Institute for Private Investors

The Changing Role of Private Investorsin the Capital Markets

Gregory Friedman, Chief Investment OfficerGreycourt & Co., Inc.

October 2007

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I. Institutional versus Private Capital…the way it was…why its changed…the way it is

II. How we’re different…principals versus agents…tax sensitivity…sheer mass…ability to replenish capital

III. Can we survive and prosper?…is alpha drowning?…are we truly competing?…what we must do.

OverviewInstitute for Private

Investors

Private investors haven’t changed

Institutions have…

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RISKY investments used to be the exclusive domain of individual investors…

Institutions started

investing only in:

Equity 1950s

Real Estate 1975

Venture Capital 1975

LBOs 1981

Hedge Funds 2002

Private investors used to be the only game in town…

The Way It Was...Institute for Private

Investors

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Changing Taxation…1940’s

Inland Steel Pension ruling…1948

Performance reporting…1966

Consultants appear…1969

Passage of ERISA…..1974

Update to Prudent Man Rule…1979

Introduction of PC…1981

Government policies…

Evolving laws…

Technological advances…

Caused explosive growth in institutional capital.

What Changed?Institute for Private

Investors

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0.0%

20.0%

40.0%

60.0%

80.0%

1950 1960 1970 1980 1990 2000 2007

Government policies…

Evolving laws…

Technological advances…

Caused explosive growth in institutional capital.

The Pros Take Over…Institute for Private

Investors

Percentage of U.S. stocks owned by pension funds, mutual funds and other professional investors…

9.8%

74.1%

As of March 31st Source: Federal Reserve

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Yale’s David Swenson writes book explaining his secrets…

Traditional markets tank at same time…

Other endowments face board pressure to emulate Yale…

Flood into Alternatives Started With a Book…Institute for Private

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Institutional investors…

Late to alternatives game…

Swing a BIG bat!

Tsunami of Institutional Capital…Institute for Private

Investors

Swensen Publishes…

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Large Endowments Led the Way Into Alternatives…

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If a LITTLE is good, a LOT must be better…Right?

Institute for Private Investors Some Late to Game but Dive Headfirst…

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US Endowments and Foundations control more than $550 Billion in assets.

Increases in hedge fund allocations have principally come from bonds and cash…

Institute for Private Investors

Changes in Endowment & Foundation Allocations

1994 to 200612-Year

Asset Class 2006 AllocationAverage Allocation (%) Change (%)

Equity 57.7 0.8

Fixed Income 20.2 -11.0

Cash 3.4 -3.1

Change in Traditional Assets -13.3

Hedge Funds 9.6 8.0

Private Equity/ VC 2.8 2.0

Real Estate 3.5 1.5

Natural Resources 1.5 1.2

Other 1.4 0.7

Change in Alternative Assets 13.4

A Tsunami of Institutional Capital…

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If you thought Endowments and Foundations control a lot…

U.S. Pensions control some $4.5 Trillion in capital…

When they show up… Watch Out!

Institute for Private Investors A Tsunami of Institutional Capital…

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Private investors and Institutional investors are structurally different:

Taxability

Cash flow needs

Time horizons

Ability to refresh capital base

Fundamental structural differences lead to different needs…

Private Investors versus Institutions…Institute for Private

Investors

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Private investors and Institutions have quite different decision-making processes:

Principals vs. Agents

Business Acumen vs. Investing Acumen

Personal Well Being vs. Reputation Risk

Investing in Individuals vs. Investing in Organizations

Fundamental differences in needs leads to different decision making…

Private Investors versus Institutions…Institute for Private

Investors

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Near Term: Maturing private wealth will feed growth in endowments & foundations (e.g., Gates & Buffet)

Long Term: Wealth shifting overseas

1. EM pensions funds to grow

2. Growing pools of sovereign capital

3. Slowing GDP in western world

4. Eventual repatriation of US$ assets

5. Rising importance of non-US individual and institutional investors

Emotional differences lead to different decisions…

Balance of Power Will Shift Even More…Institute for Private

Investors

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Institutions have lower return expectations from hedge funds than private investors had demanded…

Institutions Expect Less…Institute for Private

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Low volatility hedge funds and fund of funds may soon not be attractive to private investors…

Are Institutions Ruining Hedge Funds?Institute for Private

Investors

Historic Returns

Institutional Expectations

Pre-tax Gross Return 17.0% 14.5% 12.0% 10.8%

Pre-tax Net Return - HF 12.0% 10.0% 8.0% 7.0%

Pre-tax Net, Net Return - HFOF 10.0% 8.1% 6.2% 5.2%

After-tax Net, Net Return 6.5% 5.2% 4.0% 3.4%

Expected T-E Bond Return 4.8% 4.8% 4.8% 4.8%

Advantages to Hedge FOF 1.7% 0.5% -0.7% -1.4%

Do Hedge Funds Make Sense for Private Investors?

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Hedge funds may soon not be as attractive to private investors…

Are Hedge Funds Still Appropriate?Institute for Private

Investors

Yes…but…private investors must carefully seek out strategies that are sustainable and offer attractive after-tax net returns:

Seek skill not arbitrage

Seek firms having aligned interests

Favor tax-efficient strategies

Don’t avoid risk but diversify it

Capitalize on institutional herd mentality

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Access to top tier fund managers is CRITICAL in private equity…

…and with the competition from institutions it’s now even harder to get it.

Institute for Private Investors Is Private Equity a Fool’s Errand?

Not if we live in Lake Wobegone where we’re all above average…

BUYOUTU.S.

VintageYear IRR +/- S&P IRR +/- S&P

1995 12.7% 0.9% 6.1% -5.7%1996 10.1% 0.4% 4.9% -4.8%1997 10.8% 2.4% 2.5% -5.9%1998 10.9% 4.9% 6.4% 0.4%1999 8.4% 5.0% 0.6% -2.8%2000 17.3% 16.2% 6.4% 5.3%2001 18.3% 15.4% 11.1% 8.2%2002 19.8% 13.6% 5.1% -1.1%

AVG. = 7.4% AVG. = -0.8%

Source: Venture Economics

U.S. MarketTop Quartile1

U.S. MarketMedian1

Buyout Returns thru Dec 31 2006

Otherwise, yes!

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Low fees

Tax efficient

Low correlation

Expensive & tax inefficient

Active Long-Only Managers Will Diminish in Importance…

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Private investors need to protect their own interests as managers will increasingly pander to institutions…

ConclusionInstitute for Private

Investors

Institutional capital to surge

Big managers to get bigger

Private investors less important

Products increasingly tax-inefficient

Traditional long-only managers squeezed

Beta becoming cheaper

Alpha will remain expensive

Private investors must follow own path

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Gregory Friedman

Chief Investment Officer

Greycourt & Co., Inc.

(503) 226-0470

Fax (503) 226-0471

gfriedman@greycourt.com

www.greycourt.com

Contact InformationInstitute for Private

Investors