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The Future of Global Capital Markets:
Will the U.S. Continue to Rule?
Sponsored By:
Financial Innovation : Last 1000 Years
1000 1100 1200 1300 1400 1500 1600 1700 1800 1900
1156:Foreign exchange contract1160: Bill of Credit
3000 - 2000 BC: Development of Banking in Mesopotamia
806: Paper money
1401: Bank of Barcelona founded
1494 : Double entry book keeping1498: Capital and foreign exchange markets
1609: The central bank founded
1633: Promissory notes1640: Short sale for cash flow financing.
1681: First public note-issuing bank founded
1723: Notes secured by Mortgage
1751: Consols1770: Clearing House1772: Branch Banking1775: Savings and Loans
1829: Deposit Insurance
1881: Post office notes
1200:Contracts promising future delivery (derivatives)
1868: Chicago board of trade;Mutual Fund Started
1920: Payment card
Financial Innovation: Last 50+ Years
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
1995: Electronic Cash Card
1997: Bowie Bonds : Bond Backed By Copyrights
1990: First international computerized matching service for foreign exchange rates
1973: Black-Scholes formula
1951: First credit card issued
1970: Magnetized Credit Card
1977: First financial future contract traded
1974: Modern high-yield market started
1960s: Warrant and Convertibles Bonds
1967: First ATM machine
1970: First mortgage backed securities issued
2003: DRAM future contract launched
1994: First credit enhanced securitization of aircraft lease 1994: Catastrophe bond
1999: Italy Securitized delinquency social security receipts
1989: First securitization of non-performing loans
1997: Weather derivatives
World’s Equity Market Share
Market Capitalization1950
Other6%
Europe26%
U.S.59%Japan
9%
Market Capitalization2003
Other10%
Europe26%
U.S.52%
Japan9%
World’s Equity Market Share
Market Capitalization1988
Other14%
Europe26%
U.S.29%
Japan40%
Market Capitalization2003
Other10%
Europe26%
U.S.52%
Japan9%
World Equity Market PerformanceTop 10 2004 USD Adjusted Returns
NorwayMexico
PolandPeru
JordanAustria
Czech RepublicHungary
ColombiaEgypt
140
120
100
80
60
40
Percent Change, Year Ago
$100 in the Dow in 1995 = $280 Today
2004200320022001200019991998199719961995
300
250
200
150
100
50
Jan. 1995 = 100
DJIAFTSEMSCI WORLD
Decline of the Dollar
200420032002200120001999
1.20
1.10
1.00
0.90
0.80
0.70
135
130
125
120
115
110
105
100
Euros Yen
Euros per DollarYen per Dollar
2004200220001998199619941992199019881986
0
-1
-2
-3
-4
-5
-6
50
40
30
20
10
0
U.S. Trillions % of GDP
Cumulative Trade Deficit Since 1985
Cumulative Trade Balance as % of GDP (R)
$4.8 trillions as of 2004Q3
Cumulative Trade Deficit Since 1985 (L)
20042003200220012000
-2.0
-2.5
-3.0
-3.5
-4.0
-4.5
-5.0
130
120
110
100
90
80
70
U.S. Trillions Jan 2000 = 100
Trade Deficit and US Dollar
Yen/Dollar (R)
Euro/Dollar (R)
Cumulative Trade Deficit Since 1985 (L)
$4.8 trillions as of 2004Q3
Lower Dollar, Higher Oil Price
20042003200220012000
200
180
160
140
120
100
80
60
145
136
127
118
109
100
91
82
Jan 2000 = 100 Jan 2000 = 100
Crude Oil
Trade-weighted dollar
Growing U.S. Budget Deficit
04999489847974
4
2
0
-2
-4
-6
-8
% of GDP
20042003200220012000
8.0
7.5
7.0
6.5
6.0
5.5
66
64
62
60
58
56
U.S. Trillions % of GDP
In 2005, U.S. Public Debt Increases $2.1 Billions Daily
U.S. Government Outstanding Debt (L)
Outstanding Debt as % of GDP (R)
$7.78 Trillions as of Mar. 31, 2005
Interest Expense on Public Debt$322 Billions in 2004
200420022000199819961994199219901988
400
350
300
250
200
10
8
6
4
2
U.S. Billions %
Declining interest rate on public debt (R)
Declining interest expense as % of GDP (R)
Interest expenses on total government debt
Total Debt Outstanding Since the 60s
20041994198419741964
70
60
50
40
30
% of GDP
Total Debt Outstanding Since the 30s
20041994198419741964195419441934
140
120
100
80
60
40
20
0
% of GDP
Raising Gov. Debt and Sovereign Rating
66
A-30ChinaBBB-34RussiaAAA40United KingdomBB-59BrazilBB+60IndiaAAA62United StatesDDD66ArgentinaAAAGermanyAA170Japan
Sovereign Debt Rating
Public Debt % of GDP
20042003
180
160
140
120
100
80
60
60
50
40
30
20
Jan 2003 = 100 $US Per Barrel
Stock and Crude Oil Price
Emerging Markets
Nikkei
DJIA
FTSE
WTI Crude Oil Price (R)
0604020098969492908886848280
3.5
3.0
2.5
2.0
1.5
1.0
0.5
US$ per Gallon
Rising U.S. Retail Gasoline Prices
Real (2005 dollars)
Nominal
Proj
ectio
ns
U.S. Energy ConsumptionShare of GDP
04989286807468625650
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
Percent
Gasoline and Oil
Fuel Oil and Coal
Quickly Flattening Treasury Yield Curve
March 31, 2004
September 30, 2004
March 31, 2005
20Y10Y7Y5Y3Y2Y1Y6M3M1M
6
5
4
3
2
1
0
Percent
Rising Costs of Raw Materials
200420032002
350
300
250
200
150
100
50
Percent
Crude Oil
Scrap Steel
Copper
00959085807570
1400
1200
1000
800
600
400
200
0
US$ Billions, Annualized
U.S. Corporate Profits
$1.27 trillion dollars in 2004 Q4, of which 15% is profit from abroad
Domestic non-financial
Domestic financial
Profits from abroad
China Trade Surplus with U.S., Deficit with Rest of The World
2004200220001998199619941992
100
50
0
-50
-100
US$ Billions
$US 95 billions annual trade surplus with the U.S.
$US 44 billions annual trade deficit with rest of the world
Relative Growth Rate Comparisons
Japan
United States
Germany
009590858075706560
25
20
15
10
5
0
-5
Percent Change in GDP, Year Ago
Relative Growth RatesReal GDP Growth
8.59.58.29.79.8China6.77.35.45.75.6India6.07.16.8-5.2n/aRussia3.75.21.91.83.0Brazil0.82.61.41.73.7Japan2.12.52.02.02.1EU3.64.42.43.13.1United States
2005E200400-0390-9980-89
Relative Inflation Rates
3.03.90.47.87.5China4.04.84.09.69.1India
11.810.918.0411.9n/aRussia6.56.69.3854.8332.3Brazil-0.20.0-0.71.22.5Japan2.02.22.37.59.5EU3.03.02.53.05.6United States
2005E200400-0390-9980-89
World’s Interest Rate OptionsNotional Amount
1990 $595.4 Billions
Asia10.3%
Europe33.0%
North America56.7%
2004 $24.6 Trillions
North America62.1%
Others0.1%
Asia0.1%
Europe37.7%
World’s Currency FuturesNotional Amount
1990 $17 Billions
Other Markets
1.2%Asia0.6%
North America98.2%
2004 $104.5 Billions
North America88.6%
Others0.1%
Asia3.5%
Europe0.3%
2003 Share of World Trade
Total: $7.4 trillion
EU40%
United States10%
Japan6%
China6%
Canada4%
Rest of World31%
Hong Kong3%
Top Oil Producing Nations: 2003
LibyaBrazil
AlgeriaNigeria
KuwaitUK
UAECanada
Ven.Norway
ChinaMex
IranUSA
RussiaS. Arabia
10
8
6
4
2
0
Barrels per day, Millions
World Oil Consumption 2003
Total: $78.1 million Barrels per Day
Rest of World48%
United States25%
Germany3%
China8%
Japan7%
Russia3%
South Korea3%
India3%
Bond Market: Amount Outstanding
S. AmericaMiddle East & Africa
AsiaEurope
N. America
25
20
15
10
5
0
US$ Trillions
199020002004
New Private Placements2004
EuropeU.S.AsiaLatin America
300
250
200
150
100
50
0
US$ billions
World Financial Structure
2003200220012000199919981997199619951994
160
140
120
100
80
60
40
Percent of World GDP
Bank AssetsEquity Market CapitalizationDomestic Debt
RussiaIndia
BrazilUSA
JapanChina
GermanyUK
400
300
200
100
0
Percent of GDP
Bank AssetsEquity Market CapitalizationDomestic Debt
Structure of Financial MarketsSelected Countries, 2003
Countries that Export Capital: 2004
Taiwan 3%
Korea 3%
Netherlands 2%
Hong Kong 2%
Other Countries
21%
Singapore 3%
Sweden 3%
China5%
Switzerland 4% Norway5%
Russia7%
Germany14%
Saudi Arabia6%
Japan19%
Canada 3%
Countries that Import Capital: 2004
United States71%
Greece 1%
Turkey 1%Italy 2%
France 1%
United Kingdom
5%
Portugal 1%
Australia 4%
Spain 4%
Hungary 1%Other
Countries9%
Global Futures MarketNotional Amounts
040302010099989796959493929190
20
15
10
5
0
800
600
400
200
0
US$ trillions US$ billions
Interest Rate (L)
Equity Index (R)
Currency (R)
Global Options MarketNotional Amounts
040302010099989796959493929190
25
20
15
10
5
0
140
120
100
80
60
40
20
0
US$ trillions US$ billions
Interest Rate (L)
Equity Index (L)
Currency (R)
Global Credit Derivatives Market
20042003200220012000199919981997
5
4
3
2
1
0
US$ Trillions
04020098969492908886848280
2000
1500
1000
500
0
40
30
20
10
0
US$ Billions Percent Change, Year Ago
Gross Domestic Product - LGDP Growth - R
China: Gross Domestic Product1980-2004
20502045204020352030202520202015201020052000
50
40
30
20
10
0
Nominal GDP, US$ Trillions
China
United StatesIndia
Japan
Germany
China GDP Will Pass Japan, Germany and United States
1966-76 Cultural
Revolution
1990Shanghai and
Shenzhen Stock Exchanges established
2001Member of
WTO
China: More Than Two Decades of Growth
200019951990198519801975197019651960
20
10
0
-10
-20
-30
Percent Change in RGDP, Year Ago
China: Stock Market vs. GDP Growth
2004200320022001200019991998199719961995
2500
2000
1500
1000
500
0
12
11
10
9
8
7
6
Index Percent, Year Ago
Shanghai Stock Exchange Composite IndexReal GDP Growth
U.S. - Japan Financial HoldingsDecember 2004
Equity 7.4%
Equity 32.4%
Bond 9.7%
Bond 2.5 %
Banks 55.9%
Banks 12.4%
Insurance and Pension
30.0%
Insurance and Pension
28.0%
Others 15.5 %
Others 6.2%
0% 20% 40% 60% 80% 100%
Japan
US
$13.9T
$36.8 T
Undiversified Financial System
High Income Countries
Bank31%
Equity34%
Bond35%
Bank56% Bond
22%
Equity22%
Equity31%
Bond12%
Bank57%
Low Income Countries
Middle Income Countries
Corporate Bond Credit SpreadYield to Maturity
ML Corp AAA 1-5 Yr (R)
ML Corp BBB 1-5 Yr (R) Spread (L)
2004200320022001200019991998199719961995
300
250
200
150
100
50
0
10
8
6
4
2
0
Basis Points Percent
040302010099989796959493929190
500
400
300
200
100
0
-100
10
8
6
4
2
0
-2
Basis Points Percent
U.S. Treasury Bond Maturity SpreadMiddle Rate
Treasury 3 Month (R)
Treasury 1 Year (R) Spread (L)
Sources of Hedge Funds’ $66 Billion of Institutional Money, 2003
Public Plans18%
Endowments and
Foundations53%
Private Plans22% Other
7%
Hedge Fund Investing Institutional Investors’ Top Concerns, 2003
Fees13%
Transparency 15%
Headline risk38%
Impact of capital flows on returns
34%
• Absolute Performance- Hedge Funds attempt to produce consistent absolute returns regardless of the market direction.
• Focus on Risk Management- Hedge Fund Managers focus on preserving capital by carefully managing investment risks. – Hedge Fund Managers are often heavily invested in their
own funds.• Greater Diversification- Funds of Hedge Funds add a
further dimension of risk management, investor discipline and access to a diversified portfolio.
• Lower Volatility- The combined focus on absolute performance, risk management and diversification lead to a low volatility of performance.
Why Invest in Hedge Funds
Comparative Risk Adjusted ReturnsJanuary 1990-February 2005
MSCI World Index
S&P 500
Hedge Funds
HY BondsLehman Agg. Bond Index
Gov't Bonds1-5Yr
90 Day T-Bill
0%
4%
8%
12%
16%
0% 2% 4% 6% 8% 10% 12% 14% 16%Risk (Standard Deviation)
Annualized Return
Hedge funds are represented by the HFRI Fund Weighted Composite Index. Asset class statistics were derived using monthly returns of major market indices from January 1994 through August 2004.
Historical Hedge Fund Performance 1990- Feb 2005
20042002200019981996199419921990
8
6
4
2
0
Jan 1990 = 1
Lehman Brothers Agg. Bond Index
Hedge Fund Composite S&P 500
Historically, Hedge Funds have Outperformed both Equity and Bond Indices.
Hedge Funds are represented by the HFRI Fund Weighted Composite Index. All Index monthly returns and performance statistics werederived from and calculated by the Pertrac Software.
Long/Short Equity
Emerging Mkts
S&P 500
MSCI World Index
Distressed Securities
Event Driven
Hedge Fund Composite
Relative Value
Convertible Arb
Merger Arb
Equity Market Neutral
Fixed Income Arb
Lehman Agg. Bond
0%
4%
8%
12%
16%
20%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%Risk (Standard Deviation)
Composite Risk Adjusted Performance Risk vs. Reward Analysis of Hedge Fund Strategies (1990-2005)
Annualized Return
All Index monthly returns and performance statistics were derived from and calculated by the Pertrac Software.
Historical Hedge Fund Asset Growth
20042000199819951990
1200
1000
800
600
400
200
0
US$ Billions
1000
600
350
190
50
Asset Growth figures from 1990-2002 are from Bernstein Research Call – May 2003. Total Current Assets are from HedgeCo.net.
Looming Risks to Fixed Income
• Rising Interest Rates:– Telegraphed by the Fed
• Increasing Default Rates:– Default rates abnormally low last 4 years
• Undue Pressure to Chase Yield:– Credit spreads are the lowest in 6 years
Impact of Portfolio Losses on Overall Return The Importance of Protecting the Downside
1,459,142 63.88*1,459,142 6.502005
890,348 10.881,370,087 6.502004
802,983 28.701,286,466 6.502003
623,919 -22.101,207,950 6.502002
800,923 -11.881,134,225 6.502001
908,900 -9.111,065,000 6.502000
US$ 1M Invested on Jan. 1, 2000
Annual Return
(%)
US$ 1M Invested on Jan. 1, 2000
Annual Return
(%)Year
S&P 500 InvestmentHypothetical Fixed Return
*The S&P 500 must return 63.88% in 2005 to match the return of the Hypothetical Fixed Return Fund.
Demonstrated Impact of Alternative Investments
10M-50M50M-100M100M-500M500M-1B>1B
100
90
80
70
60
50
16
14
12
10
8
Percent Percent
8.99.3
10.010.8
12.5
89.687.8
81.8
74.5
55.0
NACUBO 10 Year Annual Performance (R)
Daily Liquidity of Portfolio (L)
Source: Commonfund Presentation, Commonfund Allocation Planning ModelTM and Commonfund Benchmarks Study ® - Educational Endowment Report. 2003 NACUBO Endowment Study, the two smaller fund groupings as reported by NACUBO, $26M - $50M and <$25M, are represented in the $10M - $50M grouping equally weighted.
22
6
1516 18
9
19
1114
7
20
1014
9
17
11 1115
2824
37
4245
48
9
0
10
20
30
40
50
60
Hedge Funds Venture Capital Private Equity Energy &Natural
Resources
Private/PublicEquity Real
Estate
FY 2000
FY 2001
FY 2002
FY 2003
FY 2004
Alternative Strategies Asset Mix Trends for Endowments
Percent
Source: Commonfund Presentation. Commonfund Benchmarks Study®
23
41 4250 50 47
13
1520
21 24 29
17
1514
13 10 8
9
23
129
5 419 15 12 9 7 4
5
23
2 5
3
0%
20%
40%
60%
80%
100%
> $1B $500M - $1B $100M -$500M
$50M -$100M
$10M - $50M $0M - $10M
Dom. Equities Fixed Income Intl. Equities
Short Term Securities/Cash Alternatives Hedge Funds
Allocations by Asset Classes
Source: 2005 Commonfund Benchmarks Study – Educational Endowment ReportCopyright 2003 The Commonfund for Nonprofit Organizations
17.8
7.8 12
.2
10.1
37.6
16.8
11.7
7.2 12
.2
4.7
22.9
14.7
11.5
7.1 11
.0
4.2
0
10
20
30
40
50
DomesticEquities
DomesticBonds
AbsoluteReturn
ForeignEquities
PrivateEquities
Real Assets 10 YearPerformance
Yale ReturnsActive BenchmarkPassive Benchmark
Yale Performance Relative to Benchmarks (10 Years)
Active Benchmarks:Domestic Equity: Frank Russell Median Manager, U.S. EquityFixed income: Frank Russell Median Manager, Fixed IncomeAbsolute Return: CSFB CompositeForeign Equity: Frank Russell Median Manager Composite, Foreign EquityPrivate Equity: Cambridge Associates CompositeReal Assets: NCREIF and Cambridge Associates Composite
Passive Benchmarks:Domestic Equity: Wilshire 5000Fixed income: Lehman Brothers U.S. Treasury IndexAbsolute Return: 1-year Constant Maturity Treasure +6%Foreign Equity: 50% MSCI EAFE Index, 50% MSCI EM IndexPrivate Equity: University Inflation +10%Real Assets: University Inflation +6%
$<1B
–12
.5
$100
M -
500M
–8.
9
Yal
e R
etu
rns
–16
.8
4.6% CAGR Difference Between Domestic Bonds and Absolute Performance.
Asset Allocations
3.53.2Cash18.86.3Real Estates14.55.5Private Equity14.815.6Foreign Equity26.115.1Absolute Return7.417.5Fixed Income
14.836.8Domestic Equity
Yale University
(%)
Educational Institutions
(%)
Rising Short-term Interest Rates
JANJULJANJULJAN200520042003
3.0
2.5
2.0
1.5
1.0
0.5
Percent
Fed Fund Target
3-month Treasury
Corporate Bond Default Rates
04020098969492908886848280
15
12
9
6
3
0
%
Corporate Defaulted Bonds Par Values
04020098969492908886848280
100
80
60
40
20
0
US$, billions
High Yield Spread Over Treasuries
0402009896949290
2500
2000
1500
1000
500
0
Basis points
High Yield Distressed Debt
200420022000199819961994
300
250
200
150
100
50
Index, 1994=100
All DistressedEmerging Mkts Event Driven
Hedge Fund Returns by Strategy
200420022000199819961994
300
250
200
150
100
50
Index, 1994=100
Risk Arb Global MacroLong/Short Equity Mkt Neutral
Hedge Fund Returns by Strategy
U.S. vs. Europe Equity Markets Comparison
• Significant growth of market capitalisations on both sides of the Atlantic with U.S. still outstripping Europe (US$13tn vs. US$10tn)
• Total market capitalisations currently U.S. 57% vs. 43% in Europe, roughly the same in 1995
• Significant trading volume growth in Europe over last 10 years, both markets now evenly balanced
• Europe now closing gap in terms of forward trading multiples with US vs. late 90s/early 2000 when U.S. was two to three points higher than Europe
• Number of US IPOs (288 in 2004) still significantly ahead of Europe (89 in 2004) but U.S. deals smaller on average
• US$44bn raised in U.S. in 2004 with average size of US$237m, US$35bn raised in Europe with average size of US$353m
U.S. vs. EuropeBroad Themes
• Spitzer has made his mark on both sides of the Atlantic• Sarbanes-Oxley compliance having a significant impact on
non-US companies– over half of large European companies spending more than 100,000
hours on corporate governance, double number of their US counterparts
– increasing propensity to consider delisting and then deregistering• Increasing interest in trading directly on a Company’s home market
– demise of ADR trading, reduced number of 144A placings• Investor audience changing rapidly
– global vs domestic portfolio managers• Hedge fund explosion, now over US$1 trillion (7,000–8,000
worldwide)– uses of derivatives, contracts for differences– generated as much as US$25bn in revenues for investment banks– largely unregistered, actively managed, performance oriented– account for 30–50%of LSE volumes
U.S. vs. EuropeLooking Forward
• UBS forecasting continued dollar weakness, supportive of underweight US call, overweight Europe, Japan, Asia
• Broad rate increases driven by US and this will continue—UBS forecasting year end Fed Funds rate of 4% and US 10 year treasuries at 5.3%
• Positive on non-US equities– valuations more supportable– profitability and restructuring– productivity gains and lower unit labor costs
• Extremely healthy global corporate picture spurring growth, job creation and greater price competition
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