JPM Prime Brokerage Global Hedge Fund Trends March 2013

J.P. Morgan Prime Brokerage Global Hedge Fund Trends

1

This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.

March 12, 2013

Executive Summary There was a slight pullback in risk assets1 during February. All of the major hedge fund strategies posted gains except for Global Macro, which fell -0.67%. The HFRI Global Hedge Fund Index inched up +0.14%, with Relative Value (+0.66%) being the top performer among the key hedge fund strategies for February. The HFRI Equity Hedge Index increased +0.50% and Event Driven rose +0.06%.

Leverage For all accounts in the Prime Brokerage portfolio, gross leverage2 fell from 1.91 to 1.88 (-1.5%) in February as market participants slightly reduced exposure and leverage in light of increased market volatility. Net exposure3 for equity-focused strategies fell from 0.78 to 0.70 (-9.6%). Net leverage for equity-biased strategies declined from 0.69 to 0.64 (-7.2%) due largely to a decrease in long exposure. Securities Lending As the Dow Jones Industrials and S&P 500 indices approached all-times highs in February, clients were reluctant to add short exposure. The U.S. Prime Brokerage short book was therefore net covered in February, offsetting January’s increase in short activity. In Europe, new deal activity was light, with new trading flows stemming primarily from capital raising events. Flows were also light across Asia. Institutional Investor Sentiment Fewer new allocations are going to structured credit from U.S. investors. At the same time, U.S. allocators are showing heightened appetite for directional strategies. European allocators continue to upgrade portfolios while Asian investors are pulling back from longer-biased credit exposure.

Market Perspectives Tightening measures in China, disappointing data from Europe and the perpetual impasse in Washington were sufficient to cause only a pause in the 2013 rally. The U.S. continues to lead the global recovery. However, it may be infeasible for the U.S. economy – and in turn the global recovery – to attain “escape velocity” absent longer-term clarity with respect to fiscal policy in Washington, including the pace with which, and the extent to which, federal spending will be pared back.

1 Assets other than cash and government fixed income securities. 2 Gross leverage is the total market value of long and short positions divided by clients' equity in J.P. Morgan’s Prime Brokerage portfolio. 3 Calculated for Equity Long Short and Market Neutral funds on J.P. Morgan’s Prime Brokerage platform only. Net leverage is defined as the market value of long positions (LMV) minus the market value of short positions (SMV), divided by clients’ equity (Eq). Net exposure is defined as the ratio of LMV and SMV, minus one.

Figure 1: February 2013 performance HFRI and Market Indices. Monthly Returns

Source: Bloomberg, Hedge Fund Research

Table 1: Performance of hedge fund strategies and asset classes HFRI and Market Indices4

Feb-13 Year-to-Date HF Index 0.14% 2.67% Equity LS 0.50% 3.84% Event Driven 0.06% 2.38% Macro -0.67% 0.98% Relative Value 0.66% 2.40% S&P 500 1.36% 6.61% Fixed Income -1.08% -2.56% CMDTY -4.02% 0.25% USD 3.46% 2.73% Credit 0.76% 0.04%


Figure 2: Hedge fund beta to equities Rolling 21-day beta of HFRX equal-weighted index returns to the S&P 500 Total Return Index


4 Market indices from Bloomberg are as follows: S&P 500 (SPTR Index), Fixed Income (JPMGGLBL Index), CMDTY (SPGSCI Index), USD (DXY Index), and Credit (JULIR Index).

-4.5%

-3.5%

-2.5%

-1.5%

-0.5%

0.5%

1.5%

2.5%

3.5%

HF Index Equity LS Event Driven

Macro Rel Value S&P 500 Fixed Income

CMDTY USD Credit

2,100

2,200

2,300

2,400

2,500

2,600

2,700

2,800

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13

Equity Beta (LHS) S&P 500 Total Return Index (RHS)

Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk Exposures

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This section presents a summary of the changes that we have observed in leverage and sector exposures across the range of hedge funds that we work with. The confidentiality of our clients’ positions is important to us and as such this information has been aggregated and displayed in an anonymous manner in an effort to mitigate the risk of revealing or alluding to any one fund’s exposures. Information may be excluded due to the perceived risk of revealing sensitive information. The information discussed is specific to activities on J.P. Morgan’s books, and may not represent total client activity. These numbers should only be viewed as representative observations.

Market Overview

There was a slight pullback in risk assets during February. Although the S&P 500 Index increased +1.1%,5 the MSCI AC World Index declined -0.2%. European markets exerted a drag, with the Euro Stoxx Index down -6.2%. Emerging markets equities also underperformed, with the MSCI EM Index falling -1.3% through month-end. Year to date, however, equities continue to rally. The S&P 500 is up +6.46% and the Russell 2000 has risen +7.70%. Additionally, the S&P 500 / 10-Year Treasury return differential stands at +6.54%. Alongside February’s slight pullback in risk assets, the HFRI Global Hedge Fund Index inched up +0.14%. All of the major hedge fund strategies posted gains except for Macro, which reversed two consecutive months of positive performance.

On the macro economic front, inconclusive election results in Italy captured news headlines but the impact was primarily localized, as demonstrated by declining yields on Spanish and Portugese debt (though Italian yields rose). The Yen continued to weaken in February pursuant to “Abenomics,” further bolstering Japanese equities. Year to date, the Nikkei remains one of the world’s strongest markets, having surged +11.65%. High expectations surrounding new leadership for the Bank of Japan have helped drive yields on 10-year JGBs to a decade-long nadir.

Relative Value Relative Value was the best performer among the major hedge fund strategies in February, with the HFRI Relative Value Index increasing +0.66%. Multi-strategy relative value managers profited from active commodity spread trading. Gains among multi-strategy fixed income arbitrage and convertible arbitrage strategies also contributed to February’s positive returns. Multi-strategy fixed income arbitrage managers benefitted from global credit exposures as the HFRI Relative Value Multi-Strategy Index rose +1.49%. Convertible arbitrage funds with directional exposures to Asia Pacific convertible securities performed well, with the HFRI Fixed Income-Convertible Arbitrage Index up +0.45% month-over-month.

5 References are to SPX Index vs. SPTR Index as in Table 1.

Equity Hedge Equity Hedge strategies returned +0.50% in February according to the HFRI Equity Hedge Index. Overall, defensives led other sectors. The MSCI World Consumer Staples Index was up +2.4% in February compared to +0.5% for the MSCI World Consumer Discretionary Index and a decline of -2.9% for the MSCI Market Materials Index. Market neutral managers benefitted from small cap and pair trading strategies while fundamental growth strategies capitalized on gains in the U.S. Small Cap, Cyclical and Financial sectors. Event Driven The HFRI Event Driven Index was largely flat in February, inching up +0.06% month-over-month amidst robust strategic, financial and distressed M&A activity. LBO activity was particularly strong in February, accounting for $51 billion out of $200 billion in total M&A globally according to J.P. Morgan Global Asset Allocation. February thus marked the strongest month for LBO activity since July 2007, when volumes reached $55 billion (See Figure 3). February’s heightened LBO activity was spurred by low yields, record levels of cash on corporate balance sheets and robust demand for high yield loans, as evidenced, for example, by record new issuance of loans and high yield bonds in February (See Figure 4).

Figure 3: LBO transactions as a percentage of total M&A

Source: J.P. Morgan Global Asset Allocation

0%

5%

10%

15%

20%

25%

30%

35%

40%

Jan-00 Apr-02 Jul-04 Oct-06 Jan-09 Apr-11


3


Figure 4: Loan and HY bond new issuance ($ billions)

Source: J.P. Morgan High Yield and Leveraged Loan Research

While the HFRI Event Driven Index was more or less flat in February, managers with exposures to active target companies in pending mergers have benefitted from robust year to date corporate activity (See Figure 5). If conditions such as low interest rates and high levels of cash on corporate balance sheets persist, the auspicious M&A climate is likely to continue, especially as companies seek to grow through acquisition rather than organically. Merger arbitrage managers should in turn benefit, assuming that completion rates follow the same trajectory. Figure 5: S&P Long-Only Merger Arbitrage Index year to date performance

Source: Bloomberg

Global Macro Global Macro strategies declined in February, blunting the gains of the prior two months. The HFRI Macro Index fell –0.67% as negative performance among systematic CTAs (-1.11%)6 partially offset gains among currency and fixed income discretionary managers. Discretionary managers with long USD and short JPY exposures posted gains as most currencies sold off against the

6 HFRI Macro: Systematic Diversified Index, February 2013.

USD. Several factors underpinned this trend, including a further decline in the Yen (-0.9%) due to anticipated easing measures by the Bank of Japan, Moody’s UK downgrade, and renewed pressure on the Euro (-3.8%) as a result of disappointing fourth quarter GDP.

33 22

34 27 46

20 17 1 7 10

24 4

26 40 42

22 19 13 23 32 47 43

31 31 48

30

7

50 44

14

38

18 16

8 6 8

10

10

6

19 27

22 26

13 14

24

34 52

30 33

32

113

0

20

40

60

80

100

120

140

Jan‐11

Feb‐11

Mar‐…

Apr‐11

May‐…

Jun‐11

Jul‐11

Aug‐11

Sep‐11

Oct‐11

Nov‐…

Dec‐11

Jan‐12

Feb‐12

Mar‐…

Apr‐12

May‐…

Jun‐12

Jul‐12

Aug‐12

Sep‐12

Oct‐12

Nov‐…

Dec‐12

Jan‐13

Feb‐13

Institutional loans

High‐yield bonds

1840

1850

1860

1870

1880

1890

1900

1910

2-Jan 9-Jan 16-Jan 23-Jan 30-Jan 6-Feb 13-Feb 20-Feb 27-Feb

S&P Long-Only Merger Arbitrage Index


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Leverage and Risk Exposures

Gross Leverage Gross leverage and net exposure for clients in the Prime Brokerage Portfolio were stable in the first half of February but trailed off towards month-end as market participants reduced exposure and leverage slightly because of increased market volatility. For all accounts in the Prime Brokerage portfolio, gross leverage fell from 1.91 to 1.88 (-1.5%) (See Figure 6). By contrast, gross leverage of levered accounts in the Prime Brokerage portfolio increased from 2.50 to 2.59 (+3.8%) (See Figure 7). This dichotomy was a reversal from the pattern in January. As fewer clients deployed leverage in February, gross leverage among levered accounts was skewed higher since clients that retained debits did so at higher levels. Month-over-month, leverage in the Prime Brokerage portfolio was subdued relative to the gain in the S&P 500 (See Figure 8).

Figure 6: Daily gross leverage and the S&P 500 Index

Source: Bloomberg, J.P. Morgan Prime Brokerage Figure 7: Gross leverage (levered accounts) 5-day moving average and the S&P 500 Index

Source: Bloomberg, J.P. Morgan Prime Brokerage

Figure 8: Z-score of gross leverage and the S&P 500 Index The Z-score measures how many standard deviations an observation is above or below the mean

Source: Bloomberg, J.P. Morgan Prime Brokerage

Gross Leverage by Strategy Gross leverage rose for High Yield Fixed Income from 1.26 to 1.42 (+12.4%). Gross leverage for Market Neutral also increased in February from 4.26 to 4.47 (+4.9%). By contrast, gross leverage fell for High Grade Fixed Income, which declined from 2.41 to 2.06 (-14.3%). All strategies are running leverage above their average 2-year levels except for High Grade Fixed Income. Figure 9: Gross leverage by strategy

Source: J.P. Morgan Prime Brokerage

1.75

1.80

1.85

1.90

1.95

1,250

1,300

1,350

1,400

1,450

1,500

1,550


S&P 500 Index (LHS) Gross Leverage (RHS)

2.4

2.5

2.6

2.7

1,250

1,300

1,350

1,400

1,450

1,500

1,550


S&P 500 Index (LHS) Gross Leverage (Levered Accounts - RHS)

-1.3

0.0

1.3

Feb-11 Aug-11 Feb-12 Aug-12 Feb-13

Difference between gross leverage and S&P 500 Index Z-scores

0

1

2

3

4

5

Market Neutral Equity Long Short

Multi-Strategy Convertible Arbitrage

High Grade Fixed Income

High Yield Fixed Income

Dec-12 Jan-13 Feb-13


5


Table 2: Gross leverage by strategy Average and first quartile calculated for the period of February 2011 to February 2013


Net Exposure and Net Leverage Net exposure for equity-biased funds fell from 0.78 to 0.70 (-9.6%) in February and net leverage declined from 0.69 to 0.64 (-7.2%). These decreases reflected the overall pullback in February as managers reduced their net long exposure. Figure 10: Net exposure and net leverage Equity Long Short and Market Neutral funds on the Prime Brokerage platform only. LMV: Market value of long positions. SMV: Market value of short positions. Eq: Equity in the clients’ accounts


Sector Exposures The most sizeable increase in the long Prime Brokerage portfolio month-over-month once again was in the Communications sector (+0.9%). The largest declines occurred in the Basic Materials, Consumer, Non-cyclical, Financial and Utilities sectors, each of which fell -0.2%. The largest increases in the Prime Brokerage short portfolio were in the Non sector-specific ETF (+2.4%) and Communications (+0.6%) sectors. (The increase in long and short exposure for the Communications sector was attributable largely to heightened M&A activity.) The most substantial decreases in short exposure occurred with respect to the Financial (-1.0%) and Consumer, Non-cyclical (-1.0%) sectors.

Table 3: Long and short exposures by sector Long (Short) exposure by sector as a percentage of total client long (short) exposure in Prime Brokerage portfolio

Long exposure Short exposure

Feb-12 Jan-13 Feb-13 Feb-12 Jan-13 Feb-13

Basic Materials 6.2% 5.6% 5.4% 4.2% 5.2% 4.8%

Communications 11.6% 13.5% 14.4% 6.5% 6.6% 7.2%

Consumer, Cyclical 11.3% 11.0% 11.0% 8.5% 8.6% 7.9%

Consumer, Non-cyclical 14.2% 15.1% 14.9% 10.2% 11.8% 10.8%

Diversified 0.3% 0.3% 0.3% 0.0% 0.0% 0.0%

Energy 8.7% 8.6% 8.7% 7.5% 5.9% 6.2%

Non sector-specific ETF 3.3% 4.1% 4.2% 14.9% 16.0% 18.4%

Financial 20.4% 18.1% 17.9% 11.6% 11.8% 10.8%

Industrial 6.3% 5.9% 5.8% 6.2% 6.7% 6.7%

Technology 5.2% 4.0% 4.1% 5.4% 7.1% 6.6%

Utilities 1.9% 1.3% 1.1% 1.9% 1.9% 1.9%

Other 5.5% 6.3% 6.1% 9.2% 10.1% 11.8%


Dec-12 Jan-13 Feb-13 AverageFirst

Quartile% Change

Market Neutral 4.36 4.26 4.47 3.84 3.54 4.9%

Equity Long Short 1.86 1.97 1.94 1.83 1.72 -1.0%

Multi-Strategy 1.76 1.77 1.79 1.77 1.74 1.2%

Convertible Arbitrage 3.65 4.17 4.29 3.61 3.44 2.7%

High Grade Fixed Income 2.39 2.41 2.06 2.61 2.38 -14.3%

High Yield Fixed Income 1.17 1.26 1.42 1.21 1.16 12.4%

PB Portfolio (Levered Accounts) 2.54 2.50 2.59 2.53 2.48 3.8%

0.4

0.7

1.0

1.3

Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13

Net Exposure (LMV/SMV)-1 Net Leverage (LMV-SMV)/Eq

Prime Brokerage Global Hedge Fund Trends – Securities Lending

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U.S. Securities Lending

Equities As the equities market approached all-time highs in February, clients were reluctant to add short exposure, with the U.S. short book net covered for the month. As of month-end, the short sale/buy to cover ratio by market value for 2013 was flat, with shorting in ETFs offset by single name covering. Most sectors were net covered in February led by Consumer, Non-cyclical, Consumer, Cyclical and Technology. The lone outlier was the Communications sector, which was net shorted. That anomaly resulted from heightened demand for Liberty Global shares (LBTYA and LBTYK), which spiked after the planned acquisition of Virgin Media (VMED) was announced.

ETFs February was the second consecutive month during which ETFs were net shorted. SPY (SPDR S&P 500 ETF Trust), IYR (iShares Dow Jones US Real Estate) and HYG (iShares iBoxx High Yield Corp Bond) were the key drivers. Clients increased short exposure in other broad based ETFs such as QQQ (PowerShares QQQ Trust) and MDY (SPDR S&P Midcap 400 ETF). There was reduced exposure to small-cap ETFs led by IWM (iShares Russell 2000).

HYG was the most active ETF in February from a stock loan standpoint. Creating to lend HYG is unattractive and expensive due to the difference between the creation basket and the high-yield index that it tracks. When demand increases, as it did in February, borrow cost spikes and the ETF trades like a hard-to-borrow security. FXI (iShares FTSE XinhuaChina 25 Index) also was active in February, skewed towards buys-to-cover. The fund saw large outflows as demand decreased, in turn causing the cost to borrow to ease.

Event Driven M&A activity was again robust in February, continuing the trend that commenced in January:

Kinder Morgan Energy Partners (KMP) agreed to acquire Copano Energy (CPNO) in a transaction valued at approximately $5 billion. Owners of CPNO will receive 0.4563 shares of KMP for each Copano share they own. The transaction is expected to close in the third quarter of this year subject to regulatory and shareholder approvals. We are approving limited quantities of KMP. However, supply across the street remains constrained.

Liberty Global agreed to acquire Virgin Media (VMED) in a stock and cash deal valued at over $23 billion. Shareholders of VMED will receive a combination of cash and shares of Liberty series A & C shares. Liberty expects to realize synergies from the scale of the combined business once the acquisition is completed by mid-year. LBTYA and LBTYK borrows remain liquid despite increased demand.

LinnCo. LLC (LNCO) announced its acquisition of all of the Berry Petroleum (BRY) shares in an all-stock transaction. The transaction represents the first acquisition of a publicly held company by an upstream LLC/MLP. The transaction has already been approved by the boards of directors of each of Linn Energy (LinnCo.’s parent), LinnCo, and Berry, and is expected to close in the second quarter. Arbitrage funds have not been very active with this transaction due to scarce borrow in LNCO.

OfficeMax (OMX) and Office Depot (ODP) announced an all-stock merger, which has already been approved by the board of both companies. OMX stockholders will receive 2.69 shares of ODP for every share held, and the transaction is expected to close by year-end. Borrow for ODP remains liquid despite increased demand.

PPG Industries (PPG) completed the spinoff of its chemicals and commodities business to Axiall Corp (AXLL – formerly Georgia Gulf (GGC)). Overall, just under 15% of PPG shareholders elected to take part in the voluntary exchange offer.

Fixed Income There was a marked decrease in fixed income shorting for both investment grade and high yield corporate debt in February. Financials and technology were the only sectors for which there were net increases in shorts. Basic Materials, Communications, Consumer, Non-cyclical and Utilities were the leading sectors for short covering. February witnessed strong flows in the following names, partly in response to potential LBO activity: Dell, Inc., (DELL), HJ Heinz Co. (HNZ) and JC Penny (JCP).

In contrast to February’s corporate debt activity, there was a net increase in short balances with respect to convertible bonds. Several issues experienced a sudden tightening of liquidity along with headline-driven rate volatility. The U.S. Prime Brokerage book continues to see heavy flows around


7


Lam Research (LAM), Newmont Mining (NEM), Peabody (BTU), Priceline (PCLN) and RadioShack (RSH). Figure 11: Cumulative net activity Market value change of activity across equities, ETFs, and fixed income

Source: J.P. Morgan Securities Lending

Figure 12: Rolling 1-month daily short flow Daily Activity Relative to 30-Day Average (LHS) and S&P 500 Index (RHS)

Source: Bloomberg, J.P. Morgan Securities Lending

Table 4: U.S. securities lending trends by sector For the month of February 2013

5 Day 30 Day 90 Day

Price

Change

Position Change (shares)

Price Change


Price Change


Consumer, Non-cyclical 1.2% -2.4% 1.6% -4.9% 9.0% 1.0%

Financial 0.8% -1.8% 1.2% -3.5% 12.1% -3.8%

Technology 0.9% 0.0% -2.0% -3.2% 14.0% -11.5%

Energy 0.5% -3.4% 1.6% 2.8% 10.4% -4.0%

Communications 1.5% -0.3% -0.1% 7.0% 14.1% 3.4%

Industrial 1.3% 0.3% 0.9% -1.3% 14.7% -6.2%

Consumer, Cyclical 0.7% -0.5% -0.4% -1.6% 9.8% -7.2%

Basic Materials 0.7% 2.6% -6.0% 0.7% 1.8% 24.4%

Utilities 1.2% -0.1% 2.0% -0.8% 9.8% 11.3%

Source: J.P. Morgan Securities Lending Table 5: U.S. securities lending trends by ETFs For the month of February 2013

5 Day 30 Day 90 Day

Price

Change


Price Change


Price Change


SPDR S&P 500 ETF TRUST 0.9% 32.6% 1.1% 34.7% 8.9% 27.1%

ISHARES RUSSELL 2000 0.6% -1.8% 0.5% -4.4% 13.5% 3.7%

SPDR S&P MIDCAP 400 ETF 0.7% 0.0% 0.6% 17.0% 12.0% -11.2%

ENERGY SELECT SECTOR SPDR 0.8% 12.0% 1.3% -8.0% 10.0% -25.9%

ISHARES IBOXX H/Y CORP BOND

0.7% 14.4% -0.8% 41.3% 2.2% 81.9%

POWERSHARES QQQ NASDAQ 100

0.9% 9.3% 0.0% 37.4% 5.0% -15.0%

INDUSTRIAL SELECT SECTOR SPDR 1.2% -2.9% 1.5% 47.0% 12.3% 23.2%

MATERIALS SELECT SECTOR SPDR 1.9% 25.9% -2.4% 57.4% 7.2% 89.7%

SPDR BARCLAYS HIGH YIELD BOND ETF 0.3% -15.3% -1.6% 87.4% 1.6% 46.8%

CONSUMER STAPLES SPDR 0.1% -21.4% 3.5% -15.7% 8.3% -8.4%

Source: J.P. Morgan Securities Lending

‐$10.0

‐$8.0

‐$6.0

‐$4.0

‐$2.0

$0.0

$2.0

$4.0

3-Jan 17-Feb 2-Apr 17-May 1-Jul 15-Aug 29-Sep 13-Nov 28-Dec 11-Feb

Equity ETF Fixed Income Net Activity

1,400

1,450

1,500

1,550

-350%

-250%

-150%

-50%

50%

150%

250%

350%

01-Feb 08-Feb 15-Feb 22-Feb

Net Cover Activity (LHS) Net Short Activity (LHS) S&P 500 Index (RHS)


8


International Securities Lending

Europe New deal activity was light in February with most of the trading flows stemming from capital raising events. Koninklijke KPN N.V., Citycon OYJ and Royal Imtech N.V. each announced rights issues. Borrow demand was most substantial for Koninklijke KPN as funds sought shares prior to the general shareholders meeting in March. Borrow for Citycon was limited, with aggressive bidding by arbitrage funds. Utilization of Royal Imtech borrow was high in advance of its rights issue announcement. The only other trade of note was Exor S.p.A., which is planning a mandatory conversion of preferred shares. Directional trades remained a primary focus for many hedge funds in February. Nokia, which has been heavily shorted over the last 12 months, experienced heightened demand in advance of its deletion from the Euro Stoxx 50. Index tracker funds re-balanced, which in turn catalyzed recalls. Demand is still robust for Banca Monte dei Paschi, with many funds increasing short positions. The borrow level for Alcatel-Lucent continued to ease as a number of funds covered short positions. February saw heightened recalls on PagesJaunes Groupe, for which utilization is still heavy. In Spain, the Prime Brokerage book continued to see strong demand from directionally-oriented hedge funds for Bankia, Caixabank, Banco Popular and Fomento de Construc Y Contra, with recall pressure in Bankia pushing borrow rates to 70%. With respect to the Glencore/Xstrata merger, the completion date moved to mid-April. Risk arbitrage funds therefore added to their positions, which created upward pressure on borrow costs. Asia ex-Japan

Korea Overall, flows were light in February. Brokers used the opportunity to refinance existing shorts. Activity declined for OCI Co. Ltd. (010060 KS), which has been a popular name among short sellers. Demand remains strong for LG Electronics (056670 KS). Taiwan Flows were generally muted in February, with activity driven largely by investors exercising calls in anticipation of annual

general meetings in March. There was heavy activity around MediaTek Inc. (2454 TW) as market participants trimmed long positions and put on new shorts in anticipation of antitrust approval for the company’s merger with MStar Semiconductor, Inc. (3697 YW). Hong Kong As in January, fees on Evergrande (3333 HK) and Zoomlion (1157 HK) declined during February as liquidity for those names increased. Demand was heavy for company names that are under review as a result of the MSCI’s rebalancing. Japan Although the Nikkei was up +3.8% in February, activity was generally light as was the case in the rest of the region. Hedge funds sought locates in names such as Gree Inc. (3632 JP), Dena Co. Ltd. (2432 JP) and Start Today Co Ltd (3092 JP). The Prime Brokerage book experienced recalls for Bic Camera, Inc. (3048 JP) in anticipation of the company’s record date. Australia February was earnings season in Australia. There was strong demand for borrow in Monadelphous Group Limited (MND AU), as investors remain bearish on the mining services sector. Borrow for Tatts Group Ltd. (TTS AU) also was in demand ahead of the company’s earnings statement. Tatts Group continues to trade at expensive multiples relative to its peers, a fact that also helped spur demand. Additionally, there was increased short interest in Ansell Ltd. (ANN AU) on the heels of disappointing net profits.

Prime Brokerage Global Hedge Fund Trends – Institutional Investor Sentiment

9


Institutional Investor Sentiment

Americas We are approaching an inflection point in the market for institutional investor capital, as flows into structured credit are slowing while allocators are showing heightened appetite for directional strategies with higher betas. Given the strong returns and corresponding inflows that structured credit generated from 2009 through 2012 – a period during which the HFRX Fixed Income-Asset Backed Index averaged +19.63% annually – fewer investors are making new allocations since (1) the strategy now comprises part of many U.S. investors’ portfolios and (2) some investors who have not yet made allocations are concerned about the current opportunity set. There has been a palpable uptick in interest in equity long short and event driven managers. Interest in systematic strategies and CTAs remains muted. New launches continue to garner interest.

The Capital Introduction Group (CIG) spent time with institutional investors in and around Boston in February. Fund of hedge funds (FoFs) continue to grow their advisory and customized businesses while their comingled vehicles contract. Notably, Boston-area consultants were interested in learning about new launches, which have not been a traditional focus for them.

CIG also hosted a heavily attended event on convertible arbitrage managers in February. While it is too early to say that a trend is underway, we have seen an uptick in interest in convertible arbitrage, especially given heavy 2013 issuance.

Europe To the extent that any clear themes have emerged among European allocators, it is the continual upgrading of portfolios as investors rotate away from managers who have underperformed. As in the U.S., there is interest among European investors in new managers across the strategy spectrum.

CIG met with an array of investors in Switzerland. Zurich-based family offices continue to reduce their hedge fund holdings, with private equity and direct market investments benefitting from this reallocation. Swiss corporate pensions continue to disintermediate FoFs in lieu of direct investments, albeit not without the services of consultants. Overall, there is rising interest in directional equity long short strategies and, in a few instances, long-only equity as investors try to increase the volatility in their portfolios. Institutional investors in Switzerland also expressed interest in global macro and European structured credit.

Asia Asian investors are pulling back from long-biased credit exposure and instead are showing renewed interest in low directional, relative value and long short credit. Among investors who do not already have exposure to structured credit, there is strong interest in the strategy. As ever, “good” discretionary macro managers are in demand but Asian investors are generally disillusioned with underperformance among macro funds. However, there has been a slight uptick in interest in emerging markets macro.

Equity long short remains a “bread and butter” strategy among Asian investors and there is renewed interest in the region in capturing risk-on equity upside. However, only investors who are currently underweight equities are making such allocations. Asian investors are generally saturated with respect to multi-strategy funds, as most of the major multi-strategy managers already account for core allocations in investors’ portfolios. Finally, interest in CTAs has waned. Only groups that view CTAs as a tail to their portfolios remain committed to the strategy.

Table 6: Investor strategies of interest by region7

Americas Europe Asia

Direction of

Interest Level of Interest

Direction of Interest

Level of Interest

Direction of Interest

Level of Interest

Convertible Arbitrage

Neutral

Neutral

Neutral

Distressed Neutral

Neutral

Neutral

Equity Long Short

Increasing

Increasing

Neutral

Event Driven

Increasing

Neutral

Neutral

Macro Neutral

Neutral

Decreasing

CTA Neutral

Neutral

Decreasing

Market Neutral

Neutral

Neutral

Increasing

Structured Credit

Neutral

Neutral

Increasing

Legend

Low Interest

Medium Interest

High Interest

Source: J.P. Morgan Capital Introduction Group

7 This information comes from CIG conference calls and meetings with global hedge fund managers and institutional investors. This table represents views of the CIG team and may not be completely exhaustive.

Prime Brokerage Global Hedge Fund Trends – Market Perspectives

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February Commentary

The rally that commenced with vigor in January took a pause in February. Headwinds emerged as a result of tightening measures in China, disappointing data from Europe and the perpetual impasse among Washington policymakers over the federal budget. Those obstacles, however, were sufficient only to cause a pause in, rather than a reversal of, the global recovery, which continued in February but at a lower pace. The J.P. Morgan Global Manufacturing PMI was 50.8 in February, still in expansion territory but down from 51.4 in January. Significantly, data from China also blunted momentum as the country’s manufacturing PMI declined from 50.4 in January to 50.1 last month. February was therefore the fifth consecutive month during which China’s PMI signaled expansion. However, the month-over-month decline is indicative of a decrease in the rate of that expansion. The U.S., by contrast, continues to be a key driver behind the global recovery. Even as across-the-board federal spending cuts took hold, the U.S. PMI rose to 54.2 in February from 53.1 in January, the highest reading since June 2011. Additionally, the U.S. economy added 236,000 jobs in February as unemployment fell to 7.7%, the lowest level since December 2008. Furthermore, new factory orders – a key leading indicator – climbed to 57.8 in February from January’s 53.3, the largest such increase since March 2010. Accordingly, the U.S. expansion continues to gain steam in spite of the ongoing paralysis in Washington. Expiration of the continuing resolution for the federal budget and the debt ceiling loom next on the horizon. Yet markets now appear to view a refusal by Congress to renew its continuing resolution on March 27, or to lift the debt limit in May, as low probability outcomes. Such resilience notwithstanding, the pullback in federal spending, even if incremental, is likely to extract a toll. U.S. GDP slowed from 3.1% in the third quarter to 0.1% in the fourth quarter partly as a consequence of declining federal outlays, which fell at an annualized rate of 14.8% over that period. It may therefore be infeasible for the U.S. economy – and in turn the global recovery – to attain “escape velocity” absent longer-term clarity with respect to fiscal policy, including the pace at which, and the extent to which, U.S. federal spending will be pared back.

The following sections are excerpts from J.P. Morgan Research publications. The full publications can be accessed via the sources provided in the footnotes below.

Bernanke Stays the Course on Asset Purchases 8

As expected, Fed Chair Bernanke's semiannual monetary policy testimony sounded a little more dovish than the most recent FOMC minutes. In particular, while noting the costs to balance sheet expansion, he concluded that these costs were either small or nonexistent, and more than easily offset by the beneficial effects of asset purchases. These benefits were characterized as "clear" whereas the "potential" costs were methodically discussed and minimized. We believe today's testimony supports the view that the Fed remains comfortable continuing with its asset purchase program.

The first cost that the Chairman dismissed was worries that the eventual exit would un-anchor inflation expectations. To this he noted that measures of inflation expectations remain low and that the Committee was "confident" in their exit tools. The second cost was excessive risk-taking, in the form of, for example, reach-for-yield behavior. Bernanke observed that some risk-taking, such as that by entrepreneurs, is part of a healthy recovery. He also echoed Governor Stein's point that low rates encourage longer-term funding, which should reduce systemic risk. He concluded that the Fed's regulatory tools should help to head off brewing financial imbalances. Finally, on the topic of potential losses on the Fed balance sheet, he made that the point that on a through-the-cycle basis, any future decline in remittances should be more than offset by the outsized remittances that the Fed has paid to Treasury over the past few years. In sum, Bernanke brushed off the costs and risks attending to asset purchase, while noting that the benefit has been an important support to the recovery.

Bernanke's remarks on the economy were quite limited and focused on the labor market and the costs of high and extended unemployment. His testimony also commented on fiscal policy, repeating the usual advice to put in place long-run reforms in lieu of short-run fiscal austerity. The Monetary Policy Report did not add too much to the discussion, other than to more thoroughly examine the benefits of asset purchases, to which "a balanced reading of the evidence supports the conclusion that LSAPs have provided a

8 J.P. Morgan Chase North America Economic Research, Bernanke Stays the Course on Asset Purchases, February 26, 2013, J.P. Morgan Markets, https://na-markets.jpmorgan.com/research/content/GPS-1062584-0.

Prime Brokerage Global Hedge Fund Trends – Market Perspectives

11


meaningful support to the economic recovery while mitigating deflationary risks."

The Next Wiggle is a Weaker US Consumer9

Global activity indicators lifted as we turned into the New Year with the latest three-month gains in global industrial production and retail sales volumes each tracking close to a 4% pace of increase. We believe that this news points to a broad positive turn in global growth, but we recognize that the underlying pace of global growth is not as rapid as the latest activity readings suggest. Drags that weighed heavily on global growth early last quarter—notably the Japan-China dispute, Hurricane Sandy, and a temporary drop in global auto production—have faded, boosting industrial activity around year-end. Meanwhile, household spending was lifted last quarter by falling inflation. In the coming months, this boost will be replaced by large headwinds concentrated in the US, resulting from rising energy prices and a tax hike.

We have sent a message that there is upside risk to our current quarter 2.4% global GDP forecast because the lift in global activity into the New Year has proved stronger than anticipated. However, the stage is now set for moderation in the monthly data flow. Global retail sales volumes are expected to flatten during February and March as US spending contracts. Meanwhile, global production gains are expected to slow to a roughly 2.5% annualized pace over the next three months. If we are right, this softening will prove temporary and a rebound into midyear will leave 2Q13 global growth roughly in line with this quarter’s outcome.

Cyclical Lift in the Euro Area: Let’s Have Another Go10

In our view, the Euro area is moving toward exiting recession and will start to grow again from the second quarter. The last time the region made a transition from recession to expansion was in the middle of 2009. After a 5.6% drop in the level of GDP from early 2008 to the spring of 2009, the economy began to expand again from the third quarter of 2009 and enjoyed eight quarters of growth averaging 2% ar.

Despite very depressed levels of spending on durables, low inventory positions, and very low interest rates, it was always clear that the recovery from the 2008-09 recession was going to be hard work. There was significant pressure to delever

9 J.P. Morgan Economic Research, Global Data Watch: The Next Wiggle is a Weaker US Consumer, February 22, 2013, J.P. Morgan Markets, https://na-markets.jpmorgan.com/research/content/GPS-1060551-0. 10 J.P. Morgan Economic Research, Economic Research Note: Cyclical Lift in the Euro Area: Let’s Have Another Go, February 22, 2013, J.P. Morgan Markets, https://na-markets.jpmorgan.com/research/content/GPS-1060083-0.

across households, banks, and sovereigns. In the event, the rebound in spending on durables was modest overall and focused on machinery, transport equipment, and autos. The recovery relied heavily on the ending of an inventory adjustment and the recovery of global trade. The region moved back into recession in late 2011, as these exceptional supports faded, financial stress increased, and the region turned to substantial fiscal consolidation.

As we look to the coming few quarters, we expect the region to exit recession and start growing again. The initial impulse for growth is coming from a return of confidence in the integrity of the Euro area, a fading of fiscal austerity, and an improvement in the global backdrop. But, for growth in the region to be sustained, cyclical forces need to be at work. The scope for a cyclical recovery, as seen in 2009-10, is clearly there: cash balances are high, levels of spending on durables are low, and monetary policy remains very easy. But, on the other hand, inventory positions are less lean than in 2009, global trade will not be bouncing back from depressed levels, and the same deleveraging headwinds remain in place. Thus, the recovery over the coming 18 months is unlikely to be as solid as during the period from the middle of 2009 to the middle of 2011.

Important Information and Disclaimers

12


This material (“Material”) is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. This Material includes data and viewpoints from various departments and businesses within JPMorgan Chase & Co., as well as from third parties unaffiliated with JPMorgan Chase & Co. and its subsidiaries. The generalized hedge fund and institutional investor information presented in this Material, including trends referred to herein, are not intended to be representative of the hedge fund and institutional investor communities at large. This Material is provided directly to professional and institutional investors and is not intended for nor may it be provided to retail clients. This Material has not been verified for accuracy or completeness by JPMorgan Chase & Co. or by any of its subsidiaries, affiliates, successors, assigns, agents, or by any of their respective officers, directors, employees, agents or advisers (collectively, “JPMorgan”), and JPMorgan does not guarantee this Material in any respect, including but not limited to, its accuracy, completeness or timeliness. Information for this Material was collected and compiled during the stated timeframe, if applicable. Past performance is not a guarantee of future results. JPMorgan has no obligation to update any portion of this Material. This Material may not be relied upon as definitive, and shall not form the basis of any decisions. It is the user’s responsibility to independently confirm the information presented in this Material, and to obtain any other information deemed relevant to any decision made in connection with the subject matter contained in this Material. Users of this Material are encouraged to seek their own professional experts as they deem appropriate including, but not limited to, tax, financial, legal, investment or equivalent advisers, in relation to the subject matter covered by this Material. JPMorgan makes no representations (and to the extent permitted by law, all implied warranties and representations are hereby excluded), and JPMorgan takes no responsibility for the information presented in this Material. This Material is provided for informational purposes only and for the intended users’ use only, and no portion of this Material may be reproduced or distributed for any purpose without the express written permission of JPMorgan. The provision of this Material does not constitute, and shall not be construed as constituting or be deemed to constitute, a solicitation of, or offer or inducement to provide or carry on, any type of investment service or activity by

JPMorgan. Under all applicable laws, including, but not limited to, the US Employee Retirement Income Security Act of 1974, as amended, or the US Internal Revenue Code of 1986 or the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, as amended, no portion of this Material shall constitute, or be construed as constituting or be deemed to constitute “investment advice” for any purpose, and JPMorgan shall not be considered as a fiduciary of any person or institution for any purpose in relation to Material. This Material shall not be construed as constituting or be deemed to constitute an invitation to treat in respect of, an offer or a solicitation of an offer to buy or sell any securities or constitute advice to buy or sell any security. This Material is not intended as tax, legal, financial or equivalent advice and should not be regarded or used as such. The Material should not be relied upon for compliance. An investment in a hedge fund is speculative and involves a high degree of risk, which each investor must carefully consider. Returns generated from an investment in a hedge fund may not adequately compensate investors for the business and financial risks assumed. An investor in hedge funds could lose all or a substantial amount of its investment. While hedge funds are subject to market risks common to other types of investments, including market volatility, hedge funds employ certain trading techniques, such as the use of leveraging and other speculative investment practices that may increase the risk of investment loss. Other risks associated with hedge fund investments include, but are not limited to, the fact that hedge funds: can be highly illiquid; are not required to provide periodic pricing or valuation information to investors; may involve complex tax structures and delays in distributing important tax information; are not subject to the same regulatory requirements as mutual funds; often charge higher fees and the high fees may offset the fund’s trading profits; may have a limited operating history; can have performance that is volatile; may have a fund manager who has total trading authority over the fund and the use of a single adviser applying generally similar trading programs could mean a lack of diversification, and consequentially, higher risk; may not have a secondary market for an investor’s interest in the fund and none may be expected to develop; may have restrictions on transferring interests in the fund; and may affect a substantial portion of its trades on foreign exchanges. JPMorgan may (as agent or principal) have positions (long or short), effect transactions or make markets in securities or financial instruments mentioned herein (or derivatives with respect thereto), or provide advice or loans to, or participate in the underwriting or restructuring of the obligations of, issuers mentioned herein. JPMorgan may engage in transactions in a manner inconsistent with the views discussed herein. © 2013 JPMorgan Chase & Co. All rights reserved. All product names, company names and logos mentioned herein are trademarks or registered trademarks of their respective owners. Access to financial products and execution services is offered through J.P. Morgan Securities LLC (“JPMS”) and J.P. Morgan Securities plc (“JPMS plc”). Clearing, prime brokerage and custody services are provided by J.P. Morgan Clearing Corp. (“JPMCC”) in the US and JPMS plc in the UK. JPMS and JPMCC are separately registered US broker dealer affiliates of JPMorgan Chase & Co., and are each members of FINRA, NYSE and SIPC. JPMS plc is authorized and regulated by the FSA and is a member of the LSE. J.P. Morgan Securities (Asia Pacific) Limited is regulated by the HKMA.

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Economy & Finance

JPM Prime Brokerage Global Hedge Fund Trends March 2013