Risk Parity and Efficient Asset Allocation

1 Lee Partridge, CFA Roberto Croce, Katherine Kellert, CAIA Risk Parity and Efficient Asset Allocation Salient Whitepaper #2011-11 Fund ID: RP Primer Salient Capital Advisors, LLC, 2012 Authors: Lee Partridge, CFA, et. al. 2 This information is being provided to you by Salient Capital Advisors, LLC, and is intended solely for educational purposes. No other distribution or use of these materials has been authorized. The opinions expressed in these materials represent the personal views of the investment professionals of Salient Capital Advisors, LLC and is based on their broad based investment knowledge, experience, research and analysis. It must be noted, however, that no one can accurately predict the future of the market with certainty or guarantee future investment performance.

2 Past performance is not a guarantee of future results. Certain statements in this communication are forward-looking statements of Salient Capital Advisors, LLC. The forward-looking statements and other views expressed herein are as of the date of this letter. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. The Adviser disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein. There can be no assurance that the Strategy will achieve its investment objectives.

3 The value of any strategy will fluctuate with the value of the underlying securities. This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Any offering or solicitation will be made only to eligible investors and pursuant to any applicable Private Placement Memorandum and other governing documents, all of which must be read in their entirety. Please note that the returns presented in this paper are the result of a hypothetical investment framework. Backtested performance is NOT an indicator of future actual results and do the results above do NOT represent returns that any investor actually attained. Backtested results are calculated by the retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses.

4 Certain assumptions have been made for modeling purposes and are unlikely to be realized. No representations and warranties are made as to the reasonableness of the assumptions. Changes in these assumptions may have a material impact on the backtested returns presented. This information is provided for illustrative purposes only. Backtested performance is developed with the benefit of hindsight and has inherent limitations. Specifically, backtested results do not reflect actual trading or the effect of material economic and market factors on the decision-making process. Since trades have not actually been executed, results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity, and may not reflect the impact that certain economic or market factors may have had on the decision-making process.

5 Further, backtesting allows the security selection methodology to be adjusted until past returns are maximized. Actual performance may differ significantly from backtested performance. Backtested results are adjusted to reflect the reinvestment of dividends and other income. The above backtested results are do not include the effect of backtested transaction costs, management fees, performance fees or expenses, if applicable. No cash balance or cash flow is included in the calculation. Additionally, note that an investor cannot invest directly in the S&P 500 TR Index or the Barclays Aggregate Bond Index, formerly Lehman Aggregate Bond Index until November 2008. Research services are provided by Salient Capital Advisors, LLC, a wholly owned subsidiary of Salient Partners, and an SEC Registered Investment Adviser.

6 Salient research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Salient recommends that investors independently evaluate particular investments and strategies, and encourage investors to seek the advice of a financial advisor. The appropriateness of a particular investment or strategy will depend on an investor s individual circumstances and objectives. The Salient Risk Parity Index represents hypothetical performance since the Index does not reflect any particular investment program and may, therefore, have certain inherent limitations, some of which are described below. Since this is Index performance, it does not represent the performance of any investment account or the results of actual trading, and no representation is being made that any account using the Index as a benchmark will experience performance similar to the Index s performance.

7 In fact, it is not uncommon for investment programs targeting a particular index to have performance that diverges materially from the performance of the relevant index. In addition, hypothetical performance does not involve financial risk, and no hypothetical performance record can completely account for the impact of financial risk that exists in an investment program that is actually trading. For example, the ability to withstand losses or to adhere to a particular trading Salient Whitepaper #2011-11 Fund ID: RP Primer Salient Capital Advisors, LLC, 2012 Authors: Lee Partridge, CFA, et. al. 3 program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.

8 The Index has been retrospectively calculated and did not exist prior to January 2012. Accordingly, the index performance shown for periods prior to January 2012 has been developed with the benefit of hindsight. Certain futures contracts and credit default swap instruments comprising the underlying Asset classes were not available at inception of the retrospective Index performance calculation beginning in January 1990. Futures contracts unavailable at Index inception were included in the underlying Asset classes as available. Credit default swaps comprising the Global Credit Asset class were included beginning February 2009. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses.

9 Note that an investor cannot invest directly in the Index. Salient is the trade name for Salient Partners, , which together with its subsidiaries provides Asset management and advisory services. Salient Whitepaper #2011-11 Fund ID: RP Primer Salient Capital Advisors, LLC, 2012 Authors: Lee Partridge, CFA, et. al. 4 Risk Parity and Efficient Asset Allocation Abstract A risk Parity portfolio is one in which each constituent contributes an equal amount to the total variance of the portfolio1, eliminating the concentration of risk created by virtually every other Asset Allocation In this document we introduce a simple, two- Asset version of risk Parity and show that a na ve risk Parity strategy, implemented using only information available at the time of investment, would have performed on par with the maximum Sharpe ratio portfolio, which is constructed with perfect Both strategies outperform a typical 60/404 portfolio on a risk-adjusted basis.

10 Because risk Parity (i) leads to portfolios that are very similar to the maximum Sharpe ratio portfolio and (ii) can be implemented effectively without forecasting future returns, we think it serves as the most reliable proxy for the tangency These insights serve as the basis for an implementable version of Modern Portfolio Theory wherein risk Parity serves as the tangency portfolio. We show how this approach can be used to increase investor returns without increasing risk or, alternatively, to reduce risk while achieving the same level of return. 1 Risk Contribution reflects the percentage of the portfolio's risk, as defined by standard deviation, contributed by the underlying assets, equities and bonds.