SAN DIEGO CITY EMPLOYEES’ RETIREMENT SYSTEM STAFF REPORT INVESTMENT DIVISION

DATE : December 5, 2007

TO : SDCERS' Board of Administration via Investment Committee

FROM : Doug McCalla, Chief Investment Officer

SUBJECT : Recommended Changes to the Specific Investment Guidelines for Met West’s Core-Plus Fixed Income Portfolio

Summary of Recommended Changes to Met West’s Specific Investment Guidelines Staff and representatives of Met West, one of our core-plus fixed income managers, have been in discussions concerning the broadening of the specific investment guidelines for the SDCERS portfolio managed by Met West. The goal of this review process was to identify and provide access to investment opportunities expected to result in improved risk-adjusted performance. Attached is a memo from Met West that includes a draft of the proposed specific investment guidelines, along with a table that highlights the differences between the propose and current guidelines. The two major changes incorporated into the draft specific investment guidelines include:

1) Increase the maximum exposure to non-investment grade, higher yielding investments from 10% to 20% of the portfolio; and, 2) Authorize the use of the Metropolitan West High Yield Fund to affect higher yielding exposures in the portfolio in a more diversified and risk controlled manner. Use of this fund as an additional investment structure managed by Met West would not result in any additional net fees to SDCERS. 3) Reduce the portfolio’s minimum average credit quality rating from AA to A.

Other less substantive changes include: lowering the allowed quality rating on short-term commercial paper and asset-backed securities to A2/P2; authorizing investment in private placement 144a type securities; and, further defining the ever evolving types of fixed income instruments that may be included in the portfolio.

The proposal to lower the minimum credit rating on short-term commercial paper and asset-backed securities from A1/P1 to A2/P2 would not be consistent with the current SDCERS Investment Policy Statement (IPS) minimum credit quality limitation rating of A1/P2 on short-term paper. The other proposed changes are consistent with the IPS and are similar to guideline revisions previously done with PIMCO, our other core plus fixed income manager. Therefore, staff would recommend adopting Met West’s proposed changes, with the exception on lowering the minimum credit quality of short-term commercial and asset backed paper to A2/P2.

Recommended Changes to Met West’s Specific Investment Guidelines December 5, 2007 Page 2 of 2

History of Previous Core Plus Fixed Income Investment Guideline Modifications Met West was hired in June of 2001 to provide additional process diversification to our other core plus fixed income manager, PIMCO. Over the course of years, there have been a number of approved modifications to our core plus bond managers’ specific investment guidelines in response to changes in the financial markets, available investment instruments and the evolution of the managers’ total return investment processes. Examples of these evolutionary adjustments to our fixed income managers’ investment process are as follows:

In September of 1994, PIMCO’s specific investment guidelines were modified to allow a risk-controlled (at least 75% currency hedged) exposure to non-U.S. fixed income investments of up to 15% of the portfolio. This was the first non-U.S. investment exposure implemented by SDCERS. In February of 1995, PIMCO was authorized an alternative means of implementing non-U.S. exposure by buying shares in an institutional PIMCO international fund (fee neutral to SDCERS). In June of 2001, when Met West was hired and the size of the PIMCO portfolio was reduced by 50%, PIMCO’s tactical discretion for non-U.S. bond exposure was adjusted from a maximum of 15% to a maximum of 20% of the portfolio. In July of 2003, PIMCO’s emerging market investment guidelines were updated and additional institutional mutual funds were authorized as alternatives for implementing exposures (fee neutral to SDCERS).

Representatives from Met West are scheduled to present and discuss these proposed changes at the Investment Committee meeting. Staff recommends the approval of the proposed modifications to the specific investment guidelines for Met West, with the exception on lowering the minimum credit quality rating on short-term commercial and asset backed paper of A2/P2. These recommended modifications have been reviewed by our consultants from Callan Associates, who have indicated they are comfortable with the proposed changes (see attached memo).

Attachment: 1) Met West Letter of November 15, 2007 with Draft Specific Investment Guidelines and Comparative Table of Current versus Proposed Guidelines. 2) Callan Associates Memo of November 30, 2007.

Doug McCalla – Chief Investment Officer TO: Dawne Clark, CFA – Assistant Chief Investment Officer San Diego City Employees’ Retirement System

FROM: Patrick Moore – Managing Director

DATE: November 15, 2007

RE: MWAM Investment Guideline Update

Periodically, MWAM undertakes a review of our client guidelines to ensure that we are effectively drawing on the fixed income market to avail portfolios to the most optimal reward-risk opportunities. Historically, the San Diego CERS investment policy pursuant the Core Plus strategy has been near-completely consistent with MWAM’s specified full-discretion guidelines.

Enclosed please find two sets of documents to review in consideration of an update to the guidelines. The first document – Sample Investment Policy and Restriction Guidelines – represents a complete set of guideline specifications to govern the management of the portfolio. The second document represents a tabular comparison of the current San Diego CERS guidelines with the specifications of MWAM’s suggested full-discretion guidelines.

In comparing the existing and proposed set of guidelines, we observe two substantive differences, which are related. The first is that our full discretion guidelines would call for up to 20% in high yield investment (though 10% based on SDCERS risk preference is completely suitable) and the second is that the full discretion guidelines would allow MWAM to effect the high yield latitude through a commingled or mutual fund, in this case, the Metropolitan West High Yield Fund (MWHIX).

This well-diversified fund holds approximately 100 positions, from among three “tiers” of high yield exposure, including the securities of (1) longstanding and stable “BB” issuers accustomed to operating leveraged balance sheets, (2) companies downgraded from the ranks of investment grade issuers, and (3) stressed or distressed companies whose debt trades on a dollar, rather than a spread, basis. Naturally, the benefit of utilizing the Fund to gain the San Diego CERS high yield exposure is not only the diversification noted above, but also the relative liquidity that is characteristic of mutual fund investments.

The utilization of the Fund for this exposure would require the completion of the attached Authorization, which grants consent to MWAM to employ the High Yield Fund on a discretionary basis (up to the 10% or 20% authorized by the updated investment guidelines). Moreover, Exhibit A of the Authorization details the procedure by which investment management fees incurred by San Diego CERS will be offset by the Advisory Fees paid through its participation in the High Yield Fund. In other words, use of the High Yield Fund will be fee neutral to San Diego CERS.

We have also enclosed supporting information with regard to the High Yield Fund, including current Prospectus, Statement of Additional Information (SAI), and Fund Fact Sheet. If we provide additional information or answer any questions regarding the proposed guideline update or utilization of the High Yield Fund, please feel free to contact us.

SAMPLE INVESTMENT POLICY AND RESTRICTION GUIDELINES FOR SAN DIEGO CITY EMPLOYEES’ RETIREMENT SYSTEM CORE PLUS FIXED INCOME PORTFOLIO

I. Type of Fund: Public Pension

II. Type of Portfolio Management: Total Return Bond Management

III. Performance Objectives/Benchmarks: Lehman Bros. Aggregate Index

IV. Fixed Income Duration Guidelines:

Average Portfolio Duration: Benchmark +/- One Year

Individual security maturities and durations are the discretion of the manager.

V. Permissible Assets (U.S. Dollar-Denominated Only) – Subject to Concentration Guidelines specified in Section VII

A. Fixed Income Securities 1. U.S. Government and Agency Securities, including but not limited to: a. U.S. Treasury Notes and Bonds b. U.S. Treasury Inflation-Protected Securities (TIPS) c. STRIPS (Zero Coupon Issues) d. Agency Debentures i) Government-Guaranteed ii) Government-Sponsored Enterprises (GSEs)

2. Corporate Securities, including but not limited to: a. Debentures b. Medium-Term Notes c. Capital Securities d. Trust Preferred Securities e. Yankee Bonds f. Eurodollar Securities g. Floating Rate Notes and Perpetual Floaters h. Structured Notes (with fixed income characteristics) i. Private Placements i) Bank Loans ii) 144(a) Securities

3. Structured Securities, including but not limited to: a. Agency and Non-Agency Mortgage-Backed Securities (MBS) Sample Investment Policy and Restriction Guidelines for November 2007 San Diego City Employees’ Retirement System Page 2 of 3 Core Plus Fixed Income Portfolio

i) Pass-Through Securities ii) Collateralized Mortgage Obligations iii) Stripped MBS - Interest Only Strips (IOs) - Principal Only Strips (POs) iv) Floating Rate Notes v) Inverse Floaters vi) 144(a) Securities b. Asset-Backed Securities (ABS) - 144(a) Securities c. Commercial Mortgage-Backed Securities (CMBS)

B. Other Interest-Bearing Securities 1. Municipal Bonds 2. Preferred Stock a. Adjustable Rate b. Convertible

C. Short-Term Investments 1. Cash 2. U.S. Treasury Bills 3. Agency Discount Notes 4. Certificates of Deposit (CDs) and Bankers’ Acceptances (BAs) 5. Commercial Paper – Minimum Quality of A2/P2 6. Asset-Backed Commercial Paper – Minimum Quality of A2/P2 7. Money Market Funds and Bank Short-Term Investment Funds (STIF) 8. Repurchase Agreements (Repo)

D. Other 1. Fixed Income Commingled and Mutual Funds (as approved) 2. Futures and Options 3. Swap Agreements 4. Reverse Repurchase Agreements (Reverse Repo)

VI. Fixed Income Credit Quality Guidelines:

Minimum Average Quality: A* rating Minimum Quality (at purchase): 80% Baa** or above 20% B** or above

* Market-weighted portfolio average ** Rating required by one nationally recognized statistical rating organization (NRSRO) or equivalent determination of MWAM

MWAM will maintain discretion to hold securities in the event of a downgrade by any of the national rating agencies, subject to the following requirement:

Sample Investment Policy and Restriction Guidelines for November 2007 San Diego City Employees’ Retirement System Page 3 of 3 Core Plus Fixed Income Portfolio

Any holding for which the applicable credit rating falls below the minimum required for purchase will call for written notification by MWAM with a description of the ongoing investment strategy for the position.

VII. Concentration Guidelines

Issue (by CUSIP) – Maximum 2.5% of portfolio market value Issuer (By Ticker) – Maximum 2.5% of portfolio market value Issue/Issuer maximum does not apply to U.S. Treasury issues

Bank Loans – Maximum 5% of portfolio market value

IOs – Maximum 5% of portfolio market value POs – Maximum 5% of portfolio market value Inverse Floaters – Maximum 5% of portfolio market value

Approved commingled/mutual funds are subject to prospectus guidelines

VIII. Loss Taking: No restrictions

IX. Leverage: No margin purchases or leverage permitted. Leverage is defined as any derivative exposure, e.g., futures, options, or swaps, not durationally offset by a matching transaction or not backed by cash equivalents or any transaction (purchase or sale) which results in the average portfolio duration mismatching the portfolio benchmark by more than 1 year in duration.

X. Qualified Institutional Buyer (“QIB”) Status

Confirm by providing assets and date following A. or checking and initialing the box following B.

A. Plan Sponsor Investment Assets:______Date:______

B. † Initial: _____ Plan Sponsor Investment Assets Exceed $100 million

C. † Not a QIB – Checking this box will exclude 144(a) Securities from the list of Permissible Assets

Current San Diego City Employees’ Retirement System Guidelines vs. MWAM Core Plus “Full Discretion” Guidelines San Diego City Employees’ Guideline MWAM Retirement System Average Portfolio Benchmark ±One Year Benchmark ±One Year Duration US Government and • US Treasuries and Agencies • US Treasury Notes and Bonds Agency Securities • US Treasury Inflation Protected Securities (TIPS) • STRIPS (Zero-coupon issues) • Agency Debentures - Government-Guaranteed - Government Sponsored Entities(GSEs) Corporate Securities • US Corporate Securities • Debentures • Private Placement Securities • Medium Term Notes • US traditional preferred and • Capital Structures adjustable rate preferreds • Trust Preferred Securities • Eurodollar Securities of US issuers • Yankee Bonds • Eurodollar Securities • Floating Rate Notes and Perpetual Floaters • Structured Notes (w/ FI characteristics) • Private Placements - Bank Loans - 144(a) Securities Structured Securities • Mortgage Pass Through Securities • Agency and Non-Agency Mortgage- (GNMA, FNMA, FHLMC, savings Backed Securities and loans, and banks) - Pass-Through Securities • Collateralized Mortgage Obligations - Collateralized Mortgage Obligations • Asset Backed Securities (ABS) (CMOs) - Stripped MBS - Interest-only Strips (IOs) - Principal-only Strips (POs) - Floating Rate Notes - Inverse Floaters - 144(a) Securities • Asset Backed Securities - 144(a) Securities • Commercial Mortgage Backed Securities (CMBS) Other Interest Bearing • State and Local Municipals • Municipal Bonds Securities • USD Foreign Government and Supra- • Preferred Stock National Agencies - Adjustable Rate - Convertible

METROPOLITAN WEST ASSET MANAGEMENT

Short-Term Investments • US Treasury and Agency instruments • Cash • Certificates of deposit and bankers • US Treasury Bills acceptances of US banks • Agency Discount Notes • US and Eurodollar floating rate notes • Certificates of Deposits (CDs) and CDs • Bankers Acceptances (BAs) • US Foreign Government and Supra- • Commercial Paper – Minimum Quality National Agencies A2/P2 • Eurodollar CDs, TDs, and commercial • Asset Backed Commercial Paper – paper minimum quality A2/P2 • US money market funds and bank • Money Market Funds and Bank Short- STIFS Term Investment Funds (STIF) • Repurchase and Reverse Repurchase • Repurchase Agreements (Repo) Agreements Other • Futures contracts on interest rate and • Fixed Income Commingled and Mutual foreign USD related instruments: Funds (as approved) - US Treasury Securities • Futures and Options - GNMAs, CDs, Euro TDs • Swap Agreements - Muni and Corporate Bond Index • Reverse Repurchase Agreements - USD Foreign Government Supra- (Reverse Repo) National Securities • Options on interest rate and foreign USD related instruments such as those listed above • Mortgage Backed derivative instruments such as Inverse Floaters, Interest Only and Principal Only notes Fixed Income Credit Minimum Average Quality AA rating Minimum Average Quality: A* rating Quality (market value weighted) Minimum Quality (at purchase): Minimum Quality at purchase Ba/BB or 80% Baa* or above equivalent rating by at least one of the 20% B** or above major rating services, i.e., Moody’s, (See below for notes) S&P, Duff and Phelps Downgrades MWAM has discretion to hold downgraded securities but must notify SDCERS in writing if the rating falls below the minimum required for purchase. MWAM must provide a written description of the ongoing investment strategy for the position. Concentration Guidelines • Issue max 5% • Issue (by CUSIP): Max 2.5% of port • Issuer max: 5% Market Value (MV) • Non-Investment Grade 10% • Issuer (by ticker): Max 2.5% of port MV • Mortgage Backed derivatives 5% • Bank Loans: 5% of port MV • USD Foreign Investments 15% • IOs, POs, and Inverse Floaters: 5% of • Foreign Currency Exposure 0% port MV (All max except US tsy/agy) • Approved commingled/mutual funds subject to prospectus guidelines

METROPOLITAN WEST ASSET MANAGEMENT Loss Taking No restriction No restrictions

Leverage No margin purchases or leverage permitted (see sample investment guidelines for details)

* Market-weighted portfolio average ** Rating required by one nationally recognized statistical rating organization (NRSRO) or equivalent determination of MWAM

METROPOLITAN WEST ASSET MANAGEMENT

MEMORANDUM

To: Doug McCalla and Dawne Clarke

SAN FRANCISCO From: Janet Becker-Wold and Jim Callahan

NEW JERSEY Date: November 30, 2007

CHICAGO Subject: Met West Proposed Guideline Changes ATLANTA

DENVER

We have reviewed the guideline changes proposed by Met West. Overall, it seems reasonable to give Met West additional discretion given the Core Plus assignment. These are also consistent with what we see in other core plus mandates. Be aware that the new guidelines could potentially lower the overall quality of the portfolio given the proposed increase in the below investment grade portion from the current 10% to 20%. Met West, in the proposed guidelines, expands the allowable securities to include A2/P2 commercial paper, corporate bank loans and 144a securities among others and well as further defining the concentration guidelines.

The use of the High Yield Bond Fund to gain high yield exposure also appears reasonable. The fund is diversified, holding approximately 100 securities thereby reducing security specific risk. According the prospectus, the Fund may invest up to 25% in foreign securities denominated in US dollars. Also, up to 10% may be invested in emerging market debt. The fund may borrow or sell short up to one- third of the total value of the assets.

Per the memo provided by Met West, use of the High Yield Bond Fund will be fee neutral to SDCERS.

Callan is comfortable with the proposed changes and Met West’s abilities to successfully implement a broader discretion mandate given their skill and expertise in the fixed income arena.

101 CALIFORNIA STREET, SUITE 3500, SAN FRANCISCO, CALIFORNIA 94111 TELEPHONE 415.974.5060 FACSIMILE 415.291.4014 Metropolitan West Asset Management Investment Management Review

prepared for San Diego City Employees’ Retirement System

December 20, 2007 ♦ Tad Rivelle, Patrick Moore

This material is intended for use exclusively in direct presentations to potential institutional clients and / or their investment consultants. Not for reuse.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T Agenda

♦ Guideline Review and Proposal • Add latitude for Metropolitan West High Yield Fund

♦ MWAM Update, Portfolio Review and Strategy • A conversation with Fed Chairman Ben Bernanke

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T Section I

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T Guideline Review

♦ MWAM undertakes periodic review of client investment policies to assess adequate consideration of market investment opportunities.

♦ As a “Core Plus” client, San Diego City Employees’ Retirement System has historically maintained consistency with MWAM’s “full discretion” guidelines.

♦ Comparison on the following pages reveals opportunity to effect San Diego City Employees’ Retirement System allocation to high yield within MWAM’s High Yield mutual fund and lift maximum exposure to 20% of the market value. (Current allocation in authorized accounts is approximately 4.5%.)

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 1 Current San Diego City Employees’ Retirement System Guidelines vs. MWAM Core Plus “Full Discretion” Guidelines

Guideline San Diego City Employees’ Retirement System MWAM Average Portfolio Duration Benchmark ±One Year Benchmark ±One Year US Government and Agency Securities • US Treasuries and Agencies • US Treasury Notes and Bonds • US Treasury Inflation Protected Securities (TIPS) • STRIPS (Zero-coupon issues) • Agency Debentures - Government-Guaranteed - Government Sponsored Entities(GSEs)

Corporate Securities • US Corporate Securities • Debentures • Private Placement Securities • Medium Term Notes • US traditional preferred and adjustable rate preferreds • Capital Structures • Eurodollar Securities of US issuers • Trust Preferred Securities • Yankee Bonds • Eurodollar Securities • Floating Rate Notes and Perpetual Floaters • Structured Notes (w/ FI characteristics) • Private Placements - Bank Loans - 144A Securities Structured Securities • Mortgage Pass Through Securities (GNMA, FNMA, FHLMC, • Agency and Non-Agency Mortgage-Backed Securities savings and loans, and banks) - Pass-Through Securities • Collateralized Mortgage Obligations - Collateralized Mortgage Obligations (CMOs) • Asset Backed Securities (ABS) - Stripped MBS - Interest-only Strips (IOs) - Principal-only Strips (POs) - Floating Rate Notes - Inverse Floaters - 144A Securities • Asset Backed Securities - 144A Securities • Commercial Mortgage Backed Securities (CMBS)

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 2 Current San Diego City Employees’ Retirement System Guidelines vs. MWAM Core Plus “Full Discretion” Guidelines (Continued)

Guideline San Diego City Employees’ Retirement System MWAM Other Interest Bearing Securities • State and Local Municipals • Municipal Bonds • USD Foreign Government and Supra-National Agencies • Preferred Stock - Adjustable Rate - Convertible Short-Term Investments • US Treasury and Agency instruments • Cash • Certificates of deposit and bankers acceptances of US banks • US Treasury Bills • US and Eurodollar floating rate notes and CDs • Agency Discount Notes • US Foreign Government and Supra-National Agencies • Certificates of Deposits (CDs) • Eurodollar CDs, TDs, and commercial paper • Bankers Acceptances (BAs) • US money market funds and bank STIFS • Commercial Paper – Minimum Quality A2/P2 • Repurchase and Reverse Repurchase Agreements • Asset Backed Commercial Paper – minimum quality A2/P2 • Money Market Funds and Bank Short-Term Investment Funds (STIF) • Repurchase Agreements (Repo) Other • Futures contracts on interest rate and foreign USD related • Fixed Income Commingled and Mutual Funds instruments: (as approved) - US Treasury Securities • Futures and Options - GNMAs, CDs, Euro TDs • Swap Agreements - Muni and Corporate Bond Index • Reverse Repurchase Agreements (Reverse Repo) - USD Foreign Government Supra-National Securities • Options on interest rate and foreign USD related instruments such as those listed above • Mortgage Backed derivative instruments such as Inverse Floaters, Interest Only and Principal Only notes Fixed Income Credit Quality • Minimum Average Quality AA rating • Minimum Average Quality: A* rating • (market value weighted) • Minimum Quality (at purchase): • Minimum Quality at purchase Ba/BB or equivalent rating by - 80% Baa* or above at least one of the major rating services, i.e., Moody’s, S&P, - 20% B** or above Duff and Phelps (See below for notes)

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 3 Current San Diego City Employees’ Retirement System Guidelines vs. MWAM Core Plus “Full Discretion” Guidelines (Continued)

Guideline San Diego City Employees’ Retirement System MWAM Downgrades MWAM has discretion to hold downgraded securities but must notify SDCERS in writing if the rating falls below the minimum required for purchase. MWAM must provide a written description of the ongoing investment strategy for the position. Concentration Guidelines • Issue max: 5% • Issue (by CUSIP): Max 2.5% of port Market Value (MV) • Issuer max: 5% • Issuer (by ticker): Max 2.5% of port MV • Non-Investment Grade 10% • Bank Loans: 5% of port MV • Mortgage Backed derivatives 5% • IOs, POs, and Inverse Floaters: 5% of port MV • USD Foreign Investments 15% • Approved commingled/mutual funds subject to prospectus • Foreign Currency Exposure 0% guidelines (All max except US tsy/agy) Loss Taking No restriction No restrictions Leverage No margin purchases or leverage permitted (see sample investment guidelines for details)

* Market-weighted portfolio average ** Rating required by one nationally recognized statistical rating organization (NRSRO) or equivalent determination of MWAM

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 4 Metropolitan West High Yield Fund

♦ ’40 Act Mutual Fund allows for broad diversification and relative liquidity characteristic of mutual fund investments.

♦ MWAM High Yield Fund track record dates back to 2002; high yield experience dates to firm inception.

♦ Fund is “full cycle” in orientation, drawing on three tiers of high yield exposure: • Traditional and stable leveraged borrowers • Issuers downgraded from investment grade • Stressed companies for which debt trades on a dollar, rather than a spread basis

♦ Management team is deep and experienced, combining expertise of MWAM Generalist and Specialist investment professionals.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 5 Implementation of High Yield In San Diego City Employees’ Retirement System Portfolio

♦ MWAM Generalist Portfolio Managers maintain ongoing review of exposure and direct adjustment based on market conditions and security valuations.

♦ Utilization of fund will be fee-neutral to San Diego City Employees’ Retirement System overall rate of 18 basis points on first $500 million of assets under management and 10 basis points thereafter.

♦ Hard dollar fee incurred for overall management will be adjusted downward for expense ratio incurred for High Yield fund participation.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 6 Section II

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T Quarter 3 2007: Executive Summary

MWAM At A Glance (p 7) Portfolio Performance and Characteristics (p 8) • Performance above benchmark • Defensive positioning paid off in a difficult period Market Returns (p 9) • During a volatile quarter, Treasuries outpaced all fixed income sectors, while equities rallied late on Fed cut Performance Attribution (p 10) • Bias toward a steeper curve boosted performance • Corporate underweight and government overweight were additive, while some securities were negative Economic Review – Fed took action as the economy slowed and housing weakened (p 11) • Fed surprised market with a bigger than expected 50 basis point rate cut • Employment numbers disappointed, showing a loss of 4,000 jobs in August • Housing malaise continued as home sales slowed and foreclosures increased Market Review – Subprime woes led to greater volatility and sapped liquidity (p 12) • Subprime ABS sell-off market spurred contagion, affecting many different markets • Liquidity crunch hit commercial paper market, causing speculation of bankruptcies • Flight to quality rally steepened curve almost 60 basis points Economic and Market Outlook – In the midst of a bona fide deleveraging (p 13) • The market is undergoing a full-scale repositioning caused by too many houses and too much cheap capital • Unemployment is expected to gradually increase, while growth stays below trend • Inflation will continue to drift lower, while interest rates are close to fair value • Pockets of value are beginning to appear, although most sectors are not yet priced for the worst case Portfolio Strategy – Actively looking for attractive opportunities, though still cautious (p 14) • Maintain neutral duration stance since the market is discounting further Fed easing • Expect yield curve steepening to continue with the Fed in an easing mode • Maintain underweight to corporate bonds, while looking to add to select names or sectors on further weakness • Gradually start adding positions in short duration, high quality MBS and ABS where we can collect generous liquidity premiums Sector Highlight – Anatomy of a Trade (p 15) • Presents the rationale and implementation of a short position in various homebuilders Investment Approach & Organizational Update (p 16-17)

The views and forecasts expressed in this quarterly review are as of October 2007, are subject to change without notice and may not come to pass. MWAM reserves the right to change its investment perspective and outlook without notice as market conditions dictate. Past performance is no guarantee of future results.

MM E E T T R R O O P P O O L L I I T T A A N N W W E E S S T T A A S S S S E E T T M M A A N N A A G G E E M M E E N N T T 25 Quarter 3 2007: Executive Summary - MWAM Organization Update

Š Assets under management have grown to over $22 Billion:

Investment Products Description($mm) Assets Core Fixed Income Products $16,556 Ultra Short Active cash management. $492 Low Duration Relative value short duration management – total return with low durations. $3,259 Intermediate Total return with intermediate durations. $1,349 Total Return Relative value core & core plus. $11,457 Liability Driven Investments (LDI) $1,331 Long Duration High quality long duration management. $1,331 Derivative-based asset / liability matching strategies representing approximately $1.1Billion in Overlay Strategies notional value. High Yield Management $99 High Yield Disciplined, credit intensive high yield process. $99 Portable Alpha – Enhanced Equity $2,171 AlphaTrak A combination of S&P 500 ® futures and/or swap contracts backed by a short-term bond portfolio. $2,171 Non-Traditional $2,422 Strategic Income Emphasis on broad market instruments to achieve absolute return. $480 CDO Management Alternative funding invested in a diversified pool of structured finance securities. $2,277 Real Return $123 TIPS TIPS and other inflation-hedging strategies $123 Custom Mandates $113

Total Firm Assets as of 9/30/2007 $22.8 Billion

Š MWAM has over 100 total employees and 31 investment professionals.

Standard & Poor’s 500® is a trademark of The McGraw-Hill Companies.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 7

Executive Summary San Diego City Employees` Retirement System Inception Date: July 2, 2001 November 30, 2007 Market Value $482,934,153.38 Total Rate of Return Characteristics

Portfolio Index 9.00% Yield to Maturity 5.31% 4.89%

8.00% 7.64% 7.52% 7.20% Duration 4.52 Years 4.37 Years

7.00% 6.67% 6.05% 5.92% 5.86% Quality AAA AA1 6.00% 5.72% Sector Weights 4.79% 5.00% 4.78% Government 34.7% 33.3% 4.00%

3.03% Credit 17.3% 21.5% 3.00% 2.84%

2.15% Mortgage Backed 43.0% 44.2% 2.00% 1.80%

1.00% Asset Backed 1.6% 0.9%

0.00% Money Market 3.9% 0.0% November Q3 2007 Year-to-Date 1-Year 3-Year 5-Year Inception-to- Other -0.5% 0.0% 2007 Date

SDCERS Lehman Aggregate Index

Unless otherwise indicated, all returns are reflected gross of fees. Returns are annualized for periods greater than one year.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 8

Quarter 3 2007: Market Returns

During a volatile quarter, Treasuries outpaced all fixed income sectors, while equities rallied late on Fed cut

Fixed Income 2007 Q3 Return 12 Month Return Yield-to-Maturity

Treasury 3.81% 5.62% 4.30% 3 mo T-Bills 1.38% 5.29% 3.89% 1-3 Year 2.65% 5.76% 3.99% TIPS 4.54% 4.97% 4.52% Corporate 1.82% 3.93% 5.90% AA-rated 2.05% 4.13% 5.55% BBB-rated 1.58% 4.11% 6.22% High Yield 0.33% 7.54% 8.64% Mortgage-Backed 2.73% 5.33% 5.78% Asset-Backed 1.41% 4.12% 5.59%

Equity 2007 Q3 Return 12 Month Return

S&P 500 2.03% 16.44% - DJIA 4.19% 21.68% - NASDAQ 3.98% 20.52% -

Source: Bloomberg, Lehman Brothers Past performance does not guarantee future results.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 9 Quarter 3 2007: Attribution

Positioning Market Action Result

• Neutral versus the Interest rates fell across the Duration benchmark throughout the maturity spectrum on Neutral quarter expectations of Fed eases • Bulleted structure focused on Curve steepened almost 60 basis the 5 year to take advantage points between 2 years and 30 Yield Curve of curve steepening years Positive • Curve steepening range notes • Overweight governments All spread sectors underperformed Treasuries, with Sector • Underweight corporates Positive corporates the worst performing sector • Seasoned, off-the-run, well • These bonds mildly structured residential MBS underperformed generic products mortgages due to increased liquidity premiums in the 3rd quarter • CMBS, with greater perceived Issue Selection • Commercial Mortgage Slight Negative Backed Securities (CMBS) credit risk, did slightly worse than residential MBS • Secured corporate debt • More conservative corporate bonds outpaced riskier structures lower in the capital structure

The views and forecasts expressed in this quarterly review are as of October 2007, are subject to change without notice and may not come to pass. MWAM reserves the right to change its investment perspective and outlook without notice as market conditions dictate. Past performance is no guarantee of future results.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 10 Quarter 3 2007: Economic Review

Fed Surprised the Market With Bigger than Expected 50 Basis Point Cut 6.0% Š Despite hawkish rhetoric on inflation for much of the quarter and earlier use of the discount Fed Funds Target Rate 2-yr Treasury Yield window to ease liquidity concerns in the credit markets, the Federal Reserve (Fed) surprised 5.5% the market on September 18th with a 50 basis point, rather than an expected 25 basis point cut in short term interest rates. On top of the well-documented weakness in housing, the Fed 5.0% cited the added risk of tightening credit conditions spilling over into the broader economy and increased uncertainty as justification for the cut. 4.5% Š The immediate reaction of the Treasury market, as seen by higher rates, signaled a potential 4.0% policy mistake, suggesting that the Fed was now risking inflation and reinforcing the moral hazard of the perceived Bernanke/Greenspan put (i.e. bailing investors out of bad decisions). 3.5% However, economic fundamentals continued to weaken, and the move was cheered by the Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 equity and credit markets.

Employment Numbers Disappointed Š August’s non-farm payroll report showed the economy actually lost 4,000 jobs over the 400 5.2% month, the first negative print since 2003, and an economic impetus for the Fed’s decision to 350 Non Farm Payroll Monthly Change 5.0% cut interest rates. Regardless of the loss of jobs for the month, the unemployment rate 300 Unemployment Rate remained steady at 4.6% as the number of people looking for work also fell. At the same 250 4.8% 200 time, the gradually cooling economy again generated lackluster year over year GDP growth 4.6% slightly below 2%. 150 100 4.4% Š With the slowing economy, inflation, as measured by the core PCE, also drifted lower, posting (thousands) 50 a 1.8% year over year increase through August. The small decrease from last quarter’s 1.9% 4.2% - year over year rate came in the face of upward pressure from oil prices climbing higher than (50) 4.0% $80 per barrel, gold above $700 an ounce, and a weakening U.S. dollar, which declined Sep-05 Mar-06 Sep-06 Mar-07 significantly against most major currencies.

Housing Weakness Continued Š As the catalyst for the current slowdown, housing malaise continued in the third quarter. The 1,500 600 abundant supply of new and existing homes for sale remains a meaningful drag on the market 1,400 Annual Homes Sold Supply of Homes 550 as much tighter lending standards and higher mortgage rates for non-conforming loans have 1,300 reduced the pool of available buyers and slowed the rate of purchase. The supply of homes 1,200 500 hovered around 8 months of inventory at current selling rates during the quarter despite 1,100 450 housing starts falling to an annualized rate of about 1.3 million homes, more than 40% lower than the peak rate near 2.3 million hit in early 2006. 1,000 400 (thousands)

900 (thousands) Š The supply overhang was exacerbated by rising foreclosure rates across the credit spectrum. 800 350 According to data released during the quarter from the Mortgage Bankers Association, the 700 300 percent of loans in foreclosure for subprime adjustable rate mortgages (ARMs) more than doubled from year ago levels to just over 8%. Similarly, the number of prime ARM 9/30/02 9/30/03 9/30/04 9/30/05 9/30/06 foreclosures rose to 1.3%, also more than doubling from year ago levels.

Source: Bloomberg M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 11 Quarter 3 2007: Market Review

Subprime ABS Market Spurred Contagion 102 Š After the closure of two Bear Stearns ABS hedge funds in late June, a steady stream of 101 US High Yield Bank Loan Index Price bad news kept the market in retreat as several other prominent hedge funds announced suspension of withdrawals, closures, or the need for rescue financing. The market for 100 bonds and CDOs backed by subprime loans, and in particular the lower quality tranches 99 of those deals, dried up, sending pricing plummeting and making valuation difficult. 98 Š The loss of confidence in the subprime market quickly spread to other sectors, and 97 bonds repriced lower across the board as leveraged investors were forced to sell any 96 liquid asset they had to meet margin calls from the ABS positions. High yield bank loans 95 were especially hard hit, as price declines on the floating rate loans were the largest in 94 history. 3/30/07 4/30/07 5/30/07 6/30/07 7/30/07 8/30/07 9/30/07

Š The mess in subprime also spilled over into the commercial paper (CP) markets, which Liquidity Crunch Hit Commercial Paper Market were roiled in August when Countrywide announced they were unable to “roll” their 1,300 6.6% asset-backed CP program. The program was used to fund (primarily subprime) asset- ABCP Outstanding ($mm) 30 day ABCP Yield 6.4% backed loans that would then be packaged and sold off to the secondary market. The 1,200 6.2% loss of liquidity prompted markets to speculate about a rash of possible bankruptcies 1,100 6.0% as mortgage originators would not be able to fund ongoing activity, and may be forced 5.8% to close their doors. 1,000 5.6% Š As the demand for subprime bonds declined, the collateral became increasingly 900 5.4% suspect, and banks worried about taking the programs onto their balance sheets. CP 5.2% investors became unwilling to lend, even over the very short term. Similar difficulties 800 5.0% were announced at a variety of other institutions, significantly reducing the volume of 7/6/07 7/27/07 8/17/07 9/7/07 9/28/07 asset-backed CP (ABCP) issuance during the third quarter and pushing ABCP yields close to 6.5%.

Flight to Quality Rally Steepened Curve Š With markets in panic mode much of August, investors fled risky assets, seeking safety 5.5% 6/29/2007 9/28/2007 in US Treasuries, and short dated Treasuries in particular. 3 month Treasury bill rates fell from around 5% in July to end the quarter near 3.8% after bottoming out just below 5.0% 3.1% on August 20th. Adding to the rally was a strongly growing sentiment that the Fed would act to calm markets by dropping short-term interest rates. 4.5% Š Longer term Treasuries also rallied, with the 2 year Treasury falling 90 basis points to yield 4.0% and the 30 year Treasury dropping to 4.8% from 5.1% at the beginning of 4.0% the quarter. This movement steepened the curve approximately 60 basis points between 2 years and 30 years. 3.5% 6-mo 2-yr 5-yr 10-yr 30-yr

Source: Bloomberg, Lehman Brothers M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 12 Quarter 3 2007: Economic and Market Outlook

In the Midst of a Bona Fide Deleveraging The market is currently undergoing a true, full-scale economic repositioning caused by a combination of too many houses and too much cheap capital. • Over time, assets will move out of weaker hands and into stronger hands. This phenomenon is already happening in the housing markets as lending standards have tightened significantly, dramatically shrinking the new subprime market. At the same time, foreclosures are up across all market segments, but particularly in subprime loans, hastening the move away from weaker borrowers. • This transfer of assets could take 18 months to three years as several million homes must change hands. In the interim, there will be a strong desire to claim “the worst is behind us” and that markets will return to “normal”. We remain skeptical of these claims, and expect that economic weakness will continue while markets will endure a bumpy ride with many fits and starts until the deleveraging process is complete. Unemployment will gradually increase, while growth stays below trend. • Employment in the coming quarters is likely to decline, particularly in housing related sectors. The most obvious evidence of this decline can be seen in layoff announcements by many (mostly subprime) mortgage originators. • The falloff in employment should lead to lower consumer spending, the lynchpin of recent economic strength. As a result, continued below trend growth is our base case economic forecast for at least the remainder of 2007 and the first half of 2008. • Although the most likely scenario is one of low but positive growth, the risks of outright recession are higher now. In addition, those risks are almost exclusively skewed toward the downside, with few potential catalysts that could provide a positive surprise to economic growth. Inflation will continue to drift lower, while interest rates are close to fair value • Despite upward pressure from a weak dollar, high commodity prices, and an easing Fed, inflation should remain contained due to the slackening demand caused by a slowing economy. • Interest rates near 4% at the short end and 4.75% at the long end are reasonably close to fair value, especially considering the uncertainty of the economic outlook. Pockets of value are appearing in certain sectors • Deleveraging creates technical pressure as investors are forced to sell assets across the board, pushing prices down for a wide variety of securities and sectors. Investors with longer time horizons can take advantage of this selling pressure. • We remain mostly cautious, but have begun to find certain sectors that offer attractive value, particularly short duration, high quality, well structured MBS and ABS bonds which have minimal credit risk, but offer compelling liquidity premiums. • Generally speaking, the corporate market is still not pricing in the full impact of a slowing economy. While bonds may be fairly valued if growth stays at 2%, lower growth rates and lax corporate underwriting should lead to higher defaults and wider spreads, and therefore, MWAM continues to be defensive.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 13 Quarter 3 2007: Portfolio Strategy

Cautious, but Actively Looking MWAM has been defensively positioned for the better part of two years. As a result, the market action in the third quarter was not unexpected, although the speed of the correction was somewhat surprising. Because of our previous conservative risk profile, portfolios have generally weathered the storm well, and are positioned to add to risk positions as opportunities arise. However, caution is still warranted as the deleveraging process could take some time, and better buying opportunities may be more abundant in the future. Duration and Yield Curve • Duration remains consistent with that of the benchmark. Interest rates roughly approximate fair value since the Treasury market is discounting weak economic growth and further Fed easing. MWAM will look to extend duration beyond the benchmark should rates rise. • With the Fed likely in an easing mode, we expect that the curve will continue to steepen significantly in the future. Therefore, portfolios have maintained a modest bullet structure that overweights the 5 year part of the curve and underweights the long end. Where possible, structured notes designed to profit from a steepening curve have also been used. Sector • Maintain underweight to corporate bonds – In general, the corporate market does not provide adequate compensation given the risks of a slowing economy. Therefore, portfolio holdings will be focused on shorter maturities of higher quality issuers, with strong covenants and solid asset protection. – Individual names and specific corporate sectors that have been in the headlines yet remain fundamentally solid are beginning to appear attractive. While maintaining an overall defensive posture, we remain vigilant for opportunities to buy these assets inexpensively and will look to do so in the coming quarters. – In particular, there has been activity in the commercial paper sector, moving out of T-bills and agency discount notes and into the paper of large, money center banks which offer yield pickups of over 100 basis points versus T-bills and 20 basis points versus discount notes. • Gradually start adding to positions in select mortgage and asset-backed securities – Concentrate additions in short duration, high quality, well-structured securities from top-tier issuers. These issues have little credit risk, but in the current environment offer significant liquidity premiums which are attractive for longer term investors such as MWAM. – Within subprime ABS, look to extend duration of select holdings modestly or move slightly down in quality from AAA to AA. In both cases, maintain focus on long-term sustainability of issuers and solidity of credit enhancement package, where principal impairment is not an issue. – Continue to look for value in areas of the residential mortgage market that are not included in the index and where careful investors can find attractive risk/return tradeoffs such as hybrid ARMs, interest only MBS where allowed, and seasoned pass-through securities. – Target seasoned, stable commercial mortgage-backed securities in the middle part of the curve to replace corporate exposure with high quality assets, while not sacrificing yield.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 14 Quarter 3 2007: Sector Highlight Anatomy of a Trade Trade Thesis: Home builders faced significant challenges in the form of a slower economy, declining home prices, and tightening lending standards. At the same time, builder valuations were exceedingly rich. Short positions in various home builders via the credit default swap (CDS) market were therefore inexpensive and presented solid potential for excess return. Following is an analysis of the factors that went into the decision to do the trade as well as details about its implementation. Macro Factors Sector Factors Issuer Factors • GDP growth was below 2% and likely to remain low, with • Overall industry leverage among investment grade • Geographic concentration – Builders with significant substantial risks to the downside builders was climbing rapidly – from 1.5x just one year exposure to previously “hot” markets such as California, • Home sales had slowed and house price appreciation ago and heading to 5x in the near future Las Vegas, Phoenix, and Florida appeared more at risk was negative in many markets. • Credit spreads for the industry tightened significantly, • Aggressive management – Ambitious construction and expansion plans meant large upfront costs and more • Unemployment was expected to trend higher while largely due to the bid from collateralized debt obligations future risk consumer spending slowed. – CDS for investment grade builders went from • Land acquisition – Builders who acquired land via • MWAM anticipated that lending standards would tighten approximately 80 basis points a year ago to a low in the options rather than outright purchase are able to reduce as the subprime market inevitably came back to earth. high 30 basis points building commitments more easily This happened faster than expected, since during the • Overall industry profitability declined recently due to • Balance sheet – Companies who maintained a more third quarter: excessive land and home inventories conservative balance sheet should be in better shape in – Subprime lending effectively shut down • More speculative homes (homes built with no prior a downturn – Jumbo loans became much more expensive than buyer) were being put up in many markets • Price point – Builders focused on the low and high ends of the market are more exposed to disruptions in the they were even three months ago availability of subprime and jumbo mortgages respectively

Trade Implementation • Trade implemented by buying protection (buying protection is equivalent to a short credit position) on a handful of investment grade and non-investment grade builders via the CDS market • Initial positions put on in late 2006 were small (~0.2%), growing to a maximum in the middle of 2007 of a little over 1% of total portfolio market value as we dollar cost averaged into a full position • Average spreads when we initiated the position were around 80 basis points for investment grade builders. Continued adding to position as spreads tightened in to the high 30s. • Position was monitored daily to ensure risk and performance were consistent with our expectations

Trade Results • Cost of the position at peak size was less than 2 basis points per year • Over the last quarter, spreads on some positions widened out to more than 400 basis points, allowing us to take profits and reduce the total position size to about 0.7% • Total performance impact of this trade over its life through the end of the third quarter is approximately +4 basis points.

Past performance is no guarantee of future results.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 15 Investment Philosophy

♦ Apply multiple value-added strategies in the pursuit of:

– Consistent outperformance of a fixed income benchmark

– Low absolute return volatility

– Emphasis on capital preservation, particularly in rising rate environments

♦ Core Philosophical Tenets

– Appreciation for mean reverting nature of fixed income securities

– Recognition that short-term technical factors can cause fixed income pricing to temporarily deviate from the mean

– Belief that bottom-up issue selection, when used in combination with top down investment strategies, can lead to strong absolute risk adjusted returns

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 16 Investment Process

Long-Term Quarterly Economic Outlook

Mean reversion Š Duration Management Patience Monthly Š Yield Curve Management Discipline Understanding of macro risks Š Sector Management

Portfolio Structure • Diversified Client • Optimized Objectives & Guidelines • Controlled Risk

Intensive search for value Š Security Selection Daily Understanding of micro risks Š Buy / Sell Execution

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T 17 Glossary

Accrued Interest: Interest deemed to be earned, i.e. accumulated since the most recent payment date, on a security but not yet paid. Ask Price: The price at which a security is offered for sale. Basis Point: One one-hundredth (1/100) of one percent, e.g. 0.25% is the equivalent of 25 basis points. Bid Price: The price at which a buyer will buy a security. Bond Swap: The sale of a bond and the purchase of another bond of similar characteristics. Often swaps are made for a number of reasons, e.g. to upgrade credit quality, or to extend or shorten maturity, or to reduce exposure. Callable Bonds: Bonds which are redeemable, at the option of the issuer, prior to the maturity date at a specified price. CMO (Collateralized Mortgage Obligation): A bond backed by a pool of mortgage pass-through securities or mortgage loans, which generally supports several classes of obligations. Convertible: A Convertible security is a hybrid instrument that combines features of both a debt instrument and an equity security. Convertible bonds may be exchanged for a predetermined number of shares of common stock, as indicated by the conversion ratio. Coupon: The amount of interest to be paid on a fixed income security. Credit Quality: The “quality” of a debt security (i.e. its credit rating) is typically determined through a formal evaluation of the firm’s financial health or credit history, with respect to its ability to repay its obligations. These evaluations are performed by one of the major credit rating agencies (e.g. Standard & Poor’s, Moody’s Investors Service, and Fitch are major credit rating agencies that publish their ratings). The highest (most credible) rating is AAA+ and moves alphabetically lower as the probability of default increases. Current Yield: The ratio of interest to the actual market price of a fixed income security, stated as a percentage. For example, a bond with a current market price of $1000 that pays $100 per year in interest would have a current yield of 10%. CUSIP: The Committee on Uniform Security Identification Procedures developed a uniform method of identifying securities. CUSIP numbers are unique nine-digit numbers assigned to securities. Default: The failure to pay principal or interest due holders of fixed income securities. Debenture: Unsecured debt obligation, issued against the general credit of a corporation, rather than against a specific asset. Discount: The amount which the purchase price of the security is less than the par value. Discount Note: Short-term obligations with maturities ranging from overnight to 360 days. The notes are issued at a discount to par and have no periodic interest payments; the investor receives the note’s face value at maturity. Discount Rate: The rate the Federal Reserve charges on loans to member banks. Duration: Most commonly (in fixed income) duration measures the sensitivity of the bond’s price to changes in interest rates. Extension Risk: The risk that as rates rise, the underlying loans in a pool will be repaid in a slower fashion, causing investors to find their capital is committed for a longer period than expected. As a result, investors may miss the opportunity to earn a higher rate of interest on their money. Face Amount: Par value (principal or maturity value) of a security appearing on the face of a security. Federal Funds Rate: The interest rate charged on inter-bank loans.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T Glossary

Floating Rate Bond: A bond for which the interest rate is adjusted periodically according to a predetermined formula. Hedge: An investment made with the intention of minimizing or offsetting risks embedded in investing. High Yield Bond: Bonds rated Ba or BB or below by credit rating agencies. Typically, high yield bonds offer a higher yield than more creditworthy securities. Investment Grade Bond: Bonds rated Baa or BBB or above by the rating agencies. Issuer: An entity that issues a security and is obligated to pay principal and interest. Interest: Compensation paid or to be paid for the use of money. Maturity: The date when the principal amount of a security is due and payable. Mortgage Pass-Through: A security representing a direct interest in a pool of mortgage loans. Non-Callable Bond: A fixed income security which cannot be called for redemption by the issuer prior to its specified maturity date. Offer: The price at which a seller will sell a security. Par Value: The principal amount of a fixed income security due at its maturity date. Premium: The amount by which the price of a security exceeds its principal amount. Prepayment: The unscheduled partial or complete repayment of the principal amount outstanding on a security before it is due. Prepayment Risk: The risk that falling interest rates will lead to fast prepayments of underlying loans, forcing the investor to reinvest at now lower outstanding rates. Principal: The face amount of a bond, payable at maturity. Ratings: Designations used by credit rating agencies to give relative indications of credit quality. Reinvestment Risk: The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment. Settlement Date: The date for the delivery of securities and payment of funds. Trade Date: The date when the purchase or sale of a bond is executed. Yield: The annual percentage rate of return earned on a security. Yield is a function of a security’s purchase price and coupon interest rate. Yield Curve: A graphic representation depicting relative yields over a spectrum of maturities ranging from three months to 30 years. Yield To Maturity: A yield based on the assumption that the security will remain outstanding to maturity. It represents the total of coupon payments until maturity, plus interest on interest, and whatever gain or loss is realized from the security at maturity.

Source: MWAM

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T Issue selection processes and tools illustrated throughout this presentation are samples and may be modified periodically. Such charts are not the only tools used by the investment teams, are extremely sophisticated, may not always produce the intended results and are not intended for use by non-professionals.

Investment strategies may not achieve the desired results due to implementation lag, other timing factors, portfolio management decision-making, economic or market conditions or other unanticipated factors. The views and forecasts expressed in this material are as of the date indicated, are subject to change without notice, may not come to pass and do not represent a recommendation or offer of any particular security, strategy, or investments.

Securities discussed are not recommendations and are presented as examples of issue selection or portfolio management processes. They have been picked for comparison or illustration purposes only. No security presented within is either offered for sale or purchase. MWAM reserves the right to change its investment perspective and outlook without notice as market conditions dictate.

While we have gathered this information from sources believed to be reliable, MWAM cannot guarantee the accuracy of the information provided. Clients are requested to notify MWAM of any updates to Client’s organization, such as (but not limited to) adding affiliates (including broker dealer affiliates), issuing additional securities, name changes, mergers or other alterations to Client’s legal structure.

MWAM acts as a discretionary investment adviser for various clients. While MWAM primarily manages fixed income securities, it may on occasion hold a voting security (or a security for which shareholder action is solicited) in a client account. Thus, unless a client (including a “named fiduciary” under ERISA) specifically reserves the right to vote its own proxies or to take shareholder action in other corporate actions, MWAM will vote all proxies or act on all other actions received in sufficient time prior to the deadlines as part of its full discretionary authority over the assets. When voting proxies or acting on corporate actions for clients, MWAM’s utmost concern is that all decisions be made solely in the best interest of its clients (for ERISA accounts, plan beneficiaries and participants, in accordance with the letter and spirit of ERISA). MWAM will act in a manner deemed prudent and diligent and which is intended to enhance the economic value of the assets of its accounts.

Metropolitan West Asset Management, LLC manages client portfolios in a diversified, value oriented manner. For this reason, MWAM seeks maximum use of the variety of fixed income sectors, provided that a client's guidelines do not contain a specific prohibition on the use of the asset class or other similar prohibitions. MWAM frequently seeks to invest in sectors or issues which have lost sponsorship in the marketplace and thus may have suffered from substantial price erosion, ratings agency downgrades, and negative analytical or press coverage. While MWAM seeks to maximize returns for our clients consistent with guidelines, MWAM cannot guarantee that MWAM will outperform a client's specified benchmark. Additionally, the nature of portfolio diversification implies that certain holdings and sectors in a client's portfolio may be rising in price while others are falling; or, that some issues and sectors are outperforming while others are underperforming. Such out or underperformance can be the result of many factors, including duration/interest rate exposure, yield curve exposure, bond sector exposure, or news or rumors specific to a single name.

On February 21, 2007, Metropolitan West Asset Management, LLC (“MWAM”) completed its purchase of the ownership stake formerly held by Metropolitan West Financial, LLC. Metropolitan West Financial’s interest constituted 40% of the voting interest and 35.49% of the economic interest in MWAM. As a result, the ownership percentage of MWAM ultimately owned by MWAM’s management team increased to 100%. That transfer of the ownership interest did not cause any changes in the management or operations of the investment advisory functions performed by MWAM. Because the transaction resulted in a technical assignment of investment management agreements, MWAM provided notice and solicited consent from its clients in accordance with necessary requirements.

To receive a complimentary copy of MWAM’s current Form ADV Part II, a copy of the MWAM’s proxy voting policies and procedures, or to obtain additional information on MWAM’s proxy voting decisions, please contact MWAM’s Client Services at (310) 966-8910.

This presentation contains material that is protected, individually and collectively, by copyright, trademark or other proprietary rights of Metropolitan West Asset Management, LLC or others as indicated. Shares of Metropolitan West Funds are distributed by PFPC Distributors, Inc. 760 Moore Road, King of Prussia, PA 19406. This presentation must be preceded or accompanied by a prospectus, which can be obtained at MWAMLLC.COM.

M E T R O P O L I T A N W E S T A S S E T M A N A G E M E N T