The Role of Hedge Funds SDCERA 2014 Board of Trustees Retreat March Lee Partridge, CFA Roberto Croce, Ph.D. Todd Centurino, CFA

Transcription

1 The Role of Hedge Funds SDCERA 2014 Board of Trustees Retreat March 2014 Lee Partridge, CFA Roberto Croce, Ph.D. Todd Centurino, CFA

2 Disclosures The opinions expressed in these materials represent the personal views of Salient s investment professionals and are based on their broad investment knowledge, experience, research and analysis. However, market conditions, strategic approaches, return projections and other key factors upon which the views presented in these materials are based remain subject to fluctuation and change. Consequently, it must be noted that no one can accurately predict the future of the market with certainty or guarantee future investment performance. This presentation does not constitute an offering of any security, product, service or fund. No investment strategy can guarantee performance results. Past performance is no guarantee of future results. All investments are subject to investment risks, including loss of principal invested. Investment advisory and research services provided by Integrity Capital, LLC, a registered investment advisor. Registration as an investment advisor does not imply a level of skill or training. Salient Partners, L.P. is the parent company of Integrity Capital, LLC. Salient Partners, L.P. and affiliates do not provide tax or legal advice. This presentation contains forward-looking statements. Forward-looking statements can be identified by the words may, will, intend, expect, estimate, continue, plan, anticipate, could, should and similar terms and the negative of such terms. By their nature, all forward-looking statements involve risks and uncertainties, and actual results could differ materially from those contemplated by the forward-looking statements. Several factors that could materially affect actual results are the performance of the portfolio securities, the conditions in the U.S. and international financial, and other markets and factors. Actual results could differ materially from those projected or assumed in our forward-looking statements. Exposure to the commodities markets may subject the Fund to greater volatility than investments in traditional securities. The value of commodity-linked derivative investments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or sectors affecting a particular industry or commodity, such as drought, floods, weather, embargoes, tariffs and international economic, political and regulatory developments. 2

3 Summary The Role of Hedge Funds The Portfolio Role of Hedge Funds Diversification SDCERA s Approach The SDCERA Hedge Fund Portfolio Current Portfolio Proposed Portfolio Why Managed Futures / Trend SDCERA s Hedge Fund Experience SDCERA experience with HF past & present Performance vs. Benchmarks Dollar Value Added and Fees Underlying Liquidity Leverage Integrity Capital, LLC

4 The Portfolio Role of Hedge Funds 4

5 Our View on Hedge Funds and Diversification The Role of Hedge Funds We believe the value of diversification is well documented and understood by many A rational investor may be willing to accept a lower return or pay higher fees for assets that are diversifying This is why US Treasuries remain important even with lower return expectations Much of the Trust s diversification resides in the Stable Value portfolio, which we expect to: Have a fairly consistent and low volatility profile Demonstrate modest correlations to equity markets Stable Value investments are focused in two areas: Investments that reduce risk by merits of having low volatility and low correlations with other Trust investments (e.g. Treasury Bonds and TIPS) Investments that reduce risk primarily through returns that are uncorrelated with other Trust investments even other Stable Value investments (e.g. Hedge Funds) Integrity Capital, LLC 2014 No investment strategy can guarantee performance results. Past performance is no guarantee of future results. All investments are subject to investment risks, including loss of principal invested. Diversification cannot assure profit or protect against loss in a declining market 5

6 Potential Benefits of Investing in Hedge Funds The Role of Hedge Funds Adding hedge funds can have different effects based on the volatility of the hedge fund portfolio in question Adding lower volatility hedge funds historically would have significantly reduced volatility while modestly reducing returns Adding higher volatility hedge funds historically would have increased returns as well as decreased volatility we typically favor this approach Annualized Return 9.2% 9.0% 8.8% 8.6% 8.4% 8.2% 8.0% 7.8% SDCERA Policy w/5 Vol HF SDCERA Policy and Hedge Funds Jan 2003 Dec 2013 SDCERA Policy W/10 Vol HF SDCERA Policy W/O HF 7.6% 6.6% 6.7% 6.8% 6.9% 7.0% 7.1% 7.2% 7.3% 7.4% 7.5% 7.6% 7.7% Annualized Standard Deviation of Returns For illustrative purposes only The indices are unmanaged and are not available for direct investment HFRI Macro and HFRI RV indices uses as hedge fund proxies. Integrity Capital, LLC

7 Hedge Fund Diversification Benefits Vary by Strategy The Role of Hedge Funds There are two risks to this thesis: Not all hedge funds are equally diversifying High fees can make accessing this diversification expensive SDCERA s hedge fund program currently targets: Strategies and managers with modest correlation to traditional risk factors Strategies where fees are paid on actual added value and not market returns Correlation to Equities January 2000 December 2013 SDCERA Focus -1.0 to -0.5 Managed Futures (-0.14) Global Macro (0.17) -0.5 to 0.0 Relative Value (0.58) 0.0 to 0.5 Event Driven (0.74) Long/Short Equity (0.78) 0.5 to 1.0 Equities (1.0) Source: Pertrac, Integrity Capital, LLC,. Analysis, March Note: Correlation analysis uses data from 1/1/2000 to 12/31/2013. Long/Short equity is represented by the HFRI Equity Hedge (Total) Index. Event Driven is represented by the HFRI Event-Driven (Total) Index. Global Macro is represented by the HFRI Macro (Total) Index. Managed Futures is represented by the Barclay CTA Index. Past performance is not a guarantee of future results. Note that an investor cannot invest directly in the Indices. Index performance does not reflect the deduction of fees and expenses. The indices are unmanaged and are not available for direct investment No investment strategy can guarantee performance results. Past performance is no guarantee of future results. All investments are subject to investment risks, including loss of principal invested. 7

8 Focus on Divergence The Role of Hedge Funds As the 2008 experience demonstrated, there are some markets where correlations between asset classes go to one We believe Investors are well served by focusing in particular on strategies with low correlations during periods of rising volatility we call this divergence FALLING VOLATILITY RISING VOLATILITY SPX HFRX L/S Equity For illustrative purposes only. Source: Pertrac, Integrity Capital, LLC. Analysis March, 2014 Note: Correlation analysis uses data from 1/1/2000 to 12/31/2013 VIX Ret => CBOE Volatility Index Rising Volatility environment is defined as months where VIX increases by 5% or more. The indices are unmanaged and are not available for direct investment HFRX Macro HFRX Event HFRX Merger Arb HFRX Relative Val SPX HFRX L/S Equity HFRX Macro HFRX Event HFRX Merger Arb HFRX Relative Val Barclays CTA Barclays CTA 8

9 The SDCERA Hedge Fund Portfolio 9

10 The Current Portfolio The SDCERA Hedge Fund Portfolio SDCERA s Hedge Fund Portfolio consists of 9 managers (5 Macro/CTA, 4 Relative value) and plays an important diversification role within the Stable Value Allocation Inception Macro/CTA Portfolio 02/28/2014 AUM Jun-09 Brevan Howard, Series B $189,610,293 May-09 Bridgewater Pure Alpha II $73,766,064 Dec-10 Bridgewater Pure Alpha Major Markets $56,222,069 Oct-13 Cantab Core Macro Fund $101,019,348 Aug-11 DE Shaw - Heliant $117,430,637 May-13 Trend Strategy $44,147,134 Total $582,195,546 Target Allocation (10%) $977,975,843 Inception Relative Value Portfolio 02/28/2014 AUM May-09 Moon Capital $30,022,834 Aug-11 Saba Capital Partners, L.P. $92,255,202 Jun-10 AQR Delta $364,776,593 Feb-13 Blue Mountain Credit Alternative $136,922,507 Total $623,977,137 Target Allocation (10%) $977,975,843 Integrity Capital, LLC

11 The Proposed Portfolio The SDCERA Hedge Fund Portfolio The proposed asset allocation reduces the target allocation to fee-bearing hedge funds from 20% to 10% (5% Macro/CTA, 5% Relative Value), and increases the allocation to Trend Strategy (managed by Salient) to 5% We believe that this change will significantly reduce overall projected fees by ~$14MM as well as increase an allocation to a strategy (Trend) that has the most desirable Stable Value characteristics at no marginal cost to SDCERA Current Portfolio Allocation to Hedge Funds Weight Macro/CTA Portfolio 10% Relative Value Portfolio 10% Total 20% Proposed Portfolio Allocation to Hedge funds Weight Macro/CTA Portfolio 5% Relative Value Portfolio 5% Trend Strategy 5% Total 15% Projected Run Proposed Run Composite Change Rate Fees Rate Fees Hedge Funds 28,641,585 14,716,127 (13,925,459) Integrity Capital, LLC 2014 No investment strategy can guarantee performance results. Past performance is no guarantee of future results. All investments are subject to investment risks, including loss of principal invested. 11

12 Why Managed Futures (Trend Strategies)? Managed Futures Overview Managed Futures have historically had a low correlation to traditional asset classes CORRELATION MATRIX January 1990 January 2014 Managed Futures Stocks Commodities Rates Stocks 0.01 Commodities Rates 0.17 (0.08) (0.05) Credit (0.06) (0.06) Low Correlation Medium Correlation High Correlation Source: Integrity Capital, LLC and Bloomberg, March For illustrative purposes only. For definitions of the strategies above, please see the Glossary of Terms. Stocks arerepresentedbythes&p500.commodities are represented by the Continuous Commodity Index. Rates are represented by the ML 10 Year US Treasury Futures Total Return Index. Credit is represented by the Barclays Aggregate Bond Index. Managed Futures are represented by the Barclays BTOP 50 Index. See the Index Glossary for a description of each index. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees and expenses. Note that an investor cannot invest directly in an index. 12

13 Why Managed Futures (Trend Strategies)? Trend Following A Pure Expression of the Managed Futures Discipline Diversified Managed Futures products typically utilize a combination of strategies Many of these strategies may reduce volatility but are also more correlated with core market exposures COMMON MANAGED FUTURES STRATEGIES Cross-Sectional Momentum Trend Following Mean Reversion Counter-Trend FX Overlay We believe a pure and disciplined approach to investing in Managed Futures should focus only on the most diversifying phenomena Source: Integrity Capital, LLC and Bloomberg, March For illustrative purposes only. For definitions of the strategies above, please see the Glossary of Terms. Stocks are represented by the S&P 500. Commodities are represented by the Continuous Commodity Index. Rates are represented by the ML 10 Year US Treasury Futures Total Return Index. Credit is represented by the Barclays Aggregate Bond Index. Managed Futures are represented by the Barclays BTOP 50 Index. See the Index Glossary for a description of each index. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees and expenses. Note that an investor cannot invest directly in an index. 13

14 Trend Following Stable Value Characteristics Correlation to Stocks, when Stocks are <-10% in a Month January January 2014 In Isolation, the Trend Phenomenon: Is generally uncorrelated with core market exposures Is negatively correlated to equities during periods of increasing volatility Has the potential to lower the total risk of the SDCERA Portfolio Correlation (0.20) (0.40) (0.35) (0.60) Trend Market Neutral Momentum Counter Trend Mean Reversion FX Overlay Source: Integrity Capital, LLC and Bloomberg, March Past performance is not indicative of how the index will perform in the future. and is for illustrative purposes only. Index performance does not reflect the deduction of fees and expenses. An investor cannot invest directly in an index. Trend is represented by the Salient Trend Index. The Index has been retrospectively calculated and did not exist prior to February Accordingly, the index performance shown for periods prior to February 2013 has been developed with the benefit of hindsight. Certain futures contracts comprising the underlying asset classes were not available at inception of the retrospective Index performance calculation beginning in January 1, Futures contracts unavailable at Index inception were included in the underlying asset classes as available. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. The Salient Trend Index represents hypothetical performance since the index does not reflect any particular investment program and may, therefore, have certain limitations, some of which are described below. Since this is index performance, it does not represent the performance of any investment account or the results of actual trading, and no representation is being made that any account using the Index as a benchmark will experience performance similar to the Index s performance. In fact, it is not uncommon for investment programs targeting a particular index to have performance that diverges materially from the performance of the relevant index. In addition, hypothetical performance does not involve financial risk, and no hypothetical performance record can completely account for the impact of financial risk that exists in an investment program that is actually trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other facts related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results. Market Neutral Momentum is represented by Fama French Momentum Factor. Counter Trend is represented by Fama French Short Term Reversal. Mean Reversion is represented by db Mean Reversion USD Index. FX Overlay is represented by Deutsche Bank G10 FX Carry Basket. See the Index Glossary for a description of each index. 14

15 Salient Trend V10 Index Historical Returns Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Annual % -4.62% -6.05% % 2.25% -0.69% 4.57% -1.05% -1.32% 3.09% -1.19% 2.71% 2.14% 1.75% -0.99% 15.45% % 1.74% 3.84% 0.09% 3.18% -4.11% 0.62% 0.10% -4.48% 0.64% 1.04% 1.40% 2.52% % 1.94% -0.38% 2.56% -1.56% -2.93% 0.64% 0.53% -6.49% -1.57% 5.26% -0.39% -5.05% % 0.19% 4.49% -1.23% -4.65% -5.81% -2.83% 6.73% 4.74% 2.93% 1.91% 1.83% 4.56% % 1.37% -1.67% -1.59% -2.18% 2.03% 2.02% 5.58% 0.92% -2.74% 2.79% -1.99% 4.93% % 8.77% -3.52% -3.21% -0.37% 5.90% -5.43% -1.43% 4.79% 6.15% 0.54% 1.32% 10.31% % -1.73% 1.20% 3.06% 3.69% 1.04% -4.62% 2.20% 5.33% 6.22% -2.14% 1.86% 18.88% % -2.65% 6.69% 4.53% -3.94% -0.62% -1.30% 1.45% 4.23% 2.24% 1.35% 3.31% 27.10% % -1.35% 0.07% -4.42% 2.05% 3.28% 2.56% 0.55% 1.17% -2.83% 4.71% 3.02% 10.32% % 4.27% -0.11% -4.21% -1.81% 0.22% 0.59% -3.63% 7.05% 0.89% 6.47% 0.84% 9.22% % 5.08% -4.86% -2.81% -2.15% -6.27% -5.16% -0.46% 5.46% 9.27% 0.70% 5.99% 10.67% % -0.09% -6.03% 2.21% 2.32% 0.87% 2.95% 2.90% 5.94% -3.87% -4.18% 4.63% 8.48% % 6.54% 3.43% -5.81% 2.58% 2.11% 1.00% 5.36% 7.50% 3.41% -5.02% -2.36% 13.20% % 1.77% -0.28% 0.98% -0.32% 3.67% 0.19% 7.72% -1.47% -0.14% 4.65% 1.27% 17.57% % 0.83% -4.71% 3.20% -0.76% 0.15% 1.03% 0.70% -1.81% 0.57% 5.06% 7.70% 12.72% % 4.94% 3.24% 1.49% 1.91% 0.96% 3.47% 2.56% -0.76% -1.41% 5.46% 3.59% 29.72% % -2.14% -1.31% 3.54% 4.22% 0.42% 8.05% -3.98% 3.31% -0.63% 2.91% 6.77% 28.03% % 0.17% 2.47% 7.38% -1.21% -0.10% -1.84% 2.99% 7.56% 0.31% 6.76% 1.49% 23.30% % 0.12% -3.16% 2.19% 1.22% 3.59% -2.54% 0.34% 6.40% -0.15% 6.26% 1.55% 18.45% % -5.22% -4.28% -2.85% 10.68% 0.93% -1.45% 0.97% 5.69% 1.19% 3.97% 0.16% 8.89% % 5.54% 1.22% 1.29% 0.34% 0.93% 3.94% 1.72% -5.38% 7.09% 1.47% 8.02% 31.43% % 0.30% -1.28% 3.22% 1.29% 2.03% 3.41% -1.18% -0.60% -1.96% -1.15% 3.48% 4.38% % 1.94% -1.54% 3.49% -1.16% 0.79% -4.63% 1.05% 1.54% 1.86% -1.37% 8.16% 12.31% % 0.80% 4.42% 0.71% -3.00% 2.20% -0.67% 4.52% 6.39% 0.50% -3.28% 2.32% 17.36% Annualized Return Since Inception 12.73% Annualized Volatility Since Inception 11.69% The Salient Trend Index represents hypothetical performance since the index does not reflect any particular investment program and may, therefore, have certain limitations, some of which are described below. Since this is index performance, it does not represent the performance of any investment account or the results of actual trading, and no representation is being made that any account using the Index as a benchmark will experience performance similar to the Index s performance. In fact, it is not uncommon for investment programs targeting a particular index to have performance that diverges materially from the performance of the relevant index. In addition, hypothetical performance does not involve financial risk, and no hypothetical performance record can completely account for the impact of financial risk that exists in an investment program that is actually trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other facts related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results. All figures are based on current information and may be changed, suspended, or withdrawn as a result of changes in or unavailability of data, or other circumstances. The performance data herein are calculated based on data believed to be reliable and to be reasonable. The information herein has not been audited. Nothing on this website is intended to convey legal, tax, securities, financial or investment advice, nor an opinion in regards to the appropriateness of any investment. Salient is not liable for any loss arising from the use of this material. The Salient Trend Index is the exclusive property of Salient Index Management, LLC, a subsidiary of Salient Partners, L.P., and is protected by copyright and other intellectual property laws. Salient Index Management, LLC, is responsible for the administration and calculation of the index. The Index has been retrospectively calculated and did not exist prior to February Accordingly, the index performance shown for periods prior to February 2013 has been developed with the benefit of hindsight. Certain futures contracts comprising the underlying asset classes were not available at inception of the retrospective Index performance calculation beginning in January 1, Futures contracts unavailable at Index inception were included in the underlying asset classes as available. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. The illustration above shows the performance of the Salient Trend Index adjusted for volatility and a 25 bp/month assumed trading cost. 15

16 SDCERA Hedge Fund Experience 16

17 Historical: From Portable Alpha to Asset Class The SDCERA Hedge Fund Experience At the Fiscal Year-end of 2008, SDCERA had $1.1B invested in a hedge funds as part of a portable alpha strategy (Alpha Engine) A portable alpha strategy combines hedge funds with an S&P 500 swap overlay; the combined portfolio (hedge funds and S&P 500 swap) is then measured against the S&P 500 total return SDCERA Alpha Engine Portfolio As of June 30, 2008 Hedge Funds $1,120,949,495 Cash $273,534,213 S&P 500 Swap Notional Exposure $1,398,323,013 Total Exposure $2,792,806,721 Source: SDCERA FY 2008 CAFR. Numbers are rounded for illustrative purposes. 17

18 Historical: From Portable Alpha to Asset Class The SDCERA Hedge Fund Experience The losses to the Alpha Engine in the second half of 2008 led to a decrease in this allocation and the creation of the Opportunistic Portfolio, which the board approved in December 2008 The decrease in the Alpha Engine resulted in brining down swap exposure, increasing cash levels and either moving individual hedge funds to the Opportunistic Portfolio or redeeming from them SDCERA Alpha Engine Portfolio As of June 30, 2009 Hedge Funds $238,815,526 Cash $458,823,362 S&P 500 Swap Notional Exposure $519,910,887 Total Exposure $1,217,549,775 SDCERA Alpha Engine Portfolio Performance* 1 Yr 3 Yr 5 Yr Alpha Engine % % -5.42% S&P % -8.22% -2.24% Excess % -7.47% -3.18% *as of June 30, 2009 In early 2010, the Alpha Engine was completely eliminated and an explicit allocation to hedge funds was approved by the board in March of that year Source: SDCERA FY 2009 CAFR. Numbers are rounded for illustrative purposes. Return Data provided by BNY Mellon. 18

19 Historical Performance The SDCERA Hedge Fund Experience Returns Total Glbl Macro/CTA Composite 2.65% 6.77% % 5.51% 13.79% 1.69% 4.48% 0.49% Total Glbl Macro/CTA Composite ex-kenmar -0.32% 5.19% % 7.06% 14.59% 3.20% 8.75% 3.62% HFRI Macro (Total) Index 8.17% 11.11% 4.83% 4.34% 8.07% -4.14% 0.00% -0.47% Barclay CTA Index 3.55% 7.66% 14.09% -0.10% 7.03% -3.11% -1.71% -1.45% SDCERA Macro/CTA Policy Benchmark 6.62% 9.96% 7.84% 2.84% 7.72% -3.79% -0.56% -0.80% # of Managers Total Relative Value Composite 0.00% 0.00% % 17.94% 8.08% 0.33% 4.53% 4.74% HFRI Relative Value (Total) Index 12.36% 8.94% % 25.81% 11.42% 0.18% 10.56% 7.05% HFRX Relative Value (Total) Index 10.65% 5.80% % 38.47% 7.65% -4.00% 3.62% 2.96% SDCERA RV Policy Benchmark 7.01% 7.15% 4.18% 2.22% 2.16% 2.12% 2.15% 2.08% # of Managers Total Hedge Fund Portfolio 2.65% 6.77% % 12.78% 10.40% 1.30% 4.56% 2.75% Total Hedge Fund Portfolio ex-kenmar -0.32% 5.19% % 18.41% 12.74% 1.78% 9.74% 5.67% Annualized Returns Annualized Volatility 1 Year 2 Year 3 Year 5 Year Since Year 2 Year 3 Year 5 Year Since 2006 Total Glbl Macro/CTA Composite 0.49% 2.47% 2.21% 5.09% 2.59% 6.08% 5.62% 5.41% 6.99% 11.03% Total Glbl Macro/CTA Composite ex-kenmar 3.62% 6.15% 5.16% 7.37% 2.77% 6.89% 6.05% 5.58% 7.23% 11.35% HFRI Macro (Total) Index -0.47% -0.23% -1.55% 1.47% 3.87% 3.13% 3.53% 3.98% 4.65% 9.70% Barclay CTA Index -1.45% -1.58% -2.09% 0.07% 3.10% 3.17% 4.17% 4.59% 4.89% 8.86% SDCERA Macro/CTA Policy Benchmark -0.80% -0.68% -1.73% 1.01% 3.62% 3.11% 3.61% 4.07% 4.65% 8.24% Total Relative Value Composite 4.74% 4.64% 3.18% 6.96% 1.92% * 2.48% 2.25% 2.63% 3.67% 6.32% * HFRX Relative Value (Total) Index 2.96% 3.29% 0.80% 8.83% -0.25% * 2.28% 2.72% 3.63% 5.88% 9.95% * SDCERA RV Policy Benchmark 2.08% 2.12% 2.12% 2.15% 2.40% * 0.02% 0.02% 0.02% 0.02% 0.20% * Total Hedge Fund Portfolio 2.75% 3.65% 2.86% 6.27% 2.85% 3.90% 3.54% 3.44% 4.21% 9.08% Total Hedge Fund Portfolio ex-kenmar 5.67% 7.68% 5.68% 9.52% 3.84% 4.19% 3.82% 3.68% 3.94% 9.26% *Since inception on 2/29/2008 Source: Pertrac, Integrity Capital, LLC. Analysis March, 2014 All returns are net of fees and expenses Past performance is no guarantee of future results. 19

20 Portfolio Performance During Recent Market Events SDCERA Hedge Fund Experience SDCERA s Hedge Fund Portfolio has largely performed in-line with expectations during recent market events Financial Crisis (Oct 2007-Mar 2009, Annualized) Financial Crisis Recovery (Mar 2009-Apr 2010, Annualized) 2011 Drawdown (Jun 2011-Sept 2011) 2013 Rally (Jan 2013-Dec 2013) SPX % 53.97% % 32.39% Total Hedge Funds -5.95% 15.55% -0.84% 2.75% Glbl Macro/CTA Funds -3.39% 9.25% 0.83% 0.49% Relative Value Funds %* 19.59% -3.17% 4.74% *Relative Value data from February 2008-March Integrity Capital, LLC 2014 Past performance is no guarantee of future results 20

21 Correlation Experience through 2009 The SDCERA Hedge Fund Experience 1/31/1996-6/30/2009 Alpha Engine Portfolio S&P 500 MSCI EAFE MSCI Emerging Markets* Barclays Aggregate US 10Y Yield FALLING VOLATILITY GSCI Commodities Alpha Engine Portfolio S&P MSCI EAFE VIX RISING VOLATILITY MSCI Emerging Markets* Barclays Aggregate US 10Y Yield GSCI Commodities VIX *Data available from 1/31/1999. Source: Pertract Integrity Capital, LLC. Analysis March, 2014 For illustrative purposes only. 21

22 Correlation Experience (2009-Present) The SDCERA Hedge Fund Experience FALLING VOLATILITY RISING VOLATILITY 7/31/ /31/2013 Post-Alpha Engine Portfolio Macro/CTA Funds Relative Value Funds S&P 500 Post-Alpha Engine Portfolio Macro/CTA Funds Relative Value Funds S&P MSCI EAFE MSCI Emerging Markets Barclays Aggregate US 10Y Yield GSCI Commodities VIX MSCI EAFE MSCI Emerging Markets Barclays Aggregate US 10Y Yield GSCI Commodities VIX Source: Pertrac, Integrity Capital, LLC. Analysis March, 2014 For illustrative purposes only 22

23 Hedge Fund Portfolio Fee Schedule and Terms The SDCERA Hedge Fund Experience Hedge Funds as of December 31, 2013 AUM (MM) Management Fee Incentive Fee Inception Date ITD Fees (MM) ITD Date Return Red Freq/Days Notice Gate Sidepocket AQR Delta $ % 15.00% (1) Jun-10 $ % M/30 No No Blue Mountain Credit Alternative $ % 20.00% Feb-13 $ % Q/90 25%/qtr Investor Level Gate No Brevan Howard, Series B (2) $ % 25.00% Jun-09 $ % M/90 No (3) No Bridgewater Pure Alpha II $ % 20.00% May-09 $ % M/5 No (3) No Bridgewater Pure Alpha Major Markets $ % 20.00% Dec-10 $ % M/5 No (3) No Cantab Core Macro Fund $ % 0.00% Oct-13 $ % Daily/3 days No (3) 15% limit (5) DE Shaw Heliant Fund $ % 20.00% Aug-11 $ % M/30 No (3) No Moon Capital $ % 20.00% May-09 $ % Q/90 17%/qtr Investor Level Gate No Saba Capital Partners, L.P. $ % 20.00% Aug-11 $ % Q/65 25%/qtr Investor Level Gate (4) No Trend Strategy $ % 0.00% May-13 $ % Daily No No (1) AQR has a hurdle rate of T-Bills + 2% (net of management fee) (2) Fees are estimates (3) GP has the right to suspend redemptions under extraordinary circumstances (4) Fund Level Gate with a 9 month clean up (5) As a percentage of NAV at time of transfer unless there is a majority LP approval Integrity Capital, LLC

24 Dollar Value Added (DVA) by Manager Dollars added against benchmark, net of fees Positive contribution to portfolio Annual DVA ($millions) $25 $20 $15 $10 $5 $0 $5 $10 $15 Saba Graham K4D AQR Delta D.E. Shaw Heliant Kenmar $0 $1 $2 $3 $4 $5 $6 $7 Annual Fees (Millions) Cumulative DVA ($millions) $50 $40 $30 $20 $10 $0 $10 $20 $30 $40 AQR Delta Graham K4D Saba D.E. Shaw Heliant Bridgewater Pure Alpha Kenmar $0 $5 $10 $15 $20 $25 $30 $35 Cumulative Fees (Millions) Net positive DVA since July 2008 of $241 million across hedge fund portfolio Integrity Capital, LLC 2014 Dollar Value Added ( DVA ) is the net benefit in dollar terms of a manager s net of fees performance over the returns generated by the manager s benchmark. DVA is calculated by subtracting the benchmark return from the manager s net of fees monthly performance and multiplying the result by the monthly net asset value of the fund. Past performance is no guarantee of future results. 24

25 Total Monthly Redemptions ($ Millions) Hedge Fund Portfolio Liquidity Profile SDCERA has a Relatively Liquid Hedge Fund Allocation $1,400 $1,200 $1,000 $800 $600 $400 $200 As of March 2014, 79.5% of the invested capital could be returned in 5 months $0 SDCERA Hedge Fund Redemption Schedule Monthly Redemptions ($) Cumulative Redemptions (%) Integrity Capital, LLC

26 SDCERA Hedge Fund Portfolio Leverage The SDCERA Hedge Fund Experience The reporting of leverage by hedge funds varies by manager and strategy, making it challenging to perform cross sectional analysis. For example: Brevan Howard reports gross leverage as the ratio of absolute value of securities (excluding derivatives) to NAV AQR Delta reports fixed income gross leverage exposures in 7-year duration space (the approximate duration of a 10-year bond) Moon Capital modifies its reported gross leverage to reflect that derivative products are delta-adjusted and presented only on a net basis futures are presented only on a net basis CTA funds, due to their reliance on derivatives, do not report gross leverage, preferring instead the margin to equity measure The following graphs represent equal-weighted composite gross leverage for the individual composite portfolios. Due to the differing reporting conventions, the following graphs are our best estimates of aggregate leverage and could differ substantially from what is reported Integrity Capital, LLC

27 SDCERA Hedge Fund Portfolio Leverage The SDCERA Hedge Fund Experience Gross Exposure Relative Value Composite 800% 700% 600% 500% 400% 300% 200% May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Gross Exposure 900% 850% 800% 750% 700% 650% 600% 550% 500% 450% 400% Macro Composite Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Integrity Capital, LLC 2014 For illustrative purposes only. Gross exposure is calculated by dividing the absolute value of the fund s underlying long and short positions by the Net Asset Value of the fund. Relative Value Composite is an equal-weighted exposure including Moon Capital, AQR Delta, Blue Mountain Credit Alternatives, and Saba. Macro Composite is an equal-weighted exposure including Brevan Howard and D.E. Shaw Heliant. 27

28 SDCERA Hedge Fund Portfolio Leverage The SDCERA Hedge Fund Experience 25% CTA Composite 20% Margin to Equity 15% 10% 5% 0% Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Integrity Capital, LLC 2014 For illustrative purposes only. Margin to equity is calculated as the percentage of a fund s Net Asset Value which is posted as margin collateral against derivative investments. CTA Composite is an equal-weighted exposure including CCP Core Macro and Salient Trend. 28

29 Glossary of Terms Correlation - a statistical measure of how two securities move in relation to each other. Cross-Sectional Momentum/ Market Neutral Momentum A trading strategy that buys the best performing securities within an asset class and sells the worst performing securities Counter-Trend A short-term trading strategy betting that recent trends will reverse Mean Reversion Trading strategy that bets on reversals in long-run cross-sectional momentum FX Overlay A currency trading strategy that buys the highest-yielding currencies and sells the lowest-yielding currencies within its opportunity set 29

30 Index Glossary S&P An unmanaged, capitalization weighted index comprising publicly traded common stocks issued by companies in various industries. The S&P 500 Index is widely recognized as the leading broad-based measurement of changes in conditions of the U.S. equities market. Continuous Commodity Index - Made up of 17 commodities whose futures trade on U.S. Exchanges. The index is a broad measure of overall commodity price trends. There are six component groups: Energy, Grains, Industrials, Precious Metals, Livestock and Softs. Equal weighting is used for both arithmetic averaging of an individual commodity months and for geometric averaging of the 17 commodity averages ML 10 Year US Treasury Futures Total Return Index Measures the performance of a fully collateralized rolling 10-year US Treasury futures position. Barclays Aggregate Bond Index - A U.S. Aggregate index that covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SECregistered securities. The index includes government securities, mortgage-backed securities, asset-backed securities and corporate securities all with a maturity of greater than one year. Barclay BTOP50 Index - Seeks to replicate the overall composition of the managed futures industry with regard to trading style and overall market exposure. To be included in the BTOP50, the trading advisors must be: open for investment, willing to provide daily returns, at least two years of trading activity, and the advisors must have at least three years of operating history.the BTOP50 portfolio is equally weighted among the selected programs at the beginning of each calendar year and is rebalanced annually. Salient Trend Index - Comprised of 3 sub-portfolios, each of which follows a different signal (long, medium, and short). Each sub-portfolio is comprised of 45 futures contracts across equities, commodities, and global interest rates. The Index is built using a quantitative risk parity framework. The Index is calculated daily, rebalanced monthly, and targets a 20% volatility level Fama French Momentum Factor - Constructed utilizing six portfolios each month including NYSE, AMEX, and NASDAQ stocks with prior return data. To be included in a portfolio for month t (formed at the end of month t-1), a stock must have a price for the end of month t-13 and a good return for t-2. In addition, any missing returns from t-12 to t-3 must be -99.0, CRSP's code for a missing price. Each included stock also must have ME for the end of month t-1. Fama French Short Term Reversal Constructed utilizing six value-weight portfolios including, NYSE, AMEX, and NASDAQ stocks with prior return data. To be included in a portfolio for month t (formed at the end of month t-1), a stock must have a price for the end of month t-2 and a good return for t-1. Each included stock in either the monthly also must have ME for the end of month t-1. db Mean Reversion USD Index - DBLCI MR Enhanced index invests in twelve commodities covering Energy, Precious Metals, Industrial Metals and Agriculture. Deutsche Bank G10 FX Carry Basket - This is a dynamic index designed to systematically represent a long carry portfolio within the G10 sphere. It is calculated using a geometric average of long the 3 highest yielding currencies against being short the three lowest yielding averages currencies 30

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