Peter Palfrey, CFA Vice President, Portfolio Manager Ken Johnson Vice President, Client Portfolio...

Peter Palfrey, CFAVice President, Portfolio Manager

Ken JohnsonVice President, Client Portfolio Manager

FRESNO COUNTY EMPLOYEESRETIREMENT ASSOCIATION

May 3, 2006

2

CONTENTS

Guideline Summary / Investment Results

Portfolio Characteristics

Market Review & Outlook

Account Team

Appraisal of Holdings

3

Benchmark: Lehman Brothers US Aggregate Index

Position Limits: 5% per issuer (excluding Governments and GSE’s)

Below Investment Grade: up to 20% permitted

Minimum Quality: “B3” by Moody’s or Standard & Poor’s

Non-Investment Grade EMG: not permitted

Duration: +/- 30% to the Benchmark

Non-Dollar: not permitted

GUIDELINE SUMMARY

Fresno County Employees Retirement Association

4

INVESTMENT RESULTS

Annualized

1st Qtr. Since2006 1-Year 2-Year 3-Year Inception

Fresno County Employees Retir. Assn. - Gross -0.08% 2.96% 2.34% 4.30% 3.50%

Fresno County Employees Retir. Assn. - Net -0.14% 2.70% 2.11% 4.06% 3.25%

Lehman Aggregate Bond Index -0.65% 2.26% 1.70% 2.92% 4.86%

Inception 07/ 31/2001

Adjusted Benchmark: Benchmark changed from Lehman Universal Index to Lehman Aggregate Index: 7/ 1/ 03

5

Fresno County

Employees

Retirement Assn.

Lehman Aggregate

Bond Index

Yield to Maturity 5.81% 5.48%Average Maturity 7.23 years 6.66 yearsEffective Duration 4.68 years 4.67 years

Coupon Rate 5.61% 5.25%Average Quality Aa2 Aa1

Duration used is: EffectiveData source: Lehman Brothers Research

CHARACTERISTICS SUMMARY AS OF 03/31/2006

Characteristics

6

Treasury10%

Agency6%

High Yield12%US Credit

22%

Asset-backed7%

Mortgage-backed35%

CMBS5%

Cash3%

FIXED INCOME PORTFOLIO STATISTICS: Period ending 03/31/2006

Fresno County Employees Retirement Assn. Lehman Aggregate Bond Index

Portfolio Overview

CMBS5%

Mortgage-backed35%

Asset-backed1%

US Credit23%

Agency11%

Treasury25%

7

Maturity Distribution

FIXED INCOME PORTFOLIO STATISTICS: Period ending 03/31/2006

Portfolio Overview

8%

1%

19%21%

18%23%

41% 43%

1%6%

13%

6%

0%

5%10%15%

20%25%30%

35%40%45%50%

Under 1 Year 1-3 Years 3-5 Years 5-10 Years 10-20 Years Over 20 Years

Fresno County Employees Retirement Assn.

Lehman Aggregate Bond Index

67% 79%

3% 5% 4%8%

16%

8% 10%

0%0%5%

10%15%20%25%30%35%40%45%50%55%60%65%70%

AAA AA A BAA BA & Below

Fresno County Employees Retirement Assn.

Lehman Aggregate Bond Index

Quality Distribution

8

HISTORICAL US TREASURY YIELD CURVES

Bond Market Environment

Data source: Lehman Brothers

03/31/0603/31/05

0 .0

0 .5

1 .0

1 .5

0 5 1 0 1 5 2 0 2 5 3 0

M a tu ri ty (ye a rs)

0.00.51.01.52.02.53.03.54.04.55.05.5

0 5 10 15 20 25 30

Maturity (years)

Yie

ld (%

)

3 Months 6 Months 1 Year 2 Year 5 Year 10 Year 30 Year

3/31/05 2.74% 2.98% 3.20% 3.59% 3.99% 4.36% 4.71%3/31/06 4.63% 4.82% 4.88% 4.82% 4.81% 4.85% 4.90%

Yield Change (bps.) 189 184 168 124 82 50 19

Total Return (%)

03/31/05 -03/31/06 3.55 3.54 3.01 2.08 0.45 0.40 0.37

9Data Source: Lehman Brothers Fixed Income Research


BOND MARKET SECTOR RETURNS

2005

2.79 2.74

12.27

2.432.611.680.003.006.009.00

12.00

US

Corp

orat

e MBS

USTr

easu

ry

US A

gg.

US C

orp

HY

EMG

(USD

)

Ret

urn

(%)

YTD 2006

-1.23

3.462.27

-0.65-0.07-1.17-2.00

-1.000.001.002.003.00

US

Corporate

MBS US

Treasury

US Agg. US. Corp

HY

EMG (USD)

Ret

urn

(%)

10

SECTOR YTD TOTAL RETURNS through March 2006


Percent Percent

Monthly DataSource: Lehman Brothers; History Through March 2006

-0.65

1.03

-1.23

-2.25

-0.20

0.25

-0.07

0.25

-0.52

-1.17

2.89

4.22

1.62

-0.10

-0.67

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

U.S

. Agg

rega

te

3 M

onth

Tre

asur

y Bi

lls

U.S

. Tre

asur

y

U.S

. Tre

asur

y: U

.S.

TIP

S

U.S

. Age

ncy

Mun

icip

al B

ond

Fixe

d Rat

e M

ortg

age

Back

ed S

ecur

itie

s

Ass

et-B

acke

d Se

curi

ties

CM

BS:

Eris

a El

igib

le

U.S

. Cor

pora

te

Inve

stm

ent

Gra

de

U.S

. Cor

pora

te H

igh

Yiel

d

U.S

. Con

vert

ible

s: B

uste

d

Emer

ging

Mar

kets

(U.S

.

Dol

lar)

Glo

bal Agg

rega

te

Glo

bal Agg

rega

te

(Hed

ged

USD

)

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

11

SECTOR YTD EXCESS RETURNS through March 2006


Basis Points Basis Points


2944

31 38

383

338

0

100

200

300

400

U.S. Agency Fixed Rate Mortgage

Backed Securities

Asset-Backed

Securities

U.S. Corporate

Investment Grade

U.S. Corporate High

Yield

Emerging Markets0

100

200

300

400

12

US CORPORATES: INVESTMENT GRADE OAS


Option Adjusted Spread (bps) Option Adjusted Spread (bps)


50

75

100

125

150

175

200

225

250

96 97 98 99 00 01 02 03 04 05 06

50

75

100

125

150

175

200

225

250

U.S. Corporate Investment Grade

13

US CORPORATES: HIGH YIELD OAS


Option Adjusted Spread (bps) Option Adjusted Spread (bps)


200

300

400

500

600

700

800

900

1000

1100

01 02 03 04 05 06

200

300

400

500

600

700

800

900

1000

1100

U.S. Corporate High Yield

14

HIGH YIELD CREDIT QUALITY TRENDS


Yearly DataSource: Moodys; History Through March 2006

7586

109

175

241

201

90

64

92

123 114

226

317

409

370

336

252272

433748

7557 50

6484

97 100

167

137

100115

92

178

258246

34

97

325

94

167153

0

50

100

150

200

250

300

350

400

450

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

# o

f Upg

rade

s &

Dow

ngra

des E

ach

Yea

r

Downgrades Upgrades

15

US DEFAULT TRENDS


Billions of Dollars Percent

Monthly DataSource: Moodys; History Through Mar-2006, Moodys Forecast Through: Mar-2007

0%

2%

4%

6%

8%

10%

12%

14%

72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

0%

2%

4%

6%

8%

10%

12%

14%

Trailing 12-month Issuer Default RatesForecast

16

MBS: ZV OAS Through March 2006


Source: Lehman Brothers; History Through

3/31/2006

0.5

20.5

40.5

60.5

80.5

100.5

120.5

140.5

160.5

180.5

200.5

3/3

1/9

4

3/3

1/9

5

3/3

1/9

6

3/3

1/9

7

3/3

1/9

8

3/3

1/9

9

3/3

1/0

0

3/3

1/0

1

3/3

1/0

2

3/3

1/0

3

3/3

1/0

4

3/3

1/0

5

3/3

1/0

6

cc spr

1std

1std

104wk Avg

Avg

17

Current Situation and OutlookInflation• Overall CPI inflation increased

3.6% year-to-year in February. Relatively stable energy prices should trim inflation in 2006 and 2007. Employment

• The labor market improved as the disruptions from the hurricane faded. Initial jobless claims have dropped to pre-recession levels.

Monetary Policy• The Federal Reserve has tightened by

375 bp since June 2004 to a funds rate of 4.75% on March 28. Expect Fed Chairman Ben Bernanke to tighten two more times by 25 bp each. Investment Conclusions and Concerns

• The 10-year Treasury yield has trended up since mid-January 17 as economic prospects seemed to improve. The current yield is about 5.00%, our target for the end of June and the highest since June 2002.

PORTFOLIO THEME

Updated as of 04/10/06 by LS Economics 8


Percent Percent

Chain-Weighted, Seasonally-Adjusted, Quarterly Data; Shaded Areas Denote NBER-Designated RecessionsSource: Commerce Department; History Through Q4:2005 01Q-02B

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

98 99 00 01 02 03 04 05 06 07

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

Four-Week Moving Average; Seasonally Adjusted; Weekly DataSource: Department of Labor; History Through April 1, 2006 03W-01

250

300

350

400

450

500

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

250

300

350

400

450

500

REAL GDP Quarterly Change Annualized

INITIAL UNEMPLOYMENT CLAIMSFour-Week Moving Average

Seasonally Adjusted; Weekly Data

18


•According to revised estimates, real GDP rose a sluggish 1.7% in Q4:2005, seemingly because of hurricane disruption and an energy shock. Rebuilding in the Southeast and lower energy prices should boost growth in early-2006. The budget deficit will remain huge. Inflation should ease in 2006 and 2007 as energy prices stabilize.

ECONOMIC FORECAST

Calendar year – Average basis. 2006 & 2007 are projected by LS Economics as of 04/10/06.

2004 2005 2006 2007

Real GDP Growth 4.2% 3.5% 3.6% 3.3%

CPI Inflation 2.7% 3.4% 3.0% 2.3%

Current Account Balance (billion)

-$668 -$805 -$912 -$942

Federal Budget Balance, NIPA Definition (billion)

-$406 -$323 -$334 -$387

Unemployment Rate 5.5% 5.1% 4.7% 4.9%

19

PORTFOLIO THEME – NON US DOLLAR

•The currencies of countries that run current account deficits greater than 5% of GDP often depreciate significantly. The U.S. deficit was 6.4% of GDP in 2005 and is forecasted to be 6.9% in 2006 and 6.7% in 2007.


Updated by LS economics as of 04/10/06

The current account deficit points to long-term weakness in the US dollar.

Billions of Dollars Percent of GDP

Seasonally Adjusted, Quarterly Data; Shaded Areas Denote NBER-Designated RecessionsSource: Commerce Department; Loomis Sayles; History Through Q4:2005; Forecast Through Q4:2007 07Q-12F

U.S. CURRENT ACCOUNT

History Forecast

-1000

-900

-800

-700

-600

-500

-400

-300

-200

-100

0

100

200

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

-10.0

-9.0

-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

Level (Left Scale)

Percent of GNP (Right Scale)

20


Billions of Dollars Billions of Dollars

Source: Department of the Treasury; History Through January 2006 07M-18

FOREIGN OFFICIAL HOLDINGS OF U.S. TREASURY SECURITIES

550

600

650

700

750

800

850

900

950

1000

1050

1100

1150

1200

1250

1300

1999 2000 2001 2002 2003 2004 2005 2006 2007

550

600

650

700

750

800

850

900

950

1000

1050

1100

1150

1200

1250

1300Break in Data

21

Duration/Yield Curve

Sector

Security/Industry Specific

PORTFOLIO THEMES – CORE PLUS

•We are maintaining duration at 100% of benchmark, reflecting our expectation that yields on longer maturities are likely to remain range-bound over the near term. The Federal Reserve Bank has already raised short rates by 375 basis points since the most recent monetary tightening process began in June, 2004, and is expected to tighten an additional 25-50 basis points in 2006. The FOMC has indicated that it is nearing the end of the current tightening cycle, and will likely become more “data dependent” regarding future FOMC actions.

•Our emphasis on a combination of shorter and longer maturities (barbelled) remains in place, in anticipation of some additional curve flattening, or potentially, yield curve inversion.

•Tactical use of TIPS (recently exited position)

•Reduced underweight to Government market.•Reduced overweight to corporate bonds

– Yield advantage versus Treasurys approaching fair value

– Emphasis within the credit allocation is to higher yielding BBB-rated and HY securities that have stable to improving credit trends and/or deleveraging situations

•Approximately market-neutral weight to mortgages– Mortgages currently offer an attractive nominal yield

advantage versus cash and Treasurys.– Potential extension/prepayment risk needs to be

managed through security and maturity sector selection

•Overweight to AAA-rated ABS and CMBS sectors•Shifting exposure to those industries that we

believe will perform best in the present “mid-economic cycle” environment


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ACCOUNT TEAM

Contact Information

Patricia BednarekAdministrative AssistantEmail [email protected]

Phone 312-346-9750Fax 312-346-4061

Kenneth M. Johnson Vice President, Client Portfolio ManagerEmail [email protected] 312-346-9750Fax 312-346-4061

Peter W. Palfrey, CFAVice President, Portfolio ManagerEmail [email protected] 617-482-2450Fax 617-542-1358

Peter Palfrey, CFA Vice President, Portfolio Manager Ken Johnson Vice President, Client Portfolio...

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