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Lazard Alternative Emerging Markets The emerging-market alternative investment universe offers institutional investors the opportunity to enter an uncongested marketplace with unlimited growth potential. Since the term “emerging markets” originated over 30 years ago, the asset class has developed to become a common allocation for institutional investors. The number of eligible countries has increased from 10 to more than 40, while investment instruments have expanded beyond equities to include debt, frontier markets, derivatives, and more. Meanwhile, the construction of emerging markets indices has not kept pace with the asset class’s rapid development, resulting in a multitude of underexploited investment options. Compared to developed markets, emerging markets have much less participation from alternative investment strategies. While hedge funds in the developed world operate and compete in a mature marketplace, the index dominant structure of most emerging-market mandates leaves a rich alpha opportunity for emerging markets hedge funds. Lazard’s Alternative Strategies team has 25 years of investment experience in the emerging markets and has spent nearly fifteen years together identifying high-quality alternative investment managers. Investors seeking a strategy that has historically offered lower volatility than the MSCI Emerging Markets Index and strong risk-adjusted returns should consider the Lazard Alternative Emerging Markets strategy. Strategy Benefits • Expansive Investment Universe: The emergingmarket universe is one of the largest and fastest growing, with underrepresented analyst coverage, giving rise to significant mispricings. • Attractive Diversification Opportunity: Blending alternative strategies may provide a diversification advantage and virtuous asymmetry that helps manage risk in down markets while capturing a significant portion of the upside. • Significant Industry Experience: Lazard’s Alternative Strategies team has worked together for nearly fifteen years identifying quality alternative investment managers with a significant background in emerging markets. Inside Lazard they are also able to leverage the firm’s experienced emerging markets analyst teams. • Strong Track Record: Our strategy has significantly outperformed its benchmark since inception with roughly onethird of the index volatility and has shown reduced correlation to traditional asset classes. Snapshot SP23395 Benchmark Number of hedge funds Volatility Other portfolio guidelines Minimum Investment MSCI Emerging Markets Index Typically 15–25 Seeks to target less than 50% of the volatility of the MSCI Emerging Markets Index Max single fund investment: 10% Max single firm investment: 15% $100M (customization available). Development of Emerging Markets When emerging markets were identified as a distinct asset class in the 1980s, institutional investors first sought access to developing economies in order to capture the superior risk/reward dynamics of unstructured sovereign debt that benefited from comprehensive economic, and, in many cases, political reform. Once a path to macro stability was achieved, countries focused on developing their domestic capital markets. Investors were attracted to the promise of strong corporate earnings growth at compelling valuations. This meant capturing beta by investing in the best managed, most liquid companies that constituted the once nascent emerging-market indices. Institutional investors believed volatile emerging-market equity return streams were worth enduring as the expected earnings growth, and consequent capital appreciation, compensated for the risk. Thirty years later, many of the original emerging economies have developed into middle-income countries and their capital markets have matured to encompass a broad range of instruments, including equities across a broad array of sectors and market caps, sovereign and corporate external debt, domestic interest rate securities, convertible bonds, warrants, options, and distressed assets. Emerging markets now include frontier markets whose structure, maturity, and investment rationale resemble emerging economies in the 1980s. While the emerging markets have evolved, invested assets remain heavily weighted toward large-cap companies, typically accessed either passively through MSCI Emerging Markets Index funds, or actively through an emerging markets equity manager. The fairly recent segmentation into style benchmarks is a step forward, but it still leaves investors with a volatile, beta-rich emerging markets product range and significant point of entry risk. This risk was highlighted during the emerging markets sell-off in the first half of 2013, where even as market performance diverged across country, region, and asset class, standard emergingmarket bond and equity benchmarks were universally weak. This exposed the inherent risks associated with a traditional approach to investing in emerging markets. “While the emerging markets have evolved, investment vehicles remain heavily weighted towards the largecap approach...” The Case for Emerging Markets Hedge Funds As emerging markets have developed, so has the ability to short securities, trade credit default swaps and options, and construct index-based hedges. Many techniques pioneered by developed-market hedge funds are now being successfully implemented in emerging markets. However, while developed-market hedge funds now form a well understood and meaningful proportion of developed capital markets, the relatively recent ascent of emerging-market hedge funds means that they represent a smaller and less crowded constituency of their opportunity set. While hedge fund participation in developed markets exceeds $2.5 trillion in assets under management (AUM), emerging markets dedicated hedge funds only possess $0.2 trillion in AUM and are underrepresented, encompassing only 1.3% of the growing emerging-market equity and bond universe of over 2,800 issuers.1 Traditional hedge fund of funds have always prided themselves on their ability to allocate capital among a large universe of hedge funds. We believe dedicated emerging-market investing, however, not only requires regional and country expertise (often underutilized by traditional allocators), but also bottom-up security-level experience to help understand idiosyncratic risks and challenge a manager’s investment thesis. This is where we believe Lazard has a unique competitive advantage at the firm and team level. Exhibit 1 demonstrates the potential benefits that emerging markets hedge funds can provide, relative to long-only offerings. Beyond merely delivering a passive blend of emerging-market equity and debt, emerging markets alternative managers grant investors access to market segments generally not accessible through passive blend strategies (e.g., frontier markets, distressed assets, and uncorrelated styles such as emerging markets macro). Exhibit 1 Potential Benefits of Emerging Markets Hedge Funds Return (%) 12 JPM EMBI 10 HFRI EM 8 MSCI EM 6 4 2 0 5 S&P500 10 15 MSCI Global 20 25 Standard Deviation (%) The chart represents information from 1 January 2000 to 30 August 2013. Information provided for illustrative purposes only. Past performance is not a reliable indicator of future results. Source: HFR, MSCI, Barclays, Bloomberg. Not representative of any product managed by Lazard. One cannot invest in an index 3 Lazard Alternative Emerging Markets Strategy Lazard’s Alternative Emerging Markets strategy offers unique access to an uncrowded opportunity set, building on Lazard’s broader emerging markets platform and incorporating the insights of dozens of sector and regional specialists. Our experienced hedge fund investment team combines top-down and bottom-up views, and leverages Lazard’s emerging markets expertise to deepen the discussion during the manager sourcing and due diligence process. Investment Philosophy We believe the key to building a successful portfolio of hedge funds is to select managers who have the investment skill to deliver the desired return on capital and the business skill to operate a robust and fiduciarily-sound investment enterprise that ensures the return of capital. We are proud to have an analyst team composed of experienced money managers and traders enabling us to form a more refined view of a manager’s investment strategy. We utilize Lazard’s Integrated Knowledge platform to better understand markets and asset classes and to provide us with unique insights into underlying managers’ investment rationale. Lazard’s emerging markets research platform enables us to go deeper than our competition at monoline fund of fund firms. The Lazard Alternative Emerging Markets strategy may be a versatile solution for investors searching for yield, seeking absolute returns, looking to reduce volatility, or reallocating away from traditional emerging-market strategies, or passive index investments. Additionally, because of the strategy’s broad characteristics, it can be utilized for a variety of asset allocation frameworks (equity, fixed income, or absolute return). Investment Process Lazard’s investment process, depicted in the chart below, encompasses three distinct elements. Manager Selection • Screening—Based on operational and investment criteria, Lazard narrows the 1,300 EM hedge fund universe to fewer than 250 eligible funds. • Due Diligence—This process combines quantitative analysis with a systematic and detailed assessment of critical qualitative attributes where both investment and business skill are scored. Portfolio Construction • Incorporate Return Expectations—Expected sources of return are given forward-looking estimates and assigned levels of confidence. Return and volatility projections are calculated, stressed, and tested against history. • Portfolio Construction and Rebalancing—Typically the strategy’s assets will be allocated among 15 to 25 underlying funds that utilize a variety of investment strategies and manage their own portfolios with sound risk management practices. Understanding that our clients have unique investment goals, customization is available. Risk Management • Monitoring—Monthly manager dialogue helps us to identify areas of risk, assess opportunity sets, reconcile portfolio action with past strategy, and track changes in business infrastructure. • Exposure Reporting—Each manager’s underlying capital market exposures are aggregated across the portfolio regularly. Additionally, factor risk analysis is performed at the investment and portfolio level. Exhibit 2 Our Investment Process Manager Selection Portfolio Construction Risk Management Screening Incorporate Return Expectations Exposure Reporting Due Diligence Portfolio Construction and Rebalancing Monitoring For illustrative purposes only. Lazard Alternative Emerging Markets Strategy Portfolio Management Team Christopher (“Kit”) Boyatt Christian Frei, CFA Director Portfolio Manager/Analyst Director Portfolio Manager/Analyst Strategy Description Lazard Alternative Emerging Markets targets the returns of the MSCI Emerging Markets Index, while targeting less than half of the volatility of the index over a market cycle. The strategy typically invests in 15 to 25 underlying hedge funds while seeking portfolio level geographic and asset class diversification. The strategy seeks best-in-class managers invested in Asia, Latin America, Eastern Europe, Middle East and Africa, and Frontier Markets across various asset classes including equities, local markets, sovereign debt, and currencies. Typical Strategy Diversification Geographic Style Asset Class Global 40%–70% e.g., Global EM equity Long/Short, Relative Value Credit Long/Short 30%–100% Equities Regional 10%–40% e.g., LatAm Long/Short, EMEA Long/Short EM Macro 0%–30% Local Markets Country 10%–40% e.g., China Long/Short, Thailand long biased Relative Value 0%–30% Sovereign Debt Specialty 5%–15% e.g., EM distressed Assets, EM macro, EM pair trading Event Driven 0%–30% Currencies Notes 1 HFR, MSCI Red Book, August 2013 Important Information Published on 6 April 2016. An investment in any alternative investment is speculative, involves a high degree of risk, and may lose value. Privately offered investment vehicles are unregistered private investment funds or pools that invest and trade in many different markets, strategies, and instruments. Such funds generally are not subject to regulatory restrictions or oversight. Opportunities for redemptions and transferability of interests in these funds are restricted. The fees imposed, including management and incentive fees/allocations and expenses, may offset trading profits. Investors should not invest in any fund or strategy unless they are prepared to lose all or a substantial portion of their investment. The performance of the strategy is largely dependent on the talents and efforts of certain individuals. There can be no assurance that LAM’s investment professionals will continue to be associated with LAM and the failure to retain such investment professionals could have an adverse effect on the strategy. The strategy is subject to a number of actual and potential conflicts of interest involving LAM and its affiliates. LAM and its affiliates provide investment management services to other investors whose investment objectives may be similar to, or different from, the investment objective of the strategy. The directors, members, officers, and employees of the strategy, LAM and its affiliates may buy and sell securities for their own account or for the account of others. The investment manager may receive an incentive allocation and such a compensation arrangement may create an incentive to make investments that are riskier or more speculative than would be the case if such an arrangement were not in effect. The underlying hedge funds selected by the portfolio management team may invest in securities of non-US companies and which trade on non-US exchanges. These investments are denominated or traded in currencies other than US dollars involve certain considerations not typically associated with investments in US issuers or securities denominated or traded in US dollars. There may be less publicly available information about issuers in non-US countries that may not be subject to uniform accounting, auditing, and financial reporting standards and other disclosure requirements comparable to those applicable to US issuers. The underlying hedge funds selected by the portfolio management team will invest in and actively trade securities and other financial instruments using a variety of strategies and investment techniques (including but not limited to, arbitrage investing, investing in distressed and convertible securities, short selling, and utilizing leverage) with significant risk characteristics. The underlying funds invest wholly independently of one another and may at times hold economically offsetting positions or cause the strategy to be concentrated. Investment management fees and performance fees are charged by both LAM and the managers of the underlying funds. This document reflects the views of Lazard Asset Management LLC or its affiliates (“Lazard”) and sources believed to be reliable as of the publication date. There is no guarantee that any projection, forecast, or opinion in this material will be realized. Past performance does not guarantee future results. This document is for informational purposes only and does not constitute an investment agreement or investment advice. References to specific strategies or securities are provided solely in the context of this document and are not to be considered recommendations by Lazard. Investments in securities and derivatives involve risk, will fluctuate in price, and may result in losses. Certain securities and derivatives in Lazard’s investment strategies, and alternative strategies in particular, can include high degrees of risk and volatility, when compared to other securities or strategies. Similarly, certain securities in Lazard’s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Australia: FOR WHOLESALE INVESTORS ONLY. Issued by Lazard Asset Management Pacific Co., ABN 13 064 523 619, AFS License 238432, Level 39 Gateway, 1 Macquarie Place, Sydney NSW 2000. Dubai: Issued and approved by Lazard Gulf Limited, Gate Village 1, Level 2, Dubai International Financial Centre, PO Box 506644, Dubai, United Arab Emirates. Registered in Dubai International Financial Centre 0467. Authorised and regulated by the Dubai Financial Services Authority to deal with Professional Clients only. Germany: Issued by Lazard Asset Management (Deutschland) GmbH, Neue Mainzer Strasse 75, D-60311 Frankfurt am Main. Hong Kong: Issued by Lazard Asset Management (Hong Kong) Limited (AQZ743), Unit 29, Level 8, Two Exchange Square, 8 Connaught Place, Central, Hong Kong. Lazard Asset Management (Hong Kong) Limited is a corporation licensed by the Hong Kong Securities and Futures Commission to conduct Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities. This document is only for “professional investors” as defined under the Hong Kong Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) and its subsidiary legislation and may not be distributed or otherwise made available to any other person. Japan: Issued by Lazard Japan Asset Management K.K., ATT Annex 7th Floor, 2-11-7 Akasaka, Minato-ku, Tokyo 107-0052. People’s Republic of China: Issued by Lazard Asset Management. Lazard Asset Management does not carry out business in the P.R.C. and is not a licensed investment adviser with the China Securities Regulatory Commission or the China Banking Regulatory Commission. This document is for reference only and for intended recipients only. The information in this document does not constitute any specific investment advice on China capital markets or an offer of securities or investment, tax, legal, or other advice or recommendation or, an offer to sell or an invitation to apply for any product or service of Lazard Asset Management. Singapore: Issued by Lazard Asset Management (Singapore) Pte. Ltd., 1 Raffles Place, #15-02 One Raffles Place Tower 1, Singapore 048616. Company Registration Number 201135005W. This document is for “institutional investors” or “accredited investors” as defined under the Securities and Futures Act, Chapter 289 of Singapore and may not be distributed to any other person. South Korea: Issued by Lazard Korea Asset Management Co. Ltd., 10F Seoul Finance Center, 136 Sejong-daero, Jung-gu, Seoul, 100-768. United Kingdom: FOR PROFESSIONAL INVESTORS ONLY. Issued by Lazard Asset Management Ltd., 50 Stratton Street, London W1J 8LL. Registered in England Number 525667. Authorised and regulated by the Financial Conduct Authority (FCA). United States: Issued by Lazard Asset Management LLC, 30 Rockefeller Plaza, New York, NY 10112.