Credit markets closed out 2009 on solid footing, despite a slight pullback in risk at yearend.  Although credit spreads ended the year near the tights, we expect the supportive tone to continue into 2010 as investors redeploy capital and hunt for yield.  The Asian high yield space is expected to be especially active in 1H10, as January is typically an active month for issuance.

We will monitor policy risk carefully next year as central banks attempt to drain the excess liquidity from the system.  Doing so without tipping parts of the world back into recession will require finesse.  Moreover, given the current low interest rate environment, companies are likely to flock to debt capital markets to fund growth plans.  As a result, single name event risk is likely to rise as poor risk management in Asia is likely to land some of the more aggressive borrowers into trouble.

From a macro perspective, it might make sense to start viewing the world not only from the perspective of excess liquidity, but in terms of true growth recovery in some of the world’s most troubled economies.  4Q09 data will be key in revealing if demand growth has any legs, and whether or not the recovery will be synchronized globally.

The Balance of Power is Shifting to Asia

Emerging markets will exhibit a powerful recovery in 2010, led by Asia which is expected to grow at a pace exceeding 7.4%.  During the past 4 years, emerging economies contributed more to the global GDP than all developed markets.  In fact, within the next few years, emerging economies will represent 50% of global GDP versus only 24% in 2000 and 39% in 2009.  These are changes on a tectonic scale.

 

Our 2010 Themes

We believe 2010 will be defined by three major themes: 1) the growing demand for commodities; 2) the rise of the Asian consumer; and 3) stronger Asian currencies.  Based on this view, 3 Degrees funds are poised to perform well.

The Asian Debt Fund

ADF focuses on good companies, with stretched balance sheets.  ADF takes a late-stage, event-driven view towards restructuring, where investments are made at the tail end of a reorganization process.  The themes we expect to play out in 2010 will positively impact ADF in that: 1) ADF has substantial exposure to commodity companies – as demand for commodities improves, these companies will outperform, be acquired or be able to access fresh capital to refinance or repay debt; 2) as the Asian consumer strengthens, ADF portfolio companies will generate improved cashflow, resulting in accelerated debt repayment; and 3) as over 60% of the Fund is denominated in USD, stronger Asian currencies means a natural deleveraging of ADF companies, resulting in faster debt repayment.

3DPropCo

3DPropCo doubled in AUM in 4Q09 to US$25 million.  Bintan Lagoon Resort (www.bintanlagoon.com), 3DPropCo’s principal position, has performed exceptionally well through the economic crisis, exhibiting strong, positive free cash flow every single month.  In 4Q09, BLR has commenced construction on a new signature restaurant, and the much anticipated ferry/breakwater project.  The property has received Indonesian government approval to build and operate a port directly on its beach.  We are optimistic that ferry operations may commence as early as July 2010.  We expect this to be a value transforming event and we are confident 3DPropCo will continue to perform well into 2010.  Moreover, BLR is in the final stages of preparing its application to the United States Green Building Council (USGBC), whereby BLR is likely to be the first “Green” resort in Southeast Asia.

Moreover, BLR gives us tremendous insight into consumer spending patterns and trends throughout the region.  The rise of the Asian consumer has become pronounced as Indonesian guests spend more today, on average, versus European guests.  Traffic from Korea and Japan have declined as those governments are encouraging domestic travel to support the industry; but this has been more than offset from rapidly growing new markets such as India, China and the Middle East.

As the economy recovers, the Asian middle class will continue to grow, Asian currencies will continue to strengthen and Asian real estate will continue to increase in value.  3DPropCo will benefit from this perfect combination and pave the way for a possible IPO of BLR at some point late in the year.

3 Degrees Dynamic Fund

3 Degrees Dynamic is a best ideas fund that currently has investments in 3DPropCo, bank debt and outright currency positions, largely in the AUD (which encompasses both our view of rising currencies and a weaker USD).  If our 2010 themes play out as expected, 3DD will generate exceptional returns, with limited volatility.  In fact, on a trailing 12-month basis, the fund has returned a net 13.81%.

3 Degrees Credit Opportunities / Managed Accounts

We are pleased to announce that the success of our managed accounts program has led to the launch of 3DCO in January 2010.  3DCO launched with US$27.3 million and will focus on opportunities in high yielding, performing bank debt.  3DCO will target a net annual return exceeding 20% and will provide full transparency to investors.  For a detailed information package on 3DCO, please visit our virtual data room or contact us directly.

We would like to take this opportunity to thank you for all of your support over the years.  We wish you all a successful and prosperous 2010.