FC 99/6

FINANCE COMMITTEE

Table of Contents

I. Background

II. Long-term Investments

III. Short-term Investments

ANNEX A FAO LONG TERM PORTFOLIO - CURRENT HOLDINGS

ANNEX B - FAO SHORT TERM INVESTMENTS

I. Background

1. This document is submitted to the Finance Committee for information, in accordance with Financial Regulation IX, which provides, in part as follows: "The Director-General may invest monies not needed for immediate requirements seeking, wherever practicable, the advice of the United Nations Investments Committee. The investment of monies standing to the credit of any trust fund, reserve or special account shall be subject to any directives of the appropriate authority. At least once a year, the Director-General shall include in the financial statements submitted to the Finance Committee a statement of the investments currently held." ¹

2. The financial assets of the Organization referred to above, for purposes of investment are apportioned to and managed in two separate portfolios: a long-term portfolio managed by Fiduciary Trust Company; and a short-term portfolio managed by The Northern Trust Company.

II. Long-term Investments

3. The long-term investment fund is set up to enable the Organization to meet the long-term liabilities resulting from the Staff Compensation Plan, the Separation Payment Scheme and After Service Medical Liabilities². The Staff Compensation Plan Reserve Fund and the Separation Payment Scheme Fund accounts were combined in May 2000 into the FAO long-term investment account in order to take advantage of economies in terms of investment commissions and fees. The monies are invested in internationally diversified equities, fixed income instruments and venture capital, with the dual objectives of preservation of capital and capital growth. The benchmark for this portfolio as approved by the FAO Investments Committee and endorsed by the Advisory Committee on Investments is:

• 65% of the Morgan Stanley Capital International Inc. All Country Index;
• 35% of the JP Morgan Government Bond Index.

4. The benchmark combination provides a means of comparison of the returns of the portfolio in terms of both growth and income with indices whose components fairly represent the geographical and sector allocation of the portfolio. It was reviewed with the Advisory Committee in May 2001, along with all other benchmarks and investment guidelines and is currently under further review with Cambridge Associates, the Organization's financial consulting firm. Possible adjustments to the benchmark will include a Euro-based fixed income benchmark.

Long-term Portfolio Activity and Performance for 2001

5. As at 31 December 2001, the balance in the long-term portfolio amounted to:

6. The investment guidelines to the asset manager (Fiduciary Trust Company International - FTCI) for the year 2001 have been to trade, buy, sell or otherwise acquire and/or hold, the following combination of instruments: 65% equity and/or equity related securities, 35% fixed income instruments under a balanced mandate as reflected in the selected benchmarks.

7. At the end of 2001 the long-term portfolio held equities and fixed income of 50 and 31 percent respectively (excluding venture capital comprised of both investment categories) which compares with 48 and 36 percent respectively on a cost basis. The balance of the portfolio as of 31 December 2001 consisted of venture capital and temporarily invested cash and short term securities.

8. As of December 31, 2001, the FAO one year benchmark return was -10.49% while the FAO long-term portfolio one-year return was -16.75%. The table below shows the breakdown of the one-, three-, and five-year returns as of 31 December 2001.

9. In terms of accounting gains and losses, the results for 2001 show that FAO had realised losses (selling price vs. cost) of US$16.4 million and that, given the composition of the securities held at 31 December 2001, FAO has unrealised gains of US$10.3 million, as shown in the table below.

10. The above table shows that 2001 was a difficult year, particularly for growth orientated managers, which is the investment strategy followed by FAO's long term portfolio manager (Fiduciary Trust International). The unwinding of the technology "bubble" starting in 2000 spread to the wider market through 2000 as economic growth slowed worldwide. This trend continued into 2001 and the market moved down dramatically as the US economy entered recession in 2001. While moving down in the first 3 quarters of 2001, it dropped sharply following the terrorist attacks of 11 September 2001. While some recovery in the equity markets did take place in the last two months of 2001, FAO's numbers were advserely affected by the Enron Fall and by the weakness of the Euro in 2001. That is, FAO realised some US$3.6 million in losses on bonds in 2001, owing to the decline of the Euro against the US dollar over the past two years. These were French and German Government bonds which were sold in 2001 to reposition the portfolio (with positive results relative to the benchmark). While these bonds provided an appropriate return in local currency, they were acquired in 1999 when the Euro was much higher (US$1.05) thus creating losses in dollar terms when sold (the Euro below US$ 0.90).

11. Given the turbulence in the equity markets over the past year, Fiduciary under-weighted FAO's position in equities for the whole year, but this under-weighting in equities did not fully deal with specific stock selection problems. This was the case in the energy sector, telecommunications, information technology and utilities as shown in the table below.

12. The specific stocks that produced a significant impact on performance in FAO's equity holdings are listed below.

13. If one looks at the performance from a country perspective, it shows a broad based decline in practically all major equity markets in 2001, as shown in the table below.

14. What may be concluded from this analysis is that Fiduciary's sell discipline was not as effective as it could have been. With the benefit of hindsight, it looks like positions were maintained for too long. Discussions are underway with Fiduciary who have implemented a more rigorous review, triggered by a price move of 20% in any stock. This and other guidelines for closer monitoring will be discussed later this month with the FAO Advisory Committee on Investments.

15. In judging the returns for 2001, it is important to recognise that Fiduciary's growth style of management, which we now have under review, substantially out-performed growth indices over the past 5 years, significantly so prior to 2000 as shown below.

16. Annex A attached lists the securities held in the long term portfolio at 31 December 2001 and compares the cost of these securities to their market price at the end of the year.

III. Short-term Investments

17. The short-term investment account consists largely of Trust Fund deposits held pending disbursements on project implementation. These funds are currently invested by the Northern Trust Company (the custodian for FAO) in accordance with the recommendation of the FAO Advisory Committee on Investments at its Twenty-fourth Session (18 May 1998)

18. The benchmark used to measure performance on the short-term fixed income portfolio is the Northern Trust Government Select Fund. The fund invests primarily in U.S. Government and Government Agency Securities with the objectives of capital protection, income and liquidity. The total return which closely follows the returns of the short-term US interest rates, was 4.01% during 2001 versus a benchmark of 4.05% . The balance in this portfolio at 31 December 2001 amounted to US$276,639,048, which chiefly represented highly liquid Trust Fund money held by FAO. The returns on the portfolio for up to five years are shown below.

19. As part of the decision to externalize the management of the short-term portfolio, the Advisory Committee on Investments meeting on 25 May, 2001 re-endorsed the proposal to change the current short term portfolio to a proactive approach using the two specialized asset managers selected through a competitive process by the Investment Committee: Wellington Management Company and Western Asset Management. The Committee confirmed the appropriateness of the investment guidelines for these contracts, but suggested they also be reviewed by Cambridge Associates prior to finalizing agreements with the two new short-term investment managers. The contracts have been cleared by Cambridge Associates and are under implementation.

Annex A 
FAO LONG TERM PORTFOLIO - CURRENT HOLDINGS

Annex B - FAO SHORT TERM INVESTMENTS

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1 In 1998 the UN Investments Committee informed FAO that it could no longer advise FAO on investment practices. In consequence, a reorganization of the three committees which dealt with investment activities of the Organization took place; the Credit Committee was integrated into the Investment Committee which was then assigned responsibility for management of the short-term and long-term assets. In addition, the Advisory Committee on Investments has as its purpose to provide the Director-General an independent view on the policies, plans, operations and performance of the various FAO investment portfolios and on any other aspect of FAO financial management on which the Director-General seeks the Committee's advice. The Advisory Committee on Investments will review the annual report prepared by Treasury for the Investment Committee and make recommendations to the Director-General.

2 The Staff Compensation Plan, introduced on 1 January 1956, provides compensation benefits to staff members (and/or their dependants) in case of injury, illness, or death, attributable to the performance of official duties. The Organization's liability under the Plan is funded currently at 0.129% of payroll for the Regular Programme and other Headquarters Staff and 0,266% for Field Staff. These rates were confirmed by the Finance Committee at its Seventy-seventh Session (21-30 September 1993).

The Separation Payment Scheme, approved by the Council at its Sixty-sixth Session (June 1975) as part of the pay package of Rome General Service Staff with effect 1 January 1975, provides for payments upon separation at the rate of the one month's pay for each year of service computed on the basis of the rate of pay of the month of termination of contract. The Council also decided that the Organization's liability should be funded and an actuarial review of the Fund was last made at 31 December 1997 and subsequently updated as of 31 December 1999. As a result of the review, the amount of $64,838,000 was accrued in the financial statement 1998-1999 for the Separation Payment Scheme.

The After Service Medical Plan provides for worldwide coverage for necessary medical expenses of eligible former staff members and their dependants. The Plan is subject to actuarial review to ascertain the related liabilities and rates of contribution. Conference Resolution 10/99 approved, inter alia, the practice of earmarking excess investment income generated through the Separation Payments Scheme and Staff Compensation Plan investments for the After Service Medical Plan liability. The amount of the investment income designated for the After Service Medical Plan amounted to $42.8 million based on an actuarial review at 31 December 1999.

3 Return reflects realised and unrealised gains/losses and accrued income and dividends/interest income across all asset classes.

4 Capital gains and/or losses realised in the year 2001.

5 Market value of all positions held as of 31 December 2001.

6 Cost basis of all positions held as of 31 December 2001.

7 Accrued income not included of US$1,289,397.15;total cost US$169,536,497; total market US$179,817,614.

8 Lipper and ImoneyNetInc are both peer groups of funds with similar objectives.

9 Fund and perentile ranking show the Government Select Portfolio's position within each peer group for each period of return.

10 Reversal of rebate overpayments