Transcript Investment Opportunities and Risks in a Recovering Economy

Foundation For The Carolinas
Center For Nonprofits
Endowment Investment Opportunities
and Risks in a Recovering Economy
Agenda
• Welcome & Opening Remarks, Holly Welch Stubbing
• FFTC Investment & Spending Policy Overview, Judy Kerns
• Endowment Investment Opportunities & Risks in a
Recovering Economy, Scott Harsh
• Closing Remarks, David Snider
Welcome!
Agenda
• Welcome & Opening Remarks, Holly Welch Stubbing
• FFTC Investment & Spending Policy Overview, Judy Kerns
• Endowment Investment Opportunities & Risks in a Recovering
Economy, Scott Harsh
• Closing Remarks, David Snider
FFTC Investment Committee Members
Barnes Hauptfuhrer, Chair
Hugh McColl III
Tom Nelson
Todd Walker
Bill Williamson
Investment Update
(as of December 31)
2008
2009
2010
S&P 500
-37%
26%
15%
Russell 2000
-34%
27%
27%
EAFE
-43%
32%
8%
Emerging
mkts
-53%
74%
19%
FFTC Investment Pool
• Endowment assets
•Diversified portfolio
–
–
–
–
–
–
Large cap; small cap
Value; growth
Active; passive
Domestic; international
Hedge funds
Private equity, energy, real estate
Long-Term Performance Objectives
• Exceed CPI + spending +
administrative costs
• Outperform market / peers
• Outperform benchmarks
Investment Pool
Small Cap
Growth
Large Cap
Small Cap
Value
Int'l:
Developed
Emerging
Mkts.
Int'l Small Cap
Small Cap
Growth
Hedge Funds
Small Cap
Value
Private Capital
International
Large Cap
Fixed Income
2003
Other
TIPs
Fixed Income
2010
Investment Returns by Strategy
(as of December 31, 2010)
Conservative Growth & Income
Benchmark
Moderate Growth
Benchmark
Non-Endowed Long Term Growth
Benchmark
Endowed Long Term Growth
Benchmark
1 Yr
3 Yr
5 Yr
10.7%
5.1%
6.4%
10.4%
3.2%
5.0%
14.9%
2.8%
6.0%
12.5
0.2%
4.2%
14.5%
1.0%
5.5%
12.9%
-1.2%
3.8%
13.2%
0.5%
5.3%
12.9%
-1.6%
3.5%
Exceeds benchmark
Annual Returns:
Endowed Long Term Growth
2003
2004
2005
2006
2007
2008
2009
2010
Endowed LongTerm Growth
23.8% 11.3%
8.8% 15.1% 10.1% -28.6%
25.1% 13.2%
Benchmark
25.1% 11.6%
7.0% 15.3%
21.1% 12.9%
8.3% -30.2%
2011 FFTC Spending Policy
Key Terms
• Corpus, principal and historic dollar value (HDV)
– Interchangeable
– Refers to the original gift amount + any contributions
• “Spendable Income” Policy
– Board policy on total return spending rate from
endowments
• % annually
Background – 2010 FFTC Board Policy – 4%
• Calculated using 3-year rolling average
• Allow spending below corpus up to 66% of HDV
• Re-evaluate spending rate & policy in 2011
N.C. UPMIFA Factors for Consideration
1)
2)
3)
4)
5)
6)
7)
8)
General economic conditions
Possible effect of inflation or deflation
Expected tax consequences of investment decisions
Role each investment plays in overall investment portfolio
Expected total return from income and investments
Other resources of the institution
Needs of the institution and fund to make distributions
Asset’s special relationship or special value
Other FFTC Board Considerations
• 3-year average – removing 2007 balances
– Will negatively affect amount available
• Still have some funds under water
2011 FFTC Spending Policy
Spending rate
4.5%
Case-by-case staff exception
If fund above HDV, then donor
can request to spend 5%
Corpus limitation
66% of HDV
Calculation
Average of prior 3 year-end
balances
Policy application
One year
NACUBO-Commonfund Study
2010 Average Spending Rate
– Range of 3.5% - 5.7%
– Average 4.5% (compared to 4.4% for prior year)
National Association of College
and University Business Officers
Source: NACUBO-Community Fund Study of Endowments for FY2010
commonfund
Agenda
• Welcome & Opening Remarks, Holly Welch Stubbing
• FFTC Investment & Spending Policy Overview, Judy Kerns
• Endowment Investment Opportunities & Risks in a
Recovering Economy, Scott Harsh
• Closing Remarks, David Snider
Fund Evaluation Group (FEG)
• Investment consultant to FFTC since 2000
• Not a money manager but an investment consultant with the
objectives to:
– Maximize performance opportunities
– Minimize investment-related expenses
– Enhance fiduciary oversight
• Headquartered in Cincinnati
Scott Harsh
• President & CEO, Fund Evaluation Group, LLC
• 22 years financial experience
– FEG since 1990
• B.B.A. in Finance and Real Estate
– University of Cincinnati
Investment
Opportunities and Risks
in a Recovering Economy
Winter 2011
FEG Overview
Established in 1988
 100% employee-owned, with broad
equity ownership
 79 team members
 Headquartered in Cincinnati
 Boston
 Detroit
 Chicago  Indianapolis
 $31 billion under advisement
 Services:
 FEG/Consulting
 FEG/Managed Portfolios
 FEG/Research

Mission

Enabling clients to fulfill their missions
and exceed their goals through
superior investment performance

Educating our clients on current
investment strategies and trends,
thereby assisting them in making
informed decisions

Serving as an extension of our clients’
staffs, allowing our clients to focus on
their missions
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©2011 Fund Evaluation Group, LLC
Client Overview
FEG’s Clients – By Assets Under Advisement Size
(as of September 30, 2010)
Charitable
Organizations
7%
Religious
7%
Higher
Education
37%
Other
9%
Community
Foundations
10%
Healthcare
13%
Corporations
16%
“Other” is comprised of Independent Schools, Insurance, Private Foundation, Public Fund and Taft Hartley
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©2011 Fund Evaluation Group, LLC
Overview
 We revisit our 2010 recommendations, highlight the current state of the markets, and review investment
opportunities and risks for 2011.
 While the goal of this presentation is to highlight opportunities present in today’s markets, investors
should evaluate their portfolios in conjunction with their level of fiduciary risk appetite.
 All markets reviewed can be accessed through a variety of investment vehicles with different levels of
liquidity. Investors should consider liquidity needs and risk tolerance.
 Traditional long-only managers (liquid)
 Hedge funds (semi-liquid)
 Private vehicles (illiquid)
25
©2011 Fund Evaluation Group, LLC
2010 Summary
What we said: Global Fixed Income

CMBS – Commercial mortgage backed securities offer attractive yields, compensating for expected turmoil in commercial real
estate.

Investment Grade Credit – Reasonable yields and low risk of defaults creates attractiveness.

High Yield – Spreads approaching historic averages, yet yields adequately compensate for risk as defaults are expected to decline.

TIPS – Although unlikely to generate high returns, provide inflation protection.

Treasuries – Unattractive due to low yields.
What happened:
 Improvements in commercial
real estate supported a rally in
CMBS.
Performance Summary as of December 31, 2010
Returns in U.S. dollars
25%
20.8%
20%
15.1%
 Investment grade credit returns
were strong amid increased
issuance.
15%
8.5%
10%
6.5%
5.5%
 High yield posted double-digit
returns with risk assets
outperforming Treasuries.
10.0%
6.3%
5%
0%
Core Fixed
Income
Treasuries and
Agencies
TIPS
Investment
Grade Credit
Bank Loans
High Yield
CMBS
 TIPS outperformed Treasuries
and agencies amid fears of
inflation.
Source: Barclays and CSFB
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©2011 Fund Evaluation Group, LLC
2010 Summary
What we said:
Global Equity




What happened:

U.S. and emerging market equities realized double-digit gains, while
international developed market equities were somewhat
constrained by the European sovereign debt crisis.

Emerging Markets – Attractive due to reasonable
valuations and strong economic growth.
Hedged equity returns were positive, but lagged the public
markets, although with less than half of the public market’s
volatility.

Private Equity – Low valuations and lack of new
commitments create compelling opportunities.
REITs outperformed despite unattractive valuations and historically
low yield spreads to Treasuries.

Commodity returns were in-line with public equities.
Developed Equities – Mixed outlook as earnings
growth is expected to be strong, but valuations in
the U.S. have approached long-term averages.
Economic headwinds are a concern.
Hedged Equity – Given the likely return to a focus
on fundamentals, active hedged equity managers
can benefit the portfolio’s risk/return profile.
Private equity performance should be considered over the life of
the fund, and thus evaluating returns is premature.
Performance Summary as of December 31, 2010

Returns in U.S. dollars
Real Assets



40%
Private Real Estate – With commercial real estate
trading at depressed prices, focus on distressed and
value-added opportunities.
REITs – Recapitalization of REITs provided
improvement in balance sheets, but valuations are
not compelling.
Natural Resources/Commodities – Consider as
inflation protection strategies.
27.9%
20%
18.9%
16.9%
16.7%
10.4%
7.7%
0%
U.S. Equity
International
Developed
Emerging
Markets
Hedged Equity
One Year Returns
Source: Russell, MSCI, NAREIT
REITs
Commodities
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©2011 Fund Evaluation Group, LLC
2011 Opportunities and Risks
Global Equity

Developed Equities – Earnings growth is expected to
benefit returns, but risk arises as sustained profits depend
on the successful transfer from government stimulus to the
private sector in the U.S. The European sovereign debt
crisis and deflationary concerns in Japan remain ongoing
economic headwinds. Valuations are near equilibrium.

Emerging Markets – Economic growth continues to create a
favorable investing opportunity, but risk has increased with
strong capital flows and inflationary pressures.

Private Equity – Opportunities exist with decreased
fundraising, less competition, and improving market
conditions.
Global Fixed Income

TIPS/Treasuries/International – Favor TIPS versus
Treasuries; U.S. rate exposure can be diversified with
international sovereign debt.

High Yield/ Bank Loans – High yield spreads near
historical averages. Default rates likely to remain low
for bonds and loans, but loans yield approximately 80%
of high yield, with shorter duration, lower
default/higher recovery characteristics and better riskadjusted returns if a rising rate environment develops.

CMBS – Seasoned commercial mortgage backed
securities offer attractive relative yields versus high
yield bonds and bank loans.
Real Assets

Private Real Estate – With commercial real estate trading at depressed prices, focus on distressed and value-added
opportunities.

Natural Resources/Commodities – Consider as inflation protection strategies which also benefit from global economic
growth.
Diversifying Strategies

Absolute return hedge funds, as well as other non-correlated strategies such as pharmaceutical royalties and managed
futures can enhance portfolio diversification by providing risk profiles that vary from traditional portfolio risks of equity,
interest rates, and credit.
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©2011 Fund Evaluation Group, LLC
Economic Environment



Economic growth was positive for 2010, but weakness
in the recovery allowed double-dip recession concerns
to linger.
GDP Growth - Trailing Quarter
20%
15%
Unemployment persists slightly below 10%, and
remains the dominant headwind to a sustained
economic recovery.
10%
Stress in the residential real estate market continued
amid pending foreclosures and a large unsold inventory
of homes, which may lead to further declines.
-5%
5%
0%
-10%
-15%
1947 1951 1956 1960 1965 1969 1974 1978 1983 1987 1992 1996 2001 2005 2010
National Unemployment Rate
12%
Case-Shiller National Home Price Index
200
180
Case-Shiller National Home Price Index
10%
1987 Index Value CPI Adjusted
160
8%
140
120
6%
100
4%
2%
80
60
40
0%
1948 1952 1956 1960 1964 1968 1973 1977 1981 1985 1989 1993 1998 2002 2006 2010
Sources: Bloomberg LP, Bureau of Labor Statistics, Bureau of Economic Analysis, S&P/Case-Shiller
20
0
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
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©2011 Fund Evaluation Group, LLC
Volatility and Sovereign Default Risk
CBOE Volatility Index (VIX) and the S&P 500
1990 - 2009
90
1800
80
1600
60
1200
50
1000
40
800
30
600
20
400
10
200
0
1991
1992
Percentage Points
Greece
Ireland
8
Portugal
Spain
6
Italy
4
2
0
2003
2004
2005
Source: Bloomberg LP
2006
2007
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2006
2007
2008
2009
2010
Source: Bloomberg LP
12
10
S&P 500
S&P 500
VIX
0
1990
European Sovereign Credit Default Swap Rates
"PIIGS" Nations 2003 - 2010
1400
70
VIX
Volatility
 The CBOE Volatility Index (VIX) is
considered an indicator of fear in the
equity markets.
 As fear drove broad sell-offs in the global
markets, the VIX peaked at approximately
80 in late 2008 and rose over 40 in 2010
when double-dip recession fears surged.
 In late 2010, fear subsided and the VIX
declined below its average of 20.
2008
2009
2010
Sovereign Default Risk
 Credit default swap rates, a measure of the cost to
insure against default, soared for the debt of the
economically weak euro zone nations.
 The stronger euro zone nations and International
Monetary Fund provided debt support, as the weaker
nations implemented austerity measures to improve
their fiscal health, but these weaker nations have failed
to generate economic growth.
 Greece, Ireland, and Portugal comprise less than 7% of
euro zone GDP. Spain (12%) and Italy (17%) are more
meaningful to the euro zone economy.
30
©2011 Fund Evaluation Group, LLC
U.S. Equities – Earnings



Earnings growth, which averaged mid-single digits on a 10-year basis since World War II, is expected to be
approximately 16% in 2011, based on estimates as of December 31, 2010.
While profitability and corporate cash positions are generally strong, apprehension remains due to the
headwinds of unemployment and slow economic recovery.
Improvements in profitability have been driven by government stimulus. Earnings will be impacted by the extent
business investment, consumer spending, and exports can replace the eventual reduction and removal of
government stimulus.
U.S. NIPA Corporate Profits - Historical and Forecasted
Estimated S&P 500 Reported Earnings
Estimate as of each date:
$2.5
$100
Estimated Earnings
2009
2010
2011
$86.84
$80
$74.57
$70
$60
$50.97 (actual)
$50
$40
$30
$20
$14.88 (actual)
$10
Trillions, Seasonally Adjusted
2008
$90
$2.0
$1.5
$1.0
$0.5
$0
2014
2010
2005
2001
1996
1992
1987
1983
$0.0
1978
Dec-10
1974
Jul-10
1969
Date of Earnings Estimate
Feb-10
1965
Sep-09
1960
Apr-09
1956
Nov-08
1951
Jun-08
1947
Dec-07
Source: Moody's, Bureau of Economic Analysis
Source: Standard & Poor’s
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©2011 Fund Evaluation Group, LLC
Equity – P/E Ratios

U.S. equity valuations are near or above long-term
averages (depending on measure).

U.S. large cap stocks trade near the 30-year average
P/E multiple, 17.4x versus an average of 18.1x.
Historical Valuations: Large Cap
Russell 1000
30x
Average
25x
20x
18.1x
17.4x
15x
10x
5x
0x
12/81
12/82
12/83
12/84
12/85
12/86
12/87
12/88
12/89
12/90
12/91
12/92
12/93
12/94
12/95
12/96
12/97
12/98
12/99
12/00
12/01
12/02
12/03
12/04
12/05
12/06
12/07
12/08
12/09
12/10
U.S. equity markets trade at a 10-year normalized P/E
multiple that is above the long-term average.
Source: Rimes
Historical Valuations: U.S.
Historical Valuations: Small Cap
1945-2010
50x
S&P 500
50x
12/10
0x
12/08
1945 1949 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009
5x
12/06
0x
10x
12/04
5x
15x
12/02
10x
12/00
15x
24.7x
20x
12/98
18.1x
29.5x
25x
12/96
20x
30x
12/94
22.7x
Average
35x
12/92
25x
Russell 2000
40x
12/90
30x
45x
12/88
35x
12/86
Average
12/84
40x
12/82
45x
Price / Earnings (Trailing 12 Mo.)...

Small cap stocks trade above the 30-year average P/E
multiple at 29.5x earnings versus an average of 24.7x,
but below a multiple of 20x (19.6x) when excluding
negative earnings.
Price / Earnings (Real 10-Year Normalized)...

Price / Earnings (Trailing 12 Mo.)...
35x
Source: Robert Shiller and Standard & Poor’s
Source: Rimes
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©2011 Fund Evaluation Group, LLC
U.S. Equities – Price/Earnings
Annualized Return over Next 3 Years


Assume current P/E ratio of 16x and 2% dividend yield
Ending P/E Ratio
Earnings Growth

Changes in P/E ratios are a
primary contributor to
equity returns.
For example, assuming
dividend yields of 2%, no
change from the current
trailing one-year P/E ratio of
16x, and 5% earnings
growth over the next three
years would generate a
return of 7%.
The example also illustrates
that a decline in P/E ratios
or a decline in earnings
growth would diminish
returns.
Stronger earnings growth or
expanding multiples would
further improve investor
returns (see 10 year chart).
8
12
16
20
24
-5%
-23%
-12%
-3%
4%
11%
0%
-19%
-7%
2%
10%
17%
5%
-15%
-3%
7%
15%
22%
10%
-11%
2%
12%
21%
28%
15%
-7%
6%
17%
26%
34%
Source: Fund Evaluation Group
Annualized Return over Next 10 Years
Assume current P/E ratio of 16x and 2% dividend yield
Ending P/E Ratio
Earnings Growth

8
12
16
20
24
2%
-3%
1%
4%
6%
8%
4%
-1%
3%
6%
8%
10%
6%
1%
5%
8%
10%
12%
8%
3%
7%
10%
12%
15%
10%
4%
9%
12%
15%
17%
Source: Fund Evaluation Group
Note: Model returns are estimates based on P/E ratios, earnings growth, and dividends
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©2011 Fund Evaluation Group, LLC
Equity – P/E Ratios
Historical Valuations: International Developed
50 x
EAFE
Average
45 x
Price / Earnings (Trailing 12 Mo.)
International equity markets trade below historical averages and
at lower P/E ratios than U.S. stocks.
 The sovereign debt crisis and divergence of economic growth
within the euro zone, augmented by deflationary pressures in
Japan, has kept developed market valuations subdued.
 Emerging markets should experience stronger economic growth,
but also have greater inflationary pressures.
 Emerging markets sustained one of the strongest rallies and
attracted substantial fund flows. While there is potential for a
pullback in emerging equities, valuations are near average on a
P/E basis, and slightly above average on a P/B basis.

40 x
35 x
30 x
25 x
21.6 x
20 x
15.5 x
15 x
10 x
5x
12/81
12/82
12/83
12/84
12/85
12/86
12/87
12/88
12/89
12/90
12/91
12/92
12/93
12/94
12/95
12/96
12/97
12/98
12/99
12/00
12/01
12/02
12/03
12/04
12/05
12/06
12/07
12/08
12/09
12/10
0x
Source: Rimes
Net Emerging Market Fund Flows
Historical Valuations: Emerging Markets
$30
Emerging Market Equity
$20
MSCI Emerging Markets Index
Emerging Market Bonds
45x
Price / Earnings (Trailing 12 Mo.)...
$15
$10
$5
$0
Source: Morningstar
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
-$5
Average
40x
35x
30x
25x
20x
16.1x
14.6x
15x
10x
5x
0x
12/97
06/98
12/98
06/99
12/99
06/00
12/00
06/01
12/01
06/02
12/02
06/03
12/03
06/04
12/04
06/05
12/05
06/06
12/06
06/07
12/07
06/08
12/08
06/09
12/09
06/10
12/10
Billions, $U.S.
$25
Source: Rimes
34
©2011 Fund Evaluation Group, LLC
Venture Capital
Performance of all venture capital funds performed slightly
better than public equity markets in recent history, while
outperforming over the long-term.
 The drop in fundraising results in both fewer and smaller funds.
Fewer funds and less capital should reduce competition for
target companies and decrease valuations. The number of
active venture funds is estimated to be the lowest in a decade,
and continued improvements in merger and acquisition activity
are expected to strengthen exit opportunities for venture
funds.
 The venture industry often follows a circular pattern where low
fundraising leads to lower valuations, which leads to higher
returns.

Performance Through June 30, 2010
TopAllTime
Russell
Quartile Quartiles Nasdaq S&P 500
Period
2000
Venture Venture
3-Year
3.5%
-2.2%
(6.8%)
(9.8%)
(8.6%)
5-Year
11.1%
3.2%
0.5%
(0.8%)
0.4%
10-Year
6.1%
(1.6%)
(6.1%)
(1.6%)
3.0%
20-Year
36.0%
15.4%
7.9%
7.7%
8.2%
Sources: Venture Economics, Nasdaq, S&P, Russell
Source: Trends in Venture Capital Survey Third Quarter 2010.
35
©2011 Fund Evaluation Group, LLC
Buyout
Performance Through June 30, 2010
Performance
 The buyout sector rebounded significantly due
in large part to the recovery of the public
markets and the increase in the availability of
debt.
 Buyout funds have historically provided
premium returns above the S&P 500 Index
returns.
Time
Period
TopQuartile
Buyout
AllQuartiles
Buyout
S&P 500
1-Year
3-Year
5-Year
10-Year
20-year
19.3%
3.2%
23.6%
19.0%
28.8%
13.9%
-3.5%
5.1%
5.5%
9.6%
14.4%
-9.8%
-0.8%
-1.6%
7.7%
TopQuartile
Premium
over S&P
AllQuartile
Premium
over S&P
4.9% points
13.0% points
24.4% points
20.6% points
21.1% points
-0.5% points
6.3% points
5.9% points
7.1% points
1.9% points
Source: ThomsonONE/Venture Economics
Opportunity
 By these measures, the current environment
presents an opportune time for investors to
allocate to buyout managers that are cycle
tested.
300
30%
post-economic downturns
250
Performance (Pooled IRR)
 Performance was strong over the three vintage
years following economic downturns.
Buyout Fundraising vs. Performance
Fundraising (in billions)
 Historically, performance of buyout funds
peaked during periods of low or declining
fundraising.
20%
200
10%
150
0%
100
-10%
50
0
-20%
1990
1992
1994
1996
1998
Fundraising (in millions)
2000
2002
2004
2006
2008
Performance (Pooled IRR)
Source: ThomsonONE/Venture Economics
36
©2011 Fund Evaluation Group, LLC
Treasuries and Inflation
Treasuries
 Short-term rates are close to zero. Rates are expected to
remain low in the short-term as the Federal Reserve has
shown no indications of reversing easy monetary policy
until the economic recovery is on sure footing.
 Consensus estimates indicate a belief that over the longterm rates will increase, thus presenting risk of declining
asset values in fixed income.
 In the event of an economic shock, a flight-to-quality
would likely pressure long-term rates downward.
U.S. Treasury Yield Curve
12/31/2010
 Due to the substantial monetary and fiscal stimulus,
deflation concerns during the financial crisis abated, but
lingered in investors minds amid fears of a double-dip
recession in 2010.
 Longer-term inflation concerns are highly debated in the
wake of massive monetary and fiscal stimulus.
 If inflation increases over the next decade, TIPS appear
attractive contrasted to 10-year Treasuries.
The U.S. 5-year by 5-year forward inflation rate is expected 5-year inflation 5-years from now
and is calculated by subtracting the TIPS 5- year forward contract from the nominal Treasury 5year forward contract.
12/31/2009
5%
4%
3%
2%
1%
0%
1 Mth
Inflation
9/30/2010
5 Yr
10 Yr
30 Yr
Source: Bloomberg LP
5-Year by 5-Year Forward Inflation Rate
3.5%
3.0%
2.79%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Jun-2007 Dec-2007 Jun-2008 Dec-2008 Jun-2009 Dec-2009 Jun-2010 Dec-2010
Source: Bloomberg LP
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©2011 Fund Evaluation Group, LLC
Treasury and Agency Yields
 The table below illustrates the impact of interest rate changes on the Barclays Capital Aggregate Bond Index,
which is approximately 80% Treasury and agency issues, yielding 3.0% with a duration of five years as of
December 31, 2010.
Scenario Analysis - Bond Returns
Current Yield: 3%
 This example
demonstrates the risk
presented by rising
rates, but also the
mitigation of that risk
over longer time
periods.
Total Annualized Return Over Ensuing
1-Year
% Point Change in Rates
 For example, a two
percentage point
increase in rates over a
one-year period would
lead to a -7% return, but
rising rates aid longerterm returns, as income
is reinvested at higher
rates.
Duration: 5 years
3-Year
5-Year
10-Year
-2%
13.0%
5.6%
4.1%
3.0%
-1%
8.0%
4.3%
3.5%
3.0%
0%
3.0%
3.0%
3.0%
3.0%
1%
-2.0%
1.7%
2.5%
3.1%
2%
-7.0%
0.4%
2.0%
3.2%
3%
-12.0%
-0.8%
1.5%
3.3%
4%
-17.0%
-2.1%
1.1%
3.4%
5%
-22.0%
-3.3%
0.7%
3.6%
Assumes a straight line change in yield over the return period and no change in duration
Sources: Fund Evaluation Group and Barclays Capital
38
©2011 Fund Evaluation Group, LLC
International Bonds
G-20 Public Sector Debt Levels




As public sector debt levels rise, risk of
credit downgrades increase; should this
situation persist, future issuance could
require higher yields, increasing the cost
of debt service.
While higher coupons benefit new
investors, existing sovereign debt
investors experience lower prices for
their bonds as yields rise.
A broad dispersion of bond yields among
G-20 countries provides fixed income
investors the opportunity to achieve a
greater breadth of income relative to
Treasuries.
As interest income is a primary driver of
sovereign bond returns, receiving a
higher coupon can substantially improve
long-term returns.
200%
180%
= Developed
160%
= Emerging
140%
Avg. Developed
Debt/GDP = 85%
Avg. Emerging
Debt/GDP = 35%
120%
100%
80%
60%
40%
20%
0%
G-20 10 Year Note Yields
As of December 31, 2010
Australia
Canada
France
Germany
Italy
Japan
U.K.
U.S.
Brazil
China
India
Indonesia
Mexico
Russia
South Africa
South Korea
Turkey
0%
2%
4%
Note: The 20th member of the G-20 is the European Union
Source: Bloomberg LP
6%
Yield
8%
10%
12%
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©2011 Fund Evaluation Group, LLC
High Yield and Bank Loans
 High yield spreads contracted further in 2010,
moving bond prices slightly above par and returning
spreads to historical averages.
 Bank loan spreads remain above their historical
average at more than LIBOR+500 basis points (L+500)
and at an average price in the mid-90s.
20
20%
18
18%
16
16%
14
14%
12
12%
10
10%
8
8%
6
6%
4
4%
2
2%
0
0%
Altman Annual Def ault Rate
Barclays US High Yield Index Spread
Default Rate
 High yield bond spreads versus Treasuries and bank
loan spreads versus LIBOR retreated from historic
wide levels in 2009, and default rates followed,
declining in 2010.
U.S. High Yield Bond Spreads over Treasury Yields
Spread (percentage points)
 The average yield to maturity for high yield bonds is
7.5% versus 6.0% for bank loans.
Average Spread
Sources: Altman, Barclays Capital
 High yield bonds have developed more interest rate
sensitivity due to their lower absolute yields, while
bank loan rates reset every three months, mitigating
the risk of rising rates.
 Bank loan yields are approximately 80% of the yield
of comparable high yield bonds, but offer lower
default risk, higher recovery rates than high yield
bonds, and an embedded hedge to rising interest
rates.
40
©2011 Fund Evaluation Group, LLC
Commercial Mortgage Backed Securities
The CMBS market remains bifurcated; specifically by credit quality and vintage year.
 Higher rated CMBS and those that were originally rated AAA were supported by government sponsored
programs, while lower rated CMBS and older vintage year CMBS were not supported by government programs.
 This bifurcation manifests itself in wider yield spreads for unsupported CMBS.
 While spreads have declined, the gradually improving commercial real estate market still provides opportunity
with economic recovery.

CMBS Yield Spreads versus Treasuries
50
Spread (percentage points)
40
30
20
10
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Barclays Capital
AAA CMBS
BB CMBS
41
©2011 Fund Evaluation Group, LLC
Private Real Estate




Deteriorating fundamentals in commercial real estate increased cap rates for private real estate and illustrate
the opportunity in the private real estate market.
Over the next three years, in excess of $900 billion in real estate debt is scheduled to mature.
With limited financing options, property owners may struggle managing debt maturities that would normally be
refinanced. Property owners face the possibility of losing assets in this environment, creating the opportunity to
purchase assets at distressed prices.
Capital commitments to private real estate, where capital will be called and invested over the next two years
amid ongoing distress, should be well positioned to benefit from these attractive opportunities.
Commerical Real Estate Loan Maturities U.S. 2010-2013
Acquisition Yields / Cap Rates
10%
Bank/Thrift
9%
Insurance Cos.
CMBS - Floating
CMBS - Fixed
$350
$300
Billions
8%
7%
$250
$200
6%
NCREIF Current Value Cap Rate
$150
RCA Transaction Cap Rate
5%
$100
$50
4%
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
$0
Sources: Green Street Advisors, NCREIF, Real Capital Analytics
NCREIF current value cap rate is determined by current net operating income to appraised values
RCA transaction cap rate is determined by expected net operating income to transaction prices
2010
2011
2012
2013
Source: Heitman Research
42
©2011 Fund Evaluation Group, LLC
Diversifying Strategies
Pharmaceutical Royalties
 Pharmaceutical royalty returns are based on the sales of a
specific pharmaceutical product and are not correlated to
the equity market or economy.
 Royalty buyers benefit from top-line revenue growth and
are not directly affected by margins and cost structure.
 Further, pharma royalty returns are not reliant on the stock
price performance of the company marketing the product
or the sector falling out of favor with investors.
Managed Futures
 Managed futures, often known as
commodity trading advisors (CTAs), exhibit
little to no correlation to traditional markets,
particularly during periods of significant
stress.
 During the worst 20 single months for the
S&P 500 since 1980, the S&P 500 declined
9.9% on average, while the Barclay CTA
Index returned 2.2%. The Barclay CTA Index
was positive in 14 of these 20 months.
Sources: AMEX, Credit Suisse, IMS, and S&P
Performance of the CTA Index
Worst 20 Months of the S&P 500
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
Sources: S&P, Barclays
S&P 500
Barclay CTA
43
©2011 Fund Evaluation Group, LLC
2011 Summary
ASSET CATEGORIES
ATTRACTIVENESS
RISKS
GLOBAL EQUITIES
U.S. and International Developed


Earnings growth with an improved economic growth environment
Strong corporate cash positions



Emerging Markets


Higher GDP growth than developed markets
Increasing consumer demand
Many emerging nations are providers of credit
Returns potential due to low flows into private equity
Improving merger and acquisition market

Safety in times of weakness




Private Equity





Weak economic growth
European sovereign debt risk
Potential for P/E contraction
Crowded trade
Potential for P/E contraction
Inflationary pressures, including food and energy
Availability of credit and exits
Weak economic growth
GLOBAL FIXED INCOME
Treasuries


Low yields coupled with rising interest rates
Inflation – leads to negative real returns
Rising interest rates
Deflation or low inflation
Spreads widen
Higher defaults / lower recovery rates vs. expectations
TIPS

Inflation protection
High Yield and Bank Loans

High yield bond yields more than twice that of Treasuries
Bank loans provide yield and variable rate protects against rising interest rates

Attractive yields
Seasoned issues provide better protection

Lack of capital to support commercial real estate refinancing provides
opportunities


Property values decline
Properties require substantial capital

Inflation protection

Lack of global economic growth
Pharmaceutical Royalties

Non-correlated returns

Regulatory changes and poor drug selection
Managed Futures

Downside protection
Non-correlated returns

Lagging performance in a market rally


CMBS




Rising interest rates
Default risk
REAL ASSETS
Private Real Estate
Natural Resources/Commodities

Diversifying Strategies

44
©2011 Fund Evaluation Group, LLC
Disclosures







This report was prepared by Fund Evaluation Group, LLC (FEG) − an investment adviser registered under the
Investment Advisers Act of 1940, as amended − providing non-discretionary and discretionary investment advice
to its clients on an individual basis.
The information herein was obtained from various sources. FEG does not guarantee the accuracy or
completeness of such information provided by third parties. The information in this report is given as of the date
indicated and believed to be reliable. FEG assumes no obligation to update this information, or to advise on
further developments relating to it.
Index performance results do not represent any managed portfolio returns. An investor cannot invest directly in
a presented index, as an investment vehicle replicating an index would be required. An index does not charge
management fees or brokerage expenses, and no such fees or expenses were deducted from the performance
shown.
Neither the information nor any opinion expressed in this report constitutes an offer, or an invitation to make an
offer, to buy or sell any securities. FEG, its affiliates, directors, officers, employees, employee benefit programs
and client accounts may have a long position in any securities of issuers discussed in this report.
Any return expectations provided are not intended as, and must not be regarded as, a representation, warranty
or predication that the investment will achieve any particular rate of return over any particular time period or
that investors will not incur losses.
Past performance is not indicative of future results.
This report is prepared for general circulation and information only. It does not address specific investment
objectives, or the financial situation and the particular needs of any person.
45
©2011 Fund Evaluation Group, LLC
Firm Contact Information
201 East Fifth Street
Suite 1600
Cincinnati, OH 45202
Phone: 513.977.4400
Fax: 513.977.4430
[email protected]
www.feg.com
Satellite Offices: Boston / Chicago / Detroit / Indianapolis
46
©2011 Fund Evaluation Group, LLC
Agenda
• Welcome & Opening Remarks, Holly Welch Stubbing
• FFTC Investment & Spending Policy Overview, Judy Kerns
• Endowment Investment Opportunities and Risks in a
Recovering Economy, Scott Harsh
• Closing Remarks, David Snider
Spring 2011 Activities and Events
Event
Speaker
Month
FEG Investment Seminar
Scott Harsh
February
FFTC Annual Meeting
John Wood
February
Spendable Communication
FFTC
March
MSO Information Session
Tides/FFTC
April
Thank You!