Description
Quarterly Update | Behavioral Funds |
4th Quarter 2016
Philosophy
Within the firm’s suite of factor-driven equity products, Sterling Capital Management employs techniques that seek to
capitalize upon Behavioral Finance-based principles. Investors are prone to certain biases and heuristics (mental
shortcuts) that when coupled with greed, fear and ego can often lead to anomalies within the financial markets. Our
investment process and ongoing research, utilizing value and momentum-specific factors that drive our portfolio
construction techniques, produces strategies specifically designed to capitalize upon investor behavior.
4Q 2016 Major Equity Market Returns
Russell 2000 Value Index
14.1%
Russell 2000 Index
8.8%
Russell 1000 Value Index
6.7%
S&P 500 Index
3.8%
Russell 2000 Growth Index
MSCI EAFE Index
Russell 1000 Growth Index
3.6%
1.5%
1.0%
Source: MSCI, Russell, Bloomberg, Sterling Capital Management Analytics. Unlike a mutual fund the indices are unmanaged and do
not include fees, charges, taxes and expenses.
It is not possible to invest directly into an index. Past performance is no guarantee of future results. For institutional use only. Not to be distributed or communicated to the general public. .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 Mutual Fund Performance Performance: Since Strategy Changed to Behavioral Finance As of 12.31.2016 2016 2015 Q2 Q1 Q4 Q3 2013 Q4 Q3 Q2 Q1 Q4 Behavioral Small Cap Value Equity Fund (SPSCX) 15.72% 6.17% 0.57% 0.42% 2.40% -6.66% -1.63% 3.53% 7.73% -6.60% 2.38% 1.89% 10.22% 7.86% Russell 2000® Value Index 14.07% 8.87% 4.31% 1.70% 2.88% -10.73% -1.20% 1.97% 9.39% -8.60% 2.38% 1.78% 9.30% 7.59% Behavioral Large Cap Value Equity Fund (BBISX) 7.03% 2.51% 1.71% -0.82% 5.35% -7.82% 0.02% 0.81% 4.84% 1.00% 4.36% 5.10% 11.34% - Russell 1000® Value Index 6.68% 3.48% 4.58% 1.64% 5.64% -8.40% 0.11% -0.72% 4.97% -0.20% 5.10% 3.02% 10.01% - Behavioral International Equity Fund (SBIIX) 0.68% 8.03% -2.82% -3.15% 5.53% -9.50% 1.19% 3.91% - - - - - - MSCI EAFE Index (Net) -0.71% 6.43% -1.46% -3.01% 4.71% -10.23% 0.62% 4.88% - - - - - - Performance: Q3 2014 YTD 1Yr 3Yrs* 5Yrs* 10Yrs* Since Inception* Inception Date Behavioral Small Cap Value Equity Fund (SPSCX) 24.08% 24.08% 8.23% 14.54% 7.50% 10.20% Russell 2000® Value Index 31.74% 31.74% 8.31% 15.07% 6.26% 10.69% 10.69% 7.96% 12.85% 3.33% 7.74% Russell 1000® Value Index 17.34% 17.34% 8.59% 14.80% 5.72% 2.37% 2.37% - - - 0.04% MSCI EAFE Index (Net) 1.00% 1.00% - - - Q4 Q3 30 Day SEC Yield 10.21% Behavioral International Equity Fund (SBIIX) Q1 9.77% Behavioral Large Cap Value Equity Fund (BBISX) Q2 -1.59% With Waivers Without Waivers 01.02.1997 1.17% 1.02% 10.09.1992 2.37% 12.01.2014 2.79% 2.39% On September 3, 2013, the former Sterling Capital Select Equity Fund was fully transitioned to the Sterling Capital Large Cap Value Diversified Fund. In addition, the portfolio management team has changed. As of February 1, 2015, the former Large Cap Value Diversified Fund was re-named the Behavioral Large Cap Value Equity Fund. As of 06.03.2013, the Small Value Fund was renamed to the Small Cap Value Diversified Fund and the management was transferred to the current portfolio managers Robert O. Weller, CFA and Robert W. Bridges, CFA.
As of February 1, 2015, the former Small Cap Value Diversified Fund was renamed the Behavioral Small Cap Value Equity Fund. The portfolio was fully transitioned to the behavioral style of management as of 06.30.2013. *Annualized Performance is Institutional Share Class - Net of Fees. Past performance does not guarantee future results.
The performance data quoted represents past performance and current returns may be lower or higher. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. To obtain performance information current to the most recent month end, please visit www.sterlingcapitalfunds.com.
The performance shown reflects the deduction of fees for value-added services associated with a mutual fund, such as investment management and fund accounting fees. The performance shown reflects the reinvestment of all dividend and capital gains distributions.. Source: Russell Investments; BNY Mellon. Page 2 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 Mutual Funds Behavioral Small Cap Value Equity Fund (SPSCX) Sterling’s Behavioral Small Cap Value Equity Fund outperformed the Russell 2000 Value by 1.66% during the fourth quarter. Risk Model Attribution* Active Return – Q4 2016 (%) 3.2 -1.7 Factor Return Selection Effect Style Factors Of the 166 bps of outperformance during the quarter, style-based factors contributed the majority, registering over 250 basis points (bps) of positive relative return in the quarter. Value was a significant positive contributor during the quarter, while momentum was a slight detractor. Over the last year, style-based factors lagged, among the style factors momentum was a significant detractor. Value, on the back of a very strong fourth quarter, was a significant contributor over the trailing 12 months. Active Style Return - Q4 2016 (%) 4.0 3.2 3.1 3.0 3.0 2.5 2.0 2.0 1.0 1.5 0.1 0.1 -3.0 Industry Groups Industry exposure contributed approximately 70bps to returns for the quarter. contributing over 20 relative bps while consumer staples lagged modestly. Trade Activity Volatility Size Profit -3.2 Leverage -4.0 Growth Trade Activity Volatility Size Leverage Growth EarnVariab DivYld Value Momentum Profit -0.1 -0.2 -0.1 -0.2 EarnVariab 0.0 -0.4 -0.4 -0.6 -2.0 0.0 DivYld 0.1 0.0 0.0 -0.3 -1.0 0.2 Value 0.5 -1.0 0.2 0.2 0.0 1.0 -0.5 Active Style Return - 1 Yr 2016 (%) Momentum 3.5 Materials showed the most strength, Over the last year, industry positions cost approximately 100bps. Energy exposure cost over 75bps partially offset by financials which contributed approximately 40bps. Page 3 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 0.1 0.0 0.0 -0.20 -0.1 -0.2 -0.40 0.00 Utilities Industrials ConsumerStap Utilities Technology Materials Industrials HealthCare Financials HealthCare -0.8 -1.00 Energy ConsumerStap ConsumerDisc Communications -0.10 -0.2 -0.80 0.0 -0.1 Financials -0.05 0.0 -0.4 -0.60 Energy 0.0 0.1 0.00 0.1 0.10 0.1 0.1 Technology 0.20 Materials 0.2 0.15 0.05 0.4 0.40 ConsumerDisc 0.20 0.60 0.2 0.2 Active Industry Return - 1 Yr 2016 (%) Communications 0.25 Active Industry Return - Q4 2016 (%) Stock Selection/Sterling Specific Factors Stock selection, which results from Sterling’s exposure to individual stocks in the portfolio, was a net detractor from relative performance cost approximately 165bps of underperformance in the quarter not explained by the style and industry attributions discussed above. The majority of the negative stock selection return was driven by technology, materials and financial services which cost approximately 85, 45 and 45bps respectively. This was partially offset by a few single stock standouts in Financials, not enough to account for the net detraction of the overall selection in financials, and consumer discretionary. For the year just ended, stock selection accounted for approximately 500bps of the overall underperformance where stock selection in financials and energy were strong detractors costing the portfolio over 350 and 115bps offset by consumer discretionary and producer durables contributing over 60 and 50bps respectively. Behavioral Large Cap Value Equity Fund (BBISX) Sterling’s Behavioral Large Cap Value Equity Fund outperformed the Russell 1000 Value by .37% during the fourth quarter. Risk Model Attribution* Active Return – Q4 2016 (%) 0.5 -0.1 Factor Return Selection Effect Style Factors Of the 37 bps of outperformance during the quarter, factor returns were the driving force of excess return. Style based factors contributed about half the relative return, and value accounted for the majority of factor return performance. Similar to the small capitalization stocks, momentum remained out of favor in the large capitalization stocks during the quarter. For the year 2016, factor returns comprised nearly all of the underperformance versus the benchmark.
Specifically momentum cost the portfolio over 150 bps while value turned positive on the year, contributing over 40bps. Page 4 . Quarterly Update | Behavioral Funds | 4th Quarter 2016 Active Style Return - Q4 2016 (%) 0.8 Active Style Return - 1 Yr 2016 (%) 1.0 0.7 0.6 0.7 0.4 0.5 0.3 0.1 0.4 0.2 0.0 0.0 0.2 0.1 0.1 0.0 0.1 0.1 0.1 -0.2 -0.2 -0.5 0.0 -0.6 -0.2 -0.3 -1.5 Industry Groups In the quarter, industry exposure modestly contributed slightly over 25bps to returns. slightly more than 10bps while Financials cost slightly more than 5bps. Trade Activity Volatility Size Profit Leverage Growth EarnVariab DivYld Value Volatility Size Profit Leverage Growth EarnVariab DivYld Value Momentum -1.6 -2.0 Momentum -0.5 -0.6 Trade Activity -0.4 -1.0 -0.1 Consumer Staples contributed For the year just ended, industry exposure had a material negative impact on returns accounting for over 500bps of 2016 underperformance, fueled by weakness in energy which cost over 350bps and healthcare which cost 55bps exposures. This was offset by technology that contributed just under 20bps. 0.15 Active Industry Return - Q4 2016 (%) 0.1 0.50 0.1 Active Industry Return - 1 Yr 2016 (%) 0.1 0.10 -0.50 0.1 0.05 0.0 0.0 0.1 0.0 0.2 0.1 0.1 0.00 -0.2 -0.4 -1.00 -0.6 -0.4 -0.3 -1.50 0.0 -2.00 0.00 -2.50 -3.00 -0.05 -3.50 Utilities Technology Materials Industrials HealthCare Financials ConsumerStap ConsumerDisc Energy -3.6 -4.00 Communications Utilities Technology Materials Industrials HealthCare Financials Energy ConsumerStap ConsumerDisc -0.1 Communications -0.10 -0.1 Stock Selection/Sterling Specific Factors Stock selection, which results from Sterling’s exposure to individual stocks in the portfolio, was a slight net detractor to relative performance, costing 10bps of relative performance not explained by the style and industry attributions discussed above. The majority of stock selection returns was driven underperformance in consumer staples which cost just over 60bps. This was positively offset by stock selection in Energy which contributed close to 100bps. For the year just ended, stock selection accounted for less than 10bps of relative return. Stock selection was the strongest in energy which contributed over 200bps of return, but was partially offset by negative selection in pharmaceuticals which cost approximately 90bps. Page 5 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 Behavioral International Equity Fund (SBIIX) The Behavioral International Equity Fund returned 0.68% during the fourth quarter outperforming the MSCI EAFE NET index which returned -0.71%. Risk Model Attribution* Active Return – Q4 2016 (%) 1.4 0.7 Factor Return Selection Effect Style Factors Style-based factors were strongly positive during the quarter registering approximately 100 bps of the overall 140bps positive contribution from overall factor returns. Value was a strong 125 bps contributor during the quarter while momentum cost the portfolio approximately 30 bps. For the year just ended, overall factor returns registered approximately 120 bps of contribution, while style factors as a group accounted for over 190 bps of contribution, of which value comprised 200 bps of contribution and momentum cost the portfolio over 60 bps. Active Style Return - Q4 2016 (%) 1.4 Active Style Return - 1 Yr 2016 (%) 2.5 1.3 2.0 1.2 2.0 1.0 1.5 0.8 0.6 1.0 0.4 0.5 0.1 -0.2 -0.1 -0.6 Trade Activity Trade Activity Volatility Size Profit Leverage Growth EarnVariab DivYld Value -1.0 0.0 -0.1 -0.5 Volatility -0.1 Size -0.1 -0.3 Momentum -0.4 0.1 Profit -0.2 0.1 0.0 Leverage 0.1 Growth 0.0 EarnVariab 0.1 DivYld 0.0 0.0 Value 0.0 Momentum 0.2 0.5 0.3 Industry Groups, Country, and Currency In the quarter, industries were a contributor to relative returns, supplying approximately 30bps. Financials contributed over 15bps while Materials cost slightly more than 5bps. On a country basis, country exposures were essentially in-line with the index.
Currency exposure benefited the portfolio slightly more than 5 bps, led by the euro (underweight) just shy of 50 bps and offset by the Japanese yen (overweight) costing the portfolio just less than 30 bps. For the year just ended, industries were also a contributor to relative performance, returning approximately 45bps. Financials returned 30bps of relative return while technology cost just over 20bps of relative return. On a country basis, country exposures cost the portfolio just over 90 bps led by Hong Kong (overweight) which cost just shy of 25bps and Italy (overweight) which detracted just shy of 15bps, offset slightly by Spain (underweight), which supplied close to 15bps of relative performance and the UK (underweight) which returned over 10bps of relative performance. Currency exposure cost just over 20 bps, Australian dollars (under then overweight) and Japanese yen (overweight) detracting the most, slightly offset by euro (underweight). Page 6 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 0.2 0.15 0.1 0.0 0.0 0.3 0.3 0.20 0.1 0.05 Active Industry Return - 1 Yr 2016 (%) 0.30 0.10 0.10 0.1 0.0 0.00 0.1 0.1 0.0 0.0 0.0 0.00 -0.10 0.0 0.0 -0.1 -0.20 Utilities Materials Industrials HealthCare Financials Energy ConsumerStap ConsumerDisc Technology -0.2 -0.30 Communications Industrials HealthCare Financials Energy ConsumerStap ConsumerDisc Communications -0.1 Technology -0.1 -0.10 Materials -0.05 0.40 Utilities 0.20 Active Industry Return - Q3 2016 (%) Active Country Return - 4Q 2016 (%) 0.25 0.2 0.20 0.15 0.10 0.05 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (0.05) 0.0 0.0 0.0 0.0 0.0 0.0 -0.1 GL Israel UK Switzerland Sweden Spain Portugal Norway Netherlands Italy Ireland Germany France Finland Denmark Belgium Austria Japan GL New Zealand GL Australia Singapore -0.1 (0.15) Hong Kong (0.10) 0.0 0.0 Active Country Return - 1 Yr 2016 (%) 0.20 0.1 0.15 0.1 0.10 0.05 0.0 0.1 0.1 0.1 0.0 0.0 0.0 0.1 0.1 0.0 (0.05) 0.0 0.0 -0.1 (0.10) (0.15) 0.0 0.0 -0.1 -0.1 -0.1 (0.20) (0.25) UK Switzerland Sweden Spain Portugal Norway Netherlands Italy Ireland Germany France Finland Denmark Belgium Austria GL Israel Singapore Japan GL New Zealand GL Australia Hong Kong -0.2 (0.30) Page 7 . Quarterly Update | Behavioral Funds | 4th Quarter 2016 0.60 Active Currency Return - 4Q 2016 (%) 0.40 0.5 0.50 0.3 0.30 0.40 0.30 0.1 0.10 0.10 0.1 0.0 0.0 0.0 0.0 0.0 - 0.0 (0.10) (0.30) (0.40) 0.2 0.20 0.20 (0.20) Active Currency Return - 1 Yr 2016 (%) 0.0 -0.1 -0.1 -0.1 0.0 (0.10) -0.1 -0.1 (0.20) -0.1 -0.1 -0.1 -0.2 -0.3 AUD CHF DKK EUR GBP HKD ILS JPY NOK NZD SEK SGD 0.0 (0.30) AUD CHF DKK EUR GBP HKD ILS JPY NOK NZD SEK SGD Stock Selection/Sterling Specific Factors Stock selection, which is driven by the underlying momentum and value signatures of the individual stocks that we own, benefitted the portfolio 70 bps during the quarter. Stock selection was positive in materials which contributed approximately 100 bps. Stock selection was a cost relative returns particularly in consumer discretionary, detracting just over 40bps. For the year just ended, stock selection contributed just over 40 bps. Consumer Staples, more specifically food, beverage and tobacco, was the primary drivers of positive relative returns.
This was offset by weakness in energy. *Risk Model Attribution: We use the Bloomberg equity factor model which is based on fundamental factors to decipher what drives returns for any given period. The model is constructed from a wide variety of data: market, financial statements and analyst estimates. Bloomberg aims to provide a structure that is intuitive and has a fully transparent methodology.
The model has high explanatory power for contemporaneous returns, maintains high forecasting ability in high and low volatility environments and stays unbiased with no significant under- or over-forecasting of risk for a broad variety of portfolios. It is important to stress that Sterling does not use the risk model in the stock selection or portfolio construction for the Behavioral Small Cap Value, Large Cap Value or International Funds. The primary driver of our stock selection process remains Sterling’s Behavioral Value and Momentum factors, which over longer time periods will be more closely correlated with Bloomberg’s definition of Value and Momentum. That said, over shorter time periods since our factor definitions of value and momentum differ, many times one can expect to see a divergence in returns. Page 8 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 The Perfect Storm In retrospect, 2016 was the “perfect storm” for the US based Behavioral Strategies. We are often asked “in what environments will these strategies have odds against them outperforming?” For better or worse, we now have the ability to reference a specific time period and speak to what turned out to be an extreme and anomalous period in our experience of over 13 years of Behavioral Factor investing. Setting the stage for a difficult year  Value Factors: The macro economic backdrop provided extreme uncertainty – leading to people desiring “safe/more steady growth” at the expense of “unsafe/cyclical” value. Prospects for economic growth seemed slim at the outset of 2016. US Nominal GDP growth over the past 5 years averaged just north of 3.5% (chart 1).
Coming into the year we had been in an extended period of time of value underperforming. Value factor exposure represents at least half of our products relative exposure and has proven itself time and again to be a horse one would want to hook their portfolio up too for long term risk adjusted returns. That said, there will be periods where value underperforms.
By many metrics, including the simplified view below of US Large Cap Value returns relative to US Large Cap Growth returns (chart 2: using the respective Russell indices as proxies), value had entered into 2016 underperforming growth for 3 years (albeit with shorter term periods of value outperforming). Note the graph shows rolling 1 year returns, however on a monthly basis value started to underperform in earnest during 2Q13. In duration, this was one of the longest time periods where we saw value consistently struggle to outperform.
The tech and telecom bubble in the late 90’s saw a larger drawdown, but the duration was shorter. The recession at the beginning of the century saw a similar duration in length of time value underperformed. The tide turned and value started to outperform growth in the second quarter of 2016.
This was probably NOT due to the prospect of economic growth fueling these discounted companies that tend to be largely represented by cyclical and financials. Rather, the catalyst for this initial turn was probably due to the fact that the “cheap” companies had a multiyear period of underperformance (chart 3: depicts the growing forward price earnings multiple of the most expensive stocks in the S&P500 and the stale/immobile multiple of the lease expensive stocks) relative to their growth counterparts. An issue with value investing is one does not know when the market will recognize and reward discounted multiples.
Many times in our experience (including the last few years leading up to 2016!) momentum would help to either lessen the pain of value underperforming or even provide the relative return necessary to outperform our respective benchmarks. Such was not the case in 2016. We are not in the business of predicting short/intermediate term efficacy of our factors, however below are some reasons for hope of value factors continued outperformance: • Cyclicals continue to perform well on the backs of potential stimulus from the government (infrastructure projects, etc.). • Continued rising interest rates which should bode well generally for financials with the possible exception of REITS (which have been riding a multi-year wave of positive returns on the back of their yield/bond market proxy). CHART 1: US Nominal GDP 8 6 4 2 0 -2 -4 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16 Source: Bloomberg, Sterling Capital Page 9 . Quarterly Update | Behavioral Funds | 4th Quarter 2016 CHART 2: Rolling 1 Year Returns RUSSELL 1000 VALUE INDEX - RUSSELL 1000 GROWTH INDX 60% RUSSELL 1000 VALUE INDEX - RUSSELL 1000 GROWTH INDX 50% 40% 30% Value underperform Growth Starts 2Q13 20% 10% 0% -10% Value starts rebound in earnest 2Q16 -20% -30% -40% Dec-94 Sep-96 Jun-98 Mar-00 Dec-01 Sep-03 Jun-05 Mar-07 Dec-08 Sep-10 Jun-12 Mar-14 Dec-15 Source: Russell Indices, Bloomberg, Sterling Capital CHART 3: S&P500 Forward PE Ratios 45 Low Fwd P/E Q1 40 High Fwd P/E Q5 35 30 25 20 15 10 5 Jun-13 Feb-14 Oct-14 Jun-15 Feb-16 Oct-16 Source: Bank of America Merrill Lynch  Momentum Factors: As uncertainty grew in early 2016, global markets saw a massive flight to safety/yield in the first quarter (read momentum reversal). Momentum, which had supported our relative returns up through the end of 2015 and represents anywhere between one third to one half of our return driving engine, had an abrupt end to its performance as the market embarked on a flight to safety (lower volatility) as well as an increased focus on bond income proxies (dividend focused companies). It just so happens that low volatility and high dividend also are highly correlated many times. Below (Chart 4) we show the total return of the S&P500 relative to the S&P500 Dividend Aristocrats which represent the S&P500 constituents that have followed a policy of consistently increasing their dividends every year for at least 25 years.
The flight to income/low volatility began in the fourth quarter of 2015. Although the rolling one year chart does not depict it yet due to the sheer magnitude of outperformance of yield based equity strategies at the beginning of the year, the “flight to safety/yield” trade stopped in the second half of the year (the S&P500 outperformed the Aristocrats for the final 6 months of 2016). As the market had a dramatic shift, momentum was left behind. Page 10 . Quarterly Update | Behavioral Funds | 4th Quarter 2016 CHART 4: Rolling 1 Year Returns S&P 500 INDEX - S&P 500 Div Aristocrt TR 40% S&P 500 INDEX - S&P 500 Div Aristocrt TR 30% 20% 10% Dividends/Safety begin massive outperformance4Q15 0% -10% -20% -30% -40% -50% -60% Dec-94 Jun-96 Dec-97 Jun-99 Dec-00 Jun-02 Dec-03 Jun-05 Dec-06 Jun-08 Dec-09 Jun-11 Dec-12 Jun-14 Dec-15 Source: Standard and Poors Indices, Bloomberg, Sterling Capital Below are some reasons for hope of Momentum to turn around and support our performance again: • Momentum can work in value markets, in growth markets, in bull markets and bear markets. It only requires one trait…a trend. • CLARITY. As things start to take shape in the new government, clarity should develop. Once this occurs, trends are more than likely to be established which is favorable to momentum strategies. Conclusion: 2016 provided the backdrop for a perfect storm that saw momentum collapse/not work beginning in 4Q2015 and value finally ending approximately 3 years of being out of favor in the second half of 2016.
Our fourth quarter returns show the effects of value providing the relative returns we expect over the intermediate/longer term while momentum is still struggling to find the established trend. We remain committed to our investment process and feel the macro-economic environment has given reason to be optimistic about future return potential. Important Information Must be proceeded or accompanied by a prospectus. Please note: The opinions contained in the preceding commentary reflect those of Sterling Capital Management LLC. The stated opinions are for general information only and not meant to be predictions or an offer of individual or personalized investment advice.
They are not intended as an offer or solicitation with respect to the purchase or sale of any security. This information and these opinions are subject to change without notice. Any type of investing involves risk and there are no guarantees. Sterling Capital Management does not assume liability for any loss which may result from the reliance by any person upon such information or opinions. Page 11 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 Mutual fund investing involves risk including the possible loss of principal. There is no guarantees that objectives of the strategy will result in favorable performance. The funds are distributed by Sterling Capital Distributors LLC. Mutual Funds are Not a Deposit, are Not FDIC Insured, are Not Guaranteed by the Bank, are Not Insured by any Government Agency and May Lose Value. Advisory services and products offered through Sterling Capital Management LLC not affiliated with Sterling Capital Distributors LLC. Not a deposit • Not FDIC insured • May lose value • Not guaranteed by the bank • Not insured by any government agency Page 12 .
It is not possible to invest directly into an index. Past performance is no guarantee of future results. For institutional use only. Not to be distributed or communicated to the general public. .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 Mutual Fund Performance Performance: Since Strategy Changed to Behavioral Finance As of 12.31.2016 2016 2015 Q2 Q1 Q4 Q3 2013 Q4 Q3 Q2 Q1 Q4 Behavioral Small Cap Value Equity Fund (SPSCX) 15.72% 6.17% 0.57% 0.42% 2.40% -6.66% -1.63% 3.53% 7.73% -6.60% 2.38% 1.89% 10.22% 7.86% Russell 2000® Value Index 14.07% 8.87% 4.31% 1.70% 2.88% -10.73% -1.20% 1.97% 9.39% -8.60% 2.38% 1.78% 9.30% 7.59% Behavioral Large Cap Value Equity Fund (BBISX) 7.03% 2.51% 1.71% -0.82% 5.35% -7.82% 0.02% 0.81% 4.84% 1.00% 4.36% 5.10% 11.34% - Russell 1000® Value Index 6.68% 3.48% 4.58% 1.64% 5.64% -8.40% 0.11% -0.72% 4.97% -0.20% 5.10% 3.02% 10.01% - Behavioral International Equity Fund (SBIIX) 0.68% 8.03% -2.82% -3.15% 5.53% -9.50% 1.19% 3.91% - - - - - - MSCI EAFE Index (Net) -0.71% 6.43% -1.46% -3.01% 4.71% -10.23% 0.62% 4.88% - - - - - - Performance: Q3 2014 YTD 1Yr 3Yrs* 5Yrs* 10Yrs* Since Inception* Inception Date Behavioral Small Cap Value Equity Fund (SPSCX) 24.08% 24.08% 8.23% 14.54% 7.50% 10.20% Russell 2000® Value Index 31.74% 31.74% 8.31% 15.07% 6.26% 10.69% 10.69% 7.96% 12.85% 3.33% 7.74% Russell 1000® Value Index 17.34% 17.34% 8.59% 14.80% 5.72% 2.37% 2.37% - - - 0.04% MSCI EAFE Index (Net) 1.00% 1.00% - - - Q4 Q3 30 Day SEC Yield 10.21% Behavioral International Equity Fund (SBIIX) Q1 9.77% Behavioral Large Cap Value Equity Fund (BBISX) Q2 -1.59% With Waivers Without Waivers 01.02.1997 1.17% 1.02% 10.09.1992 2.37% 12.01.2014 2.79% 2.39% On September 3, 2013, the former Sterling Capital Select Equity Fund was fully transitioned to the Sterling Capital Large Cap Value Diversified Fund. In addition, the portfolio management team has changed. As of February 1, 2015, the former Large Cap Value Diversified Fund was re-named the Behavioral Large Cap Value Equity Fund. As of 06.03.2013, the Small Value Fund was renamed to the Small Cap Value Diversified Fund and the management was transferred to the current portfolio managers Robert O. Weller, CFA and Robert W. Bridges, CFA.
As of February 1, 2015, the former Small Cap Value Diversified Fund was renamed the Behavioral Small Cap Value Equity Fund. The portfolio was fully transitioned to the behavioral style of management as of 06.30.2013. *Annualized Performance is Institutional Share Class - Net of Fees. Past performance does not guarantee future results.
The performance data quoted represents past performance and current returns may be lower or higher. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. To obtain performance information current to the most recent month end, please visit www.sterlingcapitalfunds.com.
The performance shown reflects the deduction of fees for value-added services associated with a mutual fund, such as investment management and fund accounting fees. The performance shown reflects the reinvestment of all dividend and capital gains distributions.. Source: Russell Investments; BNY Mellon. Page 2 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 Mutual Funds Behavioral Small Cap Value Equity Fund (SPSCX) Sterling’s Behavioral Small Cap Value Equity Fund outperformed the Russell 2000 Value by 1.66% during the fourth quarter. Risk Model Attribution* Active Return – Q4 2016 (%) 3.2 -1.7 Factor Return Selection Effect Style Factors Of the 166 bps of outperformance during the quarter, style-based factors contributed the majority, registering over 250 basis points (bps) of positive relative return in the quarter. Value was a significant positive contributor during the quarter, while momentum was a slight detractor. Over the last year, style-based factors lagged, among the style factors momentum was a significant detractor. Value, on the back of a very strong fourth quarter, was a significant contributor over the trailing 12 months. Active Style Return - Q4 2016 (%) 4.0 3.2 3.1 3.0 3.0 2.5 2.0 2.0 1.0 1.5 0.1 0.1 -3.0 Industry Groups Industry exposure contributed approximately 70bps to returns for the quarter. contributing over 20 relative bps while consumer staples lagged modestly. Trade Activity Volatility Size Profit -3.2 Leverage -4.0 Growth Trade Activity Volatility Size Leverage Growth EarnVariab DivYld Value Momentum Profit -0.1 -0.2 -0.1 -0.2 EarnVariab 0.0 -0.4 -0.4 -0.6 -2.0 0.0 DivYld 0.1 0.0 0.0 -0.3 -1.0 0.2 Value 0.5 -1.0 0.2 0.2 0.0 1.0 -0.5 Active Style Return - 1 Yr 2016 (%) Momentum 3.5 Materials showed the most strength, Over the last year, industry positions cost approximately 100bps. Energy exposure cost over 75bps partially offset by financials which contributed approximately 40bps. Page 3 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 0.1 0.0 0.0 -0.20 -0.1 -0.2 -0.40 0.00 Utilities Industrials ConsumerStap Utilities Technology Materials Industrials HealthCare Financials HealthCare -0.8 -1.00 Energy ConsumerStap ConsumerDisc Communications -0.10 -0.2 -0.80 0.0 -0.1 Financials -0.05 0.0 -0.4 -0.60 Energy 0.0 0.1 0.00 0.1 0.10 0.1 0.1 Technology 0.20 Materials 0.2 0.15 0.05 0.4 0.40 ConsumerDisc 0.20 0.60 0.2 0.2 Active Industry Return - 1 Yr 2016 (%) Communications 0.25 Active Industry Return - Q4 2016 (%) Stock Selection/Sterling Specific Factors Stock selection, which results from Sterling’s exposure to individual stocks in the portfolio, was a net detractor from relative performance cost approximately 165bps of underperformance in the quarter not explained by the style and industry attributions discussed above. The majority of the negative stock selection return was driven by technology, materials and financial services which cost approximately 85, 45 and 45bps respectively. This was partially offset by a few single stock standouts in Financials, not enough to account for the net detraction of the overall selection in financials, and consumer discretionary. For the year just ended, stock selection accounted for approximately 500bps of the overall underperformance where stock selection in financials and energy were strong detractors costing the portfolio over 350 and 115bps offset by consumer discretionary and producer durables contributing over 60 and 50bps respectively. Behavioral Large Cap Value Equity Fund (BBISX) Sterling’s Behavioral Large Cap Value Equity Fund outperformed the Russell 1000 Value by .37% during the fourth quarter. Risk Model Attribution* Active Return – Q4 2016 (%) 0.5 -0.1 Factor Return Selection Effect Style Factors Of the 37 bps of outperformance during the quarter, factor returns were the driving force of excess return. Style based factors contributed about half the relative return, and value accounted for the majority of factor return performance. Similar to the small capitalization stocks, momentum remained out of favor in the large capitalization stocks during the quarter. For the year 2016, factor returns comprised nearly all of the underperformance versus the benchmark.
Specifically momentum cost the portfolio over 150 bps while value turned positive on the year, contributing over 40bps. Page 4 . Quarterly Update | Behavioral Funds | 4th Quarter 2016 Active Style Return - Q4 2016 (%) 0.8 Active Style Return - 1 Yr 2016 (%) 1.0 0.7 0.6 0.7 0.4 0.5 0.3 0.1 0.4 0.2 0.0 0.0 0.2 0.1 0.1 0.0 0.1 0.1 0.1 -0.2 -0.2 -0.5 0.0 -0.6 -0.2 -0.3 -1.5 Industry Groups In the quarter, industry exposure modestly contributed slightly over 25bps to returns. slightly more than 10bps while Financials cost slightly more than 5bps. Trade Activity Volatility Size Profit Leverage Growth EarnVariab DivYld Value Volatility Size Profit Leverage Growth EarnVariab DivYld Value Momentum -1.6 -2.0 Momentum -0.5 -0.6 Trade Activity -0.4 -1.0 -0.1 Consumer Staples contributed For the year just ended, industry exposure had a material negative impact on returns accounting for over 500bps of 2016 underperformance, fueled by weakness in energy which cost over 350bps and healthcare which cost 55bps exposures. This was offset by technology that contributed just under 20bps. 0.15 Active Industry Return - Q4 2016 (%) 0.1 0.50 0.1 Active Industry Return - 1 Yr 2016 (%) 0.1 0.10 -0.50 0.1 0.05 0.0 0.0 0.1 0.0 0.2 0.1 0.1 0.00 -0.2 -0.4 -1.00 -0.6 -0.4 -0.3 -1.50 0.0 -2.00 0.00 -2.50 -3.00 -0.05 -3.50 Utilities Technology Materials Industrials HealthCare Financials ConsumerStap ConsumerDisc Energy -3.6 -4.00 Communications Utilities Technology Materials Industrials HealthCare Financials Energy ConsumerStap ConsumerDisc -0.1 Communications -0.10 -0.1 Stock Selection/Sterling Specific Factors Stock selection, which results from Sterling’s exposure to individual stocks in the portfolio, was a slight net detractor to relative performance, costing 10bps of relative performance not explained by the style and industry attributions discussed above. The majority of stock selection returns was driven underperformance in consumer staples which cost just over 60bps. This was positively offset by stock selection in Energy which contributed close to 100bps. For the year just ended, stock selection accounted for less than 10bps of relative return. Stock selection was the strongest in energy which contributed over 200bps of return, but was partially offset by negative selection in pharmaceuticals which cost approximately 90bps. Page 5 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 Behavioral International Equity Fund (SBIIX) The Behavioral International Equity Fund returned 0.68% during the fourth quarter outperforming the MSCI EAFE NET index which returned -0.71%. Risk Model Attribution* Active Return – Q4 2016 (%) 1.4 0.7 Factor Return Selection Effect Style Factors Style-based factors were strongly positive during the quarter registering approximately 100 bps of the overall 140bps positive contribution from overall factor returns. Value was a strong 125 bps contributor during the quarter while momentum cost the portfolio approximately 30 bps. For the year just ended, overall factor returns registered approximately 120 bps of contribution, while style factors as a group accounted for over 190 bps of contribution, of which value comprised 200 bps of contribution and momentum cost the portfolio over 60 bps. Active Style Return - Q4 2016 (%) 1.4 Active Style Return - 1 Yr 2016 (%) 2.5 1.3 2.0 1.2 2.0 1.0 1.5 0.8 0.6 1.0 0.4 0.5 0.1 -0.2 -0.1 -0.6 Trade Activity Trade Activity Volatility Size Profit Leverage Growth EarnVariab DivYld Value -1.0 0.0 -0.1 -0.5 Volatility -0.1 Size -0.1 -0.3 Momentum -0.4 0.1 Profit -0.2 0.1 0.0 Leverage 0.1 Growth 0.0 EarnVariab 0.1 DivYld 0.0 0.0 Value 0.0 Momentum 0.2 0.5 0.3 Industry Groups, Country, and Currency In the quarter, industries were a contributor to relative returns, supplying approximately 30bps. Financials contributed over 15bps while Materials cost slightly more than 5bps. On a country basis, country exposures were essentially in-line with the index.
Currency exposure benefited the portfolio slightly more than 5 bps, led by the euro (underweight) just shy of 50 bps and offset by the Japanese yen (overweight) costing the portfolio just less than 30 bps. For the year just ended, industries were also a contributor to relative performance, returning approximately 45bps. Financials returned 30bps of relative return while technology cost just over 20bps of relative return. On a country basis, country exposures cost the portfolio just over 90 bps led by Hong Kong (overweight) which cost just shy of 25bps and Italy (overweight) which detracted just shy of 15bps, offset slightly by Spain (underweight), which supplied close to 15bps of relative performance and the UK (underweight) which returned over 10bps of relative performance. Currency exposure cost just over 20 bps, Australian dollars (under then overweight) and Japanese yen (overweight) detracting the most, slightly offset by euro (underweight). Page 6 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 0.2 0.15 0.1 0.0 0.0 0.3 0.3 0.20 0.1 0.05 Active Industry Return - 1 Yr 2016 (%) 0.30 0.10 0.10 0.1 0.0 0.00 0.1 0.1 0.0 0.0 0.0 0.00 -0.10 0.0 0.0 -0.1 -0.20 Utilities Materials Industrials HealthCare Financials Energy ConsumerStap ConsumerDisc Technology -0.2 -0.30 Communications Industrials HealthCare Financials Energy ConsumerStap ConsumerDisc Communications -0.1 Technology -0.1 -0.10 Materials -0.05 0.40 Utilities 0.20 Active Industry Return - Q3 2016 (%) Active Country Return - 4Q 2016 (%) 0.25 0.2 0.20 0.15 0.10 0.05 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (0.05) 0.0 0.0 0.0 0.0 0.0 0.0 -0.1 GL Israel UK Switzerland Sweden Spain Portugal Norway Netherlands Italy Ireland Germany France Finland Denmark Belgium Austria Japan GL New Zealand GL Australia Singapore -0.1 (0.15) Hong Kong (0.10) 0.0 0.0 Active Country Return - 1 Yr 2016 (%) 0.20 0.1 0.15 0.1 0.10 0.05 0.0 0.1 0.1 0.1 0.0 0.0 0.0 0.1 0.1 0.0 (0.05) 0.0 0.0 -0.1 (0.10) (0.15) 0.0 0.0 -0.1 -0.1 -0.1 (0.20) (0.25) UK Switzerland Sweden Spain Portugal Norway Netherlands Italy Ireland Germany France Finland Denmark Belgium Austria GL Israel Singapore Japan GL New Zealand GL Australia Hong Kong -0.2 (0.30) Page 7 . Quarterly Update | Behavioral Funds | 4th Quarter 2016 0.60 Active Currency Return - 4Q 2016 (%) 0.40 0.5 0.50 0.3 0.30 0.40 0.30 0.1 0.10 0.10 0.1 0.0 0.0 0.0 0.0 0.0 - 0.0 (0.10) (0.30) (0.40) 0.2 0.20 0.20 (0.20) Active Currency Return - 1 Yr 2016 (%) 0.0 -0.1 -0.1 -0.1 0.0 (0.10) -0.1 -0.1 (0.20) -0.1 -0.1 -0.1 -0.2 -0.3 AUD CHF DKK EUR GBP HKD ILS JPY NOK NZD SEK SGD 0.0 (0.30) AUD CHF DKK EUR GBP HKD ILS JPY NOK NZD SEK SGD Stock Selection/Sterling Specific Factors Stock selection, which is driven by the underlying momentum and value signatures of the individual stocks that we own, benefitted the portfolio 70 bps during the quarter. Stock selection was positive in materials which contributed approximately 100 bps. Stock selection was a cost relative returns particularly in consumer discretionary, detracting just over 40bps. For the year just ended, stock selection contributed just over 40 bps. Consumer Staples, more specifically food, beverage and tobacco, was the primary drivers of positive relative returns.
This was offset by weakness in energy. *Risk Model Attribution: We use the Bloomberg equity factor model which is based on fundamental factors to decipher what drives returns for any given period. The model is constructed from a wide variety of data: market, financial statements and analyst estimates. Bloomberg aims to provide a structure that is intuitive and has a fully transparent methodology.
The model has high explanatory power for contemporaneous returns, maintains high forecasting ability in high and low volatility environments and stays unbiased with no significant under- or over-forecasting of risk for a broad variety of portfolios. It is important to stress that Sterling does not use the risk model in the stock selection or portfolio construction for the Behavioral Small Cap Value, Large Cap Value or International Funds. The primary driver of our stock selection process remains Sterling’s Behavioral Value and Momentum factors, which over longer time periods will be more closely correlated with Bloomberg’s definition of Value and Momentum. That said, over shorter time periods since our factor definitions of value and momentum differ, many times one can expect to see a divergence in returns. Page 8 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 The Perfect Storm In retrospect, 2016 was the “perfect storm” for the US based Behavioral Strategies. We are often asked “in what environments will these strategies have odds against them outperforming?” For better or worse, we now have the ability to reference a specific time period and speak to what turned out to be an extreme and anomalous period in our experience of over 13 years of Behavioral Factor investing. Setting the stage for a difficult year  Value Factors: The macro economic backdrop provided extreme uncertainty – leading to people desiring “safe/more steady growth” at the expense of “unsafe/cyclical” value. Prospects for economic growth seemed slim at the outset of 2016. US Nominal GDP growth over the past 5 years averaged just north of 3.5% (chart 1).
Coming into the year we had been in an extended period of time of value underperforming. Value factor exposure represents at least half of our products relative exposure and has proven itself time and again to be a horse one would want to hook their portfolio up too for long term risk adjusted returns. That said, there will be periods where value underperforms.
By many metrics, including the simplified view below of US Large Cap Value returns relative to US Large Cap Growth returns (chart 2: using the respective Russell indices as proxies), value had entered into 2016 underperforming growth for 3 years (albeit with shorter term periods of value outperforming). Note the graph shows rolling 1 year returns, however on a monthly basis value started to underperform in earnest during 2Q13. In duration, this was one of the longest time periods where we saw value consistently struggle to outperform.
The tech and telecom bubble in the late 90’s saw a larger drawdown, but the duration was shorter. The recession at the beginning of the century saw a similar duration in length of time value underperformed. The tide turned and value started to outperform growth in the second quarter of 2016.
This was probably NOT due to the prospect of economic growth fueling these discounted companies that tend to be largely represented by cyclical and financials. Rather, the catalyst for this initial turn was probably due to the fact that the “cheap” companies had a multiyear period of underperformance (chart 3: depicts the growing forward price earnings multiple of the most expensive stocks in the S&P500 and the stale/immobile multiple of the lease expensive stocks) relative to their growth counterparts. An issue with value investing is one does not know when the market will recognize and reward discounted multiples.
Many times in our experience (including the last few years leading up to 2016!) momentum would help to either lessen the pain of value underperforming or even provide the relative return necessary to outperform our respective benchmarks. Such was not the case in 2016. We are not in the business of predicting short/intermediate term efficacy of our factors, however below are some reasons for hope of value factors continued outperformance: • Cyclicals continue to perform well on the backs of potential stimulus from the government (infrastructure projects, etc.). • Continued rising interest rates which should bode well generally for financials with the possible exception of REITS (which have been riding a multi-year wave of positive returns on the back of their yield/bond market proxy). CHART 1: US Nominal GDP 8 6 4 2 0 -2 -4 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16 Source: Bloomberg, Sterling Capital Page 9 . Quarterly Update | Behavioral Funds | 4th Quarter 2016 CHART 2: Rolling 1 Year Returns RUSSELL 1000 VALUE INDEX - RUSSELL 1000 GROWTH INDX 60% RUSSELL 1000 VALUE INDEX - RUSSELL 1000 GROWTH INDX 50% 40% 30% Value underperform Growth Starts 2Q13 20% 10% 0% -10% Value starts rebound in earnest 2Q16 -20% -30% -40% Dec-94 Sep-96 Jun-98 Mar-00 Dec-01 Sep-03 Jun-05 Mar-07 Dec-08 Sep-10 Jun-12 Mar-14 Dec-15 Source: Russell Indices, Bloomberg, Sterling Capital CHART 3: S&P500 Forward PE Ratios 45 Low Fwd P/E Q1 40 High Fwd P/E Q5 35 30 25 20 15 10 5 Jun-13 Feb-14 Oct-14 Jun-15 Feb-16 Oct-16 Source: Bank of America Merrill Lynch  Momentum Factors: As uncertainty grew in early 2016, global markets saw a massive flight to safety/yield in the first quarter (read momentum reversal). Momentum, which had supported our relative returns up through the end of 2015 and represents anywhere between one third to one half of our return driving engine, had an abrupt end to its performance as the market embarked on a flight to safety (lower volatility) as well as an increased focus on bond income proxies (dividend focused companies). It just so happens that low volatility and high dividend also are highly correlated many times. Below (Chart 4) we show the total return of the S&P500 relative to the S&P500 Dividend Aristocrats which represent the S&P500 constituents that have followed a policy of consistently increasing their dividends every year for at least 25 years.
The flight to income/low volatility began in the fourth quarter of 2015. Although the rolling one year chart does not depict it yet due to the sheer magnitude of outperformance of yield based equity strategies at the beginning of the year, the “flight to safety/yield” trade stopped in the second half of the year (the S&P500 outperformed the Aristocrats for the final 6 months of 2016). As the market had a dramatic shift, momentum was left behind. Page 10 . Quarterly Update | Behavioral Funds | 4th Quarter 2016 CHART 4: Rolling 1 Year Returns S&P 500 INDEX - S&P 500 Div Aristocrt TR 40% S&P 500 INDEX - S&P 500 Div Aristocrt TR 30% 20% 10% Dividends/Safety begin massive outperformance4Q15 0% -10% -20% -30% -40% -50% -60% Dec-94 Jun-96 Dec-97 Jun-99 Dec-00 Jun-02 Dec-03 Jun-05 Dec-06 Jun-08 Dec-09 Jun-11 Dec-12 Jun-14 Dec-15 Source: Standard and Poors Indices, Bloomberg, Sterling Capital Below are some reasons for hope of Momentum to turn around and support our performance again: • Momentum can work in value markets, in growth markets, in bull markets and bear markets. It only requires one trait…a trend. • CLARITY. As things start to take shape in the new government, clarity should develop. Once this occurs, trends are more than likely to be established which is favorable to momentum strategies. Conclusion: 2016 provided the backdrop for a perfect storm that saw momentum collapse/not work beginning in 4Q2015 and value finally ending approximately 3 years of being out of favor in the second half of 2016.
Our fourth quarter returns show the effects of value providing the relative returns we expect over the intermediate/longer term while momentum is still struggling to find the established trend. We remain committed to our investment process and feel the macro-economic environment has given reason to be optimistic about future return potential. Important Information Must be proceeded or accompanied by a prospectus. Please note: The opinions contained in the preceding commentary reflect those of Sterling Capital Management LLC. The stated opinions are for general information only and not meant to be predictions or an offer of individual or personalized investment advice.
They are not intended as an offer or solicitation with respect to the purchase or sale of any security. This information and these opinions are subject to change without notice. Any type of investing involves risk and there are no guarantees. Sterling Capital Management does not assume liability for any loss which may result from the reliance by any person upon such information or opinions. Page 11 .
Quarterly Update | Behavioral Funds | 4th Quarter 2016 Mutual fund investing involves risk including the possible loss of principal. There is no guarantees that objectives of the strategy will result in favorable performance. The funds are distributed by Sterling Capital Distributors LLC. Mutual Funds are Not a Deposit, are Not FDIC Insured, are Not Guaranteed by the Bank, are Not Insured by any Government Agency and May Lose Value. Advisory services and products offered through Sterling Capital Management LLC not affiliated with Sterling Capital Distributors LLC. Not a deposit • Not FDIC insured • May lose value • Not guaranteed by the bank • Not insured by any government agency Page 12 .
