Alternative Investments

“Outlook for the Investment

Management Industry”

San Antonio October 17, 2007

Bank Depository User Group Meeting

The Mystery of Alternative Investments The Mystery of Alternative Investments

What are they??

and what do they do????

Perception Vs. Reality

1

Alternative Investments – Perception vs. Reality

2

Questionnaire:

Do Private Equity Funds Buy Only Private Companies?

Do Hedge Funds Hedge?

Do Real Estate Investments Appreciate with Property Values?

Do Structured Products Perform Like the Underlying Asset or Index?

3

What are alternative investments?

Incentive based investment management

Less liquid and longer term investment vehicles

Absolute return investments

Skill based investment vehicles

4

Examples of Alternative Investments

Hedge Funds

Private Equity & Venture Capital

Real Estate Investment

Structured Notes

Commodity Funds?

5

Benefits of Alternative Investments in Investment Portfolios

Performance

Diversification

Non Correlation ?

Lower Volatility?

Downside Protection?

6

Do Alternative Investments Increase Portfolio Risk?

Perception

More Volatile

Market risk is large

Highly Speculative

Reality

Less Volatile

Absolute return

Provide diversification

7

What are the real risks in alternative investments?

Illiquidity

Leverage

Redemptions

Less regulated

1. Absolute Return2. Tax Inefficient3. Active Risk Management4. Variable Concentration of Holdings5. Benchmarking Less Relevant6. Not Dependent on Market Direction7. Large Assets Detract from Performance8. Less Transparent9. Less Regulated10.Higher Minimum Investment Required11.Less Liquidity – “Lock-ups” 12.Higher Fees and Manager Incentives

1. Relative Return Measurement 2. Longer Term & Tax Efficiency3. Less Turnover and Trading

Cost4. Often Greater Diversification5. Benchmarked Performance6. Will Lose Money in Down

Markets7. Scalable Asset Growth8. Greater Transparency9. Regulated10.Lower Investment Minimums11.Daily Liquidity12.Lower Fees; Lower Incentives

Traditional Long Only Investments Asset

AllocationAlternative Investments

Alternative Investments vs.Traditional Funds

Pros and Cons

8

9

Mercer Investment Consulting Survey

•Diversification

•Performance

Reducing risk in combination with enhancing return is the most common motivation for asset allocation to alternative investments – more specifically hedge funds

Survey respondents pointed to a lack of understanding ofalternative investment strategies as a serious challenge

While increased asset allocations were expected….More education was needed

10

Yale Endowment Target Asset Allocation June 2004

Absoute return25%

Hard Assets20%

Cash0%

Private Equity17%

Fixed Income8%

Foreign Stocks15%

Domestic Stocks15%

Diversification - Increased Asset Classes

11

Performance of alternative investments vs. traditional

Annualized returns 1994-2006

9.45 9.726.19

8.84 10.45

24.30

0.005.00

10.0015.0020.0025.0030.00

Multi SectorHedge Funds

S&P Lehm Agg MSCI World P.Eq.Buyouts Venture C

Source: Goldman Sachs Thomson Venture Hennessee Hedge Fund Group

1

2006 Performance for Alternative Investments

“Boom Year”

Hedge Funds Private Equity REITs

11.36%

23.3%

36.06%

11.20%10.62%

14.79%

10 year Annualized return information - Sources:Hennessee Hedge Fund Group NAREIT, Thomson Venture Capital Assoc., Institutional Investor, JP Morgan 12

Benefits of Alternative Investments

13

Annualized Return

Annualized Volatility

Max.. Drawdown

Period

Months

Recovery

Months

Beta to

MSCI

Sharpe Ratio

9.45% 3.87% -4.14% 3 3 0.13 1.37

6.19% 3.83% -5.15% 5 8 -0.01 0.63

8.95% 2.90% -6.27% 3 5 0.05 1.66

5.82% 8.05% -7.74% 5 15 -0.05 0.28

12.09% 10.05% -15.04% 29 17 0.47 0.80

11.77% 5.54% -16.05% 5 10 0.25 1.35

8.84% 13.45% -46.80%

30 401.00 0.41

Multi Strategy Fund Index

Lehman Aggregate Bond Index

Relative Value

Custom Index

Tactical Trading CTA Index

Barclay

Equity Long/Short

CSFB Index

Event Driven

CSFB Index

MSCI World Index

*Data from Goldman Sachs Jan. ’94 through Dec.’06

Non Correlation, Lower Volatility & Capital Preservation

14

Public vs. Private Investing 2005

                                                                                                       

Priv Equity, Venture, Mexx. Inflows Eq Mutual Fnd Inflows

$139.6B $135.8B

Demand for Alternative Investments

Source: Federal Reserve Bank of Chicago Private Equity Conference 2006

1

Hedge Fund Capital Under Management

                                                                                                       

$500 Billion $1.500 Billion

Demand for Alternative Investments

1999

Source: Federal Reserve Bank of Chicago Private Equity Conference 2006

$500 B

$1.500 B

2006

15

16

5.2

16.112.811.9

9.5 7.512.6

17.8

24.632.8

37.2

52.4

79.473

89.6

65

45.738.8

55

106.4

0

20

40

60

80

100

120

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Buyout Fund Assets

$ Billion

Buyout Funds (Excludes Venture Capital)

Source: Private Equity Analyst, Willis Stein Partners

Private Equity Dollars Raised

17

Institutional Asset Managers Offering Alternative Investments

32%

68%

Do not offer Alternative Investments

Offer Alternative Investments

1. Private Equity2. Real Estate3. Hedge Funds4. Structured Products

18

Alternative Investments - For Asset Managers… Disproportionate Profitability

Proportion of firm’s institutional assetsand revenues from Alternative Investments 2006

15% 36%

Source: McKinsey 2006

Assets Revenues

Alternative Investments

Pricing Power vs. Traditional Funds

19

0 50 100 150 200 250

QA + Index 2005

QA + Index 2006

Traditional

Alts 2005

Alts 2006

Structured Products Hedge FundsReal Estate

Equity –41 BPSFixed Inc.- 18 BPSMoney Market - 12 BPS

Firm Managed

Hedge Funds

Source: McKinsey

Annual Management Fees in Basis Points

Core & Satellite Investment Model

Consultants Getting on Board

As Traditional Managers Fall Out of Favor 20

Core InvestmentsMarket based returnsETFs, Index, Passive

Skill based

Skill based

Skill based

Skill based

Risk based

Risk based

Source: McKinsey & Company

0 10 20 30 40

Alternatives

Structured

R.E.

Intl Eq

US Equity

Fixed Inc

MM

Quant Active

Pure Index“Cheap Beta”

“Traditional”

Alternatives Alpha Strategies

International

Institutional AUM Favor Alternatives and Cheap Beta Growth Rates

21

Alternative Investments

22

Fixed Income +28%

Quantitative Enhanced +28%

U.S Equity –6%

Alpha Strategy Alternatives +12%

Defined Benefit Asset Allocations Trends 2006

Source: McKinsey & Company

23

2

9

1

105

23

9

37

2721

29

0

7

005

10152025303540

<7% 7 to7.5%

7.5 to8%

8 to8.5%

8.5 to9%

9 to9.5%

>10%

1999 2006

Pension Fund Return Assumptions S&P 500 Companies

Source: JP Morgan

1999 Average: 9.2%2006 Average: 8.1%

Return Assumptions

% of Companies

24

Performance of alternative investments vs. traditional

Annualized returns 2002-2006

9.10

5.60 5.50 5.10

9.10

0.00

2.00

4.00

6.00

8.00

10.00

Multi SectorHedge

Lehm Agg S&P 500 P.Eq.Buyouts Venture C

Source: Goldman Sachs Thomson Venture Hennessee Hedge Fund Group

25

More Growth is on the Way from Pension Investors

Endowments, and High Net Worth Individuals are thereAsset Allocation Percentages –

0 10 20 30 40 50 60 70

Equity

Fixed Income

Hedge Funds

Private Equity

Real Estate

Other

Endowments DB Plans High Net Worth Indiv.

Source: JP Morgan, Merrill Lynch, Cap Gemini

26

Alternative Investment Outlook – Major Themes for 2007

Expanded Customer Adoption of Alternative Investments

Diversification Driven

Non Correlation Driven

Performance Driven

Firms will increasingly look to alternative investmentsTo generate increased revenues and profitability