Staying in the PMC Tactical ETF Core Rotation Portfolios can provide the risk management clients need for the long term. Since they were launched on the Envestnet platform more than five years ago, these portfolios have been positioned defensively relative to the benchmarks, and opportunistically when sectors and markets present more attractive fundamentals, as called for by Innealta’s tactical model. The Core Rotation Portfolios’ defensive aspect has of course constrained absolute performance this past year as equity markets posted strong gains. However, the PMC Investment Committee remains confident in Innealta’s quantitative strategy and ability to tactically manage these portfolios to continue to do what they were designed to do: provide favorable risk-adjusted returns over time while preserving capital and complementing (as opposed to correlating or moving with) other asset classes to round out a fully diversified portfolio.

Compared to their equity, fixed income and blended benchmarks, the Core Rotation Portfolios have performed considerably well. More importantly, the portfolios have

maintained much lower volatility over the long term compared to their benchmarks, as demonstrated by standard deviation (Figure 1). Investors may need to be reminded of their longer-term investment objectives and risk tolerance—just how conservative are they without those recent gains in the equity markets? Not only do the Core Rotation Portfolios have the potential to generate returns comparable to their benchmarks over the long-term, they do so while minimizing investor risk exposure.

As a measure of volatility, standard deviation demonstrates the tendency of portfolio returns to rise above or fall below average returns over a given period of time. The higher the standard deviation, the greater the volatility and the riskier the investment.

Importantly, versus their all-equity and blended equity/fixed income benchmarks, the portfolios have demonstrated comparable or better risk-adjusted returns over time, as indicated by Sharpe ratios (Figure 2).

PMC Investment Committee Commentary: PMC Tactical ETF Core Rotation Portfolios

Keeping portfolios ready and healthy for the long-term

2013 may have been the year for U.S. equities, though both political and economic uncertainty will linger in the markets into 2014 and beyond. Will the monetary liquidity train come to a halt? Will the US economy dip? Does another government shutdown lie ahead? Which industries stand to lose or benefit?

PMC Investment CommitteeBrandon ThomasChief Investment Officer

Tim CliftChief Investment Strategist

Don Frerichs, CFASenior Vice President Director Portfolio Management

Lincoln RossExecutive Vice President, Investment Operations

Geoff Selzer, CFASenior Vice President, Consulting Services

J. Gibson Watson III, CIMAVice Chairman

Janis Zvingelis, PhDVice President, Director of Quantitative Research

January 2014 envestnet.com

The Sharpe ratio is a measure of risk-adjusted performance that can determine whether returns are a result of thoughtful investment decision-making or unnecessary risk-taking. It is calculated by deducting the risk-free rate from the rate of return, then dividing that result by the standard deviation of the portfolio returns. The higher the Sharpe ratio, the better the risk-adjusted performance of that portfolio, and the more an investor is compensated for the risk they take on. Some portfolio managers aim for particular Sharpe ratios to ensure that the funds they manage are in line with specific risk levels.

Volatility is not always detrimental to an investment, as there is upside and downside volatility. Investors will typically welcome upside volatility (strong upward moves in performance) and want protection against downside volatility (returns falling below a risk-free rate). The Sortino ratios show that, even when removing

upside (beneficial) volatility from the picture, the Core Rotation Portfolios have exhibited strong risk-adjusted results when compared to their benchmarks, and in fact demonstrate an ability to provide protection against downside volatility (Figure 3).

The Sortino ratio is another measure of risk-adjusted return that differentiates between upside (good) and downside (bad) volatility, and only penalizes the latter. It is computed by subtracting the risk-free rate of return from the return, then dividing the result by the downside deviation (or, the standard deviation only for the returns below the risk-free rate). The higher the Sortino ratio, the better a portfolio has performed relative to its assumed risk.

Similarly, the drawdown histories for both the Country and Sector Rotators show that these portfolios provide significantly better downside protection than their benchmarks in most observances (Figures 4 and 5).

0

5

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7.10%

13.19%

22.47%

Vola

tilit

y(s

td d

evia

tion)

6.66%

8.97%

16.01%

■ PMC Tactical ETF Core Portfolio – Country Rotation■ 60% MSCI EAFE / 40% Barclays 7–10 year Treasury■ MSCI EAFE■ PMC Tactical ETF Core Portfolio – Sector Rotation■ 60% S&P 500 / 40% Barclays 7–10 Year Treasury■ S&P 500

0.0

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0.19

Ris

k-ad

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ed r

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harp

e ra

tio)

1.24

1.39

0.98

■ PMC Tactical ETF Core Portfolio – Country Rotation■ 60% MSCI EAFE / 40% Barclays 7–10 year Treasury■ MSCI EAFE■ PMC Tactical ETF Core Portfolio – Sector Rotation■ 60% S&P 500 / 40% Barclays 7–10 Year Treasury■ S&P 500

0.0

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ortin

o ra

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2.602.42

1.60

■ PMC Tactical ETF Core Portfolio – Country Rotation■ 60% MSCI EAFE / 40% Barclays 7–10 year Treasury■ MSCI EAFE■ PMC Tactical ETF Core Portfolio – Sector Rotation■ 60% S&P 500 / 40% Barclays 7–10 Year Treasury■ S&P 500

* Time period is inception to 12/31/2013. Inception date for Country Rotation portfolio and start date for respective benchmarks is 9/1/2008; inception date for Sector Rotation portfolio and start date for respective benchmarks is 11/1/2008.

Figure 1: Volatility (standard deviation): Country and Sector Rotators vs. benchmarks*

Figure 2: Risk-adjusted returns (Sharpe ratio): Country and Sector Rotators vs. benchmarks*

Figure 3: Risk-adjusted returns (Sortino ratio): Country and Sector Rotators vs. benchmarks*

0

5

10

15

20

25

7.10%

13.19%

22.47%

Vola

tilit

y(s

td d

evia

tion)

6.66%

8.97%

16.01%

■ PMC Tactical ETF Core Portfolio – Country Rotation■ 60% MSCI EAFE / 40% Barclays 7–10 year Treasury■ MSCI EAFE■ PMC Tactical ETF Core Portfolio – Sector Rotation■ 60% S&P 500 / 40% Barclays 7–10 Year Treasury■ S&P 500

0

5

10

15

20

25

7.10%

13.19%

22.47%

Vola

tilit

y(s

td d

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tion)

6.66%

8.97%

16.01%

■ PMC Tactical ETF Core Portfolio – Country Rotation■ 60% MSCI EAFE / 40% Barclays 7–10 year Treasury■ MSCI EAFE■ PMC Tactical ETF Core Portfolio – Sector Rotation■ 60% S&P 500 / 40% Barclays 7–10 Year Treasury■ S&P 500

January 2014 envestnet.com

From inception through 2013, The maximum drawdown was -7.6% for the Country Rotator, compared to -26.1% and -44.5% for the MSCI EAFE/Barclays Treasury blend and MSCI EAFE, respectively. It was -5.1% for the Sector Rotator, compared to -12.8% and -23.2% for the S&P500/Barclays Treasury blend and S&P500, respectively.

Drawdown, another common measure of risk, is the percentage loss incurred by an investment from its peak value to its lowest value in a given period. Maximum drawdown is the loss (compounded, not annualized) that the manager incurred during any sub-period of the entire time period. Conceptually, this is the biggest “peak to trough” loss. The calculation looks at all sub-periods of the time period in question and calculates the compound return of the manager over that period. The maximum drawdown is the minimum of zero and all these compound returns.

These multiple dimensions of performance demonstrate the value of the Core Rotation Portfolios in managing volatility and preserving capital over the long-term.

In line with its commitment to comprehensive, unbiased manager research and due diligence, PMC continues to closely monitor the Tactical ETF Rotation Portfolios to ensure that the underlying quantitative approach effectively identifies and allocates to sector and country opportunities that help the portfolios generate compelling risk-adjusted results for clients.

For more information, please see the most recent marketing materials and quarterly performance reports for the PMC Tactical ETF Core Rotation Portfolios posted on the Envestnet platform.

Your Envestnet regional sales manager is also available to assist you.

Figure 4: Drawdown: Country Rotator vs. benchmarks*

Figure 5: Drawdown: Sector Rotator vs. benchmarks*

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■ PMC Tactical ETF Core Portfolio – Country Rotation■ 60% MSCI EAFE / 40% Barclays 7–10 year Treasury■ MSCI EAFE

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■ PMC Tactical ETF Core Portfolio – Sector Rotation■ 60% S&P 500 / 40% Barclays 7–10 Year Treasury■ S&P 500

* Time period is inception to 12/31/2013. Inception date for Country Rotation portfolio and start date for respective benchmarks is 9/1/2008.

* Time period is inception to 12/31/2013. Inception date for Sector Rotation portfolio and start date for respective benchmarks is 11/1/2008.

January 2014 envestnet.com

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this brochure is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment vehicle. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. Past performance is not indicative of future results.

Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) funds are subject to interest rate risk which is the risk that debt securities in a fund’s portfolio will decline in value because of increases in market interest rates.

Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Income (bond) ETFs are subject to interest rate risk which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates.

The PMC Tactical Portfolio may utilize inverse and leveraged ETFs. Leveraged ETFs are ETFs that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse ETFs utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. Inverse and leveraged ETFs are generally most suitable for sophisticated investors who understand leverage and are willing to assume the risk of magnified potential losses. Given the risk/ return trade-offs, these types of ETFs may not be appropriate for long-term investors who typically subscribe to “buy and hold” investment strategies.

Neither Envestnet, Envestnet | PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

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