March 2010
Hedge Funds: Globalization and its Consequences
Michael Stohler, Ph.D.
Chief Risk Officer, Alternative Investments, JPMorgan Private Bank
CONFIDENTIAL
Investment Products:
- Not FDIC Insured
Please read important disclosures at the end of the presentation.
- No Bank Guarantee
- May Lose Value
Agenda
• Decline of diversification – the end of investment decision?
• Global regulation
CONFIDENTIAL
• Investment opportunities
1
Throughout history, GDP growth has been non-correlated across different regions of the world
40 year correlation1 matrix of annual GDP growth (1970 – 2009)*:
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
Annual Grow t h 1970-2009
USA
UK
Japan
It aly
Canada
France
Germany
Brazil
China
Aust railia
Argent ina
India
Indonesia
M exico
Russia
Saudi Arabia
Sout h Af rica
Sout h Korea
Turkey
Hong Kong
Sw it zerland
Spain
Sw eden
1
1.0
0.6
0.3
0.6
0.9
0.4
0.4
0.2
0.4
0.5
0.3
0.0
0.0
0.7
0.1
-0.1
0.2
0.3
0.6
0.3
0.5
0.8
0.2
2
3
4
5
0.6 0.3 0.6 0.9
1.0 0.3 0.6 0.8
0.3 1.0 0.5 0.5
0.6 0.5 1.0 0.8
0.8 0.5 0.8 1.0
0.5 0.5 0.8 0.9
0.5 0.1 0.6 0.5
-0.1 0.3 0.5 0.3
0.3 0.0 0.0 -0.2
0.5 0.1 0.3 0.6
0.0 0.3 0.0 0.1
-0.1 0.3 -0.1 -0.1
0.0 0.1 0.0 0.1
0.8 0.3 0.8 0.7
0.3 0.3 0.5 0.5
-0.1 -0.2 -0.1 0.0
0.4 0.6 0.6 0.4
0.4 0.6 0.6 0.4
0.4 0.9 0.5 0.5
0.1 0.3 0.5 0.5
0.5 0.4 0.6 0.7
0.9 0.4 0.9 0.9
0.4 0.3 0.4 0.9
6
0.4
0.5
0.5
0.8
0.9
1.0
0.5
0.3
-0.2
0.3
0.1
0.0
0.1
0.7
0.4
0.0
0.4
0.3
0.5
0.2
0.6
0.8
0.6
7
8
9
0.4 0.2 0.4
0.5 -0.1 0.3
0.1 0.3 0.0
0.6 0.5 0.0
0.5 0.3 -0.2
0.5 0.3 -0.2
1.0 0.4 0.2
0.4 1.0 0.5
0.2 0.5 1.0
0.5 -0.1 0.4
0.1 0.4 0.5
0.1 0.3 0.8
0.4 0.5 0.8
0.9 0.5 0.1
0.5 0.7 0.2
0.2 0.2 -0.3
0.7 0.7 0.5
0.3 0.6 0.2
0.2 0.7 0.4
0.3 0.7 0.0
0.4 0.3 0.1
0.8 0.4 0.0
0.5 0.0 -0.2
10
0.5
0.5
0.1
0.3
0.6
0.3
0.5
-0.1
0.4
1.0
0.1
-0.1
-0.1
0.5
0.1
0.0
0.2
0.0
0.2
0.2
0.5
0.7
0.2
11
0.3
0.0
0.3
0.0
0.1
0.1
0.1
0.4
0.5
0.1
1.0
0.8
0.7
0.4
0.3
0.6
0.4
0.0
0.5
0.5
0.5
0.1
0.1
12
0.0
-0.1
0.3
-0.1
-0.1
0.0
0.1
0.3
0.8
-0.1
0.8
1.0
0.8
0.1
0.1
0.4
0.3
-0.1
0.2
0.3
0.5
-0.1
0.0
13
0.0
0.0
0.1
0.0
0.1
0.1
0.4
0.5
0.8
-0.1
0.7
0.8
1.0
0.5
0.3
0.4
0.4
0.0
0.3
0.4
0.6
0.0
0.0
14
0.7
0.8
0.3
0.8
0.7
0.7
0.9
0.5
0.1
0.5
0.4
0.1
0.5
1.0
0.5
0.4
0.6
0.3
0.5
0.4
0.7
0.8
0.8
15
0.1
0.3
0.3
0.5
0.5
0.4
0.5
0.7
0.2
0.1
0.3
0.1
0.3
0.5
1.0
0.2
0.7
0.6
0.4
0.8
0.6
0.6
0.5
16
-0.1
-0.1
-0.2
-0.1
0.0
0.0
0.2
0.2
-0.3
0.0
0.6
0.4
0.4
0.4
0.2
1.0
0.3
0.2
0.4
0.1
-0.1
0.1
-0.1
17
0.2
0.4
0.6
0.6
0.4
0.4
0.7
0.7
0.5
0.2
0.4
0.3
0.4
0.6
0.7
0.3
1.0
0.6
0.6
0.8
0.6
0.6
0.6
18
0.3
0.4
0.6
0.6
0.4
0.3
0.3
0.6
0.2
0.0
0.0
-0.1
0.0
0.3
0.6
0.2
0.6
1.0
0.3
0.6
0.2
0.4
0.2
19
0.6
0.4
0.9
0.5
0.5
0.5
0.2
0.7
0.4
0.2
0.5
0.2
0.3
0.5
0.4
0.4
0.6
0.3
1.0
0.8
0.5
0.4
0.6
20
0.3
0.1
0.3
0.5
0.5
0.2
0.3
0.7
0.0
0.2
0.5
0.3
0.4
0.4
0.8
0.1
0.8
0.6
0.8
1.0
0.2
0.5
0.1
21
0.5
0.5
0.4
0.6
0.7
0.6
0.4
0.3
0.1
0.5
0.5
0.5
0.6
0.7
0.6
-0.1
0.6
0.2
0.5
0.2
1.0
0.7
0.2
22
0.8
0.9
0.4
0.9
0.9
0.8
0.8
0.4
0.0
0.7
0.1
-0.1
0.0
0.8
0.6
0.1
0.6
0.4
0.4
0.5
0.7
1.0
1.0
23
0.2
0.4
0.3
0.4
0.9
0.6
0.5
0.0
-0.2
0.2
0.1
0.0
0.0
0.8
0.5
-0.1
0.6
0.2
0.6
0.1
0.2
1.0
1.0
Source: Bloomberg
CONFIDENTIAL
1Correlation is a statistical measure of the degree to which the movements of two variables are randomly related. Correlation can range from -1.0 to 1.0 with 1.0 indicating a perfect positive correlation and -1.0 indicating a perfect negative correlation.
Indices are not investment products and may not be considered for investment.
Please refer to the back of this presentation for definitions of world indices
Past performance is no guarantee of future results.
2
In recent years however, GDP growth across varying countries has grown and declined in similar fashion and is forecasted1 to
continue to do the same
GDP Growth
2008 Actual
2009 Forecasted
2010 Predicted 3.1%
2014 Predicted
Global Advanced
3.1%
(1.1%)
1.3%
4.8%
US
0.8%
(3.4%)
1.5%
2.6%
UK
EUR
Japan
1.1%
(2.7%)
0.9%
2.4%
0.7%
(4.4%)
0.3%
2.8%
0.8%
(4.2%)
1.7%
2.3%
Emerging
(0.7%)
(5.4%)
5.1%
2.5%
China
Brazil
India
6.0%
1.7%
9.0%
6.8%
9.0%
8.5%
3.5%
10.0%
5.1%
(0.7%)
6.4%
4.5%
Russia
7.3%
5.4%
1.5%
8.0%
5.6%
(7.5%)
5.0%
The IMF’s baseline forecast for global growth has
been upwardly revised, with advanced economies
expected to register positive growth in 2010, and
emerging economies projected to
rebound significantly.
• Prospects for global trade have improved
• Fears of widespread deflation have receded
CONFIDENTIAL
Source: International Monetary Fund, OCED; Wall Street Journal. Data as of 12/31/2009
1Forecasted by the International Monetary Fund
Past performance is no guarantee of future results.
33
Growing correlations of global indices
5 year correlation1 matrix (Mar 1995 – Feb 2000):
• National economies have recently become more closely linked,
not only because of growing international trade and investment
flows, but also due to terms of international financial
transactions.
• Influences contributing to an increased general level of
correlation among markets and markets integration include the
following:
– Development of global and multinational companies and
organizations
– Advances in information technology
– Deregulation of the financial systems of the major
industrialized countries
– Explosive growth in international capital flows
– Abolishment of foreign exchange controls
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
DJIA Index
S&P 500 Index
Mexico Bolsa Index
Brazil Bovespa Stock Idx
Dj Euro Stoxx 50
Ftse 100 Index
Cac 40 Index
Dax Index
Ibex 35 Index
Aex-Index
Omx Stockholm 30 Index
Swiss Market Index
Nikkei 225
Hang Seng Index
S&P/Asx 200 Index
1
1.0
0.9
0.6
0.6
0.6
0.7
0.6
0.6
0.5
0.4
0.6
0.5
0.5
0.6
0.6
2
0.9
1.0
0.6
0.6
0.7
0.7
0.6
0.6
0.6
0.5
0.6
0.5
0.5
0.5
0.5
3
0.6
0.6
1.0
0.6
0.5
0.5
0.4
0.4
0.4
0.4
0.4
0.4
0.3
0.4
0.6
4
0.6
0.6
0.6
1.0
0.6
0.5
0.5
0.6
0.6
0.6
0.5
0.6
0.5
0.6
0.5
5
0.6
0.7
0.5
0.6
1.0
0.7
0.9
0.9
0.8
0.8
0.8
0.8
0.7
0.5
0.5
6
0.7
0.7
0.5
0.5
0.7
1.0
0.6
0.6
0.7
0.6
0.7
0.5
0.5
0.5
0.6
7
0.6
0.6
0.4
0.5
0.9
0.6
1.0
0.8
0.7
0.8
0.7
0.8
0.6
0.5
0.4
8
0.6
0.6
0.4
0.6
0.9
0.6
0.8
1.0
0.7
0.8
0.8
0.8
0.5
0.5
0.4
9
0.5
0.6
0.4
0.6
0.8
0.7
0.7
0.7
1.0
0.7
0.7
0.7
0.6
0.4
0.6
10
0.4
0.5
0.4
0.6
0.8
0.6
0.8
0.8
0.7
1.0
0.7
0.7
0.6
0.4
0.3
DJIA Index
S&P 500 Index
Mexico Bolsa Index
Brazil Bovespa Stock Idx
Dj Euro Stoxx 50
Ftse 100 Index
Cac 40 Index
Dax Index
Ibex 35 Index
Ftse Mib Index
Aex-Index
Omx Stockholm 30 Index
Sw iss Market Index
Nikkei 225
Hang Seng Index
S&P/Asx 200 Index
1
1.0
0.9
0.5
0.7
0.9
0.9
0.8
0.8
0.8
0.7
0.8
0.8
0.8
0.5
0.7
0.6
2
0.9
1.0
0.7
0.7
0.9
0.9
0.9
0.8
0.8
0.7
0.8
0.8
0.8
0.5
0.7
0.6
3
0.5
0.7
1.0
0.6
0.6
0.6
0.6
0.6
0.6
0.6
0.6
0.5
0.5
0.5
0.6
0.7
4
0.7
0.7
0.6
1.0
0.6
0.6
0.6
0.6
0.7
0.5
0.6
0.6
0.5
0.4
0.7
0.6
5
0.9
0.9
0.6
0.6
1.0
0.9
1.0
1.0
0.8
0.9
1.0
0.9
0.8
0.4
0.6
0.6
6
0.9
0.9
0.6
0.6
0.9
1.0
0.9
0.9
0.8
0.8
0.8
0.8
0.8
0.4
0.6
0.6
7
0.8
0.9
0.6
0.6
1.0
0.9
1.0
0.9
0.8
0.9
0.9
0.9
0.8
0.4
0.6
0.6
8
0.8
0.8
0.6
0.6
1.0
0.9
0.9
1.0
0.8
0.8
0.9
0.9
0.8
0.4
0.6
0.6
9
0.8
0.8
0.6
0.7
0.8
0.8
0.8
0.8
1.0
0.8
0.8
0.8
0.6
0.5
0.6
0.6
10
0.7
0.7
0.6
0.5
0.9
0.8
0.9
0.8
0.8
1.0
0.8
0.8
0.7
0.4
0.6
0.5
11
0.8
0.8
0.6
0.6
1.0
0.8
0.9
0.9
0.8
0.8
1.0
0.8
0.8
0.4
0.6
0.7
CONFIDENTIAL
1Correlation is a statistical measure of the degree to which the movements of two variables are randomly related. Correlation can
range from -1.0 to 1.0 with 1.0 indicating a perfect positive correlation and -1.0 indicating a perfect negative correlation.
DJIA Index
S&P 500 Index
Mexico Bolsa Index
Brazil Bovespa Stock Idx
Dj Euro Stoxx 50
Ftse 100 Index
Cac 40 Index
Dax Index
Ibex 35 Index
Ftse Mib Index
Aex-Index
Omx Stockholm 30 Index
Swiss Market Index
Nikkei 225
Hang Seng Index
S&P/Asx 200 Index
1
1.0
1.0
0.8
0.7
0.9
0.8
0.8
0.9
0.8
0.8
0.8
0.7
0.8
0.6
0.7
0.8
2
1.0
1.0
0.8
0.7
0.9
0.9
0.9
0.9
0.8
0.9
0.8
0.7
0.8
0.7
0.7
0.9
3
0.8
0.8
1.0
0.7
0.8
0.7
0.7
0.8
0.8
0.7
0.7
0.6
0.6
0.7
0.6
0.7
4
0.7
0.7
0.7
1.0
0.7
0.7
0.7
0.7
0.7
0.7
0.7
0.6
0.6
0.7
0.8
0.7
5
0.9
0.9
0.8
0.7
1.0
0.9
1.0
1.0
0.9
1.0
0.9
0.8
0.9
0.8
0.7
0.9
6
0.8
0.9
0.7
0.7
0.9
1.0
0.9
0.9
0.8
0.9
0.9
0.7
0.8
0.8
0.7
0.9
7
0.8
0.9
0.7
0.7
1.0
0.9
1.0
1.0
0.9
0.9
0.9
0.8
0.9
0.8
0.7
0.9
8
0.9
0.9
0.8
0.7
1.0
0.9
1.0
1.0
0.9
0.9
0.8
0.8
0.8
0.8
0.7
0.9
9
0.8
0.8
0.8
0.7
0.9
0.8
0.9
0.9
1.0
0.8
0.8
0.8
0.8
0.7
0.7
0.8
13
0.5
0.5
0.3
0.5
0.7
0.5
0.6
0.5
0.6
0.6
0.6
0.5
1.0
0.3
0.4
14
0.6
0.5
0.4
0.6
0.5
0.5
0.5
0.5
0.4
0.4
0.4
0.4
0.3
1.0
0.4
15
0.6
0.5
0.6
0.5
0.5
0.6
0.4
0.4
0.6
0.3
0.4
0.4
0.4
0.4
1.0
12
0.8
0.8
0.5
0.6
0.9
0.8
0.9
0.9
0.8
0.8
0.8
1.0
0.7
0.4
0.7
0.6
13
0.8
0.8
0.5
0.5
0.8
0.8
0.8
0.8
0.6
0.7
0.8
0.7
1.0
0.4
0.6
0.6
14
0.5
0.5
0.5
0.4
0.4
0.4
0.4
0.4
0.5
0.4
0.4
0.4
0.4
1.0
0.5
0.5
15
0.7
0.7
0.6
0.7
0.6
0.6
0.6
0.6
0.6
0.6
0.6
0.7
0.6
0.5
1.0
0.5
16
0.6
0.6
0.7
0.6
0.6
0.6
0.6
0.6
0.6
0.5
0.7
0.6
0.6
0.5
0.5
1.0
Source: Bloomberg
5 year correlation1 matrix (Mar 2005 – Feb 2010):
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
12
0.5
0.5
0.4
0.6
0.8
0.5
0.8
0.8
0.7
0.7
0.7
1.0
0.5
0.4
0.4
Source: Bloomberg
5 year correlation1 matrix (Mar 2000 – Feb 2005):
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
11
0.6
0.6
0.4
0.5
0.8
0.7
0.7
0.8
0.7
0.7
1.0
0.7
0.6
0.4
0.4
10
0.8
0.9
0.7
0.7
1.0
0.9
0.9
0.9
0.8
1.0
0.9
0.7
0.8
0.7
0.7
0.8
11
0.8
0.8
0.7
0.7
0.9
0.9
0.9
0.8
0.8
0.9
1.0
0.8
0.8
0.8
0.7
0.8
12
0.7
0.7
0.6
0.6
0.8
0.7
0.8
0.8
0.8
0.7
0.8
1.0
0.7
0.8
0.7
0.7
13
0.8
0.8
0.6
0.6
0.9
0.8
0.9
0.8
0.8
0.8
0.8
0.7
1.0
0.7
0.6
0.8
14
0.6
0.7
0.7
0.7
0.8
0.8
0.8
0.8
0.7
0.7
0.8
0.8
0.7
1.0
0.7
0.8
15
0.7
0.7
0.6
0.8
0.7
0.7
0.7
0.7
0.7
0.7
0.7
0.7
0.6
0.7
1.0
0.7
16
0.8
0.9
0.7
0.7
0.9
0.9
0.9
0.9
0.8
0.8
0.8
0.7
0.8
0.8
0.7
1.0
Source: Bloomberg
Past performance is no guarantee of future results.
4
Increasing popularity of ETFs – adding to the problem?
• Exchange Traded Funds (ETFs) allow easier access into emerging markets and developing nations
• However, ETFs may be creating a higher correlation of their underlying securities as a byproduct of their increasing popularity
– Many investors prefer to hold a market basket, rather than individually analyze securities
– ETFs are sometimes marketed as “better alternatives” to mutual funds, because of the significantly lower cost basis
• ETFs should increase the correlation of a certain sector or basket of securities
– In a state of market deleveraging, or releveraging, they have the potential magnify the correlation effects of market swings
– May create more irrational market pricing of individual securities
– For a hedge fund manager who puts on short positions based on poor fundamentals of an individual company, if this company is in an ETF basket that is
growing in popularity, it might trade up due to the ETF volume and the hedge fund manager may lose money
ETF Industry Asset Growth
ETF Asset Projections 2009E – 2013E
Asset s ($Bn)
$800
Yearly % Increase
$700
$1,556
$1,500
$400
0%
% Increase
20%
$500
Assets ($bn)
$1,866
40%
$600
$1,276
$1,023
$1,000
$776
$300
-20%
$500
$200
-40%
$100
$0
CONFIDENTIAL
$2,000
60%
-60%
2003
2004
2005
Source: SSgA Strategy & Research as of 12/31/2009
2006
2007
2008
2009
$0
2009
2010E
2011E
2012E
2013E
Source: Cerulli Associates, 2009
5
So is this the end of equity diversification?
• Even in a highly correlated1 market like 2009
Lowest 2009 Return
Highest 2009 Return
Marshall & Ilsley
-60.0%
XL Capital Ltd
395.4%
S&P 500 Level 1
Telecommunication
+2.6%
Information Tech
+59.9%
S&P 500 Level 2
Banks
-8.9%
Auto & Comp
+114.5%
S&P 500 Level 3
Construction Materials
-24.3%
Real Estate Management Development
+214.0%
Financial Services
-3.9%
Consumer Discretionary
+61.4%
G8
Japan
+19.0%
Russia
+121.1%
G20
Japan
+19.0%
Russia
+121.1%
S&P 500 members
CONFIDENTIAL
Russell 2000
1Correlation is a statistical measure of the degree to which the movements of two variables are randomly related. Correlation can range from -1.0 to 1.0 with 1.0 indicating a perfect positive correlation and -1.0 indicating a perfect negative correlation.
Indices are not investment products and may not be considered for investment.
Please refer to the back of this presentation for terms and definitions
Past performance is no guarantee of future results.
66
Agenda
• Decline of diversification – the end of investment decision?
• Global regulation
CONFIDENTIAL
• Investment opportunities
7
We are witnessing a global effort in hedge fund regulation
•
Multiple countries banned short selling
– Banned naked shorts: Austria, Belgium, Denmark, France, Germany, Italy,
Japan, Netherlands, Portugal, Spain, and Switzerland
Recent Insider Trading Enforcement Trends:
•
– 2007: SEC formed “working group” designed to “combat hedge
fund insider trading”
– Banned covered shorts: Australia, Canada, Ireland, Italy, Netherlands,
Norway, S. Korea, Switzerland, UK, and USA
•
– 2008: SEC brought highest number of insider trading cases in its
history, including several involving hedge funds
Government bodies are requiring more of hedge funds
– 2009: SEC brought a series of increasingly high-profile “hedge
fund” insider trading cases in close coordination with criminal
authorities
– We will likely see required registration by certain hedge fund advisers under
the Investment Adviser Act of 1940
– The European Commission drafted a directive that forces transparency and
limits risk taking by funds
– Hong Kong requires all hedge fund managers engaging in regulated activities
to be licensed by the Hong Kong Securities and Futures Commission (SFC) in
the same way as "traditional" fund managers
•
SEC increased focus on insider trading by hedge funds in last 3 years
•
Foreign regulators have been following the SEC’s lead
– In April 2009, the head of the FSA identified prosecution of “insider
dealing” as a major enforcement priority
– FSA recently secured first ever criminal insider dealing conviction
in the UK
Credit Default Swap Regulation & Clearinghouses
– Regulators are looking to reduce systemic risk to the financial system while banks are hoping to increase liquidity, especially during times of market stress
– In the U.S., central clearing operations began in March 2009 , operated by InterContinental Exchange (ICE). A key competitor also interested in entering the
CDS clearing sector is CME Group
CONFIDENTIAL
– In Europe, CDS Index clearing was launched by ICE's European subsidiary ICE Clear Europe in July 2009. It launched Single Name clearing in Dec 2009
8
Global Hedge Fund Regulation: More oversight on the way
Europe
USA
•
The current administration is dissatisfied with the fact that hedge funds
are not required to register with regulators and that the government
lacked reliable, comprehensive data to monitor and access their risk
•
There are currently multiple versions of regulatory reform proposals that
may directly impact hedge fund regulation:
1.
2.
3.
CONFIDENTIAL
•
Wall Street Reform and Consumer Protection Act
The Private Fund Investment Advisors Act
The Hedge Fund Transparency Act
SEC registration would impose regulation around:
– Disclosure
– Reporting
– Recordkeeping
– SEC audit
– Internal controls
– Compliance requirements of the Investment Advisors Act
1FinAlternatives
•
The original April 2009 European Commission’s AIFM Directive proposal
outlines regulatory controls on
– Transparency/Disclosure
– Treatment of investors
– Authorization (manager would have to prove competence)
– Leverage (not quantified
•
Critics complain the proposal will place a disproportionately high regulatory
burden on hedge funds.
– AIMA, the FSA1, and other players have been very vocal about the
Directive’s shortcomings. AIMA publicly described it as “ill considered”
and “punitive”.
– Regardless, even a watered down version will bring new transparency
and oversight
•
Originally, the Directive was expected to come into force in 2010 but it is now
looking more like 2012
•
UCITS III Funds are rapidly gaining acceptance: Just one fifth of European
hedge fund managers have launched or are in the process of launching a
UCITS II fund, but another third of European players are contemplating such a
launch1
9
Agenda
• Decline of diversification – the end of investment decision?
• Global regulation
CONFIDENTIAL
• Investment opportunities
10
Global investment opportunities: Hedge fund managers aim to generate alpha among divergent global growth trends
• Asia ex-Japan growth continues to rebound, which should drive opportunities both long and short throughout the region
• BRIC (Brazil, India, China & Russia) – looking strong vs. developed markets
CONFIDENTIAL
• Europe - A pick-up in corporate activity, balance sheet restructuring, and sovereign deficit/debt concerns may lead to M&A and
credit/distressed opportunities
11
11
Asia continues to be one of the most dynamic regions in the world
Asia
Worldwide EMS1 Manufacturing Square Footage by Region2
2008
2001
Europe 7%
Asia/
Pacific
34%
Latin America 7%
Latin
America
9%
Europe
15%
Eastern Europe
3%
Eastern
Europe
4%
North America
38%
Asia/ Pacific(a)
63%
ROW
1%
Asia ex-Japan growth continues to rebound, which should drive opportunities
throughout the region3
Index, Jan 2000 = 100
Index, Jan 2000 = 100
170
350
China (RHS)
160
300
150
140
250
130
120
200
EM Asia ex China (LHS)
110
100
• Asia continues to be one of the most dynamic regions in the world
– region’s relative banking system stability, ability to afford stimulus programs and higher
expected profit growth are attractive
– many Asian countries are not burdened by the same financial and consumer leverage
problems rampant in Western economies
– globally, Asian countries are experiencing the strongest rebounds in retail sales, industrial
production, and employment
• Again, plenty of reasons to be “in” the market, just not “all in”
– Asia ex-Japan seems fairly valued at 15.1x forward P/E; in a trading environment long/short
managers generate outperformance due to alpha from stock selection, rather than through
market beta4
150
Developed Markets (LHS)
90
80
100
2000
CONFIDENTIAL
ROW
1%
Asia
Global industrial production3
180
North
America
20%
2001
2002
2003
2004
2005
2006
2007
2008
2009
Past performance is not indicative of future results. Indices are not investment products and may not be considered for investment.
1 EMS = Electronics Manufacturing Services
2 Source: Cisco, 2009
3 Source: J.P. Morgan Securities, Inc. Data as of 11/18/2009
4Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
12
China’s rapid GDP growth has been a story of capital formation
•
•
China is quickly recovering from the worst global recession in 50 years courtesy of
what might be the largest loan expansion in a modern economy on record
– China is now the world’s largest exporter, 2nd largest economy and stock
market and the largest car market
During Q4, Chinese GDP grew at an impressive 10.7% rate. However, growth
continues to be driven by fixed capital formation and not consumption
China’s GDP growth continues to rebound
Real GDP growth
15%
13%
11%
9%
7%
5%
1998
2000
2002
2004
2006
2008
Source: J.P. Morgan Securities Inc. Data as of 12/31/2009.
Fixed capital investment: China’s primary driver of GDP growth
Heavy lifting being done by the public sector
Percent of GDP
YoY % change, dotted lines represents forecast
50%
40%
Bank loans (RHS)
Fixed asset investment (LHS)
35%
55%
Trough
30%
Peak
45%
25%
35%
30%
20%
25%
20%
15%
CONFIDENTIAL
10%
2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: State Statistical Bureau, J.P. Morgan Securities, Inc. Data as of 1/31/2010.
Past performance is no guarantee of future results.
10%
15%
Japan (' 60-' 88) Germany (' 54- S. Korea (' 78' 82)
' 06)
China (' 81' 09E)
Source: International Monetary Fund, Pivot Capital.
13
Brazil, Russia, India, and China (BRIC) – looking strong vs. developed markets
Real GDP growth (QoQ saar)
EM Consumption overtook US consumption in 2008
40
BRIC
Advanced
EM
Em erging
10%
US
36
8%
32
6%
4%
2%
. 28
0%
24
-2%
20
-4%
-6%
2000
2002
2004
2006
2008
2010
2012
2014
Source: International Monetary Fund, World Economic Outlook Database 2009.
Note: Yellow shaded area denotes forecasts till 2014. cc
Developed Europe
Public Debt as % of GDP
MSCI EM
Japan
Rest of World: 7% to 8%
60%
40%
20%
2007
2008
2009F
2010F
57.4
6.8
42.3
21.9
76.7
52.1
37.7
176.2
58.3
4.6
42.6
18.8
77.6
60.6
45.3
187.6
66.9
7.2
45.0
20.0
NA
NA
NA
NA
69.6
7.4
45.7
20.0
NA
NA
NA
NA
ROW
100%
80%
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Source: J.P. Morgan. Note: Chart shows EM and US consumption as percentage of global consumption.
Scale of Emerging Economies: Global nominal GDP (%)
North America
16
Japan: 15% to 7%
Emerging Markets: 19% to 41%, BRIC increased from 8% to 27%)
Developed Europe: 26% to 22%
North America: 33% to 23%
0%
Brazil
Russia
India
China
EU
US
UK
Japan
CONFIDENTIAL
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source: J.P. Morgan, IMF. Note: The projections assume nominal GDP growth at potential real GDP growth and central banks inflation
target. To compute FX for periods beyond 2010, we assume the normalization of REER over the forecasted period.
Past performance is no guarantee of future results.
Source: J.P. Morgan economics.
14
14
The strength of the European Union is being put to the test
•
Recent worries about Greece’s mounting debt and large fiscal deficit has
raised worries in Europe and around the world about the sustainability of
government finances
– The European Union has responded to reassure the international
community that they will safeguard the financial stability of the Euro
area as a whole
Significant federal deficits are raising investor concerns
2009 government balances, % of GDP
9
6
3
0
•
This development has further increased pressure on the Euro which provides
some much needed relief in the near term
-3
-6
IRL
GBR
ESP
GRE
ISL
FRA
PRT
SWE
DEU
ITA
-12
NOR
-9
Source: J.P. Morgan Securities, Inc. Data as of 12/31/2009.
A weaker Euro should help boost Europe’s economy
Unemployment rate
Real GDP growth
EUR/USD
1.55
1.50
1.45
1.40
1.35
1.30
CONFIDENTIAL
1.25
Jan-09
Apr-09
Jul-09
Oct -09
Source: Bloomberg. Data as of 2/11/2010.
Past performance is no guarantee of future results.
Jan-10
European consumers and businesses are recovering at the expense of the
government
Unemployment rate
Spanish financial position as % of GDP, 4-q moving sums
Real GDP growth
8
Household
6
4
2
0
-2
-4
Corporate
-6
-8
-10
Government
-12
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: J.P. Morgan Securities, Inc., Spain National Statistics Institute. Data as of Q3 2009.
15
European distressed opportunity is attractive
Leveraged Loans and High Yield
High Yield Bonds
Leveraged Loans & Mezzanine
High Yield as % of Tot al New Issuance
$200
60%
50%
40%
$150
30%
$100
20%
$50
10%
$0
0%
2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: Standard and Poor’s Financial Services LLC
Volume of Defaults and Restructurings (Face Value)
€50.0
€ in Billions
Few competitors, less capital chasing after opportunities
– Many prop desks at banks and investment banks shut
down
– Many U.S.-based funds have exited European market
– Many leveraged European credit funds have liquidated
– CLOs have limited ability to inject additional capital in
distressed situations or restructurings
– Some private equity sponsors active in "repurchasing"
portfolio companies through debt exchanges but lack
true distressed experience
– Some private equity sponsors lack funds to compete
$250
% percent
–
Sizable market
– The European LBO market peaked in 2007 with issuance
of €140 billion in senior loan, versus approximately
€4.65 billion in 2009
Size of Market (U.S. $ in Billions)
–
€40.0
Rest ruct urings
€30.0
Def ault s
€20.0
€10.0
€0.0
CONFIDENTIAL
2004
Past performance is no guarantee of future results.
2005
2006
2007
2008
2009
Note: Due to the minimal LBO activity in 2009, none of these deals have fallen into distressed territory.
Source: Standard & Poor’s LCD European Leveraged Loan Review, Fourth-quarter2009
16
European distressed opportunity is attractive (continued)
–
Forced sellers
– "Fallen angels" held by mutual funds
– Structured credits held by insurance companies and mutual
funds
– CLOs are typically rating sensitive
– Non-performing and CCC-rated loans held by CLOs
– Credit opportunity funds forced to sell as collateral falls below
specific threshold
–
Rapidly evolving legal precedents
– “Jurisdiction shopping" or changes in center of commercial interests
as companies move to creditor and/or debtor-friendly jurisdictions
such as the U.K., Netherlands and Luxembourg
– Creditor-friendly jurisdictions are primary focus such as UK and
Germany
CONFIDENTIAL
European, U.S. and Global Speculative-Grade Default Rate Forecasts (Baseline Scenario)
Source: Moody’s
Past performance is no guarantee of future results.
17
Challenges to investing globally – dynamic investment solutions needed
Differing capital market rules
•
Some markets open to local investors only
•
Use of derivatives or ability to short limited
Risk of government intervention
•
Imposition of tax on foreign investment
•
Serious nationalization concerns
•
Prohibition of controlling stakes in local companies
Less developed rule of law
•
Investor rights less protected
•
Opaque legal grievance process
•
Corruption
CONFIDENTIAL
Political Instability
18
18
CONFIDENTIAL
Definitions of terms
•
An annualized return is an investment return, discounted retroactively from a cumulative figure, at which money, compounded annually, would reach the cumulative total
•
Correlation is a statistical measure of the degree to which the movements of two variables are randomly related. Correlation can range from -1.0 to 1.0 with 1.0 indicating a perfect positive correlation and -1.0 indicating a
perfect negative correlation
•
Maximum drawdown is the maximum peak to trough decline during a specific record period of an investment or fund. It is usually quoted as the percentage between the peak to the trough
•
Recovery period is the period of time required to reach the original peak from a trough formed by a drawdown
•
Standard deviation measures the dispersion or uncertainty in a random variable (in this case, investment returns.) It measures the degree of variation (in this case) of monthly net returns around the average monthly net return.
The higher the volatility of the investment returns, the higher will be the standard deviation. For this reason, standard deviation is often used as a measure of investment risk
•
The Sharpe ratio is a return/risk measure, where the return (the numerator) is defined as the incremental average monthly return of an investment over the risk free rate. Risk (the denominator) is defined as the standard
deviation of the monthly investment returns less the risk free rate. A risk free rate of 4% was used to calculate the Sharpe ratio. Values are presented in annualized terms; annualized Sharpe ratios are calculated by multiplying
the monthly Sharpe ratio by the square root of twelve
•
LIBOR (London Interbank Offered Rate) is an interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers'
Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year.
•
Leveraged loans are loans to non-investment grade companies. Purposes include: refinancing, leveraged buy-out, leveraged re-capitalization, corporate acquisition, stock buyback and working capital. M&A and refinancing
usually the biggest categories, although recently LBOs picked up to around 1/3.
•
ISDA® (International Swaps and Derivatives Association, Inc.), an association created by the private negotiated derivatives market that represents participating parties. This association helps to improve the private negotiated
derivatives market by identifying and reducing risks in the market. Created in 1985, the ISDA has members from institutions around the world.
•
OTC (Over the Counter) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase "over-the-counter" can be used to refer to stocks that trade via a dealer network as
opposed to on a centralized exchange. It also refers to debt securities and other financial instruments such as derivatives, which are traded through a dealer network.
•
SPV (special purpose vehicle) Legal entity created solely to serve a particular function, such as facilitation of a financial arrangement or creation of a financial instrument. See also special purpose corporation.
•
IRR (Internal Rate of Return) is the discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project's internal rate of
return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the
highest IRR would probably be considered the best and undertaken first. IRR is sometimes referred to as "economic rate of return (ERR)”
•
Japanese Yen was established as the national currency of Japan in 1871 and is now one of the most widely held reserve currencies in the world.
•
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
•
G8 is a forum, created by France in 1975, for governments of currently eight countries in the world: Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, and the United States.
•
G20: The Group of Twenty Finance Ministers and Central Bank Governors (known as the G-20 and also the G20 or Group of Twenty) is a group of finance ministers and central bank governors from 20 economies: 19 countries
plus the European Union. The full list of member countries and organizations includes: Argentina, Australia, Brazil, Canada, China, European Union, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia,
South Africa, South Korea, the United Kingdom, and the United States
19
Definitions of indices
CONFIDENTIAL
All index performance information has been obtained from third parties and should not be relied upon as being complete or accurate. Indices are shown for comparison purposes only. They are not investment products available for purchase. Indices are
unmanaged and generally do not take into account fees or expenses or employ special investment techniques such as leveraging or short selling. Furthermore, while some hedge fund indices may provide useful indications of the general performance of the
hedge fund industry or particular hedge fund strategies, all hedge fund indices are subject to selection, valuation, survivorship and entry biases, and lack transparency with respect to their proprietary computations.
•
DJIA Index - The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.
•
S&P 500 Index - Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major
industries. The index was developed with a base level of 10 for the 1941- 43 base period.
•
Russell 2000 Total Return Index - The Russell 2000 Total Return Index offers investors access to the small-cap segment of the U.S. equity universe. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely
reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set. The Russell 2000 includes the smallest 2000 securities in the Russell 3000.
•
Mexico Bolsa Index - The Mexican Bolsa Index, or the IPC (Indice de Precios y Cotizaciones), is a capitalization-weighted index of the leading stocks traded on the Mexican Stock Exchange. The index was developed with a base level of .78 as of October 30, 1978.
•
Brazil Bovespa Stock Index - The Bovespa Index is a total return index weighted by traded volume and is comprised of the most liquid stocks traded on the Sao Paulo Stock Exchange. The Bovespa Index has been divided 10 times by a factor of 10 since January 1, 1985,
those dates are:12/02/85, 04/14/89, 05/28/91, 01/26/93, 02/10/94, 08/29/8801/12/90, 01/21/92, 08/27/93, 03/03/97. Shares in Index displayed in Millions.
•
Dj Euro Stoxx 50 - The Dow Jones EURO STOXX 50 (Price) Index is a free-float market capitalization-weighted index of 50 European blue-chip stocks from those countries participating in the EMU. Each component's weight is capped at 10% of the index's total free float
market capitalization. The index was developed with a base value of 1000 as of December 31, 1991.
•
Ftse 100 Index - The FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. The equities use an investibility weighting in the index calculation. The index was developed with a base level of
1000 as of January 3, 1984. * Please see UKEDA100 Index andFTPTP100 Index for the official FTSE 100 Index Dividend Yield and P/E Ratio.
•
Cac 40 Index - The CAC-40 Index is a narrow-based, modified capitalization-weighted index of 40 companies listed on the Paris Bourse. The index was developed with a base level of 1,000 as of December 31, 1987. As of December 1, 2003 the index has become a free
float weighted index.
•
Dax Index - The German Stock Index is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. The equities use free float shares in the index calculation. The DAX has a base value of 1,000 as of December 31, 1987. As of June
18, 1999 only XETRA equity prices are used to calculate all DAX indices
•
Ibex 35 Index - The IBEX 35 is the official index of the Spanish Continuous Market. The index is comprised of the 35 most liquid stocks traded on the Continuous market. It is calculated, supervised and published by the Sociedad de Bolsas. The equities use free float
shares in the index calculation. The index was created with a base level of 3000 as of December 29, 1989
•
Ftse Mib Index - The Index will consist of the 40 most liquid and capitalised stocks listed on the Borsa Italiana. In the FTSE MIB Index foreign shares will be eligible for inclusion. Secondary lines will not be eligible for inclusion. The calculation and methodology will be
unchanged from S&P MIB Index.
•
Aex-Index - The AEX-Index is a free-float adjusted market capitalization weighted index of the leading Dutch stocks traded on the Amsterdam Exchange. The index was adjusted to the Dutch Guilder fixing rate. The old value as of 12/31/98 was 1186.38 and the new
value at start of trading on 1/4/99 was 538.36, after conversion. HP and GP can be adjusted back to Dutch Guilders by typing NLG.
•
Omx Stockholm 30 Index - The OMX Stockholm 30 Index is a capitalization-weighted index of the 30 stocks that have the largest volume of the trading on the Stockholm Stock Exchange. Theequities use free float shares in the index calculation. The index was
developed with a base level of 125 as of September 30, 1986. ** Effective on April 27, 1998 there was a 4-1 split of the index value.
•
Swiss Market Index - The Swiss Market Index is a capitalization-weighted index of the 20 largest and most liquid stocks of the SPI universe. It represents about 85% of the free- float market capitalization of the Swiss equity market. The SMI was developed with a base
value of 1,500 as of June 30, 1988.
•
Nikkei 225 - The Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. The Nikkei Stock Average was first published on May 16, 1949, where the average price was ¥176.21
with a divisor of 225.
•
Hang Seng Index - The Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. The components of the index are divided into four subindexes: Commerce and Industry, Finance, Utilities,
andProperties. The index was developed with a base level of 100 as of July 31, 1964
•
S&P/Asx 200 Index - The S&P/ASX 200 measures the performance of the 200 largest index-eligible stocks listed on the ASX by float-adjusted market capitalization. Representative, liquid and tradable, it is widely considered Australia's preeminent benchmark index. The
index is float-adjusted. The index was launched in April 2000.
•
MICEX Index - The MICEX Index is the real-time cap-weighted Russian composite index. It comprises 30 most liquid stocks of Russian largest and most developed companies from 10 main economy sectors. The MICEX Index was launched on September 22, 1997, base
value - 100. The MICEX Index is calculated and disseminated by the MICEX Stock Exchange - the main Russian stock exchange.
20
Key risks of investing in alternatives
General/Loss of capital. An investment in alternative investment funds involves a high degree of risk. There can be no assurance that the alternative investment fund’s return objectives will be realized and investors in the alternative
investment fund could lose up to the full amount of their invested capital. The alternative investment fund’s fees and expenses may offset the alternative investment fund’s trading profits.
Lack of information. The industry is largely unregistered and loosely regulated with little or no public market coverage. Investors are reliant on the manager for the availability, quality and quantity of information. Information regarding
investment strategies and performance may not be readily available to investors.
Limited liquidity. Interests are not publicly listed or traded on an exchange or automated quotation system. There is not a secondary market for interests, and as a result, invested capital is less accessible than that of traditional asset
classes. Also, withdrawals and transfers are generally restricted.
Dependence on Trading Manager. Performance is more dependent on manager-specific skills, rather than broad exposure to a particular market.
Event risk. Given their niche specialization, market dislocations can affect some strategies more adversely than others.
Speculation. Alternative investments often employ leverage, sometimes at significant levels, to enhance potential returns. Investment techniques may include the use of derivative instruments such as futures, options and short sales,
which amplify the possibilities for both profits and losses and may add volatility to the alternative investment fund’s performance.
Potential conflicts of interest. The payment of a performance based fee to the Trading Manager may create an incentive for the Trading Manager to cause the alternative investment fund to make riskier or more speculative investments
than it would in the absence of such incentive.
Valuation. Because of overall size or concentration in particular markets of positions held by the alternative investment fund or other reasons, the value at which its investments can be liquidated may differ, sometimes significantly, from
the interim valuations arrived at by the alternative investment fund.
Leverage. The capital structures of many financial services companies typically include substantial leverage. In addition, investments may be consummated through the use of significant leverage. Leveraged capital structures and the use
of leverage in financing investments increase the exposure of a company to adverse economic factors such as rising interest rates, downturns in the economy or deteriorations in the condition of the company or its industry and make the
company more sensitive to declines in revenues and to increases in expenses.
Currency risks and Non-United States investments. Investments may be denominated in non-U.S. currencies. Accordingly, changes in currency exchange rates, costs of conversion and exchange control regulations may adversely
affect the dollar value of investments.
Financial services industry risk factors. Financial services institutions have asset and liability structures that are essentially monetary in nature and are directly affected by many factors, including domestic and international economic
and political conditions, broad trends in business and finance, legislation and regulation affecting the national and international business and financial communities, monetary and fiscal policies, interest rates, inflation, currency values,
market conditions, the availability and cost of short-term or long-term funding and capital, the credit capacity or perceived creditworthiness of customers and counterparties, and the volatility of trading markets. Financial services
institutions operate in a highly regulated environment and are subject to extensive legal and regulatory restrictions and limitations and to supervision, examination and enforcement by regulatory authorities. Failure to comply with any of
these laws, rules or regulations, some of which are subject to interpretation and may be subject to change, could result in a variety of adverse consequences, including civil penalties, fines, suspension or expulsion, and termination of
deposit insurance, which may have material adverse effects.
CONFIDENTIAL
Risks associated with infrastructure investments generally. An infrastructure investment is subject to certain risks associated with the ownership of infrastructure and infrastructure-related assets in general, including: the burdens of
ownership of infrastructure assets; local, national and international economic conditions; the supply and demand for services from and access to infrastructure; the financial condition of users and suppliers of infrastructure assets;
changes in interest rates and the availability of funds which may render the purchase, sale or refinancing of infrastructure assets difficult or impracticable; changes in environmental laws and regulations, and planning laws and other
governmental rules; environmental claims arising in respect of infrastructure assets acquired with undisclosed or unknown environmental problems or as to which inadequate reserves have been established; changes in the price of
energy, raw materials and labor; changes in fiscal and monetary policies; negative developments in the economy that depress travel; uninsured casualties; force majeure acts, terrorist events, under-insured or uninsurable losses; sovereign
and sub-sovereign risks; contract counterparty default risk.
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