Market Volatility

“Sell everything except high quality bonds. This is about return of capital, not return on capital. In a crowded hall, exit doors are small.”

The Royal Bank of Scotland, January 2016

Source:RoyalBankofScotland.

Sovereign Debt Defaults

Sources:ThisTimeisDifferentChartbook:CountryHistoriesonDebt,Default,andFinancialCrises, CarmenM.Reinhart/MilkenInstitute

• 1828• 1898• 1902• 1914• 1931• 1937• 1961• 1964• 1983

• 1826• 1868• 1894• 1900• 1906• 1914• 1929• 1982• 1999• 2008

•1876•1915•1931•1940•1959•1965•1978•1982•2000

• 1826• 1848• 1860• 1865• 1892• 1898• 1983• 1990• 1995• 1998• 2004

Brazil Ecuador• 1839• 1885• 1917• 1918• 1947• 1957• 1991• 1998

Russia•1826•1843•1860•1894•1932•2011•2015

Greece Turkey Venezuela• 1982• 1986• 1992• 2001• 2004

Nigeria

Assets of the 4 Biggest Banks (% of GDP, 2015)279

240 235 225

179 175

112 10277

45

Source:IMFGDPestimates2015,ThomsonReuters(4/07/16).

"Progressalwaysinvolvesrisk;youcan'tstealsecondbaseandkeep

yourfootonfirst."

‐ FrederickWilcox

“Theonlystrategythatisguaranteedtofailisnottakingrisks.”

MarkZuckerberg

#MIGlobal

A cash current account surplus? Not really…China Balance of Payments (BOP) Current Account vs. SAFE Data on Net Payments (as of December 31, 2015)

Source: CEIC and State Administration of Foreign Exchange of the People’s Republic of China (SAFE).

‐200.0

‐150.0

‐100.0

‐50.0

0.0

50.0

100.0

150.0

1Q06

4Q06

3Q07

2Q08

1Q09

4Q09

3Q10

2Q11

1Q12

4Q12

3Q13

2Q14

1Q15

4Q15

SAFE Data on Net Payments

China BOP Current Account

USD (Billions)

#MIGlobal

• WMPs are more toxic and much larger than western bank asset-backed conduits & SIVs:o China’s WMPs: 9% of total assets and rising at YE2015 o Western bank conduits/SIVs: 2.5% of total assets for western banks in 2008

The Chinese banking system’s H-bomb

2006‐2007: Western Banks

Total SIVs

TotalBank

Assets

SIVs / BankAssets

Citibank1 $147bn $2,187bn 6.7%

ABN AMRO Bank2

€83bn €1,481bn 5.6%

Source: Bloomberg and Company Financials. 1FY 2007. 2FY 2006. 3FY 2015.

• The rapid expansion of Chinese banks’ wealth management products (WMPs) presents a growing threat to financial stability

• WMPs held off-balance sheet are akin to western banks’ conduits/structured investment vehicles (SIVs) in 2008

2015: Chinese BanksTotal SIVs

TotalBank

Assets

SIVs / BankAssets

China MerchantsBank3

¥1,820bn ¥5,208bn 35%

China Everbright Bank Company3

¥876bn ¥3,167bn 28%

#MIGlobal

It’s getting harder to find domestic suckersChina corporate credit defaults accelerating

• The 16 defaults YTD (through April 21) have already exceeded defaults for all of 2015 and more telling, 8 of the 16 defaults are related to state-owned enterprises

• While local governments have historically helped support struggling enterprises, there is a limit to support that state sponsors can provide, especially to companies in structurally challenged industries

Source: JP Morgan, Caixin, Quote taken from a Bloomberg News article (April 18, 2016) & company information.

“It shows the government is taking away the implicit guarantee … Now risk awareness is rising, so we

will see which issuers are swimming naked.”

- Quote from the Chief Economist at a Hong Kong Bank

0 0 0 1

9

16

51

0

10

20

30

40

50

60

Number of Corporate Credit Defaults in China

“2016 credit defaults are on pace to more than quintuple 2015 levels

0%

20%

40%

60%

80%

100%

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Loan mutual funds, financial and insurance companies Hedge,distressed and high-yield funds CLOs Banks

Institutional Investor Base for Non-investment Grade Loans

Sources:S&PLCD(4/11/16).

Concentration of Three Largest BanksTotalassetsoftop3banksasapercentageofhomecountry’sgrossdomesticproduct

0%

50%

100%

150%

200%

250%

France UnitedStates

CreditAgricole

BNPParibas

Societe Generale

197%ofGDP($4.9trillion)

34%ofGDP($6.2T)

WellsFargoBankofAmerica

J.P.Morgan

Source:Bloomberg(4/20/2016).

What’s changed?

Source:Bloomberg.

 ‐

 500

 1,000

 1,500

 2,000

 2,500

 3,000

 3,500

 4,000

 4,500

 5,000

 ‐

 5

 10

 15

 20

 25Ap

r‐00

Apr‐01

Apr‐02

Apr‐03

Apr‐04

Apr‐05

Apr‐06

Apr‐07

Apr‐08

Apr‐09

Apr‐10

Apr‐11

Apr‐12

Apr‐13

Apr‐14

Apr‐15

S&P 500 Inde

x &

Fed Ba

lance Sheet ($b

ns)

High Yield YTW &

10‐YR UST Rate (%

)

HYYTW

FedBalanceSheet

S&P500

10‐YrUST

Levels: Pre- & Post-CrisisFACTORS Common Uncommon

GEO‐POLITICAL‐Middle East‐ Brexit‐ China / Russia

‐ Zika: Impact of a Pandemic‐ Japan: Long‐term Negative Growth‐ Petro‐politics

REGULATORY

‐ Shrinking Broker‐Dealer   balance sheets

‐Market volatility‐ Bank lending standards

‐ Increased demand for private capital‐More barriers for managers‐ Growth in exogenous risks‐Mutual fund liquidity rules

CAPITAL MARKETS

‐ Near end of credit cycle‐ Greater price volatility‐ Continued low rates despite end of QE

‐ Extra innings for this credit cycle‐ New “Gap Up/Down” world‐ PE ratio / debt issuance‐ “Kicking the can” on fiscal policy

Source:Crescent.

“Skatetowherethepuckisgoing,nottowhereitis.”

‐WayneGretzky

#MIGlobal

Defensive Stocks are Trading atSignificant Premium to Cyclical StocksMSCI World Index, January 2000 – March 2016

43%

‐80%2000    2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Note: The “Forward P/E” of a stock is its price divided by the consensus EPS estimate for the next twelve months. “Premium/Discount” is themedian forward P/E ratio of the most defensive quintile divided by the median forward P/E ratio of the most cyclical quintile, less 100%. Thecyclicality of a stock is calculated as its 60-month beta to the monthly performance spread between the Russell Global Dynamic and RussellGlobal Defensive indices. Universe consists of the constituents of the MSCI World Index.

‐60%

‐40%

20%

0%

‐20%

40%

60%

80%

100% Defensive Stocks at Premium

Defensive Stocks at Discount

Source: FactSet, MSCI, Russell Investment Indices

#MIGlobal

MSCI World Value vs. MSCI World GrowthRelative Ratio of 12-month Rolling Returns, March 1992 – March 2016

Valu

eO

utpe

rform

ance

Gro

wth

Out

perfo

rman

ce

1.6

1.5

1.4

1.3

1.2

1.1

1

0.9

0.8

12/1/199

16/1/19

9212

/1/199

26/1/19

9312

/1/199

36/1/19

9412

/1/199

46/1/19

9512

/1/199

56/1/19

9612

/1/199

66/1/19

9712

/1/199

76/1/19

9812

/1/199

86/1/19

9912

/1/199

96/1/20

0012

/1/200

06/1/20

0112

/1/200

16/1/20

0212

/1/200

26/1/20

0312

/1/200

36/1/20

0412

/1/200

46/1/20

0512

/1/200

56/1/20

0612

/1/200

66/1/20

0712

/1/200

76/1/20

0812

/1/200

86/1/20

0912

/1/200

96/1/20

1012

/1/201

06/1/20

1112

/1/201

16/1/20

1212

/1/201

26/1/20

1312

/1/201

36/1/20

1412

/1/201

46/1/20

1512

/1/201

5

Source: FactSet.

#MIGlobal

Financials are Not Participating in 2016 Value RallyYTD Local Currency performance of Value Factor Components MSCI WorldUniverse – as of April 19, 2016

10.0%

7.5%

5.0%

2.5%

0.0%

‐2.5%

‐5.0%

Div Yield B/P (WORLD) B/P (EAFE) E/P E/P NTM

ex‐Financials Full Universe

Source: Bloomberg.

#MIGlobal

Valuation Gaps amongst SectorsMSCI World Book-to-Price Intra-sector Valuation Dispersion (current relative to history)December 1999 – March 2016

1.5

1

0.5

0

‐0.5

‐1

‐1.5

‐2

Standard

Deviations

Source: FactSet, Causeway Analytics.

#MIGlobal

$2,391,102,204,613,620,000,000,000,000,000,000,000,000,000 

The beauty of compounding…

5%: 2.4 x1042

2%: 1.6 x1017

Stars in the universe 1 x 1024

$1 Invested Since 1AD at 5%

Source: CQS analysis, as at 31 March 2016.

Are Return Expectations Realistic?

#MIGlobal

Regulatory danger to derivatives market

Source: BIS, Global OTC Derivatives Market notional amounts outstanding (6/10/2015).

0

100

200

300

400

500

600

700

800US$ trillions

#MIGlobal

Why very low interest rates may stick around

Source: New York Times (12/2015) and Global Finance Group.

1820 1840 1860 1880 1900 1920 1940 1960 1980 2000

Long‐term interest rates

US Civil War World War I World War II Global Financial Crisis

Britain

U.S.

15%

10%

5%

0%

20%In the long arc of history, high interest rates from 1970 to 2007 look like the aberration, not the norm

Source:Bloomberg2/5/15.

Central Bank Target Interest Rates Remain Low

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 2014 2015

Percent

Bank of England

European Central Bank

Bank of Japan

U.S. Fed