Currently in Cash: A focus on investment trends April 2013

1. Currently in Cash: A focus on investment trendsApril 2013 Kent Christian, Executive Director, Client Portfolio Manager, U.S. Short Term Fixed Income Group Kent.j.christian@jpmorgan.com 212 648 2703 Thomas Metzler, Managing Director, Head of Americas Corporate Sales Team for J.P. Morgan Global Liquidity Thomas.metzler@jpmorgan.com 212 622 3137

2. Overview • Foreign central banks have flooded the markets with liquidity • What are corporate treasurers doing now? • Regulatory reform - what is the potential impact for investors? • Interest rates are low, but will they head higher soon? • When rates normalize how will my portfolio perform? • Which way are credit spreads heading? • In summary – what are the issues and opportunities?

3. Foreign central banks have flooded the markets with liquidity

4. Bond markets reflect a global monetary experiment …Has Driven Down Developed Market Yields… Unprecedented Central Bank Intervention… Size of central bank balance sheet (in Millions of USD) US & German 2 Year Yields (%) Japanese 2 Year Yields (%) Source: Bloomberg. Data as of February 28, 2013. Source: Bloomberg, JPMSI. Data as of March 27, 2013

5. $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 '07 '08 '09 '10 '11 '12 '13 Mutual fund flows show money moving out of stocks and money market funds and into bond funds Cumulative Flows into Stock & Bond Funds Mutual Fund and ETF Fixed Income Flows for 2012 Includes both mutual funds and ETFs, $ billions Feb. ’13: $1,447 billion into bond funds and fixed income ETFs since ’07 Feb. ’13: $278 billion into stock funds and equity ETFs since ’07 Bonds Stocks Source: Investment Company Institute, J.P. Morgan Asset Management Data include flows through February 2013 and exclude ETFs. ICI data are subject to periodic revisions. World equity flows are inclusive of emerging market, global equity and regional equity flows. Hybrid flows include asset allocation, balanced fund, flexible fund, flexible portfolio and mixed income flows. Data are as of 3/31/13. Source: Morningstar, US Open-end, ETF, and MM Flows as of February 2013.

6. Source: BofA Merrill Lynch Indices. The above graph is shown for illustrative purposes only. Opinions and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice Strong technicals and good fundamentals have driven spreads and yields lower As February 28, 2013 Yield (%) BofA Merrill Lynch 1-5 Year Corporate A and above Option Adjusted Spread (bps) BofA Merrill Lynch 1-5 Year Corporate A and above Average spread 12/31/09 – 2/28/13: 128 bps Average spread 12/31/02 – 8/31/07: 56 bps

7. What are corporate treasurers doing now?

8. Segmenting liquidity needs for return optimization Total balance sheet cash Risk Profile Strategiccash Restrictedcash Reservecash Operatingcash Operating Reserve Restricted Strategic • Cash typically used for daily operating needs may be subject to unforeseen volatility • Requires preservation of principal • Late-day access • Same-day liquidity • Investment horizon of six to nine months or longer • Fairly static, same-day access not needed • Cash set aside for possible acquisition, stock buy back or R&D • Balances trapped in highly regulated jurisdictions or with repatriation-related tax issues • Cash collateral tied to credit agreements or derivative contracts • No short-term forecasted use • Cash on balance sheet that has not been historically used • Investment horizon of one year or longer The above chart is for illustrative purposes only.

9. Corporate Cash as a % of Current Assets Corporate Growth S&P 500 companies – cash and cash equivalents, quarterly $ bn , nonfarm nonfinancial capex , quarterly value of deals completed $1,300 $1,600 30% Capital Expenditures M&A Activity $1,400 $1,200 28% $1,200 26% $1,100 $1,000 24% $1,000 $800 22% $900 $600 20% $800 $400 18% $700 $200 16% $600 $0 14% '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 Dividend Payout Ratio Cash Returned to Shareholders S&P 500 companies, rolling 4 - quarter averages, billions USD S&P 500 companies, LTM $33 $160 60% Dividends per Share $140 $30 50% $120 $27 $100 $24 40% $80 $21 $60 30% $18 Share Buybacks $40 $15 $20 20% '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 Source: Standard & Poor’s, FRB, Bloomberg, FactSet, J.P. Morgan Securities, J.P. Morgan Asset Management. (Top left) Standard & Poor’s, FactSet, J.P. Morgan Asset Management. (Top right) M&A activity is the quarterly value of deals completed and capital expenditures are for nonfarm nonfinancial corporate business. (Bottom left) Standard & Poor’s, FactSet, J.P. Morgan A sse t Management. (Bottom right) Standard & Poor’s, Compustat , FactSet, J.P. Morgan Asset Management. Data are as of 3/31/13. Deploying corporate cash

10. Chart shown for illustrative and discussion purposes only. Source: J.P. Morgan Asset Management. Data as of February 28, 2013. Opinions and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice Strategies with more yield are attracting corporate cash Money Market Fund AUM ($) Managed Reserves & Short Duration AUM ($)

11. Source: JPMorgan Asset Management. Data as of March 20, 2013 Past performance is not indicative of future results. After narrowing dramatically, yield spreads among strategies appear to have stabilized Yield (%)

12. What are the options today? Data as of March 26, 2013 The above is shown for illustrative purposes only.

13. Regulatory reform – what is the potential impact for investors?

14. Money market fund regulation: Where are we going and what does it mean? U.S. Current Situation Possible SEC Proposal(s) Potential Impact • Investors value a stable NAV more than additional yield. Cash moves from Prime Funds into Government Funds • Supply/demand imbalance may occur as demand for short Treasuries, Agencies, and Repo backed by Treasuries and/or Agencies increases. • Yields on short Treasuries and Agencies may fall. • Spread between Treasuries/ Agencies and “credit” widen → yield differential between Gov’t and Credit MMF’s may widen. • Demand may increase for separate accounts? • Customization / Control • Search for Yield • Potential for greater use of bank deposits After significant reform in 2010, regulators are committed to additional reform Prime Funds = Floating NAV Treasury & Agency Funds = Stable NAV The FSOC proposed three alternatives in November 2012 Muni Funds = Stable NAV ? Floating NAV Stable NAV with “buffer” and minimum balance at risk Concerns will remain around tax and accounting issues until a firm ruling is made. Stable NAV with “buffer” and other measures There remains a wide range of regulatory proposals that must be viewed/considered in the wider context of the Cash Management industry as a whole. Other options • Stand-by liquidity facility • Ability to suspend redemptions • Enhanced transparency In Europe, Bloomberg recently received a report from the European Commission about it’s proposal for money market reform. Solution is coalescing around French style money market funds (floating rate NAV for all fund types). There is the potential to keep stable NAV, but must have a 3% buffer (held in cash).

15. Interest rates are low, but will they head higher soon?

16. Macro scenario probabilities & investment expectations: 2Q13 Expansion Contraction • Recession (5%) • GDP <0%; Inflation ~0% • We reduced our expectation for recession, as the lagged effect of negative real rates is expected to boost growth in 2013 • Recession could still result from public sector austerity leading to reduced consumption leading to a slower rate of employment gains in a negative feedback loop • Government bonds yields have risen sufficiently to offer attractive returns in this scenario • Crisis (5%) • The most likely tail event is geopolitical (MENA, East Asia) • A smaller concern is that social unrest in southern Europe boils over, causing capital flight from a weak European country • We are underweight safe haven assets, as we do not consider this scenario likely • Stagflation (0%) • GDP <0%; Inflation >3% • Central banks tacitly permit inflation to rise, targeting nominal GDP as real growth falls • In order to avoid debt deflation, inflation picks up even as real demand remains tepid while savings rates rise. • Commodities and inflation protected government bonds perform best • Base Case (80%): Sub Trend Recovery continues through 2013 • GDP 0-3%; Inflation 1-3% • For the fifth consecutive year, we are forecasting below trend growth in developed and emerging economies • Positives for global GDP include: the recovery in U.S. housing, bottoming of growth in China & Brazil, and averting a serious recession in Europe due to austerity fatigue. Continuing central bank debt monetization also improves markets for financial assets, and hence, funding • Headwinds to growth include fiscal drag in the U.S., official restraint of the property sector in China, and continuing imbalances between northern and southern Europe • High yield, local emerging market debt and IG financials are the team’s favorite sectors • Above Trend Growth (10%) • GDP >3%; Inflation ~2.5% • Unemployment rates continue to fall in the U.S., leading to a virtuous cycle of income growth and spending. Pent up demand for autos and housing sustain the growth • The weaker Japanese yen leads to more domestic consumption and capital spending in Japan • A pick up in spending on infrastructure in Brazil (World Cup 2014, Olympics 2016) and China (social housing) leads to stronger than expected EM growth • Fears that QE3 will end during 2013 cause government bond yields to rise sharply throughout the world • Investors concerned about a growth scare favored shorting Treasuries and going long EMFX to benefit from global rebalancing Source: GFICC Investment Strategy Team. As of March 12, 2013. Opinions, estimates, forecasts, projections and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. There can be no guarantee they will be met.

17. In spite of massive fiscal and monetary stimulus GDP growth remains below trend Size of Fed’s balance sheet ($ Millions) U.S. GDP Quarterly (% Annualized) Trend GDP Source: Bloomberg. As of March 28, 2013

18. Interest rates can stay low for a long time 10-year Government Bond Rates (%) Source: JPMSI. Data as of March 31, 2013. The chart is shown for illustrative purposes only.

19. When will the Fed end its zero interest rate policy? U.S. Unemployment Rate (%) U.S. Labor Force Participation Rate (%) 7.6% 6.5 63.3% Source: Bloomberg. Data as of 4/5/13. The above is shown for illustrative purposes only. Opinions and forecasts are based on current market conditions and are subject to change without notice.

20. When does the market expect interest rates to rise? When does the Fed expect interest rates to rise? Appropriate Timing of Policy Firming March 2013 FOMC Meeting When does the market expect interest rates to rise? Fed Funds (%) Source: Bloomberg. Left Chart: Data as of March 20, 2013. Right Chart: Data as of March 31, 2013. The chart is shown for illustrative purposes only.

21. When rates normalize how will my portfolio perform?

22. STRICTLY PRIVATE/CONFIDENTIAL Historical rising rate environments Treasury Yields and Fed Funds Rate, % Source: Bloomberg. Data as of February 28, 2013. Shaded areas represent rising rate periods.

23. Fund flows when the Fed turns: 1993 – 1994 fed funds rate +250 bps Fed Funds Target and 5 Year Treasury Yield Target Rate Yield Mutual Fund and ETF Fixed Income Flows 1993 Mutual Fund and ETF Fixed Income Flows 1994 5 Year UST Yield: 5.2%  7.8% ( +263bps) 5 Year UST Yield: 6.0%  5.2% ( -83bps) Millions Millions 1993 1994 Note: Data begins February 1993 Source (Top): Bloomberg March 2013. Source (Bottom): Morningstar, US Open-end, ETF, and MM Flows as of February 2013. Data includes equity and bond mutual funds and ETF flows.

24. Today there is less of a coupon cushion to offset a negative price move Coupon vs. Price Returns: BofA ML 1-5 Yr US Gov/Corp Index Returns YTM Source: Bloomberg, BofA Merrill Lynch Indices

25. Estimated effect of rising rates on the sample portfolios • From 5/31/04 to 6/30/06, interest rates rose approximately 200 bps • If rates rose the same amount over the next two years, assuming a linear upward move, we could see the following: Yield (%) Yield (%) Managed Reserves (A minimum rating) As of March 1, 2013: Starting Yield 0.47%, Duration 0.72 years Short Duration Portfolio (A minimum rating) As of March 1, 2013: Starting Yield 0.80%, Duration 2.60 years Data as of March 1, 2013 The above is shown for illustrative purposes only. These figures are subject to change based on market conditions.

26. Which way are credit spreads headed?

27. Yields are at historic lows but spreads are not As of March 31, 2013 BofA Merrill Lynch 1-5 Year Corporate OAS (bps) Yield (%) Source: BofA Merrill Lynch Indices. The above graph is shown for illustrative purposes only. Opinions and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice

28. Total Leverage Corporate Financing Gap S&P 500, ratio of total debt to total equity, quarterly Nonfarm nonfinancial corporate business, billions USD 240% $1,600 Total Internal Funds $1,400 Total Capital Expenditures 220% $1,200 Companies must $1,000 borrow 200% $800 Companies $600 can fund internally $400 180% '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 Average: 173% Interest Coverage Ratio (EBIT / Net Interest) S&P 500, quarterly 160% 3Q12 : 9x 7.2x 8x 7x 140% 6x 5x 4x 120% 3x 2x 1x 4Q12 : 108% 100% 0x '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 Corporate finances are in good shape Source: Federal Reserve, Compustat, Standard & Poor’s, FactSet, J.P. Morgan Asset Management. Data are as of 3/31/13. (Top Left): All data is from the Fed’s Flow of Funds tables report Z.1, F.102 lines 9 and 11. Total internal funds equal retained earnings plus depreciation.

29. LBO risk is back, security selection will be paramount Dell 5.4% 9/10/2040 Price and Yield Change YTD Dell Equity Price History YTD Price $ Yield Price $ The benchmark Dell dropped 20 points while yields rose 152 bps Dell stock has rallied over 30% Source: Bloomberg as of March 2013. Source: Bloomberg as of March 2013.

30. In summary – what are the issues and opportunities?

31. Summary • Foreign Central Banks have driven down interest rates and flooded the system with liquidity • The search for yield has forced investors into higher yielding investments narrowing credit spreads • Corporate treasurers are looking to put more money out the curve as cash balances grow and the need for more yield increases, diversification and cash forecasting remains critical • Floating rate NAVs are likely to be imposed on prime money market funds • We do not think interest rates are headed higher anytime soon • With interest rates low there is little cushion to offset any rise in interest rates • We remain constructive on credit spreads

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