Managing Active ETFs

1. Everything You Need to Know About Managing Active ETFs Guest Speaker: Darlene DeRemer (Grail Partners) K&L Gates Hosts: Boston (3/26/08) Stacy Fuller (DC), Francine Rosenberger (DC) and George Zornada (BO) New York (4/10/08): Stacy Fuller (DC), Beth Kramer (NY) andFrancine Rosenberger (DC) San Francisco (4/15/08): Stacy Fuller (DC), Mark Perlow (SF) and Richard Phillips (SF)

2. ETF Basics • 2007 Growth: 42% increase to $580 billion • Key Concepts • Arbitrage mechanism • Exchange Listing • Transparency • Development • Index-based ETFs • Actively managed ETFs • Quant techniques/Large-cap securities • Transparency – changing requirements

3. Overview • Background: The ETF Business • SEC’s Proposed ETF Rules • Launch Basics • ETF Distribution • Looking Ahead • Q&A

4. ETF Background: ETF Growth to Outpace that of Other Product Segments • FRC projects that US ETFs will grow faster than six other mainstream investment products including mutual funds, hedge funds and 529 Plans • US ETF assets will exceed$1.5 trillion as of 2011 WITHOUT significant ETF presence in the 401(k) market or actively managed ETFs • In 2007, flows to active Domestic Equity mutual funds were -$62B, whereas domestic equity ETFs saw $46B of inflows—evidence that investor demand is already migrating to ETFs Financial Product Segment Growth Projections – 2007 to 2012E 1 Note: Mutual fund assets exclude money market funds Source: FRC Monitor, Grail Partners Research

5. Index XYZ ETF Market Mechanics: Basic Operations Retail Investor Secondary Market: NYSE Arca / NASDAQ cash Rule Set for ETF Portfolio Financial Advisor Primary Offering of Fund Shares XYZ ETF Sponsor/ Manager Broker/ Dealers Basket of Securities(creation/ redemption units) …in kind exchange for… ETF Shares(50k or 100k ETF shares) ETF Shares Market Maker (Specialist or Authorized Participant) Broker/ Dealers cash Hedge Fund/ Institutional Investor ETF Shares

6. Active ETFs – Why are they more attractive than mutual funds? • ETFs have advantages vs. mutual funds: • Tax efficiency: in-kind trading of fund shares allows capital gains to be realized outside of the fund, at the participant level avoiding gains distribution from the fund • Low cost: an ETF trades like an individual stock, so transfer agency and other recordkeeping costs are minimal – somewhat offset by new costs in the dealer system, and commissions • Investor protection/ enhanced return: • Exchange trading eliminates the possibility of market timing • No cash held for redemption requests – better performance through full investment • Trading costs are absorbed by transacting investor, not the fund shareholders • Portfolio flexibility: ETFs are traded as individual equities, allowing investors to short and buy on margin as they build their portfolios Source: Grail Partners

7. ETF Comparative Fee Analysis • Given their passive nature and lower operating costs, ETFs generally have lower expenses as compared to both active and indexed mutual funds • However, newer ETF market entrants are pricing products above the historical market averages • ProShares funds, for example, are all priced at 95 bps for their enhanced bull and bear market index strategies 1 Mutual Funds include share classes targeted to broker/ dealer intermediaries, i.e. A-sharesSome higher-fee funds are not yet included in the Simfund database, including new Rydex and ProFunds which are priced at 95 bps. Source: Simfund; Grail Partners

8. US ETF Assets by Sponsor Source: Bloomberg as of 3/24/08; Grail PartnersNote: This table includes non-ETF exchange traded products like HOLDRS, BLDRS and ETNs.1 ELEMENTS is a partnership between Nuveen Investments, Merrill Lynch, Swedish Export Credit Corporation and BNP Paribas2 MacroShares ETFs were launched through a JV with Claymore in 2006; MacroShares bought out Claymore’s 50% stake in 8/07 3 SPA ETFs is an affiliate of London & Capital

9. Industry Competitors Described 1 Reflects AUM-weighted average of all ETFs offered by the company 2 Nasdaq transferred its QQQQ fund and 4 BLDRS to PowerShares 3/07, reducing PowerShares’ average pricing Source: Bloomberg, Grail Partners Research as of 3/24/08

10. Rule 6c-11 • “exchange-traded fund” - a registered open-end fund that either (1) discloses the identities and weights of its portfolio securities; or, (2) (a) seeks returns that correspond to an index, and (b) the index provider discloses the identities and weights of its securities • shares listed/traded on exchange • marketed as ETF with limited redeemability • transacts in creation unit aggregations (CUAs) • exchange regularly disseminates per share value of CUAs • has website with price info: NAV, market and any premium/discount

11. Disclosure Amendments • Form N-1A: Tailor for retail investors • Replace disclosure re how to transact, and cost of transacting, in CUAs with same re transactions on exchange • Require disclosure of ETF’s total return based on NAV and marketprice • Require discount disclosure on web, in pro and annual report • Section 24(d) • Product Descriptions • Not used • Summary prospectus • Rescission of Past Exemptions

12. Liberalization of Orders • Sampling • Affiliated index-based ETFs • Section 48(a) • Asset basket requirements

13. Rule 12d1-4 • Investments by registered and private funds • 4 Conditions • Limitation on control of underlying fund by investing fund • ETF is not a “fund of funds” • Fees comply with NASD Conduct Rule 2830 • No redemptions by investing fund with more than 3% of ETF • Compare traditional funds of funds • Investments by registered funds only • 12 Conditions

14. Conditions for Traditional Funds of Funds • Limitation on control of underlying fund by investing fund • Underlying fund is not a “fund of funds” • Fees comply with NASD Conduct Rule 2830 • Waiver by investing fund of certain fees based on other fees received from underlying fund • Limitation on investing fund’s influence over underlying fund • Limitation on investments by underlying fund in underwritings involving affiliate of investing fund (“affiliated underwriting”) • Finding by underlying fund board re any investment by underlying fund in affiliated underwriting • Finding by underlying fund board that any payments to investing fund were reasonable for services received in return • Finding by investing fund board that consideration received by investing fund from underlying fund did not influence investment • Finding by investing fund board that no duplicative advisory fees • Requirement of Participation Agreement (to provide notice of conditions involving board findings)

15. Launch Basics • Choose Asset Class • ETN / Grantor Trust – Corp Fin • ETF – IM • Exemptive Application • Rule 6c-11 • Market Maker / Specialist • Prepare Timeline: Precedented v. Novel Relief • Register Product • ETN / Grantor Trust – S-1 and 8-A • ETF – N-8A, N-1A and 8-A • Prospectus / PD v. Disclosure Amendments & Summary Prospectus • Approach T&M / Exchange • No action relief • Listing

16. Seed Capital: Tempering the Pace of Proliferation • To support the secondary market, launching an ETF requires a minimum market inventory be established to facilitate trading and market liquidity • Exchanges typically require at least two ETF “creation units” be issued (generally 200,000 shares) prior to fund launch. If a fund’s NAV starts at $25, this equals $5 million in AUM • This initial seed capital is typically provided by market specialists—often using borrowed securities in their effort to support a product that will yield secondary trading activity • But for those market makers, seeding ETFs is becoming a much less attractive proposition • The drag or costs of providing seed capital are real: • Cost of borrowing (up to 200 bps or more) to fund and hedge • ETF expense ratio (~50 bps and higher); ETF fees are increasing as more niche and quasi-active ETFs are launched • The proposition of acting as an ETF specialist itself has become less attractive: • Spreads in ETF trading have tightened • Given the merger of NYSE and AmEx, electronic trading will become the dominant method for ETF specialists, in turn diffusing the share of volume that the specialist can capture • Therefore, the lack of seed capital in the ETF market is expected to be a major industry “choke point” and inhibitor of product proliferation, particularly among smaller ETF sponsors Source: Grail Partners

17. ETF Distribution • Distribution • Specialists • Other institutional investors • Rule 12b-1 Plans • IPOs • Rule 12d1-4 Funds

18. Distribution: Mutual Funds vs. ETFs • Tracking sales by source in ETFs is more difficult than in mutual funds • Institutional investors (hedge funds, portfolio managers) play a larger proportional role in ETFs than is typical in mutual funds • ETFs’ offer of sector exposure and cash equitization are contributors • However, retail sources (RIAs, brokers, wealth advisors) have become a more significant force in ETF distribution in recent years • Fee-based programs help make advisors indifferent to product packages, and ETFs are benefiting from this phenomenon ETFs - Anecdotal Mutual Funds - 2007 Growth Areas Fee-Based Retirement Plans Intermediaries 25% 30% Fund Supermarkets Proprietary 10% Sales Force 5% Direct to Transaction Investor Based Brokers 10% 20% Source: FRC, Grail Partners Research

19. Looking Ahead • Trends • Next-generation ETFs • Semi-transparent ETFs • Tracking Baskets • Value Transparency • Black Box • “‘Is it critical that arbitrage be tight and strong?’ We think that’s an important question that the Commission will need to consider going forward as we face applications for non-transparent ETFs.” • Timing