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The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS ONLY

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Page 1: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

The Alternative Outlook

Ewen Cameron WattChief Investment Strategist, BlackRock Investment InstituteJanuary, 2012

FOR PROFESSIONAL INVESTORS ONLY

Page 2: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

2012 Investment Scenarios

2

Page 3: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

Scenario Probabilities

• We are currently at stagnation

• It was also agreed that this is not likely to be sustainable for all of 2012, and a move towards either Nemesis or fragmentation/divergence is expected by the majority of the investors

3

Scenario probabilities

20-25% 15-25%

40-50%

0-5%

5-10%

0%

10%

20%

30%

40%

50%

60%

Nemesis Stagnation Divergence Growth Inflation

Page 4: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

What do Asset Prices Tell Us?

4

0.31

0.21

0.07

0.12

0.29

0.04

0.96 0.96

0.85

0.400.38

0.220.20

0.08

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

US equities

UK equities

European equities

Asian equities

Latin American

equities

East Europe

equities

US real yield

UK real yield

Germ

an Bund

US inflation

expectations

UK inflation

expectations

High yield

Emerging

market debt $

Corporate

credit

perc

en

tila

ran

kiin

g

Higher valuations

Low valuations

Asset Class Prices Relative to History (Percentiles relative to own asset class history)

Source: DataStream, Bloomberg as of Q4, 2011Note: Time period varies for each asset class, depending on when the indices/asset classes were createdEquity valuations are the average of three measures: Dividend yields, book value (marked-to-market), and PE

Page 5: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

We are in a “Risk On/Risk Off” World

5

0.25

0.3

0.35

0.4

0.45

0.5

0.55

0.6

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

LT MAC

% of asset class returns explained by risk on/risk off

Risk On and Risk Off Asset Classes are Highly Correlated

Source: BlackRock

Page 6: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

The Drivers of Risk On Risk Off

6

0

200

400

600

800

1000

1200

1400

0

200

400

600

800

1000

1200

1400

1600

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Aug-11

Nu

mb

er

of

fun

ds

AU

M (

US

$b

n)

US AUM Europe AUM Rest of World AUMUS #ETFs European #ETFs Rest of World #ETFs

• The economy is more global (50% of European companies are outside Europe)

• Information is more abundant and has fostered a short term horizon culture

• New instruments are available to change asset allocation rapidly (ETFs)

• New players have entered the markets (hedge funds)

• Diminishing counter-party liquidity

• Forced deleveraging and regulatory impacts

Source: BlackRock

Page 7: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

The Hunt for Yield is On

• The world will have 2 billion pensioners by 2050

– Meanwhile, safe havens are no more, top-rated bond yields are at record lows and in some instances negative

– Where will people get yield?

• High yield, corporate bonds, dividend stocks, Asian fixed income, alternative investments (private equity, infrastructure and real estate), and options strategies

• Real estate securities look pricey after a big run-up in late 2011

• High Yield bonds and dividend stocks have appreciated but still offer value

– The key with equities is dividend growth, not yield

7

Real Bond Yields have Turned Negative in Many Developed Markets

Source: Thomson Reuters; Stock index dividend yields based on S&P 500, Topix, and FTSE All Shares

0

1

2

3

4

5

6

7

01/01/2000

01/10/2000

01/07/2001

01/04/2002

01/01/2003

01/10/2003

01/07/2004

01/04/2005

01/01/2006

01/10/2006

01/07/2007

01/04/2008

01/01/2009

01/10/2009

01/07/2010

01/04/2011

-3

-2

-1

0

1

2

3

4

01/01/2000

01/10/2000

01/07/2001

01/04/2002

01/01/2003

01/10/2003

01/07/2004

01/04/2005

01/01/2006

01/10/2006

01/07/2007

01/04/2008

01/01/2009

01/10/2009

01/07/2010

01/04/2011

-3

-2

-1

0

1

2

3

4

5

6

7

8

01/01/2000

01/10/2000

01/07/2001

01/04/2002

01/01/2003

01/10/2003

01/07/2004

01/04/2005

01/01/2006

01/10/2006

01/07/2007

01/04/2008

01/01/2009

01/10/2009

01/07/2010

01/04/2011

US Japan UK

Inflation Rate Stock Yield Index 10-Year Government Bond Yield

Page 8: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

8

What do we really mean by ‘alternatives’?

Two related definitions

An asset where the return is not directly linked to the return available from a publicly traded investment

• Implications – are listed real estate and hedge fund replication vehicles really ‘alternative’?

An asset where the return is (at least partially) a function of factors that are not easily observable

• Examples might include ‘liquidity premium’ or ‘alpha skill’

To justify an allocation an asset has to either improve diversification and / or improve net returns over time

• Consistent with all risks and costs, direct and indirect

• Diversification does not have to be in a ‘normal’ environment, and indeed may be most valuable in ‘non normal’ times

Not just different, also useful………!

Page 9: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

The institutional client landscape

9

Against this backdrop, what are the challenges and opportunities for investors

Sample Types of Alternatives1. Return

enhancement2. Risk

diversification3. Inflation protection

4. Downside protection

Hedge funds or fund of hedge funds � � �

Real Estate Equity � �

Private Equity � �

Commodities � �

Infrastructure � �

Diversified Growth � � ?

Alternative investments are well positioned to cope with the current environment

Market related challenges

Investor specific challenges

• Demand for returns/yield remains, but few options available in traditional asset classes

• Protection sought against rising rates and inflation

• Intense focus on liquid investments

• Derisking is reducing appetite for equities

• Pension funding ratios remain challenged: Most UK pension funds still in deficit (relative to ‘buy out’)

Page 10: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

10

UK Pension Alternative Investments

Source : JP Morgan Asset Management, ALTERNATIVE ASSET SURVEY 2010, Uncovering the latest trends in alternative investments.

• More than half of all UK investors have never invested in alternatives (exception: real estate)

16

16

14

12

26

5

12

7

13

10

10

11

6

2

3

10

8

5

10

18

8

57

56

64

67

30

52

50

14

11

9 16

11

6

36

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Other Real Assets

Currency

Commodities

Infrastructure

Real Estate

Private Equity

Hedge Funds

1-3 Years 4-6 Years 7-9 Years >10 Years Never Invested

Asset class split by region

Page 11: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

11

Expected increase in alternatives by institutional investors

• According to Russell Investments, most of the increase in alternative investments is expected to be drawn from a reduction in existing equity allocations

– Higher correlations between global equity sectors, styles and regions since 2008 have increased interest in alternative strategies that can help to diversify portfolios and reduce equity beta exposure

– However, we would suggest investors are increasingly waking up to the risk in their bond portfolios and thinking about using alternatives to help protect against rising rates or inflation

Russell Investments 2010 Global Survey on Alternative Investing

Type2009

Allocations2012

(Expected Allocations)2012 Expectations

relative to 2009

Private Equity 3.1% 4.9% 158%

Hedge Funds 4.2% 5.7% 136%

Real Estate 4.1% 6.6% 161%

Infrastructure 0.3% 1.4% 467%

Commodities 0.7% 1.1% 157%

Totals 12.4% 19.7% 159%

Source: Russell Investments’ 2010 Global Survey on Alternative Investing - Evaluation and re-commitment: the next phase for alternatives, June 2010EMEA participants (by assets) constituted 55% of respondents

Page 12: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

12

The spectrum of alternative investments

Short-Term Opportunities

Intermediate-Term Opportunities

Long-Term Opportunities

2 Years 4 Years 6 Years 8 Years 10 YearsInvestment Holding Period: 12+ Years

Private Equity

Distressed

Venture Capital

Buyout

Growth Capital

Mezzanine

Infrastructure

Privately Financed

Core

Value Add

Real Estate

Core

Value-Add

Opportunistic

Mezzanine Debt

Hedge Funds

Relative Value

Event Driven

Fundamental L/S

Direct Sourcing

Global Macro / Directional Trading

Commodities

Passive

Enhanced

Active

Page 13: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

13

Diversifying your alternative investments

Annual returns of alternative and traditional asset classes 2000 to 2010

Traditional Equities – MSCI World (USD Hedged) Traditional Bonds – BofAML Sterling Broad Market Index Hedge Funds – HFRI Fund of Funds composite Private Equity – Thomson Reuters PE: Buyout Real Estate – NCREIF Property Index Agriculture – NCREIF Farmland Commodities – Dow Jones UBS Commodities

Source: Bloomberg, Hedge Fund Research, Venture Economics, NCREIF. Data as of Q4 2010. Returns calculated using quarterly returns since Q1 2000.

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Commodities 24.21%

Real Estate 7.28%

Commodities 23.86%

Private Equity 26.62%

Private Equity 22.68%

Agriculture 33.90%

Private Equity 29.89%

Private Equity 21.60%

Agriculture 15.84%

Equities 23.34%

Private Equity 18.63%

Real Estate 12.24%

Bonds 4.74%

Bonds 9.59%

Commodities 22.66%

Agriculture 20.50%

Private Equity 28.63%

Agriculture 21.15%

Agriculture 15.90%

Bonds 4.27%

Commodities 18.72%

Commodities 16.67%

Bonds 9.48%

Hedge Funds 2.80%

Agriculture 6.86%

Equities 22.27%

Real Estate 14.48%

Real Estate 20.06%

Real Estate 16.59%

Real Estate 15.84%

Real Estate -6.48%

Hedge Funds 11.47%

Real Estate 13.11%

Agriculture 6.98%

Agriculture 2.01%

Real Estate 6.74%

Hedge Funds 11.62%

Equities 9.19%

Commodities 17.54%

Equities 14.83%

Commodities 11.08%

Hedge Funds -21.39%

Private Equity 10.09%

Agriculture 8.81%

Hedge Funds 4.07%

Private Equity -10.84%

Hedge Funds 1.01%

Agriculture 9.68%

Commodities 7.64%

Equities 14.05%

Hedge Funds 10.39%

Hedge Funds 10.26%

Private Equity -25.07%

Agriculture 6.32%

Equities 8.28%

Private Equity 0.31%

Equities -15.04%

Private Equity -5.24%

Real Estate 8.99%

Hedge Funds 6.87%

Bonds 8.34%

Bonds 0.70%

Equities 3.73%

Commodities -36.31%

Bonds 3.74%

Bonds 7.94%

Equities -9.36%

Commodities -22.32%

Equities -25.81%

Bonds 4.04%

Bonds 6.78%

Hedge Funds 7.49%

Commodities -2.71%

Bonds 3.27%

Equities -39.87%

Real Estate -16.86%

Hedge Funds 5.70%

Page 14: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

14

Commodity Correlations

Historically, commodities have had a low correlation with the returns on financial assets...

• This is particularly true when the impact of foreign (US$) currency exposure in commodities and foreign assets is removed

… and this is likely to persist in future

• If commodity price changes are demand-led we would expect rising commodity prices to be positively correlated with equity returns...

• … but a supply side shock to commodity prices (e.g. an ‘oil crisis’) is likely to see equity and commodity prices moving in opposite directions

• Higher commodity prices are likely to be linked to higher general inflation which will cause a fall in bond prices

Commodities therefore only require a relatively low expected return to be included within a portfolio despite their high volatility

Page 15: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

15

Correlation of commodity price inflation with consumer price inflation

• As a production input, commodity prices are clearly linked to the general rate of inflation

• Commodity investment therefore provides some protection against inflation surprises

• Commodities’ correlation with inflation is stronger over the long termC

orr

ela

tio

n

Number of years in rolling period

Source: Commodities Research Bureau, Global Financial data Inc, BlackRock

Correlation of commodity price inflation with US CPI inflation rolling periods 1924 to 2010

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1 3 5 7 10

Page 16: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

16

Oil Consumption Per Capita

0

5

10

15

20

25

30

35

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Barrels per year per person

South Korea

India

China

Oil – China and India Have Hardly Started

Source: BP Statistical Review of World Energy 2010, Respective Census Bureaus

USA

Japan

Note: Size of bubbles represent population size

Non-OECD countries are the drivers of long term energy/oil demand growth

Page 17: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

Oil Supply has been challenged

Source: Bernstein Research, October 2011

Estim

ates total w

orld discoveries (Billions of barrels)

Annual oil d

emand (B

illions of barre

ls)

Caspian

Iran: South Pars210

Iraq: Baghdad East

17

Since the 1980’s the world has consumed more oil each year than it has found

Page 18: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

18

The outlook for future supply growth appears bleak

Non-OPEC Supply is constrained

42.0

44.0

46.0

48.0

50.0

52.0

54.0

56.0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

2012E

2013E

2014E

2015E

mb

/d

Non-OPEC crude supply

New oil sands developments – large reserves but high cost

0

20

40

60

80

100

120

140

0

2,000

4,000

6,000

8,000

10,000

12,000

Cumulative Reserves (million bbls)

Bre

ak

ev

en

oil

pri

ce

($

/bb

l)

Source: IEA September 2011. Source: Wood Mackenzie. Oil sands projects with development plans expected to be approved over the near term. Internal rate of return of 10% in nominal terms.

The cost of replacing current oil production is rising

Page 19: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

The global economic cycle drives short term oil demand

Source: IEA November 2011.Global Oil Demand +0.9 mb/d 2011 YoY and +1.3 mb/d in 2012

Quarterly oil demand growth (∆mb/d YoY)% Change in real global GDP (QoQ, annualised)

Oil demand growth has recovered to pre GFC trend levelsSource: IMF World Economic Outlook “Slowing Growth, Rising Risks” September 2011

19

Page 20: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

20

Oil supply growth has not kept pace – spare capacity has been falling

Source: Wood Mackenzie May 2011. IEA November 2011.Source: Blackrock/IEA November 2011OMR/Estimates range of ultimate spare capacity using bank analysts

OPEC Effective Spare Capacity (% World Oil Demand)

Analyst Range of Forecastsat start of 2011

World Oil Supply Growth by Region (mb/d)

Supply & Demand has tightened in 2011, OPEC spare capacity peaked in 2010

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

2012E

2013E

Current Level (post Libya crisis)

IEA Demand Growth:2011e +0.9 mb/d2012e +1.3 mb/d

Page 21: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

What price is the “right” price?

• ~70% of the conventional oil production needed by the end of the decade has yet to be developed or discovered

• Upstream development in 2011 costs twice the level of 2003

• Canadian oil sands forecasted to grow at 6.6% CAGR over next five years. Marginal costs supportive of sustained high oil prices

• In the last 10 years, more than half of all new oil and gas discoveries have been offshore

Source: Wood Mackenzie, February 2011. Oil projects with development plans expected to be approved over the near term. Project economics based on a fully-taxed stand-alone basis using the appropriate fiscal terms for each sector. Internal rate of return of 10% in nominal terms. Potential synergies that can be significant on a corporate basis are excluded. Conversely, the economics are not run on a full-cycle basis and prior signature bonus and exploration/appraisal costs are not included.

Breakeven oil prices for probable new developments (IRR 10%) Fiscal oil price breakeven of OPEC nations

0 5 10 15 20 25 30 350

20

40

60

80

100

120

QAT

KUW

ANG SAU

UAE

VEN

LIB IR

N IRQ

ALG

NIG EQU

Fis

ca

l b

reak

-eve

n p

rice

($

/bb

l)

Petroleum production (million b/d)

Sources: APICORP Research 1Q 2011

21

Page 22: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

Industrial Metals – Asia and China matter

22

• China is a major component of demand for all commodities but there is significant variation in demand across

industrial commodities

• Emerging markets as a whole now make up largest component of global demand for industrial commodities

• Outlook for consumption growth in these regions is a key driver of future commodity prices

Source: UBS, October 2011

Page 23: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

23

Supply-side dynamics

Supply constrained by:

• Average mined grades falling

• Infrastructure challenges

• Discovery rates falling

• Shortage of skilled labour

• Long lead times on equipment

• Geopolitical challenges

• Production shortfalls

Challenges to forecast bulk commodity production:

Growth constrained by congestion on roads, rail and at ports

-15% -10% -5% 0%

Iron Ore

Metcoal

Copper

Under delivery of production forecasts 2007-2011

Source: Macquarie August 2011.

Page 24: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

24

Why gold: Diversification from core asset classes

Correlation of gold and other selected commodities to a selection of financial assets – long term view (10 years)

(10 year dataset)MSCI World (Equities)

S&P 500Barclays Global

Aggregate (Bonds)

Trade Weighted US$

% Performance (U$)

Gold Bullion 0.09 -0.01 0.44 -0.51 464%

BGF World Gold Fund* 0.42 0.29 0.38 -0.56 580%

GSCI Commodities Index (Total Return) 0.38 0.31 0.16 -0.37 69%

LME Copper spot 0.49 0.41 0.10 -0.32 434%

WTI Oil spot 0.29 0.24 0.10 -0.29 370%

CBOT Wheat spot 0.23 0.19 0.13 -0.22 35%

• Gold has low correlation with almost all financial assets

• Superior diversification from equities and US$ compared to other commodities

• Exposed to spot rather than futures markets, so not impacted by negative roll yields and usually physically backed

Source: DataStream, data as at 2nd January 2011 * BGF World Gold Fund shown here as an example of a gold equity fund

Page 25: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

25

A real return from a ‘risk free’ asset

-50

-40

-30

-20

-10

0

10

20

30

40

50

60

-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9

Real short-term FED funds rate (%)

% R

etu

rn

Gold Silver

Source: Deutschebank March 2011

Returns of gold and silver in a real interest rate environment

Year-on-year returns since 1970Gold a beneficiary of growing US debt

Source: Datastream 30th November 2011

• Concern over the higher risk associated with a rising US debt burden• Gold has benefited as investors have sought out ‘risk free’ assets with a real return

Page 26: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

26

Investment Demand – Key Drivers

Portfolio Diversifier Inflationary ConcernsCurrency Volatility /

Dollar Weakness

Low correlation to fixed income and equities

Impact of quantitative easing – risk of inflationary scenario has increased

What will be the next reserve currency?

0

10

20

30

40

50

60

70

80

90

100

2003 2004 2005 2006 2007 2008 2009 2010 2011

Millio

n o

un

ce

s

400

600

800

1000

1200

1400

1600

1800

US

$/o

z

GBS (ASX) GBS (LSE) NewGold (JSE) GLD (NYSE) IAU (Amex)

ZKB Gold ETF-SWX ETFS (London) XETRA (DAX) Julius Baer (SWX) ETFS(NYSE)

SGBS LN CS-XMTCH(SIX) UBS-IS Gold ETF Sprott Physical Gold Source

Claymore Central Gold Trust Dubai Central Fund CA Gold Price (US$/oz)

Source: UBS. Data as at 5 January 2012

Amount of gold backed by ETFs

Page 27: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

27

Central bank gold holdings – Strategic shift in attitude

Source: Deutschebank, World Gold Council, December 2010 Source: World Gold Council, December 2010. *Estimate ** Estimate YTD to end November

Central Bank Gold Holdings (1958-2010) Change in official sector gold holdings 2000-2010

28000

30000

32000

34000

36000

38000

40000

1958

1963

1968

1973

1978

1983

1988

1993

1998

2003

2008

To

nn

es

-600

-400

-200

0

200

400

600

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010*2011**

To

nn

es

Page 28: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

28

Central bank gold holdings

Top 20 Central Bank Gold Holdings as a % of reserves

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Po

rtu

ga

l

US

A

Ge

rma

ny

Ita

ly

Fra

nc

e

Au

str

ia

Ne

the

rla

nd

s

Ve

ne

zu

ela

Sp

ain

EC

B

Le

ba

no

n

Sw

itze

rla

nd

UK

Ind

ia

Ru

ss

ia

Ta

iwa

n

Ja

pa

n

Sa

ud

i A

rab

ia

Ch

ina

IMF

Go

ld H

old

ing

(T

on

nes

)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

% o

f re

serv

es

Gold holding (LHS) % of reserves (RHS)

• Average Central Bank gold holding as a percentage of foreign reserves ~ 10%

• Emerging markets – the growth engines of the global economy - holding significantly lower than average

• Mexico increases gold reserves to 100t, buying over 90t of gold

• Bank of Korea buys 25t of gold in June 2011

Source: World Gold Council, end Q1 2011

Page 29: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

29

World Gold Mine Production, 1988-2010

A stagnant industry

0

500

1,000

1,500

2,000

2,500

3,000

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

To

nn

es

South Africa North America Australia China RoWSource: GFMS 2011Prior to 1996, Chinese production is included in Rest of the World

• Production growth of 3.8% in 2010 vs. 2009, this compares to 7.5% growth in in 2009

• Total mine production only now above previous peak in 2001, despite a gold price rise of over 350%

• Number of world’s largest gold mines are approaching the end of their lives and grades across the industry are falling

• We estimate total cost of production (exploration, development and mining) to be in excess of US$950/oz before returns to shareholders

Page 30: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

30

Mine supply – Future supply challenged

0

50

100

150

200

250

300

350

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

Mil

lio

n o

un

ces

>10 Moz 1-10 Moz 0.1-1 Moz Other Est

Source: Gold Fields, August 2010 Source: Gold Fields, August 2010

World Discovery Trends 3-Year Rolling Average Discover Cost

0

10

20

30

40

50

60

70

80

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

Dis

co

very

Co

st

(2009 U

S$/o

z

Page 31: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

Private Equity Outlook

• Returns will be lower than in the past

– Less leverage

– Unchanged transaction valuations

• Valuations will be more closely linked to public markets

– Mark to market rules (BVCA, FASB 157, 159)

• Greater emphasis therefore on “operational model” and specialist knowledge

– Building business away from public markets

• And income may become crucial

– Distributions from business not just disposals

31

Page 32: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

32

Diversification by vintage year and type is key to successful Private Equity investing

-20

-10

0

10

20

30

40

50

60

70

80

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Net

IRR

%

All buyouts All venture capital Distressed/ turnaround

Vintage Years

Top quartile PE performance by type and vintage year as of 31 December 2010

Reflects Venture Economics VentureXpert cumulative performance since inception through 31 December 2010 for derived on 16 May 2011.

Page 33: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

Hedge Fund Outlook

• Be sure your fund actually diversifies!

• High correlations have made this difficult in many areas

• Increased divergence – our central case – aids returns

• Distressed debt, work out funds and niche investments offer interesting prospects

• Allocations likely to increase because of flexibility of investment approaches

33

Page 34: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Sep-91 Sep-93 Sep-95 Sep-97 Sep-99 Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11

1986-2011 Mean = 1.5%

34

Property offers a significant relative yield advantage over long term UK gilts

%

Attractive income characteristics provided by commercial real estate sector

Source: Investment Property Databank.

IPD Equivalent Yield Relative to Long Term UK Gilts

Page 35: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

35

Sub sector initial yields – peak to present

4.5 4.6 4.8

3.8 4.03.5

5.2 4.9 5.1 5.4

7.26.9

8.5

7.5

8.2

7.1

8.8 8.5 8.2 8.1

5.6

7.1

5.75.3

4.7

7.4 7.26.9

7.3

6.1

0

1

2

3

4

5

6

7

8

9

10

Shops –South East

Shops – RUK

ShoppingCentre

RetailWarehouses

Offices – City

Offices –West End &Mid Town

Offices –South East

Offices –RUK

Industrials –South East

Industrials –RUK

Peak of Market Initial Yield (Summer 2007) Trough of Market Initial Yield (Summer 2009)September 2011 Initial Yield

%

IPD All PropertyAverage

Average since January 1987.

Source: IPD MIPS as at 30 August 2011.

Page 36: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

36

BlackRock real estate – UK commercial real estate total return forecast

7.5 7.68.8 8.3

11.3

26.0

29.5

15.4

-8.4

-3.1-1.6

20.2

11.9

3.6

10.0

16.8

11.8

14.5

10.5

6.8

9.610.9

19.1

-3.4

-22.1

3.5

15.1

7.46.3

4.0 4.56.4

18.3 18.1

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

%

Forecast

BlackRock 2011 Forecast, IPD Annual Index,

Source: BlackRock Internal as at 30 September 2011.

Page 37: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

37

UK direct real estate – current themes

Annual total returns moderated to 8.7% in September•Capital values have risen 18% since July 2009, driven entirely by capital inflows•However, yield impact has largely run its course•Estimated rental value growth turned marginally positive in July, but remains basically flat

Polarisation continues• Prime vs. secondary; driven by investment demand/ flight to quality• London/ South East vs. Rest of UK; driven by recovering property fundamentals• Secondary assets and Rest of UK markets are expected to remain under pressure

due to Government austerity, elevated unemployment, and banks releasing stock to the market

Outlook more uncertain• Elevated levels of volatility are expected• Lack of direction as forecast gap between sectors is narrowing• London, South East and regionally-dominant Retail assets expected to outperform in

early years

UK property still positioned well in slow growth environment• Construction levels across all sectors are near historical lows, suggesting that not

much demand is needed to reduce vacancy levels and support rent growth• Property offers a significant relative yield advantage over long-term Gilts; a 5.5% to

8.5% income return is attractive from a multi-asset perspective• Estimated rental values have risen just 0.2% from their trough, with only Central

London posting real rent growth• Despite recent recovery, average valuations are still 34% below their recent peak,

suggesting more moderate downside risks to values than in other asset classes • Investor focus on secure income will likely benefit prime property, as London is seen

as a safe haven for international property investors• Having said that, slower economic growth is obviously a negative for property• We expect a muted recovery in capital values with income yields and operations

driving performance

-40

-30

-20

-10

0

10

20

30

40

01 02 03 04 05 06 07 08 09 10 11

Components of 1-Year Total R

eturn %

Income Return Rental Growth Yield Impact Total Return

Source: BlackRock, IPD, PMA

IPD Property Index Components of Return – September 2011

5 yr Forecast Relative Returns (BLK Autumn 2011)

%

Page 38: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

38

Conclusion

Scenario Divergence (40-50%) Nemesis (20-25%) Stagnation (15-25%) Inflation (5-10%) Growth (0-5%)

Ingredients A true decoupling: Emerging

economies keep

outperforming, while the

United States and Japan putt

on. Europe has a shallow

recession but a recovery at

snail's pace. China's

economy re-accelerates.

Elections in key countries

could upset the cart.

Global recession, credit

crunch, social upheaval and

steep losses across asset

classes around the world.

Sluggish global economic

growth and high

unemployment.

Inflation around the world

effectively cuts the developed

world's debt load.

Sustainable global growth just

above the long-term trend.

Triggers Policy moves halt -- but don't

solve -- the euro debt crisis.

The most likely trigger is that

the Euro debt crisis spins out

of control, leading to a partial

breakup of the union and

global banks' dumping risk

assets. Other include: An

Israeli attack on Iran's nuclear

facilities a China growth

shock or a buyers strike in the

U.S. Treasury market.

The current state of play. A tug

of war between seemingly

ineffective policy makers and

skeptical financial markets.

The world's central bankers

start running their printing

presses day and night

Developed market policy

makers don't just arrest the

debt crisis but provide a

credible road map for long

term solutions.

Probability 40-50% 20-25% 15-25% We believe the world

is at an inflection point and

see the current status quo as

untenable.

0-10% Inflation is unlikely to

perk up, especially in the

developed world.

0-5% Dream on.

Investment

strategy

Alternatives benefit from more

dispersal in risk premiums;

hedgefunds, commodities,

private equity win

Devastating for most assets.

Cash, U.S., German and

Japanese government bonds

would be kings. Gold also

may work. Overweight the

U.S. dollar, yen and pound

over the euro and emerging

currencies. Hedge funds,

private equity and

infrastructure could offer

protection if they can stomach

short-term funding crunches

and regulatory measures such

as short selling bans.

Asset move in lock step with

big price swings from one day

to the next as investors buy

into the latest policy moves to

halt the debt crisis or poke

holes in them. Banks

shedding risky assets keep a

lid on permanent gains in risk

assets. High correlation

between asset classes.

Income based strategies work

Income-focused investors

switch to risk assets.

Alternatives such as real

estate, infrastructure and

private equity should do well.

Most markets rise, especially

risk assets such as

commodities, high yield

bonds, depressed European

sovereigns and financials.

Page 39: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS

39

The following notes should be read in conjunction with the attached document:

1. Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Services Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: 020 7743 3000. Registered in England No. 2020394. For your protection telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) Limited.

2. Past performance is not a guide to future performance and should not be the sole factor of consideration when selecting a product. All financial investments involve an element of risk. Therefore, the value of your investment and the income from it will vary and your initial investment amount cannot be guaranteed. Changes in the rates of exchange between currencies may cause the value of investments to go up and down. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.

3. Mandates we manage may be exposed to finance sector companies, as a service provider or as counterparty for financial contracts. In recent months, liquidity in the financial markets has become severely restricted, causing a number of firms to withdrawn from the market, or in some extreme cases, becoming insolvent. This may have an adverse affect on the mandates we manage.

4. Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

5. This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

6. This material is for distribution to Professional Clients (as defined by the FSA Rules) and should not be relied upon by any other persons.

7. Subject to the express requirements of any client-specific investment management agreement or provisions relating to the management of a fund, we will not provide notice of any changes to our personnel, structure, policies, process, objectives or, without limitation, any other matter contained in this document.

8. No part of this material may be reproduced, stored in retrieval system or transmitted in any form or by any means, electronic, mechanical, recording or otherwise, without the prior written consent of BlackRock.

UNLESS OTHERWISE SPECIFIED, ALL INFORMATION CONTAINED IN THIS DOCUMENT IS CURRENT AS AT December 31, 2011.

© 2012 BlackRock.

Page 40: The Alternative Outlook - trigon.co.uk · The Alternative Outlook Ewen Cameron Watt Chief Investment Strategist, BlackRock Investment Institute January, 2012 FOR PROFESSIONAL INVESTORS