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CALPERS – CALSTERS DIVERSITY CONFERENCE APRIL 25, 2006. PRUDENTLY ACHIEVING DIVERSITY THROUGH AN EMERGING MANAGER PROGRAM. Tina Byles Williams Chief Investment Officer & Chief Executive Officer FIS Group. HISTORICAL PERSPECTIVE: AN UNLEVEL PLAYING FIELD.

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CALPERS – CALSTERS DIVERSITY CONFERENCE

APRIL 25, 2006

PRUDENTLY ACHIEVING DIVERSITY THROUGH AN EMERGING MANAGER PROGRAM

Tina Byles Williams

Chief Investment Officer &

Chief Executive Officer

FIS Group


Historical perspective an unlevel playing field
HISTORICAL PERSPECTIVE: AN UNLEVEL PLAYING FIELD

  • The average majority-owned firm was substantially more successful in accumulating

    assets than the average minority-owned firm, even when established in the same year.


Historical perspective an unlevel playing field cont d
HISTORICAL PERSPECTIVE: AN UNLEVEL PLAYING FIELD (cont’d)

  • Significant disparity in the number of accounts obtained by minority firms vs. majority firms;

    even when other explanatory variables are taken into account.

  • Therefore, either minority firms choose to participate in fewer searches or they get the opportunity

    to participate in fewer searches


Assets under management
ASSETS UNDER MANAGEMENT

  • EMERGING MANAGER defined as:

    Asset ClassAssets no more than:

    Large Cap Equity $2 billion

    Mid/Small Cap Equity $0.3 billion

    Fixed Income $2 billion


How does any emerging manager allocation increase diversity
HOW DOES ANY EMERGING MANAGER ALLOCATION INCREASE DIVERSITY?

ALL MANAGERSCOMBINED DATABASE PROPRIETARY DATABASE

PRODUCTS1 PRODUCTS1

MBE 58% 56% 67%

WBE42% 44% 33%

MBE/WBE TOTAL 100% 100% 100%

EQUITY256% 80% 93%

FIXED INCOME2 44%20% 7%

TOTAL 100% 100% 100%

  • A focus on Emerging Managers generally leads to greater diversity.

  • FIS has hired 80 Emerging Managers, two-thirds of which are minority or women owned.

1As of January 2006

2Several firms manage multiple asset classes.


But what about alpha
BUT WHAT ABOUT ALPHA?

  • Two components to a portfolio’s return – beta (i.e., market exposure) and alpha (i.e., return in excess of the market)

  • Alpha is the excess return due to active management of systematic (market-based) and idiosyncratic (non market-based) risks. Information Ratio measures the sustainability of alpha or skill.

  • The sources of alpha are generally breadth of decisions ”skill” implementation efficiency:

  • SKILL

  • Manager’s insight and skill into

    forecasting future returns

ALPHA

  • IMPLEMENTATION

  • Flexibility to take advantage of

  • insights and breadth

  • - Portfolio Construction

  • - Trading Efficiency

  • BREADTH

  • Number of investment opportunities

  • Range of investment opportunities

  • Frequency of opportunities


What is the emerging manager advantage
WHAT IS THE EMERGING MANAGER ADVANTAGE?

  • Structural Implementation Advantage:

    • Absence of conventional institutional patronage results in freedom to be less benchmark-sensitive

    • “Best ideas” less diluted or constrained by conventional risk mitigation institutional guidelines

    • Investment insight amplified through more concentrated portfolios

    • Trade more nimbly with negligible market impact

  • Personal compensation more directly tied to alpha production; whereas managers at established firms have

    greater “safety net” from baseline fee income from large asset pools and the firm’s franchise value

  • Passion for success and focus unencumbered by bureaucracy and “Committee think”

Result: Superior investment performance can be garnered from skillfully combining, identifying and monitoring talented investment managers in entrepreneurial firms that channel their investment acumen, focus and passion to achieve long-term success.


Historical experience
HISTORICAL EXPERIENCE

  • Above-median Emerging Managers show superior Alpha and Information Ratios in 2 out of 3 large Cap strategies relative to above-median large managers

  • The magnitude of the advantage is significant in “Down Markets” or “stock picker” markets in which divergence from the market index tends to outperform


BUT SKILLFUL MANAGER SELECTION IS CRITICAL!

  • The dispersion of returns among above-median Emerging Managers is greater than the dispersion of returns among above-median Large Managers

  • This suggests that in the Emerging Manager space, specialty manager selection skill and experience is critical!


Greater manager specific risk
GREATER MANAGER SPECIFIC RISK

  • Greater portfolio concentration leads to higher manager-specific risk (positive or negative)

  • Younger and/or smaller firms are more highly impacted by Operational/Business risks

  • Therefore, manager selection and portfolio construction processes must accurately evaluate business and stock specific risks and optimally manage/mitigate those risks on an ongoing basis


Manager selection
MANAGER SELECTION

Seven attributes of highly successful Emerging Managers:

  • Product with clear competitive edge

  • Well executed, consistent and repeatable process

  • Principals understand all risk exposures

  • Sound and stable firm culture

  • Sound Business Plan

  • Talented professionals with high integrity and dedication to long-term performance success

  • Organizational resources

  • allocated to support

  • process and people

  • OPERATIONAL REVIEW

  • Infrastructure and capacity

  • Controls and procedures

  • Clear Reporting lines

  • Compliance Procedures

  • QUALITATIVE REVIEW

  • Process review

    • Idea generation, evaluation

  • and implementation

    • Competitive advantage

    • Consistency

    • Repeatability

  • Firm/Culture

    • Assets under management

    • through time

    • Resource allocation

    • Business Plan/projection

    • Compensation structure

  • Reference checks

  • QUANTITATIVE REVIEW

  • Historical holdings analysis

    • Benchmark specification

    • Factor variance

    • Industry variance

  • Risk - adjusted characteristics

  • relative to benchmarks & peers

  • Risk in various market/economic

  • environments


Summary
SUMMARY

  • An Emerging Manager Allocation can be a Prudent and Effective approach to add Alpha and

    increasing Diversity

  • Clear framework for mandate

    • Performance objectives and measurement period

    • Market Segment

      • To fill “hole” in plan’s manager structure

      • Diversity

  • Implementation plan that is consistent with achieving those objectives, cost and time efficient

  • Implementation approach should reflect a realistic assessment of:

    • Time and resources to find and identify managers that consistently generate high active

      value added (alpha)

    • Process for consistently measuring fund level and manager specific bets


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