KKR Insights 120408

InsIghts

GLOBAL MACRO

TRENDS

InsIghts

GLOBAL MACRO

TRENDS

April 2012

The Twin Roles of

Real Assets

Economic, geopolitical and demographic factors

have combined to create a compelling environment

for investments in real assets—especially real

estate, energy production, infrastructure and soft

commodities. Such exposure may entail relinquishing

some liquidity, and is also susceptible to the risk of a

pullback in global economic growth. Yet, we believe

real assets can still serve twin objectives: hedging

against the potential effects of easy monetary policy

and possible consequences of a Mideast conflict; and

gaining exposure to attractive income—as well as yield

and growth—in a low-rate environment.

KKR global MacRo & asset allocatIon teaM

henRy h. McVey

Head of Global Macro & Asset Allocation +1 (212) 519.1628 [email protected] DaVID R. McnellIs +1 (212) 519.1629 [email protected] FRances b. lIM +1 (212) 519.1630 [email protected] Rebecca J. RaMsey +1 (212) 519.1631 [email protected] MaIn oFFIce

Kohlberg Kravis roberts & co. l.P. 9 West 57th street

suite 4200

new York, new York 10019 + 1 (212) 750-8300 coMPany locatIons

Usa new York, san Francisco, Washington, d.c., Menlo Park, houston eURoPe london, Paris asIa hong Kong, beijing, dubai, tokyo, Mumbai, seoul aUstRalIa sydney

back in January 2012, we targeted a substantial overweight alloca-tion of 10% to real assets versus a benchmark weight of 5%—and so far, roughly four months into the year, we remain confident in our outlook. In fact, given our current worldview, we would likely use any weakness to allocate even more to the asset class. Why? because, as we will explain in more detail in the following pages, we have greater conviction in three mega macro trends that we believe benefit an increasingly outsized position to real assets in the near-term:

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

2. We Want to Further Hedge Against Robust Commodity Prices. central to our asset allocation outlook for 2012—and our broader Phase III framework1 _{for the current environment—is our} view that the corporate sector is a more attractive destination for capital allocations than the government and financial-inter-mediary sectors. however, ample government intervention (in the form of fiscal stimulus) and renewed geopolitical tensions may now be fueling a price surge of many commodities—oil in particular. therefore, we feel compelled to maintain outsized exposure to an asset class that can act as a hedge to any input-cost related erosion of corporate profitability.

3. Real Assets Are Increasingly Providing the Yield Component That Changing Demographics Require in Today’s Low Rate Environment. Many real assets managers are increasingly aim-ing for higher yields and return of capital to match demographic shifts in investors’ preferences caused by aging baby boom-ers. We whole-heartedly subscribe to this strategy. after all, in an environment of low nominal rates but outsized government liquidity, our research shows that coupons linked to inflation hedging investments may become more valuable. Moreover, given our strong view regarding demographic forces in the market, we think that there is significant potential for an upward revaluation of these types of investments that can provide in-vestors with both a yield and growth component.

looking at the bigger picture, we believe our current asset-allo-cation framework reflects many of the key macro themes we see playing out. We maintain that the arbitrage between the low yields offered on government bonds and the higher yields on such “spici-er” fixed-income products as mezzanine, high-yield and emerging-1 see our paper entitled “Phase III: The Last Stage of a Bumpy Journey,” october

2011, available at KKr.com.

market debt is still compelling. not surprisingly, we continue to be underweight government bonds by a full 15%—our largest under-weight position by far (Exhibit 1). at the same time, our overunder-weight position in traditional alternatives gives us critical exposure to the upside of surging consumption in asia, distressed securities in europe and select opportunities in the United states.

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

exhIbIt 1

KKR Global Macro & Asset Allocation Suggested Portfolio

Allocation

AssET CLAss KKR GMAA TAR

GE T As s ET A L-Lo CA TI on (%) BEn CH -MARK (%) D IF FER -En CE (%) PuBLIC EquITIEs 50 53 -3 U.s. 20 20 0 eUroPe 12 15 -3 all asIa 12 12 0 latIn aMerIca 6 6 0

ToTAL FIxED InCoME 25 30 -5

global governMent 5 20 -15 MezzanIne 5 0 5 hIgh YIeld 5 5 0 hIgh grade 5 5 0 eMd 5 0 5 REAL AssETs 10 5 5 real estate 3 2 1 energY/InFrastrUctUre 5 2 3 gold/corn/other 2 1 1 oTHER ALTERnATIvEs 15 10 5 tradItIonal Pe 5 5 0

dIstressed & sPecIal sItUatIon

5 0 5

other 5 5 0

CAsH 0 2 -2

source: KKr global Macro and asset allocation as at april 6, 2012.

1

2

The Macro Case for Real Assets

Government stimulus is now oversized. one of the first films I ever went to see in a movie theater was steven spielberg’s 1975 classic, Jaws. a memorable scene from that film came to mind in which police chief Martin brody, played by roy scheider, realized what would be required to hunt down a mighty shark and exclaimed: “We’re going to need a bigger boat!”

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

how big is the central bankers’ proverbial boat these days? In the United states, monetary and fiscal stimulus is now 38% of gdP—four and a half times what the government spent during the great depression (Exhibit 2). the european central bank’s (ecb’s) balance sheet has grown 34% year-over-year as of February 2012, and is now bigger than the Fed’s in absolute and relative terms. all told, as Exhibit 3 shows, the central-bank balance sheets of the four largest developed economies have swollen to 25% of their collec-tive gdP (from 20% a year ago and 11% in december 2006) and to 37% of their collective market capitalization (from 29% a year ago and 13% at the end of 2006).

exhIbIt 2

Unprecedented Amount of Stimulus:

The U.S. Government Has Already Injected 4.5x

What it Did in the Great Depression

Pea K gd P tr o U gh gd P leng th (Mo nths) d ecl Ine In r eal gd P Mo ne tar Y FI scal co M b Ined aUg-29 Mar-33 43 27.0% 3.4% 4.9% 8.3% MaY-37 JUn-38 13 3.4 0.0 2.2 2.2 nov-48 oct-49 11 1.7 -2.2 5.5 3.3 JUl-53 MaY-54 10 2.7 0.0 -1.4 -1.4 aUg-57 aPr-58 8 3.2 0.0 3.2 3.2 aPr-60 Feb-61 10 1.0 0.7 1.0 1.7 dec-69 nov-70 11 0.2 0.3 2.4 2.7 nov-73 Mar-75 16 3.1 0.9 3.1 4.0 Jan-80 JUl-80 6 2.2 0.4 1.1 1.5 JUl-81 nov-82 16 2.6 0.3 3.5 2.8 JUl-90 Mar-91 8 1.3 1.0 1.8 2.8 Mar-01 nov-01 8 0.2 1.3 5.9 7.2 dec-07 JUn-09 18 5.1 18.3* 19.2* 37.5*

data as at January 31, 2012. *estimated against 2011 gdP of $15 trillion. source: Federal reserve, congressional budget office, grant’s Interest rate observer. KKr global Macro and asset allocation.

exhIbIt 3

Central Banks are Offsetting Austerity with Loose

Monetary Policy

Fed BoE ECB BoJ

%

data as at February 29, 2012. source: Federal reserve board, bureau of economic analysis, european central bank, bank of england, bank of Japan, swiss national bank, statistical office of the european communities, UK office for national statistics, cabinet office of Japan, haver.

“

We feel compelled to maintain

outsized exposure to an asset

class that can act as a hedge to

any input-cost related erosion of

corporate profitability.

“

“

There is significant potential for

an upward revaluation of assets

that can provide investors with

both yield and growth.

“

the good news is that recent programs—particularly the ecb’s ltro lending program—have been effective in dampening volatility2_. however, this has come at a price: real-asset prices are climbing as financial assets are incrementally debased. Exhibit 4 illustrates the correlation in recent years between declines in long-term real rates and increases in the price of commodities including gold, crude oil and real estate. We view the decline of real long-term interest rates as a good proxy for central bank liquidity, including promises of continued low policy rates in the future, quantitative easing, currency intervention, and the longer-term financing of potentially risky collateral (e.g., the ltro).

exhIbIt 4

Strong Relationship Between Lower Real Interest Rates and Higher Commodity Prices

-1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 600 800 1,000 1,200 1,400 1,600 1,800 2,000

Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Gold Px (Left)

US/EZ/UK/JP Real Yield,

% (Right, Inverted) _-1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 20 40 60 80 100 120 140

Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 WTI Crude Px (Left)

US/EZ/UK/JP Real Yield, % (Right, Inverted) -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 300 400 500 600 700 800 900 1,000 1,100

Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Dow Jones REIT TR Index (Left) US/EZ/UK/JP Real Yield, % (Right, Inverted)

data as at February 29, 2012. real yield composite is the gdP-weighted average of rates in the United states (10yr tIPs), United Kingdom (10yr Inflation-linked gilt), germany (barcap germany Inflation linked, 5yr+ Maturities), and Japan (barcap Japan Inflation linked, all Maturities). source: bloomberg, KKr global Macro & asset allocation analysis.

our current base view is that these programs are not temporary; rather, we see central banks committed to keeping interest rates low and liquidity high in the foreseeable future. as such, we think that such aggressive and unprecedented moves by the Fed and its global peers of late may continue to benefit overweight positions in such real assets as real estate, infrastructure, and oil-producing assets.

some Inflation Will Eventually Be Required to Bring Debt Lev-els Down. John Maynard Keynes once said that “by a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” While he wrote this in 1919 in response to post-World War I economic policies, we think his comment remains valid today, given that the developed world is again awash in indebtedness—much of it gov-ernment-related—and it appears that a measure of inflation could be needed to lower the debt burden at some point. Implementing an 2 ltro: long-term refinancing operations. central bank action can play an

important role in dampening interest rate volatility. ecb’s ltro has lowered implied volatility in european rates markets by 20% since its launch in mid-december according to bond Market observations, bnY Mellon as at February 2012.

inflation hedge that protects against Keynes’ alleged “confiscation of wealth” would therefore make sense, we believe.

as it stands now, total U.s. debt currently stands around 339% of gdP, down just slightly from a peak of 349% in March 2010 (Exhibit 5). Perhaps even more concerning is that economic growth seems ever more dependent on cheap credit. In each decade since the 1950s, the United states has incrementally taken on more debt for every increment of gdP growth (Exhibit 6). europe, too, has a well-documented debt overhang, but it also confronts the headwind of fiscal austerity.

exhIbIt 5

The Elephant In The Room: US Debt % of GDP

Households Corporates GSE Government Financials Mar-32, 298% Dec-11 339% 0% 50% 100% 150% 200% 250% 300% 350% 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 US Debt % GDP

gdP = gross domestic Product; gse = government sponsored enterprises. source: bea, Federal reserve, Morgan stanley research and “the statistical history of the United states” by ben Wattenberg. data through 4Q2011.

exhIbIt 6

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

1.4 1.5 1.7

2.9 3.1

5.6

1950's 1960's 1970's 1980's 1990's 2000's US Economy: Incremental Dollars of Debt

Per Incremental Dollar of GDP

gdP = gross domestic Product. 2000’s = 1999 to 2009. source: bea, Federal reserve, bloomberg.

although we believe that government austerity measures and private-sector deleveraging in europe and the United states could actually be disinflationary in the near term, we hold that an infla-tionary policy may ultimately be needed to help shrink the huge debt burden that has accumulated of late. remember that a government can control its debt burden relative to gdP via only two means: (i) running primary surpluses by having tax receipts greater than payments for non-interest expenses, including entitlements; and/ or (ii) holding nominal interest rates below the rate of nominal gdP growth. Exhibit 7 below illustrates the enormous challenge to achieving primary surpluses in the United states in coming years (and without question, we think europe faces a similar, if not greater, challenge). namely, rising old-age entitlement spending and rapidly escalating health care costs are set to push spending to historically unprecedented levels relative to gdP3_{. Meanwhile, the} 3 see our report entitled Brave New World: The Yearning for Yield Across Asset

Classes, december 2011, available at KKr.com.

United states has a long history of collecting tax revenues that av-erage about 18% of gdP, and it’s worth mentioning that it has never collected taxes above 20% of gdP for a prolonged period of time.

exhIbIt 7

Challenging Outlook for U.S. Primary Budget Deficit

Could Eventually Lead to Inflationary Policies

14% 15% 16% 17% 18% 19% 20% 21% 22% 23% 24% 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 _{2002 2005 2008} 2011 _{2014e 2017e}

2020e 2023e 2026e 2029e 2032e 2035e Revenues % GDP

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

e = estimate. revenue estimates assume federal revenues as a % of gdP revert to historical average of 18%. Primary (i.e., noninterest) spending estimates are as per cbo long-term forecasts published June 22, 2011. source: congressional budget office, KKr global Macro & asset allocation analysis.

exhIbIt 8

Holding Interest Rates Below GDP Growth Would Aid

U.S. Debt Dynamics, But Could Rekindle Inflation

1979 3.7% 1982 -4.6% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 _{2000 2004} 2008 U.S. Nominal GDP Growth, Surplus/(Deficit) Relative to Interest Rate* (3yr Rolling Average)

End of Stagflation

Headed Higher?

*We use the U.s. 5-Year treasury Yield as a proxy for government funding cost. the average maturity of U.s. total outstanding marketable debt centers around 60 months. source: bureau of economic analysis, bloomberg, KKr global Macro & asset allocation analysis.

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

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

If inflation does indeed rear its head at some point, are commodity-related real assets an effective inflation hedge? In our view, they certainly are: our research on the subject shows that commodities can serve as the most effective inflation hedge among various as-set classes. according to a study by economists gary gorton and K. geert rouwenhorst, commodities emerge as the winner versus stocks and bonds as an inflation hedge in a variety of environments (Exhibit 9).

exhIbIt 9

Correlation Of Asset Classes With Inflation* Shows

Commodities Are a Strong Hedge

-60% -50% -40% -30% -20% -10% 0% 10% 20% 30%

Inflation Change Expected

Inflation Unexpected Inflation Stocks Bonds Commodity Futures

Stocks and Bond Negatively Correlated with Inflation Commodities Positively

Correlated with Inflation

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

definitions: Inflation: Y/Y% consumer Price Index (cPI); expected inflation: t-bill rate as proxy; Unexpected inflation: Inflation - expected inflation. For additional information regarding the chart and basis for the data shown, please refer to Page 19 table 6 within Facts and Fantasies about commodity Futures. data is quarterly from July 1959 through 2004. source: gorton & rouwenhorst, Facts and Fantasies about commodity Futures: February 28, 2005.

exhIbIt 10

Inflation Hedging Power of Real Estate is Strong,

Particularly in a Low Rate Environment

57% -1% 51% 59% -3% -11% 0-4% 4-8% >8%

Correlation against Inflation

US 10 Year Yield (%)

Correlation of Real Estate Indexes and Inflation in Various Yield Environments NCREIF Total Rate of Return on Real Estate FTSE NAREIT Equity REITs Total Return Index

data from 1Q1978 to 3Q2011. correlation of Us consumer Price Index quarter-over-quarter change against ncreIF total rate of return on

real estate4 _{and nareIt equity reIts quarterly total returns. source:}

bureau of labor statistics, national council of real estate Investment Fiduciaries, Federal reserve board, bloomberg.

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

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

4 ncreIF total rate of return on real estate, where quarterly rates of return on real estate investments are calculated with net operating income, appreciation in market value and improvements made to the property. For more details, visit ncreIF.org.

“

Real assets are among the few

that offer offensive and defensive

characteristics in today’s

increasingly liquidity-driven

macro environment.

“

exhIbIt 11

The Three Phases of This Debt Bubble: From Corporates

to Wall Street to Sovereigns

0 20 40 60 80 100 120 0 5 10 15 20 25 30 35 2000 2007 2011 Government Leverage (%)

Corporate and Wall Street Leverage

Corporate Leverage Wall Street Government

Phase I Phase II Phase III

corporate leverage = s&P 500 ex-Financials net debt-to-assets; Wall street leverage = average assets-to-equity for goldman sachs and Morgan stanley; government leverage = United states: general government gross debt % of gross domestic Product (gdP). source: IMF Weo, Factset, s&P. data as at september 30, 2011.

exhIbIt 12

Rising Oil Prices Typically Move in the Opposite

Direction of Corporate Earnings

-50% -30% -10% 10% 30% 50% 70% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 86 88 90 92 94 96 98 00 02 04 06 08 10 12 S&P 500 EPS (Left Axis)

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

WtI = West texas Intermediate. source: bloomberg, s&P, thomson Financial, Factset.

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

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

exhIbIt 13

Rising Oil Prices is a Negative for Growth…

20 40 60 80 100 120 140 30 35 40 45 50 55 60 65 70 2004 2005 2006 2007 2008 2009 2010 2011 2012 Headline ISM Manufacturing (Left Axis) WTI Oil, leading 6m, reverse scale (Right Axis)

data as at February 22, 2012. source: Institute for supply Management, haver.

exhIbIt 14

...and Equity Valuations

0 50 100 150 200 250 300 350 400 450 10 11 12 13 14 15 16 17 18 2004 2005 2006 2007 2008 2009 2010 2011 2012 S&P 500 Forward NTM P/E (Left Axis)

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

data as at February 22, 2012. source: energy Information administration, s&P, thomson Financial, Factset, haver.

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

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

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

exhIbIt 15

Rapidly Aging Populations are Global in Nature

18.4 25.3 2050 26.6 2010 30.5 2030 37.1 2050 41.5 2010 12.3 2030 24.4 33.9 21.8 29.0 _33.6 5 10 15 20 25 30 35 40 45 2000 2010 2020 2030 2040 2050 Percentage of Population Age 60+

US Japan China Europe

data as at May 31, 2011. source: United nations World Population Prospects

exhIbIt 16

Retirees Have a Strong Appetite for Dividend Yield

1.5

2.8

Under 65 Over 65

Estimated Dividend Yield of Equity Portfolios, By Age of Head of U.S. Household - 2007 (%)

data as at december 6, 2011. dividend yield calculated using dividend income as reported by the Irs statistics of Income division and equity holdings as reported by the Federal reserve survey of consumer Finances. our estimate includes an assumption that roughly half of privately held businesses pay some form of dividend. source: Irs, Federal reserve, KKr global Macro and asset allocation estimates. We view return of capital as a critical component of our macro view and asset-allocation strategy, since we believe that assets offering yield and growth are likely to be revalued upward in the coming years because of demographic trends among the investor population. these trends present a strong—yet often underappreci-ated—force driving asset preferences and subsequent returns. as Exhibit 15 shows, almost every major developed economy has hit or is fast approaching an important demographic inflection point. this transition is important because, as Exhibit 16 shows, many retirees, particularly among baby boomers, aspire to materially increase the yields on their portfolios as they grow older.

these investors don’t just pursue yield in isolation; they seek yield combined with the potential for growth and, if possible, an inflation hedge. given that real assets contain all three of these attributes, we think there is great potential for an upward revaluation of such assets. additionally, since other inflation-protection instruments like tIPs now have negative yields (meaning that investors now need to pay for the inflation protection they receive), we believe the yield component of real estate and certain energy and related infrastructure investments is far more compelling in today’s market (Exhibits 17 and 18).

“

We think that recent aggressive

moves by the Fed and other central

bankers will continue to benefit

overweight positions in such real

assets as real estate, infrastructure,

and oil-producing assets.

“

exhIbIt 17

U.S. TIPS Yields Are at All Time Lows

-0.27 -1.42 -2.00 -1.00 0.00 1.00 2.00 3.00 4.00 5.00 1997 2000 2003 2006 2009 2012 U.S. 10 Year TIPS Yield (%) U.S. 5 Year TIPS Yield (%)

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

exhIbIt 18

If We Do Experience Infl ation, Government Bonds May

be at Signifi cant Risks

-1.6 -1.1 -1.1 -0.9 -0.3 0.8 1.2 2.6 6.4 -3 -2 -1 0 1 2 3 4 5 6 7

U.K. U.S. _{China Euro}

Germany France

Japan Italy Brazil Real 10 Year Yield Percentage

(Nominal 10 Yr Yield - CPI yy)

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

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

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

exhIbIt 19

Geopolitical Tensions Enhance the Appeal of Real Assets

March 8, 2012

World Powers Press Iran for talks

March 8, 2012

Iran Is Pressed on access for nuclear Inspectors

March 9, 2012

Weighing impact of Israel striking Iran

March 10, 2012

the view from tehran

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

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

libya was the world’s eighteenth largest oil producer before the uprising that unseated its government6_{. the libyan revolt claimed} a loss of 1.8 million barrels of oil-production capacity, and prices rose about 35%. but unlike libya, Iran is the world’s sixth largest oil and liquid fuels producer, with production of 3.6 million barrels per day—twice that of libya. If we lost Iran’s 3.6 million-barrel supply, historical patterns suggest that crude oil prices could rise another 85% from current levels, or about $190 per barrel. this is not our base case, but it may explain why oil prices have edged up on fears of a conflict involving Iran—and it also underscores the importance of having some downside protection in the event of a geopolitical shock that could severely crimp oil supply.

exhIbIt 20

Iran Still Produces 3.6 Million Barrels of Oil Per Day

toP 10 crUde oIl and lIQUId FUels sUPPlY/ ProdUctIon (MIllIons barrels Per daY)

1 UnIted states 10.5 2 rUssIa 10.3 3 saUdI arabIa 9.8 4 chIna 4.3 5 canada 3.8 6 Iran 3.6 7 MexIco 2.9 8 brazIl 2.8 9 IraQ 2.7 10 Uae 2.6 other 35.5 World 88.7

mb/d = Million barrels Per day. source: energy Information administration short-term energy outlook March 2012.

exhIbIt 21

Geopolitical Events Tend to Lead to Oil Price Surges

Six Day War Arab-Israeli War & Arab Oil Embargo

Iranian Revolution / Iran-Iraq War Iraqi Invasion of Kuwait Venezuelan Strike War in Iraq Hurricanes Katrina/Rita

Libya Civil War Suez Crisis Iran 2012?? 0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 0 2 4 6

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

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

data as at February 29, 2012. source: International energy agency, bloomberg.

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

22.5 barrels of oil annually per person, compared to just 2.5 barrels in china; U.s. residents consumed 907 kilograms of corn annually per person, compared to 123 kilograms in china7_{. More importantly,} china can no longer satisfy its citizens’ growing appetite for natural resources with domestic supply, and has shifted from being an exporter of such goods to an importer, in many instances. For ex-ample, china has experienced a notable surge of imports of crude oil and agricultural commodities—particularly corn—in recent years (Exhibit 22).

exhIbIt 22

China has Gone from a Net Exporter to Importer and

from Minor Consumer to Major Consumer in a Number

of Categories

  ExPoRTER In 2005 IMPoRTER In 2011 unITs

road vehIcles 9516 -5503 Us$M

corn 3665 -3800 1000 Mt

sWIne Meat 454 -290 1000 Mt cWe

beverage and

tobacco 395 -1412 Us$M

Wheat 268 -500 1000 Mt

cattle anIMals 4 -65 1000 heads

CHInA % WoRLD ConsuMPTIon

  2000 2010 ceMent 35.7% 56.2% PorK 46.9% 49.9% coal 30.7% 48.2% steel 15.1% 44.6% lead 10.2% 44.0% cotton 25.0% 40.2% alUMInUM 13.4% 39.8% coPPer 12.4% 38.3% nIcKel 5.1% 37.2% oIl 6.2% 10.4%

data as at december 30, 2011. source: china customs, United states department of agriculture, haver. as of 2010. source: Usda, Usgs, World steel association, china national bureau of statistics, eIa, Iea, bP statistical review, World bureau of Metal statistics, bloomberg, haver.

exhIbIt 23

EM Consumption is Now Bigger than U.S. Consumption

8.8 9.3 9.8 10.0 9.9 10.2 8.0 9.2 11.0 11.0 12.1 13.3 6 7 8 9 10 11 12 13 14 2005 2006 2007 2008 2009 2010 Private Consumption United States Emerging Markets US$ Trillion

emerging markets includes emerging and developing economies as defined by IMF, Korea, taiwan, and singapore. data from 2005-2010. source: IMF, KKr global Macro and asset allocation research.

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

exhIbIt 24

Urbanization is a Strong Driver of Growth…

China US Indonesia Japan Vietnam 0% 50% 100% 150% 200% 250% 300% 350% 400% 450% -10% 0% 10% 20% 30%

Change in Nominal GDP US$ 2010 vs 2000

Change in Urban Population % Total 2010 vs 2000 Urbanization Versus Growth

data as at december 31, 2010. source: IMF, World bank.

exhIbIt 25

...And China and India Have A lot More to Go

28.8 30.1 34.0 44.9 53.7 61.7 66.8 69.5 69.6 72.8 73.8 77.8 77.8 80.6 81.9 86.5 0 20 40 60 80 100 Vietnam India Thailand China Indonesia South Africa Japan Iran Turkey Russia Germany France Mexico Canada Korea, Rep. Brazil

2010 Urban Population % of Total

data as at december 31, 2010. source: IMF, World bank

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

“

We think there’s an opportunity

for managers to buy older oil

production operations at

attractive prices, resuscitate their

wells, and use the proceeds to

create a sizeable dividend stream

for investors.

“

ago as financial assets—equities in particular—were at record valuations. Fast-forward to today, and you will find that stocks have essentially gone nowhere over a decade, while gold has gone up 474%, oil has risen 269%, and the reIt index has climbed 200%8_. to use a baseball metaphor, we may not be in the ninth inning—but we’re certainly not in the first.

In addition, there is a lot of capital coming into the asset class, to energy-related investments in particular. the oil and gas industries are very capital-intensive, and over the past 12 years, capital ex-penditures in these industries have grown at an annualized rate of 16.7% to $151.0 billion—up from just $23.6 billion in 1999—whereas fixed, non-residential investment (ex-oil and ex-gas) has only grown at an annualized rate of 1.7% over the same period9_{. as a result,} oil- and gas-related capital expenditures are now running at 9.9% of total non-residential investment, up from 2.0% in 1999. While shale plays are creating somewhat of a renaissance in drilling activity, the current level of energy capital expenditures (which stands at 10% of total non-residential expenditures) has historically signaled a peak during past cycles, including in 1944 and 1981 (Exhibit 26). however, as a percentage of market capitalization, energy still ap-pears to have substantial upside before it would approach past peak levels of the s&P 500 (Exhibit 27).

exhIbIt 26

Energy Capital Expenditures is Now 10% of Total

Non-Residential Expenditures

Oil and Gas Related Investment % Non -Residential Fixed Investment

oil and gas related includes Mining exploration, shafts, Wells and Mining & oilfield Machinery. data as at december 31, 2011. source: bureau of economic analysis, haver.

8 source: bloomberg. data from december 31, 2000 to december 31, 2011. 9 source: bureau of economic analysis, haver. data as at december 31, 2011.

exhIbIt 27

Energy as a Percentage of S&P 500 is Still Well Below

Past Peak Cycles

Nov-80, 31% Nov-99, 5.3% Jun-08 16.2% 11.8% Nov-80 23.8% Mar-86 6.6% Feb-00, 6.5% Sep-02 13.4% 12.1% 0% 5% 10% 15% 20% 25% 30% 35% 1975 1980 1985 1990 1995 2000 2005 2010 Energy as a % of U.S. Market Cap Energy as a % of Europe Market Cap

data as at January 31, 2012. source: Factset, Morgan stanley research.

lastly, both commodities and real-estate prices are economically sensitive, and their correlations with a traditional 60/40 (equity/ bond) portfolio tend to increase during economic downturns10_. this is particularly true for the goldman sachs commodity Index, which many popular mutual funds currently use to theoretically gain exposure to real assets. We focus on investments that hedge some of the downside risks of commodities and, at the same time, pres-ent an opportunity to profit from production or market-share gains. and special discipline is advised for investors in real estate, namely sound financing strategies and reasonable leverage limits.

10 see exhibit 54 of Phase III: The Last Stage of a Bumpy Journey, october 2011 available on KKr.com.

“

Beyond the instability and

uncertainty wrought by the Arab

Spring, the standoff over Iran’s

nuclear program has the potential

to escalate to a broader conflict, in

which case real assets could serve

as a hedge against skyrocketing

energy prices and related

economic repercussions.

Summary

In our view, the macro backdrop is extremely compelling for in-vestments in real assets. We are targeting significant overweight positions in this asset class—including real estate, energy produc-tion, infrastructure, and soft commodities—as both a defensive and offensive strategy.

defensively speaking, we recommend hedging against highly loose monetary policy and potential fallout from geopolitical tensions stemming from the Middle east. We also view commodities, espe-cially oil assets, as an effective hedge against corporate exposure, of which we possess a fair amount in our target asset allocation. on the offensive side, we favor the income-producing components that real estate, energy infrastructure, and production-related investments can provide—a particularly appealing feature to us in today’s low-rate environment.

there are, of course, risks to our target positions. to pursue what we advocate, an investor generally must forfeit some liquidity in order to gain exposure beyond generic commodity swaps. even so, it is a bet we are willing to make in light of the poor performance features that many well-known indexes provide. Just consider that between 2004 and 2011, on an absolute basis, the gscI Index has returned just 8.5% versus 147.5% for the underlying spot commodity. another risk is that global growth may slow sharply and undermine the value of many real assets. this risk is not to be discounted—yet we think that any pullback in real-asset performance, however major, could be temporary. our belief is grounded in the underlying consumption trends in emerging markets that appear structural and secular—rather than cyclical—in nature.

Finally, any future decision by central banks worldwide to begin contracting their balance sheets may come at a price. We are thus comfortable maintaining an overweight position in real assets—es-pecially assets that have the potential to generate both yield and growth.

“

We suggest focusing on

investments that hedge some of

the downside risks of commodities

and, at the same time, present

an opportunity to profit from

production or market-share gains.

Important Information

the views expressed in this presentation are the per-sonal views of henry Mcvey of Kohlberg Kravis roberts & co. l.P. (together with its affiliates, “KKr”) and do not necessarily reflect the views of KKr itself. the views expressed reflect the current views of Mr. Mcvey as of the date hereof and neither Mr. Mcvey nor KKr undertakes to advise you of any changes in the views expressed herein. In addition, the views expressed do not necessarily reflect the opinions of any investment professional at KKr, and may not be reflected in the strategies and products that KKr offers. KKr and its af-filiates may have positions (long or short) or engage in securities transactions that are not consistent with the information and views expressed in this presentation. this presentation has been prepared solely for informational purposes. the information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. charts and graphs provided herein are for illustrative purposes only. the information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither KKr nor Mr. Mcvey guarantees the accuracy, adequacy or completeness of such information. noth-ing 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 successful. historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. target allocations contained herein are subject to change. there is no assurance that the target allocations will be achieved, and actual allocations may be significantly different than that shown here. this presentation should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. the information in this presentation may contain pro-jections or other forward‐looking statements regard-ing future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. there is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. the information in this presentation, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Performance of all cited indices is calculated on a total return basis with dividends reinvested. the indices do not include any expenses, fees or charges

and are unmanaged and should not be considered investments.

the investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Please note that changes in the rate of exchange of a currency may affect the value, price or income of an investment adversely.

neither KKr nor Mr. Mcvey assumes any duty to, nor undertakes to update forward looking statements. no representation or warranty, express or implied, is made or given by or on behalf of KKr, Mr. Mcvey or any other person as to the accuracy and completeness or fairness of the information contained in this presentation and no responsibility or liability is accepted for any such information. by accepting this presentation, the recipi-ent acknowledges its understanding and acceptance of the foregoing statement.

the MscI sourced information in this document is the exclusive property of MscI Inc. (MscI). MscI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MscI data contained herein. the MscI data may not be further redistributed or used as a basis for other indi-ces or any securities or financial products. this report is not approved, reviewed or produced by MscI.