Second Quarter 2017

We believe the low-growth, low-inflationary environment will continue through the third quarter. In our last letter we
discussed at length the disparity between “soft” data, such as optimistic consumer sentiment and strong stock market
performance, and the disappointing “hard” data surrounding economic performance. With another quarter in the books
we still haven’t moved much closer to resolving this conundrum. U.S. stock markets remain near all-time highs, while
recent economic and inflation indicators have headed south. Despite this uncertainty, bond and stock market volatility
measures remain at extraordinarily low levels.

We believe that the markets are underpricing the policy, political, and economic downside risks. Beginning with
monetary policy, in our view, the Fed has done an excellent job guiding the U.S. economy out of the Great Financial
Crisis. The markets seem to be quite confident that this success will continue as the Fed unwinds its monetary easing
programs. Currently, the Fed believes that the dip in inflation results is transitory. It expects to continue to raise rates
gradually and begin winding down its portfolio of MBS and Treasuries later this year. However, we are in new territory
in this regard, and the risk of a policy mistake is relatively high. Historically, recessions tend to occur during periods
when the Fed is raising rates.

The new administration’s proposed policies have elevated business and consumer confidence. We see potential risks
both at home and abroad. Domestically, expectations for large infrastructure spending programs, deregulation and tax
cuts provide hope of stronger economic growth and higher profitability. So far, the administration has been
unsuccessful in moving forward fiscal and tax spending legislation, bogged down by the efforts to repeal Obamacare
and the expanding investigation surrounding Russia’s election tampering. Internationally, the President’s America
First approach raises global risks. The majority of Americans want the government to focus on domestic matters.
However, the absence of a dominant and engaged superpower on the world stage increases the risk of conflict and
may evolve into disruptive activity that negatively impacts the markets.

Turning to the bond market, rates have moved back toward the middle of our expected range. We have modestly
lowered our trading range outlook for the 10-year Treasury to 1.9% – 2.5% during the third quarter. Given the
economic, political and market crosscurrents, a reasonable case can be made for rates in either direction, but we don’t
expect significant volatility. If recent weak inflation and economic data indeed prove to be transitory, the market may
move to the higher end of the range. However, a test of the low end is likely if the data continues to disappoint or
geopolitical risks rise sharply. The portfolio’s duration will be maintained within a tight band around the index duration.

We haven’t changed our sector outlooks significantly. While agency MBS spreads have widened a bit, we still see
rising net supply limiting the sector’s appeal and we remain underweight. Corporate spreads are not particularly
attractive, but we expect their modest outperformance to continue as long as current low volatility market conditions
persist and demand from overseas buyers remains strong. We continue to expect macro conditions to be generally
supportive, but believe that idiosyncratic risks will need to be managed. We will continue to employ low-risk
approaches to enhance the portfolio’s yield, such as increasing short maturity corporate bond and high-quality
structured product allocations. Please give us a call if you would like to discuss our outlook in more detail.

Disclosure – As of June 30, 2017. Source: Pugh Capital, Bloomberg, and Bloomberg Barclays Indices. This market outlook and succeeding pages contains Pugh Capital’s opinions based on the information available at the time of the analysis. Opinions are subject to change without notice. Investors should evaluate their own risk tolerance, time horizon and other restrictions for their investment decisions. Statements concerning financial market trends are based on information available and current market conditions which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions, and investors should evaluate their ability to invest for the long-term, especially during periods of volatility in the market. Please do not redistribute. Refer to Disclosures for forecast, outlook and other information.