1

Institutional Investors: It's a Whole New World

Tuesday, April 28, 20094:00 PM -

5:15 PM

ModeratorLiam Kennedy, Editor, Investment & Pensions Europe

SpeakerChristopher Ailman, Chief Investment Officer, California State Teachers' Retirement System

Harold Bradley, Chief Investment Officer, Ewing Marion Kauffman Foundation

Joseph Dear, Chief Investment Officer, California Public Employees' Retirement System Catherine Lynch, CEO and Chief Investment Officer, National Railroad Retirement

Investment Trust

Scott Minerd, Managing Partner, Guggenheim Partners; CEO and Chief Investment Officer, Guggenheim Partners Asset Management Inc.

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Global equity index

Source:

Datastream.

40

80

120

160

200

240

280

Apr 06

Jul 06

Oct 06

Jan 07

Apr 07

Jul 07

Oct 07

Jan 08

Apr 08

Jul 08

Oct 08

Jan 09

Apr 09

World

U.S.

Emerging markets

EU

January 2005 = 100

3

Correlation of global stock markets with S&P 500

Source:

Datastream.

MSCI Emerging Market

DAX 30FTSE 100

Nikkei 225

-0.5

0

0.5

1

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

250-day rolling correlation

4

Stock market volatility Volatility is off its peak

Note: The data is as of April 15, 2009; Source:

Datastream.

0

1

2

3

4

5

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

S&P 500 MSCI Emerging Market DAX 30 FTSE 100 Nikkei 225

A rolling 100-day standard deviation of equity prices

5

Private equity activities slow globally

Deal value announced(US$ millions)

Fund raised(US$ millions)

2007 2008 2007 2008United States 368,400 59,600 325,200 256,900Western Europe 185,900 88,000 101,500 96,100Asia 67,000 52,500 28,700 37,100Middle East 898 1,700 5,000 6,400Eastern Europe 27,900 8,000 14,600 5,400Latin America 4,600 1,200 4,400 4,000Africa 7,900 2,200 2,300 2,600Total 662,598 213,200 481,700 408,500

Sources: Dow Jones, Dealogic.

6

Worldwide hedge fund assets drop by 40 percent since Q2 2008

0.8 1.0 1.1 1.2 1.3 1.4 1.4 1.5 1.51.7 1.9 2.0

2.22.4

2.6 2.7 2.9 2.8 2.92.5

1.91.8

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2004 2005 2006 2007 2008 2009

US$ trillions

Sources:

Hedgefund.net, The Milken Institute.

7

Hedge fund returns, different strategy

8.6%-0.7%

3.6%5.2%5.9%6.6%7.1%7.5%

9.0%9.4%

10.3%12.4%

-5% 0% 5% 10% 15%

All hedge fundsDedicated short bias

Fixed income arbitrageEquity market neutralConvertible arbitrage

Emerging marketsRisk arbitrageMulti-strategy

Event-driven multi-strategyEvent driven

DistressedGlobal macro

Annualized return, January 1994−March 2009

-16.7%

-27.4%-21.2%-20.2%-19.3%-17.6%

-15.1%-12.5%

-8.5%-3.3%

5.8%

-43.4%

-45% -30% -15% 0% 15%

Hedge fundEquity market neutral

Emerging marketsFixed income arbitrage

Convertible arbitrageDistressed

Multi-strategyEvent driven

Event-driven multi-strategyGlobal macro

Risk arbitrageDedicated short bias

Annualized return, March 2008−March 2009

Sources:

Bloomberg, The Milken Institute.

8

Total returns of selected asset classes

Crude OilEmerging marketsHedge fundsU.S. TreasuriesCommoditiesCorporate bondsSmall CapHigh YieldS&P 500

U.S. TreasuriesCorporate

bondsHigh YieldHedge fundsEmerging marketsSmall CapS&P 500CommoditiesCrude Oil

Sources: Bloomberg, Datastream, The Milken Institute.

Annualized returnQ1 1998- Q1 2009

-3.0%3.5%3.6%

4.4%5.0%

6.2%7.0%

9.7%10.8%

-5% 0% 5% 10% 15%

Annualized returnQ1 2008- Q1 2009

-67.1%-56.5%

-38.1%-37.9%-36.5%

-16.7%-12.6%

-8.1%7.2%

-100% -50% 0% 50%

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Liam Kennedy’s Slides

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“Undertake asset allocation review; longevity risk management and real interest risk management reviews.”

“Operational risk management procedures became more relevant. These were found to be adequate.”

“We performed an ALM study that confirmed the current asset allocation.”

81% of (European) pension plans surveyed had raised risk management issues at board level in the 6-9 months to March 2009

What were the outcomes of your risk management discussions?

Source: Investment & Pensions Europe survey, March/April 2009

11

Are you confident that the models used by your asset and liability modeling (ALM) provider take into account current economic and financial market conditions?

Source:

Investment & Pensions Europe survey of pension funds, March/April 2009.

12

Overall, have consultants added value to your investment portfolio, taking their fees into account?

“Especially with manager searches they bring up external managers

based on reputation and size. Like ‘who gets fired for buying IBM?’. We prefer boutiques.”

Source: Investment & Pensions Europe survey of pension funds, January 2009.

13

I expect my fund to invest in undervalued assets or investment classes in 2009

Source: Investment & Pensions Europe survey of pension funds, December 2008.

14

Over the four-year market cycle 2004-08…

•

S&P 500 outperformed

71.9% of actively managed large cap funds

•

S&P MidCap

400 outperformed 75.9% of mid cap funds

•

S&P SmallCap

600 outperformed 85.5% of small cap funds

Source: Standard & Poor’s Index Versus Active Fund Scorecard (SPIVA), April 2009.

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Harold Bradley’s Slides

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Hedge funds as an asset class survivorship bias:

Many fund-of-funds stopped reporting in Q4 2008

Source:

HFRI database.

900

1000

1100

12001300

1400

1500

1600

2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4

Number of FOFReporting to HFR

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Constituents for HFR fund of funds index Does anybody know the real returns and volatility?

Source:

HFRI.

790 funds

675 funds

0

300

600

900

Q3 2008 Q4 2008

Num

ber o

f ind

ex c

onst

ituen

ts

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Hedge funds as an asset class:

How did they perform?

Assumption:

funds that stopped reporting lost half their value on average.

-21.3%-25.6%-30%

-20%

-10%

0%HFRI FOF Composite 2008

Adjusted For Survivorship Bias

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Private equity performance by investor type

(Funds between 1992 and 2001)

Source:

Lerner, Schoar and Wang [2007]. Courtesy of Josh Lerner, HBS

-5% 0% 5% 10% 15% 20%

EndowmentsPrivate Pensions

Insurance CompaniesPublic PensionsFunds-of-Funds

BanksS&P 500

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Why do we pay GPs to get huge…

Source:

Andrew Metrick

and Ayako

Yasuda, “The Economics of Private Equity Funds,”

the Wharton School, University of Pennsylvania, 2007

$2 billion fund $650 million fund

GP

$400 million in fees over the life

of the fund

$130 million fees in fees plus $270

million in carried interest, if invested capital returns 3.1x

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Using variable fee schedules for equity accounts

Fund A variable fee schedule40 bps + 20%*ER, min 5, max 120

120

5

65 bps standardfixed fee

0

50

100

150

-8% -6% -4% -2% 0% 2% 4% 6% 8%Excess return over benchmark

Ann

ual f

ee (b

ps)

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Using variable fee schedules for equity accounts

Fund B variable fee schedule40 bps + 15%*ER, min 20, max 120

120

20

75 bps standard fixed fee

0

50

100

150

-8% -6% -4% -2% 0% 2% 4% 6% 8%Excess return over benchmark

Ann

ual F

ee (b

ps)

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Equity-oriented mutual funds net Inflows as a share average assets 2008

Source:

Strategic Insight Simfund. Courtesy: Empirical Research

(10)

(5)0

5

10

15

20

25

30

Actively-ManagedEquities

Indexed Equities Equity ETFs Lifecycle and Like Funds

%

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Expected Dec. 31 Value

Further threats to street research –

the dependability of investor behavior…

Sources:

Standard & Poor’s, Compustat, EcoWin, FactSet, JPMorgan Asset Management. .

25

Share of general equity funds underperforming the S&P500

(1963 through 2008)

Source:

The Vanguard Group, Empirical Research Partners Analysis.

0102030405060708090

100

63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07

S&P 500 returns are negative

%Stocks

are expensive

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Joseph Dear’s Slides

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Risk managed absolute return strategies

•

$5.9 Billion as of March 1, 2009•

26 direct hedge fund investments -

$4.6B (78%)•

9 FoHFs with a niche focus -

$1.3B (22%)•

FoHFs invest in Asian-focused hedge funds, European-focused hedge funds and emerging hedge funds

•

Invest in funds that actively seek to add value in both the long

& short portfolios

•

Avoid “beta”

funds, activists, acronym funds (ABL, ABS, CLO, CDO, etc.)

•

Allocation to a maximum of 8% of total Global Equity portfolio

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The three pillars of hedge fund governance

Pillar 1: Alignment of Interests•

Fee structures that reward long-term performance, deter asset-gathering and encourage the development of institutional caliber businesses

“When our beneficiaries win, you win”

Pillar 2: Control of Assets•

Removes “game theory”

of fund redemptions; eliminates gates, suspensions and side pockets; allows immediate termination of trading authority

“Without the return of capital there is no return on capital”

Pillar 3: Transparency of Risks and Exposures•

Builds on existing security-level transparency received from 90% of current hedge funds; improves ability to tailor portfolio-wide risk exposures; provides valuable “trust but verify”

capability“If you do not trust us with information, we cannot trust you with our capital”

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Risk management measures

•

Leverage

–

Determine aggregate debt across asset classes. For public equities aggregate at the benchmark level and for private assets

at the investment company level

•

Concentration

–

Determine aggregate industry/factor exposures across asset classes

•

Credit Risk

–

Evaluate counterparty risk by monitoring trends in credit default swap spreads

•

Liquidity Risk

–

Assess by aggregating portfolios into liquidity categories. Bid/ask spread is one measure of liquidity

•

Stress Testing

–

Use the quantitative risk system to evaluate extreme market conditions

•

Reputation Risk

–

Safeguarding our reputation through disciplined communications, rigorous codes of conduct and thorough compliance monitoring.

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Five principles for financial regulation reform: a model for change•

Transparency-

Greater disclosure and transparency•

Independence-

True regulatory independence•

Corporate Governance-

An increased and effective shareowner voice in the capital markets •

Investment Opportunities-

The preservation of institutional investors’

freedom to invest in the full .range of investment opportunities

•

Systemic Risk-

Earlier identification by regulators of issues that give rise to overall market risk that threaten global markets

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CalPERS investment portfolio (as of April 14, 2009)

Asset Class Market Value ($ in Billions)

Actual (%)

Target (%)

Cash Equivalents

$12.6 7.2% 0%

Fixed IncomeDomestic 39.3 22.5 17International 4.0 2.3 2

EquitiesDomestic 35.0 20.0 28International 37.4 21.4 28

AIM (Private Equity)

22.9 13.1 10

Real Estate 19.5 11.1 10Inflation Linked 4.3 2.4 5

Total Fund $175.0 100% 100%

CashU.S. EquityIntl EquityU.S. FixedIntl FixedAIMReal EstateInflation linked

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Only the desperate are selling?

•

19 venture partnerships•

Raised between 1995 and 2004•

Cap weighted age of 10 years old (1999 vintage)•

Written down by 8% from cost to “comply”

with FASB 157•

Recently received a bid for 45 cents •

It’s crazy to take a 55% loss…right?

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55% discount is consistent with public market

-49%

34

Selling might make sense

•

Illiquidity in private equity is poorly understood•

New accounting rules still are not fully capturing true value•

Everything is an opportunity cost trade–

Sell old venture capital at 45 cents–

Buy distressed real estate and credits at 20 cents?

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Cumulative Index Returns

* Excludes venture capital finds.Source: Cambridge Associates, Bloomberg

S&P 500 and Private Equity Index Cumulative Returns

-200%0%

200%400%600%800%

1000%1200%1400%1600%1800%

Sep-

88

Sep-

89

Sep-

90

Sep-

91

Sep-

92

Sep-

93

Sep-

94

Sep-

95

Sep-

96

Sep-

97

Sep-

98

Sep-

99

Sep-

00

Sep-

01

Sep-

02

Sep-

03

Sep-

04

Sep-

05

Sep-

06

Sep-

07

Sep-

08

S&P 500 with Dividends Reinvested Cambridge Associates US Private Equity End-to-End Index* Russell 2000

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Index Comparison

Russell 2000 S&P 500 Private Equity*

Average Annual Returns 9.78% 11.60% 15.86%

Standard Deviation of Returns 20.08% 18.72% 13.92%

Sharpe Ratio 0.34 0.46 0.91

Note: Risk free rate assumed to be 10 Year Treasury Note as of 4/23/09.* Excludes venture capital finds.Source: Cambridge Associates, Bloomberg

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Build America Infrastructure Bonds

Issuer Pricing Date

Amount ($ in millions)

Rating Category

Spread to 30-Year

Indicative Rate

University of Minnesota 4/15 $37.5 AA 255 6.35%

University of Virginia 4/15 $250 AAA 255 6.35%

NJ Turnpike Authority 4/20 $1,300 A-Plus/A3 370 7.50%

California 4/22 $5,000 A 365 7.45%

NY MTA 4/23 $750 AA / A-Plus 350 7.30%

Source: Thompson Reuters, The Bond Buyer, Guggenheim Partners