Investment Outlook REITs: Don’t Don’t Call Call ItIt aa Comeback Comeback REITs: June 2014 Billie June Holiday 2014 (born Eleanora Fagan 1915-59) was an Billie Holiday (born Eleanora American songwriter and jazz Fagan 1915-59) was an singer. Born to a single mother American songwriter and jazz in Philadelphia, PA, Holiday singer. Born to a single mother endured a difficult childhood. in Philadelphia, PA, Holiday She began singing in clubs in endured a difficult childhood. Harlem assinging a teenager and in went She began in clubs on to great success Harlem as acommercial teenager and went asto a recording artist. Her on great commercial success autobiography, Lady Her Sings the as a recording artist. Blues, was published in 1956. autobiography, Lady Sings the Blues, was published in 1956. Holiday died at the age of 44 in Holiday died at the age of 44 in New York City. New York City.

E. William Stone, CFA®, CMT

E. William Stone, CFA®, CMT Managing Director, Investment and Managing Director, Investment and PortfolioStrategy Strategy Portfolio Chief Investment Strategist Chief Investment Strategist

MarsellaMartino Martino Marsella SeniorInvestment InvestmentStrategist Strategist Senior Rebekah RebekahM. M.McCahan McCahan Investment InvestmentStrategist Strategist Nicholas NicholasM. M.Srmag, Srmag,CFA® CFA® Fixed FixedIncome IncomeStrategist Strategist

Ryan Whidden Ryan Whidden Senior Portfolio Strategist

“I'm always making a comeback but nobody ever tells me where I've been.” REITs: Don’t Call It a Comeback “I'm always making a comeback but nobody ever tells me—Billie where Holiday I've been.” Executive Summary

Real estate investment trusts (REITs) have been on a blistering—Billie pace thisHoliday year. TM ® The FTSE Summary NAREIT All Equity REITs Index is up more than 14% on a total Executive return basisinvestment year to date, far (REITs) outpacinghave the been S&P on 500a®blistering , which is pace up more Real estate trusts this than year. TM ® 4%.FTSE This is in stark contrast to 2013, whenIndex REITs far more underperformed, 2.9% The NAREIT All Equity REITs is up than 14% onup a total ® for thebasis yearyear versus 32.4% the S&Pthe 500. This500 flipped switch has led many return to date, farfor outpacing S&P , which is up more than 4%. This istoinask: stark contrast to 2013, when underperformed, investors What changed? Where areREITs REITsfar now? And can suchup 2.9% for the year versus 32.4% for the S&P 500. This flipped switch has led many performance continue?

investors to ask: What changed? Where are REITs now? And can such We think thecontinue? discussion becomes more interesting still as a broader topic, which performance

we will touch upon in this month’s outlook. What is happening in real estate

We think the discussion becomes more interesting still as a broader topic, which overall? What are the trends and demographic shifts? We believe the dynamics we will touch upon in this month’s outlook. What is happening in real estate of what What is happening in REITs beyond the perspective of a the direct overall? are the trends andreach demographic shifts? We believe dynamics investment, and we find it useful from a market and economic viewpoint of what is happening in REITs reach beyond the perspective of a direct to understand and whatwe fundamental drivers REIT returns are at play. investment, find it useful from of a market and economic viewpoint to understand what fundamental drivers of REIT returns are at play. In this month’s Investment Outlook we discuss: In this Outlook we discuss:  month’s driversInvestment of REIT performance;  drivers of REIT performance; real estate cycles and trends;  real estate cycles and trends;  economy, economy, economy;  economy, economy, economy;  REITs and interest rates; and  REITs and interest rates; and  fundamentals and valuations.  fundamentals and valuations.

Ouroutlook outlookfor forthe theUnited UnitedStates Statesfor for2014 2014isiscontinued continuedeconomic economicexpansion, expansion, Our with several helpful tailwinds, including less fiscal drag and political turmoil, with several helpful tailwinds, including less fiscal drag and political turmoil, strongcorporate corporateprofits, profits,low lowinflation, inflation,and andrising risingasset assetprices, prices,among amongother other strong things.According Accordingtotothe thePNC PNCEconomics Economicsteam, team,recent recentdata, data,including includingbetter better things. housingand andfalling fallingunemployment unemploymentinsurance insurancegains, gains,ininaddition additiontotoimproved improved housing economic economicindicators, indicators,are arefurther furtherproof proofthat thatthe theU.S. U.S.recovery recoveryisisnot notimperiled, imperiled, despite despitemarket marketconcerns concernsthat thathave havepushed pusheddown downlong-term long-terminterest interestrates ratesinin recent recentweeks. weeks.The Theeconomy’s economy’sfundamentals fundamentalsremain remainsolid, solid,with withrecord recordcorporate corporate profits, profits,growing growingemployment employmentand andconsumer consumerincome, income,an anexpanding expandingglobal global economy, a recovering housing market and continued low interest rates. economy, a recovering housing market and continued low interest rates.

Senior Portfolio Strategist

PNC is forecasting GDP growth of 4.0% for second-quarter 2014 and 2.8% for PNC is forecasting GDP growth2014 of 4.0% for second-quarter 2014 and 2.8% for second-half 2014. Our full-year forecast for GDP growth is 2.4%.

Director of Portfolio Strategy

PNC’s six traditional asset allocation profiles are shown on the back page of PNC’s six traditional asset allocation profiles are shown on the back page of this outlook.

Paul J. White, PhD, CAIA® Paul J. White, PhD, CAIA® Director of Portfolio Strategy Michael Zoller Michael Zoller Investment Strategist

Investment Strategist

pnc.com pnc.com pnc.com

second-half 2014. Our full-year 2014 forecast for GDP growth is 2.4%.

this outlook.

Investment Outlook

REITs REITs and and Performance Performance REITs have been in existence for about 50 years, but were mostly private and not well understood until many began to go public in the early 1990s, garnering interest from the investing community. The structure allows investors to purchase a share of a REIT, which provides ownership in a real estate firm exposed to the fundamentals of corporate real estate with the advantages of investing in a comparatively more liquid asset—a publicly traded stock. An investor can participate by purchasing the stocks of individual REITs or by investing in REIT mutual funds or exchange-traded funds (ETF). A successful allocation to REITs aims to provide income generation and growth potential with the proven portfolio diversification benefits of owning REIT shares. For a detailed introduction to REITs see our February 2012 Investment Outlook, REIT this Way, and white paper, A REIT Primer. Historically, owning REITs has benefited investors by increasing total return, lowering the overall risk in portfolios, or both. REITs historically have had the additional benefits of modest correlation with stocks, less market price volatility, and higher current income. Over a long-term investment holding period, REITs have tended to outperform the S&P 500 on a total return basis (Chart 1). Year to date, REITs are up more than 14%, far outpacing the S&P 500, and in contrast to 2013 when REITs far underperformed. Chart Chart 11 FTSE NAREITAll AllEquity Equity Index versus S&P FTSE NAREIT Index versus S&P 500500 (through 2014) (through May 27, 2014) 450 400

50

FTSE REITS

40

S&P 500

20

300

10

250 200

Income Return

0 -10

150

-20

100

-30

50

-40

0 2000

Price Return

30

350 Percent

Total Return, Index, 6/2000=100

500

Chart 2 Chart FTSE NAREIT NAREIT All Return Component FTSE AllEquity EquityREITs, REITs, Return Component

-50

2002

2004

2006

Source: Bloomberg L.P., PNC

2008

2010

2012

1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012

Source: NAREIT, Bloomberg L.P., PNC

REITs provide steady current income, producing dividend yields competitive with investment-grade bonds, with the potential for increases in dividend and share price. Since 1972, REITs have produced an average income return of 8.3% (Chart 2). This represents about 60% of the REIT industry’s average annual total return of approximately 13.7%. From a diversification perspective, according to NAREIT, from 1980 through 2010, REIT stocks’ correlation with the S&P 500 was just 0.55. With the financial crisis came market dislocation, and REITs, like other stocks, became more closely correlated with the S&P 500. As capital markets began to normalize, correlations have trended lower over time to reflect fundamentals, and today listed REITs trade back near historical averages. This is a positive from a portfolio diversification standpoint.

2

June 2014

REITs: Don’t Call It a Comeback Investment in a REIT affords an investor the opportunity to share in the potential profits of owning real estate in markets or sectors for which an investor may lack the resources or expertise to own property directly. Some individual investors may question why own REITs when they already own direct residential real estate (their homes). The dynamics of the housing market differ considerably from those of commercial real estate. Commercial real estate owners tend to be long-term investors, collecting lease income until a property is sold.

Chart 33 Chart less 10-Year Treasury FTSE NAREIT NAREITDividend DividendYield Yield less 10-Year Yield Treasury Yield 800 700 600

The REIT dividend yield is often compared with the yields of other equities, while it also tends to be somewhat correlated with the 10-year Treasury yield. The key difference is that unlike Treasuries, a REIT’s income can increase over time—the REIT can add to its existing portfolio and generate higher cash flows, and underlying property values can increase. Comparing the REIT dividend yield with the 10-year Treasury yield also serves as a valuation metric. The difference between the two has a historical average of around 100 basis points (Chart 3).

Basis Points

500 400 300 200 100 0 Average

-100 -200 1990

1994

1998

2002

2006

2010

2014

Source: NAREIT, Bloomberg L.P., PNC

While somewhat changed since the Great Recession, REITs historically have tended to be less volatile on a day-to-day basis than stocks for two reasons.  They tend to have more stable earnings flows.  The dividend yield can act like a buffer. Table Table 11 Investment Performance Property Sector Subsector* Investment Performance byby Property Sector and and Subsector* (Data as of April 30, 2014)

Property Sector/Subsector FTSE NAREIT All Equity REITs Industrial/Office Industrial Office Mixed Retail Shopping Centers Regional Malls Free Standing Residential Apartments Manufactured Homes Diversified Lodging/Resorts Health Care Self Storage Timber Infrastructure

Total Return Dividend Number 2013 Year to Date Yield of REITs 2.86% 11.76% 3.57% 145 5.97 7.40 5.57 5.56 1.86 4.99 -0.98 7.29 -5.36 -6.20 10.46 4.33 27.18 -7.06 9.49 7.86 4.80

12.76 10.44 13.61 12.98 12.62 12.75 13.10 10.96 16.24 16.40 13.41 9.08 10.47 16.84 18.83 -2.95 3.86

3.36 3.32 3.10 4.64 3.76 3.63 3.09 6.07 3.58 3.55 4.14 4.48 3.19 5.08 3.17 3.49 1.09

Equity Market Capitalization (billions) $732.0

33 8 19 6 33 19 8 6 16 13 3 23 16 14 4 4 2

125.6 29.6 78.8 17.2 192.6 57.0 107.4 28.2 93.1 87.2 5.9 63.7 45.6 80.4 41.3 32.3 57.4

*Date derived from the constituents of the FTSE NAREIT Composite REIT Index Source: FTSE, NAREIT, PNC

3

Investment Outlook REIT volatility jumped in 2008 and 2009 in response to concern about REITs’ balance sheets, not dissimilar to conditions for other Financials and other industries. But as we will discuss, underlying fundamentals have dramatically improved. Typically an equity REIT will focus the majority of its business on the management of a particular property type (Table 1, page 3). A REIT investor, therefore, is participating in the business of commercial real estate—apartments, major office buildings, shopping malls, hotels, industrial space, self-storage, and health care, among others—while leaving the management of said properties to a professional management team. REIT investors benefit from liquidity (being able to sell a position into the market) and the transparency provided by REIT corporate governance. Also, the large owners of real estate typically have better access to capital with which to improve or add to the existing portfolio of properties. Owners of commercial real estate can limit risk by diversifying across sectors, geographic location, and tenant type. If certain sectors are weak, with the underlying tenants doing poorly, it is often true that other property types and tenants are doing fine. Given REITs’ structure, income generation and dividend component, underlying asset fundamentals, and interrelated economic cycles, we view REITs as a buy-andhold investment rather than a market timing decision. Investment in REITs better serves investors not aiming for quick capital gains but for dividend income and modest price appreciation.

Real Estate Estate Cycles Cyclesand andTrends Trends Cycles

Real estate is a cyclical industry. REITs experienced back-to-back years of negative returns in 1974-75, 1998-99, and most recently in 2007-08. REIT cycles are not easy to predict but often follow similar paths: 1  depression—characterized by high vacancies and low rents;  gradual recovery—during which leasing activity accelerates, occupancy rates stabilize, and rents firm;  boom—with high occupancy, owners to begin to raise rents and construction adds new supply; and  overbuilding and downturn—too many owners trying to cash in on high profits cause overbuilding, which in turn causes vacancies to rise and rents to begin to decline. Let us look at the past decade or so. REITs entered a boom period in 2000. Eventually, the real estate market became overheated, with rising property values financed by ever-increasing borrowing, exacerbated by the use of mortgage-backed securities. Peak to trough, February 7, 2007, through March 6, 2009, REITs tumbled a painful 73% (based on the FTSE NAREIT All Equity Index). In hindsight, the perfect storm included the runup of commercial real estate to rich levels. The overconfidence of REITs, as well as many other businesses, believing global growth could continue to boom, cost dearly. REITs faced their own challenge, with leverage ratios having risen to higher than historically normal levels (although not to the egregious levels of some other Financials). As credit markets froze, so did financing for commercial real estate, which declined precipitously. The decline in commercial

1

4

Ralph Block, Investing in REITs: Real Estate Investment Trusts: Fourth Edition, (Hoboken, NJ: Bloomberg Press, 2012).

June 2014

REITs: Don’t Call It a Comeback real estate values affected REITs’ net asset values (NAVs), and vacancy rates rose across the United States. Macroeconomic issues are not something within REITs’ control. At the depths of the recession, REIT management teams were faced with serious challenges to their businesses, and many responded by reworking their balance sheets. Firms were able to issue equity once the capital markets opened up in 2009, although often times at dilutive terms. And to the near-term dismay of many investors, many REITs also cut their dividends in response to lower cash flows and in efforts to preserve capital. Some REITs, however, were able to maintain the dividend or pay it through a special stock option granted by the Internal Revenue Service during the crisis. REITs were able to survive reasonably well through the Great Recession, one that many consider a Financials-sector and real-estate centric crisis. Management teams appear to have made tough decisions that did not always please shareholders, but in hindsight they appear to have ensured the REITs’ survival.

Trends The nature of real estate is that it is always changing and responding to trends and the economy. Real estate is largely a function of supply and demand. The biggest positive to the current environment is that there has not been a huge buildup of supply or new construction, therefore demand is naturally absorbing available space. New commercial real estate supply is at multi-decade lows, given the slowdown in new projects during the financial crisis. Real estate then naturally moves from vacancy to equilibrium to rent pickups. Real estate experts believe we are still in the early innings in the real estate cycle, which generally is pretty long. The old adage of “location, location, location” holds significant merit in commercial real estate. Properties are successful as long as they are in the right location and in the right markets. Ultimately the value of real estate comes back to what is the value of the land; the use may change over time, but good locations can adapt. Consequently, different property types are recovering at different rates. Apartment REITs are the best performing sector in 2014, after having a tough 2012 and 2013. Apartment REITs are benefiting from tighter supply in addition to better occupancy rates. Occupancy rates this year have remained relatively stable. Overall first-quarter earnings were better than expected. Apartments have benefited from a decline in home ownership while there has been a lack of new capacity coming on board. There has been some building Chart 44 Chart of apartments and conversion in order to meet demand, Apartment Vacancy Total U.S. Metropolitan Apartment VacancyRate Rate Total U.S. Metropolitan which is expected to be absorbed over time. 8.5

In addition, effective apartment rents averaged $1,089 per month in the first quarter, up from $1,055 a year prior, led by technology- and energy-driven markets, such as San Jose, San Francisco, Houston, and Seattle. In some cities apartment rents are passing office rents with demographic and lifestyle shifts.

7.5

Percent

According to REIS, Inc., the apartment vacancy rate in the first quarter was 4%, its lowest level since the early 2000s and well below the average since 1980 of 5.7% (Chart 4). In contrast, office vacancy was 16.7% at year-end 2013, relatively in line with its post-recession high in 2010 of 17.6% and well below the long-term average of 14.9%.

6.5

5.5

4.5

3.5 2007

2008

2009

2010

2011

2012

2013

2014

Source: REIS, Inc.; PNC

5

Investment Outlook Demographic changes are playing a strong part in what is happening in cities across the United States. Young adults are preferring to live in apartments versus owning a home. And more specifically they want to live in urban environments. In addition, other Americans, including older Americans, are seeing the benefits of urban life and are moving back into cities. This goes beyond just the big cities in America; midsized cities are also working to meet this demand. The Wall Street Journal recently published an article showcasing that in some cities, which formerly had high vacancy rates in office buildings that were not fully occupied, building owners are working to convert these buildings into apartments to meet waiting list demand for individuals looking to move to the city. 2 Retail has experienced shifting trends, driven by changing consumer behaviors, most especially online shopping. Operators note that this is not felt across the board; higher-end malls have continued to perform strongly compared with other malls. Office space is being affected by changes to fewer square feet per employee. However, office demand should be supported by job growth and low supply. In addition, conversion of office buildings to other uses, such as apartments, helps remove supply and support pricing. Industrial spaces are also changing in light of online shopping and more strategic placement of distribution centers. Storage has benefited from increased usage.

Economic Growth and REITs Commercial real estate has generally been a lagging indicator to economic growth. REITs strong performance in 2014 can be attributed partly to the expectation that the U.S. economy will continue to expand. REITs stand to benefit from such an improvement in the U.S. economy because their earnings exposure is essentially all domestic.

5

45

4

35

3

25 15

2

5

1

-5

0 -1 -2 -3 1990

Percent

Percent

Chart Chart 55 GDP REIT Returns Returns GDP versus versus REIT

-15 -25

US Real GDP Growth (L) FTSE NAREIT All Equity Index Total Return (R) 1993

1996

1999

2002

-35 -45 2005

2008

2011

2014

Source: Bloomberg L.P., PNC

REIT performance historically has been tied to periods of economic growth. In times of accelerating GDP growth, REIT performance has mostly been positive (Chart 5). PNC is forecasting inflation-adjusted GDP growth of 2.4% from the fourth quarter of 2013 to the fourth quarter of 2014. This compares with 1.9% growth in 2013. We expect the continued recovery in the housing market to support economic and employment growth. Less drag from federal fiscal policy, continued gains in consumer spending, an improving global economy, and a pickup in business investment will also support growth.

Household Formation Jobs have been and continue to be key to the economic recovery. Consequently, job growth is also important for REITs. Job growth is a factor in improving fundamentals because jobs support economic activity, office needs, and so on. In addition, jobs are a driver of household formation and housing demand, both rental and ownership. U.S. housing starts in April jumped 13.2%, the best month of data since November 2013. Almost all of the increase stemmed from multifamily, where starts were up 2

6

Eliot Brown, “Developers Turn Former Office Buildings into High-End Apartments in Cleveland and Other U.S. Cities,” The Wall Street Journal (May 7, 2014).

June 2014

REITs: Don’t Call It a Comeback

Household formation seems to have diverged from housing starts. There are several anecdotal suppositions regarding possible causes, including underemployment, delaying marriage, and continuing to live with family. As we have discussed, trend shifts in young adults are affecting economic growth.  Household formation is still below prerecession peaks for adults under age 30 (Chart 7).  In addition to feeling the weight of student loans, which we have mentioned can cause young adults to avoid taking on new debt (Chart 8), the jobs market, while improved, still shows a declining participation rate (Chart 9). Considering housing as related to formation and the economy in general, data indicate that after a slow start to 2014, the housing recovery is resuming. For the first time in four months, existing home sales rose in April, up 1.3%. In addition to bad weather, reduced affordability, tight credit, and limited inventories had been structural drags. Chart 88 Chart Total StudentLoan LoanDebt Debt Outstanding Total Student Outstanding

2,000

Multifamily (R)

450 400

1,600

300

1,200

250

1,000

200

800

Thousands

350

1,400

150

600 400

100

200

50

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Census Bureau, PNC

Chart Chart77 NumberofofHouseholds, Households, Householder under Number Householder under 30 Years

30 Years 16,500

16,000

15,500

15,000

14,500

14,000 2000

2002

2004

2006

2008

2010

2012

Source: Census Bureau, Moody’s, PNC

Chart 9 Chart U.S. Labor Labor Force Aged 25-34 Years U.S. ForceParticipation, Participation, Aged 25-34 Years

1.2

86

1.0

85 84

0.8 Percent

Trillions of Dollars

Single Family (L)

1,800

Thousands

Multifamily construction is benefiting from increased demand for rental units, partly due to tighter credit conditions for homebuyers. Young adults are also choosing to live in apartments versus homes and in urban areas, which are typically rental markets. They are wary of taking on debt after the financial crisis in addition to student loan debt, helping spur apartment demand.

Chart Chart 66 Single and Multifamily MuitifamilyHousing HousingUnits Unitsunder under Single and Construction Construction

Thousands

43%. Multifamily starts have recovered to their prerecession level, but single-family starts are still down significantly (Chart 6). April starts were strongest in the Midwest, up 42%, and Northeast, 20%, both coming off a hard winter. Starts did rise in the West, 11%, and South, 1%. The growth was dominated in all four regions by multifamily.

0.6

83 82

0.4

81

0.2 2003

2005

2007

2009

2011

Source: Federal Reserve Bank of New York, PNC

2013

80 2000

2002

2004

2006

2008

2010

2012

2014

Source: Bureau of Labor Statistics, PNC

7

Investment Outlook We expect that bigger inventories, an improving job market, better consumer confidence, and increased lending will all support home sales over the next couple of years. Price growth will slow to a more sustainable pace as new inventories come on the market and rates rise. Demand seems to be improving more quickly for condominiums and co-ops, with single-family homes increasing at a more modest pace. The Federal Reserve (Fed) identifies ongoing weakness in housing as the biggest threat to acceleration in economic growth. How consumers feel about economic growth is important. Interest rates are also key, as is the availability of credit. Even as jobs recover, tight credit standards are hindering growth, despite the low cost of borrowing. Before the financial crisis, the mean average credit score (as measured by FICO) for purchase home loans was 690. The current mean is around 735.

Interest Rates Rates REITs and Interest One of the most talked about topics over the past year has been what happens when interest rates rise? Topically as it relates to REITs, we revisit the now infamous taper talks, which began last spring as then Fed Chairman Ben Bernanke began to warn the market. Time and again history dictates that markets tend to react quickly to rising rates, and in some cases overreact, and then settle back May 21, 2013: Eve before down when things are more known.

Chart 10 Chart 10 2013 Path 2013 REIT REIT Path 610

Bernanke’s “Taper Talks”

590

Looking at REITs in 2013, performance as measured by the FTSE NAREIT All Equity REITs Index was keeping pace with the market until May 22, 2013, when Chairman Bernanke made the taper comments. From then through the rest of the year REITs sold off (Chart 10).

Index

570 550 530 510 490 1/13

3/13

5/13

7/13

9/13

11/13

1/14

3/14

5/14

Source: Bloomberg L.P., PNC

Once the initial shock wore off, broader markets appeared to gradually accept that rates will eventually rise. Because REITs are more liquid as a capital markets instrument, they are more volatile. The Fed may speak or events may occur that would cause markets to go up and down, affecting REITs’ pricing and not the underlying properties. Volatility does not equal risk. Stocks may go up and down based on sentiment and not value.

Chart 11 Chart 11 REIT Dividend CPICPI REIT DividendGrowth Growthversus versus 14 U.S. CPI, Year-Earlier Percentage Change 47.5% REIT Dividend Growth, Percent 29.2%

12 10

19.3%

8 6 4 2 0

-25.3%

-2 -4 1992

1995

1998

2001

2004

2007

Source: NAREIT, Department of Labor, PNC

8

2010

There are a few points to consider when examining this period. REITs are a capital markets instrument and trade as stocks, so they are subject to market trading. The fundamentals of REITs, however, did not change. Commercial real estate continued to perform well. And earnings at REITs were positive.

2013

REITs are more dependent on economic growth than on interest-rate sensitivity. Dividend growth rates for REIT shares have outpaced inflation over the past decade. Although the Great Recession was an exception, historically speaking REITs have been able to increase their dividends at a rate above inflation. Since 1992, REIT dividend growth has exceeded inflation as measured by the Consumer Price Index (CPI) in every year but two— 2002 and 2009 (Chart 11).

June 2014

REITs: Don’t Call It a Comeback For REITs, rising interest rates bring a few considerations. 

 

Why are rates rising? If rates are rising because the economy is improving then it is a fundamental benefit for REITs. Job growth and economic growth are a positive. An interest rate shock would be of concern, as would a scenario of rising interest rates without growth. If rates rise gradually, REITs have the opportunity to adapt and increase cash flows and often experience gains in underlying rents. On the other side of the balance sheet, interest rates are important from a cost-of-capital perspective. But again all companies need to adjust to rising rates.

Interest rates, however, are expected to remain low for some time. Historically, REITs have performed well in rising interest rate environments predicated by stronger economic growth. The recent decline in the 10-year Treasury is attributed to many factors, including geopolitical risks in Russia/Ukraine, short covering, and some believe concern regarding downside risks to a picture of accelerating U.S. economic growth. At this juncture, the market seems to be already pricing in a rise in long-term rates. REITs can adjust to a gradual increase.

Fundamentals and Valuations Valuations REITs tend to have more stable income flows than other corporations, generated from rental income secured by long-term lease agreements with tenants of their commercial properties. The value of a REIT’s share price is generally tied to predictable and growing streams of revenue and a price/earnings multiple assigned by the marketplace. Investors use several valuation metrics in valuing REITs including NAV, multiples to funds from operations, dividend yields, and capitalization, or cap, rates.

While NAV can be used as a reference point for the valuation of REITs, it has not historically proven a great predictor of forthcoming stock prices. Rather, more often it represents investor views of commercial real estate pricing trends. From this perspective, REITs seem to be trading below the long-term average for NAV.

Chart 12 Chart 12 Historical PricetotoNet Net Asset Value Historical Price Asset Value 140 130 120 Percent

NAV for REITs equals the estimated market value of a REIT’s total assets minus the value of all liabilities. Measuring NAV is useful for REITs because they own commodity-like assets—real estate. When divided by the number of common shares outstanding, the NAV can be used as a guideline for determining the share price. There appears to be some value in REITs, which are trading at a NAV/common shares outstanding of 94% versus the longterm average of 101%—a 7-percentage-point discount to the historical average of a 1% premium (Chart 12).

110

Average

100 90 80 70 1997 1999 2001 2003 2005 2007 2009 2011 2013

Source: ISI Group, Bloomberg L.P., PNC

Capital markets have been strong, helping to support valuations. Improved balance sheets and improved fundamentals of underlying real estate have been supportive of lower costs of capital. Cap rates are another tool investors use to analyze REITs. Cap rates equal the annual net operating income produced by an asset, in this case commercial real estate

9

Investment Outlook Chart 13 Chart Implied Cap-Rate Spread Treasury Yield Implied Cap Rate Spread to to Treasury Yield

Chart 14 Chart 14 REIT Price/Adjusted from Operations REIT Price/AdjustedFunds Funds from Operations 30

9.5 9.0

25

8.5

20

Percent

8.0 7.5

15

7.0

Average

6.5

10

6.0

5

5.5 5.0 2002

2004

2006

2008

2010

2012

5/14

0 1993

Source: ISI Group, PNC

1996

1999

2002

2005

2008

2011

5/14

Source: ISI Group, Bloomberg L.P., PNC

property, divided by its cost (or value). Cap rates are an indirect measure of how fast an investment will pay for itself. A lower cap rate denotes a longer payback period. For real estate purposes, you can determine the price of real estate to be equal to net operating income divided by prevailing market cap rates. Thus a lower rate spread equates to higher commercial real estate prices. Lower cap rates may also indicate higher risk; cap rates reached very low levels during the peak in 2006 and 2007 on optimistic assumptions. Currently cap rate spreads appear to be at reasonable levels (Chart 13). Dividend yields for REITs are low at 3.6% versus the historical average of 6.0%. However, this is attractive compared with other asset classes. The S&P 500 dividend yield is currently 2.0%. Dividend growth rates for REIT shares have outpaced inflation over the past decade. This should help preserve purchasing power. Growth in funds from operations (FFO) stems from a combination of internal growth; rent increases; tenant upgrades; property sales; and external growth, acquisitions, and development. ISI currently estimates REITs will grow FFO at a healthy 10.0% in 2014. Current consensus estimates for the S&P 500 indicate earnings growth of 7.0%. Valuations appear in line with long-term averages (Chart 14).

Recommendations PNC Current Recommendations PNC’s recommended allocations continue to reflect our positive view regarding the durability of the economic expansion while considering the continued downside risks inherent in the market and economic outlook:  a baseline allocation of stocks relative to bonds;  a tactical allocation to PNC Systematic Tactical Asset Rotation (STAR);  a tactical allocation to real estate investment trusts;  a tactical allocation to leveraged loans within the bond allocation;  a tactical allocation to absolute-return-oriented fixed-income strategies within the bond allocation;  an allocation to emerging markets within the international equity component;  a preference for high-quality stocks;  a tactical allocation to global bonds within the bond allocation;

10

June 2014

REITs: Don’t Call It a Comeback   

a tactical allocation of 52% value and 48% growth within U.S. large-cap stocks; a tactical allocation to global dividend-focused stocks; and an allocation to alternative investments for qualified investors.

Baseline Allocation of Stocks Relative to Bonds Since one cannot accurately determine the short-term movement of stocks, we believe that investors should focus on what is knowable and controllable. The one thing investors can truly control is asset allocation reflective of their needs and risk tolerance. PNC’s six baseline asset allocation models are shown on page 20.

Preference for High-Quality Stocks Any relapse to stressed capital markets or to another credit crunch from a financial crisis likely poses a higher threat to lower-quality and highly leveraged companies. Companies with weak balance sheets and less-robust business models have a much higher risk to their survival. Unfortunately, the economic outlook continues to be subject to continued downside risks in the wake of the financial crisis. We favor a preference for high-quality stocks as a method of risk control against unexpected shocks to the economic system. This is also consistent with our explicit allocation to dividend-focused stocks.

International Equities International equities offer a geographic diversification benefit and open the opportunity set to invest in firms around the world. Beyond the benefits of diversification and exposure to many of the world’s leading companies, there are other potential benefits to investing outside U.S. borders, including unique opportunities associated with Asia and Europe. Within the international equity component we recommend an allocation to emerging markets. A reasonable assumption regarding returns is that the United States and other developed markets have similar long-term expected returns. Much of the difference is likely to come from currency gains or losses. We remain mindful of the currency risk inherent in international investing. While at times the weaker dollar makes international investing look more attractive than the underlying fundamentals might dictate, the reverse is true when the strong dollar punishes the international returns of U.S. investors. Chart 15 Chart 15 Barclays Capital by by Country Barclays CapitalGlobal GlobalAggregate Aggregate Country

Allocation to Global Bonds within Bonds

The strategic rationale for including global bonds in the portfolio rests on expanding the opportunity set within the investible bond universe. The Barclays Capital Global Aggregate Index, our proxy for high-quality global bonds, contains less than 40% U.S. issues (Chart 15). (For further details on global bonds, see the July 2011 Investment Outlook, Pulling the Fourth Lever.) We believe investors who decline to look outside the United States may be missing out on opportunities for diversification and perhaps enhanced returns. A primary motivation for allocating to global bonds is the introduction of currency exposure to a portfolio. Although currency adds another level of volatility to a portfolio’s

(May 21, 21, 2014) 2014) (May

34.7% United States 16.9% Japan 8.7% Other 6.5% France 6.4% United Kingdom 6.0% Germany 4.5% Italy 3.4% Canada 3.1% Spain 2.3% Supranational 2.1% Netherlands 1.7% Australia 1.4% South Korea 1.2% Belgium 1.1% Sweden

Source: Barclays Capital, PNC

11

Investment Outlook Chart 17 Chart 17 Barclays Capital Aggregate Excluding United Barclays CapitalGlobal Global Aggregate Excluding States, States, Correlation with U.S. with Aggregate United Correlation U.S. Aggregate

1.2

1.2

0.8

0.8

36-Month Rolling Correlations

36-Month Rolling Correlations

Chart Chart 16 16 Barclays GlobalAggregate AggregateExcluding Excluding Barclays Capital Capital Global United United Unhedged, Correlation with Dollars States,States, Unhedged, Correlation with Dollar

0.4 0.0 -0.4 -0.8 -1.2 1993

1996

1999

2002

2005

2008

2011

Source: Bloomberg L.P., Barclays Capital, PNC

2014

0.4 0.0 -0.4 -0.8

Unhedged Hedged

-1.2 1993

1996

1999

2002

2005

2008

2011

2014

Source: Bloomberg L.P., Barclays Capital, PNC

fixed-income allocation, investors gain what traditional domestic fixed-income asset classes cannot offer—a natural hedge against devaluation of the dollar (Chart 16). The prospect of higher global economic growth outside the United States is another motive for allocating fixed income globally. As world economies grow more quickly, international bond investors may have the opportunity to reap the benefits of tightening global credit spreads relative to the United States. More importantly, investors can take advantage of higher interest rates abroad to gain higher yields. The addition of the currency exposure that comes with an unhedged global bond can act to lower the correlation with U.S. bond returns (Chart 17).

Chart 18 18 Chart 10-Year Treasury Treasury Yields 10-Year Yields

In general, we suggest that active management makes the most sense in this allocation. Generally, global bond index construction focuses on allocating more assets to countries with more outstanding debt. This may or may not be a good thing. Larger and more stable economies are likely to be able to safely support higher debt levels, but some fundamental analysis is likely helpful. We also believe that the current state of the global economy, with the large dichotomy between most developed and emerging economies, provides a possible opportunity for active managers in terms of credit and foreign exchange exposure.

4.0 3.5

Percent

3.0 2.5 2.0 1.5 1.0 1/11 5/11 9/11 1/12 5/12 9/12 1/13 5/13 9/13 1/14

Source: Bloomberg L.P., PNC

12

In our opinion, it is likely that many managers’ allocations will differ greatly from the index. This also affects the risk metrics, typically to the upside in terms of volatility, index tracking error, and historical drawdowns. This was explicitly taken into consideration by the PNC Investment Policy Committee when it sized the recommended allocation to global bonds. Given the concerns regarding how the United States will handle upcoming monetary and fiscal policy decisions, as well as what effects those decisions might have on the value of the dollar, we believe an allocation outside traditional fixed-income bond sectors is prudent. We believe the advantage of higher global growth and diversification benefits, along with the ability to benefit from currency exposure outside the dollar, make investing

June 2014

REITs: Don’t Call It a Comeback in the global bond sector a viable complement to traditional dollar-based fixedincome assets. This allocation can be seen as adding to PNC’s defensive posture on U.S. interest rates, with 10-year Treasury rates now above 2% and our view that yields will rise over time as the current economic soft patch and the flight to safety fade (Chart 18, page 12). We also see this as an opportunity to benefit from higher bond yields elsewhere in the world.

Allocation to Leveraged Loans within Bonds 3

In summary, this allocation could be characterized as lowering the portfolios’ interest-rate risk while raising their credit risk and correlation with equities. We believe it accomplishes this without a large impact on portfolio income. In our opinion, this correlation with equities, which we have noted since recommending the allocation, has become more apparent in the recent stock market downturn, allowing investors an attractive entry point.

Chart 19 Chart 19 3-Month LIBOR 3-Month LIBOR

Percent

We believe an allocation to leveraged loans within the bond portion of a portfolio should help defend against higher interest rates. Since leveraged loans are adjustablerate instruments tied to short-term interest rates (typically the 3-month London Interbank Offered Rate, or LIBOR), we believe holders should benefit from rising rates (Chart 19). If longer-term interest rates rise, we expect the shorter duration of leveraged loans should result in much better performance relative to longer-duration fixed income, such as the Barclays U.S. Aggregate Bond Index.

0.59 0.56 0.53 0.50 0.47 0.44 0.41 0.38 0.35 0.32 0.29 0.26 0.23 0.20 1/10 6/10 11/10 4/11 9/11 2/12 7/12 12/12 5/13 10/13 3/14

Source: British Bankers’ Association, Bloomberg L.P., PNC

Allocation to Absolute-Return-Oriented Fixed-Income within Bonds 4 We believe an allocation to absolute-return-oriented fixed-income strategy within the bond portion of a portfolio has several benefits, including:  defending against higher interest rates;  further expanding the opportunity set for fixed income; and  increasing exposure to credit. Given our belief that the economy will continue to improve, strategies that protect against the risk of rising rates will become increasingly important. While we do not believe interest rates will necessarily move markedly higher in the near term, rate volatility has certainly increased, and we expect that the downside risk to holding excessive duration will increase the longer rates remain low. We believe it makes sense to further hedge against this risk while maintaining the ability to participate in upside credit potential. This is also consistent with our current tactical allocations to global bonds and leveraged loans. We believe the Fed will continue to support the economy as necessary until the economy can grow and function without additional monetary policy accommodation. This should lend itself to further credit spread tightening over the short to intermediate term. Even with spreads at relatively attractive levels compared with The March 2010 Investment Outlook, Shakespeare for Primates, provides details about leveraged loans. 4 The July 2013 Investment Outlook, Breaking the Bonds, provides details about absolute-return-oriented fixed income. 3

13

Investment Outlook historical standards, we admit the absolute low level of yields increases the difficulty of adding alpha within spread sectors. This is one aspect in which we believe an absolute-return long-short approach can add value. Absolute-return strategies have the ability to exploit mispricing via both long and short positions and also expand the opportunity set of strategies typically not accessible by traditional long-only managers. Typical trading strategies include, but are not limited to, capital structure arbitrage, convertible arbitrage, event driven, and pairs trading. Table 2 illustrates the behavior of various products on the PNC platform consistent with the absolute-return-oriented fixed-income strategies during periods of rising interest rates. The strong relative performance in rising-rate environments is notable and is consistent with our expectation. Table 2 Table Periods ofRising RisingRates Rates Periods of Begin Date End Date 10-Year Yield Begin End Basis-Point Change

12/30/08 6/10/09

10/8/10 2/8/11

9/22/11 10/27/11

1/31/12 3/19/12

7/25/12 8/16/12

12/6/12 3/11/13

2.05% 3.95% 190

2.39% 3.74% 135

1.72% 2.40% 68

1.80% 2.38% 58

1.40% 1.84% 44

1.59% 2.06% 47

7.97% 7.75% -22 -212

5.62% 6.25% 63 -72

5.04% 5.46% 42 -26

5.07% 5.42% 35 -23

4.73% 5.09% 36 -8

4.55% 4.94% 39 -8

-0.47% 13.08% 10.77% 5.23%

-3.09% 4.65% 0.55% -0.62%

-1.68% 2.26% -0.20% -0.96%

-1.18% 3.29% 1.22% 0.09%

-1.21% 0.48% 0.31% -0.37%

-1.01% 2.42% 1.73% 0.60%

BAA Yield Begin End Basis-Point Change Spread Basis-Point Change Total Return during Period Barclays U.S. Aggregate Driehaus Active Income (LCMAX) BlackRock SIO (BSIIX) PIMCO Unconstrained (PFIUX) Source: Bloomberg L.P., PNC

Overweight of U.S. Large-Cap Value Stocks Relative to Growth 5 We believe the majority of the seven components of our decision framework continue to support an overweight to U.S. large-cap value style relative to growth. These components are:  earnings growth;  interest-rate level;  inflation;  volatility;  foreign growth;  valuation; and  yield-curve slope. In particular, we focus on the yield-curve slope because the results of our analysis show that a steep curve is supportive of value style outperformance relative to 5

14

The March 2011 Investment Outlook, Quest for Value, provides details about the value style recommendation.

June 2014

REITs: Don’t Call It a Comeback Chart 21 Chart 21 10-Year to30-Year 30-Year Treasury Yield Spread 10-Year to Treasury Yield Spread

300

200

200

150

100

100

10- to 30-Year

Basis Points

Basis Points

Chart 20 Chart 20 2-Year to 10-Year 10-YearTreasury Treasury Yield Spread 2-Year to Yield Spread

0 -100

2- to 10-Year 1988

1993

1998

2003

2008

2013

We continue to monitor the possibility that the typical impact of the steep yield curve might be derailed by:  the credit cycle;  capital constraints; or  lack of loan demand. Bank loan data seem to be past their worst levels, and we believe there are reasons for cautious optimism.  Banks are showing a greater willingness to extend consumer loans (Chart 22).

1993

1998

2003

2008

2013

Chart 22 22 Chart U.S.Banks’ Banks’ Willingness to to Make Consumer Loans U.S. Willingness Make Consumer Loans

(percentagemore morewilling willing minus percentage (percentage percentage less less willing) willing) 30 20 10 0 -10 -20 -30 -40 -50 -60 2000

2002

2004

2006

2008

2010

2012

2014

Source: Federal Reserve, Bloomberg L.P., PNC

10

Residential Total Loans Credit Cards

9

8

8 Ratio

Percent

1988

Chart 24 Chart 24 U.S. CoreCapital CapitalRatio Ratio U.S. Bank Core

Chart 23 Chart 23 U.S. Delinquency forfor Loans U.S. DelinquencyRates Rates Loans

6

7 6

4

5

2

4

0 1991

1983

Source: Bloomberg L.P., PNC

growth. To be clear, it is not a concrete rule that value outperformance over growth in a steep yield curve always exists, but it is an indication of a higher probability. Though recent Fed activities have flattened them to a degree, both the 2- to 10-year (Chart 20) and 10- to 30year (Chart 21) Treasury slopes remain historically steep and supportive of the value overweight.

10

0

-100 1978

Percent

1983

Median

Source: Bloomberg L.P., PNC

12

50

-50

-200 -300 1978

Median

1994

1997

2000

2003

2006

2009

Source: Federal Reserve, Bloomberg L.P., PNC

2012

1984

1988

1992

1996

2000

2004

2008

2012

Source: Federal Deposit Insurance Corporation, Bloomberg L.P., PNC

15

Investment Outlook  

Bank loan quality has continued to improve, implying a tailwind to bank earnings and a possible turn in the deleveraging cycle (Chart 23, page 15). Bank capital ratios have more than recovered, which should allow for loan growth and likely help prevent relapse of financial crisis within the banking industry (Chart 24, page 15).

Our value allocation has underperformed during the market downturn, given its more cyclical exposure. We believe it will perform better as global growth concerns fade.

Allocation to Global Dividend-Focused Stocks A global dividend-focused allocation expands the opportunity set to invest in highquality dividend-paying stocks domiciled in North America and beyond, where in some cases companies have exhibited faster dividend growth, essentially opening up the opportunity to invest in firms outside the United States, including the emerging markets. In addition, focusing on the combination of dividends and dividend growth has historically been a winning combination.

Chart 25 Chart 25 Dividends andDividend Dividend Growth around World Dividends and Growth around thethe World 1980 to March 2013 Japan

1.6

2.4

Canada -0.2

Germany

United States

Dividend Yield

5.2

3.2

United Kingdom

4.2 0

2

Dividend Growth

9.8

6.5

3.5

10.0 7.6

4.8

2.8

-0.4

-2

7.7

4.2

-0.1

9.9

6.4 0.2

3

Australia

France

6.0

1.9

1.2

9.8

6.9

11.5

4

6 8 10 12 14 Percent Multiple Expansion Total Ann. Return

Source: Société Général S.A.; MSCI; BlackRock, Inc.; PNC

The reinvestment of dividends greatly enhances an investor’s return and is a large component of the dividendfocused strategy. Over time, the compounding of dividends drives the total return. As an investor’s investment holding period increases, dividends typically comprise a larger portion of return. As a reference point, from 1926 to 1959 dividends contributed more than 50% to total returns for the S&P 500. We believe the global dividend-focused allocation is positioned to take advantage of global opportunities and diversify across countries and sectors (Chart 25). A globally generated income stream is inherently more diverse than one from a single country or region. This can help to avoid concentration in terms of end markets, which may drive sales and revenues. A global dividend allocation may also allow an investor to invest in sectors perhaps underrepresented by a particular country.

Allocation to Alternative Investments We also believe alternative asset classes should be considered for qualified investors because they may provide an effective risk management tool for portfolios. Our argument is that if alternative and traditional investments are put on even footing with regard to expected returns, then solely by virtue of the two investments being different, the risk of the overall portfolio is reduced without altering the portfolio’s expected return. The risks may not be less, but they are in some ways different, so we believe this diversification may help manage overall portfolio risk. Every action (or inaction) involves risk, and we believe investors should think about risk when they consider alternative investments. However, our research suggests that adding carefully selected alternative investments to a diversified portfolio of traditional investments may reduce the overall risk (as defined by the volatility of returns) of that portfolio without affecting expected returns. We believe that alternative investments should be considered as a tool for managing portfolio risk, not for adding risk to increase returns, for qualified investors. As an example of the possible value alternatives, in particular hedge funds, can bring to a portfolio in the current environment, look at the correlation between the S&P 500

16

June 2014

REITs: Don’t Call It a Comeback Chart 26 Chart 26 HFRX Macro 500 Correlations HFRX MacroIndex Indexand andS&P S&P 500 Correlations

Chart 27 Chart 27 HFRX Macro Macro Index HFRX Indexand andS&P S&P500 500 140

1.0

HFRX Macro S&P 500

Indexes, April 29, 2011=100

30-Day Rolling Correlations

High: 0.97 0.5

0.0

-0.5 Latest: 0.50

Low: -0.94

-1.0 2007

2008

2009

2010

2011

2012

2013

130 120 110 100 90 80 5/11

2014

Source: HFR Asset Management, LLC; Bloomberg L.P.; PNC

9/11

1/12

5/12

9/12

1/13

5/13

9/13

1/14

5/14

Source: HFR Asset Management, LLC; Bloomberg L.P.; PNC

and the HFRX™ Macro Index (Chart 26). Low correlation with stocks at times when they are falling would be a distinct positive in terms of reducing the downside. While at times these two very different assets move nearly in unison, the hedge funds do have exposure to other factors than solely stocks and also might adapt to the environment by changing exposures. In fact, the HFRX Macro Index had significantly outperformed the S&P 500 during previous downturns since the lateApril 2013 market peak (Chart 27). Given the current market environment, including a number of factors (such as low returns on cash and occasional spikes in macroeconomic concerns) that could continue to result in increased volatility, we believe alternative investments are worthy of consideration for qualified investors. 6

Allocation to PNC STAR

In backtests, PNC STAR has produced excess returns with a volatility level similar to the benchmark S&P 500, resulting in a higher Sharpe ratio. In addition, the analysis has shown that the strategy has handled periods of crisis better than the S&P 500 and was generally quicker to recover. While past performance is not indicative of future results, historically this model has produced outperformance of just under 0.40% per month. In addition, the drawdown analysis has shown that the

Chart 28 Chart 28 10% STAR/90%S&P S&P 500 Combination Total 10% PNC PNC STAR/90% 500 Combination Total Return Return 12 Indexes, November 30, 1990=$1

The PNC STAR strategy uses broad exchange-traded funds to apply momentum exposure to industries, size, and international factors in a systematic way. We believe adding a small allocation of the PNC STAR strategy to a portfolio may help increase return without increasing risk and, with small allocations, may help marginally reduce risk (Chart 28).

10

S&P 500 10% STAR/90% S&P 500 Combined

8 6 4 2 0 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Source: Bloomberg L.P., PNC

6

For more details, see our October 2009 Investment Outlook, Alternative Medicine, and our August 2009 white paper The Science of Alternative Investments.

17

Investment Outlook strategy has handled periods of crisis better than the S&P 500 did and was generally quicker to recover. Momentum performance has dipped since the financial crisis, but appears to be regaining some momentum (to turn a phrase). If momentum continues to work in the future as it has historically, the strategy may lead to excess returns that should help improve the tactical allocation portfolios.

Allocation to REITs The strategic rationale for including REITs in the portfolio rests on expanding the opportunity set for income investors. The REIT mandate requires at least 90% of income to be distributed to shareholders in the form of dividends. Given the nature of the dividend model, we believe REITs fare better with investors not aiming for quick capital gains but for dividend income and modest price appreciation. Over a long investment holding period, REITs have tended to outperform the S&P 500 on a totalreturn basis (Chart 1, page 2). The total-return perspective is unique for REITs in that it has historically kept pace with or exceeded the broader market, with the additional benefits of:  modest correlation with stocks;  less market price volatility; and  higher current returns. REITs provide steady current-income-producing dividend yields competitive with investment-grade bonds, with the potential for increases in dividend and share price. REITs allow shareholders to invest in commercial real estate while remaining liquid and leaving the management to professionals. REITs historically have had lower correlations versus other stocks, providing diversification benefits. Given the complex nature of the interrelated economics and industry fundamentals, leaving the investment in real estate to the professionals and buying for the long term into strong companies is a standing argument for long-term investing versus market timing. We believe the asset class should bring some diversification benefits in spite of the correlation tightening with the S&P 500. REITs are not so much interest-rate sensitive as dependent on economic growth. Dividend growth rates have outpaced inflation over the past decade (Chart 11, page 8).

18

June 2014

REITs: Don’t Call It a Comeback

19

As of market close, Friday, May 23, 2014 : S&P 500®

DJIA

1892.49

90-DAY T-BILL

16606.27

10-YEAR T-NOTE

0.03%

Asset Allocation Recommendations

2.54%

Equity Allocation Capitalization: Baseline Plus Dividend Focus within Large-Cap

Current Tactical

83% Large-Cap 83% Large-Cap 55% 55%

100

35%

4% REIT 4% REIT 4% Small-Cap 4% Small-Cap 9% Mid-Cap 9% Mid-Cap

65% 50%

25% 30%

50% 35%

25% 30%

70% Core

20 35%% 15%

(Baseline is 85LC/10MC/5SC) 15% Leveraged Loans(Baseline is 50/50)

20%

Preservation

15%

Aggressive

0

100% 100% 80%

40

0

100% 100%

80% 65%

60

20

20%

20%

Growth Aggressive

20

50%

35%

Balanced Growth

40

65%

50%

Moderate Balanced

60

55

Conservative Moderate

80

80

Preservation Conservative

100

55% %

65%

Style: Overweight Value within U.S. Large Cap

Absolute-Return Oriented Global Positioning: Baseline Plus5% Global Dividend Focus and Smart Beta 10% Global 20% International 5% Smart Beta-PNC STAR 75% Domestic

Baseline

80

80%

60

65%

30%

30% 35%

20 0

50%

15%

35

20% 100% 100% 80%

(Baseline is 80/20)

Fixed Income Allocation

65%

Credit Positioning: Core, Leveraged Loans, Global, and Absolute-Return Oriented

50%

%

15%

Bonds Bonds

100%

100%

Stocks Stocks

Aggressive

40

35% 20%

Growth Aggressive

0

50% 35%

Balanced Growth

20

65% 50%

Moderate Balanced

40

55% 65%

Conservative Moderate

60

55%

Preservation Conservative

80

100

Preservation

100

70% Core 15% Leveraged Loans 20% International 5% Absolute-Return Oriented 5% Smart Beta-PNC STAR 10% Global 75% Domestic

CashCash (Baseline is 100% Core)

For qualified investors, we recommend an allotment to alternative assets of 20% of a balanced allocation to complement the traditional allocation. The PNC PNC Financial FinancialServices ServicesGroup, Group, Inc. (“PNC”) provides investment wealth management, fiduciary services, FDIC-insured banking and products andand services, lending of funds The Inc. (“PNC”) provides investment and and wealth management, fiduciary services, FDIC-insured banking products services, lendingand of funds through its through itsPNC subsidiary, PNC Bank, National Association, which a Member FDIC, and provides certainservices fiduciary and agency services through PNCThis Delaware Company. subsidiary, Bank, National Association, which is a Member FDIC,isand provides certain fiduciary and agency through PNC Delaware Trust Company. report isTrust furnished for theThis use report furnished forand thedoes usenot of PNC and its andofdoes not constitute to any person. It is not preparedobjectives, with respect to thesituation specificor investment constitute theclients provision investment advice tothe anyprovision person. Itofisinvestment not preparedadvice with respect to the specific investment financial particular of PNCisand its clients objectives, situation particular of any specific person. of this report dependent the judgment by duly authorized investment needs of anyfinancial specific person. Use or of this report isneeds dependent upon the judgment andUse analysis applied by is duly authorized upon investment personnel and who analysis consider aapplied client’s individual account circumstances. personnel who consider a client’s individual circumstances. Persons reading this should consult with their PNC accountor representative regarding the appropriateness of should consult withaccount their PNC account representative regarding thereport appropriateness of investing in any securities adopting any investment strategies discussed or Persons reading this report investing in anyinsecurities adopting investment recommended in this and should understand that statements regarding future prospects may not be recommended this reportorand should any understand thatstrategies statementsdiscussed regarding or future prospects may not report be realized. The information contained in this report was obtained from sources deemed realized. The information contained in this report was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy, timeliness or completeness by PNC. reliable. Such information is not guaranteed as to its accuracy, timeliness or completeness by PNC. The information contained in this report and the opinions expressed herein are subject to change The information contained in this report and the opinions expressed herein are subject to change without notice. Past performance is no guarantee of future results. Neither the without notice. Past performance is no guarantee of future results. Neither the information in this report nor any opinion expressed herein constitutes an offer to buy or sell, nor a recommendation information in this report nor any opinion expressed herein constitutes an offer to buy or sell, nor a recommendation to buy or sell, any security or financial instrument. Accounts managed by by PNC andrecommended its affiliates may take positionsbyfrom time to time in securities recommended and tax followed by PNC affiliates. to buyand or sell, any security or financial instrument. PNC its affiliates may take positions fromAccounts time to managed time in securities and followed PNC affiliates. PNC does not provide legal, or accounting advicePNC and does not tax, orinaccounting advice and does not services into any jurisdiction in which it is not authorized to conduct business. are not bank deposits, nor they does notprovide providelegal, services any jurisdiction in which it isprovide not authorized conduct business. Securities are not bank deposits, nor Securities are they backed or guaranteed byare PNC or areguaranteed not issued by, by, guaranteed or or obligations of the FDIC or Board. the Federal Reserveinvolve Board. investment Securities involve backed or guaranteed by PNC of its by, affiliates, andby, any of its affiliates, and are or notany issued insured by,insured or obligations of the by, FDIC the Federal Reserve Securities risks,investment including risks, including loss of principal. possible loss ofpossible principal.

©2014 The PNC Financial Services Group, Inc. All rights reserved.