MONTANA BOARD OF INVESTMENTS

DEPARTMENT OF COMMERCE

 2401 Colonial Drive, 3 rd Floor

Helena, Montana

December 2, 2004

MINUTES

CALL TO ORDER

Chairman Anderson called the regular meeting of the Board of Investments (Board) to order at 9:15 a.m. in the conference room at 2401 Colonial Drive, 3 rd Floor, Helena, Montana. As noted above, the meeting convened with sevenmembers of the Board present. Member Ryan and Member Wilson were absent.

Member Moore motioned for approval of the October 21, 2004 minutes with one change.

• Member Moore abstained from the vote on the Thompson River Co-Gen Collateral Release Request, as well as Member Ryan. The vote passed 7-0 instead of 8-0 as stated in the October 21, 2004 minutes.

Member Klawon seconded the motion and the motion was passed 7-0.

PRESENTATION

Mr. Bon French and Mr. Kevin Callahan presented to the Board its annual Portfolio Update and presented the 2005 Adams Street Partnership Fund Program.

Recommendation

Staff recommends that the Montana Board of Investments commit up to $20 million to the Adams Street Partnership Fund – 2005 US Fund, and up to $5 million to the Adams Street Partnership Fund – 2005 Non-US Fund.

Member Klawon motioned for approval of staff recommendation as presented; Member Beams seconded the motion and the motion was passed 7-0.

ADMINISTRATIVE BUSINESS

 Chairman Anderson and Member Fleming presented Employee Service Pins to:

• Mr. Bob Bugni – 25 years with the State of Montana;
• Mr. Richard Cooley – 20 years with the State of Montana;
• Mr. Rande Muffick – 15 years with the State of Montana;
• Mr. Richard Bridegroom – 10 years with the State of Montana;
• Mr. Steve Strong - 5 years with the State of Montana;
• Ms. Roberta Diaz – 5 years with the State of Montana.

Mr. David Ewer addressed the Board and thanked them for the 19 years that he was on staff. Mr. Ewer spoke of the “positive accomplishments that took place while he was on staff. The INTERCAP Program was established, as was the CRP Program. High schools were built in Heart Butte and Lame Deer; school districts were kept open when no one else was able to fund them; Montanans in every corner of the state have been helped by the leadership of the Board and the staff of the Board of Investments”. Chairman Anderson thanked Mr. Ewer for his many years of service and the Board wished him the best of luck in his new position. Note: Mr. David Ewer was appointed by newly elected Governor Brian Schweitzer as the Budget Director for the State of Montana.

Ms. Gayle Moon introduced to the Board the newest member of the Accounting staff, Ms. Marilyn Umstead.

Executive Session

Chairman Anderson, as presiding officer, determined that the demands of individual privacy clearly exceed the merits of public disclosure, as such; the regular meeting was adjourned and went into a Closed Executive session.

Personnel Committee Report

The Regular Meeting of the Board reconvened with Member Fleming, Chairperson of the Personnel Committee recommending the following: “Exempt staff all receive the 3.25% increase granted to non-exempt employees, retroactive to the pay period beginning October 2, 2004; Mr. Ed Kelly’s salary be restored to its original amount retroactive to the pay period beginning October 2, 2004, plus the 3.25% increase; and that Mr. Bob Bugni receive an additional $2,000.00 per month while he is interim CIO, retroactive to the pay period beginning August 1, 2004”.

Member Fagg moved for approval of the recommendation; Member Klawon seconded the motion and the motion was passed 7-0.

Audit Committee Charter Discussion

Chairman Anderson presented to the Board a copy of a sample Audit Committee Charter supplied to the Board by Independent Fiduciary Services. The formation of an Audit Committee is being recommended by Independent Fiduciary Services as well. Terry Moore, Maureen Fleming and Karen Fagg will serve on the committee.

Member Fleming moved for approval of the formation of an Audit Committee; Member Beams seconded the motion and the motion was passed 7-0,

Member Fagg accepted the duties of the Committee Chair.

Member Moore suggested that the first task that the Audit Committee addresses is the Charter of the Audit Committee.

PUBLIC COMMENT – Public Comment on Board-Related Items

Chairman Anderson called for Public Comment of Board-Related Items. No Public Comment was made.

BOND PROGRAM

Activity Report

The Board reviewed this report for the period ending October 31, 2004

Staff Approved Loans Report

Ms. Louise Welsh reported that:

has been approved by staff.

INTERCAP

Ms. Louise Welsh presented staff’s recommendation that the Board authorize staff to proceed with processing and closing the following loans using the Board’s standard Bond Program Office procedures:

Member Fleming moved for approval of this recommendation; Member Moore seconded the motion and the motion was passed 7-0.

Member Long opened discussion on the issue of the loan to Ravalli County to finance an aggregate crushing plant and an excavator. He expressed a concern that by the state loaning this money to Ravalli County, it takes away opportunity from the private industry which gets taxed by the state of Montana. Member Fleming requested that a motion be made in order for further discussion to take place regarding this issue. Member Fleming who made the original motion to approve the loan requests stated that she would be happy to accept an amendment to the motion.

Member Long motioned that we do not approve a loan to a government agency that is going to compete with private industry, such as the crusher for Ravalli County. Member Fleming withdrew her original motion.

Further discussion took place and comments made included:

• Does the Board have the authority to make policy decisions in this type of meeting forum?
• Do administrative rules need to be changed to make this type of decision?
• Should a public hearing be held in order for guideline/policy be established to determine and create criteria of the types of loans that can be made by the INTERCAP Program?
• Should this be a legislative role to determine who can borrow money?
• Is this a prudent loan or is the Board setting a precedence?

Member Long’s motion was not seconded.

Member Fleming motioned to pass the original recommendation made and presented by staff; Member Klawon seconded the motion. Chairman Anderson called for a roll call vote.

Jay Klawon – “Yea” Maureen Fleming – “Yea” Dennis Beams – “Yea”

Terry Moore – “Yea” Karen Fagg – “Yea” Joel Long – “Nay”

Dick Anderson – “Nay”

The motion to approve staff recommendation that the Board authorize staff to proceed with processing and closing the following loans using the Board’s standard Bond Program Office procedures was passed 5 – 2. Member Tim Ryan and Member Calvin Wilson were absent from the meeting.

LOAN PROGRAMS

Consideration of Commercial Loan Participation – Permanent Coal Trust Fund

Ms. Delrene Rasmussen presented staff’s recommendation to participate in the following loan request:

Member Long moved for ratification of loan committee recommendation; Member Moore seconded the motion and the motion was passed 7-0.

Member Beams moved for ratification of loan committee recommendation; Member Klawon seconded the motion and the motion was passed 7-0.

Coal Tax Loan Program Activity Report

Ms. Delrene Rasmussen presented and the Board reviewed this report for September and October.

Pension Mortgage Program Activity Report

The Board reviewed this report for September and October.

CHIEF INVESTMENT OFFICER REPORTS

Proxy Guidelines

Mr. Bob Bugni was scheduled to present a revised version of the Proxy Guidelines for Equities. The Board asked Mr. Bugni to postpone discussion of the Proxy Policy until after Independent Fiduciary Services has made their recommendations.

Mr. Bugni stated that this is acceptable with the exception of one addition to the Policy that he would like approved. He recommended that “Staff has the option to recall securities on loan so they can be voted” by added to the Policy. Member Fleming motioned for approval of this recommendation; Member Fagg seconded the motion and the motion was passed 7-0.

Quarterly Investment Performance Report

Mr. Bugni presented the Montana Board of Investments Quarterly Board Performance Report for the period ending September 30, 2004.

Asset Allocation Report

Mr. Bugni presented the October 31, 2004 Asset Allocation Plan.

Rebalancing Guidelines – Retirement Funds

Mr. Bob Bugni presented staff request to be given clear authority to rebalance monthly under the following scenarios:

1. For total equity, the range is 60-70 with a target of 67 percent. Once we exceed 70 percent then staff will rebalance half way back to the target, which is 68.5 percent. The staff will then determine whether to sell MDEP, MTIP or MPEP units and how to rebalance these pools.
2. For domestic equity, the range is 40-50 for MDEP with a target of 45 percent. Once we exceed 50 percent then staff will rebalance half way back to the target, which is 47.5 percent. The staff will then determine how to rebalance this pool.
3. For international equity, the range is 12-18 for MTIP with a target of 15 percent. Once we exceed 18 percent then staff will rebalance half way back to the target, which is 16.5 percent. The staff will then determine how to rebalance this pool.

The reason to rebalance half way back to the target on the upper end of the ranges is to reduce the large downside risk imbedded in the equity asset class. This strategy will reduce the risk as soon as possible without the time delay of waiting for approval at the next Board meeting

Member Moore motioned for approval of this request as presented by staff; Member Beams seconded the motion and the motion was passed 7-0.

Recommendation for MDEP:

Mr. Bob Bugni presented an in-depth report on Montana Domestic Equity Pool which included 6 recommendations:

• Establish a benchmark for the MDEP Pool – A benchmark is needed to compare our performance to the passive alternative. In addition, it is critical that a pool benchmark be established before a mid-cap mandate is established.

Recommendation : Select the S & P 1500 Composite Index as the benchmark for MDEP.

• Add a mid-cap allocation - Adding mid-cap stocks to the pool would increase diversification, reduce tracking error against the pool benchmark, and increase the expected return over the long-term.

Recommendation :

a. Set a target of 8 percent for the pool with a range of 4-10 percent.

b. Given recent out performance of mid-caps over large-caps since 1999 a “go slow” approach is warranted. Diversifying over time is recommended to avoid investing at the top of the mid-cap cycle.

c. Start with only $5-10 million a month. If mid-caps sell off, then accelerate purchases.

d. Invest in a passive index fund:

• A separate account would not be practical to start for a number of reasons.
• A commingled fund would provide instant diversification across all 400 securities in the S&P 400 Index.
• Staff resources are limited and there is no major benefit to prepare a RFP for active/enhanced manager. Plus there is no guarantee that an active/enhanced manager would add value after fees.
• Less risk and more diversification than an active/enhanced manager.
• An active or enhanced, manager could be hired at some point in the future when we are closer to target.

e. Use our existing passive manager, Barclays Global Investors (BGI). The effective fee would be only 3 basis points to add this index.

3. Reduce the target for small caps - Performance for small-caps has exceeded the returns for mid-cap and large-caps over the past 1, 2 and 3-year periods ending 9/30/04. This is probably a good time to realize our gains and reduce our exposure.

 Recommendation:

1. Reduce the target from 10 percent to 6 percent. A target of 6 percent would still overweight small-caps by 50 percent.
2. Rebalance back to 6 percent. This will require us to sell approximately $146 million DFA units.
3. Place the proceeds into the passive S&P 500 account until it is needed to fund mid-cap or large-cap enhanced.

4. Consider adding enhanced for large caps–

• The Board has already approved an enhanced mandate with a target of 12 percent for the pool.
• The recommendation is not to use it for mid-caps at this time.
• The small-cap space is relatively small at only 4 percent of total market cap. Our existing active manager has been able to outperform the benchmark with a very diversified portfolio.
• The logical spot to use an enhanced manager is to diversify the large-cap sector. It can be used to increase the potential return over passive or reduce our active risk. Plus with a target of 12 percent, all or most of the target has to be used for large-caps.

Recommendation :

Target the enhanced mandate for large-caps. Staff will provide more analysis on large-cap enhanced managers including different styles, tracking error ranges, fee structures, and risk/return tradeoffs versus passive and active mandates. We also need to determine if an RFP process is required since this would consume a lot of staff time and delay the initial funding date.

5. Rebalance Large-Caps - MTCOMP is 76 percent of our large-cap exposure and is above the upper end of the investment policy range.

Recommendation : Rebalance MTCOMP back to target, and place the proceeds into the passive S&P 500 account until it is needed to fund large-cap enhanced and/or mid-cap.

• Revise the MDEP Investment Policy Statement –

Recommendation :

• Use the S&P 1500 Composite Index as the pool benchmark.
• For small-caps, reduce the target from 10 percent to 6 percent and change the range to 4-8 percent.
• For mid-caps, set a target of 8 percent and a range of 6-10 percent. Start with a passive index investment vehicle benchmarked off the S&P 400 Index.
• Place the enhanced mandate under large-caps.

Member Fleming motioned for approval of this recommendation; Member Klawon seconded the motion and the motion was passed 7-0. Member Fagg left the meeting at this time.

INVESTMENT ACTIVITY - Equity

Domestic Equities (Montcomp)

Mr. Rande Muffick presented September and October transactions, the holdings report as of October 31, 2004 and the current investment strategy. Member Klawon moved for approval of the Montcomp strategy as presented; Member Moore seconded the motion and the motion was passed 6-0.

PRESENTATION

Mr. William Hopkins, Managing Principal and Mr. Muzzi Mirza, Managing Principal presented to the Board a report on Odyssey Investment Partners and its middle market private equity buyout fund (OIPF III).

Recommendation

Mr. Ed Kelly presented staff recommendation that the Montana Board of Investments commit $25 million to the Odyssey Investment Partners Fund III (OIPF III). Member Fleming moved for approval of staff recommendation as presented; Member Beams seconded the motion and the motion was approved 6-0.

Montana Private Equity Pool (MPEP)

Mr. Ed Kelly presented September and October transactions and the holdings report as of October 31, 2004.

INVESTMENT ACTIVITY – Fixed Income

Intermediate Funds

Mr. Rich Cooley presented September and October Treasurer’s Fund transactions the Treasurer’s Fund holdings report as of October 31, 2004, the September and October State Fund transactions, the State Fund holdings report as of October 31, 2004 and the current investment strategy for both of these funds. Member Klawon moved for approval of the Treasurer’s Fund and State Fund strategy as presented; Member Beams seconded the motion and the motion was passed 6-0.

Long Term Funds

Mr. Rich Cooley presented September and October transactions, and the current investment strategy. Member Beams moved for approval of the Fixed Income strategy as presented; Member Long seconded the motion and the motion was passed 6-0.

INVESTMENT ACTIVITY – FYI Items

The following Investment Activity reports were available for informational purposes. None of these items requires Board action.

• STIP Transactions/Holdings Report
• Security Lending Report

NEXT MEETING

The next regularly scheduled meeting of the Board will be January 13, 2005.

ADJOURNMENT

There being no further business, the meeting was adjourned at 3:00 p.m.

BOARD OF INVESTMENTS

APPROVE:

Dick Anderson, Chairman

ATTEST:

Carroll South, Executive Director

DATE: