introduction to alternative investments
TRANSCRIPT
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Introduction to Alternative Investments
2013
INVESTMENT PRODUCTS: NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE
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Table of Contents
I. Introduction to Alternative Investments
II. Hedge Funds
III. Fund of Hedge Funds
IV. Managed Futures
V. Private Equity
VI. Real Estate
VII. Exchange Funds
VIII. Appendix
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I. Introduction to Alternative Investments
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Introduction to Alternative Investments
Alternative investments generally refer to a diverse range of investment strategies thatfall outside the traditional, long-only purchase and sale of stocks and bonds
Hedge Funds, Hedge Fund of Funds, Managed Futures Funds, Private Equity Funds, RealEstate Funds and Exchange Funds
The appeal of alternative investments lies in their potential to provide attractive risk-adjusted performance, lower volatility and addit ional diversif ication relative to traditionalasset classes1
The name "alternative investments" suggests new and obscure investments, howeveralternative investments have existed and been established for decades
Hedge Funds (1949)2, Modern Venture Capital (1946)3, Real Estate (centuries old)
Alternative investments of ten share a few principal character is tics that help identifythem as such:
Historically low to moderate correlation with traditional asset classes (stocks and bonds)4
Not listed on an exchange
Private investment funds available only to high net worth and institutional investors
Reduced liquidity1 Diversification does not ensure against loss.
2 Source: Mark Anson, Handbook of Alternative Assets, (New York: John Wiley & Sons, Inc., 2002), p. 12.
3 Source: Mark Anson, Handbook of Alternative Assets, (New York: John Wiley & Sons, Inc., 2002), p. 262.
4Past correlations do not guarantee future correlations. Real results may vary.
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Major Alternative Asset Classes1
Hedge Funds
Privately managed investment funds that uti lize sophisticated strategies in both
the international and domestic markets. They're designed to potentially offsetlosses during a market downturn and often seek to generate returns higher thantraditional stock and bond investments.
Fund of FundsActively and professionally managed port fo lios cons isting of mult ip le hedgefunds offering diversification across managers, strategies, styles, and/or sectors.
Private Equity
Typically invests globally in nonpublic entities with a value-add approach,
seeking to acquire undervalued/underperforming entities or ones with signi ficantgrowth potential with the objective of reselling at a higher price in the future.Underlying asset classes include buyouts, venture capital, and mezzanine debt.
Real EstateNegot iated private investments in real estate assets with the objective ofgenerating current income and/or reselling at a higher value in the future.
Managed Futures
Employs professional money managers called Commodity Trading Adv isors to
direct investments in global currencies, interest rates, equities, metals, energyand agricultural markets through the use of futures, forwards and options on thebasis of technical and fundamental analysis.
Exchange FundsPrivate vehicles which enable holders of concentrated stock posi tions toexchange those stocks for a diversified portfolio.
1 Please see the Appendix for Risk Considerations.
Consider a Different Way to Diversify Your Portfolio
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Alternative Investments Differ From Traditional Investments
Alternative InvestmentsAlternative Investments Traditional Investments
Relative performance objective1
Limited or no leverage
Performance generally dependent primarily onmarket returns
Historically high correlation withmarket indices
Typically offers daily liquidity
No performance fees but may include fixedmanagement fees for professionalmanagement
Absolute performance objective1
May use leverage
Performance dependent primarily onalternative investment manager skill
Historically low to moderate correlation withmarket indices
Typically have reduced liquidity ranging frommonthly to 12+ year lock-ups
Generally higher fees which may includeperformance fees2
1 There is no guarantee that these objectives will be met.2 Generally includes fees such as management and performance fees for professional management.
Please see the Glossary for key definitions and Appendix for Risk Considerations.
Alternative investments describe a spectrum of strategies that cannot be accessedthrough traditional fixed income and equity markets.
These strategies have the potential to help lower volatility and increase
diversification in clients portfolios.
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Large College Endowments Are Heavily Invested In Alternatives
Source: National Association of College and University Business Officers (NACUBO) 2012 study of 831 institutions published March 2013. Portfolio returns are based on data ending June 30,
2012.This study does not i ndicate the percentage of portfoli o returns attribut able to the allocation to alternatives. Note: The larger the endowment, the better the ability t o diversify.
Past performance does not guarantee future results. Real results may vary. Traditional Strategies include Equity, Fixed Income and Cash. Alternatives Strategies include Real Estate,
Hedge Funds, Private Equity, Venture Capital, Natural Resources and Other.
Portfo lio A llocations for Fiscal Years 2011 and 2012
TotalInst itutions Over $1 Billion
$501 Million -$1 Billion
$101 - $500Million
$51 - $100Million
$25 - $50Million
Under $25Million
Number of Institutions 823 831 73 68 66 71 251 250 162 164 134 128 137 150
2011 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 2012
Asset Class
Traditional 47% 46% 40% 39% 54% 52% 65% 64% 77% 76% 82% 81% 90% 89%
Alternative Strategies 53% 54% 60% 61% 46% 48% 35% 36% 23% 24% 18% 19% 10% 11%
Average Five- and 10-Year Net Returns for Fiscal Years 2011 and 2012
TotalInst itutions Over $1 Billion
$501 Million -$1 Billion
$101 - $500Million
$51 - $100Million
$25 - $50Million
Under $25Million
Number of Institutions 823 831 73 68 66 71 251 250 162 164 134 128 137 150
2011 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 2012
5-Year Net Return 4.7% 1.1% 5.4% 1.7% 4.8% 1.2% 4.4% 0.7% 4.4% 1.0% 4.7% 1.0% 5.2% 1.5%
10-Year Net Return 5.6% 6.2% 6.9% 7.6% 6.0% 6.6% 5.3% 6.0% 5.1% 5.7% 5.0% 5.8% 4.9% 5.7%
For Illustrative Purposes Only
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Academic Leaders Are Significantly Invested in Alternatives
Note: The allocations represented here are for illustrative purposes only. Alternative investments are not suitable for all investors.
Source: Stanford University 2012 Annual Report, Yale Endowment 2012 Annual Report, Harvard Management Company Endowment Report 2012. Stanfords portfolio includes a 6%
allocation to cash and equivalents and 7% to Natural Resources, Yales Portfolio includes a 3% allocation to cash and 8% to Natural Resources, Harvards Portfolio includes a 15%
allocation to Natural Resources and equivalents.
For Illustrative Purposes Only
16%21%
10%
18%15%
15%
12%
35%
16%
37%
14%
33%
10% 4%
11%
Stanford Yale Harvard
Strategic Endowment Asset Allocations 2012
FixedIncomeEquities
PrivateEquityHedgeFundsRealAssets
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II. Hedge Funds
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What is a Hedge Fund?
A hedge fund is an alternat ive investment strategy that is designed to reduce overal lportfolio volatility, increase diversification and provide the potential for enhancedreturns
They consist of investments in both domestic and international markets and typicallyemploy sophisticated trading strategies, using leverage and derivative instruments intheir goal to generate alpha1
A manager's ability to generate alpha is primarily based on its investment strategy oftenutilizing: Leverage, Short-selling, Derivatives, and Illiquid securities
These tools, strategies and securities are used by hedge fund managers with the objectiveof enhancing returns and reducing risks, however they also increase the risk of losses2
Hedge Funds are not new they have been in existence for over 50 years
Typically, Hedge Funds seek an absolute return3
Unlike traditional vehicles, which manage to a relative benchmark
Primarily invest in publicly-traded securities
Stocks/Bonds/Commodities/Currencies
1 When considering including hedge funds as a portion of an investors overall portfolio, it is important that an investor considers the various risks associated with these potentially
speculative and illiquid investments, and that investors have the financial sophistication to be able to understand and assume such risks
2 Increased flexibility for the manager may increase risks to the investor
3 There is no guarantee that this objective will be met.
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90% Bonds, 10% HedgeFunds
90% U.S. Stocks, 10%Hedge Fund
100% Bonds
50% Bonds, 50% U.S.Stocks
100% U.SStocks
45% Bonds, 45% U.S.Stocks, 10% Hedge Funds
6.20%
6.45%
6.70%
6.95%
7.20%7.45%
7.70%
7.95%
8.20%
8.45%
8.70%
2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00%
Com
poun
dAnnualReturn
Annual ized Standard Deviation
Hypothetical Portfolio Allocations Using Index Returns
January 1992 - December 2012
12
Traditional Portfolios may benefit from Hedge Fund Allocations
U.S. Stocks represented by the S&P 500 Index; Bonds represented by the Barclays Aggregate Bond Index; Hedge Funds represented by the HFRI Fund WeightedComposite Index. Sourced from PerTrac Financial Solutions, LLC (Memphis, TN). Indices are unmanaged and investors cannot directly invest in them. Compositeindex results are shown for illustrative purposes and do not represent the performance of a specific investment. Indices of hedge funds have material inherentlimitations. Reference the Appendix for index descriptions and key definitions. This information is forILLUSTRATIVE PURPOSES ONLY and is not intended to
represent the performance of any specific investment. Past performance is no guarantee of future results.
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Source: HFR Global Hedge Fund Industry Report Year End 2012, Bloomberg, PerTrac. Past performance does not guarantee future results. Real results may vary.Indexes are unmanaged and investors cannot directly invest in them. Composite index results are shown for illustrative purposes and do not represent the performance of a specific investment.
Data point descriptions are on the following page. Please see Appendix for index descriptions and key definitions.
Risk Return Comparison
0%
2%
4%
6%
8%
10%
12%
14%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18%
AnnualizedCompoun
dReturn(%)
Annualized Standard Deviation (%)
Hedge Fund Strategy Risk Return ComparisonJanuary 1992 - December 2012
Emerging Markets
Long/Short EquityEvent Driven
Distressed
Relative Value
MacroHedge Funds
Convertible ArbitrageMerger Arbitrage Real Estate
Fixed Income
Equity Market Neutral
Fund of Funds U.S. Bonds
Managed Futures
Emerging Markets - Asiaex-Japan
U.S. Equities
Global Equity
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Hedge Fund Risk Return Comparison: List of indices used
U.S. Equity S&P 500
Global Equity MSCI EAFE - Net
U.S. Bonds Barclays Aggregate Bond Index
Managed Futures Barclay CTA Index
Real Estate NCREIF Property Index Returns
Equity Market Neutral HFRI EH: Equity Market Neutral Index
Event Driven HFRI Event-Driven (Total) Index
Distressed HFRI ED: Distressed/Restructuring Index
Merger Arbitrage HFRI ED: Merger Arbitrage Index
Macro HFRI Macro (Total) Index
Long/Short Equity HFRI Equity Hedge (Total) Index
Hedge Funds HFRI Fund Weighted Composite Index
Fund of Funds HFRI Fund of Funds Composite Index
Emerging Markets HFRI Emerging Markets (Total) Index
Emerging Markets ex-Asia HFRI Emerging Markets: Asia ex-Japan Index
Fixed Income HFRI RV: Fixed Income-Corporate Index
Relative Value HFRI Relative Value (Total) Index
Convertible Arbitrage HFRI RV: Fixed Income-Convertible Arbitrage Index
Source: HFR Global Hedge Fund Industry Report Year End 2012, Bloomberg, PerTrac. Indexes are unmanaged and investors cannot directly invest in them. Composite index results are shownfor illustrative purposes and do not represent the performance of a specific investment. Please see Appendix for index descriptions and key definitions.
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III. Funds of Hedge Funds
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Fund of Hedge Funds
Professional management
Manager sourcing
Rigorous due diligence
Portfolio construction
On-going monitoring
Fund of Hedge Funds Characteristics1
Invests in multiple hedge fund strategieswhile circumventing single manager
concentration risk
Diversification across different: strategies,managers, and investment styles
Low correlation with traditional securities
markets
An additional layer of fees for professionalinvestment allocation
Business risk and operations due diligence
Ongoing monitoring and risk management
Potential to access closed and/or exclusivemanagers
Fund of
Hedge FundManager
GlobalMacro
MergerArbitrage
Commodities
ShortBias
EmergingMkts
Activist
CreditArbitrage
MarketNeutral
Distressed
L/SEquity
Hypothetical Fund of Hedge Fund Allocation
Diversified across multiplemanagers/strategies
Allocations arerebalanced according to atargeted risk budget
1The hypothetical allocations above are for illustrative purposes and do not represent the allocations of a specific investment. Reference the Glossary for strategy descriptions and key definitions.
Please see the Appendix for Risk Considerations.
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Rationale for Professional Hedge Fund Selection
Hedge Fund Characteristic Consideration
Investment flexibility Hedge funds allow for the use of trading strategies such as short selling, options andother derivative instruments, as well as hedging techniques and use of leverage,which, while potentially increases investment returns, can be high ly volatile and
increase an investors risk of investment loss. Significant investment expertise andexperience is often required to perform a meaningfu l fund evaluation.
Abil ity to be opportunistic in changing marketenvironments
Hedge fund managers can exercise their judgment without most traditionalconstraints, making it challenging to evaluate and forecast investment risk.
Intended to generate alpha or excess returndelivered by an investment manager
Alpha ident if ication is di ff icul t due to:- Complexity of trading strategies,
- Reduced transparency,- Valuation challenges,- Changing strategies and changing conditions.
Exclusive access Hedge funds often have high investment minimums and at times may be inaccessibledue to limited capacity.
Hedge funds offer many appealing characteristics toinvestors. At the same time, there are certain attributesof hedge funds that require careful consideration and
assessment that should be conducted by highly skilledprofessionals following a detailed research process.
Fund of hedge fund managers are uniquelyspecialized and resourced to evaluate and select qualityhedge funds for the purpose of constructing a portfolioof hedge fund strategies. See the below table for certainhedge fund characteristics and considerations.
Individual funds will have specific risks related to their investment programs that will vary from fund to fund. Please review and be familiar with the funds offering materials, including the private
placement memorandum or prospectus. Please see the Glossary for key definitions and Appendix for Risk Considerations.
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Funds of Hedge Funds: HFRI Fund of Funds Composite Index, source: Hedge Fund Research, Inc. U.S. Large Cap Equity: S&P 500 Indexwith the reinvestment of dividends, source: Bloomberg.
The HFRI Fund Weighted Index is net of fees and expenses. Indexes are unmanaged and investors cannot directly invest in them. The composite index results above are for illustrative purposesand do not represent the performance of a specific investment. Volatility as measured by annual standard deviation. Past performance is no guarantee of future results . Reference the
Appendix for index descriptions and disclosures.For Illustrative Purposes Only
-50.00%-40.00%
-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
MonthlyCumulativeRateofReturn
Funds of Hedge Funds Performance Compared to U.S. Large Cap Equit iesJanuary 1, 2002 - December 31, 2012
Fund of Hedge Funds U.S. Large Cap Equities
Index Growth Comparison
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IV. Managed Futures
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Managed Futures
What are Managed Futures?
An alternative investment vehicle
Limited liability investment vehicles that trade futures, forwards and options on futuresand forwards
Use professional portfo lio management
Offer potential global market exposure through a single investment vehicle
Assets allocated to professional trading managers called Commodi ty Trading Advisors(CTAs)
What is a CTA?
A professional trading manager who manages customer money in the futures, forwards,
and options markets
CTAs use tested trading methods and money management techniques in their attempt toachieve profits and control r isk
Please see Appendix for Risk Considerations.
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Markets Traded
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For Illustrative Purposes Only
Not all markets are traded in any given Morgan Stanley Wealth Management managed futures funds.Markets traded may inc lude, but are not limited to:
Metals
Energies
Brent crude oil
Crude oilGas oilGasolineHeating oilKeroseneNatural gas
AluminumCopperGoldLeadNickelPalladiumPlatinumSilverTin
Zinc
BarleyCocoaCoffeeCornCottonFeeder cattleLean hogsLive cattleLumber
MilkOatsOrange juicePork belliesRapeseedRough riceRubberSoybean mealSoybean oil
SoybeansSugarWheat
Agriculturals
Australian dollarBrazilian realBritish poundCanadian dollarChilean pesoChinese YuanColombian pesoCzech korunaEuro
Hong Kong dollarHungarian forintIndian rupeeIsraeli shekelJapanese yenKorean wonMexican pesoNew Zealand dollarNorwegian krone
Philippine pesoPolish zlotyRussian rubleSingapore dollarSouth African randSwedish kronaSwiss francTaiwan dollarTurkish lira
U.S. dollar
Foreign Exchange
AEXAll ShareCAC 40DAXDow 30FTSE 100Euro Stoxx 50Euro Stoxx 600H-Shares
Hang SengIBEX 35MIB 30NASDAQ 100Nikkei 225NYSE CompositeOMX 30Russell 2000S&P Canada 60
S&P/MIBS&P MidcapS&P NiftyS&P 500Singapore FreeSPI 200TaiwanTopix
Stock Indices
Australian Bank BillAustralian Treasury BondsBritish Long GiltBritish Short SterlingCanadian Bankers AcceptancesCanadian Government BondEuriborEurodollarEuropean Bonds
EuroyenJapanese Government BondMuni Bond IndexNew Zealand BillSwapnotesSwiss Government BondU.S. Treasury BondsU.S. Treasury Notes
Interest Rates
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Managed Futures vs. Stocks
Since 1980, stocks have declined more than 10% on six occasions, with an average decline of 28.6% on theseoccasions. Managed futures has had an average rate of return of 18.7% during those six periods.
For Illustrative Purposes Only
38.8%
9.7%
18.6%
5.6%
23.1%
16.1%
-16.5%
-29.6%
-14.7% -15.4%
-44.7%
-51.0%-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
Dec 80-Jul 82 Sep 87-Nov 87 Jun 90-Oct 90 Jul 98-Aug 98 Sep 00- Sep 02 Nov 07-Feb 09
Barclay CTA Index S&P 500 Index
RampantInflation
StockMarketCrash
First GulfWar
RussianDebtDefault
TechBubbleBursts
CreditCrisis
Data: January 1980 December 2012. Monthly returns for the S&P 500 Index provided by PerTrac Financial Solutions, LLC (Memphis, TN) and monthlyreturns for the Barclay CTA Index provided by BarclayHedge, Ltd. (Fairfield, IA). Managed futures investments do not replace equities or bonds but rather act asa complement to help in potentially smoothing overall portfolio returns. Monthly returns for the Barclay CTA Index reflect the composite fee structure of therepresentative commodity trading advisors, and therefore, may be higher or lower than those fees applicable to any one particular managed futures fund.Indexes are unmanaged and investors cannot directly invest in them. Composite index results are shown for illustrative purposes and do not represent theperformance of a specific investment. Please see Appendix for Index descriptions.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
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Annualized Return of Managed Futures vs. Stocks
For Illustrative Purposes Only
Jan-1980 to Dec-2012 US Stocks US BondsInternational
StocksManaged Futures
Average Annual Return 11.2% 8.6% 9.6% 10.7%
Annualized Standard Deviation 15.5% 5.6% 17.8% 14.9%
Worst Draw Down -51.0% -9.0% -56.4% -15.7%
Best /Worst 12 Month Return 61.2% / -43.3% 35.2% / -5.1% 103.7% / -49.9% 63.7% / -7.9%
% Positive 12 Month Periods 79.2% 94.8% 70.4% 84.2%
Return / Risk 0.72 1.52 0.54 0.72
In the performance table above, average annual return is based on annualized compounding of monthly returns. The standard deviation statisticmeasures the dispersion of monthly returns about the mean and is used to represent the volatility or risk. The worst drawdown is the largestpercentage loss incurred from the highest value to its lowest value for the given time period. The Return/Risk statistic is related to the SharpeRatio, return divided by the standard deviation and is unadjusted for the risk-free Treasury Bill rate. Statistical comparisons on a 12-month holdingperiod basis are based on monthly data from January 1980 through December 2012, producing 385 observations. Sources: U.S. Stocks (S&P 500Index), U.S. Bonds (Barclays Aggregate Bond Index), International Stocks (MSCI EAFE Index)PerTrac Financial Solutions, LLC (Memphis, TN);Managed Futures (Barclay CTA Index)BarclayHedge, Ltd. (Fairfield, IA). Monthly returns for the Barclay CTA Index reflect the composite feestructure of the representative commodity trading advisors, and therefore, may be higher or lower than those fees applicable to any one particularmanaged futures fund. Indexes are unmanaged and investors cannot directly invest in them. Composite index results are shown for illustrativepurposes and do not represent the performance of a specific investment. Please see Appendix for index descriptions.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
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Index Growth Comparison
Managed Futures: Barclay CTA Index, source: BarclayHedge, Ltd. (Fairfield, IA) U.S. Large Cap Equity: S&P 500 Index with the reinvestment of dividends, source: Bloomberg. Indexes are
unmanaged and investors cannot directly invest in them. The composite index results above are for illustrative purposes and do not represent the performance of a specific investment. Volatility as
measured by annual standard deviation. Past performance is no guarantee of fut ure results. Reference the Appendix for index descriptions and disclosures.
-50.00%
-40.00%-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
100.00%
110.00%
MonthlyCumulativeR
ateofReturn
Managed Futures Compared to U.S. Large Cap Equit iesJanuary 1, 2002 - December 31, 2012
U.S.LargeCapEquitiesManagedFutures
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V. Private Equity
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Private Equity: Key Characteristics
Private equity can be broadly defined as privately negotiated investments in (most often) non-public companies where managers are often active investors
Long-term investments which seek low correlation with public equity markets seeking returns in
excess of traditional asset classes
May provide diversification across various market cycles and vintage years
May improve the risk-return trade-offPotential BenefitsPotential Benefits Risks
Attractive long-term return potential Potential for exceeding returns of public
equity
Diversification benefits Relatively low correlations with public equity
and bonds Broad and diverse range of different private
equity strategies (buyouts, venture capital,
special situations) Vintage year diversification1 (commitment
drawn over time)
Strong alignment of interest with investors
Illiquidity Investments are locked up for a significant period
of time
Imprecise Interim Value Measurement2
Investments are non-public Quarterly marks imprecise indications of
eventual/exit value
Costs Funds are subject to annual management and
performance fees
Note: These investments are only suitable for long term investors willing to forgo liquidity and put capital at risk for an indefinite time. Past
performance is no guarantee of future results.1 Since direct private equity and fund of funds invest over multiple years, vintage year diversification is achieved.2 Private equity valuations are generally estimate until there is a realization event.
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Private Equity Strategies
Early Stage Venture Capital
Seed or startup equity in private
companies that may not begenerating revenue or profits
Growth Equity
Equity investments in moremature companies to providefunding for growth andexpansion
Buyouts
Equity investments to acquire acontrolling interest in acompany
Mezzanine
Subordinated debt or preferredstock that earns a coupon andmay have warrants or
conversion featuresDistressed / Special Situations
Investments in unconventionalstrategies such as energy,royalty, and distressed funds
Stages of a Company Life Cycle1
1. There can be no assurance that investors will receive the results shown above. Past performance is no
guarantee of future results. No guarantee that objectives will be met.
For Illustrative Purposes Only
EarningsGrowth
(%)
Private Only Public or Private
Distressed /Special Situations
Early Stage Venture CapitalGrowthEquity
Buyouts
Mezzanine
Expansion / Late StageVenture Capital
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Private Equity Investing
For Illustrative Purposes Only
The J Curve
Economic outcome of a private equity fund investment not know for years
For a successful fund, performance typically follows a JCurve pattern
J-Curve drivers:
Management fees drawn on committed capital during the portfolio construction phase
Value Creation: Investments held at cost for at least first few years
Interim mark-ups are generally based on conservative approach
0
FundIRR(%)
Time
Harvesting
Value Creation
Portfolio Construction
There can be no assurance that investors will receive the results shown above. Pastperformance is no guarantee of future results.
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Methods of Accessing Private Equity1,2
Note: Past performance is no guide to future performance and the value of investments and income from them can fall as well as rise.
1 Governance structures at the company level are designed on a case by case basis to be appropriate. Private equity does not use one-size-fits-all approach to boardcomposition or number of seats.
2 Not all fund of funs have the same structure or invest in all of the same types of private equity investments.
Primary Fund Investing
Typically based on a GP-LP structure,whereby investors (the limited partners, or
LPs) commit funds to the private equity fund(the general partners, or GP)
The fund pools these commitments and usesthem to invest in underlying assets
Once the investment is realized, capital flows inthe reverse direction back to the LPs asdistributors
For Illustrative Purposes Only
Secondary Fund Opportunities
Involves acquiring direct interests of primaryfunds from existing LPs at a discount to NAV
Secondary purchases tend to eliminate blindpool risk
Smooth out / mitigate the J-Curve effect
Secondary purchases acquired during theharvest period may have a shorter duration
Potentially distressed sellers in need of liquidity
Fund of Private Equity Funds
Multiple layers of fees
Large footprint allowing diversification acrossgeographies and strategies
Advisory Board seats due to bigger
investments and good relationships
Large pool of resources for due diligence
Legal and commercial review of terms
Monitoring and administrative efficiency
Co-investment Opportunities
Invest alongside GPs in individual deals
Typically offered to preferred existing LPs in thefund on a no fee, no carry basis
Increasingly prevalent in current market
environment where debt financing is difficult toobtain or prohibitively expensive: GPs arelimited by portfolio constraints on singleinvestments in their fund, and have to partnerto meet equity requirements
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Private Equity Returns
How Private Equity Can Generate Return Premiums
Illiquid assets acquired at a discount to public/liquid alternatives
Access to more information
Strong interest alignment between management and owners
Control, value-added investing
Highly adaptive governance1
Mechanisms for Value Creation
Earning Growth revenue improvement, operating efficiency
Multiple Expansion2 private-to-public arbitrage
De-Leverage debt pay down
How to Measure Private Equity Returns
IRR3%
Cash Multiple4
Long-Dated Horizon generally 3 to 5 year hold periods, 7 to 10 year fund life (possibly longer)
Note: Past performance is no guide to future performance and the value of investments and income from them can fall as well as rise.1 Governance structures at the company level are designed on a case by case basis to be appropriate. Private equity does not use one-size-fits-all approach to boardcomposition or number of seats.2 When the purchase prices is less than what public markets would value the company.3 Internal Rate of Return is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal to zero.4 Quarter of returns
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VI. Real Estate
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Real Estate
Internal Rate of Return objective*
Leverage (typically 0 to 75%)
Historically, low correlation with market
indices
Less volatility compared to equities andfixed income
Physical asset
Relatively illiquid
Potential inflation hedge
Relative performance objective*
No leverage
Historically, high correlation with market
indices
More volatility than real estate, evenduring periods of out performance
Financial asset
Highly liquid
Historically vulnerable to inflation
Real EstateReal EstateTraditional InvestmentsTraditional Investments
*There is no guarantee that these objectives will be met.
Individual funds will have specific risks related to their investment programs that will vary from fund to fund. Please review and be familiar with the funds offering materials, including the privateplacement memorandum or prospectus. Please see the Glossary for key definitions and Appendix for Risk Considerations.
Potential benefits to Real Estate investing when compared to traditional investments.
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The 4 Quadrants of Commercial Real Estate Investing
Public and Private Debt and Equity
Commercial Mortgage BackedSecurities (CMBS)
Collateralized Debt Obligations(CDOs)
Real Estate Investment Trusts(REITs)
Real Estate Operating Companies(REOCs)
Whole Mortgage Loans(First Mortgages)
Mezzanine Financing
Bridge Loans
Construction Loans
Limited Partnerships
Private REITs
Open or Closed End Funds
Separate Accounts
Public
Private
Debt Equity
Note: These investments are only suitable for long term investors willing to forgo liquidity and put capital at risk for an indefinite
time. Past performance is no guarantee of future results.
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Real Estate Investment Strategies1
Core Investing:
Lower Risk/Lower Return Potential
Well managed, high quality properties
High grade credit quality tenants,
substantially leased Diversified across property types
Return derived primarily form income
Value-Added Investing:
Moderate Risk/Return Potential
Undervalued properties due to sub-optimal management
Value potential through renovation, re-leasing, repositioning or redevelopment
Improved income as a result of bettermanagement
Opportunistic Investing: High Risk/High Return Potential
Limited current income
Distressed investments
Driven by capital appreciation
Speculative development
1 Individual funds will have specific risks related to their investment programs that will vary from fund to fund. Please review and be familiar with the funds offering materials, including the privateplacement memorandum or prospectus. Please see the Glossary for key definitions and Appendix for Risk Considerations.
A Range of Opportuni ties to Satisfy Objectives (2)
Expected Return (2)
Lower Higher
Risk
Lower
H
igher
Core
Opportunistic
ValueAdded
2 There can be no assurance that any targeted or expected return can be realized or that actual returns or
performance results will not be materially lower than expected returns. They are based on industry consensus
and the opinions of the team are being provided for informational purposes only. The expected returns do not
reflect the performance of any Morgan Stanley investment.
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Why Invest in Commercial Real Estate (CRE ) U.S. real estate is a huge asset class $6.8 trillion in 20121
Over the long term, real estate may provide diversification benefits due to historically lowercorrelations with other asset classes 2
Contractual leases may provide greater stability due to cash flow / income streams2
1 2012 Update, A Birds Eye View of Global Real Estate Markets. Source: Prudential Real Estate Investors.2 These are the opinions of AIG as of the date of the presentation and are subject to change at any time due to changes in market or economic conditions.
3 Past performance is not indicative of future results. Real results may vary. Please see Appendix for Risk Considerations andIndex definitions.4 Indexes are unmanaged and investors cannot directly invest in them. Composite index results are shown for illustrative purposesand do not represent theperformance of a specific investment.
Correlation of Total Returns
Quarterly, Last 10 Years (3)(4)
Stocks BondsHedgeFunds
PrivateEquity
Commodities REITs Core RE Opty RE
Stocks 1.00 (0.29) 0.65 0.82 0.49 0.79 0.20 0.41
Bonds 1.00 (0.41) (0.33) (0.34) (0.06) (0.12) (0.20)
Hedge Funds 1.00 0.79 0.65 0.54 0.36 0.62
Private Equity 1.00 0.49 0.67 0.44 0.74
Commodities 1.00 0.37 0.17 0.32
REITs 1.00 0.24 0.38
Core RE 1.00 0.85
Opty RE 1.00
Source: MSREI Strategy calculations, data from NCREIF, REITs (FTSE NAREIT US Real Estate Index Series), Stocks (S& P 500), Bonds (U.S. Barclays Capital AggregateBond Index), Private Equity (Thomson VentureXpert Private Equity Index), Hedge Funds (HFRI Hedge Fund Composite Index), Commodities (Thomson Reuters /Jefferies CRB Commodity Index), Core RE ( NFI-ODCE Index), and Opty RE (NCREIF Townsend Opportunity Fund Index)
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VII. Exchange Funds
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3831
Exchange Funds
Private placement vehicles enabling holders of concentrated single-stock positions toexchange those stocks for a diversified portfolio
Typically comprised largely of equities, exchange funds may also include other qualifying
assets such as real estate or commodities Investors may benefit from:
Greater diversification by exchanging a concentrated stock position for fund shares withouttriggering a taxable event
Risk Considerations Dividends are pooled
Investors forfeit their stock voting rights
Investment may be illiquid for several years
Investments may be leveraged or contain derivatives
Significant early redemption fees may apply Changes to the U.S. tax code which could be retroactive (potentially disallowing the favorable tax
treatment of exchange funds)
Investment risk and potential loss of principal
Individual funds will have specific risks related to their investment programs that will vary from fund to fund. Please review and be familiar with the funds offering materials, including the privateplacement memorandum or prospectus. Please see the Appendix for Risk Considerations.
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