Vanguard’s economic and market outlook May 2015 Andrew J Patterson, CFA Investment Analyst Investment Strategy Group

For institutional investor use only. Not for public distribution.

Vanguard’s distinct approach to the economic and investment outlook

• In this presentation, Vanguard presents our

perspectives on the future of growth, inflation, interest rates, and the returns on stocks, bonds, and other asset classes • The asset-return distributions shown here

represent Vanguard’s view on the potential range of risk premiums that may occur over the next ten years; such long-term projections are not intended to be extrapolated into a short-term view of the next year Vanguard’s distinct approach to forecasting

• Vanguard firmly believes that the principles

of portfolio construction remain unchanged given our expected outlook for stocks and bonds • For further details not addressed in this

presentation, please refer to the full Vanguard research paper (cover shown here)

For institutional investor use only. Not for public distribution.

To treat the future with the deference it deserves, Vanguard believes that market forecasts are best viewed in a probabilistic framework. This publication’s primary objectives are to describe the projected long-term return distributions that contribute to strategic asset allocation decisions and to present the rationale for the ranges and probabilities of potential outcomes. This analysis discusses our global outlook from the perspective of a U.S. investor with a dollardenominated portfolio.

Themes and outlook Growth: • World: Frustratingly fragile

Inflation and interest rates: • Global deflationary pressures

continue, but stable oil prices and global QE should help

• U.S.: Remains resilient with

slightly above 2%-trend growth, but not immune to poor outlook overseas

• U.S. wage growth should rise,

but strong dollar may keep inflation < 2% for some time

• Europe: Still very weak, but

improving outlook fueled by QE, Euro weakness and oil prices

• Fed to liftoff: Likely 2015,

but slower and lower, with pause around 1% possible

• China: Permanently slower,

but hard landing unlikely

• A marked rise in global bond

yields unlikely

• Japan: Growth rebound

constrained by VAT. Should fall short of Abenomics goals

• Divergent monetary policies:

For institutional investor use only. Not for public distribution.

ECB and BoJ may not raise rates this decade

Asset returns: • A marked rise in global bond

yields unlikely; risk premiums remain compressed • Credit and equity risk may be

higher than duration risk • Outlook for equity risk premium

remains formative; central tendency of 6%–8% nominal 10-year returns • In near term, equity returns

biased lower • Lowest projected expected

returns since 2006 for balanced portfolios

U.S. growth outlook: Modest cyclical thrust above low 2%-trend Vanguard’s U.S. dashboard of leading economic indicators 100%

Vanguard’s 2015 U.S. growth outlook (2.5-3.0%) Estimated distribution of growth outcomes 30%

10%

4% 50%

2% 0%

25%

Trend growth

Odds of an acceleration

33%

2.1%

45%

22%

6%

-2%

21%

20% 17%

Probability

75%

Real GDP growth (YoY)

Percentage of indicators

8%

Odds of a slowdown

16% 14% 10% 10%

-4% 0% 1998 2000 2002 2004 2006 2008 2010 2012 2014

-6%

Above-trend growth: Housing, labor market, consumer confidence

0% Recession: Stagnation: Status Quo: 1.5% to Less than 0.5 to 1.5% 2.5% 0.5%

Cyclical Rebound: 2.5% to 3.5%

Robust Growth: 3.5% to 4.5%

Overheating: More than 4.5%

Below trend, but positive momentum: Government, financial conditions, business confidence, manufacturing Below trend and negative momentum: Lending/credit Real GDP year of year (at right) Sources: Vanguard calculations, based on data from Moody’s DataBuffet.com. Data as of 3/31/2015. For institutional investor use only. Not for public distribution.

Note: Distribution of growth outcomes generated by bootstrapping the residuals from a regression based on a proprietary set of leading economic indicators and historical data, estimated from 1960 to 2014 and adjusting for the time-varying trend growth rate. Trend growth represents Projected Future estimated trend growth which is presented in Figure 1B. Sources: Vanguard calculations, based on data from U.S. Bureau of Economic Analysis and Federal Reserve.

Fundamentals of consumer spending in place, but with no leverage Main drivers of consumer spending are up

Financing costs down and deleveraging slowing

1

18.0

0

-1

Composite of Consumer Drivers*

-2

Consumer Spending (core PCE)

-3

-4 1990

1994

1998

2002

2006

2010

2014

Composite includes compensation of employees, unemployment rate, Consumer Confidence Index, Consumer Confidence Index: Expectations, West Texas Intermediate Spot Oil Price, and the yield on the 10-year U.S. Treasury . Sources: Vanguard calculations based on data from DataBuffet, U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics, The Conference Board, U.S. Energy Information Administration, and the U.S. Federal Reserve. For institutional investor use only. Not for public distribution.

140

Financial Obligations Ratio (LHS)

130

Household Debt/Disposable Income (RHS)

17.5

120

17.0

110

16.5

100

16.0

90

15.5

80

15.0 1990

70 1994

1998

2002

2006

2010

2014

Composite includes compensation of employees, unemployment rate, Consumer Confidence Index, Consumer Confidence Index: Expectations, West Texas Intermediate Spot Oil Price, and the yield on the 10-year U.S. Treasury . Sources: Vanguard calculations based on data from DataBuffet, U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics, The Conference Board, U.S. Energy Information Administration, and the U.S. Federal Reserve.

% of Disposable Income

18.5

% of Disposable Income

Z-scores (above/below trend growth)

2

China: Moving to high-income status means slower growth Historical real GDP growth versus GDP per capita for various Asian economies 12%

China 2002-2003

China 2009-2010

Annual real GDP growth

10%

China 2019

Percentiles key:

8%

95th 6%

China 2014

75th

4%

Median 25th

2%

5th 0% 5000

10000

15000

20000

25000

30000

GDP per capita (USD)

Notes: Chart illustrates real GDP growth rates against GDP per capita for China (for the years shown) and for Hong Kong, Japan, Taiwan, South Korea, and Singapore (represented by the blue “bars and whiskers”) for 1951–November 2014. For each level of GDP per capita, we calculated distribution of real GDP growth rates across the five Asian economies. China 2014 and 2019 forecasts represent data from IMF World Economic Outlook (WEO), October 2014. Sources: Vanguard calculations, based on data from Penn World Tables (version 8.0 for 1951–2011) and IMF WEO, October 2014.growth rates across the 5 Asian economies. Sources: Vanguard calculations based on data from the Penn World Tables 8.0. (period 1951 – 2011) and IMF – WEO, October 2014. For institutional investor use only. Not for public distribution.

Europe: Inflationary expectations are below target and Euro area growth is worse than Japan’s in the 1990s Euro Area Core HICP

Aggregate euro area, core and periphery real GDP relative to Japan

2.5% YE headline inflation expectations (2016)

ECB Inflation Target

102 1.8%

1.5%

1.4% 1.2 % 1.1 %

1.0%

0.5%

100 Real GDP Index

Euro Area Core HICP YoY%

2.0%

104

98 96 94

0.0%

92

-0.5% 2008 2009 2010 2011 2012 2013 2014 2015

90 2006 2007 2008 2009 2010 2011 2012 2013 2014

Euro area (ECB)

Greece (IMF)

Eurozone

Core

Germany (Bundesbank)

Japan (IMF)

Periphery

Japan (1994-2003)

Note: HICP = Harmonized Index of Consumer Prices. Sources: Vanguard calculations, based on data from Bloomberg, Thomson Reuters Datastream, ECB Survey of Professional Forecasters, Deutsche Bundesbank, and IMF. For institutional investor use only. Not for public distribution.

Sources: Vanguard calculations, based on data from Moody’s Analytics Data Buffet, Eurostat, National Bank of Belgium (NBB)–Belgostat, French National Institute of Statistics and Economic Studies (INSEE), Deutsche Bundesbank, Hellenic Statistical Authority (ELSTAT), Central Statistics Office (CSO, Ireland)–National Accounts Quarterly, Italian National Institute of Statistics (ISTAT), Statistics Netherlands, Instituto Nacional de Estatística (INE), and Cabinet Office-Japan.

Global monetary policies diverging Global central bank assets as a percentage of a regions 2008 GDP

Break even inflation (BEI) 5

600

Onset of global financial crisis

10Y Forward Inflation Expectations (%)

Total assets (% of 2008 GDP) Index (Jan 2008=100)

Lehman collapse 500

400

300

200

100

0 2007 2008 2009 2010 2011 2012 2013 2014 2015

4 3 2 1 0 -1 -2 2004

2006

2008

Federal Reserve

Bank of England

US

UK

European Central Bank

Bank of Japan

EU

Japan

Notes: Total assets for each central bank are shown as percentage of that country’s or region’s 2008 GDP. Data as of March 2015. Sources: Vanguard calculations, based on data from Federal Reserve, Bank of England, ECB, Bank of Japan, and IMF. For institutional investor use only. Not for public distribution.

2010

2012

2014

Typical range of developed market central bank inflation targets (1-3%)

Note: Figure displays 10Y forward inflation expectations for each country. US and UK represent 10Y Break Even Inflation, Japan represents 10Y US BEI less 10Y yield differential between US and Japan through 10/31/2013 and 10Y Break Even Inflation thereafter, and EU represents 10Y Inflation swaps. Sources: Vanguard calculations, based on data from U.S. Federal Reserve, Bank of Japan, Bank of England, and ECB. Data as of March 31, 2015.

Fed outlook: Terminal rate more important than liftoff date Theoretical policy rate paths under cyclical and structural slack assumptions

4.5–5% (Fed “dots”) Cyclical view = later lift off Structural slack = earlier lift off

~3.0% (Vanguard) Cyclical view = higher long-term rate Structural slack = lower long-term rate

Secular stagnation slack = much later liftoff and a much lower long-term rate

Secular stagnation

Cyclical rebound

Note: Hypothetical illustration of path and end point of federal funds rate. Source: Vanguard. For institutional investor use only. Not for public distribution.

Structural deceleration

~1.0%

Wage pressures and core inflation Vanguard wage inflation composite index and core CPI

Wages and inflation expectations

Output gap/ "slack"

Commodity prices

U.S. dollar

0%

50%

100%

Fed’s inflation target

5.0%

3.5% 3.0%

4.0% 2.5% 3.0%

2.0% 1.5%

2.0%

Year-over-year growth

Current inflationary pressures

Three-month moving average (year-over-year growth)

Decomposition of variance of U.S. core inflation, 1983–2014

1.0% 1.0%

0.0% 2000

Productivity growth and inflation target

0.5% 0.0%

2003

2006

2009

2012

2015

Wage Composite, 3m avg, 12m lag, Lhs Core CPI, YoY, Rhs

Note: Chart based on inflation-variance decomposition described in Vanguard research (Davis, 2007). Sources: Vanguard, based on data from U.S. Bureau of Labor Statistics, Federal Reserve Board, Bridge/Commodity Research Bureau, and Federal Reserve Bank of Philadelphia. For institutional investor use only. Not for public distribution.

Notes: Vanguard wage composite consists of 26 weighted wage indicators across industries and is calibrated to core CPI. It leads CPI by 11 months. Left and right axes aligned based on estimate of inflationary level of wage growth and Fed’s target inflation. Productivity growth and inflation target on left represents 2% inflation target plus estimated productivity growth of 1%. Right axis represents Fed’s inflation target of 2%. Sources: Vanguard calculations, based on Thomson Reuters Datastream and Moody’s Analytics Data Buffet.

Projected U.S. Consumer Price Index (CPI) inflation rate, current and 2013 ten-year outlooks VCMM-simulated distribution of annualized expected average

Probability

35%

Annualized inflation: 1950–2014……... 3.6%

30%

Annualized inflation: 2000–2014……... 2.2%

25%

10-year TIPS break-even inflation as of December 31, 2014……. 1.7%

20% 15% 10% 5% 0% Less than 0%

0-1% rate

1-2% rate

2-3% rate

3-4% rate

Greater than 4%

10-Year annualized Inflation Current 10 year outlook Outlook as of December 2013

IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM, derived from 10,000 simulations for Global equity returns and fixed income returns. Simulations as of December 31, 2014. Results from the model may vary with each use and over time. For more information, please see the Important information slide. Source: Vanguard calculations, based on data from U.S. Bureau of Labor Statistics. For institutional investor use only. Not for public distribution.

Projected global fixed income ten-year return outlook VCMM-simulated distribution of expected average annualized return of the global fixed income market, estimated as of December 2013 and December 2014 25% Global bond returns

Probability

20%

15%

1926–2014

5.4%

1926–1969

3.1%

1970–2014

7.8%

2000–2014

5.6%

10%

5%

0% Less than 1.0%

1.0% to 1.5% 1.5% to 2.0% 2.0% to 2.5% 2.5% to 3.0% 3.0% to 3.5% 3.5% to 4.0% 4.0% to 4.5%

More than 4.5%

10-year annualized return Current 10-year outlook

Outlook as of December 2013

IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM, derived from 10,000 simulations for global equity returns and fixed income returns in USD. Simulations as of December 31, 2014. Results from the model may vary with each use and over time. For more information, please see the Important information slide. Note: Figure displays projected range of returns for a portfolio of 80% U.S. bonds and 20% ex-U.S. bonds, rebalanced quarterly. For details, see Vanguard’s economic and investment outlook (Davis, Aliaga-Diaz, Patterson, and Ahluwalia 2014). Source: Vanguard. For institutional investor use only. Not for public distribution.

Bonds can provide ballast in an equity bear market Median return of various asset classes during the worst decile of monthly equity returns, 1988–2014 2%

0%

Median return

-2%

-4%

-6%

-8%

-10% U.S. stocks

Emerging market stocks

REITs

Dividend stocks

Commodities

High-yield bonds

Emerging Hedge funds market bonds

Corporate bonds

Treasury bonds

Int'l bonds (unhedged)

Int'l bonds (hedged)

Notes: U.S. stocks, U.S. bonds, and international bonds represented by indexes listed on page 4. Emerging market stocks represented by FTSE Emerging Index and emerging market bonds by Barclays Emerging Markets Tradable USD Sovereign Bond Index. REITs represented by FTSE NAREIT Equity REIT Index, dividend stocks by Dow Jones U.S. Select Dividend Total Return Index, commodities by S&P GSCI Commodity Index, high-yield bonds by Barclays U.S. Corporate High Yield Index, hedge funds by median hedge fund-of-funds return as identified by Morningstar, Inc., corporate bonds by Barclays U.S. Corporate Investment Grade Index, and Treasury bonds by Barclays U.S. Treasury Index. Sources: Vanguard calculations, based on data from S&P, Citigroup, Barclays, Dow Jones, MSCI, CRSP, and FTSE. For institutional investor use only. Not for public distribution.

Duration tilts: Short-duration strategies are not without risks

Low-yield scenario

Expected yield scenario

High-yield scenario

Yields below 25th percentile

Yields between 25th and 75th percentiles

Yields above 7th percentile

Five-year annualized return

15%

10 Percentiles key: 95th

5

75th 0 Median 25th

-5

5th -10 Treasury index Short-term Treasury index Long-term Treasury index

Notes: Forecast displays distribution of 10,000 VCMM simulations for five-year annualized returns of asset classes shown as of September 2014. Scenarios are obtained based on sorting the three-month and 30-year Treasury yields at the end of every year from the VCMM. The three scenarios combined are a subset of the 10,000 simulations from the VCMM. See appendix section titled “Index simulations,” for further details on asset classes shown here. Source: Vanguard. For institutional investor use only. Not for public distribution.

Hedging currency in fixed income: Why all the negativity? Regardless of the yield environment the expected hedge return is the difference between the forward curves

At the time of the hedge, investors are indifferent between domestic and international bonds hedged back to their currency

3.0

2.5

2.5

2.0

2.0 1.5

This difference is the expected return from hedging: positive for USD, negative for EUR

1.0

Yield (%)

Yield (%)

1.5 1.0

0.5

0.5

0.0

0.0

-0.5 12

24

36

48 60 72 Months Forward

84

96

108 120

A USD investor could achieve a similar yield to Treasuries by hedging bunds. The hedged yield would be identical to the US spot yield under perfect foresight.

-0.5 12

24

US 1 Month Forward

US Spot

DEU 1 Month Forward

DEU Spot

36

48

60 72 Maturity

DEU Spot + CuAvg Hedge Return

Notes: U.S. spot and German yield curve data as of 4/1/2015. Source: Vanguard calculations based on data from Board of Governors of the Federal Reserve and Bundesbank. For institutional investor use only. Not for public distribution.

84

96

108 120

Projected global equity ten-year return outlook VCMM-simulated distribution of expected average annualized return of the global equity market, estimated as of December 2013 and December 2014 25%

Global equity returns

Probability

20%

15%

Shift in distributions since last year

1926–2014

10.2%

1926–1969

9.7%

1970–2014

10.6%

2000–2014

4.6%

10%

5%

0% Less than 0%

0% to 3%

3% to 6%

6% to 9%

9% to 12%

12% to 15%

15% to 18%

More than 18%

10-year annualized return Current 10-year outlook

Outlook as of December 2013

IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM, derived from 10,000 simulations for global equity returns and fixed income returns in USD. Simulations as of December 31, 2014. Results from the model may vary with each use and over time. For more information, please see the important information slide. Notes: Figure displays the projected range of returns for a 70% U.S., 30% ex-U.S. equity portfolio, rebalanced quarterly. For details, see Vanguard’s economic and investment outlook (Davis, Aliaga-Diaz, Patterson, and Ahluwalia 2014). Source: Vanguard. For institutional investor use only. Not for public distribution.

Valuations stretched in the US and developed markets Valuation for global equity indexes Price over 36-month trailing earnings

Long-term valuation for US equities, Selected valuation metrics 4

40 35 30

Diverging again?

25 20 15 10 5 0 1998

2000

2002

2004

2006

2008

2010

2012

2014

United States Developed International Emerging Markets Notes: Figure displays the price/earnings ratio with 36-month trailing average earnings. United States is defined as the MSCI United States Index, developed markets ex-U.S. are defined as the MSCI All-World US Index, and emerging markets are defined as the MSCI Emerging Markets Index. Sources: Vanguard calculations, based on data from MSCI Data as of March 31, 2015. For institutional investor use only. Not for public distribution.

Standard deviation from long-term mean

45

Broad Market Price to Earnings Broad Market Price to Sales

3

Broad Market Price to Book Shiller CAPE (10-year)

2

Shiller CAPE (3y)

1

0

-1

-2 1925 1935 1945 1955 1965 1975 1985 1995 2005 Notes: Figure displays valuation metrics standardized to have a long-term average of 0.0 and a standard deviation of 1.0. Broad market price/earnings displays the market value of domestic corporations from the Federal Reserve Flow of Funds database relative to the trailing four-quarter average of after-tax corporate profits from the BEA’s national accounts. Broad market price/sales displays the market value of domestic corporations from the Flow of Funds database relative to the Gross Value Added of Corporate Business from the BEA’s national accounts. Broad market price/book displays the market value of domestic corporations relative to the net worth at historical cost of Nonfinancial Corporate Business, both from the Flow of Funds database. Shiller CAPE (10-year) is the ten-year cyclically adjusted price/earnings ratio as defined in Shiller (2000). Shiller CAPE (3-year) is Shiller’s measure, adjusted to smooth earnings over a trailing 36month period. Sources: Vanguard calculations, based on data from Federal Reserve, U.S. Bureau of Economic Analysis, and Robert Shiller’s website, aida.wss.yale.edu/~shiller/data.htm. Data as of March 31, 2015

The benefits of long term perspective, balance and diversification A balanced, diversified investor has fared relatively well

Balanced portfolio value (indexed to 100 as of market peak)

160

+55.51% +54.28% +51.51%

Peak to trough return

140

120

100

–11.55

80

–24.03 60

–55.25 40 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 100% Stock

50% Stock / 50 % Bond

30% Stock / 70 % Bond

Source: S&P 500 Index and Barclays U.S. Aggregate Bond Index (rebalanced monthly). Data provided by Factset, as of March 31, 2015. For institutional investor use only. Not for public distribution.

Peak through March 31, 2015

Projected ten-year nominal return outlook for balanced portfolios

Forecast

20%

20%

15%

15%

10%

10%

5%

5%

0%

0%

-5%

-5%

Percentiles key: 95th

75th Median

2010

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

1955

1950

1945

1940

25th

1935

10-year annualized returns

History

5th

20%/80%

60%/40%

History 1926-2014

80%/20%

History 2000-2014

20%/80%: Equity/bond portfolio 60%/40%: Equity/bond portfolio 80%/20%: Equity/bond portfolio

IMPORTANT: The projections or other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of December 31, 2014. Results from the model may vary with each use and over time. Note: Forecast displays 5th/25th/75th/95th percentile ranges of 10,000 VCMM simulations for projected real returns for balanced portfolios in USD. The equity portfolio is 70% U.S. equity and 30% global ex-U.S. equity. The bond portfolio is 80% U.S. bonds and 20% global ex-U.S. bonds. For details, see Vanguard’s economic and investment outlook (Davis, Aliaga-Diaz, Patterson, and Ahluwalia 2014). Source: Vanguard For institutional investor use only. Not for public distribution.

Important information This information is intended for investors outside the United States and should not be provided to individual investors in the United States. The information contained herein does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. Broker-dealers, advisers and other intermediaries must determine whether their clients are eligible for investment in the products discussed herein. IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based. The Vanguard Capital Markets Model™ is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time. All investing is subject to risk, including the possible los s of the money you invest. Bond funds are subject to interest rate, credit, and inflation risk. Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets. Diversification does not ensure a profit or protect against a loss. Morningstar data ©2014 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.

© 2015 The Vanguard Group, Inc. All rights reserved. For institutional investor use only. Not for public distribution.

Appendix

For institutional investor use only. Not for public distribution.

Sector dashboard of the U.S. economy

2007

2008

2009

Housing

Financial markets

Sentiment / confidence

Consumer/ lending and credit

Manufacturing and trade

Labor market

Source: Vanguard Investment Strategy Group. Data as of 3/31/2014. For institutional investor use only. Not for public distribution.

2010

2011

2012

2013

2014

2015

Structural forces driving trend growth Developed-market trend GDP growth and components

Contribution to real GDP growth

7%

Estimates for next 10 years

6% 5% 4%

4.9% 3%

3.4% 2%

2.4% 1.6%

1%

1.0%

0.7%

0.6%

0.4%

1950s-1970s

1980s-1990s

2000s

Next 10 years

0%

Population growth Productivity Growth

Notes: Potential GDP growth based on developed countries’ weighted-average real GDP growth rates during non-recessionary periods for the global economy. Global recessions include the following years: 1961, 1967, 1970, 1974–1975, 1980–1982,1991–1993, 2001, and 2008–2009. Sources: Vanguard calculations, based on data from Penn World Tables (version 8.0. for 1951–2010) and International Monetary Fund’s (IMF’s) World Economic Outlook (WEO). For institutional investor use only. Not for public distribution.

What is causing slower growth: Secular stagnation or structural deceleration? Drivers, economic and policy implications

Structural deceleration

Secular stagnation

Demographic changes and productivity slowdown reducing trend growth

Deleveraging and insufficient policy responses restraining spending and growth

Inflation expectations

Stable

Falling

Output gap (“slack”)

Small and closing

Gap not closing

Inflation and wage pressures

Building from a low base

Deflation risk increasing

Monetary policy

Gradual tightening is appropriate

More quantitative easing (QE) needed

Fiscal policy

Infrastructure spending

More fiscal stimulus

Primary drivers

Economic implications

Policy implications

Note: For more details on drivers of each scenario and a full quantitative assessment of various markets, see Vanguard’s economic and investment outlook (Davis, Aliaga-Diaz, Patterson, and Ahluwalia, 2015). Source: Vanguard. For institutional investor use only. Not for public distribution.

Supply and demand both pushing oil prices lower Decomposition of the largest oil-price drops varies Five largest declines, 1983–present

Percentage change

20% 0% -20% -40% -60%

-56%

-80% Spring 1986

Supply factors

Spring 1991

Demand factors

Fall 2001

Fall 2008

Current (as of 1/2015)

Strength of U.S. Dollar

Notes: Components of oil-price drop—Supply = 7-month cumulative price change (CPC) in WTI spot oil prices minus 7-month CPC in spot copper prices; Demand = 7-month CPC in spot copper prices minus 7-month CPC in USD; Strength of U.S. dollar = 7-month CPC in USD major currencies index. Sources: Vanguard calculations, based on data from Thomson Reuters Datastream, U.S. Energy Information Administration, Standard & Poors, Federal Reserve, and Federal Reserve Bank of St. Louis. Monthly WTI spot values were used from Federal Reserve Bank of St. Louis, 1983–1985, and month-end WTI spot values from U.S. Energy Information Administration, January 1986–January 2015. For institutional investor use only. Not for public distribution.

Questions around drivers and implications of strong dollar Strong dollar in part driven by strong U.S. economy 40% 30%

0.6% 20% 0.4% 10%

0.2% 0.0%

0%

-0.2%

-10%

-0.4% -20%

Net exports contribution to GDP (%)

0.8%

3.00

% deviation from trend

5-year average ppt difference in growth rates

1.0%

Magnitude of trade impact is varied

2.00

y = -0.0513x - 0.176 R² = 0.0845

1.00

0.00 -15

-10

-5

0

5

10

-1.00

-2.00

-0.6% -30%

-0.8%

-3.00 -1.0% 1973

-40% 1983

1993

2003

2013 -4.00

Real GDP growth diff: US versus Developed (Left)

6 Mo. cumulative change in USD

USD Major Currencies index nominal (Right)

Sources: Vanguard calculations, based on data from Moody’s Analytics Data Buffet, IMF, Federal Reserve, U.S. Census Bureau and U.S. Bureau of Economic Analysis. Data as of 12/31/2014. For institutional investor use only. Not for public distribution.

15

20

Emerging markets dashboard Emerging markets’ financial systems are much different today Total reserves (% of total External external debt service debt) (% exports)

Crisis years

External debt (% of GDP)

Brazil, 2002

47.7

16.2

Hungary, 1997

52.1

Malaysia, 1997

Total reserves (% of total external debt)

External debt service (% exports)

Years of coverage

Currency peg

Years of coverage

Currency peg

Today

External debt (% of GDP)

71.1

4.9

N

Brazil

21.5

73.8

28.6

4.4

N

36.4

32.9

0.5

Y

Hungary

147.4

23.6

97.4

8.4

N

36.4

44.0

7.4

3.5

Y

Malaysia

68.1

62.6

3.5

4.4

N

Mexico, 1994

33.9

4.6

27.0

0.2

Y

Mexico

35.1

39.6

10.3

6.6

N

South Africa, 1997

19.7

16.0

17.2

2.2

N

South Africa

38.1

32.1

8.3

2.2

N

Turkey, 1997

32.1

22.0

22.3

7.1

N

Turkey

47.2

28.6

28.7

1.7

N

Argentina, 2001

57.4

9.7

49.2

3.8

Y

Argentina

21.9

20.7

13.7

5.9

N

Indonesia,1997

51.6

12.2

30.3

3.3

Y

Indonesia

29.6

37.2

19.4

3.3

N

Russia, 1998

64.8

6.5

29.0

55.8

Y

Russia

34.8

69.9

32.0

14.9

N

South Korea, 1997

31.8

12.6

N/A

8.5

Y

South Korea

31.9

83.3

N/A

52.5

N

Notes: Data for total reserves as percentage of exports for Hungary begin in 2000. Data for external debt service as percentage of exports for Hungary and Russia begin in 2005. Years of coverage represent total reserves/current account deficit and reflect number of years a nation’s foreign currency reserves could fund a trade deficit. Latest available data for “Today” are as of December 31, 2013. Sources: Vanguard calculations, based on data from World Bank; International Monetary Fund; Oxford Economics; Bank of Korea, Korea Customs Service; Central Bank of the Russian Federation; Department of Statistics Malaysia; CEIC Data; Central Bank of Hungary; and Ethan Ilzetzki, Carmen Reinhart, and Kenneth Rogoff, 2011, The Country Chronologies and Background Material to Exchange Rate Arrangements into the 21st Century: Will the Anchor Currency Hold? (London: London School of Economics). For institutional investor use only. Not for public distribution.

Economic growth and equity returns: Be wary of the allure of high economic growth Real GDP growth and real stock returns 1970–2014 15%

Average annual real equity market return

Mexico South Africa

10% U.K 5%

R² = 0.03

U.S India

Germany

China

Chile

Brazil 0%

-5%

-10% -Russia -15% 0%

1%

Emerging

2% PIGS

3% BRICS

4% Europe Core

5%

6%

7%

8%

9%

10%

Developed

Notes: Figures display each country’s average annualized real GDP growth rate along with that country’s average annualized real stock return. We include all members of the FTSE All World Index (except the United Arab Emirates, for a lack of return history). The period covered begins in 1970, with the starting point for each country depending on the availability of both returns and GDP data (most developed markets have data from 1970 onward, and most emerging markets have data from 1988 onward). Real growth rates are computed using data from the IMF’s World Economic Outlook database (for data prior to 1980, we use the April 2004 database; otherwise we use the April 2013 database). Return data are based on MSCI country indexes spliced with FTSE indexes once the latter are available. Both growth and return data are in real local terms, with the index returns deated using the GDP deator from the IMF databases. The 95% confidence interval for the crosssectional regression slope of returns on GDP growth is –0.51 to 0.61, with an R-squared of 0.00.Source: Vanguard, based on data from the IMF, MSCI, and FTSE. For institutional investor use only. Not for public distribution.

Lack of near-term predictability is another reason Vanguard stresses a long-term perspective Average return on U.S. stock VCMM estimated probability distribution 25%

20%

15%

10%

5%

0% Less

-20% to -16% to -12% to -8% to -16% -12% -8% -4%

1-year returns

-4% to 0%

0% to 4%

4% to 8%

8% to 12%

12% to 16% to 20% to 24% to 28% to 32% to 36% to 16% 20% 24% 28% 32% 36% 40%

More

10-year returns

IMPORTANT: The projections or other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from Vanguard Capital Markets Model® (VCMM), derived from 10,000 simulations for U.S. equity returns and fixed income returns. Simulations as of December 31, 2014. Results from the model may vary with each use and over time. For more information, please see the important information slide. For institutional investor use only. Not for public distribution.

Market outlook Bond return math suggests low current yields correlate with low expected returns 18

10-year annualized return (%)

16

Current yield on 10-year: 1.92%

14 12 10 8 6 4 2 0 1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

Initial yield on 10-year treasury Sources: Historical yield data for the 10-year CMT provided by Shiller from 1926 through 3/1953 and the Federal Reserve Board thereafter. Total returns for US bonds represented by Ibbotson Associates Intermediate Term Treasury Bond Index from 1926 through 1975 and 10-year CMT US Treasury from Barclay’s Capital thereafter. Yields shown through March 31, 2005; Returns through March 31, 2015. For institutional investor use only. Not for public distribution.

Market and VCMM interest rate projections A rise in interest rates is already priced in by the markets 6%

5%

Yield

4%

3%

2%

1%

0% 3 Month

1 Year

2 Year

5 Year

7 Year

10 Year

20 Year

30 Year

Maturity VCMM 25th- and 75th-percentile bounds

Spot curve

Forward curve

VCMM five-year-ahead median

Note: This yield-curve forecast displays the 25th- to 75th-percentile range of 10,000 VCMM simulations for projected yields (five years ahead) of U.S. Treasury curve as of December 31, 2014. Sources: Vanguard calculations based on data from Bloomberg and Moody’s Analytics. For institutional investor use only. Not for public distribution.

Stocks and rising rates: It depends on the source Correlation of U.S. stock returns with changes in inflation and real rates† Change in inflation*

Change in real rate** 30%30%

20%20%

10%10%

0% 0%

R2 = 0.22 -6%

-4%

R2 = 0.22 -2%

0%

2%

4%

-10% -10% -6%

-4%

-2%

0%

2%

4%

6%

Source: Investment Strategy Group, data as of March 2015. * Inflation is the change in Consumer Price Index. CPI data from Jan. 1931 to present derived from Robert J. Shiller’s homepage http://www.econ.yale.edu/~shiller/data.htm accessed: June 04, 2013. ** Real rate is the difference between cash and inflation. Cash is defined as U.S. cash reserve annual returns using Ibbotson U.S. 30-Day Treasury Bill Index from Jan. 1931 to Dec. 1977 and the Citigroup 3-Month Treasury Bill Index thereafter. † U.S. Equities is defined as Standard & Poor’s 90 from Jan. 1931 to Feb. 1957; the Standard & Poor’s 500 Index from Mar. 1957 to Dec. 1974; the Wilshire 5000 Index from Jan. 1975 to Apr. 2005; and the MSCI US Broad Market Index thereafter. Note: Change in inflation (and real rate) is defined as the difference between two non-overlapping 5-year periods in a 10-year time-frame. The difference is known as “actual” minus “expected”. Beginning in 1931, the annualized geometric return for the first 5-year period beginning Dec. 1931 and ending Dec. 1935 is defined as “expected”. The subsequent 5-year period beginning Jan. 1936 and ending Dec. 1940 is defined as “actual”. Plotted on the y-axis is the geometric annualized returns of U.S. Equities of the “actual” period, first of which is Jan. 1936 to Dec. 1940. Plotted are the results for 73 periods ending March 2015. For institutional investor use only. Not for public distribution.

Are high equity valuations becoming the norm? Shiller CAPE versus estimated fair-value CAPE 50

40

30

20

10

0 1950

1960

1970

1980

1990

2000

2010

+/- 1 Std Error range Shiller's CAPE Median fair-value estimate Note: “Fair-value CAPE” is based on a statistical model that corrects CAPE measures for the level of inflation expectations and for lower interest rates. The statistical model specification is a three-variable vector error correction (VEC), including equity-earnings yields, ten-year trailing inflation, and ten-year U.S. Treasury yields estimated over the period January 1940–June 2014. Sources: Vanguard calculations, based on Robert Shiller website, at aida.wss.yale.edu/~shiller/data.htm., U.S. Bureau of Labor Statistics, and Federal Reserve Board. For institutional investor use only. Not for public distribution.

Bond market ten-year return outlook: Setting reasonable expectations

U.S. TIPS Global Bonds ex-U.S. hedged in USD U.S. Bonds Percentiles key:

U.S. High Yield Corporate Bonds

95th

75th

U.S. Credit Bonds

Median 25th

U.S. Treasury Index 5th

U.S. Cash U.S. Inflation

-2%

0%

2%

4%

6%

8%

10%

12%

14%

10 year annualized return Volatility (median annual standard deviation of returns) IMPORTANT: The projections or other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of December 31, 2014. Results from the model may vary with each use and over time. Notes: Forecast corresponds to distribution of 10,000 VCMM simulations for ten-year annualized nominal returns as of December 31, 2014 in USD for asset classes highlighted here. For details, see Vanguard’s economic and investment outlook (Davis, Aliaga-Diaz, Patterson, and Ahluwalia 2014). Source: Vanguard. For institutional investor use only. Not for public distribution.

Equity market ten-year return outlook: Setting reasonable expectations, being aware of widely dispersed potential returns

Global Equity ex-U.S. unhedged in USD Percentiles key:

U.S. Equity

95th

75th

U.S. REITs

Median 25th

Commodities Futures

5th

-10%

-5%

0%

5%

10%

15%

20%

25%

10 year annualized return Volatility (median annual standard deviation of returns)

IMPORTANT: The projections or other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of December 31, 2014. Results from the model may vary with each use and over time. Notes: Forecast corresponds to distribution of 10,000 VCMM simulations for ten-year annualized nominal returns as of December 31, 2014 in USD for asset classes highlighted here. For details, see Vanguard’s economic and investment outlook (Davis, Aliaga-Diaz, Patterson, and Ahluwalia 2014). Source: Vanguard. For institutional investor use only. Not for public distribution.