1

Thomas SchneeweisDirector

CISDM/University of Massachusetts-AmherstAmherst, Massachusetts 01003

Ph: 413-545-5641Email: CISDM@SOM.UMASS.edu

Web: WWW.CISDM.ORG

October 4, 2002

THE PRESENTATION IS BASED ON INFORMATION OBTAINED FROM SOURCES THAT CISDM CONSIDERS TO BE RELIABLE; HOWEVER, CISDM MAKES NO REPRESENTATION AS TO, AND ACCEPTS NO RESPONSIBILITY OR LIABILITY FOR, THE ACCURACY OR COMPLETENESS OF THE INFORMATION.

Hedge Fund StrategiesWhat are the Real Risk and Return Characteristics

2

Thomas Schneeweis is the Michael and Cheryl Philipp Professor of Finance at the University of Massachusetts, Director of the Center for International Securities and Derivatives Markets, Editor of The Journal of Alternative Investments and is on the Board of the Chartered Alternative Analyst Association. He has published over 70 articles in academic and financial practitioner journals, has presented papers at numerous professional meetings in areas of traditional and alternative investment, and has been quoted in widely in the financial press (Business Week, Financial Times, Wall Street Journal). He has edited several books including the Applications in Finance, Investment, and Banking (Kluwer, 1999) and The Handbook of Alternative Investments: An Investor's Guide (Institutional Investor, 1999). Dr. Schneeweis is also President of Schneeweis Partners LLC, which provides investment management and analytical support to institutional investors primarily in the area of alternative investments.

Background

3

I. Hedge Fund Investment: Background

II. Return and Risk Analysis in Hedge Funds

III. Hedge Fund Indices and Benchmarks

IV. Asset Allocation: Strategic and Tactical

V. Risk Analysis: VaR and Manager Analysis

Hedge Fund Strategies: Risk and Return

4

I: Hedge Fund Background: What is a Hedge Fund?

Term “Hedge Fund” is a misnomer with little descriptive power

1950’s: A.W. Jones Model

Long/Short U.S. equities

“Hedge fund” term accurately reflected his underlying strategy

2000’s: Generic reference to a private, commingled vehicle investing in marketable securities

Strategy characteristics vary widely

Risk/return characteristics vary widely

Common organizational and structural characteristics

5

Growth in Assets (in $billions)

0

100

200

300

400

500

600

700

1990 2001

Growth in Assets (in$billions)

6

Growth in Hedge Fund Managers

0

1000

2000

3000

4000

5000

6000

7000

1990 2001

Number of Managers/Funds

7

Source: Investments & Pensions Europe, May 2001

Wide International Interest

Country Interest In Hedge Fund Investment

010203040506070

Scandinavia

Netherlands

Italy

Sw

itzerland

UK

Europeantotal

France

Germ

any

% Institutions Likely to Invest In Hedge Funds

8

Recently, a substantial number of large U.S. and non-U.S. institutions, California Public Employees Retirement System, Northeastern University, Nestlé and UK Coal Pension and Yale University have indicated their continued interest in hedge fund investment.

Sources: New York Times, Pensions and Investments, Financial Times, IHT

Yale University: Asset Allocation (2000)

Foreign stocks9%

Hedge funds19%

Other8%

Private Equity26%

Real Estate15%

U.S. Stocks14%

Bonds9%

Growth of Hedge Funds

9

Sources: New York Times, Pensions and Investments, Financial Times, IHT

Institutional Interest in Hedge FundsAverage Asset Allocation of 25 Largest Universities

Fixed Income18%

Foreign Equities14%

Real Estate7%

Private Equity8%Hedge Funds

8%

High Yield Bond2%

U.S. Equity43%

Institutional Interest

10

Sources: New York Times, Pensions and Investments, Financial Times, IHT

Composition of Hedge Fund Investors

Composition of Hedge Fund Investors (1999)

U.S. Banks3.1% U.S. Endowments

8.4%U.S. Foundations

2.0%

U.S. Pensions8.2%

U.S. Fund of Funds13.1%

U.S. Individual47.6%

Trust4.0%

Corporate Account3.7%

U.S. Other4.8%U.S. Insurance

0.3%U.S. Family Office

4.7%Types of Hedge Fund Investors

High Net Worth Individual

Offshore Individual

Offshore Institution

University Endowment

Pension Fund

11

Hedge Fund Strategy Composition (2000)

Global Macro15.4%

Risk Arbitrage11.6%

Short Sellers0.1%

Convertible Arbitrage

3.4%

Distressed Securities

2.6%

Emerging Markets3.3%

Long/Short Equity37.9%

Equity Market Neutral5.0%

Long Only11.5%

Fixed Income Arbitrage

9.3%

Hedge Fund Strategy Composition (1990)

Global Macro71.1%

Long/Short Equity15.6%

Long Only0.6%

Equity Market Neutral1.7%

Fixed Income Arbitrage

3.2%

Short Sellers0.1%

Convertible Arbitrage

0.5%

Risk Arbitrage4.4%

Distressed Securities

2.4%

Emerging Markets0.4%

Growth of Hedge Funds

12

Myths of Hedge Fund Investment

•Hedge Funds Are An Investment Product of the 1990’s

•Hedge Funds Are Unique In Their Investment Strategies

•All Hedge Funds Are Risky Because They Use Derivatives

•Hedge Funds Are Highly Levered Risky Investments

13

Hedge Fund Facts

•Hedge Funds Are Not More Volatile Than Traditional Stock and Bond Funds

•Many Hedge Funds Are As Transparent Than Traditional Stock and Bond Funds (Fund Based or Separate Accounts)

• Most Hedge Funds Are As Liquid As Traditional Stock and Bond Funds (Depends on Strategy)

14

Hedge Fund Facts

•Hedge Funds Provide Unique Return Opportunities Not Available in Traditional Markets)

•We Know the Source of Hedge Fund Returns

•Indices Exist which Track Hedge Funds

15

Hedge Fund Facts

•Fees: (1 and 10 Fee Above Hurdle is Approximately 2-3% and Is Pure Active Return Whereas Traditional Mutual Funds Are About 1-2% much of which is Benchmarked to Index)

•Lack of Liquidity Is Reduced By New Forms of Guarantees

• Academic Evidence Shows That Trading Impacts on Local Market Are Limited Due To Relative Size of Hedge Fund Market In Comparison to Traditional Markets

•Some Evidence of Hedge Fund Affecting Individual Securities tocks but Little Evidence of Systemic Risk Within Markets or Across Countries

16

Goals of Hedge Fund Investment

• Take advantage of the ability to profit in a range of market environments

• Develop a diversified approach to capturing ‘alpha’

• Efficiently deliver returns at a risk level defined by the investor

17

Hedge Fund Core Portfolio• Manager Selection

• Select managers consistent with return and risk stability• Consistent sensitivity to market factors which underlie return drivers• Stability over time in relationship to index and other managers in style

• Strategy Selection• Take advantage of the ability to profit in a range of market environments• Develop a diversified approach to capturing ‘alpha’

18

Re

turn

Risk

Optimal Return to Risk Generator

Low Factor Sensitivity to Stock and Bond

Diversification of Judgment and Style

Small Incremental Return

Beneficial If Adds Alpha (Higher Return Same Factor Risk E.G., Equity Replication) Return Reduction

for Incremental Risk Reduction

Low Equity ExposureSatellite

(Specialist – E.G. Low

Equity, Credit Sensitivity)

Core Hedge Fund Portfolio

(Low Stock andBond Beta)

Satellite(Specialist -

(E.G. Equity Bias,Short Vol.)

Return/Risk Tradeoff

19

II: Risk and Return Analysis in Hedge Funds

• Investors get paid for bearing certain risks

• Beta is an important one. Credit risk, term structure risk, volatility risk, and liquidity risk are others

• Hedge fund strategies generally minimize beta and maximize exposure to the other risks

• Often misconstrued as absolute return (or return to skill)• Factor models quantify a fund’s exposure to these risks - separate

‘natural’ return from ‘skill

20

Each Hedge Fund Strategy or Managed Futures Strategy Has Own Economic Source of Return

• Equity Market Neutral - Relative Mispricing

• Convertible Arbitrage - Volatility, Credit Risk

• Merger Arbitrage - Equity And Credit Exposure

• Distressed Securities - Credit Spreads, Liquidity Risk

• Hedged Equity - Equity Factor Sensitivity, Volatility

• Managed Futures – Markets Trends

21

Hedge Fund Exposure to Market Factors

Univariate Regression of Returns Against Factors1990-02

Russell 1000 Russell 2000Lehman

AggregateChange in 10-

Year RateCredit

Spread

Change in Credit Spread VIX

Change in VIX

Traditional Portfolio (60/40) 0.57 0.33 -0.48 3.28 -3.17 -3.91 -0.34 -0.56Hedge Fund Portfolio (EW) 0.16 0.16 -0.05 0.82 -2.56 -2.28 -0.13 -0.16HFR Convertible Arbitrage 0.04 0.04 -0.02 0.40 -1.44 -0.50 -0.03 -0.04HFR Equity Hedge 0.48 0.44 -0.37 2.39 -5.23 -7.70 -0.29 -0.42HFR Event Driven 0.24 0.25 -0.09 1.87 -3.42 -3.55 -0.18 -0.30HFR Distressed Securities 0.12 0.14 0.03 0.47 -1.69 -2.34 -0.14 -0.16HFR Merger Arbitrage 0.08 0.07 -0.07 0.83 -2.15 0.11 -0.09 -0.09HFR Equity Market Neutral -0.02 0.02 0.19 -1.10 -1.01 0.55 0.02 0.07Russell 1000 1.00 0.47 -1.39 7.06 -4.39 -4.94 -0.48 -0.95Russell 2000 0.92 1.00 -1.44 8.94 -6.65 -8.36 -0.68 -1.18Lehman Aggregate -0.05 -0.03 1.00 -3.42 -0.17 -1.75 0.06 0.08Lehman Corp High Yield 0.26 0.23 0.06 2.06 -2.27 -5.52 -0.18 -0.37Treasuries, 10+ Yrs -0.14 -0.08 2.06 -7.99 -0.01 -1.75 0.17 0.25Treasuries, 3-5 Yrs -0.09 -0.06 0.94 -3.52 0.16 -1.82 0.10 0.13MSCI Emerging Markets 0.99 0.74 -1.88 10.38 -1.54 -12.83 -0.58 -1.14MSCI EAFE 0.73 0.49 -0.85 4.73 -2.18 -7.70 -0.38 -0.65

Betas With Respect to

22

Managed Futures Exposure to Market Factors

Factor Correlations (1990-2001)S&P 500 Leh. Bros. Bond Change in Credit Spread Change in

Moody's (Baa-Aaa) VIX Managed Futures

CISDM CTA$ -0.10 0.27 -0.02 0.18CISDM CTAEQ -0.14 0.20 0.10 0.20CISDM Currency 0.01 0.14 0.01 0.04CISDM Discretionary -0.06 0.18 -0.07 0.11CISDM Diversified -0.13 0.25 -0.01 0.24CISDM Financial -0.06 0.35 -0.04 0.17CISDM Trendfollowing -0.14 0.27 0.00 0.23

Hedge fundsCISDM Event Driven Univ. 0.47 0.10 -0.30 -0.41CISDM HF FOF Univ. 0.52 0.19 -0.15 -0.34CISDM Global Est. Univ. 0.78 0.17 -0.26 -0.47CISDM Mkt. Neutral Univ. 0.30 0.11 -0.21 -0.11

Traditional Assets

S&P 500 1.00 0.28 -0.15 -0.64Leh. Bros. Bond 0.28 1.00 -0.06 -0.06

23

Managed Futures Exposure to Market Factors

Factor Correlations: CISDM Managed Futures (1996-2001)S&P 500 Leh. Bros. Bond Change in Credit Spread Change in Trendfollowing Trendfollowing Trendfollowing Trendfollowing

Moody's (Baa-Aaa) VIX Interest Rate Currency Stock Physicals

CISDM CTA$ -0.07 0.48 0.02 0.15 0.58 0.54 0.28 0.22CISDM CTAEQ -0.10 0.37 0.20 0.15 0.58 0.61 0.27 0.18CISDM Currency 0.08 0.10 0.20 -0.13 0.00 0.69 -0.18 -0.06CISDM Discretionary 0.11 0.25 -0.21 -0.03 0.35 0.23 0.22 0.09CISDM Diversified -0.13 0.45 0.00 0.23 0.58 0.44 0.40 0.32CISDM Systematic -0.07 0.43 0.04 0.12 0.53 0.52 0.23 0.27CISDM Financial -0.10 0.51 0.04 0.18 0.64 0.48 0.26 0.13CISDM Trendfollowing -0.18 0.47 0.10 0.25 0.62 0.55 0.35 0.21

S&P 500 1.00 0.06 -0.07 -0.68 -0.07 -0.14 -0.23 -0.23Leh. Bros. Bond 0.06 1.00 0.06 0.08 0.48 0.13 0.28 0.12

* CTA returns are CISDM Universe Medians

** Trendfollowing Interest Rate, Currency, and Stock are Passive Systematic CTA Indices (See www.CISDM.org)

24

Hedge Fund Exposures During Extreme Periods

• Returns on hedge fund indices and various asset classes and factors were grouped in quartiles. Each group holds 25% of observations.

• The bottom quartile holds 25% of observations that are the lowest, while the top quartile holds 25% of observations that the highest.

• Returns on hedge fund indices and other asset classes were ranked using the dates that correspond to the observations in each quartile.

25

Exposures During Extreme Periods

Ranked on S&P500: 90-02

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

1 2 3 4

S&P 500 Return Convertible Arbitrage Equity Hedge

Event Driven Distressed Securities Merger Arbitrage

Equity Market Neutral

26

Exposures During Extreme Periods

Ranked on Aggregate Bond: 90-02

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

1 2 3 4

Lehman U.S. Aggregate Convertible Arbitrage Equity Hedge

Event Driven Distressed Securities Merger Arbitrage

Equity Market Neutral

27

Exposures During Extreme Periods

Ranked on Changes in VIX: 90-02

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

1 2 3 4

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

Convertible Arbitrage Equity Hedge Event Driven

Distressed Securities Merger Arbitrage Equity Market Neutral

Change in VIX

28

Exposures During Extreme Periods

Ranked on Changes in Credit Spread: 90-02

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

1 2 3 4

-0.10%

-0.05%

0.00%

0.05%

0.10%

0.15%

Convertible Arbitrage Equity Hedge Event Driven

Distressed Securities Merger Arbitrage Equity Market Neutral

Change in Credit Spread

29

Managed Futures Exposures During Extreme Periods

Ranking by S&P 500 (1990-12/2001)

S&P 500

CTA$

S&P 500

CTA$

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

Portfolio Groupings

Ave

rage

Mon

thly

Ret

urn

S&P 500 -4.4% 0.1% 2.6% 6.1%

CTA$ 1.0% 1.0% 1.3% 0.5%

Zurich Event Driven Universe 0.2% 1.0% 1.5% 1.3%

Zurich Fund of Funds Universe -0.1% 0.9% 1.3% 1.3%

Zurich Global Established Universe -1.4% 0.7% 2.5% 3.4%

Zurich Market Neutral Universe 0.8% 0.9% 0.9% 1.0%

1 2 3 4

30

Hedge Fund Managers

Questions:

• How Persistent Are The Benefits Of Hedge Fund Managers?

• How Persistent Are Benefits Of Hedge Fund Strategies?

31

Persistence of Performance: Manager Based or Strategy Based

• We regressed monthly excess returns of several hedge fund managers against monthly excess returns on S&P500 and Lehman Aggregate Bond Index

• Risk is measured in terms of exposures to equity and bonds.

• The intercept represents the manager’s alpha.

32

Persistence of Alphas: Index Alpha High - Manager Alpha Low

Alphas for Convertible

-0.06

-0.05

-0.04

-0.03

-0.02

-0.01

0

0.01

0.02

0.03

-0.025 -0.02 -0.015 -0.01 -0.005 0 0.005 0.01

Alpha 97-99

Alp

ha 0

0-0

1

33

Persistence of ExposuresS&P Beta Convertible Arb

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

-0.2 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8

S&P Betas 97-99

S&

P B

eta

s:

00-0

1

34

Persistence of Exposures

Aggregate Bond Beta for Convertible Arb

-4

-3

-2

-1

0

1

2

-3.5 -3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1

Agg Bond Betas 97-99

Ag

g B

on

d B

eta

s 0

0-0

1

35

Summary

• Alphas at managers levels are not persistent.

• Alphas at the index levels are persistent.

• The same story can be said about risk exposures.

• With minor changes, these results hold for all strategies.

36

• Manager Based

• Security Based

• Factor Based

III: Hedge Fund Indices and Benchmarks

37

•No Universe of Manager Performance Index Exists• Current Universe of Managers (e.g., Zurich, TASS, …) Provide only limited representation of true Universe

•Most current ‘Universe Indices’ are not ‘True’ indices • Collection of self reporting managers

•Passive Versus Active Indices• Passive Index requires systematic security (e.g., strategy) or factor based representation of manager strategy and should reflect active manager index

Hedge Fund Universe Versus Hedge Fund Index

38

Hedge Fund Universe, Sub-Universe, Index

Universe of HedgeFunds (5000)

CISDM Sub-Universe (2500 approx)

HFR Sub Universe

TASS Sub-Universe

Zurich Hedge Fund Indices

CSFB/Tremont Index

•Composite of World Unknown•Sub-universe (e.g., HFR, TASS,Zurich) may or may not represent World Index•Personal Libraries (e.g., Zurich Hedge Fund Indices, CSFB, EACM) may better represent characteristics of specific area

than general random selection of books in general sub universe

Some intersection of hedge funds in variousSub-universes

39

EACM CSFB CISDM Passive LehmanS&P 500/ Lehman

Yearly Return 100 Tremont Fund of Funds S&P 500 Gov/Corp Portfolio*

1996 21.10% 14.39% 17.07% 22.22% 11.39% 22.96% 2.90% 14.65%1997 16.79% 16.20% 14.60% 25.94% 15.53% 33.36% 9.76% 23.66%

1998 2.62% -5.11% 1.58% -0.36% 8.17% 28.58% 9.47% 21.35%

1999 31.29% 26.47% 23.72% 23.43% 9.71% 21.04% -2.15% 11.40%

2000 4.98% 4.07% 7.93% 4.85% 8.06% -9.10% 11.85% -0.92%

2001 4.62% 2.80% 2.78% 4.42% 7.34% -11.89% 8.50% -3.68%

2002 to September -3.84% 0.33% 1.47% 0.90% 1.64% -28.16% 9.15% -14.61%

Jul-02 -2.81% -1.25% -0.93% -1.35% -1.50% -7.79% 1.20% -4.19%

Aug-02 0.52% 0.39% 0.57% 0.85% 0.84% 0.66% 2.24% 1.29%

Sep-02 -1.38% -0.48% -0.21% 0.08% 0.19% -10.87% 2.15% -5.66%

Annualized Return 10.92% 8.29% 9.96% 11.55% 9.10% 5.86% 7.24% 6.83%

Standard Deviation 8.59% 7.00% 4.93% 9.34% 3.04% 17.49% 3.99% 10.54%

Sharpe Ratio 0.74 0.54 1.10 0.75 1.50 0.08 0.68 0.22

Maximum Drawdown -11.42% -13.08% -6.25% -13.81% -2.62% -44.73% -3.77% -22.63%

Correlation with S&P 500 0.73 0.56 0.52 0.51 0.43 1.00 -0.04 0.99

Correlation with Lehman Gov't/Corp -0.11 -0.04 0.01 0.13 0.04 -0.04 1.00 0.11

Correlation with HFR FWC 1.00 0.91 0.88 0.77 0.48 0.73 -0.11 0.71

Correlation with HFR FOF 0.91 1.00 0.94 0.91 0.40 0.56 -0.04 0.55

Correlation with EACM 100 0.88 0.94 1.00 0.88 0.44 0.52 0.01 0.51Correlation with CSFB 0.77 0.91 0.88 1.00 0.32 0.51 0.13 0.53

CISDMMajor Hedge Fund Indices: Comparative Performance Analysis

September 2002

HFR Fund Weighted

CompositeHFR Fund of

Funds

Last Three Months

Performance: January-96 - September-02

40

Overview of Hedge Fund Indices

Selection Criteria: Decision rules determine which hedge funds are included in the index. Examples of selection criteria include length of track record, assets under management, and restrictions on new investment;

Style Classification: How each hedge fund is assigned to a style-specific index, and whether or not a fund that fails to satisfy the style classification methodology is excluded from the index;

Weighting Scheme: How much weight a particular fund’s return is given in the index. Common weighting schemes are equally weighted and dollar-weighted based on assets under management;

Rebalancing Scheme: What determines when assets are reallocated among the funds in a particular index. For example some funds are rebalanced monthly, while others assume annual rebalancing; and

Investability: Is the index directly or indirectly investable

41

Overview of Hedge Fund Indices

Zurich Hedge Fund

Indices

CISDM Hedge Fund

Universe

HFR Hedge Fund

Indices

EACM 100

CSFB/Tremont Hedge Fund

Indices

MSCI Hedge Fund

Indices

S&P Hedge Fund

Indices

Launch Date

2001 1994 1994 1996 2000 2002 2002

Index Committee

Yes No No No No No Yes

Composition Published

Yes No No No Yes No Yes

Classifications Primary/Sub

5 9/10 14/17 5/13 9 18/90 3/9

Report a “Hedge Fund Composite”

No No Yes Yes Yes Yes Yes

Approximate

Number of Funds

60 1600 1500 100 340 750 40

42

Overview of Hedge Fund Indices

Zurich

Hedge Fund Indices

CISDM Hedge Fund

Universe

HFR Hedge Fund

Indices EACM 100

CSFB/Tremont Hedge Fund

Indices

MSCI Hedge Fund

Indices

S&P Hedge Fund

Indices

Classification Methodology

Quantitative, independently

verifiable

Manager self classification

Manager self classification

Classified by EACM

Classified by Tremont

Classified by MSCI

Classified by S&P

Minimum

Assets

Varies ($25m

to $75m) None None

Not reported

$10m $25m Unknown

Min. Track

Record $25m for at least 2 yrs

None None Not

reported 1 year or $500m

assets 2 year or $200m

assets Unknown

Includes funds closed to new

investment Yes Yes Yes No Yes Yes No

43

Overview of Hedge Fund Indices

Zurich

Hedge Fund Indices

CISDM Hedge Fund

Universe

HFR Hedge Fund

Indices EACM 100

CSFB/Tremont Hedge Fund

Indices

MSCI Hedge Fund

Indices

S&P Hedge Fund

Indices

Measure of Performance

Equal Weight

Median Equal

Weight Equal

Weight Cap-Weighted Equal Weight

Styles - Equal Weight & Strategies -

Equal Weight

Rebalanced

Quarterly Monthly Monthly Annually Quarterly Annually Annually

Announcement of Index Changes

Prior to start of quarter

N/A N/A N/A Prior to start of

quarter Prior to start of

year Prior to start of

year

44

Alternative Hedge Fund Databases: Performance Comparisons (Jan 1998 – June 2002)

Zurich Convertible Arbitrage 10.52% 4.37% 1.40 1.00Hennessee Convertible Arbitrage Index. 10.93% 4.16% 1.57 0.74CSFB/Tremont Convertible Arbitrage 10.71% 5.70% 1.10 0.88EACM Convertible Hedge Relative Value 7.73% 6.38% 0.52 0.65HFR Convertible Arbitrage 12.55% 3.60% 2.26 0.80

Zurich Hedged Equity 10.51% 20.11% 0.30 1.00CSFB/Tremont Long/Short 12.33% 14.15% 0.56 0.91EACM Domestic Opportunistic Equity Hedge 15.57% 12.94% 0.86 0.77HFR Equity Hedge 14.20% 11.88% 0.82 0.96

Zurich Event Driven 9.14% 8.44% 0.56 1.00Hennessee Event Driven Index 9.29% 7.17% 0.68 0.92CSFB/Tremont Event Driven 7.58% 7.53% 0.42 0.91EACM Multi- Strategy Event Driven 12.01% 6.59% 1.15 0.90Zurich Universe Event-Driven Median 8.40% 4.97% 0.80 0.93HFR Event Driven 8.79% 7.95% 0.55 0.94

Zurich Distressed Securities 9.00% 9.74% 0.47 1.00Hennessee Distressed Index 6.59% 7.40% 0.29 0.85EACM Bankruptcy/ Distressed Event Driven 8.16% 6.43% 0.58 0.62Zurich Universe Distressed Securities Median 6.74% 6.36% 0.37 0.74HFR Distressed Securities 6.89% 6.85% 0.36 0.84

Zurich Merger Arbitrage 9.50% 4.03% 1.26 1.00Hennessee Merger Arbitrage Index 9.58% 4.55% 1.14 0.96EACM Risk Arbitrage Event Driven 6.89% 5.34% 0.46 0.92Zurich Universe Risk Arbitrage Median 8.76% 4.36% 1.00 0.92HFR Merger Arbitrage 9.24% 4.55% 1.06 0.93

Average Ann. Return

Ann. Standard Deviation Sharpe Ratio

Correlation with Zurich Index

45

Relative Index Performance: Fund of Fund Performance

Overall Hedge Fund IndicesMonthly Return Distributions: 1994-2001

0

5

10

15

20

25

30

35

-4.4

%

-3.3

%

-2.2

%

-1.1

%

0.1

%

1.2

%

2.3

%

3.4

%

4.6

%

Mo

re

Monthly Returns

Fre

qu

en

cy

EACM 100

HFR Weigt. Fund Index

CSFB Hedge Fund Index

46

Hedge Fund Databases: Convertible Arbitrage Example

Average Annualized Return and Standard Deviation (01/98-06/02)Convertible Arbitrage

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

Average Ann. Return 10.52% 10.93% 10.71% 7.73% 12.55%

Ann. Standard Deviation 4.37% 4.16% 5.70% 6.38% 3.60%

Zurich Convertible Arbitrage

Hennessee Convertible

CSFB/Tremont Convertible

EACM Convertible Hedge Relative

HFR Convertible Arbitrage

47

Index Creation: Index Based Replication

Fund of FundsAnnual Mean 10.68%Annual Std Deviation 7.59%Correlation with S&P500 32.80%Correlation with LB Bond Index16.25%

Hennessee Macro HFRI F of F EACM 100Annual Mean 9.70% Annual Mean 9.34% Annual Mean 11.85%Annual Std Deviation 8.68% Annual Std Deviation 7.03% Annual Std Deviation 4.86%Corr with S&P500 50.71% Correlation with S&P500 53.30% Correlation with S&P500 47.88%Corr with LB Bond Index 21.17% Correlation with LB Bond Index1.30% Correlation with LB Bond Index 8.29%Corr with 's 75.13% Corr with 's 77.05% Corr with 's 79.41%

Portfolio 1 Weights Portfolio 2 Weights Portfolio 3 WeightsHennessee Macro 87.37% HFRI F of F 79.35% EACM 100 60.04%S&P500 0.00% S&P500 20.65% S&P500 39.96%LB Aggregate Bond 0.79% LB Aggregate Bond 0.00% LB Aggregate Bond 0.00%T-Bill 11.84% T-Bill 0.00% T-Bill 0.00%

Mean Ret on the Portfolio 9.12% Mean Ret on the Portfolio 11.36% Mean Ret on the Portfolio 14.76%Std. Deviation of the Portfolio 7.59% Std. Deviation of the Portfolio 7.59% Std. Deviation of the Portfolio 7.59%Corr with 's 75.13% Corr with 's 69.47% Corr with 's 55.37%Corr with S&P500 50.72% Corr with S&P500 78.31% Corr with S&P500 94.13%Corr with LB Bond Index 21.63% Corr with LB Bond Index 10.96% Corr with LB Bond Index 22.54%

Portfolio 4 WeightsHennessee Macro 59.6%HFRI F of F 40.4%EACM 100 0.0%S&P500 0.0%LB Aggregate Bond 0.0%T-Bill 0.0%

Mean Ret on the Portfolio 9.55%Std. Deviation of the Portfolio 7.59%Corr with 's 80.0%Corr with S&P500 54.5%Corr with LB Bond Index 14.9%

-0 .10 0-0 .08 0-0 .06 0-0 .04 0-0 .02 00 .00 00 .02 00 .04 00 .06 00 .08 0

F u n d o f F u n d s R ep lic a t in g P ort fo lio 4

Replicating Active FOF Manager: Fund of Funds

48

CISDM Active EACM Systematic CSFB-Tremont HFI Managed Futures CISDMAnnualized Return 7.42% 8.22% 5.55% 9.83%Standard Deviation 8.38% 12.58% 11.22% 8.26%

CISDM Active EACM Systematic CSFB-Tremont HFI Managed Futures CISDMSharpe Ratio 0.29 0.26 0.05 0.58

CISDM Active EACM Systematic CSFB-Tremont HFI Managed Futures CISDMCorrelation 0.79 0.76 0.78 1.00

Ranked Returns: 1996-5/2002

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77

CISDM Active

EACM Systematic

CSFB-Tremont HFIManaged Futures

CISDM

Security Based Passive Indices (CTA Example)

49

EACM HFRI CSFB-Tremont CISDMAnnualized Return 16.1% 16.6% 14.7% 15.6%Standard Deviation 12.1% 10.7% 12.8% 11.1%

EACM HFRI CSFB-Tremont CISDMSharpe Ratio 0.92 1.08 0.76 0.96

EACM HFRI CSFB-Tremont CISDMCorrelation 0.57 0.86 0.75 1.00

Ranked Returns 1996-2001

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77

EACM DomOpp

HFRI Equity Hedge Index

CSFB-Tremont HFI Long-Short Equity

CISDM

Multi-Factor Based Index Replication

50

IV: Asset Allocation

• Issues in Asset Allocation

• Number of Managers Required• Index and Fund Tracking • Return Forecasting

• Traditional Approaches Fund Creation

• Strategic and Tactical

51

Allocation for the Institutional Investor

Naïve Multi-Manager Portfolios: An equal weighted portfolio of 8 to 10 mangers generally Reduces the risk of the portfolio to that of the universe of managers from which they are drawn: Variance of an Equal Weighted Portfolio= 1/N*(average variance of all managers – average covariance between managers) + average covariance between managers. Naïve diversification is more effective the larger the difference between the average variance and the average covariance of all managers (e.g., more heterogeneous the manager strategies)

Markowitz Mean/Variance Asset Allocation: Managers are naively selected to maximize the return to risk (e.g., standard deviation) tradeoff. The Return of the Portfolio = weighted average of the individual managers and the Variance of the Portfolio = the combination of the weighted variances of the individual managers plus their weighted covariances. The benefits of mean/variance asset allocation depend on the relative returns, variances and covariances (e.g., correlations and standard deviations).

Inputs to Markowitz Mean/Variance Problem

2[ ] [ ] [ , ]

[ , ] [ ]

p i i

p i i i j i j

i j i j Market

R X R

Var R X Var R X X Cov R R

Cov R R Var R

52

18

Naïve Diversification

Source: Center for International Securities and Derivatives Markets University of Massachusetts at Amherst.

Effect of Diversification (Equal Weighted)

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

1 5 9

13

17

21

25

29

33

37

Number of Managers

Mo

nth

ly S

tan

dard

Devia

tio

n (

%)

RelativeValueLong ShortEquity

ConvertibleHedgeBond Hedge

Naïve Multi-Manager Portfolios

53

21

Active Manager Based: Style Pure

A v e ra g e P o r tfo lio C o rre la tio n w ith P a ire d E A C M In d e x : E q u a l W e ig h te d P o r tfo lio s R a n d o m ly S e le c te d

0

0 . 1

0 . 2

0 . 3

0 . 4

0 . 5

0 . 6

0 . 7

0 . 8

0 . 9

1

1 3 5 7 9 11 13

15

17

19

21

23

25

27

29

31

33

35

37

39

41

43

S iz e o f P o r tfo l io

Co

rre

lati

on

D is t re s s e d R is k A rb it ra g e G lo b a l E s ta b l is h e d

Indices Which Reflect Performance of Investable Hedge Funds

•Zurich•EACM

Naïve Multi-Manager Portfolios

54

Comparison of Passive Index and Active Portfolio Factor Correlations (1998-2000)

Manager Based Fund FoF Mkt Neutral Arbitrage Global Macro* Long/ShortEquity

Change in Credit Spread -0.39 0.17 0.12 -0.55 -0.38Change in Stk (VIX) Implied Vol. -0.04 -0.11 -0.31 -0.21 -0.28S&P 500 0.26 0.18 0.30 0.30 0.41Lehman Bond 0.04 -0.15 -0.23 0.20 -0.07

Comparison Indices EACM100 Equity Arbitrage** Global Macro* Long/ShortMkt. Neutral Portfolio Equity

Change in Credit Spread -0.38 0.05 -0.21 -0.20 -0.33Change in Stk (VIX) Implied Vol. -0.31 0.16 -0.35 -0.09 -0.18S&P 500 0.50 0.03 0.42 0.27 0.32Lehman Bond -0.15 0.07 -0.42 0.26 -0.06

* 7/99-12/2000

** 25% Merger Arbitrage; 45% Convertible Arbitrage; 10% Bankruptcy; 10% Bond Hedge; 10% Long/Short

In Asset Allocation, Indices Must Reflect Asset Manager’s Sensitivity to Factors

55

Evolution of Hedge Fund Assets, 1991-2000

0%

20%

40%

60%

80%

100%

1/1

/91

1/1

/92

1/1

/93

1/1

/94

1/1

/95

1/1

/96

1/1

/97

1/1

/98

1/1

/99

1/1

/00

EmergingMarkets

Fixed Income

Equity Hedge

Convertible

Relative Value

ManagedFutures

Short Sellers

Global Macro

Global Macro

Relative Value

Equity Hedge

Emerging Markets

Historical indexes May not Reflect Future Returns of Current Index

56

Return Relationships (1990-2000)

R-Square R-Square CAPM Multi-factor SharpeHistorical Volatility Sharpe Beta Market Model Multi-factor Estimate Return Estimate Return Estimate Return

Return

HFRI Convertible Arbitrage Index 11.4% 3.4% 1.92 0.09 0.12 0.19 5.9% 6.4% 7.7%HFRI Distressed Securities Index 14.6% 6.6% 1.48 0.19 0.15 0.26 7.0% 7.3% 10.3%HFRI Emerging Markets (Total) 15.3% 16.4% 0.63 0.67 0.32 0.36 12.5% 14.2% 18.4%HFRI Emerging Markets: Asia Index 10.1% 14.5% 0.36 0.49 0.22 0.23 10.4% 11.5% 16.8%HFRI Equity Hedge Index 21.2% 9.3% 1.75 0.41 0.37 0.37 9.5% 11.4% 12.5%HFRI Equity Market Neutral Index 11.0% 3.3% 1.87 0.05 0.05 0.03 5.5% 6.4% 7.6%HFRI Equity Non-Hedge Index 19.2% 14.4% 0.99 0.78 0.56 0.60 13.7% 16.4% 16.7%HFRI Event-Driven Index 16.1% 6.4% 1.75 0.27 0.35 0.47 8.0% 8.7% 10.1%HFRI Fixed Income (Total) 10.9% 3.7% 1.62 0.11 0.17 0.22 6.1% 6.4% 7.9%HFRI Fixed Income: Arbitrage Index 8.7% 4.9% 0.78 -0.03 0.01 0.00 4.6% 4.4% 8.9%HFRI Fixed Income: High Yield Index 9.9% 6.9% 0.72 0.21 0.17 0.33 7.2% 6.9% 10.6%HFRI Fund of Funds Index 11.5% 6.3% 1.05 0.19 0.17 0.19 7.0% 7.7% 10.0%HFRI Fund Weighted Composite Index 16.4% 7.3% 1.58 0.35 0.45 0.50 8.9% 10.1% 10.9%HFRI Macro Index 17.9% 9.3% 1.41 0.29 0.19 0.24 8.2% 8.3% 12.5%HFRI Market Timing Index 14.8% 6.9% 1.43 0.32 0.42 0.41 8.5% 10.1% 10.5%HFRI Merger Arbitrage Index 13.2% 3.9% 2.15 0.11 0.16 0.28 6.1% 6.7% 8.0%HFRI Relative Value Arbitrage Index 13.4% 4.0% 2.12 0.10 0.12 0.20 6.0% 6.3% 8.2%HFRI Sector (Total) 23.9% 14.2% 1.34 0.50 0.24 0.27 10.6% 12.1% 16.5%HFRI Statistical Arbitrage Index 11.1% 3.8% 1.66 0.14 0.27 0.26 6.5% 7.8% 8.0%

Historical Returns May Be Poor Forecasts Of Future Hedge Fund Return

57

Current New Expected <---------------- Annualized Expected Returrsn to be entered by userAsset Classes Weights Weights Min Max ReturnsHFRI Convertible Arbitrage Index 0% 0% 0% 5% 12%HFRI Distressed Securities Index 0% 5% 0% 5% 12%HFRI Equity Hedge Index 0% 5% 0% 5% 12% Use Historical Returns? Yes = 1, No = 0HFRI Equity Market Neutral Index 0% 0% 0% 5% 12% Enter 1 or 0 0HFRI Event-Driven Index 0% 5% 0% 5% 12%HFRI Merger Arbitrage Index 0% 5% 0% 5% 12%Russell 1000 (TR) 50% 50% 40% 50% 12%Russell 2000 (TR) 10% 10% 5% 10% 12%Treasuries, 1-3 year 5% 5% 5% 20% 12%Treasuries, 7-10 year 10% 5% 5% 20% 12%Corporate AAA 7-10 year 15% 5% 5% 20% 12% Total risk is defines as:Corporate BBB 7-10 year 10% 5% 5% 20% 12% Lambda * Std + (1-Lambda)* Std of Tracking ErrorGS Commodity TR (Total Return) 0% 0% 0% 0% 12% Lambda = 1 will minimize StdNAREIT-Equity TR (Total Return) 0% 0% 0% 0% 12% Lambda = 0 will minimize tracking error riskTotal 100% 100% 1 1

First Column of Data 1 Read the instruction on the data sheetLast Column of Date 145

Riskless Rate 5%Total Risk 9.9%

Mean Stdev Sharpe Ratio Portfolio Trac Port Alpha Lambda 1.0Portfolio 12.00% 9.47% 0.74 1 0.99 0.28 Target 11.0%Tracking Portfolio 12.00% 9.94% 0.70 0.99 1 0.41Alpha 0.00% 1.35% 0.28 0.41 1

Annualized Correlations versus

Traditional Approach to Mean Variance Optimization

58

Asset Allocation

• Given problems in return forecasts, one may simply assume traditional asset weights are chosen correctly and one wishes to chose hedge fund replacement strategies which produce alpha.

• We consider the case of an investor who wants to reduce his/her holdings of a traditional asset class and invest the proceeds in a portfolio of hedge funds.

• The goal is to make the new portfolio a close substitute for the original portfolio.

59

Stand Alone Substitutes for Assets Classes Equity

Russell 1000 80%Russell 2000 20%

HFR Conv Arb 10%HFR Eq Hedge 35%HFR Ev Driven 25%HFR Dist Sec 10%HFR Merg Arb 10%HFR EMN 10%

SharpeMean Stdev Skewness Kutrosis Auto-Corr VaR 5% Min Max Ratio

Equity 13.0% 12.5% -0.31 1.15 1% -5.07% -10.0% 10.7% 0.64HF 16.2% 4.9% -0.58 0.95 37% -1.16% -3.3% 4.7% 2.30Alpha 3.2% 9.7% -0.29 1.13 -8% -8.0% 8.1%

MonthlyAnnualized

Mean Stdev Sharpe Ratio Equity HF AlphaEquity 13.04% 12.48% 0.64 1 0.70 -0.93HF 16.21% 4.87% 2.30 0.70 1 -0.39Alpha 3.17% 9.73% -0.93 -0.39 1

Annualized Correlations versus

60

Stand Alone Substitutes for Assets Classes Equity

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

Jan-9

0

Apr-9

0

Jul-9

0

Oct-9

0

Jan-9

1

Apr-9

1

Jul-9

1

Oct-9

1

Jan-9

2

Apr-9

2

Jul-9

2

Oct-9

2

Jan-9

3

Apr-9

3

Jul-9

3

Oct-9

3

Jan-9

4

Apr-9

4

Jul-9

4

Oct-9

4

Jan-9

5

Apr-9

5

Jul-9

5

Equity HF

61

Stand Alone Substitutes for Assets Classes Corporate Bonds

Corporate AAA, 7-10 Yrs 50%Corporate BBB, 7-10 Yrs 50%

HFR Conv Arb 37%HFR Eq Hedge 10%HFR Ev Driven 10%HFR Dist Sec 10%HFR Merg Arb 10%HFR EMN 23%

Mean Stdev Sharpe Ratio Equity HF AlphaEquity 9.89% 5.27% 0.93 1 0.51 -0.79HF 12.90% 3.29% 2.40 0.51 1 0.13Alpha 3.01% 4.57% -0.79 0.13 1

Annualized Correlations versus

SharpeMean Stdev Skewness Kutrosis Auto-Corr VaR 5% Min Max Ratio

Equity 9.9% 5.3% -0.21 0.41 27% -1.76% -2.9% 5.2% 0.93HF 12.9% 3.3% -0.79 0.53 57% -0.68% -1.8% 3.1% 2.40Alpha 3.0% 4.6% 0.06 0.74 17% -3.8% 3.7%

MonthlyAnnualized

62

Stand Alone Substitutes for Assets Classes Corporate Bonds

-0.04

-0.03-0.02

-0.01

0.000.01

0.02

0.03

0.040.05

0.06

Jan-9

0

Apr-9

0

Jul-9

0

Oct-9

0

Jan-9

1

Apr-9

1

Jul-9

1

Oct-9

1

Jan-9

2

Apr-9

2

Jul-9

2

Oct-9

2

Jan-9

3

Apr-9

3

Jul-9

3

Oct-9

3

Jan-9

4

Apr-9

4

Jul-9

4

Oct-9

4

Jan-9

5

Apr-9

5

Jul-9

5

Equity HF

63

Traditional Assets & Hedge Funds

Current NewAsset Classes Weights WeightsHFR Convertible Arbitrage 0% 10%HFR Equity Hedge 0% 40%HFR Event Driven 0% 20%HFR Distressed Securities 0% 10%HFR Merger Arbitrage 0% 10%HFR Equity Market Neutral 0% 10%Russell 1000 50% 0%Russell 2000 10% 0%Lehman Aggregate 40% 0%Lehman Corp High Yield 0% 0%Treasuries, 10+ Yrs 0% 0%Treasuries, 3-5 Yrs 0% 0%MSCI Emerging Markets 0% 0%MSCI EAFE 0% 0%Total 100% 100%

Mean Stdev Sharpe RatioTraditional PortfolioHedge Fund PortfolioAlphaTraditional Portfolio 9.67% 9.46% 0.49 1 0.75 -0.79Hedge Fund Portfolio 14.46% 5.95% 1.59 0.75 1 -0.18Alpha 4.80% 6.35% -0.79 -0.18 1

Annualized Correlations versus

-0.10

-0.08

-0.06

-0.04

-0.02

0.00

0.02

0.04

0.06

0.08

0.10

Jan-90

Jul-90

Jan-91

Jul-91

Jan-92

Jul-92

Jan-93

Jul-93

Jan-94

Jul-94

Jan-95

Jul-95

Jan-96

Jul-96

Jan-97

Jul-97

Jan-98

Jul-98

Jan-99

Jul-99

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Traditional Portfolio Hedge Fund Portfolio

Data: 1990-02

64

Strategic and Tactical Asset Allocation

• Strategic Asset Allocation (Long Term Allocation)

• Hedge Funds to Replicate Hedge Fund Indices• Hedge Funds to Replicate Cash Market Indices

• Tactical Asset Allocation (Short Term Rebalancing)

• Hedge Fund Strategies Lead/Lag Relationships with Economic Variables

65

Hedge Funds Replicate Hedge Fund Indices

Current OptimizedAssets Weights Weights Min Max Mean StdLehman Aggregate Bond Index 0.0% 0.00% 0.00% 0.00% 8.29% 3.55%EACM Dom Opp. 100.0% 0.00% 0.00% 0.00% 19.40% 12.04%Russell 2000 (TR) 0.0% 0.00% 0.00% 0.00% 13.43% 19.76%MSCI Europe 15 Local Currency 0.0% 0.00% 0.00% 0.00% 16.18% 15.13%HE Bennett/Lawrence Partners, L.P. 0.0% 5.00% 5.00% 25.00% 21.92% 29.20%HE Aquila International Fund Ltd 0.0% 5.00% 5.00% 25.00% 5.58% 15.77%HE Richmont Opportunity Composite 0.0% 5.00% 5.00% 25.00% 15.85% 14.88%HE Gardner Lewis Fund L.P. 0.0% 5.00% 5.00% 25.00% 28.43% 31.93%HE WPG-Farber, Present Fund, L.P. 0.0% 25.00% 5.00% 25.00% 22.13% 24.24%HE FLA International Fund Ltd 0.0% 5.00% 5.00% 25.00% 22.10% 18.77%HE DeSantis Capital Partners LP 0.0% 5.00% 5.00% 25.00% 19.75% 17.14%HE Aggressive Growth Partners L.P. 0.0% 5.00% 5.00% 25.00% 14.79% 34.73%HE Zweig-DiMenna Partners, L.P. 0.0% 5.00% 5.00% 25.00% 20.69% 23.79%HE TGT Capital Partners L.P. 0.0% 13.0% 5.00% 25.00% 18.47% 14.57%HE Needham Emerging Growth Partners , L.P. 0.0% 5.00% 5.00% 25.00% 30.62% 21.35%HE Steel Partners II, L.P. 0.0% 16.97% 5.00% 25.00% 21.91% 13.92%Total 0.0% 0.00% 0.0% 0.0% 15.38% 4.08%HFRI Relative Value Arbitrage Index 0.0% 0.00% 0.0% 0.0% 15.93% 3.76%HFRI Short Selling Index 0.0% 0.00% 0.0% 0.0% -18.77% 22.00%HFRI Statistical Arbitrage Index 0.0% 0.00% 0.0% 0.0% 11.59% 3.35%Total 100.0% 100.0% 100% 100.0%

5.0% 5.00% 0.00% 0.00%

Mean Std Sharpe EACM Dom Opp. Optimized TE T Bond IT S&PEACM Dom Opp. 19.40% 12.04% 1.20 1 0.83 0.00 -0.13 0.27Optimized Portfolio 20.64% 14.59% 1.07 0.83 1 0.56 -0.07 0.48Tracking Error 1.25% 8.2% 0.00 0.56 1.00 0.07 0.47

Annualized

Annualized Correlations

Hedge Funds can be used Replicate EACM 100 Index used in Asset Allocation

66

Hedge Funds can be used Replicate Russell Index used in Asset Allocation

Current OptimizedAssets Weights Weights Min Max Mean StdLehman Aggregate Bond Index 0.0% 0.00% 0.00% 0.00% 8.29% 3.55%Russell 1000 (TR) 0.0% 0.00% 0.00% 0.00% 17.56% 15.63%Russell 2000 (TR) 100.0% 0.00% 0.00% 0.00% 13.43% 19.76%MSCI Europe 15 Local Currency 0.0% 0.00% 0.00% 0.00% 16.18% 15.13%HE Bennett/Lawrence Partners, L.P. 0.0% 5.00% 5.00% 50.00% 21.92% 29.20%HE Aquila International Fund Ltd 0.0% 5.00% 5.00% 50.00% 5.58% 15.77%HE Richmont Opportunity Composite 0.0% 13.39% 5.00% 50.00% 15.85% 14.88%HE Gardner Lewis Fund L.P. 0.0% 20.24% 5.00% 50.00% 28.43% 31.93%HE WPG-Farber, Present Fund, L.P. 0.0% 5.00% 5.00% 50.00% 22.13% 24.24%HE FLA International Fund Ltd 0.0% 5.00% 5.00% 50.00% 22.10% 18.77%HE DeSantis Capital Partners LP 0.0% 5.00% 5.00% 50.00% 19.75% 17.14%HE Aggressive Growth Partners L.P. 0.0% 5.00% 5.00% 50.00% 14.79% 34.73%HE Zweig-DiMenna Partners, L.P. 0.0% 9.80% 5.00% 50.00% 20.69% 23.79%HE TGT Capital Partners L.P. 0.0% 13% 5.00% 50.00% 18.47% 14.57%HE Needham Emerging Growth Partners , L.P. 0.0% 5.00% 5.00% 50.00% 30.62% 21.35%HE Steel Partners II, L.P. 0.0% 8.96% 5.00% 50.00% 21.91% 13.92%Total 0.0% 0.00% 0.0% 0.0% 15.38% 4.08%HFRI Relative Value Arbitrage Index 0.0% 0.00% 0.0% 0.0% 15.93% 3.76%HFRI Short Selling Index 0.0% 0.00% 0.0% 0.0% -18.77% 22.00%HFRI Statistical Arbitrage Index 0.0% 0.00% 0.0% 0.0% 11.59% 3.35%Total 100.0% 100.0% 100% 100.0%

5.0% 5.00% 0.00% 0.00%

Mean Std Sharpe Russell 2000 (TR)Optimized TE T Bond IT S&PRussell 2000 (TR) 13.43% 19.76% 0.43 1 0.93 -0.50 -0.07 0.64Optimized Portfolio 21.04% 17.28% 0.93 0.93 1 -0.14 -0.10 0.65

Tracking Error 7.61% 7.5% -0.50 -0.14 1.00 -0.04 -0.18

Annualized

Annualized Correlations

67

Tactical Asset Allocation

• Returns on traditional assets classes are somewhat predictable using lagged values of certain variables

• Credit risk, Volatility, Term Premium, Returns, etc

• We used the lagged values of a set of factors to predict returns to various hedge fund strategies.

68

Tactical Asset Allocation

• We considered rebalancing our portfolio on a systematic basis.

• The estimation period is a rolling 2-years period and starts on Jan 1990 and ends with Dec 1999.

69

Tactical Asset AllocationHFR

Convertible Arbitrage

Change in Credit Spread

Change in VIX

Change in Term Spread

Russell 1000

Lehman Aggregate

Mean 0.9% 0.0% 0.1% 6.0% 0.9% Standard Deviation 1.0% 0.1% 3.9% 1.2% 4.3%

Regression Results Intercept

Change in Credit Spread

Change in VIX

Change in Term Spread

Russell 1000

Lehman Aggregate

Coeffcients 0.010 -0.522 -0.041 -0.042 0.046 0.151Standard Errors 0.004 0.906 0.025 0.063 0.024 0.070T-Stat 2.677 -0.576 -1.628 -0.669 1.949 2.171Prob 1% 57% 11% 50% 5% 3%R Squared 17%

1-Month Lagged Variables

HFR Distressed Securities

Change in Credit Spread

Change in VIX

Change in Term Spread

Russell 1000

Lehman Aggregate

Mean 1.2% 0.0% 0.1% 6.0% 0.9% Standard Deviation 1.8% 0.1% 3.9% 1.2% 4.3%

Regression Results Intercept

Change in Credit Spread

Change in VIX

Change in Term Spread

Russell 1000

Lehman Aggregate

Coeffcients 0.004 -4.220 -0.100 0.119 0.072 -0.022Standard Errors 0.007 1.731 0.048 0.120 0.045 0.133T-Stat 0.532 -2.438 -2.094 0.990 1.594 -0.163Prob 60% 2% 4% 32% 11% 87%R Squared 17%

1-Month Lagged Variables

70

Tactical Asset Allocation To Best of Five

• Systematic reallocation is beneficial

• Benefits are reduced when the reallocation interval is increased.

Equally Weighted Portfolio

Reallocation Based on Forecast

Reallocation Based on 1-Month Wait

Reallocation Based on 2-Month Wait

Reallocation Based on 3-Month Wait

Perfect Foresight

Annualized Return 11.33% 21.71% 14.05% 14.46% 14.08% 29.57%Annualized St Dev 4.56% 6.62% 6.47% 8.47% 7.02% 6.53%

71

V: Risk Analysis• Manager Level

• Sophisticated risk management including VaR analysis to ensure style consistency, and leverage management

• Segregated accounts to eliminate possibility of fraud, and gross mismanagement

• Style Level: Oversight ensures level of concentration within individual securities/sectors within appropriate limits

• Portfolio Level: Daily reports to clients/structuring partners outlining risk levels

72

VaR Analysis on Portfolio AssetsCurrent New

Asset Classes Weights Weights Min MaxS&P500 35% 25% 20% 35%Russell2000 20% 15% 15% 20%Lehman Agg 10% 10% 5% 10%Lehman High Yield Credit Bond 15% 15% 5% 15%Lehman Global Aggregate Index 5% 5% 0% 5%MSCI EAFE 5% 5% 5% 5%MSCI Europe 15 U.S. Currency 0% 0% 0% 0%GS Commodity TR (Total Return) 0% 0% 0% 0%NAREIT-Equity TR (Total Return) 5% 5% 5% 5%3-Month Treasury 5% 5% 5% 5%HFR Eq Mkt Neutral 0% 0% 0% 0%HFR Conv Arb 0% 0% 0% 0%HFR Fixed Inc Arb 0% 0% 0% 0%HFR Dist Sec 0% 5% 5% 5%HFR Merger Arb 0% 0% 0% 0%HFR Event 0% 0% 0% 0%HFR Hedged Eq 0% 10% 0% 10%HFR Macro 0% 0% 0% 0%MAR CTA$ 0% 0% 0% 0%Total 100% 100% 1 1

SharpeMean Stdev Skewness Kutrosis Auto-Corr Var = 95% Min Max Ratio

Original Portfolio 10.6% 9.7% -0.80 1.59 5% -4.23% -11% 7% 0.58Optimized Portfolio 11.4% 8.5% -0.84 1.77 7% -3.55% -9% 7% 0.75Alpha 0.7% 1.5% -0.05 0.49 -2% -1% 1%S&P500 13.4% 14.4% -0.47 0.85 -10% -6.18% -14% 11% 0.58Russell2000 12.1% 18.4% -0.45 1.06 10% -8.30% -19% 17% 0.38Lehman Agg 8.0% 3.8% -0.20 0.17 22% -1.18% -2% 4% 0.79Lehman High Yield Credit Bond 9.1% 7.5% 0.00 5.47 35% -2.56% -7% 11% 0.54Lehman Global Aggregate Index 7.2% 4.9% 0.17 -0.09 27% -1.68% -3% 5% 0.44MSCI EAFE 4.2% 17.0% -0.05 0.45 -8% -7.72% -14% 16% -0.05MSCI Europe 15 U.S. Currency 9.8% 15.0% -0.42 0.42 -8% -6.79% -13% 10% 0.32GS Commodity TR (Total Return) 7.1% 18.2% 0.96 2.74 14% -6.24% -12% 23% 0.11NAREIT-Equity TR (Total Return) 11.4% 12.6% 0.28 0.44 9% -4.71% -9% 11% 0.513-Month Treasury 5.0% 0.4% 0.36 0.19 98% 0.26% 0% 1% 0.01 HFR Eq Mkt Neutral 10.8% 3.3% -0.10 0.34 -3% -0.68% -2% 4% 1.77HFR Conv Arb 11.5% 3.4% -1.41 3.35 54% -0.98% -3% 3% 1.88HFR Fixed Inc Arb 8.6% 4.8% -1.66 8.42 41% -1.91% -6% 5% 0.75HFR Dist Sec 14.6% 6.5% -0.73 5.68 50% -2.02% -9% 7% 1.49HFR Merger Arb 12.1% 4.4% -3.23 14.99 15% -1.63% -6% 3% 1.60HFR Event 15.4% 6.6% -1.49 6.13 27% -2.36% -9% 5% 1.56HFR Hedged Eq 19.4% 9.4% 0.12 1.23 11% -2.68% -8% 11% 1.54HFR Macro 16.8% 9.1% 0.23 0.15 18% -2.73% -6% 8% 1.30MAR CTA$ 11.2% 10.2% 0.86 2.56 2% -3.00% -6% 14% 0.61

MonthlyAnnualized

73

Due Diligence, Controls & Portfolio Monitoring

Due Diligence

Background checks

Registrations and regulatory checks

Verification of education and certification

Investment methodology and risk protocol

Systems and procedures review (including disaster recovery, back office and compliance practices)

On-site visits

Controls & Portfolio Monitoring

Separate account structure

Custody of all assets

Leverage limitations

Favorable liquidity terms

Transparency and risk analytics

Defined portfolio guidelines

74

Conclusions

• Style Pure Fund or Manager Indices Provide Surrogates for Risk and Return Process Underlying Strategy

• Factor Based Indices Provide Surrogates for Risk and Return Process Underlying Strategy If Strategy Has Fundamental Market Factor Driving Process

• Security Based Indices Provide Tradable Surrogate Risk and Return Process Underlying Strategy If Strategy Is Traded In A Systematic Manner

75

Appendix

CSFB EACM HFR CISDM Passive CSFB EACM HFR CISDM Passive CSFB EACM HFR CISDM Passive

Convertible Convertible Convertible Convertible Long/Short Equity Equity Equity Fixed Inc. Bond Fixed Income Fixed Income

Yearly Return Arbitrage Arbitrage Arbitrage Arbitrage Equity Hedge Hedge Hedge Arbitrage Hedge Arbitrage Arbitrage

1996 17.87% 13.57% 14.56% 8.01% 17.12% 22.08% 21.75% 21.34% 15.93% 16.37% 11.89% 11.00%

1997 14.48% 11.69% 12.72% 12.74% 21.46% 18.29% 23.41% 24.48% 9.34% 7.30% 7.02% 8.65%

1998 -4.41% 2.60% 7.77% 8.76% 17.18% 6.02% 15.98% 11.09% -8.16% -16.62% -10.29% 1.24%

1999 16.04% 16.96% 14.41% 7.47% 47.23% 59.31% 44.22% 30.63% 12.11% 8.90% 7.38% 8.74%

2000 25.64% 5.34% 14.50% 11.31% 2.08% 1.99% 9.09% 13.62% 6.29% -1.99% 4.78% -1.38%

2001 14.58% 7.73% 13.37% 5.19% -3.65% -6.57% 0.40% 5.13% 8.04% 5.45% 4.81% -4.08%

2002 to September -0.61% 2.39% 4.73% 3.36% -2.98% -10.02% -7.62% -9.89% 7.37% 4.11% 8.95% 1.52%

Jul-02 -1.55% -2.42% -1.33% -1.02% -2.95% -3.53% -4.02% -5.60% 1.08% 1.87% 1.68% -0.70%

Aug-02 0.60% 0.84% 0.63% 0.33% 1.01% 0.30% 0.19% -0.48% 1.23% 0.38% 0.85% 0.69%

Sep-02 1.37% 1.31% 1.37% 0.53% -0.47% -2.45% -2.29% -2.63% -1.14% -2.92% 0.85% 1.35%

Annualized Return 11.94% 8.82% 12.12% 8.39% 13.44% 11.55% 14.83% 13.56% 7.30% 2.99% 4.89% 3.66%

Standard Deviation 4.92% 5.45% 3.19% 3.53% 12.64% 13.10% 10.87% 11.25% 4.20% 5.61% 4.70% 4.57%

Sharpe Ratio 1.51 0.79 2.37 1.09 0.70 0.54 0.95 0.80 0.66 -0.28 0.08 -0.19

Maximum Drawdown -12.03% -8.53% -4.69% -2.42% -15.04% -22.65% -11.24% -12.55% -12.48% -20.65% -14.42% -9.61%

Corr. with S&P 500 0.13 0.22 0.35 0.38 0.59 0.62 0.70 0.71 0.03 0.12 -0.13 0.16

Corr. with Lehman Bond -0.06 -0.10 -0.08 0.15 0.00 -0.09 -0.08 -0.08 -0.07 -0.22 -0.12 -0.31

% of Winning Months 87.65% 82.72% 90.12% 76.54% 62.96% 60.49% 65.43% 65.43% 85.19% 77.78% 79.01% 64.20%

Average Gain 1.36% 1.25% 1.17% 1.10% 3.08% 3.21% 2.88% 2.91% 0.96% 0.92% 0.89% 1.03%

% of Losing Months 12.35% 17.28% 9.88% 23.46% 37.04% 39.51% 34.57% 34.57% 14.81% 22.22% 20.99% 35.80%

Average Loss -1.93% -1.80% -0.91% -0.68% -2.21% -2.42% -1.96% -2.28% -1.49% -2.07% -1.39% -0.99%

CISDMHedge Fund Subindices: Comparative Performance Analysis

September 2002

Last Three Months

Performance: January-96 - September-02

76

Appendix

CSFB HFR CSFB EACM HFR CISDM Passive HFR CISDM Passive EACM EACM EACM CSFB

Emerging Emerging Event Event Event Event Merger Merger Arbitrage Discretionary Systematic Managed Futures

Yearly Return Markets Markets Driven Driven Driven Driven Arbitrage Arbitrage

1996 34.50% 27.14% 23.06% 15.59% 24.84% 19.54% 16.61% 13.58% 14.46% 24.47% 16.75% 11.97%

1997 26.59% 16.57% 19.96% 13.72% 21.23% 25.95% 16.44% 19.44% 12.03% 23.50% 11.04% 3.12%

1998 -37.66% -32.96% -4.87% 3.18% 1.70% 8.05% 7.23% 14.31% 5.25% -11.73% 18.48% 20.64%

1999 44.82% 55.86% 22.26% 16.39% 24.33% 15.00% 14.34% 13.48% 14.24% 15.14% -5.95% -4.69%

2000 -5.52% -10.71% 7.26% 12.96% 6.74% 1.21% 18.02% 11.19% 14.84% 3.92% 8.14% 4.24%

2001 5.84% 10.36% 11.50% 6.96% 12.18% 15.88% 2.76% 4.93% 0.24% 5.74% 2.42% 1.90%

2002 to September 3.10% -1.41% -3.13% 0.08% -7.17% -5.42% -2.62% -5.78% -4.06% -1.96% 19.65% 20.63%

Jul-02 -1.19% -4.95% -3.10% -1.88% -4.17% -5.23% -2.36% -3.24% -2.06% -2.23% 3.29% 6.12%

Aug-02 1.26% 1.59% 0.27% 0.69% 0.44% 0.64% 0.37% 0.35% 0.83% -0.45% 2.38% 3.36%

Sep-02 -1.98% -4.26% -0.20% -0.31% -1.14% -2.36% 0.05% -2.01% -0.39% -0.27% 2.57% 4.11%

Annualized Return 7.06% 6.24% 10.72% 10.05% 11.83% 11.42% 10.54% 10.27% 8.20% 8.02% 10.10% 8.19%

Standard Deviation 18.12% 17.42% 6.82% 5.01% 7.38% 7.76% 4.24% 3.65% 4.78% 9.64% 12.80% 11.70%

Sharpe Ratio 0.14 0.10 0.91 1.10 0.99 0.89 1.42 1.57 0.77 0.36 0.43 0.31

Maximum Drawdown -45.14% -43.37% -16.05% -9.49% -10.78% -9.73% -6.32% -7.51% -7.86% -19.47% -15.06% -14.23%

Corr. with S&P 500 0.56 0.61 0.58 0.55 0.66 0.71 0.52 0.50 0.55 0.54 -0.05 -0.20

Corr. with Lehman Bond -0.15 -0.20 -0.14 -0.16 -0.14 -0.08 -0.15 -0.14 -0.14 0.06 0.46 0.52

% of Winning Months 56.79% 61.73% 82.72% 83.95% 74.07% 67.90% 85.19% 83.95% 81.48% 65.43% 56.79% 56.79%

Average Gain 4.12% 3.65% 1.45% 1.24% 1.87% 2.06% 1.23% 1.18% 1.15% 1.91% 3.25% 2.91%

% of Losing Months 43.21% 38.27% 17.28% 16.05% 25.93% 32.10% 14.81% 16.05% 18.52% 34.57% 43.21% 43.21%

Average Loss -3.77% -4.23% -1.91% -1.41% -1.65% -1.47% -1.37% -1.05% -1.43% -1.64% -2.25% -2.17%

Last Three Months

Performance: January-96 - September-02

77

Appendix

CSFB EACM HFR CISDM Passive CSFB HFR EACM CISDM

Equity Mkt Long/Short Equity Market Equity Market Global Macro Macro Global Asset Passive

Yearly Return Neutral Equity Neutral Neutral Allocators Macro

1996 16.60% 12.77% 14.20% 10.70% 25.58% 9.32% 20.72% 10.94%

1997 14.83% 9.38% 13.62% 12.54% 37.11% 18.82% 17.19% 20.72%

1998 13.31% 2.98% 8.30% 11.78% -3.64% 6.19% 3.37% 8.68%

1999 15.33% 2.51% 7.09% 14.17% 5.81% 17.62% 4.25% 5.90%

2000 14.99% 4.45% 14.56% 7.83% 11.67% 1.97% 6.14% 4.41%

2001 9.31% 5.07% 6.71% 5.11% 18.38% 6.87% 4.22% 13.40%

2002 to September 5.78% 6.81% 3.08% 2.51% 11.52% 7.37% 8.52% 1.99%

Jul-02 1.84% 0.06% 0.17% -0.94% 2.15% 0.25% 0.53% -1.66%

Aug-02 0.57% 0.41% 0.72% 0.23% 1.22% 0.79% 0.96% 0.91%

Sep-02 -0.03% 0.35% 0.04% 0.44% 0.76% 2.48% 1.15% 0.32%

Annualized Return 13.32% 6.46% 9.94% 9.52% 15.13% 9.96% 9.37% 9.64%

Standard Deviation 2.99% 2.83% 3.51% 2.63% 13.25% 7.56% 8.45% 7.57%

Sharpe Ratio 2.94 0.68 1.54 1.89 0.80 0.72 57.14% 0.67

Maximum Drawdown -1.15% -3.95% -2.72% -2.35% -26.79% -7.32% -5.76% -9.28%

Corr. with S&P 500 0.57 -0.07 0.15 0.08 0.25 0.40 0.27 0.73

Corr. with Lehman Bond 0.03 0.13 0.18 0.31 0.27 0.21 0.38 0.24

% of Winning Months 88.89% 80.25% 86.42% 90.12% 69.14% 62.96% 58.02% 65.43%

Average Gain 1.23% 0.82% 1.05% 0.94% 3.14% 2.03% 2.30% 2.06%

% of Losing Months 11.11% 19.75% 13.58% 9.88% 30.86% 37.04% 41.98% 34.57%

Average Loss -0.41% -0.68% -0.82% -0.83% -2.97% -1.24% -1.33% -1.60%

Last Three Months

Performance: January-96 - September-02