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PERSONAL

MARKET REVIEW

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OUTLOOK

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CONFIDENTIAL

- 2015

INTRODUCTION

Every January, the investment committee at Gryphon Advisors internally conducts an extensive review of our
2014 performance, refining and adjusting our cyclical (six to twenty-four months) and secular (seven to ten years)
investment theses. In the past, the analyses and conclusions that result from this review have been sent to our clients in
a heavily-edited, brief two-page summary. This year, Gryphon has decided to give our clients a deeper perspective on
the investment committees process by supplying a Market Review & Outlook that is more expansive than past issues.
We believe you will find the following both straight-forward and informative.
2014 REVIEW INTERNATIONAL DIVERSIFICATION AND SMALL CAPITALIZATION STOCKS
Many globally diversified portfolio managers, including Gryphon Advisors, struggled in 2014. When
broadcasting investment returns data, the media predominately focuses on those generated by large capitalization
(cap) stocks domiciled in the United States; for instance, the Dow Jones Industrial Average and the S&P 500 Index.
These securities generated returns of almost 15% over the past year. If one held a portfolio that simply consisted of
mega market cap stocks from America, the year was fantastic.
However, the pool of securities available to an investor extends far beyond US large cap equities. At Gryphon,
we build portfolios based in part on the principle of diversification, owning assets with different risk and return
profiles, thereby reducing the volatility of our investment returns across the entire portfolio. In addition to US large
cap stocks, we invest in cash, bonds, stocks from markets outside of the US, commodities, real estate and alternative
strategies. Consequently, our allocated portfolios will always generate a return lower than the best performing asset
class. Despite the high returns from large cap US equities this past year, a portfolio that invested 80% in equities from
across the globe and 20% in bonds returned only 3.45% while a portfolio half invested in equities from across the
globe and half in bonds was up only 4.24%. Gryphons benchmark Global All Asset Benchmark, which includes cash,
hard assets and alternative strategies in addition to stocks and bonds, returned only 3.51%. The S&P 500 generated
returns of almost 15%, but bonds were only up 5% while all non-US stocks were down 4% and commodities fell by
17%. Even in the US stock market, smaller companies returned less than 5%. If an investor simply followed the
headlines on CNN, Fox or CNBC, the viewer likely received the false impression that all investment securities
generated favorable returns in 2014.
Among the core tenets of the Gryphon investment process are ownership of 1) high risk assets from outside of
the United States such as stocks from Europe or emerging economies and 2) the stocks of smaller companies such as
those in the Russell 2000 index. Exposure to these securities provides the enhanced risk-adjusted return benefit of
diversification, the only free lunch available to investors. The underperformance of these diversifiers relative to the
S&P 500 over the past 12 months will in no way dissuade us from continuing to include them in our prudently
allocated portfolios. One of the most serious mistakes an investment portfolio manager can make is over-emphasizing
recent performance in the search for attractive investments. In the three years leading up to the onset of the financial
crisis, foreign equities outperformed US stocks by almost 10% each year. The magnitude of the outperformance of US
large cap stocks over international stocks over the past two years has occurred less than 20% of the time historically
going back almost a half century. Despite their mediocre recent returns, small cap US stocks actually beat their large
cap peers in the crisis year of 2008, and since that time have only trailed large caps in 2011 and 2014. The meaningful,
persistent and exploitable outperformance of smaller cap stocks is exhibited in investment research. In the early
1980s, in the Journal of Finance, Banz (1981) and Basu (1983) exhibited the excess returns available from investing in
small caps and Fama and Frenchs seminal 1992 essay in the same publication provided further evidence for the
outperformance of smaller companies as part of their three-factor model explaining portfolio returns.

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Market Review & Outlook - 2015


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Adhering to the principles of 1) diversification by investing in stocks from non-US markets and 2)
overweighting smaller cap companies harmed our portfolio performance in 2014. However, our extensive and
continuous research indicate that these tenets are no less applicable today than they were last year, or ten years ago.
We would do a grievous disservice to our investors if we abandoned these proven principles because the precepts have
briefly gone out of style. We cannot promise that our portfolios will always generate outperformance on an annual
basis, but we can assure our investors that we will pursue, with discipline, the time-tested and proven sources of longterm, risk-adjusted outperformance. As famed investor Jeremy Grantham wrote in 2012, to be at all effective
investingit is utterly imperative that you know your limitations as well as your strengths and weaknesses. If you can
be patient and ignore the crowd, you will likely win. But to imagine you can, and to then adopt a flawed approach that
allows you to be seduced or intimidated by the crowd into jumping in late or getting out early is to guarantee a pure
disaster.
THE END OF THE DEBT SUPERCYCLE

A HISTORICAL INFLECTION POINT

Our secular view revolves around what analysts in the investment community refer to as the end of the debt
super-cycle and the onset of secular stagnation. For the developed market economies this is a historical inflection
point, and for emerging economies this is a pause in their economic and credit growth trajectory. Before the onset of
the debt super-cycle in the early 1980s, excess accumulation of debt was unwound during recessions when bad debts
were written off and companies that survived the recession borrowed less due to credit constraints. While these
periodic credit contractions caused immense economic pain to citizens, they cleansed the system of intemperate
leverage.
Over the past four decades, leverage grew at historically elevated rates in the private sector. As inflation
became well-tamed in the early 1980s, the Federal Reserve gained the ability to keep interest rates low not just in
recessions, but also during the succeeding expansions. Consequently, downturns became less severe and credit-fueled
growth rates remained unsustainably high as bad debts were propped up and households and companies accumulated
excess leverage, most particularly during the middle part of the 2000s. This process finally ended in the Great
Recession and accompanying financial crisis of 2008. Then, the final inning of the debt super-cycle played itself out as
sovereign governments attempted to continue the buildup of debt by increasing their own borrowing in an attempt to
make up for the fall-off of credit creation in the private sector. The European debt crisis and double-dip recession in
2011 marked the end of the developed economies ability to maintain the debt super-cycle through government
borrowing.
As demographics in the developed world continue to skew towards the elderly, the world economy has entered
a sustained environment of secular stagnation. The rate of debt accumulation will be significantly less than the past
forty years. This leads to 1) low real and nominal growth rates (as GDP growth has struggled to rise above 3% in even
the strongest of developed economies), 2) low wage growth (as real average hourly earnings have grown around 1% in
the US since the financial crisis), 3) low inflation (as post-crisis inflation in the Euro-area has mostly persisted at levels
below 1%) and 4) low interest rates (as a higher propensity to save has led to greater demand for debt from investors
amidst a decrease in supply, raising the price of debt, reflected by low interest rates). This type of economic
environment will lead to historically depressed returns from all asset classes as the price of interest-rate-tied securities
(cash and bonds) cannot go much higher while low growth rates limit the ability of companies to grow their revenue,
making risk assets (stocks) less attractive due to falling earnings growth.
In looking beyond the secular stagnation horizon, we believe that the most likely factor to end this affliction is
an intense levering up in the emerging economies. Their private-sector and public-sector debt levels are generally
lower, and their earnings growth prospects are better. Unlike the past four decades, when credit growth in the
developed markets buoyed economic growth and asset prices in the emerging economies, the post-secular stagnation
environment will feature an inversion in which the credit-fueled growth from the emerging markets will support
growth and asset prices in the developed markets.
However, the developing economies are not yet in a position to ramp up credit growth. Some, such as China,
are still experiencing indigestion from a massive increase in credit during 2008-2009. Others, such as Brazil, are
struggling to grow their economies because of the decline in commodity prices. Finally, only a small handful, such as
Mexico and India, have begun to implement the type of institutional free market reforms that are necessary for
sustained prosperity in which earnings flow to the private sector instead of the government and inefficient state-owned
enterprises.
In the future, we will reach an environment in which the developed nations have cleansed themselves of
excess debt and emerging economies are ready to absorb increasing credit and growth. However, over the course of the
next market cycle, declining debt and depressed growth will prevail.

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CYCLICAL OUTLOOK AND STRATEGY

EUROPE FINALLY LOOKS ATTRACTIVE

Our cyclical view revolves around the economic, corporate and political factors that are likely to influence
returns over the next six to twenty-four months. We expect the Federal Reserve to raise short-term interest rates by
incremental amounts beginning in the second half of 2015, although long-term yields on ten-year and thirty-year
bonds wont substantially increase. Central banks in Europe and Japan will keep their rates near zero while expanding
their balance sheets by purchasing bonds, increasing the amount of money in their economies. Monetary policymakers
in emerging economies, particularly China, India and Brazil, are unlikely to meaningfully increase rates. The disparity
between interest rates in the US and other countries, coupled with the relative attractiveness of US risk assets, will lead
to a US dollar that is either flat or strengthening versus most other currencies. Inflation across the developed world
will remain below central banks preferred 2% threshold. The developed markets will experience moderate economic
growth in the low single digits, enough to avoid widespread recessions and prevent corporate health from
deteriorating.
These conditions will prevent a major sell-off in developed market bonds, but fixed income from these
markets are limited in their attractiveness as their price is already at extremely elevated levels. Less tame inflation
conditions and deteriorating growth in the emerging economies mean that all but the highest investment grade bonds
in these markets will be prone to risk-aversion selling.
The strengthening dollar and weak demand resulting from moderate developed market growth and declining
emerging market growth will lead to commodity prices that are flat or slightly negative. Most major commodities have
already experienced sharp price declines, but the economic conditions needed to sustain price increases, such as
increasing demand or an unexpected decrease in supply, are not in place. OPEC oil producers, particularly Saudi
Arabia, are unlikely to reduce supply despite lower prices. Large oil companies have already begun to reduce capital
expenditures in the exploration for and production of black gold, but this will only have a drawn-out and
incremental impact. Because of the expected flat returns from bonds and commodities, we will continue to
underweight our exposure to these assets in favor of cash, real estate and alternative strategies.
Unlike the low risk and interest-rate-dependent investments mentioned above, equities are positioned for a
more nuanced and exciting year. The US market is the most likely to deliver average returns as two competing forces
play themselves out. On the one hand, valuations such as profit margins, dividend yield, price-to-earnings and priceto-sales are at significantly elevated levels relative to the historical mean. On the other hand, expenses will be easily
controlled because of conditions such as sustained low interest rates and low production costs, especially low wage
growth. Combined with aggregate demand that is historically low but directionally positive, it is unlikely that earnings
will meaningfully decline. Some larger, internationally-exposed firms will suffer from a stronger dollar, but the overall
impact should not be enough to trigger a bear market.
However, the potential for significant price appreciation is present in other developed markets outside of the
United States, most especially Europe. Historically low valuation metrics provide a margin of safety by lessening the
probability of a large sell-off. A massive quantitative easing program from the ECB, annual increases in non-financial
private sector total borrowing , lower oil prices, and diminished fiscal drag all lay the groundwork for a stimulation of
aggregate demand within the Eurozone. Meanwhile, a weakening euro will stoke demand from outside the Eurozone
for Euro-area-produced goods and services because the relative price of these goods and services has declined as the
dollar price of the Euro has fallen from over $1.30 to just over $1.10. These factors are laying the groundwork for both
earnings growth and multiple expansion among European equities.
The cyclical environment is much less bullish for emerging market (EM) equities. Monetary conditions are
simply neutral. Money growth is not expanding above historical norms and EM central banks will not engage in the
large scale easing of the ECB and BOJ. Fiscal support from governments will be mixed as some countries, such as
Brazil, may increase spending to placate a restless population, while others, such as China, pull back on government
borrowing as their economies continue to struggle to effectively digest the large increase in private debt that occurred
in the few years directly succeeding the financial crisis. Finally, most EM countries failed to institute free market
reforms during the heady days of the mid-2000s. Consequently, too much of the wealth still flows to governments and
state-owned enterprises. Weak social institutions and corruption make corporations and citizens nervous about their
financial future, encouraging a high propensity to save. Finally, weak commodity prices will depress growth in those
economies, such as Latin America, that generate significant revenue through the sale of natural resources. Despite a
mild positive effect from currency depreciation versus the US dollar, EM companies are unlikely to see increased
domestic and foreign demand. Declining earnings will be coupled with multiple contraction as foreign capital
continues to flow out of EM risk asset markets, increasing the probability of poor relative performance from emerging
market stocks in 2015.

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Over the course of the next year or two, the stimulative characteristics of the Euro area will fade away while
many emerging economies will begin to recover from the downturn in their business cycles. Anticipating these cyclical
conditions, and their eventual reversal, allow us to continue to add value to our portfolio returns by exploiting the
excess return available because of these short-term investment characteristics.
ASSET CLASS REVIEW

2014, CYCLICAL AND SECULAR

In constructing investment portfolios, Gryphon identifies two time horizons that frame our analysis. The
cyclical market environment describes short-term market inefficiencies that can be sources of excess return, but will
likely dissipate within the six to twenty-four months. These opportunities warrant smaller, tactical adjustments that
are beneficial, but in the relatively efficient and liquid markets in which Gryphon invests, the extra return is usually
limited to a percent or so. There are instances when tactical decisions can have significant effects on portfolio
performance, such as our substantial overweight to cash during the financial crisis and the early stages of the 2009
market rally. However, this is a rare situation, and only occurs during historically extreme events such as a massive
bear or bull market.
The secular market environment describes long-term shifts in the market paradigm that havent been
identified by most investors and will likely persist over the course of a full market cycle, or about seven to ten years.
These factors will lead to excess returns far above those available from cyclical inefficiencies. The decisions that
determine Gryphons secular outlook will be most responsible for any persistent performance deviation from our
benchmark.
For each asset class on the following pages, we have reviewed 2014 performance and then presented our
cyclical and secular views. Our opinions on the short-term and long-term prospects of asset classes may be in conflict
since different forces determine returns across distinct time horizons. However, there will be no conflict or wavering in
the well-researched and disciplined process that Gryphon pursues in constructing our globally diversified portfolios.
We remain confident that our approach will deliver long-term outperformance by exploiting inefficiencies that arise in
investment markets.

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FIXED INCOME

2014 Review
The aggregate bond benchmark returned just under 6% for 2014, more than we expected and driven largely by a continued decline in
intermediate and long term interest rates. We entered 2014 with a 10% underweight to bonds, 6% of which we placed in cash and the
remainder held in alternative strategy investments. As our investments in alternative strategies generally returned around 4% (and cash
returns were close to zero), this underweight to fixed income was a negative for returns relative to the benchmark. Within our fixed
income investments, our focus on credit risk over interest rate risk products led to returns of around 4% and our weighted exposure to
our three tactical managers generated returns of around 5%, as two of the three avoided significant interest rate exposure.

Cyclical View
In the US, real GDP will likely exceed 3%. Coupled with strong growth in the labor market, the Federal Reserve should begin to raise
rates in the middle of the year. Meanwhile, the Bank of Japan is also implementing polies aimed at increasing inflation. These actions
are a negative for bond returns, especially shorter maturity bonds. However, there is weak growth and deflationary pressure in the
Eurozone. Growth is also slowing in major emerging economies and declining commodity prices are keeping a lid on inflationary
forces. These characteristics are positive for sovereigns with strong credit. As these competing forces play against one another, the fact
remains that interest rates are at extraordinarily low levels across many different economies and fixed income products, significantly
limiting the upside return potential for most types of bonds. As such, we will continue to maintain a significant underweight to fixed
income in 2015, with greater credit risk and less interest risk than the benchmark.

Secular View
In the developed markets, the rate of increase in debt that has generally supported economic growth for decades peaked in the later
part of the 2000s. As the debt super-cylce begins to decline, the result will be mediocre economic growth in developed economies
and a reduction in the supply of debt. Combined with a volatile but sustained decrease in commodity prices and historically low
increases in wages, inflation across the developed world will remain low despite accommodative monetary policy. While the current
low level of interest rates do not leave much room for upside appreciation in bonds, these structural forces will prevent a significant
increase in interest rates. As such, we will opportunistically reduce our portfolios of their significant fixed income underweight over the
next few years. Bonds are by no means an attractive investment over the next ten years, but they will be better than cash returns that
will likely be well below the rate of inflation.

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US EQUITIES

2014 Review
The Russell 3000 US equity benchmark returned just above 12.5% in 2014.We entered 2014 noting the overvaluation of US equities
across a wide variety of reliable valuation measures, but we decided to enter 2014 maintaining our 1% dynamic overweight to domestic
stocks because of accommodative monetary policy, tame inflation and improving growth. We then adjusted our policy model in
mid-2014, further increasing US equity exposure by 1% (at the expense of emerging market equities). In the fall, we further increased
our dynamic weighting to US equities by an additional 1.5%. Our US equity portfolios had returns closer to 7%-8.5%,
underperforming the Russell 3000 benchmark because, while the index largely consists of large cap equities which returned almost
14%, we overweighted small cap stocks, and that index returned less than 5%. We did overweight large cap stocks relative to our Policy
Model, but our dynamic weighting to mid and small cap stocks was still greater than 50% while the equity benchmark has only a 25%
exposure to smaller cap stocks. In addition, two of our key managers, the flagship large cap fund from Manning and Napier and the
fund run by the mid cap value team at Artisan, generated unusually poor performance.

Cyclical View
After another year of double-digit returns, the US equity market remains at a historically expensive level. On the other hand, low
interest rates, depressed wage pressures, a boost to personal consumption via falling energy prices, and a number of other factors mean
that profit margins and other determinants of corporate performance in the US bode well for equity returns. Therefore, on a cyclical
basis, we are increasing our 22.5% exposure to US stocks up to 24.5%, at the expense of emerging market equities. Within the US
equity market, we are increasing our weighting to large cap stocks from 55.5% of our US stock exposure up to 70% with a focus on
dividend stocks. This is a defensive measure driven by the idea that lower nominal returns (due to high valuations) will make the yield
on high-quality US value stocks more attractive. In addition, when historically elevated profit margins do begin to revert to the mean,
smaller companies that are more exposed to the business cycle will suffer greater earnings impairment. Despite the cyclical increase in
our weighting to US equities, we continue to remain lukewarm on US stocks, as evidenced by a dynamic weight (24.5%) below policy
(25%) and a shift towards more defensive companies.

Secular View
We entered 2014 with a policy weighting of 19% to US stocks in the overall portfolio, and this equated to just over one-third of our
equity exposure. After moving our policy weighting to 20% last year, we are now increasing our policy weighting again; this time to
25% of the overall portfolio and 45% of our equity investments. This increased secular exposure to US equities is driven less by the
absolute attractiveness of US stocks and more by their characteristics relative to deteriorating conditions in foreign developed markets.
In particular, US demographics still exhibit higher domestic birth rates and stronger immigration rates. In addition, the more
productive private sector still drives the preponderance of the US economy, US policy is favorable towards business innovation, such as
energy extraction, and free trade, and there is growing appreciation for the benefits of lower corporate income tax rates. Coupled with
persistently low interest rates, and with the cost of goods remaining low due to declining commodity prices and modest wage
pressures, US profit margins will continue to ride a trajectory above historical averages for a sustained period. As such, this warrants an
increased policy weighting toward US equities, although our 45% is still under than benchmarks 48.5%. Within the US equity asset
class, we are maintaining our 52% weighting towards mid and small cap stocks relative to the benchmarks 25%. Despite recent
underperformance, and the risk of continued underperformance in a bear market, the outperformance of small cap equities articulated
by Fama and French has consistently been identified across multiple market environments both in the domestic and foreign markets.
Similarly, we will continue to maintain our overweight to value stocks (50% versus 35% for the benchmark). Despite widespread
knowledge of these sources of excess return, the magnitude of outperformance generated by smaller cap and value stocks has not
meaningfully declined.

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FOREIGN DEVELOPED EQUITIES

2014 Review
Foreign developed stocks generated the worst return in the equity universe, returning about negative 5%. We decided to enter 2014
with a 3% dynamic overweight to EAFE stocks, driven by fundamental valuations. However, this was still below the benchmarks
22.5% EAFE weighting. In mid-2014, we then increased our policy weighting to foreign developed equities by 1% (at the expense of
emerging market equities), but did not increase our dynamic weighting. Finally, in the fall, we increased our dynamic weighting by
0.5%, ending the year with a 21.5% weighting to EAFE stocks; 2.5% above our policy weighting but 1% below the All Asset
benchmark. Our EAFE portfolio generally returned a benchmark-like negative 5%. Our positive attributes were strong manager
selection with the exception of the small cap growth team at Franklin and our meaningful exposure to smaller cap stocks, which
outperformed large cap equities by 2%. However, these were offset by our value tilt, as EAFE value trailed growth by 1%, and the fact
that we increased exposure to EAFE stocks later in the year, as EAFE peaked in late June and returned almost down 10% in the second
half of the year.

Cyclical View
From a cyclical perspective, EAFE stocks are attractive relative to the US equity market on a number of fundamental levels; P/E ratio
under 15 versus over 17, price-to-sales of 1 versus almost 2, a dividend yield of 3% versus 2% and price-to-book of 1.5 versus 2.5.
These valuations are coupled with the recent implementation of a massive easing program from the ECB and the BOJs easing policies,
diminished fiscal drag as the Euro area now has a cyclically-adjusted surplus of over 1%, lower oil prices, a weaker currency, and an
end to the negative annual change in non-financial private sector total debt. Consequently, EAFE stocks look attractive. These positives
are offset by some negatives; for example, the quality of earnings from EAFE firms are worse than US companies as the former
significantly trail the latter in earnings growth, sales growth, cash flow growth and the like. Furthermore, high debt levels are combined
with recessionary and deflationary episodes across a number of EAFE countries, which has depressed stock prices relative to their
fundamentals. Although the long-term outlook for the euro area remains uninspiring, we are maintaining our 21.5% cyclical weighting
to EAFE stocks, a level which now exceeds the All Asset benchmark by almost 1% and our policy weight by 3.5%.

Secular View
We entered 2014 with a 18% policy weighting towards EAFE stocks, compromising just under one-third of our overall equity
portfolio. After increasing our policy weighting to 19% in mid-2014, we are now decreasing our policy weighting back to 18%,
reallocating that exposure to US equities. Quite a few of the major EAFE economies, such as Japan and most of the major European
countries, have demographic issues where an increasing number of elderly are becoming dependent on a shrinking labor force and
immigration is not as widely accepted as it is in the US. In addition, high debt levels will constrain growth in economies where growth
already suffers from the fact that the public sector drives more of the economy than the more private sector-focused US economy. A
prolonged period of deflation would increase the real value of existing debt liabilities, while high levels of unemployment would sap
the tax base and reduce the productive capacity of the economy. The remaining free market institutions in the Euro economy are
becoming more susceptible to populist political extremes from both the right (the National Front in France) and the left (Syriza in
Greece and Podemos in Spain). There are still good reasons to have meaningful exposure to EAFE stocks, such as diversification and
attractive valuations; these companies will still generate earnings, its just that they will grow these earnings less than other equity asset
classes. In addition, a couple of the factors which favor this asset class in the shorter-term, such as a weakening currency and lower oil
prices, will likely find a floor in the next twelve months and therefore cease to act as a buoy to stock prices. As such, EAFE equities will
now occupy just under a third of our policy equity exposure versus almost 40% for the benchmark. Similar to our US equity
investments, we are maintaining our overweight to small cap equities (40% of total EAFE exposure) and value (50% of total EAFE
exposure) as these factors of outperformance have been shown to consistently outperform across multiple time periods and regions.

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EMERGING MARKETS EQUITIES

2014 Review
Emerging market (EM) stocks generated a negative 2.19% for 2014 on a roller coaster ride that saw them generate 10.63% through the
end of August (outperforming both EAFE and US stocks) and then return -11.58% from late summer to years end. Going in to 2014
we slightly reduced our exposure to emerging market equities, and within the space, we are reallocating towards Asian and frontier
markets and away from equity markets that feature more commodity-linked and natural resource-related firms, such as those in Latin
America. However, we continued to contend that the long-term fundamentals that support this asset class remain largely in place
driven by positive demographics and growing wealth. We entered 2014 with an 18% policy weight to emerging market stocks and a
dynamic underweight of 4%, equating to 14% exposure. In mid-summer, we then reduced our policy weighting to 16% but kept the
dynamic weight at 14%. Finally, in late fall we decreased the dynamic weighting to 12%, re-instating our 4% underweight versus the
policy model. Our EM portfolio returns were generally flat to slightly negative for the entire year, generating index-like returns of
10.5% in the rally, but only falling about 10.5% when the index sold off by over 11.5%. Our portfolios were meaningfully helped by
our exposure to a strong-performing frontier markets fund as well as some timely sales in mid-June and mid-August.

Cyclical View
Similar to EAFE stocks, emerging market equities are attractive based on a number of fundamental valuation levels with a P/E ratio of
about 12, a price to sales of 1.15, a dividend yield over 2.55 and a price-to-book of 1.5. However, many significant EM economies such
as Brazil, Russian and China are suffering from growth recessions or slowdowns. In some EM economies, such as China, this is due to
the natural business cycle retraction in credit growth that predictably results from the severe increase in private sector credit that
occurred in the couple of years just after the Great Recession. Other economies, such as Russia, are suffering from more idiosyncratic
difficulties such as capital flight due to collapsing currency and energy prices coupled with antagonistic foreign policy. In addition,
over the next 12 months, currencies across the EM universe are likely to materially sell-off versus a stronger US dollar, weakening EM
stock returns for US dollar-based investors. Based on these near-term headwinds, particularly the business-cycle driven decline in
private credit growth, we are lowering our dynamic exposure to EM stocks to 10%. This is a 2% underweight relative to our new, lower
policy weighting of 12%, placing EM stocks at just over 17% of our overall equity exposure.

Secular View
We entered 2014 with an 18% policy weighting to EM, compromising about one-third of our overall equity exposure. After decreasing
the policy weight to 16% in the middle of the year, we are now reducing our policy weighting to EM stocks by an additional 5%, down
to 12%. This means that EM stocks will now compromise slightly over a fifth of our overall equity exposure on a policy basis. This
represents a significant decrease from the 18% policy weighting, but is still more than double the exposure that a benchmark-weighted
portfolio would have to emerging market stocks. This begs two questions: 1) what did Gryphon get wrong, warranting such a
meaningful decline in policy exposure and 2) why is Gryphon still maintaining such a significant overweight to EM equities relative to
the global equity benchmark? We overestimated the ability of emerging market economies to decouple from the global business cycle.
Specifically, although EM economies are in much better condition in terms of overall debt burdens, their sovereign governments have
not been able to make up for the decline is credit growth that is emanating from the developed economies due to the end of the debt
super-cycle. As such, investments in EM equities will not be able to provide the diversification benefits that we had hoped would come
from economies that we thought could continue to generate growth via credit even in time periods when developed economies were
experiencing credit-contraction recessions. In addition, while intra-EM trade has increased and therefore made the EM economies
somewhat less reliant on developed nations, the financial markets of these economies are still, on the margin, subject to the hot
money of developed market investors, meaning that periods of fear in developed markets are likely to coincide with selling in EM risk
assets. On the other hand, we are still maintaining a significant policy overweight relative to the global equity benchmark because many
EM economies have significantly better debt profiles than developed economies, particularly in the sovereign debt market. In addition,
inflation in the EM economies has become more manageable and the cost of labor is significantly more attractive relative to developed
economies. Combined with positive demographics where a younger labor force is available to support a much smaller base of the
elderly, EM equity markets have the factors in place that will lead to better returns on investment than developed markets. As such,
over the long term, capital should flow from developed market equities into EM risk assets to take advantage of this higher return on
capital. As a result, we are still most bullish on EM equities in the long run, and it is the only equity asset class where we are overweight
the global equity benchmark on a policy basis.

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HARD ASSETS

2014 Review
Hard asset investments had quite a mixed year in 2014. The global property index returned about 13.5%, driven by just over 30%
returns in US real estate investment trusts (REITs) and returns in the low single digits for international REITs. Meanwhile, the
commodity index fell by 17% with returns in agriculture about flat, oil down more than 40%, natural gas down about -25%, industrial
metals down about -7% and precious metals down slightly more than 5%. Finally, the natural resource equity index was down about
10%, driven largely by energy-related firms, who returned negative 10%, while metals & mining firms had returns down more than
20%. Ultimately, the blended hard asset benchmark returned negative 5%. Similar to emerging market equities, the negative return
was due to poor performance in the 2nd half of the year, as the blended benchmark was up over 11.5% in the first half when REITs
returned over 11%, commodities were up over 7% and natural resource equities returned almost 16.5%. In the second half of the year,
the blended benchmark declined by 15% as REITs had small positive returns but commodities and natural resource equities declined
by more than 20%. We entered 2014 with a 1% dynamic underweight to hard assets at 9% overall exposure, with 3.5% allocated to
REITs, 2.5% to the broad commodity index, 1% to gold and 2% to natural resource equities. Near the end of the year, we further
reduced our dynamic exposure by 1%, eliminating our dedicated investment in gold. Our hard assets portfolios slightly trailed the
blended benchmark at negative 6%, delivering below-benchmark returns of 11% during the first half rally, but slightly outperforming
(down only 14%) during the second half sell-off. Our dedicated exposure to gold helped us outperform commodities. Our natural
resource equity investments trailed the benchmark due to concentrated energy investments and poor performance from our allocated
hard assets fund. Finally, our REIT returns trailed the benchmark due to poor performance from our active manager in the non-US
REIT. (We replaced this manager with a passive index investment during our year-end tax-loss-harvesting).

Cyclical View
Valuations are mixed in the hard asset space. REITs are expensive on a P/E basis, but still yield more than double the 10-year US
treasury yield. Natural resource equities generally have P/Es of 14, lower than the overall US equity index, and a REIT-like yield of
over 3.5%, but the recent descent in the price of oil will make it difficult for many firms to maintain earnings. Meanwhile, weak global
growth and a strong US dollar will act as major headwinds for commodity prices. Based on these forces, we are maintaining our 2.5%
weighting to natural resource equities, but eliminating our dedicated 2.5% weighting to commodity contracts and re-investing those
proceeds in REITs, which will now make up 5.5% of our overall investment portfolio.

Secular View
We are maintaining our 10% policy weighting to hard assets. However, while we allocated one-third of this exposure to each sub-class
in 2014, on a secular basis we are moving half of this exposure to REITs and placing one-quarter in commodities and an identical
amount in natural resource equities. The low level of interest rates that should prevail over the next ten years will make high-yielding
REITs attractive to the constantly-growing investment bucket of elderly, yield-seeking investors. Meanwhile, the secular end of creditfueled growth in the developed markets will lead to consistently sluggish demand over the next ten years, so production growth will be
low and the price of input goods (commodities) will not have the support that they did in the 2000s. Therefore, the price of
investments in commodities futures contracts will decline in real terms and the earnings of firms that explore for, produce, refine and
sell the commodities will decline as they struggle to maintain margins. In addition, persistently low inflation will drive financial
investors from the commodities markets, as they invested in commodities seeking a hedge (against inflation) that will be less necessary
over the next 10 years.

PERSONAL

&

CONFIDENTIAL

Market Review & Outlook - 2015


Page 10
ALTERNATIVE STRATEGIES

2014 Review
Alternative strategies generated a predictably steady return in 2014, with the hedge fund of funds index up 3.43% for the full year, with
low single digit returns during both the risk asset rally in the first half of the year and the risk asset sell-off in the second half of the
year. Some of the larger bear market funds generated returns in the negative mid-teens, conservative allocation funds returned about
5%, some of the most prominent long/short funds returned 5-7%, and market neutral & arbitrage funds had positive returns in the
low single digits. Many of the largest fund of funds also had positive returns in the low single digits while prominent managed futures
funds had returns just above 10%. We entered 2014 with a significant 5% overweight to alternative strategies because, as we wrote in
our 2014 outlook, we will continue to overweight alternative strategies in 2014 due to our negative outlook for fixed income, the
paltry returns from cash and the deteriorating valuations among developed market equities. In the middle of the year, we increased
our alts overweight to 6% and then up to a 7.5% overweight at year-end, resulting in a cumulative 12.5% weighting to this asset class
by December (compared to a 5% policy weighting). Our alternative strategy portfolios returned a benchmark-like 3.5%, helped by our
dedicated exposure to managed futures, our decision not to renew our risk-asset put options for 2014, and one of our more equityfocused allocation funds which returned almost 7%. Meanwhile, our two other tactical, global macro allocation funds returned about
0.5%.

Cyclical View
In a normal market environment, alternative strategies are not an asset class to which we would have a large overweight. During
periods of growth, we would overweight equities and, during periods of contraction, we would favor bonds. However, at this particular
moment, global growth is mediocre while global interest rates are at historic lows, meaning neither conventional low-risk assets nor
high-risk assets are worth significantly overweighting. Meanwhile, returns from holding cash are practically zero, resulting in a
consistent decline in purchasing power if one holds cash. As such, we have taken a significant portion of our dynamic underweight to
fixed income and placed the proceeds into alternative strategies, leading us to maintain our 7.5% overweight to alternative strategies in
2015. Because both major asset classes (equities and bonds) are expensively priced, they are significantly more vulnerable to sharp
declines than they have been over the last 6 years. As such, investments with tactical allocation managers who can quickly react to the
advent of meaningful sell-offs should help fortify our portfolios if we experience sharp declines in either bonds or stocks.

Secular View
We are maintaining our 5% policy weighting to alternative strategies. Over the course of a full market cycle, we would expect most of
these investments to generate returns in the mid-single digits; well below the near double digit historical returns generated by the
equity risk asset class. However, we expect our alternative strategies to produce volatility similar to the much safer fixed income asset
class and, most important, a return profile that is not significantly correlated to either bonds or equities. While these investments are
relatively lower returning compared to the risk assets that make up the majority of our portfolios, their ability to enhance risk-adjusted
return still warrants their inclusion. In addition, our exposure in this asset class consists of significant investments with strategic
allocation managers who manage portfolios utilizing the same philosophies that guide Gryphons overall allocation portfolios. These
managers are not subject to the same constraints that we are (trading costs, tax costs, etc), and they are therefore able to implement
more tactical, short-term portfolio changes that we favor, but cannot execute because of real-world feasibility constraints.

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