TEXAS ECONOMICS TEXAS ECONOMICS ASSOCIATIONASSOCIATION

February 10, 2010

UPCOMING EVENTSUPCOMING EVENTSFebruary 14th – First Study GroupFebruary 17th– Special guest

speechLate February – Bowling nightMarch 7th – Kite Festival @ ZilkerMarch 26th – Dallas Fed

Conference

Important infoPAY YOUR DUEST-Shirts – Only $10Next meeting in JGB 2.216

IMPORTANT INFO – CONT’D

TODAY’S SPEAKERTODAY’S SPEAKER

Larry White

AQS Asset Management

A Discussion of the Capital Markets

and

How We Got Here from There

by

Larry White

Managing Director, co-Founder

AQS Asset Management, LLC

Austin, TX

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AQS Asset Management:

•Is a registered investment advisor (RIA) reporting to the Securities Exchange Commission

•Manages fixed income investment portfolios for insurers

•Was founded by brothers, Larry and Byron White

•Larry White, BSME, Rice University

•Byron White, CPA, CFA, BA Mathematics, University of Texas at Austin

•Developed a proprietary asset liability management software product, PALM, initially licensed to Cigna with the aid of the Director of the Institute for Computational Finance, then Patrick Jaillet

•The brothers began working as brokers in the fixed income markets and sensing the upcoming market trading transparency reinvented their service to a fee-based advisor, AQS Asset Management, LLC in 2003

•Today, AQS manages about $900mm in fixed income – a small manager by fixed income standards

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AQS Asset Management:

•Typical insurance client has a fixed income portfolio, mandated by insurance statute, with a value of $50mm - $500mm

•Annuity, life, property and casualty liabilities

•Deal directly with an investment committee made up of employees of the insurer. Report to the board quarterly results

•Typical investment grade portfolio has a duration of 2 – 6 and a yield of 5% - 6%

•Most valuable player: the rainmaker

•Most easily interchangeable player: the analyst, administrator.

•Rainmakers, portfolio representatives can start at about $125m with incentives that make compensation about $500m annually. Requires deep knowledge of insurance operations. Preferred background is former CFO of a mid to large insurers.

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The Financial Industry in a Nutshell

Buy Side

Banks, Insurers, Pensions, Mutual Funds, Hedge Funds

Sell Side

Broker/Dealers

Service Side

Managers, Accounting, Audit, Custodial

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Sell Side

•Brokers: Commissioned salespeople 100% commission; compensation unlimited. The rainmakers. Sales

•Traders: Salary + bonus; compensation limited by the firm. Poker players. Horse traders. Experience but not necessarily academic credentials

•Analysts: Salaried, some bonus. Analytical. The dog and pony guys.

•Management: As in any organization, management skills and academic credentials matter

Buy Side

•Portfolio Managers: Strategy and client interface. Communicate client preferences within the context of the portfolio parameters to traders. Make recommendations to clients based on trader bias.•Traders: Salary + bonus; compensation limited by the firm. Poker players. Horse traders. Experience but not necessarily academic credentials•Analysts: Salaried, some bonus. Analytical. The dog and pony guys.•Management: As in any organization, management skills and academic credentials matter

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Service Industry

Goods and services run the gamut. Degrees from all disciplines compensated based on experience, need, type service or product.

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State of the Financial Market

In a word: fragile

In 15 words or less: Leverage exacerbated the problem. Until we deleverage, it will be difficult to achieve real growth

Mark to market: a theoretical construct that brought about the liquidity spiral that characterized 2009

Mark to market: a theoretical construct that, combined with leverage, created unreal earnings valuations and expectations for equity market returns.

The Federal Reserve is employing its own leverage to mitigate the effects of extreme liquidity – a shock absorber. Established in the ’30s (check me on that) to mitigate bank runs.

The Federal Reserve is coming to the end of a strategy termed Quantitative Easing whereby the Fed acts as a large buyer (using printed money) and establishes a sense of liquidity in the markets

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Federal Reserve Open Market Net Purchases(January 7, 2009 to present)

-$25

-$15

-$5

$5

$15

$25

$35

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2009

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2009

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2009

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2009

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2009

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2009

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2009

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2009

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2009

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1/7/

2010

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2010

3/7/

2010

$Bill

ion

Data from 1/20/10 to 3/31/10 is estimated $12b/week assuming Fed ends program at $750b authorized

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AQS’ Outlook for 2010

The Fed will continue to keep short rates low

Treasury will continue to sell record amounts of debt stacking the average maturity to about 72 months versus 48 months previously

The resultant ‘steep’ yield curve will allow banks to rebuild capital

Healthy bank capitalization is necessary to fund the burgeoning deficit via lending, which creates jobs, which generates taxes.

At some point, the Japanese and Chinese which each own approximately $1trillion in treasury securities will find something else to do with their money.

The 30 year treasury sold in 1981 is the single highest total return instrument over the last 30 years with a yield and total return of 15%

Markt-to-market insanity will continue to be relaxed. Enabling fragile financial companies to re-capitalize.

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Market adages

If you can’t spot the patsy at the table, it’s you.

Markets will always behave in a fashion that makes the greatest fools out of the largest numbers of investors

If you saw it on the news, you’re too late

Pay no attention to the man behind the curtain or, for that matter, kindly gentlemen from Omaha - ditto for poker players from California. They’re not giving you advice, they’re selling you the position they put on last week.

Yield is a state of mind.

The streets are littered with the last ‘smartest guy in the room’

Buyer beware. Seller beware. You too.