HEDGE FUND STRATEGY INSIGHT REPORT JANUARY 2012

A good decision is based on knowledge and not on numbers Plato (427 BC-347 BC) - The Republic
AURELIANO GENTILINI aureliano.gentilini@mathema.co MASSIMO MAURELLI massimo.maurelli@mathema.co Leading Intelligence & Independent Insight

Executive Summary
Global Markets
Markets appeared to awaken in January to a renewed sense of optimism towards global economic perspectives, with greater appetite for risk Equity allocation models favored US equities through January as concerns about European equities mounted Despite rosier expectations, cloud formations still extend above the horizon. The macro picture remains bleak in the short run and investment themes remain sensitive to changes in economic policies and sovereign risk. Euro-area governments have to repay more than 1.1 trillion of both long- and short-term debt in 2012, of which about 519 billion of Italian, French and German debt mature in the first half of the year. European banks have about U.S.$665 billion of debt coming due in the first six months of the current year, with a further U.S.$370 billion maturing by the end of 2012 Portugal appears to have started a path towards bankruptcy. The path started in the second half of January after Standard & Poors downgraded 15 Eurozone countries, assigning Portugal a junk speculative grade, along with Greece. While Portugal's public debt (at 113% of GDP) is lower than Greece's, the private sector bear a larger amount of debt and country's total debt load is higher, at 360% of GDP Likewise 2008 the interbank market in Europe is not functioning properly: banks park their cash with the ECB as they do not trust each other. Bank-to-bank lending rates declined to fresh lows in January on both sides of the Atlantic In the unsecured funding market banks are effectively competing with sovereigns: here the problem lies A liquidity rally, driven by a successful long-term refinancing operation from the European Central Bank in December, sustained emerging stocks in January. At the same time, emerging sovereign debt spreads traded at the end of January around the lowest levels since mid-November, reflecting growing risk appetite. According to data from Nomura, foreign investors favored Japanese and South-Korean markets in the first four weeks of January Despite food price inflation, a cooling housing market, and modest manufacturing sector expansion China should maintain a vibrant rate of growth. To boost consumption, policymakers could pull a number of short-term levers. At the same time, the government is willing to invest heavily in manufacturing, particularly in the central and western regions, offering incentives to attract industrial companies inland Eurozone ten-year swap spread at the end of January still appears to incorporate less-clear information regarding changes in expectations of future economic activity Macro data on manufacturing activity are expected to confirm a sluggish start in 2012 for a number of economies As current and estimated nominal P/Es remain historically low, in absence of any macro- and market sentiment-driven stock market upside trend, any disappointment on the earnings front will hold back stock market index price Despite easing from 2011 record levels, a relatively wide three-month LIBOR-OIS spread continues to highlight a decreased banks propensity to lend to each other
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Global Risks

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Executive Summary (Contd)

Investment: risk assessment
Debt: massive trade imbalances between Eurozone peripheral countries and core countries will render any debt solution a moot point, since a country cannot balance its budget while it runs a trade deficit and its citizens and businesses also deleverage. Also, the Eurozone debt crisis poses a problem of sustainability of public finances. Taking into account the inter-temporal government budget constraintsconsidering the interest rate and the GDP growth as exogenous variablesthe common rule of thumb says that the debt ratio will increase indefinitely if the real interest rate exceeds real GDP growth, unless the primary budget is in sufficient surplus. A question arises here. Despite economic policy measures that will be enforced, is this a condition sustainable to achieve for some of the PIIGS countries in the current macro setting and faltering economic recovery? Equity: o US: near-zero rate policy and QE3 support liquidity. Low bond yields support valuations o Europe: January rally is not sustainable: deep-recession and contagion risk post fat tail risks on the downside. LTRO may affect the risk appetite for crowded trades in to high-yielding names o Emerging countries: Largest outflows already occurred during 2011. India to surprise on the upside Currency: USD to outperform vs. risks posted by political intervention, trade blocks and European crisis Commodities: Contango vs. backwardation conditions of the futures term structures of the two main grains in the agriculture index, i.e. wheat and corn, along with supply-and-demand dynamics and imbalances, will dictate investment decisions in agriculture commodities. Moderate risk in energy and potential high risk in precious metals (bubbles to burst)

Hedge Fund strategies: analysis

Compared to 2010 readings, the dispersion of manager returns in 2011, which increased significantly for Convertible Arbitrage, Global Macro, and Long/Short Equity managers, determined a lower intracorrelation, i.e., a lower correlation among managers and strategies December 2011 confirmed the steady and significant correlation pattern of most of the hedge fund strategies with the MSCI World TR Index,

Hedge Fund strategies: risk assessment

Equity Strategies: exchanges restrictions in Europe, tail risks due to short-squeezes and unwinding of crowded trades Relative Value Strategies: interbanking market (tail-risk signaled by the LIBOR-OIS spread), unconventional intervention on secondary market, volatility spikes and margin calls Credit Strategies : widening corporate spreads and default rate increase in private sector due to restrictions in borrowing and slowing growth Discretionary & Quantitative Trading Strategies: political uncertainty driving FX markets distortions and unwinding carry trades
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Rise in Global Stock Markets

S&P 500 - Index Sector Price Return
January 2012

Index Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials -3.94% Telecommunication Services Utilities
-6.00%

4.36% 5.86% -1.70% 1.48% 7.96% 2.96% 6.91% 7.58%

Markets appeared to awaken in January to a renewed sense of optimism towards global economic perspectives, with greater appetite for risk. Market sentiment was sustained by hopes for definitive agreement on a Greek bond deal, a new fiscal compact setting new measures on country budget discipline, and easing pressures on banks as the second long-term refinancing operation (LTRO) by the European Central Bank comes due on February 29 Nonetheless geopolitical risk continued to top rank investors concerns. According to the latest iteration of the BofA Merrill Lynch Survey of Fund Managers the proportion of respondents considering geopolitical risk as "above normal" has jumped to 69% in January from 48% in December 2011. Historically, this has been correlated with a spike in the oil price. Equity allocation models favored US equities through January as concerns about European equities mounted. Eurozone debt crisis, corporate profits decline, and uncertainties about European growth all weighed on investors decisions. U.S. Federal Reserves decisions to keep the door open for more quantitative easing, along with Ben Bernankes announcement it would likely keep interest rates near zero until at least late 2014, also sustained a benign market sentiment Despite rosier expectations, cloud formations still extend above the horizon. We have the opinion that the macro picture remains bleak in the short run and investment themes remain sensitive to changes in economic policies and sovereign risk. Portugal might be the next Greece in a new round of bailouts in the Eurozone region, where unemployment at the end of last year hit a record high since the introduction of the single currency

11.06%

-3.66%
-3.00% 0.00% 3.00% 6.00% 9.00% 1 2.00%

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Market Volatility
After staying in December 2011 below the 30-mark (except for December 8), implied volatility as measured by the CBOE VIX dropped 16.92% month on month in the first month of 2012 to 19.44 at the end of January, indicating that fears of a Eurozone sovereign debt crisis spreading globally receded at the beginning of the year A subdued volatility environment also sustained a stock market rally in January, with the S&P 500 Index posting a 4.36% increase. Januarys performance represents the best opening month of the Index since 1997when it posted a 6.13% in January and a 31.01% for the whole year. According to S&P figures, overall, equity markets gained U.S.$1.8 trillion in January, cutting the 2011 loss of U.S.$3 trillion by 60% in one month Macro data on manufacturing activity are expected to confirm a sluggish start in 2012 for a number of economies . In particular, Siemensthe German conglomerate that is generally taken into account as the barometer of manufacturing activity in Europe reported a 23% decline of operating profits in the first quarter Retail sales in the Eurozone dropped unexpectedly 0.4% month on month in December and 1.6% year on year, suggesting poor evidence of economic recovery in the region. The annual drop was the biggest since December 2008 when retail sales also declined 1.6% in the month. Even in Germany sales declined 1.4% compared with one month before, while sales and shoppers stayed away from the malls in France and Spain, where sales slid 0.3% and 0.8% respectively As the positioning largely changed to net-short in the second week of January, large speculators added net-short positions in the S&P 500 delta-adjusted options and futures combined to the tune of about US$6.41 billion notional value (as reported in the readings of the Commitment of Traders Report on the Chicago Mercantile Exchange for the five-week period ended January 31). As a result, large speculators outstanding notional amount on January 31 declined to the tune of US$3.61 billion net short. Large speculators net position on January 31 got close to the crowded short region that was entered at the beginning of August 2011

Daily Index Value

Large Speculator Net Position in S&P 500 Delta-adjusted Options and Futures Combined as a Percentage of Total Open Interest
0.090 0.075 Crowded Long 0.060 0.045 -0.034278 0.030 0.015 0.000 -0.015 -0.030 -0.045 -0.060 Crowded Short -0.075 -0.090 -0.105 -0.120 -0.135 -0.150 Dec May Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct 06 07 08 09 10 11 12 05

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Emerging Markets
A liquidity rally, driven by a successful long-term refinancing operation from the European Central Bank in December, sustained emerging stocks in January. Emerging markets returned 11.56% in January according to the S&P Global Broad Market Index (BMI), Emerging (compared to Decembers 1.42% decrease, and 2011s 22.92% loss), as eight countries posted double-digit gains on their path to recovery. Eqypt (+25.25%) held the top spot month on month, while Hungary (+21.81%) and India (+20.42%) were the runner up. BRIC members outperformed their peers (considered as a group), with Brazil gaining 14.81%, Russia increasing 14.23%, India up 20.42% and China adding 10.84% (slightly below the aggregate performance reading) Emerging sovereign debt spreads traded at the end of January around the lowest levels since mid-November, reflecting growing risk appetite. Similarly, emerging currencies rallied to multi-month highs since the start of January. Demand for higher-yielding assetssustained by expectations of ultra-low U.S. interest rates through late 2014 drove Latin American currencies, namely Mexicos and Chiles peso and Brazils real, to multi-month highs. Official Chinas PMI reading signaled a modest expansion in factorys activity at the beginning of the year. Data showed China's manufacturing sector expanded modestly in January, with an official PMI reading increasing to 50.5 from 50.3 in December, above a 49.5 reading according to market expectations. According to data from Nomura, foreign investors favored Japanese and South-Korean markets in the first four weeks of January. They bought US$6.52 billion of Japanese equities and US$4.61 billion of South-Korean stocks in 2012 up to January 27. Foreign net investment in South-Korean stocks up to January 27 accounted for more than 31% of year-to-date net investments into an aggregate region that includes seven Asia ex-Japan markets.

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Safe Haven Assets

Swiss franc traded within ranges in January and is expected to range-trade in the short run, mainly driven by improved sentiment in the U.S.$ currency area and expectations of Swiss National Bank's intervention. Two factors will be at play in driving money flows to safe-haven. USD/CHF cross rate is capped to the upside by broadly weaker demand for safe-haven USD as investors risk appetite improves on better-than-expected macro data, though failure to reach an agreement on Greece's second bailout loan will drive capital flight back to the U.S. dollar Because of reversing in the second week of January, according to the Commitment of Traders Report on the Commodity Exchange Inc., in the five-week period ended on January 31 large speculators sentiment on gold stayed bullish (for the same period net-long exposure amounted to approximately US$8.93 billion notional value). Increasing since December close, outstanding net long exposure to gold for the overall five-week period ended January 31 peaked to the tune of about US$32.72 billion notional value Leading Intelligence & Independent Insight 7

Tail Risk Market Expectations

Despite easing from November and December 2011 highs the Eurozone ten-year swap spread at the end of January still appears to incorporate less-clear information regarding changes in expectations of future economic activity After surging towards the end of November last year at levels close to those recorded in mid-December 2008, the annualized ten-day rolling window volatility of the euro swap spread tapered off at the end of January, appearing to reflect more-stable and lessnegative expectations about the aggregated likelihood of default prevailing among market participants. Investors shrugged off concerns about a contagion effect in the Eurozone, triggered by the debt crisis, An early propensity to risky assets investing appeared to dominate investors agenda in January

Basis Points

Percentage

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Tail Risk Stock Market Positioning

U.S. stock market closed the last trading session of January on a flat note as a number of economic reports took investors by surprise. After declining 0.7% month on month in October, the S&P/Case-Shiller composite index of singlefamily home prices in 20 metropolitan areas decreased in November a higher-thanexpected 0.7% on a seasonally adjusted basis. At the same time an index of consumer attitudes published by the U.S. Conference Board Board dropped to 61.1 in January from 64.8 for December. A gloomy perspective of both the job market and disposable income weighed on consumers sentiment. Also, weighing on the market sentiment was a report that showed business activity in the U.S. Midwest grew lower than expected in January. Weaker labor market conditions contributed to the disappointing reading As current and estimated nominal P/Es remain historically low, in absence of any macro- and market sentiment-driven stock market upside trend, any disappointment on the earnings front will hold back stock market index price. Earnings growth for the S&P 500 Index is expected to be 9% for the current year The ten-day exponential moving average of the CBOE Equity Put/Call Ratio, a gauge of the sentiment of speculative traders (which hit a multi-year record low of 0.472 on April 15, 2010 and a 2011 low on January 19) continues to move along a pattern to the downside within the bullish-bearish range
9

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Credit Spreads
Eurozone, CDS, 5 Year
11000 10000 9000 8000 7000 6000
Greece: 10,306.27 bps on 5 January, 2012

As central banks maintain dovish monetary stances and the U.S. Federal Reserve pledges to keep rates low through late 2014 high-yield debt are expected to benefit from investors hunt for yield. Credit markets in January were characterized by a massive supply/demand imbalance as scarcity of new supply in recent months did not match investors demand. At the same time, high-yield mutual funds posted massive inflows in JanuaryUS$5.79bn recorded year to date according to Lipper FMI data As a result of the supply/demand imbalance above, the average price of junk bonds rose above par for the first time since August. January recorded a healthy return of 2.9%, according to the BofA-Merrill Lynch High Yield Master II Index Standard & Poor's estimated the 12-month-trailing speculative-grade corporate default rate to have increased significantly, to 2.37% as of January 31 from 1.98% in December, as Eurozone problems persist and concerns about slowing global growth continue to impact investment decisions. Standard & Poors highlighted that default rate is a lagging indicator, and an increasing trend usually results from sustained deterioration in both market fundamentals and economic growth." Despite positive U.S. macro readings and narrowing spreads, as investors risk aversion did not fade away due to uncertainties about haircuts on Greek debt and the timing of a resolution to the Eurozone debt crisis the U.S. distress ratio decreased to 15.3% in January, according to Standard & Poor's Global Fixed Income Research. Januarys reading of the distress ratio stood at levels higher than those posted in August and September last yearwhen fears of a Eurozone sovereign default caused it to spike. Portugal appears to have started a path towards bankruptcy. The path started in the second half of January after Standard & Poors downgraded 15 Eurozone countries, assigning Portugal a junk speculative grade, along with Greece. Portugals speculative grade and the current levels of bond yields make almost impossible for Portugal to access debt markets The cost of insuring debt against default (through CDS) and the levels of yield on Portugal debt have climbed since the downgrading to a junk status. As expected, Portugals yield curve inverted, signaling a crisis of confidence on Portugal debt
10

5000 4000
Portugal: 1,600.98 bps on 31 January, 2012

3000
Ireland: 1,249.106 bps on 19 July, 2011

2000 1000
France: 245.27 bps on 25 November, 2011

Italy: 586.7 bps on 15 November, 2011 Spain: 484.09 bps on 23 November, 2011

0 Feb

Nov 08 Italy

Feb

May

Aug 09

Nov Spain

Feb

Ireland

May Aug 10 Portugal

Nov

Feb

May

Greece

Aug Nov 11 France

12

Markit, CDX Indices, 5 Year

1100 1000 900 800 700 600 500 400 300 200 100 0 Dec 06

Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug 07 08 09 10 11 Emerging Markets, CDX Index, EM North America, CDX Index, IG

Dec 12

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Commodities

The S&P GSCI rose 2.23% in January, mainly driven by strength in the metals. Benign market sentiment buoyed by rosy macro readings in the U.S. and China, along with U.S. dollar weakness in January, provided support for commodities. The S&P GSCI Precious Metals index held the top spot for January as it posted a 11.98% gain month-on-month, while the S&PGSCI Industrial Metals index was the runner up with a 10.13% increase. Silver top performed among all the S&P GSCI commodities in January, with a 19.16% increase month on month in the S&P GSCI Silver index. On a 20-day rolling window annualized volatility basis, silver traded at the end of January 1/24th the daily volatility of gold (27.4% versus 669.1%) Oil prices rose 3.17% in January as supply worries from OPEC's second-largest producer, Iran, weighed on supply-and-demand dynamics The S&P GSCI Agriculture Index was the bottom performing sector index in January with a modest 0.03% increase. A decline in wheat prices determined the poor performance for the subsector. A considerable increase in exportable grain production in Ukraine, along with estimates of the largest Australian wheat crop in history and the potential that Australia will export 20 million metric tons throughout 2012the most ever according to the USDAs Foreign Agriculture Serviceadded to pressure on wheat Safe haven drivers apart, in the last two years trade weighted US dollar, in general, and EURUSD cross rate, in particular, have been the key determinants of gold price movements. We expect that a weakening euro will continue acting in the short run as a key factor in curbing any gold price gains. Also, aggressive long-term refinancing operation (LTRO) by the ECB are expected to cap gold price movements to the upside.
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Yield Curves
U.S. Yield Curve, December 30, 2011, January 31, 2012, and January 31, 2011 (source: Mthm calculations on market data)
5 4 3 2 1 0

30-Dec-2011 31-Jan-2012 31-Jan-2011

An improved market sentiment sustained by: a) rosier perspectives about the global economy, b) lower concerns about the eurosovereign debt crisis, and c) U.S. Fed chairman Bernanke announced plans to keep rates low until late 2014which buoyed secondary markets in the last few trading sessions of the monthdrove outperformance in January in higher yielding country debts Those sovereigns, such as Norway and New Zealand, that benefited in previous months of flight-to-quality drivers lagged in the performance ranking for January Amid signs of an improving economy, Mexico held the top spot in January as investors directed money flows to the country, following Bernankes decision to maintain a zero interest rate policy until late 2014 and Mexicos central bank decision to keep its overnight rate at 4.5%

Y ie ld

1 month

3 month

6 month

1 year

2 year

3 year

5 year

10 year

20 year

30 year

Maturity

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5

Eurozone Yield Curve, December 30, 2011, January 31, 2012, and January 31, 2011 (source: Mthm calculations on market data)

Y ie ld

30-Dec-2011 31-Jan-2012 31-Jan-2011

Steepening trades on the Eurozone yield curve were profitable in January US 30yr-2yr yield spread 8 bps yield curve steepening and a negative 1-bp average shift month on month at the end of January Eurozone 30yr-2yr yield spread 8 bps yield curve steepening and a positive 9-bps average shift month on month on January 31

1 month

3 month

6 month

1 year

2 year

3 year

5 year

10 year

20 year

30 year

Maturity
Greece Yield Curve, December 30, 2011, January 31, 2012, and January 31, 2011 (source: Mthm calculations on market data) 30-Dec-2011 31-Jan-2012 31-Jan-2011

250.0 200.0 150.0

Y ie ld

As the agreement over Greeces debt restructuring and deal with private bondholders failed to materialize in January, Greeces yield curve continued to stay inverted, with 2-year government benchmark yield peaking at a record 219.52% on January 31

100.0 50.0 0.0

1 month

3 month

6 month

1 year

2 year

3 year

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10 year

15 year

30 year

Maturity

12

Leading Intelligence & Independent Insight

Yield Curves
UK 30yr-2yr spread 6 bps yield curve flattening and a negative 1-bp average shift month on month at the end of January 2012
UK Yield Curve, December 30, 2011, January 31, 2012, and January 31, 2011 (source: Mthm calculations on market data)
5.000000 4.000000 3.000000 2.000000 1.000000 0.000000

The Bank of England is expected to extend in the first week of February its bond-buying program by at least GBP50 billion from GBP275 billion. Disputes mounted around the additional round of the money supply program in the UK despite some recent survey evidence suggested that the UK economy enjoyed a spike up in activity in January after GDP contracted 0.2% quarter-on-quarter in the fourth quarter of 2011. Lord Lamont, former Chancellor in the John Major government, has slammed quantitative easing (QE) as a "panic measure" that could damage the recovery

Y ie ld

30-Dec-2011 31-Jan-2012 31-Jan-2011

1 month

3 month

6 month

1 year

2 year

3 year

5 year

10 year

20 year

30 year

Maturity

2.5 2.0 1.5

Japan Yield Curve, December 30, 2011, January 31, 2012, and January 31, 2011 (source: Mthm calculations on market data)

Japan 30yr-2yr yield spread as global risk sentiment resumed Japans yield curve was almost flat month on month amid reduced safe-haven appeal of yen and yen-funded carry trades, and expectations of Japan MOF's yen-selling intervention

Y ie ld

1.0 0.5 0.0

30-Dec-2011 31-Jan-2012 31-Jan-2011

1 month

3 month

6 month

1 year

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10 year

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30 year

Maturity

13

Leading Intelligence & Independent Insight

Yield Curves
Portugal 30yr-2yr spread 110 bps yield curve flattening and a positive 410-bps average shift month on month at the end of January. Portugals yield curve amplified its inversion in January as short-end yields rose an average 494 bps compared to an average 295 bps increase in the long-end segment
Y ie ld
25.0 20.0 15.0 10.0 5.0 0.0

Portugal Yield Curve, December 30, 2011, January 31, 2012, and January 31, 2011 (source: Mthm calculations on market data)

30-Dec-2011 31-Jan-2012 31-Jan-2011

Italy 30yr-2yr yield spread 122 bps yield curve bull steepener and a negative 115-bps average shift month on month at the end of January 2012. Managers in fixed income strategies locked in profits in January through steepeners on Italys yield curve

2 year

3 year

5 year
Maturity

10 year

15 year

30 year

Italy Yield Curve, December 30, 2011, January 31, 2012, and January 31, 2011 (source: Mthm calculations on market data)
8.000000 7.000000 6.000000 5.000000

Y ie ld

4.000000 3.000000 2.000000 1.000000 0.000000

30-Dec-2011 31-Jan-2012 31-Jan-2011

3 month

6 month

9 month

1 year

2 year
Maturity

3 year

5 year

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30 year

14

Leading Intelligence & Independent Insight

Money & Interbanking Markets

Euro three-month Ted spread (the difference between three-month Libor

interbank rates and Treasury Bill yields) as a measure of stress in the Eurozone, just as it anticipated the credit crisis in 2007, declined 25.51% in January from multi-year record level posted on December 29 last year at 148.229. Despite easing from 2011 record levels, a relatively wide three-month LIBOR-OIS spread, which is the difference between the rate banks charge for loans in the interbank market and the overnight index swap ratewhich captures central bank interest-rate riskcontinues to highlight a decreased banks propensity to lend to each other Bank-to-bank lending rates declined to fresh lows on both sides of the Atlantic. In both cases Central Banks action offered a silver lining. In the Eurozone, the European Central Bank (ECB) is poised to offer the second long-term refinancing operation (LTRO) at the end of February. In the U.S. Federal Reserve Chairman Ben Bernanke lent support to expectations about a new program of about $600 billion of asset purchases to further stimulate the economy in the first half of the year 15

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Money & Interbanking Markets

Despite being swamped with ample liquidity as the European Central Bank pumped 489 billion into the system in December in its first-ever offering of 3-year refinancing operations, banks recourse to the European Central Bank deposit facility overnight was sustained throughout January, with aggregate average deposits for the month staying above the 480-billion mark As Eurozone banks continue to park excess funds at the ECB overnight deposits at the ECB hit a record high of 528 billion at the peak of the ECB's last reserves period in the week ending January 20. Deposits dropped to 492 billion on January 23 as banks arbitrage on the greater degree of freedom they have at the start of the monthly ECB reserves cycle

16

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Sovereign Benchmark Yields

Markets continue to neglect the potential deterioration of financial conditions in peripheral Eurozone countries and some Central and Eastern European countries

The sentiment only increases the potential of a market correction. Should conditions change adversely the impact on opening positions would be dramatic

A crisis of confidence in Greece is still evident as the two-year government benchmark yield continues to climb well above the tenyear government benchmark. On January 31 Greeces two-year government YTM peaked at a record 225.239%
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Sovereign Benchmark Spreads

Alleging a worsening outlook and vulnerability in the near-term to monetary and financial stocks, on January 27 Fitch downgraded the sovereign credit ratings of Belgium, Cyprus, Italy, Slovenia, and Spain, Fitch also indicated there was a 1-in-2 chance of further cuts in the next two years 10-year Eurozone sovereign spreads continued to widen for Greece and Portugal in January Greeces and Portugals 10-year sovereign spreads against German Bund hit new record highs at the end of January at 32.509% and 15.553%, respectively Italys sovereigns sold off after January 13 as market participants responded to a rating downgrade to BBB+ with negative outlook by S&P, which cited rising external financing risks. Debt fears also mounted after Standard & Poors cut its AAA rating for two major European economies, France and Austria, as well as for the European Financial Stability Facility Following the double digit returns that posted in 2011 both Denmark and Sweden, the two countries suffered a loss on their sovereign debt in January Irelands sovereign debt continued to show some resilience as 10year yield spreads decoupled from a generalized widening pattern

18

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Hedge Fund Strategy Performance

Comparative Hedge Fund Index Performance: Dow Jones Credit Suisse Indices
410

Asian Crisis Aug-Oct '97 Russian Financial Crisis & LTCM Collapse - Jul-Sep '98

Bull Market Rally - April '03August '07

Greece's Fiscal Position Crisis December '09

Convertible Arbitrage Dedicated Short Bias ED Distressed Securities ED MultiStrategies ED RiskArbitrage Emerging Markets Equity Market Neutral

370

Post Credit Crisis March '09

330

290

Tech Stocks Bubble Collapse Feb'00-Mar'03

Credit Crisis August '07-Feb '09

250

210

Event Driven Fixed Income Arbitrage Political Unrest in MENA & Earthquake in Japan Jan-March '11 Global Macro Eurozone Debt Crisis - MayJune '11 Long/Short Equity Multi-Strategies Managed Futures

170

130

90

50
A ug -9 7 Fe b98 A ug -9 8 Fe b99 A ug -9 9 Fe b00 A ug -0 0 Fe b01 A ug -0 1 Fe b02 A ug -0 2 Fe b03 A ug -0 3 Fe b04 A ug -0 4 Fe b05 A ug -0 5 Fe b06 A ug -0 6 Fe b07 A ug -0 7 Fe b08 A ug -0 8 Fe b09 A ug -0 9 Fe b10 A ug -1 0 Fe b11 A ug -1 1

Short bias outperformed in December (+1.65%, returning 3.85% for 2011) as the strategy benefited from global stock markets declines and uncertainties on the macro front until mid-December. Performance for the strategy was capped thereafter as stock market volatility tapered off in the second half of the month and the Santa rally detracted from monthly return. Global Macro (+6.44% year on year on December 30) held the top spot in the performance league table for the whole year 2011. In the last part of the year the strategy benefited from a number of profitable trades along the various ends of the yield curves on both sides of the Atlantic, and short euro vs. long U.S. dollar exposure

Comparative Hedge Fund Index Performance:Dow Jones Credit Suisse Indices

175 170 165 160 155 150 145 140 135 130 125 120 115 110 105 100 95 90 85 80 75 70 65 60 55 50 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11

Convertible Arbitrage Dedicated Short Bias Event Driven Distressed Securities Event Driven MultiStrategy Event Driven Risk Arbitrage Emerging Markets

Equity Market Neutral Event Driven

Event-driven Multi-Strategies (-1.25% month on month in December, -11.96% for 2011), bettered by Long/Short Equity (-0.88% month on month, -7.31% year on year at the end of December) and Emerging Markets (-0.70% month on month, -6.68% for 2011), ranked at the bottom of the performance league table of the various hedge fund substrategies for the whole year

Fixed Income Arbitrage Global Macro

Long/Short Equity

Multi-Strategies

19

Leading Intelligence & Independent Insight

Hedge Fund Strategy Performance Dispersion

Dispersion of Hedge Fund Strategy Returns (Dow Jones Credit Suisse HF Indices January 1994-December 2011)
12

10

After peaking at record levels in September last year, monthly performance dispersion among the Dow Jones Credit Suisse hedge fund strategy indices at the end of 2011 declined significantly at readings close to pre-2008 crisis levels. It decreased 4 bps month on month in December (332 bps below 2010s highest level in September) and ended at 289 bps, signaling the market of hedge fund strategies was more crowded Generally speaking, compared to 2010 readings, the dispersion of manager returns in 2011 increased significantly for Convertible Arbitrage, Global Macro, and Long/Short Equity managers (in the chart on the left, positive returns are in sky blue on the right bar; negative returns are in blue on the left bar; red lines on the bars indicate median values). An increased dispersion of returns generally determines a lower intracorrelation, i.e., a lower correlation among managers and strategies. Generally, lower intracorrelation among managers and hedge fund strategies leads to higher levels of diversification for investorsa desirable featureas well as higher expected risk-adjusted returns. Notably, in the Global Macro sectorthe top-performing strategy for 2011more than 43% of the funds tracked in the analysis posted positive returns for the period, with 14% of the funds recording performance equal to or above the 10% threshold. About 87% of the funds classified in the runner-up strategy in the performance league table for 2011Fixed Income Arbitragedelivered an annual performance in positive territory, with 13% recording monthly returns equal to or above the 10% threshold.
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31 /0 31 1/1 /0 99 7 4 31 /1 /0 99 1 4 31 /1 /0 99 5 31 7/1 /0 99 1 5 31 /1 /0 99 7 6 31 /1 /0 99 6 31 1/1 /0 99 7 7 31 /1 /0 99 7 31 1/1 /0 99 7 8 31 /1 /0 99 8 31 1/1 /0 99 7 9 31 /1 99 /0 1 9 31 /2 /0 00 7/ 0 31 2 /0 00 1 0 31 /2 /0 00 1 31 7/2 /0 00 1 1 31 /2 00 /0 7 2 31 /2 /0 00 2 31 1/2 /0 00 7 3 31 /2 00 /0 3 31 1/2 /0 00 7 4 31 /2 /0 00 4 31 1/2 /0 00 7 5 31 /2 /0 00 1 5 31 /2 /0 00 6 31 7/2 /0 00 1 6 31 /2 /0 00 7 31 7/2 /0 00 1 7 31 /2 /0 00 7 8 31 /2 /0 00 8 31 1/2 /0 00 7 9 31 /2 /0 00 9 31 1/2 /0 01 7 0 31 /2 01 /0 0 31 1/2 /0 01 7/ 1 20 11

-4.35

Multi-Strategy Managed Futures Long/Short Equity Global Macro Fixed Income Arbitrage Event Driven Equity Market Neutral Emerging Markets Dedicated Short Bias Credit Focus Convertible Arbitrage

-66%
-4.54%

47% -46%
-6.0%

117% 198%

-59%
-3.53%

-41%
6.07%

105% -22%
-1.28%

29% 41%
1.63%

-36% -14%
-12.58%

73% 55%
3.49%

-70% -15%
2.82%

53% 25%
0.49%

-23% -76%
-60% -40% -20% 0%

13%
20% 40% 60% 80% 100% 120% 140% 160% 180% 200%

-120% -100% -80%

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Hedge Fund Strategy Correlations

Correlation of Credit Suisse Dow Jones HF Strategy Indices Vs. MSCI World TR Index December 31, 2011
Correlation 6 Months Correlation 1 Year Correlation 3 Years
1 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 -1

Correlation of Credit Suisse Dow Jones HF Strategy Indices Vs. Reuters/Jefferies CRB Index December 31, 2011
Correlation 6 Months 1 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 -1 Correlation 1 Year Correlation 3 Years

In an era when sovereign risk persists a risk-on/risk-off paradigm creates an investment environment where correlation across asset classes zeroes out the benefit of diversification. Correlation across various asset classes and markets at the end of 2011 remained close to historical highs. Among other factors, the six-month rolling correlation between the S&P GSCI and the S&P 500 at the end of December 2011 stood at 0.84, two notches below the highest reading since October 1980 recorded at the end of November 2010. A similar reading was observed for the six-month correlation between the S&P GSCI and the MSCI World TR.

December 2011 confirmed the steady and significant correlation pattern of most of the hedge fund strategies with the MSCI World TR Index, similarly to what has been evidenced throughout 2010. Dedicated Short-Bias, along with Managed Futures, and, although of a lower magnitude, Global Macro, continued to show a negative correlation against the index (-0.97, -0.56, and -0.19 for the six-month period at the end of December, respectively). The Credit Suisse Dow Jones Hedge Fund Composite Index recorded a firm level of positive correlation with the global stock market index at 0.91 for both the sixmonth and one-year periods. Equity hedge strategies, namely Long/Short Equity, along with Event-Driven and Equity Market-Neutral, continued to be somewhat long-biased; in other words, the strategies maintained a significantly high positive correlation to equities (a correlation between 0.92 and 0.99 for the six-month period) despite macroeconomic themes and macro information flow arrival dominated financial markets for most of 2011a frustration for stock pickers
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Investment Risk Assessment

INVESTMENT RISK TYPE
Europe: default in Greece & Portugal, rising borrowing cost in Spain, Italy & France. US: curve steepening

RISK LEVEL
Very High

COMMENTARY
Eurozone: massive trade imbalances between peripheral countries and core countries will render any debt solution a moot point, since a country cannot balance its budget while it runs a trade deficit and its citizens and businesses also deleverage. US: zero-rate policy and QE3 will push yield curve to steepen as markets anticipate the end of the long bull market in fixed income.

Sovereign Debt

High

Spread widening

High Moderate

Corporate Debt

Default rate increase

Sovereign crisis to infect he corporate sector: global recession, borrowing constraints and FX volatility put pressures on corporate debt. Financials in Europe: growing fears of multiple defaults makes most of the banks in Europe at risk of being insolvent with the need of hundreds of billions of euros of new capital. Two opposing forces at work: 1) massive deleveraging (recessionary and deflationary force) and 2) aggressive monetary easing in history by the Fed and other central banks (seeding the next inflationary asset bubble). Deflationary forces to give way to the monetization of sovereign debt and the resulting inflation. Near-zero rate policy and QE3 support liquidity. Low bond yields supporting valuations. US Industrial growth diverging positively from stagnant international industrial growth rate. Macro news affect volatility. January rally is not sustainable: deep-recession and contagion risk post fat tail risks on the downside. LTRO may affect the risk appetite for crowded trades in to high-yielding names. Largest outflows already occurred during 2011. The magnitude of China soft landing together with news from Europe may affect short-term volatility. India to surprise on the upside.
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Prepayment Risk

Low Low

Mortgages

Interest Rate Risk

Liquidity Volatility -

Low - Mid- Low

Equity US

Leverage

Liquidity Volatility -

Mid-High - High

Equity Europe

Leverage

Equity Emerging Markets

Liquidity Volatility Leverage

Mid Mid - Low

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Investment Risk Assessment (Contd)

INVESTMENT RISK TYPE RISK LEVEL COMMENTARY
Volatility Government Very High Moderate USD to outperform: obstructionist debate around presidential elections easing, international investments in U.S. gas resourcesfor the first time since the 1950s the U.S. became a net energy product exporter as supplies of North American natural gas rapidly increasedChina need of liquidity to sustain growth, and weakness of the Euro all suggest an upward pressure on the U.S. dollar.

FX rates

Restrictions

Energy/Metals

Moderate

Contango vs. backwardation conditions of the futures term structures of the two main grains in the agriculture index, i.e. wheat and corn, along with supply-anddemand dynamics and imbalances, will dictate investment decisions in

Commodities

Agriculture

Low

agriculture commodities. Metals at peaks level: recession in Europe and China soft landing are expected to put pressure on the downside. Gold price might be back soon at levels where the bubble could burst. In a low interest rate

Precious Metals

High

environment gold is considered by many investors as a quasi-currency. Eurozone-defaults, employment readings in the US, tensions in Iran, the magnitude of China soft landing, and political worries in East-Europe all pose a potential major threat to the markets.

Volatility

Tail Risk

High

Emerging Markets

Debt Equity

Moderate Moderate/Low

The withdrawal of European banks from the EM syndicated loan market coupled with low long term rates could make 2012 a record year for net EM corporate credit issuance

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Leading Intelligence & Independent Insight

HF Strategies Risk Assessment & Outlook

HF STRATEGY RISK COMMENTARY
Exchanges restrictions in Europe on top of Eurozone debt collapse are still set for a high-volatility bear market. US: quality large cap names maintain attractive valuations while many small caps have becoming overvalued.

Short

Medium-Long

Equity Hedged

EU: Short selling Ban, recession and widening corporate spreads. US: seasonally adjusted unemployment and consumption readings disappointing

NEUTRAL TO NEGATIVE (EU) NEUTRAL TO POSITIVE (US)

POSITIVE +

Equity Market Neutral

Short-selling ban; momentum drivers

Positive: fundamental factors increasingly overstating political and macro factors. Negative: sector rotation & unpredictable political interventions Unless uncertainty on macro scenarios fades away and volatility in the global financial markets tapers off M&A activity is seen muted in the short run. The factors above are keeping the IPO and M&A markets on a leash. Nonetheless, Facebook may initiate a new season of IPOs. Potentially, high liquidity supports M&A and shares buy-backs. Recession in Europe weighs on the negative side; risks remain on macro environment Worsening conditions in borrowing costs are expected to affect assets swaps and corporate financing in a stagflationary environment Convertible Arbitrage will be negatively impacted by worsening bond valuations as equity markets reverse recent rallies and credit-spread widening. Should a market shock materialize , liquidity might become an issue and exit trades an expensive exercise
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NEUTRAL

POSITIVE

Equity Event Driven

Macro environment

NEUTRAL

POSITIVE+

Credit

Widening corporate spreads

NEGATIVE

NEUTRAL/ POSITIVE

Convertible Arbitrage

Widening spread; tail-risk

NEUTRAL

NEUTRAL

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HF Strategies Risk Assessment & Outlook (Contd)

HF STRATEGY RISK COMMENTARY
The continuing impact of the Volker Rule, together with increasing bank regulation (Dodd-Frank, Basel III) will result in less competition for trades, with bigger dislocations and potentially higher volatility than in the past, as banks have a diminished capacity to warehouse risk. This environment, coupled with coordinated support from Central Banks, generate increasing arbitrage opportunities along the various ends of the yield curves and debt structure of private sectors. US: High yields - or low price-to-rent ratios - putting upward pressure on prices over the longer term; QE3 and larger asset purchases announced by the U.S. Federal Reserve support liquidity in the segment; zero-rate policy protecting from interest rate risk. Europe: banks are forced to sell NPLs. Massive injection of liquidity (LTRO, QE3), central banks coordination, improving US economy, soft vs. hard landing in China all support a lower risk environment (government intervention vs. fundamentals). Directional FX and Equity trades offering best opportunities; riskier trades exist in rates & commodities. Currency & equity positive vs. commodities & rates neutral

Short

Medium-Long

Fixed Income Arbitrage

Unconventional intervention on secondary market

POSITIVE

NEUTRAL

MBS/ABS Arbitrage

Negative surprise on U.S. growth and unemployment readings; real-estate bubble to burst vs. soft deleveraging in European markets

NEUTRAL/ POSITIVE

POSITIVE

Global Macro

Political uncertainty; FX markets policy intervention

NEUTRAL

NEUTRAL/ POSITIVE

Managed Futures

FX markets distortions; unwinding carry trades

NEUTRAL Discretionary trading POSITIVE Systematic trading

POSITIVE

Emerging Markets

China growth & liquidity issues

Positive factors include lower liquidity risk due to global coordination among central banks and rising appetite for NEUTRAL TO POSITIVE investing in emerging economies. Recession and debt NEGATIVE defaults in Europe still represent the main threat. Leading Intelligence & Independent Insight 25

Disclaimer
Mthm 2012. All Rights Reserved. The report was closed with information available as of the market close on January 31, 2012. Mthm Hedge Fund Strategy Insight Reports are for informational purposes only, and do not constitute investment advice or an offer to sell or the solicitation of an offer to buy any security of any entity in any jurisdiction. Although the information herein is believed to be reliable and has been obtained from sources believed to be reliable, we make no representation or warranty, express or implied, with respect to the fairness, correctness, accuracy, reasonableness or completeness of such information. No guarantee is made that the information in this report is accurate or complete and no warranties are made with regard to the results to be obtained from its use. Mthm will not be liable for any loss or damage resulting from information obtained from this Report. Furthermore, past performance is not necessarily indicative of future results. This report is for individual and internal use only. It may not be reproduced or transmitted in whole or in part by any means, electronic, mechanical, photocopying, or otherwise, without Mthm's prior written approval.

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