J.P. Morgan

J . P . M O R G A N A S S E T M A N A G E M E N T 7 appropriate stewardship of national assets dictates that national wealth be kept "at home." Other investors create home-country concentrations because they have intimate knowledge of their local and regional markets. Whatever the motivation, an essential benefit to a home-country bias is that these investors tend to be more likely to hold equity risk through periods of uncertainty and volatility. Such commitment allows them to reap the benefits of long-term compounding and has been a main differentiator between investment success and failure for many investors. Of course, long periods of underperformance or no positive performance may require locally biased investors to be extremely patient. There also are the important downsides to home-country bias: industry concentrations and public capitalizations that do not capture the breadth and higher growth segments of an economy, as previously discussed. Where there is a preference for home-country bias beyond established benchmark or GDP weights, we suggest investors examine the potential cost of this bias. Specifically, how large is your home-country bias in terms of the impact versus the potential global return and diversification benefits of more globally diversified benchmark metrics? Putting it all together The final step is to put it all together in a customized, institutionally appropriate portfolio. At this point, we balance between public market opportunity and liquidity, private market alpha potential and illiquidity—all with an eye toward risk moderation, if not risk optimization. (See "Exhibit 11: Sample portfolio allocation to equity strategies," page 15.) The following factor allocation represents our best thinking as it relates to a portfolio with a balanced + risk profile, relatively high level of "t+3" liquidity and an above-average assumption regarding due diligence prowess. The allocation weights and themes are those of the Absolute Return Portfolio (ARP), which is a focus model portfolio used for the management of long-term balanced + risk profile investors willing to accept risk through asset allocation, liquidity and strategy selection. Strategic allocation is likely to be the main determinate of risk and return over the longer term. However, a tactical process is also applied to portfolios within the Endowments & Foundations Group as a means to navigate short- to medium-term economic and valuation discrepancies versus the longer-term strategic outlook. Our thinking, applied Short-term tactical positions may be established to take advantage of current market inefficiencies, but strategic asset allocations are not expected to deviate dramatically year-to- year. Some of the key strategic and implementation themes guiding investment decisions over the long term in our J.P. Morgan Absolute Return Portfolio for endowments and foundations include: • Strategic allocation themes: - Geographic tilt in favor of Asia ex-Japan to capture the highest expected returns (according to J.P. Morgan) in the global public markets over a strategic timeframe - Underweight to commodity-oriented emerging markets, to reflect the end of the commodity "supercycle" and the slowing growth of China - Underweight to EAFE versus MSCI ACWI, to express the slow pace of European deleveraging and the somewhat elevated probability of tail risk versus the United States, but a tactical overweight to capture the valuation discount and cyclical rebound afforded by a global economic rebound, aggressive ECB quantitative easing, and less of an emphasis on austerity as a strategy to deal with the long-term deleveraging prospects of the region - Meaningful weight to private equity both in the United States and globally to capture the equity risk premium as well as the potential to capture substantial alpha versus the rest of capital markets - Significant weight to equity-based hedge funds to potentially capture a meaningful 75% of equity upside and with less than 60% of volatility. A wide dispersion of strategy returns offers the opportunity for further upside • Implementation themes: - Core portfolio beta is initially established by opting for lower-cost passive index vehicles. This passive core is then enhanced with alpha, using carefully selected active managers with high tracking error

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