country, which acts as the probability weight for each state.6 The
weighted average, based on the country’s percentile rank, of the productivity value in each of the two states is the
overall weighted productivity change for each country.

Results
C onsistent with the expectation of slower global growth over the next decade, as of this writing (Summer 2015),
future real interest rates are expected to be lower than in the past, with real interest rate differentials between
the United States and other developed economies expected to be in the -1% to 1% range, and between the United
States and emerging economies remaining in the 2% to 4% range. Figure 1 and Figure 2 reflect these interest rate
differentials along with the expected appreciation or depreciation of real exchange rates going forward.

The rank of the country, 100% being the highest, represents the weight given to state 1. One minus the rank is the weight for state 2.
6

DOMESTIC & FOREIGN CASH | 9

 FIGURE 1
Forecasted Developed Market Excess Cash Returns to USD
10%

8%

6%

4%

1.9% 2.0%
2% 1.6% 1.4%
0.7% 0.5%
0%
-0.1% -0.2%

-2%

-4%
AUSTRALIAN CANADIAN EURO HONG KONG JAPANESE YEN SWEDISH KRONA SWISS FRANC BRITISH POUND
DOLLAR DOLLAR DOLLAR

Source: Research Affiliates, LLC, based on data from Bloomberg and the United Nations

FIGURE 2
Forecasted Emerging Market Excess Cash Returns to USD
10%

8%

5.8% 6.0% 5.9%

6% 5.7%
5.2% 4.9%
4.9%
4.0% 4.1%
4% 3.6% 3.7%

2.5%
2.0%
2%

0%

-2%

-4%
BRAZILIAN CHINESE INDIAN INDONESIAN MALAYSIAN MEXICAN POLISH RUSSIAN SOUTH KOREAN TAIWANESE THAILAND TURKISH
REAL YUAN RUPEE RUPIAH RINGGIT PESO ZLOTY ROUBLE AFRICAN WON DOLLAR BAHT LIRA
RAND

Source: Research Affiliates, LLC, based on data from Bloomberg and the United Nations

10 | DOMESTIC & FOREIGN CASH

REFERENCES

Arnott, Robert D., and Denis B. Chaves. "Demographic Changes, Financial Markets, and the Economy." Financial
Analysts Journal, vol. 68, no. 1 (January/February):23-46.

Clarida, Richard, Jordi Galí, and Mark Gertler. 2000. "Monetary Policy Rules and Macroeconomic Stability:
Evidence and Some Theory." Quarterly Journal of Economics, vol. 115, no. 1 (February):147-180.

Feenstra, Robert C., Robert Inklaar, and Marcel Timmer. 2013. The Next Generation of the Penn World Table. NBER
Working Paper No. 19255.

Johansson, Åsa, Yvan Guillemette, Fabrice Murtin, David Turner, Giuseppe Nicoletti, Christine de la Maisonneuve,
Phillip Bagnoli, Guillaume Bousquet, and Francesca Spinelli. 2013. "Long Term Growth Scenarios." OECD
Economics Department Working Papers, No. 1000 (January 28). Paris, France: OECD Publishing.

Jorgenson, D.W., and Z. Griliches. 1967. "The Explanation of Productivity Change." Review of Economic Studies,
vol. 34, no. 3 (July):249-283.

Laubach, Thomas, and John C. Williams. 2001. Measuring the Natural Rate of Interest. Washington D.C.:
Board of Governors of the Federal Reserve System. Available at http://www.federalreserve.gov/Pubs/
FEDS/2001/200156/200156pap.pdf.

Nechio, Fernanda. 2011. "Monetary Policy When One Size Does Not Fit All." FRBSF Economic Letter. Federal
Reserve Bank of San Francisco. (June 13.) Available at http://www.frbsf.org/economic-research/publications/
economic-letter/2011/june/monetary-policy-europe.

Pesaran, M. Hashem, Yongcheol Shin, and Ron P. Smith.1999. "Pooled Mean Group Estimation of Dynamic
Heterogeneous Panels." Journal of the American Statistical Association, vol. 94, no. 446 (June):621-634.

Ramsey, F.P. "The Mathematical Theory of Saving." 1928. Economic Journal, vol. 38, no. 152 (December):543-559.

Romer, David. 2011. Advanced Macroeconomics, 4th edition. New York: McGraw-Hill .

Shepherd, Shane. 2014. "The Outlook for Emerging Market Bonds." Research Affiliates. Available at http://www.
researchaffiliates.com/Our%20Ideas/Insights/Fundamentals/Pages/227_The_Outlook_for_Emerging_Market_
Bonds.aspx.

Solow, Robert M. 1956. "A Contribution to the Theory of Economic Growth." Quarterly Journal of Economics, vol.
70, no. 1 (February):65-94.

Solow, Robert M. 1957. "Technical Change and the Aggregate Production Function." Review of Economics and
Statistics, vol. 39, no. 3 (August):312-320.

Taylor, Alan M., and Mark P. Taylor. 2004. "The Purchasing Power Parity Debate." Journal of Economic Perspectives,
vol. 18, no. 4 (Fall):135-158.

Taylor, John B. 1993. "Discretion versus Policy Rules in Practice." Carnegie-Rochester Conference Series on Public
Policy, vol. 39 (December):195-214.

DOMESTIC & FOREIGN CASH | 11

 DISCLAIMER
The information contained herein regarding Asset Allocation and Expected Returns may represent real return forecasts
for several asset classes and not for any Research Affiliates (“RA”) fund or strategy. These forecasts are forward-looking
statements based upon the reasonable beliefs of RA and are not a guarantee of future performance. Forward-looking
statements speak only as of the date they are made, and RA assumes no duty to and does not undertake to update forward-
looking statements. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change
over time. Actual results may differ materially from those anticipated in forward-looking statements.

All projections provided are estimates and are in U.S. dollar terms, unless otherwise specified. Given the complex risk-
reward trade-offs involved, one should always rely on judgment as well as quantitative optimization approaches in setting
strategic allocations to any or all of the above asset classes. Please note that all information shown is based on qualitative
analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any
particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions
are passive only–they do not consider the impact of active management. References to future returns are not promises or even
estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative
purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, derivatives
or financial instruments of any kind. Forecasts of financial market trends that are based on current market conditions
or historical data constitute a judgment and are subject to change without notice. We do not warrant its accuracy or
completeness. This material has been prepared for information purposes only and is not intended to provide, and should not
be relied on for, accounting, legal, tax, investment or tax advice. There is no assurance that any of the target prices mentioned
will be attained. Any market prices are only indications of market values and are subject to change.

Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record,
simulated results do not represent actual trading, but are based on the historical returns of the selected investments, indices
or investment classes and various assumptions of past and future events. Simulated trading programs in general are also
subject to the fact that they are designed with the benefit of hindsight. Also, since the trades have not actually been executed,
the results may have under or over compensated for the impact of certain market factors. In addition, hypothetical trading
does not involve financial risk. No hypothetical trading record can completely account for the impact of financial risk in actual
trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of the trading losses
are material factors which can adversely affect the actual trading results. There are numerous other factors related to the
economy or markets in general or to the implementation of any specific trading program which cannot be fully accounted for
in the preparation of hypothetical performance results, all of which can adversely affect trading results.

The asset classes are represented by broad-based indices which have been selected because they are well known and are
easily recognizable by investors. Indices have limitations because indices have volatility and other material characteristics that
may differ from an actual portfolio. For example, investments made for a portfolio may differ significantly in terms of security
holdings, industry weightings and asset allocation from those of the index. Accordingly, investment results and volatility of
a portfolio may differ from those of the index. Also, the indices noted in this presentation are unmanaged, are not available
for direct investment, and are not subject to management fees, transaction costs or other types of expenses that a portfolio
may incur. In addition, the performance of the indices reflects reinvestment of dividends and, where applicable, capital gain
distributions. Therefore, investors should carefully consider these limitations and differences when evaluating the index
performance.

No investment process is risk free and there is no guarantee of profitability; investors may lose all of their investments. No
investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment.
Diversification does not guarantee a profit or protect against loss. Investing in foreign securities presents certain risks
not associated with domestic investments, such as currency fluctuation, political and economic instability, and different
accounting standards. This may result in greater share price volatility. The prices of small- and mid-cap company stocks are
generally more volatile than large-company stocks. They often involve higher risks because smaller companies may lack the
management expertise, financial resources, product diversification and competitive strengths to endure adverse economic
conditions.

Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline
of the value of your investment. High-yield bonds, also known as junk bonds, are subject to greater risk of loss of principal and
interest, including default risk, than higher-rated bonds. Investing in fixed-income securities involves certain risks such as
market risk if sold prior to maturity and credit risk especially if investing in high-yield bonds which have lower ratings and are
subject to greater volatility. All fixed-income investments may be worth less than original cost upon redemption or maturity.
Income from municipal securities is generally free from federal taxes and state taxes for residents of the issuing state. While

12 | DOMESTIC & FOREIGN CASH

the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for some investors may be subject to the
federal alternative minimum tax (AMT).

There are special risks associated with an investment in real estate, including credit risk, interest-rate fluctuations and the
impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.

Hedge funds or alternative investments are complex, speculative investment vehicles and are not suitable for all investors.
They are generally open to qualified investors only and carry high costs and substantial risks and may be highly volatile.
There is often limited (or even nonexistent) liquidity and a lack of transparency regarding the underlying assets. They do not
represent a complete investment program. The investment returns may fluctuate and are subject to market volatility so that
an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Hedge funds are not required
to provide investors with periodic pricing or valuation and are not subject to the same regulatory requirements as mutual
funds. Investing in hedge funds may also involve tax consequences. Speak to your tax advisor before investing. Investors in
funds of hedge funds will incur asset-based fees and expenses at the fund level and indirect fees, expenses and asset-based
compensation of investment funds in which these funds invest. An investment in a hedge fund involves the risks inherent in
an investment in securities as well as specific risks associated with limited liquidity, the use of leverage, short sales, options,
futures, derivative instruments, investments in non-U.S. securities, junk bonds and illiquid investments. There can be no
assurances that a manager’s strategy (hedging or otherwise) will be successful or that a manager will use these strategies
with respect to all or any portion of a portfolio. Please carefully review the Private Placement Memorandum or other offering
documents for complete information regarding terms, including all applicable fees, as well as other factors you should
consider before investing.

Buying commodities allows for a source of diversification for those sophisticated persons who wish to add commodities to
their portfolios and who are prepared to assume the risks inherent in the commodities market. Any purchase represents a
transaction in a non-income producing commodity and is highly speculative. Therefore, commodities should not represent a
significant portion of an individual’s portfolio. Buying gold, silver, platinum and palladium allows for a source of diversification
for those sophisticated persons who wish to add precious metals to their portfolios and who are prepared to assume the risks
inherent in the bullion market. Any bullion or coin purchase represents a transaction in a non-income-producing commodity
and is highly speculative. Therefore, precious metals should not represent a significant portion of an individual’s portfolio.

Trading foreign exchange involves a high degree of risk. Exchange rates between foreign currencies change rapidly do to a
wide range of economic, political and other conditions, exposing one to risk of exchange rate losses in addition to the inherent
risk of loss from trading the underlying financial product. If one deposits funds in a currency to trade products denominated in
a different currency, one’s gains or losses on the underlying investment therefore may be affected by changes in the exchange
rate between the currencies. If one is trading on margin, the impact of currency fluctuation on that person’s gains or losses
may be even greater.

Investments that are concentrated in a specific sector or industry increase their vulnerability to any single economic, political
or regulatory development. This may result in greater price volatility.

This information has been prepared by RA based on data and information provided by internal and external sources. While we
believe the information provided by external sources to be reliable, we do not warrant its accuracy or completeness.

Research Affiliates is the owner of the trademarks, service marks, patents and copyrights related to the Fundamental Index
methodology. The trade names Fundamental IndexTM, RAFITM, Research Affiliates EquityTM, RAETM, the RAFI logo, and the
Research Affiliates corporate name and logo among others are the exclusive intellectual property of Research Affiliates,
LLC. Any use of these trade names and logos without the prior written permission of Research Affiliates, LLC is expressly
prohibited. Research Affiliates, LLC reserves the right to take any and all necessary action to preserve all of its rights, title and
interest in and to these terms and logos.

Various features of the Fundamental IndexTM methodology, including an accounting data-based non-capitalization data
processing system and method for creating and weighting an index of securities, are protected by various patents, and
patent-pending intellectual property of Research Affiliates, LLC. (See all applicable US Patents, Patent Publications, and Patent
Pending intellectual property located at http://www.researchaffiliates.com/Pages/legal.aspx#d, which are fully incorporated
herein.)

© Research Affiliates, LLC. All rights reserved. Duplication or dissemination prohibited without prior written permission.

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