This paper is intended for Professional and Institutional investors only who understand the strategies and views

introduced in this paper and can form an independent view of them. Investing in hedge fund is not suitable for all investors.

2014 Hedge Fund Outlook

Alternatives & Fund Solutions

Hedge funds should be able to deliver another solid performance in 2014, with a number of sectors likely to be particularly well suited to the market environment. Below, we review hedge fund returns in 2013 by strategy. In the subsequent section, we set out our market expectations for 2014 and assess which strategies have greater potential to do well and which may struggle.

Against this backdrop, hedge funds outperformed their long-term average. As proxied by the HFRI Fund Weighted Composite Index, they returned 9.3% during 2013, which compares favourably with a 7.6% annualised return over the 15 years to end December 2013. dbX-Active, our liquid actively managed fund, did better still. Driven by a combination of strategy and manager selection, it returned just over 9.8%. As well as outperforming the broader hedge fund industry, it bettered its liquid hedge fund peer group, as proxied by the HFRX Global Index, by three percentage points. Equity long/short: leading the way Equity long/short led the broad strategy groups in 2013, with performance of the strategy bettered in the recent past only in 2009. The HFRI Equity Hedge Index rose 14.6%, with certain sub-sectors among them technology and healthcare delivering more than 20%, in no small part thanks to a fertile IPO market. Returns were driven by an improved stock-picking environment and the supportive direction of equity markets. By region, developed market equity long/short strategies outperformed dedicated emerging market funds. The latter had to contend with both a withdrawal of liquidity during the summer and macro-economic concerns about certain emerging markets, particularly in Latin America.

2013 review
The US equity market enjoyed a strong year in 2013. At almost 30% during 2013, the return on the S&P500 was the biggest since 1997. Even this, though, was eclipsed by the Japanese market, which posted a more than 50% rise. It was a more difficult year for government bonds: yields may now have touched their lows for this cycle, but we have certainly yet to see their highs. In credit markets, relative performance reflected both duration risk, with high yield outperforming investment grade, and international flows, with developed markets outperforming emerging markets. Commodity markets struggled to find direction, while volatility for FX majors remained muted.

Tim Gascoigne
Head of Hedge Fund Advisory +44(0)20754-13774 tim.gascoigne@db.com

Claudia Roering
Portfolio Manager +49(69)910-18560 claudia.roering@db.com
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Equity market neutral: expanding opportunities Equity market neutral funds also outperformed their long-term average, with the HFRI Equity Market Neutral Index rising 7.1%. Fundamental factor-driven strategies benefited from investors being increasingly focused on individual company valuations, while reduced capital in the sector improved the opportunity set for the remaining universe of managers. Statistical arbitrage funds also enjoyed positive performance. The strategy benefited from the fact that it too has become relatively uncrowded, which helped managers overcome the challenges of the trending, non-mean-reverting stock-price movements witnessed in recent years. Discretionary macro: a challenging year Discretionary macro funds experienced a mixed 2013, with the lack of sustainable trends (except long equities) impacting returns for most of the year. Currency trading outside Japan was especially difficult, with both the euro and sterling confounding Q1 forecasts by appreciating substantially against the US dollar. Positioning for a rise in government bond yields was negligible ahead of the first 'taper talk' on May 22. This trade temporarily unwound after the Federal Reserves surprise 'no taper move' on September 18. Trading commodities continued to be generally loss-making, resulting in investor withdrawals from specialist funds in the sector. Partial salvation for discretionary macro came toward the end of the year, with the late reemergence of the Japan trade (both Nikkei long and yen short). This was just enough to keep overall performance flat for the year rather than negative. CTAs: back-ups and reversals Reversals in trends resulted in negative returns for CTAs. The HFRI Systematic Macro Index, for example, retreated 0.7% over the calendar year. One of the principal reasons for this disappointing performance was the back-up in government bond yields after May 22. This briefly reversed after September 18 but then switched direction again towards the end of the year. Another factor was the stubborn range-trading of the euro against the US dollar, which hindered both systematic and discretionary macro strategies in generating
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performance from trends. Commodities offered little relief, with short gold the only significant source of return. Credit strategies: risk drives returns Credit strategies delivered positive performance, with the HFRI RV Fixed Income Corporate Index returning 6.1% a solid return given tight spreads. Support for directional strategies came from bountiful liquidity and investor appetite for yield, while relative value approaches also benefited from companies continued (and elevated) refinancing activities. Helped by improving fundamentals in the US housing market in particular, asset-backed strategies significantly outperformed plain-vanilla corporate credit. It is important to note, however, that funds invested further and further down the capital structure, so increasing risk, in an effort to maintain return expectations. Event-driven: another bumper year The HFRI Event Driven Index rose 12.5%. Like equity long/short, the sector enjoyed its best year since 2009. Event-driven strategies benefited from three key factors. The first was a welcome, if modest, increase in merger activity though realizable returns from announced deals remain relatively uninteresting from a historical point of view. The second was strong performance by activist managers, aided by rising equity markets; they once again began to look beyond companies listed in North America and Northern Europe, turning their attention to Japan and other regions. Meanwhile, special situations arose in many forms, as companies continued to refocus their business lines and optimize financing. Distressed: more double-digit gains The HFRI Distressed Index rose 13.6%. With managers continuing to profit from opportunities generated by the significant bankruptcies during the global financial crisis, the sector delivered its fourth double-digit gain in the past five years. Returns for the strategy were helped by the fact that capital was increasingly seeking the riskier elements of capital structures. Notable opportunities were to be found in the powergeneration and gaming sectors and in certain municipalities, which faced significant challenges in 2013.

2014 outlook
Market outlook
Our hedge fund performance forecasts are derived from our market outlook for 2014, which is based on the following expectations: Global growth will accelerate above consensus, driven by a consumer recovery in the US and Europe Market participants in developed markets will respond relatively benignly to Fed tapering; by contrast, we expect a more substantive negative reaction in the weaker emerging markets China's economy will hold up well; our constructive view is supported by recently announced economic and social reforms, which have positive long-term implications The USD will be supported by a clearer demarcation in policy between the Federal Reserve and the European Central Bank. This should increase volatility in developed market FX and fuel continued spikes in volatility in emerging market FX Stock selection will become more dominant as developed equity markets move higher at a much slower rate In fixed income markets, valuations should further reflect progress towards the normalization of US monetary policy. We expect credit spreads to stay firm and default rates to remain low

Hedge fund outlook

We expect hedge funds will again outperform their historical average return in 2014. Below, we set out our forecast for each strategy, based on the market outlook given above. Equity long/short: Overweight Our positive forecast for equity long/short is underpinned by our expectations of steady gains for equities and a helpful environment for stockpickers, particularly as progress on tapering is priced into markets during the year. The latter will be a continuation of conditions in 2013, when correlations declined within equity markets and managers were rewarded for their research on individual company valuations. In the US, we think equity markets will reflect company fortunes first and foremost, rather than macro and political influences we do not expect a re-run of last year's Congressional stalemate. Overall, the Federal Reserves reiteration of its low interest rate policy should support growth and equity valuations. We have a similar outlook for Europe, where the tail risk of a eurozone unwind has diminished markedly, the German election results support the future of Europe as a single entity, and signs of economic recovery are increasing. In emerging markets, we see more selective opportunities driven by individual country risk. Equity market neutral: Overweight Both factor-driven and statistical arbitrage managers should receive tailwinds in 2014. Factordriven approaches should benefit from the improved stock-picking environment, as well as an increased focus on style and valuation factors by investors in more stable markets. Further support should come from the re-opening of new markets to the strategy (including Japan), as well as reduced capital in the sector, which should expand the opportunities for the remaining universe of managers. Statistical arbitrage managers should also benefit from a relatively uncrowded operating
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Hedge fund outlook: Summary

environment, as well as likely intermittent rises in volatility. Discretionary macro: Neutral/Overweight For some time this sector has been battling headwinds in the form zero interest rates and compressed FX volatility. We expect these to abate, especially during the second half of 2014, at last allowing managers to expand their opportunity set into interest rate and FX markets. In particular, the timing and pace of tapering in the US should offer opportunities for fixed income curve trading. The contrast in the use of central bank balance sheets in the US and Europe throughout 2013 expansion for the Federal Reserve, contraction for the European Central Bank should create relative fixed income trading opportunities and, by implication, FX opportunities in 2014. Any change in ECB policy, perhaps sparked by the spectre of deflation, will increase volatility and return potential. In Japan the reflation theme should continue to provide trading opportunities, while in emerging markets weaker economies more reliant on international capital flows should witness higher volatility in their exchange rates. CTAs: Neutral/Underweight We are marginally negative on medium-term and long-term trend followers in a portfolio context. CTA strategies will offer more for investors only when trends pervade beyond long equities. For now, long-term trends are likely to be in short supply in an environment of gradually rising equity markets, where the balance of returns is driven by stock-picking. The Federal Reserve and other central banks are making greater use of forward guidance to try to head off sharp moves in risk assets. That said, some short-term strategies may benefit from the intermittent volatility we expect to see across certain asset classes. Credit strategies: Neutral/Overweight Despite current tight spreads and the potential for rising interest rates, we are constructive on credit. These headwinds are tempered somewhat by opportunities in floating-rate paper and higher convertible bond issuance.

Long/short credit strategies should benefit from the improved conditions for fundamental approaches, even though spreads are likely to remain unchanged. In this sector astute research by managers will be required, because many bonds continue to trade above par, limiting the upside against call risk. There are opportunities for longer-term strategies in structured credit. These are supported by an improving US housing market and the potential for rising interest rates, which would reduce prepayments and thus support mortgage derivatives. Meanwhile, higher equity markets have spurred new issuance in the convertibles market, creating opportunities in secondary markets. Event-driven: Overweight Event-driven strategies should continue to perform well. Activist managers should be able to derive opportunities from the significant cash piles on company balance sheets. For merger specialists, the potential for consolidation in the telecoms and materials sectors especially should drive increased returns. Similarly, we expect better performance for risk arbitrage and merger arbitrage managers on higher deal flow driven by company management teams' desire or necessity to increase return on capital. Distressed: Underweight The dearth of bankruptcies (both current and expected) will drag on returns for managers in this sector throughout 2014. Default rates are currently at a historically low level of 2.2% (compared to an average of 4.9%), and forecasts suggest they will remain muted throughout 2014. Debt maturities will not ramp up until late 2016. Valuations remain full, with defaulting bonds and bank debt trading above long-term averages. The proportion of performing credit trading at either stressed or distressed levels is therefore also historically very low. As a result, there appear to be few opportunities and significant money is chasing those that do exist, especially in Europe.

Summary of key drivers for hedge fund returns Below is a non-exhaustive list of market parameters that we believe drive hedge fund returns and our forecasts for these drivers.

Implications for a Balanced Portfolio What this means for a balanced hedge fund portfolio is set out below, with desired allocations in the penultimate column.

Important Notes/Sources
HFR index data sourced from Hedge Fund Research Jan 2014. Market data soourced from Bloomberg Jan 2014 Default rates sourced from FT Jan 2014 This paper has been produced for information purposes only by the Hedge Fund Advisory team of Alternatives & Fund Solutions in DeAWM. It is not intended to constitute investment advice or independent research. The opinions presented in this paper are solely those of the team and not those of any other part of Deutsche Bank This paper is intended for Professional and Institutional investors only who understand the strategies and views introduced in this paper and can form an independent view of them. Investing in hedge fund is not suitable for all investors.. Any past performance referred to herein is not an indicator of future performance and any forecast or projection may not be realised. Any investment in hedge funds can go down as well as up and investor capital may be at risk up to total loss. This document is for informational purposes only. It is not to be construed as an offer to buy or sell, or a solicitation of an offer to buy or sell, any hedge or mutual funds, shall not be taken as any form of commitment or contract on the part of Deutsche Bank AG or one of its affiliates (collectively Deutsche Bank) and does not create any legally binding obligations on its behalf. This document has been prepared by Deutsche Asset and Wealth Management for discussion purposes only. Although the information herein has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. Deutsche Bank has no obligation to update, modify or amend this document or to otherwise notify the recipient in the event that any matter stated herein, or any opinion, projection forecast or estimate set forth herein, changes or subsequently becomes inaccurate. To the extent permitted by law, Deutsche Bank accepts no liability for loss arising either directly or indirectly from the use of the material in this document. This material was not produced, reviewed or edited by any research department within Deutsche Bank. Any opinions expressed herein may differ from the opinions expressed by other Deutsche Bank departments including the research departments. Deutsche Bank may engage in transactions in a manner inconsistent with the views discussed herein. Deutsche Bank trades or may trade as principal in the instruments (or related derivatives), and may have proprietary positions in the instruments (or related derivatives) discussed herein. Deutsche Bank may make a market in the instruments (or related derivatives) discussed herein. The investments discussed in this document may not be suitable for all investors and investors must make their investment decisions based upon their specific financial situations and investment objectives. Nothing in this document constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you . Deutsche Bank does not advise on the tax consequences of investments and recipients are advised to contact an independent tax advisor. Please note in particular that the bases and levels of taxation may change. Investments are subject to various risks, including market fluctuations, regulatory change, possible delays in repayment and loss of income and principal invested. The value of investments can fall as well as rise and you may not recover the amount originally invested at any point in time. Furthermore, substantial fluctuations of the value of the investment are possible even over short periods of time.

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