CS Quarterly Alternatives Q2 2011

Asset Management

Message from the Chief Investment Officer

Hedge Funds

Private Equity

Credit Strategies

Commodities

Brazil Strategies

Asset Management Alternatives Quarterly Q2 2011

Credit Suisse Asset Management Alternatives Quarterly

About the Asset Management Alternatives Quarterly

Credit Suisse Asset Management’s Alternatives Quarterly offers investors authoritative insight on economic trends and capital markets around the world, spanning a wide spectrum of asset classes and investment styles.

Drawing directly from our mission to share knowledge and provide focused investment solutions to investors worldwide by leveraging the firm’s best ideas, access, resources and capabilities, the publication compiles views from our Chief Investment Officer on current macroeconomic and investment themes as well as a range of analyses from our leading alternatives portfolio managers on the trends and opportunities shaping today’s financial markets.

We hope you find the insights in this publication to be an important tool in helping you develop solutions and investment strategies.

We would also like to hear your feedback as we continue to further develop this quarterly publication.For more information or to comment on any views expressed here, please contact your Credit Suisse Asset Management relationship manager or write to us at [email protected].

Credit Suisse Asset Management | Alternatives Quarterly 1

Message from the Chief Investment Officer

In our market outlook at the beginning of the year, we highlighted that 2011 could follow a similar pattern to 2010, especially from an overall economic perspective and the behaviour of most asset classes: Tailwinds from favorable macroeconomic and fundamental factors pointed to further upswings globally in real assets, such as equities, while a broad array of risks presented potential for corrections and consolidation phases.

Indeed, the first quarter of 2011 showed both sides of the coin: Macroeconomic fundamentals, along with positive corporate earnings and valuations, generally supported global equity markets, but were accompanied by periodic increases in risk aversion and volatility in various capital and commodity markets. Uncertainty was triggered by well known risk factors, such as the tensions in the Middle East and North Africa (MENA) region, as well as unforeseen events such as the Japanese nuclear disaster.

Other existing risk factors—i.e., the European debt crisis, inflation pressures in emerging markets and policy discussions by developed nations’ central banks—failed to exert a significant drag on financial markets. We take this as an indication that global capital markets, in general—and equities, in particular—have already priced in many of these risks (at least partially). Accordingly, we believe the market dips presented good opportunities to add to positions. Staying overweight in real assets in general—and equities in particular—remained a sensible strategy, in our view.

We believe this pattern will continue in the coming months. Key positive elements include ongoing broad-based global economic growth, the still attractive valuations of global equity markets, the strong corporate sector in many parts of the world and continued accommodative policies by developed nations’ central banks. We expect these factors to drive equity-price appreciation over the coming year, albeit with disruptions and episodic bursts of heightened risk aversion. We think that uncertainty and setbacks will not be triggered by well known risk factors, but rather by a mix of new questions over economic growth in select parts of the world, in combination with ongoing inflation concerns and the potential for a cooling down in corporate earnings revisions. We also believe these potential market setbacks will be temporary.

Consequently, we believe investors should maintain a clear focus on specific asset classes in 2011, especially real assets, such as equities, real estate and selective commodities. We anticipate that these assets could benefit from the current cycle in which government bond values generally decreased further. In our view, the overall macroeconomic and inflation environment is not yet appropriately priced into the traditional government bond markets, and, accordingly, we remain underweight sovereigns and stay with short-duration bonds. We do believe, however, that some areas of the fixed income market—especially floating-rate instruments, emerging markets, selective credit and high yield—may still deliver added value, despite some stretched valuations.

In addition, from an asset category perspective, we strongly recommend including alternative investments in general, and hedge funds in particular, as the third strong pillar in an overall portfolio, in addition to equities and fixed income. But, as already stated at the beginning of the year, the key to successful portfolio management will be a combined focus on strategic trends as well as tactical necessities.

Stefan KeitelGlobal Chief Investment Officer Credit Suisse Asset Management and Private Banking

Credit Suisse Asset Management | Alternatives Quarterly2

Event DrivenSebastien Fiaux Americas/EMEA Portfolio Manager, Alpha Strategies Group

Distressed Credit Ɓ We believe that the opportunity set for large-cap distressed

situations that came out of the global financial crisis has narrowed globally, while the pipeline for the traditional set of small- and medium-size companies is still robust. These smaller, niche deals favor nimble fund managers who are less constrained by economies of scale.

Ɓ Currently, opportunities are clustered around the following areas:

– Small- and middle-market companies in the US that, in aggregate, are still experiencing financial stress and need to restructure their balance sheets (Display 1). Hedge fund managers may engage with these distressed companies’ management to devise financial and/or operational solutions to help address their challenges;

– European distressed opportunities coming from banks that still need to deleverage, and that have implemented sizeable asset-disposition programs;

Hedge Funds

– Post-reorganization equity opportunities (globally) arising from previously restructured companies across a broad array of industries.

– A recent example of a post-reorganization equity opportunity is a US packaging company that filed for bankruptcy in 2010. During the bankruptcy process, certain distressed managers acquired the packaging company’s unsecured bonds that also gave them exposure to newly issued post-reorganization equity, which they perceived to be valued at discounted levels to the company’s fundamental value. In January 2011, a competitor offered to acquire the company at a substantial premium to its stock price upon emergence from bankruptcy, creating meaningful contributions to managers’ returns independent of overall equity market moves.

Ɓ Although deals have become smaller and require more specific distressed expertise, with many hedge fund managers becoming more actively involved in creating value in their investments, we continue to see a robust opportunity set in the space.

Data from June 2008 to March 2011Source: Standard & Poors

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Display 1: Still high default rates for mid-cap companies may generate distressed opportunities

Alternatives Quarterly Credit Suisse Asset Management | 3

Risk Arbitrage Ɓ We remain optimistic that global mergers and

acquisitions (M&A) activity will continue to increase, as capital-rich companies are indicating greater confidence for engaging in corporate actions. Risk arbitrage managers have noted that the transaction pipeline has increased, with the expectation that the number of deals will grow in sectors such as energy, healthcare, natural resources and technology.

Ɓ Strategic acquirers are leading the charge in the merger market globally (i.e., corporation-led mergers as opposed to those sponsored by financial acquirers, such as private equity firms or hedge funds). We expect that private equity firms will become more active in this space, however, as they need to invest previously raised capital.

Hedge Funds

Display 2: First quarter M&A activity has been healthy, and should continue to grow

Data from January 2008 to March 2011Source: Bloomberg

Ɓ M&A deal spreads generally remain tight worldwide as interest rates have been low and financing has been abundantly available. In this context, managers tend not to favor pure merger-spread arbitrage that have lower return expectations, but rather special situations that are linked to merger activity (such as bidding wars, pre-mergers and distressed exchanges).

Ɓ There were over $530 billion of newly announced transactions in the first quarter, indicating a healthy level of M&A activity (Display 2).

Event Driven (continued)Sebastien Fiaux Americas/EMEA Portfolio Manager, Alpha Strategies Group

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Ɓ Overall, global macro managers remained diversified and flexible in the first quarter. They ran lower-than-average value-at-risk (VaR) levels, with their main focus on option-like payouts on potentially mispriced events.

Ɓ We expect macro managers to increase risk levels as market sentiment recovers from the first quarter’s destabilizing events—e.g., the political unrest in the Middle East and North Africa, Japan’s tragic disasters and Eurozone debt concerns. On the other hand, we believe managers will remain cautious, with an emphasis on liquidity at the position level, allowing them to trade tactically and opportunistically across various geographies and asset classes.

Ɓ Divergence of economic conditions within the Eurozone continued over the quarter, and a number of member nations face ongoing headwinds of relatively high debt levels and relatively low growth (Display 3). As the European Central Bank and Eurozone governments seek

Global MacroSami RobbanaTarek Rizk, Ph.D. Co-Heads, Tactical Trading Research, Alpha Strategies Group

Display 3: Macro managers are focusing on economic divergence in Europe...

Hedge Funds

to address imbalances related to inflation (Display 4), unemployment, non-financial debt and current account surpluses/deficit, we expect many macro managers to focus on asset classes and instruments affected by policy issues. Eurozone nations are constrained on an individual basis in addressing these macro issues because of their shared currency and central bank, requiring complex and hard-to-achieve policy coordination.

Ɓ Accordingly, we continue to favor global macro hedge funds with an edge in policy analysis, and the flexibility to capitalize on related trading opportunities.

Ɓ For commodity-oriented managers, geopolitical events in the Middle East and Japan resulted in significant commodity price action in the first quarter. The energy complex was most affected by the Middle East, while Japan’s disasters impacted metals due, among other things, to potential disruptions in Japanese car production.


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Hedge Funds

Ɓ Bottom-up global corporate earnings remain generally supportive of equity markets, especially in the United States, the United Kingdom and the Eurozone.

Ɓ On a macroeconomic level, the developed markets’ business-cycle momentum has been decelerating slightly, but remains at levels that support equities, particularly in the US (Display 5).

Global Tactical Asset Allocation/Global MacroAnne Sophie Van Royen, Ph.D.Portfolio Manager, Head, GTAA/Global Macro

Xiaomeng Yang, CFA, Ph.D. Co-Portfolio Manager, GTAA/Global Macro

Ɓ The outlook for global sovereign bond markets improved in the first quarter, acting as a hedge against the increasing risk in the equity space in our models.

Ɓ With rising fiscal challenges across Europe and rising inflationary pressures in emerging Asian economies, cross-country market divergence could present an increase in relative-arbitrage opportunities.

Data from July 2008 to March 2011Source: Bloomberg

Display 5: In developed economies, business-cycle momentum is now favoring the US over Eurozone

OECD leading indicators summarize information on early signals contained in a number of key short-term economic indicators known to have a leading relationship with GDP for 35 countries.

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Hedge Fund ReplicationJordan Drachman, Ph.D. Head, Alternative Beta Strategies Research

Peter Little Head, Alternative Beta Strategies Portfolio Management and Implementation

Ɓ The replication model for long/short equity hedge funds added back its exposure to emerging markets in the first quarter for the first time since October 2010, as hedge fund managers appeared to become increasingly confident in a global recovery, and began to move their money into riskier non-US assets.

Ɓ Additionally the long/short replication model added a long growth/short value position, which it maintained throughout the first quarter. As Display 6 illustrates, the position contributed considerably to the returns in the space from the beginning of February through the end of March.

Ɓ In the event driven replication model, managers seem to have transferred money from distressed credit to distressed equities, as the high yield five-year CDX1 spreads reached

Display 6: The long/short hedge fund replication model favored growth over value in the first quarter

The spread is calculated as the Russell 2000 Growth Index’s performance minus the Russell 2000 Value Index’s performance.Data from January 2011 to March 2011Source: Bloomberg

Hedge Funds

new 12-month lows. This decision seems to be consistent with managers’ belief in a global recovery.

Ɓ During this last recession, with interest rates at historic lows, many investors sought greater yield by moving into the credit space, causing a large rally in the high yield bond market—as of March 31, 2011, the Credit Suisse High Yield Index was up 97.1% from its low on December 11, 2008, and 31.8% higher than its pre-crisis peak on May 31, 2007. If, as implied by the replication models, we are in an economic recovery, we may be nearing the end of this credit bull market. As the global economy improves, interest rates are likely to increase, making investment grade bonds more attractive and reducing the need for investors to chase yield.

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1The CDX index allows investors to trade the credit default swap (CDS) market across a broad spectrum of credits. CDS are bilateral contracts in which a buyer pays a premium to the seller for credit protection on a fixed income instrument. In the event the instrument defaults, the buyer receives the par value of the bond from the seller of the CDS.

Spread of the Russell 2000 Growth vs. the Russell 2000 Value Indices


Hedge Funds

Ɓ Long/short equity managers posted mixed results in the first quarter of 2011. Global equity markets remained volatile on the back of ongoing concerns about global inflation—particularly in emerging markets—as well as Eurozone debt worries, rising input costs globally, political unrest in the Middle East and North Africa and the tragic events in Japan.

Ɓ While the overall environment remained uncertain, long/

short equity managers continued to have a positive outlook for the strategy in 2011 for three main reasons: a) the equity-risk premium appears more favorable than the credit-risk premium in aggregate; b) managers reported greater dispersion and differentiation among

Long/Short EquityVanita GaonkarHead, Fundamental Strategies Research, Alpha Strategies Group

Display 7: Long/short equity managers have increased their gross exposures...

stocks in Europe and the US, which is favorable for stock pickers; and, c) fundamental valuations appear to be more relevant versus macro factors in many markets around the world.

Ɓ We have seen this positive outlook expressed in changes

in managers’ gross and net exposures.2

Ɓ Gross exposure has increased while net exposure has decreased (Displays 7 and 8), pointing to the fact that managers are seeing a more balanced and diversified opportunity set on both the long and short sides. We expect this trend to continue.

Source: Credit Suisse Asset Management

Display 8: ...While reducing their net exposure due to a more diversified opportunity set

Long/Short Equity Managers’ Aggregate Gross Exposure Long/Short Equity Managers’ Aggregate Net Exposure

Source: Credit Suisse Asset Management

2Gross exposure consists of a manager’s aggregate long and short positions. Net exposure is calculated by subtracting the short book from the long book. The amount of gross exposure over 100% represents the amount of leverage being used by an investor.

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Ɓ Fixed income arbitrage managers generally continued to curtail exposure and maintained considerable hedges in the first quarter, as concerns about tail risks intensified with social unrest in the Middle East (and consequent rise in oil prices) and the tragic events in Japan. The cost of insuring Japanese debt increased considerably after the earthquake, with credit default swaps (CDS)3 jumping from approximately 80 basis points (bps) to 125 bps. Certain managers also expressed concern that the European debt crisis could spread and become a global debt crisis.

Ɓ Managers are generally positioned for interest-rate volatility to increase across sovereign curves globally. Shorter-term rates are under increasing inflation pressure, mainly in the UK and continental Europe, with central bank rhetoric in certain developed economies turning more hawkish. The end of the US quantitative easing program is expected in June, which may cause longer-term yields in the US to rise since it is unclear who might replace the demand created by the Fed.

Relative ValueFred ShekHead, Relative Value Research, Alpha Strategies Group

Display 9: Managers expect volatility4 in the short end of the curve to generate trading opportunities

Data from August 2010 to March 2011Source: Bloomberg

Hedge Funds

Ɓ Higher levels of short-term interest-rate volatility (Display 9) and sudden changes in risk sentiment (risk on/risk off) might create an opportunity-rich trading environment for relative value strategies, though managers will likely be keeping an eye on tail risk.

Ɓ US mortgage specialists continued to outperform as inefficiencies and prepayment uncertainty—both in the agency and the non-agency market—persisted. Returns in the non-agency space are expected to decrease slightly going forward, however, due to considerable capital flowing into the market, which has pushed yields down.

Ɓ In the convertible arbitrage space, managers maintained long-biased positioning in the first quarter as convertible bond valuations generally richened globally. Given the more volatile environment created by events in Japan, the Middle East and North Africa, managers may increase their focus on special situations and idiosyncratic trades.

Ɓ Additionally, convertible arbitrage managers have generally indicated they will keep leverage and net exposures low relative to historic levels, while maintaining diversified and flexible portfolios.

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3 Credit Default Swaps (CDS) are bilateral contracts in which a buyer pays a premium to the seller for credit protection on a fixed income instrument. In the event the instrument defaults, the buyer receives the par value of a bond from the seller of the CDS.

4Fixed income short-term rate volatility is illustrated by the 6-month forward implied volatility of the one-year swap.


Ɓ Private equity (PE) firms are proceeding cautiously with committed capital based on recent global market developments. This follows strong deal flow in the fourth quarter of 2010. As of late March 2011, there have been seven deals with transaction sizes over $1 billion in the quarter totalling $31 billion globally. This compares to 13 deals in the fourth quarter of 2010 totalling $52 billion. For middle-market buyout with transaction sizes below $1 billion, there have been 52 deals totalling approximately $10 billion, which is below the 78 deals worth $21 billion in the fourth quarter of 2010.5

Ɓ Despite the caution being taken for investments, there continues to be significant activity for PE exits, including initial public offerings (IPO) (Display 10) and M&A. Most recently, HCA Inc., backed by Bain Capital and Kohlberg Kravis Roberts & Co. (KKR), made history with the largest PE-backed IPO in history, raising over $4 billion. Approximately 70% of US IPOs issued have been sponsor-backed in 2011. In fact, three of the 10 largest PE-backed IPOs that have ever been transacted occurred this year. It is CFIG’s view that significant proceeds from PE exits support the case for improving deal flow for the remainder of the year.

Fund of Private Equity FundsKelly Williams Head, Customized Fund Investment Group

Nadim BarakatChief Investment Officer, Customized Fund Investment Group

5 Dealogic, March 22, 20116 LAVCA, March 2011

Display 10: PE-backed IPO issuance has been growing steadily since the ’08-’09 global financial crisis...

Data from January 2003 to December 2010Source: Renaissance Capital

Data from January 1998 to March 2011Source: Standard & Poor’s Leveraged Commentary Data and Credit Suisse Asset Management

Display 11: ...And senior loans issuance is providing support for greater investment activity

Private Equity

Ɓ Many PE investors are preparing for the possibility of rising inflation. Accordingly, real assets have been active—including infrastructure, clean technology, real estate and energy investments—as they have historically helped mitigate the impact of inflation on portfolios.

Ɓ Trends in institutional senior loan volumes supported the case for greater investment activity in 2011 (Display 11). Dollar volume in the first quarter is approximately four times higher than the same period last year. Senior loans and other debt offerings are often part of PE deal financing and leverage.

Ɓ PE funds continue to increase their investment focus in emerging markets, as these regions have become more receptive towards PE deal structures. PE firms focused on Latin America raised approximately $8 billion in 2010, compared to $3.6 billion in the prior year. CFIG believes that middle-market opportunities in this region are becoming more common because their valuations have been more favorable versus large-cap deals.6

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Credit Strategies

John G. PoppGlobal Head, Credit Investment Group

US Senior Secured Loans

Ɓ Technical factors for senior loans worldwide have remained strong in the first quarter, and we have seen continued large inflows into retail mutual funds. Lipper/FMI reported over $10 billion of inflows to retail funds, in addition to over $10 billion of loan repayments not related to loan re-pricings.

Ɓ Refinancings and re-pricings dominated the new issue market in the first quarter. We do not expect this trend to continue, as some of these deals were lower quality credits that have struggled in the secondary market (and a majority of the higher quality credits already having refinanced).

Ɓ Covenant light (cov-lite)7 loans were less than 10% of the new issue market between 2008 and 2010, but have increased to approximately 25% of volume in the first

Display 12: US senior loans look attractive as issuers’ credit fundamentals continue to improve

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quarter of 2011. This trend stems from increased demand (including retail investors), and provides greater latitude for issuers in pricing and structuring new issues.

Ɓ Default rates have been very low and the expectation is this situation will continue for the next 12 months (Display 12). Recent macroeconomic and geopolitical events, such as the earthquake in Japan, have not caused any strategists to revise their default expectations.

Ɓ We think that senior loans continue to look attractive given their position in the capital structure and floating-rate nature, based on the potential for higher inflation and rising interest rates.

7 Covenant light (cov-lite) is a financial industry term for loan agreements which do not include the usual protective covenants for the benefit of the lender (or buyer of the senior loans).

Senior Loan Issuer Default Rates


Credit Strategies

Display 13: Record high yield issuance in 2010 allowed many companies to refinance and extend debt maturities, lowering risk of defaults

John G. Popp (continued)Global Head, Credit Investment Group

8A bond’s yield-to-worst (YTW) considers the multiple call scenarios associated with the bond, and identifies which scenario has the lowest yield.

US High Yield Bonds

Ɓ The high yield market remained resilient in the first quarter despite volatility related to events in Japan and the Middle East. High yield spreads tightened 63 basis points versus the US Treasury market in the first quarter, ending the period at +508 basis points. Yield-to-worst ended March at 6.95%.8

Ɓ The percentage of “distressed” securities, defined as those trading at spreads of more than 1,000 basis points over Treasuries, fell steadily throughout 2010, and continued to decrease in 2011, ending at 6.4% for March 2011. This ratio has been below its long-term average level of 15%, and is at its lowest level since October 2007 (5.5%).

Ɓ High yield mutual funds experienced inflows with over $4 billion in assets entering the asset class, consistent with the average monthly inflows the market experienced in 2010, according to Lipper FMI. According to JPMorgan, there was a moderation in high yield new issuance versus previous months, with $21.8 billion pricing during February, for example.

Ɓ Record new issuance in debt markets in 2009 and 2010 has made capital available to a broad selection of companies, allowing many non-investment grade issuers to refinance and extend debt maturities (Display 13). The improved liquidity, combined with a stabilizing fundamental backdrop, has significantly decreased expectations for upcoming defaults. JPMorgan reported that the par weighted default rates of high yield bonds ended March at 0.8%, and is forecasting rates to be below historical averages through 2012.

Ɓ Though fundamentals are stabilizing for individual companies, and technicals remain strong, we remain cautious on high yield bonds based on mixed economic data and the potential for the Federal Reserve to address the threat of inflation with interest-rate hikes.

Data from January 1988 to March 2011 Source: Credit Suisse Leveraged Finance

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Commodities

Ɓ Commodities were up 4.45% for the first quarter of 2011 (as measured by the Dow Jones-UBS Commodity Index total return) amidst heightened geopolitical and market volatility.

Ɓ Monetary policy developments included China’s interest-rate hike and further increases in bank reserve requirements in an effort to fight inflation; on the other hand, the US Federal Reserve remained committed to low interest rates, with US core inflation appearing to be well anchored for the time being; the US government’s fiscal policy also stayed accommodative, while state and local governments showed signs of increasing strains.

Ɓ Indications of a robust global economic recovery continued. Industrial production generally continued to improve in both developed and emerging markets (Display 14), and the mix driving the improvement became more broad based. We expect commodities to generally remain well supported for the remainder of 2011 by the following:

Display 14: Global industrial production growth should support commodities

Nelson LouieGlobal Head, Commodities Group

Christopher Burton, CFAPortfolio Manager, Commodities Group

– Reduced spare capacity for crude oil because of events in the Middle East and North Africa;

– Developed nations’ low interest rates and concerns over eventual inflation worldwide, which should support precious metals;

– Tight supplies for key soft commodities, on the back of multiple supply shocks and growing demand;

– Robust emerging market growth, which should continue to support demand for industrial metals.

Ɓ Accordingly, we believe commodities will continue to offer value for investors despite uncertainty and potential volatility across capital and commodity markets. Markets’ uncertainty can impact traditional asset classes and commodities differently, potentially providing valuable diversification for investors.

Data from January 2007 to December 2010 Source: Credit Suisse Fixed Income Research

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Emerging Markets: Brazil Fixed Income and Currencies

Ɓ The key issue (and perhaps opportunity) in Brazilian fixed income is currently the threat of inflation, and how effective the Brazilian central bank and government will be in controlling it. We begin with some context on the issue. Since the late 1990s, the Brazilian government has successfully implemented three key reforms: an inflation targeting system, a primary fiscal surplus and a floating exchange rate system. Prices have been under control mainly because the central bank earned the credibility that it will use its power to achieve its target.

Ɓ After the election of Dilma Rousseff as Brazil’s president in 2010, we are now facing a new context of central bank monetary policy for inflation, which represents the most important changes in policy since 2002. The central bank has signalled that it intends to use other tools besides interest rates to achieve its inflation target, which in our opinion represents a risk of overshooting. These measures may include increasing bank reserve requirements and tightening other credit instruments. We believe that monthly inflation readings will cool down in the coming months to near 0.60%, reducing pressure on the central bank (although projected annual inflation remains above its target of 4.5%).

Ɓ On the fiscal front, the government has taken two critical steps: the approval in the legislative houses to limit the increase in minimum wage, and the decision to cut the 2011 fiscal budget by 50 billion reais (US$ 30 billion). The government is clearly trying to repair its fiscal image, which was tarnished following recent increases in expenditures, especially leading up to last November’s presidential

Ettore MarchettiPortfolio Manager, Fixed Income Funds—Credit Suisse Hedging Griffo

Richard Valente Portfolio Manager, Fixed Income Funds—Credit Suisse Hedging Griffo

election. However, this new fiscal discipline is likely to have a political cost and create friction with several constituencies, such as representatives in congress, cabinet members and workers. Accordingly, the pressure from the government on the central bank to ease policy is likely to increase.

Ɓ We believe this scenario makes the allocation in Brazilian inflation-linked bonds attractive. Display 15 illustrates how the market has tested the central bank in recent months. Break-even inflation for the one-year bond has almost touched the maximum ceiling targeted for inflation (6.5%), a result which may lead the central bank to face a credibility risk for its inflation-targeting system.

Ɓ Real rates in Brazil (as reflected in inflation-linked bonds, Display 16) now range between 5.9% and 6.5% per year, depending on the maturity. This level remains high, in our view, compared to other emerging and comparable countries (e.g., Chile, Mexico, South Africa, South Korea and Turkey).

Ɓ There are also external risks, such as the Middle East crisis and the recent Japanese disasters, which could lead to further outflows from Brazilian investments, and to a deceleration in global growth and inflation. However, it is worth remembering that the current base case for the global scenario is an overall shift from stimulus-driven economies to inflation concerns around the world. The European Central Bank language has already taken a more hawkish tone and most emerging countries are now in a tightening process.

Data from July 1999 to February 2011Source: IBGE and Brazilian Central Bank

Display 15: Inflation has been testing Brazil’s central bank inflation target’s upper band limit...

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Display 16:...and real rates are high

Data from May 2007 to February 2011Source: Andima and BM&F Bovespa


Emerging Markets: Brazil Equities

Ɓ Recent macroeconomic shifts have had a significant impact on Brazil’s first quarter equity performance. First, after posting strong GDP growth in 2010 at close to 8%, supported by household consumption and investments, we forecast that GDP will slow to 4.2% in 2011. Second, high inflation expectations have been at the core of the economic debate, leading the government to turn to a more austere fiscal policy by reducing public expenditures. Also, Brazil’s central bank has embarked on a tightening cycle. As a result, we expect consumer prices to remain stable in the coming year.

Ɓ With the expected relative deceleration of the Brazilian economy in 2011, many investors shifted equities to developed markets, where growth expectations were increasingly robust: As a result, Brazil’s Bovespa Index fell just over 1.0% in the first quarter; the Brazilian Small Caps index was down 1.5%, while the S&P rose 5.4%.

Ɓ Additionally, certain sectors in the Brazilian stock exchange were more heavily penalized by the dynamics of inflation and tighter monetary policy. For example, the real estate sector struggled in this environment (the Brazilian real estate index was down 10% in the first quarter, impacted by the tightening policy measures and poor operating figures for certain companies). We believe, however, that this short-term weakness may create favorable longer-term investment opportunities for stock pickers who understand the differences in the real estate companies’ operational performance.

Display 17: Rising funds for operations (FFO) yields for shopping malls may present an opportunity

Andre Caldas, CFAPortfolio Manager, Equity Funds Team—Credit Suisse Asset Management Brazil

André BassiPortfolio Manager, Equity Funds Team—Credit Suisse Asset Management Brazil

Ɓ One example is shopping malls. We were surprised by the poor performance of shopping malls in the first quarter of 2011, which was in line with the correction seen in the broader real estate sector. Shopping malls are supposed to be more defensive, mainly due to their lower leverage. However, looking ahead, we do not believe that the vacancy rate will increase despite the slowdown in Brazil’s economic growth and, if we only consider the minimum rent level, the sector should have a sound cash generation. Illiquidity is among the technical factors that help explain the poor performance of shopping malls stocks in the first quarter of 2011.

Ɓ Specifically, shopping-mall stocks declined 4% in the first quarter of 2011, which led to an increase in the funds for operations (FFO)9 yield of the stocks (FFO yield is similar to a current dividend yield which equals the annual dividend divided by current share price). The sector’s average FFO yield for the quarter of 2011 rose to a healthy 6.5% during the first quarter, a trend we expect to continue. If we compare the sector’s FFO yield with the real return on inflation-linked public securities, after the drop in the share prices in the second half of 2010, we see the trend invert with the FFO yield higher than the return on public bonds (Display 17). We believe this may be an entry point for the sector, which as a real asset class, also presents inflation-hedging characteristics that may benefit investors if the governments’ tightening actions fail to contain consumer prices.

Data from October 2009 to February 2011Source: Credit Suisse Asset Management

Shopping-Mall Average FFO Yield vs. Brazil’s Sovereign Inflation-Linked Bonds

4

5

6

7

8

Oct 09 Dec 09 Feb 10 Apr 10 Jun 10 Aug 10 Oct 10 Dec 10 Feb 11

%

Shopping Mall FFO Yield Sector Average

Inflation-Indexed Brazil National Treasury Notes Yield (Zero Coupon)

Opportunity

9Funds for operations (FFO) consists of net income, excluding non-cash items (mostly depreciation and amortization), and including maintenance capital expenditures.


About the Authors

Stefan Keitel, Managing Director, is the Global Chief Investment Officer for Credit Suisse Asset Management and Private Banking. Mr. Keitel holds a Masters degree in Finance (Diplom-Kaufmann) from Mainz University.

Nadim M. Barakat, Managing Director, is the Chief Investment Officer of the Customized Fund Investment Group within Private Equity in Alternative Investments. Mr. Barakat holds a B.Sc. (Hons) degree in Systems Engineering and Operations Research from the University of Virginia.

André Bassi, Vice President, is a Portfolio Manager for the Equity Funds Team in the Credit Suisse Asset Management Brazil. He has a degree in Business Administration from the Escola de Administração de Empresas de São Paulo—Fundação Getulio Vargas.

Christopher Burton, CFA, Director, is the Lead Portfolio Manager and Trader for the Commodities Group. Mr. Burton earned a B.S. in Economics with concentrations in Finance and Accounting from the University of Pennsylvania’s Wharton School of Business. He is a CFA charter holder.

André Caldas, CFA, Director, is a Portfolio Manager responsible for the Equity Funds Team in Credit Suisse Asset Management Brazil. Andre holds a degree in Computer Science from Universidade Federal do Rio Grande do Sul, and a MBA from MIT Sloan School of Management. He is a CFA charter holder.

Jordan Drachman, Ph.D., Director, is Head of Research for the Liquid Alternative Beta team. Mr. Drachman has received a B.S. in Mathematics from MIT and Ph.D. in Mathematics from Stanford University.

Sebastien Fiaux, Director, is the Portfolio Manager (Americas/EMEA) for the Alpha Strategies Group. Mr. Fiaux earned an M.S. in Finance, Economics and Statistics from ENSAE, an M.A. in Political Science from the Institute of Political Science and a Masters in Financial Engineering from Cornell University.

Vanita Gaonkar, Director, is the Head of Fundamental Strategies and on the Hedge Fund Research and Selection team for the Alpha Strategies Group. Ms. Gaonkar earned a B.A. in Mathematics and Economics from Wesleyan University.

Peter Little, CFA, Director, is Head of Portfolio Management and Implementation for the Liquid Alternative Beta team. Mr. Little holds a B. Comm. in Finance from the University of Port Elizabeth in South Africa.

Nelson Louie, Managing Director, is Global Head of the Commodities Group. Mr. Louie holds a B.A. in Economics from Union College.

Ettore Marchetti, Director, is a Portfolio Manager and Head of Credit Suisse Hedging-Griffo Fixed Income Funds. Mr. Marchetti has a B.S. in Engineering from Universidade de São Paulo and M.S. in Economics from Ibmec-São Paulo Business School.

John G. Popp, Managing Director, is the Global Head of the Credit Investments Group, with primary responsibility for making investment decisions and monitoring processes for CIG’s global investment strategies. Mr. Popp graduated with a B.A. from Pomona College and an M.B.A. from the Wharton Graduate School of the University of Pennsylvania.

Tarek Rizk, Ph.D., Director, is the Co-Head of Tactical Trading and on the Hedge Fund Research and Selection Team for the Alpha Strategies Group. Mr. Rizk earned a Ph.D. in Engineering from George Washington University, an M.B.A. with highest honors from the University of Alabama at Birmingham, and B.A. and M.S. degrees in Engineering from the American University in Cairo. Dr. Rizk completed graduate courses in Financial Engineering at Michigan. Sami Robbana, Director, is the Co-Head of Tactical Trading and on the Hedge Fund Research and Selection team for the Alpha Strategies Group. Mr. Robbana earned a B.B.A. in Finance from L’Ecole des Hautes Commerciales (H.E.C) de Montreal, a minor in Economic Sciences from L’Université de Montreal, and attended McGill University Graduate Business School. Fred Shek, CFA, Director, is the Head of the Relative Value sectors in the Hedge Fund Research and Selection team for the Alpha Strategies Group. Mr. Shek earned a B.S. in Accounting from Binghamton University in 1994 and is a CFA charter holder.


Anne-Sophie van Royen, Ph.D., Managing Director, is a Senior Portfolio Manager and Head of the Global Tactical Asset Allocation/Global Macro strategies and products at Credit Suisse. Ms. van Royen holds an M.S. in Business Studies from the Ecole des Hautes Etudes Commerciales (HEC); a B.A. in Psychology from the Université de Paris–Saint Denis; and Ph.D. and M.S. degrees in Mathematical Economics from the Université de Paris–Sorbonne.

Ricardo Valente, Vice President, is a Portfolio Manager for the Credit Suisse Hedging-Griffo Fixed Income Funds. Mr. Valente has a B.A in Business Administration from the Escola de Administração de Empresas de São Paulo–Fundação Getulio Vargas.

About the Authors

Kelly M. Williams, Managing Director, is Head of the Credit Suisse Customized Fund Investment Group. Ms. Williams graduated magna cum laude from Union College in 1986 with a B.A. in Political Science and Mathematics, and received her Juris Doctor degree from New York University School of Law in 1989.

Xiaomeng Yang, CFA, Ph.D., Director, is a Portfolio Manager for the Global Tactical Asset Allocation/Global Macro strategies and products. Ms. Yang holds a B.A. in economics from Tsinghua University in Beijing, and a Ph.D. in Economics from Boston College. She is a CFA charter holder.


Credit Suisse Asset Management Publications

The views and opinions expressed within these publications are those of the authors, are based on matters as they exist as of the date of preparation and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof.

For a copy of any of these papers, please contact your relationship manager or visit our website at www.credit-suisse.com.

Robert Parker, Credit Suisse Senior AdvisorApril 2011 Market UpdateApril 2011—The Market Update provides an overview of recent market developments around the world, and outlines where Bob believes they are headed.

Managing Fixed Income Investments in a Rising Inflation and Interest-Rate EnvironmentMarch 2011—This paper addresses key challenges facing fixed income investors today: How to achieve higher returns in a still low-yield environment while mitigating the rising threats of inflation and interest-rate risks? The ISS team’s analysis suggests that diversifying fixed income exposure into specific instruments as well as adding inflation hedges may present an efficient way to manage these challenges. A full case study helps to illustrate the team’s findings.

Credit Suisse Asset Management Alternatives QuarterlyJanuary 2011—Credit Suisse Asset Management Alternatives Quarterly offers important insights from our Chief Investment Officer as well as our leading alternatives portfolio managers on the trends and opportunities shaping today’s financial markets. Investment strategies covered in this quarterly publication include hedge funds, private equity, credit strategies and commodities.

How Commodities Can Help Investors Face the Uncertainty of the Inflation/Deflation DebateDecember 2010—In this paper, our Commodities Team argues that uncertainty about the consumer-price outlook in developed economies creates challenges for capital markets to properly price in inflation expectations. The Commodities Team’s research suggests that exposure to real assets can help investors cushion the impact on the portfolio of unexpected changes in the inflationary environment in the long run.

The Anatomy of a Modern Emerging Markets PortfolioNovember 2010—This paper examines the quickly evolving emerging markets investment landscape and argues that the proliferation of sophisticated investment vehicles in these markets presents an opportunity for investors to augment the efficiency of their emerging markets portfolios.

Liquid Alternative Beta: Enhancing Liquidity in Alternative PortfoliosJune 2010—How to increase a portfolio’s liquidity without sacrificing returns, especially in a post-crisis, low-yield environment? The paper illustrates how institutional investors can use Liquid Alternative Beta to seek to enhance portfolio liquidity, increase portfolio transparency, short hedge fund sectors and gain hedge-fund-like exposure when investment policies restrict direct hedge fund investments.

Can Infrastructure Investing Enhance Portfolio Efficiency? May 2010—The paper provides an in-depth look at infrastructure as an investment tool, and analyzes what role the asset class might play in institutional portfolios. Specifically, the paper examines whether infrastructure can be an effective tool to mitigate inflation and duration risks, reduce funding gaps and enhance portfolio efficiency. Credit Portfolio Management in 2010: A Nimble Approach NeededJanuary 2010—Tracking and timing credit cycles can be challenging, particularly since today’s credit environment appears to be going through increasingly rapid cycle changes. We believe that fixed income investors need to be increasingly nimble and tactical in 2010, while at the same time considering strategic preparations for medium-to-longer-term regime changes in interest rates and inflation.

Risk Management: A Changing ParadigmNovember 2009—Renewed interest in risk management and the creation of a culture of risk awareness are driving current investment committee meeting agendas. This should come as no surprise in light of market events in 2008 and early 2009. While experience and judgment that have been battle-tested under various market conditions prepares CIOs for uncertainty in the future, how do they implement risk-based solutions while facing real-world events?

Risk Parity—A Risk-Based Approach to Portfolio StructuringNovember 2009—This paper discusses a different approach to portfolio risk management, called risk parity, which aims to equate the contribution of risk across asset classes and, as a result, create a portfolio which performs better in a variety of market conditions.

Credit Suisse Asset Management | 18 Alternatives Quarterly

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Every investment involves risk and in volatile or uncertain market conditions, significant fluctuations in the value or return on that investment may occur. Investments in foreign securities or currencies involve additional risk as the foreign security or currency might lose value against the investor’s reference currency. Alternative investments products and investment strategies (e.g. Hedge Funds or Private Equity) may be complex and may carry a higher degree of risk. Such risks can arise from extensive use of short sales, derivatives and leverage. Furthermore, the minimum investment periods for such investments may be longer than traditional investment products. Alternative investment strategies (e.g., Hedge Funds) are intended only for investors who understand and accept the risks associated with investments in such products.

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