1. A Better Way to Assess Global Risk & Return Ronnee Ades Senior Director, Institutional Markets

2. A Better Way to Assess Risk & Return AGENDA  Risk Management  Index Methodology Market Representation Market Segmentation  Conclusions

3. A Better Way to Assess Risk & Return Risk Management Trustees Money Managers Consultants Investment Strategy Decision Making

4. A Better Way to Assess Risk & Return Risk Management  Pension Plan’s #1 Objective: Meet Funding Obligations  Pension Plan’s #1 Problem: Projected Payments Out > Projected Payments In

5. A Better Way to Assess Risk & Return Risk Management  The Plan Sponsor’s Responsibility to Meet Funding Obligations involves the process of Risk Management.  The overall goal of the risk management process should be an investment fund having well understood and desirable risk and return characteristics.

6. A Better Way to Assess Risk & Return Risk Management  BUT what is risk?  The definition of risk is variability of return.  For the Pension Plan it is commonly the percentage change in assets over 1 Qtr., 1 year.

7. A Better Way to Assess Risk & Return Risk Management—Developing an Investment Strategy  Investment strategies behave differently relative to the chosen definitions of risk and return.  The First step in the process requires assumptions about asset class behavior.  Then you choose your Plan’s investment strategy (policy portfolio) having what you judge to be the optimal risk versus return trade off.  Then you choose managers to implement the strategy.  You may use passively managed index funds and/or add what may be termed implementation risk and hire active managers.

8. A Better Way to Assess Risk & Return Risk Management  Benchmarks are used in the process as:  Proxies for Asset Class behavior  Targets for Investment Return in passive portfolios  Performance benchmarks for the active managers and also, their universe for stock selection

9. A Better Way to Assess Risk & Return Index Methodology  Knowing the construction parameters (methodology) of the popular benchmarks is critical to assessing the best choice for your Plan. Criteria for a good benchmark:  Rules-based & transparent  Market representation  Market segmentation

10. A Better Way to Assess Risk & Return Index Methodology—Market Representation  Typical Investment Strategy Starts With a  60/40 Asset Allocation Equities 60% Fixed Income 40%

11. A Better Way to Assess Risk & Return Index Methodology—Market Representation  Actual Investing is Typically in Market Segments Large Cap 35% Fixed Income 40% International Equity 10% Small Cap 10% Alternative Investments 5%

12. A Better Way to Assess Risk & Return Index Methodology—Rules Based  Committee-based indexes Subjective selection Review frequency is usually as needed Examples – Dow Jones Industrial Average, S&P 500  Rules-based indexes Objective selection Review frequency are usually scheduled Examples – Dow Jones Wilshire 5000, Russell 2000

13. A Better Way to Assess Risk & Return Index Methodology—Rules Based  Rules–based and Representative  David Blitzer from S&P on CNBC’s “Squawk on the Street”:  “we were slightly underweight technology throughout most of the tech boom specifically because we look for companies that have at least a year of solid profit.”  “…stood us in very good stead”  Good stead versus what? – the market?  Underweight versus what? – the market?

14. A Better Way to Assess Risk & Return Wilshire 5000 Today Index Methodology—Market Representation Evolution of US Stock Market Benchmarks  In the 1970s there was the S&P 500  Then in the 1990s there was the Russell 3000  And now there is the Dow Jones Wilshire 5000 1990s1970s DJW 5000 Russell 3000 S&P 500

15. A Better Way to Assess Risk & Return Index Methodology—Market Representation  The S&P 500 components are selected by committee, in private.  The DJW 5000 is rules based and those rules are transparent.  The S&P 500 components are not the 500 biggest stocks. In fact, after the top 350, they scatter down to nearly the 2000 rank within the DJW 5000. DJ Wilshire 5000S&P 500 Rank #1788

16. A Better Way to Assess Risk & Return Index Methodology—Market Representation Evolution of Global Stock Market Benchmarks DJWG ~12000 FTSE ~7900 EAFE ~1140 ACWI ~2600  In 1969 there was the MSCI EAFE  Then in 1987 there was the MSCI All-Country World Index  Then in 1993 the FTSE World Index started  And now there is the Dow Jones Global Total Market Index Today 1993 1987 1969

17. A Better Way to Assess Risk & Return Depth of Coverage within the Counties Investable Universe  Number of Countries Covered World INDEX B 50 Countries World INDEX A Investable Universe Investable Universe 40 Countries

18. A Better Way to Assess Risk & Return Index Methodology—Market Segmentation  Segmentation is a extension of Representation: How is the broad market sliced?:  Industry Groups/Sectors  Size Segments  Style Segments

19. A Better Way to Assess Risk & Return DOW JONES GLOBAL TOTAL MARKET INDEX Index Methodology—Market Segmentation  Market Size Distinctions RUSSELL DOW JONES WILSHIRE S&P Small-Cap 1,750 Stocks Micro-Cap 2,500+ Stocks Large-Cap 750 Stocks Small-Cap 2,000 Stocks Large-Cap 1,000 Stocks Micro-Cap 2,000 Stocks Large-Cap 500 Stocks Small-Cap 600 Stocks Mid-Cap 400 Stocks Micro-Cap 0 Stocks US ~5000 World ExUS ~7000

20. A Better Way to Assess Risk & Return Index Methodology—Market Segmentation YEARLY TOTAL RETURN PERFORMANCE Index 20052004200320022001200019991998199719961995 DJ Wilshire 5000 6.3412.6231.64-20.86-10.97-10.8923.5623.4331.2921.2136.45 DJ Wilshire U.S. Large-Cap Index 6.3811.6528.89-21.07-12.96-10.5021.9328.5932.9722.5237.61 DJ Wilshire U.S. Small-Cap Index 7.3719.46 49.02-18.983.13-9.0829.251.3524.8717.3831.07 DJ Wilshire U.S. Micro-Cap Index 1.2117.1883.20-8.7124.31-18.2940.995.9522.0217.8136.42 Shaded values indicate top-performing segments. 7.3719.46 83.20-8.7124.31 -9.08 40.99 28.5932.9722.5237.61

21. A Better Way to Assess Risk & Return Index Methodology—Market Segmentation YEARLY TOTAL RETURN PERFORMANCE Index 20062007 DJ Wilshire Global DJ Wilshire Global Large-Cap Index DJ Wilshire Global Small-Cap Index ? ? 20082009201020112012201320142015 ? ?? ? ? ?? ?

22. A Better Way to Assess Risk & Return Market Segmentation—Style Methodology Distinctions  Factors used for Mapping Stocks into Growth and Value Segments Historical Trailing Revenue Growth Trailing Earnings Growth Current Price-to-Book Ratio Dividend Yield Projected Projected Earnings Growth Projected Price-to-Earnings Ratio DOW JONES WILSHIRERUSSELLS&P citi

23. A Better Way to Assess Risk & Return Index Methodology—Market Segmentation Style Distinctions RUSSELL DOW JONES WILSHIRE Micro-caps Small Cap Growth Small Cap Value Large Cap Growth Large Cap Value Micro-caps Large Cap Growth Large Cap Value Small Cap Growth Small Cap Value

24. A Better Way to Assess Risk & Return Index Methodology  We know that the Benchmarks are different – S&P 500 vs. DJW 5000  Over a 10 year period we can reasonably expect the returns will be significantly different  55% probability the 1 year return difference exceeds 1.5%  55% probability the 3 year return difference exceeds 1.0%  40% probability the 5 year return difference exceeds 1.0%  20% probability the 10 year return difference exceeds 1.0%  Impact on $50 million @ 1% (100bps) = $500,000 It does matter in the long run – it does make a difference!

25. A Better Way to Assess Risk & Return  Compare Broad Market Managers to the Broad Market Benchmarks  Should your Plan pay for BETA?  Should a manager who had 5.75% return be given a performance bonus or potentially fired? ReturnsS&P 500Russell 1000DJW 750 6.34%6.27%4.91%1 Year 4.91%6.27%6.34% Comparative Index Returns, Major US Index Families As of December 31,2005 Large GROWTHVALUE S&PRussellDJWS&PRussellDJW 0.02%-0.31%-0.05%0.05%0.61%0.29% 1.27%2.98%3.12%2.94%1.27%1.61% 1.14%5.26%7.13%8.71%7.05%5.72% 11.20%13.23%14.36%17.69%17.49%16.16% -3.68%-3.58%-2.74%4.54%5.28%4.8% 8.47%6.85%7.61%9.60%11.24%10.29% ReturnsS&P 500Russell 1000DJW 750 1 Month0.03%0.14%0.13% 3 Months2.09%2.12%2.32% 1 Year4.91%6.27%6.34% 3 Years (% pa) 14.39%15.42%15.24% 5 Years (% pa) 0.54%1.07%1.01% 10 Years (% pa) 9.07%9.29%9.17%

26. A Better Way to Assess Risk & Return 1 Year7.68%4.55%7.37%  Compare Small-Cap Market Managers to the Small-Cap Benchmarks  Should your Plan pay for BETA?  Should a manager who had 5.75% return be given a performance bonus or potentially fired? ReturnsS&P 600Russell 2000DJW 1750 7.37%4.55%7.68%1 Year Comparative Index Returns, Major US Index Families As of December 31,2005 Small GROWTHVALUE S&PRussellDJWS&PRussellDJW -1.04%-0.15%0.54%-0.81%-0.77%-0.32% -0.48%1.61%2.49%1.24%0.66%0.85% 7.27%4.15%9.68%8.47%4.71%5.3% 22.69%20.93%25.4%22.28%23.18%22.75% 9.68%2.28%5.32%11.76%13.55%13.74% 10.69%4.46%7.13%14.25%13.31%13.73% ReturnsS&P 600Russell 2000DJW 1750 1 Month0.92%-0.46%0.10% 3 Months0.39%1.13%1.65% 1 Year7.68%4.55%7.37% 3 Years (% pa) 22.38%22.13%24.10% 5 Years (% pa) 10.76%8.22%9.82% 10 Years (% pa) 11.17%8.88%10.80%

27. A Better Way to Assess Risk & Return Index Methodology  Using indexes from multiple providers has serious implications for your investment strategy.  What happens when you don’t use one consistent index methodology?

28. A Better Way to Assess Risk & Return Methodology—Multiple Vendor Dilemma—An Example S&P 500 + S&P Mid Cap 400 + Russell 2000  Missing 250 names from the universe of 3000  Over 130 of top 750 stocks missing  Double count 140 stocks with median market cap over $1 Billion  Missing micro cap

29. A Better Way to Assess Risk & Return Methodology—Multiple Vendor Dilemma—An Example Some Missing Companies  Amazon.com  Directv Group  Fox Entertainment Group  Genentech  Kraft Foods

30. A Better Way to Assess Risk & Return Methodology—Multiple Vendor Dilemma—An Example Double Counted Companies  Callaway Golf  Calpine  Cooper Tire & Rubber  Delta Air Line  Goodyear Tire & Rubber

31. A Better Way to Assess Risk & Return Methodology—Multiple Vendor Dilemma—The Point (on a global scale) S&P 500 + Russell 2000 + MSCI EAFE  Gaps  Overlaps

32. A Better Way to Assess Risk & Return Trustees TRUSTEES Conclusions —The Process Begins and Ends with the Investors ConsultantsMoney Managers

33. A Better Way to Assess Risk & Return Conclusions—What Every Trustee Should Know  Benchmarks should be rules-based and transparent  Objective Selection  Scheduled Reviews

34. A Better Way to Assess Risk & Return Today Conclusions—What Every Trustee Should Know The benchmark selected should provide the relevant opportunity set of stock market returns. 1990s 1970s DJW 5000 Russell 3000 S&P 500

35. A Better Way to Assess Risk & Return Conclusions—What Every Trustee Should Know Discrete market size segments that add up to the total market Large Cap Fixed Income International Equity (Ex-US) Small Cap Alternative Investments Micro Cap Exclusive style segments with an emphasis on purity Growth Value Growth Value  Greater explanatory power (of Benchmark Mismatch, Asset Class Misfit, Alpha) can be obtained by using an index family with:  Risk management in the global space requires: Rules Based Indexes Consistent Methodology  Size and Style (growth/value) segmentation matters.

36. A Better Way to Assess Risk & Return Conclusions  Not all Benchmarks are the same  Don’t make the Benchmark decision lightly  Seek information from the index provider  Dow Jones Wilshire: A Better Way to Assess Risk & Return