AAN INVESTMENT STRATEGY DEVELOPED TO

1 Washington Trust Bank Wealth Management & Advisory Services Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities. A AN INVESTMENT STRATEGY DEVELOPED TO OUTPERFORM WHEN INTEREST RATES RISE Nicholas Reynolds Portfolio Manager OVERVIEW Interest rates, or nominal interest rates, reflect the sum of two components: a real interest rate and an inflation rate.

As such, interest rate changes (both rises and declines) can reflect a change of the real interest rate or the inflation rate. These interest rate changes can be driven by improving or weakening economic data, changing inflation expectations, or changes in the supply and demand to lend/borrow money. A change in interest rates can have varying impacts on portfolio performance. With interest rates at historic lows, a lot of investor discussion and concern has centered on the probability that interest rates will eventually rise, and the impact this event will have on portfolio performance. Rising interest rates can be of investor concern given the differing impacts they can have on asset class performance (particularly fixed income).

At Washington Trust Bank, we believe investors should focus on whether an overall investment strategy is performing to meet his or her investment objectives. As part of our process, we continually research and explore investment strategies optimized to perform in differing environments.

This research paper seeks to identify an asset allocation strategy optimized to outperform in a rising interest rate environment. Using historical interest rate data, we identify recent time periods of rising interest rates. An investment strategy is then developed to outperform in this environment. We then compare the performance of the developed strategy against that of our existing Global Strategy. December 2014 WEALTH MANAGEMENT & ADVISORY SERVICES

2 Washington Trust Bank Wealth Management & Advisory Services Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy.

Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities. STUDY METHODOLOGY Substantial changes in the yield on the 2-year U.S. Treasury were used to identify periods of rising and declining interest rates. The 2-year U.S. Treasury was used, since it is a short-maturity bond with interest rates set by the open market. Analyzing the 2-year U.S. Treasury yields since 1997 shows there have been two periods of rising interest rates (10/30/1998 to 4/28/2000 and 6/30/2003 to 6/30/2006). During these periods, the 2-year U.S.

Treasury yield increased 3.20% on average from trough to peak over 2.3 years. Table 1 details the 2-year U.S. Treasury yield change in rising interest rate environments. Table 1 - 2-Year U.S. Treasury Yield Change in Rising Interest Rate Environments Trough Date Trough Yield Peak Date Peak Yield Yield Change Time Change 10/30/98 4.12% 4/28/00 6.68% 2.56% 1.5 Years 6/30/03 1.30% 6/30/06 5.15% 3.85% 3.0 Years Average 3.20% 2.3 Years Looking at the 2-year U.S. Treasury, there have been three periods of declining interest rates. In these periods, the 2-year U.S. Treasury yield decreased 3.33% from peak to trough over 1.2 years on average (4/28/2000 to 10/31/2001, 3/29/2002 to 6/30/2003, and 5/31/2007 to 3/31/2008).

Table 2 details the 2-year U.S. Treasury yield change in declining interest rate environments.

Table 2 - 2-Year U.S. Treasury Yield Change in Declining Interest Rate Environments Peak Date Peak Yield Trough Date Trough Yield Yield Change Time Change 4/28/2000 6.68% 10/31/2001 2.42% -4.25% 1.5 Years 3/29/2002 3.71% 6/30/2003 1.30% -2.41% 1.3 Years 5/31/2007 4.91% 3/31/2008 1.59% -3.33% 0.8 Years Average -3.33% 1.2 Years Using these identified time periods of declining and rising interest rates, historical asset class performance data was reviewed. When asset class indices were not available, composites were built using available mutual fund manager performance data. We analyzed performance data which included total annualized return, standard deviation (which quantifies portfolio volatility), and Sharpe ratio (a measure of risk-adjusted return).

3 Washington Trust Bank Wealth Management & Advisory Services Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities. Table 3 details the historical performance data of the asset classes in the rising interest rate environments. Table 3 - Asset Class Performance in Rising Interest Rate Environments Asset Classes Total Return Standard Deviation Sharpe Ratio Emerging Markets Equity 38.55 21.72 1.86 International Small Cap 37.76 17.60 2.21 International Large Cap 24.87 11.99 2.13 Domestic Mid Cap 22.19 12.41 1.84 Domestic Small Cap 20.68 16.59 1.32 Volatility Protection 19.79 16.13 1.29 Emerging Markets Bond 16.37 12.18 1.40 Domestic Large Cap 16.30 12.56 1.35 Real Estate 14.89 19.42 0.86 Infrastructure 14.22 7.85 1.85 Commodities 13.56 13.18 1.09 High Yield Bonds 6.57 5.35 1.26 Global Macro 6.13 2.63 2.35 Floating Rate Loans 5.83 0.94 6.19 Market Neutral 3.31 2.18 1.53 Inflation 3.19 1.10 2.90 Mortgage-Backed 2.88 2.02 1.44 Inflation-Protected Bonds 2.66 3.96 0.69 Short-Term Bonds 1.80 1.73 1.05 Managed Futures 0.03 9.33 0.05

4 Washington Trust Bank Wealth Management & Advisory Services Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities. Table 4 details the historical performance data of the asset classes in the declining interest rate environments. Table 4 - Asset Class Performance in Declining Interest Rate Environments Asset Classes Total Return Standard Deviation Sharpe Ratio Managed Futures 17.95 12.48 1.50 Inflation-Protected Bonds 13.03 3.61 3.63 Commodities 12.14 16.55 0.82 Emerging Markets Bond 10.25 10.39 1.04 Short-Term Bonds 9.38 2.19 4.30 Mortgage-Backed 8.87 3.01 2.96 Global Macro 8.19 3.58 2.30 Real Estate 5.73 19.13 0.41 Market Neutral 4.29 3.60 1.21 High Yield Bonds 2.90 11.20 0.32 Inflation 2.71 0.85 3.17 Floating Rate Loans 1.50 5.23 0.32 Volatility Protection (0.56) 7.70 (0.03) Infrastructure (8.04) 10.63 (0.69) Domestic Mid Cap (8.63) 12.83 (0.60) Domestic Small Cap (9.88) 15.02 (0.57) Emerging Markets Equity (9.97) 22.76 (0.30) International Small Cap (12.47) 17.92 (0.58) Domestic Large Cap (12.93) 11.35 (1.07) International Large Cap (13.30) 14.08 (0.86) The asset class performance data shows that, in general, stocks perform well when interest rates rise.

The top five performing asset classes were Emerging Markets Equity, International Small Cap, International Large Cap, Domestic Mid Cap, and Domestic Small Cap. When interest rates decline, bonds generally outperformed. Managed Futures, Inflation-Protected Bonds, Commodities, Emerging Markets Bond, and Short-Term Bonds were the top performing asset classes. This comparison allows us to see that asset classes perform differently given changes in interest rates. The comparison also shows us that both equities and fixed income asset classes are affected by these changes. These observations are important as they indicate that it is possible to identify an asset allocation optimized to outperform in a rising interest rate environment.

5 Washington Trust Bank Wealth Management & Advisory Services Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities. Using the historical performance data in the identified rising interest rate environments, we developed a strategy optimized to improve risk-adjusted return when interest rates rise. Table 5 compares the asset allocation of the existing Washington Trust Bank Global Strategy to that of the strategy optimized for rising interest rates.

Table 5 - Global Strategy Asset Allocation Compared to Rising Interest Rate Strategy Asset Classes Global Strategy Asset Allocation Rising Interest Rate Strategy Domestic Large Cap 21.60% 21.60% Domestic Mid Cap 5.40% 2.20% Domestic Small Cap 0.00% 0.00% International Large Cap 3.00% 9.75% International Small Cap 4.20% 11.02% Emerging Market Equity 3.90% 2.20% Commodities 3.00% 2.20% Infrastructure 3.00% 2.20% Real Estate 3.00% 2.20% Volatility Protection 3.90% 2.20% Market Neutral 6.00% 2.20% Managed Futures 3.00% 2.20% Growth Subtotal 60.00% 60.00% Short-Term Bonds 19.00% 19.00% Inflation-Protected Bonds 4.30% 1.62% High Yield Bonds 4.20% 1.62% Emerging Markets Bond 6.50% 1.62% Floating Rate Loans 3.00% 8.08% Mortgage-Backed 0.00% 0.00% Global Macro 3.00% 8.08% US Inflation 0.00% 0.00% Income Subtotal 40.00% 40.00% Total 100.00% 100.00% As shown in the table, the strategy optimized for rising interest rates has a higher allocation to International Large Cap, International Small Cap, Floating Rate Loans, and Global Macro.

Conversely, the allocations declined for Domestic Mid Cap, InflationProtected Bonds, High Yield Bonds, and Emerging Markets Bond. These changes in allocation appear largely consistent with the performance comparison differences observed between asset classes in a rising interest rate environment as opposed to a declining interest rate environment.

The period of review for the study was 11/30/1997 to 6/30/2014, which included the rising and declining interest rate time periods and allowed for available historical asset class performance data. Additional information on the study methodology is presented in Appendix 1.

6 Washington Trust Bank Wealth Management & Advisory Services Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

Analysis and Results Table 6 below presents the total return, risk (as measured by standard deviation), and risk-adjusted return (as measured by Sharpe ratio) of the Washington Trust Bank Global Strategy and the rising interest rate strategy.

Table 6 - Global Strategy Asset Allocation Performance Compared to Rising Interest Rate Strategy Asset Mix Total Return Standard Deviation Sharpe Ratio Global Strategy 13.31 6.14 2.20 Rising Interest Rate Strategy 14.94 6.53 2.32 As shown above, the rising interest rate strategy has a higher total return in the two historical periods of rising interest rates (10/30/1998 to 4/28/2000 and 6/30/2003 to 6/30/2006). As measured by standard deviation, which is a measure of portfolio risk, the rising interest rate strategy also has higher risk than the existing Global Strategy. Looking at the Sharpe ratio, which is a measure of risk-adjusted return, is important as it shows how much return the portfolio is receiving for a given level of risk.

The Sharpe ratio shows that the rising interest rate strategy has a higher risk-adjusted return than that of the Global Strategy.

Conclusion This performance data, as measured by total return, standard deviation (risk), and Sharpe ratio (risk-adjusted return) demonstrates that a strategy optimized to outperform in a rising interest rate environment has been successfully identified. This conclusion is not surprising, as the strategy reflects increases in allocation to asset classes that perform well in a rising interest rate environment and declines in allocation to assets classes that underperform. This research provides important insight should interest rates rise.

With interest rates at historic lows and the probability that interest rates will rise in the future, an investment strategy designed to perform in a rising rate has appeal.

The challenge to investors continues to be the ability to forecast a rising interest rate environment before it occurs and to be able to invest a portfolio to best take advantage of it. Given the difficulty in correctly making this determination as markets are constantly changing, we continue to argue that an investor’s focus should be on whether an overall investment strategy is performing to meet his or her investment objectives.

  • 7 Washington Trust Bank Wealth Management & Advisory Services Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities. Appendix 1 – Additional Information on Study Methodology
  • Asset class indices were used in this study as they appropriately represent asset class performance, but do not reflect investment manager bias. When asset class indices were not available, composites were built using available mutual fund manager performance data.
  • The period of review for the study was 11/30/1997 to 6/30/2014, which included the rising and declining interest rate time periods and allowed for available historical asset class performance data. This period ensures that the performance analysis is significant over multiple market cycles.
  • The back-tested models and traditional blended benchmarks were rebalanced once a year to target weights (on a rolling calendar basis).
  • The study assumes that an investor was invested in the asset allocation for the full time period studied. We recognize that many investors may not have utilized all the asset classes shown for the full time period and that your actual investment results may be different as a result.
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