KKR Insights 120408

Insights GLOBAL Macro Global MACRO TRENDS Trends April 2012

The Twin Roles of Real Assets

KKR Global Macro & Asset Allocation Team Henry H. McVey Head of Global Macro & Asset Allocation +1 (212) 519.1628 [email protected] David R. McNellis +1 (212) 519.1629 [email protected] Frances B. Lim +1 (212) 519.1630 [email protected] Rebecca J. Ramsey +1 (212) 519.1631 [email protected]

Main Office Kohlberg Kravis Roberts & Co. L.P. 9 West 57th Street Suite 4200 New York, New York 10019 + 1 (212) 750-8300 COMPANY Locations USA New York, San Francisco, Washington, D.C., Menlo Park, Houston Europe London, Paris Asia Hong Kong, Beijing, Dubai, Tokyo, Mumbai, Seoul Australia Sydney © 2012 Kohlberg Kravis Roberts & Co. L.P. All Rights Reserved.

2

KKR

Insights: Global Macro Trends

Economic, geopolitical and demographic factors have combined to create a compelling environment for investments in real assets—especially real estate, energy production, infrastructure and soft commodities. Such exposure may entail relinquishing some liquidity, and is also susceptible to the risk of a pullback in global economic growth. Yet, we believe real assets can still serve twin objectives: hedging against the potential effects of easy monetary policy and possible consequences of a Mideast conflict; and gaining exposure to attractive income—as well as yield and growth—in a low-rate environment.

2 We Want to Further Hedge Against Robust Commodity Prices. 2. Central to our asset allocation outlook for 2012—and our broader Phase III framework1 for the current environment—is our view that the corporate sector is a more attractive destination for capital allocations than the government and financial-intermediary sectors. However, ample government intervention (in the form of fiscal stimulus) and renewed geopolitical tensions may now be fueling a price surge of many commodities—oil in particular. Therefore, we feel compelled to maintain outsized exposure to an asset class that can act as a hedge to any inputcost related erosion of corporate profitability. 3. 3 Real Assets Are Increasingly Providing the Yield Component That Changing Demographics Require in Today’s Low Rate Environment. Many real assets managers are increasingly aiming for higher yields and return of capital to match demographic shifts in investors’ preferences caused by aging Baby Boomers. We whole-heartedly subscribe to this strategy. After all, in an environment of low nominal rates but outsized government liquidity, our research shows that coupons linked to inflation hedging investments may become more valuable. Moreover, given our strong view regarding demographic forces in the market, we think that there is significant potential for an upward revaluation of these types of investments that can provide investors with both a yield and growth component. Looking at the bigger picture, we believe our current asset-allocation framework reflects many of the key macro themes we see playing out. We maintain that the arbitrage between the low yields offered on government bonds and the higher yields on such “spicier” fixed-income products as mezzanine, high-yield and emerging1 See our paper entitled “Phase III: The Last Stage of a Bumpy Journey,” October 2011, available at KKR.com.

Exhibit 1

KKR Global Macro & Asset Allocation Suggested Portfolio Allocation Difference (%)

1 Additional Central Bank Liquidity Injections Could Drive Even 1. More Money Toward Real Assets. The balance sheets of developed markets’ central banks are ballooning to record proportions as a result of aggressive monetary policies intended to minimize the impact of slower growth, rolling financial crises and currency headwinds. In total, central-bank balance sheets of the four largest developed economies (the United States, the Eurozone, Japan, and the U.K.) have reached 25% of their collective GDP and 37% of their combined equity market capitalization. Furthermore, given the size of their mounting debts, these governments’ only remaining tool to control their debt burdens could be to hold interest rates below the nominal rate of GDP growth for an extended period of time. History shows this course of action is often inflationary in nature.

Finally, as we mentioned above and detail below, we are increasingly of the mindset that the real assets category is currently one of the few asset classes that offer both offensive and defensive characteristics in today’s increasingly liquidity-driven macro environment.

Benchmark (%)

Why? Because, as we will explain in more detail in the following pages, we have greater conviction in three mega macro trends that we believe benefit an increasingly outsized position to real assets in the near-term:

market debt is still compelling. Not surprisingly, we continue to be underweight government bonds by a full 15%—our largest underweight position by far (Exhibit 1). At the same time, our overweight position in traditional alternatives gives us critical exposure to the upside of surging consumption in Asia, distressed securities in Europe and select opportunities in the United States.

KKR GMAA Target Asset Allocation (%)

Back in January 2012, we targeted a substantial overweight allocation of 10% to real assets versus a benchmark weight of 5%—and so far, roughly four months into the year, we remain confident in our outlook. In fact, given our current worldview, we would likely use any weakness to allocate even more to the asset class.

50

53

-3

U.S.

20

20

0

Europe

12

15

-3

All Asia

12

12

0

Latin America

6

6

0

Total Fixed Income

25

30

-5

Global Government

5

20

-15

Mezzanine

5

0

5

High Yield

5

5

0

High Grade

5

5

0

EMD

5

0

5

10

5

5

Real Estate

3

2

1

Energy/Infrastructure

5

2

3

Gold/Corn/Other

2

1

1

Other Alternatives

15

10

5

Traditional PE

5

5

0

Distressed & Special Situation

5

0

5

Other

5

5

0

0

2

-2

Asset Class Public Equities

Real Assets

Cash

Source: KKR Global Macro and Asset Allocation as at April 6, 2012.

KKR

Insights: Global Macro Trends

3

Decline in Real GDP

Monetary

Fiscal

Combined

How big is the central bankers’ proverbial boat these days? In the United States, monetary and fiscal stimulus is now 38% of GDP—four and a half times what the government spent during the Great Depression (Exhibit 2). The European Central Bank’s (ECB’s) balance sheet has grown 34% year-over-year as of February 2012, and is now bigger than the Fed’s in absolute and relative terms. All told, as Exhibit 3 shows, the central-bank balance sheets of the four largest developed economies have swollen to 25% of their collective GDP (from 20% a year ago and 11% in December 2006) and to 37% of their collective market capitalization (from 29% a year ago and 13% at the end of 2006).

Length (Months)

In some ways, it seems as if the world’s central bankers collectively have been cast as Chief Brody 37 years later — this time, dealing with the repercussions of a financial crisis. Indeed, it appears that many of them initially espoused traditional monetary and fiscal tools to deal with the aftermath of the Great Recession. But after realizing that traditional measures weren’t enough to sustain a global economic recovery, they resolved to deploy the remedy of a “bigger boat.”

Unprecedented Amount of Stimulus: The U.S. Government Has Already Injected 4.5x What it Did in the Great Depression Trough GDP

Government Stimulus is Now Oversized. One of the first films I ever went to see in a movie theater was Steven Spielberg’s 1975 classic, Jaws. A memorable scene from that film came to mind in which police chief Martin Brody, played by Roy Scheider, realized what would be required to hunt down a mighty shark and exclaimed: “We’re going to need a bigger boat!”

Exhibit 2

Aug-29

Mar-33

43

27.0%

3.4%

4.9%

8.3%

May-37

Jun-38

13

3.4

0.0

2.2

2.2

Nov-48

Oct-49

11

1.7

-2.2

5.5

3.3

Jul-53

May-54

10

2.7

0.0

-1.4

-1.4

Aug-57

Apr-58

8

3.2

0.0

3.2

3.2

Apr-60

Feb-61

10

1.0

0.7

1.0

1.7

Dec-69

Nov-70

11

0.2

0.3

2.4

2.7

Nov-73

Mar-75

16

3.1

0.9

3.1

4.0

Jan-80

Jul-80

6

2.2

0.4

1.1

1.5

Jul-81

Nov-82

16

2.6

0.3

3.5

2.8

Jul-90

Mar-91

8

1.3

1.0

1.8

2.8

Mar-01

Nov-01

8

0.2

1.3

5.9

7.2

Dec-07

Jun-09

18

5.1

18.3*

19.2*

37.5*

Peak GDP

The Macro Case for Real Assets

Data as at January 31, 2012. *Estimated against 2011 GDP of $15 trillion. Source: Federal Reserve, Congressional Budget Office, Grant’s Interest Rate Observer. KKR Global Macro and Asset Allocation.

Exhibit 3

Central Banks are Offsetting Austerity with Loose Monetary Policy

“ We feel compelled to maintain outsized exposure to an asset class that can act as a hedge to any input-cost related erosion of corporate profitability. “

Central Bank Balance Sheet % GDP Fed

35

BoE

ECB

BoJ

% 30 25 20 15 10 5 0 2006

2007

2008

2009

2010

2011

2012

Data as at February 29, 2012. Source: Federal Reserve Board, Bureau of Economic Analysis, European Central Bank, Bank of England, Bank of Japan, Swiss National Bank, Statistical Office of the European Communities, UK Office for National Statistics, Cabinet Office of Japan, Haver.

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KKR

Insights: Global Macro Trends

The good news is that recent programs—particularly the ECB’s LTRO lending program—have been effective in dampening volatility2. However, this has come at a price: Real-asset prices are climbing as financial assets are incrementally debased. Exhibit 4 illustrates the correlation in recent years between declines in long-term real rates and increases in the price of commodities including gold, crude oil and real estate. We view the decline of real long-term interest rates as a good proxy for central bank liquidity, including promises of continued low policy rates in the future, quantitative easing, currency intervention, and the longer-term financing of potentially risky collateral (e.g., the LTRO).

“ There is significant potential for an upward revaluation of assets that can provide investors with both yield and growth. “

Exhibit 4

Strong Relationship Between Lower Real Interest Rates and Higher Commodity Prices WTI Crude Px (Left)

Dow Jones REIT TR Index (Left)

US/EZ/UK/JP Real Yield, % (Right, Inverted)

US/EZ/UK/JP Real Yield, % (Right, Inverted)

US/EZ/UK/JP Real Yield, % (Right, Inverted)

2.0 40

Oct-11

Apr-11

Oct-10

Apr-10

Oct-09

Oct-08

Apr-09

Oct-07

Apr-08

20 Apr-07

Oct-11

Apr-11

Oct-10

Apr-10

Oct-09

Oct-08

Apr-09

3.0 Oct-07

600 Apr-08

2.5

Apr-07

800

0.0

0.5

800

0.5

1.0

700

1.0

1.5

600

1.5

2.0

500

2.0

2.5

400

2.5

3.0

300

3.0 Oct-11

60

900

Apr-11

1.5

1,000

80

0.0

Oct-10

1.0 1,200

-1.0 -0.5

Apr-10

0.5

1,400

100

-0.5

Oct-09

0.0

1,600

1,100 1,000

Oct-08

120

-1.0

Apr-09

1,800

140

Oct-07

-0.5

Apr-08

-1.0

Apr-07

2,000

Gold Px (Left)

Data as at February 29, 2012. Real yield composite is the GDP-weighted average of rates in the United States (10yr TIPS), United Kingdom (10yr Inflation-Linked Gilt), Germany (BarCap Germany Inflation Linked, 5yr+ Maturities), and Japan (BarCap Japan Inflation Linked, All Maturities). Source: Bloomberg, KKR Global Macro & Asset Allocation analysis.

Our current base view is that these programs are not temporary; rather, we see central banks committed to keeping interest rates low and liquidity high in the foreseeable future. As such, we think that such aggressive and unprecedented moves by the Fed and its global peers of late may continue to benefit overweight positions in such real assets as real estate, infrastructure, and oil-producing assets. Some Inflation Will Eventually Be Required to Bring Debt Levels Down. John Maynard Keynes once said that “by a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” While he wrote this in 1919 in response to post-World War I economic policies, we think his comment remains valid today, given that the developed world is again awash in indebtedness—much of it government-related—and it appears that a measure of inflation could be needed to lower the debt burden at some point. Implementing an

inflation hedge that protects against Keynes’ alleged “confiscation of wealth” would therefore make sense, we believe. As it stands now, total U.S. debt currently stands around 339% of GDP, down just slightly from a peak of 349% in March 2010 (Exhibit 5). Perhaps even more concerning is that economic growth seems ever more dependent on cheap credit. In each decade since the 1950s, the United States has incrementally taken on more debt for every increment of GDP growth (Exhibit 6). Europe, too, has a welldocumented debt overhang, but it also confronts the headwind of fiscal austerity.

2 LTRO: Long-term refinancing operations. Central bank action can play an important role in dampening interest rate volatility. ECB’s LTRO has lowered implied volatility in European rates markets by 20% since its launch in mid-December according to Bond Market Observations, BNY Mellon as at February 2012. KKR

Insights: Global Macro Trends

5

United States has a long history of collecting tax revenues that average about 18% of GDP, and it’s worth mentioning that it has never collected taxes above 20% of GDP for a prolonged period of time.

Exhibit 5

The Elephant In The Room: US Debt % of GDP Dec-11 339%

US Debt % GDP

350% 300%

Exhibit 7

Challenging Outlook for U.S. Primary Budget Deficit Could Eventually Lead to Inflationary Policies

Mar-32, 298%

250% U.S. Federal Revenues and Primary (Noninterest) Spending 200% Revenues % GDP Primary Spending % GDP

Financials

150%

Government

100%

GSE Corporates

50% 0% 1920

Households 1930

1940

1950

1960

1970

1980

1990

2000 2010

1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014e 2017e 2020e 2023e 2026e 2029e 2032e 2035e

GDP = Gross Domestic Product; GSE = Government Sponsored Enterprises. Source: BEA, Federal Reserve, Morgan Stanley Research and “The Statistical History of the United States” by Ben Wattenberg. Data through 4Q2011.

24% 23% 22% 21% 20% 19% 18% 17% 16% 15% 14%

Exhibit 6

Now, More Than Ever, It Takes Money To Make Money 5.6

US Economy: Incremental Dollars of Debt Per Incremental Dollar of GDP

e = estimate. Revenue estimates assume federal revenues as a % of GDP revert to historical average of 18%. Primary (i.e., noninterest) spending estimates are as per CBO long-term forecasts published June 22, 2011. Source: Congressional Budget Office, KKR Global Macro & Asset Allocation analysis.

Exhibit 8 2.9

1.4

1.5

3.1

Holding Interest Rates Below GDP Growth Would Aid U.S. Debt Dynamics, But Could Rekindle Inflation

1.7

U.S. Nominal GDP Growth, Surplus/(Deficit) Relative to Interest Rate* (3yr Rolling Average) 5% 1950's

1960's

1970's

1980's

1990's

2000's

1979 3.7%

4% 3%

GDP = Gross Domestic Product. 2000’s = 1999 to 2009. Source: BEA, Federal Reserve, Bloomberg.

2% Headed Higher?

1% 0%

3 See our report entitled Brave New World: The Yearning for Yield Across Asset Classes, December 2011, available at KKR.com.

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KKR

Insights: Global Macro Trends

-1% -2%

End of Stagflation

-3% -4%

2008

2004

1996

2000

1988

1984

1976

1980

1972

1968

1964

1956

1992

1982 -4.6%

-5% 1960

Although we believe that government austerity measures and private-sector deleveraging in Europe and the United States could actually be disinflationary in the near term, we hold that an inflationary policy may ultimately be needed to help shrink the huge debt burden that has accumulated of late. Remember that a government can control its debt burden relative to GDP via only two means: (i) running primary surpluses by having tax receipts greater than payments for non-interest expenses, including entitlements; and/ or (ii) holding nominal interest rates below the rate of nominal GDP growth. Exhibit 7 below illustrates the enormous challenge to achieving primary surpluses in the United States in coming years (and without question, we think Europe faces a similar, if not greater, challenge). Namely, rising old-age entitlement spending and rapidly escalating health care costs are set to push spending to historically unprecedented levels relative to GDP3. Meanwhile, the

*We use the U.S. 5-Year Treasury Yield as a proxy for government funding cost. The average maturity of U.S. total outstanding marketable debt centers around 60 months. Source: Bureau of Economic Analysis, Bloomberg, KKR Global Macro & Asset Allocation analysis.

So, if running significant primary surpluses is likely unachievable, then the government’s only remaining tool to control its debt burden may be to hold interest rates below the nominal rate of GDP growth for an extended period of time. Exhibit 8 shows that would not be an unprecedented maneuver, as U.S. GDP outstripped interest rates

If inflation does indeed rear its head at some point, are commodityrelated real assets an effective inflation hedge? In our view, they certainly are: Our research on the subject shows that commodities can serve as the most effective inflation hedge among various asset classes. According to a study by economists Gary Gorton and K. Geert Rouwenhorst, commodities emerge as the winner versus stocks and bonds as an inflation hedge in a variety of environments (Exhibit 9). Exhibit 9

Correlation Of Asset Classes With Inflation* Shows Commodities Are a Strong Hedge

Exhibit 10

Inflation Hedging Power of Real Estate is Strong, Particularly in a Low Rate Environment Correlation of Real Estate Indexes and Inflation in Various Yield Environments NCREIF Total Rate of Return on Real Estate FTSE NAREIT Equity REITs Total Return Index

57%

59% 51%

Correlation against Inflation

consistently from the 1950s through the 1970s, which helped reduce its World War II debts. Unfortunately, that policy also helped set off the stagflationary woes of the 1970s: As Exhibit 8 clarifies, it wasn’t until Paul Volcker tightened monetary policy aggressively in the 1980s that the United States entered a disinflationary trend that has been the norm for the past 30 years.

-1%

-11% 0-4%

Quarterly Correlation of Assets with Components of Inflation July 1959 – December 2004 Stocks

Bonds

Commodity Futures

Commodities Positively Correlated with Inflation

30% 20%

-3%

4-8%

>8%

US 10 Year Yield (%)

Data from 1Q1978 to 3Q2011. Correlation of US Consumer Price Index quarter-over-quarter change against NCREIF Total Rate of Return on Real Estate4 and NAREIT Equity REITs quarterly total returns. Source: Bureau of Labor Statistics, National Council of Real Estate Investment Fiduciaries, Federal Reserve Board, Bloomberg.

10% 0%

Among real assets, real estate also emerges as a beneficiary of rising inflation. This is particularly true in low-interest environments like the current one, in which any modest rise in financing costs is unlikely to undermine the attractiveness of potential investments (Exhibit 10).

-10% -20% -30% -40% Stocks and Bond Negatively Correlated with Inflation

-50% -60% Inflation

Change Expected Inflation

Unexpected Inflation

Definitions: Inflation: Y/Y% Consumer Price Index (CPI); Expected inflation: T-bill rate as proxy; Unexpected inflation: Inflation - Expected inflation. For additional information regarding the chart and basis for the data shown, please refer to Page 19 Table 6 within Facts and Fantasies about Commodity Futures. Data is quarterly from July 1959 through 2004. Source: Gorton & Rouwenhorst, Facts and Fantasies about Commodity Futures: February 28, 2005.

“ Real assets are among the few that offer offensive and defensive characteristics in today’s increasingly liquidity-driven macro environment. “

Real Assets Are Also an Attractive Hedge Against Our Bullish View of the Corporate Sector. When we laid out our initial investment framework in October, we promoted the view that an unleveraged corporate sector was the best place to allocate capital, particularly relative to financial institutions and government entities. Our view remains unchanged. In aggregate, U.S. corporations currently have low leverage and their operations generate healthy cash flows, yet credit spreads remain well above the historical average while equity valuations remain significantly below it. By comparison, the U.S. government currently exhibits record-high indebtedness and a lackluster equivalent of “cash flow from operations” (as measured by the current account deficit and fiscal primary balance)—yet it continues to borrow money at historically low yields (Exhibit 11). Meanwhile, financial institutions have de-levered, but questions remain about their ability to sustain returns above their cost of capital.

4 NCREIF Total Rate of Return on Real Estate, where quarterly rates of return on real estate investments are calculated with net operating income, appreciation in market value and improvements made to the property. For more details, visit NCREIF.org. KKR

Insights: Global Macro Trends

7

Exhibit 11

The Three Phases of This Debt Bubble: From Corporates to Wall Street to Sovereigns Phase I

Phase III

Corporate Leverage Wall Street Government

Exhibit 13 120

30

100

25

80

20 60 15 40

10 5

20

0

0 2000

2007

Rising Oil Prices is a Negative for Growth… Government Leverage (%)

Corporate and Wall Street Leverage

35

Phase II

the ISM index.5 In many instances, the ISM falls in response to both higher input costs and lower-end demand (Exhibit 13). In addition, equity valuations typically contract when oil and other commodity prices increase (Exhibit 14). Hence, quite frankly, we believe it makes sense to have investment exposure to the culprit behind thinner corporate profit margins and slower economic growth— rather than solely having exposure to the culprit’s target.

Headline ISM Manufacturing (Left Axis) WTI Oil, leading 6m, reverse scale (Right Axis) 70

20

65

40

60 60

55

2011

50

Corporate Leverage = S&P 500 ex-Financials Net Debt-to-Assets; Wall Street Leverage = Average Assets-to-Equity for Goldman Sachs and Morgan Stanley; Government Leverage = United States: General Government Gross Debt % of Gross Domestic Product (GDP). Source: IMF WEO, Factset, S&P. Data as at September 30, 2011.

80

45

100

40 120

35 30 2004 2005 2006 2007 2008 2009 2010

Exhibit 12

Rising Oil Prices Typically Move in the Opposite Direction of Corporate Earnings

140 2011

2012

Data as at February 22, 2012. Source: Institute for Supply Management, Haver.

Exhibit 14 S&P 500 EPS (Left Axis)

60%

WTI Crude, 12mo Moving Avg. Y/Y (Right Axis, Inverted, Leading 18mo)

...and Equity Valuations -50% S&P 500 Forward NTM P/E (Left Axis)

50%

-30%

40% 30%

-10%

20%

10%

10% 0%

30%

-10%

50%

-20%

70% 86 88 90 92 94 96 98 00 02 04 06 08 10 12

WTI = West Texas Intermediate. Source: Bloomberg, S&P, Thomson Financial, Factset.

Given the propensity of surging oil prices to dampen corporate profits and growth (Exhibit 12), we think that increasing exposure to real assets creates an important hedge to our sizeable exposure to the corporate sector. There are two factors underlying our rationale. First, as oil prices increase, there is usually a slowdown in

KKR

0

17

50

16 15 14 13

-30%

8

Gasoline Prices Leading 6m, reverse scale (Right Axis) 18

Insights: Global Macro Trends

12

100 150 200 250 300 350

11

400

10 2004 2005 2006 2007 2008 2009 2010 2011 2012

450

Data as at February 22, 2012. Source: Energy Information Administration, S&P, Thomson Financial, Factset, Haver.

5 The Institute for Supply Management (ISM) Manufacturing Index is a survey released on the first business day of every month of more than 300 manufacturing companies, which monitors employment, production inventories, new orders and supplier deliveries.

In Many Instances We Are Now Getting Paid to Wait as Real Assets Are Increasingly Tied into our Yield-and-Growth Theme. What makes many real asset investments especially compelling in our view is that many of today’s investments in the asset class now offer not only appreciation—but also attractive return of capital along the way. It wasn’t always this way.

Exhibit 16

Retirees Have a Strong Appetite for Dividend Yield Estimated Dividend Yield of Equity Portfolios, By Age of Head of U.S. Household - 2007 (%) 2.8

For example, today we see a growing number of real estate and oil production investments being structured such that investors can get dividend income of 4–8% upfront, in addition to inflation hedging and the potential for capital appreciation. The income component has always been germane to public real estate investment trusts (REITs), but now we increasingly see investment managers in private real assets pursuing attractive dividend yields and still retaining the potential for capital appreciation. Probably more important though, is the opportunity for managers to buy older oil production operations at attractive prices, resuscitate their wells, and use the proceeds to create a sizeable dividend stream for investors. Exhibit 15

Under 65

Rapidly Aging Populations are Global in Nature Percentage of Population Age 60+ 2050 41.5

45 2030 37.1

40 35

33.9

2010 30.5

29.0

30 25

10 5 2000

33.6

25.3 21.8

2050 26.6

2030 24.4

20 15

1.5

US

18.4

Japan China

2010 12.3 2010

Europe 2020

2030

2040

2050

Data as at May 31, 2011. Source: United Nations World Population Prospects

“ We think that recent aggressive moves by the Fed and other central bankers will continue to benefit overweight positions in such real assets as real estate, infrastructure, and oil-producing assets. “

Over 65

Data as at December 6, 2011. Dividend yield calculated using dividend income as reported by the IRS Statistics of Income Division and equity holdings as reported by the Federal Reserve Survey of Consumer Finances. Our estimate includes an assumption that roughly half of privately held businesses pay some form of dividend. Source: IRS, Federal Reserve, KKR Global Macro and Asset Allocation estimates.

We view return of capital as a critical component of our macro view and asset-allocation strategy, since we believe that assets offering yield and growth are likely to be revalued upward in the coming years because of demographic trends among the investor population. These trends present a strong—yet often underappreciated—force driving asset preferences and subsequent returns. As Exhibit 15 shows, almost every major developed economy has hit or is fast approaching an important demographic inflection point. This transition is important because, as Exhibit 16 shows, many retirees, particularly among Baby Boomers, aspire to materially increase the yields on their portfolios as they grow older. These investors don’t just pursue yield in isolation; they seek yield combined with the potential for growth and, if possible, an inflation hedge. Given that real assets contain all three of these attributes, we think there is great potential for an upward revaluation of such assets. Additionally, since other inflation-protection instruments like TIPS now have negative yields (meaning that investors now need to pay for the inflation protection they receive), we believe the yield component of real estate and certain energy and related infrastructure investments is far more compelling in today’s market (Exhibits 17 and 18).

KKR

Insights: Global Macro Trends

9

repercussions—a consequence to be expected given Iran’s central role in the world’s oil supply (Exhibit 20).

exhIbIt 17

U.S. TIPS Yields Are at All Time Lows

exhIbIt 19 5.00

U.S. 10 Year TIPS Yield (%) U.S. 5 Year TIPS Yield (%)

4.00

Geopolitical Tensions Enhance the Appeal of Real Assets

3.00 March 8, 2012

2.00

World Powers Press Iran for talks

1.00 0.00

-0.27 March 8, 2012

-1.00 -1.42

Iran Is Pressed on access for nuclear Inspectors

-2.00 1997

2000

2003

2006

2009

2012

tIPs = treasury Inflation Protection securities. data as at March 12, 2012. source: bloomberg.

March 9, 2012

Weighing impact of Israel striking Iran exhIbIt 18

If We Do Experience Inflation, Government Bonds May be at Significant Risks

March 10, 2012

the view from tehran 7

Real 10 Year Yield Percentage (Nominal 10 Yr Yield - CPI yy)

6

6.4

source: Publications cited, KKr global Macro and asset allocation team.

5 4

history has validated our concerns: In past supply disruptions, crude oil prices rose an average of 62%, depending on the magnitude of the shock to supply. additionally, the correlation between peak supply loss and the peak of oil prices is 91%, so the larger the supply loss, the higher the price increase (Exhibit 21).

2.6

3 2 0.8

1

1.2

0

Brazil

Italy

Japan

Euro

-0.3

France

-0.9

Germany

-1.1 China

-3

-1.6 U.K.

-2

-1.1 U.S.

-1

real yield calculated as current nominal yield minus current inflation. this yield may not be representative of yields earned by foreign investors which may be subject to other levies and taxes (e.g., brazil has an IoF or Financial operations tax of 6% on certain instruments). data as at January 31, 2012. source: bloomberg.

Real Assets May Help Hedge Against Rising Geopolitical Tensions. among the many headwinds of today’s global macro environment, we think Middle east tensions are among the most significant and pose a sizeable tail risk to the global economy. beyond the instability and uncertainty wrought by the arab spring, the standoff over Iran’s nuclear program has the potential to escalate to a broader conflict (Exhibit 19), in which case real assets could serve as a hedge against skyrocketing energy prices and related economic

10

KKR

InsIghts: global Macro trends

libya was the world’s eighteenth largest oil producer before the uprising that unseated its government6. the libyan revolt claimed a loss of 1.8 million barrels of oil-production capacity, and prices rose about 35%. but unlike libya, Iran is the world’s sixth largest oil and liquid fuels producer, with production of 3.6 million barrels per day—twice that of libya. If we lost Iran’s 3.6 million-barrel supply, historical patterns suggest that crude oil prices could rise another 85% from current levels, or about $190 per barrel. this is not our base case, but it may explain why oil prices have edged up on fears of a conflict involving Iran—and it also underscores the importance of having some downside protection in the event of a geopolitical shock that could severely crimp oil supply.

6 source: energy Information administration International statistics.

Exhibit 20

Iran Still Produces 3.6 Million Barrels of Oil Per Day Top 10 Crude Oil and Liquid Fuels Supply/ Production (Millions Barrels Per Day) 1

United States

10.5

2

Russia

10.3

3

Saudi Arabia

9.8

4

China

4.3

5

Canada

3.8

6

Iran

3.6

7

Mexico

2.9

8

Brazil

2.8

9

Iraq

2.7

10

UAE

2.6

Other World

22.5 barrels of oil annually per person, compared to just 2.5 barrels in China; U.S. residents consumed 907 kilograms of corn annually per person, compared to 123 kilograms in China7. More importantly, China can no longer satisfy its citizens’ growing appetite for natural resources with domestic supply, and has shifted from being an exporter of such goods to an importer, in many instances. For example, China has experienced a notable surge of imports of crude oil and agricultural commodities—particularly corn—in recent years (Exhibit 22). Exhibit 22

China has Gone from a Net Exporter to Importer and from Minor Consumer to Major Consumer in a Number of Categories  

Exporter in 2005

Importer in 2011

Units

Road Vehicles

9516

-5503

US$m

35.5

Corn

3665

-3800

1000 MT

88.7

Swine Meat

454

-290

1000 MT CWE

Beverage and Tobacco

395

-1412

US$m

Wheat

268

-500

1000 MT

4

-65

1000 Heads

mb/d = Million Barrels Per Day. Source: Energy Information Administration Short-Term Energy Outlook March 2012.

Exhibit 21

Cattle Animals

Rise in WTI Crude Oil Price From Trough to Peak (%)

Geopolitical Events Tend to Lead to Oil Price Surges

China % World Consumption  

2000

2010

Cement

35.7%

56.2%

Pork

46.9%

49.9%

Coal

30.7%

48.2%

Steel

15.1%

44.6%

Lead

10.2%

44.0%

Cotton

25.0%

40.2%

Aluminum

13.4%

39.8%

Copper

12.4%

38.3%

Nickel

5.1%

37.2%

Oil

6.2%

10.4%

180% Iranian Revolution / Iran-Iraq War

160% 140%

Arab-Israeli War & Arab Oil Embargo

120% 100% Iran 2012??

Iraqi Invasion of Kuwait

80% 60%

Hurricanes Katrina/Rita

40%

War in Iraq Venezuelan Strike

Libya Civil War

20%

Suez Crisis 0% 0

Six Day War 2

4

6

Crude Oil Gross Peak Supply Loss (Millions of Barrels Per Day)

Data as at February 29, 2012. Source: International Energy Agency, Bloomberg.

Emerging-Market Growth Appears to Favor Real Assets—Commodities in Particular. We see real assets as a sort of investment “play” on the rising consumption patterns of emerging-market populations. As high population countries like China accelerate their urbanization and experience an increase in personal income, the demand for such commodities as corn, cotton, and oil may continue to rise. Consider the following: In 2010, U.S. residents consumed

Data as at December 30, 2011. Source: China Customs, United States Department of Agriculture, Haver. As of 2010. Source: USDA, USGS, World Steel Association, China National Bureau of Statistics, EIA, IEA, BP Statistical Review, World Bureau of Metal Statistics, Bloomberg, Haver.

7 Source: BP Statistical Review, UN World Population Prospects. KKR

Insights: Global Macro Trends

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Exhibit 23

Exhibit 24

EM Consumption is Now Bigger than U.S. Consumption

Urbanization is a Strong Driver of Growth…

Private Consumption Urbanization Versus Growth

US$ Trillion

450% United States

13

13.3

Emerging Markets 12.1

12 11

11.0

10

9.3

8.8

9.2

9 8

11.0

9.8

10.0

9.9

10.2

8.0

7 6 2005

2006

2007

2008

2009

2010

Emerging markets includes emerging and developing economies as defined by IMF, Korea, Taiwan, and Singapore. Data from 2005-2010. Source: IMF, KKR Global Macro and Asset Allocation Research.

400% Change in Nominal GDP US$ 2010 vs 2000

14

China

350% 300%

Indonesia

250%

Vietnam

200% 150% 100% 50%

US

0% -10%

Japan 0%

10%

20%

30%

Change in Urban Population % Total 2010 vs 2000

Emerging markets are big and getting bigger: Their combined consumption is now not only larger than that of the United States, but is also growing faster (Exhibit 23). A key catalyst to this growth is the urbanization of countries like China and India (Exhibit 24). The proportion of China’s population living in areas classified as urban stands at only 45%, and India’s is even less, at 30% (Exhibit 25). As urbanization percentages increase for these vastly populated countries, we expect demand for natural resources, including oil and soft commodities, to maintain its steady upward trend.

Data as at December 31, 2010. Source: IMF, World Bank.

Exhibit 25

...And China and India Have A lot More to Go 2010 Urban Population % of Total Brazil

86.5

Korea, Rep.

81.9

Canada

80.6

Mexico

77.8

France

“ We think there’s an opportunity for managers to buy older oil production operations at attractive prices, resuscitate their wells, and use the proceeds to create a sizeable dividend stream for investors. “

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Insights: Global Macro Trends

77.8

Germany

73.8

Russia

72.8

Turkey

69.6

Iran

69.5

Japan

66.8

South Africa

61.7

Indonesia

53.7

China

44.9

Thailand

34.0

India

30.1

Vietnam

28.8 0

20

40

60

80

100

Data as at December 31, 2010. Source: IMF, World Bank

But We Need to Be Mindful of the Risks, Too. Even the most persuasive investment ideas bear risks worth considering, and while we retain an overweight position in real assets with strong conviction, we observe several noteworthy pitfalls to keep an eye on. First, the bull market for real assets started more than a decade

ago as financial assets—equities in particular—were at record valuations. Fast-forward to today, and you will find that stocks have essentially gone nowhere over a decade, while gold has gone up 474%, oil has risen 269%, and the REIT index has climbed 200%8. To use a baseball metaphor, we may not be in the ninth inning—but we’re certainly not in the first. In addition, there is a lot of capital coming into the asset class, to energy-related investments in particular. The oil and gas industries are very capital-intensive, and over the past 12 years, capital expenditures in these industries have grown at an annualized rate of 16.7% to $151.0 billion—up from just $23.6 billion in 1999—whereas fixed, non-residential investment (ex-oil and ex-gas) has only grown at an annualized rate of 1.7% over the same period9. As a result, oil- and gas-related capital expenditures are now running at 9.9% of total non-residential investment, up from 2.0% in 1999. While shale plays are creating somewhat of a renaissance in drilling activity, the current level of energy capital expenditures (which stands at 10% of total non-residential expenditures) has historically signaled a peak during past cycles, including in 1944 and 1981 (Exhibit 26). However, as a percentage of market capitalization, energy still appears to have substantial upside before it would approach past peak levels of the S&P 500 (Exhibit 27). Exhibit 26

Energy Capital Expenditures is Now 10% of Total NonResidential Expenditures Oil and Gas Related Investment % Non -Residential Fixed Investment

14 12 10

1981, 11.9 1933, 9.6

2011, 9.9 2008, 10.3

1944, 10.3

Exhibit 27

Energy as a Percentage of S&P 500 is Still Well Below Past Peak Cycles Energy as a % of U.S. Market Cap Energy as a % of Europe Market Cap Nov-80, 31%

35% 30% 25%

Nov-80 23.8%

20%

Sep-02 13.4%

15%

Jun-08 16.2% 12.1%

Feb-00, 6.5%

10%

11.8%

Mar-86 6.6%

5%

Nov-99, 5.3%

0% 1975

1980

1985

1990

1995

2000

2005

2010

Data as at January 31, 2012. Source: Factset, Morgan Stanley Research.

Lastly, both commodities and real-estate prices are economically sensitive, and their correlations with a traditional 60/40 (equity/ bond) portfolio tend to increase during economic downturns10. This is particularly true for the Goldman Sachs Commodity Index, which many popular mutual funds currently use to theoretically gain exposure to real assets. We focus on investments that hedge some of the downside risks of commodities and, at the same time, present an opportunity to profit from production or market-share gains. And special discipline is advised for investors in real estate, namely sound financing strategies and reasonable leverage limits.

8 6 4 2

1999, 2.0

0 1929

1949

1969

1989

2009

Oil and Gas Related includes Mining Exploration, Shafts, Wells and Mining & Oilfield Machinery. Data as at December 31, 2011. Source: Bureau of Economic Analysis, Haver.

8 Source: Bloomberg. Data from December 31, 2000 to December 31, 2011. 9 Source: Bureau of Economic Analysis, Haver. Data as at December 31, 2011.

“ Beyond the instability and uncertainty wrought by the Arab Spring, the standoff over Iran’s nuclear program has the potential to escalate to a broader conflict, in which case real assets could serve as a hedge against skyrocketing energy prices and related economic repercussions. “ 10 See Exhibit 54 of Phase III: The Last Stage of a Bumpy Journey, October 2011 available on KKR.com. KKR

Insights: Global Macro Trends

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Summary In our view, the macro backdrop is extremely compelling for investments in real assets. We are targeting significant overweight positions in this asset class—including real estate, energy production, infrastructure, and soft commodities—as both a defensive and offensive strategy. Defensively speaking, we recommend hedging against highly loose monetary policy and potential fallout from geopolitical tensions stemming from the Middle East. We also view commodities, especially oil assets, as an effective hedge against corporate exposure, of which we possess a fair amount in our target asset allocation. On the offensive side, we favor the income-producing components that real estate, energy infrastructure, and production-related investments can provide—a particularly appealing feature to us in today’s low-rate environment. There are, of course, risks to our target positions. To pursue what we advocate, an investor generally must forfeit some liquidity in order to gain exposure beyond generic commodity swaps. Even so, it is a bet we are willing to make in light of the poor performance features that many well-known indexes provide. Just consider that between 2004 and 2011, on an absolute basis, the GSCI Index has returned just 8.5% versus 147.5% for the underlying spot commodity. Another risk is that global growth may slow sharply and undermine the value of many real assets. This risk is not to be discounted—yet we think that any pullback in real-asset performance, however major, could be temporary. Our belief is grounded in the underlying consumption trends in emerging markets that appear structural and secular—rather than cyclical—in nature. Finally, any future decision by central banks worldwide to begin contracting their balance sheets may come at a price. We are thus comfortable maintaining an overweight position in real assets—especially assets that have the potential to generate both yield and growth.

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“ We suggest focusing on investments that hedge some of the downside risks of commodities and, at the same time, present an opportunity to profit from production or market-share gains. “

Important Information

investment or other decision.

The views expressed in this presentation are the personal views of Henry McVey of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, “KKR”) and do not necessarily reflect the views of KKR itself. The views expressed reflect the current views of Mr. McVey as of the date hereof and neither Mr. McVey nor KKR undertakes to advise you of any changes in the views expressed herein. In addition, the views expressed do not necessarily reflect the opinions of any investment professional at KKR, and may not be reflected in the strategies and products that KKR offers. KKR and its affiliates may have positions (long or short) or engage in securities transactions that are not consistent with the information and views expressed in this presentation.

There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Target allocations contained herein are subject to change. There is no assurance that the target allocations will be achieved, and actual allocations may be significantly different than that shown here. This presentation should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.

This presentation has been prepared solely for informational purposes. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither KKR nor Mr. McVey guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an

The information in this presentation may contain projections or other forward‐looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this presentation, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Performance of all cited indices is calculated on a total return basis with dividends reinvested. The indices do not include any expenses, fees or charges

and are unmanaged and should not be considered investments. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Please note that changes in the rate of exchange of a currency may affect the value, price or income of an investment adversely. Neither KKR nor Mr. McVey assumes any duty to, nor undertakes to update forward looking statements. No representation or warranty, express or implied, is made or given by or on behalf of KKR, Mr. McVey or any other person as to the accuracy and completeness or fairness of the information contained in this presentation and no responsibility or liability is accepted for any such information. By accepting this presentation, the recipient acknowledges its understanding and acceptance of the foregoing statement. The MSCI sourced information in this document is the exclusive property of MSCI Inc. (MSCI). MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

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