ASSET ALLOCATION/HEDGE FUND INVESTMENTS

This memo presents a status report as to the research completed to date regarding investing in hedge funds. Preliminary observations are outlined below:

1.	A 5% investment allocation to Hedge Funds that are classified as Absolute Return Funds has the potential to improve the Foundation's risk adjusted performance. Absolute return funds provide respectable risk adjusted returns with low downside deviation and correlation with standard benchmark indices. Target returns range from CPI +5.0% to 8-10% over risk-free rate of return. See discussion beginning on page 3.

2.	A number of options exist for implementing a hedge fund strategy. Various options are outlined on page 6.

3.	A 5% hedge fund allocation would result in revised asset allocation targets as outlined on page 8.

4.	Invest additional $3,000,000 with Urdang Investment Management for investment in REITs (page 9).

Background

At the February 21, 2000 Investment Committee meeting, representatives from Goldman Sachs & Co. discussed the Report on Alternative Investing by Tax-Exempt Organizations (1999) prepared by Goldman, Sachs & Co., and Frank Russell Company.

Based on their review of the Bradley Foundation's alternative investment portfolio, the Goldman Sachs representatives indicated that the Foundation's alternative investment portfolio was well diversified except for a possible under-weighting in venture capital funds. They also indicated that the Foundation should evaluate the merits of hedge funds even though such funds lack disclosure and transparency. They indicated that good hedge funds can provide risk control in an overall diversified portfolio.

These discussions prompted a research project to answer the following two questions:

1.	Does it make sense for the Bradley Foundation to establish a 5% asset allocation target for hedge funds?

2.	If the answer is yes, what would be the most appropriate implementation strategy (Hedge fund manager, Fund of Funds, Internal selection, etc.)?

Asset Allocation Analysis

Goldman Sachs volunteered to complete an asset allocation analysis of the Bradley Foundation's portfolio at no cost to the Foundation. Exhibit A is a report of their conclusions. They believe that shifting assets from US Small Cap to an investment in hedge funds has the potential for a 5% increase in the Sharpe Ratio (risk adjusted return) of the Foundation's investment portfolio. This would represent a meaningful improvement to the Foundation's risk adjusted performance. Their recommended asset allocation model also includes a 5% allocation to REITs.

What is a Hedge Fund?

The term "hedge fund" is historically rooted and has since evolved to identify a multitude of investment strategies. The common element among these strategies is the use of investment and risk management skills to seek positive returns regardless of market direction. The most attractive hedge funds have a disciplined investment and risk control process, which both manages downside risk and maintains low correlations with traditional asset classes. This subset of hedge funds is called "Absolute Return" funds due to their exclusive focus on using skill to generate returns that have low correlations to traditional asset classes.

The term "absolute return" is important because it contrasts with what most capital markets managers seek -- "relative return." Relative return is performance relative to a benchmark such as the S&P. An absolute return strategy aims for returns in the 10-15% range regardless of capital markets returns.

Absolute Return funds can be classified into four primary sectors based on investment strategy:

Equity and Fixed Income Long/Short -- These are long and short strategies which actively manage portfolio beta and duration.

Market Neutral -- These are zero beta or zero duration relative value strategies.

Event Driven -- These are transaction-based strategies such as risk arbitrage and distressed securities investing.

Tactical Trading -- These are strategies that attempt to time the markets and thus profit from both rising and falling markets.

According to the Goldman Sachs/Frank Russell report, the number of single-strategy hedge fund managers has grown significantly. As of December 1998, there were 402 mangers reporting continuous five- year performance to Financial Risk Management (FRM), up from 277 one year earlier. 768 managers were reporting for the entire year of 1998, while by August 1998 the number of hedge fund managers in the database had grown to 879. The actual number of hedge funds far exceeds the 879 managers reporting their results. In fact, one source indicates that there are approximately 3,000 domestic hedge funds.

Exhibit B provides an Executive Summary of hedge funds facts taken from a Goldman, Sachs & Co. publication.

The Case for Hedge Funds (Absolute Return Funds)

If the market in the next five years would perform as it has for the last five years, one could argue that hedge funds may not be necessary. However, the market for the next five to ten years will most likely return to more historical performance levels with increased volatility. Diversification in an asset class, such as absolute return funds, provides respectable risk adjusted returns with low downside deviation and correlation with standard benchmark indices. Target returns range from CPI +5.0% to 8-10% over risk- free rate of return. Exhibit C presents an excellent discussion of absolute return fund performance in down markets.

As opposed to private equity investments, absolute return funds have greater liquidity. Private equity investments usually lock up funds for 3 to 10 years. Absolute return funds commonly have quarterly entrance and exit points after an initial one year lock- up. Absolute return funds are marked to market based on the underlying marketable securities. Private equity investments typically are not readily marketable and the value is an estimate of the general partner. Also, private equity is generally more correlated with traditional asset classes than absolute return funds. This occurs because the public market is often used to value private equity transactions and it also represents a general partner's exit strategy and financing costs.

Hedge funds (absolute return funds) are becoming more popular with endowments and foundations. According to Monticello associates, Yale University has 22% of its endowment dedicated to absolute return funds.

Risks Associated With Absolute Return Funds

Like all investments, absolute return funds have risks as outlined below:

Leverage risk: Leverage is often high and may be misapplied. The excessive leverage utilized at Long Term Capital (some reports estimate 40-50 times leverage) was one of the major reasons that the firm had to be bailed out by a Wall Street consortium.

Liquidity risk: There are several types of liquidity risk. First, as an investor in absolute return hedge funds, daily liquidity is not available. Generally, liquidity is quarterly although sometimes monthly and sometimes annually. A few firms require lock-ups ranging from one quarter to three years. Second, if a significant percentage of the fund is redeemed at one time, the fund may be required to liquidate positions in an unfavorable environment or in a way that will adversely affect trades that remain in place. Third, if liquidity in the markets in which the manager operates is reduced, the ability to execute trades and receive narrow bid/ask spreads could be hampered.

Disclosure risk: Hedge funds are not regulated by the SEC. They are operated as private partnerships. They are audited, usually by well-respected, major accounting firms. However, partners are not generally able to look at the contents of the portfolio. This lack of regulation and disclosure might make it more difficult for investors to identify potential problems in the portfolio.

Opportunity risk: If trading opportunities dry up, the manager may have difficulty earning a competitive return. For example, if the supply of convertible bonds goes down while the number of convertible bond arbitrageurs rises, opportunities for profit may be reduced. For this reason, some absolute return managers have gone to a multi-strategy approach. This allows them the flexibility to pursue the most attractive strategy at any given time and to vary the weighting in each strategy over time.

Systems risk: Many absolute return funds depend heavily on computer, risk management and accounting systems for risk control. Problems with these systems could diminish the effectiveness of risk control and could ultimately endanger principal.

Owner/operator risk: There is some overlap here, as leverage and systems risk can be a part of owner/operator risk. Other types of owner/operator risk include the loss of key personnel, bad judgment on what trades to put on and even the risk of fraud. One of the major selling points of the fund-of-funds approach is that owner/operator risk is significantly reduced. This risk reduction must be weighed against the cost, in terms of added fees, of the fund-of-funds structure.

Implementation Strategy for Absolute Return Fund Investments

Implementing the process of investing in Absolute Return funds is similar to the process of deciding on traditional managers, but is more complex. The increased complexity is due to the diversity and sophistication of the strategies and the diversity of approaches to strategy implementation.

Substantial resources are required to evaluate the merits and risks of different strategies as well as to determine normal risk and return profiles for individual managers. Because strategy implementation differs so much among managers, investors need to evaluate a large number of managers. Unfortunately, information on the managers is often not readily available.

The first implementation decisions facing investors are whether or not to outsource part or all of the implementation process, and whether to construct a portfolio of single manager funds with the assistance of a consultant or to use existing multi-manager funds.

Implementation Options Include:

Implementation Strategy	Comment

1.	Internal Management

Foundation selects and identifies	Not practicable.

individual absolute return fund	Lack of expertise.

managers.

2.	Funds of Funds

Foundation adopts a fund of funds	Less risky than 1

approach and selects funds. Fund	above, but lack of

of funds provide diversification	expertise is of

covering a defined spectrum of	concern to intially

absolute return fund strategies.	implement the

General partner of fund of funds	program. Fund of

normally charges a 1% to 1.25% base	funds adds a layer

fee plus a 5-10% incentive fee	of fees.

after a preferred return to the

limited partners.

3.	Retain Hedge Fund Manager/Consultant

An independent investment manager/	Provides most

consultant who specializes in hedge	comprehensive

funds. Retained by investor to search	approach to

out and recommend hedge fund invest-	establish, control

ments. Investment is made in the name	and monitor a long

of the investor. Investment manager	term absolute return

charges a fee of 50 to 125 basis	fund strategy.

points based on the dollar value of

the assets under management. Hedge

fund investments could include both

an individual hedge fund or a fund

of funds. However, based on research

to date, it is quite possible to

develop a diversified absolute return

fund strategy with minimal use of fund

of funds investments.

4.	Retain Consultant - Special Project

Retain hedge fund manager/consultant	This strategy

for a one-time specific project to	requires a one-time

develop a hedge fund strategy	fee but it hope-

and select initial hedge fund	fully would launch a

managers. One organization has	more organized hedge

been identified that is willing to	fund strategy.

complete such a project: the

Hennessee Group. The Hennessee Group

Group quoted a fee of approximately

$100,000 to establish a hedge fund

strategy, identify and recommend hedge

fund investments and evaluate the

performance and strategy after the

first year.

Additional information is still being gathered regarding implementation strategies.

Proforma Revision to Asset Allocation Targets

Based on the Goldman Sachs & Co. asset allocation review, and assuming a 5% hedge fund allocation, revision to the Foundation's asset allocation strategy is summarized below:

Present

Allocation	Proforma

(6/1/98)	Allocation

Cash/Cash Equivalents	1.5%	1.5%

Fixed Income:

Bonds	10.5	10.5

High yield bonds	3.0	3.0

13.5	13.5

Equities:

U.S. Large Cap	35.0	34.0

Foreign	22.0	20.0

U.S. Stocks-

Small/Mid-cap	18.0	14.0

75.0	68.0

Alternative/Other

Investments:

Private equity	10.0	10.0

Hedge funds (Absolute

Return Funds)	0.0	5.0

REITs	0.0	2.0

10.0	17.0

100.0%	100.0%

Additional Investment in REITs

In February, 2000 Urdang Investment Management was retained to manage a $10,000,000 REIT portfolio. Through April 30, 2000 this strategy proved correct with this portfolio achieving a year to date return of 9.44% while the overall equity market incurred losses for the same period.

The REIT strategy was initially adopted to diversify the portfolio with an asset class that was undervalued and had lower volatility than equities. The under valuation resulted in dividend yields of almost 9% in 1999. While the REITs have had a comeback in 2000, buying opportunities still exist according to Urdang Investment Management. They indicated that one cannot expect "home-run" returns, but respectable returns of 12-14% in the long-term with less volatility than the equity market. (See Exhibit D.)

Goldman Sachs & Co. Model Portfolio (Exhibit A) includes a 5% allocation to REITs. This allocation is driven in part by the current undervaluation of REITs and the low correlation with broader market indices.

Based on Urdang and Goldman Sachs observations, it is recommended that an additional $3,000,000 be invested in Urdang's REIT portfolio. This would increase the REIT allocation to approximately 2% of the total investment portfolio.