We seek to generate excellent long-term performance for our clients, regardless of how public securities markets behave. As a consequence, we focus on achieving absolute return targets, measured in real return terms, instead of measuring performance on a short term basis against one or more benchmarks.

We believe that good investment performance results from a combination of appropriate market exposure and access to managers with exceptional skill. In other words, asset allocation and manager selection both add value, one with respect to the choices about exposure to different markets and the other with respect to access to managers with exceptional skill.

• Asset allocation provides an important framework for making disciplined decisions.

Integral to the concept of asset allocation is the creation of diversified portfolios. Diversification manages risk and enhances return. During the 1990s bull market, we built portfolios that were diversified primarily among U.S. stocks and U.S. bonds. U.S. public equities were a good place to be in the 1990s, and our clients benefited from the returns generated by the raging bull market of that time. Since 2000, however, U.S. publicly traded equities have not generated the returns that we desire, and we think there are other more compelling opportunities. We now build portfolios that are diversified among several uncorrelated return streams that include both private and public investments.

Our allocation choices are driven by our view of possible scenarios for the future. Those scenarios guide our decisions as we ask ourselves where there are clear opportunities to build value and what obvious risks we should avoid. Predominant themes involve continued economic globalization, advancing technology, and significant demographic changes. We expect ancillary effects of those forces to include continued high energy prices and growing middle class populations in places such as China and India. As a result, our current asset allocation includes a specific allocation to energy and natural resources, as well as a significant allocation to international and emerging markets equities.

Since 2000, we also have been increasing our recommended allocations to private investments. The best investments are often illiquid, complex or out of favor. Careful research, knowledge of each investor’s liquidity needs, and access to top tier managers operating in inefficient spaces can manage the risk of illiquidity and in many cases can generate exceptional results.

• Access to managers with exceptional skills has the potential to enhance returns. In the 1990s bull market, few managers beat the equity indices over any extended period of time. When markets are rising in general, exposure to the market in the form of low cost index funds will produce satisfactory returns. When equity markets produce flat or negative returns, index returns will be disappointing to investors who want to increase their wealth.

Signature believes that one likely scenario involves lackluster returns for domestic equity markets over the next several years. Accordingly, we are employing active management within the domestic equity markets, since we believe that security selection will enhance returns in this environment. We are willing to own concentrated portfolios where managers know the underlying investments well and pay little attention to index weightings. For markets where we believe momentum will raise prices across the board, we recommend investing in exchange traded funds that reflect the broad market.

In inefficient markets, active management is always important, and access to the best managers is a necessity. Inefficient markets are defined as markets where values cannot be ascertained easily, where information is not readily available, and where skill can be rewarded in the form of significant performance. Investments in inefficient markets include hedge funds, private equity, real estate, natural resources, and small cap equity markets, both domestic and abroad.

The need for access to the best managers is evidenced by studies showing dispersion of returns among active managers. In a study compiled by David Swensen at Yale showing results over the period of 1988-1997, active bond managers generated average returns ranging from 8.5% to 9.7%, a difference of less than 1.3%. In contrast, venture capital managers over that same period generated average returns ranging from 3.9% to 25.1%, a difference of over 21%. Investing with an average venture capital manager would have produced a return less than that of the S&P 500 Index. Clearly the investor would not have been paid for the illiquidity and risk incurred.

We select managers carefully with a view towards hiring managers who demonstrate exceptional skill. By hiring a manager, we are subcontracting the management of our portfolios to the managers with whom we invest, and we are relying on their skill and ability to invest to generate returns. We take our responsibility seriously and devote significant resources to making good choices.