Alternative Investments in Down-Cycle Markets LEHMNABROTHER S Ron Lubash Februrary 4, 2001.

Alternative Investments Alternative Investments in Down-Cycle Marketsin Down-Cycle Markets

LLEHEHMM NNAA BBRROOTTHHEERRSS

Ron LubashRon Lubash

Februrary 4, 2001Februrary 4, 2001


““The economic landscape has changed dramatically over the last few The economic landscape has changed dramatically over the last few months and the local market now faces a new reality of significantly months and the local market now faces a new reality of significantly diminished prospects for future growth.”diminished prospects for future growth.”(Jerusalem Post, 01/03/2001)

Executive SummaryExecutive Summary

Decreasing capital market growthDecreasing capital market growth Decline in Israeli high-tech growth Decline in Israeli high-tech growth Consumer slowdown in the U.SConsumer slowdown in the U.S Geo-Political instability Geo-Political instability

Can investors increase their capital gains in such a down-cycle Can investors increase their capital gains in such a down-cycle market?market?


Year 2000 - Global Market OverviewYear 2000 - Global Market Overview


Year 2000 – Highlights Year 2000 – Highlights

Total of 384 IPOs with average first day return of 55.6%, Total of 384 IPOs with average first day return of 55.6%, compared to 466 IPOs in 1999 with first day return of 69.9%compared to 466 IPOs in 1999 with first day return of 69.9%

Total capital raising in IPOs was $66 billion compared to $64.7 Total capital raising in IPOs was $66 billion compared to $64.7 billion in 1999billion in 1999

Major investments in telecom and computer software sectorsMajor investments in telecom and computer software sectors Scientific breakthroughs encouraged investment in the Scientific breakthroughs encouraged investment in the

biotechnology sector biotechnology sector High returns on NIS investmentsHigh returns on NIS investments

Source: SDC


Year 2000 - Capital MarketsYear 2000 - Capital Markets

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

NASDAQ NYSE LSE TOKYO

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

NASDAQ NYSE LSE TOKYO

00

5050

100100

150150

200200

250250

NASDAQNASDAQ NYSENYSE LSELSE TOKYOTOKYO

19991999 20002000

Data in $ millions except numbers of IPOs

Source: Autex

$ Amount Raised Number of IPOs


Dow Jones Historical Index Dow Jones Historical Index

0

2,000

4,000

6,000

8,000

10,000

12,000

1928 1940 1952 1964 1976 1988 2000

Source: Dow Jones web Site

Down-cycle Period

1929Down-cycle

1987Down-cycle

2000Down-cycle


Year 2000 Wake Up Call Year 2000 Wake Up Call

Decreasing expectations in the global high-tech industry lead to Decreasing expectations in the global high-tech industry lead to a decline in most major capital markets a decline in most major capital markets

Indications of slower growth in the U.SIndications of slower growth in the U.S

Political turmoil and security concerns in IsraelPolitical turmoil and security concerns in Israel

Deceleration in Israeli economy’s growth rate Deceleration in Israeli economy’s growth rate


Year 2000 Decline in Major U.S Indices Year 2000 Decline in Major U.S Indices On December 31, the NASDAQ was down 39.3% year-to-date, and On December 31, the NASDAQ was down 39.3% year-to-date, and

Israeli technology stocks showed a 26% average dropIsraeli technology stocks showed a 26% average drop

2000 was a record year for Israeli high-tech’s public and private 2000 was a record year for Israeli high-tech’s public and private funding, but a poor period on a return on investment basisfunding, but a poor period on a return on investment basis

-10%-6%

-39%

16%11%

-4%

6%2%

21%

7% 9% 10%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

S&P 500 DJIA

NASDAQ

S&PMidCap

400

S&PSmallCap

600 Russell2000

2000 Jan 2001


Lehman Brothers’ 2001 ForecastLehman Brothers’ 2001 Forecast


Lehman Brothers’ forecast for 2001Lehman Brothers’ forecast for 2001

Global growth will decrease from 3.9% to 3.4%Global growth will decrease from 3.9% to 3.4% DecelerationDeceleration of U.S growth of U.S growth Expected drop in U.S consumer pricesExpected drop in U.S consumer prices Price targets for the S&P 500 and DJIA are 1,675 and 13,000 respectivelyPrice targets for the S&P 500 and DJIA are 1,675 and 13,000 respectively Expected returns are 21% for stocks, 8% for Lehman’s bond portfolio and Expected returns are 21% for stocks, 8% for Lehman’s bond portfolio and

6% for cash6% for cash Technology sector should outperform the market over the next several Technology sector should outperform the market over the next several

years years Expected devaluation of up to 5% in NIS/$ - ($1= 4.22NIS)Expected devaluation of up to 5% in NIS/$ - ($1= 4.22NIS)

Source: Lehman Brothers` Research Reports


Asset Allocation for Year 2001Asset Allocation for Year 2001

Global asset allocation should consist of 60% Equities, 35% Global asset allocation should consist of 60% Equities, 35% Bonds and 5% cashBonds and 5% cash

Increasing exposure to Cyclical Stocks (Oil, Gas and Healthcare) Increasing exposure to Cyclical Stocks (Oil, Gas and Healthcare) Though still underweight, increasing technology exposure, Though still underweight, increasing technology exposure,

mainly in the under-valued telecom sectormainly in the under-valued telecom sector Prospects of a stronger EURO hence, increasing exposure in Prospects of a stronger EURO hence, increasing exposure in

continental Europecontinental Europe

Source: Lehman Brothers` Research Reports


Down-Cycle Historical PerspectiveDown-Cycle Historical Perspective


Dow Jones - 1929 Down-Cycle Dow Jones - 1929 Down-Cycle


0

50

100

150

200

250

300

350

1896 1909 1922 1935

1929Down-cycle


Dow Jones – 1987 and 2000 Down-CyclesDow Jones – 1987 and 2000 Down-Cycles


0

500

1,000

1,500

2,000

2,500

3,000

1970 1974 1978 1982 1986 1990

1987Down-cycle

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1990 1992 1994 1996 1998 2000

2000Down-cycle


General Trends in Down-Cycle Behaviour General Trends in Down-Cycle Behaviour Total of 14 down-cycles between the years 1944-1995 with an Total of 14 down-cycles between the years 1944-1995 with an

average downturn duration of 14 months and index decrease of average downturn duration of 14 months and index decrease of 19.5% 19.5%

An estimated 5% of stock assets were redeemed 6 weeks after the An estimated 5% of stock assets were redeemed 6 weeks after the beginning of down-cyclesbeginning of down-cycles

Shareholders’ response to a down-cycle period tend to be spread Shareholders’ response to a down-cycle period tend to be spread over timeover time

Shareholders react moderately, enhancing their long-term Shareholders react moderately, enhancing their long-term investment objectives and horizonsinvestment objectives and horizons

Source: Investment Company Institute -(Mutual Fund Shareholders Activity During U.S Stock Market Cycles 1944-1995)Note: Information includes 30 large Mutual funds which at that time held 80% of equity fund assets


Case Study - October 1987Case Study - October 1987

On average, monthly basis outflow was $7.5 billionOn average, monthly basis outflow was $7.5 billion Approximately 70% of the outflow occurred on the first 3 days of Approximately 70% of the outflow occurred on the first 3 days of

down-cycledown-cycle Share redemption was mainly in the second half of October, Share redemption was mainly in the second half of October,

representing an approximately $8.2 billion outflowrepresenting an approximately $8.2 billion outflow Only 5% of the stock-fund shareholders had redeemed shares Only 5% of the stock-fund shareholders had redeemed shares

during and since the market breakduring and since the market break Net outflow moderated and tapered off in November and Net outflow moderated and tapered off in November and

December 1987December 1987

Note: Information includes 30 large Mutual funds which at that time held 80% of equity fund assets Source:Investment Company Institute -(Mutual Fund Shareholders Activity During U.S Stock Market Cycles 1944-1995)


““Alternative Investment Opportunities” Alternative Investment Opportunities”


Return Per Asset Class (1926-1998)A

nn

ual R

an

ges o

f R

etu

rn

-100%

Highest Annual Return

Lowest Annual Return

Average Return

14.7%

29.1%

142.9%

54.0%

40.4%

-5.1%

-43.3%

-9.2%

-58.0%

0.0%

-50%

0%

50%

100%

150%

Small Company

StocksLarge

CompanyStocks

Long-TermGovernment

Bonds

Medium Term Government

Bonds

Cash

12.4% 11.2% 5.3% 5.3% 3.8%

Source: Ibbotson Associates. Note: Each bar shows the range of annual total returns for each asset class over the period 1926-1998.


Annual Returns By Region (1970-1998)A

nnual R

anges

of

Ret

urns

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

United States

International

Europe37.4%

69.9%79.8%

107.5%

-26.5% -23.2% -22.8%-34.3%

Pacific

13.5% 12.7% 13.7% 12.1%

Average Return

Source: Ibbotson Associates (Highs and Low. From 1970-1998)


Contributing Factors of Portfolio Performance

Asset Allocation91%

Security Selection5%

Transaction and Other Costs

2%Market Timing2%


Lehman Brothers’ Investing SynergiesLehman Brothers’ Investing SynergiesAverageAnnualReturn

20% Stocks, 80% Bonds

Minimum Risk Portfolio:10% Stocks, 90% BondsBonds

100% U.S. Government Bonds

Standard Deviation (Risk)

100% U.S. Stocks

An additional 5-10% of non-correlated alternative investments to the portfolio can substantially reduce the standard deviation on the expected return

• The goal of modern Portfolio theory is to maximize return at a given risk

• An efficient portfolio will always have the highest expected return for a given level of risk


Alternative Investments’ Opportunities Alternative Investments’ Opportunities GrowthGrowth


Alternative Assets - Sector Overview

Alternative investments implement various financial instruments (such as: Hedging tools, Bonds, Options)

Over $12 billion were invested in European hedge funds in 1999 by European and US Institutions and high net worth individuals, bringing total assets to $28 billion

Close to 60 new European hedge funds were launched in 1999, bringing the total number of hedge funds to approximately 200

The US market has over 2000 hedge funds. It is expected that over 300 funds will be launched in Europe over the next 3 years


0

100

200

300

400

500

600

700

800

900

$ B

illion

s

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

*

19

99

*

20

00

*

Alternative Assets - A Growing Asset Class

Alternative Assets - Industry Overview

Source: Hedge Fund Research, LLC

* - estimates


Alternative investment example: Alternative investment example: Lehman Brothers’ Offshore Multi-strategy Lehman Brothers’ Offshore Multi-strategy

Fund IIFund II


Major Financial ObjectivesMajor Financial Objectives

Take advantage of investment opportunities around the worldTake advantage of investment opportunities around the world Implement a variety of financial instruments (such as: beta Implement a variety of financial instruments (such as: beta

hedging, convertible arbitrage and event oriented analysis), in hedging, convertible arbitrage and event oriented analysis), in order to achieve a superior total return with moderate order to achieve a superior total return with moderate volatility over the long termvolatility over the long term

Employ a multi-manager investment approachEmploy a multi-manager investment approach Leverage the capabilities of a global investment bankLeverage the capabilities of a global investment bank


Risk vs. Return ProfileRisk vs. Return Profile

0%

5%

10%

15%

20%

25%

30%

0% 5% 10% 15% 20%

Risk (Standard Deviation)

Retu

rn

Lehman’s Offshore Multi-Strategy Fund II provides a substantially higher return compared to traditional fixed income investments at a given risk level

Multi Strategy Fund II

S&P 500

Aggregate Lehman Bond Index


Fund Performance

Accumulated Performance Measured in U.S. Dollars

-2%0%2%4%6%8%

10%12%14%

J an-

00

Feb-

00

M ar -

00

A pr -

00

M ay-

00

J un-

00

J ul -

00

A ug-

00

Sep-

00

Oc t-

00

Nov-

00

Multi-Strategy Fund II Agg. Lehman Bond Index


Conclusions Conclusions

In a down-cycle market, an investor should strive for a In a down-cycle market, an investor should strive for a diversified portfolio with a world wide perspective diversified portfolio with a world wide perspective

Alternative investments opportunities are designed to Alternative investments opportunities are designed to outperform the market utilising various financial outperform the market utilising various financial instrumentsinstruments

Today, more and more investors consider alternative Today, more and more investors consider alternative investment opportunities as a material part in their investment opportunities as a material part in their portfolioportfolio


Thank You Thank You

Alternative Investments in Down-Cycle Markets LEHMNABROTHER S Ron Lubash Februrary 4, 2001.

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