2012 Annual Investment Plan by STRS Ohio

Fiscal 2012 INVESTMENT PLAN

June 16, 2011

60-118, 6/11/65

Fiscal 2012 Investment Plan

Table of Contents I. Purpose................................................................................................................................1

II. Investment Plan Overview .................................................................................................3 s &ORECAST IN "RIEF ...............................................................................................................3 s %CONOMIC /VERVIEW.........................................................................................................3 s 4OTAL &UND /UTLOOK ..........................................................................................................5 s )NVESTMENT 0LAN 4HEMES ..................................................................................................6 s /UTLOOK FOR THE !MORTIZATION 0ERIOD ...............................................................................6

III. Asset Allocation/Risk Budget ............................................................................................7 s !SSET #LASS 3UMMARIES ....................................................................................................7 s !SSET !LLOCATION ...............................................................................................................8 s 2ISK "UDGET......................................................................................................................9

IV. Fiscal 2012 Economic Outlook........................................................................................13 s 5 3 %CONOMIC 'ROWTH AND )NmATION /UTLOOK ...............................................................13 s 5 3 %CONOMIC &ORECAST .................................................................................................20 s )NTERNATIONAL %CONOMIC 'ROWTH AND )NmATION /UTLOOK .................................................21 s )NTERNATIONAL &ORECASTS ...................................................................................................24

V. Fixed-Income Investments ...............................................................................................25 s /UTLOOK ..........................................................................................................................25 s 3TRATEGY ..........................................................................................................................27

VI. Domestic Equities Investments .......................................................................................31 s /UTLOOK ..........................................................................................................................31 s 3TRATEGY .........................................................................................................................34 VII. International Investments................................................................................................35 s /UTLOOK ..........................................................................................................................35 s 3TRATEGY ..........................................................................................................................38 VIII. Real Estate Investments ...................................................................................................41 s /UTLOOK ..........................................................................................................................41 s 3TRATEGY ..........................................................................................................................43 IX. Alternative Investments â&#x20AC;&#x201D; Private Equity ....................................................................47 X. Alternative Investments â&#x20AC;&#x201D; Opportunistic/Diversified .................................................51

Fiscal 2012 Investment Plan

I. Purpose 4HE )NVESTMENT 0LAN PROVIDES STRATEGY FOR lSCAL BASED ON THE 3TATE 4EACHERS 2ETIREMENT "OARD S LONG TERM OBJECTIVES AND THE FORECASTED CLIMATE "ECAUSE THE STAFF FORECAST IS BASED ON ESTIMATES OF A FUTURE ECONOMIC CLIMATE MODIlCATIONS TO THE PLAN MAY BE NECESSARY -ODIlCATIONS WILL BE COMMUNICATED TO THE 2ETIREMENT "OARD IN MONTHLY REVIEWS OF THE PLAN AS NEEDED )N IMPLEMENTING THE PLAN THE STAFF WILL ENSURE THAT ALL POTENTIAL /HIO INVESTMENTS IN EACH ASSET CLASS RECEIVE A THOROUGH ANALYSIS ACCORDING TO POLICY

Fiscal 2012 Investment Plan

II. Investment Plan Overview FORECAST IN BRIEF Fiscal 2012 Projected Ranges

Fiscal 2011 Forecast

2EAL 0ERSONAL #ONSUMPTION

2EAL "USINESS &IXED )NVESTMENT

n n

Fiscal 2012 Projected Ranges

May 2011

2EAL 'ROSS $OMESTIC 0RODUCT

(OUSING 3TARTS MILLIONS 2EAL .ET %XPORTS BILLIONS #ONSUMER 0RICE )NDEX 3 0 %ARNINGS

&EDERAL &UNDS 2ATE 9EAR 4REASURY .OTE

ECONOMIC OVERVIEW $URING THE lRST lVE QUARTERS OF THE ECONOMIC EXPANSION REAL GROSS DOMESTIC PRODUCT '$0 GROWTH ROSE MODESTLY ABOVE THE ECONOMY S LONGER TERM POTENTIAL GROWTH RATE OF ROUGHLY (OWEVER BUSINESS INVENTORY GROWTH ACCOUNTED FOR MOST OF THE ADVANCE IN THE ECONOMY Â&#x2C6; A SITUATION THAT NORMALLY IS NOT CONDUCIVE TO FUTURE ECONOMIC GROWTH BECAUSE OF THE MISMATCH IT CREATES BETWEEN SUPPLY AND DEMAND 'ROWTH IN REAL lNAL SALES ECONOMIC GROWTH EXCLUDING THE CHANGE IN INVENTORIES WAS VERY WEAK LEAVING THE INVENTORY BUILDUP ACCOUNTING FOR NEARLY TWO THIRDS OF TOTAL ECONOMIC ACTIVITY 4HAT CHANGED IN THE SECOND QUARTER OF lSCAL 7HILE TOTAL ECONOMIC GROWTH IMPROVED TO A ANNUALIZED RATE REAL lNAL SALES SOARED TO A YEAR HIGH OF 2OBUST CONSUMER SPENDING DURING THE HOLIDAY SHOPPING SEASON AN IMPRESSIVE IMPROVEMENT IN THE COUNTRY S TRADE BALANCE FROM STRONG EXPORT GROWTH AND AN UNUSUAL DROP IN IMPORT GROWTH STRONG BUSINESS INVESTMENT IN EQUIPMENT AND EVEN A MARGINAL GAIN IN THE DISTRESSED HOUSING SECTOR OFFSET THE SIGNIlCANT SLOWDOWN IN INVENTORY ACCUMULATION AND NEGATIVE FEDERAL STATE AND LOCAL GOVERNMENT SPENDING 4HIS COMBINATION OF ECONOMIC SECTORS DROVE lNAL DEMAND HIGHER AND SUGGESTED AS IT DID IN WHEN THAT EXPANSION GAINED TRACTION THAT THE ECONOMY HAD ENTERED A NEW STRONGER PHASE BEYOND THE DISAPPOINTING SLOW RECOVERY TO THE h'REAT 2ECESSION v (OWEVER THE ECONOMY AGAIN FACED A SETBACK IN THE THIRD lSCAL QUARTER AS SOARING ENERGY AND FOOD COSTS ATE AWAY AT DISCRETIONARY CONSUMER SPENDING AND GEOPOLITICAL CRISES PLAYED OUT IN THE OIL PRODUCING -IDDLE %AST ! SEVERE EARTHQUAKE AND TSUNAMI IN *APAN LATE IN THE QUARTER CONTRIBUTED ADDITIONAL SHOCKS TO THE 5 3 AND GLOBAL ECONOMIES 2EAL '$0 GREW JUST AT AN ANNUAL RATE WHILE REAL lNAL SALES HARDLY ADVANCED AT ALL GROWING JUST )NCREASINGLY HEADLINE INmATION WAS HURTING REAL ECONOMIC GROWTH AND DAMAGING CONSUMER CONlDENCE

Fiscal 2012 Investment Plan

"ECAUSE THE HOUSING SECTOR WILL LIKELY CONTINUE TO SEE ONLY SLOW PROGRESS INTO lSCAL AND GOVERNMENT BODIES INCREASINGLY FACE lSCAL AUSTERITY 5 3 ECONOMIC PROSPECTS WILL CONTINUE TO BE HEAVILY DEPENDENT UPON CONSUMER SPENDING BUSINESS lXED INVESTMENT AND TO SOME EXTENT INTERNATIONAL TRADE 4HE MOST IMPORTANT ECONOMIC SECTOR WILL BE CONSUMER SPENDING AND IT WILL LARGELY DEPEND UPON STRONGER EMPLOYMENT AND INCOME GAINS 4HE UNEMPLOYMENT RATE REMAINS VERY HIGH AND JOB GROWTH NEEDS TO BE MUCH STRONGER TO SIGNIlCANTLY IMPROVE LABOR CONDITIONS (OWEVER THIS RATE ALONG WITH VIRTUALLY ALL OTHER JOB MARKET SURVEYS AND INDICATORS HAS STARTED MOVING IN THE RIGHT DIRECTION TOWARD BETTER EMPLOYMENT AND ULTIMATELY BETTER WAGE GROWTH IN lSCAL .EVERTHELESS BECAUSE OF ONGOING DELEVERAGING IN THE CONSUMER AND BUSINESS SECTORS AND THE NEED TO REBUILD LOST WEALTH FROM THE HOUSING AND lNANCIAL MARKET COLLAPSES GROWTH IN CONSUMER SPENDING WILL LIKELY REMAIN ONLY SLIGHTLY ABOVE LONGER TERM POTENTIAL RATHER THAN SURGE FORWARD "USINESS lXED INVESTMENT WILL ALSO NEED TO BE A MAJOR CONTRIBUTOR TO ECONOMIC ACTIVITY OVER THE NEXT YEAR AND A HALF TO AVOID ANOTHER SLOWDOWN LIKE THAT SEEN LAST SPRING AND SUMMER 4HOUGH INVESTMENT IN STRUCTURES WILL NOT ADD A GREAT DEAL TO ECONOMIC ACTIVITY BUSINESS SPENDING ON CAPITAL EQUIPMENT HAS BEEN ROBUST AND WILL LIKELY CONTINUE TO CONTRIBUTE TO OVERALL GROWTH !FTER THE BROAD BASED SLOWDOWN LAST YEAR BOTH MANUFACTURING AND NONMANUFACTURING ACTIVITY HAVE SOARED ,ARGER COMPANIES HAVE DONE BETTER THAN SMALLER COMPANIES BUT EVEN AMONG SMALL COMPANIES OPTIMISM HAS MOVED INTO EXPANSION TERRITORY SINCE LAST FALL &OREIGN TRADE WILL LIKELY IMPROVE MODESTLY IN lSCAL AFTER THE TRADE WEIGHTED DOLLAR DEPRECIATED SIGNIlCANTLY DURING lSCAL 4HOUGH THE TERMS OF TRADE HAVE IMPROVED FROM A 5 3 PERSPECTIVE ECONOMIC GROWTH IS GOING TO BE UNEVEN ACROSS COUNTRIES -OST DEVELOPED COUNTRIES WILL GROW AT A MODERATE TREND LIKE PACE WHILE MOST EMERGING COUNTRIES ARE GOING TO SOFTEN MARGINALLY FROM THEIR RECENT TORRID ECONOMIC GROWTH /N THE INmATION FRONT COMMODITY PRICES HAVE MOVED BROADLY HIGHER EVEN ACCELERATING DURING THE CURRENT lSCAL YEAR -UCH OF THE INCREASE CAN BE ATTRIBUTED TO THE RETURN OF 5 3 AND FOREIGN DEMAND FOR SCARCE ENERGY INDUSTRIAL AND AGRICULTURAL COMMODITIES TO FEED MORE RAPIDLY GROWING ECONOMIES 4HE INCREASE IN COMMODITY PRICES HAS LED TO A SURGE IN PRODUCER PRICES BUT IT HAS ONLY SPARINGLY BEEN PASSED THROUGH TO CORE CONSUMER PRICES #ONSUMER 0RICE )NDEX ;#0)= EXCLUDING VOLATILE FOOD AND ENERGY COSTS OR BROADER ECONOMY WIDE MEASURES OF INmATION 4HE THREAT FROM SWELLING COMMODITY PRICES IS OFFSET SOMEWHAT BY A HUGE OUTPUT GAP AND LOW WAGE EXPECTATIONS 4HERE IS A GREAT DEAL OF EXCESS CAPACITY IN THE ECONOMY THAT HAS YET TO BE SWALLOWED UP BY GROWING DEMAND THAT WOULD ALLOW INmATION PRESSURES TO STICK 4HE RECENT SURGE IN HEADLINE INmATION INDICATORS FROM LARGELY ENERGY AND FOOD COSTS SHOULD EASE AS THE ECONOMY MOVES THROUGH lSCAL 4HOUGH THERE MAY CONTINUE TO BE GEOPOLITICAL SHOCKS IN SENSITIVE ENERGY PRODUCING REGIONS IN THE UPCOMING YEAR CORE INmATION WILL LIKELY REMAIN BEHAVED %LSEWHERE HEADLINE INmATION SHOULD INCH UP FURTHER IN MOST DEVELOPED COUNTRIES AND BETTER DEMAND SHOULD ENSURE THAT CORE MEASURES OF INmATION GRADUALLY RISE "Y CONTRAST INmATION SHOULD REMAIN A THREAT IN EMERGING COUNTRIES EVEN SEEPING INTO WAGES ESPECIALLY IN COUNTRIES THAT PREVENT THEIR CURRENCY S EXCHANGE RATE FROM APPRECIATING !LONG WITH A RENEWED FOCUS AT THE FEDERAL STATE AND LOCAL GOVERNMENT LEVELS TOWARD lSCAL AUSTERITY THE &EDERAL 2ESERVE S CAMPAIGN TO SUPPORT ECONOMIC ACTIVITY THROUGH MORE AND MORE ACCOMMODATIVE MONETARY POLICIES IS ENDING )NTEREST RATES WILL NOT LIKELY BE RAISED BEFORE MID lSCAL AT THE EARLIEST BECAUSE THE UNEMPLOYMENT RATE WILL LIKELY REMAIN ELEVATED AND CORE INmATION SHOULD STAY BELOW THE &EDERAL 2ESERVE S PREFERRED RATE OF ROUGHLY .EVERTHELESS FURTHER QUANTITATIVE EASING WILL NOT EXTEND INTO lSCAL UNLESS ANOTHER CRISIS DEVELOPS IN MAJOR ECONOMIES ! CONCERTED MOVE TOWARD MONETARY POLICY TIGHTENING HOWEVER IS LIKELY ABOUT A YEAR AWAY GIVEN THE EXPECTED SLOW IMPROVEMENT IN ECONOMIC FUNDAMENTALS AND THE LACK OF A SUSTAINED THREAT TO CORE INmATION MEASURES

Fiscal 2012 Investment Plan

FROM ENERGY AND FOOD COSTS -EANWHILE CENTRAL BANKS IN MANY DEVELOPED COUNTRIES SHOULD CAUTIOUSLY AND MARGINALLY INCREASE POLICY INTEREST RATES %MERGING COUNTRIES CENTRAL BANKS SHOULD CONTINUE LIFTING POLICY INTEREST RATES AND ADOPT VARIOUS PRUDENTIAL MACRO POLICY TOOLS SUCH AS HIGHER RESERVE RATIOS AND CREDIT RESTRICTIONS TO PREVENT INmATION FROM WORSENING 5NABLE TO SUBDUE INmATION ADEQUATELY MANY EMERGING COUNTRIES MAY HAVE TO ALLOW THEIR CURRENCIES TO APPRECIATE AGAINST THE 5 3 DOLLAR MORE THAN WHAT THEY HAVE SO FAR "ECAUSE THE ECONOMY HAS STRENGTHENED IN RECENT MONTHS THE RISKS TO THE BASELINE CYCLICAL FORECAST OF NEAR POTENTIAL ECONOMIC GROWTH WITH CONTAINED CORE INmATION ARE NOW MORE EVENLY SPREAD AROUND THE BASELINE FORECAST 4HERE CONTINUE TO BE A VARIETY OF DOWNSIDE RISKS THAT WILL KEEP A LID ON THE ECONOMY S EXPANSION INTO lSCAL Â&#x2C6; AMONG THEM THE WEAK HOUSING INDUSTRY CONTINUED DELEVERAGING MODEST HIRING AND BANK LENDING lSCAL RESTRAINT AND DEVELOPMENTS ABROAD (OWEVER CYCLICAL GROWTH PROSPECTS HAVE IMPROVED ADDING UPSIDE RISKS FOR THE lRST TIME IN THIS EXPANSION TO THE ECONOMIC FORECAST FOR THE REMAINDER OF lSCAL AND lSCAL 9ET LONGER TERM STRUCTURAL PROBLEMS REMAIN FROM DEVELOPED COUNTRIES THAT ARE ADAPTING TO SLOWER LONGER TERM GROWTH PROSPECTS LEAVING THE GLOBAL ECONOMY VULNERABLE TO ADDITIONAL SHOCKS FROM %UROPE S AND !MERICA S DEBT PROBLEMS POLITICAL UNREST IN THE -IDDLE %AST AND EVEN NATURAL DISASTERS LIKE *APAN HAS FACED !S A RESULT POSITIVE CYCLICAL TRENDS AND DEVELOPMENTS NEED TO BE TEMPERED BY LONGER TERM CONCERNS

TOTAL FUND OUTLOOK $URING lSCAL 3423 /HIO INVESTMENT ASSETS ARE PROJECTED TO GROW MODESTLY TO APPROXIMATELY BILLION AT MARKET VALUE FROM AN ESTIMATED BILLION IN *UNE 4HIS BILLION INCREASE CONSISTS OF INCOME AND MARKET APPRECIATION MINUS NET CONTRIBUTIONS 3INCE NET CONTRIBUTIONS WHICH ARE CONTRIBUTIONS LESS BENElTS AND OPERATING EXPENSES CONTINUE TO BE NEGATIVE MINUS BILLION ANNUALLY THE GROWTH IN ASSETS COMES TOTALLY FROM INVESTMENT RETURNS 4HE PROJECTED MARKET RETURN IN THIS MONTH PERIOD IS LESS THAN WHICH IS CONSISTENT WITH THE RETURN OUTLOOK IN THE TABLE ON 0AGE #AUTION IS REQUIRED WHEN ESTIMATING FUTURE MARKET VALUES OF ASSETS BECAUSE OF THE POTENTIAL FOR MARKET mUCTUATIONS OVER SHORT TIME PERIODS 4HE TABLE ON 0AGE ILLUSTRATES THE EXPECTED ANNUAL MARKET RETURN FOR EACH ASSET CATEGORY FOR lSCAL RELATIVE TO THE 2ETIREMENT "OARD S POLICY FOR EXPECTED AVERAGE ANNUAL RETURNS !S DETAILED IN THE VARIOUS SECTIONS OF THIS PLAN WE PROJECT THIS PERIOD TO BE BELOW NORMAL FOR THE 3423 /HIO TOTAL FUND RETURN BASED UPON MARKET LEVELS IN -AY 7ITH lSCAL S TOTAL FUND RETURN OF AND lSCAL S RETURN PROJECTED TO BE EVEN HIGHER SOME SETBACK IS EXPECTED FOR lSCAL (OWEVER 3423 /HIO REMAINS AHEAD OF ITS PLANNING GOAL SET NEARLY MONTHS AGO OF ACHIEVING A ANNUALIZED RETURN OVER THE PERIOD OF lSCAL TO lSCAL

Fiscal 2012 Investment Plan

ANTICIPATED MARKET RETURNS Board Policy Expected Average Annual Benchmark Returns

Benchmark Annualized Return Expectation for Fiscal 2012*

,IQUIDITY 2ESERVES

"ELOW .ORMAL

&IXED )NCOME

"ELOW .ORMAL

$OMESTIC %QUITIES

"ELOW .ORMAL

)NTERNATIONAL

"ELOW .ORMAL

2EAL %STATE

!BOVE .ORMAL

!LTERNATIVE )NVESTMENTS

.ORMAL

Total Fund

7.7%

Below Normal

*Based upon market levels in mid-May 2011. Should market levels change significantly by late June 2011, an updated projection will be issued.

INVESTMENT PLAN THEMES )N ADDITION TO MEETING OR EXCEEDING THE 2ETIREMENT "OARD S GOAL OF BASIS POINTS OF NET VALUE ADDED TO THE INVESTMENT PORTFOLIO IN lSCAL WE ANTICIPATE THE FOLLOWING WILL OCCUR

-ONITOR MARKETS VERY CLOSELY TO ASSESS THE RISK LEVELS IN RESPONSE TO THE THREAT OF GOVERNMENT debt contagion producing a potential global financial crisis.

)MPLEMENT A GLOBAL PORTFOLIO IN EQUITIES 4HIS MAY SERVE AS A TEMPLATE FOR THE FUTURE MANAGEMENT OF EQUITIES

7ORK VERY CLOSELY WITH #ALLAN AND THE 2ETIREMENT "OARD ON THE !SSET ,IABILITY 3TUDY TO ENSURE THE BOARD HAS THE EDUCATION AND KNOWLEDGE TO PARTICIPATE FULLY IN MAJOR DECISIONS

0ARTNER WITH 3423 /HIO S (UMAN 2ESOURCE 3ERVICES $EPARTMENT TO EFFECTIVELY USE THE ANNUAL -C,AGAN COMPENSATION SURVEY TO ENSURE 3423 /HIO INVESTMENT COMPENSATION MEETS THE 2ETIREMENT "OARD S STATED OBJECTIVE

#ONTINUE TO IMPLEMENT A SUCCESSION PLAN TO SUSTAIN THE OVERALL MANAGEMENT OF THE )NVESTMENT $EPARTMENT

OUTLOOK FOR THE AMORTIZATION PERIOD 7ITH THE EXCELLENT TOTAL FUND RETURN IN lSCAL THE lNANCIAL HEALTH OF 3423 /HIO WILL IMPROVE HOWEVER THE AMORTIZATION PERIOD WILL REMAIN AT INlNITY 3423 /HIO SHOULD BEGIN lSCAL WITH A FUNDED RATIO IN THE RANGE OF UP FROM AT *UNE 4HE FUNDED RATIO SHOULD REMAIN IN THAT RANGE AT *UNE DESPITE AN EXPECTED LESS THAN RETURN DUE TO THE FOUR YEAR SMOOTHING OF UNREALIZED GAINS (OWEVER TO PUT 3423 /HIO ON A SOUND lNANCIAL BASIS THE 2ETIREMENT "OARD S PROPOSED LEGISLATIVE CHANGES NEED TO BE ENACTED

Fiscal 2012 Investment Plan

III. Asset Allocation/Risk Budget ASSET CLASS SUMMARIES Liquidity Reserves 4HE EXTREMELY LOW SHORT TERM INTEREST RATES SHOULD BEGIN TO RISE IN lSCAL 4HE &EDERAL 2ESERVE HAS BEEN KEEPING THESE RATES NEAR ZERO TO ENSURE THE 5 3 ECONOMY CONTINUES TO RECOVER IN THE WAKE OF THE GLOBAL CREDIT CRISIS AND h'REAT 2ECESSIONv OF AND )T IS LIKELY THE &EDERAL 2ESERVE WILL BEGIN TO REMOVE THE EXCESS LIQUIDITY AND RATES WILL RISE MODESTLY YET STILL BE STIMULATIVE TO THE ECONOMY (OWEVER RETURNS ON LIQUIDITY RESERVES WHICH WILL BE BETTER THAN lSCAL WILL STILL BE VERY LOW $ESPITE THIS LOW RETURN 3423 /HIO PLANS TO HAVE A SIGNIlCANT OVERWEIGHT IN LIQUIDITY RESERVES AS A RISK LOWERING TOOL This Investment Plan provides for raising the maximum policy range for liquidity reserves to 10% from 5% until June 30, 2012.

Fixed Income ,ONG TERM INTEREST RATES HAVE REMAINED LOW AS THE &EDERAL 2ESERVE IMPLEMENTED hQUANTITATIVE EASING ONEv 1% AND WILL COMPLETE 1% ON *UNE 7E ANTICIPATE RATES WILL RISE MODESTLY AS THE ECONOMY CONTINUES TO IMPROVE AND THE &EDERAL 2ESERVE REMOVES LIQUIDITY 4HIS RISE IN RATES WILL CAUSE PRICES ON lXED INCOME SECURITIES TO DECLINE 7E PROJECT RETURNS ON THE lXED INCOME BENCHMARK "ARCLAY S 5NIVERSAL )NDEX TO BE BELOW NORMAL FOR lSCAL 7E PLAN TO REMAIN UNDERWEIGHT IN lXED INCOME UNTIL LONG TERM RATES RISE TO THE UPPER HALF OF OUR PROJECTED RANGE 7E WOULD ANTICIPATE PLACING FUNDS IN lXED INCOME AT THAT POINT JUST AS WE DID IN lSCAL BILLION AND MILLION

Domestic and International Equities 4HE WORLDWIDE EQUITY MARKETS HAVE INCREASED APPROXIMATELY IN lSCAL AND NEARLY IN THE PAST MONTHS 7HILE THE ECONOMIC OUTLOOK INmATION EXPECTATIONS AND CORPORATE PROlTS PROVIDE A GOOD ENVIRONMENT IN lSCAL FOR EQUITIES VALUATIONS ARE NOT CHEAP )N ADDITION THE EQUITY MARKETS DO NOT APPEAR TO BE BUILDING IN A RISK PREMIUM FOR UNCERTAIN ENERGY PRICES WORLDWIDE UNREST AND GOVERNMENTAL DEBT CONTAGION !LSO THE mOOD OF LIQUIDITY PROVIDED BY THE &EDERAL 2ESERVE WHICH ENHANCED THE PRICES OF RISK ASSETS EQUITIES IS LIKELY TO END SOON 4HEREFORE WE ARE PROJECTING THAT EQUITIES WILL HAVE A BELOW NORMAL YEAR IN lSCAL

Real Estate 0ROPERTY PRICES IN THE .0) .ATIONAL #OUNCIL OF 2EAL %STATE )NVESTMENT &IDUCIARIES 0ROPERTY )NDEX HAVE INCREASED OVER THE PAST FOUR QUARTERS AND ARE APPROACHING PEAK LEVELS FOR HIGH QUALITY INVESTMENTS 2EAL ESTATE HAS BEEN A BENElCIARY OF THE LOW INTEREST RATE ENVIRONMENT IN THE PAST TWO YEARS 4HE 2%)4 2EAL %STATE )NVESTMENT 4RUST MARKET HAS BEEN EVEN STRONGER WITH PRICES UP MORE THAN IN lSCAL 3423 /HIO USED THE STRONG REAL ESTATE MARKET TO SELL PROPERTIES THAT WERE TARGETED FOR DISPOSITION YET WE HAD DIFlCULTY WITH NEW PURCHASES BASED UPON HIGH PRICES 4HUS 3423 /HIO REMAINS UNDERWEIGHT IN REAL ESTATE 7HILE WE ANTICIPATE AN ABOVE AVERAGE RETURN YEAR FOR REAL ESTATE IN lSCAL RETURNS ON NEW ACQUISITIONS WILL BE MORE IN LINE WITH THE LONG TERM RETURN OF DUE TO LAG EFFECT OF THE BENCHMARK 7E WILL CONTINUE TO PURSUE NEW ACQUISITIONS YET IN ALL LIKELIHOOD WILL REMAIN UNDERWEIGHTED

Alternative Investments 3423 /HIO HAS AGGRESSIVELY PURSUED ALTERNATIVE INVESTMENTS ESPECIALLY IN THE OPPORTUNISTIC DIVERSIlED SUBSET 2ETURNS IN ALTERNATIVES HAVE REBOUNDED RECENTLY WITH THE OVERALL STRENGTH OF THE EQUITY MARKETS 7E ANTICIPATE THIS CATEGORY WILL HAVE NORMAL RETURNS IN lSCAL 7E PLAN TO ACCELERATE OUR FUNDING IN OPPORTUNISTIC DIVERSIlED ESPECIALLY IN ABSOLUTE RETURN HEDGE FUNDS TO COMPLEMENT OUR STRATEGY OF LOWERING THE RISK OF THE TOTAL FUND

Fiscal 2012 Investment Plan

ASSET ALLOCATION AVERAGE LONG-TERM POLICY WEIGHT, ESTIMATED JUNE 2011 WEIGHT AND STRATEGY FOR FISCAL 2012 AS A PERCENTAGE OF TOTAL ASSETS AT MARKET

Average Long-Term Allocation

Estimated June 2011 Weight

100%

,IQUIDITY 2ESERVES &IXED )NCOME %QUITIES $OMESTIC )NTERNATIONAL 4OTAL %QUITIES 2EAL %STATE !LTERNATIVE )NVESTMENTS 0RIVATE %QUITY /PPORTUNISTIC $IVERSIlED

4OTAL !LTERNATIVES Total

General Strategy for Fiscal 2012* 3423 /HIO BEGINS THE NEW lSCAL YEAR WITH A SUBSTANTIAL OVERWEIGHT IN LIQUIDITY RESERVES 7E PLAN TO MAINTAIN THAT OVERWEIGHT UNTIL EQUITIES BECOME MORE ATTRACTIVE ON A RISK RETURN BASIS OR LONG TERM INTEREST RATES RISE This plan increases the maximum allowable weight to 10% until June 30, 2012. 7E ANTICIPATE THAT LONG TERM INTEREST RATES SHOULD INCREASE IN lSCAL AS THE &EDERAL 2ESERVE BEGINS TO REMOVE LIQUIDITY AND ECONOMIC RECOVERY CONTINUES 3HOULD INTEREST RATES RISE INTO THE HIGH END OF OUR PREDICTED RANGE WE WOULD PLACE FUNDS INTO lXED INCOME INVESTMENTS 7ORLDWIDE EQUITY MARKETS HAVE RISEN SINCE THE END OF THE CREDIT CRISIS AND THE h'REAT 2ECESSION v 7E PLAN TO REMAIN UNDER WEIGHT EQUITIES UNTIL MARKETS MORE FULLY DISCOUNT THE POTENTIAL UNCERTAINTIES INCLUDING THE GOVERNMENT DElCIT AND DEBT ISSUES 7E ANTICIPATE THAT PROPERTY PRICES WILL CONTINUE TO INCREASE ON QUALITY PROPERTIES IN lSCAL 7E WILL AGGRESSIVELY SEARCH FOR NEW ACQUISITIONS YET IT IS VERY LIKELY 3423 /HIO WILL REMAIN UNDERWEIGHT IN REAL ESTATE 3423 /HIO HAS AGGRESSIVELY SOUGHT ALTERNATIVE INVESTMENTS AND HAS INCREASED THE WEIGHT TO 7E PLAN TO ACCELERATE THE FUNDING OF THE OPPORTUNISTIC DIVERSIlED SEGMENT IN lSCAL TO ENHANCE OUR RISK LOWERING STRATEGY

* -ORE DETAILED ASSET WEIGHTINGS AND PROJECTIONS ARE PROVIDED TO THE 2ETIREMENT "OARD AT ITS MONTHLY MEETINGS 4HIS PROVIDES THE 2ETIREMENT "OARD MORE CURRENT UPDATES TO THE OVERALL STRATEGY RATHER THAN PLACING THEM IN THE )NVESTMENT 0LAN

/PPORTUNISTIC $IVERSIlED TARGET WEIGHT IS SCHEDULED TO INCREASE PER YEAR UNTIL A MAXIMUM TARGET WEIGHT IS OBTAINED EFFECTIVE *ULY 4HE !VERAGE ,ONG 4ERM 0OLICY 7EIGHT ABOVE REmECTS THE NEW POLICY WEIGHTS EFFECTIVE *ULY

Fiscal 2012 Investment Plan

RISK BUDGET Investment Portfolio Risk Introduction 4HERE ARE TWO PRIMARY TYPES OF INVESTMENT RISK THAT THE 2ETIREMENT "OARD AND STAFF NEED TO MANAGE CAPITAL MARKET RISK AND ACTIVE MANAGEMENT RISK 4HE lRST DESCRIBES THE VOLATILITY OF THE POLICY RETURNS AND IS A RESULT OF THE PLAN ASSETS BEING INVESTED IN THE SELECTED ASSET CLASSES 4HE LAST !SSET ,IABILITY 3TUDY DETERMINED AN ACCEPTABLE AMOUNT OF CAPITAL MARKET RISK AND ESTABLISHED APPROPRIATE ALLOCATIONS 3423 /HIO ACTIVELY MANAGES MOST OF ITS INVESTMENTS THEREFORE THE FUND WILL HAVE ACTIVE MANAGEMENT RISK 4HIS RISK REFERS TO THE RETURN mUCTUATIONS AROUND THE BENCHMARK RETURN THAT RESULT FROM ACTIVE MANAGEMENT DECISIONS 4HE AMOUNT OF ACTIVE MANAGEMENT RISK INDICATES HOW CLOSELY THE PORTFOLIO RETURNS WILL MATCH THE BENCHMARK RETURNS 4HE STAFF USES THE RISK BUDGET TO MANAGE THIS RISK !LTHOUGH ACTIVE MANAGEMENT IS A SOURCE OF VOLATILITY IT IS MUCH LOWER THAN AND UNCORRELATED WITH CAPITAL MARKET RISK 4HIS MEANS THAT ADDING ACTIVE MANAGEMENT RISK TO THE FUND WILL NOT CAUSE A LARGE INCREASE IN TOTAL FUND VOLATILITY 4HUS OVER THE LONG RUN THE ACTIONS OF THE STAFF ARE NOT EXPECTED TO CHANGE THE TOTAL VOLATILITY OF THE FUND MATERIALLY Asset Allocation and Capital Market Risk 4HE APPROPRIATE AMOUNT OF CAPITAL MARKET RISK FOR THE 3423 /HIO PORTFOLIO IS DETERMINED THROUGH AN !SSET ,IABILITY 3TUDY 4HE STUDY ESTABLISHES AN OPTIMAL TARGET WEIGHT AND WEIGHT RANGE FOR EACH ASSET CLASS 4HIS MEANS THERE IS NO OTHER COMBINATION OF ASSET CLASSES THAT HAS LOWER RISK WHILE ACHIEVING THE SAME EXPECTED RETURN WITHOUT VIOLATING THE CONSTRAINTS DECIDED UPON IN THE !SSET !LLOCATION 3TUDY #ALLAN REVIEWED THE STUDY IN -ARCH AND GENERALLY CONCURRED WITH ITS CONCLUSIONS ALTHOUGH INDICATED THE EXPECTED RETURN MIGHT BE SLIGHTLY HIGHER AT 4HE 2ETIREMENT "OARD WILL BEGIN AN !SSET ,IABILITY 3TUDY IN !UGUST 4HE FOLLOWING TABLE CONTAINS THE CURRENT AND TARGET ALLOCATIONS FOR EACH ASSET CLASS AND THE EXPECTED RETURN AND CAPITAL MARKET RISK

Asset Class

Expected Return

Capital Market Target Rebalancing Risk Allocation Range

Estimated June 2011 Weight

$OMESTIC %QUITIES

)NTERNATIONAL %QUITIES

&IXED )NCOME

2EAL %STATE

0RIVATE %QUITY

/PPORTUNISTIC $IVERSIlED

,IQUIDITY 2ESERVES

7.7%*

12.3%

Total Fund

$OES NOT INCLUDE ACTIVE MANAGEMENT RETURNS

4HIS PLAN REQUESTS A REBALANCING RANGE OF n UNTIL *UNE

4HE EXPECTED CAPITAL MARKET RISK FOR THE TOTAL INVESTMENT PORTFOLIO BENCHMARK IS WHICH MEANS THERE IS A PROBABILITY THAT THE INVESTMENT PORTFOLIO RETURNS WILL BE IN THE RANGE OF n TO !NOTHER RISK CONCEPT WE USE IS THE hVALUE AT RISK v !CCORDING TO THIS MEASURE THERE IS ON AVERAGE A CHANCE UNDER THE TARGET ALLOCATION THAT THE FUND COULD LOSE BILLION OR MORE IN A SINGLE YEAR

Fiscal 2012 Investment Plan

3TAFF IS ALLOWED TO DEVIATE FROM THE ASSET CLASS TARGET WEIGHTS WITHIN THE ALLOWABLE REBALANCING RANGES AS SPECIlED IN THE 3TATEMENT OF )NVESTMENT /BJECTIVES AND 0OLICY 4HE INVESTMENT PORTFOLIO WILL BEGIN lSCAL WITH AN UNDERWEIGHT IN EQUITIES 3INCE THIS ASSET CLASS HAS HIGHER VOLATILITY RELATIVE TO THE OTHER ASSET CLASSES THE CURRENT EXPECTED CAPITAL MARKET RISK OF THE INVESTMENT PORTFOLIO WILL BE SLIGHTLY LOWER THAN THE EXPECTED AVERAGE Risk Budgeting and Active Management Risk !CTIVE MANAGEMENT RISK REFERS TO PORTFOLIO RETURN mUCTUATIONS AROUND THE BENCHMARK RETURN THAT RESULT FROM ACTIVE MANAGEMENT DECISIONS 2ISK BUDGETING IS A TOOL USED BY STAFF TO EFlCIENTLY ALLOCATE ACTIVE MANAGEMENT RISK AMONG THE ASSET CLASSES BY ASSIGNING ACTIVE MANAGEMENT RISK RANGES 4HE GOAL OF A RISK BUDGET IS TO MAXIMIZE THE ACTIVE MANAGEMENT RETURNS EARNED WITHIN A BOARD APPROVED ACTIVE MANAGEMENT RISK RANGE FOR THE TOTAL FUND %MPIRICAL EVIDENCE SHOWS THAT LESS EFlCIENT MARKETS SUCH AS REAL ESTATE AND EMERGING MARKETS OFFER GREATER OPPORTUNITIES FOR ACTIVE MANAGEMENT RETURNS COMPARED TO MORE EFlCIENT MARKETS SUCH AS DOMESTIC EQUITIES AND DOMESTIC lXED INCOME 4HEREFORE THE ESTIMATED ACTIVE MANAGEMENT RISK FOR REAL ESTATE AND INTERNATIONAL EQUITIES SHOULD BE HIGHER THAN THE OTHER ASSET CLASSES "ASED UPON QUANTITATIVE WORK DEVELOPED BY STAFF WE ESTIMATE THAT THE TOTAL FUND LEVEL OF ACTIVE MANAGEMENT RISK IS CURRENTLY BASIS POINTS 4HE 3423 /HIO TOTAL FUND RETURN SHOULD TRACK WITHIN PLUS OR MINUS TWO TIMES THE EXPECTED ACTIVE MANAGEMENT RISK LEVEL RELATIVE TO THE TOTAL FUND COMPOSITE BENCHMARK 4HUS IF THE TOTAL FUND COMPOSITE BENCHMARK EARNS FOR THE YEAR THE 3423 /HIO RETURN IS EXPECTED TO BE WITHIN TWO TIMES OF THIS RETURN I E BETWEEN AND 3IMILARLY IN A YEAR WHEN THE BENCHMARK RETURN IS n THE 3423 /HIO RETURN IS EXPECTED TO BE BETWEEN n AND n 4HE POLICY RANGE OF ACTIVE MANAGEMENT RISK FOR THE TOTAL FUND IS ESTABLISHED TO ACHIEVE THE NET ACTIVE MANAGEMENT RETURN GOAL OF BASIS POINTS AS SPECIlED IN THE !SSET !LLOCATION 3TUDY 4HIS POLICY RANGE IS THE BASIS FOR THE POLICY RANGES OF THE INDIVIDUAL ASSET CLASSES %XPECTED OPERATING RANGES FOR THE ASSET CLASSES ARE CREATED BY STAFF EACH YEAR TO EFlCIENTLY ACHIEVE THE DESIRED LEVEL OF ACTIVE MANAGEMENT RISK FOR THE TOTAL FUND /PERATING RANGES MUST FALL WITHIN THE POLICY RANGES FOR EACH ASSET CLASS AND FOR THE TOTAL FUND 4HE TABLE ON 0AGE SHOWS THE *UNE ESTIMATE AND THE lSCAL EXPECTED OPERATING RANGE OF ACTIVE MANAGEMENT RISK FOR EACH ASSET CLASS 4HESE MEASURES ARE EXPECTED TO mUCTUATE SLIGHTLY OVER THE lSCAL YEAR HOWEVER NO MATERIAL DEVIATIONS FROM THESE MEASURES ARE ANTICIPATED 4HE ACTIVE MANAGEMENT RISK OF THE TOTAL FUND IS EXPECTED TO FALL IN THE RANGE OF TO BASIS POINTS DURING lSCAL 4HIS RANGE INCLUDES TACTICAL RISK DUE TO ASSET ALLOCATION BETS THAT IS NOT INCLUDED WITHIN THE INDIVIDUAL ASSET CLASS ACTIVE MANAGEMENT RISK ESTIMATES 4HESE ASSET ALLOCATION BETS ARE LIKELY TO VARY THROUGHOUT THE YEAR SO THIS WILL RESULT IN VARIOUS AMOUNTS OF TACTICAL RISK

Fiscal 2012 Investment Plan

FISCAL 2012 ACTIVE MANAGEMENT RISK Estimated June 2011 Active Management Risk (basis points)

Fiscal 2012 Operating Range (basis points)

Policy Range (basis points)

. !

&IXED )NCOME

$OMESTIC %QUITIES

)NTERNATIONAL %QUITIES

2EAL %STATE

!LTERNATIVE )NVESTMENTS

. !

4ACTICAL !SSET !LLOCATION

. !

Total Fund

60â&#x20AC;&#x201C;95

20â&#x20AC;&#x201C;160

Asset Class ,IQUIDITY 2ESERVES

!S EXPLAINED IN THE PARAGRAPH BELOW THIS ESTIMATE IS STATIC UNLESS A SIGNIlCANT PORTFOLIO ADJUSTMENT OCCURS

5NLIKE OTHER ASSET CLASSES REAL ESTATE DOES NOT HAVE A MODEL THAT CAN BE USED TO ACCURATELY ESTIMATE ACTIVE MANAGEMENT RISK )NSTEAD THE ESTIMATE IS BASED ON HISTORICAL ACTIVE MANAGEMENT RETURNS THE AMOUNT OF LEVERAGE IN THE PORTFOLIO AND PAST REAL ESTATE MARKET VOLATILITY 4HESE FACTORS ARE UNLIKELY TO CHANGE MUCH OVER TIME WITHOUT A SIGNIlCANT CHANGE TO THE PORTFOLIO THEREFORE THE ESTIMATED ACTIVE MANAGEMENT RISK FOR REAL ESTATE WILL BE STATIC MOST YEARS 4HE CHART BELOW EXPLAINS WHERE THE ACTIVE MANAGEMENT RISK FOR THE TOTAL FUND IS GENERATED

CONTRIBUTION TO ACTIVE MANAGEMENT RISK 50%

45%

40%

35%

30%

29%

25%

20%

14%

15%

10%

Domestic Equities

International Equities

Fixed Income

Real Estate

Private Equity

Opportunistic/ Diversified

Liquidity Reserves

Tactical Asset Allocation

Fiscal 2012 Investment Plan

7ITH THIS )NVESTMENT 0LAN WE ARE INCLUDING THE CURRENT %NTERPRISE 2ISK -ANAGEMENT %2- INVESTMENT MATRIX 7E WILL UPDATE IT AS NEEDED THROUGHOUT THE YEAR 'IVEN THE ITEMS IN THE UPPER LEFT FOUR QUADRANTS 3423 /HIO IS ATTEMPTING TO LOWER THE OVERALL RISK OF THE TOTAL FUND INCLUDING USING A HIGHER LIQUIDITY RESERVE POLICY RANGE

IMPACT AND PROBABILITY ANALYSIS FOR INVESTMENTS PROBABILITY HIGH

MEDIUM

HIGH

s 'LOBAL &INANCIAL #RISIS 'OVERNMENT $EBT #ONTAGION

LOW s 0OOR !SSET #LASS 2ETURNS ,ONG 4ERM s $IVERSIlCATION )NEFFECTIVE

s .OT %ARNING ,ONGER 4ERM

MEDIUM

s 'LOBAL &INANCIAL 0ROBLEMS

s $OUBLE $IP 2ECESSION s $EmATION s ,ONG 4ERM )NmATION 'REATER 4HAN

s .OT %ARNING IN A &ISCAL 9EAR

LOW

FINANCIAL IMPACT

s #ORPORATE &RAUD 3ECURITIES ,ITIGATION

s )MPRUDENT OR 0OOR )NVESTMENT

s "UY /HIO

s %THICS 6IOLATIONS

s $IVESTMENT s )NVESTMENT /PERATIONS &AILURES

Fiscal 2012 Investment Plan

IV. Fiscal 2012 Economic Outlook U.S. ECONOMIC GROWTH AND INFLATION OUTLOOK 4HE h'REAT 2ECESSIONv OFlCIALLY ENDED IN *UNE AFTER A YEAR AND A HALF SLUMP )N THE POST 7ORLD 7AR )) PERIOD PRIOR RECESSIONS HAD AVERAGED ROUGHLY HALF THAT LENGTH OF TIME &URTHERMORE THE PEAK TO TROUGH DECLINE IN REAL INmATION ADJUSTED '$0 DURING THE RECENT RECESSION WAS MAKING IT THE STEEPEST OUTPUT DROP SINCE THE END OF 7ORLD 7AR )) %CONOMIC ACTIVITY FOLLOWING DEEP RECESSIONS TYPICALLY REBOUNDS WITH A QUICK SURGE OF GROWTH (OWEVER THE LATEST RECOVERY TO THIS DEEP RECESSION DISAPPOINTED ON NEARLY ALL ACCOUNTS Â&#x2C6; UNTIL THE SECOND QUARTER OF THE CURRENT lSCAL YEAR WHEN A SOLID ECONOMIC EXPANSION WITH MORE BREADTH lNALLY DEVELOPED $URING THE lRST lVE QUARTERS OF THE ECONOMIC EXPANSION REAL '$0 GROWTH AVERAGED AN ANNUALIZED Â&#x2C6; MODESTLY ABOVE THE ECONOMY S LONGER TERM POTENTIAL GROWTH RATE OF ROUGHLY %CONOMIC GROWTH IN lSCAL WAS AND WAS FOLLOWED BY A SLOWER BUT STILL MODERATE ANNUALIZED GROWTH RATE IN THE lRST QUARTER OF lSCAL (OWEVER BUSINESS INVENTORY GROWTH ACCOUNTED FOR MOST OF THE ADVANCE IN THE ECONOMY Â&#x2C6; A SITUATION THAT NORMALLY IS NOT CONDUCIVE TO FUTURE ECONOMIC GROWTH BECAUSE OF THE MISMATCH IT CREATES BETWEEN SUPPLY AND DEMAND 2EAL lNAL SALES ECONOMIC GROWTH EXCLUDING THE CHANGE IN INVENTORIES GREW A WEAK ANNUALIZED RATE IN THE lRST lVE QUARTERS OF THE RECOVERY LEAVING THE INVENTORY BUILDUP ACCOUNTING FOR NEARLY TWO THIRDS OF TOTAL ECONOMIC ACTIVITY 4HAT CHANGED IN THE SECOND QUARTER OF lSCAL 7HILE TOTAL ECONOMIC GROWTH IMPROVED TO A ANNUALIZED RATE REAL lNAL SALES SOARED TO A YEAR HIGH OF 2OBUST CONSUMER SPENDING DURING THE HOLIDAY SHOPPING SEASON AN IMPRESSIVE IMPROVEMENT IN THE COUNTRY S TRADE BALANCE FROM STRONG EXPORT GROWTH AND AN UNUSUAL DROP IN IMPORT GROWTH STRONG BUSINESS INVESTMENT IN EQUIPMENT AND EVEN A MARGINAL GAIN IN THE DISTRESSED HOUSING SECTOR OFFSET THE SIGNIlCANT SLOWDOWN IN INVENTORY ACCUMULATION AND NEGATIVE FEDERAL STATE AND LOCAL GOVERNMENT SPENDING 4HIS COMBINATION OF ECONOMIC SECTORS DROVE lNAL DEMAND HIGHER AND SUGGESTED AS IT DID IN WHEN THAT EXPANSION GAINED TRACTION THAT THE ECONOMY HAD ENTERED A NEW STRONGER PHASE BEYOND THE DISAPPOINTING SLOW RECOVERY TO THE h'REAT 2ECESSION v (OWEVER THE ECONOMY AGAIN FACED A SETBACK IN THE THIRD lSCAL QUARTER AS SOARING ENERGY AND FOOD COSTS ATE AWAY AT DISCRETIONARY CONSUMER SPENDING AND GEOPOLITICAL CRISES PLAYED OUT IN THE OIL PRODUCING -IDDLE %AST ! SEVERE EARTHQUAKE AND TSUNAMI IN *APAN LATE IN THE QUARTER CONTRIBUTED ADDITIONAL SHOCKS TO THE 5 3 AND GLOBAL ECONOMIES 2EAL '$0 GREW JUST AT AN ANNUAL RATE WHILE REAL lNAL SALES HARDLY ADVANCED AT ALL GROWING JUST )NCREASINGLY HEADLINE INmATION WAS HURTING REAL ECONOMIC GROWTH AND DAMAGING CONSUMER CONlDENCE "ECAUSE THE HOUSING SECTOR WILL LIKELY CONTINUE TO SEE ONLY SLOW PROGRESS INTO lSCAL AND GOVERNMENT BODIES INCREASINGLY FACE lSCAL AUSTERITY 5 3 ECONOMIC PROSPECTS WILL CONTINUE TO BE HEAVILY DEPENDENT UPON CONSUMER SPENDING BUSINESS lXED INVESTMENT AND TO SOME EXTENT INTERNATIONAL TRADE 4HE MOST IMPORTANT ECONOMIC SECTOR WILL BE CONSUMER SPENDING AND IT WILL LARGELY DEPEND UPON STRONGER EMPLOYMENT AND INCOME GAINS 7HILE THE COUNTRY S UNEMPLOYMENT RATE STEADILY MOVED HIGHER TO START lSCAL PEAKING AT IN .OVEMBER THERE HAS BEEN SIGNIlCANT IMPROVEMENT IN EMPLOYMENT OVER RECENT MONTHS 4HE UNEMPLOYMENT RATE FELL A PERCENTAGE POINT TO IN -ARCH AND PRIVATE PAYROLL GROWTH AVERAGED A MODERATE GAIN A MONTH BEFORE THE UNEMPLOYMENT RATE EDGED UP TO IN !PRIL WHILE PRIVATE PAYROLL GROWTH SOARED TO A GAIN OF 3TILL THE UNEMPLOYMENT RATE REMAINS VERY HIGH AND JOB GROWTH NEEDS TO BE MUCH STRONGER TO SIGNIlCANTLY IMPROVE LABOR CONDITIONS (OWEVER THIS RATE ALONG WITH VIRTUALLY ALL OTHER JOB MARKET SURVEYS AND INDICATORS HAS STARTED MOVING IN THE RIGHT DIRECTION

Fiscal 2012 Investment Plan

TOWARD BETTER EMPLOYMENT AND ULTIMATELY BETTER WAGE GROWTH IN lSCAL .EVERTHELESS BECAUSE OF ONGOING DELEVERAGING IN THE CONSUMER AND BUSINESS SECTORS AND THE NEED TO REBUILD LOST WEALTH FROM THE HOUSING AND lNANCIAL MARKET COLLAPSES GROWTH IN CONSUMER SPENDING WILL LIKELY REMAIN ONLY SLIGHTLY ABOVE LONGER TERM POTENTIAL RATHER THAN SURGE FORWARD 2EAL SPENDING IS EXPECTED TO GROW IN lSCAL MATCHING ITS PACE FROM lSCAL #ONSUMER SPENDING IN THE lNAL QUARTER OF THE CURRENT lSCAL YEAR AND lRST HALF OF lSCAL IS EXPECTED TO GROW AROUND BEFORE SLOWING IN THE SECOND HALF OF THE lSCAL YEAR TOWARD WHEN SOME BENElCIAL TAX CHANGES EXPIRE "USINESS lXED INVESTMENT WILL ALSO NEED TO BE A MAJOR CONTRIBUTOR TO ECONOMIC ACTIVITY OVER THE NEXT YEAR AND A HALF TO AVOID ANOTHER SLOWDOWN LIKE THAT SEEN LAST SPRING AND SUMMER 4HOUGH INVESTMENT IN STRUCTURES WILL NOT ADD A GREAT DEAL TO ECONOMIC ACTIVITY BUSINESS SPENDING ON CAPITAL EQUIPMENT HAS BEEN ROBUST AND WILL LIKELY CONTINUE TO CONTRIBUTE TO OVERALL GROWTH !FTER THE BROAD BASED SLOWDOWN LAST YEAR BOTH MANUFACTURING AND NONMANUFACTURING ACTIVITY HAVE SOARED ,ARGER COMPANIES HAVE DONE BETTER THAN SMALLER COMPANIES BUT EVEN AMONG SMALL COMPANIES OPTIMISM HAS MOVED INTO EXPANSION TERRITORY SINCE LAST FALL )MPROVING BUSINESS OUTLOOKS WILL KEEP BUSINESS INVESTMENT IN CAPITAL EQUIPMENT STRONG THROUGH lSCAL 4OTAL REAL BUSINESS INVESTMENT IS EXPECTED TO GROW IN lSCAL AFTER A GAIN IN THE CURRENT lSCAL YEAR 7HILE STRUCTURES INVESTMENT IS EXPECTED TO GROW ONLY EQUIPMENT INVESTMENT SHOULD ADVANCE BY ROUGHLY &OREIGN TRADE WILL LIKELY IMPROVE MODESTLY IN lSCAL AFTER THE TRADE WEIGHTED DOLLAR DEPRECIATED ROUGHLY DURING THE lRST MONTHS OF lSCAL 4HOUGH THE TERMS OF TRADE HAVE IMPROVED FROM AN 5 3 PERSPECTIVE ECONOMIC GROWTH IS GOING TO BE UNEVEN ACROSS COUNTRIES -OST DEVELOPED COUNTRIES WILL GROW AT A MODERATE TREND LIKE PACE WHILE MOST EMERGING COUNTRIES ARE GOING TO SOFTEN MARGINALLY FROM THEIR RECENT TORRID ECONOMIC GROWTH 2EAL EXPORTS ARE EXPECTED TO GROW AFTER AN INCREASE IN THE CURRENT lSCAL YEAR WHILE REAL IMPORTS SHOULD GROW AFTER A ADVANCE THIS YEAR !S A RESULT REAL NET EXPORTS ARE FORECASTED TO IMPROVE SLIGHTLY FROM NEARLY A BILLION DElCIT IN lSCAL TO A BILLION DElCIT NEXT lSCAL YEAR -ODERATE OVERALL ECONOMIC GROWTH WILL LIKELY CONTINUE THROUGH THE END OF lSCAL 4HE 3423 /HIO ECONOMIC FORECAST PROJECTS THAT REAL '$0 GROWTH IN THE lRST HALF OF THE lSCAL YEAR WILL BE STRONGER THAN IN THE SECOND HALF AFTER SOME ADVANTAGEOUS TAX POLICIES EXPIRE 2EAL '$0 IS EXPECTED TO GROW IN THE lRST HALF OF THE lSCAL YEAR BEFORE YIELDING TO A SLOWER PACE IN THE SECOND HALF Â&#x2C6; AVERAGING OUT TO A ADVANCE IN REAL ECONOMIC ACTIVITY FOR THE ENTIRE lSCAL YEAR THAT IS ROUGHLY IN LINE WITH THE ECONOMY S LONGER TERM POTENTIAL GROWTH RATE

Fiscal 2012 Investment Plan

REAL GROSS DOMESTIC PRODUCT (GDP) VERSUS ONE YEAR AGO lSCAL YEAR BASIS 10%

-2%

-4%

-6%

613 1963 633 1961

653 673 113 1965 1967 693 1969 713 1971 733 1973 753 1975 773 1977 793 1979 813 1981 833 1983853 1985873 1987893 1989913 1991933 1993 953 1995 973 1997 993 1999 013 2001 033 2003 053 2005 073 2007 093 2009 2011

'$0 &ORECASTED '$0

Note: Shaded areas denote recession.

7HILE THE CYCLICAL DYNAMICS OF THE 5 3 ECONOMY HAVE IMPROVED LONGER TERM STRUCTURAL OBSTACLES REMAIN THAT WILL ACT AS AN ONGOING HEADWIND TO ECONOMIC ACTIVITY 5 3 GOVERNMENT DEBT HAS GROWN RAPIDLY IN RECENT YEARS DUE PRIMARILY TO THREE FACTORS AN IMBALANCE BETWEEN REVENUES AND SPENDING THAT WAS OCCURRING BEFORE THE MOST RECENT RECESSION MUCH LOWER REVENUE GROWTH AND ELEVATED SPENDING IN MANDATORY PROGRAMS LIKE UNEMPLOYMENT INSURANCE DURING THE RECESSION AND THE HIGH COSTS OF FEDERAL lSCAL POLICIES THAT WERE IMPLEMENTED TO lGHT THE RECESSION AND SPARK AN ECONOMIC RECOVERY 4HOSE FACTORS HAVE DRIVEN FEDERAL DEBT COMPARED TO TOTAL ECONOMIC OUTPUT TO ITS HIGHEST LEVELS EXCEPT FOR THE PERIOD AROUND 7ORLD 7AR )) IN 5 3 ECONOMIC HISTORY 4YPICALLY AFTER AN ECONOMIC SHOCK LIKE THE ONE WE EXPERIENCED IN n A STRONG ECONOMIC TURNAROUND GENERATES MUCH HIGHER REVENUE GROWTH AND COUNTERCYCLICAL SPENDING FALLS OFF CREATING A FAR BETTER DElCIT AND DEBT ENVIRONMENT 9ET THE RECOVERY FROM THE h'REAT 2ECESSIONv AND lNANCIAL COLLAPSE HAS ONLY BEEN MODERATE LEAVING DElCITS AND THEIR CONTRIBUTIONS TO THE NATION S DEBT AT HISTORICALLY HIGH LEVELS &URTHER INCREASES IN FEDERAL DEBT TO NOMINAL OUTPUT LIE AHEAD IF CURRENT ENTITLEMENT AND TAX POLICIES REMAIN IN PLACE 4HE AGING POPULATION FROM "ABY "OOMERS REACHING RETIREMENT AGE THIS YEAR AND FEWER WORKERS PER RETIREE OVER THE NEXT TWO DECADES WILL PLACE A HUGE STRAIN ON THE FEDERAL GOVERNMENT TO PAY OFF THE PROMISED BENElTS ESPECIALLY IN THE MIDST OF RISING HEALTH CARE COSTS 3OCIAL 3ECURITY WAS CREATED WHEN THE COUNTRY HAD ROUGHLY WORKERS TO CONTRIBUTE TO EACH PERSON S RETIREMENT -EDICARE WAS IMPLEMENTED WHEN THERE WERE ABOUT WORKERS PER RETIREE 4ODAY THERE ARE ONLY ABOUT lVE WORKERS PER RETIREE /VER THE NEXT TWO DECADES THAT NUMBER WILL FALL TO ROUGHLY THREE BEFORE STABILIZING 4HE UPCOMING DEMOGRAPHIC CHANGES FOR THE COUNTRY CARRY HUGE RAMIlCATIONS FOR FUTURE FEDERAL GOVERNMENT SPENDING AND TAXATION TO SUPPORT THAT SPENDING /VER THE PAST TWO DECADES *APAN HAS GONE THROUGH A SIMILAR DEMOGRAPHIC SHIFT Â&#x2C6; ONE THAT COINCIDED WITH ABYSMAL AVERAGE REAL '$0 GROWTH OF LESS THAN PER YEAR *APAN S GROSS FEDERAL DEBT TO NOMINAL '$0 IS CURRENTLY PUSHING UP TOWARD

Fiscal 2012 Investment Plan

)NEFFECTIVE lSCAL AND MONETARY POLICY STIMULUS AND UNSUPPORTIVE DEMOGRAPHIC TRENDS HAVE KEPT A HEAVY HAND ON POTENTIAL *APANESE ECONOMIC GROWTH DURING THE PAST YEARS 4HE DANGER FOR THE 5NITED 3TATES IS THAT IT IS APPROACHING SOME OF THE SAME PROBLEMS IN THE NEXT TWO DECADES THAT THE *APANESE EXPERIENCED DURING THE PAST TWO DECADES ,IKE *APAN THE COUNTRY S DEBT SITUATION COULD EASILY AND QUICKLY REACH UNSUSTAINABLE LEVELS THAT WEIGH ON THE ECONOMY 2ECENTLY 3TANDARD AND 0OOR S LOWERED THE OUTLOOK FOR 5 3 DEBT AS IT WARNED THAT THE COUNTRY S lSCAL PATH CANNOT CONTINUE WITHOUT FORCING A FUTURE DOWNGRADE OF ITS EXCEPTIONAL CREDIT 0ERSISTENT DElCITS AND CONTINUALLY MOUNTING DEBT WOULD HAVE SEVERAL NEGATIVE ECONOMIC CONSEQUENCES FOR THE 5NITED 3TATES &OR INSTANCE A GROWING PORTION OF THE COUNTRY S SAVINGS WOULD GO TOWARD PURCHASING GOVERNMENT DEBT INSTEAD OF BEING INVESTED IN PRODUCTIVE CAPITAL GOODS THAT ALLOW THE ECONOMY TO GROW AT GREATER NONINmATIONARY RATES )N TURN THAT hCROWDING OUTv OF CAPITAL INVESTMENT LEADS TO LOWER ECONOMIC OUTPUT AND INCOME GROWTH THAN IF THE SAVINGS HAD GONE TOWARD PRODUCTIVE EQUIPMENT 3OARING INTEREST COSTS ON THE EVER GROWING PUBLIC DEBT COULD ALSO FORCE POLICYMAKERS TO RAISE MARGINAL TAX RATES 4HAT IN TURN WOULD DISCOURAGE WORK AND SAVING WHILE FURTHER REDUCING ECONOMIC OUTPUT AND ULTIMATELY FORCE SPENDING CUTS IN GOVERNMENT PROGRAMS -OST IMPORTANTLY UNCONTROLLED AND RISING DEBT WILL INCREASINGLY RESTRICT THE ABILITY OF POLICYMAKERS TO USE lSCAL POLICY RESPONSES FOR FUTURE ECONOMIC DOWNTURNS AND CRISES "ESIDES THE ECONOMIC CONSEQUENCES THAT COULD PLAY OUT OVER LONGER PERIODS THE 5NITED 3TATES RUNS THE RISK OF SHAKING INVESTORS CONlDENCE IN THE GOVERNMENT S ABILITY TO MANAGE ITS BUDGET 4HE %UROPEAN SOVEREIGN DEBT CRISIS OF THE PAST YEAR IS A WARNING SIGN FOR THE WORLD S LARGEST AND SAFEST ECONOMY WHOSE CURRENCY IS THE STANDARD FOR INTERNATIONAL TRANSACTIONS THAT IT TOO IS VULNERABLE TO DISRUPTIONS !N ABRUPT LOSS OF CONlDENCE LIKE THAT EXPERIENCED IN 'REECE )RELAND AND 0ORTUGAL WOULD LEAD TO A SUDDEN SHARP INCREASE IN INTEREST RATES ON GOVERNMENT DEBT Â&#x2C6; EXACERBATING THE UNDERLYING DEBT PROBLEM AND WEIGHING ON THE VALUE OF THE DOLLAR ! RESULTING SURGE IN IMPORTED INmATION COULD NEGATIVELY FEED BACK INTO EVEN HIGHER INTEREST RATES THAT SPIRAL UPWARD CREATING FURTHER PROBLEMS FOR THE 5 3 ECONOMY .ORMALLY lSCAL CRISES HAPPEN DURING ECONOMIC DOWNTURNS AND AMPLIFY THE NEEDED BUT DIFlCULT lSCAL POLICY ADJUSTMENTS (EALTHIER ECONOMIC CLIMATES CAN HIDE MANY lSCAL POLICY PROBLEMS 4ODAY THE 5 3 ECONOMY IS STUCK SOMEWHERE IN BETWEEN THOSE TWO ECONOMIC ENVIRONMENTS AND IT S STUCK THERE WHILE DEBT TO '$0 RATIOS STEADILY MOVE INTO UNSEEN TERRITORY 4HE LONGER THE COUNTRY WAITS TO ADDRESS ITS DEMOGRAPHIC AND ENTITLEMENT ISSUES THE MORE LIKELY A TIPPING POINT FOR A lSCAL CRISIS WILL APPROACH 7HEN A lSCAL CRISIS DOES DEVELOP POLICYMAKERS ARE FORCED BY SPOOKED INVESTORS TO ENACT SPENDING CUTS AND TAX INCREASES WELL BEYOND THOSE THAT WOULD HAVE BEEN NECESSARY WITH EARLIER SOLUTIONS 4HE COUNTRY S ONGOING DEBT PROBLEMS WILL WEIGH ON ECONOMIC GROWTH FOR YEARS TO COME LIMITING UPSIDE POTENTIAL FOR AN ECONOMY THAT DESPERATELY NEEDS STRONGER GROWTH TO UNDUE THE PROBLEMS CREATED BY THE lNANCIAL COLLAPSE OF n &URTHERMORE THE SOVEREIGN DEBT ISSUES THREATEN TO HINDER ECONOMIC GROWTH BEYOND THIS DECADE IF POLICYMAKERS DO NOT lND A BETTER BALANCE BETWEEN SPENDING AND TAXATION

Fiscal 2012 Investment Plan

CONSUMER PRICE INDEX (CPI) AND GDP PRICE INDEX VERSUS ONE YEAR AGO lSCAL YEAR BASIS 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% 1961 1963

1965 1967 1969 1971 1973 1975

1977 1979 1981 1983 1985 1987 1989

1991

1993 1995

1997

1999

2001 2003

2005

2007 2009 2011

#0) '$0 0RICE )NDEX &ORECASTED #0) &ORECASTED '$0 0RICE )NDEX

Note: Shaded areas denote recession.

4HE INmATION ENVIRONMENT ALSO HAS CHANGED DRAMATICALLY &ROM ITS TROUGH BEFORE THE END OF THE RECESSION COMMODITY PRICES HAVE MOVED BROADLY HIGHER Â&#x2C6; EVEN ACCELERATING DURING THE CURRENT lSCAL YEAR -UCH OF THE INCREASE CAN BE ATTRIBUTED TO THE RETURN OF 5 3 AND FOREIGN DEMAND FOR SCARCE ENERGY INDUSTRIAL AND AGRICULTURAL COMMODITIES TO FEED MORE RAPIDLY GROWING ECONOMIES 4HE INCREASE IN COMMODITY PRICES HAS LED TO A SURGE IN PRODUCER PRICES BUT IT HAS ONLY SPARINGLY BEEN PASSED THROUGH TO CORE CONSUMER PRICES OR BROADER ECONOMY WIDE MEASURES OF INmATION 7HILE PRODUCER PRICES GREW AN ANNUALIZED IN THE lRST THREE QUARTERS OF THE lSCAL YEAR MOST OF THAT GAIN OCCURRED IN THE LAST TWO QUARTERS WHEN THEY ADVANCED BY AT AN ANNUAL RATE #ORE PRODUCER PRICES THAT EXCLUDE VOLATILE ENERGY AND FOOD COSTS ROSE AT ONLY A ANNUAL RATE DURING THE PAST TWO QUARTERS CONlRMING THAT MOST OF THE PRICE PRESSURES ARE COMING FROM ENERGY AND FOOD COSTS -EANWHILE CONSUMER PRICES GREW AN AVERAGE IN THE lRST HALF Â&#x2C6; ROUGHLY AT THE &EDERAL 2ESERVE S PREFERRED TARGET FOR INmATION Â&#x2C6; BUT SOARED TO A ANNUALIZED RATE IN THE THIRD lSCAL QUARTER !S WITH CORE PRODUCER PRICES CORE CONSUMER PRICES GREW AT JUST A ANNUAL RATE IN THE THIRD lSCAL QUARTER 4HE THREAT FROM SWELLING COMMODITY PRICES IS OFFSET SOMEWHAT BY A HUGE OUTPUT GAP AND LOW WAGE EXPECTATIONS 4HE OUTPUT GAP MEASURES THE DIFFERENCE BETWEEN ACTUAL ECONOMIC ACTIVITY AND POTENTIAL ACTIVITY !T MID lSCAL YEAR THE OUTPUT GAP WAS ROUGHLY Â&#x2C6; MEANING THE REAL '$0 LEVEL WAS THAT AMOUNT BELOW ITS POTENTIAL LEVEL 4HAT IS AN IMPROVEMENT FROM THE NEARLY GAP REGISTERED A YEAR BEFORE BUT HISTORICALLY IT REMAINS QUITE LARGE 4YPICALLY CHANGES IN THE OUTPUT GAP PRECEDE CHANGES IN INmATION BY ONE TO TWO YEARS )N FACT UNTIL THE GAP CLOSES COMPLETELY AND TURNS TOWARD ACTUAL ACTIVITY EXCEEDING POTENTIAL LEVELS INmATION PRESSURES WILL LIKELY REMAIN RELATIVELY WELL BEHAVED "ECAUSE TODAY S OUTPUT GAP IS SO LARGE MOST OF THE COMMODITY PRICE PRESSURES WILL NOT LIKELY BE PASSED ON TO CONSUMERS FOR SOME TIME 4HERE IS A GREAT DEAL OF EXCESS CAPACITY IN THE ECONOMY THAT HAS YET TO BE SWALLOWED UP BY GROWING DEMAND THAT WOULD ALLOW INmATION PRESSURES TO STICK !T THE SAME TIME

Fiscal 2012 Investment Plan

CONSUMERS REMAIN QUITE PRICE CONSCIOUS WAGE INCREASES HAVE ONLY BEEN MODERATE DURING THIS PERIOD OF HIGH UNEMPLOYMENT AND PRODUCTIVITY GAINS HAVE BEEN STRONG HOLDING DOWN UNIT LABOR COSTS FOR BUSINESSES FACING HIGHER COMMODITY PRICE INPUTS )N ADDITION INmATION EXPECTATIONS IN THE lNANCIAL MARKETS AND IN CONSUMER SURVEYS REMAIN WELL ANCHORED 4HE RECENT SURGE IN HEADLINE INmATION INDICATORS FROM LARGELY ENERGY AND FOOD COSTS SHOULD EASE AS THE ECONOMY MOVES THROUGH lSCAL 4HOUGH THERE MAY CONTINUE TO BE GEOPOLITICAL SHOCKS IN SENSITIVE ENERGY PRODUCING REGIONS IN THE UPCOMING YEAR CORE INmATION WILL LIKELY REMAIN BEHAVED 4HE INCREASE IN PRODUCER PRICES EXPECTED FOR lSCAL SHOULD EASE TO IN lSCAL #ONSUMER PRICES ARE EXPECTED TO RETURN TO AN ACCEPTABLE RANGE FROM THE &EDERAL 2ESERVE S PERSPECTIVE OF ABOUT IN lSCAL AFTER A INCREASE THIS lSCAL YEAR "ROADER MEASURES OF INmATION THAT BEHAVE MORE LIKE CORE INmATION MEASURES WILL MODESTLY MOVE HIGHER &OR INSTANCE THE '$0 PRICE INDEX SHOULD GROW ONLY IN lSCAL AFTER A INCREASE THIS lSCAL YEAR !LONG WITH A RENEWED FOCUS AT THE FEDERAL STATE AND LOCAL GOVERNMENT LEVELS TOWARD lSCAL AUSTERITY THE &EDERAL 2ESERVE S CAMPAIGN TO SUPPORT ECONOMIC ACTIVITY THROUGH MORE AND MORE ACCOMMODATIVE MONETARY POLICIES IS ENDING $ISCUSSIONS AT THE &EDERAL 2ESERVE IN THE MONTHS AHEAD WILL FOCUS ON WHEN AND HOW TO TIGHTEN lNANCIAL CONDITIONS !N OVERT ACTION TO RAISE INTEREST RATES IS PROBABLY NOT IN THE CARDS BEFORE MID lSCAL AT THE EARLIEST BECAUSE THE UNEMPLOYMENT RATE WILL LIKELY REMAIN ELEVATED AND CORE INmATION SHOULD STAY BELOW THE &EDERAL 2ESERVE S PREFERRED RATE OF ROUGHLY .EVERTHELESS FURTHER QUANTITATIVE EASING WILL NOT EXTEND INTO lSCAL UNLESS ANOTHER CRISIS DEVELOPS IN MAJOR ECONOMIES 7HEN THE TIME COMES FOR THE &EDERAL 2ESERVE TO TIGHTEN MONETARY POLICY IT WILL LIKELY DO SO WITH SIMULTANEOUS INCREASES IN THE RATE PAID ON EXCESS RESERVES AND THE RATE ON FEDERAL FUNDS LEAVING THE lNANCIAL MARKETS TO DETERMINE APPROPRIATE LONGER TERM INTEREST RATES 4HE &EDERAL 2ESERVE COULD INITIALLY REPLACE SECURITIES ON ITS BALANCE SHEET FROM ITS 1% POLICY AS THEY MATURE LIKE IT HAS DONE WITH 1% BUT BY MID lSCAL IT WILL LIKELY HAVE SIGNALED THAT IT WILL SOON STOP EVEN THAT POLICY ! CONCERTED MOVE TOWARD MONETARY POLICY TIGHTENING HOWEVER IS LIKELY ABOUT A YEAR AWAY GIVEN THE EXPECTED SLOW IMPROVEMENT IN ECONOMIC FUNDAMENTALS AND THE LACK OF A SUSTAINED THREAT TO CORE INmATION MEASURES FROM ENERGY AND FOOD COSTS -ONETARY POLICY WILL LIKELY CHANGE ONLY SLOWLY WITH SHORT TERM INTEREST RATES RAISED BY BASIS POINTS OR SO IN THE SECOND HALF OF THE lSCAL YEAR FROM TODAY S NEAR ZERO RATE

Fiscal 2012 Investment Plan

INTEREST RATES 4REASURY .OTE 9IELD AND &EDERAL &UNDS 2ATE lSCAL YEAR BASIS 20 20% 18 18% 16 16% 14 14% 12 12% 10 10% 8 8% 6 6% 4 4% 2 2% 0 0%

1961 633 1963 653 1965 673 1967 693 1969 1971 1993 953 1995 973 1997 993 1999 013 2001 033 2003 053 2005 073 2007093 2009113 2011 613 713 1973 733 1975 753 1977 773 1979 793 1981 813 1983 833 1985 853 1987 873 1989 893 1991 913 933

&EDERAL &UNDS 2ATE 4REASURY .OTE 9IELD

Note: Shaded areas denote recession.

Period

Federal Funds Rate

10-Year Treasury Yield

&ISCAL 2ANGES

.OTE 4HE RANGES LISTED ANTICIPATE CAPTURING OF THE DAILY CLOSES DURING THE PERIOD DESCRIBED "RIEF EXCURSIONS ABOVE OR BELOW THESE RANGES THAT ARE QUICKLY REVERSED SHOULD NOT BE CONSIDERED VIOLATIONS OF THE FORECAST

"ECAUSE THE ECONOMY HAS STRENGTHENED IN RECENT MONTHS THE RISKS TO THE BASELINE CYCLICAL FORECAST OF NEAR POTENTIAL ECONOMIC GROWTH WITH CONTAINED CORE INmATION ARE NOW MORE EVENLY SPREAD AROUND THE BASELINE FORECAST 4HERE CONTINUE TO BE A VARIETY OF DOWNSIDE RISKS THAT WILL KEEP A LID ON THE ECONOMY S EXPANSION INTO lSCAL Â&#x2C6; AMONG THEM THE WEAK HOUSING INDUSTRY CONTINUED DELEVERAGING MODEST HIRING AND BANK LENDING lSCAL RESTRAINT AND DEVELOPMENTS ABROAD (OWEVER CYCLICAL GROWTH PROSPECTS HAVE IMPROVED ADDING UPSIDE RISKS FOR THE lRST TIME IN THIS EXPANSION TO THE ECONOMIC FORECAST FOR THE REMAINDER OF lSCAL AND lSCAL 9ET LONGER TERM STRUCTURAL PROBLEMS REMAIN FROM DEVELOPED COUNTRIES THAT ARE ADAPTING TO SLOWER LONGER TERM GROWTH PROSPECTS LEAVING THE GLOBAL ECONOMY VULNERABLE TO ADDITIONAL SHOCKS FROM %UROPE S AND !MERICA S DEBT PROBLEMS POLITICAL UNREST IN THE -IDDLE %AST AND EVEN NATURAL DISASTERS LIKE *APAN HAS FACED !S A RESULT POSITIVE CYCLICAL TRENDS AND DEVELOPMENTS NEED TO BE TEMPERED BY LONGER TERM CONCERNS

Fiscal 2012 Investment Plan

U.S. ECONOMIC FORECAST Fiscal Year Ranges

FY 2012

FY 2012 H1 H2

FY 2011

FY 2011 H1 H2

FY 2010

'ROSS $OMESTIC 0RODUCT

0ERSONAL #ONSUMPTION

.ONRESIDENTIAL )NVESTMENT

2ESIDENTIAL )NVESTMENT

%XPORTS OF 'OODS 3ERVICES

)MPORTS OF 'OODS 3ERVICES

&EDERAL #ONSUMPTION )NVESTMENT

3TATE ,OCAL #ONSUMPTION )NVESTMENT

&INAL 3ALES

$OMESTIC &INAL 3ALES

2EAL $ISPOSABLE 0ERSONAL )NCOME

.OMINAL '$0 #ORPORATE 0ROlTS

!FTER 4AX

0RODUCER 0RICE )NDEX

#ONSUMER 0RICE )NDEX

#HAIN 7EIGHTED '$0 0RICE )NDEX

'$0 )MPLICIT 0RICE $EmATOR

Composition of Real GDP

Incomes

Prices

Other Key Measures 2EAL .ET %XPORTS "

2EAL #HANGE IN "USINESS )NVENTORIES "

,IGHT 6EHICLE 3ALES -

.EW (OUSING 3TARTS -

5NEMPLOYMENT 2ATE

)NDUSTRIAL 0RODUCTION

.OTE !VERAGING THE HALF YEAR AVERAGE GROWTH RATES APPROXIMATES THE 1 1 GROWTH RATES

Fiscal 2012 Investment Plan

INTERNATIONAL ECONOMIC GROWTH AND INFLATION OUTLOOK 4HE BUSINESS EXPANSION IN DEVELOPED COUNTRIES HAS BEEN FORTIFYING AS THEY TRY TO REGAIN THEIR FULL ECONOMIC POTENTIALS (OWEVER DEBT BURDENS PERSISTENT UNEMPLOYMENT AND VOLATILE ENERGY PRICES ARE WEIGHING DOWN ON DEMAND MAKING PROGRESS SLOWER THAN THAT OF PAST BUSINESS EXPANSIONS 4HAT SLOW PROGRESS NONETHELESS HAS AVERTED THE PROSPECT OF DEmATION AND MODEST INmATION HAS GAINED TRACTION )N RESPONSE MANY CENTRAL BANKS HAVE BEEN GRADUALLY RAISING THEIR POLICY INTEREST RATES REMOVING ONE EXTRAORDINARY ASPECT OF THEIR MONETARY POLICIES NEAR ZERO INTEREST RATES ADOPTED DURING THE NADIR OF THE lNANCIAL CRISIS 0OLICY INTEREST RATES WILL BE CAUTIOUSLY LIFTED FURTHER DURING lSCAL "Y CONTRAST MOST MAJOR EMERGING COUNTRIES WILL CONTINUE ADVANCING AT MORE THAN THEIR LONG TERM TREND RATES (AVING BEEN UNABLE TO REIN IN INmATION DURING THE PAST YEAR CENTRAL BANKS OF KEY EMERGING COUNTRIES WILL BE RAISING POLICY INTEREST RATES FURTHER DURING lSCAL !DDITIONAL POLICY TOOLS THAT RESTRAIN CREDIT GROWTH WILL BE DEPLOYED TO REINFORCE THE MONETARY TIGHTENING 4O EXPAND THEIR ARSENALS AGAINST INmATION POLICYMAKERS COULD ALSO LET THEIR CURRENCIES APPRECIATE MORE THAN WHAT THEY HAVE BEEN WILLING TO ALLOW SO FAR $ESPITE lRMER ECONOMIC GROWTH ECONOMIC POLICIES HAVE MUCH ROOM FOR ERROR DURING lSCAL )NVESTORS REMAIN RESTIVE ABOUT THE lSCAL DEBTS OF DEVELOPED COUNTRIES AND ABOUT THE POLICYMAKERS INABILITY TO REPAIR lSCAL AFFAIRS WITHOUT FUNDAMENTALLY CHANGING THE ROLE OF THE STATE (OWEVER POLICIES THAT CAN REPAIR lSCAL IMBALANCES COME WITH THE RISK OF WEIGHING DOWN CYCLICAL RECOVERY AS WELL 4HOSE RISKS HAVE BEEN PLAYING OUT IN THE EURO AREA S SOVEREIGN DEBT CRISIS )NVESTORS HAVE BEEN QUESTIONING THE REGION S EXISTING ARRANGEMENT OF lNANCIAL ASSISTANCE IN WHICH THE RECIPIENTS CAN KEEP COMING UP SHORT AS lSCAL AUSTERITY Â&#x2C6; THE CONDITION FOR RECEIVING ASSISTANCE Â&#x2C6; HURTS ECONOMIC GROWTH LOWERS TAX REVENUES AND ONLY WORSENS THE lSCAL GAPS &OR EXAMPLE $ESPITE ALL THE lNANCIAL ASSISTANCE AND THE lSCAL RETRENCHMENT 'REECE S lSCAL IMBALANCES HAVE TURNED UP UNSUSTAINABLE AGAIN 4HE YIELD ON 'REECE S SOVEREIGN BONDS HAS ONLY RISEN DELIVERING THE MESSAGE THAT THE POLICIES IT HAS ADOPTED FOR lSCAL REPAIR ARE NOT WORKING )N !SIA THE RECENT MAGNITUDE EARTHQUAKE AND THE ENSUING TSUNAMI HAVE SIGNIlCANTLY WORSENED *APAN S NEAR TERM GROWTH OUTLOOK WHILE ADDING UNCERTAINTY ABOUT ENERGY SUPPLY TO THE COUNTRY S LONGER TERM ECONOMIC CHALLENGES !MID THE POLITICAL STRIFE OCCURRING IN THE -IDDLE %AST THE PROSPECT FOR DEMOCRATIC INSTITUTIONS STILL HANGS IN THE BALANCE 3OME COUNTRIES HAVE CRACKED DOWN ON DISSIDENTS WHILE OTHERS THAT HAVE OUSTED AUTHORITARIAN REGIMES HAVE YET TO ESTABLISH FULLY FUNCTIONING DEMOCRATICALLY ELECTED GOVERNMENTS -EANWHILE IN MANY EMERGING COUNTRIES WAGE PUSH PRICE PRESSURES ARE GOING TO DEVELOP AS HIGH INmATION RATES ENTER WAGE NEGOTIATIONS #ONSEQUENTLY POLICYMAKERS RUN THE RISK OF BEING UNABLE TO CONTAIN INmATION QUICKLY ENOUGH AND THAT SPELLS GREATER UNCERTAINTY ABOUT THEIR MONETARY AND EXCHANGE RATE POLICIES AHEAD !T THE REGIONAL LEVEL THE EURO AREA S ECONOMIC RECOVERY REMAINS UNEVENLY DISTRIBUTED !FTER SHRINKING AT AN ANNUAL RATE OF DURING lSCAL REAL '$0 FOR THE EURO REGION GREW DURING lSCAL AT AN ANNUAL CLIP OF FOLLOWED BY AN ANNUAL GROWTH RATE OF ROUGHLY DURING lSCAL (OWEVER BENEATH THE SURFACE THE RECOVERIES OF MEMBER COUNTRIES VARY WIDELY !FTER RECOUPING THE BULK OF THEIR LOSSES FROM THE ECONOMIC DOWNTURN 'ERMANY &RANCE AND THE .ETHERLANDS WILL CONTINUE TO PROGRESS FURTHER WHILE OTHERS SUCH AS )TALY 'REECE 3PAIN 0ORTUGAL AND )RELAND HAVE STRUGGLED TO RECOVER THE LOSSES AND INSTEAD FACE ECONOMIC STAGNATION &ISCAL YEAR TO DATE 'ERMANY S REAL '$0 HAS GROWN WHILE 'REECE S HAS SHRUNK 4HE OVERALL UNEMPLOYMENT RATE IN THE EURO AREA IS RANGING FROM AS HIGH AS IN 3PAIN TO AS LOW AS IN THE .ETHERLANDS 7HILE UNDERLYING INmATION HAS PICKED UP GRADUALLY IN ALL MEMBER COUNTRIES SOME SUCH AS )RELAND REMAIN ON THE BRINK OF DEmATION &URTHERMORE INVESTOR CONlDENCE IN THE REGION S POLICIES REMAINS PRECARIOUS 'OVERNMENTS IN 'REECE )RELAND 0ORTUGAL AND 3PAIN HAVE CUT SPENDING IN THE FACE OF ANEMIC PRIVATE DEMAND ONLY TO lND THAT THEIR lSCAL DElCITS HAVE WIDENED )N CONTRAST OTHERS SUCH AS 'ERMANY HAVE SHRUNK THEIR lSCAL GAPS AS GROWTH FUELED TAX REVENUES HAVE BEEN REPLENISHING THE GOVERNMENT S COFFERS 4HOUGH ADEQUATE lNANCIAL ASSISTANCE TO lSCALLY TROUBLED COUNTRIES IS AVAILABLE FROM VARIOUS AGENCIES THE RECIPIENTS

Fiscal 2012 Investment Plan

OF ASSISTANCE 'REECE )RELAND AND 0ORTUGAL COULD YET END UP RESTRUCTURING THE LOANS AS INSUFlCIENT ECONOMIC GROWTH PREVENTS THEM FROM MEETING THEIR OBLIGATIONS ON TIME #ONSEQUENTLY THE YIELDS ON THEIR SOVEREIGN DEBTS HAVE BEEN RISING Â&#x2C6; A CLEAR INDICATION THAT THE EURO AREA S POLICIES FOR RESTORING lSCAL HEALTH TO ITS MEMBERS HAVE BEEN UNABLE TO RESTORE INVESTORS CONlDENCE $ESPITE THE UNEVEN ECONOMIC GROWTH AND THE SHAKY CONlDENCE THE %UROPEAN #ENTRAL "ANK %#" DECIDED TO LIFT ITS SHORT TERM POLICY INTEREST RATE BY TO DURING lSCAL 4HE REGION S HEADLINE INmATION HAS RISEN TO FROM THE ANNUAL RATE ONLY A YEAR AGO $URING THAT PERIOD CORE INmATION THAT EXCLUDES VOLATILE ENERGY AND FOOD PRICES HAS INCREASED TO FROM THE ROUGHLY ANNUAL RATE 4HOUGH INmATION RATES VARY ACROSS THE MEMBER COUNTRIES DURING lSCAL THE %#" S CONCERN ABOUT THE DIRECTION OF INmATION WILL LEAD IT TO RAISE THE POLICY INTEREST RATE TO FROM IN INCREMENTS (OWEVER AT EACH STEP THE %#" WILL BE WATCHFUL OF THE REGION S PATCHY ECONOMIC RECOVERY ITS HIGH UNEMPLOYMENT RATE AND THE CONDITION OF ITS SOVEREIGN DEBT MARKET !CROSS THE %NGLISH #HANNEL STAGmATION LIKE CONDITIONS HAVE DEVELOPED IN THE 5NITED +INGDOM 4HE CONSUMER PRICE INmATION HAS SURPASSED THE "ANK OF %NGLAND S "O% TARGET RATE BY MORE THAN TWO PERCENTAGE POINTS 4HE "O% ALSO EXPECTS THE HEADLINE INmATION RATE TO BE ROUGHLY THROUGH MID lSCAL 4HE POUND STERLING S DEPRECIATION THE VALUE ADDED TAX 6!4 INCREASES THE ELEVATED UNIT LABOR COSTS AND HIGHER ENERGY PRICES HAVE TENDED TO LIFT INmATION )NmATION HAS PERSISTED DESPITE THE FRAGILE DEMAND AND THE lSCAL AUSTERITY THAT HAS RAISED THE CHANCES OF MORE LAYOFFS WHEN THE UNEMPLOYMENT RATE IS ALREADY 4HE ECONOMY REMAINS FAR FROM RECOVERING THE OUTPUT LOST DURING THE RECESSION AND IS ADVANCING AT LESS THAN ITS FULL POTENTIAL RATE 2ISING INmATION UNDER SUCH CONDITIONS INDICATES THE FULL POTENTIAL OUTPUT LEVEL MAY ITSELF HAVE FALLEN AND THAT BODES ILL FOR THE PROSPECTS OF ECONOMIC GROWTH AS WELL AS FOR THE ABILITY OF THE GOVERNMENT TO IMPROVE ITS lSCAL HOUSE THROUGH DOSES OF AUSTERITY ALONE &ACING INmATION IN A SOFT ECONOMY THE "O% HAS THE CHALLENGING TASK OF REINING IN INmATION AS WELL AS OF MAINTAINING MONETARY CONDITIONS THAT PROMOTE ECONOMIC GROWTH ,IFTING THE POLICY INTEREST RATE TO COMBAT INmATION MAY PRECIPITATE ANOTHER ECONOMIC DOWNTURN WHILE CONTINUING THE EXISTING GROWTH SUPPORTING EXPANSIONARY POLICY LETS INmATION AND ITS EXPECTATIONS DISLODGE FROM THE POLICY TARGET .EITHER OF THOSE OUTCOMES IS DESIRABLE #ONSEQUENTLY LIKE THE %#" THE "O% IS GOING TO BE VERY CAUTIOUS ABOUT COMMITTING POLICY ERRORS AS THE ECONOMY WADES THROUGH THIS DIFlCULT PATCH 4HE "O% WILL LIKELY RAISE THE POLICY INTEREST RATE GRADUALLY TO FROM THE CURRENT DURING lSCAL )N *APAN AFTER THE MAGNITUDE EARTHQUAKE AND THE ENSUING TSUNAMI HIT IN -ARCH MANUFACTURING ACTIVITY FELL AND RETAIL ACTIVITY PLUMMETED COMPARED TO THE PRIOR MONTH PUSHING THE STRUGGLING ECONOMY BACK INTO RECESSION "ESIDES DELIVERING A MAJOR BLOW TO CONSUMER AND BUSINESS CONlDENCE THE NUCLEAR PLANT DISASTER HAS FOGGED *APAN S ENERGY POLICY AT A TIME WHEN KEY LONG TERM MONETARY AND lSCAL CHALLENGES NEED TO BE ADDRESSED (AVING SPENT MUCH OF THE POLICY AMMUNITION ON REVIVING ECONOMIC GROWTH FOR TWO DECADES POLICYMAKERS HAVE FEW LEVERS LEFT TO PULL EVEN THOUGH DECISIVE POLICY ACTION IS STILL NEEDED -ONETARY POLICY IS CONSTRAINED BECAUSE THE SHORT TERM POLICY INTEREST RATE HAS BEEN NEAR ZERO AND CANNOT BE CUT FURTHER &ISCAL POLICY HAS BECOME INCREASINGLY PERILOUS AS THE GOVERNMENT S DEBT IS OF '$0 AND EXPECTED TO SURPASS SOON $ESPITE THE PRIVATE SECTOR S DELEVERAGING OVER THE PAST TWO DECADES *APAN HAS SOMBER GROWTH PROSPECTS AS ITS POPULATION IS AGING AND SHRINKING IN NUMBER (OWEVER THE ECONOMY WILL EXPERIENCE SOME CYCLICAL BOOST FROM THE RECONSTRUCTION ACTIVITY THAT IS GOING TO OCCUR DURING lSCAL "ENElTTING ALSO FROM EXPORTS TO RAPIDLY GROWING !SIAN NEIGHBORS REAL '$0 MAY EXPAND BUT IT RISKS BEING HELD BACK BY THE REPAIR TO lSCAL AFFAIRS THAT MUST FOLLOW THE RECONSTRUCTION 4HE "ANK OF *APAN IS EXPECTED TO KEEP ITS POLICY INTEREST RATE NEAR ZERO LEADING TO A WIDER INTEREST RATE DIFFERENTIAL WITH MOST OTHER COUNTRIES THAT WILL BE RAISING THEIR SHORT TERM POLICY RATES )N CONTRAST TO DEVELOPED COUNTRIES MOST EMERGING COUNTRIES HAVE BEEN GROWING STRONGLY 4HEIR INmATION RATES HAVE REMAINED STUBBORNLY HIGH FOR MANY REASONS !FTER THE ECONOMIC DOWNTURN DURING THE lNANCIAL CRISIS IN EMERGING COUNTRIES WERE QUICK TO PROVIDE lSCAL STIMULUS (OWEVER AS THEIR

Fiscal 2012 Investment Plan

ECONOMIES SOARED THE GOVERNMENTS EITHER DID NOT WITHDRAW THE STIMULUS OR DID NOT WITHDRAW IT FAST ENOUGH -ONETARY POLICIES ALSO REMAINED EXPANSIONARY UNTIL WELL AFTER THE RECOVERY WAS ENTRENCHED AND INmATION HAD ACCELERATED -EANWHILE DEPRECIATED CURRENCY EXCHANGE RATES BOOSTED DEMAND FOR THEIR EXPORTS RAISING EXPORT INCOMES AND OVERALL INTERNAL DEMAND &INALLY THE &EDERAL 2ESERVE S MONETARY POLICY DEPRECIATED THE DOLLAR RAISING GLOBAL PRICES IN DOLLAR TERMS AS WELL AS IN TERMS OF THE CURRENCIES ALIGNED TO THE DOLLAR Â&#x2C6; MOST OF THEM BEING EMERGING COUNTRIES 0OLICYMAKERS lRST BEGAN COMBATING INmATION BY RAISING THEIR POLICY INTEREST RATES (OWEVER THAT WAS WIDENING THE INTEREST DIFFERENTIAL WITH DEVELOPED COUNTRIES LIKE THE 5NITED 3TATES 4HE WIDER DIFFERENTIALS ATTRACTED HOT CAPITAL INmOWS APPRECIATING THE EXCHANGE RATES AGAINST THE 5 3 DOLLAR .OT WANTING RAPID CURRENCY APPRECIATION POLICYMAKERS BEGAN TIGHTENING MONETARY CONDITIONS BY RAISING THE BANKS RESERVE RATIOS CREDIT RATIONING AND IMPOSING SOFT CAPITAL CONTROLS SUCH AS TAXES ON FOREIGN CAPITAL INmOWS (OWEVER SUCH POLICIES WILL LIKELY BE UNABLE TO SUBDUE INmATION ENOUGH AND POLICYMAKERS MAY HAVE TO RETURN TO RAISING INTEREST RATES ONCE AGAIN -EANWHILE SECULAR GROWTH PROSPECTS BRIGHTER THAN THOSE OF DEVELOPED COUNTRIES ALONE SHOULD KEEP PUSHING EMERGING COUNTRIES CURRENCIES HIGHER AND THAT CAN HELP COOL DOMESTIC INmATION #HINA FOR INSTANCE COULD USE ALL THE HELP FROM ITS EXCHANGE RATE 4HE ANNUAL RATE OF CONSUMER PRICE INmATION HAS RISEN FROM TOWARD THE BEGINNING OF CALENDAR TO A YEAR LATER $URING THAT TIME THE ANNUAL RATE OF PRODUCER PRICE INmATION SPED UP TO FROM 7HOLESALE FOOD PRICES SO CRITICAL TO THE BUDGETS OF MILLIONS OF #HINA S HOUSEHOLDS HAVE SOARED TO ABOUT A ANNUAL CLIP FROM DURING THAT SAME PERIOD AS WELL )NmATION HAS BEEN FUELED BY EXPORT INCOMES AS WELL AS ROBUST ECONOMIC ACTIVITY lNANCED BY RAPID MEDIUM TO LONG TERM LOAN GROWTH 7HILE THIS LOAN GROWTH HAS MODERATED COMPARED TO LAST YEAR IT IS STILL ADVANCING AT A RAPID ANNUAL CLIP )TS ADVANCE HAS BEEN ACCOMPANIED BY A SOLID ANNUAL GROWTH OF CONSUMPTION LOANS AND AN ACCELERATION OF SHORT TERM LOAN GROWTH TO ABOUT A ANNUAL CLIP RECENTLY FROM A ANNUAL RATE MONTHS AGO -EANWHILE THE CENTRAL BANK S INTEREST RATE HIKES TOTALING TO HAVE BEEN INSUFlCIENT FOR RESTRAINING INmATION 0OLICYMAKERS HAVE ALSO BEEN RAISING THE BANKS RESERVE REQUIREMENT RATIOS INCREASING THEM FOR SMALL DEPOSITORY INSTITUTIONS TO FROM AND FOR LARGE INSTITUTIONS TO FROM -ORE SUCH MEASURES WILL BE ADOPTED DURING lSCAL UNTIL THERE ARE RELIABLE SIGNS THAT INmATION IS RECEDING )NVESTORS ARE ALSO GOING TO WATCH CLOSELY IF THE GOVERNMENT IS GOING TO LET THE YUAN APPRECIATE MORE THAN THE IT HAS ALLOWED DURING THE PAST MONTHS #HINA IS EXPECTED TO POST ANOTHER YEAR OF SOLID GROWTH EVEN AS POLICYMAKERS REMAIN PREOCCUPIED WITH STEPS THAT CAN RESTRAIN INmATION AND PREVENT IT FROM STOKING SOCIAL DISCONTENT 3IMILARLY INmATION HAS BECOME A PRIMARY CONCERN IN )NDIA 7HOLESALE PRICES AS WELL AS CONSUMER PRICES HAVE SOARED !LTHOUGH CONSUMER PRICE INmATION HAS EASED FROM THE TORRID ANNUAL RATE DURING SOME MONTHS IT IS STILL RUNNING AT A HIGH n ANNUAL CLIP 4HE ECONOMY HAS GROWN ROBUSTLY AND WILL POST ANOTHER YEAR OF STRONG GROWTH #ONSEQUENTLY POLICYMAKERS ARE LIKELY TO LEAN AGAINST INmATION BY RAISING THE POLICY INTEREST RATE FURTHER BY n (OWEVER IT MAY TAKE LONGER FOR THEM TO BRING DOWN THE INmATION RATE ONCE IT ENTERS WAGE NEGOTIATIONS THAT GENERATE COST PUSH PRESSURES ON PRICES IN THE YEAR AHEAD )N +OREA THE CENTRAL BANK IS EXPECTED TO KEEP RAISING THE POLICY INTEREST RATE ALTHOUGH ITS MONETARY TIGHTENING MAY SLOW IF THE +OREAN WON IS ALLOWED TO APPRECIATE MORE )N ,ATIN !MERICA "RAZIL S ECONOMY HAS GALLOPED AHEAD AMID RISING INmATION AND INmATION EXPECTATIONS 4HE CENTRAL BANK HAS INCREASED ITS POLICY INTEREST RATE TO FROM DURING lSCAL !N ADDITIONAL INCREASE IN THE POLICY RATE SHOULD BE DELIVERED DURING lSCAL AS THE UNDERLYING ECONOMIC GROWTH IS STRONG AND INmATION HAS BEEN ADVANCING 4HE SECOND ROUND EFFECTS THROUGH WAGE NEGOTIATIONS REMAIN THE KEY RISK TO INmATION IN THE UPCOMING YEAR -EANWHILE #HINA HAS NOW BECOME ONE OF "RAZIL S LARGEST TRADING PARTNERS 7HILE THAT WILL BOOST "RAZIL S ECONOMIC GROWTH IT IS ALSO GOING TO COMPLICATE THE EXCHANGE RATE POLICY IN THE MONTHS AND YEARS AHEAD ESPECIALLY IF "RAZIL IS FORCED TO LET ITS CURRENCY APPRECIATE TO COOL OFF INmATION WHILE #HINA KEEPS ITS YUAN CLOSELY ALIGNED TO THE 5 3 DOLLAR 4HAT POLICY DILEMMA WILL BE EASED ONLY IF #HINA LETS THE YUAN APPRECIATE MORE

Fiscal 2012 Investment Plan

-EXICO S ECONOMY IS GOING TO IMPROVE ALONG WITH THAT OF THE 5NITED 3TATES 7HILE HEADLINE INmATION HAS RECENTLY SURPASSED THE CENTRAL BANK S POLICY RANGE CORE INmATION REMAINS CONTAINED %XPORTS HAVE NOW SURPASSED THEIR PRE RECESSION LEVEL AND ARE EXPECTED TO GROW FURTHER 2EAL '$0 HAS BEEN GROWING AT TREND LIKE PACE AND THAT MAY IMPROVE GOING INTO lSCAL !S A RESULT THE CENTRAL BANK IS LIKELY TO SIGNAL HIGHER POLICY INTEREST RATES (OWEVER IT WILL BE CAUTIOUS ABOUT WIDENING THE INTEREST RATE DIFFERENTIAL WITH THE 5NITED 3TATES &OR THE SAME REASON #ANADA S CENTRAL BANK IS ALSO LIKELY TO RAISE ITS POLICY INTEREST RATE BY ONLY DURING lSCAL 4HE STRENGTHENED #ANADIAN DOLLAR MAY CONTINUE TO DAMPEN CORE INmATION AND INmATION EXPECTATIONS MAKING IT EASIER FOR THE CENTRAL BANK TO CHANGE ITS POLICY INTEREST RATE GRADUALLY -OREOVER EXPORTS HAVE YET TO RECOVER TO THE PRE RECESSION LEVEL AND THAT MAY CONSTRAIN THE CENTRAL BANK FROM TIGHTENING MONETARY CONDITIONS AHEAD OF THE &EDERAL 2ESERVE /VERALL WHILE ECONOMIC GROWTH IS STRENGTHENING IN MANY DEVELOPED COUNTRIES SEVERAL POLICY CHALLENGES LIE AHEAD #ENTRAL BANKS ARE GOING TO LIFT POLICY INTEREST RATES BUT WILL DO SO VERY CAUTIOUSLY )N CONTRAST ROBUST GROWTH IS GOING TO CONTINUE IN EMERGING COUNTRIES (OWEVER INmATION WILL BE THE PROBLEM PREOCCUPYING POLICYMAKERS THERE 7HILE THEY WILL CONTINUE TO TIGHTEN MONETARY CONDITIONS THEY COULD START LETTING THEIR CURRENCIES APPRECIATE AGAINST THE 5 3 DOLLAR AS YET ANOTHER WAY OF RESTRAINING INmATIONARY PRESSURES -EANWHILE lSCAL ISSUES ARE GOING TO BE AT THE FOREFRONT IN DEVELOPED COUNTRIES AS THEY TRANSITION FROM CYCLICAL RECOVERIES TOWARD THE LONGER TERM CHALLENGES POSED BY THEIR AGING POPULATIONS

INTERNATIONAL FORECASTS Real Gross Domestic Product Country/Region

Consumer Prices

FY 2012

FY 2011

FY 2012

FY 2011

Canada

United Kingdom

Eurozone

'ERMANY

&RANCE

)TALY

*APAN

#HINA

(ONG +ONG

)NDIA

3OUTH +OREA

"RAZIL

-EXICO

Asiaâ&#x20AC;&#x201C;Pacific

Latin America

Fiscal 2012 Investment Plan

V. Fixed-Income Investments TREASURY YIELD CURVE 5.00% 4.50% 4.00%

0ERCENT 9IELD

3.50%

3.00%

2.50% 2.00% 1.50% 1.00% 0.50% 0.00% 3m

2yr

5yr

10yr

30yr

-ATURITY June 30, 2010

April 30, 2011 Mid-November

OUTLOOK Bond Market Returns 7E FORECAST TOTAL RETURNS IN THE lXED INCOME MARKET TO BE BELOW THE 3423 /HIO POLICY RETURN OF IN lSCAL )N THIS LOW INTEREST RATE ENVIRONMENT THE COUPON INCOME OF BEGINS THE YEAR BELOW THE POLICY RETURN 3INCE WE FORECAST PRICES IN THE BENCHMARK WILL GENERALLY DECLINE AS INTEREST RATES RISE WE EXPECT THE TOTAL RETURN TO lNISH lSCAL NEAR

Federal Reserve 4HE &EDERAL 2ESERVE HAS MAINTAINED A HIGHLY ACCOMMODATIVE MONETARY POLICY TO SUPPORT THE ECONOMIC RECOVERY !SIDE FROM MAINTAINING THE FEDERAL FUNDS RATE NEAR FOR MONTHS A SECOND ROUND OF QUANTITATIVE EASING WAS EMPLOYED DURING THE lSCAL YEAR 4HE &EDERAL 2ESERVE PURCHASED BILLION IN 5 3 4REASURY SECURITIES NEARLY EQUIVALENT TO THE NET ISSUANCE OF THE 5 3 4REASURY FOR AN EIGHT MONTH PERIOD 4HE POLICY CONTRIBUTED TO THE PRICE APPRECIATION OF RISK ASSETS ARRESTED DEmATION CONCERNS AND STIMULATED THE ECONOMY

Fiscal 2012 Investment Plan

4HE &EDERAL 2ESERVE S POLICY OBJECTIVE IS TO ACHIEVE SUFlCIENT ECONOMIC GROWTH THAT SUPPORTS JOB CREATION WITHOUT MATERIALLY INCREASING LONG TERM INmATION EXPECTATIONS 4HE CHIEF RISK IN MAINTAINING AN ACCOMMODATIVE POLICY FOR AN EXTENDED PERIOD OF TIME IS THAT LONG TERM INmATION CONCERNS CAN DEVELOP (OWEVER THE ABUNDANCE OF RESOURCE SLACK AND GLOBAL ECONOMIC UNCERTAINTY SERVE TO CURB THESE INmATION CONCERNS AND SUPPORT THE CURRENT POLICY STANCE 4HE &EDERAL 2ESERVE WILL CONTINUE TO MAINTAIN AN ACCOMMODATIVE MONETARY POLICY DURING lSCAL )T WILL MARGINALLY REDUCE THE LEVEL OF ACCOMMODATION AS A PRECAUTIONARY MEASURE DURING THE LATTER HALF OF THE lSCAL YEAR 4HE &EDERAL 2ESERVE WILL ACCOMPLISH THIS BY GRADUALLY INCREASING THE FEDERAL FUNDS RATE ACCOMPANIED BY A SIMILAR REDUCTION IN THE LEVEL OF QUANTITATIVE EASING 4HIS WILL INITIATE A MULTIYEAR TRANSITION TO A NEUTRAL POLICY STANCE )N THE NEAR TERM THE GRADUAL REDUCTION OF ACCOMMODATION WILL HAVE LITTLE IMPACT ON THE ECONOMIC RECOVERY WHILE MAINTAINING WELL ANCHORED INmATION EXPECTATIONS (OWEVER SHOULD INmATION EXPECTATIONS BECOME ELEVATED IN THE NEAR TERM THE &EDERAL 2ESERVE IS ABLE TO QUELL THOSE EXPECTATIONS QUICKLY )T MAY INCREASE INTEREST RATES ON EXCESS RESERVES AND ENGAGE IN REVERSE REPURCHASE AGREEMENTS TERM DEPOSITS AND ASSET SALES Â&#x2C6; ALL OF WHICH SERVE TO REMOVE LIQUIDITY FROM THE lNANCIAL SYSTEM AND INCREASE INTEREST RATES /UR FORECASTED RANGE FOR THE FEDERAL FUNDS RATE IS TO

Market Interest Rates 4HE EXPECTED INTEREST RATE RANGE FOR THE YEAR 4REASURY YIELD IS BASED ON THE 3423 /HIO ECONOMIC FORECAST OF A SLOWLY IMPROVING ECONOMY CONTAINED INmATION AND THE INITIATION OF A MODEST REVERSAL IN MONETARY POLICY LATER IN THE lSCAL YEAR /UR FORECASTED RANGE IS TO /UR RATIONALE FOR AT THE BOTTOM OF THE RANGE BEGINS WITH LOW SHORT TERM INTEREST RATES AS WE EXPECT THE &EDERAL 2ESERVE WILL MAINTAIN THE POLICY RATE NEAR FOR AT LEAST THE lRST HALF OF THE lSCAL YEAR !DDITIONALLY INTEREST RATES HAVE DECLINED MEANINGFULLY WHEN THE 5 3 ECONOMY HAS PROVEN VULNERABLE TO GLOBAL EXTERNAL SHOCKS DURING THE PAST YEAR 4HIS BECAME EVIDENT AS SOVEREIGN DEBT ISSUES DEVELOPED LAST YEAR IN %UROPE AND MORE RECENTLY AS ENERGY PRICES SPIKED AMID UNREST IN THE -IDDLE %AST 5NTIL THE 5 3 ECONOMIC RECOVERY DEMONSTRATES MORE RESILIENCE THE BOTTOM OF OUR YEAR RANGE REQUIRES A LOW RATE 4HE UPPER END OF THE RANGE INCORPORATES THE VIEW THAT FOR THE lRST TIME IN THIS ECONOMIC EXPANSION THE 3423 /HIO ECONOMIC FORECAST REmECTS UPSIDE RISKS TO THE OUTLOOK AS CYCLICAL GROWTH PROSPECTS HAVE IMPROVED )N ADDITION THE 5 3 4REASURY HAS BEEN SUCCESSFULLY FUNDING ITS LARGE DElCIT AT RELATIVELY LOW RATES BUT WE REMAIN ALERT TO THE POSSIBILITY lXED INCOME INVESTORS COULD BECOME IMPATIENT WITH THE LACK OF A CREDIBLE PLAN TO RESTORE lSCAL DISCIPLINE IN 7ASHINGTON 7HILE THERE IS NO IMMINENT THREAT TO 5 3 LIQUIDITY OR SOLVENCY HIGHER lNANCING COSTS FOR THE GROWING DEBT OF THE 5 3 GOVERNMENT REMAINS A POSSIBILITY IF POLICYMAKERS FAIL TO ADDRESS THIS IMPORTANT LONG TERM ISSUE /UR BASE FORECAST IS FOR THE YEAR 4REASURY YIELD TO RISE MODERATELY FROM ITS CURRENT LEVEL OF AS THE lSCAL YEAR UNFOLDS lNISHING BETWEEN AND &EDERAL 2ESERVE POLICY WILL BE ONE INmUENCE FOR THIS UPWARD MOVE 7E EXPECT THE AFOREMENTIONED RISING FEDERAL FUNDS RATE TO EXERT SOME UPWARD PRESSURE ON MARKET INTEREST RATES AND TO mATTEN THE YIELD CURVE LATER IN THE lSCAL YEAR !DDITIONALLY THE COMPLETION OF THE SECOND QUANTITATIVE EASING PROGRAM BY THE &EDERAL 2ESERVE AT THE BEGINNING OF THIS lSCAL YEAR HAS ALREADY BEEN ANNOUNCED WHICH MEANS THE PREDOMINANT BUYER OF 4REASURIES FOR THE PAST EIGHT MONTHS MUST BE REPLACED AS A SOURCE OF DEMAND IN THE NEW lSCAL YEAR ! SECOND INmUENCE ON RISING RATES IS OUR VIEW THAT CORE INmATION LIKELY BOTTOMED IN lSCAL BELOW AND HAS BEGUN TO RISE 7E EXPECT CORE INmATION TO BE CONTAINED BELOW DURING THE lSCAL YEAR BUT A DIRECTIONAL RISE IN THIS MEASURE WILL PROVIDE JUSTIlCATION FOR MARGINALLY HIGHER LONG TERM RATES

Fiscal 2012 Investment Plan

Credit Quality 4HROUGHOUT lSCAL CREDIT QUALITY IMPROVED AS THE ECONOMIC RECOVERY BOLSTERED CORPORATE PROlTABILITY AND CASH mOW &IRMS ENJOYED STRONG ACCESS TO THE CAPITAL MARKETS &INANCIAL INSTITUTIONS EXPERIENCING IMPROVED ASSET QUALITY CONTINUED TO ENHANCE THE AMOUNT AND QUALITY OF CAPITAL THROUGH RETAINED EARNINGS WHILE MAINTAINING A HIGH LEVEL OF LIQUIDITY .ONlNANCIAL COMPANIES USED STRONG CASH mOW TO INCREASE CAPITAL EXPENDITURES AND SHAREHOLDER PAYMENTS WHILE PRESERVING CASH BALANCES 7E EXPECT GENERALLY STABLE CREDIT TRENDS THROUGHOUT lSCAL AS WE PROGRESS THROUGH THE CREDIT CYCLE &INANCIAL INSTITUTIONS WILL LARGELY REMAIN IN THE RECOVERY PHASE OF THE CREDIT CYCLE IN lSCAL ,OAN PORTFOLIO ASSET QUALITY WILL FURTHER IMPROVE CONTRIBUTING TO INCREASED PROlTABILITY AND INTERNAL CAPITAL GENERATION %ARNINGS GROWTH WILL HOWEVER BE TEMPERED BY MODEST LOAN GROWTH &INANCIAL lRMS WILL MAINTAIN HIGH LEVELS OF LIQUIDITY AND MARGINALLY BUILD CAPITAL AS STRICTER REGULATIONS ARE INSTITUTED DUE TO DOMESTIC AND GLOBAL lNANCIAL REFORM .ONETHELESS AFTER YEARS OF BALANCE SHEET REPAIR AS THE SOLE FOCUS THE STRONGEST lNANCIAL lRMS WILL LOOK TO RETURN SOME CAPITAL TO SHAREHOLDERS SUBJECT TO REGULATORY APPROVAL $URING lSCAL NONlNANCIAL lRMS WILL EXPERIENCE A MODERATE RISE IN REVENUE AND EARNINGS WHILE LEVERAGE REMAINS STABLE 0ROlT MARGINS WILL REMAIN STRONG IN SPITE OF MODEST COST PRESSURES IN SOME INDUSTRIES &IRMS WILL CONTINUE TO PRODUCE SOLID FREE CASH mOW HOWEVER LESS WILL BE DEDICATED TO DEBT REDUCTION &IRMS WILL DEPLOY CASH mOW AND LARGE CASH BALANCES TO FUND SHARE REPURCHASES DIVIDENDS AND MERGERS AND ACQUISITIONS AS MANAGEMENT TEAMS ARE MORE CONlDENT IN THE ECONOMIC RECOVERY 7E EXPECT MORE AGGRESSIVE SHAREHOLDER REMUNERATION FROM SOME lRMS BUT DO NOT EXPECT lNANCIAL POLICIES TO INCREASE LEVERAGE IN AGGREGATE 7E EXPECT HIGH YIELD CREDIT QUALITY WILL BE STABLE THIS YEAR &UNDAMENTAL CREDIT METRICS RELATED TO BALANCE SHEET LEVERAGE AND CASH mOW MARGINS HAVE BEEN IMPROVING DURING THE PAST TWO YEARS BUT ARE BEGINNING TO LEVEL OUT #APITAL SPENDING SHOULD BEGIN TO INCREASE AND SHAREHOLDER FRIENDLY ACTIVITY WILL LIKELY PICK UP FROM VERY LOW LEVELS THIS YEAR 4HIS IS MANAGEABLE AS HIGH YIELD COMPANIES ARE MAINTAINING EXCESS CASH ON THEIR BALANCE SHEETS THAT HAS ROOM TO BE DRAWN DOWN WHILE STILL PRESERVING SUFlCIENT LIQUIDITY AND CREDIT QUALITY .EW ISSUANCE HAS BEEN WELL RECEIVED BY INVESTORS AS RElNANCING ACCOUNTS FOR THE MAJORITY OF THE ACTIVITY PERMITTING THE EXTENSION OF DEBT MATURITY PROlLES FOR MANY HIGH YIELD ISSUERS )N AGGREGATE COMPANY ACTIONS TO PRESERVE LIQUIDITY AND CREDIT QUALITY HAVE CONTRIBUTED TO THE MOST POSITIVE CREDIT RATING TRENDS IN MORE THAN A DECADE 7E EXPECT THE HIGH YIELD DEFAULT RATE WILL REGISTER A LOW SINGLE DIGIT RATE IN lSCAL REmECTING ACCOMMODATIVE lNANCIAL CONDITIONS STABLE CREDIT QUALITY AND GROWING INVESTOR RISK TOLERANCE FOR THIS SECTOR %MERGING MARKET MACROECONOMIC FUNDAMENTALS ARE GENERALLY SOLID SUPPORTED BY STRONG GROWTH TRENDS -OST OF THE COUNTRIES IN THE BENCHMARK HAVE LOW DEBT AND MANAGEABLE lSCAL BALANCES AT THE SOVEREIGN LEVEL ESPECIALLY COMPARED TO THE lSCAL PROlLES OF MOST DEVELOPED COUNTRIES /NE IMPORTANT DEVELOPMENT THAT DESERVES CLOSE MONITORING IS THE ISSUE OF ELEVATED INmATION RESULTING FROM ABOVE TREND ECONOMIC GROWTH AND RISING FOOD AND ENERGY PRICES 4HIS ISSUE IS BEING ADDRESSED THROUGH TIGHTENING OF MONETARY POLICY AND APPRECIATING CURRENCIES BUT COULD REPRESENT A FUTURE RISK TO STABILITY IF THE POLICY IS MISCALCULATED /VERALL WE EXPECT STABLE CREDIT QUALITY FOR BOTH SOVEREIGN AND CORPORATE CREDITS IN THE EMERGING MARKETS

STRATEGY Overview. 4HE lXED INCOME PORTFOLIO WILL BEGIN lSCAL WITH AN ACTIVE MANAGEMENT RISK OF BASIS POINTS #OMPARED TO THE PAST SEVERAL YEARS THIS LEVEL IS RELATIVELY LOW AND REmECTS THE STABLE CONDITIONS AND REDUCTION IN VALUE ADDED OPPORTUNITIES IN THE lXED INCOME MARKET THIS YEAR 4HE FOLLOWING POINTS SUMMARIZE OUR OUTLOOK AND PORTFOLIO STRATEGY FOR lSCAL

Fiscal 2012 Investment Plan

4HE &EDERAL 2ESERVE WILL SPEND AT LEAST THE lRST HALF OF THE lSCAL YEAR ON HOLD AS IT EVALUATES THE ECONOMY AND lNANCIAL MARKETS FOLLOWING THE COMPLETION OF ITS SECOND QUANTITATIVE EASING PROGRAM )F CONDITIONS REMAIN STABLE THEN THE INITIATION OF A GRADUAL TRANSITION IN MONETARY POLICY COULD BEGIN DURING THE SECOND HALF OF THE lSCAL YEAR

7E EXPECT THE YEAR 4REASURY YIELD TO RISE ABOUT n BASIS POINTS DURING lSCAL YEAR 7E ARE POSITIONED FOR THIS FORECAST OF RISING INTEREST RATES WITH A PORTFOLIO RELATIVE DURATION OF AS OF MID -AY EXPECTING THE YEAR YIELD TO lNISH THE lSCAL YEAR BETWEEN AND

4HE GRAPH ON 0AGE ILLUSTRATES THE CONTINUATION OF A HISTORICALLY STEEP YIELD CURVE THAT HAS PERSISTED FOR SEVERAL YEARS !S THE INITIAL STEPS OF MONETARY POLICY NORMALIZATION OCCUR LATER THIS lSCAL YEAR WE EXPECT THE YIELD CURVE TO BEGIN TO mATTEN AS SHORT TERM RATES RISE MORE THAN LONG TERM RATES 7E HAVE POSITIONED OUR PORTFOLIO MATURITY DISTRIBUTION TO BENElT FROM A mATTENING OF THE YIELD CURVE Â&#x2C6; ONE OF OUR MOST IMPORTANT STRATEGIES IN THE PORTFOLIO THIS UPCOMING lSCAL YEAR

/UR RELATIVE SECTOR WEIGHTINGS CONTRIBUTE LESS TO OUR OVERALL STRATEGY THAN MOST YEARS 7E ARE NEUTRAL IN THE THREE LARGEST SECTORS COMPRISING ABOUT OF THE BENCHMARK 4HIS INCLUDES 5 3 4REASURIES INVESTMENT GRADE CORPORATE BONDS AND AGENCY MORTGAGE BACKED SECURITIES 7E WILL RETAIN A PORTFOLIO STRUCTURE THAT PROVIDES US WITH THE mEXIBILITY TO RESPOND TO OPPORTUNITIES IN THESE IMPORTANT SECTORS

7E CURRENTLY lND THE SMALLEST SECTORS IN THE BENCHMARK OFFER THE MOST COMPELLING RELATIVE VALUE 7E BEGIN THE YEAR WITH AN OVERWEIGHT IN HIGH YIELD EMERGING MARKET DEBT AND COMMERCIAL MORTGAGE BACKED AND ASSET BACKED SECURITIES

Treasuries 7E BEGIN lSCAL WITH A NEUTRAL WEIGHT AS RELATIVE VALUE IS BALANCED VERSUS THE LARGEST SPREAD SECTORS 4HE &EDERAL 2ESERVE S DIRECT PURCHASES OF 4REASURIES UNDER THE SECOND QUANTITATIVE EASING PROGRAM ENDS AT THE BEGINNING OF lSCAL ! TRANSITION IN DEMAND FROM THE &EDERAL 2ESERVE BACK TO TRADITIONAL INVESTORS WILL BE IMPORTANT AS THE GOVERNMENT S ONGOING NEED TO FUND ITS LARGE BUDGET DElCITS HAVE THIS SEGMENT OF THE BENCHMARK EXPANDING 7E WILL MONITOR THIS DYNAMIC CLOSELY FOR OPPORTUNITIES WHILE USING OUR LARGE AND LIQUID 4REASURY HOLDINGS TO ACTIVELY IMPLEMENT TACTICAL YIELD CURVE STRATEGIES AND EFlCIENTLY MANAGE THE PORTFOLIO S DURATION RELATIVE TO THE BENCHMARK Government Related. 7E BEGIN THE lSCAL YEAR WITH A LARGE UNDERWEIGHT 3UPPLY IN THIS SECTOR HAS DECLINED SIGNIlCANTLY AS &ANNIE -AE AND &REDDIE -AC THE PRIMARY ISSUERS HAVE REDUCED THEIR BALANCE SHEETS IN LINE WITH REGULATORY IMPOSED PORTFOLIO ASSET LIMITATIONS 4HE CURRENT OBJECTIVE OF PUBLIC POLICY IS TO INCREASE THE PRIVATE SECTOR S PRESENCE IN THE HOUSING lNANCE MARKET AND REDUCE GOVERNMENT INVOLVEMENT BY WINDING DOWN &ANNIE -AE AND &REDDIE -AC )MPORTANTLY THE GOVERNMENT HAS CONTINUED TO REITERATE ITS CREDIT AND CAPITAL SUPPORT OF &ANNIE -AE AND &REDDIE -AC 6ALUATIONS HAVE BEEN AUGMENTED BY STRONG DEMAND AS INVESTORS HAVE SOUGHT HIGHLY RATED LIQUID SECURITIES THAT YIELD MORE THAN 4REASURIES $UE TO RELATIVELY NARROW YIELD SPREADS IN THIS SECTOR WE PLAN TO MAINTAIN OUR UNDERWEIGHT CMBS (Commercial Mortgage-Backed Securities) and ABS (Asset-Backed Securities). $URING lSCAL WE MAINTAINED AN OVERWEIGHT POSITION AS COMMERCIAL REAL ESTATE FUNDAMENTALS IMPROVED AND RELATIVE VALUATIONS REMAINED ATTRACTIVE 4HROUGH ACTIVE PURCHASES SALES AND MATURITIES THE PORTFOLIO IS POSITIONED WITH A BLEND OF SEASONED NEW ISSUE AND WELL STRUCTURED SECURITIES 7E WILL CONTINUE TO MAINTAIN AN OVERWEIGHT POSITION AS RELATIVE VALUE REMAINS ATTRACTIVE 3ECURITY SELECTION WILL REmECT IMPROVING FUNDAMENTALS EMPHASIZING STRUCTURE AND UNDERWRITING 7E BEGIN lSCAL WITH A LARGE OVERWEIGHT TO THE !"3 SECTOR 7E INCREASED OUR EXPOSURE IN CONSUMER AUTO LOANS LEASES AND DEALER mOOR PLANS AS THE FUNDAMENTALS CONTINUE TO IMPROVE AND

Fiscal 2012 Investment Plan

VALUATIONS REMAIN ATTRACTIVE 7E HAVE MAINTAINED A HIGH QUALITY LIQUID PORTFOLIO OF mOATING RATE NOTES 4HESE mOATING RATE SECURITIES REDUCE THE INTEREST RATE RISK OF THE PORTFOLIO AND ARE RELATIVELY MORE ATTRACTIVE THAN SHORT TERM 4REASURIES AND GOVERNMENT RELATED SECURITIES 7E ARE LIKELY TO MAINTAIN AN OVERWEIGHT POSITION AND MAY SELECTIVELY ADD TO OTHER TYPES OF !"3 PROVIDED RELATIVE VALUE IS ATTRACTIVE Mortgages. 7E BEGIN THE lSCAL YEAR WITH A NEUTRAL WEIGHT TO AGENCY MORTGAGE BACKED SECURITIES !T THE BEGINNING OF lSCAL WE HAD A LARGE UNDERWEIGHT AS THE SECTOR WAS OVERVALUED 7E AGGRESSIVELY ADDED TO THE SECTOR LATE IN THE lRST HALF OF lSCAL AS A SPIKE IN VOLATILITY TRIGGERED BY A RAPID RISE IN INTEREST RATES CAUSED MORTGAGE DURATIONS TO EXTEND AND VALUATIONS TO CHEAPEN #ONTINUED TIGHT UNDERWRITING STANDARDS AND DEPRESSED HOME PRICES ARE EXPECTED TO KEEP MORTGAGE PREPAYMENTS SUBDUED WHEN COMPARED TO SIMILAR PERIODS IN THE PAST SUPPORTING MORTGAGE VALUATIONS (OWEVER SALES OF MORTGAGE BACKED SECURITIES BY THE 5 3 4REASURY COMBINED WITH &ANNIE -AE &REDDIE -AC AND THE &EDERAL 2ESERVE NOT REINVESTING THEIR RESPECTIVE PORTFOLIO CASH mOWS INTO MORTAGES HAVE EXPECTED SUPPLY EXCEEDING ESTIMATED DEMAND 4HIS TOGETHER WITH THE POTENTIAL FOR INCREASED INTEREST RATE VOLATILITY COULD LEAD TO A HIGHER DEGREE OF VARIABILITY IN MORTGAGE VALUATIONS !S A RESULT WE PLAN TO SEEK OPPORTUNITIES TO SELECTIVELY ADD EXPOSURE AS ATTRACTIVE RELATIVE VALUE OPPORTUNITIES BECOME AVAILABLE Investment Grade Corporates. 7E BEGIN lSCAL WITH A NEUTRAL WEIGHT TO THE INVESTMENT GRADE CORPORATE CREDIT SECTOR AS FUNDAMENTALS ARE GENERALLY STABLE VALUATIONS REMAIN FAIR AND WE EXPECT ONLY MODEST SPREAD TIGHTENING POTENTIAL #REDIT SPREADS HAVE TIGHTENED DURING lSCAL LEAVING CERTAIN SECTOR SPREADS WITHIN THE HISTORICAL RANGE REmECTIVE OF A BENIGN CREDIT ENVIRONMENT 'OING FORWARD WE EXPECT NAME SELECTION TO BE INCREASINGLY IMPORTANT AS THE MARKET DIFFERENTIATES BETWEEN lRMS STRIVING TO MAINTAIN CREDIT QUALITY VERSUS lRMS EMPLOYING GREATER LEVERAGE IN THE CAPITAL STRUCTURE 7E GENERALLY EXPECT lNANCIAL INSTITUTIONS TO MODESTLY OUTPERFORM NONlNANCIALS BUT WITH GREATER SPREAD VOLATILITY (OWEVER IN CONTRAST TO THE LAST CREDIT CYCLE lNANCIAL INSTITUTION ISSUER SPREADS WILL CONTINUE TO BE GREATER THAN SPREADS OF NONlNANCIAL lRMS 7E RETAIN THE mEXIBILITY TO INCREASE OR DECREASE OUR EXPOSURE AS RELATIVE VALUATIONS MERIT BUT WE DO NOT EXPECT THE WEIGHT TO DEVIATE MEANINGFULLY FROM NEUTRAL UNDER MOST SCENARIOS High Yield Corporates. 7E BEGIN THE YEAR WITH A MODERATE OVERWEIGHT TO HIGH YIELD CORPORATES 9IELD SPREADS RELATIVE TO 5 3 4REASURIES ARE CONSISTENT WITH LONG TERM AVERAGES BUT TIGHTENING WILL BE LIMITED BY THE COMBINED CHARACTERISTICS OF HIGH PRICES LOW YIELDS AND CALL RISK IN THE HIGH YIELD MARKET 4HIS ASSURES THE OUTSIZED RETURNS OF THE PAST TWO YEARS WILL NOT BE REPEATED THIS lSCAL YEAR BUT WE STILL EXPECT THE SECTOR TO OUTPERFORM THE INVESTMENT GRADE SEGMENTS OF OUR PORTFOLIO AND DELIVER COMPETITIVE lXED INCOME RETURNS !N UNDERWEIGHT TO THE HIGH YIELD SECTOR IS UNLIKELY THIS YEAR UNLESS CREDIT QUALITY OR VALUATION CHANGES MATERIALLY Emerging Market Debt. 7E ENTER lSCAL WITH AN OVERWEIGHT TO EMERGING MARKET DEBT 7E OBSERVE AN ONGOING SHIFT IN ISSUANCE TRENDS CONTRIBUTING TO A RAPID CHANGE IN THE OVERALL BENCHMARK AND RELATIVE VALUATION 6ALUATIONS FOR THE MOST STABLE SOVEREIGNS ARE NO LONGER CHEAP BUT CAN BE JUSTIlED BY STRONG CREDIT TRENDS AND LIMITED NEW ISSUANCE IN 5 3 DOLLARS 4HESE ISSUERS ARE INCREASINGLY USING LOCAL CURRENCY lNANCING AS THEIR PRIMARY FUNDING SOURCE 4HUS A LARGE PORTION OF 5 3 DOLLAR DENOMINATED SOVEREIGN DEBT FORMERLY IN THE BENCHMARK IS BEING REPLACED BY EMERGING MARKET CORPORATES AND QUASI SOVEREIGNS PRESENTING A MORE DIVERSE SET OF ACTIVE MANAGEMENT OPPORTUNITIES IN THIS EVOLVING MARKET /UR STRATEGY WILL CONTINUE WITH AN OVERWEIGHT AS WE MONITOR RISKS AND VALUATION FOR EITHER INCREASING OR DECREASING THE OVERWEIGHT

Fiscal 2012 Investment Plan

PORTFOLIO STRUCTURE AS OF !PRIL

Portfolio Annualized Tracking Risk1 â&#x20AC;&#x201D; 49 basis points Portfolio Duration2 â&#x20AC;&#x201D; 4.88 Years

Relative to Index â&#x20AC;&#x201D; 97.0%

Market Value ($ millions)

Percent of Portfolio

Yield

Relative to Index3

4REASURIES

'OVERNMENT 2ELATED4

-ORTGAGES5

)NVESTMENT 'RADE #ORPORATES

(IGH 9IELD #ORPORATES8

%MERGING -ARKET $EBT9

$11,530

100%

3.3%

Sector Weights

#-"3 !"36 7

Total Fixed Income

! STATISTICAL MODEL IS USED TO GENERATE TRACKING RISK WHICH IS AN ESTIMATE OF THE EXPECTED DIFFERENCE IN ANNUAL PERFORMANCE BETWEEN THE PORTFOLIO AND THE INDEX &OR EXAMPLE THE lXED INCOME PORTFOLIO CURRENTLY HAS A TRACKING RISK OF BASIS POINTS MEANING THE PERFORMANCE OF THE PORTFOLIO RELATIVE TO THE INDEX IS EXPECTED TO BE WITHIN BASIS POINTS FOR ONE STANDARD DEVIATION OF ALL MARKET OUTCOMES 2 ! MEASURE OF THE SENSITIVITY OF THE PRICE OF THE lXED INCOME PORTFOLIO TO A CHANGE IN INTEREST RATES EXPRESSED IN YEARS 4HE CURRENT PORTFOLIO DURATION OF YEARS IMPLIES THE AVERAGE PRICE OF THE PORTFOLIO IS EXPECTED TO RISE BY FOR A BASIS POINTS DECLINE IN INTEREST RATES AND IS EXPECTED TO FALL BY FOR A BASIS POINTS INCREASE IN INTEREST RATES 4HE PORTFOLIO DURATION RELATIVE TO THE INDEX CURRENTLY AT IS THE PORTFOLIO S DURATION DIVIDED BY THE DURATION OF THE INDEX ! NUMBER LESS THAN IMPLIES THE PORTFOLIO HAS A DURATION LESS THAN THAT OF THE INDEX AND REmECTS AN EXPECTATION OF RISING RATES 3 4HE RELATIVE EXPOSURE TO EACH SECTOR VERSUS THE INDEX BASED UPON MARKET VALUE AND DURATION ! NUMBER GREATER THAN X INDICATES AN OVERWEIGHT AND REmECTS A SECTOR THAT WE BELIEVE IS UNDERVALUED ! NUMBER LESS THAN X INDICATES AN UNDERWEIGHT AND A SECTOR WE BELIEVE IS OVERVALUED 4 #ONSISTS OF 5 3 'OVERNMENT 3PONSORED %NTERPRISE DEBT AND OTHER HIGHLY RATED NONCORPORATE DEBT 5 -ORTGAGES ARE SECURED BY A DIVERSIlED POOL OF LOANS ON RESIDENTIAL PROPERTIES 6 #OMMERCIAL -ORTGAGE "ACKED 3ECURITIES #-"3 ARE SECURED BY A DIVERSIlED POOL OF LOANS ON COMMERCIAL PROPERTY SUCH AS OFlCE BUILDINGS INDUSTRIAL COMPLEXES RETAIL CENTERS HOTELS AND MULTIFAMILY DEVELOPMENTS !SSET "ACKED 3ECURITIES !"3 ARE SECURED BY POOLS OF CONSUMER LOANS INCLUDING CREDIT CARD RECEIVABLES AND AUTO LOANS 7 #ONSISTS OF DEBT FROM INDUSTRIAL UTILITY AND lNANCIAL INSTITUTION ISSUERS THAT IS RATED INVESTMENT GRADE WHICH IS """ AND ABOVE 8 #ONSISTS OF DEBT FROM INDUSTRIAL UTILITY AND lNANCIAL INSTITUTION ISSUERS THAT IS RATED NON INVESTMENT GRADE WHICH IS "" AND BELOW 9 #ONSISTS OF BONDS ISSUED BY COUNTRIES AND COMPANIES IN EMERGING MARKETS THAT ARE RATED """ AND BELOW 1

Fiscal 2012 Investment Plan

VI. Domestic Equities Investments OUTLOOK Summary &ISCAL SAW THE 5 3 EQUITY MARKET RISE DRAMATICALLY FOR THE SECOND CONSECUTIVE YEAR AS THE ECONOMY AND lNANCIAL MARKETS RETURNED TO HEALTH FROM THE UNPRECEDENTED DECLINES CAUSED BY THE n lNANCIAL CRISIS !S OF THE END OF !PRIL THE 3 0 HAS RISEN MORE THAN TO FROM AT THE BEGINNING OF THE lSCAL YEAR 4HE 3 0 HAS CLIMBED ROUGHLY SINCE THE -ARCH MARKET LOWS OF THE h'REAT 2ECESSION v 4HE YEARLY RETURN IS SIGNIlCANTLY ABOVE THE LONG TERM POLICY EXPECTATION FOR DOMESTIC EQUITIES OF

S&P 500 PRICE INDEX Avg. 1941â&#x20AC;&#x201C;43=10

Source: Financial Times

Note: Shaded areas denote recession.

Economic Drivers 7E WOULD NORMALLY EXPECT THE ECONOMY TO REBOUND STRONGLY AFTER A SEVERE RECESSION (OWEVER WHEN A RECESSION IS COMBINED WITH A lNANCIAL CRISIS WE GENERALLY SEE A MORE MEASURED RECOVERY FOR AN EXTENDED PERIOD OF TIME 0REDICTABLY THIS HAS BEEN THE RECENT EXPERIENCE &ISCAL HAS SEEN THE 5 3 ECONOMY GROW AT A RATE OF FOLLOWING ONLY GROWTH IN lSCAL WELL BELOW THE GROWTH SEEN AFTER A TYPICAL RECESSION $ESPITE THE STRONG DOMESTIC EQUITY MARKET THE ECONOMY REMAINS FRAGILE %MPLOYMENT GROWTH CONTINUES TO BE SLUGGISH AND THE UNEMPLOYMENT RATE IS AT LEVELS LAST SEEN IN THE S 4HE HOUSING MARKET REMAINS WEAK AND HOME PRICES CONTINUED TO FALL THROUGHOUT THE YEAR /IL PRICES ARE AT ELEVATED LEVELS DUE TO UNREST IN THE -IDDLE %AST AND RISING INTERNATIONAL DEMAND !DDITIONALLY CREDIT STANDARDS

Fiscal 2012 Investment Plan

ARE MUCH STRICTER RELATIVE TO RECENT HISTORY CONSTRICTING LOAN GROWTH AND SPENDING &INALLY THE RECESSION AND WEAK RECOVERY HAVE EXPOSED GLOBAL GOVERNMENT BUDGETARY DElCITS THAT WILL LIKELY HINDER GOVERNMENT SPENDING AND RESULT IN ONGOING CONSUMER AND GOVERNMENT DELEVERAGING )N THE FACE OF CONTINUED ECONOMIC WEAKNESS THE &EDERAL 2ESERVE HAS MAINTAINED A POLICY OF EXTREMELY LOW RATES AND QUANTITATIVE EASING IN AN EFFORT TO JUMP START THE ECONOMY AND OFFSET THE DEmATIONARY IMPACT OF DELEVERAGING 4HE FEDERAL FUNDS RATE REMAINS AT n WITH LITTLE LIKELIHOOD OF INCREASING IN THE NEAR TERM &OR lSCAL THE 3423 /HIO 5 3 ECONOMIC FORECAST CALLS FOR A CONTINUATION OF SLUGGISH ECONOMIC GROWTH 2EAL '$0 GROWTH IS PROJECTED TO BE ONLY FOR THE YEAR )T IS LIKELY THE CONSIDERABLE HEAD WINDS OF FEDERAL STATE AND LOCAL BUDGET DElCITS Â&#x2C6; COMBINED WITH GLOBAL SOVEREIGN DEBT PROBLEMS Â&#x2C6; WILL RESULT IN EXTENSIVE GOVERNMENT CUTBACKS AND OR TAX INCREASES THAT WILL LIKELY ACT AS A DRAG TO THE 5 3 ECONOMY FOR AN EXTENDED PERIOD POTENTIALLY HAMPERING ECONOMIC GROWTH AND MARKET APPRECIATION 4HESE ISSUES SHOULD BE SOMEWHAT OFFSET BY STRONG CORPORATE BALANCE SHEETS CONTINUED EARNINGS GROWTH AND STRENGTH SEEN BY EMERGING ECONOMIES

Earnings 3 0 EARNINGS CONTINUED TO RECOVER FROM THE RECESSION HOWEVER AT A LESS RAPID RATE THAN THE GROWTH SEEN IN 4HE 3 0 IS EXPECTED TO EARN APPROXIMATELY IN lSCAL UP FROM IN lSCAL AND ABOVE OUR ORIGINAL FORECAST OF %ARNINGS WERE BUOYED BY CORPORATE COST CONTROLS AS COMPANIES DID AN EXEMPLARY JOB OF BELT TIGHTENING AND IMPROVING EFlCIENCY 3TRONGER CORPORATE EARNINGS HAVE PRIMARILY RESULTED FROM BETTER MARGINS 'OING FORWARD WE EXPECT EARNINGS TO GROW ALBEIT AT A DECLINING RATE AS MARGIN IMPROVEMENT WILL BE MORE DIFlCULT AND GROWTH WILL INCREASINGLY HAVE TO COME FROM REVENUE IMPROVEMENT /UR lSCAL POINT ESTIMATE FOR 3 0 EARNINGS IS 4HIS WOULD RESULT IN AN EARNINGS GROWTH RATE OF ROUGHLY 7HILE THIS IS CURRENTLY OUR BEST ESTIMATE WE RECOGNIZE THERE IS A GREAT DEGREE OF VARIABILITY AROUND OUR POINT ESTIMATE AS THE ECONOMIC BACKDROP REMAINS UNCERTAIN 0ROJECTED EARNINGS OUTCOMES ARE DEPENDENT ON COMMODITY PRICES AND HOW THE ECONOMY REACTS TO THE RESOLUTION OF BUDGET DElCITS AT THE FEDERAL STATE AND LOCAL LEVEL !DDITIONALLY THE GLOBAL SOVEREIGN DEBT CONCERNS AND UNREST IN THE -IDDLE %AST COULD IMPACT OUR FORECAST )N THE EVENT OF BETTER THAN EXPECTED ECONOMIC ACCELERATION INCREASED LOAN GROWTH AND OR IMPLEMENTATION OF GLOBAL DEBT SOLUTIONS OUR POINT ESTIMATE FOR MAY BE TOO LOW )N THIS SCENARIO EARNINGS COULD CLIMB TO OR MORE FOR THE 3 0 )N THE EVENT THAT DEBT PROBLEMS WORSEN A GLOBAL RECESSION COULD OCCUR MAKING OUR EARNINGS ESTIMATES TOO OPTIMISTIC )N THIS SCENARIO EARNINGS COULD FALL BACK TO THE RANGE 4HE RISK OF A LARGE MARKET DOWNTURN OF INCREASES SIGNIlCANTLY IF THE LONG TERM DElCIT IS NOT ADDRESSED IN A TIMELY MANNER 7ITH THE CONSIDERABLE UNCERTAINTY AHEAD WE WOULD NOT BE SURPRISED TO SEE THE MARKET TRADE IN A WIDE BAND 4HIS ARGUES FOR A NIMBLE STRATEGY SIMILAR TO THE ONE EMPLOYED QUITE EFFECTIVELY OVER THE PAST FEW YEARS ADDING TO EQUITIES ON DECLINES AND LOWERING OUR EXPOSURE TO EQUITIES ON MARKET RALLIES

Fiscal 2012 Investment Plan

S&P 500 OPERATING EARNINGS S&P 500 Composite: Operating Earnings per Share 4-qtr Moving Total

$/share

S&P 500 Composite: Operating Earnings per Share % Change â&#x20AC;&#x201D; Year to Year

4-qtr Moving Total

$/share

Source: Standard and Poorâ&#x20AC;&#x2122;s

Note: Shaded areas denote recession.

Valuations 4HE 3 0 IS CURRENTLY TRADING AT TIMES TRAILING MONTH EARNINGS 4HIS IS AT THE HIGH END OF THE HISTORICAL AVERAGE OF n TIMES 7E EXPECT THE PRICE TO EARNINGS 0 % MULTIPLE FOR THE MARKET TO CONTRACT SLIGHTLY TO NORMALIZED LEVELS AS CORPORATE EARNINGS GROWTH SLOWS AND MARKETS CONTINUE TO WEIGH THE HEADWINDS OF THE GLOBAL BUDGETARY CRISIS AND THE POTENTIAL OF FUTURE INTEREST RATE INCREASES

Forecast &OR lSCAL WE EXPECT A GRADUALLY IMPROVING ECONOMY TO LEAD TO POSITIVE ALBEIT MORE MODERATE STOCK RETURNS /UR lSCAL 3 0 TARGET IS RESULTING IN AN APPROXIMATE RETURN FROM THE LEVEL OF THE END OF !PRIL 4HIS FORECAST IS DERIVED BY PLACING A 0 % OF TIMES OUR 3 0 EARNINGS ESTIMATE 4HERE IS HOWEVER CONSIDERABLE UNCERTAINTY AROUND THIS PROJECTION BECAUSE OF HIGHLY VARIABLE GLOBAL ECONOMIC AND lNANCIAL CONDITIONS 4HE OUTCOME OF THE CURRENT BUDGETARY WOES OF THE 5NITED 3TATES AND %UROPE COULD CHANGE OUR TARGET DRAMATICALLY )N A BEST CASE OUTCOME THE lSCAL CRISIS WILL BE RESOLVED WHICH WOULD LEAD TO AN IMPROVED LENDING ENVIRONMENT AND INCREASED APPETITE FOR RISK BY INVESTORS 4HIS WOULD RESULT IN RENEWED CONlDENCE IN THE lNANCIAL MARKETS AND THE ECONOMY MAKING OUR 3 0 FORECAST TOO LOW )N OUR WORST CASE SCENARIO THE GLOBAL BUDGET CRISIS ESCALATES OR UNREST IN THE -IDDLE %AST RESULTS IN EXTREMELY HIGH OIL PRICES LEADING TO ANOTHER RECESSION 4HE RAMIlCATIONS OF THIS SCENARIO WOULD BE SEVERE AND WOULD LIKELY RESULT IN A SHARP DROP IN THE EQUITY MARKETS )T IS DIFlCULT TO PLACE PROBABILITIES ON SUCH SCENARIOS OCCURRING

Fiscal 2012 Investment Plan

STRATEGY 7E REMAIN BALANCED IN BOTH STYLE AND MARKET CAPITALIZATION WITHIN THE EQUITY MARKET 7HILE WE DO NOT PLAN TO MAKE DRAMATIC ALLOCATION CHANGES WE BELIEVE LARGE CAPITALIZATION VALUE STOCKS OFFER THE BEST POTENTIAL RETURNS IN THE DOMESTIC EQUITY MARKET AND PLAN TO TACTICALLY ADJUST ALLOCATIONS ACCORDINGLY !LTHOUGH OVERALL VOLATILITY HAS DECLINED RECENTLY THE UNCERTAIN ECONOMY MAY PROVIDE PERIODS OF ELEVATED VOLATILITY IN lSCAL 7E PLAN TO TAKE ADVANTAGE OF THE VOLATILITY BY OPPORTUNISTICALLY INCREASING OUR EXPOSURE TO THE MARKET ON PULLBACKS AND DECREASING OUR EQUITY EXPOSURE ON MARKET RALLIES 7E WILL ALSO SEEK TO IMPLEMENT OTHER TACTICAL HEDGES THAT MAY BE EMPLOYED TO PROTECT ASSETS FROM OUR DOWNSIDE SCENARIO

Fiscal 2012 Investment Plan

VII. International Investments OUTLOOK &OLLOWING THE GOOD REBOUND IN lSCAL THE INTERNATIONAL MARKETS CONTINUED TO RISE STRONGLY IN lSCAL 4HE 7ORLD EX 53 )NDEX HEDGED FOR DEVELOPED MARKETS WAS NEARLY THROUGH MID -AY WHILE THE -3#) %-& )NDEX FOR EMERGING MARKETS HAD RISEN !S A RESULT THE 3423 /HIO "LENDED "ENCHMARK CONSISTING OF OF THE 7ORLD EX 53 )NDEX HEDGED RETURN AND OF THE -3#) %-& )NDEX RETURN IS SHOWING AN INCREASE OF !T THIS WRITING THE STAFF EXPECTS MODESTLY BELOW NORMAL RETURNS FROM THE INTERNATIONAL ASSET CLASS IN lSCAL

Developed Markets $EVELOPED MARKETS CONTINUED TO MOVE HIGHER UP NEARLY IN DOLLAR TERMS DURING THE CURRENT lSCAL YEAR 3LIGHTLY MORE THAN HALF OF THE GAIN CAME FROM LOCAL MARKETS APPRECIATION AND THE REMAINING PORTION FROM A WEAKENING 5 3 DOLLAR .ONE OF THE RISKS IDENTIlED LAST YEAR Â&#x2C6; WHETHER IT BE %UROPEAN 5NION %5 SOVEREIGN DEBT CRISES 5 3 MORTGAGE CRISIS OR THE INmATION DEmATION DEBATE Â&#x2C6; HAVE BEEN RESOLVED )F ANYTHING ALL RISKS HAVE BECOME MORE ACUTE AND IT IS ACTUALLY BECOMING EVEN MORE DIFlCULT TO SEE ANY KIND OF BENIGN RESOLUTION /DDLY MARKET VOLATILITY WAS RELATIVELY TAME IN THE LAST MONTHS #OULD THIS BE THE PROVERBIAL CALM BEFORE THE STORM 4HE EXPECTED RETURN OF DEVELOPED MARKETS OVER THE NEAR TERM IS $ESPITE THE DEVELOPED MARKETS VALUATION BEING SLIGHTLY LOWER THAN THE 5 3 MARKET THE LACK OF ANY SUBSTANTIAL CORRECTION PLUS LOW VOLATILITY IN THE PAST MONTHS HAS RESULTED IN A HIGHER DEGREE OF INVESTOR COMPLACENCY THAN SEEMS WARRANTED .ONE OF THE AFOREMENTIONED MAJOR RISKS HAVE BEEN RESOLVED NOR DID WE EXPERIENCE ANY OF THE FACTORS THAT TEND TO REDUCE RETURNS 'ROWTH RATES HAVE MODESTLY RECOVERED BUT NEW DOUBTS ARE BEGINNING TO ARISE OVER THEIR SUSTAINABILITY ,ASTLY INmATION IS BECOMING MORE PREVALENT IN EMERGING MARKETS WHILE DEmATION APPEARS LIKELY TO PERSIST IN THE DEVELOPED MARKETS 4HE MARKETS CAN DEAL WITH SUBDUED LEVELS OF EACH BUT TOO MUCH OF EITHER HURTS EQUITY RETURNS 3HOULD ANY OF THESE ITEMS BREAK THE WRONG WAY THE EXPECTED MODEST GAIN FOR THE NEXT lSCAL YEAR COULD TURN INTO A DECENT SIZED DECLINE 4HE DEVELOPED EQUITIES MARKET RESEMBLES THE MOVEMENT OF A YO YO OVER THE PAST DECADE 4HE INDEX LEVEL TOOK THREE YEARS TO FALL APPROXIMATELY FROM THE BUBBLE TOP lRST QUARTER ROSE MORE THAN IN THE NEXT Â YEARS FELL IN THE FOLLOWING Â YEARS AND HAS RISEN SLIGHTLY MORE THAN IN THE LAST YEARS $URING THE PAST YEARS THE PRICE COMPONENT HAS APPRECIATED ONLY BETWEEN OVERALL OR PER YEAR COMPOUNDED !DD TO THE PRICE PORTION THE DIVIDEND COMPONENT OF PER YEAR AND THE COMPOUNDED TOTAL RETURN IS ROUGHLY PER YEAR 4HAT IS A LOT OF AGGRAVATION FOR A MEAGER ANNUAL RETURN 5NFORTUNATELY THIS KIND OF PRICE VOLATILITY IS EXPECTED TO CONTINUE AS LONG AS THESE MAJOR RISK FACTORS REMAIN UNRESOLVED 4HEREFORE ONE MUST ALLOW mEXIBILITY AND INVEST OPPORTUNISTICALLY IN WHAT THE MARKET OFFERS OR RAISE CASH WHEN EQUITIES RUN AHEAD OF THE FUNDAMENTALS 6ALUATIONS IN THE DEVELOPED MARKETS ARE NOT EXPENSIVE AT CURRENT LEVELS 4HE 0 % MULTIPLE CURRENTLY STANDS NEAR TIMES WITH A RANGE OF TO TIMES DURING THE LAST YEARS 7ITH NEAR PEAK PROlT MARGINS AND THE CURRENT MACRO ISSUES THE 0 % RATIO WOULD NEED TO BE CLOSER TO TIMES TO COMFORTABLY PREDICT MORE NORMAL RETURNS 4HE CURRENT DIVIDEND YIELD IS IN THE LOWER HALF OF THE NORMAL TO RANGE 3TICKING TO AN OPPORTUNISTIC THEME WHEN THE MARKET MAKES ONE OF ITS PERIODIC DIPS PURCHASES CLOSER TO A YIELD OR ABOVE SHOULD PROVIDE REASONABLE LONGER TERM RETURNS #URRENCY MOVEMENTS CAN ENHANCE OR REDUCE 5 3 DOLLAR RETURNS )N THE LAST MONTHS THE DOLLAR HAS FALLEN HELPING TO BOOST 5 3 DOLLAR RETURNS 4HE DOLLAR IS CLOSE TO A RECORD COMPOSITE LOW FOR THE

-ORGAN 3TANLEY #APITAL )NTERNATIONAL %MERGING -ARKETS &REE )NDEX

Fiscal 2012 Investment Plan

LAST YEARS AND THERE IS NOTHING IN THE FUNDAMENTALS TO SUGGEST THE DOLLAR SHOULD STRENGTHEN OVER THE NEXT YEAR (OWEVER A COUNTER TREND RALLY LASTING A NUMBER OF MONTHS COULD EASILY OCCUR WHICH WOULD REDUCE DOLLAR BASED RETURNS 4HE RALLY COULD BE INITIATED BY THE &EDERAL 2ESERVE IF IT ENDS QUANTITATIVE EASING THIS *UNE 5NTIL THE 5NITED 3TATES MORE EFFECTIVELY RESOLVES ITS lSCAL ISSUES PROJECTED UNFUNDED LIABILITIES AND lNANCIAL CRISIS IT IS HARD TO MAKE A CASE THAT THE DOLLAR WILL STRENGTHEN ON A LONGER TERM BASIS 0ERIODIC DOLLAR STRENGTH WILL MORE LIKELY BE A RESPONSE TO ACTIONS IN OTHER TROUBLE SPOTS IN THE WORLD THAT MAKE THE DOLLAR APPEAR RELATIVELY LESS BAD TO AVAILABLE ALTERNATIVES 3UCCESSFUL INVESTMENT RESULTS IN DEVELOPED MARKETS USUALLY REQUIRE A GREATER FOCUS ON PICKING THE RIGHT COMPANIES IN THE MOST FAVORABLE INVESTABLE SECTORS E G ENERGY INDUSTRIALS UTILITIES CONSUMER STAPLES HEALTH CARE ETC AND DE EMPHASIZING THOSE SECTORS WITH THE LEAST ATTRACTIVE CHARACTERISTICS 2EGIONAL OR COUNTRY DIFFERENCES HAVE HAD A MUCH LOWER INmUENCE IN DETERMINING SUCCESS UNLIKE THE EMERGING MARKETS UNIVERSE WHERE REGION AND COUNTRY HAVE THE GREATEST WEIGHT 'IVEN THE CURRENT MACRO ENVIRONMENT THESE HISTORICAL RELATIONSHIPS IN THE DEVELOPED MARKETS MAY BE PUT TO THE TEST 4HE TEST COMES IN THE FORM OF THE lNANCIAL MARKET S REACTION TO THE SOVEREIGN DEBT CRISIS AND THE KIND OF MEASURES TAKEN TO RESOLVE THE CRISIS ! FEW YEARS AGO THE DEBTOR IN QUESTION WAS A 5 3 HOME OWNER WHO COULD NOT MAKE HIS MORTGAGE PAYMENT 4ODAY WE HAVE MOVED FROM THE MICRO LEVEL TO THE MACRO Â&#x2C6; THE DEBTORS IN QUESTION ARE WHOLE COUNTRIES THAT HAVE LIVED BEYOND THEIR MEANS AND ACCUMULATED DEBT BEYOND WHAT THEY ARE ABLE TO REPAY 4HE MAJOR PROBLEM Â&#x2C6; SOVEREIGN CREDIT Â&#x2C6; IS THE CORNERSTONE OF MODERN lNANCE E G SOURCE OF THE hRISK FREEv RATE OF RETURN )F IT IS BEING QUESTIONED WE HAVE ENTERED UNCHARTED WATERS 4HEREFORE WILL THIS 'REEK )RISH 0ORTUGUESE hCONTAGIONv SPREAD TO THE REST OF %UROPE I E 3PAIN AND )TALY AND BEYOND #ONTAGION IN A lNANCIAL MARKET SENSE REFERS TO THE SELLING OF RELATIVELY GOOD ASSETS BECAUSE LIQUIDITY EXISTS TO SELL WHEREAS THE ASSET CATEGORY IN WHICH THE CRISIS IS TAKING PLACE HAS NO LIQUIDITY 4HERE HAVE BEEN TWO ROUNDS OF CONTAGION EFFECTS E G MARKET DECLINES IN FOURTH QUARTER TO lRST QUARTER AND SECOND QUARTER IN THE EQUITY MARKETS BEFORE TEMPORARY SOLUTIONS WERE FOUND FOR THE 'REEK AND )RISH DEBT SITUATIONS 5NTIL A CREDIBLE SOLUTION HAS BEEN IDENTIlED AND INITIATED IT IS UNCLEAR WHETHER THE CONTAGION CAN BE CONTAINED )N THE MEANTIME PERIODIC DOWNDRAFTS SHOULD BE ANTICIPATED AS THE MARKET EXPERIENCES RENEWED FEAR OF POTENTIAL DEFAULTS 7HILE THE COUNTRY FACTOR MAY GROW IN IMPORTANCE ONE OF THE MOST CRITICAL FACTORS IN DETERMINING DEVELOPED MARKET OPPORTUNITIES WILL BE INDIVIDUAL COMPANY SELECTIONS E G STOCK PICKING 'IVEN THE CURRENT ENVIRONMENT STOCK PICKING GROWS IN SIGNIlCANCE 7HILE IT MAY SEEM BEST TO AVOID THE TROUBLED COUNTRIES THERE ARE SITUATIONS WHEN IT MAKES SENSE GIVEN THE RIGHT CIRCUMSTANCES &OR EXAMPLE A "RITISH MANUFACTURER WHO PRIMARILY EXPORTS ITS PRODUCTS WOULD BE AN IDEAL CANDIDATE SINCE IT CAN TAKE ADVANTAGE OF THE WEAK CURRENCY AND GAIN SHARE BY UNDERCUTTING THE PRICE OF OTHER COMPETITORS /N THE OTHER HAND BUYING A "RITISH RETAILER AND EXPOSING ONESELF TO CONSUMERS IN THE 5NITED +INGDOM 5+ MAY NOT MAKE SENSE IF THAT ECONOMY SHOULD DOUBLE DIP )N THE CASE OF *APAN THE 4OHOKU $ISASTER 'REAT %AST *APAN %ARTHQUAKE HIGHLIGHTED THE UNIQUE AND OFTENTIMES SINGULAR ROLE *APANESE COMPANIES PLAY IN THE HIGH VALUE ADDED GLOBAL SUPPLY CHAIN #OMPANIES THROUGHOUT THE WORLD SCRAMBLED TO MAINTAIN PRODUCTION IN SPITE OF THE POTENTIAL DELAYS AND SHORTAGES OF CRITICAL *APANESE MADE PARTS !S SUCH THE TWO LARGEST COMPONENTS IN THE DEVELOPED MARKETS INDEX THE 5+ AND *APAN ARE OVERWEIGHTED IN THE PORTFOLIO 'IVEN THE DISCUSSION ABOVE IT IS IRONIC THAT THESE TWO COUNTRIES ARE WELL REPRESENTED GIVEN THEIR RESPECTIVE CIRCUMSTANCES BUT IT REINFORCES COMMENTS MADE REGARDING INDIVIDUAL COMPANY SELECTION 4HE MOST ATTRACTIVE 5+ COMPANIES ARE THE LARGE GLOBAL PLAYERS IN THE ENERGY AND HEALTH CARE SECTORS THAT SPORT HIGH YIELDS AND UNDEMANDING 0 % MULTIPLES *APAN IS ALSO BLESSED WITH GLOBALLY COMPETITIVE INDUSTRIAL COMPANIES THAT CARRY SOME OF THE LOWEST VALUATIONS ON SOME MEASURES

Fiscal 2012 Investment Plan

IN THE LAST THREE DECADES 4HE RECENT EARTHQUAKE AND TSUNAMI DISASTER AND CONCURRENT MARKET DECLINE GAVE AN INVESTOR WITH IDLE CASH A CHANCE TO PICK UP SOME REAL BARGAINS ESPECIALLY FOR THOSE INVESTORS WITH A LONG TERM INVESTMENT HORIZON 2EGIONALLY THE DEVELOPED MARKETS PORTFOLIO IS UNDERWEIGHT NON *APAN !SIA NEUTRAL WEIGHT #ONTINENTAL %UROPE UNDERWEIGHT #ANADA AND OVERWEIGHT IN BOTH *APAN AND THE 5+ 4HE RESOURCE RICH COUNTRIES OF #ANADA AND !USTRALIA ARE BOTH UNDERWEIGHT SINCE THE INDIVIDUAL STOCKS APPEAR EXPENSIVE AND AMID SOME CONCERN THAT GROWTH PROSPECTS IN #HINA MAY FALTER NEAR TERM )F THE %5 CAN lND A CREDIBLE SOLUTION TO THE DEBT AND lSCAL PROBLEMS EXPERIENCED BY ITS MEMBERS E G 'REECE 0ORTUGAL 3PAIN AND )TALY THE WEIGHTINGS OF THE PORTFOLIO COULD SWING APPRECIABLY TOWARD A LARGER %UROPEAN POSITION OVER THE NEXT MONTHS 4HIS WOULD BE A FUNCTION OF HOW FAR %UROPEAN STOCKS DROP AS THE CRISIS CONTINUES )F THEY DROP ENOUGH UPON THE MARKET RECOGNIZING A SOLUTION IS NEAR FUNDS WOULD mOW OUT OF THE SAFE HAVENS E G 'ERMANY AND 3CANDINAVIA TOWARD THE BARGAINS )N SUMMARY THE POINT ESTIMATE FOR DEVELOPED MARKET RETURNS OVER THE MEDIUM TERM IS 4HERE ARE MANY MEASURES THAT ACT TO REDUCE THE RATE OF RETURN FROM THE MORE NORMAL )NCREASED VOLATILITY LOWER GROWTH PROSPECTS MEDIOCRE VALUATIONS AND NEAR TERM STRENGTH IN THE DOLLAR ARE A FEW OF THE ITEMS THAT COULD HOLD DOWN RETURNS TO A 5 3 DOLLAR BASED INVESTOR 4AKING ADVANTAGE OF MARKET OPPORTUNITIES WHEN THEY PRESENT THEMSELVES CAN HELP ENHANCE RETURNS 4HE CONTINUING lNANCIAL CRISIS AND THE POLICY RESPONSES WILL NEED TO BE FOLLOWED MORE CLOSELY THAN USUAL IN THE DEVELOPED MARKETS 'OOD OLD FASHIONED STOCK SELECTION SHOULD STILL BE ABLE TO ADD VALUE TO PORTFOLIO RETURNS IT IS JUST UNCLEAR WHAT THE MAGNITUDE OF THOSE RETURNS WILL BE ON AN ABSOLUTE BASIS

Emerging Markets %MERGING MARKET RETURNS IN lSCAL HAVE BEEN ROBUST FOR THE SECOND STRAIGHT YEAR INCREASING APPROXIMATELY THROUGH MID -AY 4HE RETURNS ARE SLIGHTLY BELOW THE 5 3 EQUITY RETURNS AND MODERATELY BETTER THAN RETURNS IN DEVELOPED INTERNATIONAL MARKETS DURING THE CURRENT lSCAL YEAR (OWEVER THE EMERGING MARKET RETURNS TO DATE FOR CALENDAR YEAR ARE LAGGING THE DEVELOPED WORLD S AS INVESTORS ARE CONCERNED ABOUT THE PERSISTENT INmATIONARY PRESSURES PRESENT IN MANY EMERGING COUNTRIES 4HE CENTRAL BANKS AND lSCAL AUTHORITIES IN MANY OF THESE EMERGING COUNTRIES WILL NEED TO CONTINUE RAISING INTEREST RATES AND IMPLEMENTING CREDIT RESTRAINING MEASURES 4HEREFORE WE BELIEVE THAT THE LAGGED EFFECTS FROM THE ANTI INmATION EFFORT WILL PROVIDE A LESS FAVORABLE EQUITY MARKET ENVIRONMENT MAKING IT DIFlCULT TO GENERATE EMERGING MARKET EQUITY RETURNS AS ROBUST AS THOSE THAT OCCURRED THE PAST TWO YEARS )F THE MONETARY TIGHTENING IN EMERGING COUNTRIES IS SUCCESSFUL AGAINST INmATIONARY PRESSURES ALREADY IN THE PIPELINE THEN THE EQUITY MARKETS COULD STILL GENERATE ATTRACTIVE RETURNS (OWEVER THERE ARE RISKS OF A NEW ROUND OF INmATIONARY PRESSURES COMING FROM SUCH THREATS AS EVEN HIGHER OIL PRICES DUE TO SPREADING -IDDLE %AST TURMOIL OR HIGHER FOOD PRICES IF POOR WEATHER HARMS GLOBAL AGRICULTURAL PRODUCTION 4HE OVERALL VALUATIONS IN EMERGING MARKETS COMPARED TO THE DEVELOPED WORLD HAVE NOT CHANGED MATERIALLY SINCE LAST YEAR S ANNUAL PLAN 2ETURNS ON EQUITY IN EMERGING MARKETS REMAIN HIGHER THAN IN THE DEVELOPED WORLD WHILE VALUATIONS ON BOOK VALUE ARE AT A REASONABLE PREMIUM 6ALUATIONS ON TRAILING EARNINGS AND FORWARD EARNINGS ARE AT DISCOUNTS TO THE DEVELOPED MARKETS BUT THESE DISCOUNTS ARE STILL NOT EXCEPTIONALLY ATTRACTIVE /VERALL WE BELIEVE THE EMERGING MARKETS ARE FAIRLY VALUED %ARNINGS ESTIMATES OVERALL ARE STILL BEING RAISED SLIGHTLY BUT WE BELIEVE THAT COST PRESSURES CREATE THE RISK FOR EARNINGS DISAPPOINTMENTS AS MANY COMPANIES ARE ALREADY GENERATING CYCLE HIGH PROlTS (IGHER INTEREST RATES COMBINED WITH THE CYCLE HIGH PROlTABILITY MAY CAUSE VALUATION MULTIPLES ON EARNINGS TO MODERATELY CONTRACT #HINA HAS ATTEMPTED TO RESTRAIN INmATIONARY PRESSURES OVER THE PAST YEAR BY RAISING INTEREST RATES HIKING BANKING RESERVE REQUIREMENTS AND ALLOWING ITS CURRENCY TO APPRECIATE SLIGHTLY VERSUS THE 5 3 DOLLAR (OWEVER THESE MEASURES HAVE NOT SUCCESSFULLY LOWERED THE INmATION RATE TO A LEVEL TARGETED BY

Fiscal 2012 Investment Plan

THE GOVERNMENT 4HEREFORE WE EXPECT MORE TIGHTENING MEASURES TO COOL DOWN VARIOUS SECTORS SUCH AS THE PROPERTY MARKET 4HERE IS THE CONTINUED RISK THAT THE #HINESE AUTHORITIES MAKE A POLICY ERROR THAT CAUSES THE ECONOMY TO DECELERATE TOO QUICKLY 4HIS WOULD NOT ONLY BE A PROBLEM FOR EMERGING MARKET RETURNS SINCE THE COUNTRY HAS A WEIGHT IN THE BENCHMARK BUT ALSO BECAUSE OTHER EMERGING COUNTRIES ARE HEAVILY DEPENDENT ON EXPORTING COMMODITIES AND MANUFACTURED GOODS TO #HINA 3423 /HIO REMAINS SIGNIlCANTLY UNDERWEIGHT #HINA AND SOME OTHER LARGE COUNTRIES WITH INmATION PROBLEMS SUCH AS "RAZIL AND )NDIA #ONTRIBUTING FACTORS TO THE ROBUST EMERGING MARKET RETURNS IN THE PAST YEAR INCLUDE AMPLE LIQUIDITY AND A WEAKENING 5 3 DOLLAR 4HE &EDERAL 2ESERVE S QUANTITATIVE EASING PROGRAM HAD A POSITIVE IMPACT ON RISK ASSETS SUCH AS EMERGING MARKET EQUITIES BUT IT IS DIFlCULT TO QUANTIFY THE IMPACT (OWEVER THE PLANNED EXIT FROM QUANTITATIVE EASING BY THE &EDERAL 2ESERVE WILL WITHDRAW SOME OF THE SUPPORT TO EMERGING MARKETS !LSO IF IT BEGINS TO RAISE INTEREST RATES AS EXPECTED IN THEN THE 5 3 DOLLAR MAY BEGIN TO APPRECIATE VERSUS SOME EMERGING MARKET CURRENCIES AND THUS DETRACT FROM OVERALL PERFORMANCE IN 5 3 DOLLAR TERMS

STRATEGY !S lSCAL DRAWS TO A CLOSE THE INTERNATIONAL PORTFOLIO IS APPROXIMATELY BILLION OR OF TOTAL ASSETS WHICH IS JUST BELOW THE NEUTRAL TARGET WEIGHT OF 4HE INTERNATIONAL ASSET CLASS WAS UNDERWEIGHTED THROUGHOUT THE LAST HALF OF lSCAL AFTER WITHDRAWALS OF APPROXIMATELY BILLION DURING PERIODS OF EXCEPTIONAL MARKET STRENGTH AND WILL END THE YEAR UNDERWEIGHTED 3TAFF IS PROJECTING A SLIGHTLY BELOW NORMAL RETURN FOR THE 3423 /HIO "LENDED "ENCHMARK FOR THE NEXT MONTHS WITH BOTH THE DEVELOPED AND EMERGING MARKETS RETURNING BELOW THEIR LONG TERM EXPECTED AVERAGE OF 4HE INTERNATIONAL ASSET CLASS WILL LIKELY BE HELD BELOW THE NEUTRAL TARGET WEIGHT IN lSCAL UNLESS THE RISK REWARD OUTLOOK BECOMES MORE FAVORABLE ,OOKING AT THE PORTFOLIO FROM A RISK BUDGETING STANDPOINT THE HIGHEST AMOUNT OF RISK IS COMING FROM THE EXTERNAL MANAGERS 4HIS IS DUE IN LARGE PART TO THE LARGE CORE %!&% %UROPE !USTRALASIA &AR %AST PRODUCT BEING RUN INTERNALLY 3EVERAL OF THE OTHER INTERNAL PORTFOLIOS ARE BEING RUN VERY ACTIVELY 4HE STAFF DOES NOT ANTICIPATE MUCH CHANGE IN THE ALLOCATION OF RISK ACROSS THE INTERNATIONAL PORTFOLIO IN lSCAL 4HE CHART ON 0AGE SHOWS ALLOCATIONS FOR INTERNALLY MANAGED EXTERNALLY MANAGED DEVELOPED COUNTRY AND EMERGING MARKET INVESTMENTS !T lSCAL YEAR END WE WILL BE NEAR AN SPLIT BETWEEN THE DEVELOPED AND EMERGING MARKETS WITHIN THE ASSET CLASS WHICH IS AT THE NEUTRAL POINTS SET FOR EACH !S A PERCENT OF TOTAL ASSETS STAFF ANTICIPATES KEEPING THE EMERGING MARKET WEIGHT NEAR THE TARGETED NEUTRAL WEIGHT OF CURRENTLY IN lSCAL AND THE DEVELOPED MARKETS WILL BE KEPT BELOW THE NORMAL WEIGHT OF OF TOTAL ASSETS CURRENTLY 4HE SPLIT BETWEEN EXTERNALLY AND INTERNALLY MANAGED FUNDS REMAINED STATIC DURING lSCAL AS THE WITHDRAWALS WERE DIVIDED BETWEEN THE INTERNALLY AND EXTERNALLY MANAGED PORTFOLIOS !S SHOWN ON 0AGE THE SPLIT IS CURRENTLY INTERNAL AND EXTERNAL

Fiscal 2012 Investment Plan

FISCAL YEAR-END 2011 (estimated) $ Invested (at Market)

Percent of International Assets

%XTERNAL -ANAGERS

MILLION

)NTERNAL -ANAGERS

MILLION

$14,500 million

100%

$EVELOPED -ARKETS

MILLION

%MERGING -ARKETS

MILLION

$14,500 million

100%

Fiscal 2012 Investment Plan

VIII. Real Estate Investments OUTLOOK Overview !T THIS TIME LAST YEAR STAFF INDICATED IT EXPECTED THE BLENDED REAL ESTATE BENCHMARK TO RETURN FOR lSCAL 4HROUGH -ARCH THE BENCHMARK RETURN STANDS AT ALMOST 7HILE THE OPERATING FUNDAMENTALS OF REAL ESTATE Â&#x2C6; RENTS AND OCCUPANCY Â&#x2C6; HAVE BEEN IMPROVING OVER THE COURSE OF THE lSCAL YEAR THEY HAVE NOT RECOVERED TO THE LEVELS THESE RETURNS WOULD IMPLY )T IS ONCE AGAIN THE CAPITAL MARKET THAT HAD THE MOST IMPACT ON PRICING )T IS A COMBINATION OF CONTINUED LOW INTEREST RATES INCREASING AVAILABILITY OF DEBT AND THE SUPPLY OF CAPITAL OUTSTRIPPING THE SUPPLY OF PROPERTY LISTED FOR SALE ,AST YEAR S ANNUAL PLAN INDICATED THE PEAK TO TROUGH DECLINE OF WAS NOTEWORTHY BECAUSE OF THE RAPIDITY WITH WHICH IT OCCURRED EIGHT QUARTERS VS IN THE S FOR A SIMILAR DECLINE 4HIS YEAR THE PACE OF THE RECOVERY IN PRICES IS EQUALLY NOTEWORTHY ESPECIALLY IN LIGHT OF FUNDAMENTALS THAT ARE STILL IN SOME CASES SEVERAL YEARS AWAY FROM EQUILIBRIUM !S lSCAL COMES TO A CLOSE PRIVATE MARKET COMMERCIAL REAL ESTATE AS MEASURED BY THE .0) HAS HAD FOUR CONSECUTIVE QUARTERS OF POSITIVE PRICE APPRECIATION THROUGH -ARCH AND A lSCAL YEAR TO DATE TOTAL RETURN OF 4RANSACTION VOLUME IN THE PRIVATE MARKETS AS MEASURED BY .#2%)& FOR CALENDAR YEAR WAS UP ALMOST OVER BUT THIS IS OFF AN EXTREMELY LOW BASE 4HE ROLLING FOUR QUARTER AVERAGE IS RUNNING ABOUT TRANSACTIONS DURING THE PEAK YEARS OF n IT WAS BETWEEN TO TRANSACTIONS 2EGULATORS HAVE GIVEN BANKS mEXIBILITY DURING THE LAST SEVERAL YEARS TO EXTEND MATURITIES FOR UNDERWATER MORTGAGES WHICH CONTRIBUTED TO THE LOW VOLUME OF TRANSACTIONS (OWEVER BANKS ARE NOW MORE LIKELY TO TAKE BACK THESE PROPERTIES GIVEN THE INCREASE IN VALUES AND PLACE THEM FOR SALE ON A MEASURED BASIS 4HIS WILL BRING TRANSACTION VOLUME BACK UP TO MORE NORMALIZED LEVELS 4HERE IS A DICHOTOMY ACROSS THE MARKETPLACE WITH ASSETS LOCATED IN COASTAL MARKETS THAT ARE HIGH QUALITY AND WELL LEASED ATTRACTING MOST OF THE CAPITAL mOW 4HIS HAS HELPED FUEL THE RAPID VALUE RECOVERY IN THESE MARKETS AND PROPERTIES IN SOME CASES TO PRE CRISIS LEVELS 3ECOND TIER MARKETS HAVE SEEN MUCH LESS ACTIVITY AND THEREFORE LESS VALUE RECOVERY (OWEVER WITH THE INCREASING AVAILABILITY OF lNANCING SIGNS OF A REAL ESTATE RECOVERY AND THE lERCE COMPETITION IN lRST TIER MARKETS INVESTORS ARE NOW LOOKING TO SECOND TIER PROPERTIES AND MARKETS FOR ACQUISITION OPPORTUNITIES !S THE OVERALL ECONOMY CONTINUES TO RECOVER WE EXPECT THIS TREND TO CONTINUE AS INVESTORS ARE MORE WILLING TO TAKE ON ADDITIONAL RISK 4HE RECOVERY IN PUBLIC MARKET REAL ESTATE 2%)4S IS ENTERING ITS THIRD YEAR &ROM THE LOW POINT IN -ARCH 2%)4S HAVE RISEN APPROXIMATELY $ESPITE THIS 2%)4S ARE STILL ABOUT BELOW THE HIGH WATER MARK SET IN 3IMILAR TO THE PRIVATE MARKET THERE ARE SEVERAL POSITIVE FACTORS THAT HAVE CONTRIBUTED TO THIS TREND 4HESE INCLUDE THE DRAMATIC IMPROVEMENT IN THE DEBT MARKETS INVESTOR APPETITE FOR RELATIVELY HIGH YIELDING INVESTMENTS INSTITUTIONAL DEMAND FOR REAL ESTATE ASSETS AND lNALLY AN IMPROVING PROPERTY FUNDAMENTAL PICTURE !S OF LATE -AY THE 2%)4 BENCHMARK STANDS AT APPROXIMATELY lSCAL YEAR TO DATE 2%)4S HAVE TAKEN ADVANTAGE OF FAVORABLE PRICING FOR BOTH DEBT AND EQUITY 4HROUGH MID !PRIL 2%)4S RAISED ALMOST BILLION ACCORDING TO 3., 3ECURITIES #APITAL mOWS INTO 2%)4 MUTUAL FUNDS AND %4&S EXCHANGE TRADED FUNDS ARE ON RECORD PACE 4HE SECTOR HAS GARNERED MORE CAPITAL IN THE LAST lVE MONTHS THAN IN ENTIRE CALENDAR YEAR WHICH WAS THE LAST PEAK FOR CAPITAL INmOWS 2%)4S HAVE USED THIS CAPITAL TO PAY DOWN AND EXTEND DEBT MATURITIES AND MORE RECENTLY THEY HAVE BECOME VERY ACTIVE BUYERS OF INDIVIDUAL ASSETS IN THE PRIVATE MARKET ALONG WITH PUBLIC MARKET MERGER ACTIVITY

Fiscal 2012 Investment Plan

)N lSCAL STAFF ANTICIPATES A BLENDED BENCHMARK TOTAL RETURN OF APPROXIMATELY (OWEVER WE EXPECT TRANSACTION PRICING ON NEW ACQUISITIONS TO BE ON AVERAGE CONSISTENT WITH THE 2ETIREMENT "OARDgS LONG TERM EXPECTED RETURN FOR THE ASSET CLASS

Property Markets 4HE REAL ESTATE MARKET IS RECOVERING FROM THE SIGNIlCANT DOWNTURN EXPERIENCED IN AND (OWEVER THE PROPERTY MARKETS LAG THE OVERALL ECONOMY 7ITH THE LACKLUSTER JOB GROWTH TO DATE PROPERTY OPERATING FUNDAMENTALS WHILE IMPROVING ARE STILL WEAK IN MANY AREAS 4HE COASTAL MARKETS WITH THEIR INHERENT GEOGRAPHIC SUPPLY CONSTRAINTS AND GREATER PARTICIPATION IN THE GLOBAL ECONOMY WILL CONTINUE TO LEAD THE RECOVERY RELATIVE TO THE MIDDLE OF THE COUNTRY &ROM A PROPERTY TYPE PERSPECTIVE APARTMENTS HAVE DONE EXTREMELY WELL WHICH WE ANTICIPATE WILL CONTINUE IN lSCAL 'IVEN THE SHORT TERM NATURE OF THEIR LEASES RELATIVE TO OTHER PROPERTY TYPES APARTMENTS CAN BENElT FROM INCREASING DEMAND BY RAISING RENTS MORE RAPIDLY )NDUSTRIAL ASSETS ARE BENElTING FROM INVENTORY BUILDUP GLOBAL TRADE AND IMPROVED RETAIL SALES HOWEVER THERE IS STILL EXCESS SUPPLY AND UNDERUTILIZATION THAT NEEDS TO BE ABSORBED BEFORE MEANINGFUL INCREASES IN RENT CAN OCCUR "OTH RETAIL AND OFlCE FUNDAMENTALS WILL TAKE LONGER TO RECOVER (OWEVER THERE HAS BEEN LIMITED NEW SUPPLY ACROSS ALL PROPERTY TYPES THAT BODES WELL PARTICULARLY FOR OFlCE GIVEN ITS LONG LEAD TIME FOR DEVELOPMENT /NCE DEMAND TAKES HOLD THOSE MARKETS WITH LIMITED AVAILABILITY FOR NEW DEVELOPMENT MAY QUICKLY SEE SIGNIlCANT RENTAL INCREASES AS VACANCIES DECLINE

Returns 4HE CHART BELOW DEMONSTRATES THE CHANGES IN PRIVATE REAL ESTATE RETURNS OVER THE LAST THREE YEARS 4YPICALLY RETURNS ARE NOT THIS VOLATILE NOR THIS HEAVILY SKEWED TO PRICE /VER THE LONG TERM PRICE ACCOUNTS FOR APPROXIMATELY OF THE TOTAL RETURN FOR REAL ESTATE WITH INCOME ACCOUNTING FOR APPROXIMATELY OF THE TOTAL RETURN 4HE .0) ACCOUNTS FOR OF THE 3423 /HIO REAL ESTATE BLENDED BENCHMARK NCREIF Property Index (NPI) One Year Ending

Income

Price

Total

-ARCH

Three-Year Average Annual

6.1%

n n â&#x20AC;&#x201C;9.3%

â&#x20AC;&#x201C;3.6%

2EAL ESTATE RETURNS ARE DRIVEN BY BOTH THE UNDERLYING PROPERTY FUNDAMENTALS AND THE CAPITAL MARKETS &OR SEVERAL YEARS THE CAPITAL MARKETS HAVE BEEN THE PRIMARY DRIVER OF RETURNS AND WAS NO DIFFERENT "ROADLY SPEAKING RETURNS IN lSCAL SHOULD BE MORE RELIANT ON OPERATING FUNDAMENTALS THAN THEY HAVE BEEN IN THE RECENT PAST *OB GROWTH DRIVES ALL SECTORS OF THE REAL ESTATE MARKET AND THERE NEEDS TO BE REAL AND SUSTAINED IMPROVEMENT FOR THE ASSET CLASS TO CONTINUE ITS RECOVERY !S IS TYPICAL IN THE EARLY PART OF A RECOVERY THERE WILL BE WIDE VARIATIONS ACROSS PROPERTY TYPE AS WELL AS GEOGRAPHY 2%)4 STOCKS ARE NEAR THE TOP END OF THE RANGE FOR FAIR VALUE PRICING AND APPEAR EXPENSIVE RELATIVE TO THE BROAD STOCK MARKET -OST OF THE GOOD NEWS Â&#x2C6; IMPROVING PROPERTY FUNDAMENTALS EXPECTATION OF CONTINUED RELATIVELY LOW INTEREST RATES AND A RECOVERING ECONOMY EVEN A SLOW ONE Â&#x2C6; APPEARS TO BE ALREADY PRICED IN AT CURRENT LEVELS ! MINOR CORRECTION IS TO BE EXPECTED IN THE NEAR TERM GIVEN THE RUN UP IN lSCAL AND lSCAL HOWEVER ABSENT AN UNEXPECTED STEEP OR RAPID UPWARD MOVEMENT IN INTEREST RATES 2%)4S ARE EXPECTED TO RETURN IN THE RANGE FOR lSCAL

Fiscal 2012 Investment Plan

3TAFF ANTICIPATES A BLENDED BENCHMARK TOTAL RETURN FOR THE ASSET CLASS OF APPROXIMATELY IN lSCAL (OWEVER WE EXPECT TRANSACTION PRICING ON NEW ACQUISITIONS TO BE ON AVERAGE CONSISTENT WITH THE LONG TERM EXPECTED RETURN FOR THE ASSET CLASS 4HE CHART BELOW OUTLINES THE EXPECTED RANGE OF RETURNS BASED ON PROPERTY TYPE FOR NEW ACQUISITIONS IN lSCAL 4YPICALLY THE COASTAL MARKETS WILL BE AT THE LOW END OF THE RANGE WITH THE MIDDLE OF THE COUNTRY AT THE UPPER END ALTHOUGH THERE MAY BE EXCEPTIONS Return Expectations for Fiscal 2012 Acquisitions Property Type

Initial Yield*

2ETAIL

!PARTMENTS

)NDUSTRIAL

/FlCE

!VERAGE ANNUAL YEAR HOLDING PERIOD RETURNS ARE EXPECTED TO RANGE FROM n HIGHER THAN THE INITIAL YIELD

STRATEGY Allocation 3TAFF ANTICIPATES ENDING lSCAL WITH APPROXIMATELY BILLION IN REAL ESTATE 4HIS REmECTS AN WEIGHTING TO TOTAL FUND WHICH IS BELOW THE NEUTRAL WEIGHT OF FOR THE ASSET CLASS )N lSCAL 2011, 3423 /HIO SOLD EIGHT ASSETS ACROSS THE FOUR PROPERTY TYPES 3423 /HIO ACHIEVED TOTAL GAINS OF ALMOST MILLION OVER 3423 /HIO S VALUE OF MILLION !LTHOUGH NO SIGNIlCANT DISPOSITIONS ARE SPECIlCALLY PLANNED FOR lSCAL THERE COULD BE A FEW SALES LATE IN THE lSCAL YEAR IF MARKET AND PROPERTY LEVEL CONDITIONS ARE RIGHT !NTICIPATED GROWTH AT THE TOTAL FUND LEVEL INDICATES POTENTIAL CAPACITY OF UP TO BILLION INCLUDING APPRECIATION IN NEW ALLOCATION TO REAL ESTATE FOR lSCAL TO REACH A NEUTRAL WEIGHTING IN THE ASSET CLASS !S MENTIONED EARLIER PRICING IN lSCAL FOR NEW REAL ESTATE ACQUISITIONS IS ANTICIPATED TO BE ON AVERAGE CONSISTENT WITH THE LONG TERM EXPECTED RETURN FOR THE ASSET CLASS !CQUISITION ACTIVITY IS EXPECTED TO REMAIN LOW DURING THE lRST HALF OF THE lSCAL YEAR BUT INCREASE IN THE SECOND HALF AS MORE ASSETS COME TO MARKET

Diversification Public Investment (REITs) /VER THE SHORT TERM 2%)4S PERFORM MORE LIKE EQUITIES THAN REAL ESTATE 7ITH THE OUTSIZED RETURNS IN 2%)4S THIS YEAR THE ALLOCATION IS APPROXIMATELY AS OF LATE -AY DOWN FROM A HIGH OF EARLIER IN THE YEAR !S WE EXPECT 2%)4S TO REVERT TO A MORE NORMALIZED RETURN IN THE RANGE WE WILL CONTINUE TO REDUCE OUR WEIGHTING TO THE NEUTRAL TARGET Private Investment Geographic !S SHOWN IN THE TABLE ON 0AGE THE DIRECT PORTFOLIO Â&#x2C6; ESTIMATED TO END lSCAL AT JUST UNDER BILLION Â&#x2C6; IS DIVERSIlED ACROSS THE FOUR REGIONS ALTHOUGH THE -IDWEST CONTINUES TO BE

Fiscal 2012 Investment Plan

A SIGNIlCANT OVERWEIGHT )N lSCAL STAFF REDUCED THE ABSOLUTE WEIGHTING IN THE -IDWEST BY THREE PERCENTAGE POINTS THROUGH THE SALE OF INVESTMENTS TOTALING MILLION WHICH ALSO HELPED TO REDUCE ITS RELATIVE WEIGHTING 4HE 3OUTH REGION ALSO SAW ITS WEIGHTING DECLINE ON BOTH AN ABSOLUTE AND RELATIVE BASIS WITH THE SALE OF ONE ASSET VALUED AT APPROXIMATELY MILLION "OTH THE %AST AND 7EST REGIONS ACQUIRED ONE ASSET AT APPROXIMATELY MILLION EACH 4HIS COUPLED WITH APPRECIATION GAINS IN BOTH REGIONS INCREASED THEIR RELATIVE WEIGHTS TO THE BENCHMARK Geographic Diversification (Core Only) (estimate as of June 30, 2011) STRS Ohio

STRS Ohio vs. NPI

%AST

-IDWEST

3OUTH

7EST

3TAFF WILL CONTINUE TO FOCUS PORTFOLIO HOLDINGS AND THEREFORE ACQUISITIONS IN MAJOR METROPOLITAN MARKETS ACROSS THE COUNTRY TO PROVIDE FOR DIVERSIlCATION Â&#x2C6; BOTH GEOGRAPHIC AND ECONOMIC -AJOR MARKETS ARE EMPHASIZED GIVEN THE NEED TO HOLD A MIXED PORTFOLIO WITH CRITICAL MASS TO ENABLE EFlCIENT ASSET MANAGEMENT AS WELL AS TO BENElT FROM THE INCREASED LIQUIDITY TYPICALLY FOUND IN THESE MARKETS 3TAFF IS COMFORTABLE WITH THE UNDERWEIGHT IN THE 3OUTH AS IT REmECTS OUR LONG TERM VIEW BROADLY SPEAKING OF THE REGION RELATIVE TO OTHER MARKETS 4HE OVERWEIGHT TO THE -IDWEST IS A DRAG ON THE PORTFOLIO RELATIVE TO THE BENCHMARK HOWEVER ON AN ABSOLUTE BASIS IT IS THE SMALLEST PORTFOLIO 4HIS REGION WILL LIKELY ONLY BE REDUCED AS A RESULT OF GROWTH IN THE OTHER REGIONS AS ANY DISPOSITIONS IN THE -IDWEST ARE LIKELY TO MONTHS IN THE FUTURE FOR PROPERTY SPECIlC REASONS -OST ACQUISITION ACTIVITY WILL BE IN THE %AST AND 7EST REGIONS Property Type !CTIVE REBALANCING IS ACCOMPLISHED THROUGH BOTH ACQUISITIONS AND DISPOSITIONS !S MENTIONED ABOVE 3423 /HIO ACQUIRED TWO ASSETS IN lSCAL Â&#x2C6; BOTH IN THE RETAIL SECTOR Â&#x2C6; TO REDUCE THE UNDERWEIGHT TO THIS PROPERTY TYPE AS WELL AS SOLD EIGHT ASSETS ACROSS ALL PROPERTY TYPES 4HE TABLE BELOW DETAILS 3423 /HIO S WEIGHTINGS IN THE FOUR PROPERTY SECTORS AS WELL AS THE COMPARISON TO THE BENCHMARK 4HE PORTFOLIO IS OVERWEIGHT TO THE BENCHMARK IN THE OFlCE SECTOR AND UNDERWEIGHT TO RETAIL )N BOTH THE APARTMENT AND INDUSTRIAL PROPERTY TYPES THE PORTFOLIO IS ESSENTIALLY NEUTRAL Property Type Diversification (Core Only) (estimate as of June 30, 2011) STRS Ohio

STRS Ohio vs. NPI

!PARTMENT

)NDUSTRIAL

/FlCE

2ETAIL

Fiscal 2012 Investment Plan

4HE LARGEST OVERWEIGHT IN THE PORTFOLIO IS IN THE OFlCE SECTOR !S DISCUSSED IN PREVIOUS YEARS STAFF HAS BEEN PRUNING THE OFlCE PORTFOLIO TO WHAT IT BELIEVES ARE THE BEST PERFORMING OFlCE ASSETS OVER THE LONG TERM 4HREE OFlCE ASSETS THAT DID NOT lT THE PROlLE WERE SOLD THIS YEAR 4HE OFlCE PORTFOLIO WAS IMPACTED BY THE PULLBACK IN THE lNANCIAL SECTOR AND EXPERIENCED SIGNIlCANT UNDERPERFORMANCE IN lSCAL (OWEVER THE MAJORITY OF 3423 /HIO S OFlCE ASSETS ARE LOCATED IN SUPPLY CONSTRAINED MARKETS THAT AS NOTED IN LAST YEARgS ANNUAL PLAN SHOULD ALLOW FOR A SHORTER RECOVERY TIME 4HAT INDEED WAS THE CASE AND 3423 /HIO S PORTFOLIO SIGNIlCANTLY OUTPERFORMED THE BENCHMARK IN lSCAL 7E EXPECT IT TO OUTPERFORM AGAIN IN lSCAL AS WELL 4HE OFlCE PORTFOLIO HAS OUTPERFORMED THE BENCHMARK THROUGH lSCAL ON A ONE THREE lVE AND YEAR BASIS 3TAFF IS COMFORTABLE WITH THE OFlCE OVERWEIGHT AS 3423 /HIO HAS A PORTFOLIO THAT WARRANTS IT 4HE MOST ACQUISITION OPPORTUNITIES NEXT YEAR WILL LIKELY BE FOUND IN THE OFlCE SECTOR $ESPITE THE OFlCE OVERWEIGHT WE MAY LOOK TO ADD TO THE PORTFOLIO ON A VERY SELECT BASIS THOSE ASSETS THAT ARE CONSISTENT WITH THE QUALITY AND CHARACTERISTICS OF THE EXISTING PORTFOLIO 4HE APARTMENT SECTOR IS ESSENTIALLY NEUTRAL TO THE BENCHMARK 7HILE THE DEMOGRAPHICS ARE VERY FAVORABLE FOR THE SECTOR AND NEW SUPPLY HAS BEEN EXTREMELY LIMITED TO DATE THERE IS SIGNIlCANT INVESTOR DEMAND PUSHING PRICING TO hPRE BUBBLEv LEVELS IN SOME MARKETS )T WILL BE A CHALLENGE TO ADD APARTMENTS TO THE PORTFOLIO IN lSCAL DUE TO PRICING CONCERNS HOWEVER FOR THE RIGHT ASSET WITH UNIQUE LOCATIONAL ATTRIBUTES MOST LIKELY IN URBAN OR MORE INlLL LOCATIONS WE WILL CONSIDER IT 4HIS SECTOR IS ONE WHERE STAFF MAY CONSIDER NEW DEVELOPMENT 4HE INDUSTRIAL SECTOR IS ALSO SLIGHTLY NEUTRAL TO THE BENCHMARK )T IS DIFlCULT TO BUILD AN INDUSTRIAL PORTFOLIO AS THE INDIVIDUAL ASSET SIZES TEND TO BE SMALLER HOWEVER WE WILL AGAIN CONCENTRATE ON ADDING TO THIS AREA ESPECIALLY IN THE 7EST REGION MARKETS WHERE WE ARE SIGNIlCANTLY UNDERREPRESENTED 4HE LARGEST hBETv IN THE PORTFOLIO CONTINUES TO BE THE SIGNIlCANT UNDERWEIGHT IN THE RETAIL SECTOR !S MENTIONED EARLIER WE ACQUIRED TWO ASSETS IN lSCAL TOTALING MILLION AND HAVE SEVERAL CURRENTLY UNDER REVIEW AND SEVERAL MORE SPECIlC ASSETS THAT WE ANTICIPATE WILL BE AVAILABLE LATER IN THE YEAR 7HILE THERE ARE MIXED SIGNALS IN THIS SECTOR GIVEN mUCTUATING STORE SALES AND CONSUMER CONlDENCE A NUMBER OF RETAILERS THAT PUT EXPANSION PLANS ON HOLD THE LAST SEVERAL YEARS ARE NOW LOOKING TO ADD STORES ALBEIT ON A MUCH SCALED BACK BASIS 4HIS WILL HELP TO ABSORB EXISTING VACANCIES LEFT BY MAJOR RETAILERS THAT NO LONGER EXIST AND OR THOSE THAT ARE TEETERING ON THE EDGE 4HIS MAY ALSO PROVIDE VALUE ADD OPPORTUNITIES IN SUPPLY CONSTRAINED MARKETS THAT ARE DIFlCULT TO ACCESS )NDIVIDUAL MARKET DYNAMICS ARE PARTICULARLY IMPORTANT IN ALL PROPERTY SECTORS GIVEN THE RECOVERY IS NOT TAKING PLACE UNIFORMLY THROUGHOUT THE COUNTRY BUT RATHER IS PROCEEDING AT DIFFERENT PACES Property Life Cycle 'IVEN WE ARE STILL IN THE RECOVERY PHASE OF THE CYCLE IT IS NOT LIKELY WE WILL INVEST IN DEVELOPMENT PROJECTS WITH THE EXCEPTION OF POSSIBLY APARTMENTS )F FUNDAMENTALS CONTINUE TO IMPROVE OVER THE COURSE OF THE YEAR WE WILL CONSIDER LESS DEFENSIVE INVESTMENTS THAT MAY HAVE HIGHER THAN AVERAGE VACANCY OR NEAR TERM LEASE ROLLOVER THAT WILL ALLOW US TO TAKE ADVANTAGE OF THE IMPROVING MARKET WITH NEW LEASES (OWEVER THIS WILL BE MORE LIKELY IN THE SECOND HALF OF THE lSCAL YEAR ASSUMING A SUSTAINED RECOVERY

Leverage !T lSCAL YEAR END WE ANTICIPATE THE LEVERAGE RATIO TO BE APPROXIMATELY DOWN FROM AT THE END OF lSCAL 4HIS IS SPLIT ROUGHLY BETWEEN JOINT VENTURE INVESTMENTS AND ASSETS WHOLLY OWNED BY 3423 /HIO )N -AY 3423 /HIO EXTENDED ITS CREDIT FACILITY FOR AN ADDITIONAL TWO YEARS AT AN ATTRACTIVE INTEREST RATE AND INCREASED THE AMOUNT BY MILLION FOR A TOTAL OF MILLION $EPENDING ON PRICING IT IS LIKELY WE WILL RENEW THIS FACILITY WHEN IT MATURES IN -AY 3TAFF WILL CONTINUE TO MANAGE THE USE OF LEVERAGE IN THE PORTFOLIO BELOW THE POLICY LIMIT OF

Fiscal 2012 Investment Plan

International 4HE INTERNATIONAL PORTFOLIO REPRESENTING OF TOTAL REAL ESTATE CONSISTS OF FUNDS WITH MANAGERS .INE FUNDS ARE IN THE INVESTMENT STAGE WHILE EIGHT FUNDS HAVE COMPLETED THEIR INVESTMENT PROGRAMS AND ARE ACTIVELY POSITIONING THEIR INVESTMENTS FOR SALE 4HE INVESTMENTS CURRENTLY OWNED BY THE FUNDS ARE ALLOCATED TO !SIA TO %UROPE AND TO ,ATIN !MERICA 5NFUNDED COMMITMENTS AT YEAR END STAND AT MILLION REPRESENTING A MILLION DECREASE FROM THE PRIOR YEAR 4HE DECREASE IS ATTRIBUTABLE BOTH TO CAPITAL CALLS MADE BY THE MANAGERS TO ACQUIRE ASSETS OVER THE COURSE OF THE YEAR AND TO THE RELEASE OF OBLIGATIONS OUTSTANDING AS COMMITMENT PERIODS EXPIRED 4HE LATTER IS REmECTIVE OF THE DIFlCULT INVESTMENT ENVIRONMENT EXISTING FOR THE PAST TO MONTHS !FTER A TWO YEAR DECLINE REAL ESTATE TRANSACTION VOLUMES ARE TRENDING UP IN BOTH !SIA AND %UROPE 4HE LEVEL OF ACTIVITY IN BOTH REGIONS IS PROJECTED TO REACH LONG TERM HISTORICAL AVERAGES DURING CALENDAR YEAR AS THE DESIRE FOR RELATIVELY HIGHER YIELDING ASSETS ATTRACTS INSTITUTIONAL CAPITAL 4HE INVESTMENT MOMENTUM APPEARS TO BE GROUNDED IN PROJECTED '$0 GROWTH AND IMPROVING PROPERTY FUNDAMENTALS PRIMARILY ATTRIBUTABLE TO THE LACK OF NEW SUPPLY Â&#x2C6; SIMILAR TO WHAT WE HAVE SEEN IN THE 5NITED 3TATES )N ADDITION THE SUPPLY OF DEBT CAPITAL IN !SIA AND THE MODEST INCREASE OF SUCH IN %UROPE LEND FURTHER SUPPORT TO BUYERS 4HE ACTIVITY HAS CAUSED CAPITALIZATION RATES TO COMPRESS ALLOWING FOR CAPITAL VALUE INCREASES )MPROVING VALUES AND ACTIVITY ARE ISOLATED TO A FEW KEY MARKETS AND SECTORS )N %UROPE THE CORE MARKETS OF 'ERMANY &RANCE AND THE 5+ ARE CAPTURING THE VAST MAJORITY OF THE ACTIVITY WITH SOME GOING TO THE .ORDIC REGION 7ITHIN THIS GROUP ,ONDON IS DOMINATING THE ACTIVITY )N !SIA THE ACTIVITY HAS BEEN FOCUSED ON (ONG +ONG 3INGAPORE #HINA AND !USTRALIA (ONG +ONG AND 3INGAPORE ARE CAPTURING CAPITAL MAKING A CYCLICAL PLAY AFTER DECREASES IN VALUES IN THE LAST TWO YEARS !BSENT FROM THE INCREASE IN INVESTMENT ACTIVITY IS *APAN AS A RESULT OF THE LACK OF PROMISING ECONOMIC DATA AND CONSUMER CONlDENCE NOW WORSENED BY THE EARTHQUAKE )T SHOULD BE NOTED THAT THE EARTHQUAKE CAUSED LESS THAN MILLION IN DAMAGES TO AN APPROXIMATE MILLION PORTFOLIO OF ASSETS HELD BY THE FUNDS IN WHICH 3423 /HIO IS INVESTED )N lSCAL INVESTMENTS ACQUIRED FROM THROUGH HAVE RECOVERED OF THE VALUE LOST IN THE PRIOR TWO YEARS 7E EXPECT THIS RECOVERY TO CONTINUE OVER THE NEXT TO MONTHS ALBEIT NOT TO PEAK LEVELS BUT WITH NO LOSS OF PRINCIPAL 4HE RECOVERY IS ATTRIBUTABLE TO HAVING A %UROPEAN PORTFOLIO HEAVILY CONCENTRATED IN 'ERMANY &RANCE AND THE 5+ IN OPERATING ASSETS SUCH AS HOTELS AND WELL LOCATED OFlCE BUILDINGS AS WELL AS IN !SIAN INVESTMENTS HELD OUTSIDE OF *APAN 4HE PORTFOLIO WILL CONTINUE TO CONCENTRATE ON MANAGERS THAT PRINCIPALLY INVESTMENT IN CORE MARKETS EXHIBITING OPPORTUNITIES CREATED BY IMPROVING PROPERTY FUNDAMENTALS AND IN EMERGING DEVELOPING MARKETS EXHIBITING SUSTAINABLE STRONG GROWTH UNDERPINNED BY STABLE GOVERNMENTS AND FUNCTIONING lNANCIAL MARKETS 4HE FOCUS WILL BE ON THE FOLLOWING THE LONG TERM GROWTH OF #HINA (ONG +ONG AND 3INGAPORE WHERE RETURNS ARE INmUENCED BY STRONG CYCLICAL CAPITAL mOWS AND GOVERNMENT CONTROL OF DEVELOPABLE INVENTORY PARTICIPATION IN VALUE CREATION AND RECOVERY IN THE CORE MARKETS OF 'ERMANY &RANCE AND THE 5+ AND IN ANY GROWTH OPPORTUNITIES PRESENT IN #ENTRAL AND %ASTERN %UROPE HIGH GROWTH PROSPECTS OF "RAZIL AND DISTRESSED OPPORTUNITIES IN *APAN #ONSISTENT WITH THESE LAST THEMES 3423 /HIO MADE TWO NEW COMMITMENTS TOTALING MILLION IN lSCAL 4HESE FUNDS ARE FOCUSED ON THE DISTRESSED LOAN SECTOR IN *APAN AND THE OFlCE INDUSTRIAL SECTORS IN "RAZIL 4HE CURRENT PORTFOLIO IS ALLOCATED FAIRLY EVENLY AMONG THE PROPERTY SECTORS RESIDENTIAL n HOTELS n OFlCE n RETAIL n INDUSTRIAL n AND OTHER n WITH APPROXIMATELY IN DEVELOPMENT PROJECTS LAND 4HE PORTFOLIO HAVING SURVIVED A TUMULTUOUS MONTH PERIOD HAS GENERATED ALMOST A RETURN THROUGH -ARCH

Fiscal 2012 Investment Plan

IX. Alternative Investments â&#x20AC;&#x201D; Private Equity &ISCAL REPRESENTS THE TH YEAR SINCE A STATUTE REVISION REMOVED A LIMITATION THAT RESTRICTED ALTERNATIVE INVESTMENTS SOLELY TO /HIO COMPANIES OR VENTURE CAPITAL lRMS HAVING AN OFlCE IN /HIO )N -AY THE 2ETIREMENT "OARD APPROVED A BROAD DOMESTIC AND GLOBAL INVESTMENT PLAN FOR ALTERNATIVE INVESTMENTS AND ESTABLISHED A ALLOCATION FOR THIS ASSET CLASS 4HE ALLOCATION WAS INCREASED WITH EACH SUBSEQUENT !SSET !LLOCATION 3TUDY OR !SSET ,IABILITY 3TUDY -OST RECENTLY AS PART OF THE !SSET !LLOCATION 3TUDY THE ALTERNATIVE INVESTMENT PORTFOLIO WAS SPLIT INTO TWO ALLOCATIONS TO PRIVATE EQUITY AND OPPORTUNISTIC DIVERSIlED WITH PLANS TO INCREASE THE LATTER TO OVER TIME 4HE OPPORTUNISTIC DIVERSIlED INVESTMENTS ARE DISCUSSED IN 3ECTION 8 4HE FOLLOWING CHART SHOWS THE FUND COMMITMENT ACTIVITY IN THE PRIVATE EQUITY PORTFOLIO SINCE INCEPTION

ANNUAL SUMMARY OF CAPITAL COMMITMENTS Fiscal Year

$ Committed

New Managers

Existing Managers

AND 0RIOR

MILLION

MILLION EST

Total

$8,012 million

PROJECTED

TO MILLION

Fiscal 2012 Investment Plan

,AST YEAR S )NVESTMENT 0LAN PROJECTED NEW COMMITMENTS RANGING FROM TO MILLION &UND RAISING ACTIVITY IN GENERAL DROPPED OFF DRAMATICALLY DURING THE LAST TWO lSCAL YEARS AS MANAGERS WERE FOCUSED ON IMPROVING AND EXITING THEIR EXISTING PORTFOLIO COMPANIES !LSO THE FUND RAISING ENVIRONMENT WAS NOT HOSPITABLE TO GENERAL PARTNERS HOPING TO RAISE NEW FUNDS -ANAGERS WERE MET WITH INVESTORS STILL CONCERNED WITH LIQUIDITY AND ALLOCATION ISSUES AND NOT IN A POSITION TO COMMIT NEW CAPITAL TO PRIVATE EQUITY !S A RESULT VERY FEW OF 3423 /HIO S TARGET MANAGERS RAISED FUNDS IN lSCAL AND NEW COMMITMENT ACTIVITY DURING THAT PERIOD DROPPED TO ONE OF THE LOWEST LEVELS SEEN IN THE LAST YEARS $URING lSCAL CREDIT MARKETS SURPRISINGLY INCREASED TO NEAR PEAK CONDITIONS IN BOTH THE HIGH YIELD DEBT AND SENIOR LOAN MARKETS 4HIS BENElTED EXISTING PORTFOLIO COMPANIES FACING DEBT MATURITIES BY ALLOWING THEM TO hAMEND AND EXTENDv THEIR DEBT OBLIGATIONS GIVING THEM MORE TIME TO RECOVER FROM THE RECESSION THAT FOLLOWED THE CREDIT CRISIS -OST PORTFOLIO COMPANIES ALSO SHOWED IMPROVED TOP LINE AND BOTTOM LINE PERFORMANCE THUS ENABLING THEM TO OBTAIN MANAGEABLE DEBT COVENANTS OR TO EFFECTIVELY ELIMINATE THEM ALTOGETHER )N SOME CASES COMPANIES WERE ABLE TO EXECUTE DIVIDEND RECAPITALIZATIONS 4HE DIVIDEND RECAPITALIZATIONS A PRACTICE THAT MANY THOUGHT WOULD NOT BE SEEN AGAIN FOR SOME TIME TO COME ALLOWED MANAGERS TO RETURN SOME OR ALL OF THE INVESTORS CAPITAL WHILE MAINTAINING A MANAGEABLE LEVEL OF DEBT IN THE PORTFOLIO COMPANY 4HE CAPITAL MARKETS ALSO IMPROVED DRAMATICALLY DURING THE YEAR PROVIDING MANAGERS THE OPPORTUNITY TO SELL PORTFOLIO COMPANIES OR TO RAISE CAPITAL IN THE PUBLIC MARKETS 4HESE ACTIVITIES WERE ASSISTED BY THE AVAILABILITY OF DEBT AS DESCRIBED ABOVE FOR BUYERS THAT USE LEVERAGE WHEN PURCHASING COMPANIES AND THE LARGE AMOUNT OF CASH THAT WAS ACCUMULATED ON THE BALANCE SHEETS OF BUYERS LOOKING FOR STRATEGIC ACQUISITIONS 4HIS RECENT ENVIRONMENT HAS CAUSED PRICES TO INCREASE BEYOND LEVELS THAT SOME MANAGERS ARE WILLING TO PAY FOR TARGET COMPANIES WHICH IRONICALLY HAS TAKEN SOME PRESSURE OFF THEIR NEED TO RAISE NEW CAPITAL IN THE NEAR TERM (OWEVER WE EXPECT FUND RAISING ACTIVITY TO PICK UP NEXT YEAR &OR lSCAL WE PROJECT NEW COMMITMENTS TO PRIVATE EQUITY WILL RANGE FROM MILLION TO MILLION 4HIS COMPARES TO AN AVERAGE OF MILLION PER YEAR OVER THE LAST YEARS AND AN AVERAGE OF MILLION OVER THE LAST lVE YEARS 4HE INVESTED LEVEL OF PRIVATE EQUITY WAS AT THE END OF !PRIL WHICH IS ABOVE ITS TARGET ALLOCATION BUT STILL WITHIN ITS TO REBALANCING RANGE 4HE THREE COMMITMENTS EXPECTED FOR lSCAL ARE DISTRIBUTED ON A DOLLAR WEIGHTED BASIS AMONG DOMESTIC PRIVATE EQUITY FUNDS AT AND DOMESTIC VENTURE CAPITAL FUNDS AT &OR lSCAL THE ALTERNATIVE INVESTMENT PLAN PROVIDES A FRAMEWORK FOR SELECTING APPROPRIATE INVESTMENTS 4HE CATEGORIES THAT WILL BE CONSIDERED FOR NEW INVESTMENTS ARE Domestic Private Equity Funds s 'ENERAL BUYOUT FUNDS s )NDUSTRY TARGETED BUYOUT FUNDS s 'ROWTH EQUITY FUNDS s -EZZANINE AND SUBORDINATED DEBT FUNDS Domestic Venture Capital Funds s 'ENERAL EARLY TO LATE STAGE VENTURE FUNDS s )NDUSTRY TARGETED EARLY TO LATE STAGE INVESTMENT FUNDS s 3TRUCTURED VENTURE lNANCE FUNDS Global/International Private Equity Funds s 0RIVATE EQUITY FUNDS IN ESTABLISHED AND OR EMERGING REGIONS s 6ENTURE CAPITAL AND OTHER TYPES OF PRIVATE CAPITAL

Fiscal 2012 Investment Plan

4HE PRIMARY VEHICLE FOR PRIVATE EQUITY INVESTMENTS IS COMMINGLED PARTNERSHIP FUNDS WITH A TERM OF YEARS &UND OF FUNDS AND SEPARATE ACCOUNT RELATIONSHIPS ARE USED ON A MORE SELECTIVE BASIS DUE TO THE COST OF AN ADDITIONAL LAYER OF MANAGEMENT FEES &UND OF FUNDS ARE BEING USED ALONG WITH SEPARATE ACCOUNTS TO ACCESS THE TYPE OF INVESTMENTS OR TYPES OF FUNDS THAT 3423 /HIO HAS DIFlCULTY ACCESSING E G THE VERY TOP PERFORMING VENTURE CAPITAL FUNDS CO INVESTMENTS AND SECONDARY PURCHASES THAT CAN PRODUCE ATTRACTIVE EXPECTED RETURNS NET OF ALL FEES 3423 /HIO DOES NOT EXPECT TO PARTICIPATE DIRECTLY IN THE SECONDARY MARKET AS A SELLER OF FUNDS IN ITS PORTFOLIO SINCE THIS CONTINUES TO BE UNATTRACTIVE DUE TO THE DISCOUNTS EXPECTED BY BUYERS 3423 /HIO WILL CONSIDER PURCHASING ADDITIONAL INTERESTS IN EXISTING FUNDS FROM OTHER LIMITED PARTNERS WHO DECIDE TO SELL THEIR INTERESTS IN THE FUNDS OF TOP MANAGERS !S IN THE PAST THE FOLLOWING INVESTMENT OPPORTUNITIES WILL NOT BE CONSIDERED FOR THE PRIVATE EQUITY PORTFOLIO MICRO CAP STOCK FUNDS SEED OR hANGELv FUNDS AND ECONOMICALLY TARGETED FUNDS !LSO INVESTMENTS IN lRST TIME FUNDS ARE HIGHLY UNLIKELY DUE TO THE HEAVY EMPHASIS PLACED ON THE PROVEN ABILITY OF THE ENTIRE INVESTMENT TEAM TO WORK TOGETHER TO PRODUCE ATTRACTIVE RETURNS .EW CAPITAL COMMITMENTS PROJECTED FOR lSCAL WILL BE FOCUSED ON EXISTING MANAGERS AND MANAGERS THAT ARE NEW TO 3423 /HIO WHO HAVE THE CLEAR POTENTIAL TO OFFER TOP PERFORMING FUNDS IN THE CATEGORIES LISTED BELOW 4HE PORTFOLIO IS WELL DIVERSIlED 4HE COMMITMENTS AS OF !PRIL ARE SHOWN WITH THE CURRENT PERCENTAGES SHOWN IN PARENTHESES )T IS ANTICIPATED THE CATEGORY ALLOCATIONS DURING lSCAL WILL GENERALLY STAY WITHIN THE PERCENTAGE RANGES SHOWN

CAPITAL COMMITMENTS BY CATEGORY Actual Commitments April 30, 2011

Projected Allocation Ranges Fiscal 2012

$OMESTIC 0RIVATE %QUITY &UNDS

MILLION

$OMESTIC 6ENTURE #APITAL &UNDS

MILLION

'LOBAL )NTERNATIONAL 0RIVATE %QUITY &UNDS

1, MILLION

$7,553 million

100%

TOTAL

-OST ALTERNATIVE INVESTMENT OPPORTUNITIES INVOLVE A LONG TERM INVESTMENT HORIZON ILLIQUIDITY AND HIGH VOLATILITY OF RETURNS &OR THESE REASONS EXPECTED lNANCIAL RETURNS SHOULD EXCEED THOSE OF THE OTHER ASSET CLASSES "ASED ON THE !SSET !LLOCATION 3TUDY PRIVATE EQUITY RETURNS ARE EXPECTED TO BE NET OF FEES OVER THE LONG TERM WITH A VOLATILITY OF )N PRIVATE EQUITY RETURNS ON INDIVIDUAL FUNDS GENERALLY FOLLOW A PATTERN REFERRED TO AS THE h* CURVE v WHICH ANTICIPATES NEGATIVE RETURNS DURING THE EARLY YEARS OF THE FUND DUE TO MANAGEMENT FEES AND EARLY WRITE DOWNS FOLLOWED BY PROGRESSIVELY INCREASING POSITIVE RETURNS THEREAFTER 4HE POSITIVE RETURNS THE PORTFOLIO GENERATED DURING THE LAST TWO lSCAL YEARS ARE DUE TO A THE PORTFOLIO MATURING B THE INCREASE IN BOTTOM LINE PERFORMANCE COMBINED WITH IMPROVEMENT IN THE COMPARABLE 0 % MULTIPLES USED TO DETERMINE MARKET VALUES AND C THE SALE OF ASSETS ABOVE THEIR REPORTED VALUES 4HE PRIVATE EQUITY PORTFOLIO HAS NOW HAD TWO GOOD YEARS OF PERFORMANCE SINCE lSCAL WHEN ALTERNATIVE INVESTMENTS RETURNED A n &ISCAL YEAR TO DATE PERFORMANCE THROUGH !PRIL IS FOR PRIVATE EQUITY AND FOR ALTERNATIVE INVESTMENTS INCLUDING PRIVATE EQUITY AND OPPORTUNISTIC DIVERSIlED 4HE lSCAL YEAR TO DATE RETURNS HAVE LAGGED THE HIGH ABSOLUTE RETURNS GENERATED BY THE PUBLIC MARKETS &OR lSCAL THE PROJECTED RETURN FOR THE ALTERNATIVE INVESTMENT ASSET CLASS IS A hNORMALv RETURN OF

Fiscal 2012 Investment Plan

)N THE PAST MONTHS STAFF MADE GOOD PROGRESS ON THE GENERAL GOALS OUTLINED IN THE lSCAL ANNUAL PLAN INCREASING OUR ACCESS TO TOP VENTURE FUNDS AND LIQUIDATING MILLION OF PUBLIC SHARES HELD IN THE STOCK DISTRIBUTION PORTFOLIO 4HERE IS MILLION REMAINING IN THE STOCK DISTRIBUTION PORTFOLIO $URING lSCAL STAFF WILL s

#ONTINUE TO EVALUATE SUCCESSOR AND NEW FUND OPPORTUNITIES TO IMPROVE THE OVERALL RETURN POTENTIAL OF THE PORTFOLIO

#ONTINUE TO DECLINE COMMITMENTS TO THE FOLLOW UP FUNDS BEING RAISED BY EXISTING MANAGERS WHOSE TRACK RECORDS CAUSE US TO BELIEVE THAT THEIR NEXT FUND WILL NOT PRODUCE ATTRACTIVE RETURNS AND

#ONTINUE TO OPPORTUNISTICALLY SELL PUBLIC SHARES DISTRIBUTED TO US BY THE GENERAL PARTNERS

Fiscal 2012 Investment Plan

X. Alternative Investments â&#x20AC;&#x201D; Opportunistic/ X. Diversified !S PART OF THE !SSET !LLOCATION 3TUDY THE ALTERNATIVE INVESTMENT PORTFOLIO WAS SPLIT INTO TWO ALLOCATIONS TO PRIVATE EQUITY AND TO OPPORTUNISTIC DIVERSIlED 4HE OPPORTUNISTIC DIVERSIlED ALLOCATION INCREASED PER YEAR THEREAFTER TO AT THE BEGINNING OF lSCAL )T WILL INCREASE TO AT THE BEGINNING OF lSCAL AND ULTIMATELY WILL INCREASE TO ON *ULY !S THE NAME IMPLIES THIS ALLOCATION IS OPEN TO A WIDE VARIETY OF INVESTMENT TYPES SOURCED FROM ALL ASSET CLASSES BOTH LIQUID AND ILLIQUID 4HE GOAL OF THE OPPORTUNISTIC DIVERSIlED ALLOCATION IS TO EARN EQUITY LIKE RETURNS NET OF FEES OVER THE LONG TERM BUT WITH DOWNSIDE PROTECTION DURING EQUITY BEAR MARKETS 4HE FOLLOWING CHART SHOWS THE FUND COMMITMENT ACTIVITY IN THE OPPORTUNISTIC DIVERSIlED PORTFOLIO SINCE INCEPTION THROUGH !PRIL

SUMMARY OF ACTIVITY Strategy

$ Targeted

$ Committed

$ Market Value

,EGACY !SSETS 00)0

MILLION

)NFRASTRUCTURE

MILLION

NONE

"ANK &$)# !SSISTED

MILLION

(EDGE &UNDS

MILLION

%NERGY .ATURAL 2ESOURCES

MILLION

NONE

3PECIALTY &INANCE

MILLION

NONE

Subtotal

$2,900 million

$1,201 million

$ 918 million

)NITIAL 0ORTFOLIO &UNDS

MILLION

Total

$3,776 million

$2,077 million

$1,673 million

TO MILLION

PROJECTED

!T THE END OF !PRIL THE MARKET VALUE OF OPPORTUNISTIC DIVERSIlED WAS OF TOTAL FUND COMPARED TO ITS TARGET ALLOCATION OF &OR lSCAL WE ARE PROJECTING THAT WITHIN OUR TARGETED AND INITIAL PORTFOLIOS NEW COMMITMENTS WILL BE IN THE MILLION TO MILLION RANGE PARTIALLY AS THE RESULT OF A MILLION ADDITIONAL ALLOCATION TO HEDGE FUNDS THAT IS BEING PREVIEWED DURING THE *UNE 2ETIREMENT "OARD MEETING /F THE MILLION TOTAL COMMITTED TO OPPORTUNISTIC DIVERSIlED MILLION IS STILL UNFUNDED )F THAT AMOUNT IS ADDED TO THE CURRENT MARKET VALUE THE TOTAL WOULD BE MILLION )F THE TOP END OF THE PROJECTED RANGE OF NEW COMMITMENTS OR MILLION IS ACHIEVED DURING lSCAL THE POTENTIAL TOTAL OVER TIME WOULD BE APPROXIMATELY MILLION WHICH WOULD EQUATE TO OF TOTAL FUND 4HIS WOULD PUT OPPORTUNISTIC DIVERSIlED ABOVE ITS MAXIMUM TARGET ALLOCATION &OR lSCAL WE WILL CONTINUE TO LOOK FOR ATTRACTIVE NEW TARGETS FOR THE OPPORTUNISTIC DIVERSIlED PORTFOLIO (OWEVER ANY NEW TARGETS IDENTIlED MAY REQUIRE US TO REDUCE SOME OF OUR EXISTING TARGETS THAT MAY NOT BE PROVIDING OPPORTUNITIES THAT ARE AS ATTRACTIVE

Fiscal 2012 Investment Plan

4HE PRIMARY VEHICLES FOR OPPORTUNISTIC DIVERSIlED INVESTMENTS ARE DIRECT INVESTMENTS IN PUBLIC OR PRIVATE COMPANIES HEDGE FUNDS AND INVESTMENTS IN AND ALONGSIDE COMMINGLED PARTNERSHIP FUNDS INCLUDING SECONDARIES AND CO INVESTMENTS ! SIX PERSON TEAM OF SENIOR INVESTMENT STAFF MEMBERS REPRESENTING ALL ASSET CLASSES HAS BEEN TASKED WITH DEPLOYING CAPITAL FOR THIS ALLOCATION ! SEVENTH MEMBER IS BEING ADDED THAT HAS EXPERIENCE IN FOREIGN EXCHANGE AND DERIVATIVES &ISCAL YEAR TO DATE PERFORMANCE THROUGH !PRIL IS COMPARED TO A RETURN FOR THE PREVIOUS lSCAL YEAR #ONSISTENT WITH THE PERFORMANCE GOALS ESTABLISHED FOR THIS ALLOCATION THE OPPORTUNISTIC DIVERSIlED RETURNS ARE EXPECTED TO BE OVER THE LONG TERM WITH AN ESTIMATED VOLATILITY OF