New York, 28 June 2012 Research Monthly Alternative Investment Research Investment horizon: 612+ months

Research Monthly US

Alternative Investments Hedge funds navigating through rough waters

Private Banking

Editorial In the strong market correction in May, hedge funds gave up some of their previous gains (DJ CS Hedge Fund Index 1.3%). Nevertheless, compared to the severe correction in equity and commodity markets (S&P 500: 6.0%; DJ-UBS Commodity Index 9.1%), hedge funds held up very well. As already mentioned last month, with reduced leverage and low exposure to equities, managers were optimally positioned for this challenging market environment. Continued concerns in relation to European debt issues overshadowed the surprisingly strong earnings season in the USA. Directional strategies which, as the name suggests, are the most exposed to market direction consequently took a hard hit. The only strategy exhibiting considerable gains was managed futures, which benefited from its net short positioning. Hedge funds remain cautiously positioned, and all signs point to a clear risk-off environment. Hedge funds reduced commodity and equity exposure and increased their relative share of short positions. At the same time, they decreased leverage and held a higher share of cash. Despite a spike in volatility, our Hedge Fund Barometer continues to indicate positive conditions for hedge fund investment at the end of May. Support comes mainly from a further easing of liquidity conditions. All in all, the environment for the majority of hedge funds continues to look favorable, and we continue to recommend overweighting the asset class. With regard to our base case scenario of a continued economic recovery, equity markets and accordingly directional strategies are expected to outperform on a tactical and strategic time horizon. In case of a severe setback, we expect central banks (both the US Federal Reserve and the European Central Bank) to provide further support (see Figure 1). In addition, we expect managers to be flexible enough to adjust their exposure accordingly, as they are already cautiously positioned. In line with our positive stance on the longer-term economic outlook, and more specifically our positive view on equities, we are upgrading the directional style to overweight.

Highlights

The environment for hedge funds continues to be favorable. We are now overweighting directional strategies (Page 3). Private equity: The distressed debt cycle is not over yet, and we expect a substantial number of opportunities to arise (Page 7). Commodities are torn between positive fundamentals and negative technicals. Over the strategic time horizon, fundamentals should prevail (Page 8). Real estate stocks: We continue to see value in real estate equities (Page 9).

Figure 1 Additional liquidity would support risky assets including equities.

Index 170 Index 3'000'000

150

2'500'000

130 2'000'000 110

90

Fed announces QE 1 25 Nov 2008

Fed announces QE 2 3 Nov 2010

Further easing to 1'500'000 support risky assets?

70

1'000'000

50 500'000 Jun 08 Oct 08 Feb 09 Jun 09 Oct 09 Feb 10 Jun 10 Oct 10 Feb 11 Jun 11 Oct 11 Feb 12 Jun 12
Average of [S&P 500, MSCI EM, Gold, Silver,Copper & Crude Oil performance] US Condition of All Federal Reserve Banks Total Assets in million

Source: Credit Suisse

Important disclosures are found in the Disclosure appendix

Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For a discussion of the risks of investing in the securities mentioned in this report, please refer to the following Internet link: https://research.credit-suisse.com/riskdisclosure

New York, 28 June 2012

Hedge funds

The Dow Jones Credit Suisse Hedge Fund Index (DJCS: 1.3%) lost some of its gains in May. We now favor directional strategies such as long short equity and emerging markets.
Retail participation in the hedge fund universe has been limited and mainly confined to certain fund of hedge fund products. However, this situation has changed with the growing popularity of hedge funds that are compliant with UCITS (Undertakings for Collective Investment in Transferable Securities). Below is a round-up of this small-but-growing section of the hedge fund industry. An update on the UCITS hedge fund sector UCITS-compliant funds attempt to generate returns using strategies similar to those of hedge funds. At the same time they are available to retail investors. Their return potential, however, depending on the specific strategy, can be lower compared to their offshore peers as a consequence of the somewhat more restrictive regulation of UCITS-compliant funds with regards to their levels of leverage, ability to short certain assets and use of derivatives. Being European Unionregulated investment products, the primary upside for this category remains its wider distribution among retail investors. From a management perspective, setting up a UCITS-based fund also involves higher organizational cost. Expense ratios for UCITS funds are generally higher by 100 200 basis points, as estimated by UCITS Hedge. This difference is reflected in part in their underperformance to their lessregulated hedge fund peers. In 2011, UCITS returns stood at 4.1% (versus 2.5% for the DJ-CS Hedge Fund Index). Running into 2012, while the rest of the hedge fund industry witnessed a satisfactory first quarter performance (DJ-CS Hedge Fund Index: +4.0%), UCITS-based funds realized only about half of such performance (UCITS-HFS: +2.2%). Impact of high correlation High correlations among risky asset classes reduce their diversification potential within a portfolio and hence set a challenging environment for asset managers to generate alpha. The tendency of cross-asset-class correlations to increase has now lasted for several years, hitting a record high in 2011. Among hedge funds, in the last four years, strategy price movements against broader benchmarks have increased to much higher levels relative to history (see Figure 3). Meanwhile the ongoing crisis, accompanied by sovereign default risks in some of the larger developed economies of the world, is arguably the second largest downturn in the last 100 years. High correlations during such periods are an indication that macro news as opposed to fundamentals is driving the markets. Since asset prices in such an environment are determined more by macro-level events, delivering alpha consistently calls for some extraordinary skills from fund managers.

Figure 2 Hedge funds booked a loss of 1.3% in May.

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse / IDC

Table 1: Hedge fund style performance and recommendations

DJ CS hedge fund strategies DJ CS Indices Long short equity Emerging markets Global macro Managed futures (CTA) Merger arbitrage Distressed debt Convertible arbitrage Equity market neutral Fixed income arbitrage Multi strategy Dedicated short bias
1

SAA1 Style Weight Directional Directional Tactical trading Tactical trading Event driven Event driven Relative value Relative value Relative value Directional Directional
2

20122 2.6%

May 1.3% 4.5% 3.8% 0.2% 2.4% 1.5% 1.2% 0.8% 3.2% 0.2% 1.2% 9.0%

32.5% 22.5% 22.5%

1.9% 2.2% 1.5% 2.2% 0.1% 4.7% 3.7% 2.3% 3.9% 4.1% 7.6%

22.5%

Not rated

SAA: Strategic Asset Allocation

Year-to-date performance May 2012

Source: Thomson Reuters DataStream, the BLOOMBERG PROFESSIONAL service

Figure 3 Sub-par absolute performance in the previous years can be attributed to higher-than-average correlations with equities.
Correlation with S&P 500 1.00

0.80

0.60

0.40

0.20

(0.20)

Since inception

Last 4 years

Source: HFR, Credit Suisse

Research Monthly US

New York, 28 June 2012

Strategy comments In May, hedge funds mirrored the weak trends in global financial markets (DJ-CS: 1.3%; HFRI: 2.3%). Markets were jittery once again with Greek elections imminent, causing most risky assets to book major losses with the S&P 500 down by 6.0% and the DJ-UBS Commodity Index down 9.1%. Even as many investors failed to predict market direction correctly, hedge fund managers were able to limit losses by maintaining their conservative stance. We are convinced that mangers remain agile enough to expand exposures quickly in the event of a policy-triggered rally. In the meanwhile, outperformance to most global benchmarks continues and year-to-date returns for all strategies (except equity market neutral) remains positive. Style 1: Tactical trading Tactical trading strategies had a positive month in May. However, 2012 has become anything but easy to handle for managers within this style. While global macro managers are still facing a difficult and unsettled market environment, managed futures are fighting with the whipsawing nature of it. After two months of successive losses macro funds finally delivered positive returns in May (DJ-CS: +0.2%, HFRI: +1.4%). As the trend turned negative, funds that had held less profitable short positions through the first quarter performed well. Uncertainty and the lack of broad-based trends continued as the divergence of US and European markets reached a peak. Managed futures were the best performers for the month (DJ-CS: +2.4%; BarclayHedge: +2.6%). The downtrend that began in March gained momentum in May resulting in strong returns for managers with a net short positioning. By May most trend-following CTA models had opened net short positions, irrespective of their horizon. However, the strong rally at the beginning of June might have triggered stop-loss orders especially for strategies trading a mid-term horizon. Historically the tactical trading style has proved to generate alpha and provide portfolio protection in unfavorable market environments. However, while managed futures especially offer a good hedge against short- and mid-term tail-risks, global macro managers are able to provide decent returns in all kinds of market scenarios (see Figure 5). Since our base case remains for a continuation of the recovery within a highly fluctuating environment, we clearly prefer global macro over managed futures. However, since our views on both tactical trading strategies offset each other, we are downgrading the style to neutral. Style 2: Directional The month was dominated by volatility and uncertainty, amid which directional strategies lost most of their year-to-date gains as equity markets seemed to be pricing in all negatives. Long short equity funds gave back a large part of their year-to-date performance in May (DJ-CS: 4.5%; HFRI: 4.6%). Uncertainty in Europe overshadowed the broad strength of the earnings season in the USA. Inter-stock correlations increased in this sentiment-driven environment but remained far below the high levels witnessed in 2011. As a

Figure 4 Style weights: We favor the directional style, as a strong policy response should bring equities back in favor.

Source: Credit Suisse

Figure 5 Managed futures historically have outperformed global macro and equities in times of severe market shocks.
Performance 6.0%

Volatility
28

4.0%

26

2.0%

24

0.0%

22

-2.0%

20

-4.0%

18

-6.0%

16

-8.0% Jan-12 Global macro Feb-12 Managed futures Mar-12 Apr-12 S&P 500 Index May-12 VIX Index

14

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse / IDC

Figure 6 Corrections in emerging markets tend to be extremely steep. After peaking in March, indices lost over 10% in May.
130

120

110

100

90

80

70

60 Jan 11

Mar 11

May 11

Jul 11

Sep 11

Nov 11

Jan 12
MSCI India

Mar 12
MSCI China

May 12

MSCI EM Free USD

MSCI Brazil

MSCI Russia

Source: MetaStock, Reuters, Credit Suisse

Research Monthly US

New York, 28 June 2012

result, fundamental, bottom-up stock pickers performed better than macro-oriented equity funds. Emerging market funds also had a disappointing month (DJ-CS: 3.8%; HFRI: 6.1%). Emerging equities, especially in Asia, suffered deep setbacks. However, managers were able to limit losses and outperformed the broader benchmark (MSCI Emerging Index lost 11.7% in May, see Figure 6). The correction over AprilMay reinforced the case for investing in equities. While uncertainty remains fairly high, chances for a strong recovery are increasing. Although substantial decisions concerning fiscal steps have to be made over the next couple of weeks, a new round of monetary easing might be just round the corner. Due to the relatively defensive positioning of directional managers, downside risk seems to be limited, although the correct political steps forward seem slow to materialize. Hence we are upgrading the directional style to overweight. We prefer emerging market slightly over long short equity funds based on higher total return expectations for emerging market equities. Style 3: Event driven All strategies within the event-driven style were down in May. Managers were maintaining a lower beta exposure owing to the lack of resolution on macro issues in Europe. Merger arbitrage lost 1.5% during the month of May (DJCS; HFRI: 0.5%). Merger activity was once again short of market expectations in spite of supportive conditions. Managers expect the slow trend in activity to continue as macro concerns cloud deal-making activity (see Figure 7). Distressed debt posted its first monthly loss for 2012 (DJCS: 1.2%; HFRI: 1.6%) indicating waning investor appetite for high-yield securities (see Figure 8). However, managers believe the European restructuring process is due to last several years, and idiosyncratic opportunities are expected to continue to emerge. Style 4: Relative value Returns within the relative value style have been mixed so far in 2012. While handsome gains accrued to convertible arbitrage funds in the first quarter's equity market rally, market neutral funds lost ground significantly. Fixed income arbitrage, on the other hand, has been quite regular in posting monthly gains (see Figure 9). With 3.2% in May and 2.3% for the year, the market neutral strategy is the only one with negative year-to-date returns (DJ-CS; HFRI: 0.5%). Volatility during the month trended upwards in a choppy manner. European fundamental and trend-following models provided the largest source of negative attribution during the month. May was yet another positive month for the fixed income arbitrage strategy (DJ-CS: +0.2%; HFRI: +0.5%), despite widening credit spreads. Constant macro-level events and their impact on bond yields kept the sector abuzz with activity. Besides that, regular bond auctions and a liquid mortgage basis provided an additional source of alpha for managers. Convertible arbitrage was down for the month (DJ-CS: 0.8%; BarclayHedge: 0.5%). However, the strategy outperformed the broader convertible benchmarks. (Merrill Lynch All US Convertibles Index: 4.1%).

Figure 7 Merger activity remains muted with no major expectations for 2012.
USD bn No. of deals

600

3500
3000 2500 2000

500

400

300 1500

200

1000 500

100

0
2007 2008 2009 Deal volume 2010 2011 2012 Deal count (r.h.s.)

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Figure 8 Narrowing spreads has aided distressed debt strategy performance so far. However, spreads have witnessed some widening lately.
2000 Basis points
CS US High Yield spread CS European High Yield spread HFR Distressed debt / HFR Composite (r.h.s.)

Index

130

1600

120

1200

110

800

100

400

90

0 80 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse / IDC

Figure 9 Equity market neutral has clearly been the underperformer in the relative value pack.
Performance
5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0%

-2.0%
-3.0% -4.0% Fixed income arbitrage YTD returns Convertible arbitrage Average returns - 2012 Equity market neutral May-2012

Source: Dow Jones Credit Suisse, the BLOOMBERG PROFESSIONAL service, Credit Suisse / IDC

Research Monthly US

New York, 28 June 2012

Hedge fund market dynamics Despite an environment dominated by extreme risk-off trends, our Hedge Fund Barometer continues to signal a low-risk environment for hedge funds (see Figure 11). The resilience is attributable to swift positioning adjustments made by hedge funds in recent weeks that limited the impact of ongoing market weakness. During the month, volatility shot up in response to increased European bank and sovereign bond risk (see Figure 10). Nevertheless, systemic risks remain at moderately low levels (see Figure 12) and liquidity continues to show remarkable strength, holding up well (see Figure 13). In case of resurfacing tension in the euro zone we expect central banks to provide further impetus through additional monetary easing. Hence, with special emphasis on liquidity, we maintain our overweight stance on hedge funds.

Figure 11 The hedge fund barometer continued to show a favorable environment in May (2.1).
Index
Hedge fund barometer HFB Smoothed 13W

Dangerous conditions
Subprime crisis Credit crisis

Russian crisis

Dot-com bubble

9/11 4

Favorable conditions
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Looking ahead We believe the correction in May already discounts most of the negative newsflow for now. Interim dips in the meanwhile can be viewed as entry points for investing in equities. Hence, although it may appear early to do so, we would like to upgrade the directional style, considering its close link to equity markets. We think long short equity and emerging market strategies are positioned to benefit the most as central banks stand ready to provide continued support to counter potential setbacks. Meanwhile, the tactical trading style is mostly positioned for weak markets. Also, given this styles tendency to underperform in rallying markets, we are downgrading its rating to neutral but with a positive outlook for global macro. Our ratings on relative value and event-driven remain unchanged.

Source: Thomson Reuters DataStream, the BLOOMBERG PROFESSIONAL service, Credit Suisse

Figure 12 Our systemic risk heat map signals no major risks on an aggregated basis.
Aggregate
Style dispersion Top - bottom quartile difference Pairwise style correlation

Beta sensitivity
Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12

Source: Thomson Reuters DataStream, the BLOOMBERG PROFESSIONAL service, Credit Suisse

Figure 10 Volatility might be susceptible to an up-move, as upcoming events in European politics unfold.
70 60 50 %
Volatility forecast - upper band

Figure 13 Markets are awaiting the next impetus to liquidity.

Percentile rank value 1.2

Volatility forecast - lower band
S&P 100 - implied option volatility

Index

Liquidity tight
1.0

0.8

40
30 20 10
0.6 0.4 0.2

Liquidity composite 13W MAV composite

0 1986

0.0
1991 1996 2001 2006 2011
93 95 97

Liquidity plentiful
03 05 07 09 11

99

01

Source: Thomson Reuters DataStream, the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: Thomson Reuters DataStream, the BLOOMBERG PROFESSIONAL service, Credit Suisse

Research Monthly US

New York, 28 June 2012

Hedge fund positioning Compared to the second quarter of 2011, fund managers responded differently this time to avoid a repetition of last year. With net exposures as low as they are now, hedge funds have been watchful rather than indulgent but have stayed flexible to be able to adjust upwards rapidly in the event of a positive surprise. Amidst high risk aversion, leverage remained low as of 20 June 2012, according to Credit Suisse Prime Services (see Figure 14). The cyclical-to-defensive ratio slipped to last year's low of 3.0x. Net long bias came in at a three-year low of 26.0% and cash piles remain significantly high at 23.1%. Since the start of June, hedge funds have marginally cut exposure across all regions. Among sectors, however, many began to see relative favor over last month. Only industrials and information technology witnessed a cut in exposure. Traders expanded exposure overall but particularly in safehaven currencies, according to the Commitment of Traders Report. The same reasoning led to an increase in long positions in gold. With deteriorating risk appetite traders shifted exposure in equities to net short. Concerns about economic growth caused a decrease in oil and copper positions. The Federal Reserves Operation Twist caused traders to move positions to longer-dated Treasuries. The twoand five-year note futures saw steep falls in long exposures while positions on the ten-year note shifted to net long (see Figures 15 and 16). Data is based on Credit Suisse Prime Services as well as the Commitment of Traders (COT) Report.

Figure 14 Leverage remains low. At 2.50x, exposures are down to preLTRO levels.
% 2.80 2.70 2.60 2.50 2.40 2.30 2.20 2.10 2.00 1.90 Dec 08 2.5

Apr 09

Aug 09

Dec 09

Apr 10

Aug 10

Dec 10

Apr 11

Aug 11

Dec 11

Apr 12

Gross leverage hedge funds

Source: Credit Suisse Prime Services, Credit Suisse

Figure 15 Risk sentiment only marginally improved in June, as compared to May.

80 60 40 20 0 -20 -40 -60 %
22.06.2012 25.05.2012

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Figure 16 The Commitment of Traders (COT) Report reflects the positioning of speculative market participants such as hedge funds.

Example S&P 500: Speculative long positions in the S&P 500 future decreased by -1.7% to net short in the week from 15 June to 22 June and decreased by -1.1% to net short between 25 May and 22 June 2012. Source: Credit Suisse / the BLOOMBERG PROFESSIONAL service

Research Monthly US

New York, 28 June 2012

Private equity

The distressed debt cycle is not over, and we expect a substantial number of opportunities to arise. Annual returns of 15% to 20% can reasonably be expected for private equity funds that invest in distressed debt, in our view.
Private equity

Figure 17 S&P expects leveraged loan default rates to pick up again.

12%

Lagging 12-month leveraged loan default rate by amount

10%
Bankruptcies peak after dotcom bust

Crisis hits, bankruptcies peak

8%

6%

Mounting liquidity issues Supportive monetary policy, ample liquidity

In the years leading up to the 2008 financial crisis, declining lending standards along with low interest rates encouraged companies to take out large volumes of low-quality loans. The economic downturn that started in 2007 has created a challenging environment for companies to service their debt obligations (see Figure 17). It is precisely in such an environment that opportunities for distressed debt investments are created. Distressed debt is mainly an alpha strategy Distressed investing refers to the purchase of securities of companies that are unlikely to meet their debt obligations, are already in default or are under bankruptcy protection (e.g. Chapter 11 in the USA). The strategy is characterized by high returns, but also entails high risk. The return profile is countercyclical, which means that its correlation with traditional asset classes is low. This low correlation holds particularly true for the more illiquid, active strategies because the value of such an investment is primarily driven by company-specific developments and insolvency proceedings rather than broad macroeconomic drivers. The return on investment in distressed debt is generally highest shortly after the economy has bottomed (see Figure 18). The strategy is mainly an alpha strategy meaning that it is mostly driven by manager skill rather than market forces. We would expect annual returns of about 15% to 20% (internal rate of return, IRR) with returns typically higher for more active investment strategies. Our outlook for the strategy is positive While distressed opportunities exist across all stages of the business cycle, we would expect a higher number of opportunities now and over the next few years. In Europe, the unresolved sovereign debt crisis and bank de-leveraging are setting the stage for distressed investments. This, as well as an uptick in interest rates, can trigger an increase in default rates. In the near term, we would expect more opportunities to be found in specific sectors of the US economy. Further on in the future, Europe should provide an abundance of opportunities.

4%

Restructurings

Easy credit

2%

slower growth, more defaults expected

0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2011 2012 2013

Default rate

Projected default rate by S&P LCD

Source: S&P LCD, Credit Suisse

Figure 18 Distressed debt has delivered the best returns after a recession, when the economy is recovering.

21% 19%

16%

13%

16%

15%

20% 13%

13%

-5% -14% -15% -17% -17%

-8%

-12%

All Private Equity

All Private Equity

All Private Equity

All Private Equity

Real Estate

Real Estate

PMI > 50 (increasing)

PMI > 50 (decreasing)

PMI < 50 (decreasing)

PMI < 50 (increasing)

Source: Preqin, the BLOOMBERG PROFESSIONAL service, Credit Suisse

Figure 19 Distressed debt has been one of the best-performing strategies over the past decade.
Index
400 350

300 250
200 150 100 50 0 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 2000 2001 2002 2003 2003 2004 2005 2006 2006 2007 2008 2009 2009 2010 2011 Buyout Index Distressed Private Equity Index S&P 500 All private equity

Source: Preqin, the BLOOMBERG PROFESSIONAL service, Credit Suisse

Research Monthly US

Real Estate

Distressed

Distressed

Distressed

Real Estate

Distressed

Buyout

Buyout

Buyout

Buyout

New York, 28 June 2012

Commodities

Commodities are torn between positive fundamentals (undervaluation, catching up potential to global growth) and negative technicals (momentum and trend). Over the strategic time horizon fundamentals should prevail, but implied volatility is likely to rise further.
Commodities After the steep correction in April and May, commodity prices tentatively stabilized in June. However, sentiment remains shaky, and many market participants currently lack conviction. Slowing growth is an increasing concern We think there are mainly two reasons for the steep sell-off in April and May. First, the escalation of the European debt crisis triggered an environment where financing conditions deteriorated. As a result, market participants significantly reduced their exposure to commodities in order to increase their liquidity positions. The asset class hence saw significant outflows. Second, leading economic indicators surprised to the downside. Global economic growth was losing momentum particularly in Europe, but also in China. Being a very procyclical asset category, commodities were affected negatively. Other factors such as the strong USD reinforced these negative effects on commodity prices. Environment is challenging near term, but undervaluation should generate longer-term opportunities While it is clear that market conditions deteriorated, the question is by just how much. In this context, our Commodity Compass can give some guidance. The Commodity Compass measures trading conditions for commodities, using an aggregate of cyclical and technical indicators, valuation and financing conditions. The short- and medium-term versions of the Compass put higher emphasis on technical analysis and financing conditions, while the long-term version is more skewed toward valuation and cyclical factors. The shorter-term versions have clearly deteriorated, reflecting challenging financing conditions as well as deteriorating trend and momentum. In contrast to that, the long-term version has actually improved, mainly due to valuation and the fact that global growth remains positive and interest rates low. Overall, we do see conflicting signals, which is one reason why implied volatility is elevated. Near term, a more cautious investment approach seems warranted, focusing on the more stable markets such as gold or oil and on yield-generating strategies. Longer term, we think commodity markets have the potential to stage a comeback. Undervalued metals markets in particular should have recovery potential.

Figure 20 Valuations have improved.

Deviation from fair value in % 120 Overvalued 90 60 30 0 -30 -60 -90

Undervalued

-120

Wheat

Lead

Copper

Coffee

Cotton

Cocoa

WTI Crude oil

Gasoline

US Natural gas

Brent Crude oil

Platinum

Soybean

Nickel

Sugar

Aluminum

21-Jun-12

Palladium

-1 Stdev

+1 Stdev

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service

Figure 21 Cycle: Commodities look cheap relative to growth.

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service

Figure 22 Technical trend and momentum for commodities deteriorate.

Source: Credit Suisse, Thomson Reuters DataStream, the BLOOMBERG PROFESSIONAL service

Silver

Corn

Gold

Zinc

Tin

Research Monthly US

New York, 28 June 2012

Real estate

Direct real estate: Prime rental yields are low, but generally still attractive versus bonds. Rental incomes seem unlikely to rise much near term due to subdued tenant demand. Real estate stocks: We continue to see value in real estate equities and advise holding a well-diversified global portfolio with some focus on the USA and Asia.
Real estate Commercial real estate remains attractive to investors looking for real assets with yield. Prime rental yields are often low in absolute terms, but they still offer attractive rental carry compared with "safe" fixed income investments (see Figure 24). Rental income growth is likely to continue to slow down globally in the near term (see Figure 23), due to heightened economic uncertainty. In our view, however, a return to broadbased rental declines is unlikely in most cities, given constrained construction activity and our expectation of continued economic expansion in the second half of the year. However, investors should be selective regarding regional and sector exposure. German property offers attractive risk/return prospects We believe that German real estate currently offers attractive risk/return prospects on a medium-term horizon. German property markets should benefit from the countrys sound economic fundamentals with declining unemployment, rising real income levels and healthy consumer balance sheets. We expect stable rental markets in the office segment, and see some rental upside for retail properties. Within the retail sector, Berlin is currently our favorite pick, but high-street shops in the other major centers should also perform well. From an investment perspective, German property offers appealing rental income yields. According to real estate data provider IPD, average German office real estate had a net income yield of about 4.9% in 2011, and retail real estate a yield of 5.6%. These yields are attractive compared to the 10-year German government bond yield of below 2%. Real estate equities: Medium-term buying opportunity We are also maintaining our cautiously positive stance toward global real estate equities, as we see attractive medium-term upside potential on valuation grounds in most regions. Many stocks are trading at large discounts to net asset value (NAV) in a historical comparison. Also, real estate companies have reduced their leverage significantly since the financial crisis, so that they now have sustainable debt-to-equity ratios, in our view.

Figure 23 Global rental market recovery is likely to slow down.

Source: JLL, Credit Suisse

Figure 24 Prime rental yields lower but still attractive.

Prime office yields, % 9

8
7 6

5
4 3

2
01 02 03 04 05 06 07 08 09 10 11
Frankfurt Singapore LA

12

London City Sydney Tokyo

Paris Hong Kong New York

Source: PMA, Credit Suisse

Figure 25 Global real estate equity: Positive year-to-date performance.

Real estate equity return indices (1.1.2012 = 100) 140 135 130 125 120 115 110 105 100 95 01.12 02.12
Asia Switzerland Australia

03.12

04.12
Europe ex UK UK

05.12

06.12
Japan US

Source: Thomson Reuters DataStream, Credit Suisse

Research Monthly US

New York, 28 June 2012

Hedge Fund Barometer Variables

Figure H1 Our business cycle indicator remains in healthy territory supporting event driven and directional styles.
16% 10% 10% 7% 6% 5% 4% 1% -2% -7%
Relative value Relative value Relative value

Hedge Fund Asset Allocation

Figure A1 Strategic Asset Allocation (SAA) portfolio weights.

14% 14%

17%

16% 14%

5%

Directional

Directional

Directional

Directional

Tactical trading

Tactical trading

Tactical trading

Relative value

Event driven

Event driven

Event driven

Event driven

PMI > 50 (increasing)

PMI > 50 (decreasing)

PMI < 50 (decreasing)

PMI < 50 (increasing)

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Tactical trading

Source: Credit Suisse

Figure H2 Volatility has picked up slightly. Historically, all styles have returned moderate positive returns in this kind of environment.
23% 18% 9% 15% 11% 7% 9% 9% 8% 18% 16% 9%

Figure A2 Model alternative investment portfolio with recommended medium-term asset allocation (6M12M horizon).

5%

-3%

-6% -11%

Relative value

Relative value

Relative value

Tactical trading

Tactical trading

Tactical trading

Directional investing

Directional investing

Directional investing

High volatility (increasing)

High volatility (decreasing)

Low volatility (increasing)

Directional investing

Low volatility (decreasing)

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Tactical trading

Relative value

Event driven

Event driven

Event driven

Event driven

Source: Credit Suisse

Figure H3 Liquidity conditions have continued to improve. In line with business cycle and volatility, directional as well as event driven strategies should be supported.
20% 16% 14% 13% 10% 7% 5% 15% 16% 14% 10% 13% 9%

Figure A3 Model alternative investment portfolio with recommended medium-term asset allocation (6M12M horizon) including private equity.

0%

0%

-1%

Tactical Trading

Tactical Trading

Tactical Trading

Relative value

Relative value

Relative value

Tactical Trading

Low liquidity (decreasing)

Low liquidity (increasing)

High liquidity (decreasing)

High liquidity (increasing)

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Relative value

Directional investing

Directional investing

Directional investing

Event driven

Event driven

Event driven

Directional investing

Event driven

Source: Credit Suisse

Research Monthly US

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CS Risk Monitor
Figure S1 Risk premiums in equity markets as well as in credit markets are picking up again. Figure S2 Short-term correlations of hedge funds with bonds have fallen recently.
26W rolling correlations 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 2008
DJ CS AllHedge Index - MSCI World DJ CS AllHedge Index - Barclays G7 Global Govt. Bond Index

2009

2010

2011

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Thomson Reuters DataStream, Credit Suisse

Figure S3 Discounts to NAV on closed-end funds remain at moderate levels.

6 %
Discount / premium to NAV S&P 500 price index

Figure S4 The 3M EUR basis swap indicates slightly increasing funding pressure in the European interbank market.

Performance

2000

1600

-6 1200

-12
800

-18

-24 92 94 96 98 00 02 04 06 08 10 12

400

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Figure S5 Hedge fund assets reached a new all-time high of USD 2.13 trillion in Q1 2012.

Figure S6 The forward redemption indicator has picked up but continues to indicate rather low redemption pressure on hedge funds.
DJ CS Hedge Fund Index Redemption Indicator

500
3.31%

0 0.02

480 460 440 420 400 380

0.04
0.06 0.08 0.10 0.12 0.14 0.16

360
340 Jan 08

0.18
0.20 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12
DJ CS Hedge Fund Index Redemption Indicator inverse (r.h.s.)

Source: Hedge Fund Research

Source: the BLOOMBERG PROFESSIONAL service, GlobeOp, Credit Suisse

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CS Stress Monitor
Figure S7: Global heat map Systemic risks across asset classes continue to remain low. Figure S8: Emerging market heat map Systemic risks across emerging markets remain at moderate levels.

Aggregate

FX

Bank index High Yield HG corp. credit CMBS Municipal bonds 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: the BLOOMBERG PROFESSIONAL service, Thomson Reuters DataStream, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Thomson Reuters DataStream, Credit Suisse

Figure S9: Real annualized returns on commodities Five-year real returns across commodities have shown weakness recently amidst decreasing risk appetite.

Figure S10: Real annualized returns on REITs Average five-year real returns on REITs continue their downward trend that started in 2010.

Source: the BLOOMBERG PROFESSIONAL service, Thomson Reuters DataStream, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Thomson Reuters DataStream, Credit Suisse

Figure S11: Open interest on commodity futures The notional value of open interest on commodity futures is decreasing again.

Figure S12: Risk premiums on REITs Risk premiums (difference between dividend yield and real bond yield) on REITs have picked up again.
12 10

REIT risk premia in %

8
6 4 2 0 -2 2001

2002

2003
EU

2004

2005
UK

2006

2007

2008
Japan

2009

2010
USA

2011

2012

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Thomson Reuters DataStream, Credit Suisse

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AI Performance Monitor
Figure P1: Hedge funds (HFRI Fund Weighted Composite Index) Figure P2: Private equity (Cambridge Associates)

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: Cambridge Associates, Credit Suisse

Figure P3: Commodities (DJ-UBS Total Return Index)

Figure P4: Listed real estate (GPR REIT World Index)

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Figure P5: FX overlays (Barclay Currency Traders Index)

Figure P6: Gold (Spot)

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

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Figure B1 Asset class volatilities

MSCI World Price Index Fixed income arbitrage 0.30 Real estate Equity market neutral Convertible arbitrage Relative value
0.25 0.20 0.15 0.10

Figure B2 Asset class betas

36-month volatility 52-week volatility
Real estate Fixed income arbitrage Equity market neutral
1.0 1.5

Commodities Gold Oil

36-month beta 52-week beta

Commodities Gold Oil

Convertible arbitrage
0.5

Relative value

0.0

FX strategies

Distressed debt

0.05 0

Swiss Re Cat Bond Index

Event driven
-0.5

Swiss Re Cat Bond Index

Merger arbitrage

DJ CS Index
Managed futures (CTA) DJ CS Index

Event driven Managed futures (CTA) Global macro Tactical trading Multi strategy

Directional Long short equity Dedicated short bias Emerging markets

Global macro Tactical trading Multi strategy Emerging markets Directional Long short equity Dedicated short bias

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Figure B3 Asset class Sharpe ratios

MSCI World Price Index Fixed income arbitrage Equity market neutral Convertible arbitrage
6.0 4.0 2.0 0.0 -2.0

Figure B4 Asset class Mar and Calmar ratios

Real estate Commodities Gold
36-month Sharpe ratio 52-week Sharpe ratio

MSCI World Price Index Fixed income arbitrage Equity market neutral Convertible arbitrage
2.5 2.0 1.5 1.0

Real estate Commodities

36-month Calmar ratio Mar ratio

Swiss Re Cat Bond Index

Relative value

Oil

Relative value

0.5 0

DJ CS Index

Event driven

-4.0

FX strategies

Distressed debt

-0.5

Directional

Managed futures (CTA)

Swiss Re Cat Bond Index Merger arbitrage Long short equity

Global macro Tactical trading Multi strategy Emerging markets

DJ CS Index Event driven Directional Long short equity Dedicated short bias Managed futures (CTA) Global macro Tactical trading Dedicated short bias Emerging markets Multi strategy

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Definitions for Figures B1B4:

Hedge fund universe: We use the DJ CS Index series for monthly calculations and the DJ CS Sector Invest Index series for weekly calculations. Mar ratio: The Mar ratio is a performance measure and is calculated by dividing annualized historical returns by the maximum drawdown over the same period. A Mar ratio above one indicates an attractive risk / return payoff. We use month-to-date data back to 31.12.1993. The Calmar ratio is a rolling 36-month MAR ratio. Sharpe ratio: The Sharpe ratio is defined as excess return over cash divided by volatility. Real estate: We use the GPR 250 Property Index as the benchmark for global real estate, due to the lack of direct global real estate benchmarks.

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Imprint
This publication has been authored by Private Banking Global Research US Contact Information Investment Strategy and Advisory: Barbara M. Reinhard, Chief Investment Strategist Managing Director Tel. +1 212 538 7604 E-mail barbara.reinhard@credit-suisse.com Philipp E. Lisibach, Director Tel. +1 212 538 0311 E-mail: philipp.lisibach@credit-suisse.com Jimmy James, Director Tel. +1 212 538 5944 E-mail: jimmy.james@credit-suisse.com Samuel Baumann, Assistant Vice-President Tel. +1 212 538 5194 E-mail: samuel.baumann@credit-suisse.com Scott Rosenblatt, Assistant Vice-President Tel. +1 212 325 4458 E-mail: scott.rosenblatt@credit-suisse.com Ryan Sullivan, Assistant Vice President Tel. +1 212 538 2194 E-mail: ryan.sullivan@credit-suisse.com

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