Asset allocation and Private Equity – an institutional perspective Argentum Private Equity Conference Elias Korosis 5 September 2012

“I cannot conceive how different Nations could agree to put an Imaginary Value upon any thing, especially upon Silver, by which all other Goods are valued; Or that any one Country would receive that as a Value, which was not valuable equal to what it was given for; Or how that Imaginary Value could have been kept up.” PE Asset Allocation Research: a ‘renaissance’ level of understanding? 5 September 2012 John Law on the value of silver (1705), from Money and Trade Considered 1

A quick journey through portfolio design history 5 September 2012 Source: Citi Prime Finance Contemporary (2000s) Traditional Passive Active Passive Active No fixed allocation Discretionary investment in Hedge Funds, Private Equity, Infrastructure or Commodities Equity Bonds/ Fixed Income Opportunistic Passive Active Passive Active Hedge Funds Private Equity Infrastructure and Real Assets Equity Bonds/ Fixed Income Alternatives 2

Portfolio design – the future? (ATP example) 5 September 2012 Source: ATP ( ), Citi Prime Finance Hedging portfolio Is designed to hedge ATP’s pension liabilities as efficiently as possible to offset changes in interest rates. The portfolio mainly comprises of interest-rate swaps and long-dated bonds Investment portfolio Is required to generate an absolute return that is sufficient to ensure growth in our reserves so that we may preserve the long-term purchasing power of pensions Beta portfolio The beta portfolio, totalling DKK309.0bn, is used primarily to assume market risks. Investments are distributed among five risk classes. Over time, this type of investment generates higher returns than risk-free investments because investors charge a premium for assuming investment risks. The return is seen as compensation to investors for accepting risk and is known as “beta” Alpha portfolio The alpha portfolio, totalling DKK7.6bn, is actively invested, e.g. through the purchase and sale of invidividual equities that are expected to show the greatest rise or fall over a given time horizon. The return achieved by active asset management is known as “alpha”. The return on the alpha portfolio is independent of financial market ups or downs Passive Active Long only Directional Hedge Funds Corporate Private Equity Macro Funds Volatility and Tail Risk Funds Commodities Market neutral Funds Arbitrage related strategies Relative value strategies Infrastructure Real Estate Other (i.e. Timber) Equity risk Inflation / Stable Value Absolute Return Real Assets 3 (Citi PF illustration)

High-level portfolio design framework 5 September 2012 ProcessKey issues to consider 1.First, define your portfolio goals and tolerance regarding falling short of these goals  Time horizon and loss tolerance  Determine hedging vs. return-seeking allocations in the overall portfolio  If ‘hedging’-oriented, how to catch up if underfunded? 2.Second, what split of alpha and beta?  Expectations on individual asset classes and how they move together  Beliefs around beta (reliability), skills and confidence in alpha 3.Third, how to construct your beta portfolio?  Capital vs. risk allocation  Active vs. passive implementation  Economic environment linkages 4.Fourth, how to construct and benchmark your alpha portfolio?  Sources of alpha  Access  Manager diversification 5.Fifth, implement, monitor and evaluate performance versus expectations, adjust and repeat  Portfolio benchmarking  Risk controls  Identifying embedded betas 4

Discussion of the role of private equity in an institutional portfolio – Key considerations 5 September 2012 Select research issues / challenges  Understanding and quantifying the value creation in PE: Revenue growth, margin growth, multiple expansion, debt paydown  Understanding and quantifying risk  Understanding risk-return properties at the sub-asset class level (sector, region, stage etc)  Understanding correlation properties at the sub-asset class level and relationship with economic environments  Analytical rigour in manager selection  Cash flow modelling / forecasting  Market structure evolution (e.g. co-investment model)  Appropriate regulatory treatment Proposed benefits  High absolute returns: Equity risk premium, illiquidity premium, PE value creation (incl. leverage)  Strong risk-return relationship (Sharpe ratio improvement ?)  Imperfect (if material) correlation with public equities Risks and costs  Large dispersion of performance  Cash flow timing risks  Fees  Regulation 5

Source: West Midland Pension Fund ( Private Equity in sample institutional portfolios (contemporary example) 5 September 2012 March 2011 benchmark % 31 March 2011 % UK equities Global equities Overseas equities North America Europe (ex UK) Japan2.0 Pacific Basin (ex Japan)3.5 Emerging markets Private equity Total equities UK gilts and other fixed interest Index-linked gilts Non-government bonds Cash Total fixed interest Property Absolute return strategies Commodities Emerging market debt Infrastructure Total complementary Total

Private Equity in sample institutional portfolios (risk-aligned) 5 September 2012 Source: Calpers ( ATP ( ) The beta portfolio is divided into five risk classes In the beta portfolio we systematically assume market risks by investing in a number of different assets assigned to different risk classes. We anticipate that this approach will ultimately yield higher returns than risk-free investments, since investors require a premium for assuming those risks that are not readily diversified We allocate the assets in the beta portfolio between five risk classes with very different risk profiles in order to ensure that the return is as stable and as independent of economic conditions as possible The five risk classes are  Interest rates, which focuses on bonds subject to interest-rate sensitivity. For example, this includes government and mortgage bonds  Credit, which focuses on the creditworthiness of the issuers. For example, this risk class includes low-rated government and corporate bonds  Equities, which focuses on corporate earnings. Examples of assets in this risk class would be listed equities, private equities and venture capital  Inflation, which focuses on general price trends. This would include index-linked bonds, real, estate and infrastructure assets  Commodities, which focuses on oil-price developments. This risk class primarily includes oil-indexed bonds Asset class Actual investment ($bn) Actual investment (%) Interim strategic target (%) Growth$153.0bn65.0%64.0% Public equity$120.0bn51.0%50.0% Private equity$33.0bn14.0% Income$40.4bn17.0% Liquidity$8.0bn3.0%4.0% Real assets$21.8bn9.0%11.0% Real estate$18.9bn8.0%9.0% Forestland/ infrastructure $2.9bn1.0%2.0% Inflation$7.5bn3.0%4.0% Absolute return strategy $5.2bn2.0%n/a Total fund*$236.0bn100.0% 7

Fin 5 September 2012 Source: Lyrique Private Equity 8