“Citywire Forum”

Milan, Thursday 27th October 2011

The framework1. Investment philosophy

2. Arbitrage rather than directional strategies

3. The benefits of diversification

Recent portfolio performance1. From value to deep value

2. Diversification on strike

3. Market dislocation

Strategies and portfolios1. Deep value pushes macro-scenarios to the backseat…

2. … while bringing views on correlations to the fore

3. Current risk allocation

H2O’s Investment Process and Strategies

The framework: investment philosophy

• Over the long term, value investment offers a strong and stable success ratio

• Diversification creates value and it is the best way to absorb short & medium term volatility

• Risk is always an input, never an output in order to generate an absolute return profile

Value diversification is a robust and stable alpha source

The framework: arbitrage rather than directional strategies

Bonds Currencies Credit Equities

Global exposure

Regional allocation

Country /sector allocation

USEMU

UK JAPAN

(US dollar)

EUR bloc EMU UK

US

JPY bloc

Commodity fx bloc

EMU countries

EURbloc

JPYbloc

Com. bloc

EMUNorth

America

UK JAPAN

Countries SectorsCorpo. Emg

Directional(< 1/3)

Relative( > 2/3)

Other

Average number

of strategies

The framework: quantifying diversification

-60%

-40%

-20%

0%

20%

40%

60%

USD

Credit

Equities

30 vs. 5 Year German

NOKvs.

SEK

EURvs.

GBP

AUDvs.

NZD

AUDvs.

CAD

Venezuelavs.EM

Turkeyvs. EM

US vs. EMequities

Directional Relative strategies

Correlation of bonds with…

Source: H2O AM, weekly data, 10 year history, exponential smoothing (half life of 2 years)

Diversifying additions to

bonds

The framework: the benefits of diversification

• No stop-loss, as diversification means that some strategies are flat or positive when an individual strategy is underperforming

• Improved success ratio of individual strategies, as time is earned for value to generate performance

• Less stress for the investment manager means better decisions

Diversification is the engine of alpha generation

The framework1. Investment Philosophy

2. Arbitrage rather than directional strategies

3. The benefits of diversification

Recent portfolio performance1. From value to deep value

2. Diversification on strike

3. Market dislocation

Strategies and portfolios1. Deep value pushes fundamentals to the backseat…

2. … while bringing views on correlations to the fore

3. Current risk allocation

Review of performance

From value to deep value

The CHF has reached extreme overvaluation in August

source: Bloomberg

PPP

2 standard-deviation

2 standard-deviation

From value to deep valueEquity vs. Bonds

source: Bloomberg

buy Equity

buy Bonds

Diversification on strike

In July and August, risky commodity currencies like the Australian dollar had a negative correlation with European equities

source: Bloomberg

Market dislocation

Liquidation in sequence

source: Bloomberg, H2O calculation , logarithm

Core EMU

CreditEM Fx

Very poor performance during the Summer

source: H2O AM

Liquidation vs. valuation and the lack of ex-post diversification explain the poor performance from early July to mid-September

The framework1. Investment philosophy

2. Arbitrage rather than directional strategies

3. The benefits of diversification

Recent portfolio performance1. From value to deep value

2. Diversification on strike

3. Market dislocation

Strategies and portfolios1. Deep value pushes the macro-scenario to the backseat…

2. … while bringing views on correlations to the fore

3. Current risk allocation

Review of performance

Strategies less dependent on the macro-scenario

• Deep-value strategies are multi-scenario

• Vvalue strategies ranked along the sequence of liquidation

• Prefer assets de-rated early in the crisis (EMU) to those liquidated recently (EM FX)

Deep-value means that the worst economic outlook is already priced in some assets

Expect shifts in correlations

• Crisis-mode correlations are the most transitory state of affairs in risk measure

• Normalisation of correlations precedes market reversal

• Universal expensive hedges are the most at risk (German bonds, US Treasuries)

Now that correlations have shifted to crisis-mode, the risk of reverting to the mean is significant

Expect shifts in correlationsNo more protection in bonds

600

700

800

900

1000

1100

1200

1300

1400

1500

1600

Apr-08

May-08

Jun-08

Jul-0

8

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-0

9

Apr-09

May-09

Jun-09

Jul-0

9

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mar-1

0

2

2.5

3

3.5

4

4.5

S&P (total return index)US 10-Year Treasuries (yield)

Sharp move up in yields during the last leg dow

on equities

Remember Q1 2009: your best protection can turn into a nightmare

n

source: H2O AM

Current risk allocation

Balanced across asset classes Less directional strategies

Yielding and value strategies

Current risk allocation

Main H2O views

Bonds Portugal 1-Year and Greece distressed bonds Specific

FX Euro-bloc versus commodity bloc (AUD, NZD) Relative

Credit Emerging sovereign debt (Argentina & Venezuela) Direct. & Specif.

Equity Continental Europe vs. Rest-of-the-World Relative

Bonds All G3 bond markets Directional

Equity US Tech vs. Defensive & Insurance vs. Industrials Relative

Equity Extreme under-valuation Directional

FX Short CHF vs. other euro-bloc currencies Relative

Equity Private equity, financial advisors, M&A targets Relative

Bond Curve flattening in Germany (2-10Y) & US (10-30Y) Relative

19.

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