Global ARC Boston 2010 Briefing Package

Dear Global ARC Boston Participant:

We are at a critical juncture in the history of institutional and alternative investing. More than ever, the productive exchange of ideas requires a common baseline definition of the challenges facing investors and investment managers worldwide.

To encourage the exchange of ideas during our panel sessions, Global ARC is pleased to furnish participants with the following set of briefing notes. These notes are designed to provide background, seed discussions and supply the audience with ‘food for thought’ prior to and during each panel session.

Global ARC would like to thank the Chartered Alternative Investment Analyst (CAIA) Association for assembling these notes. As you are aware, the CAIA Association is a longtime partner of Global ARC and shares our mission of encouraging dialogue and fostering the exchange of knowledge.

This Global ARC briefing is an initiative of the Chartered Alternative Investment Analyst (CAIA) Association, a global non-profit educational organization and sponsor of the CAIA designation. The CAIA Association has offices in the US, Europe and Asia, and maintains chapters in all of the world‘s major financial centres. (www.caia.org) About the CAIA Association

The Chartered Alternative Investment Analyst (CAIA) Association designation was launched in 2002 as a partnership between the alternative investment industry (Alternative Investment Management Association, AIMA) and academia (The Center for International Securities and Derivatives Markets, CISDM, at the University of Massachusetts).

Based in Amherst, Massachusetts, with offices in London and Singapore, the non-profit CAIA Association now counts over 4,200 members in 70 countries around the globe. CAIA designees include financial advisors, hedge fund managers and marketers, consultants, lawyers, accountants, fund administrators, risk managers, regulators and major investors.

The rigorous CAIA program is designed for self-study and comprised of two levels, both of which are offered every March and September. The CAIA program provides individuals with the core competencies required to create, manage, and monitor an institutional-quality portfolio consisting of both traditional and alternative investments.

For more on the CAIA Association, visit CAIA.org. Panel Briefing Notes

Institutional Investor Allocations to Alternatives

Background & Description The investor perspective: what are the implications for institutional investors‘ alternative asset allocation policies in a world in which 4-5% per annum investment returns across the conventional asset classes is the new long term norm? Panelists will discuss how they are coping in this low rate paradigm and how they might include alternatives in their portfolios to increase risk-adjusted returns.

Data Points Investors gravitate to alternatives Investors increasing alternatives allocations

45% 3% 5% 3% 3% 100% 12% 2% 3% 30% 13% 13% 16% 75% 31% 18% 20% 15% 35% 33% 35% 50% 35% 35% 54% 0% 25% 41% 51% 46% -15% 0% 45% 43% -30% -45%

Cash Alternatives Fixed Income Equities 6 months Source: JP Morgan Alternative Asset Survey 3 years Source: bfinance bi-annual Pension Fund Survey (2010) conducted May 2010 2009 (left three bars) and 2010 (right three bars) surveys Pension plans expect to increase allocations to virtually all show investors‘ targets and allocations to alternatives are alternatives (and fixed income) at the expense of their rising—at the expense of equities. equities. (Chart shows difference in increase v. decrease.)

Hedge funds et al still attractive Endowments lead the way

35% 80% 8% 30% 60% 8% 25% 8% 20% 40% 52% 61% 15% 46% 10% 5% 20% 9% 10% 9% 16% 17% 5%

0% 0% Alternativesallocation

% planning to % investing Corporate fund Public fund Endowment/Foundation Source: JP Morgan Alternative Asset Survey Source: JP Morgan Alternative Asset Survey From a smaller base, infrastructure should see Endowments/foundations, early adopters of alternatives phenomenal growth, while HFs, PE and RE continue to investing, show the way for public and corporate plans to gain ground. allocate to non-traditional managers and asset classes.

Key Trends & Recent Developments

 Whereas once investment in hedge funds was the preserve of the super-wealthy, the industry is coming to be dominated by investments from pension funds and insurance companies. – Financial Times  Specifically, in 2009 the UK‘s Royal Mail upped its bet on UK and overseas equities through futures contracts from £2.1 billion (in 2008) to £5.13 billion—or almost 20% of the scheme‘s AUM—in a bid to reduce its estimated deficit of £10 billion. Some speculate if ―significant profits‖ were made by this move. – The Daily Telegraph

Potential Questions/Points of Debate  With an increase in popularity, will the institutionalization of alternatives, especially hedge funds, lessen managers‘ ability to ‗go out on a limb‘ and create unique and dynamic alpha?  Will there become two camps of investors? Those who derive alpha from their alternatives exposure and those who eschew alternatives and are left with meager beta returns?  Is the time coming when investors will internalize alternatives strategies—either on their own or via inter- investor investment schemes?

Further Research Title (Year) Author(s) Main Thesis or Conclusion The Impact of Alternative Donald Basch Evidence of 1999-09 shows alternatives increased Investments on Private Colleges' performance of public college endowments, Endowment Investment Returns especially larger ones, although 2009 illustrated how (2010) one year could make alternatives look bad in the short run. Background Risk and University Stephen Background (exogenous, non-tradable) risk levels of Endowment Funds (2010) Dimmock endowments affects their asset allocation vis-à-vis fixed income vs. alternatives whereby a one standard deviation increase in background risk increases fixed income allocation by circa 15% relative to the mean. Wealthier, highly selective universities hold riskier portfolios. Participants Fan Hua Michael Strachan Managing Director of Asset Allocation and Chief Investment Officer Strategy Equisuper – Australia China Investment Corporation – China

Christian Nistler Chief Investment Officer Syngenta International AG Pension – Switzerland

Moderator: Christopher Holt, Senior Advisor, Chartered Alternative Investment Analyst Association – USA

Will Smaller Hedge Funds Continue to Outperform Larger Ones?

Background & Description Smaller, nimbler hedge funds have traditionally offered the best performance for investors, but some analysts question whether the need for more comprehensive risk reporting and regulatory reports make disproportionately more strenuous cost demands on smaller managers, eroding their competitive advantage. Will the ‗mid range‘ manager – with between half a billion and 3 billion dollars AUM – constitute the new ‗sweet spot‘: large enough to shoulder the regulatory burden whilst small enough to swiftly enter and exit markets?

Data Points

Smaller managers exhibit outperformance Larger funds give < risk-adjusted returns

80 70 1 60 50 0.8 40 0.6

30 adjusted returns (%) returnsadjusted 20 - 0.4 Cumulative performanceCumulative 10 0 0.2

Monthly risk Monthly 0.1 10 1000

Smallest 20% Largest 20% Assets (USD millions, log scale) Source: Teo (2009) Source: Teo (2009) Study compared cumulative abnormal returns of smallest Relationship between fund abnormal returns—estimated two percentiles of hedge funds and largest two percentiles by Fung and Hsieh (2004) risk factors—and past assets. of hedge funds. (Jan ‘94 to June ‘08, chart is reproduction of original)

Alpha peaks at the median More small fund alpha in certain strategies

12% 8% 10% 6% 8% 4% 6% 4% 2%

2% 0%

Per annum average excess excess return average annum Per excess return average annum Per

Single manager funds FoHFs Source: Shawky, Wang (2010) Source: Shawky, Wang (2010) A study of excess return (alpha) on quintiles of managers Jan ‘94 to Dec ‘08 study shows excess alpha comparing from Jan ‘94 to Dec ‘08 revealed a ‗sweet spot‘ around the largest & smallest quintiles varies by strategy. EMN, EM median for single manager funds, declining FoHF alpha. with largest discrepancy vs. Global Macro and Short Bias.

Key Trends & Recent Developments  Registration with the US SEC and other regulatory bodies adds cost (either outsourced or in staffing) to hedge funds that had been much leaner.  US legislation and political/economic climate are pushing proprietary desk traders from investment and commercial banks to fledgling hedge funds.  Post-Madoff, many institutional investors and consultants are requiring services such as managed accounts which may be prohibitively expensive for smaller funds to establish and maintain (both in cost and trading sophistication required).

Potential Questions/Points of Debate  Will the administrative burden facing emerging managers lead to a wholesale change in their business model (e.g., outsourcing risk modeling and analytics)?  Certain investors demand minimum infrastructure (e.g., risk managers) . While this may be relatively easily accommodated in a large fund company, can smaller funds do so and remain (as) economically viable?  How will new funds reach the critical mass required to have the infrastructure required (assuming they really need it) and how might this affect performance?

Further Research

Title (Year) Author(s) Main Thesis or Conclusion Liquidity Risk and the Size- Hany A. Shawky, When liquidity risk is accounted for: small, high liquidity Performance Relationship Ying Wang risk hedge funds outperform large ones by an average of in the Hedge Fund Industry 9.5% p.a.; large, low liquidity risk FoHFs outperform (2010) small funds by an average of 8.4% p.a. Does Size Matter in the Melvyn Teo Smaller funds outperform larger ones by 3.65% due to Hedge Fund Industry? significant diseconomies of scale including capacity (2009) constraints. Participants Deepak Gurnani Dr. Arvind Raghunathan Managing Director and Head of Hedge Funds Founder and Chief Executive Officer Investcorp – USA Roc Capital – USA

Michael Karsch Alexander Neszvecsko Founding Partner and Chief Executive Officer Portfolio Manager Karsch Capital – USA European Patent Office Pension – Germany Designated Investor Questioner

Jeff Tarrant Apurva Mehta Co-Founder, CEO and CIO Director of Portfolio Investments Protégé Partners – USA The Julliard School – USA Designated Investor Questioner

Moderator: Christopher Holt, Senior Advisor, Chartered Alternative Investment Analyst Association – USA

Outlook for High Yield and Asset Based Credit Markets

Background & Description Has the extraordinary demand for yield in a near zero interest rate world distorted the credit markets? Has the breathing space provided to the high yield credit markets by the last two years of quantitative easing been wasted? Consequently, will the next two years see a dramatic increase in bankruptcies? With the demise of quantitative easing will hedge funds be able to position themselves as direct lenders to the small and mid-sized market?

Data Points MBS originations Global high yield issuance

Originations: € 125.0 (billions) $3,945 $2,920 $3,120 $2,980 $2,430 $1,500 $1,815 $320 € 100.0 100% € 75.0 € 50.0

50% (billions) € 25.0 € -

2009 2007 2008 2010 2007 2008 2009 2010 2007 2008 2009 2010

US Asia Pacific Europe Conv/Conf FHA/VA Jumbo Subprime Alt-A Home Equity Q1 Q2 Q3 Q4 (or full-year)

Source: Inside Mortgage Finance Source: Dealogic The crucible of securitization, MBS origination, has cooled HY issuance in the US is roaring back (2009 total in 2Q10 and now leans heavily on Conventional/Conforming alone), Asia Pacific is still similar to 2009 (although with paper—vis-à-vis subprime and Alt A a few years ago. less of a drop that year) and Europe is percolating.

HY down-upgrade + default Maturities pushed further out

120% 14% $300 $274 $250 100% 12%

80% 10% $200 $153 $156 $131 $133 $138 60% 8% $89 $92 40% 6% (billions) $100 $55 $53 $58 $77 $64 20% 4% $15 $7 $13 $1 0% 2% $- -20% 0%

High yield bonds Institutional leveraged loans (Downgrades-Upgrades)/Total Par HY Defaults Source: Bank of America Merrill Lynch As of June 14, 2010 Source: JPM A lagging indicator in the 2002 credit crunch, (down- After near-death experiences of late, 70% of issuance upgrades)/total par foretold rising and (continued) falling from 2Q09-2Q10 (inclusive) was earmarked for default rates in the recent global credit crisis. refinancing, extending maturities until at least 2013-14.

Key Trends & Recent Developments  ―After being whipsawed by horrible returns during 2008‘s credit crisis and a rally that boosted virtually every credit security in 2009, more institutional investors are looking to reduce their long exposure to credit and protect their credit portfolios on the downside... it‘s a good time to be looking at long/short credit.‖ – Pensions & Investments,  A large majority of the 2014 maturities are issues sold in 2007 in conjunction with LBO transactions, which explains the growing proportion of speculative-grade borrowers with debt coming due. In fact, approximately 71% of the speculative-grade debt due in 2014 was issued in 2007 by 53 companies in headline-making LBOs. – Standard & Poor's

Potential Questions/Points of Debate

 Now that the global credit crisis is - we hope - behind us, what mispricings persist that managers can exploit for out-sized profits?  How have the tools and strategies available to managers changed over the last three years?  How might the contemplated implementation of QE2 (Quantitative Easing, part 2) in both the United States and United Kingdom affect the ABS and high yield markets going forward? Will it differ from or align with that of the original program?

Further Research

Title (Year) Author(s) Main Thesis or Conclusion Are Junk Bonds Junk? Guangdi Junk bonds have higher Sharpe ratios than investment grade— (2010) Gordon they are underpriced. Junk has higher returns in all economic Chang states: fewer losses with default and higher returns without default. Model Risk and the Adam Model risk, substantial but not catastrophic in first-generation Design of CDO Metzler (ABS) securities, proves dire with second-generation (CDO) ones Tranches (2010) due to cross-correlations not included in Gaussian factor models. Participants Steve Shapiro Anilesh „Neil‟ Ahuja Founding Partner and Portfolio Manager Chief Investment Officer GoldenTree – USA Premium Point Investment – USA

John M. Bader Eni V. Panggabean Co-Chairman and Chief Investment Officer Head of Bureau and Directorate of Reserve Halcyon Asset Management – USA Bank of Indonesia – Indonesia Designated Investor Questioner

David Sherr Samuel Belk Founder and Managing Partner Managing Director One William Street – USA Dartmouth College Endowment – USA Designated Investor Questioner

Moderator: Christopher Holt, Senior Advisor, Chartered Alternative Investment Analyst Association – USA

US Budget Deficit: Cases, Implications & Possible Solutions

Background & Description Continued indefinitely in its current form, the US budget deficit threatens to undermine US credibility, and ultimately, through ever-increasing foreign borrowing, US power. Yet the current precarious state of the US economy may preclude immediate tax hikes and/or spending cuts for fear of exacerbating the other current deficit, that in jobs. How should the US manage the conflicting needs of the US budget and jobs deficit in the short to medium term? In the longer run, how should we reform the US tax system and US spending patterns to create a lasting resolution to the budget deficit? Data Points US budget deficit projections Mandatory federal spending % of GDP

Actual Projections Actual Projected 10% 500 8% 0 6% -500 4% -1,000 2%

($billions) -1,500 -2,000 0% -2,500

Medicaid, CHIP & Exchange subsidies Medicare

Source: Congressional Budget Office, Heritage Foundation CHIP=Children’s Health Insurance Program Source: Congressional Budget Office The CBO and White House see >$500 billion deficits for Under the CBO‘s extended-baseline scenario, spending the next 20 years. CBO forecast is ‗extended-baseline‘, on Medicare, Medicaid and related health programs will not the more conservative ‗alternative fiscal scenario‘. reach 10% of GDP, about twice today‘s proportion.

Mind the gap US public-held debt as % of nominal GDP

50% 15% 12.3%

10% 7.9% 4.8% 5.7% 25%

5% (% GDP) of (%

0% 0% Actions Actions Actions Actions begin in begin in begin in begin in 2011 2015 2020 2025

Source: Congressional Budget Office Source: US Government Accountability Office Reductions in primary spending (excl interest payments) Public holdings of US debt are at levels not seen in 60 or increase in revenues needed to close the 25-year fiscal years—when the US was growing its way out of WWII gap in the CBO‘s alternative fiscal scenario. debt.

Key Trends & Recent Developments  Budget deficit on pace to hit $1.47 trillion by fiscal year end September 30 – ABC  Only $387 billion of the $700 billion TARP budget was allocated. Recent estimates of the cost of the program are only $29 billion (after much higher forecasted costs). – New York Times  FOMC Chairman Ben Bernanke said recently that the US public finances are on an ―unstable path‖ (Wall Street Journal) while fund manager George Soros called for more stimulus, not a slashed deficit. – Financial Times.  The IMF cut its US 2010 growth forecasts from 3.3% to 2.6%, 2011 from 2.9% to 2.3% – Bloomberg

Potential Questions/Points of Debate  What will come of state budgets, such as that of California, if they cannot balance? Would the federal government assist them as it has with other groups?  Industry pundits earlier prognosticated the buy-ins of bank stock-holdings by federal stimulus programs might be a boon for the Treasury (show a profit). Is this the case—and if so, when?  Maturing debt can be paid with new currency, but at what cost from inflation– is this a viable option?  How should cuts to social programs, that so many rely on, be made?

Further Research Title (Year) Author(s) Main Thesis or Conclusion Fiscal Policy in the United Glenn Follette, During 2008-09, the combined effects of federal, state States: Automatic Byron Lutz and local budgets on aggregate demand (from both Stabilizers, Discretionary discretionary actions and automatic stabilizers) may have Fiscal Policy Actions, and lifted the level of GDP by 2.5% 2009. the Economy (2010) Rebalancing the US Barry Bosworth, US currently has low private savings rates and a very Economy in a Postcrisis Susan Collins large budget deficit with a cyclically depressed rate of World (2010) investment. Corporate tax structure changes, Participants reconsideration of capital controls, and further decline in real exchange rates could ameliorate a potentially very hard post-recession landing. Participants Peter Orszag Kris Kowal Member, President Obama‟s Cabinet (2009-10) Chief Investment Officer – Fixed Income Director, Office of Management and Budget Du Pont Investment Management – USA (2009-10) Designated Investor Questioner Director, Congressional Budget Office (2007-08) Senior Economist, President Clinton‟s Council of Economic Advisors (1995-97) – USA Vicente Tuesta Head of Research Prima Pension – Peru Designated Investor Questioner

How Vulnerable Are We to a Sovereign Debt Avalanche?

Background & Description Europe came precariously close to a chain of sovereign debt defaults in the spring of this year and economists agree the emergency measures taken failed to address the underlying debt problems; they merely postponed the day of reckoning. Our panellists will: offer their analysis of the likelihood of sovereign debts occurring at both the nation state level and (for the US) at the state and municipal level; discuss where such defaults may occur and their effects on global financial markets and various hedge fund strategies; and offer their recommenda- tions on how institutional investors should be arranging their portfolios to mitigate against such risks. Data Points US reliance on foreign holders higher Comparing sovereigns

5 400% 4

300% 3 200% 2 ($trillions) 100% 1 0% 0

Debt/GDP Debt/Revenue US securities – foreign holders of which Mainland China Source: US Treasury *Federal government Source: Eurostat, CBO, Morgan Stanley Research Foreign holdings of US securities has increased 23% Although US debt/GDP is lowest (at 53%), its debt/ CAGR for 3 years ending June 2010. China percentage revenue (or debt/aggregate federal tax) is high (358%) – stalled at 37% in July 2009 and fell to its current 27%. higher than Greece (312%) and Ireland (248%).

French & German banks PIGS bond holdings Estimates of government net worth

100% Rest of World 400%

80% 0% US ($3 billion) -400% 60% -800%

UK ($8 billion) GDP) of %

40%

-1200% (as 20% France ($56 -1600% 0% billion) Germany ($33 billion)

(Parenthetical values show capital impact associated with PIGS Cost of Aging Structural Deficit Initial Debt Level government bond holdings.) Source: Lloyds TSB, Bloomberg, BIS Source: EU Commission, Eurostat, CBO, IMF, Morgan Stanley Research A Sept 10, 2010 report shows very high exposures of Based on admittedly rough assumptions, the picture of German and French banks to PIGS bonds. Combined sovereigns‘ net worth is particularly bleak on the right end capital impact of $89 billion could be quite a blow for both. of the scale.

Key Trends & Recent Developments  Norway, perhaps ―investing to infinity‖, has taken a large position in Greek debt—counter to PIMCO‘s view that ―Greece eventually restructures or defaults.‖ – Bloomberg  Ireland slammed media reports that IMF intervention was imminent based on a 25% deficit (including bank bail-outs, only 10%, or 3 times the EU limit, ex bail-outs). – Reuters  BIS data reports France has over 2x and 3x exposure to Greece and Portugal, respectively, than were used in stress test. – Lloyds TSB  Euro-region governments to repay €582 billion of debt in 2011, up from €521 billion in 2010. – Bloomberg

Potential Questions/Points of Debate  In the spring, the PIIGS (Portugal, Italy, Ireland, Greece, Spain) were touted as primed for default and austerity measures are currently taking hold in various forms. Will these emergency actions be enough?  Given the shaky sovereign debt in many (especially European) bank balance sheets, could sovereign be the next hammer to fall on capital ratios?  How far might a sovereign credit contagion reach? Could Japan and the US fall victim as well?  What role might China and other countries‘ currency reserves have if sovereigns become distressed?

Further Research

Title (Year) Author(s) Main Thesis or Conclusion Fiscal Deficits, Public Debt Emanuele Baldacci, A fiscal deficit of 5% of GDP could raise long-term and Sovereign Bond Yields Manmohan S. interest rates by 1% plus 20bps for each 1% over (2010) Kumar 5%—50bps per 1% if adverse circumstances prevail. Creditor Discrimination Aitor Erce, Javier If debt crisis follows a banking crisis, sovereigns tend During Sovereign Debt Díaz-Cassou to discriminate against non-residents; if domestic Restructurings (2010) banking is sound, sovereigns discriminate against residents in a ―gamble for redemption‖ strategy. Participants Takayuki Hirai Derek Kaufman General Manager of Investments Head of US and European Fixed Income Bank of Tokyo and Mitsubishi UFJ Pension Citadel – USA Fund – Japan Designated Investor Questioner

Warren Wright Iker Zubizarreta Finance Director Chief Investment Officer Fondo Latinoamericano de Reservas – DGAM – Canada Columbia Designated Investor Questioner Victor Khosla Founder and Senior Managing Partner Strategic Value Partners – USA

Moderator: Christopher Holt, Senior Advisor, Chartered Alternative Investment Analyst Association – USA

What is the Outlook for Global Macro and CTA Strategies?

Background & Description Over the last couple of years, the performance of stocks and commodities has been driven less by their individual characteristics than by wider political, economic and regulatory macro factors. Correlation of stocks in the S&P500, which averaged 27% in 2000-06, jumped to 80% in 2008 and now, in calmer markets, is still at an elevated 60% – representing heights not seen since the Great Depression. Panelists will examine the continuance of this trend as well as which emerging political and socio-economic trends might profoundly impact investment returns in the coming years. Data Points

Macro and CTA Favored Global Macro, long volatility

60% 51% 40% 33% 30% 36% 40% 27% 26% 29% 21% 20%

26% 23% month returns month

- 10% 20% 0% -10% 0% -20% -30%

-45% -30% -15% 0% 15% 30% Global6 Rolling Macro MSCI World Index rolling 6-month returns

Source: Preqin Source: Credit Suisse/Tremont Hedge Fund Index (replicated from source) Recent survey shows European banks‘ FoHF units put In times of market moves, Global Macro managers post macro and CTA strategies in preferred top 5 going higher returns—essentially, these (and CTA) managers forward. are long volatility.

Global Macro continues to produce Global Macro/CTA AUM

2008: +4.83% 2009: +4.34% 2010*: +0.93% 25% 14,000 20% 13,500 15%

13,000 10% 5% 12,500 0% 12,000

*to August 2010 Source: HFRI Source: BarclayHedge As markets tumbled and correlated, Global Macro AUM of Global Macro/CTA is middle-of-the-pack, Global managers were able to eke out positive returns over the Macro having less prominence than in the 1980s/90s last two years—a rather exemplary feat. when Soros, et al. made headlines; CTA having grown.

Key Trends & Recent Developments

 The S&P500 and 10-year Treasury rates were 84% correlated in the 60 trading days through June 16— the highest reading since 1962. The 2000-07 bull market, when equity prices doubled, was presaged by a similar coefficient. – Bloomberg  Hedge Fund Research reported macro managers returned average 2.16% to 3.65% gains in August, against a 1.28% drop among directional equity strategies. The hedge fund industry as a whole rose a marginal 0.38% in August, bucking the 4.3% decline in the DJIA. – Wall Street Journal

Potential Questions/Points of Debate  What are the key trends managers have capitalized on in 2010? Which ones, if any, are expected in 2011?  How can investors determine the efficacy of CTA or Global Macro models—especially given that the former are typically quant(itative) in nature, whilst the latter may have more subjectivity in trade selection and scaling?  What has caused the surge in CTA AUM over the last decade, and will they rebound from the drop (from being the ATM/cash withdrawal window strategy) seen over the last few years?

Further Research

Title (Year) Author(s) Main Thesis or Conclusion Systematic Global Macro: Peter Park, Oguz Portfolios with significant investments in Systematic Performance, Risk and Tanrikulu, Guodong Global Macro strategies have historically outperformed Correlation Characteristics Wang portfolios without allocations to Systematic Global (2009) Macro strategies. The Fundamentals of Gary Gorton, Commodity price volatility is higher when inventories Commodity Futures Fumio Hayashi, K. are low, leading to higher futures risk premiums as Returns (2008) Geert Rouwenhorst commercial hedgers take positions. Participants Jean Philippe Bouchaud Anthony O‟Toole Chairman and Chief Scientific Officer Chief Financial Officer CFM – France American Legacy Foundation – USA Designated Investor Questioner

Patrick McMahon Scott Hayman Co-Founder and Co-Chief Investment Officer Chief Investment Officer MKP Capital – USA Oceanpath – Canada Designated Investor Questioner

Luke Dixon Portfolio Manager for Absolute Return Strategies Universities Superannuation Scheme – United Kingdom

Moderator: Julie Winkler, Managing Director, CME Group – USA

Investment Opportunities in West Africa

Background & Description In May of this year, Global ARC London showcased a rousing speech from the world‘s foremost development economist, Professor Paul Collier of Oxford University, in which he compellingly argued the economic case for investing in Africa. A distinguished panel, including, from Nigeria, His Excellency President Dr. Goodluck Jonathan and Nigeria‘s Minister of Finance The Hon. Dr. Olusegun Aganga and, from Benin, His Excellency President Dr. Thomas Yayi Boni and Benin‘s Minister of Finance The Hon. Idriss Daouda will afford investors a rare opportunity to meet key economic decision makers of two of Africa‘s most dynamic governments. Data Points Top 10 African nations: proved oil reserves Technology in Africa

9 400 70% 45 10 Global ranking 60% 300 50% 30 40% 16 200 15 18 30% 24 28 (millions) (billions barrels) of 33 34 36 39 100 20% - 10% 0 0%

Number of subscribers (LHS) % population with cell phone coverage (RHS) Source: CIA World Factbook, 2009 Source: Acker, Mbiti (2010) The aggregate of these 10 countries‘ proved reserves Cellular penetration has rapidly expanded, making it a hot (116 billion bbl) equals that of Iraq (#4 global ranking), and investment opportunity and valuable component of more than that of Venezuela, Kuwait or the UAE. infrastructure that will support further developments.

African economies: steady, heady growth Robust West African growth 6% $1,600 5%

$1,200 4% 3% $800 2% 1% $400 0% $- -1%

Source: IMF; World Bank World Development Indicators; McKinsey Global Institute Source: CIA Factbook African nations‘ CAGR of 4.9% from 2000-08 puts it Comparing average GDP growth from 2007-09, larger among the fastest growing regions in the world. A rate West African countries (>$10 billion GDP) show good much higher than the 2% CAGR of developed economies. growth compared to BRIC and developed countries.

Key Trends & Recent Developments  ―As part of an emerging markets and increasingly frontier markets strategy, Africa has been attracting asset inflows as investors turn away from lower growth developed markets towards regions with higher potential for growth.‖ – Pensions & Investments  Nigeria is now (July‘10) the #3 exporter of oil to the US, at 1.14 million bpd, or 11.4% of total US imports— up from 0.674 mbpd for YTD (July) 2009, supplanting Saudi Arabia and Venezuela. Similar movement in rankings occurred in US petroleum imports as well. – USEIA  Perhaps in response to global conditions, members of the Economic Community of West African States (ECOWAS) look to increase intra-regional trade. – The Guardian Nigeria  Oil revenues for West African states such as Ghana provide a large measure of government revenue, and are projected to increase over the next few years. – afrol News

Potential Questions/Points of Debate  Some African nations have had a difficult transition from imperialism to democracy: has that past mainly been ameliorated with the passage of time and creation of new, more benevolent governments?  Many regions have particular industry specializations, which can morph over time (Japan from making toys and cheap electronics to luxury road sedans and LCDs). What is West Africa‘s industry calling card presently and which industries are planned for development in the future?  How have West African nations financed the extraction of natural resources such as oil and minerals in the past, and how do they plan to finance the same in the future in order to optimize growth and development and national and population wealth?  How has moving from a cash-crop economy in some West African countries allowed greater prosperity and what might have been sacrificed in the process?  Which political and socio-economic obstacles have West African countries surmounted over the last few years and which continue to exist—and how might they be overcome?  Which areas of investment have the best short, intermediate and long-term prospect for foreign investors?  Which are West African nations‘ predominant trading partners and how has the global financial crisis affected the level of trade with these countries?

Participants His Excellency President Dr. His Excellency President Dr. Thomas Yayi Boni Goodluck Jonathan President, The West African Development Bank Vice-President, Federal Republic of Nigeria (1994-2006) (2007-2010) Chief Economic Advisor to the President, Governor, Bayelsa State (2005-2007) – Federal Republic of Benin (1992-1994) – Republic of Republic of Nigeria Benin

Kurt Silberstein Senior Portfolio Manager CalPERS – USA Designated Investor Questioner

Emerging Markets Exposure: Via Hedge or Long-Only?

Background & Description

Institutional investors have dramatically ramped up their exposure to emerging markets over the last five years. However, some investors have questioned whether hedge fund strategies may be the ideal means of gaining such exposure as they feel that such strategies exacerbate the already high cost and opaqueness associated with such geographic markets. How informed are such criticisms of EM hedge funds? If an institutional investor does consider investing in an EM hedge fund, how must it augment its hedge fund due diligence checklist?

Data Points US Institutions active in EM Hedge strategies preferred in EM

0% 10% 20% 30% 0% 20% 40% 60%

Endowment Plan 29% Long-Short Equtiy 51% Fund of Hedge Funds 28% Macro 35% 30% Family Office/Foundation 19% Distressed Securities Fund of Hedge Funds 27% Public Pension Funds 13% CTA 24% Private Pension Funds 6% Credit 23% Other 5% Event Driven 23% Market Neutral 15%

Source: Preqin Source: Preqin A fairly wide gap exists between EM exposure of Long-short EM strategies top the list when US institutional endowment plans and private pension funds—similar to investors were asked, in a July 2010 report, which hedge that of their use of hedge funds. strategies they prefer in emerging markets.

HFRI EM Asia ex-Japan Index EM Hedge Funds define efficient frontier 10,000 10% 9,000 8% EM HFs Brazil

8,000 6% Asia ex-Japan HFs LatAm HFs China 7,000 4% India 6,000 2% 5,000 0% Korea 4,000 returnsAnnual -2% Hong Kong MSCI EM 3,000 -4% 2,000 MSCI Global -6% Singapore 1,000 -8% S&P 500 Taiwan 0 5% 10% 15% 20% 25% 30% Annual volatility

Source: HFRI Source: Yahoo Finance, MSCI Barra, Eurekahedge Moribund for the first half of the decade, Asian EM hedge From Jan 2000 – Feb 2009, EM Hedge Funds displayed managers leapt to life, dropped in 2008 and revived in mean-variance dominance against EM, US and global 2009, recouping their losses. indices as well as many EM country equity indices.

Key Trends & Recent Developments  As the July 2010 Preqin survey shows that of US investors with a preference for EM:  17% have a preference for EM hedge funds  The most favored investment approach is direct (over FoHF or a mixture of direct and FoHF)  Average overall allocation to hedge funds for US investors allocating to EM is 19%  August 2010: in 1H10, AUM of EM hedge funds fell $3.2 billion to $95 billion, perhaps because investors prefer fixed income to equities presently and Russia and most Asian markets are equity-focused. Latin American and Middle East hedge funds continue to attract investments, though. — Wall Street Journal

Potential Questions/Points of Debate  Given the degree of opacity in emerging markets, is it advisable to add another layer of the same by investing in an EM hedge fund?  In some countries, such as India, so-called long-only managers use many of the same tools of hedge funds (e.g., futures and options, arbitrage strategies) and hedge managers are limited in some of their methods (e.g., short-selling). With this blurry distinction, which is the better option?  Is there a risk that EM regulators might shut down hedge funds and allow only mutual funds in the future?

Further Research Title (Year) Author(s) Main Thesis or Conclusion Market Volatility and Hedge Bolong Cao, EM hedge fund returns are not affected by stock or bond Fund Returns in Emerging Shamila A. market volatility, are typically passive investments and Markets (2010) Jayasuriya show very little ability to produce excess alpha. They also have a high turnover rate. New Evidence on Value Zhipeng Yan, A value investing-based system of long/short positions Investing in Emerging Yan Zhao based on an EM country‘s GDP, price-earnings and Markets (2010) dividend yield can be very profitable. Time-Varying Performance of Harry J. EM mutual funds provide strongly positive and significant International Mutual Funds Turtle, state dependent alphas when the idiosyncratic volatility of (2010) Chengping emerging markets is small. However, ignoring time- Zhang varying volatility could misstate mutual fund metrics.

Participants

Kurt Silberstein Mark Dow Senior Portfolio Manager Senior Portfolio Manager CalPERS – USA Pharo Management – United Kingdom

Dr. Karim Abdel-Motaal Co-Head of Emerging Markets GLG – United Kingdom

Diversification vs. „Diworsification‟: High Conviction Managers

Background & Description

Do the last three years prove that in periods of turbulence that diversification is actually ‗diworsification‘? Does the future belong to more concentrated, high conviction managers? “The old cure for extreme events was simple diversification: spreading your bets among a broad array of asset classes. But the financial crisis showed that asset allocation isn’t always reliable when markets tumble in unison. Diversification works most of the time, but when it doesn’t work those times really kill you.” – Wall Street Journal

Data Points Fund managers beat by their bogeys Correlation of S&P500 constituents to index 80% 80% 69% 52% 58% 60% 60%

39% 40% 40% 27% 17% 20% 20%

0% 0%

*YTD June 21, 2010 Source: Compustat, Goldman Sachs Global ECS Research Source: Barclays Capital, Morningstar Only about one quarters of mutual fund managers beat Getting non-correlated returns in S&P500 equities is more their benchmark by about half-way into 2010—even difficult than before—it takes a high conviction manager to moreso than in 2008/09 when markets were crashing. differentiate from the crowd.

Optimal number of portfolio assets 12 Excess benefits of diversification 10 8 25 # of positions where excess benefit = 0 6 20 VaR ES Std Dev 4 15 2 10 0 5 -2 0 Standard Deviation VaR* Expected Shortfall* 0.7 1 2 3 9 10 11 12 29 30 31 Investor RRA (Relative Risk Aversion) * Calculated at 0.001 probability With short-selling constraint Without short-selling constraint

Source: Melkumian (2009) Source: Hyung, De Vries (2010) As RRA increases, more is allocated to risk-free bonds, Diversification benefits fall quickly re higher moment risks but even at low risk-aversion levels (<4) the optimal than lower; portfolio construction in a fat-tail environ by number of assets is below 25. safety first investors necessitates focused portfolios.

Key Trends & Recent Developments  In 1998, LTCM delved outside of its core relative value trades, among other actions, which gave the aura of diversification, only to see correlations spike when Russia defaulted. In August 2007, Global Alpha, AQR, PDT, Renaissance Technologies and others found that each of these quant funds had diversified into the same crowded trades (financed with the same, cheap Japanese interest rates).  Over the last few months, ―U.S. small-cap stocks, emerging-markets, commodities, and real-estate trusts are trading more in step with the S&P 500, on a price basis, than they have ever been‖—which contradicts modern portfolio theory‘s mantra of diversification as a means of volatility dampening. In 2008 almost everything correlated downward while now everything seems to correlate upward. – Market Watch

Potential Questions/Points of Debate

 Is being a high conviction manager enough? If one is in the same trade as others, then diversification benefits can be lost as prices fall and liquidity evaporates. How can managers differentiate themselves?  What is the definition of a high conviction manager: focused on one or few industries, countries, investment themes? Is there a preferred number of stocks or proportion of constituent company market cap?  What risks do high conviction managers attract and what risks do they shed or ameliorate?

Further Research Title (Year) Author(s) Main Thesis or Conclusion Do Arbitrageurs Really Avoid High Itzhak Ben- Small, undiversified hedge funds are more likely Idiosyncratic Risk Stocks? (2010) David, Denys to own high idiosyncratic risk stocks; hedge Glushkov, Rabih funds earn higher returns from investing in high Moussawi idiosyncratic stocks than low. Create better diversified high- Dominiek Using the PDI portfolio construction algorithm conviction equity portfolios using the Crezée, Laurens results in well-diversified high-conviction equity Portfolio Diversification Index (2010) Swinkels portfolios. Diversification in the Hedge Fund Hany Shawky, Sector/asset class diversification outperforms Industry (2010) Na Dai, Douglas style diversification. Geographical diversification Cumming does not significantly impact hedge fund performance. The Downside Risk of Heavy Tails Hyung, De Vries If a safety first investor cares about downside Induces Low Diversification (2010) risk and is cognizant of fat tails, optimal portfolio sizes are smaller than traditional correlation based diversification analysis suggests.

Participants Kathryn Crecelius Jim Higgins Chief Investment Officer Founder, CEO and CIO Johns Hopkins University Endowment – USA Sorin Capital Management – USA

Moderator: Karen Fang, Managing Director, Bank of America – USA

What Is the Most Effective Means of Protecting from Fat Tails?

Background & Description The Great Recession has forced investors to dramatically reappraise the probability of fat tail risk, and with this the amount of time and resources that they deploy to protect against it. How do we avoid simply putting in place a tail risk protection system that protects against a 2008 shock but fails to protect against future types? Is it possible to cheaply embed negative correlation into the portfolio through tactical asset allocation? Do off-the- shelf derivative products provide sufficient protection for most institutional investors, or does the extra protection afforded by customised products justify the extra time and expense involved? Data Points Tail risk and volatility Implied vs. realized volatility

3% 80% Probability of 60% 2% drawdowns over 30% 40% 1% 30% vol: 16% 20% 15% vol: 2% 0% 0%

30% Volatility 15% Volatility VIX Realized Volatility Source: Brockhouse Cooper Source: Standard and Poor’s Using a normal distribution, doubling volatility to 30% Realized volatility is usually lower than implied vol (VIX)— increases the probability of a 30% drawdown eight fold. except in certain spike scenarios—and, as one can see, Higher kurtosis distributions would be more pronounced. both are time-varying and not particularly predictable.

S&P500 distribution is non-normal Cost of 1-year 15% OTM SPX puts 500 12% 450 400 10% 350 300 8% 250 6% 200 150 4% 100 50 2% 0 0%

Frequency Normal Frequency OTM=out of the money, SPX=S&P500 Source: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital 1-year periods for the last 60 years, plotted against a Since the credit crisis, the cost of insurance has normal distribution illustrates the market‘s tendency to skyrocketed and continues to be higher than previously. crowd at the mean and have significant down-years. (Datapoints as at exercise dates)

Key Trends & Recent Developments

 In the 1970s/80s, investors delta-hedged listed options with their associated path dependency and non- linear decay. In the 1990s, OTC-traded variance swaps made pricing simpler and precluded potentially messy trading programs. In the last decade, listed VIX futures and options became the preferred route to trade volatility (instead of variance).  Current major models of tail risk hedging include: rolling various tenors and levels of OTM index option, hedging with futures positions and choosing opportunistic hedges based on scenario/contingency analysis.

Potential Questions/Points of Debate  With the recent increased cost of option-based insurance, are there as effective and/or cheaper to implement methods that investors might prefer in today‘s environment?  How might investors (or their consultants/advisors) be able to choose the best method of tail risk hedging and the associated levels of passive/active or choice of outlooks and hedging tools available?  Should tail-hedging strategies be implemented as an alpha engine or as a true hedge? If as a hedge, then hedging all market exposure or on an opportunistic basis against overlay or AI-only exposures?

Further Research Title (Year) Author(s) Main Thesis or Conclusion Why Did the Crisis of 2008 N.N. Taleb Fat (negative) tails are an artifact of the current Happen? (2010) financial, academic and governmental system and only a radical re-invent might lead to their amelioration. We Don‘t Quite Know What D.G. Goldstein & Finance professionals underestimate normal We are talking About When We N.N. Taleb distribution events by 25%—fat-tailed events by a Talk About Volatility (2007) shocking 90%. Participants Brian Pennington Harvey Toor Chief Risk Officer Chief Risk Officer GoldenTree – USA Abu Dhabi Investment Council – Abu Dhabi Designated Investor Questioner

Deepak Gurnani Michal Zajac Head of Risk Management Managing Director and Head of Hedge Funds National Bank of Slovakia – Slovakia Investcorp – USA Designated Investor Questioner

Dr. Ronan O‟Connor Head of Risk Management & Asset Allocation National Treasury Management Agency – Ireland

Where Does the Future of Funds of Funds Lie?

Background & Description How should a 2010 due diligence fund of funds checklist differ from that of 2007? Is liquidity management even more important than manager selection in the creation of an institutional-quality FoF? Will customization and niche strategies provide the keys to a successful future for the FoHFs industry? Or, will FoFs morph into a more advisory role, focused on assisting institutional investor clients as they construct in- house, diversified direct hedge fund portfolios—without the FoF actually managing the money?

Data Points AUM still under HWM Year moved from FoF to Direct

$800 10%

$600 10%

$400 (billions)

$200 80%

$- 1990-1999 2000-2007 2008-2010 Source: Hedge Fund Research Inc. Source: Prequin Thanks to markets and Bernie Madoff, 2008 was a blow to July 2010 survey shows that of those institutional FoHFs. Markets have rebounded in some sectors, but investors who go direct for hedge fund exposure, 80% did FoF AUM continues to languish. so in the last three years vs. 20% for 18 years prior.

Investors choose FoF and Direct Pros and Cons 0% 25% 50% 75% Diversification 66% Purposes Funds of Hedge Reasons Lack of In-House Funds Only 40% to use Expertise FoF 34% 35% Direct Only Increased 33% Transparency Funds of Hedge Funds and Direct Lower Fees 60% 31% Reasons More Control Over 54% to go Investments direct More In-House 13% Resources Source: Prequin Source: Preqin July 2010 survey indicates roughly one-third split between Institutions use FoFs to get up-and-running quickly without global institutional investors going direct, using FoF headcount, but some find that after they gain knowledge exclusively or using a combination of approaches. they‘d rather reduce fees and gain more control.

Key Trends & Recent Developments  Of those investors who went direct in the last few years, some retained their FoHF companies, but on a retainer/advisory level. One FoHFs reports up to 70% of its AUA is in the form of advisory contracts with institutional investors vs. in-house managed funds or managed accounts.  “In the years ahead, funds of funds are likely to see pension fund inflows grow... USD 250 billion of pension fund money is expected to flow in over the next three years.” The Financial Times, 11th July 2010  Smaller European FoHFs are expected to close or merge in the near future. – Reuters

Potential Questions/Points of Debate  If the new model of FoHFs is advisory and not (higher margin) asset management, how might some companies attract and retain talent?  Which might be better for the investor over the long term: a dedicated asset management team at a FoHF or a consultant-type relationship where the portfolio is ‗managed‘ in concert with in-house staff?  If FoHFs move into consultancy, would the best business plan be to specialize in one area, such as operational due diligence or asset allocation, or to offer holistic packages for clients?

Further Research Title (Year) Author(s) Main Thesis or Conclusion Do Funds of Hedge Serge Darolles, FoHF add value in the areas of strategic asset allocation Funds Really Add Value? Mathieu Vaissié (sticking to an allocation during difficult times) and in fund- (2010) picking. Tactical AA, however, is neutral to negative. A Random Walk by Fund Frans De Roon, FoHF invested HFs are larger in size; a longer operational of Funds Managers? Jinqiang Guo, history and higher average initial investment; and are (2010) Jenke ter Horst more likely to hire an auditor and use a HWM. Their managers have more investment experience, and have a greater proportion of CFA charterholders. Selecting Prior Year‘s Top Greg Gregoriou, Using a naïve strategy of investing in (up to six) top- Fund of Hedge Funds as Razvan performing FoHF from the year previous can beats This Year‘s Choice (2010) Pascalau benchmark FoHF indices.

Participants Gregory Doyle Cheryl Alston Chief Investment Officer Executive Director & Chief Investment Officer Kruger Corporate Pension – Canada Employees Retirement Fund of the City of Dallas – USA Designated Investor Questioner Stephen Harper Founder and Chief Executive Officer Strathmore Capital – United Kingdom

Moderator: Gary Enos, Executive Vice President, State Street – USA

Operational Due Diligence: Best Practices

Background & Description

Operational due diligence includes assessing hedge funds financing and counterparty risks and establishing consistent valuation and audit procedures. Given the limited size of most investment divisions, what proportion of the due diligence process can realistically be carried out in-house and what proportion by external consultants and advisors?

Data Points Fewer funds, perhaps fewer headaches Hedge fund due diligence timeframe

100% 100%

80% 80%

60% 60%

40% 40%

20% 20% 0% 0% 2006 2008 2009 2010 2008 2009 2010 120+ 100-120 80-100 60-80 >1 year 7-12 months 3-6 months <3 months 40-60 20-40 0-20 Source: 2010 Deutsche Bank Alternative Investment Survey Source: 2010 Deutsche Bank Alternative Investment Survey Investors have pared the number of hedge funds they Investor due diligence is becoming bar-belled with a invest in. Fewer funds means more attention from staff greater proportion taking under 3 months and over 6 per fund—and more due diligence, including operational. months compared to 2009.

It looks good to have a clean desk Ways that hedge funds are improving

Do improvements in operations/automation have a positive 0% 50% 100% impact on the ability to attract investors?

Reduce counterpary 69% risk 33% Yes Improve 38% No reporting/transparency 67% Secure independent 33% valuations/accounting

Source: 2010 Hedge Fund Operational Challenges Research – Greenwich Associates & Omgeo Source: 2010 Hedge Fund Operational Challenges Research – Greenwich Associates & Omgeo The majority of surveyed hedge fund managers believe Hedge funds have started to spruce up their operations, that investors prefer funds with efficient and organized the most prevalent being reducing counterparty risk (e.g., operations and trading systems. via collateral management) but also in pricing.

Key Trends & Recent Developments  A 2003 Capco white paper revealed >50% of hedge fund failures were due to identifiable operational problems: ―expanding due diligence and monitoring processes to understand back-office capabilities can make a big difference in preventing or avoiding these failures‖. 90% of investors said operational due diligence was a top priority, says a 2010 survey by Rothstein Kass. – Financial Times  Key drivers of recent FoHF mergers and acquisitions is operational due diligence and scale—investors, left wanting when major, respected FoHFs were found to be invested in Madoff and other frauds, demand more up-front and on-going research on invested funds. – Dow Jones

Potential Questions/Points of Debate

 Which might be a better model for efficient use of operational due diligence resources: each investor having its own team; investors ‗clubbing‘ to share specialized groups; or a credit rating model where a third-party agency or corporation provides ratings on funds?  Should investor/plan trustees/senior managers be held accountable for (operational) due diligence gaffs—in the spirit of Sarbanes-Oxley? Would that increase the duty of care required and delivered?  Should governments mandate minimum due diligence thresholds, or rely on market forces?

Further Research Title (Year) Author(s) Main Thesis or Conclusion Trust and Delegation Stephen Brown Operational risk does not seem to be a material (2010) William Goetzmann, concern for investors. Due diligence is often follows Bing Liang, impressive performance and, had issues been Christopher Schwarz uncovered, could have improved returns. Hedge Fund Investing: Mohsen Mazaheri There are identifiable characteristics of hedge fund Identification of Potential culture, business model, and senior management 'Blow-Up' Managers (2008) psychological profile that conduce to excessive risk and ―blow-up‖ magnitude losses. Hedge Fund Operational Jason Scharfman Post-Madoff, due diligence increasingly focuses on: Due Diligence: The Madoff cash controls, quality and length of relationship with Effect (2010) service providers and transparency and reporting.

Participants Kate Murtagh Dominic Blais Managing Director Portfolio Manager for Public Assets Harvard Management Company – USA Canadian Medical Protective Association – Canada Designated Investor Questioner Elizabeth Hewitt Senior Investment Officer The Robert Wood Johnson Foundation – USA

Moderator: Gary Enos, Executive Vice President, State Street – USA

Choosing a Managed Accounts Platform

Background & Description How do you choose the managed account platform that best satisfies your organization‘s needs? Managed accounts definitely reduce the risk of fraud and provide investors increasingly detailed information on which to measure risk. Some managers do not offer them for a variety of reasons including fear of front-running (their trades)—whether justified or not. The question for investors sometimes is: are managed accounts the only way to get what they want?

Data Points Events of 2008 exposed flaws Top four reasons for managed accounts

10% 15%

28% Improved transparency 19% 47% 39% 16% 48% Improved liquidity 11% Validation of assets 13% 4% Ability to impose guidelines/ 2009 2010 13% restrictions

More likely Less likely No difference Already use MA 0% 5% 10% 15% 20%

Source: 2009/2010 Deutsche Bank Alternative Investment Survey 2010 Deutsche Bank Alternative Investment Survey Question posed to investors: Will you be more or less Top reasons concern measurement and control. Runner- likely to make a proportion of your investments through ups: no gating, sole investor/no commingling, independent managed accounts in the future? valuation/NAV, more frequent valuation/NAV.

Terms investors would like improved Allocations to managed accounts

Transparency at fund level 53% 3% 3% 7% 47% None Lock-up period 7% Redemption frequency 42% 0-10% Performance fee 37% 53% 10-20% Redemption fee 37% 20-30% 26% Management fee 27% 30-40% Other 11% >40% 0% 20% 40% 60%

Source: Preqin 2010 Deutsche Bank Alternative Investment Survey September 2010 survey shows that although 42% of Question: what is the total allocation to managed accounts investors agree transparency has improved over the last as a percentage of your total hedge fund portfolio? 12 months, 53% would like to see more data.

Key Advantages Key Disadvantages  Position transparency  Monitoring requirements and dependence upon managed account platform manager  Ownership of underlying investments (including shareholder activities such as proxy voting and  Complex trade execution and order execution potential board representation) system forced on manager  Increased liquidity  Unequal treatment of investors  Possible to alter investment guidelines  Increased costs  Reduced risks to:  Conflicts of interest (e.g., kickbacks)  Misappropriation  Decreased transparency with regard to:  Misrepresentation and incorrect pricing  AUM of manager  Trading outside of the operating mandate  Reliability of true track record because:  Managed account platform manager may be  Manager may perform differently another ‗set of eyes‘ watching the portfolio and under idiosyncratic mandate risk metrics  Difficult to calculate performance of  May be possible to shut down or reverse heterogeneous account mandates particularly egregious trades Compiled from Swiss Analytics and EDHEC Potential Questions/Points of Debate  How much data might be appropriate for certain classes of investors (e.g., plan sponsors of varying size, consultants, family offices, fund of funds)?  Which investor types would get the most from a managed account?  How can risk metrics from managed accounts be used most effectively?  How can investors access best managers through managed accounts?  Is it appropriate to raise money for a fund with stated and transparent terms and then raise more through managed accounts that might have differing terms?  Which strategies or types of managers are best suited to a managed account environment?  In what circumstances might a managed account have a gate imposed or side-pocket created?  At what AUM level do managers typically offer managed accounts? What metrics (quantitative or qualitative) might a manager use to create one for lower than its stated minimum amount? Participants Christopher Vogt Nathanaël Benzaken Portfolio Manager – Hedge Funds Managing Director Allstate Insurance Corporation – USA Lyxor Asset Management – USA

Deepak Gurnani Dan McDonald Managing Director and Head of Hedge Funds Portfolio Manager Investcorp – USA Ontario Teachers‟ Pension Plan – Canada

Moderator: George Sullivan, Executive Vice President and Global Head of AI Services, State Street – USA

Financial Sector Reform, Dodd-Frank and the „Volcker Rule‟

Background & Description The events of the last few years have rent asunder much of the previously sacrosanct notions of banking and finance in the US, and the world. Following the carnage, US and other legislators have devised new, ostensibly more appropriate and effective, statues designed to prevent a re-enactment of recent history. What are these laws and how do they affect banking and finance going forward? Do they provide the protection sought, how so, and for how long?

Data Points US banking is big(ger) business “More stringent” prudential standards Banks and Non-bank Financial Companies (NFCs) 30% 75% are subject to: 25% • Liquidity requirements – exact levels not specified 20% 50% • Risk management requirements 15% • Requirement for risk committee - enterprise-wide 10% 25% risk management including independent directors 5% and one with relevant risk experience 0% 0% • Stress tests – annual and semi-annual tests 1955-1965 1966-1975 1976-1985 1986-1995 1996-2005 • Examinations and reports – both by request and Credit market instruments/GDP (RHS) pro-actively from the institutions. Financial sector share of US corporate profits (LHS) Finance share of GDP (LHS) • Limits on concentration and credit exposures – Source: Pilippon (2007), Haver Analytics, Gluskin Sheff <25% exposure to non-affiliated companies. • Enhanced public disclosures – concerning risk Banking‘s share of GDP and the ratio of credit instruments profile, capital adequacy, and risk management vs. GDP almost doubled from 1955 to 2005. Perhaps laws enacted in the 1930s and 40s need to be updated. capabilities thereof. • Limits on short-term debt – includes off-balance sheet exposures. The „Volcker Rule‟ • Leverage limits – debt/equity no greater than 15:1. • Off-balance sheet activities – all off-balance sheet Banking entities cannot engage in proprietary trading holdings, transactions and guarantees incorporated (including through a hedge fund or PE subsidiary). in financial statements and ratios. Exemptions – transactions due to • Enforcement – extreme penalties for non- underwriting/market-making in certain government compliance if primary regulator quiet for 60 days. securities. • Resolution plans – writing of a ‗living will.‘ Compliance period – divestures to be completed in • Early remedy of financial distress about three or four years, perhaps as many as nine. • Intermediate holding companies Ownership restriction – cannot own hedge or PE • Limits on transactions with affiliates fund, except for bona fide fiduciary or investments • Limitations on activities – including mergers and advisory services for clients. Ownership cannot product lines; could lead to divestment. exceed 3% of the fund (after one year) and aggregate • Acquisition of banks – 5% threshold for approval equity stakes cannot exceed 3% of Tier 1 capital and • Prior review of acquisitions – to limit industry stakes will be deducted from assets and tangible concentration risks. equity (levered commensurate with leverage level of • Prohibition against management interlocks the relevant fund). Source: Fein (2010) Source: Fein (2010)

Key Trends & Recent Developments  Major swap counterparties (MSCs) would face increased scrutiny and potentially higher costs if regulated under the Dodd-Frank Act, but CFTC Chairman Gary Gensler and SEC Chairman Mary Schapiro agree the number of MSCs would be ―very small.‖ – The Wall Street Journal  The SEC plans on implementing ―Say on Pay‖ rule (one of 100 from the Dodd-Frank Act) in the next few weeks. – Market Watch  BofA already sacking prop traders to comply with Volcker Rule. – Zack‘s Investment Research  Application of Dodd-Frank is progressing and will lead to changed dynamics in US banking. – NY Times

Further Research Title (Year) Author(s) Main Thesis or Conclusion Dodd-Frank Act: Implications for Melanie Fein Summary of key provisions of the Dodd-Frank Wall Securities Activities of Banks Street Reform and Consumer Protection Act that will and Their Affiliates (2010) affect securities activities of banks and their affiliates. Dodd-Frank and Board Dino Increasing the ―accountability‖ of boards in corporations Governance: New Political- Falaschetti, and the Federal Reserve System may compromise Legal Risks to Monetary Policy Fred business judgments and monetary policy – and reviews and Business Judgments? Karlinsky, considerable evidence that, while governance reforms (2010) Richard Fidei like Dodd-Frank often promise increased productivity, their implementation can empower one set of interests (e.g., shareholders, borrowers) to gain from others‘ losses (e.g., bondholders, lenders). ―Under the Volcker Rule…‖ Ted Harding The financial services industry to devise new products (2010) means the Volcker proposals may be circumvented. The real and more challenging task is to devise regulatory responses based on an understanding of how an evolving and multi‐faceted, interconnected system actually functions.

Noted Participants Professor Laurence Kotlikoff Paul Volcker William Fairfield Warren Professor, Boston Chairman, President Obama’s Economic University Recovery Advisory Board Senior Economist, President Reagan‟s Council Chairman of the Board of Governors, Federal of Economic Advisors (1981-1982) – USA Reserve (1997-1987) – USA Professor Raghuram Rajan Chris Paolino 2003 Fisher Black Prize winner Head of Hedge Fund Investments Eric J. Gleacher Distinguished Service The Hartford Insurance Management Company Professor of Finance, University of Chicago’s – USA Booth School of Business Chief Economist, The IMF (2003-2007) – USA Larry Powell Deputy Chief Investment Officer Utah Retirement System – USA

The Great Debate: Inflation or Deflation?

Background & Description

Economists seem torn between worrying about the inflationary risks embedded in excessive stimulus spending and the deflationary risks carried by a premature curtailment of stimulus spending. Our two teams of panellists—one inflation team and one deflation team—will debate whether deflation or inflation poses the greater imminent threat to the recovery of the world economy.

Data Points M2 spiked in 2008, CPI swooned 10-year TIPS yields at all-time low, again

125 5% 120 4% 115 3% 110 105 2% 100 1%

0% M2 CPI Jan 2010 = 100 Source: U.S. Federal Reserve, U.S. Bureau of Labor Statistics Source: US Treasury Long term (1959-2010) M2 and CPI correlation is 97% but Recent record-low 10-year TIPS yields indicates investors in last 2 and 5 years (to July 2010), correlation is zero with are concerned about inflation (and bidding up prices) and M2 rising over 5% p.a. and inflation of zero and 2%, resp. not willing to risk a surprise spike in CPI.

Median CPI a harbinger of disinflation TRJ/CRB shows muted price movement

500 6% 450 400 3% 350 300 0% 250 200 -3% 150 100

CPI-All Items CPI-Core Median CPI* Source: Cleveland FRB Source: Thomson Reuters | Jefferies Cleveland FRB and Ohio State University‘s Median CPI The Commodity Research Board index shows commodity (50% and 25% more accurate than All Items CPI and Core prices spiked in 2008 (mostly due to oil‘s rise and fall) and CPI, respectively) points to falling prices in the short term. have been quite tame for the last 15 months.

Key Trends & Recent Developments  In September, Fairfax Financial Holdings Ltd. purchased $21.5-billion notional value (roughly its total AUM) of US inflation floors—an OTC derivative that pays if CPI slips below a certain level. Conversely, PIMCO has sold $8.1-billion of inflation floors over the prior six months—effectively assuming the other side of the deflation bet. Both trades are believed to be 10-year, 2% CPI contracts. – Globe and Mail  FOMC statement after September 21st meeting resulted in no change: ―With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.” – Wall Street Journal

Potential Questions/Points of Debate  Will the dramatic increase in the monetary base (M2) lead to inflation, or did it simply counter the oppressive tightening of loan standards around the globe? What should central banks focus on?  Where is gold in the debate? Is it an inflation bellweather, or does it have a momentum of its own due to demand pressures from many investor groups?  Which would be more destructive to investor portfolio values: inflation or deflation?  Is there a way to hedge against both inflation and deflation without incurring oppressive risk or costs?

Further Research Title (Year) Author(s) Main Thesis or Conclusion Why Does the Treasury Issue Matthias Fleckenstein, Contrary to classical asset pricing theory, the TIPS? (2010) Francis Longstaff, Treasury is leaving money on the table by issuing Hanno Lustig TIPS instead of traditional paper. Inflation Hedging, Asset Benedikt Fleishmann, The inflation-hedging efficacy of equities, cash, Allocation and the Investment Christian Rehring, bonds and real estate vary between short, Horizon (2010) Steffan Sebastian medium & long term horizons. Real or nominal target investors‘ asset allocation should differ. The Long Horizon Benefits of George Martin Equities are neither a good long term nor short Traditional and New Real term inflation hedge. Only TIPS, commodities, Assets in the Institutional timber and farmland hedge in both timeframes. Portfolio (2010)

Participants Marco Ruiz Mark Attanasio Head of Foreign Reserves Director of Hedge Fund Investments Central Bank of Columbia (Banco la Republica General Motors Asset Management – USA de Columbia) – Columbia

Raìvo Vanags Steve Algert Member of the Board and Head of Market Director of Hedge Fund Investments Operations The J. Paul Getty Trust – USA Central Bank of Latvia (Latvijas Banka) – Latvia