Pension Trust Management Review As of 31st July 1981

I The Historical Perspective

II The past two years' economic environment and investment activity

III The first six months of 1981

IV The Future Outlook

V Recommendations

I The Historical Perspective

Governmental policies of stimulus and economic growth

Cover Page

Cultural, political and economic changes resulted in the US exporting inflation

Page Two

Wealth peaked in 1968 with the astute like Warren Buffet cashing out

Page Three

Government interventionist policies matched the election cycle requiring more resources each time concomitant with the credibility gap

Page Four

1971 wage and price controls and dollar convertibility suspended let to growth stock excesses in 1972

Page Five

Monetarism and money supply awareness were largely absent as money supply growth accelerated during the election year of 1972

Wage and price controls ended 11th January 1973 and the US equity market peaked. Inflation was at +8% before the impact of the quadrupling of the price of oil and its embargo. The markets tanked in 1974.

Government deficits soared to multiples of previous deficits after 1974 while the money supply growth rate accelerated. The credibility gap opened widely.

From 1976 to 1979 money supply grew by +8%, budget deficits averaged $35 billion and the US federal debt increased by one-third. Inflation increasing +10% per year from 1977 to 1980 produced increased taxes for the government, but short term interest rates reached 18% at the start of 1980.

Equity prices rose and bond prices fell for the four years 1977 to 1980. Stimulation policies begun in the 1930s ended their beneficial impact from over use resulting in inflation and dislocation.

"Economic reality will dominate regardless of the rhetoric and smokescreens designed as palliatives." Naivete gives way to awareness.

Kondratieff long cycles from the War of 1812 to the present in the US. Identifying factors of influence to assess future outcomes.

II The past two years' economic environment and investment activity

Tax policy change in the wind, and newly appointed Federal Reserve Chairman Paul Volcker's "Saturday Night Special."

Investment management and asset allocation changes effective 28th February 1980

Drastic money supply changes during the 1980 election year accompanied by credit controls to dampen speculation in the financial markets created a double dip recession the evidence for which emerged later

Liquidity did find its way into financial market speculation, and the stop/go monetary policy had a similar effect on interest rates in early 1981 as it had in 1980. M1B had been introduced to add savings banks NOW (Negotiable Orders of Withdrawals) accounts which were money supply equivalents to M1A to accurately track money supply changes from the introduction of NOW accounts at the start of 1981. This created problems for money supply management by the Federal Reserve that contributed to the see saw effect upon interest rates.

Complex interactions between money supply liquidity, economic activity, loan demand and interest rates described although the Federal Reserve is still pursuing a fundamental deflationary money supply policy underneath all that was visibly happening.

Fiscal policy restraint begins to show in early 1981 as the Reagan administration takes over in order to curtail the Federal budget deficit while tax cut bill's passage delay helps maintain higher revenue.

Investment management strategy outlined for secular trend changes occurring.

Current Federal Reserve monetary policy restraint and credit controls created equity investing risk, i.e., volatility. The second oil shock and energy sector equities boom in 1980 was followed by interest rate sensitive equities appreciating in 1981 that was successfully met with allocation from passive to active equity investment management for a +25% ($40 to $50 million).

III The first six months of 1981

The anticipated economic transition which was reinforced by the political change from the incoming Reagan administration led to committing cash reserves to long term, call protected 30-year US government bonds starting at the end of February 1981. Evaluation of overall investment results since the earlier February 1980 changes.

IV The Future Outlook

Overview so far and consideration of tax policy changes

Fiscal and monetary policy changes coordinated with Reagan actually implementing his election promises by a government that meant what it said, reflected economic reality and eliminated the credibility gap.

Implementing fiscal policy including a demand lid on the economy with the Federal budget growth at 0.5% per year, yet no one was doing a careful analysis of the Federal budget generally at this point in time. Balancing the budget with tax cuts.

Tax cuts will work to close the budget deficit over time. A budget surplus is predicted along with a decline in inflation, but initially some "therapeutic pain" will be necessary. There will be a state of transition to an individual enterprise economy away from a nationally dominated environment.

V Recommendations

Period of substantial equity investment risk.

Current total pension fund investment allocation. Hedge strategy for equities. Cash out completely from one equity manager.

Create a equity call option portfolio in another manager based upon selling the equities and investing in 30-year, call protected government bonds using its income to buy the call options.

Equity investment diversification

Conclusion for total fund pension asset management during a period of change that would protect against risk and preserve return opportunity. Signed 31st July 1981