INSIGHTS

GLOBAL MACRO TRENDS

VOLUME 6.5 SEPTEMBER 2016

Time to Focus: Five Key

Investment Themes
 Time to Focus: Five Key
Investment Themes
Rising macroeconomic and geopolitical tensions are
creating both opportunities and risks for global investors
across the entire global capital markets. We continue to
emphasize our five key macro themes, many of which we
think can perform against a variety of economic backdrops.
KKR GLOBAL MACRO & ASSET First, we believe that assets with Yield and Growth will
ALLOCATION TEAM continue to outperform. Second, we would avoid exposures
HENRY H. MCVEY linked to Chinas structural slowing, though we do finally
Head of Global Macro & Asset Allocation
+1 (212) 519.1628 see some emerging investment opportunities in Chinas
henry.mcvey@kkr.com new export strategy. Third, we see the opportunity for a
DAVID R. MCNELLIS significant and potentially sustained upward revaluation
+1 (212) 519.1629
david.mcnellis@kkr.com in the securities of large domestically-oriented economies.
FRANCES B. LIM
Fourth, the dismantling of the traditional financial services
+61 (2) 8298.5553 industry has emerged as both a blessing and a curse for
frances.lim@kkr.com
investors; we outline our approach for navigating this
REBECCA J. RAMSEY
+1 (212) 519.1631
complicated segment of the global economy. Finally, given
rebecca.ramsey@kkr.com the bifurcation across markets that we are now seeing,
AIDAN T. CORCORAN we believe folks should consider increasing exposure to
+ (353) 151.1045.1
aidan.corcoran@kkr.com
complex stories, including earnings misses, restructurings,
and/or corporate repositionings; at the same time we
BRETT J. TUCKER
+1 (212) 519.1634 would be selling simplicity in instances where future
brett.tucker@kkr.com earnings streams appear over-priced.
Research assistance was provided by
Amanda See.

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COMPANY LOCATIONS
What good is the warmth of
AMERICAS New York, San Francisco, summer, without the cold of winter
Washington, D.C., Menlo Park, Houston,
Louisville, So Paulo, Calgary EUROPE
to give it sweetness.
London, Paris, Dublin, Madrid ASIA Hong
Kong, Beijing, Singapore, Dubai, Riyadh, Tokyo,

Mumbai, Seoul AUSTRALIA Sydney JOHN STEINBECK
AMERICAN AUTHOR
2016 Kohlberg Kravis Roberts & Co. L.P. All
2 KKR INSIGHTS: GLOBAL MACRO TRENDS
Rights Reserved.
Summer is usually the time of year that allows investors to take a step
back and reflect on some of the key long-term trends in our business.
However, with Brexit, speculation of helicopter money in Japan, and
another punk U.S. GDP reading in 2Q16, it certainly has felt like any-
thing but vacation time for many in the investment community. Thats
the bad news.
The good news, we believe, is that dislocations and distractions create
opportunity for our approach to investing. Indeed, recent geopolitical
and macro-related events have only increased our conviction about
our key investment themes, as well as the upside potential in our
current target asset allocation positioning1. See below for full details,
but we note the following five macro trends on which we believe that
performance-oriented, multi-asset class investors should focus:
Interest Rate Outlook: Lower for Longer Continues to Drive
the Yearn for Yield and Growth Without question, we remain in
the lower for longer camp regarding rates. Importantly, recent
events across Asia and Europe, Brexit in particular, only give us
further confidence in our outlook. We also think that it is critical
for investors to understand that the Federal Reserve in the U.S.
may be signaling that it is now actually at an already modestly
accommodative stance, despite rates at a record low and the Feds
balance sheet at a record high. If we are right, then the traditional
neutral level for the Fed Funds rate could be significantly lower
than many economists now think. Not surprisingly, against this
backdrop, we remain overweight both Opportunistic Liquid Credit
and Private Credit, including Direct Lending and Mezzanine/Asset
Based Lending. We also favor Real Assets that can produce both
Yield and Growth, including Real Estate, Real Estate Credit, and
Infrastructure assets such as pipelines, and are three hundred
basis points overweight the asset class. One can see our prefer-
ences in Exhibit 9.
Chinese GDP Growth Is Still Slowing; a New Playbook Is Re-
quired for Global Trade Despite temporary periods of economic re-
acceleration, we believe that China is structurally slowing. Embed-
ded in this view is our cautious outlook for global trade, particularly
as it relates to traditional Chinese imports. On the export side,
our research shows that China is making huge inroads into higher
value-added exports (Exhibit 25); this transition is a big deal and
warrants investor attention for both offensive and defensive rea-
sons in sectors such as telecommunications equipment, healthcare
equipment, and optical equipment. At the same time, China appears
to be flooding certain global markets with excess capacity in low
value-added exports. If we are right, then it is too early to bottom
fish in several cyclical industries, particularly those with excess
capacity, unless valuations are extremely compelling. We also see
additional margin headwinds in industries previously dominated by
U.S. and European multinationals. By comparison, we think that
there are increasing opportunities to partner with Chinese firms as
they expand abroad. Details below.
Post-Brexit, the Upward Revaluation of Domestic-Facing,
Consumer-Oriented Economies Is Coming In a post-Brexit envi-
ronment, we expect an upward revaluation of countries that have
large domestic-oriented consumer economies, particularly relative
to trade-oriented economies that rely more on exports to grow.
1 KKR GMAA Target Asset Allocation uses a benchmark similar to that of a large
U.S. public pension.
The United States is clearly the most obvious beneficiary, given
its economys absolute size as well as the health of its consum-
ers. However, we also anticipate India, Indonesia, and Mexico to
be major beneficiaries of this change in investor perception. If we
are right, then valuations in these countries could actually hold or
even increase from current levels in certain instances.
The Ongoing Dismantling of Levered Financial Services In-
termediaries Our travels across Europe, the U.S., and parts of
Asia lead us to believe that the trend towards traditional financial
services companies becoming more utility-like is ongoing, given
the move towards low/negative rates by central banks as well as
the desire by governments for significantly heightened regulation.
Somewhat ironically, one outcome of these headwinds across
traditional financial services is that credit creation will actually be
harder to stimulate, which means central banks will likely have to
continue to overcompensate with even more aggressive monetary
policy initiatives. The other consequence of the current financial
services backdrop is that more and more complex transactions
will move into the non-bank market, which could provide signifi-
cant opportunities for investors to step in and serve as important
providers of liquidity.
Buy Complexity, Sell Simplicity Given todays increasingly
bifurcated market (one that feels similar to what we saw in
1999/2000 when tech and telecomunications stocks traded
expensively at the same time cyclical stocks traded cheaply), we
want to move capital to take advantage of the arbitrage we now
see between complexity and simplicity. Indeed, despite record
highs in the S&P 500, we are increasingly finding attractively
complex stories that the market does not like because of limited
earnings visibility, increased volatility, and/or cyclically out of
favor offerings (Exhibit 41). For our nickel, we think that with
some value-added restructuring, repositioning, and/or tuck-in
acquisitions there is a significant opportunity today to dramati-
cally boost valuation by merely improving a companys earnings
visibility, something that the market desperately craves in todays
low rate, slow growth world. On the other hand, it also feels
to us that investors are now willing to potentially overpay for
earnings visibility and/or yield. Indeed, with simplicity of story
being so hot right now, we believe opportunities exist across
the corporate and real asset sectors to carve out and monetize
distinct earnings streams that are trading at what we believe are
premium valuations relative to their long-term intrinsic value.
While we believe that our macro themes can help deliver differentiated
relative performance for investors, we must also acknowledge that at
this point in the cycle we have entered an environment of lower abso-
lute returns for many asset classes. This insight is not, however, new
news. One can see in Exhibits 1 and 2 that returns have been actually
trending down since 2000 in absolute terms, largely consistent with a
41% decline in nominal GDP growth (and interest rates) over the same
period. However, with $13 trillion in negative yielding bonds around the
globe, we have clearly entered into a new and more complicated era of
financial repression. Just consider that, despite accounting for only four
percent of the Barclays Multiverse index, U.S. junk bonds now make up
almost 20% of total remaining positively yielding bonds in the world.2
2 Data as at August 18, 2016. Source: FT, Desperate investors turn to US junk
bond market.
KKR INSIGHTS: GLOBAL MACRO TRENDS 3
EXHIBIT 1 EXHIBIT 3

Returns for Financial Assets (Treasuries, Private Equity, With Bond Yields So Low, Equity Needs to Deliver
MSCI ACWI and High Yield) Have Been Falling Since Double-Digit Returns for Pensions to Come Even Close to
1995 Hitting Their Return Hurdles
Trailing 5 Year Average Returns by Main Asset Class, % Expected Returns for a 60% Equities, 40% Bond Portfolio

Treasury Returns Global PE Return EXPECTED BOND RETURNS OVER THE NEXT 5 YEARS
ACWI Return HY Return 4 3 2 1 0 -1 -2
25
-2 0.4 0.0 -0.4 -0.8 -1.2 -1.6 -2.0
20
0 1.6 1.2 0.8 0.4 0.0 -0.4 -0.8

EXPECTED STOCK RETURNS

15 2 2.8 2.4 2.0 1.6 1.2 0.8 0.4

4 4.0 3.6 3.2 2.8 2.4 2.0 1.6

10
6 5.2 4.8 4.4 4.0 3.6 3.2 2.8
5
8 6.4 6.0 5.6 5.2 4.8 4.4 4.0
0
1990 1995 2000 2005 2010 2015
10 7.6 7.2 6.8 6.4 6.0 5.6 5.2

Data as at December 31, 2015. Source: Bloomberg. 12 8.8 8.4 8.0 7.6 7.2 6.8 6.4

14 10.0 9.6 9.2 8.8 8.4 8.0 7.6

EXHIBIT 2
Data as at August 12, 2016. Source: KKR Global Macro & Asset
Allocation.
Five-year Trailing Nominal GDP Growth Rate in the
U.S. Has Fallen by More Than 40% Since 2000. Not
Surprisingly, Returns Too Have Slipped EXHIBIT 4
Trailing 5 Year Average Returns of Near-Term Returns for the Investment Management
Four Key Asset Classes vs. U.S. Nominal GDP Growth, %
Industry Are Likely Headed Lower
Avg. Nominal GDP (rhs)
CAGR Past 5 Years: 2010-2015, %
16 14.2 7 CAGR Next 5 Years: 2015-2020e, %
14 6
12.6 12.2
12 11.1
10.0 5
11.7 10.7
10 8.3
4
8 7.5
3
6 6.1
6.6 5.5 5.0
2 4.6
4
2 1 2.3
0 0
1990 1995 2000 2005 2010 2015

Four key asset classes include: Global Private Equity, U.S. Treasuries, -0.3
Global Listed Equities and U.S. High Yield. Data as at December 31, 2015.
U.S. 10 Year S&P 500 Private Hedge Real Estate
Source: Bloomberg. Treasury Equity Funds (unlevered)
Bond

e = KKR GMAA estimates. Data as at May 13, 2016. Source: Bloomberg,

Cambridge Associates, NCREIF, HFRI Fund Weighted Composite Index,
KKR Global Macro & Asset Allocation.
We believe we have entered an
environment of lower absolute To be sure, we think that the one-two punch of monetary and fiscal
returns for many asset classes. stimulus can help to mitigate some of the aforementioned macro
headwinds, including the slowdown in nominal GDP, in the near term.
However, what we believe is really needed to sustain an improve-

4 KKR INSIGHTS: GLOBAL MACRO TRENDS

ment in the outlook for absolute growth and returns, particularly in the EXHIBIT 7
developed world, is a reacceleration in long-term productivity trends.
U.K. CFOs Confidence Has Fallen to the Lowest
Unfortunately, as Exhibits 5 and 6 illustrate, productivity has been
consistently declining this cycle. Given that productivity is one of the
Ever Level
two key inputs to GDP growth (with labor force growth as the other U.K. CFO Survey Next 12 Months, %
one, and we do not currently see any major positive changes to im- (Axis Inverted)
migration policy), recent trends are quite concerning, in our view. Decrease in Capex Spending
Decrease in Hiring
EXHIBIT 5
Decrease in Operating Margins
Productivity Has Been Falling Around the Globe Decrease in Corporate Profits At or Greater Than 50%
0
Productivity: 10 Year CAGR, %
20
Japan China

10% U.S. Euro Area 40

60
8%

80
6%
100
4%
120

Mar-13

Mar-14

Mar-15
Mar-11

Mar-12

Mar-16
Sep-14
Dec-14
Sep-10
Dec-10

Sep-11
Dec-11

Sep-12
Dec-12

Sep-13
Dec-13

Sep-15
Dec-15
Jun-13

Jun-14

Jun-15
Jun-11

Jun-12

Jun-16
2%

0%
Data as at June 30, 2016.Source: Deloitte LLP, Haver Analytics.
70 75 80 85 90 95 00 05 10 15

Note: Real GDP growth equals labor force growth times productivity
EXHIBIT 8
growth. Data as at April 12, 2016. Source: IMF, UN, Haver Analytics.
Uncertainty Is Driving Defensive (Simplicity)
Outperformance; We Now Favor Complexity
EXHIBIT 6
U.S. Policy Uncertainty Index and Performance
and Has Actually Been Negative In the U.S. This Cycle of Russell Defensive / Small Cap

Productivity Growth Comparison, % News Based Uncertainty Index

Russell Defensive / Small Cap (RHS)
2005-2010 CAGR 2010-2015 CAGR 320 0.65
290 0.60
10.9%
10.3% 260
0.55
230
200 0.50

170 0.45
140 0.40
110
0.35
80
0.9% 50 0.30
0.5% 0.4% 0.3% 0.6%
20 0.25
Jan-07
Mar-04
May-01

Jul-15
Nov-09
Jan-90

Sep-12
Jul-98
Sep-95
Nov-92

-1.1%
Japan Euro Area U.S. China
Data as at July 31, 2016. Source: Bloomberg, Measuring Economic
Note: Real GDP growth equals labor force growth times productivity Policy Uncertainty by Scott Baker, Nicholas Bloom and Steven J. Davis
growth. Data as at April 12, 2016. Source: IMF, UN, Haver Analytics. at www.PolicyUncertainty.com.

KKR INSIGHTS: GLOBAL MACRO TRENDS 5

Beyond the need for a notable improvement in productivity, we
also think some clarity around the global political landscape is now
required too. Unfortunately, however, we do not see an imminent
improvement in this area. For starters, we are still poised to have a
divisive election in the United States; maybe more important, though,
is that we also face surprisingly murky electoral outlooks across
Italy, the Netherlands, Germany and France during the next 12-18
months. In each of these markets, protectionism, anti-immigration,
and populism will likely feature prominently, we believe. Finally, we
face increasing global uncertainty from the emergence of strong
men leaders such as Vladimir Putin, Xi Jinping, and Recep Tayyip
Erdoan. Importantly, all these games of political chess are occurring
at a time of notable instability across the Middle East.
In our view, it is the unusual and sometimes unsettling intersection
of all these macroeconomic and geopolitical forces that still keeps
us in an environment that we refer to as Adult Swim Only. As such,
we continue to favor an asset allocation that rewards yield, embraces
volatility, and tilts more idiosyncratic in nature at this point in the
cycle. To this end, our most significant overweight positions include
Private Credit, Opportunistic Liquid Credit, and select parts of Real
Assets. One can see this in Exhibit 9.
EXHIBIT 9
Select Overweight Positions in KKR GMAAs 2016
Target Asset Allocation
ASSET OR SUB-ASSET CLASS KKR GMAA STRATEGY
JUNE 2016 BENCH-
TARGET, % MARK
U.S. PUBLIC EQUITIES 22 20
DIRECT LENDING 10 0 forces are likely to win out over fundamentals in the near term, given
REAL ASSETS 8 5
ACTIVELY MANAGED OPPORTUNISTIC CREDIT 5 0
DISTRESSED / SPECIAL SITUATION 5 0
MEZZANINE / ASSET BASED LENDING 3 0
Please note that as of December 31, 2015 we have recalibrated Asia
Public Equities as All Asia ex-Japan and Japan Public Equities. Strategy
benchmark is the typical allocation of a large U.S. pension plan. Data as
at July 31, 2016. Source: KKR Global Macro & Asset Allocation (GMAA).
If we are wrong in our outlook and growth reaccelerates more than
expected, we think that returns across risk assets will ultimately be
capped. Key to our thinking is that sustained stronger global growth
would turn central bankers more hawkish (or at least less dovish),
which likely would not be good for the global capital markets, cur-
rencies and rates in particular. As such, our base case remains a
volatile backdrop that never fully favors the bulls or the bears, lending
support to our base view that the global economy and the capital
markets that support it remains in an asynchronous recovery.
6 KKR INSIGHTS: GLOBAL MACRO TRENDS
DETAILS
In the following section we provide both further analyses on the key
macro themes mentioned above as well as what we believe to be the
key investment implications.
Interest Rate Outlook: Lower for Longer Continues to Drive the
Yearn for Yield and Growth
Since we arrived at KKR in 2011, we have been pushing our Brave
New World thesis (see Brave New World: The Yearning for Yield Across
Asset Classes, December 2011), which we originally developed during
our time at Morgan Stanley in macro strategy during the 2004-2007
period. Our basic premise has been and remains that secular
macro forces, disinflation and demographics in particular, would ul-
timately drive an upward revaluation of securities that could provide
investors with both yield and earnings growth. Put another way, the
cash flow required to grow the dividend needs to be regenerative
in nature, as we think that investors would ultimately shun levered
entities that just squeeze yield out of a declining stream of cash from
operations.
Whether we have been lucky or good, our Brave New World the-
sis has played out nicely in recent years. Today, however, we have
begun to wonder whether this investment theme has fully run its
course, given that the global capital markets are now filled with more
than $13 trillion in negative yielding fixed income securities as well
as many dividend yielding equities trading with valuations north of
20 times.3
To be sure, one has to be more selective at this stage in the cycle (in-
cluding buying complexity), but our base view remains that technical
that central bank buying is now overwhelming supply. One can see
this in Exhibit 10, which shows that net issuance minus quantitative
easing (QE) has actually shrunk to negative $300+ billion, compared
to positive net issuance less QE of $1.1 trillion in 2011.
We believe that the Federal
Reserve may be signaling that
it is now actually at an already
modestly accommodative stance;
if so, then the traditional neutral
rate for the Fed Funds rate could
be significantly lower than many
economists now think.
3 Data as at July 31, 2016. Source: Bloomberg.
EXHIBIT 10 Importantly, we believe these statistics are likely to be revised down-
ward (i.e., more shrinkage) following the Bank of Englands recent
G4 Aggregate Net Issuance Is Now Actually
announcement on August 4, 2016 (BoE will be buying 60 billion
Negative additional gilts as well as 10 billion of corporate bonds). Also, we
G4 Total Net Issuance in U.S.$B Equivalents expect the European Central Bank to initiate some additional easing
measures on September 8th, 2016; at the same time, we look for
NET IS- Y/Y % CENTRAL Y/Y % NET IS- Y/Y % intensifying efforts from the Bank of Japan to buy both equity and
SUANCE CHANGE BANK PUR- CHANGE SUANCE CHANGE
CHASES LESS QE fixed income products.

2011 2,446 1,300 1,146 Beyond the aforementioned quantitative easing, there is another
influence that shapes our view on our lower for longer thesis regard-
2012 2,064 -16% 1,508 16% 557 -51%
ing rates. Specifically, despite a lot of the recent banter in the press
2013 1,890 -8% 1,063 -29% 826 48% surrounding the potential for higher rates, we are increasingly of the
mindset that the Federal Reserve is closer to the real neutral rate
2014 1,482 -22% 809 -24% 674 -18% through the cycle than many investors may now think. One proxy to
measure this viewpoint is the Atlanta Fed, which shows that some-
2015 1,044 -30% 1,091 35% -48 -107%
thing akin to 75-85 basis points is where the neutral rate may be.
2016E 1,045 0% 1,414 30% -369 -669% One can see this in Exhibit 12.

2017E 987 -6% 1,360 -4% -373 -1% We also believe that the Fed is sending important signals about how
long and how low short-term rates may stay. At the June 2016
TOTAL 10,958 8,545 2,413
FOMC press conference, Federal Reserve Chairwoman Janet Yellen
G4 equals U.S., Japan, U.K., Euro (Germany, France, Italy, Spain, succinctly said that there are long-lasting, more persistent fac-
Netherlands, Austria, Finland, Belgium, Greece, Ireland, Portugal). tors that may be at work that are holding down the longer-run level
QE = quantitative easing. Data as at July 23, 2016. Source: National of neutral rates. She followed up by indicating that It could stay
Treasuries, Morgan Stanley Research. low for a prolonged time... All of us are in a process of constantly
reevaluating where the neutral rate is going, and what you see is a
downward shift over time, that more of what is causing this to be low
EXHIBIT 11 are factors that will not be disappearing. Not surprisingly, given all
More Than a Third of Developed Market Bonds Now these types of remarks as well as sluggish growth, the Fed Funds
rate is now below one percent, and we think it will stay there over
Have Negative Yields
most of the time through 2020. One can see this in Exhibit 13.
% of Negative Yielding Government Securities
EXHIBIT 12
U.K. 0%
U.S. 0% Some Fed Measures Suggest That Much of the Requisite
Spain 16% Tightening Has Already Occurred
Italy 19%
TOTAL DM 36% Recessions
Slovakia 44% Federal Funds Target Rate, %
Slovenia 49% Atlanta Fed Shadow Fed Funds Rate, %
Belgium 56%
Ireland 57% 8
Denmark 63%
France 66% 6
Austria 67%
Netherlands
4
74%
Finland 74%
2
Japan 80%
Germany 84% 0
Sweden 84%
Switzerland 97% -2
Luxembourg 100%
-4
Data as at July 19, 2016. Source: Bloomberg. Universe: Bloomberg Global 98 00 02 04 06 08 10 12 14 16
Developed Sovereign Bond Index.
Note: Unlike the observed federal funds rate, the shadow rate does not
have a zero lower bound because it accounts for other monetary policy
tools beyond rate cuts. Data as at July 31, 2016. Source: Federal Reserve
Board, Federal Reserve Bank of Atlanta, National Bureau of Economic
Research, Haver Analytics.

KKR INSIGHTS: GLOBAL MACRO TRENDS 7

 EXHIBIT 13 EXHIBIT 14

We Think That the Fed Funds Rate Could Trend Below With Rates So Low, We Think That Traditional Pension
One Percent Until At Least 2020 Plans Will Struggle To Achieve Their Target Returns
U.S. Federal Funds Rate, % Performance: Portfolio 60% Equities, 40% Bonds
(Dotted Line Represents KKR GMAA Forecasts)
7.0 15 Yr CAGR 10 Yr CAGR 5 Yr CAGR
25
6.0

5.0 20

4.0
15
3.0 We think central tendency
of Fed Funds could remain
2.0 below 1.0% until 2020 10

1.0
5
0.0
Dec-00

Jun-13

Mar-17
Jun-08

Mar-12

Dec-15

Sep-19
Jun-03

Mar-07

Dec-10

Mar-22
Jun-98

Sep-04
Mar-02

Sep-09
Dec-05

Jun-18

Dec-20
Mar-97

Sep-99

Sep-14
Dec-95

Data as at August 10, 2016. Source: Federal Reserve Board, KKR Global
-5
Macro & Asset Allocation analysis. 55 60 65 70 75 80 85 90 95 00 05 10 15

Data as at July 2016. Source: Shiller data http://www.econ.yale.

Separately, Fed Governor John C. Williams recently authored a edu/~shiller/data.htm, Thomson Financial, S&P, Factset, Haver Analytics.
somewhat provocative essay that indicated that new important
forces, such as global supply, shifting demographics and slower trend
productivity, would all lead to a lower neutral rate. The key take- EXHIBIT 15
away from these global trends is that interest rates are going to stay
lower than we have come to expect in the past, he wrote. Interest-
Including 2016 YTD, the S&P 500 Has Actually Delivered
ingly, he also noted that, this future low level of interest rates is
Positive Returns for Eight Years, Which Is Highly Unusual
not due to easy monetary policy; it is the rate expected to prevail
# OF CONSECUTIVE CUMU-
when the economy is at full strength and the stance of monetary
YEARS OF POSITIVE LATIVE
policy is neutral4. RETURNS START END RETURN CAGR

Against this backdrop, we think that the asset allocation implications 3 1904 1906 67% 19%
of our thesis are quite significant for long-term investors. Specifical- 3 1954 1956 111% 28%
ly, we think that the opportunity for a traditional 60/40 equity/bond
strategy to achieve a seven or eight percent return for its constitu- 3 1963 1965 60% 17%
ents is now quite limited. Indeed, if bond yields stay flat or increase 3 1970 1972 40% 12%
from current levels, then public equities would have to return 10% or
more per annum for most allocators of capital to meet their hurdle 4 1942 1945 143% 25%
rates, a feat we see as highly unlikely after seven straight up years
4 1958 1961 102% 19%
in the S&P 500 (Exhibit 15). Importantly, as we outlined in Exhibit 4,
which details our forward looking expected returns for the major as- 5 2003 2007 83% 13%
set classes we track, our fundamental work suggests an annual total
return of around six percent for stocks (including dividend yields), 6 1947 1952 148% 16%
while we have an even more modest total return for bonds (i.e., es-
7 2009 2015 159% 17%
sentially flat).
8 1921 1928 435% 23%

8 1982 1989 291% 19%

9 1991 1999 450% 21%

AVG. CAGR 19%

Data as at December 31, 2015. Source: Standard & Poors, Shiller data.
4 http://www.frbsf.org/economic-research/publications/economic-letter/2016/
august/monetary-policy-and-low-r-star-natural-rate-of-interest/

8 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 16

We Are Leaving a Period of Very Strong Returns For Traditional Asset Allocation Programs
Annualized Real Returns for a 60% Stocks, 40% Bonds Portfolio, %

12.2% 11.8%
9.4% 9.1% 9.3%
8.4%

4.4% 4.7%
3.9%
3.2%
2.5% 2.0%
1.1%

-1.4%
-4.3%
1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010-15 Avg Best Other
Four Decades
Decades

Data as at December 31, 2015. CPI adjusted returns. Source: Bloomberg, Factset, S&P, Shiller data.

Given this outlook, our strong belief is that there will be a meaning- EXHIBIT 17
ful shift in allocation strategies by certain pensions, endowments, and
even individual investors. For our nickel, we think that most major allo- Given Changes in the Banking Sector, We View the
cators of capital will likely shift from a diversified cross-asset strategy Illiquidity Premium as More Secular Than Cyclical
(including both active and passive) towards more of a barbell one that
includes: 1) active, idiosyncratic managers that can truly deliver either Weighted Average Yield of Originated Senior Term Debt
alpha and/or operate in a market of higher returns relative to tradition- 12-Month Average Yield of Traded Loans
al liquid assets; and 2) extremely low-cost index funds that maximize
12.0% 11.4%
beta exposure with limited tracking error. If we are right, then toler- 11.3%
11.2% 10.7% 10.8%
ance for performance mediocrity, particularly for liquid products with
9.7% 9.6%
periodic drawdowns of significance, will become quite limited. 8.7% 8.5%
8.3% 8.2% 8.5%
7.8%
On the other hand, we think that the opportunity set for certain manag-
5.8% 5.8% 6.0% 5.9% 6.1%
ers, particularly in private credit, is large and growing. Indeed, in an 5.1% 4.9% 5.5%
environment where the risk-free rate is near zero in real terms and
between one and two percent in nominal terms, the opportunity to pick
up three percent via an illiquidity premium (Exhibit 17), particularly
if there is sound credit underwriting, is quite attractive, in our view,
against a traditional seven to eight percent hurdle rate. Private equity
too should benefit in both developed and emerging markets. Within the 2007 2008 2009 2010 2011 2012 2013 2014 2015 Q1 Q2
public equity markets, we are finally beginning to see more value in EM 2016 2016
markets than DM markets. One can see the basis for our argument in Data as at June 30, 2016. Source: Bloomberg, Ares company filings, KKR
Exhibit 18 which shows that some mean reversion might be likely after Credit.
70 consecutive months of EM under-performance.

We do worry that the inability of
banks to earn their cost of capital
means that their capacity to repair
their balance sheets by issuing
accretive equity has vanished.

KKR INSIGHTS: GLOBAL MACRO TRENDS 9

EXHIBIT 18 EXHIBIT 19

If the Fed Is Now More Dovish, the Long Drought in EM Global Trade Has Actually Declined in Recent Years
Underperformance Could Finally Be Over
Global Merchandise Exports as a % of Global GDP
Relative Total Return, MSCI EM/DM
(Feb'89 = 0%) 28 Sep-08
27
Sep-10
350% Sep-94 305% 24
288%
300% 81
months 84
months 70 Mar-16
250% 20
108 months 22
months
200%
16
150%

100% 12
Jul-16 80 85 90 95 00 05 10 15
50% 128%
Sep-01 Data as at March 31, 2016. Source: IMF, Haver Analytics, KKR Global
0% 17% Macro & Asset Allocation analysis.
87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

Data as at July 31, 2016. Source: KKR Global Macro & Asset Allocation
analysis. EXHIBIT 20

Nominal GDP Growth in China Has Fallen a Full 12.4%

in Absolute Terms Since 2Q11, While Real GDP Has
Chinese GDP Growth Is Still Slowing; a New Playbook Is Required
Slipped a More Modest 3.3%
for Global Trade
China Real vs. Nominal GDP Growth, Y/y, %
Anybody who has had the opportunity to read our Insights papers
2Q11 2Q16
in recent years knows that we feel strongly that China has endured
19.7%
a distinctly hard landing when it comes to nominal GDP growth.
Indeed, one can see the severity of the trend in Exhibit 20, which
shows that nominal GDP has actually fallen over 12 percentage points -63%
since 2Q11, compared to just the 3.3 percentage point decline that -33%
many sell-side forecasts use when describing real GDP during the 10.0%
same period. A decline of such magnitude in nominal terms is a big 7.3%
6.7%
deal. In particular, from the perspective of an owner and operator
of businesses, nominal not real is what matters because the
revenues that cover overhead, pay employees, and hopefully generate
a profit for investors are measured in nominal, not real terms.
China: Real GDP Y/y China: Nominal GDP Y/y

Data as at June 30, 2016. Source: China National Bureau of Statistics,

Haver Analytics.

That Chinas overall growth at this point is slowing is certainly not
We see the opportunity for new news to investors, we fully acknowledge. What we believe
a significant and potentially may not be fully understood are all the long-term consequences and
long-term nature of this slowdown. We see several important ones
sustained upward revaluation to consider. First, as we show in Exhibit 19, global trade is slowing
in the securities of large as China downshifts. To be sure, some of this reduction is linked to
lower commodity prices, but there is another factor to consider. From
domestically-oriented economies. what we can tell (and our data shows), China is also insourcing more
of its production of intermediate goods, which means it now relies
less on ships, planes, and content from its traditional trading part-
ners. One can see the magnitude of this shift in Exhibit 21.

10 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 21 Another important issue to consider is that less global trade means
less foreign direct investment (FDI). Interestingly, a larger percent-
The Gap Between Imports and Exports in China
age of FDI is now coming from countries like China moving assets
Continues to Widen overseas than developed market economies putting fresh capital into
China: LTM Current Account Balance, U.S.$B (L) fast-growing emerging markets. For example, in 2013 and 2014,
China Exports as a % of Global Exports, 12mma (R) Greater Chinas cross border M&A made up 28% and 24% of world
China Imports as a % of Global Imports, 12mma (R) cross-border M&A, respectively.5 Trends of late have been even more
powerful, as Chinas outbound direct investment surged to $64B in
600 2Q16 from just $9B in 1Q11 and zero (yes zero) in 1Q07.6
14
500 EXHIBIT 23
12
400
China Is Rebalancing to Higher Value Add Exports; We
10 Now Think That Investors Should Focus on Facilitating -
300
8 Not Fighting - This Transition
200 China % Total Exports, 12mma
6

100 4 Ordinary Trade (Higher Value Add)

60
Reexports (Lower Value Add)
0 2
Jul-16
55
55.0
-100 0 Focus Here
90 92 94 96 98 00 02 04 06 08 10 12 14 16
50
Data as at March 31, 2016. Source: Source: IMF, State Administration of
Foreign Exchange, Haver Analytics. 45

Avoid Here
40
EXHIBIT 22
35 Jul-16
Notably, the Mix of Imports Is Shifting Towards 33.9
Consumers and Away From Investment-related Goods 30
02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
China: Imports as a % of Total Goods Imports, 12mma
Data as at July 31, 2016. Source: China Customs, Haver Analytics.
Investment Related Consumer Related
70%

Oct-08
67% Jun-16
60%
60%

50%

40%
Oct-08
Jun-16
40%
33%
From our vantage point, Chinas
30%
95 97 99 01 03 05 07 09 11 13 15
slowdown is secular, not cyclical,
Data as at June 30, 2016. Source: China Customs, Haver Analytics.
and we see continued pricing
pressure amidst slower activity
Even within its import sector, China is importing less traditional across not only Asia but parts of
goods and services. Indeed, as Exhibit 22 shows, investment-related
imports have fallen to 60% in June 2016 from a peak of 67% in
Europe and Latin America.
October 2008. On the other hand, consumer-related imports have
jumped to 40% from 33% over the same period. We look for both

trends to gain momentum in the quarters ahead.
5 Greater China includes China, Hong Kong, Taiwan, and Macao. Source:
UNCTAD.
6 Data as at June 30, 2016. Source: United Nations Conference on Trade and
Development, Haver Analytics.

KKR INSIGHTS: GLOBAL MACRO TRENDS 11

EXHIBIT 24 EXHIBIT 25

Outward FDI Has Started to Flow from the EM World to China Is Gaining Dominant Global Market Share in
the DM World Higher Value-Added Sectors as Well as Moving Into New
Important Growth Sectors
Cross-Border M&A by Purchaser, U.S.$B

CHINA EXPORTS AS A % OF GLOBAL EXPORTS

Emerging & Developing Economies
Developed Economies 1995 2000 2010 2015 2015 VS
1200 EM % World (R) 50% 2000

TELCO EQUIPMENT 3% 6% 30% 38% 32.9%

1000
40%
OPTICAL INSTRUMENTS AND
800 5% 8% 29% 37% 28.7%
APPARATUS
30%
600 HOUSEHOLD TYPE
4% 10% 30% 37% 26.5%
EQUIPMENT
20%
400
VAPOR GENERATING
BOILERS, AUXILIARY PLANT; 1% 4% 32% 24% 20.4%
10%
200 PARTS

0 0% MOTORCYCLES AND CYCLES 5% 12% 27% 31% 19.6%

90 92 94 96 98 00 02 04 06 08 10 12 14
ELECTRIC POWER MACHIN-
Data as at December 31, 2015. Source: United Nations Conference on 7% 10% 23% 29% 19.4%
ERY, AND PARTS THEREOF
Trade and Development, Haver Analytics.
MINERAL MANUFACTURE 2% 2% 9% 17% 15.2%

In terms of investment implications, there are several things to RAILS AND RAILWAY TRACK
2% 4% 10% 18% 14.0%
CONSTRUCTION MATERIAL
consider, in our view. First, we generally think that much of the com-
modity complex linked to Chinas aggressive build-out during the last CIVIL ENGINEERING AND
decade is likely to remain under pressure. Key commodities to poten- CONTRACTORS PLANT AND 1% 1% 8% 12% 10.5%
tially avoid, in our view, include iron ore, steel, and coal, all of which EQUIPMENT
we still expect to trade flat to down in the coming quarters. Con-
ELECTRO-DIAGNOSTIC
sistent with this view, we also think that many of Chinas traditional APPARATUS FOR MEDICAL 0% 1% 5% 8% 7.0%
trading partners, particularly those with an old economy interface, SCIENCES
are not as well positioned to benefit from the countrys shift towards
more consumer-oriented imports. This shift in focus by the Chinese Data as at December 31, 2015. Source: UNCTAD, Haver Analytics.
is a big deal, in our view, and it will likely put additional pressure on
much of South East Asias existing export product suite.
Given this backdrop, we think that an opportunity on the positive
There are also unanticipated knock-on effects. For example, given the side of the ledger, particularly for global private equity firms and
slowdown in Chinas exports as well as the shift in its import mix, we certain multinationals, is to partner with Chinese companies looking
remain leery that excess capacity in over-built areas such as ships to expand abroad. In many instances, European and U.S. firms can
and logistics may not snap back as quickly as the consensus now provide local knowledge about consumer behavior, help to overcome
thinks. Separately, as China moves up the value chain in terms of regulatory hurdles, and teach operational best practices. Chinese
value-added offerings (Exhibit 25), it is likely to increase competition, firms will also need help with mergers and acquisitions, which
denting margins of well-known incumbents in key markets like the should drive incremental need for local strategic advice, financings,
U.S. and Europe. If we are right, then shareholder returns for publicly and management talent.
traded companies in certain key markets could be at risk, we believe.
The Upward Revaluation of Domestic-Facing, Consumer-Oriented
Economies

We continue to favor an asset While many investors are focused on the negative long-term rami-
fications of Brexit, including slower global trade, less tolerance
allocation that rewards yield, around immigration, and growing social/economic discord, we see
an important silver lining. Specifically, we think that there will be a
embraces volatility, and tilts more notable upward revaluation opportunity in the economies of countries
idiosyncratic in nature. with large domestic markets that are less affected by many of the
aforementioned macroeconomic concerns. Key to our thinking is that
investors increasingly do not want to be dependent on economies
that are overly reliant on global connectivity (i.e., trade and/or flows)

12 KKR INSIGHTS: GLOBAL MACRO TRENDS

to deliver growth. Said differently, after the boom in globalization that lution9. Today, by comparison, rig count in the U.S. is now just 408,
we have seen over the past 20-30 years, we now think that inten- compared to a peak of 1,608 in October 2014, supporting our view
sifying geopolitics and macroeconomic concerns may lower the risk that an important part of the U.S. manufacturing/commodity sector
premium for countries that do not have to depend on outside forces has already experienced a major boom-to-bust cycle.
to sustain their current way of living.
EXHIBIT 26
A favorite within our framework is the United States, which we keep Consumption In the U.S. Is Almost 70% of GDP and Far
as the one overweight position within Public Equities (where we are Outpaces Other Global Economies
actually underweight as an asset class) in our target asset allocation.
We see several important positives to consider: PRIVATE CONSUMPTION PRIVATE
(US$ TRILLIONS) CONSUMPTION
U.S. housing is still well below trend See below for details, but we CAGR 2015 AS A % OF
continue to think that U.S. residential construction is one of the least 2005 2015 VS. 2005 (%) GDP
cyclically extended areas of the global economy. Just consider that U.S. 8.8 12.3 6.9% 68.4%
we estimate that residential construction is currently near a historic
low of just 55% of structural demand. By comparison, we estimate JAPAN 2.5 2.4 -0.3% 59.0%
that construction activity was running at 116% and 115% of true
GERMANY 1.6 1.8 2.6% 53.0%
structural demand in 1986 and 2005, respectively (which were the
big housing busts). As such, we retain the bullish outlook we laid U.K. 1.5 1.8 4.2% 63.1%
out on the housing sector and its subcomponents dating back to U.S.
Housing: A Changing Dynamic, March 2012. FRANCE 1.2 1.3 2.6% 54.0%

CHINA 0.9 3.7 31.9% 33.9%

The U.S. consumer is in much better shape From our vantage point,
it appears that the U.S. consumer has been acting well very BRAZIL 0.6 1.0 11.6% 54.1%
un-American during the current expansion. Indeed, 86 months into
AVERAGE 8.5% 55.1%
a recovery, savings rates are going up, not down; at the same time,
consumption of basic consumables is running well below trend7. Also, Data as at July 26, 2016. Source: IMF, Haver Analytics.
given low rates and improving net worth, debt service burdens have
actually reached historic lows. However, the consumer is spending,
but as we detail below, investors should focus more on businesses EXHIBIT 27
that can deliver value-added experiences to the consumer.
The Savings Rate Is Now More Than Double 2007 and
U.S. corporate profits are not so far above trend relative to prior On Par with the Beginning of the Last Cycle (2003)
cycles After essentially no earnings growth during the last 36
U.S. Personal Savings as a % of
months in the U.S., it is abundantly clear we have not had the typi- Personal Disposable Income
cal broad-based earnings recovery that defines the average cycle. 9
In fact, earnings growth for the S&P 500 has delivered just a 2.6%
8
CAGR in EPS since 2009, compared to a solid 15% during the prior
cycle8. To be sure, margins are now high across several sectors, but 7 Jul-03
earnings relative to nominal GDP suggest less of a shock than what 6 5.5
investors endured in the 1987 and 2007 downturns. 5 Jul-16
4 5.7
We have already experienced a manufacturing/trade recession in
3
the United States With Chinas notable slowing reverberating across
Asia as well as the oil bust in the U.S., many parts of the manu- 2 Nov-07
facturing sector have already experienced peak to trough declines 1 2.5
in their businesses. To be sure, manufacturing does not hold the 0
same influence in the U.S. the way it did in the past, but it is still an
Apr-14
Jan-12

Jul-16
Jan-15
Jul-13
Apr-02

Jul-04

Apr-08
Apr-05
Jan-06

Jan-09
Jan-03

Jul-07

Oct-12

Oct-15
Oct-00

Apr-11
Oct-06

Oct-09
Oct-03
Jul-01

Jul-10
Jan-00

important part of the U.S. economy. Moreover, until recently the en-
ergy industry and its related sectors were key drivers of U.S. capital
expenditures. Specifically, we estimate that roughly 15% of total U.S. Data as at July 31, 2016. Source: U.S. Bureau of Economic Analysis,
investment growth from 2011 to 2014 was related to the shale revo- Haver Analytics.

9 Data based on the growth of investment in oil and oilfield machinery, mining
7 Data as at August 31, 2016. Source: U.S. Bureau of Economic Analysis, Haver
exploration/shafts/wells, and power facilities. Data as at August 22, 2016.
Analytics.
Source: Bureau of Economic Analysis, Haver Analytics, KKR Global Macro &
8 Data as at August 24, 2016. Source: Bloomberg. Asset Allocation analysis.

KKR INSIGHTS: GLOBAL MACRO TRENDS 13

EXHIBIT 28 Beyond the U.S., we think that investors should too consider increas-
ing exposure to some of the larger consumer-facing EM econo-
Historically, Residential Construction Downturns Have
mies, including Indonesia, India, and Mexico. Indeed, as we show in
Been Split Between Mild and Extreme Exhibit 30, these three economies have, on average, a full 62% of
Peak-to-Trough Change in U.S. Housing Starts their economies, or $2.5 trillion in absolute buying power, linked to
domestic consumption, which should provide them with more of a
buffer than many other countries to the slowdown in trade, cross-
border flows, and China growth that we continue to forecast. They
-6% -4%
are all fast growing, representing a major force in the 16% increase in
EMs share of total global consumption since 2003.10
When housing activity is
running near structurally low EXHIBIT 30
levels, the cyclical downturns
tend to be mild
In Addition to the U.S., We Believe Investors Will Seek
-44% Out Large EM Consumption Stories in the Coming Years
HOUSEHOLD CONSUMP- % CHANGE CONSUMP-
TION IN U.S.$ TRILLIONS FROM TION AS A
2005 TO % OF GDP,
-73% COUNTRY 2005 2015 2015 2015
'86-91 '94-95 '99-00 '05-09
INDIA 0.5 1.2 150% 59%
Data as at July 19, 2016. Source: Census Bureau, Haver Analytics, KKR
Global Macro & Asset Allocation analysis.
INDONESIA 0.2 0.5 167% 57%

MEXICO 0.6 0.8 35% 69%

EXHIBIT 29
U.S. 8.8 12.3 40% 68%
The Mild GDP Downturns Tend to Occur When
Construction Activity Isnt Structurally Excessive, Which Data as at 2015. Source: World Bank, Haver Analytics.
Is Clearly the Story Today
U.S. Residential Housing Completions EXHIBIT 31
as a % of Structural Demand*
150% As a Macro Theme, We See Global Capital Supporting/
Improving Valuations in Large Domestic Economies
1986 2005
130% 115%
116% Forward Price-to-Earnings Ratio

110% '68-'08 +/-1 Std Dev Current Forward P/E Avg

Avg. 22
2020e
100% 85%
90% 1999 20
96% 19.0 18.7
18
70% 17.4
16.9
1994 16
81%
50% Mild downturns 2015
14
o low bases 55%
12
30%
2001
1989

2007
1980
1983

2010
2013
2004

2019e
1992

1998
1995
1971

2016e
1968

1977

1986
1974

10

8
* Structural housing demand is a KKR GMAA estimate composed of the U.S. India Mexico Indonesia
following:
Data as at July 31, 2016. Average since January 2006. Shaded area
1. Structural demand from household formation: This is the demand that
would come from pure population growth, assuming no change in house- represents +/- one standard deviation. Source: Bloomberg.
hold headship rates (grouped by age decile) vs. the prior year
2. Structural demand from scrappage: This is the demand that would come
from the scrappage of existing housing stock, assuming that it is scrapped
at the 10yr trailing average rate relative to the total housing stock

e = KKR GMAA estimate. Data as at July 19, 2016. Source: Census

Bureau, Haver Analytics, KKR Global Macro & Asset Allocation analysis.

10 Data as at December 31, 2015. Source: World Bank, Haver Analytics.

14 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 32 In our view, another point to consider is that strategic buyers are
likely to deploy more capital into these economies, which means
Global Household Consumption Has Roughly Doubled
cross-border M&A could accelerate further. Importantly, we expect
Since 2013; EM Consumption Is Now Growing 3x as Fast to see both private and strategic capital intensify their focus on
as DM Consumption these countries. Finally, with a backdrop of a more dovish Fed, local
Global Household Consumption currencies and bond yields in these economies are likely to remain
(U.S.$ Trillions) 2014 well bid, which should help with cost of capital decisions, particularly
50 44.8 those linked to refinancing opportunities.
45 Developed Markets
40 Emerging Markets The Ongoing Dismantling of Levered Financial Services Intermedi-
35
aries
30 2013-2014 CAGR: 2003
DM 4.0% 23.3 Over the years we have had the good fortune to meet with a variety
25 EM 11.9% of central bank officials from around the world. Inevitably, after the
20 obligatory deep-dive into growth and inflation trends, our discussions
15 turn towards interest rates and the banking system. To date and
despite a lot of attempts to sway our thinking we still have not had
10
anyone convince us that Negative Interest Rate Policy (NIRP) makes
5
sense. Simply stated, we believe that negative rates fundamentally
0 violate the unwritten but fundamental tenets of financial ser-
90 92 94 96 98 00 02 04 06 08 10 12 14
vices theory that:
Data as at December 31, 2014. Source: World Bank, Haver Analytics.
A bank should be able to make money from holding risky inven-
tory;
EXHIBIT 33
Users of capital should be charged some economic rent for
EM Share of Global Consumption Has Exploded
borrowing capital
in Recent Years, Despite a More Sluggish Growth
Environment Beyond negative rates, we also note that reregulation has become a
Emerging Market Consumption as a % of Global
major negative headwind for banks in two ways. First, as we show
Consumption in Exhibit 34, banks have paid out nearly 14% of their equity in fines
40
since 2009. In addition, banks are increasingly being forced to hold
36.5
huge sums of money against their positions, which all but ensures an
35 inability to earn their costs of capital. One can see this in Exhibit 35.
Since 2003, EM's share
of global consumption
has grown 16.1 ppt
30

25

20.4
20

15
90 92 94 96 98 00 02 04 06 08 10 12 14

Data as at December 31, 2014. Source: World Bank, Haver Analytics.
What we believe is really needed
to sustain an improvement
If we are correct in the notable change in investment perception that
in the outlook for absolute
we are forecasting, then the long-term implications are significant. growth and returns, particularly
Specifically, large, consumer-oriented countries could see their valu-
ation multiples stay at the high end of their historical ranges or in the developed world, is a
even increase further as global investors reallocate towards more
stable, consumer-oriented economies. Under this outcome (which we
reacceleration in long-term
think likely), multiples are not likely to contract quite as much during productivity trends.
recessions, which mean trough multiples could be higher than in the
past (Exhibit 31).

KKR INSIGHTS: GLOBAL MACRO TRENDS 15

EXHIBIT 34 EXHIBIT 36

Seven Years of Fines Have Taken a Heavy Toll on Banks, The U.S. Yield Curve Is Actually Still Steep Relative to the
Wiping Out the Equivalent of 14% of Total Equity Capital Eurozone, the U.K. and Japan
Ten Banks Total Equity Capital 10y-2y Government Bond Yield, %
2/10 Curve (LHS) 10y Rate (RHS)
Loss Due to 0.9 1.6
Fines and
0.8 1.4
Penalties
14% 1.2
0.7
1.0
0.6
0.8
0.5
0.6
0.4
0.4
0.3
0.2
0.2 0.0
0.1 -0.2
0 -0.4
US *Japan *Germany *France UK

*Part or all of curve in negative yield despite upward slope. Data as at

Ten Banks include Barclays, Bank of America, Citigroup, Credit Suisse, July 29, 2016. Source: Bloomberg
Deutsche Bank, GS, HSBC, JPM, MS and UBS. Data as at March 27,
2016. Source: FT, Corlytics.

EXHIBIT 37

Given Current Valuations, Capital Raises Across the

EXHIBIT 35 Global Banking Industry Are Now Dilutive
Banks Have Built Over $100 Billion of Common Equity Select Bank Indices Price To Book Ratio
Between 2012 and 2015, Deteriorating Their Core ROEs 0.90
by At Least 100 Basis Points
Aggregate Core ROEs for Money Centers and WFC 0.66

0.50 0.48
8.6% -0.4%

-0.4%

-0.3%

7.6%

S&P 500 Banks FTSE All Share Euro Stoxx Topix Banks
Banks Banks

Data as at July 30, 2016. Source: Bloomberg.

2012 Core 2013 Capital 2014 Capital 2015 Capital 2015 Core
ROE Build Build Build ROE on Without question, we are all living in an unusual time when a banks
2012 cost of capital is actually rising as its leverage profile is declining. As
Earnings
a result, today banks can only issue dilutive equity (i.e., below book
Data as at May 16, 2016. Source: Company documents, Goldman Sachs value, as shown in Exhibit 37), which ensures that they may not be
Global Investment Research 2016 CCAR Preview. able to create the necessary equity buffer required to sustain a cycli-
cal downturn in credit quality.

For investors, we think that the most actionable opportunity is to

participate as a substitute lender where complex transactions are
moving off-market. We see this opportunity best presenting itself in
the direct lending arena, which often includes mid-market financings,
acquisitions, and divestitures. In addition, within the asset-based

16 KKR INSIGHTS: GLOBAL MACRO TRENDS

finance market, we believe there are a growing number of off-market EXHIBIT 39
financings now occurring, including first or second lien loans with
Central Bank Policy Towards Negative Rates Has
some form of upside equity participation.
Significantly Affected Bank Performance
Separately, given that we continue to forecast slow nominal GDP, Bank Equity Performance (Oct '15 = 100)
we think that the potential for non-performing loans to increase,
120 Europe Japan
particularly in regions where nominal lending growth is still running
U.S. U.K.
well above nominal GDP growth, is significant. If we are right, then
110
distressed credit and restructuring managers in markets ranging
from Italy to Greece to China to India should prosper, especially if
100
we are right about a more synchronized global economic slowdown
in 2018. Finally, unless central bank strategy shifts in major mar- 90
kets like Japan and Europe, we think that the opportunity for active
management across both public and private markets to outperform 80
relative to static benchmarks (the lions share of which are heavily Europe and
weighted towards banks) is now quite significant. Implicit in what we 70 Japan move to
negative yields
are saying is that services-based investments, particularly those that
are levered to rising GDP-per-capita, are likely to outperform spread 60
Brexit
lending institutions in todays low rate world. uncertainty
50
EXHIBIT 38
40
Current Bank Market Capitalizations In Europe Appear

May-16
Jun-16
Jun-16
Jul-16
Apr-16
Apr-16

Aug-16
Jan-16
Jan-16
Sep-15
Oct-15

Dec-15

Feb-16
Mar-16
Nov-15
Nov-15
Notably Sub-Scale Relative to Their Asset Bases
Major European Bank Capital Data as at August 16, 2016. Source: Bloomberg.

Assets / Tangible Common Equity

70 Assets / Market Capitalization
Buy Complexity, Sell Simplicity
60
As we mentioned in our mid-year update (see Adult Swim Only:
50 43.6 2016 Mid-year Update, June 2016), we believe that the market is now
potentially over-pricing assets with steady cash flows, while under-
40 paying for complexity, particularly around cyclical earnings, conglom-
erates, and/or busted deals. On the one hand, there are an increasing
30
20.4 number of opportunities to monetize cash flows on long-term invest-
ments, particularly in areas such as Real Estate, Infrastructure, and
20
Private Equity. Specifically, there have been more and more opportu-
10 nities to carve out and sell certain long-term leases at low cap rates
and use proceeds to essentially de-risk much of the overall real estate
0 investment project. On the other hand, we see forced sellers across
Dec-07

Dec-10

Dec-13

Jun-16e
Dec-08

Dec-09

Dec-11

Dec-12

Dec-14

Dec-15

the private markets that need capital to avoid downgrades and/or

reposition their businesses to compete more effectively. Importantly,
this opportunity set is a global one; in fact, we actually believe that
Data as at June 30, 2016. Source: Bloomberg.
there will be more near-term activity surrounding complex situations
in Europe and Asia, Japan in particular, than in the United States over
the next 12 months. Key to our thinking is that slower growth in Japan
and Europe are forcing executives in these regions to think more thor-
oughly through the strategic value of their existing footprints.

Our base view remains that Looking at the big picture, our base view is that a 1998-2000 anal-
technical forces are likely to win out ogy is a good one to use. In 1998, the Federal Reserve eased, which
fueled a concentrated bet into speculative technology and telecom
over fundamentals in the near term, stocks at the same time that many other parts of the market be-
came extremely unloved. Just consider that in the fall of 1998 (right
given that central bank buying is before the China Growth Miracle unfolded), Caterpillar was trading
now overwhelming supply. at 9 times depressed earnings, while Deere was trading at 8 times
near-trough earnings. At the same time, however Cisco and Micro-
soft commanded multiples of around 48 times forward earnings.
Meanwhile, the S&P 500 was trading 21 times, so these technology
multiples were over 200% of the markets elevated multiple, while

KKR INSIGHTS: GLOBAL MACRO TRENDS 17

CAT was at 50% of the markets multiple. This was right before the EXHIBIT 41
decade that saw CATs earnings triple11.
Bottom Quintile Performing Stocks in the S&P 500 Are
Today, we see yield not high flying technology and telecommunica-
the Most Volatile; We Would Shop for Bargains in This
tions stocks per se getting expensive. Just consider that at 1.5%,
Area of the Market
the 10-year Treasury trades at ~66 times its yield, while U.S. Utility Average Volatility of S&P 500 Stocks, By 1 Year
stocks trade at 20 times earnings. A similar revaluation has occurred Performance Quintile, as of July 2016 and July 2014
in the U.S. REIT sector.
32.7 Jul-16 Jul-14

While we do expect rates to remain low, we are increasingly of the

mindset that investors are starting to overpay for the forward earn-
ings stream of many yield-oriented equity securities. If we are right, 26.2
25.5
investors could similar to 1999 end up buying great companies 23.6
that prove to be less stellar investments because the entry multiple 22.1 22.0
21.4 21.0
was just too high to provide solid, above average performance. 19.8 19.9

EXHIBIT 40

Utilities in the U.S. Are Trading at 20x Forward EPS. In Bottom 4th Quintile 3rd Quintile 2nd Quintile Top
General, We Are a Seller of Simplicity/Visibility of EPS Performance Performance
Quintile Quintile
Dow Jones Utility Index, NTM P/E Ratio Quintile of 1 Year Performance

Data as at July 31, 2016. Source: Bloomberg.

NTM P/E Ratio
20
+2SD Conclusion
18
+1SD
16 Overall, we continue to view the current cycle as the Asynchronous
14 Avg. Recovery (see Investment Implications of an Asynchronous Global
Recovery, September 2014). Indeed, rising macroeconomic and
12 -1SD
geopolitical tensions are creating both opportunities and risks
10 -2SD for global investors across both equities and fixed income. Our
8
base view is not to shun risk. Rather, we continue to suggest that
investors should embrace our key macro themes, many of which
6 we think can perform against a variety of economic backdrops and
Jan-03

Jan-09

Jan-11
Jan-12

Jan-14
Jan-07

Jan-15
Jan-16
Jan-02

Jan-04

Jan-10

Jan-13
Jan-05
Jan-06

Jan-08

capital markets environments.

Data as at August 17, 2016. Source: Bloomberg. First, as we discussed earlier in this paper, we believe that assets
with Yield and Growth will outperform. Strong demographic forces,
coupled with low inflation and shrinking supply, lead us to believe
that yield assets, particularly those that can compound their cash
flows, should do quite well in the environment that we envision.
Consistent with this view, we hold overweight positons across Real
Large, consumer-oriented Assets, including Real Estate, Real Estate Credit, and Infrastructure.
We also favor both spicy Liquid and Private Credit.
countries could see their
Second, we would avoid exposures linked to Chinas structural
valuation multiples stay at the slowing. From our vantage point, Chinas slowdown is secular,
high end of their historical not cyclical, and we see continued pricing pressure amidst slower
activity across not only Asia but parts of Europe and Latin America.
range or even increase further That said, we are increasingly of the mindset that there is the
as global investors reallocate opportunity to help Chinese companies expand abroad. Key areas of
focus include telecommunications, optical instruments, and electric
towards more stable, consumer- power machinery.
oriented economies. Third, we see the opportunity for a significant and potentially
sustained upward revaluation in the securities of large domestically-
oriented economies. Some of this has already occurred, but we think
it could go further than some in the investment community now think.
11 Data as at August 24, 2016. Source: Caterpillar, Cisco, Microsoft company The U.S. remains our top choice, though other countries, including
filings, Bloomberg. India, Mexico, and Indonesia could benefit as well.
18 KKR INSIGHTS: GLOBAL MACRO TRENDS
Fourth, the dismantling of the traditional financial services opportuni-
ty is both a blessing and a curse. On the opportunity side, we believe
that non-bank lending will continue to gain share, and by doing so,
provide pensions and endowments with the opportunity to earn a
yield that often exceeds their current target return rate. In our view,
this opportunity is a secular, not a cyclical one, though we do believe
that the current illiquidity premium could face some downward cycli-
cal pressure. On the other hand, we do worry that the inability of
banks to earn their costs of capital means that their capacity to repair
their balance sheets by issuing accretive equity has vanished. This
shift in the landscape is important because it means that banks will
be forced to rely primarily on retained earnings to deal with cycli-
cal flare-ups in credit quality not an easy task when net interest
margins are shrinking. As a result, total credit creation is likely to
remain subpar, which is not a favorable backdrop for helping global
GDP rebound towards more normalized levels.
We believe that the market is now
potentially over-pricing assets with
Finally, given the bifurcation across markets, we advise folks to
consider increasing exposure to complex stories, including earn- steady cash flows, while under-
ings misses, restructurings, and/or corporate repositionings. At the
moment, Japan appears to be one of the most actionable markets,
paying for complexity.
though we are also seeing some interesting opportunities in the
United States and Europe. Conversely, we think that earnings visibil-

ity and simplicity are potentially being overvalued, and as such, our
inclination is to harvest existing gains in these areas.

Overall, our message is that the current environment is not likely to

change materially in the near term, and as such, pursuing idiosyncrat-
ic themes like the five mentioned above is likely to yield better perfor-
mance results than increasing exposure to beta plays at this point in
the cycle. Not surprisingly, this world view leads us to overweight po-
sitions across Private Equity, Opportunistic Credit, and Private Credit.
By comparison, we fund these positions with underweight positions in
Public Equities, Government Bonds, and Growth Equities.

Important Information
The views expressed in this publication are the personal
views of Henry McVey of Kohlberg Kravis Roberts & Co.
L.P. (together with its affiliates, KKR) and do not neces-
sarily reflect the views of KKR itself or any investment
professional at KKR. This document is not research and
should not be treated as research. This document does
not represent valuation judgments with respect to any
financial instrument, issuer, security or sector that may be
described or referenced herein and does not represent a
formal or official view of KKR. This document is not intend-
ed to, and does not, relate specifically to any investment
strategy or product that KKR offers. It is being provided
merely to provide a framework to assist in the implementa-
tion of an investors own analysis and an investors own
views on the topic discussed herein. 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. Opinions
or statements regarding financial market trends are based
on current market conditions and are subject to change
without notice. The views expressed herein may not be
reflected in the strategies and products that KKR offers,
including strategies and products to which Mr. McVey pro-
vides investment advice on behalf of KKR. It should not be
assumed that Mr. McVey has made or will make investment
recommendations in the future that are consistent with the
views expressed herein, or use any or all of the techniques
or methods of analysis described herein in managing client
accounts. Further, Mr. McVey may make investment recom-
mendations and 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 document. This publication 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 illustra-
tive purposes only. The information in this document 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 investment or other decision. There can
be no assurance that an investment strategy will be suc-
cessful. 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 assur-
ance that the target allocations will be achieved, and actual
allocations may be significantly different than that shown
here. This publication 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.
The information in this publication may contain projec-
tions or other forwardlooking 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 document,
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 calcu-
lated 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 publication and no
responsibility or liability is accepted for any such informa-
tion. By accepting this document, the recipient acknowl-
edges 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 se-
curities or financial products. This report is not approved,
reviewed or produced by MSCI.

KKR INSIGHTS: GLOBAL MACRO TRENDS 19

www.kkr.com