Research

M ARKET O UTLOOK A ND B EST O PPORTUNITIES 2013

Jan 31, 2013

STRATEGIC OVERVIEW FOR 2013

EQUITIES
REGION
NEGATIVE NEUTRAL POSITIVE

CAPITALIZATION
NEGATIVE NEUTRAL POSITIVE NEGATIVE

STYLE
NEUTRAL POSITIVE

U.S. NonBRIC EM BRIC Asia Europe

Large Cap Mid Cap Small Cap Micro Cap

Growth High Dividend Value

STRATEGIC OVERVIEW FOR 2013 (contd)

FIXED INCOME ALTERNATIVES
HEDGE FUNDS
NEGATIVE NEUTRAL POSITIVE
NEGATIVE NEUTRAL POSITIVE

PRIVATE FUNDS
NEGATIVE NEUTRAL POSITIVE

High Yield Non-Agency Mortgages Bank Debt Sovereign Debt EM Local Debt IG Corporates EM Corporates

Equity Market Neutral Hedged Equity Relative Value Distressed/High Yield Global Macro Structured Debt

LBO Large Cap LBO Mid Mkt Mezzanine Venture Cap Real Estate Direct Lending

STRATEGIC OVERVIEW FOR 2013

ECONOMIC OUTLOOK
Global central bank easing Increase in global industrial production and export activity US and emerging market economies reigniting Bottoming phase in Europe

ASSET CLASS OUTLOOK

Risky assets in favor versus less risk assets Equity risk premium favors equities over fixed income Mega Cap equities in the U.S. are expected to outperform Emerging Markets and Europe outperform on valuation basis Higher yielding assets are preferred in fixed income

ALTERNATIVE INVESTMENTS FAVORED STRATEGIES

Long/Short Equity Event Driven/Distressed Global Macro Structured Credit

WHAT AREAS DID WE LIKE IN 2012?

STRUCTURED SECURITIES: DEEP VALUE FUNDS
Distressed Asset Sales Non-Agency MBS ABS Distressed Real Estate

TOTAL RETURN

30%+

SPECIALIZED CREDIT FUNDS

TruPs Preferred CLO Tranches TARP Preferred

30%+

DIRECT LENDING
U.S. Mid-market Senior Debt European Bank Loans

12%+

MARKET OUTLOOK

GLOBAL ECONOMIC OUTLOOK

UNITED STATES
At year-end 2012, the White House, Senate, and House reached a fiscal cliff compromise and kicked the can down the road in order to buy time to work more extensively on a comprehensive plan to reduce spending. This helped the U.S. avoid the automatic spending cuts and a dramatic rise in tax rates, which helped to quell the risk of another recession. The U.S. private sector has strong balance sheets and the U.S. consumer has reduced their debts/liabilities to the lowest levels since the early 1980s. Recent U.S. housing data has recently turned positive relative to home price appreciation and new home/existing home sales. The government has reduced uncertainty through the fiscal cliff resolution and the continuation of QE III. As investor and consumer anxiety abates, we believe that a wave of capital and consumer spending could be unleashed. This wave could potentially raise expected GDP growth above the mediocre projected growth rate of about 2.0% by 2H2013.

GLOBAL ECONOMIC OUTLOOK

EUROPE
The ECB eliminated the regions tail risk by providing unlimited financial support through its OMT program. The region should slowly crawl out of its recession by 2H 2013 as financial conditions improve and the fiscal drags begin to wane. Asset prices have increased, bank funding conditions have improved, bank deposits are rising again, financial conditions are improving, and business sentiment is turning positive. The greatest risk to the region is political in nature, as weak growth and high levels of unemployment can engender political extremism, potentially causing social unrest. A key barometer of Europes socio-political sentiment may be expressed in Italys general election, scheduled to take place in April 2013.

GLOBAL ECONOMIC OUTLOOK

ASIA
The biggest drivers to economic growth should be China and Japan. The QE policies enacted by the governments in China and Japan to build infrastructure, increase employment, and re-inflate asset values will help to improve overall economic growth as well. In China, the new policy makers are already seeing an uptick in economic growth, which bottomed out earlier last year. In December, merchandise exports rose stronger than expected at a rate of 14.1% versus 2.9% in November. The Japanese government has approved stimulus measures with an estimated total figure of Yen 20 trillion (4% of GDP). The rise in Chinas and Japans economic growth will help to foster growth in the other Asian countries.

GLOBAL ECONOMIC OUTLOOK

EMERGING MARKETS
Overall inflation rates have abated. We should see some modest policy easing in 2013 to lift economic growth, which will be helped by a slow but steady increase in demand from developed countries. While economic growth was a bit sluggish in late 2012, it should improve in 2H 2013 in response to interest rate cuts. Emerging markets should benefit from increased risk appetite and liquidity. EM countries will need to maintain a delicate balance of avoiding potential asset bubbles, controlling capital flows, managing currency valuations, and sustaining growth without igniting high rates of inflation.

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YOU WANT MODERATE GLOBAL GROWTH BECAUSE.

Money supply velocity is abnormally low and cash balances are at extremely high levels. Any pick-up could lead to a flash of activity that will require a global concerted tightening effort. This would cause a reset in interest rates. The beneficiary, if this occurs, will be Equities, where inflation is relatively controlled and Commodities, if inflation is allowed to rise above 5%.

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AREAS OF OPPORTUNITY

WHERE ARE THE OPPORTUNITIES IN TRADITIONAL INVESTMENTS?

I. STRUCTURED DEBT SECURITIES (EXCLUDING AGENCY MORTGAGES)
A wide range of underlying collateral types (ABS, CMBS, and non agency mortgages) have attractive risk/return Securities provide exceptional yield given each expected average life of the position Durations are typically shorter than 5 years and typically less than 2 years Ability to purchase at a discount to Par and at discounts to underlying collateral value

II. EMERGING MARKET DIVIDEND STOCKS

Higher dividend yield than long duration US Bonds Higher growth rates than developed market indexes MSCI EM index trading at a 25% discount to the MSCI World

III. CHINESE EQUITY LISTED IN HONG KONG AND SINGAPORE

Monetary easing and fiscal stimulus have been implemented to help accelerate economic growth Government programs have helped to increase manufacturing and consumption boosting projected GDP above 8.0%

IV. BRAZILIAN EQUITY AND INFLATION LINKED BONDS

Government is once again deploying pro-growth policies Inflation linked bonds in local currency have more of a direct inflation link to domestic economy

V. JAPANESE EQUITY
Companies will benefit from higher impact government policies Management has moved towards more shareholder alignment

VI. VALUE INDEXES DRIVEN HIGHER BY FINANCIALS (AND TO A SMALLER DEGREE ENERGY AND AGRICULTURE)
Banks and S&Ls Specialty Finance

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HOW ABOUT SOMETHING SIMPLE?

US VALUE EQUITY
Valuation discrepancy gap between Value and Growth Financial Services capital has been restored and conservatively calculated using Basel II & III methods, except in Europe Reprieve recently given to banks in regard to liquidity buffer requirements and risk capital charges Yet limited ROE versus the past Ability to underwrite wider spread loans to improve Net Interest Margins Life Insurance return to margins in a higher interest rate environment Energy sector has fallen mostly out of the growth sectors Companies are levered to a pick up in global demand Market discount much lower prices Higher dividend Materials-Agriculture Food demand increasing in EM

Underweight Growth Equity except HealthCare Consumer Discretionary has performed too well Increasing taxes Relative valuation Lower dividends

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WHERE ARE THE OPPORTUNITIES IN HEDGE FUNDS?

LONG/SHORT EQUITY
Stock correlations have dropped below 40%. We were seeing 80% levels in 2012 when macro factors overwhelmed fundamentals in driving stock prices. Fundamental stock pickers will perform well as the dispersion of earnings, revenues, and growth rates between companies will widen in 2013. Managers should add alpha through their bets on the industry groups that will out or under perform.

EVENT DRIVEN/DISTRESSED
The strategy will benefit from continued spread compression, higher yielding assets, special situation opportunities, and continued low default rates. High yield bonds at 6.00% still provide a significant return advantage versus U.S. Treasuries or German Bunds. Special Situations such as stock buy backs, specials dividends, spin-offs, and reorganizations offer attractive opportunities.

GLOBAL MACRO
Profit opportunities will be prominent due to changing levels of market volatility and price trends in equities, interest rates, currencies, commodities, and fixed income. A relative value approach with the ability to quickly adjust gross and net exposures should perform well.

STRUCTURED CREDIT
Direct lending offers investors a favorable yield pick-up versus conventional fixed income investments. Senior secured loans to middle market companies with a tenor of five years while providing a net yield of 11% to 14%.

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WHAT COUNTRIES SHOULD WE FOCUS ON?

Country growth rates are out of sync, but policies have been orchestrated to foster growth The place to be is in the Recovery Zone (blue countries below), where: Valuation is low relative to growth potential Global Franchises with presence in each of these key areas will lead

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LARGE CAP BIAS RETURN OF THE MEGA CAPS

New Government policies have not been kind to small businesses, which has limited the pace of overall growth. These include: Obama Care taxing on small businesses Payroll tax lapsed Cheap capital for large companies provided by capital markets (Investment Grade and High Yield bonds and Loans) Limited Small Mid Market funding available for the sub $250 million issues

Yet employment is growing -

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BRAZIL AND CHINA FOCUSED -LATAM AND ASIA EXPOSURE

Both region's deceleration in 2012 was welcome, helping prevent imbalances. Production capacity has recovered in the two regions, allowing for growth potential in 2013. Both regions still need reform to prosper amid slow global recovery and reduced fiscal space. In 2012, Latin America recovered the production capacity it lost during the 2009 recession. Domestic demand continues to be the main engine of growth, thus partly compensating for external weakness. Reduced fiscal space limits the use of countercyclical measures. Given the slow global recovery and reduced policy flexibility, the region should focus on deepening structural reforms to strengthen its sources of permanent growth.

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EQUITY RETURNS PRECEDE ACTUAL CONSUMER STRENGTH

Consumer sector has rallied greatly but will the consumer actually justify the rally with increased spending.

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HISTORICALLY LOW VALUATION ACROSS MARKETS

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CONCLUSION
There is a changing paradigm in investment climate and investment alternatives due to historical low interest rates, fair to over valuation in a number of asset classes, asset return premium versus liquidity, and interest and duration risk in fixed income. Investors should seek out better absolute and relative return investments with superior collateral, asset pricing, credit risk, current yield, and trading opportunities Target Returns from 6%-20% with Std Deviation of 5%-18% estimated We believe that there are opportunities for our clients based on the above parameters, to achieve higher absolute and relative returns in Structured Credit, Emerging Markets, Asian Equity, and Hedge Funds. Structured Credit provides excellent yields, protection against rising interest rates, and excellent collateral coverage. Additionally, less competition and the capability to invest in mortgage securities and structure middle market corporate loans leads to excess return opportunities in investments that have a investment horizon from two to five years. Emerging markets in Equities and Debt provide excellent return potential. Emerging market countries are enacting growth policies that foster higher growth than developed markets and also have economies that are generating a surplus and stable currencies. Asian Equities are attractive as the central banks in China and Japan are implementing stimulus plans to foster economic growth, which should help their domestic companies as well others found in the Asian region. Hedge funds are attractive as they should benefit from lower security and market correlations. Security prices should be driven by fundamentals as opposed to macro economic factors.

Clearbook can exploit a knowledge advantage in these asset classes through our senior team, which has followed these strategies for decades.

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