Zephyr Style Advisor Client Conference 2003

The Bradley Foundation is a conservative, private grant-making foundation devoted to strengthening American democratic capitalism and the institutions, principals and values that sustain and nurture it. Its programs support limited, competent government; a dynamic marketplace for economic, intellectual, and cultural activity; and a vigorous defense at home and abroad of American ideas and institutions. In addition, recognizing that responsible self-government depends on enlightened citizens and informed public opinion, the Foundation supports scholarly studies and academic achievement.

Currently, the Foundation's assets are around $500 Million, all of which is managed externally. The Finance team is responsible for financial reporting, budgeting, internal control, IRS compliance and oversight, grant payments and financial analysis, tax return preparation, investment reporting and analysis, and manager search and selection. All the above activities are completed internally and outside services and consultants are used on a limited basis for selected projects. All of the activities of the Finance team are reported to the President, and ultimately approved by the finance committee of the Board of Directors, which has a very active role in the direction of the investment philosophy of the Foundation.

SPENDING POLICY ANALYSIS

Studies have shown that there isn't an absolute payout percentage that provides for corpus preservation. Corpus preservation is a function of the payout ratio and asset allocation. The federal mandate requires private foundations to pay out a minimum 5% of average assets. This typically becomes the starting point for spending analysis. In November 2001, Goldman Sachs published its study "Sustainable Spending Policies for Endowments and Foundations." The key findings were that it is difficult to balance competing objectives of spending 5% and growing, or even preserving, the real value of the corpus and maintaining stable spending levels. The study, using a Monte Carlo simulation model, makes several general suggestions:

•	The asset allocation should be 70% equity and 30% fixed income. Over the long run this may have more upside and be less likely to erode corpus.

•	The 70%/30% allocation will likely create volatility. There will be swings in corpus value and spending in the short run.

•	A 5% annual payout coupled with an asset allocation of 50% equities and 50% fixed income has a greater than 34% probability for a greater than 10% decline in the corpus over 10 years. The 34% probability drops to 29% if the asset allocation is 70% equities and 30% fixed income.

•	Raising the annual payments to 6% will increase the probability of 10% decline to 48% over 10 years if the asset allocation is 50%/50%. The probability drops to 41% with a 70%/30% asset allocation.

Spending Policy Analysis Software

The Finance staff now has the internal capability of completing a spending analysis using the Zephyr Allocation Advisor Monte Carlo simulation model. This model projects future asset values based on the current asset allocation, actual historical index return data and spending assumptions. The model can be used to determine the effect on the portfolio value by modifying the following assumption of: volatility, spending and changes in asset allocation. The goal in modifying assumptions is to get a better picture of the risks and rewards associated with spending in relation to the asset allocation.

While other spending analysis models exist in the marketplace, the Finance staff believes the Zephyr model is acceptable for our current needs. However, we will continue to evaluate other spending analysis models to insure we have one that is the most responsive to the needs of the Bradley Foundation.

Given the market volatility that has occurred in the past three years one could argue that once you get out even past two years it's too fuzzy so that projections become meaningless. However, we believe completing a more formal analysis will provide an ongoing methodology and basic framework to monitor the long-term spending policy and asset allocation strategy of the Foundation and provide data to test the effect of various market conditions on the overall portfolio.

Spending Analysis Calculation

A 15 year spending analysis calculation was completed with the Zephyr Monte Carlo model using the Foundation's actual asset allocation as of December 31, 2002 as a starting point. The basic assumption is that after 15 years the target projected portfolio value should be $738,000,000 to maintain real growth with an average inflation rate of 2.5%. Other assumptions include alternative annualized grant payout amounts plus investment expenses of .7%. Administrative expenses are projected to rise at the rate of inflation instead of a percentage of assets.

A summary of the results of the analysis are as follows:

•	The current asset allocation resulted in a projected mean annualized return of 11.5% with a standard deviation of 13.44%.

•	Probability of

Payout	Attaining

Alternatives	$738,000,000 Goal	Exhibit

4.5%	68%	I

5.5%	55%	II

6.5%	41%	III

•	There is a 10% probability the assets will grow to $1,483,984,000 and a 90% probability the assets will be at least $412,177,440.

Changing the asset allocation to 60% equities and 40% fixed income results in a mean return of 7.4% with a 9.4% standard deviation. With a 5.5% grant payout, the probability of meeting the Foundation's goal of $738,000,000 drops dramatically to a 8% probability (Exhibit IV).

Michael W. Senske, CPA

Assistant Controller

The Lynde and Harry Bradley Foundation

Milwaukee, WI