Element Global Opportunities Equity Portfolio

December 2012

The Element Global Opportunities Equity Portfolio has the mandate to go anywhere in pursuit of attractive investment opportunities, using a bottom-up investment approach. Being equity focused, the portfolio has at least 70% of its assets invested in international equity markets. The portfolio uses as benchmark the MSCI World (Local) but it does not seek to mimic or track this index in any way.

Portfolio Details
Net Asset Value (NAV) : 99.44 Launch date: Portfolio Manager: 14-January-2011 Filipe Alves da Silva, CAIA
105 100 95 90
85

Weekly Performance Chart

MSCI World Local Portfolio

80 Jan/11

Jun/11

Oct/11

Feb/12

Jun/12

Oct/12

Monthly Performance
Jan 2011 2012 -1,11% 7,06% Feb 1,61% 5,19% Mar -2,05% 1,62% Apr 3,30% May Jun Jul Aug Sep Oct 8,70% -1,50% Nov Dec YTD -1,25% -1,72% -1,37% -7,23% -7,20% 2,62% 0,62% 2,67% 1,35% -2,83% -1,18% -12,57% 0,97% 0,87% 13,73%

-0,86% -6,98%

Investment Highlights

My wish list for an investment is the following:

high expected rate of return, coupled with a high probability of getting that return; high/conservative margin of safety and a low probability of loss of capital; a value unlocking catalyst in the foreseeable future; enough liquidity to be able to build the position and, eventually, to exit it. The position I added this month ticks all the boxes above, and my only setback was not becoming aware of it earlier. Before giving the rationale for the investment I must first explain why the opportunity exists. Picture this: you are 40 years old and the only income provider in your household. You want to take precautions so that, if you pass away, your immediate family will be taken care of. For this purpose you go to an insurance company and do a life insurance: you will pay a regular premium to the insurance company and, in turn, when you pass away, your family is entitled to receive, for example, $1mn (the benefit). Fast-forward 30 years. Your family is well-off and has no need for the financial security provided by the life insurance you purchased 30 yrs before anymore. Before, your only alternative was to cancel the policy and get a small sum from your insurance company. But, because investors are always looking for new ways of making money, especially ones that are uncorrelated with traditional asset classes, you now can sell your policy, at a higher value, to one of these investors. This process is called life settlement and your insurance policy becomes a traded life interest. Say you decide to sell your policy to an investor, for $0.5mn. He will keep on paying premiums to the insurance company until you eventually pass away (or mature, as it is called in this industry). When this time comes, the investor will cash-in on the $1mn benefit. Everyone is better off: you get rid of your life insurance and receive a higher value than you would from the insurance company, and the investor gets his uncorrelated investment. His final payoff is equal to the $1mn benefit he receives when you mature minus the sum of the $0.5mn he paid you for the policy and the premiums he pays until you mature.

Element Global Opportunities Equity Portfolio

Investment Highlights (cont.) Because the investor would buy dozens of these life insurance policies he should in theory, to a high degree of certainty, predict the all important maturity schedule for his basket of policies, which is dependent on the life expectancy of each insured individual. He would then structure his investment so that he could leave enough money to pay the premiums during the first years, after which the cash-flow stream would become positive, as more and more policies reach maturity. But, in reality, there is a middle-man, which buys the policies from the original policyholders and re-sells them to investors, called the life settlement provider. Since this middle-mans fee is paid upfront and (generally) depends on the number and volume of the policies rather than their long-term investment performance, there is a serious moral hazard. The degree of diligence that can be expected from life settlement providers during the acquisition process is questionable. More specifically, to increase their chance of prevailing in the competitive bidding process for a policy they could, e.g., be tempted to avoid medical underwriters which issue rather conservative life expectancy estimates, since those would be associated with a lower offer price. Once acquired, the policy is then resold by the life settlement provider to the fund whose investors ultimately have to bear the risk of a misestimated life expectancy. Then investors greed came into play. The expected return from traded life interests was not enough to satisfy investors anymore, and they leveraged their investments, succumbing to debt to magnify the expected returns. What could go wrong, after all what is more certain than death? Well it turns out that a lot can, and did go wrong. Quoting Warren Buffett: when you combine leverage with ignorance you get some pretty interesting results. Oh, and interesting they were! Funds started being created specifically to buy traded life interest policies (this was especially popular in the UK, where funds were created to invest in US traded life policies) and, after being properly leveraged, were sold to retail investors as the sure thing. Just picture the salesman pitching that the only other certainty for the investor would be the taxes he would pay on his hefty profits.

The fund managers greed in not giving the funds a cash position that would allow for a conservative margin of safety, combined with unreliable life expectancy estimates magnified by the use of debt, paved the way for disaster. Funds ran out of money to pay the premiums and were forced to sell policies to raise money, which in turn drove the policies market valuation lower. Investors started facing losses on their sure investment and an avalanche of complaints flooded the banks, that had marketed the investment as very safe. Many funds had to be liquidated, driving the prices of traded life policies further down. The amount of lawsuits combined with the UK regulator prohibiting the marketing of this type of investment to retail clients made sure no one wanted to get near that type of funds. It was a bloodbath
The cherry on top or the cake came when some funds, at inception, decided to hedge their USD exposure (the original currency of the funds is GBP). The USD appreciated against the GBP creating a loss in the hedging position, using-up the funds already tight cash position. This combination of events created the perfect storm. After it was all said and done, many of the funds were closed and the ones that were left looked like abandoned houses, long forgotten by their owners. The few surviving funds are illiquid, and trade at a discount to net asset value (NAV - the value of the funds assets minus its liabilities divided by the number of shares outstanding). In a situation so messed up as this one, one is bound to find opportunities. And I think I found a really interesting one.

Element Global Opportunities Equity Portfolio

Investment Highlights (cont.) This month I bought shares in a (close-ended) mutual fund called Alternative Asset Opportunities (TLI:LN). As you probably have guessed by now, the fund invests in traded life policies, and its management incurred many of the mistakes that plagued the rest of the industry: they were greedy in the use of leverage and hedged their USD exposure. But thankfully, they were not as greedy as their colleagues, and the fund survived, this despite being forced to sell some policies. After witnessing what happened to their competition, the fund raised capital to repay its loan, meaning that it is now debt free, which resulted in a substantial reduction of risk. This fund was assembled in 2004-06 to buy (whole-life) US-traded life interests. From its original portfolio the fund still holds in its books 106 traded life policies with a $162mn face value. When I started buying, the fund had a market capitalization of $55mn and traded at a discount to its NAV of $64.5mn. The average age and life expectancy of the insured is 89 and 4.3 years, respectively Currently the fund has operating expenses of about $1mn/yr and pays close to $8mn/yr in premiums. Note that each time a policy matures, the amount the fund pays in premiums decreases. The math is simple: as the average life expectancy is now only 4.3yrs, the maturity schedule will start to pick up and the fund will eventually cash-in on the $163mn face value of its policies. Also, as time continues its unstoppable run, more and more policies will reach maturity, and the NAV will start to tick-up, faster at first and then slower. As I like to be conservative when making estimations, I increased the life expectancy by 23% to 5.3yrs. With this more conservative life expectancy, I estimate the funds NAV to increase by 16%, 12% and 9% in 2013, 2014 and 2015, respectively, and expect the discount of the share price to NAV to correct over the next 3 years, as more and more policies mature. Combining the NAV evolution with the correction in the discount to NAV yields an IRR of 18.5% over the next 3 years. Plugging-in the original life expectancy of 4.3yrs increases the IRR to 19.7%.

The funds mandate states that managers will use the proceeds from policy maturities to pay-off debt (fund is now debt free), buy-back shares (as long as the discount persists this should be the preferable option) or distribute cash back to investors. Also, the fund is now pass its targeted maturity (May-2012) and is subject to an annual continuation vote. My guess here is that the fund will be kept alive for another 3-4 yrs, and then liquidated, with the proceeds being distributed back to investors.
Due in part to its illiquidity, but also to my style of building positions gradually, the current allocation of the portfolio to this fund is still low, at 1.4%. Nevertheless, given the fact that this investment ticks all the boxes on my wish list, I expect to see it among the TOP10 positions soon. I see this as the ultimate even-driven investment, where the event is certain and the only thing an investor has to do is wait.

The portfolio outperformed its benchmark slightly for the year, ending 2012 with a performance of +13.73% versus +13.07% for its benchmark, the MSCI World Local Index.

Element Global Opportunities Equity Portfolio

Investment Guidelines
Max. Long Exposure: Min. Long Exposure: Use of Derivatives: 130% 70% May use options or warrants (Max notional exposure of 20%) Max individual position 2.5% Max gross short exposure 30% Hedged on a best effort basis

Largest Positions
Name
i Sha res MSCI Worl d ETF Hedged IBM Appl e Inc Fi del i ty Chi na Speci a l Si tua ti ons Mi cros oft Corpora ti on Peps i Co BMW Ama deus IT Hol di ngs Berks hi re Ha tha wa y Teva Pha rma ceuti ca l s

Weight
9,6% 8,9% 7,4% 6,3% 5,7% 5,1% 4,5% 4,2% 4,2% 3,4%

Ability to Short:

Currency Hedging:

Total

59,4%

Allocation by Sector
Cash
Real Estate Utilities Telecommunication Services Materials Health Care Consumer Staples Consumer Discretionary Energy 1,5% 2,3% 0,3% 5,2% 3,7% 6,9%

Allocation by Country
Cash Others Brazil China Netherlands Italy Sweden Spain Switzerland Germany Australia France Canada United Kingdom Japan United States 0% 6,9% 7,5% 1,6% 7,8%

0,1% 0,1% 0,1%

6,6% 0,4%

5,0%
12,0% 17,4%

4,8%
0,4% 4,2% 4,8% 1,2% 0,8% 52,7% 10% 20% 30% 40% 50% 60%

Industrials
Information Technology Financials 0%

1,2%
31,1% 11,1% 5% 10% 15% 20% 25% 30% 35%

Currency Exposure
120% 100% 80%
102,7%

Contacts
For more information please contact Filipe Alves da Silva directly or send an email to element.cap@gmail.com

60% 40% 20%

0% -20%
-19,7% 6,9%

Disclaimer
1,6%
4,2%

0,5%

2,2%

1,1%

Past performance is not indicative of future performance. Reference in this document to specific securities should not be construed as a recommendation to buy or sell these securities. You should conduct the due diligence yourself.

-40%
EUR USD CNY BRL CAD GBP UAH HKD

E L E M E N T

Element Global Opportunities Equity Portfolio

Complete List of Holdings

Name
iShares MSCI World ETF Hedged IBM Apple Inc Fidelity China Special Situations Microsoft Corporation PepsiCo BMW Amadeus IT Holdings Berkshire Hathaway Teva Pharmaceuticals Archer Daniels Midlands Lowe's BlackRock Chatham Lodging Trust Telefnica Avangard Societe d'Edition de Canal+ Corning Inc Renault MRV Engenharia Alternative Asset Opportunities IMAX Corporation Jakks Pacific Monument Mining Energold Drilling PAX Global Technology OPAP Cninsure Veris Gold Corp Calfrac Well Services GAP Inc Ted Baker Addvantage Technologies La Seda de Barcelona Cash

Weight
9,6% 8,9% 7,4% 6,3% 5,7% 5,1% 4,5% 4,2% 4,2% 3,4% 3,2% 3,0% 2,9% 2,3% 2,2% 2,2% 2,0% 1,9% 1,7% 1,6% 1,4% 1,1% 1,1% 1,1% 1,0% 1,0% 0,9% 0,6% 0,6% 0,5% 0,3% 0,3% 0,2% 0,1% 7,4% 100,0%

Total

Disclaimer: Past performance is not indicative of future performance. Reference in this document to specific securities should not be construed as a
recommendation to buy or sell these securities. You should conduct the due diligence yourself.