Managing Working Capital Risk and Return

1. Managing Working CapitalRisk and Return Mark R. Wetzel President Fiduciary Investment Advisors, LLC Joseph G. Trainor Senior Vice President for Finance University of the Sciences

2. Managing Working CapitalRisk and Return Period of Global Turmoil 2008 - 2010 • What happened during this period of turmoil? • Auction Rate Preferred securities failed at auction • The Reserve Primary Money Market fund broke the buck • Yields on 3-month treasuries went negative for the first time ever • Sovereign debt crisis impacts Club-Med & Euro

3. Managing Working CapitalRisk and Return The “TED Spread” reached an all time high. Source: JPMorgan Asset Management

4. Managing Working CapitalRisk and Return • How did Higher Education misread the markets? • Concentrated our liquid funds • Did not fully understand tail risks • Assumed prior results were an indicator of future performance risks • Increased leveraging, especially with low variable rate debt • Expanded operating budgets based upon continued strong endowment performance • Assumed market would always provide liquidity • Assumed alternative funds distribution would offset any capital calls

5. Managing Working CapitalRisk and Return Those who cannot remember the past are condemned to repeat it. George Santayana • Impact upon Higher Education: • Liquidity • All money market-like funds were not liquid • Marketable securities were not as marketable as expected • Some investments liquidate at a deeply discounted price • Investment managers imposed new liquidity gates • Collateral postings were required • Alternative funds distributions did not offset capital calls • Debt • Failed remarketing of demand debt • Rising variable rate interest expense and letter of credit fees • Collateral posting and liquidation penalties for swaps • Operating budgets were cut due to weak investment performance

6. What is a VP of Finance to do? Understand the relationship between risk and return Understand and document the different types of risks involved Re-evaluate the institution’s risk tolerance and return goals What is the cost of liquidity? And what risks are being taken in search of return? Managing Working CapitalRisk and Return

7. How can we balance risk and reward? Solution: A tiered approach to working capital management Allows for a custom cash investment strategy to fit the investor’s risk tolerance, liquidity requirements and preservation of capital needs Ability to combine liquidity with the opportunity for yield enhancement by moving away from money market strategies to other short term strategies Let’s look at two approaches… Managing Working CapitalRisk and Return

8. Managing Working CapitalRisk and Return Segmenting Cash by liquidity needs and profile

9. Managing Working CapitalRisk and Return HIGHER RISK LOWER Tier 1 LOWER LIQUIDITY HIGHER • Operating Cash Tier 2 • Reserve Cash Tier 3 • Restricted and Strategic Cash Source: PIMCO

10. Managing Working CapitalRisk and Return Tier 1 Operating Cash HIGHER RISK LOWER • Purpose: Utilize for daily operating expenses • Primary Objectives: Principal preservation, daily liquidity • Typical Strategies: Money Market or STIF • Typical Investment Discretion: Restrictive LOWER LIQUIDITY HIGHER LOWER LIQUIDITY HIGHER Tier 2 Reserve Cash Tier 3 Restricted and Strategic Cash Source: PIMCO

11. Managing Working CapitalRisk and Return Tier 1 Operating Cash HIGHER RISK LOWER LOWER LIQUIDITY HIGHER Tier 2 Reserve Cash • Purpose: Semi-permanent allocation to cash utilized for acquisitions, capital expenditures, R&D, dividends, stock repurchases (for-profit) • Primary Objective: Enhance returns to cash • Typical Strategies: Short-Term (max. 1 yr duration) or Low Duration (1-3 yr duration) • Typical Investment Discretion: Depends on portfolio’s impact on company’s income statement Tier 3 Restricted and Strategic Cash Source: PIMCO

12. Managing Working CapitalRisk and Return Tier 1 Operating Cash HIGHER RISK LOWER Tier 2 Reserve Cash LOWER LIQUIDITY HIGHER Tier 3 Restricted and Strategic Cash • Purpose: Used if institution has large cash balance and long-term spending needs • Primary Objective: Grow cash balance over long term • Typical Strategies: Moderate Duration, Total Return, High Yield, Emerging Markets, etc. • Typical Investment Discretion: Broad due to longer-term investment horizon Source: PIMCO

13. Tier 1 – Operating Cash Objective: preservation of principal and daily liquidity Suitable strategies: money market funds STIF funds Managing Working CapitalRisk and Return Data as of 3/31/10 Source: Morningstar Direct

14. Managing Working CapitalRisk and Return Data as of 3/31/10 Source: Morningstar Direct, Barclays Capital 1-3 month US T Bill. Index returns shown for illustrative purposes only.

15. Managing Working CapitalRisk and Return • Tier 1 – Operating Cash • Implementation & Operational Considerations: • Develop a working capital investment policy • Develop a 12 month rolling cash flow forecast • Ask your bankers to prepare 1 – 3 year cash analysis with monthly cash flows, balances, returns and fees • Prepare weekly cash flash reports to monitor cycles, spikes, opportunities and risks • Anticipate major scheduled receipts (Direct and Alternative Loans) • Ask your banker for suggestions and/or perform RFP

16. Managing Working CapitalRisk and Return • Tier 1 – Operating Cash • Implementation & Operational Considerations: • Research and understand the factors affecting risks and returns for demand w/ & w/o compensating balances, money market, NOW, not-for-profit, repos and sweep accounts • Evaluate the tradeoffs between administration, internal control, net yield, liquidity, debt covenants, risk tolerance, collateral and safety • Integrate working capital solutions to be consistent with your institutional needs • Do not assume anything

17. Managing Working CapitalRisk and Return • Do you know the Money Market Fund Regulations? • Investment Company Act of 1940 - Rule 2a-7 & as amended in 2010 requires: • majority of funds being in the highest rated debt • separate rules & limits for illiquid or second tier assets • daily & weekly liquidity test • high quality securities to mature within 397 days & second tier within 45 days • Weighted Average Maturity (WAM) of 60 days or less • Weighted Average Life (WAL) of 120 days or less • ceiling in one issuer, except for govt. securities and repos at 5% • funds to report their portfolio holdings monthly to the Commission and post them on their Web sites • stress testing fund portfolios periodically to determine if they can withstand market turbulence

18. Tier 2 – Reserve Cash Objective: Enhanced return on cash not needed for daily use (6 – 9 month investment horizon) Suitable strategies: short term funds low duration funds laddered CDs Managing Working CapitalRisk and Return

19. Managing Working CapitalRisk and Return Data as of 3/31/10 Source: Morningstar Direct, ML US Corp/Gov’t 1-3 Year Index. Index returns shown for illustrative purposes only.

20. Tier 2 – Reserve Cash Implementation & Operational Considerations: Build upon 12 month cash forecast Leverage Fall & Spring cash receipts with funding needs for summer, capital and debt service Options Short and low duration funds Positive same to next day availability can select fund to match institutional risk profile limited market interest rate risks Negative interest rate risks generally uninsured credit risk tied to unknown underlying investments Managing Working CapitalRisk and Return

21. Managing Working CapitalRisk and Return Tier 2 – Reserve Cash Implementation & Operational Considerations: Options - continued Laddered CDs (WAM < 1 year) Considerations purchase individually or through an intermediary or consortium bank’s reserve capital ratio FDIC registered number Positive FDIC insurance possible minimal market volatility match maturities to specific date fund needed Negative cumbersome if intermediary not used broker and custodian risks liquidity subject to CD terms or secondary market

22. Tier 3 – Strategic / Restricted Cash Objective: Grow cash balance earmarked for long term spending needs (investment horizon of 1 year or longer) Suitable strategies: moderate duration high yield total return balanced funds Managing Working CapitalRisk and Return

23. Managing Working CapitalRisk and Return Data as of 3/31/10 Source: Morningstar Direct, Barclays Capital US Aggregate Bond Index. Index returns shown for illustrative purposes only.

24. Tier 3 – Strategic / Restricted Cash Implementation & Operational Considerations: What are the purposes for these funds? Does investment timeline match utilization needs? Is investment earnings budget too optimistic? Should equities be part of investment strategy? What happens if earnings are negative for fiscal year? What if corpus is eroded or illiquid when project funding is needed? Should corpus be transferred to quasi-endowment? Managing Working CapitalRisk and Return

25. Tiers 1 - 3 Overall Considerations Understand your cash cycles Assess marketplace options Develop working capital policy Establish realistic guidelines and budgets Address internal controls and due diligence Evaluate concentration risks Determine if equities should be part of working capital Managing Working CapitalRisk and Return

26. Managing Working CapitalRisk and Return Due Diligence 101 Missteps • Dismiss 2008-2010 as an aberration • Don’t read the prospectus or financial reports • Don’t evaluate inherent risks and long-term implications of strategies • Assume what others do has been tested & should be followed • Fail to recognize performance warning flags

27. Investment Policy Key Components scope of policy objectives in relation to investment strategy roles and responsibilities benchmarks permissible investments liquidity targets reporting custody evaluation and compliance Managing Working CapitalRisk and Return

28. Summary Risks are real and here to stay. Current yields on cash markets (i.e. Gov’t money market securities, T-bills, and Agency discount notes) are far from the investment targets set by most institutional investors. The only constant is change. At the end of the day, the optimal strategy is to manage your risks and maintain an ongoing evaluation of liquidity needs and return goals. Managing Working CapitalRisk and Return

29. Comments & Questions Managing Working CapitalRisk and Return

30. Contacts and References Contacts: Joseph G. Trainor, j.trainor@usp.edu or 215.596.8862 Mark Wetzel, mwetzel@fiallc.com or 860.697.7410 References: FDIC locator and comparisons: http://www2.fdic.gov/idasp/main_bankfind.asp FDIC failed banks: http://www.fdic.gov/bank/individual/failed/banklist.html Moody’s Investors Services: www.moodys.com Morningstar reviews: http://www.morningstar.com/