THE UNIVERSITY OF MICHIGAN REGENTS COMMUNiCATiON

REQUEST FOR ACTION

Subject: Managers

Action Requested: Appointment ofCenturion Investment Group, Farallon Capital Management, Highfields Capital, and Och-ZiffCapital Management Group

Background and Summary:

The term "absolute return" describes investment strategies whose objective is to produce positive returns in all types ofmarkets. These strategies attempt to produce returns more dependent upon manager skill than on the direction ofthe capital markets. Thus, a traditional investment manager is evaluated on a relative basis compared with the appropriate market index, while an absolute return manager is evaluated against an absolute return standard. The Regents will be asked to consider the appointment offour absolute return management organizations. All four are led by individuals with strong long-term investment performance, sensitivity to the importance ofrisk controls, and virtually all oftheir own assets invested in the funds they manage. We recommend initial funding at a level of$25 million each.

The University has invested with managers who can be characterized as "absolute return" managers for many years; for example, we have invested in distressed debt funds since 1989, and have a number of investments in this category. We also have long/ stock managers who focus on emerging markets and others who focus on the energy industry.

Our objective in recommending the managers is to decrease market exposure while increasing exposure to manager skill. In this item, we propose the appointment ofCenturion, a long/short stock manager focusing on the U.S. We also recommend the appointment ofthree managers, Farallon, Highfields, and Och-Ziffwho pursue a broad array of investments. Although the aim ofabsolute return managers is to produce returns independent ofmarket returns, long/short stock managers like Centurion are likely to be more correlated with the markets on which they focus than are managers pursuing multiple strategies such as FaralIon, Highfields, and Och-Ziff. Below is a summary ofeach manager, with further details on asset size, personnel, and fund terms attached as exhibits.

Centurion. Robert Raiffformed Centurion after many years as a stock analyst at C.J. Lawrence and as a manager ofglobal securities and U.S. small capitalization stocks in the Soros organization. Though the Centurion legal documents afford broad latitude in investing (a common feature ofabsolute return funds), Raifffocuses on U.S. stocks, and has used little leverage in recent years. He employs a highly focused, value-oriented strategy to select stocks for long and short positions, and uses his analysis ofbroad economic trends to screen his stock picks. His short sales are intended as money-making positions, not hedges; hence, he shorts individual stocks rather than indexes. The fund tends to be net long, but could be net short (with short positions exceeding long positions) under certain market conditions. Annual Total Returns 8 mos. 1992 1993 1994 1995 1996 1997 1998 Centurion Investment Group 24.0 14.6 -1.2 38.2 22.2 44.4 -1.6

91-Day Treasury Bills 3.6 3.1 4.5 5.7 5.3 5.3 3.5 S&P 500 7.6 10.1 1.3 37.6 23.0 33.4 -0.4 Median Common Stock Manager 9.4 13.4 0.4 34.1 22.2 30.1 NA

Average Annual Compound Returns through 12/31/97

6 Years 5 Years 4 Years 3 Years 2 Years Centurion Investment Group 22.8 22.5 24.6 34.6 32.8

91-Day Treasury Bills 4.6 4.8 5.2 5.4 5.3 S&P 500 18.1 20.3 23.0 31.2 28.1 Median Common Stock Manager 17.8 19.3 20.9 28.6 26.2

Note: Perfonnance represents the Centurion Partners . Perfonnance is net ofadvisory and perfonnance­ related incentive fee.

The following three managers have a common eclectic bent. Over time, they can be expected to actively alter their strategies to take adapt to changing market conditions.

Farallon. Farallon founder Thomas Steyer worked in the risk department ofGoldman, Sachs, then in 1986 became a general partner ofHellman & Friedman and started HFS Partners I, the predecessor to Farallon Capital Partners. Given Steyer's background in , the fund started with a focus on mergers and other corporate events, arbitraging the current value ofthe securities with their value upon consumation ofthe transaction. The fund focus shifted in the late eighties to emphasize distressed debt. In the past several years, a significant component ofreal estate investment has been added, along with other arbitrage strategies and the expansion of investments overseas, primarily in Europe, but also including emerging markets. Up to 30% ofcapital can be invested in illiquid assets such as real estate and . Farallon offers an investment team with broad capabilities and the ability to deploy resources opportunistically. The fund does not use leverage, but does employ derivatives and short positions.

Annual Total Returns 8 mos. 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Farallon 27.2 20.8 9.1 21.0 13.0 22.8 8.2 16.4 16.4 18.5 7.9

91-Day T-Bills 7.1 8.7 8.0 5.6 3.6 3.1 4.5 5.7 5.3 5.3 3.5 S&P 500 16.6 31.7 -3.1 30.5 7.6 10.1 1.3 37.6 23.0 33.4 -0.4 Median Event Arb. Manager 37.5 11.2 6.7 17.3 9.6 23.7 7.5 17.2 15.1 17.2 NA

-2- Average Annual Compound Returns through 12/31/97

10Yr 9Yr 8 Yr 7Yr 6Yr 5Yr 4 Yr 3 Yr 2 Yr Farallon 17.2 16.1 15.6 16.5 15.8 16.4 14.8 17.1 17.4

91-Day T-Bills 5.7 5.5 5.1 4.7 4.6 4.8 5.2 5.4 5.3 S&P 500 18.0 18.2 16.6 19.8 18.1 20.3 23.0 31.2 28.1 Median Event Arb. Manager 14.3 12.1 12.8 14.2 14.8 16.0 13.6 16.7 16.1

Note: Performance represents the Farallon Capital Institutional Partners Limited Partnership. Performance is net ofadvisory and performance-related incentive fee. Performance prior to 1990 represents the net/net returns for HFS Partners 1.

Highfields. With a background in equity arbitrage at Shearson Lehman, Jonathon Jacobson managed an equity portfolio at Harvard Management Company for seven years before leaving to found Highfields Capital. Based on Jacobson's history, we would expect this to be the most eclectic ofthese three funds with no predetermined comitment to specific strategies, industries, or geographies. At Harvard, Jacobson employed an ever-changing mix ofevent-driven and arbitrage strategies; for example, investing in closed­ end funds trading at a discount to the net asset value ofunderlying securities, creating "stub" positions through combinations oflong and short positions in related securities, and exploiting share class price discrepancies. The fund will employ leverage, take both long and short positions, and invest in a wide variety ofsecurities and derivatives. Up to 15% ofthe fund can be invested in illiquid assets.

Annual Total Returns 8 mos. 1991 1992 1993 1994 1995 1996 1997 1998 Highfields Capital 24.2 15.7 22.4 10.5 37.0 32.8 39.2 NA

91-Day Treasury Bills 5.6 3.6 3.1 4.5 5.7 5.3 5.3 3.5 S&P 500 30.5 7.6 10.1 1.3 37.6 23.0 33.4 -0.4 Median Common Stock Manager 33.6 9.4 13.4 0.4 34.1 22.2 30.1 NA

Average Annual Compound Returns through 12/31/97

7 Years 6 Years 5 Years 4 Years 3 Years 2 Years Highfields Capital 25.6 25.8 27.9 29.3 36.3 36.0

91-Day Treasury Bills 4.7 4.6 4.8 5.2 5.4 5.3 S&P 500 19.8 18.1 20.3 23.0 31.2 28.1 Median Common Stock Manager 20.0 17.8 19.3 20.9 28.6 26.2

Note: Performance prior to 111/98 represents the Mercury Fund managed by Jonathon Jacobson while at Harvard Management Company and has been estimated from gross performance numbers using Highfield's fee schedules. There are differences between investment policies and strategies ofthe Mercury Fund and those ofthe Highfields funds.

-3- Och-ZitT. Daniel Och was recruited from u.s. equity trading at Goldman, Sachs to form an absolute return investment vehicle for the Zifffamily in 1994. After five years ofinvesting exclusively for the Ziff family, the fund was opened to outside investors in 1998. The fund invests in merger arbitrage involving publicly announced deals only; in with strict hedging requirements based on their estimate ofmaximum downside exposure; and in other event-driven situations such as spin-offs, partial tenders, and changes in management. The fund utilizes moderate leverage, short positions, and derivatives. Up to 20% ofthe fund can be invested in illiquid assets. Och anticipates an increasing emphasis on non-U.S. investments.

Annual Total Returns 8 mos. 1995 1996 1997 1998 Och-Ziff 23.9 27.8 26.8 7.3

91-Day Treasury Bills 5.7 5.3 5.3 3.5 S&P 500 37.6 23.0 33.4 -0.4 Median Event Arbitrage Manager 17.2 15.1 17.2 NA

Average Annual Compound Returns through 12/31/97

3 Years 2 Years Och-Ziff 26.2 27.3

91-Day Treasury Bills 5.4 5.3 S&P 500 31.2 28.1 Median Event Arbitrage Manager 16.7 16.1

Note: Performance represents the OZ Domestic Partners Limited Partnership. Performance is net ofadvisory and performance­ related incentive fees except for the first 8 months of 1998, which is reported gross ofall fees.

We recommend the appointment ofCenturion Investment Group, Farallon Capital Management, Highfields Capital, and Och-ZiffCapital Management Group, subject to a favorable legal review ofthe documents by the General Counsel's office. We recommend initial funding at $25 million each.

Respectfully submitted,

Robert Kasdin Executive Vice President

September 1998 attachments

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