1

2014 MIDYEAR INVESTMENT REVIEW

THE BOARD OF PENSIONS BALANCED INVESTMENT PORTFOLIO

Reprise 2007? As Good As It Gets, How Bad It Got and Investment Opportunities in My Alphabet Soup What if this is as good as it gets? Jack Nicholson as Melvin Udall in “As Good As It Gets” (1997)

Alphabet Soup 2014 Once Mother said my little pet You ought to learn your alphabet So in my soup I used to get All the letters of the investment alphabet I learned them all from A to Z And now my Mother is giving me Investment opportunities in my soup ABS, MBS, CDOs, CDS and FRNs loop the loop Gosh oh gee but I have fun Swallowing Cov Lite provisions one by one In every bowl of soup I see Portfolio alpha and beta opportunities for me I make ‘em jump right through a hoop These leveraged investment opportunities in my soup

Updated from Freyer 2007 lyrics for 2014 investment environment. Original Lyrics/Music T. Koehler & I. Caesar/R. Henderson. Sung by Shirley Temple.

Overview The Board of Pensions Balanced Investment Portfolio returns net of fees and the asset allocation on June 30, 2014, were as follows:

YTD 2014

Return

Asset Allocation Long-Term

Strategic Asset Allocation Ranges

$ Millions Percent

U.S. Equity 6.3% $3,190 36.2 30-50%

International Equity 5.0 1,882 21.4 10-25

Fixed Income 4.1 2,607 29.6 25-45

Alternative Investments 8.4 1,127 12.8 1-20

Total 5.7% $8,806 100.0%

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Mark Twain is quoted as saying, “History does not repeat itself, but it does rhyme”. While 2014 may not be a reprise or repeat of 2007, there are many similarities or rhymes that should give investors pause as to where we are in the U.S. economic and market cycle. Those who read the financial section of the newspaper or listened to the evening news way back when in 2006 and 2007 undoubtedly heard about subprime mortgages, FICO scores, MBS, and LBOs. However, if you tended to read the sports pages and put the financial section in the bottom of the canary cage, perhaps a brief primer on “Investment Alphabet Soup” would be appropriate. We have included some history of 2007 in the notes on page 27. If you know your alphabet, just fast forward a few paragraphs. So let’s do a 2014 reality check to see what parts of the alphabet soup are still edible in 2014:

ABS=Asset Backed Securities are still a part of the fixed income market.

MBS=Mortgage Backed Securities are less relevant now that the Federal Reserve has become the primary buyer.

CDOs=Collateralized Debt Obligations died in 2008 when Wall Street could no longer mint money issuing them but are making a comeback.

CDS=The use of Credit Default Swaps contributed to the near-collapse of Greece but are still around.

FRN=Floating Rate Notes are very popular with investors reaching for yield and are used as high yield, short-term debt in retail mutual funds.

Before we review investment performance for the first half of 2014, we should put performance in context first by reviewing several of the major factors that shaped our environment in the U.S. and global markets and which could give us pause.

Mergers and acquisitions activity returns to 2007 levels. The graph that follows shows the value of announced U.S. mergers and acquisitions from 2007 through June 2014. Mergers and acquisitions in 2007 exceeded $1.3 trillion, falling to below $800 billion with the global financial crisis in 2008. After bottoming in 2009, the value of deals steadily increased from 2010 to 2013. With strong stock market performance in 2013, significant corporate cash balances, and ready cash available from existing limited partnership investors, nearly $700 billion in deals were announced in the first half of 2014, the fastest pace since 2007. The second quarter of 2014 was the largest quarter for M&A activity since the third quarter of 2007.

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Mergers and acquisitions valuations return to 2007 levels.

The graph that follows shows mergers and acquisitions multiples from 2007 through 2013, as well as a forecast for 2014 and 2015. Valuation is the EV, or enterprise value, divided by EBITDA, or earnings before interest, taxes, depreciation, and amortization expenses. The valuation multiple was at a high of 11.1 in 2007. It declined to 8.3 in 2009, rose in 2010 and 2011 and was 8.2 in 2012. Multiples have steadily increased since the bottom in 2013 and are estimated to be at 10.5 in 2014 and exceeding the 2007 level of 11.1 in 2015.

0

200

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1000

1200

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1600

2007 2008 2009 2010 2011 2012 2013 2014

Va

lue

of

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als

, b

illi

on

s o

f d

oll

ars

U.S. Mergers and Acquisitions Value of Deals Announced

4Q 3Q 2Q 1Q

Sources: MergerMarket, www.soberlook.com

$695 billion: Fastest

pace since 2007

$405 billion: Largest quarter since 3Q '07

11.1

10.0

8.3

9.9 9.7

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9.2

10.5

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0

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2007 2008 2009 2010 2011 2012 2013 2014 (F) 2015 (F)

EV

/EB

ITD

A

Global M&A Valuation Multiples

Source: MergerMarket

2014 prices are rising rapidly and are approaching 2007 levels

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Quarterly Leveraged Loan Issuance Exceeds 2007 Levels

The graph that follows tracks the growth in leveraged loans from the first quarter of 2003 ($18 billion) through the second quarter of 2014 ($128 billion). Leveraged loans for mergers and acquisitions peaked in the first and second quarters of 2007, with $139 and $145 billion in quarterly issuance. Volume dried up in 2009 but began to increase in early 2010, with $21 billion in leveraged loans. Volume declined in 2012, with an increase in 2013. The second quarter of 2014 was the seventh straight quarter with issuance in excess of $100 billion.

Is 2014 a reprise of 2007? We will only know in hindsight but there are enough “rhymes” to make investors pay attention to the possibilities for global excess.

Year-to-Date 2014 Global Market Performance The graph that follows provides an overview of global market performance in the first half of 2014. Investors had many opportunities for success, with the best performing asset, U.S. long treasury bonds (purple line), up 12% year-to-date, and the worst performing asset, international developed market stocks (red line), up 5%. In a reversion to the mean, the worst performers in 2013, Treasuries and commodities, led the markets and were the best performers in the first half of 2014. In between the narrow band of the top return of 12% and bottom return of 5%, were four other asset classes. A commodities basket (orange) returned 7% for the first half of 2014, with U.S. stocks (black line) providing the same 7% return. Emerging market stocks (green line), returned 6%. High yield bonds (blue line) had the same 5% performance for the six months ended June 30, 2014 as international stocks.

18 23 23 26

33

44 36

41

53

43 42 46

77

87

59

102

139 145

46

59

24 24 21

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42 34

56

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72

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1Q03 1Q05 1Q07 1Q09 1Q11 1Q13

Bil

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of

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rs

Quarterly Leveraged Loan Issuance

Source: J.P. Morgan

2Q 2014 represented the seventh straight quarter of issuance in excess of $100 billion

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The surprise recovery was emerging market stocks. After a significant decline in January, emerging market stocks bottomed and pulled out of negative return territory to return 6% for the first half of 2014, beating the 5% return of developed markets. While investment performance is always volatile, the consistent performance across asset classes in 2014 stands in stark contrast to prior years, and may be another “rhyme” for sharp-eared investors to appreciate.

The 2014 timeline contrasts the interest rate on the 10-year U.S.Treasury (green line) and the value of the S&P 500 Index (red line). After beginning 2014 at 3.0%, few investors would have expected the 10-year Treasury to decline to 2.6% by early February, move in a range of 2.60% to 2.80% before reaching a low of 2.45% in late May, closing at 2.52% on June 30, 2014. The harsh U.S. winter dampened growth, sending interest rates and stocks lower in early 2014. Interest rates continued lower, driven by geopolitical events in the Ukraine and the Middle East as well as the continued demand for U.S. Treasuries by investors, including the demand by corporate pension plans implementing liability driven investment strategies. The 10-year Treasury yield ended the period 50 basis points lower than the start of 2014. The S&P 500 Index began the year at 1848. After falling in the early part of 2014, stocks responded to decent corporate earnings growth throughout the spring. Stocks then began a steady advance to close at 1960 on June 30, 2014, an increase of 6% for the first half of 2014.

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Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14

2014 Global Market Performance

US Stocks Int'l Stocks Emg Mkt Stocks

Treasury Bonds High Yield Bonds Commodities

7% US Stocks

5% Int Stocks

5% HY

12% UST

6% EM Stocks

7% Comm

Sources: Bloomberg, Russell

Weak economic data during the winter hurt equity markets....

... but decent earnings and global central bank liquidity supported a

recovery in asset prices.

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Commodities are a small part of the Balanced Investment Portfolio as a direct investment, yet the prices of commodities impact companies in developed and emerging markets as well as the U.S. Consumer Price Index. As shown on the graph that follows, returns on commodities experienced significant dispersion in 2014, from 20% for livestock to 1% for industrial metals. Livestock (purple line) was the best performer primarily due to demand outstripping supply as herd size is at a 60 year low. Precious metals (blue line) had a very volatile first half of 2014, with gold and silver rebounding after a terrible 2013, then experiencing a sharp decline in May before finishing the six months ended June 30, 2014 with a 10% return. Energy (black line) declined sharply in early 2014 but recovered to close up 6% year-to-date. Droughts in California and Brazil impacted global agriculture in 2014, driving a year-to-date return of 18% by May 2014. As drought conditions eased, prices fell sharply and agriculture ended the six month period up 2%. Expectations for reduced demand resulted in a 10% decline in industrial metals by early February 2014. The outlook for industrial metals improved with revised forecasts for global growth, especially in China, leading to a 1% return from industrial metals for the first half of 2014.

1650

1700

1750

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1850

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2.4

2.6

2.8

3

3.2

12/31 1/31 2/28 3/31 4/30 5/31 6/30

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10

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2014 U.S. Timeline

10 yr Treasury Bond (left) S&P 500 Index (price - right)

Sources: Bloomberg, Federal Reserve

Harsh winter weather dampens growth,

sending stocks and interest rates lower

/13

Decent corporate earnings support a rebound in stock prices

Interest rates continue lower, driven by geopolitical events in Ukraine and the Middle

East, as well as continued demand for U.S. Treasuries

S&P 500: +6% 10 yr Treasury Rates: 0.51% lower

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Review of the Board of Pensions Balanced Investment Portfolio Before we begin the detailed review of the asset class components of the Board of Pensions Balanced Investment Portfolio, we should review its performance of 5.7% for the six months ended June 30, 2014 compared to the returns of market indices. As shown on the graph that follows, all major asset classes provided positive returns for the six months ended June 30, 2014. Stocks of all U.S. companies, as measured by the total market index of the Russell 3000 Index, provided the highest return of 7.3% for the six months ended June 30, 2014. The Russell 2000 Index of small capitalization companies provided the lowest, albeit positive return, of 3.2%. Stocks in emerging market countries, as represented by the MSCI EM Index, were the second best performing stock group year to date, with a 6.1% return. Fixed income securities also provided a positive return of 3.9% as represented by the Barclays Government/Credit Index.

3.2

3.9

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5.6

5.7

6.1

6.9

0 5 10

Russell 2000

Barclays Govt/Credit

MSCI EAFE

CG High Yield Cash Pay

MSCI ACWI ex US

BOARD OF PENSIONS

MSCI EM

Russell 3000

% Return

Returns of Market Indices and

Board of Pensions Balanced Investment Portfolio

Year to Date June 30, 2014

Sources: BNY Mellon, MSCI (net)

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125

Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14

2014 Commodity Group Performance

Energy Industrial Metals Agriculture

Livestock Precious Metals

6% Energy

1% Ind Mtl

10% Prec Mtl

20% Livestock

2% Agr

Source: Bloomberg

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What is the Structure of the Board of Pensions Balanced Investment Portfolio? The Board of Pensions Balanced Investment Portfolio uses external investment management firms for the day-to-day investment of $8.8 billion in assets. The Portfolio is unitized on a monthly basis and is the investment portfolio for the Pension Plan as well as other plans and programs administered by the Board of Pensions. The U.S. equity component of the Portfolio has eleven investment managers, plus market-based index funds. The international equity component has nine managers, including three managers focused solely on emerging markets. The fixed income component has seven managers, including dedicated assignments to managers for high yield or below investment grade securities, global bonds and emerging market debt. Alternative investments include commitments to 54 funds or limited partnerships investing in distressed debt, private equity, venture capital, and real and absolute return strategies. Portfolio diversification is a function of the long-term expected return for each asset class, but also must include risk assessment based on investment styles, liquidity and the potential firm risk for each investment manager retained by the Investment Committee. Each year separate account managers for the Balanced Investment Portfolio are provided a list of those companies on the current Prohibited Securities Lists. The lists include companies on the General Assembly Divestment List for involvement in military weapons and tobacco, as well as those companies whose primary businesses are in the alcohol, gaming and hand gun industries. The Board of Pensions policy does not force the sale of companies newly added to the lists, which could reduce the investment return on the portfolio. Instead the policy prohibits the future purchase of the securities. At the 221st General Assembly (2014), the Assembly urged the Board of Pensions to divest of companies in the not-for-profit prison business. The Board does not currently own common stock in Corrections Corporation of America or Geo. Those companies will be added to the 2015 Prohibited Securities Lists provided to all active managers in December 2014. The General Assembly urged the Board of Pensions to divest from Caterpillar, Hewlett-Packard and Motorola Solutions for activities that are not conducive to the peace process in Israel and Palestine. Those companies will be added to the 2015 Prohibited Securities Lists. Managers holding shares will be grandfathered and can retain the shares until sold in accounts with similar total return expectations. This is in accordance with the Board of Pensions Policy on Divestment/Prohibition as approved by the Executive Committee of the Board in May 2006.

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BOARD OF PENSIONS BALANCED INVESTMENT PORTFOLIO

PERIODS ENDED JUNE 30, 2014

Annualized Rate of Return

YTD 1 Year 2 Years 3 Years 5 Years 10 Years 15 Years 20 Years

BOP U.S. EQUITY 6.3 25.5 24.9 16.6 19.9 8.8 6.2 10.5 Russell 3000 Index 6.9 25.2 23.3 16.5 19.3 8.2 5.0 9.9 BOP INTERNATIONAL EQUITY 5.0 20.9 19.2 8.3 12.6 9.0 6.8 7.6 MSCI All Country World Index ex US (gross) 5.9 22.3 18.1 6.2 11.6 8.2 5.7 6.3

BOP FIXED INCOME 4.1 5.9 4.2 5.5 7.4 5.7 6.1 6.7 Barclays Gov/Credit Index 3.9 4.3 1.8 4.1 5.1 4.9 5.7 6.2

BOP PRIVATE PARTNERSHIPS 8.4 14.5 12.7 9.8 14.2 11.9 14.9 -- BOP LIQUID ALTERNATIVES 8.5 13.9 7.1 5.7 12.8 -- -- -- Consumer Price Index + 500 basis points -- 7.1 6.9 6.8 7.0 -- -- -- BOP BALANCED PORTFOLIO 5.7 17.1 15.2 10.5 13.6 7.7 6.4 8.8

BOP RELATIVE BENCHMARK Asset Mix Policy Benchmark* 5.8 17.1 14.6 10.5 13.2 7.5 5.8 8.3

LONG-TERM INVESTMENT RETURN Pension Plan Actuarial Assumption N/A 7.0 7.0 7.0 7.0 7.0 7.0 7.0

Notes: Returns are net of management fees.

The Index +500 basis points is calculated monthly and linked to provide an annualized number that will be different than the sum of the annual return of the Index +500 basis points.

*Effective 1/1/2005, the Asset Mix Policy Benchmark is calculated using each asset class midpoint multiplied by its index. The policy benchmark is:

U.S. Equity = 47.5% * Russell 3000 Index International Equity = 17.5% * MSCI All Country World Index ex US (ACWI) Fixed Income = 35% * Barclays Gov/Credit Bond Index Alternative Investments = 0%

Performance of the Board of Pensions Balanced Investment Portfolio is measured against both a relative benchmark and the 7.0% annual long-term investment return assumption for the Pension Plan.

The Relative Benchmark: The Asset Mix Policy Benchmark of Investable Market Indices

The relative benchmark, or asset mix policy benchmark, is used to compare the performance of the Board of Pensions Balanced Investment Portfolio to that of investable market indices. The asset mix policy benchmark is the return the Portfolio would have achieved by investing in each asset class using a passively managed index fund at the mid-point of the long-term strategic allocation range for each asset class. Alternatives are not included in the benchmark since there are no investable market indices for alternative investments.

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The Balanced Investment Portfolio lagged the asset mix policy benchmark year to date. The portfolio met or exceeded the return of the asset mix policy benchmarks for the one, two, three, five, ten, fifteen and twenty years ended June 30, 2014. The Long-Term Investment Return: The 7.0% Pension Plan Actuarial Assumption In calculating the health and solvency of the Pension Plan, our actuary uses certain assumptions about Plan demographics and financial metrics. These assumptions are reevaluated regularly to ensure that they are reasonable and current. One of the critical assumptions is the investment return of Pension Plan assets. The Pension Plan design assumes that the annual return on the Balanced Investment Portfolio will, over the long term, meet or exceed 7.0%. It is important to remember that this is a long-term goal and will not be met in every calendar year. For the long-term health and stability of the Pension Plan, it is imperative that the actual return on assets meet or exceed the Plan investment return assumption. The Balanced Investment Portfolio exceeded the 7% return assumption for the one, two, three, five, ten, fifteen and twenty years ended June 30, 2014.

The U.S. Equity Component of the Balanced Investment Portfolio

The U.S. equity component of the Board of Pensions Balanced Investment Portfolio had a return of 6.3% for the six months ended June 30, 2014, lagging the 6.9% return of the Russell 3000 Index. The U.S. equity component exceeded the return of the benchmark index for the one, two, three, five, ten, fifteen and twenty years ended June 30, 2014.

As shown on the graph that follows, large company value stocks in the Russell 1000 Value Index provided a return of 8.3%, the highest return for the period, while small company growth stocks provided the lowest return of 2.2%.

U.S. Equity Index ReturnsYear to Date June 30, 2014

7.1

8.3

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6.3

4.2

6.3

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0 5 10

Russell 2000 Growth

Russell 2000 Value

Russell 1000 Growth

Russell 3000

S&P 500

Russell 1000 Value

% Return

* Preliminary June 30, 2008 dataSource: BNY Mellon

Board of Pensions U.S. Equity

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The large capitalization component of the portfolio returned 7.3% exceeding the 7.1% return of the S&P 500 Index. All three core managers outperformed the return of the benchmark S&P 500. One of the three value managers exceeded the 8.3% return of the Russell 1000 Value Index. None of the three growth stock managers exceeded the 6.3% return of the benchmark Russell 1000 Growth Index. While, in combination, the large capitalization managers exceeded their benchmark, stronger stock selection, especially by the growth stock managers, would have added to already strong performance in the first half of 2014. The small and mid capitalization component of the Portfolio returned 1.6%, lagging the Russell 2000 Index return of 3.2% for small company stocks. The small capitalization core manager returned 3.1%, slightly worse than the 3.2% return of the Russell 2000 Index. The small capitalization growth manager had a return of -0.8% compared to the 2.2% return of the benchmark Russell 2000 Growth Index. It is important to note that despite short-term underperformance in 2014, the Investment Team believes that managers in the U.S. equity component of the Balanced Investment Portfolio are well positioned to provide superior long-term performance.

Market Capitalization and Style

Investors know that the size of the companies they invest in, or company market capitalization, can significantly impact portfolio success. Small company stocks in the Russell 2000 Index returned 8.7% annually for the ten years ended June 30, 2014, exceeding the 7.8% return of large company stocks in the S&P 500 Index. Investment styles also affect results as investors allocate capital believing growth or value stocks will benefit more in the next period, though the style impact on performance can be more volatile in the short term. Stocks in the Russell 1000 Growth Index returned 8.2% annually for the ten years ended June 30, 2014, slightly exceeding the 8.0% return of the Russell 1000 Value Index. As shown in the table that follows, style impacts were mixed; small value companies outperformed small growth and large value companies outperformed large growth.

U.S. STOCK MARKET PERFORMANCE BY MARKET CAPITALIZATION AND STYLE January 1 – June 30, 2014

Russell 3000 – Total Market 6.9% %

S&P 500 Index (Large Capitalization) 7.1

Russell 1000 Index (Large Capitalization) 7.3

Russell Mid Cap Index (Mid Cap) 8.7 5.5% advantage to midcap

Russell 2000 Index (Small Capitalization) 3.2

Russell 1000 Growth Index 6.3 { 2.0% advantage to value

Russell 1000 Value Index 8.3

Russell Midcap Growth Index 6.5 { 4.6% advantage to value

Russell Midcap Value Index 11.1

Russell 2000 Growth Index 2.2 { 2.0% advantage to value

Russell 2000 Value Index 4.2

Sources: Aronson + Johnson + Ortiz, LP, Vestek Systems

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The graph that follows highlights the pattern of investment performance by size (large and small) and style (value and growth) in the first half of 2014. While the stocks of small growth companies were the best performers through early March 2014, investors began to sell high momentum stocks in mid-March. Large company stocks, both value and growth, outperformed small company value and growth stocks through June 30, 2014.

Sector Performance

The U.S. stock market, as represented by the Russell 3000 Index, had a return of 6.9% for the six months ended June 30, 2014. As shown on the graph that follows, all sectors had positive returns ranging from a low of 1.0% for companies in the consumer discretionary sector to a high of 18.1% for utilities. Consumer discretionary was the best performing sector in 2013, with a return of 44.6%. While telecommunication services were the worst sector in 2013, with a return of 15.0%, utilities were next in line for weakest performance, with a return of 15.1%. Investing in the best stocks in each sector is important for portfolio performance. On June 30, 2014, the two largest market sectors were financials and information technology. Companies in those two sectors represented 35.6% of the Russell 3000 Index. Financials, with a return of 5.2%, provided a return below the 6.9% return of the Russell 3000 Index, while stocks in the information technology sector returned 7.9%, outpacing the broader market.

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Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14

2014 U.S. Size and Style Performance

Large Growth Large Value Small Growth Small Value

Large stocks have outperformed small stocks in 2014, and value has outperformed growth

Investors sold high momentum stocks beginning in mid-March

6.3% LG

8.3% LV

4.2% SV

2.2% SG

Source: Russell

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18.3

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12.51.0

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Consumer Discretionary

Industrials

Telecommunication Services

Financials

Consumer Staples

Russell 3000

Information Technology

Materials

Health Care

Energy

Utilities

% Return

Russell 3000 Index

Sector Returns and WeightsYear to Date June 30, 2014 June 2014

Weights

Source: BNY Mellon

%

Sector Selection in the U.S. Equity Component

If we explore the structure and composition of the U.S. equity component of the Board of Pensions Balanced Investment Portfolio compared to the sectors of the Russell 3000 Index, as shown in the graph that follows, we can see that the sector allocations in the portfolio’s U.S. equity component do not look like the Russell 3000. Active portfolio manager selection of companies with the greatest potential for stock price appreciation should result in a portfolio that does not look like an index fund. Since these are decisions made at the individual company level rather than the sector level, the resulting portfolio has over and underweights when compared to the sector weights of the Russell 3000. The three best sectors in the first half of 2014 were utilities, energy and health care. Manager stock selection in the U.S. equity component resulted in an underweight in utilities and energy. This detracted from performance while an overweight in the health care sector helped performance. Managers had a collective overweight to the index in information technology stocks, which returned 7.9%, outperforming the 6.9% return of the Russell 3000 and added to performance. Managers had a 23.1% weight in information technology on June 30, 2014 compared to the 18.3% weight in the Russell 3000 Index. The three worst sectors were consumer discretionary, industrials and telecommunications services. Manager stock selection in the U.S. equity component resulted in an overweight in consumer discretionary and industrials, detracting from performance. Due to the small size of the sector, at 2.2% of the Russell 3000, an underweight to telecommunications services had minimal portfolio impact. Individual company selection significantly impacted manager performance. Not owning or underweighting the best performing technology companies, Micron Technology (+51%), Hewlett-Packard (+20) and Intel (+19%), and owning or overweighting the worst performing companies, Yahoo (-13%), IBM (-3%) and Google C (0%), would have impacted performance in the first half of 2014.

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U.S. Equity Component

Sector Weights vs. Russell 3000 Index

June 30, 2014

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17.318.3

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30

Energy Materials Industrials Consumer Discretionary

Consumer Staples

Health Care Financial Services

Information Technology

Telecom Services

Utilities

Total U.S. Equity Component Russell 3000

Stock Selection in the U.S. Equity Component

The top ten stocks in the U.S. Equity component on June 30, 2014 were Google, Microsoft, Biogen Idec, Texas Instruments, Charles Schwab, Johnson & Johnson, Wells Fargo, Visa, Qualcomm, and Adobe Systems. The nine stocks in bold type were in the top ten holdings on June 30, 2013. These top ten U.S. stock holdings on June 30, 2014 were a diverse representation of companies in the information technology, financial, and health care sectors. Active portfolio managers select individual stocks based upon valuations and expectations for future growth. Many of the best managers call themselves “benchmark agnostic”, meaning they don’t select stocks or sectors based upon the weighting in a benchmark. It is important to remember that the composition of most indices is backward looking, since it reflects the performance of prior periods. The weighting of an individual stock and its sector in most indices is based upon the total market value of the company, so strong past performance leads to a higher weighting. When investors buy an index fund, they are buying more of the recent winners, and less of the recent losers. Since active managers try to anticipate the next winners, the stocks and sectors in their portfolios can differ significantly from an index.

The International Equity Component of the Balanced Investment Portfolio

The international equity component of the Board of Pensions Balanced Investment Portfolio returned 5.0% for the six months ended June 30, 2014, lagging the 5.6% return for the MSCI All Country World Index ex U.S. While individual stock selection contributed to below benchmark performance, sector, country allocation and currency were also critical factors in performance. The international equity component lagged the return of the benchmark index year-to-date 2014 and for the one year ended June 30, 2014. The portfolio exceeded the return of the benchmark MSCI All Country World Index ex U.S. for the two, three, five, ten, fifteen and twenty years ended June 30, 2014.

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Four of the eight international equity managers outperformed their respective benchmarks, to include two of the six managers with developed market mandates as well as both emerging market equity managers. It is important to note that despite short-term underperformance in 2014, the Investment Team believes that managers in the international equity component of the Balanced Investment Portfolio are well positioned to provide superior long-term performance. As shown on the graph that follows, while Japanese stocks were the best performers in 2013, with a return of 27.2%, in the first half of 2014, the MSCI Japan Index returned 0.7%. The international equity component had a slightly lower than benchmark weight of 13.3% in Japanese stocks; however three managers had between 25-27% of their portfolios invested in Japanese stocks, which detracted from their portfolio performance. While emerging market stocks in Europe were the worst performers, stocks of companies in emerging Latin American and Asian markets were the best performers for the six months ended June 30, 2014. Stocks of companies in the emerging markets index, MSCI EM, returned 6.1% with stocks in the developed markets EAFE Index returning 4.8% over the same period. The Board of Pensions added a new emerging markets equity manager in the first quarter of 2014. The international equity component of the Balanced Investment Portfolio had a 21.4% weight in emerging markets on June 30, 2014, in line with the 21.3% allocation to emerging markets in the MSCI All Country World Index ex U.S.

International Equity Index ReturnsYear to Date June 30, 2014

7.2

6.9

5.2

5.0

0.7

4.8

0.3

5.6

6.1

5.5

0 5 10

MSCI EM Europe

MSCI Japan

MSCI EAFE

Board of Pensions International Equity

MSCI United Kingdom

MSCI Europe

MSCI ACWI ex U.S.

MSCI EM

MSCI EM Asia

MSCI EM Latin America

% Return

Sources: BNY Mellon, MSCI (net)

While managers are making active stock decisions, it is useful to compare the country weights of the international equity component to those of the benchmark index. The graph that follows shows how over and underexposure to companies based in countries and regions helped or hurt performance. Stocks of companies in Japan were among the worst performers, so an underweight by Board of Pensions managers would have helped relative performance. However, as noted, individual managers had significant portfolio overweights in Japanese stocks. The international equity component was underweight the two best performing regions, emerging markets in Latin America and Asia, and overweight emerging markets in Europe. While the

16

component allocation to Europe excluding countries in the European Monetary Union (EMU) appears to be slightly greater than the benchmark ACWI ex U.S. Index of 25.6% on June 30, 2014, two of the six developed markets international equity managers had allocations of 40-42%. While the component allocation to EMU countries is lower than the 22.2% ACWI ex U.S. weight of countries in the European Monetary Union (EMU), two of the managers had allocations to EMU countries of 40%. With economic conditions in Europe stabilizing or improving in most countries in 2014, stocks of companies based in Europe were among the best performers in the first half of 2014 with a return of 5.5%.

7.8

27.5

13.3

20.1

11.7

4.72.9

10.2

1.60.0

13.3

4.04.0

22.2

8.6 7.6

25.6

14.4

0

10

20

30

40

EMU Europe ex

EMU

Japan Pacific ex

Japan

Canada EM-Latin

America

EM-Asia EM-

Europe,

Middle East

& Africa

USA / cash

International Equity Component ACWI ex U.S.

International Equity Component Characteristics

Country Weights vs. ACWI ex U.S. Index June 30, 2014

% o

f m

ark

et

valu

e

Source: BNY Mellon

International Market Sector Performance

As shown in the graph that follows, the utilities sector, with a 3.6% weight and a 13.9% return, was the best performing sector in the MSCI ACWI ex U.S. Index for the six months ended June 30, 2014. Financial stocks continued to be the largest sector in the index, with a weight of 26.5% on June 30, 2014, compared to the 17.3% financial weight in the Russell 3000 Index of U.S. companies. As investors review portfolio performance in 2014, it is important to appreciate the difference in composition between the Russell 3000 Index of U.S. companies and the ACWI ex U.S. Index of international companies. Information technology had a sector weight of 18.3% in the Russell 3000 Index on June 30, 2014. With fewer global technology companies based outside the U.S., information technology had only a 6.9% weighting in the ACWI ex U.S. Index. The three best performing sectors, utilities, energy and health care made up 21.4% of the ACWI ex U.S. Index while the same three best performing sectors, utilities, energy and health care, were 26.0% of the Russell 3000 Index.

17

3.6

9.6

8.2

6.9

9.9

---

8.5

11.0

26.5

10.8

5.21.0

2.7

3.2

4.0

5.6

6.0

8.2

11.2

12.2

13.9

3.5

0 5 10 15 20

Telecommunication Services

Consumer Discretionary

Financials

Industrials

Materials

MSCI ACWI ex U.S.

Consumer Staples

Information Technology

Health Care

Energy

Utilities

% Return

MSCI ACWI ex U.S. Index

Sector Returns and WeightsYear to Date June 30, 2014 June 2014

Weights

Source: MSCI (net dividends)

%

As shown on the graph that follows, managers in the international equity component made active stock decisions that led to over and underweights to industry sectors. The three best sectors in the MSCI All Country ex U.S. in the first half of 2014 were utilities, energy and health care, the same as in the Russell 3000 Index. Manager stock selection in the international equity component resulted in an underweight in utilities and energy. This detracted from performance while an overweight in the health care sector helped performance. Managers had a collective overweight to the index in information technology stocks, which returned 8.2%, outperforming the 5.6% return of the MSCI All Country ex U.S. and added to performance.

The three worst performers were stocks of companies in the telecommunication services, consumer discretionary, and financials sectors. Manager stock selection in the international equity component resulted in an underweight in telecommunications, consumer discretionary, and financial stocks, helping performance.

10.4

6.9

15.6

8.5

23.2

9.610.1

4.7

1.8

9.3

5.2

26.5

6.8

3.6

8.29.6

10.89.9

8.5

11.0

0

10

20

30

Energy Materials Industrials Consumer

Discretionary

Consumer

Staples

Health Care Financial

Services

Information

Technology

Telecom

Services

Utilities

International Equity Component ACWI ex U.S.

International Equity Component Characteristics

Sector Weights vs. ACWI ex U.S. Index June 30, 2014

% o

f m

ark

et

valu

e

Source: BNY Mellon

18

The Fixed Income Component of the Balanced Investment Portfolio

The fixed income component of the Board of Pensions Balanced Investment Portfolio had a return of 4.1% for the six months ended June 30, 2014, exceeding the 3.9% return of the Barclays Government/Credit Index. The fixed income component exceeded the return of the benchmark index year to date and for the one, two, three, five, ten, fifteen and twenty years ended June 30, 2014. Portfolios managed by core fixed income managers comprised 40.3% of the assets of the fixed income component. Two of the three active core fixed income managers exceeded the 4.3% return of the Barclays Government/Credit Index, providing returns of 4.8% and 5.1%. The 4.1% return of the fixed income component included the returns from core fixed income managers as well as a 4.4% return from the high yield portfolio, 1.2% return from the short duration portfolio, 5.6% from the global bond portfolio and 12.2% from the emerging markets debt portfolio. The short duration portfolio and cash comprised 18.0% of the fixed income component on June 30, 2014. The strategic short duration allocation of approximately 125% of annual benefits payments was approved by the Investment Committee in July 2008. The allocation to the short duration strategy improved the performance of the fixed income component of the Balanced Investment Portfolio in 2013 as interest rates rose sharply. The allocation to the short duration portfolio detracted from the fixed income portfolio component return in the first half of 2014 when the yield on longer duration U.S. Treasury securities continued to decline. As shown on the graph that follows with investment performance, the return on the fixed income component was 4.1%. However, excluding the short duration and cash portfolios, the return on the fixed income component would have been 4.8%. During periods of declining interest rates, the short duration portfolio detracts from the return of the fixed income component. It is important to note that the short duration portfolio is an integral part of the long-term strategic asset allocation to fixed income. The short duration portfolio provides important total portfolio liquidity for benefits payments and capital calls for alternative investments. It is also a key component in the implementation of a fixed income strategy that permits the use of less liquid and potentially more volatile strategies in high yield, global bonds and emerging market debt.

Investment Performance

Bond performance depends on multiple factors but usually the most important ones are the level and direction of interest rates, portfolio duration, credit quality and investor appetite for risk, as reflected in the spread over U.S. Treasuries for corporate bonds. As shown in the graph that follows, risk was rewarded in 2014, with a 8.7% return for investors in a portfolio of emerging market debt, or the JPM Emerging Markets Global Diversified Bond Index, and a 5.9% return for investors in the Citigroup Non-U.S. World Government Bond Index of unhedged developed market sovereign bonds. Investors in high yield bonds, the Citigroup High Yield Cash Pay Index, had a return of 5.3%. Each of these fixed income assets benefited from the narrowing of credit spreads, which led to capital appreciation. In the six months ended June 30, 2014, risk averse investors who owned only U.S. Treasury bills had a zero return while investors in a Barclays Government Bond Index received a 2.7% return.

19

0.0

2.7

3.9

4.1

4.8

5.3

5.9

8.7

0 5 10

BofA ML 3 Month T-Bill

Barclays Government

Barclays Govt/Credit

Board of Pensions Fixed Income

Board of Pensions Fixed Income ex Cash

CG High Yield Cash Pay

CG Non-US WGBI Unhedged

JPM Emg Mkts Bond - Global Diversified

% Return

Fixed Income Index ReturnsYear to Date June 30, 2014

Source: BNY Mellon

Interest Rates The Federal Reserve’s target for the federal funds rate was 4.25% at the start of 2008. This is the interest rate at which private depository institutions, primarily banks, lend balances at the Federal Reserve on an overnight basis to other depository institutions. On December 16, 2008, after six reductions in the first ten months of 2008, the Federal Open Market Committee made the unprecedented move of setting the funds target rate in the range of zero to 0.25%. No change in the fed funds target rate has been made since that date. The Federal Reserve has added additional liquidity to the financial system through large scale purchases of bonds, known as Quantitative Easing (QE). The Federal Reserve has since reiterated their stance that there will be no increase in the federal funds rate until the economy is on sound footing and the labor market has substantially healed. The Fed began a program of tapering, or ending the purchase of bonds, in late 2013. The goal of an extended period of negative real interest rates has been to help U.S. consumers, banks and corporations unwind their debts and repair their balance sheets after the collapse of financial asset and real estate values.

Despite historically low interest rates, the yields on most U.S. Treasury securities declined in 2014. The yield on the 3-month Treasury bill decreased by 5 basis points from 0.07% on December 31, 2013 to 0.02% on June 30, 2014. The yield on the 2-year note increased by 8 basis points from 0.38% on December 31, 2013 to 0.46% on June 30, 2014. The 10-year Treasury yield decreased by 51 basis points, from 3.03% on December 31, 2013 to 2.52% on June 30, 2014.

The graph below is the U.S. Treasury yield curve for different maturities, over different time periods.

The green line (1) at the top of the graph is the level of rates on December 31, 1999, with short rates above 5% and long interest rates above the 6% level.

The red line (2) is the yield curve on December 31, 2007, prior to the collapse of global financial markets and the Fed actions to maintain low interest rates and liquidity.

20

The blue line (3) is the yield curve one year later, on December 31, 2008, with the significant decline in rates from one period to the next. Short rates have remained at virtually zero from 2008 through the present.

The brown line (4) is the yield curve on December 31, 2012, reflecting the continued drop in interest rates since 2008.

The black line (5) is the yield curve on December 31, 2013, reflecting the increase in interest rates as the Federal reserve begins the tapering program and the end of bond purchases.

The purple line (6) is the yield curve on June 30, 2014. Given the level of interest rates on December 31, 2013, few investors expected interest rates to decrease in 2014.

1

U.S. Treasury Yield Curve

0

1

2

3

4

5

6

7

8

3mo 6mo 1yr 2yr 3yr 5yr 7yr 10yr 20yr 30 yr

% Y

ield

December 31, 2013

December 31, 2012

2

3

4

5

6

December 31, 1999

December 31, 2007

Source: Federal Reserve, statistical release

December 31, 2008

June 30, 2014

1

The graph that follows helps us put the level of current interest rates in perspective. The interest rate on the 10-year U.S. Treasury bond peaked in September 1981 at 15.3%. It continued a cyclical decline over the next 32 years, bottoming at 1.53% in July 2012 and closing on December 31, 2013 at 3.0%. As we can see from the graph, with an interest rate of 2.0% in January 1941, there were actually 22 years, from 1934 to 1956 that the 10-year Treasury remained in the range of 2% - 3%.

21

Duration Successful bond investors in 2014 had to be right on the duration of their portfolios, adjusting throughout the year as interest rates changed. Duration is one of the most commonly used measures of bond risk. It is the measurement of how many years it will take for the price of the bond to be repaid by its internal cash flows, both payment of interest and repayment of principal. The calculation of the duration of a bond includes its coupon, final maturity date, call provisions for early repayments as well as market interest rates. Short duration bonds have less price volatility than bonds with higher durations, since investors will receive their cash back in a shorter time period. A short duration portfolio might hold securities maturing in less than three years, for a portfolio duration of 1.5 years. Shorter duration proved to be a good strategy in 2013 as U.S. interest rates unexpectedly increased in May and June of 2013 but proved to be the wrong strategy in the first half of 2014. A long duration strategy of 10 years or more would be positively impacted when rates unexpectedly decrease. In order to make any, let alone the correct duration decision, an investor must have some opinion on the direction of interest rates. Getting duration wrong during volatile markets can result in poor and even negative investment performance.

The fixed income component core managers made active duration decisions in 2014. The duration of the benchmark Barclays Government/Credit Index was 5.6 years on December 31, 2013 and 5.9 years on June 30, 2014. The duration of the Balanced Investment Portfolio fixed income component was 5.0 years on December 31, 2013 and 4.5 years on June 30, 2014. The duration of the fixed income portfolio decreased in 2014 while the duration of the benchmark index increased. A shorter than benchmark duration detracted from performance.

One core manager began 2014 with a duration of 4.8 years and reduced it to 4.6 years on June 30, 2014. Their return for the six months was 4.8%. Another core manager began 2014 with a duration of 5.2 years, and increased duration to 5.9 years on June 30, 2014. That portfolio manager return was 5.1% for the six months ended June 30, 2014. A third core manager began 2014 with a duration of 5.5 years and reduced it to 4.2 years on June 30, 2014. Their return for the six months was 2.8%. All three managers had opinions on the direction of interest rates and positioned their portfolios accordingly. For the first half of 2014, the manager with a portfolio

0

2

4

6

8

10

12

14

16

18

04 09 14 19 24 29 34 39 44 49 54 59 64 69 74 79 84 89 94 99 04 09

Inte

rest ra

te

Historical Yield on 10-Year U.S. Treasury Bond

Sept 1981 15.32

June 1984 13.56

July 2012 1.53

Source: Federal Reserve from 1953 to 2013; Robert Shiller from 1900 to 1953. Reflects monthly averages which differ from daily data shown elsewhere.

Multidecade period of sustained low rates

June 2014 2.65

22

duration longer than the benchmark index in a period of falling interest rates saw their portfolio increase in value more than the portfolios with below benchmark duration.

Credit Quality and Spreads

Credit ratings are given to bonds based on Standard & Poor’s and Moody’s analyses of the ability of the government or corporation to pay interest and repay principal on schedule to bondholders. In the graph that follows, the green bars represent 2014 year-to-date returns, with U.S. Treasury bonds and all quality ratings of corporate bonds providing investors with positive returns. In 2013, the increase in interest rates and yields on U.S. Treasuries led to negative returns in these highest quality securities, forcing investors to look at lower quality corporate bonds for higher yields and potentially greater return.

Investors expect to receive a spread or premium for investing in securities with lower quality ratings than U.S. Treasury securities. The U.S. Treasury bond is typically considered the highest quality long-term investment with the greatest liquidity and no default risk. As such, it is the benchmark security used by investors to price all other long term bonds. The spread for investment grade corporate bonds is a risk premium, or additional yield that investors require for any bond that is not a U.S. Treasury bond. The spread is calculated in basis points, with 1% equal to 100 basis points. As an example, if a 10-year corporate bond has a yield of 3.65% and the benchmark 10-year U.S. Treasury has a yield of 1.65%, the spread would be 200 basis points.

With a return of 7.1%, investors in BBB-rated securities, or the lowest investment grade rating, had the best returns for the six months ended June 30, 2014. In 2014, investors received the coupon from bonds and the increase in the market value of the bonds due to the decrease in interest rates and the narrowing of credit spreads.

2.7 2.2

3.2 3.9

5.2

7.1

5.9 5.0

5.8

-2.7

-1.4 -2.1 -2.0 -1.9 -2.0

5.1

7.3

13.8

-5

0

5

10

15

U.S. Treasury

U.S. Agency AAA AA A BBB BB B CCC

% R

etu

rn

Returns by Credit Quality 2013 Full Year and Year to Date June 30, 2014

YTD 2014 2013

Sources: Barclays Capital; Dodge & Cox

23

Investment Grade Corporate Bond Spreads to U.S. Treasury Bonds

As shown on the graph that follows, the option adjusted spreads to U.S. Treasuries for investment grade corporate bonds was at a low of 55 basis points in September 1997. As the global financial crisis roiled fixed income markets, drying up all liquidity in the fourth quarter of 2008, spreads increased on all corporate bonds, and by November 2008, the spread for investment grade corporate bonds was at a high of 607 basis points. When corporate bond spreads widen, the relative value of a bond decreases, resulting in a negative investment return. Conversely, the narrowing of spreads results in an increase in the relative value of bonds and positive investment performance. Spreads for investment grade corporate credit narrowed in 2014, from 152 basis points on December 31, 2013 to 99 basis points on June 30, 2014. We do not have a dedicated corporate credit strategy so the allocation to investment grade corporate bonds will be made by core fixed income managers.

High Yield Bond Spreads

As shown in the graph that follows, high yield bond spreads followed a similar pattern to investment grade corporate spreads, albeit at significantly higher spread levels and with greater portfolio volatility. High yield spreads were at a high of 1,103 basis points in October 2002 after the default of high yield bonds in the cable and telecommunications industries. High yield spreads narrowed to 262 basis points in May 2007. High yield markets were essentially frozen in the fourth quarter of 2008, with spreads on high yield bonds of 1,979 basis points on November 30, 2008. Spreads declined from 433 basis points on December 31, 2013 to 330 basis points on June 30, 2014. At current spreads, we are not increasing the allocation to high yield. We have changed the dedicated high yield manager mandate to global high yield to benefit from the increase in international investment opportunities.

0

100

200

300

400

500

600

700

Jul-89 Jul-92 Jul-95 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 Jul-13

Basis

poin

ts

Investment Grade Corporate Spreads Excess Yield Over U.S. Treasuries

Sept 1997 55 bps

65 bps

Sources: Reams, Barclays

91 bps

Oct 2002 247 bps

Feb 2007 85 bps

Nov 2008 607 bps

Nov 2011 243 bps

June 2014 99 bps

158 bps

24

Emerging Market Sovereign Spreads

Investing in emerging market debt has become mainstream in the last few years but was a highly unpredictable and volatile asset class from 1995 through 2011. The Balanced Investment Portfolio has invested in emerging market debt since 1995. The investment at that time was within a global markets balanced portfolio. The allocation in 2014 is through dedicated emerging market debt managers. In March 1995, the excess yield or spread over U.S. Treasuries for a basket of emerging market sovereign bonds was 1,555 basis points. That spread dropped to 350 basis points in 1997, spiked to 1,322 in August of 1998 with the collapse of Long Term Capital Management. Spreads were at 155 basis points in May 2007 but increased to 748 after the October 2008 global markets collapse.

Spreads stabilized in 2011, closing the year at 426 basis points. Spreads remained in a tight range throughout 2013 before declining to 285 basis points on June 30, 2014.

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Jul-89 Jul-92 Jul-95 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 Jul-13

Basis

poin

ts

High Yield Spreads Excess Yield Over U.S. Treasuries

Aug 1997 257 bps

343 bps

Sources: Reams, Barclays

369 bps

Oct 2002 1103 bps

May 2007 262 bps

Nov 2008 1979 bps

Sept 2011 856 bps

June 2014 330 bps

565 bps

25

Summary and Investment Outlook

We have gone on record as supporters of the U.S. economy and markets in our last four or more years of Midyear and Year-End Investment Reviews. In each review we advocated investing in the U.S. economy and stock market as the proverbial best house on a bad block and the best developed market for investors. See notes for past Investment Reviews. However, we need to go back five years to the 2009 Midyear Investment Review: Honey, I Shrunk the Economy. When we wrote this review in 2009, we did not really believe it would take this long to get back to some form of normal, whether old normal, new normal or “new neutral”. We wrote:

….. but you know the economy is not doing well and whether the Consumer Sentiment Index is 50 or 70, the economy is still in a recession and those green shoots of growth some economists think they see are probably plastic plants from an old aquarium. While the total U.S. economy has not shrunk to 1% of its former size, it might well appear the case to foreclosed homeowners and the unemployed. Our happy economic ending may be a bit rockier and take years longer than we would like. There are no Cheerio life rafts for us and unfortunately President Obama does not have that magic machine to re-size our economy to the old normal or even the new normal.

What is the Investment Outlook for 2014 and Beyond? As we noted in 2013, whether you are a socialist in your economic views, aligned with Bertolt Brecht and believe that what there is in this world shall go to those who are good for it, or a capitalist in your capital market views and believe with Ayn Rand that traders shall inherit the earth, at the Board of Pensions, we strive to avoid extreme investment strategies and consistently seek the middle ground by investing for the long-term.

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12

Basis

poin

ts

Emerging Market Sovereign Spreads Excess Yield Over U.S. Treasuries

Sept 1997 350 bps

Sources: Reams, J.P. Morgan

May 2007 155 bps

Nov 2008 748 bps

Dec 2011 426 bps

June 2014 285 bps

Mar 1995 1555 bps

Aug 1998 1322 bps

26

So where are we for the short and longer term?

Observations on Where We Are Today in Mid-2014 There are virtually no global market opportunities with signs that read, “Buy me, I am

undervalued. You will regret not adding risk or leverage or committing cash to seize this opportunity”.

We continue to see an unfamiliar and challenging era for fixed income investors as U.S. Quantitative Easing, or “QE”, ends and U.S. interest rates increase.

We expect low U.S. interest rates until mid-2015 but rate increases could be sooner if the economy improves faster than expected and exceeds current projections for employment and growth.

The U.S. economy has bottomed and there are strong, real green shoots of growth to build upon. We need to expand corporate expenditures to enhance long-term productivity.

Peripheral Europe/European banks have begun to restructure their balance sheets and economies, yet Europe will continue to be a drag on global economic growth for several years.

Global economic and political instability increased in 2014, with warfare in the Middle East, Ukraine, Iraq and Afghanistan. These regional conflagrations have de-stabilizing, potentially long-term negative impacts for the global economy and markets.

Powerful and often unanticipated global linkages mean that political and economic instability/crises/slowdowns in one country or region could have wider economic and investment implications.

So Where Do We Invest in 2014 and Beyond?

The absolute and relative performance of U.S. stocks in 2014 raises valuation questions. While U.S. stocks remain competitive compared to interest rates on bonds, they are no longer cheap in absolute terms.

European stocks should outperform U.S. stocks but investors must be highly selective and superior stock selection will be critical. While valuations are attractive, political pressures and election results will likely continue to drive short-term performance.

U.S. high yield investments should be retained but not increased due to historically tight credit spreads.

Investments in distressed debt, especially European distressed debt, could be attractive after four years of banks delaying balance sheet deleveraging.

Although distressed real estate remains attractive, the U.S. housing market has bottomed in most distressed areas with reduced direct investment opportunities.

Selective investment in 2014 in emerging market stocks and emerging market bonds will provide superior long-term returns. The poor performance of emerging market stocks in 2013 has substantially improved the valuation backdrop for long-term investors, but significant volatility should be expected over shorter time horizons.

27

Risk parity strategies should diversify risk and improve returns. However, a spike in interest rates in May 2013 led to poor performance. In light of expectations for an increase in U.S. interest rates, caution is warranted.

While we don’t expect inflation will be a problem in 2014, the Investment Committee and staff will continue to evaluate inflation and real return strategies that could help to maintain the purchasing power of the portfolio in periods of inflation.

We will continue to use short-term market outperformance or volatility in individual asset classes to raise cash to pay benefits. Benefits payments will require cash in excess of dues of more than $280 million in 2014.

We are long-term investors. We have a long-term strategic asset allocation based on our liabilities, or the future benefits to our Plan members. We will not increase portfolio risk by using short-term trading strategies to improve investment performance.

We are socially responsible investors and partner with the denomination’s Committee on Mission Responsibility Through Investment (MRTI) to assist in the mission of the denomination on issues of corporate governance and social responsibility.

July 31, 2014 Judy Freyer Telephone: 215/587-7245 Email: jfreyer@pensions.org

The 2014 Midyear Investment Review was prepared by the Investment Team of the Board of Pensions of the Presbyterian Church (U.S.A.) Theme and narrative commentary by Judith D. Freyer, CFA Graphs and charts by Frank C. Grunseich, CFA, Peter T. Maher, Jr., CFA, and Lydia M. Yost Additional research and assistance by Mary Elizabeth C. Pfeil, CFA, Donald A. Walker, III, CFA, Martha D. Smyrski and Christine A. Cappo

Notes: 1. Prior Investment Reviews shamelessly supporting investment in the U.S. market:

2013 Investment Review: Who is in Charge?

2013 Midyear Investment Review: Oh Middle, Where Art Thou?

2012 Investment Review: The Cockeyed Optimist Slays Debbie Downer

2012 Midyear Investment Review: Knowing, Drifting, Steering and Taking Care of Each Other in a Global Economy: GBS and the Boss

2011 Investment Review: In Regione Caecorum Rex Est Luscus or In the Land of the Blind the One-Eyed Man is King (the U.S. as we detailed in the review is the one-eyed man.)

2011 Midyear Investment Review: We Ain’t Down Yet! Titanic 2011: Surviving the Global Icebergs (the U.S. is the strongest developed economy for the long-term)

2010 Investment Review: Show Me! (Or We Are All Missourians Now)

28

2. A History of Alphabet Soup (From the 2007 Midyear Investment Review)

The interest rate on a subprime mortgage has almost nothing to do with the Prime Rate, the interest rate banks charge their most credit-worthy customers. The subprime mortgage market exploded in recent years as interest rates fell and lenders discovered how they could profitably lend to subprime borrowers, people with less than stellar credit records. These borrowers usually have low FICO or Fair Isaac Corporation credit scores and would be considered high risk for home mortgage or equity loans. In the old days your community bank would review your income, assets and down payment to determine the rate for your mortgage. The local bank then held that mortgage until you repaid it over 30 years. Banks now generally spread the risk by selling mortgages to consolidators who use them as collateral for bonds known as MBS or mortgage-backed securities. Investors liked MBS so much that ABS or asset-backed securities were created, backed by home equity loans, credit card receivables, auto loans and subprime mortgage loans.

What is new in recent years is the development and use of the CDO or collaterized debt obligation to package various bonds with different cash flow structures and credit quality. A large package of bonds is divided by credit quality into several tranches or layers, each with a different credit rating. In the lowest level are the subprime mortgages that often have no chance of repayment when the low initial teaser interest rates reset at higher rates in 2007 or later. Rating agencies review the entire package and often give the CDO a triple- A or highest quality rating, even though the bonds in the lowest layer have a very high probability of default. Hedge funds buy CDOs with borrowed money, creating additional layers of risk in the marketplace should the value of the CDOs decline. An LBO or leveraged buyout occurs when buyers use leverage or borrowed money to purchase a company. When interest rates are low and lenders are eager to lend money for deals, lenders loosen loan covenants or restrictions on the borrower. Typical loan covenants require borrowers to maintain minimum cash levels or income relative to interest payments. “Cov Lite” loans with looser lending standards may encourage the use of too much debt financing to purchase a company, which in a weak economic environment can result in reduced company profitability or even bankruptcy. What does Alphabet Soup have to do with investment markets? Unfortunately we live and work in a global economy, so letters really do matter, especially the “L(everage)” word. While it may seem a stretch to think that a decrease in home values and an increase in foreclosures in Southern California will be a global financial event, the interrelated nature of financial markets means the collapse of highly leveraged investments, whether CDOs or LBOs, can ripple throughout financial markets. July 30, 2007