Envestnet eBooks

12 | Envestnet | PMC Investment Methodology Guide FOR ONE-ON-ONE USE WITH A CLIENT'S FINANCIAL ADVISOR ONLY and continuously to evaluate the ongoing investment merits of the various investment options on the Envestnet platform. Updates to the research statuses of the investment strategies on the platform are announced approximately eight weeks after each quarter-end, and are implemented approximately 12 weeks after each quarter-end. Quantitative Approval PMC's QRG team implements and maintains the quantitative process that evaluates the investment options offered on the platform, resulting in a list of approved products each quarter. QRG's quantitative evaluation consists of two processes: one to evaluate actively managed mutual funds and SMAs, and a separate one to evaluate indexed mutual funds, SMAs, and ETFs. The quantitative ranking and approval methodology for actively managed products comprises six components— three return-based and three risk- based—that are each evaluated on multiple investment horizons. The return-based components include: active return, batting average, and information ratio; risk-based components are beta, R-Squared, and tracking error (TE). To be eligible for inclusion in PMC's quantitative approval process, an actively managed mutual fund or SMA product must exhibit the following: • three or five years (depending on Envestnet peer group) of complete, historical performance available on the Morningstar data feed; and • a Morningstar-style category universe membership. Each quarter, PMC downloads the data from Morningstar for all managers satisfying these criteria, classifies it according to Envestnet's peer groups, and assigns best-fit benchmarks. We use Morningstar-assigned benchmarks, which are unique to the Morningstar-style category, to analyze managers. Some Envestnet peer groups (e.g., International Developed Markets), are formed by mapping multiple Morningstar-style categories into a single peer group. Managers also are subject to a regression analysis to determine whether the assigned Morningstar benchmark is appropriate. When possible, a benchmark whose fit is deemed to be considerably better than the Morningstar benchmark is selected from a pre-determined list for that particular Envestnet peer group. Finally, if the fit to the Morningstar benchmark (or any other benchmark in the pre-determined set of benchmarks) is poor, PMC reverts to the benchmark used in the fund's prospectus for the analysis. This process results in a "Q-Score," a quantitative ranking derived from a 12-factor model comprising risk and return components associated with each individual portfolio being evaluated. The model places a premium on managers with the following characteristics: • Consistent active return—portfolios that have consistently beaten their benchmark over time. • Effective and consistent risk control—portfolios that have consistently tracked their respective benchmark over time. • Efficient risk/return profile— portfolios that have generated meaningful active returns relative to the risk taken. To achieve initial "Approved" research status, the Q-Score must rank in the top 30 percent of the manager's peer group, and must rank in the top 50 percent to maintain it. However, even with a high Q-Score, a portfolio may still be excluded from the Approved List. Managers who have had 100% portfolio management team turnover in any of the last 12 quarters will be screened out. Additionally, there is also a check if a manager denoted that they have GIPS information in the Morningstar database. If GIPS information is missing from the Morningstar database, an independent performance audit may be used as a manual override to the GIPS requirement, and certain SMAs may not be eligible from becoming "Approved" as a result of non GIPS compliance or no performance audit. Mutual funds and SMAs that are configured as accessible options on the Envestnet platform that pass the quarterly Q-Score analysis (and not excluded due to GIPS non-compliance or have 100% manager turnover) are added to the Approved List with the "Approved-Quantitative" status. The PMC Research team holds regular meetings with QRG to review and update the inputs and factors that make up the methodology. Indexed Funds The quantitative ranking and approval methodology for passively managed products looks at TE, liquidity, and costs. The PMC Research team does not apply a qualitative review process to passively managed mutual funds, SMAs, or ETFs. Passively managed mutual funds, indexed SMAs, laddered bonds, and ETFs are all considered for quantitative approval by the PMC QRG team via the following process at this time. Return Components • Active Return • Batting Average • Information Ratio Risk Components • Beta • R-Squared • Tracking Error

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