Presentation by: Austin Applegate Michael Cormier Paul Hodulik Carl Nordberg Nikki Zadikoff

1. Granite Investments Global Asset Allocation Presentation by: Austin Applegate Michael Cormier Paul Hodulik Carl Nordberg Nikki Zadikoff February, 26 2004 0

2. Agenda Agenda • Introduction • Methodology • Factors • 1-Year EPS Growth • 3-Year EPS Growth • Dividend Yield • % Change in FY1 Estimates over 3 Months • Up vs. Down EPS Est. Revisions • LTM EPS Yield • Estimated FY1 EPS Yield • Scored Strategy Returns • Subjective Estimates • Optimized Estimates • Summary 1

3. Introduction Establishing Long-Short Trading Strategy • Objective • Generate positive returns • Limit risk through hedging • Quantitative stock screen • Seven factors • Find predictive powers on positive and negative returns • Select factors with strong predictive powers • Go long stocks in top quintile • Go short stocks in bottom quintile 2

4. Methodology Description of parameters used for screening process • Sample • US equities listed on both NYSE and NASDAQ • Market capitalization above $100 million • Monthly data • In-sample time frame: 1988 – 1998 • Out-of-sample time frame: 1999 – 2003 • Selected variables believed to best predict future stock returns • Allocated factors into quintiles based on selected criteria • Resampled factors each month • Analyzed output and performance over time 3

5. Factors Description of Factors • 1-Year EPS Growth: expected growth in EPS over 1 year • 3-Year EPS Growth: expected average yearly growth in EPS over 3 years • Dividend Yield: indicated dividends / current price • % Change in FY1 Est. over 3 Months: % change in earnings estimates over a 3 month period (momentum play) • Up vs. Down EPS Est. Revisions: [(# of Up - # of Down revisions)/Total Estimates] (momentum play) • LTM EPS Yield: yield on EPS over the last twelve months (EPS yield is inverted P/E ratio) • Estimated FY1 EPS Yield: FY1 EPS estimate / current price 4

6. Factor: 1-Year EPS Growth 1-Year EPS Growth not a suitable factor for a long-short strategy • Difference between quintile 1 and quintile 5 not large enough • Quintile 1 not consistently enough best performing portfolio, and quintile 5 not consistently enough worst performing portfolio 5

7. Factor: 3-Year EPS Growth 3-Year EPS Growth not a suitable factor for a long-short strategy • Magnitude of returns too small and difference between quintile 1 and quintile 5 not large enough • Quintile 1 not consistently enough best performing portfolio, and quintile 5 not consistently enough worst performing portfolio 6

8. Factor: Dividend Yield Dividend Yield displays some positive predictive ability • Quintile 5 outperforms quintiles 3 and 4 on average, mitigating the short portion of the strategy • Quintile 1 does outperform all other quintiles on a reasonably consistent basis, pointing to some predictive power • This factor could be used in a multivariate scored long-short strategy 7

9. Factor: % Change in FY1 Est. over 3 Months % Change in FY1 Est. over 3 Months has the potential to make a contribution in multivariate model, but not on its own • Turnover rate is rather high which would lead to high transaction costs • Quintile 1 is fairly consistent yielding the highest return, and quintile 5 is also fairly consistent in yielding the lowest return 8

10. Factor: Up vs. Down EPS Est. Revisions Up vs. Down EPS Est. Revisions would not guarantee returns high enough on its own, but could be used in a multivariate model • Difference in returns between quintile 1 and quintile 5 not high enough to make this strategy attractive for a long-short strategy • Factor performs very well in three turbulent years, 2000 – 2002, suggesting that it could play a valuable role in a multivariate model 9

11. Factor: LTM EPS Yield LTM EPS Yield does a remarkable job in adequately repeating the highest return yielding portfolio • Wide spread between quintile 1 and quintile 5 which would make this strategy attractive from a return perspective • Quintiles 1 and 5 perform as expected over time, except for 1999, which would have been disastrous and led to a return of (68)% 10

12. Factor: LTM EPS Yield LTM EPS Yield does a fairly consistent job of outperforming the market • On most observations, the factor outperforms the market, especially during years where the market went down • However, in 1999, following a trading strategy based on this factor would have been disastrous 11

13. Factor: Estimated FY1 EPS Yield Estimated FY1 EPS Yield is most promising factor, with consistently high and low returns for quintiles 1 and 5 respectively • Long-short strategy generates significant positive return in all years except 1999 with a loss of (54.71%) • Including this loss, this strategy would still generate a 728% cumulative gain over the past 5 years • Consider utilizing other variables in a scored strategy to mitigate 1999 returns 12

14. Factor: Estimated FY1 EPS Yield Estimated FY1 EPS Yield shows significant upside • In most years, a long-short strategy based on this factor would outperform the S&P 500 Index, with returns exaggerated in down markets • As discussed before, 1999 would have produced catastrophic negative returns 13

15. Scored Strategy Returns Considerations • Rationale • Some factors were useful predictors of either upside or downside returns • Scoring system utilizes predictive power of numerous factors • 2 Methodologies • Subjective Scoring • Looking at historical results, determine most useful factors • Assign weights using intuition and group discussion • “Optimized” Scoring • Construct correlation matrix of several factors • Conduct mean-variance analysis, using data derived from one-factor models • Apply “optimal” weights to several factors 14

16. Scored Strategy Returns: Subjective Estimates Determining scored factors and weights • Subjective Estimates • Evaluated 7 factors, but selected only 3 factors • FY1 EPS Yield • High correlation with LTM EPS Yield but better results • (+5 if 1, +1 if 2, -3 if 5) • Dividend Yield • Positive Performance Predictive Ability • (+2 if 1) • Up vs. Down EPS Est. Revisions • High correlation with % Change in FY1 Est. over 3 Months but lower turnover • (+3 if 1) 15

17. Scored Strategy Returns: Subjective Estimates Very powerful predictive ability of high and low returns • Continues to generate positive returns in each year except 1999, but losses are reduced to (25.23%) • Including this loss, this strategy would generate a 437% cumulative gain over the past 5 years • Standard deviations and betas of quintiles 1 and 5 are almost identical 16

18. Scored Strategy Returns: Subjective Estimates Subjective Scored Estimates display similar trend as previous best model (FY1 Yield), but less volatility • Graph below depicts equal weighted annual returns of long-short strategy of Subjectively Scored Strategy and FY1 Yield Strategy • While Subjective Scored Strategy sacrifices some upside, it performs much better during market anomaly of 1999 17

19. Scored Strategy Returns: Optimized Scoring Determining scored factors and weights • Optimized Estimates • Utilized a mean-variance optimizer • Each selected quintile is essentially a portfolio with a mean and variance • Evaluated all 7 factors in optimization model, and selected 4 factors (6 total quintiles) • Estimated FY1 EPS Yield • (+3.42 if 1, +0.64 if 2, -1.20 if 5) • FY1 Revision Ratio • (0.04 if 1) • Dividend Yield • (0.92 if 1) • LTM EPS Yield • (-2.83 if 1) 18

20. Scored Strategy Returns: Optimized Scoring Value Weighted Portfolio shows intriguing results • The equal weighted portfolio using optimized scoring produces very noisy results • However, the value weighted portfolio possesses the favorable step distribution • Over the past 5 years, a long-short strategy with the value weighted portfolio would have garnered a cumulative 174% gain. 19

21. Scored Strategy Returns: Optimized Scoring Value weighted optimization appears to perform slightly worst than equal weighted subjective portfolio • The value weighted optimized portfolio produces a negative return twice and performs worst than the subjective portfolio in 1999 • The significant turnover of quintile 5 (37%) could also pose a problem with respect to trading costs 20

22. Summary Initial findings have 5 MBA students pondering quitting school, rejecting their job offers, and starting a hedge fund… • Estimated FY1 EPS Yield • Empirically and logically a very strong factor • In most markets and at most times, earnings continue to drive stock prices • However, market anomalies such as 1999 make this strategy vulnerable • Combining this factor with others should reduce volatility • Subjective Scoring • Adding reasonably uncorrelated factors drives down standard deviation • Utilizing intuitive weights for variables proves to be a valuable exercise • Best results of tested strategies • We realize this is not an exhaustive list of long-short strategies, but are confident this model can produce significant returns • A small (or large) hedge fund cannot incur losses of 50% or more in 1 year, so we are pleased with reduced volatility at expense of some upside that the scoring system brings 21