Mathema May 2012 Global Investment Insight Report

7/31/2019 Mathema May 2012 Global Investment Insight Report

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Pag. 4 Executive Summary

Pag. 8 Global Stock Markets

Pag. 10 Market Volatility

Pag. 12 Emerging Markets

Pag. 14 Safe Haven Assets

Pag. 16 Tail Risk Market Expectations

Pag. 17 Tail Risk Stock Market Positioning

Pag. 19 Credit Spreads

Pag. 21 Financials

Pag. 23 Commodities

Pag. 26 Eurozone Sovereign Debt Market

Pag. 27 Yield Curves

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Pag. 30 Money & Interbanking Markets

Pag. 31 Sovereign Benchmark Yields

Pag. 32 Sovereign Benchmark Spreads

Pag. 33 Hedge Fund Strategy Performance

Pag. 34 Hedge Fund Strategy Performance Dispersion

Pag. 35 Hedge Fund Strategy Correlations

Pag. 37 Investment Risk Assessment: Debt

Pag. 39 Investment Risk Assessment: Equities

Pag. 40 Investment Risk Assessment: Currencies & Commodities

Pag. 41 Hedge Fund Strategies Risk Assessment & Outlook

Pag. 45 Mathemas Hedge Fund Strategies Forecast

Pag. 46 Disclaimer

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As we predicted in an earlier analysis a post-election (Greece and France) scenario materialized. The usual risk-on risk-off phenomenon broadly infected investment themes as high correlations across asset classes and geographies continuedto dominate global markets

G20 leaders found common agreement that Europe must intensify its efforts to stabilize highly indebted Eurozonecountries while establishing the ground for financial, fiscal and political union as the path to save monetary union. Atthe same time Europe committed "to consider concrete steps towards a more integrated financial architecture"

In Greece Samaras's conservative New Democracy party narrow victory in June 17s new round of election highlightedthe controversy of a country deeply divided over whether to implement a harsh austerity package to save its near-bankrupt economy

In an attempt to regain its economic credibility Spain requested and obtained from EU on June 10 a financial lifeline of

up to 100 billion to shore up its troubled banking system. The bailout will not impose any new economic reformconditions on Spanish government. The financial lifeline will take the form of an access to temporary fund ofEuropeanFinancial Stability Facility (EFSF) rather than to the permanent mechanism of ESM, as to avoid investors concernsabout the preferred creditor status ofESM. The dramatic development came after Fitch Ratings cut Madrid's sovereigncredit rating by three notches to BBB on June 7, just highlighting the Spanish banking sector's exposure to bad propertyloans and to contagion from Greece's debt crisis

In the global macro picture a recessionary pattern in Europe couples with a softening path of recovery in the U.S. andslowing growth in many emerging markets


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The economy in the U.S. is still a major concern in the run-up to the Presidential election. Everything elseunchanged at the end of 2012 about 42 tax benefits will expire at the end of 2012. Also, additional pressures on theU.S. economy comes from excess unemployment and its deflationary impact

China has continued and is expected to continue capturing investors attention as recent macro data support both ahard- and soft-landing

Eurozone ten-year swap spread appears to incorporate less-clear information regarding changes in expectations offuture economic activity. At the same time, the annualized ten-day rolling window volatility of the U.S. dollarswap spread that climbed at the end of May, tripling from March month-end lows, appears to reflect more-negative expectations about the aggregated likelihood of default prevailing among market participants

Despite first-quarter 2012 operating earnings posted their third best quarter in the S&P 500s history, the currentmacro environment and U.S. government fiscal and economic policies undermine investors confidence in forwardearnings

Phenomenon of de-euroisation. Cross-border holdings of government bonds by euro area Monetary FinancialInstitutions (MFIs), as a ratio to total holdings, has been on a declining trend since 2006 and has now returned tothe levels observed before the beginning of the third stage of Economic and Monetary Union (EMU)


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Debt

o In Europe debates focus on the fiscal compact vs. growth policy, banking crisis in Spain, rising borrowing cost in Spain, Italy& France. In the U.S. the current inflationary pattern and the pace of economic growth are not consistent with negative realrates. Recent prices of Treasuries and negative yields in real terms are justified only by flight-to-quality drivers

Equity

o USA: Loose monetary policy supports liquidity, bond yields at historic lows favor equity investment, global risks,macroeconomic data and inflation may affect volatility in the short- to medium-term

o Europe: the macro scenario remains uncertain in perspective. Nevertheless, the resolution of uncertainties in Greece andSpain could trigger a market rally, potentially sustained by a new round of LTRO. On the other hand, it is expected thatrecent markets rise which followed the granting of the financial lifeline to Spain to shore up its banking sector will be shortlived. A series of questions await further clarification: first of all, where, i.e. from where the promised funds will come;secondly, how, i.e. how the country will manage the lifeline in order to avoid the impact on the growth of the debt-to-GDPratio; and finally, how much, given the fact market participants wonder whether the measure will be sufficient for the fullrescue of the Spanish banking system, or, rather, additional funding will be required

o Emerging countries: the scenario is still uncertain as geopolitical disturbances are at play. There are creeping risks of severeslowdown in the Chinese economy as a result of lack of monetary stimulus

Currency

o The macro context backs an appreciation pattern of the U.S. dollar. Flight-to-quality drivers also favor JPY, NOK, and GBP.Opportunities exist on AUD following Government's plans to achieve a budget surplus within 12 months

Commodities

o A recessionary pattern in Europe and a slowdown in China and Brazil, the never-ending debt crisis in theEurozone with increased market volatility, oversupply in the market for many commodities, and the strength ofthe U.S. dollar are all factors compatible with a scenario of prolonged weak commodity prices


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Year-to-date performance dispersion within hedge fund strategies resemble the pattern to tightening observed acrossDow Jones Credit Suisse hedge fund strategy indices at the end of April. Monthly performance dispersion among theDow Jones Credit Suisse hedge fund strategy indices at the end of April declined significantly at readings close to pre-2008 crisis levels

As sovereign risk continue to rage in Europe, despite mitigating in the first quarter, asset classes are becoming againincreasingly correlated, as it was in the post-summer period of last year

April confirmed the steady and significant correlation pattern of most of the hedge fund strategies with the MSCI WorldTR Index, similarly to what has been evidenced throughout 2010 and 2011

Equity Strategies: macro and geopolitical drivers are expected to continue prevailing on fundamental factors in the shortrun

Relative Value Strategies: Unconventional intervention on secondary market. Credit crunch due to banks default orinterbanking market failure (tail-risk signaled by the LIBOR-OIS spread)

Credit Strategies : bankruptcy in Europe, increase in the number and volume of fallen angels, and widening corporate

spreads globally due to cost of borrowing Discretionary & Quantitative Trading Strategies: FX markets distortions and carry trades unwinding. Choppy markets

due to short-term patterns of volatility clustering


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The usual risk-on risk-off phenomenon broadly infected investmentthemes as high correlations across asset classes and geographiescontinued to dominate global markets. Global investors lived a djvu as headlines about Eurozones debt crisis continued to trigger adeterioration in market sentiment and impact on investors risk

aversion

As we predicted in an earlier analysis a post-election (Greece andFrance) scenario materialized. The scenario of high volatility anduncertainty that characterized part of last years summer and fallmade a comeback, weighing on market sentiment. Global marketseroded gains posted in the first quarter market rally as they lost

U.S.$483 billion of market capitalization in April, according to S&P Risk indicators in the equity and currency options market suggest

increased concerns. Implied volatility of one-month at-the-moneyoptions in euro-dollar jumped to a more than one-month high in asign of increased anxiety and concerns the euro may depreciatefurther. In the stock market, the CBOE Volatility Index VIX onMay 31 increased more than 40% since the end of April, having

risen above the 20-mark for the first time in almost three weeks onMay 9

1,77%

4,19%

-1,02%

-1,92%

-1,15%

-0,34%

-2,49%

-0,98%

0,10%

1,24%

-0,75%

May; -0,13%

May; 2,60%

May; -7,99%

May; -7,85%

May; -6,36%

May; -3,89%

May; -9,32%

May; -10,62%May; -1,28%

May; -5,87%

May; -6,27%

-12,00% -10,00% -8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% 6,00%

Utilities

Teleco mmunication Services

Materials

Information Technology

Industials

Health Care

Financials

Energy

Consumer Stables

Consumer Discretionary

S&P 500

S&P 500 - Index Sector Price ReturnApril & May 2012


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In Greece, after a fractured parliament struggled to form acoalition as candidates who rejected bailout pledges and austeritymeasures imposed by the troika to tackle with countrys debt crisiswere elected, Samaras's conservative New Democracy partynarrow victory in June 17s new round of election highlighted the

controversy of a country deeply divided over whether toimplement a harsh austerity package to save its near-bankrupteconomy

In the global macro picture a recessionary pattern in Europecouples with a softening path of recovery in the U.S. and slowinggrowth in many emerging markets. Still the macro picture

remains bleak in the short run and investment themes remainsensitive to changes in economic policies and sovereign risk


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After being subdued in March, except for a spike on March 6,implied volatility as measured by the CBOE VIX rose 10.65%month on month in April 2012 to 17.15 at the end of April,indicating renewed fears of a Eurozone sovereign debt crisisspreading globally. CBOE VIX surged 40.29% in May, spikingabove the 20-mark on May 9 (as it was on April 10 and April11)

After two full quarters of strong market gains (up 24.49%), theS&P 500 was expected to consolidate its gains in April. Majorconsolidation never happened, with the worst point of themonth being off only 3.6% and the index closing off just 0.75%

Supporting the market were first-quarter earnings, which werecoming in as the third best in the S&P 500s history. Whileconcern continues over large-cap earnings, and their slowerrate of growth, strong earnings with high operating margins(9.18%; the historical average is 7.19%) continue to be thetrend

Standard & Poors, 500 Composite, Index, Price ReturnS&P 500 5-day Rolling Window Annualised Volatility

CBOE, Volatility Index (VIX)

Dec

06 07

Aug Dec

08

Apr Aug Dec

09

Apr Aug Dec

10

Apr Aug Dec

11

Apr Aug Dec

12

Apr

-250

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The economy in the U.S. is still a major concern in the run-upto the Presidential election. Everything else unchanged at theend of 2012 about 42 tax benefits will expire at the end of 2012.At that point there will be record drag (roughly 4%) on GDPfrom reduction of those tax benefits to spending. At the same

time, US government spending runs at approximately $1.50 forevery $1.00 raised. This level of spending is only comparable tolevels observed during World War II and is unsustainablebeyond the short term. Also, additional pressures on theeconomy comes from excess unemployment and its deflationaryimpact. According to the U-6 employment report there areabout 20 million still unemployed versus the long term average

of about 13 million (the effective unemployment rate stands at14.5%, well above the official 8.1%)

Despite positioning flipped to net-short in the second and third week of May, large speculators added net-long positionsin the S&P 500 delta-adjusted options and futures combined to the tune of about US$724.27 million notional value (asreported in the readings of the Commitment of Traders Report on the Chicago Mercantile Exchange for the five-weekperiod ended May 29). As a result, large speculators outstanding notional amount on May 29 increased from April 24

reading to the tune of US$1.34 billion net long. Large speculators net position as a percentage of total open interest onMay 29 got close to the zero-mark that separates long and short regions


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China continued to capture investors attention as recent macro datasupported both a hard- and soft-landing. Weakerthan-expectedexports and stalling headline import growth signal that governmentspending is the key factor sustaining the economy. The countryremains exposed to risks of a fresh downturn in demand for goodsfrom its massive factory sector. Recent trade readings show how

annual growth in imports in April was just 0.3%, far below forecastsof an 11% increase, while exports managed growth of just 4.9%versus expectations of 8.5%

Emerging markets eased 1.83% in April according to the S&P BMIEmerging Index with 12 of the 20 markets closing in the red.Notably, while the soft- vs. hard-landing debate continued, China

rose 2.38% in April, as consumption data were buoyed by Applessales in that country. Columbia (+5.40%) held the top spot in Aprilwhile Morocco (-6.84%) ranked at the bottom of the performanceleague table for April, according to the S&P BMI Emerging IndexEmerging countries underperformed their developed peers in May asthey amplified Aprils loss

The S&P BMI Emerging Index plunged 11.42% month on month in May. Morocco, which tried to rebound (-4.35%) from

Aprils decline, held the top spot in May while Hungary (-23.20%) ranked at the bottom of the performance league table forMay, according to the S&P BMI Emerging Index. China (-11.05%) outperformed the aggregate index by 37 bps, making itthe best of the BRIC countries. Russia was the worst BRIC member in May, dropping 21.73%. At the same time, Indiadropped 11.57% and Brazil plunged 14.55%


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In the local debt markets, Brazil was among the best performers in April (+2.36%) as the Central Bank cut rates by another75bps and fueled expectations about additional incremental cuts

According to data from Nomura, resembling the pattern observed since the start of the year, foreign investors favored Japan,India and South-Korea among Asian markets in the 19-week period until May 11. They bought US$18.51 billion of Japaneseequities and US$8.55 and US$8.33 billion of Indian and South-Korean stocks in 2012 up to May 11, respectively. Foreign netinvestment in Indian and South-Korean stocks up to May 11 accounted, respectively, for 34,27% and 33.40% of year-to-datenet investments into an aggregate region that includes seven Asia ex-Japan markets. In an attempt to attract new capital flowsinto Indian debt Indias finance ministry announced before the end of May that foreign retail investors can invest in Indian

corporate bonds as well as debt schemes for up to US$1 billion, in addition to the existing US$20 billion limit

Emerging markets sovereigns returned a healthy 1.48% in Aprilaccording to the BofA Merrill Lynch Emerging Markets Sovereign PlusIndex. The positive return was mainly due to a duration effect as theexcess return over a comparable benchmark was negative (-0.47%).Despite emerging sovereign debt spreads widened 7 bps in April the yieldis on declining path and is approaching the 4.85% all-time low. A

breakdown by currency highlights how US$-denominated emergingsovereigns widened for the first time in 2012 (+10 bps), while EUR-denominated emerging sovereign index tightened 10 bps

There was a clear Eastern Europe trend in April in the BofA MerrillLynch Emerging Markets Sovereign Plus Index as Ukraine (+5.15%) topranked and Hungary (+3.77%)which recovered from March after the

EU agreed to begin negotiating a bail-out packagealong with Georgia(+3.53) and Belarus (+2.83%) were among the best performers. Argentinabottom ranked in April (-3.98% month on month; +0.49% year-to-date) asthe country faced heavy selloffs after the government announced itsnationalization plans regarding YPF, the countrys largest oil company


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Flight to quality drivers that led appreciation of the Swiss franc prompted the Swiss National Bank to set a cap lastSeptember, citing the risk of deflation and recession. Swiss franc faced significant appreciation pressure in recent weeks asthe Eurozone crisis had deepened and Spain banks crisis triggered additional safe haven flows, prompting a temporarybreach of the cap in April. Switzerlands strong growth in the first quarter raises questions on the currency cap, as themeasure was originally set to prevent a recession. Quarter on quarter, Switzerlands GDP rose 0.7%, beating a Reuters

forecast for flat quarterly growth. Year-on-year, Switzerlands GDP rose a better-than-expected 2.0 % (expectations were setfor a rise of just 0.9%). A strong franc as well as slowing economic growth in trading partners hit Switzerlands foreign trade.In the first quarter exports of goods and services declined 0.4% quarter on quarter, although were up 0.7% year on year.Nonetheless, partly because of strong consumptionskilled immigration is high and unemployment rate is just 3.1% theeconomy gained momentum despite the overvalued franc


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U.S. dollar strength coupled with flight to safety that pushed the U.S. 10-year Treasury yield to an all-time low of 1.575%in May continued to feature a weakening pattern for gold. Despite flipping net exposure to long in the two weeks endingMay 1 and May 22, according to the Commitment of Traders Report on the Commodity Exchange Inc., in the five-weekperiod ended on May 29 large speculators sentiment on gold stayed bearish (for the same period net-short exposure

amounted to approximately US$5.93 billion notional value). Decreasing since April 24 close, outstanding net long exposureto gold for the overall five-week period ended May 29 decreased to the tune of about US$15.78 billion notional value.Large speculators net position in gold delta-adjusted options and futures combined as a percentage of total open intereststayed deeply further in the buy zone at the end of May


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After edging downward in the first quarter fromDecember 2011 highs the Eurozone ten-year swapspread stayed on an upward pattern in April and Maywith increased volatility, appearing to incorporate less-clear information regarding changes in expectations of

future economic activity

After tapering off at the end of January and staying on adeclining pattern for the rest of first quarter, theannualized ten-day rolling window volatility of the U.S.dollar swap spread climbed at the end of May, tripling

from March month-end lows, appearing to reflect more-negative expectations about the aggregated likelihood ofdefault prevailing among market participants. Marketsfactored in concerns about a contagion effect in theEurozone, triggered by the banking crisis worsening inSpain and peripheral countries debt sustainability. Anearly propensity to risky assets investing that dominated

investors agenda in the first quarter reversed to a risk-off mode in April and May

Perce

ntage

Basis

Points


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After the preliminary Q1,12 U.S. GDP value came in at a lower-than-expected 2.2%, (against a forecast of 2.4%), the readingwas later revised down to 1.9%. Businesses restocked shelves at a moderate pace and government spending plunged.Nonetheless, the Q1 2012 U.S. EPS value came in strong, and could render the years first quarter the third best quarter inhistory. Housing news were mixed, but the housing market was buoyed by lower inventory and willingness to buy. Existinghome sales were up, along with their prices (but inventories were also up). New homes also recorded better (but not as goodas existing home sales) readings and their inventories ticked down

Despite operating earnings are set to post their third best quarter (behind Q3,11 which is first, and Q2,11, which is second)in the S&P 500s history, the current macro environment and U.S. government fiscal and economic policies undermineinvestors confidence in forward earnings. Other things equal, if the current market was selling at the historical average 19.1operating P/E, the S&P 500 would be at 1817.52 and not 1310 (on May 31). Is it just a matter of confidence? Or, does itimply the market is adjusting to a new normal in valuation by multiples? In real P/E ratio terms U.S. equities still arevalued as unappealing


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Large-cap U.S. equity names continue to show a betterresilience than small- and mid-cap stocks in a verydifficult environment

May S&P 500 dividend payments were 23.3% higher thanin May 2011, and the YTD payment is up 17.8%; the

indicated dividend rate is now at an all-time high, up11.4% YTD. The U.S. Congressional Budget Officeforecast that the first half of 2013 could see the return of arecession if Congress doesnt do something to counter (orprevent) the scheduled tax increase and stimulusprograms that are ending. Amongst the measures that arescheduled to begin in 2013 there is also the 59% increase

in capital gains and the almost tripling of the dividend tax

The ten-day exponential moving average of the CBOEEquity Put/Call Ratio, a gauge of the sentiment ofspeculative traders (which hit a multi-year record low of0.472 on April 15, 2010 and a 2012 low on March 21)continues to move along a pattern to the downside within

the bullish-bearish range


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As flight-to-quality dominated global debt markets in April andMay spreads in the corporate sector were on the rise again after athree-month tightening run. Nevertheless, spread widening wasof modest magnitude in April almost canceling out the previousmonths tightening

According to BofA Merrill Lynch the total face amount of ratingmigrations declined by a small amount in April (U.S.$203bn vs.U.S.$216bn the prior month), with the amount of upgradescontinuing to rise. Compared to the amount of downgrades(U.S.$166bn) the upgrade total was still fairly small (U.S.$37bn),but April was the third consecutive month in which the faceamount of upgrades increased month on month. At the sametime, for both March and April the amounts of downgrades andfallen angels have also decreased

After a one-month setback in March the BofA Merrill Lynch USHigh Yield Index came back strong with a 1% return in April. Fora sixth consecutive month the performance differential betweenthe BB- and B-rated segments of the index was inside 0.5%,

which is below the 0.69% 10-year average

Basispoint


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Interestingly, as highlighted by BofA Merrill Lynch research thespread gap between BBs and Bs is higher than average, as istypical in periods of uncertainty. Even more interesting about thecurrent B-BB spread gap is that it comes along with a strongflattening in the B-rated credit. The spread of the 2-year and 5-

year points on the B-rated curve is now almost flat. That is muchlower than in the previously mentioned periods of uncertainty

Europe and US high yield seem to be at polar opposites. Whilethe US rebounded from a modest loss in March to a solid 1+%gain in April, European high yield did the reverse. As expected,given the Euro sovereign debt crisis continues to dampen theperformance of banks in the region, Europe lags the US by morethan 1% in the Banking sector

Given the rising pattern of the monthly variability between USand European high yield, which only represents a return to themean, and in light of fundamental divergences in the respectivepatterns to economic recovery, we may expect a decouplingbetween European and US high yield indices, with lower

correlation in the two indices than that observed in the last twoyears

Basispoin

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Reflecting concerns about the global macro picture and mimickingequity markets decline, the S&P GSCI decreased 0.51% in April(+5,34% year-to-date), mainly driven by weak agriculture andlivestock sectors. Factoring in cautious optimism about global macroprospects, despite continuing nervousness about Chinas growthprospects, the S&P GSCI Industrial Metals index held the top spot forApril with a 0.19% increase (+6,52% year-to-date). The industrialmetals was the only sector to post gains in April

Year to date at the end of April energy has continued to be the maindriver of commodity gains, as measured by the 7.04% increase in theS&P GSCI Energy index. In April, the Energy index was almost flat asgains in crude oil (+1.31%) were offset by declines in Brent crude (-

2.02%) and unleaded gas (-3.35%). Easing tensions with Iran,increasing recession risk in Europe, increasing economic optimism inNorth America, and the potential for an earlier-than-anticipatedreversal of the U.S. Seaway pipeline to move crude out of the CushingOklahoma storage area toward the sea for export all contributed tonarrow the Brent crude versus WTI crude oil spread. Brent crudespremium over WTI crude oil declined to $14.60/bbl at the end of April

from $19.86/bbl at the end of March. Reflecting tightening supply anddemand conditions, the petroleum futures curves as depicted by theS&P GSCI Energy subindices generally moved toward backwardationin April, except heating oil that ended the month in contango


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The S&P GSCI Soybean Index top performed among all the S&P GSCI commodities in April (+7.09% month on month), also

ending the month as the best-performing year-to-date single-commodity index, with a gain of 23.57%. Price tensions onsoybeans were sparked off by Chinese Vice President Xi Jinpings visit to the U.S. grain belt in February, signaling increasedpurchases of U.S. grain. Under strong global demand poor weather conditions in South America have added support to the beanmarket in April. Future prices continue to depict an extreme backward shaped futures curve for soybean (the percentage ofbackwardation stood at 11.1% at the end of April)

The S&P GSCI Livestock Index was the bottom performing sector index in April with a negative 2.52% decrease (-7.26% YTD).Abundant supplies, supported by mild North American weather and moderating feed costs have sustained a boost in carcass

weights along with increased global production, mainly from China. Livestock investors continued to face negative roll returnsmainly due to the high costs of storage as all three livestock commodities (live cattle, feeder cattle, and lean hogs) were at theupper end of the futures curve range, in the contango section

The S&P GSCI Softs index was the worst-performing subsector index in April (-6,79% month on month; -6.70% year to date),detracting the most from performance of the agriculture sector. Sugar was the biggest drag on Softs index returns, as reflectedby the 11.94% decline in the S&P GSCI Sugar index in April. More balanced supply/demand conditions pushed all of the softs in

contango at the end of April


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Chesapeake (CHK.N), the second-largest U.S. natural gas producer, confronts a funding gap that Fitch Ratingsestimated at $10 billion this year. On May 9 Moodys Investors Service changed its outlook for Chesapeakes debtto negative from stable, citing an even-larger capital spending funding gap for 2012, due both to lower energyprices and higher spending. Despite posting its first monthly gain in a year in April and bouncing further in thepast few weeks, U.S. natural gas prices remain close to their lowest levels in a decade. Low prices of natural gascompress cash flows for energy producers and raise concerns that companies may need to take impairment chargeson the value of their properties

According to Markit data the price of credit protection on Chesapeake debt in the credit default swap market rose24.12 percentage points to 10.13% upfront on May 11. This means investors seeking five-year protection againstdefault on a $10 million bond have to pay $1,013,000 initially

Dai ly QCHK.N 03/01/2012 - 11/05/2012 (NYC)

Line; QCHK.N; 11/05/2012; 14,8100; -2,3700; (-13,80% ); SMA; QCHK.N; 11/05/2012; 17,6940Pr i c e

U SD

. 1 2 3 4

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Vo l; Q C HK.N; 11 /05/ 20 12 ; 1 3, 33 0M

V o lu m e

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10 M

03 09 17 23 30 06 13 21 27 05 12 19 26 02 09 16 23 30 07g e n 1 2 f e b 1 2 m a r 1 2 a p r 1 2 m a g 1 2

Despite natural gas prices recentlybenefited from the aftermath ofthe Fukushima nuclear accident inJapan, the front natural gas futureclosed April 2012 at $2.29/MMBtuwith the one year out futuretrading at a contango of about 48%as oversupply and sluggish NorthAmerican demand due to the mildwinter weighed


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The latest European Central Bank s report on financial integration in the Eurozone highlights how cross-border holdings ofgovernment bonds by euro area Monetary financial institutions (MFIs), as a ratio to total holdings, has been on a declining trendsince 2006 and has now returned to the levels observed before the beginning of the third stage of Economic and MonetaryUnion (EMU). Initially, portfolio reallocation to corporate bonds and international assets might have contributed to thephenomenon ofde-euroisation. Recent declines are most probably ascribable to banks increased propensity to hold domesticgovernment bonds, which accelerated as a result of recent LTRO policies by the European Central Bank

A recent analysis by Rabobank, which extrapolated the average rate of decline in foreign holdings of sovereign debt over thelast six months, forecast that foreign holdings in the Italian sovereign debt market will hit 1998 levels by July 2013, whileinternational holdings of Spanish government debt will decline to1998 levels by 2013 year end


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In global debt markets renewed concerns aboutEurozone debt led government rally with flight-to-quality driving performance throughout April and May.Thanks to an impressive Treasury rally, the BofA MerrillLynch US Large Cap Index (1.12%) recorded in April itsbest monthly return since last August

A sell-off in the debt of larger members of theperiphery (Spain and Italy) led eventually to France aswell

Australia (2.21%) held the top spot within the BofAGlobal Government Index in April while US Treasuries(1.53%) were the runner-up. As inflation reached its

lowest level since the 1990s expectations of rate cutsdrove the rally in Australian government debt.Australias central bank delivered a 50bp rate cut onMay 1 and a further 25bp easing in the first week of June

Steepening trades on the Eurozone yield curve wereprofitable in April

0

1

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1 month 3 month 6 month 1 year 2 year 3 year 5 year 10 year 20 year 30 year

Yield

Maturity

U.S. Yield Curve, March 30, 2012, April 30, 2012, and May 31, 201 2

(source: Mthm calculations on market data)

30-mar-2012

30-apr-2012

31-mag-2012

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Eurozone Yield Curve, March 30 , 2012, April 30, 2012, and May 31, 2012


30-mar-2012

30-apr-2012

31-mag-2012

US 30yr-2yr yield curve spread 17 bps yield curve bull flattening and a negative 10-bp average shift month on month at theend of April - 47 bps yield curve bull flattening and a negative 12-bp average shift for the period April 30-May 31

Eurozone 30yr-2yr yield curve spread 5 bps yield curve bull steepening and a negative 10-bp average shift month onmonth at the end of April - 55 bps yield curve bull flattening and a negative 21-bps average shift for the period April 30-May31


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Despite Februarys accord on Greeces sovereign debt,which enabled Athens to launch a bond swap withprivate investors who took losses of 53.5% on thenominal value of their bonds, equivalent to about 70%loss on the net present value of the debt, Greeces yieldcurve continued to stay slightly inverted, with 10-year

government benchmark yield peaking at 29.941% onMay 31. Greeces yield curve featured a steepening biasin both April and May. Nonetheless, steepening tradeswere only profitable in April as Greeces 30yr-10yryield curve spread recorded a 15-bps yield curvebullish steepener and a negative 62-bps average shiftmonth on month. Conversely, in May Greeces 30yr-

10yr yield curve spread featured a 9-bps yield curvebearish steepener and a positive 637-bps average shiftmonth on month

Italy 30yr-2yr yield curve spread 11 bps yield curvebear flatteners and a positive 32-bps average shiftmonth on month at the end of April 2012. Italys yield

curve featured a similar pattern in May as it recorded a131 bps yield curve bear flatteners and a positive 85-bps average shift month on month at the end of May2012. Steepener trades on Italys yield curve detractedfrom performance of fixed income arbitrage strategiesin both April and May

0,0

5,0

10,0

15,0

20,0

25,0

30,0

35,0

3 month 6 month 1 year 2 year 3 year 5 year 10 year 20 year 30 year

Yield

Maturity

Greece Yield Curve, April 30, 201 2, March 30, 2012, and May 31, 2 012


30-mar-2012

30-apr-2012

31-mag-2012

0

1

2

3

4

5

6

7

3 month 6 month 1 year 2 year 3 year 5 year 10 year 20 year 30 year

Yield

Maturity

Italy Yield Curve, April 30, 20 12, March 30, 2012 , and May 3 1, 2012


30-mar-2012

30-apr-2012

31-mag-2012


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After surging in the second half of April, Euro three-month Ted spread(the difference between three-month Libor interbank rates and TreasuryBill yields) as a measure of stress in the Eurozone, just as it anticipatedthe credit crisis in 2007, declined 9.72% month on month in May,staying on a declining pattern from multi-year record level posted onDecember 29 last year at 148.229

Despite continuing to ease from 2011 record levels, a relatively widethree-month euro LIBOR-OIS spread, which is the difference betweenthe rate banks charge for loans in the interbank market and theovernight index swap ratewhich captures central bank interest-rateriskcontinues to highlight a decreased banks propensity to lend toeach other


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Debt markets in April and May factored in the potential deterioration offinancial conditions in peripheral Eurozone countries and sustainability offiscal measures agreed under the so-called fiscal compact

Among Eurozone peripherals Spain and Italy mimicked each other. BothSpains and Italys GDPs fell in first quarter for a second consecutive quarterand both countries entered their second recession since 2009. At the sametime unemployment in Spain reached an 18-year high and the country,

together with 16 banks, was downgraded by S&P for the second time this year.

Italy also recorded an increase in its borrowing costs after the governmentmoved back its balanced-budget target to 2014. At the same time, thedeterioration of the Spanish banking sector and a potential lack of confidenceon Spains economy appear to have triggered at the end of May an earlyinversion of the short-end segment of Spanish yield curve


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The sentiment only increases the potential of a market correction.

Should economic and financial conditions either worsen or becomeunsustainable the impact on opening positions would be dramatic

In the sovereign debt market U.S. , Germanys, and Japanssovereigns continued to benefit from flight-to-quality drivers, withyields bottoming out at historical record lows. Real yields furtherdeepened in the negative region at the end of May

Results of Irelands referendum on fiscal compact on May 31removed an additional source of volatility clustering on Eurozoneperipheral debt in view of the next round of elections in GreeceIrelands sovereign debt continued to show recently some resiliencein global debt markets as 10-year yield spreads decoupled from ageneralized widening pattern observed among Eurozone peripheralcountries

Source: U.S. Department of the Treasury


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April confirmed the steady and significant correlation pattern of most of thehedge fund strategies with the MSCI World TR Index, similarly to what has beenevidenced throughout 2010 and 2011. For a number of hedge fund strategies thesix-month rolling correlation against the MSCI World Index increasedsignificantly at the end of April. Dedicated Short-Bias and, although of a lower

magnitude, Managed Futures and Global Macro, continued to show a negativecorrelation against the index (-0.95, -0.23, and -0.03 for the one-year period atthe end of April, respectively). The Credit Suisse Dow Jones Hedge FundComposite Index recorded a firm level of positive correlation with the globalstock market index at 0.95 for the six-month and 0.91 for the one-year periods .Equity hedge strategies, namely Long/Short Equity, along with Event-Drivenand, to a minor extent, Equity Market-Neutral, continued to be somewhat long-

biased; in other words, the strategies maintained a significantly high positivecorrelation to equities (a correlation between 0.65 and 0.97 for the six-monthperiod) despite macroeconomic themes, sovereign risks, and macro informationflow arrival started to dent again on stock picking allocation models.Interestingly, the six-month rolling correlation against the MSCI World Index ofrelative value strategies (Convertible Arbitrage and Fixed Income Arbitrage)peaked at critical positive levels at the end of April (0,98 and 0,87, respectively)

Correlation of Cre dit Suisse Dow Jones HF Strategy Indices Vs. MSCI World TR Index

April 30, 2012

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

Correlation 6 Months Correlation 1 Year Correlation 3 Years

Correlation of Credit Suisse Dow Jones HF Strategy Indices Vs. Reuters/Jefferies CRB Index

April 30, 2012

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

Correlation 6 Months Correlation 1 Year Correlation 3 Years


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EUROPE: fiscalcompact vs. growth

policy, banking crisisin Spain, rising

borrowing cost inSpain, Italy & France

USA: increase of long-

term rates

in the coming months we will observe whether the concertedstrategy from Brussels will be successful, or whether the internationalcommunity will lose confidence in the Euro (EURUSD exchange rate at1.24-1.26 is not consistent with the Eurozone recessionary pattern). Greeceis no longer a problem for the banking system and probably a NON-issuefor the stability of the Euro. The instability in the Hellenic country is awarning for other countries (Ireland, Portugal, Spain, etc.) which wouldconsider restructuring debt and return to the local currency. The realproblem has always been and remains in Spain: the banking system is nearcollapse and the Spanish Government has finally admitted the need torecapitalize

current inflationary pattern and the pace of economic growth are notconsistent with negative real rates. Recent prices of Treasuries and negativeyields in real terms are justified only by flight-to-quality drivers. Ascenario of recession appears to be unlikely for the U.S. economy

Spread widening

Default rate increase

: The liquidity injected into the global system favors purchase ofhigher-yielding securities. Nonetheless, investors' preferences will unfoldalong a diverging trend between the U.S. and Europe because of problemsrelated to the Eurozone debt crisis that impacts on the banking sector. Weexpect an increase of this difference over time, fueled by recessionarypressures that will also affect non-financial related sectors

A risk of insolvency in the banking sector (exacerbated by theproblems in Spain) remains. A new round of LTRO by the ECB may comethis summer


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SOVEREIGN

CORPORATE

Sovereign debt in local currency will be left at the post, held back by thenature of the rally driven by investment flows into safe-haven assets,which will continue to favor liquid developed market sovereign debt.Trade surpluses, higher consumer demand and currency appreciation

support valuations in the long-term: a slower pace of growth in China,inflation in India and contraction in Brazil does not affect the quality ofdebt; on the contrary, short-term uncertainties represent an investmentopportunity to buy. A confirmation of the investment opportunity abovecomes from the observation of the sovereign debt spread: despite a slightincrease of 7 bps in April and further 70 bps and in May, mainly driven bya sizable rally in the underlying benchmark curves, the trend to narrowinginterest rate continues to historic lows as yields have increased onlyfractionally compared to the spread

PREPAYMENT RISK

INTEREST RATE

RISK

: The scenario highlights a continuous improvement. Data confirm lowlevels of prices, dynamic acceleration of purchases in value areas and signsof recovery in new construction. Strong improvement in credit availabilityand the quality of loans financed

: When compared to previous months the scenario is unchanged.Germany (no housing bubble), Ireland, and United Kingdom (bank debtabsorbed by the government) do not present remarkable risks. Valuationsof both real estate and mortgage securitizations do not reflect economicfundamentals and financial situation in Italy, Spain and France. The majorproblem is in Spain


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LIQUIDITY

VOLATILITY

LEVERAGE

Previous months' scenario appears to be confirmed: loose monetary policysupports liquidity, bond yields at historic lows favor equity investment(risk premium and dividends), global risks, macroeconomic data andinflation may affect volatility in the short- to medium-term. Rosier

readings related to consumer demand and real estate, along with the"presidential elections" factor, are a further support

LIQUIDITY

VOLATILITY

LEVERAGE

As shown in previous months, rally started in January was not sustainable.With the exception of Belgium and Denmark, European stock indexes arenegative year- to-date. German ten-year yields (which hit a record low of1.173% on June 1) confirm the flight to quality. In opportunistic terms, thegrowth of consumer demand in Germany (sustained by the deal in the

industrial sector for an average salary increase of 4%) and the resolution ofuncertainties in Greece and Spain could trigger a market rise, perhapssupported by a new round of LTRO. The flight to quality has decreased theleverage risk

LIQUIDITY

VOLATILITY

LEVERAGE

Risks: severe slowdown in the Chinese economy as a result of lack ofmonetary stimulus, which is not realistic as inflation readings continue torise. The recent rate cut in China, which caught market participants by

surprise, seems to signal a pre-emptive action by Chinese authorities withrespect to something already known or an expected risk. It is worth notingrising inflation and political uncertainty in India, where, however, thescenario of economic growth (consumption and investment ininfrastructure) remains positive. Brazil is ready to enforce maneuvers ofmonetary stimulus


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VOLATILITY

GOVERNMENT

RESTRICTIONS

Appreciation pattern of the U.S. dollar stemming from increaseduncertainties in the Eurozone, concerns about the pace of growth inChina, improvement in the balance of trade and the overall U.S. economy.

Flight-to-quality drivers also favor JPY, NOK, and GBP. Opportunitiesexist on AUD following Government's plans to achieve a budget surpluswithin 12 months. Short-term risks on Brazilian real given monetarypolicy interventions to sustain exports

ENERGY/METALS

A recessionary pattern in Europe and a slowdown in China and Brazil, thenever-ending debt crisis in the Eurozone with increased market volatility,oversupply in the market for many commodities, and the strength of the

U.S. dollar are all factors compatible with a scenario of prolonged weakcommodity prices. Then, in the first week of June, according to theCommitment of Traders data as published by the U.S. Commodity FuturesTrading Commission, hedge funds have withdrawn about U.S.$1.7 billioninvested in long positions in commodities markets. The price of gold, inaddition to suffering from a series of profit taking, continues to bepenalized by the levels of the U.S. dollar (on May 31 the U.S. Dollar Indexwas up 5.51% from the lows recorded on April 27)

AGRICULTURE

PRECIOUS METALS

TAIL RISK

The banking crisis in Spain, the solution of which will likely boost marketconfidence only temporarily, Greek politics equilibrium in a post-electionscenario, the geopolitical escalation of crisis in Syria, the risk of hardlanding in China, and potential protectionist measures in Brazil representthe most prominent themes in coming months


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Macro environment & recession inEurope

Potentially, high liquidity supports M&A andshares buy-backs. Recession in Europe & macrouncertainty still weight on the negative side.China, India and big Private Equity names could

play a key role within the M&A game.

Bankruptcy in Europe andwidening corporate spreadsglobally due to cost of borrowing

In light of fundamental divergences in therespective patterns to economic recovery, wemay expect a decoupling between European andUS high yield and corporate indices, withcorrelation in the two indices lower than thatobserved in the last two years. At corporate

level, high grade names and components ofsector indices are expected to continuebenefiting from flight-to-quality drivers andallocation to safe haven assets. In the currentmacro context, autos might continue exhibitinga better resilience allowing the sector to performrelatively well on an excess return basis

Widening spread; tail-risk

Convertible Arbitrage exposed to worseningbond valuations and credit-spread widening. Onthe positive side: corporate activity in the US isto pick up due to an improvement in economicperspectives and resumed action at convertibleissuers level


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Unconventional interventionon secondary market. Creditcrunch due to banks default orinterbanking market failure

: reversal of flight-to-quality drivers,massive trade imbalances between peripheralcountries and core countries coupled with liquidity

issues in the banking system sustain a high volatilityenvironment. near zero-rate policy andexpected QE3 will push yield curve to steepen asmarkets anticipate the end of the long bull marketin fixed income. This environment will increasearbitrage opportunities.

US: negative surprise onConditional Prepayment Rate(CPR) & interest rates (FOMCmay ends its near zero-rate

policy before 2014) Europe:real-estate bubble to burst vs.soft deleveraging.

In the U.S. the MBS market is sustained by supply

almost peaking at historical highs. Federal Reservesnear zero-rate policy continues to allow positivecarry on mortgage-backed securities (one-monthU.S. Libor represents MBS roll funding basis), hencethe positive roll characteristics are still in play. TheU.S. Mortgage Bankers Association (MBA) on May24 announced an upward revision of its mortgage

origination forecast for 2012 by almost $200 billion,due entirely to an increase in refinances. MBA nowexpects that mortgage originations will reachUS$1.28 trillion in 2012, up from US$1.26 trillion in2011. Positive factors that contributed to betterestimates included HARP 2.0 initiatives and recordlow mortgage rates


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Uncertainty over economic andfiscal policy measures; assetbubbles on precious metals vs.

market shock; reversal in FXcarry-trades; escalation of theSyrian uprising

Recent Ben Bernankes speech suggest the economyis not out of the woods yet and an additional roundof quantitative easing remains an option if thingsworsen. After first quarters honeymoon, as the

macro picture remain bleak, markets will continueto be driven by geopolitical biases, rather thanfundamental factors. Still directional FX and Equitytrades offer best opportunities; riskier trades exist inrates & commodities

FX markets distortions; carrytrades unwinding

Positive: currency & equity. Neutral: commodities &rates

Choppy markets due to short-term patterns of volatilityclustering

Positive: high frequency trading & currencyprograms. Negative on trend-following programs

Macro environment(recessionary pattern in theEurozone and falteringrecovery in the US)

Potential risk: China remains exposed to risks of afresh downturn in demand for goods from its

massive factory sector as concerns over risinginflationary pressures and labor force costs, alongwith banks need of refinancing, mount. Positivefactors: rising consumption in all emergingeconomies and money-outflow already occurred in2011. BRIC countries performance might continueto disappoint in the short run


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Short Medium-

Long

Short Medium-

Long

Short Medium-

Long

Short Medium-

Long

Short Medium-

Long


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Mthm 2012. All Rights Reserved.

The report was closed with information available as of the market close on May 31, 2012.

Mthm Hedge Fund Strategy Insight Reports are for informational purposes only, and do not constituteinvestment advice or an offer to sell or the solicitation of an offer to buy any security of any entity in anyjurisdiction.

Although the information herein is believed to be reliable and has been obtained from sources believed to bereliable, we make no representation or warranty, express or implied, with respect to the fairness, correctness,accuracy, reasonableness or completeness of such information. No guarantee is made that the information inthis report is accurate or complete and no warranties are made with regard to the results to be obtained fromits use. Mthm will not be liable for any loss or damage resulting from information obtained from thisReport. Furthermore, past performance is not necessarily indicative of future results.

Documents

Mathema May 2012 Global Investment Insight Report