INVESTMENT VOLATILITY: ARE ALTERNATIVES AN ALTERNATIVE?

1. INVESTMENT VOLATILITY: ARE ALTERNATIVES AN ALTERNATIVE? Council on Foundations Annual Conference April 28, 2003 Edward B. Kacic, Irvine Health Foundation Bruce Madding, Kaiser Family Foundation Jim Martin, M.J. Murdock Charitable Trust

2. Today’s Discussion What We’ll Cover: • “Alternatives 101” • Introduce Concepts • Discuss Types of Alternative Assets • Discuss Use of Alternatives • Discuss Benefits and Potential Pitfalls Council on Foundations Annual Conference - April 28, 2003

3. Today’s Discussion What We Won’t Cover: • “Investments 101” • Basic Asset Allocation • In-Depth Details of Sub-Strategies • “Sales Pitches” for Specific Products Council on Foundations Annual Conference - April 28, 2003

4. Glossary – What We Mean • Volatility: Standard deviation of returns • Correlation Coefficient: Degree to which assets move in relation to one another (always expressed as range of -1 to +1) • Alpha: Excess return (e.g., returns that exceed benchmark) Council on Foundations Annual Conference - April 28, 2003

5. Glossary – What We Mean • Beta: Sensitivity of an asset/portfolio to the movement of the market (Market beta equals 1. Beta of 1.1 indicates asset is expected to move 10% more than the market) Council on Foundations Annual Conference - April 28, 2003

6. What Are “Alternatives?” • “Non-traditional” Strategies • Debt, Equity, and/or Real Assets • Lower Correlation to “Traditional” Assets • Can Contribute to Lower Portfolio Volatility • Can Contribute to Higher Expected Return Council on Foundations Annual Conference - April 28, 2003

7. Commonly Described: Private Equity Private Debt Venture Capital Absolute Return Hedge Funds Real Estate Natural Resources Commodities/Futures We’ll Call Them: Private Equity Hedge Real Assets Not Discussed Here Types of Alternative Investments Council on Foundations Annual Conference - April 28, 2003

8. Investment Methodologies • Direct Investment • Partnerships • Funds • Funds of Funds Council on Foundations Annual Conference - April 28, 2003

9. Considerations • Asset Allocation • Liquidity • Finding Appropriate Investments • Minimum Investment Requirements Council on Foundations Annual Conference - April 28, 2003

10. Considerations • Expected Returns • Performance Evaluation • Fees • Legal Issues Council on Foundations Annual Conference - April 28, 2003

11. Commonly Described: Private Equity Private Debt Venture Capital Absolute Return Hedge Funds Real Estate Natural Resources Commodities/Futures We’ll Call Them: Private Equity Hedge Real Assets Not Discussed Here Types of Alternative Investments Council on Foundations Annual Conference - April 28, 2003

12. Council on Foundations54th Annual ConferenceDallas, TexasApril 28 – 30, 2003************************************* Investment Volatility Are Alternatives an Alternative? Jim Martin 4:00 pm – 5:30 pm Monday, April 28, 2003

13. Discussion • Jim Martin Background • M. J. Murdock Charitable Trust • Overview • Asset Allocation Policy/History • Return Expectations/Risk • Volatility • Alternatives - Traditional Asset Classes Council on Foundations Annual Conference - April 28, 2003

14. Discussion • Alternatives – M. J. Murdock Charitable Trust • Alternatives – Issues to Consider • Direct or Fund-of-Funds Investing • Performance Measurement Considerations • Historical Returns Council on Foundations Annual Conference - April 28, 2003

15. Jim Martin Background • Deloitte & Touche (formerly, Deloitte Haskins & Sells) • 18 years • Partner • M. J. Murdock Charitable Trust • 1987 – Present • Chief Investment and Financial Officer Council on Foundations Annual Conference - April 28, 2003

16. Jim Martin Background • Registered Investment Advisor • Manage Approximately $125 million on Fully Discretionary Basis • Investment Committees • Sunkist ($200 mil) • Rasmuson Foundation ($425 mil) • Boy Scouts Cascade Pacific Council ($1.2 mil) • Vancouver Rotary Foundation ($1.2 mil) • Red Cross Clark County, Washington ($1.4 mil) • Community Foundation of Southwest Washington ($30 mil) Council on Foundations Annual Conference - April 28, 2003

17. M.J. Murdock Charitable Trust Overview • Private Foundation • Vancouver, Washington • $460 Million • Formation • Jack Murdock’s Estate - 1975 • Tektronix Co-Founder • Assets at Inception • $91 million • Grantmaking • Five Northwest States • Cumulative Grants Since Inception $386 million • Primarily Scientific Research and Education Council on Foundations Annual Conference - April 28, 2003

18. M.J. Murdock Charitable TrustAsset Allocation Policy/History Council on Foundations Annual Conference - April 28, 2003

19. M.J. Murdock Charitable TrustReturn Expectations/Risk Council on Foundations Annual Conference - April 28, 2003

20. Volatility • Volatility • Not Your Friend • Career Risk • Standard Deviations Measurement • Extreme Volatility • Any Asset • Any Investment • Biggest Risk • Not Having Dollars When Needed Council on Foundations Annual Conference - April 28, 2003

21. Volatility • Minimizing Volatility • Multiple Asset Classes • Asset Class Diversity • Use Alternatives • Non-Product Correlation • Asset Class Return Guarantee Council on Foundations Annual Conference - April 28, 2003

22. Alternatives Traditional Asset Classes • Alternatives = Non-Traditional Products • Not Long Only Bonds or Equities • Looks Like A Duck – Sounds Like a Duck = Alternative • Modeled Risk/Return Characteristics • Asset Class • Capital Preservation • Murdock Trust Example Council on Foundations Annual Conference - April 28, 2003

23. Alternatives M. J. Murdock Charitable Trust • Various Options • M. J. Murdock Charitable Trust Structure • Private Equity • Venture Capital • Private Placements • Oil and Gas • Mezzanine • Secondaries • Global • Distressed Securities • Hedge Funds • Other Council on Foundations Annual Conference - April 28, 2003

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30. Liquidity Need Cash Flow Building the Class and Distributions back Commitment Sizes 10- to 15-year Product Commitments Valuations Daily, Monthly, Quarterly, Annual Perceptions Constituency Other Interested Parties AlternativesIssues to Consider Council on Foundations Annual Conference - April 28, 2003

31. Direct or Fund-of-Funds Investing • Invest Direct • For the Big Boys • Significant Assets • Minimum Requirements • Prudent Diversification • Diversification • Type • Vintage Year Council on Foundations Annual Conference - April 28, 2003

32. Direct or Fund-of-Funds Investing • Fund-of-Funds • Diversification • Expertise • Due Diligence Leveraging • Fees Council on Foundations Annual Conference - April 28, 2003

33. Performance Measurement Considerations • Private Equity Investments • Not Marked to Market • Best Measurement • IRR? • Time Weighted Returns? • Cash Flow Multiples? • Combination Thereof or Hybrid? • Combining Alternative and Traditional Asset Class Return Council on Foundations Annual Conference - April 28, 2003

34. Historical Returns Council on Foundations Annual Conference - April 28, 2003

35. Historical Returns Council on Foundations Annual Conference - April 28, 2003

36. Questions?

37. Types of Alternative Investments Commonly Described: Private Equity Private Debt Venture Capital Absolute Return Hedge Funds Real Estate Natural Resources Commodities/Futures We’ll Call Them: Private Equity Hedge Real Assets Not Discussed Here Council on Foundations Annual Conference - April 28, 2003

38. What really is a hedge fund? “The term ‘hedge fund’ is a catchall that applies to thousands and thousands of investment funds of all strategies. A hedge fund can be any limited partnership that’s constructed in such a way as to give the general partners – the managers of the fund – a share of the profits earned on the limited partners’ money.” - Andy Serwer & Carol Loomis, Fortune Council on Foundations April 28, 2003

39. Hedge Funds Defined • Private pooled investment vehicles • Short positions, derivatives, leverage, hedging, arbitrage • Normally charge an incentive fee based on fund performance • Specialized, skill-based alternative investment strategies • Seek to capitalize on pricing inefficiencies Source: Northern Trust C&IS Conference 2001 Council on Foundations April 28, 2003

40. Why Invest? • Diversification of equity market risk • Higher comparative liquidity • Positive returns in negative market environments Source: Northern Trust C&IS Conference 2001 Council on Foundations April 28, 2003

41. Short Term Performance Source: EIM Group Presentation, The Promise and the Reality of Hedge Fund Investing Council on Foundations April 28, 2003

42. Long Term Performance Source: EIM Group Presentation, The Promise and the Reality of Hedge Fund Investing Council on Foundations April 28, 2003

43. Hedge vs. Greater Market HFRI vs. Greater Market Indices Council on Foundations April 28, 2003

44. Historical Risk/Returns Source: EACM Council on Foundations April 28, 2003

45. Steps to develop a hedge fund portfolio • Articulate your investment beliefs • Management of complexity • Understanding all the strategies • Automation, database management, well-defined processes • Search for unique sources of alpha • Undertaking individual manager due diligence • Advanced Portfolio Construction • Name, measure and immunize the portfolio from as many potential shocks as possible • Structuring the portfolio to meet the organization’s risk and return expectations - Northwater Capital Management Council on Foundations April 28, 2003

46. Alternative Asset Program Objectives • Define Objectives of the Program • Diversification • Low correlation to equity market • Low volatility to equity market • Expected return: inflation + 8% • AGGRESSIVE: • Outperform broad equity • market w/ 60-80% of volatility • Significant directional risk • CONSERVATIVE: • Low volatility/low return • Emphasis on diversification • MODERATE: • Some equity market directional risk • Volatility 1/3 of equity market Council on Foundations April 28, 2003

47. Hedge Fund Categories • Relative Value • Long/Short Equity • Convertible Arbitrage • Fixed Income Arbitrage • Market Neutral Equity Arbitrage • Multi-Strategy Hedge • Event-Driven • Deal Arbitrage • Bankruptcy/Distressed • Multi-Strategy • Equity Hedge Funds • Long Biased • Opportunistic • Global/International • Global Asset Allocators • Discretionary • Systematic • Short Selling Council on Foundations April 28, 2003

48. Hedge Fund Spectrum Hedge funds cover a broad spectrum of risk/return characteristics Global Macro Emerging Equities Managed Futures Dedicated Short Bias ` Market Timing Long/short Equity Distressed Securities Fixed Income Arbitrage Convertible Arbitrage Merger Arbitrage Equity Market Neutral Return Low Volatility High Council on Foundations April 28, 2003

49. Choosing Appropriate Strategies Define Objectives of the Program • Conservative Strategies: • - Distressed Securities (Senior) • Diversified Arbitrage • (Low/No Leverage) • Event Arbitrage • Market Neutral • (Broad Market + Sectors) • Moderate Strategies: • Convertible Arbitrage • Distressed Securities (Post Bankruptcy) • Diversified Arbitrage • (Some Leverage) • Event Arbitrage (Higher Risk Deals) • Market Neutral • Short-Biased • Long/short US Equity (No Leverage) • Aggressive Strategies: • Global Long/Short • Global Macro (Leveraged) • Long/short US Equity (Concentrated Value or cap-size focus) • Sector Funds • (Sector Directional Risk) Council on Foundations April 28, 2003

50. Kaiser Hedge Allocations Council on Foundations April 28, 2003