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February 13t, 2013

Global Buy-side Investment Trends

February 13th, 2013

Institutional Capture Rate (ICR)

2

• ICR is defined as (13F Buys + 13F Sells) / Total Volume

• Useful in identifying percentage of trading sourced back to institutions (1 minus ICR is a good proxy for % of trading sourced to HFT)

• ICR across the market has increased ever since volatile 3Q11 (Euro crisis)

• Institutional trading shows slight declines alongside sharper declines in total trading volume

S&P 500 Median ICR of Index Components 12/08 - Curr

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

De

c-0

8

Mar

-09

Jun

-09

Sep

-09

De

c-0

9

Mar

-10

Jun

-10

Sep

-10

De

c-1

0

Mar

-11

Jun

-11

Sep

-11

De

c-1

1

Mar

-12

Jun

-12

Sep

-12

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

De

c-0

8

Mar

-09

Jun

-09

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-09

De

c-0

9

Mar

-10

Jun

-10

Sep

-10

De

c-1

0

Mar

-11

Jun

-11

Sep

-11

De

c-1

1

Mar

-12

Jun

-12

Sep

-12

S&P 400 Median ICR of Index Components 12/08 - Curr

HFT and Market Structure – is the Tide Turning?

3

2007 - 2010

•Sharp increases in trading volumes (particularly in large caps)

•HFT programs take advantage of electronic trading to profit from volatility / large institutional movements

•Dark pools expand to allow anonymity for institutions to move large trades without price impact

•Expansion of ETF market, trading associated with ETF issuance / cancellation

2011 - 2012 – Peak HFT?

•Volatility falls sharply, ICR rises, after 3Q11 / 4Q11

•Trading volumes decline versus year-ago periods – (particularly in large caps dominated by HFT)

•Regulatory response – EU, German legislation

•ETF market continues expansion, builds into new EU / Asian markets

Shrinking Volumes Mean…

4

Issuer Impact

•Institutions form a greater part of the market for securities

•Institutions may need stronger convictions in order to build positions they may not be able to liquidate easily

•Small brokerages disappearing (Rodman & Renshaw, ThinkEquity, Rochdale)

•Sell-side (bulge bracket) must more clearly justify its spending on corporate access and research

•Small-caps are losing less volume as a percentage of overall trading, but continue to face challenges in gaining attention from brokers and raising profile

0

10,000

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Jan

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Jul-

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Jul-

12

NYSE Group Volume (mm shares) 2004 - Curr

0

50,000

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S&P 500 S&P 400 S&P 600

Total Volume, S&P 1500 by Index

Growth in global investing from outside of North America has staying power

Overseas Mutual Funds – Going Global

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Tota

l EA

UM

($

T)

Global International

0.0%

2.0%

4.0%

6.0%

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10.0%

12.0%

14.0%

16.0%

6/3

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% o

f A

ll A

ctiv

e M

F A

sse

ts

Global International

Overseas shareholding in S&P 500 issuers have, on average, 11.4% of the total institutional shareholder base, has grown 7.2% per year since 2005

Overseas Ownership of US Stocks

6

0%

2%

4%

6%

8%

10%

12%

14%

2005 2006 2007 2008 2009 2010 2011

CAGR 7.2%

Overseas Ownership Drivers: Revenue vs. Ownership

7

0%

2%

4%

6%

8%

10%

12%

14%

Top Quartile Second Quartile Third Quartile Bottom Quartile Other

Top

Quartile Second Quartile

Third Quartile

Bottom Quartile Other

Average Overseas Revenue 72.7% 52.1% 36.9% 14.0% 0.0%

Average Overseas Ownership 10.9% 13.1% 12.6% 10.8% 11.0%

Average No. of Overseas Investors 265 349 249 199 207

Overseas Ownership Drivers: Market Cap & Global Brands

8

Revenue Ownership

Security Name Sector Market

Cap ($M) % US

% Overseas

% US

% Overseas

Coach, Inc. Consumer Services 16,306.9 68.1% 31.9% 86.3% 13.7%

Google, Inc. Technology 177,434.2 46.3% 53.7% 83.9% 16.1%

Johnson and Johnson Healthcare 195,033.1 43.8% 56.2% 85.3% 14.7%

McDonald's Corporation Consumer Services 88,015.9 32.0% 68.0% 86.1% 13.9%

Microsoft Corporation Technology 234,835.3 52.7% 47.3% 84.3% 15.7%

The Coca-Cola Company Consumer Goods 166,031.0 44.4% 55.6% 89.3% 10.7%

The Estee Lauder Companies, Inc. Consumer Goods 14,624.6 36.9% 63.1% 88.4% 11.6%

The Procter & Gamble Company Consumer Goods 187,720.7 35.2% 64.8% 86.5% 13.5%

Visa, Inc. Financials 71,988.5 54.7% 45.3% 88.9% 11.1%

Yahoo, Inc. Technology 19,605.4 66.9% 33.1% 88.1% 11.9%

Average 117,159.6 48.1% 51.9% 86.7% 13.3%

Market Cap >$50B $20B-$50B $10B - $20B $5B - $10B <$5B

Average Overseas Ownership (All) 13.1% 12.3% 12.2% 10.0% 10.6%

Average Overseas Ownership (Active) 16.2% 15.1% 14.9% 12.1% 13.4%

Average Overseas Revenue 36.4% 19.2% 18.1% 21.9% 22.4%

Average No. of Overseas Investors 482 273 222 178 134

Major asset managers operating hedge fund long/short

• asset managers such as Pyramis, Wellington, AllianceBernstein operating hedge fund strategies, hiring former hedge fund employees

• Pension Plans and Endowments Increased Allocation to Hedge Funds significantly YoY, with the 200 largest increasing allocation by 20.3%

Notable Allocations Include:

• Teacher Retirement System of the State of Texas (+$9.6B)

• Kaiser Foundation Health Plan Inc., Oakland, Calif. (+$1.3B)

• Wisconsin State Investment Board, Madison (+$2.8B)

Large diverse hedge fund managers

• diverse HF’s are able to handle broad types of allocations

• Top 25 HF’s represent 35% of all long equity assets, top 50 represents 50%

The Institutionalization of Hedge Funds

9

Hedge Funds – Concentration of Assets

10

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100,000

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1,000,000

0%

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3/31/2009 9/30/2009 3/31/2010 9/30/2010 3/31/2011 9/30/2011 3/31/2012 9/30/2012

Dis

culo

sed

Lo

ng

($M

)

% o

f To

tal D

iscl

ose

d

Trailing 16 Quarters - US Hedge Fund Asset Concentration

Top 25 Next 25 Next 25 All Others EAUM ($M)

Hedge Funds - Core Turnover

11

Institution* Equity

Assets ($M)

Total Equity Portfolio

Turnover (%)

Core Turnover

(%)

Renaissance Technologies Corporation

32,518 123.3 70.2

Citadel Advisors, LLC 32,480 163.4 91.7

D.E. Shaw & Company, L.P. 27,580 95.1 48.1

SAC Capital Advisors, LLC 17,089 194.1 106.0

Viking Global Investors, L.P. 14,670 150.5 102.8

Millennium Management, LLC 13,024 172.3 95.5

OZ Management, L.P. 10,499 121.4 52.7

Soros Fund Management, LLC 9,462 160.7 71.9

UBS O'Connor, LLC 6,676 175.9 86.4

Discovery Capital Management, LLC 6,607 123.5 70.9

Highbridge Capital Management, LLC

5,652 179.0 91.7

Carlson Capital, L.P. 5,467 175.3 98.0

PointState Capital, L.P. 4,820 226.1 67.6

Numeric Investors, LLC (U.S.) 4,588 125.6 73.7

Average of US Non-Hedge Fund Investors**

- 63.0 -

Selected Investors: Turnover Differential Key Takeaways

Sample Sets

• Turnover among the top 15 holdings in the hedge funds’ portfolios is significantly lower than the overall portfolio, reducing from a median of 131% to 77%.

• Event Driven fund saw the lowest

differential (-34%), likely due more concentrated portfolios and a lower investment opportunity incidence.

*US hedge funds; >$500M EAUM; >50 Equity Securities - 164 Investors ** US non-hedge fund investors; >$1B EAUM; Actively managed – 6686 Investors

Expansion of Passive Investment

12

3Q09-3Q10 Net Activity ($M), All US Equities, by Strategy

3Q10-3Q11 Net Activity ($M), All US Equities, by Strategy

0

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Active Passive

3Q11-3Q12 Net Activity ($M), All US Equities, by Strategy

-300,000

-200,000

-100,000

0

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Active Passive

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Active Passive

Expansion of Passive Investment

13

• Inflection point in mid-2011 – consistent net sells from active equities while inflows to passive equities continue

• Passive investing is a scalable business = higher barrier to entry, most inflows into largest ETF providers (Vanguard, Blackrock)

• ETF’s now offer sufficient liquidity to even be used for corporate cash management

• Retail investors continue to pull back from single-equity ownership and active management in favor of passive investment (particularly ETF’s)

Tale of Two Fund Companies

14

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Pri

ce P

erfo

rman

ce (

%)

Fun

d F

low

Ch

ange

($

M)

American Funds Cumulative Fund Flow $M Change, m/m Vanguard Cumulative Fund Flow $M Change, m/m

American Funds Price Performance (secondary axis) Vanguard Price Performance (secondary axis)

American Funds vs. Vanguard (Cumulative Fund Flows Jan. '10 - Dec. '12)

*Source: Morningstar