M A N A G I N G W E A LT H I N A N E W W O R L D

Leverage: A thoughtful approach

IN BRIEF

Leverage is a powerful but often underutilized way to enhance wealth and create financial flexibility. Conducting a review of your personal balance sheet can help you see where and how a borrowing strategy may be thoughtfully integrated to help you achieve immediate aims and long-term goals. Adding modest leverage to a portfolio or specific investment can be a smart strategy to help you meet your objectives within risk parameters you find acceptable.

Many individuals understandably have adopted a more cautious view of debt in recent years. However, it is important to remember the strategic and valuable role a modest use of leverage can play, both in managing day-to-day finances and achieving longer-term financial goals. At J.P. Morgan, we view leverage as a potentially powerful resource that can be strategically employed in many ways: Within the context of your overall balance sheet, leverage can help you monetize assets, providing the liquidity to achieve personal or business objectives. Integrated into a well-planned asset allocation strategy, leverage can help you manage certain risks and diversify a portfolio. As a tactical move, leverage can provide liquidity, potentially enhance returns or help you achieve other goals within risk parameters you find acceptable. However, before moving forward, we recommend a complete balance sheet and cash flow review. Gaining a clear picture of assets, liabilities and cash flows can help you determine where and how leverage can best be integrated into your financial plans.
The views and strategies discussed in this paper may not be suitable to all investors. This information is provided for informational purposes and is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Please read the important information at the end of this paper.

MANAGING WEALTH IN A NEW WORLD

CONSIDERING MODERATE LEVERAGE WITHIN YOUR BALANCE SHEET

Conducting a review of all your holdingsnot just your investment portfoliocan help you determine if your assets and liabilities are working well enough together to keep your financial plans on track, while managing risk at a level you deem acceptable.

A balance sheet review can help you assess your progress toward important goals and objectives. It also gives you an opportunity to evaluate your liquidity needs and identify potential funding sources, such as real estate, investments or artwork. In this broad context, we can help you determine if you are exposed to too much risk, such as having your wealth concentrated in a single stock. Using a modest amount of leverage may help you manage this risk exposure. Indeed, strategic financing is a flexible wealth management tool that can be applied to a wide range of near- or longer-term objectives; for example, allowing you to: Bridge gaps in your cash flow Start or expand a business Diversify your portfolio Potentially enhance the performance of select investments Importantly, given the flexibility it offers as a wealth management tool, strategically using leverage may allow you to achieve several objectives at the same timeas the examples below illustrate.
Gain liquidity

that he regularly employed in the course of running his oil business. As a result, he established three lines of credit: one to fund a trust for his children, another to add liquidity to the partnership, and a third to enhance his own cash flow. Moreover, looking ahead, the executive indicated an interest in further using credit as new investment opportunities presented themselves.
Diversify holdings

Using leverage can help you diversify exposures and take advantage of timely opportunities. Example: The CEO of a Brazilian agribusiness company acquired by a European conglomerate was asked to lead a key growth initiative. In exchange for doing so, he was offered a bonus incentive of $10 million per year of parent company stock, denominated in Euros, with a cash-out option at the end of five years. By the third year, the business had met its growth target, earning the CEO his bonus. However, his concentrated stock position was vulnerable to financial and currency market fluctuations. Working with his J.P. Morgan team, he established a line of credit against the stock and is currently using the funds to more broadly diversify his portfolio, both in terms of asset classes and currencies.
Identify opportunities

Leverage can provide sufficient liquidity to help you face emergency expenses, satisfy tax or other financial obligations, or gain flexibility in when or how you take advantage of new opportunities. Example: The CEO of an oil exploration company also served as the head of a family limited partnership, which held diverse holdings securities, family vacation property, aircraft, real estate, fine artand employed no leverage. Historically, the partnership sold assets to acquire new ones, willingly accepting that this strategy might limit its growth potential. A balance sheet review allowed this executive to weigh these limitations against the potential gains that could result from using leveragea strategy

Looking at both sides of your balance sheet can help you identify cost savings and potential sources of funding to help meet a range of liquidity, investment and wealth planning objectives. Example: Three years ago, a U.S.-based executive opted to cover the cost of a residential real estate purchase with funds from several personal loans. Unaware of how far mortgage rates had fallen during the same period, a balance sheet review helped her realize she could save more than $21,000 a month by replacing those three five-year loans with a 15-year fixed-rate mortgage, which she

LEVERAGE: A THOUGHTFUL APPROACH

could repay at any time with no penalties. The monthly savings are now earmarked for a charitable organization she supports.
Fund growth plans

restaurants in other cities. In fact, using financing was critical to the startups growth strategy, as it was not yet possible for the new restaurant business to obtain standalone financing. Taking the advice of his J.P. Morgan team, the client pledged securities and established a line of credit to use as working capital for the business. Importantly, this strategy not only allowed him to fund his restaurant venture during its build-out stage and achieve his goal of expansion, it also allowed him to preserve his cash and keep his portfolio intact.

As markets change or when business opportunities appear, having ready access to credit can position you to respond quickly. Example: After opening his first successful restaurant with 100% equity, a London-based hedge fund manager now wanted to finance his plans to open

Adaptable to any rate environment

It is a given that in periods when interest rates are low, the strategic use of credit may be particularly attractive, allowing you to cost-effectively acquire assets, for example. However, even in a rising-rate environment, using credit may be advantageous, affording you the liquidity to meet obligations, such as large tax payments, or to be opportunistic in countless ways. At J.P. Morgan, we believe that leverage can be effectively used in all market cycles. Thus, we help you consider how and not just when to employ the strategic use of credit.

IN A LOW-RATE ENVIRONMENT Consider floating-rate credit facilities that allow you to benefit from the lower cost of credit

IN A RISING-RATE ENVIRONMENT Lock in fixed-rate loans, interest rate swaps, equity collars or other strategies designed to mitigate interest rate risk (that is, control your credit costs) for longer-term credit needs Apply floating-rate strategies for shorter-term uses

IN A HIGH-RATE ENVIRONMENT While borrowing costs are higher, they are more stable than in a risingrate environment

Dial up the use of leverage on highconviction investment ideas to take advantage of the low cost of capital Take advantage of the potential to enhance portfolio profitability due to the low cost of funds

Apply floating-rate strategies for shorter-term uses

Understand that higher borrowing costs may affect profitability

Employ financing more selectively

MANAGING WEALTH IN A NEW WORLD

THE ROLE OF LEVERAGE IN YOUR PORTFOLIO

Leverage can add an important dimension to a portfolio, providing liquidity to help you diversify your holdings to manage risk, fund new investments or potentially enhance returns. You may be comfortable with the asset allocation of your current portfolio and still want to pursue potentially higher returns. There are several strategies that you can consider to meet this objective, such as: Change your risk tolerance level Add illiquid assets Go down in credit quality Extend duration Add leverage in a thoughtful way While strategic asset allocation is the main driver of portfolio returns, adding a moderate amount of leverage to your portfolio may allow you to boost your overall portfolio returns. It also can help you slightly adjust your risk profile, without significantly altering the targeted risk/return relationship of your portfolio.
Assess how much leverage is appropriate

Similar to selecting portfolio managers or taking advantage of opportunistic trading ideas, employing leverage can be part of an overlay of timely moves made to complement the strategic asset allocation that is the bedrock of your financial investments.

Generally speaking, leverage strategies can be designed to fit the financial objectives and risk parameters of various types of investors. For investors with a Conservative portfolio, we typically recommend that leverage levels not exceed 20%; for investors with a Balanced portfolio, we typically recommend up to 15%. Keeping leverage

Modest leverage can boost potential returnswithin your current asset allocation and risk profile
Adding modest leverage may increase returns while subjecting a portfolio to more volatility, but without taking on the asset risk associated with a wholly different asset allocation.

Sample asset allocations for various types of investors

CONSERVATIVE
30% 50% 20%

BALANCED
30% 30%

GROWTH
15%

Equities Alternatives Fixed Income/Cash

40% 35%

50%

No leverage
Expected equilibrium return** Expected volatility

Levered 20% 6.4% 8.4%

No leverage 7.2% 10.2%

Levered 15% 7.8% 11.7%

No leverage* 8.1% 12.5%

5.9% 7.0%

Less Risk

More Risk

* We typically do not recommend adding leverage to Growth-modeled portfolios as these types of portfolios are already positioned for more aggressive risk/return potential. ** Equilibrium return represents the value around which market returns will tend to fluctuate over a long period of time. It is a forward-looking assessment based on our best estimates and does not represent a promise or estimate of actual returns. Please see Understanding equilibrium estimates on back page for further explanation. Source: J.P. Morgan Portfolio Construction, November 2011 These are J.P. Morgan Global Strategic Model Allocations and are presented for illustrative purposes only. All statistics are pre-tax. Your actual portfolio will be constructed based upon investments for which you are eligible and based on your personal investment requirements and circumstances. Consult your advisor regarding the minimum asset size necessary to fully implement these allocations. See back page for important information.

LEVERAGE: A THOUGHTFUL APPROACH

levels low helps position a portfolio a bit further along the risk continuum, thereby enhancing the likelihood of higher returns without dramatically altering the portfolios risk classification (see chart on previous page). However, exceeding these recommended levels may result, for example, in a Conservative portfolio going beyond the risk levels generally associated with a conservative approach. In determining whether to incorporate leverage in your existing portfolio, it is helpful to view the potential impact of a moderate amount of leverage on the value of your portfolio over a longer timeframe (see chart below). While adding leverage introduces additional risk, it allows you to enhance the likelihood of higher returns within your current
A look at the potential impact of leverage at year 15

asset allocation and risk profile without moving to a completely different type of portfolio. Any investment associated with leverage includes additional risks, such as potentially higher volatility, exposure to rising interest rates (borrowing costs) and margin calls, which may occur if the underlying investment declines below its minimum lending values. Leverage also will magnify losses as well as gains. It is for these reasons that we typically do not recommend adding leverage to a Growth portfolio. As this type of portfolio is already positioned for more aggressive risk/return potential, introducing leverage will likely exacerbate its volatility. Still, for some investors, the potential rewards and risks may be acceptable.

Adding modest leverage adds risk to enhance the likelihood of higher returns, but without moving to a completely different type of portfolio. Assumptions in hypothetical scenario: Initial net value = $10 million; output is net of leverage and does not include taxes; long-term borrowing = 3.5% (a longer-term estimate of cash + 100 basis points).

Range of projected wealth values: Year 15

($MM) 70 60 50 40 Median CVaR 30 20 10 0

CONSERVATIVE

BALANCED

GROWTH

22.9 13.7
No leverage

23.8 13.2
Levered 20%

26.6

27.8

29.2

12.7
No leverage

12.2
Levered 15%

11.9
No leverage*

Less Risk

More Risk

The top of each bar represents the 95th percentile wealth value (i.e., the high point for 95% of all probable wealth values modeled in this scenario). The bottom of each bar represents the 5th percentile wealth value (i.e., the lowest point for all but 5% of the probable wealth values modeled in this scenario). The most darkly shaded area indicates the range in and around the 50th percentile or median. The white line indicates the median, the middle wealth value of the entire range of probable wealth values. CVaR: The average allocation value in the worst 5% of the simulations. * We typically do not recommend adding leverage to Growth-modeled portfolios as these types of portfolio are already positioned for more aggressive risk/return potential. Source: J.P. Morgan Portfolio Construction, November 2011 This projection is for illustrative purposes only and does not represent investment in any particular vehicle. References to future wealth values are not promises or even estimates of actual returns you may experience. Furthermore, the material is incomplete without reference to, and should be viewed in conjunction with, the verbal briefing provided by your J.P. Morgan representative.

MANAGING WEALTH IN A NEW WORLD

APPLYING LEVERAGE AS A TACTICAL MOVE

Selectively adding leverage to an investment strategy can potentially generate yield or augment returns on high-conviction positions without significantly altering your risk exposure. Not every investment is a suitable leverage candidate. Generally, we recommend adding leverage to investments with lower price volatility, shorter maturities and higher liquidity levels. This reduces the probability, and potential impact, of a margin call. An investor seeking higher yield might choose to purchase bonds with longer maturities or those of lesser credit quality, perhaps overlooking that: Lower-quality securities carry a greater risk of default, thereby adding volatility to the portfolio (see chart below). Extending maturity (that is, adding duration) magnifies declines in principal value when interest rates rise. In contrast, adding modest leverage to high-quality bonds to take advantage of a market dislocation, for example, may enhance returns. This may allow you to maintain your income level without having to move further out on the yield curve or invest in lower-quality securities to obtain higher yields.
Managing market risks

It is important to keep in mind that changes in interest rates or other market risks can magnify gains and losses. Adding leverage to a fixed income strategy may be positively or negatively impacted by changing interest rates, credit spreads and foreign exchange rates, for example. Similarly, the value of an equity investment may be affected by share price or dividend changes. For these reasons, we view leverage as a strategy that can also be used tactically, ideally moving the amount of leverage up or down according to the prevailing market environment and your own personal situation.
Downside scenarios

At J.P. Morgan, we consider downside scenarios as well as potential gains. To that end, we recommend borrowing an amount less than the maximum loan-to-value ratio (the advance rate) that is established for any investment. In this way, you can seek to enhance returns while reducing the probability of a margin call.

Moving to lower-quality investments adds risk

Lower-quality investments can expose your portfolio to principal volatility and default risk.
3500

3000

CCC rated Global High Yield Spreads BB rated Global High Yield Spreads A rated Investment Grade Spreads

10-year default rates CCC C 17.50 BB 0.79 A 0.12

2500

2000

1500

1000

500

0 1/2000 1/2001 1/2002 1/2003 1/2004 1/2005 1/2006 1/2007 1/2008 1/2009 1/2010 1/2011 1/2012

Sources: J.P. Morgan, Bloomberg, November 2011 Past performance is not a reliable indicator of future results. Spreads are relative to U.S. Treasuries. Investors may get back less than the amount invested.

LEVERAGE: A THOUGHTFUL APPROACH

Case study: Applying leverage to an opportunistic investment idea

In the summer of 2011, a pullback in credit markets generated an outsized increase in short-dated yields relative to longer-dated bonds. This created an opportunity to earn attractive yields with limited interest rate risk (duration of 2.3 years). Believing that this dislocation would soon reverse, at the end of October we recommended applying modest leverage to a portfolio of diversified credits, which was by then yielding 5.8%. Seeing further opportunity, we recommended adding 50% leverage to the strategy. This increased the yield to 9.7% (assuming borrowing costs of 1.9%) with limited interest rate risk. For example, if the leverage amount maximized the 65% loan-to-value ratio of the underlying securities, the strategy would have to fall by about 23% before a collateral shortfall would occur. A timely application of leverage offers an opportunity to enhance portfolio performance.

Leverage tailored to your personal circumstances

Leverage can offer you a number of benefits within the context of your personal situation and risk appetite, allowing you to achieve important nearor longer-term goals, such as buying a residence or making tax-efficient investments. It also can be part of a well-thought-out strategy for preserving generational wealth and growing your portfolio by enhancing investment returns. Your J.P. Morgan team can evaluate your liquidity needs and help you determine the right financing structure. Additionally, your dedicated Capital Advisor, as part of your J.P. Morgan team, can provide a wide range of ideas beyond the ones outlined in this paper.

J.P. Morgan Private Bank is a marketing name for private banking business conducted by JPMorgan Chase & Co. and its subsidiaries worldwide. Bank products and services are offered by JPMorgan Chase Bank, N.A. and its affiliates. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. J.P. Morgan Securities LLC or its brokerage affiliates may hold a position or act as market maker in the financial instruments of any issuer discussed herein or act as an underwriter, placement agent, advisor or lender to such issuer. The views and strategies described herein may not be suitable for all investors. The discussion of loans or other extensions of credit in this material is for illustrative purposes only. No commitment to lend should be construed or implied. In the United Kingdom, this material is approved by J.P. Morgan International Bank Limited (JPMIB) with the registered office located at 125 London Wall EC2Y 5AJ, registered in England No. 03838766, and is authorized and regulated by the Financial Services Authority. In addition, this material may be distributed by: JPMorgan Chase Bank, N.A. (JPMCB) Paris branch, which is regulated by the French banking authorities Autorit de Contrle Prudentiel and Autorit des Marchs Financiers; J.P. Morgan (Suisse) SA, regulated by the Swiss Financial Market Supervisory Authority; JPMCB Dubai branch, regulated by the Dubai Financial Services Authority; JPMCB Bahrain branch, licensed as a conventional wholesale bank by the Central Bank of Bahrain (for professional clients only); JPMCB Hong Kong branch, regulated by the Hong Kong Monetary Authority and JPMCB Singapore branch, regulated by the Monetary Authority of Singapore. Past performance is no guarantee of future results. The material above is intended for informational purposes only. Opinions expressed herein are those of J.P. Morgan Private Bank and may differ from those of other J.P. Morgan employees and affiliates. This information in no way constitutes J.P. Morgan research and should not be treated as such. Further, the views expressed herein may differ from that contained in J.P. Morgan research reports. The above summary/prices/quotes/statistics have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness; any yield referenced is indicative and subject to change. Investors cannot invest directly in an index.

IMPORTANT INFORMATION Please note that lines of credit are extended at the discretion of J.P. Morgan, and J.P. Morgan has no commitment to extend a line of credit or make loans available under the line of credit. Any extension of credit is subject to credit approval by the lender in accordance with the terms contained in definitive loan documents.
RELATED TO PAGES 4 AND 5

Sample asset allocations All statistics are pre-tax. For further information, see Understanding equilibrium estimates below. For illustrative purposes only. These are J.P. Morgan Global Strategic Model Allocations and are presented for illustrative purposes only. Your actual portfolio will be constructed based upon investments for which you are eligible and based upon your personal investment requirements and circumstances. Consult your advisor regarding the minimum asset size necessary to fully implement these allocations. J.P. Morgan offers specialized financial services through legal entities licensed for specific activities. The type of account you open, your investment objectives, and other factors will ultimately determine the range of products and services of which you can avail yourself. Not all accounts or services can provide a strategic investment plan. Investment strategies shown may not be suitable for all investors. Speak with your J.P. Morgan representative concerning your personal investment needs and allocation requirements. Understanding equilibrium estimates Our investment management research incorporates our proprietary projections of the equilibrium returns and volatility of each asset class over the long term, as well as equilibrium estimates of the correlations among asset classes. Clearly, financial firms cannot predict how markets will perform in the future. But we do believe that by analyzing current economic and market conditions and historical market trends, and then, most critically, making projections of future economic growth, inflation and real yields for each country, we can estimate the equilibrium performance for an entire asset class. The equilibrium return is simply the central tendency over a very long period of time around which market returns will tend to fluctuate, because it represents the value inherent in that market. It is possibleindeed, probablethat actual returns will vary considerably from this equilibrium, even for a number of years. But we believe that market returns will always at some point return to the equilibrium trend. We further believe that these kinds of forward-looking assessments are far more accurate than historical trends in deciding what asset class performance will be, and how best to determine an optimal asset mix. In reviewing this material, please understand that all references to expected return are not promises, or even estimates, of actual returns one may achieve. They simply show what the equilibrium return should be, according to our best estimates. Also note that actual performance may be affected by the expertise of the person who actually manages these investments, both in picking individual securities and possibly adjusting the mix periodically to take advantage of asset class undervaluations and overvaluations caused by market trends.
RELATED TO PAGES 6 AND 7

The estimated yields are for illustration/discussion purposes only and are subject to significant limitations. An investor should not expect to achieve actual yields similar to the estimated yields shown above. The estimated yields are the managers estimate based on the managers assumptions, as well as past and current market conditions, which are subject to change. Because of the inherent limitations of the estimated yields, potential investors should not rely on them when making a decision on whether or not to invest in this strategy. The estimated yields cannot account for the impact that economic and market factors have on the implementation of an actual investment program. Unlike actual performance, the estimated yields do not reflect actual trading, liquidity constraints, fees, expenses and other factors that could impact the future returns of the strategy. The managers ability to achieve the estimated yields is subject to risk factors over which the manager may have no or limited control. No representation is made that the strategy will achieve the estimated yield or its investment objective. Prospective investors should understand the risk factors associated with the strategy. Actual returns could be higher or lower than the estimated yields. This assumption does not take into account variations in credit risk.

RISK CONSIDERATIONS Leverage as a return-enhancement strategy As a tactical investment strategy, leverage may be dialed up or down over time, according to market conditions. A leveraged investment strategy is relatively attractive in a low interest rate environment when the cost of borrowing is modest, though using leverage in a rising-rate environment may also be effective at an appropriate level. However, even in a low-rate environment, not all investments are suitable leverage candidates. Generally, we recommend you consider adding leverage to those investments with lower price volatility and higher liquidity levels. Leverage may add risk to a portfolio Adding leverage to an investment can magnify gains as well as losses. Please consider the following: Margin calls J.P. Morgan establishes a maximum loan-to-value ratio for investments (i.e., the maximum amount of a loan collateralized by that financial investment). If the market declines, and the value of the underlying asset moves lower than the lending value required to support the loan, J.P. Morgan will request additional funds to maintain the required lending value amount. A margin call requirement can be met either with cash or additional securities. In exercising its remedies, J.P. Morgan will not be required to marshal assets or act in accordance with any fiduciary duty it otherwise might have. Increased collateral requirements At any time, and without prior written notice, J.P. Morgan can decrease the advance rate for an investment securing a loan, thereby triggering a margin call. Loans collateralized by securities involve certain risks and may not be suitable for all investors. If the market declines, you may be required to deposit additional securities and/or cash into your account. Sale of securities In the event that a margin call is not met, J.P. Morgan has the right to sell securities held in the accounts to satisfy the obligation, as well as the right to decide which assets to sell. J.P. Morgan will attempt to notify a client before a collateral sale is made. However, we are not required to do so. Some or all of the securities sold to meet a margin/maintenance call may be sold at prices higher than their initial cost, which may result in adverse tax consequences. You should consult your tax advisor in order to fully understand the tax implications associated with pledging securities in connection with a margin loan. Please read your Customer Agreement carefully so that you understand your obligations. Higher borrowing costs Borrowing costs may increase over time if short-term interest rates move higher.
2011 JPMorgan Chase & Co. All rights reserved.
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