Sudler

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FEAC_at_ND
Quo Vadis? Where to Now?
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Words of Wisdom
Any plan conceived in moderation, must fail
when
circumstances are set in extremes Prin
ce Metternich Convictions are more dangerous
enemies of truth than lies Friedrich
Nietzsche
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Old Plan Produced Poor Returns For Over a Decade
GOLD Buffet
SP NASDAQ
2000 2001
2002 2003 2004
2005 2006 2007
2008 2009
Source Bigcharts.com
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Hedged Equity Outperforms for Nearly Two Decades
Hedge Funds and SP 500 Historical Performance
For 19 Year Period, SP 500 returned 5.6, Hedge
Funds returned 13.1
Source Bloomberg, HFRI
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How Did We Get Here?
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Words of Wisdom

• And you may ask yourself, well, how did I get
  here?
• David Byrne Talking Heads
• A surplus of cash led to a shortage of sense
• Marc Faber Gloom,
  Doom Boom Report

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Total Credit Market Debt as a Percentage of U.S.
GDP 1922-2008
How We Got Here 56 Years of Increasing Leverage

• Massive build-up of corporate and consumer
  leverage supported by falling interest rates,
  declining underwriting standards and reduced
  regulatory oversight.

Source Federal Reserve, U.S. Commerce Dept., Ned
Davis Research
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Deflation Hit Equities Hard in 2008, Just Like
1930s

• The SP experienced its 2nd largest decline ever
  from its all-time high in Oct 07 (almost 52),
  second only to the drop in 32 (over 80).
• SP 500s 2008 loss of 37 was second worst
  annual loss (largest was 1931 decline of 43)

Source Bloomberg
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Huge Government Policy Response to Deflation
Threat
Federal Reserve Assets B
Federal Reserve Liabilities B

• Federal Reserve balance sheet increased by over
  100 in last year
• TARP legislation includes huge investments,
  loans, guarantees
• AIG/Fannie/Freddie/Citi bailouts requiring
  massive commitments

Source Federal Reserve Release H.4.1.
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Fed Writing Checks Their Body Cant Cash ??
Source TIS Group
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Where Do We Go From Here?
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Words of Wisdom
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Demographics Points to Deflationary Shake-Out
Source HS Dent Foundation
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Deflation Deleveraging A Lethal Combination
Source UBS
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Worse Than Normal Recession, not Depression, Yet

• Annual GDP Growth (Recession) Range -2 to -5
• 4Q 2008 -6.2
• 1Q 2009 -6.5
• 2Q 2009 -4.5 (projection)
• Average 3.5 (1930-present)
• Unemployment (Repession)
• 8 to 15
• June 9.4
• GS forecasts at least 10 by the end of 2011
• Average (Post-WW II) 5.6

Source Bloomberg
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But, Deflation Cycles Can Last LONG Time
Source GMO
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Developed World Deep in Debt, Race to Become Japan
Source CLSA
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Seen This Movie Before More Debt, Stocks
Yields Fall
Source Hoisington Capital Management
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Market Outlook
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Financial Crisis Keeps Growing, Trouble for Banks
New IMF Estimate is 4.1 Trillion (only 1.5
Trillion written off)
Source IMF Annual Report
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Forecast Equity Returns Attractive, But Path
Dependent
Absolute Return Alpha
7.5
Source GMO
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Current Trends Suggest Lower Future Returns
May be difficult to match long-term domestic
equity performance going forward.
Source of Equity Returns Current Environment
Source of Equity Returns SP 500 1926-2008
10.8

• Price Earnings Multiples remain above long term
  average levels
• Real Earnings Growth is expected to be
  below normal for some time
• Dividends remain at below average levels
• Inflation is currently much lower than the
  historical average

P/E Expansion (1.3)
Real Earnings Growth (2.1)
5.0
P/E Expansion (0) At Best
Dividends (4.3)
Real Earnings Growth (1.1)
Dividends (2.9)
CPI / Inflation (3.1)
CPI / Inflation (1.0)
Source Research Study conducted by Ibbotson
Chen. Research Report dated 2000. Study has not
been replicated since 2000. Statistics above
may not reflect current market statistics.
Dividends represent dividend yield of Standard
Poors 500 as of 12/31/08. Inflation rate
reflects CPI as of 12/31/08 (information from
Labor of Bureau Statistics).
Source Hatteras Investment Partners
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Traditional Portfolios Will Struggle to Meet
Objectives
In the past, a traditional portfolio of equities
and bonds generated enough return to meet your
investment objectives. However, this may not be
the case in the near future.
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100 Equities
10
Investment Objective gt 10
60/40 Mix
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100 Fixed Income
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Rate of Return
100 Cash
100 Equities
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60/40 Mix
Historic Performance 1926-20031
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100 Fixed Income
Efficient Frontier Current Environment2
100 Cash
0
0
3
6
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1 Ibbotson 2004 Yearbook 2 GMO Expected Returns,
60/40 Mix 60 SP 500, 40 LGCI
Risk
Source Hatteras Investment Partners
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Making the Case for Building a Different CORE
Portfolio
Adding Uncorrelated Investments to the
Traditional Portfolio can boost expected returns,
while reducing portfolio volatility.
Alternative asset classes, contribute to the
portfolio construction process by pushing back
the efficient frontier, allowing the creation of
portfolios with higher returns for a given level
of risk or lower risk for a given level of
returns. David Swensen
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100 HFRI FoF Index
10
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40 FoF Added
Rate of Return
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20 FoF Added
100 Equities
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100 Fixed Income
60/40 Mix
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Efficient Frontier of Traditional Asset Classes
Current Environment1
Efficient Frontier with HFRI Fund of Funds Added
Current Environment1,2
Incremental Addition of HFRI Fund of Funds to
60/40 Stock/Bond Mix
100 Cash
0
0
3
6
9
12
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1 GMO Expected Returns, 60/40 Mix 60 SP 500,
40 LGCI 2 PerTrac Model
Risk
Source Hatteras Investment Partners
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Trouble With Bubbles is They Tend to Overcorrect
Real Issue Is Where Are We Now?
Source GMO
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Earnings Still Under Pressure, Estimates Too High
Source TIS Group
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Valuations Will Fall Whether Deflation or
Inflation
10.8
Strategas
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History Says Likely to be Another Serious Leg
Down
Source GMO
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Growth Investing in Future Leads to Developing
World
Population Growth Creating Huge Bottom of the
Pyramid
Source MSN Encarta
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Wealth Moved West Following Industrial Revolution
Source Hamish McRae The World in 2020
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Oil Demand Rises as Countries Industrialize
Source BP Statistical Review of World Energy
Respective Census Bureaus Mark Faber Limited NGP
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Be Afraid, Be Very Afraid, We WILL Run Out.
Source Salient Partners
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Still Time to Play Defense, But We Can Score
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Words of Wisdom

• Creative risk taking is essential to success in
  any goal where the stakes are high. Thoughtless
  risks are destructive, of course, but perhaps
  even more wasteful is thoughtless caution which
  prompts inaction and promotes failure to seize
  opportunity.
• Gary Ryan Blair - Author

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Move Up Capital Structure, Own Credit, Reduce Risk
Risk Yield Low
High High Low
Source Stern.NYU
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Real Companies, Equity Worthless or Bonds Worth
Par
17.5
Equity Returns (and then some) From Senior
Secured DEBT
Source Sankaty
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Absolute Return Arbitrage Spreads Near Records

• Merger Arbitrage spreads remain the most
  attractive since 2000, continue to reflect degree
  of uncertainty that is inconsistent with probable
  outcomes.

Source Paulson
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Real Estate RMBS Very Attractive Yields Plus
Upside

• Pricing on AAA rated mortgage backed securities
  indicates potential base case IRR in the low 20s,
  little downside for strong underwriters

Source TCW Research, Deutsche Bank ABX AAA
tranche data
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Equities - EM Upside (modest assumptions) is Huge
Source Everest Capital
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Private Equity Best Vintages During Stress
Periods

• Capital deployed during Recessions yields
  superior returns as those vintage year
  investments outperform more stable investment
  periods

Source GS Research
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Still Time to Think Differently

• Reduce Risk Across the Portfolio and Diversify
  Broadly
• Domestic Equity - Long/Short Sector Specialist
  Managers
• International Equities - Japan, Asia, Long/Short
  Europe
• Emerging Markets Equity - Long/Short, BRIC
• Real Assets - Including Energy Natural
  Resources
• Private Real Estate, U.S. REITs - Long/Short,
  Intl RE/REITs
• Absolute Return Strategies - Enhanced Low
  Volatility
• Opportunistic Equity Strategies - Hedged Global
  Managers
• International Distressed Debt Opportunities -
  Europe, China
• Private Equity - International, Small Buyouts,
  Targeted VC/GC
• Enhanced Fixed Income - Private Debt, Structured
• Cash Flow Finance - Structured Products
• Emerging Manager Development
• Real Estate Development
• Energy Exploration and Production

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