confidential and proprietary 1 july 2009 confidential and proprietary presentation prepared for cfa...

1 Confidential and Proprietary

JULY 2009

Confidential and Proprietary

PRESENTATION PREPARED FOR

CFA Hawaii Institutional Investor Conference


AGENDA

Introduction

Private Equity Market Then and Now Secondary Investing Outlook and Activity

Hedge Fund Market The Case for Hedge Funds Process Breakdown Key Trends

©2009 Pathway Capital Management, LLC

NOTE: The information contained in this presentation is proprietary and confidential in nature and must not be disclosed to any third party except to the extent required under applicable law or as expressly permitted pursuant to a written agreement with Pathway Capital Management, LLC.


PRIVATE EQUITY MARKET

Private equity was...

“Blackstone IPO—Sign of the Times?” Ninth largest U.S. IPO of all time

Wall Street Journal, March 23, 2007

“The New Kings of Capitalism” “In two decades, private-equity firms have moved from the outer

fringe to the center of the capitalist system”The Economist, November 27, 2004

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“Going Private” “Hotshot executives are fleeing the scrutiny

of public companies for the mad money of the private equity boom”Business Week, February 27, 2006

“Unprecedented Heights” “PE Deal Volume and Funds Raised On Course to Hit New Highs” Buyouts magazine, July 10, 2007

THEN: 2003–2007


The 2003–2007 time period was marked by extraordinary capital activity and the prominence of the private equity industry.

PRIVATE EQUITY MARKETTHEN: 2003–2007

Economic Drivers Low cost of capital Attractively priced assets (2002–2004)

Flexible Financing: Cov-Lite, PIK

GP Activity Record LBO volume & debt issuance

Robust fundraising Strong portfolio performance

Private Equity Themes The Club Deal Public-to-Private Transactions The Mega Deal

Private Equity Investor Mindset Increased target allocations to private equity

Easy money to be made in buyouts High confidence in superior return potential


The credit crisis has dramatically altered the private equity landscape.

PRIVATE EQUITY MARKETNOW: 2009-

Economic Drivers Challenging credit markets Larger equity contributions Purchase price multiples declining

GP Activity Preservation of value & operational initiatives

Debt exchange offers and debt buybacks

Slower fundraising process

Private Equity Themes Secondaries & distressed strategies “in favor”

Flight to quality Greater alignment of interests

Private Equity Investor Mindset

Investors dealing with liquidity issues

Investors over-allocated to PE

Deal activity is slow

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Yesterday


Secondary Market TimingThere has been record fundraising over the past few years to capture the anticipated expansion of investment opportunities resulting from “liquidity” sellers.

What Happened Transaction volume has not matched expectations due to valuation difficulties and

disparities.

This sector is not immune to financial market difficulty—2008 quarter-over-quarter secondary pricing declines were in nearly perfect correlation with the S&P.

Bid/ask spreads have narrowed as a result of low transaction activity.

A number of prominent dedicated secondary funds that were early movers into the market have been burned and are now extremely cautious.

Sellers are unhappy with bid pricing and have become wary. Some have aborted portfolio sales—Harvard Management, Columbia University.

Underwriting rates have risen substantially—from the low teens in 2007 to the 20% range in the second half of 2008—reflecting the riskiness of this market.

Important Considerations Deep discounts on assets will persist until audited financials are released for 2008.

Further declines may occur as FMV is reconciled by the GPs.

Secondary investing is not a “gimme” as promoted. The basic premise of shortening return horizons and gaining higher near-term IRRs has been shaken, if not discredited.

Better to focus on GP quality and selectively target specific opportunities in the primary or secondary markets.

SECONDARY INVESTING



Secondary Market Private Equity Funds RaisedMore than $70 billion raised since 2004

NOTE: Based on data from Private Equity Intelligence, Thomson Financial VentureXpert, and UBS Investment Bank estimates.aLexington Capital Partners IV Closed commitments of $2.5 billion in 2006 and $1.3 billion in 2007.bRepresents the closed commitments in 2008.

($ billions)

SECONDARY INVESTING



Rise of “Mega-Deals”

Highest Amount of Capital Raised by Private Equity Funds

Private Equity Garnered Larger Share of Overall M&A Markets

Record-Setting Deal Volume

Secondary Pricing—% of NAVPricing trends are dramatically lower as a result of the credit crunch and the decline in public markets. There remains a large disparity between buyer and seller expectations.

SOURCE: Cogent Partners.

SECONDARY INVESTING


Yesterday


Private equity has entered into a new investment cycle, characterized by more-rational capital structures, lower purchase prices, and a greater reliance on operational management skills than on financial engineering. Established and proven general partners that have been through difficult economic cycles are best-positioned to thrive in the prospective market environment.

This period will serve to differentiate the highest-quality managers to a greater degree than in the recent past. Median-performing GPs will find fundraising market place very difficult.

Buyouts: The best buyout managers are adapting to the changed environment to take advantage of attractive opportunities made available by the current financial and economic dislocation. Greater focus on smaller transactions, growth equity investments, and build-up opportunities Structured equity investments Restructuring opportunities Discounted leveraged loans

Venture Capital: Technological refinement and innovation will continue to drive investment opportunities, but large disparity in performance among venture capital managers warrants continued emphasis on selectivity.

Attractive investment opportunities are beginning to emerge. Experienced managers with “dry powder” to invest will be well positioned to take advantage of changing market conditions. However, until the credit markets re-open, investment pace will be carefully managed.

Outlook

OUTLOOK & ACTIVITY



Buyout Performance in Post-Recessionary YearsU.S. buyout funds have historically shown superior performance in the two years following a U.S. recession.

aVenture Economics Final December 31, 2008, return benchmarks.bBureau of Economic Analysis.

OUTLOOK & ACTIVITY


PRIVATE EQUITY MARKETDistressed

Debt

General partners are focused on managing their existing investments and in accessing emerging areas of opportunities.

Existing Portfolio Investment Opportunities Operational Initiatives

Apply cost-cutting measures Evaluate capital expenditure plans Refocus on core businesses vs. new initiatives

Balance Sheet Adjustments Debt exchange offers Debt buybacks Covenant amendments/equity cures Debt refinancing/credit facility extensions/creative financing (fee deferrals, annex funds, lower LP co-investment thresholds) Evaluate Existing Portfolio Companies Critically

Which companies have the greatest chance of success? Rank portfolio company financing needs by priority

Operational Initiatives Conserve cash, reduce non-essential expenses, reduce headcount

Focus on reaching cash flow breakeven rather than growth

Bar Has Been Raised for New and Follow-on Investments

Lower Purchase Prices Late-stage companies at early-stage prices Opportunistic cram-down financings

Sectors of Interest/Emerging Sectors & Geographic Regions

Pharmaceuticals (drug pipeline needs driving industry consolidation), clean technology, China/India, cloud computing

Heavily Discounted Leveraged Loans & Bonds Equity-like returns for senior/secured positions

Opportunistic Add-on Acquisitions Lower Purchase Prices

Average purchase price multiple in 2H08 was 8.8x Ebitda vs. 9.7x Ebitda in 2007. Multiples are expected to decrease further.

More-rational capital structures -lower leverage, higher equity contribution rates

Restructuring/Distressed Investments > Rescue Capital Structured Equity (PIPEs, Preferred Equity Investments)

Relative Value Analysis of Existing Portfolio Sell existing investments to reinvest in more-attractive opportunities

Invest/Recycle Interest Income in More-Attractively Priced Opportunities

Add to Existing Positions on the Way Down If Confident in Underwriting Case

Gain control of restructuring process/reorganized equity

Opportunity Set Has Increased Significantly in Past 12 Months

4.1% default rate in 2008, representing $430 billion in par value

65% of high-yield bond market trading at >1,000 bps over U.S. Treasuries >$300 billion in par value

Severe Dislocation in Leveraged Loan Market Forced selling by CLOs and hedge funds have driven yields in loan market to unprecedented levels

Equity-like returns for senior/secured positions

Venture

Capital

Acquisitions

OUTLOOK & ACTIVITY


HEDGE FUND MARKET

Reasons Why Institutions Will Increase Their Commitments to Hedge Funds in the Coming Years

Diversification Opportunistic and diversified allocation, practiced by the best and brightest, make hedge

funds attractive on a risk-adjusted basis.

Capital Preservation and Risk Reduction Hedge funds are best-equipped to manage risk through hedged portfolio management.

Structural Change Regulatory developments, institutional preferences, and economic reality will result in

more-attractive terms, more control, and transparency for investors.

Industry Contraction The bigger get better (and bigger); the bad go away. Fewer participants means less

efficient markets and, therefore, better opportunities to generate alpha.

The Environment Requires Expertise Markets of change are best exploited by employing the expertise and execution

capabilities offered by select, sector-specialist hedge fund managers.

THE CASE FOR HEDGE FUNDS


HEDGE FUND MARKETTHE CASE FOR HEDGE FUNDS

Long-Term, Risk-Adjusted PerformanceThere are a number of compelling reasons why allocations to hedge funds make sense. The first is long-term performance.

Sharpe Ratio

SOURCE: PAAMCO and Bloomberg.


Long/Short vs. Long-Only PerformanceHedged portfolio management consistently outperforms long-only, and does so with substantially lower risk.

HEDGE FUND MARKET

SOURCE: PAAMCO and Bloomberg.

Through December 31, 2008, long/short equity portfolios had a standard deviation of 6.5%; the S&P 500 had 14.5%.

THE CASE FOR HEDGE FUNDS


HEDGE FUND MARKET

Process Breakdown: What Ever Happened to Due Diligence?Funds of Funds Invested with Madoff

PROCESS BREAKDOWN

Grosvenor Capital Management LLC, Arden Asset Management Inc., and EIM Management (USA) had investments with Madoff but redeemed funds over the past few years.

Investor Description Amount of Exposure Comment

Austin Capital Management

Fund of Funds Based in Austin, Texas

$10,000,000 The exposure is about 7.5% of assets.

Bramdean Alternatives An Asset Manager $31,200,000 The exposure is about 9.5% of assets.

Fairfield Greenwich Advisors

An Investment Management Firm

$7,500,000,000 More than half of Fairfield Greenwich's $14.1 billion in assets under management, or about $7.5 billion, was connected to Madoff.

Man Group PLC A UK Hedge Fund $360,000,000 Invested in funds directly and indirectly subadvised by Madoff Securities; Madoff acted as broker-dealer for these funds. Madoff investment represents 1.5% of the company's funds under management for its RMF fund-of-funds business and 0.5% of funds under management for Man Group itself, according to a Dec. 15 disclosure. Man Group is considering taking legal action to recover some of its investments.

Maxam Capital Management

A Fund of Funds Based in Darien, Connecticut

$280,000,000 The fund reported a combined loss of $280 million on funds the firm had invested in.

Meridian Capital Partners

Fund of Funds Based in Albany, NY

$100,000,000 NA

Tremont Group Holdings An Asset Management Firm

$3,300,000,000 The investment firm is owned by OppenheimerFunds and Massachusetts Mutual Life Insurance Co. Tremont's Rye Investment Management business had $3.1 billion invested, and its Fund-of-Funds Group invested another $200 million. The loss is more than half of all assets overseen by Tremont.

Union Bancaire Privée Swiss Bank $700,000,000 Half of UBP's 22 funds of funds put at least some of their money into Madoff-related investment vehicles, including one run by J. Ezra Merkin. The principal fund, Dinvest Total Return, had about 3% of its more than $1 billion of assets in Madoff-related funds. One fund of funds had as much as 6.9% of assets in Madoff-related funds. The bank had most recently met with Madoff Nov. 25 as part of an ongoing vetting process.


HEDGE FUND MARKET

Key Industry Trends

Concentration of Assets Investors will commit capital only to those managers viewed as having sustainable businesses.

Investors in the Driver’s Seat Investors focus increasingly on transparency and risk-management. Scrutiny on liquidity terms and management fees.

Traditional Assumptions are Insufficient Realistic investment objectives with flexible and opportunistic allocations.

Institutionalization of the Industry Asset Base More stable asset base and more-mature operating platforms.

KEY TRENDS

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