Eli Lilly 2012 Annual Report Download - page 87

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less expensively than could be accomplished through the use of the cash markets. The plans utilize both
exchange-traded and over-the-counter instruments. The maximum exposure to either a market or
counterparty credit loss is limited to the carrying value of the receivable, and is managed within contractual
limits. We expect all of our counterparties to meet their obligations. The gross values of these derivative
receivables and payables are not material to the global asset portfolio, and their values are reflected within
the tables below.
The defined benefit pension and retiree health benefit plan allocation for the U.S. and Puerto Rico currently
comprises approximately 80 percent growth investments and 20 percent fixed-income investments. The
growth investment allocation encompasses U.S. and international public equity securities, hedge funds,
private equity-like investments, and real estate. These portfolio allocations are intended to reduce overall risk
by providing diversification, while seeking moderate to high returns over the long term.
Public equity securities are well diversified and invested in U.S. and international small-to-large companies
across various asset managers and styles. The remaining portion of the growth portfolio is invested in private
alternative investments.
Fixed-income investments primarily consist of fixed-income securities in U.S. treasuries and agencies,
emerging market debt obligations, corporate bonds, mortgage-backed securities, and commercial mortgage-
backed obligations.
Hedge funds are privately owned institutional investment funds that generally have moderate liquidity. Hedge
funds seek specified levels of absolute return regardless of overall market conditions, and generally have low
correlations to public equity and debt markets. Hedge funds often invest substantially in financial market
instruments (stocks, bonds, commodities, currencies, derivatives, etc.) using a very broad range of trading
activities to manage portfolio risks. Hedge fund strategies focus primarily on security selection and seek to be
neutral with respect to market moves. Common groupings of hedge fund strategies include relative value,
tactical, and event driven. Relative value strategies include arbitrage, when the same asset can
simultaneously be bought and sold at different prices, achieving an immediate profit. Tactical strategies often
take long and short positions to reduce or eliminate overall market risks while seeking a particular
investment opportunity. Event strategy opportunities can evolve from specific company announcements such
as mergers and acquisitions, and typically have little correlation to overall market directional movements. Our
hedge fund investments are made through limited partnership interests primarily in fund-of-funds structures
to ensure diversification across many strategies and many individual managers. Plan holdings in hedge funds
are valued based on net asset values (NAVs) calculated by each fund or general partner, as applicable, and we
have the ability to redeem these investments at NAV.
Private equity-like investment funds typically have low liquidity and are made through long-term partnerships
or joint ventures that invest in pools of capital invested in primarily non-publicly traded entities. Underlying
investments include venture capital (early stage investing), buyout, and special situation investing. Private
equity management firms typically acquire and then reorganize private companies to create increased long
term value. Private equity-like funds usually have a limited life of approximately 10-15 years, and require a
minimum investment commitment from their limited partners. Our private investments are made both
directly into funds and through fund-of-funds structures to ensure broad diversification of management styles
and assets across the portfolio. Plan holdings in private equity-like investments are valued using the value
reported by the partnership, adjusted for known cash flows and significant events through our reporting date.
Values provided by the partnerships are primarily based on analysis of and judgments about the underlying
investments. Inputs to these valuations include underlying NAVs, discounted cash flow valuations, comparable
market valuations, and may also include adjustments for currency, credit, liquidity and other risks as
applicable. The vast majority of these private partnerships provide us with annual audited financial statements
including their compliance with fair valuation procedures consistent with applicable accounting standards.
Real estate is composed of both public and private holdings. Real estate investments in registered investment
companies that trade on an exchange are classified as Level 1 on the fair value hierarchy. Real estate
investments in funds measured at fair value on the basis of NAV provided by the fund manager are classified
as Level 3. These NAVs are developed with inputs including discounted cash flow, independent appraisal, and
market comparable analyses.
Other assets include cash and cash equivalents and mark-to-market value of derivatives.