Strategic Asset Allocation

1. Strategic Asset Allocation The experience of Fundo de Estabilização Financeira da Segurança Social Portugal ISSA Conference, Merida, Mexico Henrique Cruz Instituto de Gestão de Fundos - Portugal

2. Portugal Area: 91,951 Km2 Population: 10,6 m Age Struct.: <15 (17%); 15-64 (66%); 64> (17%) GDP: $ 188.7 bn Govnmt: Parliamentary democracy Instituto de Gestão de Fundos - Portugal

3. Strategic Asset Allocation - FEFSS • Fundo de Estabilização Financeira da Segurança Social (FEFSS) • Social Security Reserve Fund • Target amount: 200% annual expenditure with pensions • As at 31.08.2005: 6 bn € / 80% of annual expenditure with pensions / 4.4% Portuguese GDP • 3.99% real rate of return since Dec.’02 Instituto de Gestão de Fundos - Portugal

4. Strategic Asset Allocation - FEFSS • Inflows: • Between 2/11ths and 4/11ths of the employees contributions; • unless the Portuguese economy is in an adverse macroeconomic condition • Annual superavits • Proceeds from the sale of property • Reinvestments Instituto de Gestão de Fundos - Portugal

5. Strategic Asset Allocation - FEFSS • Investment requirements: • OECD issuers, currencies and markets; • At least 50% in Portuguese Gvnmt Debt; • Max. 40% in investment grade Debt; • Max. 25% in equities; • Max. 15% in unhedged currency exposure; • Max. 10% in real estate; • Max. 5% in a strategic reserve. Instituto de Gestão de Fundos - Portugal

6. Strategic Asset Allocation - FEFSS • Investment Policy: • in the long run, FEFSS returns must be in excess of the cost of the Portuguese public debt portfolio with similar volatility; • Use of impairment in hold to maturity bonds; • Positive average real rate return in maximum 3 years rolling period; • Beat the annual benchmark. Instituto de Gestão de Fundos - Portugal

7. Strategic Asset Allocation - FEFSS • Asset Allocation Study inputs: • Max. volatility 4%; • Use of impairment in 25% of the portfolio; • Max. 10% in real estate; • Investment in Euro denominated assets vs investment in OECD currency den. assets; • Long term risk and return matrix; • Correlation matrix. Instituto de Gestão de Fundos - Portugal

8. Strategic Asset Allocation - FEFSS • Asset Allocation Study results (Euro): • Asset Allocation Study results (OECD): [1]The estimated  maximum number of years (with a 95% confidence level) required to achieve average annual positive real returns is computed as follows: [risk x INV.NORMAL(95%; 0;1) / return ] ^2 Instituto de Gestão de Fundos - Portugal

9. Strategic Asset Allocation - FEFSS • Governance model: • Indexed vs active management • External management • New asset classes • SAA Revision Instituto de Gestão de Fundos - Portugal

10. Index Index +1% +1% +2% +2% +4% +4% US Aggregate Bonds 89 94 European Government Bonds European Corporate Bonds UK Aggregate Bonds 91 79 86 89 91 94 US Equities 71 77 83 UK Equities 68 77 83 Efficient Global Equities 69 75 81 Inefficient Emerging Mkt Debt 59 67 74 84 European Equity 55 64 72 84 EM Equity 54 63 70 82 Semi-Efficient US Small Cap 42 51 57 67 Japanese Equity 39 51 61 75 Strategic Asset Allocation - FEFSS • Indexed vs active management “Inverse relationship between the efficiency in asset pricing and the appropriate degree of active management” David Swensen – Pioneering Portfolio Management” History shows that some benchmarks are much harder to beat than others. Source: Micropal, Lipper, Schroders; Percentile ranking of widely used indices on a rolling 3-year basis up to 30 June 2005. 100 best 1 worst. Mutual fund returns are measured after all fees. Instituto de Gestão de Fundos - Portugal

11. Strategic Asset Allocation - FEFSS • External management • Indexed management outsourced on an ‘all-in’ cost basis • including the cost of trading, settlement, safekeeping, income collection, tax recovery, securities lending, etc. • Balanced portfolios submitted to decision benchmarking • internally against the benchmarks and externally by subcontracting managers to benchmark the excess return achieved by the in-house team • Real Estate: buy expertise • best managers at fair prices Instituto de Gestão de Fundos - Portugal

12. Strategic Asset Allocation - FEFSS • New Asset Classes • Portfolio’s diversified VaR is concentrated on equities and currencies; • We need to keep portfolio’s volatility under 4%. • Explore benefits of low correlation between equities and hedge funds and between equities and commodities Instituto de Gestão de Fundos - Portugal

13. Strategic Asset Allocation - FEFSS • New Asset Classes • The hedge fund industry • trust • systems • credit risk. • Commodities • high volatility • low correlation with equities • reduction in the diversified value at risk of a portfolio. Instituto de Gestão de Fundos - Portugal

14. Strategic Asset Allocation - FEFSS • SAA revision • Monitor: • inflows and outflows of the FEFSS • pattern of return, risk and correlation of asset classes. Instituto de Gestão de Fundos - Portugal

15. Strategic Asset Allocation - FEFSS • Final Remarks • Indexed management is dominant in FEFSS investments; • FEFSS is invested in classical asset classes subject to a 4% volatility ceiling; • Diversification is always under consideration; • The current strategic benchmark is expected to produce an annual real rate of return of 3.88%. Instituto de Gestão de Fundos - Portugal

16. Instituto de Gestão de Fundos - Portugal