Randal W. Harrison

1
Key Investment Issues

Presented By Randal W. Harrison Managing
Director, Senior Portfolio Manager
2
UNPRECEDENTED CONFLUENCE OF EVENTS

• Housing and CDO Bubble Bursts
• Yield Spreads Widened Between Treasuries and
  Other Assets
• Bear Stearns Lost Two Hedge Funds
• Global Liquidity Crisis, Has Affected Money
  Market and LGIP Instruments / Funds

3
HOUSING AND CDO BUBBLE

• Exploding housing values were built on cheap
  and readily available credit
• Assumed house price appreciation supported
  speculative excesses
• Unfortunately, Rating agencies made similar
  assumptions in rating booming MBS/ABS/CDO
  issuance

Source Bloomberg, National Association of
Realtors
4
AGENCY BOND SPREADS WIDEN AS FINANCIAL STRESS
INCREASES
Yields on agency securities widened relative to
Treasuries, beginning in the second quarter of
2007.  Rising prices in agency securities did not
keep pace with increasing Treasury prices,
reflecting the market stress.

As of 4.28.08/1100am Source Lehman
5
GLOBAL MONEY MARKET AND LIQUIDITY CRISIS

• Graph shows market stresses increasing as the
  spread in value between treasuries and other
  short instruments increase dramatically
• A number of money market funds encounter
  trouble due to exposures to ABCP issues
  associated with SIVs or with heavy underlying
  exposure to CDOs are of particular concern

Source Bloomberg Treasury vs. Euro-Dollar
Contracts
6
MARKET RESPONSE
Global Financial Sector Write-Downs

• Top 10 Banks/Dealers/Insurers ( Billion)
• UBS 37.10
• Citigroup 32.00
• Merrill Lynch 24.50
• AIG 14.80
• HSBC 12.40
• Morgan Stanley 11.86
• IKB Deutsche 8.90
• Bank of America 7.90
• Deutsche Bank 7.50
• Bayerische Landesbank 6.70
• Total 291.81

Net of equity infusions global markets have
experienced capital shrinkage of about 110
billion to date. Assuming a 15x ballpark leverage
ratio, global liquidity has been reduced by
roughly 1.5 trillion. - Lehman Brothers The
extent of liquidity drained from the system has
caused both realized and estimated values of
many securities to fall well below intrinsic
value
Source Lehman
7
MARKET IMPACT THROUGH THE PAST 12 MONTHS

• Leverage Drained From System
• Countrywide Sold at Distressed Levels to
  BankAmerica
• Bond Insurers AAA Ratings and Franchises
  Threatened
• Auction Rate Securities Market Collapses
• Creditor Run On Bear Stearns, Threatens Lehman
  Brothers and Merrill Lynch
• Falling Home Prices, Rising Energy and Other
  Costs, and Increasing Unemployment Fears
  Consumer Confidence Plunges
• Combined, the Three Rating Agencies Downgraded
  More Than 28,000 Investment Grade ABS and MBS
  During the 1st Quarter Alone
• 1Q08 Global Hedge Fund Returns Averaged -3.13
  Fixed Income Relative Value Funds Returned
• -5.87 for the Quarter (Lehman Brothers)

8
RECENT MONETARY AND FISCAL RESPONSES

• Fed, ECB, and Ultimately BOE Inject Reserves to
  Support Improved Global Liquidity
• Fed Aggressively Lowers the Fed Funds and
  Discount Rates
• Fed Develops Four New Liquidity Tools
• Fed Engineers Rescue of Bear Stearns
• Congress and President Quickly Pass 150 Billion
  Stimulus Package
• Legislative and Regulatory Efforts Made Toward
  Keeping More Borrowers In Their Homes
• Only Precedent For Some of These Maneuvers Comes
  From the Great Depression

9
AGGRESSIVE ACTION BY FEDERAL RESERVE

• Feds Response to Crisis
• Fed Funds Rate September 18, 2007 50 bps
• October 31, 2007 25 bps
• December 11, 2007 25 bps
• January 22, 2008 75 bps
• January 30, 2008 50 bps
• March 18, 2008 75 bps
• TOTAL 300 bps
• Discount Rate August 17, 2007 50 bps
• September 18, 2007 50 bps
• October 31, 2007 25 bps
• December 11, 2007 25 bps
• January 22, 2008 75 bps
• January 30, 2008 50 bps
• March 18, 2008 75 bps
• TOTAL 325 bps

Source FactSet
10
THE FEDERAL RESERVE LEADS GOVERNMENT INTERVENTION
Asset Deflations and Credit Contractions are
Nearly Impossible to Solve Through Monetary
Policy Alone Policy Changes Can Take Long to
Affect the Real Economy Government Intervention
Has Become a Necessity Time Line of Government
Mortgage Proposals 8/31/07 FHA Secure program
announced 12/6/07 Fast Track Loan Modification
Plan announced by Bush administration 1/23/08 Sen
ator Chris Dodd suggests a federal corporation
similar to depression era HOLC funded with 20
billion 2/5/08 ASF (American Securitization
Forum) proposes to broaden FHA Secure 2/13/08 Eco
nomic Stimulus plan passed and signed 2/13/08 Sti
mulus plan expands conforming loan limit from
417k up to 729,750 for one year in highest cost
areas 2/27/08 OFHEO announces removal of GSE
portfolio caps (as of March 1st) and reduction in
the 20 OFHEO directed capital
requirements 3/13/08 Congressman Barney Franks
announcement of proposal for FHA guaranteed
refinancing of voluntarily written-down
mortgages
Source Banc of America Securities LLC
11
MONETARY POLICY AND THE MORTGAGE MARKET

• Monetary policy does not directly impact
  long-term financing costs
• Mortgage refinancing incentive limited due to
  tighter terms and higher risk premiums
• Full impact of Fed action on consumer credit
  rates will not be felt until bank balance sheets
  and loan portfolios stabilize

Source Bloomberg/Voyageur
12
MOST INVESTMENT YIELD SPREADS ARE WIDE BASED ON
HISTORICAL AVERAGES
Investment Yield Spreads of Alternatives Above
Either the Targeted Federal Funds Rate or For the
2-Yr. and 5-Yr. Agencies Comparable Treasury
Yields
2y agency data only goes 9 years back Source
Bloomberg, LehmanLive
13
MOST INVESTMENT YIELD SPREADS ARE WIDE BASED ON
HISTORICAL AVERAGES
Investment Yield Spreads Above Comparable
Treasury Yields as of 4.28.08
Source Bloomberg, LehmanLive
14
FUTURE STRATEGY-KEY INVESTMENT ISSUES

• Ensure Sufficient Minimum Liquidity Maintained
• Invest Within Your Capabilities
• Diversify Risk to the Extent Possible
• Do Not Rely On External Ratings of Individual
  Assets
• Make Sure Risk Controls Are In Place and that
  Brokers and Other Counterparties Are Strong
• Opportunities to Add Quality Securities at Prices
  Well Below Their Intrinsic Value
• Investing Patiently Today Can Lay the Foundation
  for Strong Relative Performance After an
  Anticipated Stabilization of the Market
  Emphasize Income
• Selling Sound Securities Before Their Liquidity
  Is Needed Can Result In Punitive Bids

15
CASH INVESTING THAT NEEDS TO STAY CASH

• Depositories Have Been an Alternative During the
  Crisis, but Their Lower Provided Yields are a
  Significant Opportunity Cost
• When Seeking a Money Market Fund or LGIP Look For
  the Following
• Sponsor who has size and strength to support
  their fund
• Transparency is important know what you are
  buying
• Strong management team
• Fund managers with a disciplined credit review
  and counterparty approval process
• Managers who actively maintain approve issuers
  list
• Strong diversification across issuers and
  industries
• Funds that have avoided the recent pitfalls are
  likely to have a tradition of strong risk
  controls
• Consider that paying an investment advisor a
  few basis points may be an inexpensive way to
  gain a level of assurance

16
KEYS TO A FUNDS LONGEVITY

• Stability High Retention of Investment
  Professionals
• Ethics Professional Conduct Aligned with
  Interest of Clients
• Performance Long-Term Focus on Risk Adjusted
  Returns
• Service Unrivaled Client Commitment

17
IMPORTANT ETHICAL STANDARDS FOR INVESTMENT
PARTNERSHIPS

• A Business of Trust
• Professional and ethical behavior should be the
  standard
• The reputation of clients must be protected
• Written Code of Ethics for Personal Investing
• Avoid conflicts of interest
• Quarterly transaction reports
• Reviewed by independent individual
• Compensation Should Be Based on Long-Term
  Performance and Not Related to Short-Term
  Performance-Based Formulas

18
SPECIFIC VALUE OBSERVATIONS INCOME IS CHEAP

• Treasuries Have Been Trading Expensively Relative
  to Other Securities
• Non-Callable Agency Debt Offers an Attractive
  Income and Liquidity Without Many of the Other
  Risks of Other Investments
• Agency Mortgages Can Provide Good Excess Returns
  For Investors That Can Assess Their Value

19
WHAT TO AVOID

• Avoid Taking On Risks that are Difficult to
  Measure Including
• Callable bonds
• Floating rate instruments that may be capped
• Dont Rely on Security Ratings, Particularly for
  Bonds That Are Supported by a Bond Insurer
• Commercial Paper Should Be Pre-Approved By the
  Investment Manager Through Careful Consideration
  of the Issuers Financial Strength
• Dont Concentrate Investment Maturities
• Avoid Investing a Material Block At An
  Unattractive Rate, Dollar Average Into This
  Market
• Beware of Investments From Firms Who Lack Deep
  Pockets, Sound Risk Controls, and Valid Errors
  and Omissions Insurance