Item 1: Business
(a) General Development of Business:
ML JWH Strategic Allocation Fund L.P. (the “Partnership”) was organized under the Delaware Revised Uniform Limited Partnership Act on December 11, 1995 and began trading operations on July 15, 1996. The Partnership trades through its Joint Venture, ML/JWH Strategic Joint Venture (the “Joint Venture”), in the international futures and forward markets through a joint venture with John W. Henry & Company, Inc. (“JWH ®”), utilizing JWH’s proprietary trading strategies.
Merrill Lynch Alternative Investments LLC (“MLAI”), an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. (“Merrill Lynch”), is the general partner of the Partnership. Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S”), a wholly-owned subsidiary of Merrill Lynch, is the Partnership’s commodity broker. (As used herein, the capitalized term “MLAI” also refers to the general partner at times when its name was MLIM Alternative Strategies LLC, as applicable.)
JWH® has utilized its Strategic Allocation Program since inception. JWH® manages capital in commodities, interest rate and foreign exchange markets for international banks, brokerage firms, pension funds, institutions and high net worth individuals. JWH® trades a wide range of futures and forward contracts on a 24-hour basis in the United States, Europe and Asia, and is one of the largest advisors in the managed futures industry in terms of assets under management, trading approximately $1.7 billion in client capital as of December 31, 2006.
The Partnership may offer its units of limited partnership interest (“Units”), when available for sale, as of the beginning of each month. Investors whose subscriptions are accepted during a month are admitted to the Partnership as Limited Partners as of the beginning of the following month, acquiring Units at the Net Asset Value per Unit as of the date of admission. Investors’ customer securities accounts are debited in the amount of their subscriptions on a single monthly settlement date within approximately five business days of the issuance of their Units.
As of December 31, 2006, the aggregate Net Asset Value of the Partnership was $792,303,062, and the Net Asset Value per Unit, originally $100 as of July 15, 1996, had risen to $175.61
Through December 31, 2006, the highest month-end Net Asset Value per Unit was $272.23 (May 31, 2003) and the lowest $98.89 (August 31, 1996).
(b) Financial Information about Segments:
The Partnership’s business constitutes only one segment for financial reporting purposes, i.e., a speculative “commodity pool.” The Partnership does not engage in sales of goods or services.
(c) Narrative Description of Business:
General
The Partnership trades in the international futures, options on futures and forward markets applying the multiple proprietary trading strategies (“Programs”) of JWH®. In managing the Partnership’s trading, JWH® uses its “JWH® Strategic Allocation Program” in which JWH® selects, allocates and reallocates Partnership assets in different combinations of its JWH® Programs. The Partnership’s primary objective is achieving, through speculative trading, substantial long-term capital appreciation. At the same time, the use of multiple JWH® Programs has the potential to reduce the expected volatility and risk of loss, which would typically be associated with the use of any single Program.
The Strategic Allocation Program uses a multi-strategy approach. The joint venture agreement provides that JWH® has full discretionary authority over the selection of which JWH ® Trading Programs to use for the joint venture and the leverage to be applied in the Strategic Allocation Program.
One of the objectives of the Partnership is to provide diversification to a limited portion of the risk segment of the Limited Partners’ portfolios in an investment field that has historically often demonstrated a low degree of performance correlation with traditional stock and bond holdings. Since it began trading, the Partnership’s returns have, in fact, frequently been significantly non-correlated (not, however, negatively correlated) with the United States stock and bond markets.
Leverage Considerations
The larger the joint venture’s market commitment (generally equivalent to the face amount of the positions held) in relation to its assets, the higher the position size in relation to account equity at which it is said to be trading. In general, the larger the joint venture’s market commitment, the profit potential increases, as well as the risk of loss. JWH® adjusts the joint venture’s market commitment to levels, which JWH® believes are consistent with its desired risk/reward objectives. For example, in volatile markets, JWH® might decide - in order to reduce market exposure and, accordingly, the risk of loss, but with a corresponding decrease in profit potential - that the positions ordinarily appropriate for a $50 million allocation are all a $75 million allocation should acquire. On the other hand, market factors might cause JWH® to decide - in order to increase market exposure and, accordingly, profit potential as well as risk of loss - that the positions ordinarily indicated for a $100 million allocation are appropriate for an allocation of only $50 million. JWH® monitors and adjusts on an ongoing basis the leverage at which the Strategic Allocation Program trades; position size in relation to account equity can range from 50% to 150% of standard program trading levels.
At certain times - for example, after substantial gains in several of the Programs - JWH® may conclude that the portfolio offers more risk than reward. If so, JWH® may reduce the market commitment, both taking profits and controlling risk. Conversely, JWH® may commit more than the total assets of the account to the markets if the profit potential seems to justify the added risk.
John W. Henry & Company, Inc.
Background
John W. Henry & Company began managing assets in 1981 as a sole proprietorship and was later incorporated in the State of California as John W. Henry & Co., Inc. to conduct business as a commodity trading advisor. JWH® reincorporated in Florida in 1997. JWH®’s principal offices are at 301 Yamato Road, Suite 2200, Boca Raton, Florida, 33431-4931. JWH®’s registration as a commodity trading advisor became effective in November 1980. JWH® is a member of the National Futures Association (“NFA”) in this capacity.
Trading Strategy
The following description of JWH®’s trading strategy relates to JWH® generally and not to the Partnership itself.
General
JWH® specializes in managing institutional and individual capital in the global futures, interest rate and foreign exchange markets. Since 1981, JWH® has developed and implemented proprietary trend-following trading techniques that focus on long-term rather than short-term, day-to-day trends. JWH® currently operates eleven trading programs.
Implementing the Program
The first step in the JWH® investment process is the identification of sustained price movements - or trends - in a given market. While there are many ways to identify trends, JWH® uses mathematical models that attempt to distinguish real trends from interim volatility. It also presumes that trends often exceed in duration the expectation of the general marketplace.
JWH®’s historical performance demonstrates that because trends often last longer than most market participants expect, significant returns can be generated from positions held over a long period of time. JWH® focuses
on attempting to implement a trading methodology, which identifies a majority of the significant, as opposed to the more numerous small, price trends in a given market.
JWH® attempts to pare losing positions relatively quickly while allowing profitable positions to mature. Most losing positions are closed within a few days or weeks, while others - those where a profitable trend continues -are retained. Positions held for two to four months are not unusual, and positions have been held for more than one year. Historically, less than one third of all trades made pursuant to the investment methods have been profitable. Large profits on a few trades in positions that typically exist for several months have produced favorable results overall.
The greatest cumulative percentage decline in net asset value, which JWH® has experienced in any single program, was nearly sixty percent on a month-to-month composite basis since its inception. Investors in the Partnership should understand that similar or greater drawdowns are possible in the future.
JWH does not expect that all trend signals will lead to profitable trades. Stop-losses are used in some models and managed in a proprietary manner to balance the potential loss on any trade versus the opportunity for maximum profit. Stop-losses may not necessarily limit losses, since they become market orders upon execution; as a result, a stop-loss order may not be executed at the stop-loss price. Other models do not have any stop-loss methodology but rely on market diversification and a change in directional signals to offset risk. Risk in some programs may also be managed by varying position size or risk levels for a market, based in part on assessment of market volatility, while other programs will maintain position size in markets regardless of changes in volatility. There are no systematic constraints on portfolio volatility or the maximum drawdown for any program. Volatility will not cause systematic adjustments to be made to existing positions. Some programs consider volatility in determining the size of positions initiated. Other programs do not consider volatility in determining the size of positions initiated.
Modern portfolio techniques are used in an effort to construct an overall diversified portfolio for each JWH trading program. However, some programs have limited diversification because of their sector focus or because JWH requires demonstrated liquidity in the contracts selected for a portfolio. These techniques will attempt to take into account the volatility and correlation of the markets that are included in the program, as well as projected price behavior during specific projections of market extremes. However, no assurances can be made that historical market correlations and diversification will occur or persist in all market conditions. In an attempt to maintain portfolio diversification, portfolio adjustments will be made to account for systematic changes identified by JWH’s research in the relationships across markets. Consistent with JWH’s view of markets, portfolios are managed to meet longer-term risk and volatility tolerances, rather than trading on the basis of short-term tends or short-term volatility.
To reduce exposure to volatility in any particular market, most JWH® programs participate in several markets at one time. In total, JWH® programs participate in up to 80 markets, encompassing interest rates, foreign exchange, global stock indices and commodities such as agricultural products, energy, precious and base metals.
JWH® at its sole discretion may override computer-generated signals, and may at times use discretion in the application of its quantitative models, which may affect performance positively or negatively. This could occur, for example, when JWH® determines that markets are illiquid or erratic, which may occur cyclically during holiday seasons or on the basis of irregularly-occurring market events. Subjective aspects of JWH®’s quantitative models also include the determination of the size of the position in relation to account equity, when an account should commence trading, investments of assets provided through additions and reallocations, markets traded, contracts and contract month selection, and effective trade execution.
Program Modifications
Research is conducted across JWH departments in collaboration with JWH’s investment policy committee. Research may include analysis of the dynamic elements of the JWH investment process, including refining
risk management techniques and monitoring market capacity to the extent consistent with basic JWH methodologies. Research also includes the examination of profit opportunities in markets not currently traded by JWH programs and in new instruments as they become available.
All cash in a JWH® investment program is available to be used to trade in a JWH® program. The amounts committed to margin will vary from time to time. As capital in each JWH® trading program increases, additional emphasis and weighting may be placed on certain markets, which have historically demonstrated the greatest liquidity. Furthermore, the weighting of capital committed to various markets in the trading programs is dynamic, and JWH® may vary the weighting at its discretion as market conditions, liquidity, position limit considerations and other factors warrant. MLAI will generally not be informed of any such changes.
Adjustments to the size of trading positions taken in relation to account equity have been and continue to be an integral part of JWH®’s investment strategy. At its dis­cretion, JWH® may adjust position size in relation to account equity in certain markets or entire programs. Position size in relation to account equity adjustments may be made at certain times for some programs but not for others. In the case of declines in equity, position sizes are generally maintained in spite of any trading losses. Systematic methods for maintaining or adjusting the trade size in an account may affect performance and will alter the risk exposure of the account, with position size increasing in relation to account equity in down markets until losses are offset, and decreasing in profitable market conditions until systematic adjustments are made. Factors which may affect the deci­sion to adjust position size in relation to account equity include: ongoing research; pro­gram volatility; current market volatility; risk expo­sure; and subjective judgment and evaluation of these and other general market conditions. Such decisions to change position size in relation to account equity may positively or negatively affect performance, and will alter risk exposure for an account. Position size in relation to account equity adjust­ments may lead to greater profits or losses, more fre­quent and larger margin calls and greater brokerage expense. No assurance is given that such position size in relation to account equity adjust­ments will be to the financial advantage of investors in the Partnership. JWH® reserves the right, at its sole discretion, to adjust its position size in relation to account equity policy without notification to MLAI.
Addition, Redemption and Reallocation of Capital for Commodity Pool or Partnership Accounts
Investors purchase or redeem Units at Net Asset Value (“NAV”) on the close of business on the last business day of the month. In order to provide market exposure commensurate with the Partnership’s equity on the date of these transactions, JWH®’s general practice is to adjust positions as near as possible to the close of business on the last trading date of the month. The intention is to provide for additions and redemptions at a NAV that will be the same for each of these transactions, and to eliminate possible variations in NAVs that could occur as a result of inter-day price changes if, for example, additions were calculated on the first day of the subsequent month. Therefore, JWH® may, at its sole discretion, adjust its investment of the assets associated with the addition or redemp­tion as near as possible to the close of business on the last business day of the month to reflect the amount then available for trading. Based on JWH®’s determination of liquidity or other market conditions, JWH® may decide to commence trading earlier in the day on, or before, the last business day of the month, or at its sole discretion, delay adjustments to trading for an account to a date or time after the close of business on the last day of the month. No assurance is given that JWH® will be able to achieve the objectives described above in connection with Partnership equity level changes. The use of discretion by JWH® in the application of this procedure may affect performance positively or negatively.
Physical and Cash Commodities
JWH® may from time to time trade in physical or cash commodities for immediate or deferred delivery, including specifically gold bullion, as well as futures and forward contracts when JWH® believes that cash markets offer comparable or superior market liquidity or the ability to execute transactions at a single price. The Commodity Futures Trading Commission (“CFTC”) does not regulate cash trans­actions, which are subject to the risk of these entities’ failure, inability or refusal to perform with respect to such contracts.
The Joint Venture Agreement
The advisory arrangement between the Partnership and JWH® is a joint venture (“Joint Venture”), a general partnership structure. The Joint Venture Agreement terminates on December 31, 2007 subject to automatic one-year renewals, unless either the Partnership or JWH® elects not to renew.
The Partnership has agreed to indemnify JWH® and related persons for any claims or proceedings involving the business or activities of the Partnership, provided that the conduct of such persons does not constitute negligence, misconduct or breach of the Joint Venture Agreement or of any fiduciary obligation to the Partnership and was done in good faith and in a manner reasonably believed to be in, or not opposed to, the best interests of the Partnership.
JWH® and related persons will not be liable to the Joint Venture, the Partnership or any of the Partners in connection with JWH®’s management of the Partnership’s assets except (i) by reason of acts or omissions in breach of the Joint Venture Agreement, (ii) due to their misconduct or negligence, or (iii) by reason of not having acted in good
faith and in the reasonable belief that such actions or omissions were in, or not opposed to, the best interests of the Partnership. Mr. John W. Henry will not be liable except for his fraud or willful misconduct.
JWH® originally invested $100,000 in the Joint Venture. As of December 31, 2006, JWH®’s investment was valued at $177,435.
The Partnership and the Joint Venture are herein collectively referred to as the “Partnership” unless the context otherwise requires.
Use of Proceeds and Cash Management Income
Subscription Proceeds.
The Partnership’s cash is used as security for and to pay the Partnership’s trading losses as well as its expenses and redemptions. The primary use of the proceeds of the sale of the Units is to permit JWH® to trade on a speculative basis in a wide range of different futures, forwards and options on futures markets on behalf of the Partnership. While being used for this purpose, the Partnership’s assets are also generally available for cash management, as more fully described below under “Available Assets.”
Market Sectors.
The Partnership trades in a diversified group of markets under the direction of JWH®. JWH® can, and does, from time to time, materially alter the allocation of its overall trading commitments among different market sectors. Except in the case of certain trading programs which are purposefully limited in the markets which they trade, there is essentially no restriction on the commodity interests which may be traded by JWH® or the rapidity with which JWH® may alter its market sector allocations.
Market Types.
The Partnership trades on a variety of United States and foreign futures exchanges. Substantially all of the Partnership’s off-exchange trading takes place in the highly liquid, institutionally based currency forward markets.
Many of the Partnership’s currency trades are executed in the spot and forward foreign exchange markets (the “FX Markets”) where there are no direct execution costs. Instead, the participants, banks and dealers in the FX Markets take a “spread” between the prices at which they are prepared to buy and sell a particular currency and such spreads are built into the pricing of the spot or forward contracts with the Partnership.
In its exchange of futures for physical (“EFP”) trading, the Partnership acquires cash currency positions through banks and dealers, including Merrill Lynch. The Partnership pays a spread when it exchanges these positions for futures. This spread reflects, in part, the different settlement dates of the cash and the futures contracts, as well as prevailing interest rates, but also includes a pricing spread in favor of the banks and dealers, which may include a Merrill Lynch entity.
As in the case of its market sector allocations, the Partnership’s commitments to different types of markets - U.S. and non-U.S., regulated and unregulated - differ substantially from time to time as well as over time. The Partnership has no policy restricting its relative commitments to any of these different types of markets, although generally the bulk of the Partnership’s trading takes place on regulated exchanges.
Custody of Assets.
All of the Partnership’s assets are currently held in customer accounts at MLPF&S.
Available Assets.
The Partnership earns income, as described below, on its “Available Assets,” which can be generally described as the cash actually held by the Partnership. Available Assets are held primarily in U.S. dollars and are comprised of the Partnership’s cash balances held in the offset accounts (as described below), which include “open trade equity” (unrealized gain and loss on open positions) on United States futures contracts, which is paid into or out of the Partnership’s account on a daily basis and the Partnership’s cash balance in foreign currencies derived from its trading in non-U.S. dollar denominated futures and options contracts, which includes open trade equity on those exchanges which settle gains and losses on open positions in such contracts prior to closing out such positions. Available Assets do not include, and the Partnership does not earn interest on, the Partnership’s gains or losses on its open forward, commodity option and certain foreign futures positions since such gains and losses are not collected or paid until such positions are closed out.
The Partnership’s Available Assets may be greater than, less than or equal to the Partnership’s Net Asset Value (on which the redemption value of the Units is based) primarily because Net Asset Value reflects all gains and losses on open positions as well as accrued but unpaid expenses.
Interest Earned on the Partnership’s U.S. Dollar Available Assets.
The following description relates to the Partnership’s U.S. dollar Available Assets.
The Partnership’s U.S. dollar Available Assets are held in cash in offset accounts or may be invested in short-term U.S. Treasury bills purchased from dealers unaffiliated with Merrill Lynch. Offset accounts are non-interest bearing demand deposit accounts maintained with banks unaffiliated with Merrill Lynch. An integral feature of the offset arrangements is that the participating banks specifically acknowledge that the offset accounts are MLPF&S customer accounts, not subject to any Merrill Lynch liability.
Merrill Lynch credits the Partnership, as of the end of each month, with interest at the effective prevailing 91-day Treasury bill rate on the average daily U.S. dollar Available Assets held in the offset accounts during such month. The Partnership receives all interest paid on the short-term Treasury bills in which it invests.
The use of the offset account arrangements for the Partnership’s U.S. dollar Available Assets may be discontinued by Merrill Lynch whether or not Merrill Lynch otherwise continues to maintain its offset arrangements. The offset arrangements are dependent on the banks’ continued willingness to make overnight credits available to Merrill Lynch, which, in turn, is dependent on the credit standing of Merrill Lynch. If Merrill Lynch were to determine that the offset arrangements had ceased to be practicable (either because Merrill Lynch credit lines at participating banks were exhausted or for any other reason), Merrill Lynch would thereafter attempt to invest all of the Partnership’s U.S. dollar Available Assets to the maximum practicable extent in short-term U.S. Treasury bills. All interest earned on the U.S. dollar Available Assets so invested would be paid to the Partnership, but MLAI would expect the amount of such interest to be less than that available to the Partnership under the offset account arrangements. The remaining U.S. dollar Available Assets of the Partnership would be kept in cash to meet variation margin payments and pay expenses, but would not earn interest for the Partnership.
The banks at which the offset accounts are maintained make available to Merrill Lynch interest-free overnight credits, loans or overdrafts in the amount of the Partnership’s U.S. dollar Available Assets held in the offset accounts, charging Merrill Lynch a small fee for this service. The economic benefits derived by Merrill Lynch - net of the interest credits paid to the Partnership and the fee paid to the offset banks - from the offset accounts have not exceeded 0.75% per annum of the Partnership’s average daily U.S. dollar Available Assets held in the offset accounts. These revenues to Merrill Lynch are in addition to the Brokerage Commissions and Administrative Fees paid by the Partnership to MLPF&S and MLAI, respectively.
Interest Paid by Merrill Lynch on the Partnership’s Non-U.S. Dollar Available Assets.
Under the single currency margining system implemented for the Partnership, the Partnership itself does not deposit foreign currencies to margin trading in non-U.S. dollar denominated futures contracts and options, if any. MLPF&S provides the necessary margin, permitting the Partnership to retain the monies which would otherwise be required for such margin as part of the Partnership’s U.S. dollar Available Assets. The Partnership does not earn interest on foreign margin deposits provided by MLPF&S. The Partnership does, however, earn interest on its non-U.S. dollar Available Assets. Specifically, the Partnership is credited by Merrill Lynch with interest at prevailing short-term local rates on assets and net gains on non-U.S. dollar denominated positions for such gains actually held in cash by the Partnership. Merrill Lynch charges the Partnership Merrill Lynch’s cost of financing realized and unrealized losses on such positions.
The Partnership holds foreign currency gains and finances foreign currency losses on an interim basis until converted into U.S. dollars and either paid into or out of the Partnership’s U.S. dollar Available Assets. Foreign currency gains or losses on open positions are not converted into U.S. dollars until the positions are closed. Assets of the Partnership while held in foreign currencies are subject to exchange rate risk.
Charges The following table summarizes the charges incurred by the Fund during 2006, 2006 and 2004.
The Partnership’s average month-end Net Assets during 2006, 2005 and 2004 equaled $1,050,574,066, $1,266,792,130, and $957,699,076, respectively.
In addition to the above charges, the Partnership and JWH® share in the profits of the Joint Venture based on equity provided that 20% of the Joint Venture’s quarterly New Trading Profits are allocated to JWH®. For the years ended December 31, 2006, 2005 and 2004, JWH® received a profit share allocation of $0, $0 and $38,968,456, and earned interest of $0, $6,312 and $83,034, on such amounts, respectively.
Description of Current Charges
The Partnership is subject to the following charges and priority profit allocation (“Profit Share”):
Regulation
MLAI, JWH® and MLPF&S are each subject to regulation by the CFTC and the NFA. Other than in respect of its periodic reporting requirements under the Securities Exchange Act of 1934, and the registration of the Units for continuous public distribution under the Securities Act of 1933, the Partnership itself is generally not subject to regulation by the Securities and Exchange Commission (“SEC”). However, MLAI itself is registered as an “investment adviser” under the Investment Advisers Act of 1940. MLPF&S is also regulated by the SEC and the National Association of Securities Dealers.
(i) Through (xii) - not applicable.
(xiii) The Partnership has no employees.
(d) Financial Information about Geographic Areas:
The Partnership and the Joint Venture do not engage in material operations in foreign countries, nor is a material portion of the Partnership’s revenues derived from customers in foreign countries. The Partnership does, however, trade from the United States on a number of foreign commodity exchanges. The Partnership does not engage in the sales of goods or services.
Item 1A:
Item 1A: Risk Factors
The Large Size of the Partnership’s Trading Positions Increases the Risk of Sudden, Major Losses
The Partnership takes positions with face values which are as much as 15 times its total equity.
Investors Must Not Rely on the Past Performance of the Partnership in Deciding Whether to Buy Units
The performance of the Partnership is entirely unpredictable, and the past performance of the Partnership is not necessarily indicative of its future results.
The price data which JWH® has researched in developing its programs may not reflect the changing dynamics of future markets. If not, the JWH® programs would have little chance of being profitable. An influx of new market participants, changes in market regulation, international political developments, demographic changes and numerous other factors can contribute to once-successful strategies becoming outdated. Not all of these factors can be identified, much less quantified. There can be no assurance that JWH® will trade profitably for the Partnership.
JWH® Analyzes Only Technical Market Data, Not Any Economic Factors External to Market Prices
The JWH® programs focus exclusively on statistical analysis of market prices. Consequently, any factor external to the market itself which dominates prices is likely to cause major losses. For example, a pending political or economic event may be very likely to cause a major price movement, but JWH® would continue to maintain positions that would incur major losses as a result of such movement, if its programs indicated that it should do so.
The likelihood of the Units being profitable could be materially diminished during periods when events external to the markets themselves have an important impact on prices. During such periods, JWH®’s historical price analysis could establish positions on the wrong side of the price movements caused by such events.
Lack of the Types of Price Trends Which JWH® Programs Can Identify Will Cause Major Losses
The Partnership cannot trade profitably unless major price trends occur in at least certain markets that it trades. Many markets are trendless most of the time, and in static markets the JWH® programs are likely to incur losses. In fact, JWH® expects more than half of its trades to be unprofitable; it depends on significant gains from a few major trends to offset these losses. Since inception, the Partnership has had 64 unprofitable and 62 profitable months, and there have been significant periods during which the Net Asset Value of the Partnership has declined. It is not just any price trend, but price trends of the type which JWH®’s systems have been designed to identify, which are necessary for the Partnership to be profitable.
The Danger to the Partnership of “Whipsaw” Markets
Often, the most unprofitable market conditions for the Partnership are those in which prices “whipsaw,” moving quickly upward, then reversing, then moving upward again, then reversing again. In such conditions, the programs may establish a series of losing positions based on incorrectly identifying both the brief upward or downward price movements as trends.
The Similarities Among the JWH® Programs Reduce Diversification, Increasing the Risk of Loss
The similarities among the programs reduce the Partnership’s diversification. The less diversification, the higher the risk that the market will move against a large number of positions held by different programs at the same time, increasing losses.
Overlap of the Markets Traded by JWH® Also Reduces Diversification, Increasing the Risk of Loss
The programs as a group emphasize trading in the financial instrument and currency markets. The degree of market overlap changes with the program mix. However, in general, JWH® expects approximately a minimum 50% concentration in these two sectors while the current programs continue to be used for the Partnership. Market concentration increases the risk of major losses and unstable Unit values, as the same price movements adversely affect many of the Partnership’s concentrated positions at or about the same time.
As it is impossible to predict where price trends will occur, certain trend-following managers attempt to maximize the chance of exploiting such trends by taking positions in as many different markets and market sectors as feasible. The Partnership does not follow this approach and, as a result, may not capture trends which would have been highly profitable.
The JWH® Strategic Allocation Program Is Not a Formal Program or System
The JWH Strategic Allocation Program is not a systematic selection process, and JWH® does not apply any formal selection policies or criteria in choosing combinations of programs for the Partnership. Such combinations are developed solely on the basis of the subjective market judgment and experience of certain JWH® principals. Subjective, judgmental decision-making may be less disciplined and objective than a more systematic method, and there can be no assurance that JWH® will select the optimal combinations of programs for the Partnership.
The Partnership’s Substantial Expenses Will Cause Losses Unless Offset by Profits
The Partnership pays fixed annual expenses of 5.75% brokerage and 0.25% administrative fees of its average month-end assets. The Partnership will also reimburse MLAI for ongoing offering costs subject to a ceiling of .25 of 1% of the Partnership’s average month-end assets in any fiscal year. Miscellaneous costs in connection with its currency trading and commercial paper investments, when applicable, have equaled approximately 0.25% of the Partnership’s average month-end assets annually. The Partnership is also subject to 20% quarterly Profit Shares during its profitable quarters. Because these Profit Shares are calculated quarterly, they could represent a substantial expense to the Partnership even in a breakeven or losing year. Based on MLAI’s experience with other commodities investment partnerships which MLAI manages, MLAI expects that approximately 1% of the Partnership’s average month-end assets might be paid out in Profit Shares even during a losing year. Overall, investors may expect that the Partnership will pay about approximately 7.30% per year in expenses, 10.30% including the 3% redemption charge paid by investors in effect through the end of the first twelve months after a Unit is issued; such figures do not take into account any interest earned by the Partnership.
The Partnership’s expenses could, over time, result in significant losses. Except for the Profit Share, these expenses are payable whether or not the Partnership is profitable.
Increased Competition from Other Trend-Following Traders Could Reduce JWH®’s Profitability
There has been a dramatic increase over the past 25 years in the amount of assets managed by trend-following trading systems like the JWH® programs. In 1980, the amount of assets in the managed futures industry were estimated at approximately $300 million; by the end of 2006, this estimate had risen to approximately $170 billion (these figures include trend-following and other advisors). This means increased trading competition. The more competition there is for the same positions, the more costly and difficult they are to acquire.
JWH®’s High Level of Equity Under Management Could Lead to Diminished Returns
JWH® has a significant amount of assets under management. As of January 1, 1990, JWH® had approximately $197 million under management; as of December 31, 2006, this figure had risen to approximately $1.7 billion. The more money JWH® manages, the more difficult it may be for JWH® to trade profitably because of the difficulty of trading larger positions without adversely affecting prices and performance. Large trades may result in more price slippage than smaller orders.
Illiquid Markets Could Make It Impossible for JWH® to Realize Profits or Limit Losses
In illiquid markets, JWH® could be unable to capitalize on trading opportunities or close out losing positions. There are numerous factors which can contribute to market illiquidity, far too many for JWH® to be able to predict. There can be no assurance that a market which has been highly liquid in the past will not experience periods of unexpected illiquidity.
Unexpected market illiquidity has caused major losses in recent years in certain sectors. There can be no assurance that the same will not happen to the Partnership from time to time. The large size of the positions which JWH® acquires for the Partnership increases the risk of illiquidity by both making its positions more difficult to liquidate and increasing the losses incurred while trying to do so.
The Partnership Trades Extensively in Foreign Markets; These Markets Are Less Regulated Than U.S. Markets and Are Subject to Exchange Rate, Market Practice and Political Risks
The programs trade a great deal outside the U.S. From time to time, as much as 30%-50% of the Partnership’s overall market exposure could involve positions taken on foreign markets. Foreign trading involves risks - including exchange-rate exposure, possible governmental intervention and lack of regulation - which U.S. trading does not. In addition, the Partnership may not have the same access to certain positions on foreign exchanges as do local traders, and the historical market data on which JWH® bases its strategies may not be as reliable or accessible as it is in the United States. Certain foreign exchanges may also be in a more or less developmental stage so that prior price histories may not be indicative of current price dynamics. The rights of clients in the event of the insolvency or bankruptcy of a non-U.S. market or broker are also likely to be more limited than in the case of U.S. markets or brokers.
Risks of Electronic Trading and Order Routing Systems
JWH® may from time to time trade on electronic trading and order routing systems, which differ from traditional open outcry pit trading and manual order routing methods. Transactions using an electronic system are subject to the rules and regulations of the exchanges offering the system or listing the contract. Characteristics of electronic trading and order routing systems vary widely among the different electronic systems with respect to order matching procedures, opening and closing procedures and prices, error trade policies and trading limitations or requirements. There are also differences regarding qualifications for access and grounds for termination and limitations on the types of orders that may be entered into the system. Each of these matters may present different risk factors with respect to trading on or using a particular system. Each system may also present risks related to system access, varying response times and security. In the case of Internet-based systems, there may be additional risks related to service providers and the receipt and monitoring of electronic mail.
Trading through an electronic trading or order routing system also entails risks associated with system or component failure. In the event of system or component failure, it is possible that for a certain time period, it might not be possible to enter new orders, execute existing orders or modify or cancel orders that were previously entered. System or component failure may also result in loss of orders or order priority. Some contracts offered on an electronic trading system may be traded electronically and through open outcry during the same trading hours. Exchanges offering an electronic trading or order routing system and listing the contract may have adopted rules to limit their liability, the liability of futures brokers and software and communication system vendors and the amount that may be collected for system failures and delays. These limitation of liability provisions vary among the exchanges.
The Partnership Could Lose Assets and Have Its Trading Disrupted Due to the Bankruptcy of MLPF&S or Others
The Partnership is subject to the risk of MLPF&S, exchange or clearinghouse insolvency. Partnership assets could be lost or impounded during lengthy bankruptcy proceedings. Were a substantial portion of the Partnership’s capital tied up in a bankruptcy, MLAI might suspend or limit trading, perhaps causing the Partnership to miss significant profit opportunities.
Regulatory Changes Could Restrict the Partnership’s Operations
The Partnership implements a speculative, highly leveraged strategy. From time to time there is governmental scrutiny of these types of strategies and political pressure to regulate their activities. For example, foreign governments have from time to time blamed the declines of their currencies on speculative partnerships and imposed restrictions on speculative trading in certain markets, and the collapse of a major hedge partnership in 1998 led to significantly increased regulatory monitoring of the activities of these partnerships and, to an extent, commodity pools such as the Partnership.
Regulatory changes could adversely affect the Partnership by restricting its markets, limiting its trading and/or increasing the taxes to which Unitholders are subject. MLAI is not aware of any pending or threatened regulatory developments which might adversely affect the Partnership. However, adverse regulatory initiatives could develop suddenly and without notice.
Premature Termination of the Partnership
MLAI may withdraw as general partner from the Partnership upon 120 days’ notice, which would cause the Partnership to terminate unless a substitute general partner were obtained. Other events, such as substantial losses suffered by the Partnership, could also cause the Partnership to terminate before the expiration of its stated term. This could cause you to liquidate your investments and upset the overall maturity and timing of your investment portfolio.
Item 2:
Item 2: Properties
The Partnership does not use any physical properties in the conduct of its business.
The Partnership’s administrative office is the office of MLAI (Merrill Lynch Alternative Investments LLC, Princeton Corporate Campus, 800 Scudders Mill Road - Section 2G, Plainsboro, New Jersey 08536). MLAI performs all administrative services for the Partnership from MLAI’s offices.
Item 3:
Item 3: Legal Proceedings
There have been no administrative, civil or criminal actions, whether pending or concluded, against MLAI or Merrill Lynch or any of its individual principals during the past five years which would be considered “material” as that term is defined in Section 4.24(l)(2) of the Regulations of the CFTC, except as described below.
On May 21, 2002, MLPF&S, with no admission of wrongdoing or liability, agreed to pay $48 million to the State of New York, $50 million to the remaining states, Washington, D.C. & Puerto Rico and $2 million to NASAA relating to an investigation conducted by the New York Attorney General concerning research practices.
On March 19, 2003, Merrill Lynch & Co., Inc., the parent company and an approved person of MLPF&S, consented to an injunctive action instituted by the Securities and Exchange Commission (the “SEC”). In its complaint, the SEC alleged that three years ago, in 1999, Merrill Lynch aided and abetted Enron Corp.’s (“Enron”) violations of Sections 10(b), 13(a), 13(b)(2) and 13(b)(5) of the Exchange Act and
Rules 10b-5, 12b-20, 13a-1, 13a-3 and 13b2-1 thereunder, as a result of Merrill Lynch engaging in certain year-end transactions designed and proposed by Enron. Without admitting or denying the allegations, Merrill Lynch consented to the entry of an injunction enjoining it from violating the above-referenced provisions, and agreed to pay disgorgement, penalties and interest in the amount of $80 million. In its release announcing the settlement, the Commission acknowledged that in agreeing to resolve this matter on the terms described above, the Commission took into account certain affirmative conduct by Merrill Lynch.
In April 2003, MLPF&S entered into a settlement with the SEC, the National Association of Securities Dealers (the “NASD”) and the New York Stock Exchange (the “NYSE”) as part of a joint settlement with the SEC, the NASD and the NYSE arising from a joint investigation by the SEC, the NASD and the NYSE into research analysts conflicts of interests. Pursuant to the terms of the settlement with the SEC, NASD and NYSE, MLPF&S, without admitting or denying the allegations, consented to a censure. In addition, MLPF&S agreed to a payment of (I) $100 million, which was offset in its entirety by the amount already paid by MLPF&S in the related proceeding with the State of New York and the other states (II) $75 million to fund the provision of independent research to investors; and (III) $25 million to promote investor education. The payments for the provision of independent research to investors and to promote investor education are required to be made over the course of the next five years. MLPF&S also agreed to comply with certain undertakings.
In March 2006, MLPF&S entered into a settlement with the SEC arising from an investigation related to MLPF&S’ retention and production of e-mail. The SEC found that MLPF&S willfully violated Section 17(a) of the Exchange Act, and Rules 17a-4(b)(4) and 17a-4(j) thereunder. Without admitting or denying the allegations, Merrill Lynch consented to the entry of an injunction enjoining it from violating the above-referenced provisions, entered into an undertaking regarding its policies and procedures and agreed to pay a civil penalty $2,500,000.
Item 4:
Item 4: Submission of Matters to a Vote of Security Holders
None
PART II
Item 5:
Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 5
(a) Market Information:
There is no established public trading market for the Units, and none is likely to develop. Limited Partners may redeem Units as of the end of each month at Net Asset Value, subject to certain early redemption charges.
(b) Holders:
As of December 31, 2006, there were 31,808 holders of Units, including MLAI.
(c) Dividends:
MLAI has not made, and does not contemplate making, any distributions on the Units.
(d) Securities Authorized for Issuance Under Equity Compensation Plans:
Not applicable.
Item 5(a) Recent Sales of Unregistered Securities; Uses of Proceeds From Registered Securities:
Not applicable.
Item 5(b)
Not applicable.
Item 5(c)
Not applicable.
Item 6:
Item 6: Selected Financial Data
The following selected month-end Net Asset Value per Unit information has been derived from the financial and accounting data of the Partnership:
Pursuant to CFTC policy, monthly performance is presented from January 1, 2002, even though the Units were outstanding prior to such date.
ML JWH STRATEGIC ALLOCATION FUND L.P.
December 31, 2006
Type of Pool: Single-Advisor/Publicly-Offered/Not “Principal Protected”(1)
Inception of Trading: July 15, 1996
Aggregate Subscriptions: $1,980,192,819
Current Capitalization: $792,303,062
Worst Monthly Drawdown:(2) (13.89)% (1/05)
Worst Peak-to-Valley Drawdown:(3) (34.49)% (12/04 - 12/06)
(1) Certain funds, including funds sponsored by MLAI, are structured so as to guarantee to investors that their investment will be worth no less than a specified amount (typically, the amount initially invested) as of a date certain after the date of investment. The CFTC refers to such funds as “Principal Protected.” The Partnership has no such feature.
(2) Worst Monthly Drawdown represents the largest negative Monthly Rate of Return experienced by the Partnership since January 1, 2002; a Drawdown is measured on the basis of month-end Net Asset Value only, and does not reflect intra-month figures.
(3) Worst Peak-to-Valley Drawdown represents the greatest percentage decline from a month-end cumulative Monthly Rate of Return without such cumulative Monthly Rate of Return being equaled or exceeded as of a subsequent month-end experienced by the Partnership since January 1, 2002. For example, if the Monthly Rate of Return was (1)% in each of January and February, 1% in March and (2)% in April, the Peak-to-Valley Drawdown would still be continuing at the end of April in the amount of approximately (3)%, whereas if the Monthly Rate of Return had been approximately 3% in March, the Peak-to-Valley Drawdown would have ended as of the end of February at approximately the (2)% level.
(4) Monthly Rate of Return is the net performance of the Partnership during the month of determination (including interest income and after all expenses accrued or paid) divided by the total equity of the Partnership as of the beginning of such month, inclusive of subscription activity.
Item 7:
Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
General
JWH®’s programs do not predict price movements. No fundamental economic supply demand analysis is used and no macroeconomic assessments of the relative strengths of different national economies or economic sectors are used. Instead, the programs apply proprietary computer models to analyze past market data, and from this data alone attempt to determine whether market prices are trending. Technical traders such as JWH ® base their strategies on the theory that market prices reflect the collective judgment of numerous different traders and are, accordingly, the best and most efficient indication of market movements. However, there are frequent periods during which fundamental factors external to the market dominate prices.
If JWH®’s models identify a trend, they signal positions which follow it. When these models identify the trend as having ended or reversed, these positions are either closed out or reversed. Due to their trend-following character, the JWH® programs do not predict either the commencement or the end of a price movement. Rather, their objective is to identify a trend early enough to profit from it and to detect its end or reversal in time to close out the Partnership’s positions while retaining most of the profits made from following the trend.
In analyzing the performance of JWH®’s trend-following programs, economic conditions, political events, weather factors, etc., are not directly relevant because only market data has any input into JWH®’s trading results. Furthermore, there is no direct connection between particular market conditions and price trends. There are so many influences on the markets that the same general type of economic event may lead to a price trend in some cases but not in others. The analysis is further complicated by the fact that the programs are designed to recognize only certain types of trends and to apply only certain criteria of when a trend has begun. Consequently, even though significant price trends may occur, if these trends are not comprised of the type of intra-period price movements which the programs are designed to identify, the Partnership may miss the trend altogether.
The following performance summary outlines certain major price trends which the JWH® programs have identified for the Partnership since inception. The fact that certain trends were captured does not imply that others, perhaps larger and potentially more profitable trends, were not missed or that JWH® will be able to capture similar trends in the future. Moreover, the fact that the programs were profitable in certain market sectors in the past does not mean that they will be so in the future.
This performance summary is an outline description of how the Partnership performed in the past, not necessarily any indication of how it will perform in the future. In addition, the general causes to which certain price movements are attributed may or may not in fact have caused such movements, but simply occurred at or about the same time.
While there can be no assurance that trading directed by JWH® will be profitable under any given market condition, markets in which substantial and sustained price movements occur typically offer the best profit potential for the Partnership.
Performance Summary
The Partnership’s performance was an overall loss in 2006 with metals and stock indices posting gains and agriculture, interest rates, energy and currencies posting losses.
The metals sector was the most profitable for the Partnership. At the beginning of the year, gold surged to a 25 year high and silver climbed to its highest level since March 1984. This trend continued through the second quarter with silver climbing 51%. Factors contributing to the rise in silver include the escalating dispute with Iran combined with a falling U. S. dollar which helped to push the precious metal higher as investors look for a safe-haven given the global geopolitical uncertainty. Both base and precious metals began to retreat from highs set in the middle of the quarter. Gold fell to a three month low after reaching a 26-year high in May. The sharp sell-off was caused by the combination of a stronger U.S. dollar, as investors bought dollars as an alternative to gold, and speculation that the Federal Reserve could hike interest rates as much as 50 basis points. Silver’s rally was due to increased demand throughout the world and expectations of continued economic expansion of developing nations. Base and precious metals suffered as commodities as an asset class had their biggest quarterly decline in at least 50 years. During the third quarter, gold and silver prices continued to fall as lower energy prices and a stronger U.S. dollar eroded the appeal of the precious metals as an alternative to U.S. stocks and bonds. Although weakness in precious metals hurt performance, the Partnership was able to profit from falling base metal prices. New York copper futures fell 10 percent in December as inventories of the metal used in wires and pipes grew, a sign of weakening demand. London Metals Exchange copper for March delivery touched $6,250 a metric ton, the lowest since April 20th. Nevertheless, copper’s gain for the year in London was 44 percent and 41 percent in New York.
Stock indices also posted profits for the Partnership. European stock indices had their best January rally in eight years as energy stocks along with miners and steelmakers gained on expectations earnings would benefit from higher commodity prices. The middle of the first quarter was volatile for the stock indices sector as the Asian stock indices posted their first monthly decline since October 2005, however the decline reversed at the end of the quarter as Asian stocks approached a 16-year high partly due to surging demand for metals and oil. The interest rate rise, along with China asking the nation’s banks to restrict lending to prevent the economy from overheating, sent shares of mining companies and commodity producers lower on speculation that increased borrowing costs could curb demand for raw materials in China’s economy. Global equity markets began to fall mid year after the U.S. Federal Reserve met and an additional rate hike was still a possibility in June. The losses continued through the end of the second quarter due to mounting speculation that actions of the U.S. Federal Reserve would hurt economic growth and 16 central banks raised interest rates to contain inflation. However, as it became evident that the U.S. Federal Reserve was actually closer to ending its rate hiking cycle world equity markets rallied. The third quarter began with a substantial portion of world equity markets trend-less as investors continued to speculate over the U.S. Federal Reserve’s next move. Global equities reversed the recent losing trend and rallied partly due to decreased concerns about inflation. U.S. Federal Reserve policy makers signaled that the economy may have cooled enough to preclude further interest rate increases for the remainder of the year. European stocks rallied at the end of the quarter to a five-year high. The fourth quarter began with the All Ordinarys index rising to a record. Also advancing were the U.S. benchmark indices, as earlier optimism that United States households would sustain economic growth pushed the Dow industrials to a record high during October and sent the S&P 500 to its highest level since November 2000. Three United States benchmarks had their biggest monthly gain since November 2005, with the Dow gaining 3.4 percent, the S&P 500 climbing 3.2 percent, and the NASDAQ advancing 4.8 percent. The year ended as Japanese stocks completed their longest yearly winning streak since 1989. The Japanese yen reached an all-time low of 156.73 against the Euro helping to advance Japanese equities (a weaker Japanese yen boosts the value of euro-denominated sales when converted back into local currency).
The agriculture sector posted losses for the Partnership. The year began with record highs as a result of the surging cost of crude oil which increased the demand for ethanol, a sugar cane by-product. Brazil, the biggest producer and exporter of sugar, has been converting more of its sugar cane crop to ethanol in connection with record gasoline prices. New York coffee rose to seven month highs as worldwide demand outpaced supply. New York coffee and New York sugar hindered returns in the middle of the first quarter while trading in Chicago Board of Traders (“CBOT”) wheat limited losses. The first quarter ended with sugar prices in London rising to their highest levels since 1989 on speculation that a jump in the cost of oil will force Brazil to direct more of its output towards producing ethanol. Mid-year, cotton fell to its lowest close since December 2, 2005. The gains in cotton were not enough, however, to offset the losses in the rest of the sector as choppy price action dominated the sector’s performance. Sugar, whose demand has
increased on its ability to be made into ethanol, fell as energy prices dropped mid-year. Weather conditions had severe affects on various crops in the U.S. and around the world. CBOT wheat fell to a five-week low in the middle of June, after warm dry weather in the central U.S. helped farmers speed up the harvest. At the beginning of the third quarter, New York and London sugar under performed on speculation that global demand will slow. Corn and soybeans also hurt performance as price volatility caused by fluctuating weather conditions in the U.S. Midwest threatened crop yields. Also contributing to corn price volatility was a report issued by the U.S. Department of Agriculture that indicated approximately 59% of the corn crop was in good condition, which was the lowest percentage of the year. Losses in wheat third quarter were offset by gains in sugar. World sugar production in 2006 was higher than previously forecasted easing a third straight annual shortfall as favorable weather in India helped the harvest. The third quarter ended with sugar prices plunging on speculation that demand would fall as lower energy costs discouraged the use of sugar as an alternative fuel source eroding the value of ethanol. At the beginning of the fourth quarter, corn, the biggest U.S. crop, reached a two-year high. Wheat prices fell 13 percent since reaching $5.57, a ten year high, on October 17th. Wheat prices fell on speculation that U.S. farmers may increase the acreage planted with the grain this year. The sector’s worst performer was London sugar. Sugar fell as supplies are set to grow 3.9 percent faster than expected demand in 2007 which may leave unsold stockpiles at approximately 49 percent of global consumption by the end of September 2007, the highest percentage in ten years. Toward the end of 2006, corn and soybean futures in Chicago rose on signs that export demand for the two biggest U.S. crops remained strong even after price rallies. Farmers in Brazil, growers of Robusta and Arabica beans traded in New York, held back supplies because drought conditions may reduce the 2007 crop. 2006 ended with soybean prices falling on prospects that rains may have improved South American crops. Despite the fall, soybeans rose to a 17-month high on December 29th in Chicago on speculation that rising corn prices will cut plantings of the oilseed. Corn is more appealing than soybeans for U.S. farmers because of record demand for ethanol, a fuel being added to gasoline to meet federal mandates for renewable energy.
The interest rate sector posted losses for the Partnership. The year began with fixed income markets in the U.S., Europe and Japan selling off over fears of their respective central banks raising interest rates. The sector benefited from Japanese Government bonds, which was a price decline. Eurodollar posted gains which were offset by losses in U.S. 30 year bonds, German bunds and bobl. During the first quarter, the U.S. Federal Reserve and the European Central Bank raised their respective interest rates 25 basis points. A catalyst for the sell-off was growing speculation in the markets that both central banks would be forced to continue to raise rates after confidence reports released in both Europe (IFO) and the U.S. (consumer confidence) on March 28th were stronger than expected. Mid-year European, Japanese and U.S. fixed income markets sold off which significantly added to the Partnership’s performance. The Japanese ten year bond (“JGB’s”) added to the sector’s performance as it fell for a fifth month, the longest since 1990, on concerns that the Bank of Japan will raise interest rates this year. Yields on U.S. ten year Treasuries rose for a fifth straight month mid-year, the longest stretch since 1999. During the third quarter, the U.S. benchmark ten year along with the U.S. ten year Treasury bond were the worst performers in the sector as the slowing U.S. economy spurred speculation that the U.S. Federal Reserve will stop raising interest rates. The Bank of Japan raised the rate between lenders 25 basis points on July 14th ending a five-year policy of keeping borrowing costs near zero percent. Japanese government bonds, German bunds, and the U.S. benchmark ten year Treasury bond rallied. Investors drove yields lower as a smaller than expected increase in consumer prices, as well as a sharp drop in industrial production, caused speculation that the Bank of Japan would keep interest rates at their current level for the remainder of the year. U.S. bonds were supported by the U.S. Federal Reserve’s decision to benchmark
U.S. interest rate at 5.25 percent, ending a record two-year run of 17 straight rate increases. The U.S. ten year yield touched a seven month low of 4.53 percent on September 25th, down from 5.14 percent on June 30th as expectations that the U.S. Federal Reserve would raise interest rates further gave way to the view that it may lower them in the near future. During the beginning of the fourth quarter, U.S., European, and Japanese debt markets suffered reversals over speculation surrounding potential global interest rate moves. Japanese ten year bonds and German ten year government bonds (“Bunds”) were the worst performing components in the sector on expectations that the European Central Bank (“ECB”) and Bank of Japan (“BOJ”) would have to keep raising interest rates to help contain inflation. Later in the fourth quarter, U.S. Treasuries rose, pushing the benchmark ten-year note yields to 4.46 percent, the lowest since January. U.S. Treasuries gained after the NAPM-Chicago business barometer declined to 49.9 from 53.5 in October, (a reading below 50 signals a contraction). The U.S. Federal Reserve’s last series of interest rate cuts in 2001 began five months after the business barometer dropped below 50. The year ended as German and U.S. government
bonds fell, experiencing reversing trends while JGB’s oscillated due to market speculation on whether the BOJ would raise interest rates. On December 8th, JGB’s posted their biggest weekly decline in four months as investors increased their positions based on the belief that the BOJ would raise rates at its December meeting. German government bonds fell on speculation the ECB will keep lifting rates into next year. Benchmark U.S. two-year notes had their longest losing run in more than 15 years in December, driving yields to their highest in more than four years. U.S. Treasuries also fell, enduring their first December loss in five years.
The energy sector posted losses for the Partnership. At the beginning of the year volatility within the energy sector increased as oil and natural gas were being used as “geopolitical weapons” by Iran, Russia, Venezuela and militants in Bolivia. Natural gas fell 17 percent around the beginning of the year as mild weather in several of the largest U.S. consuming regions cut demand which limited the need for utilities to pull from reserves . The market continued to be apprehensive in connection with geopolitical conflicts in the middle East and Nigeria. Mid-year concerns that the U.N. Security Council will impose sanctions that could lead Iran, the fourth-largest oil producer, to cut shipments drove crude oil for June delivery to a new high of $75.35 a barrel. Increased geopolitical uncertainty drove all petroleum based products higher. While the sector benefited from increased instability in the world, mild weather in the U.S. hindered performance as natural gas has fallen 20 percent and approached a nine month low as demand slowed. Crude oil spiked on July 14th to a record high on concern that the fighting in Lebanon might spread to other parts of the Middle East, which is the source of approximately a third of the world’s oil. Crude oil plunged 25 percent in October, since reaching a record high on July 14th. Energy prices continued their downward trend as warm weather in the northern U.S. reduced fuel demand. Also contributing to the downward price movement were signs that OPEC would not cut production as much as previously pledged. Crude oil fell to a 17-month low. The year ended with the population centers of the Midwest and Northeast, where demand for gas is highest, experiencing weather as much as 25 percent warmer than normal. Forecasters said an El Nino weather pattern, which typically brings above-average winter temperature, is affecting much of the U.S. crude oil for February 2007 delivery touched $59.99, the lowest since November 27th, while heating oil for January 2007 delivery touched $1.5995, the lowest since October 31st.
The currencies sector posted the greatest losses for the Partnership. At the beginning of the year foreign exchange sector suffered losses as the U.S. dollar posted its biggest monthly decline against the euro since November 2004. This was significantly due to the market’s anticipation of the U.S. Federal Reserve’s removal of “measured pace” from its statement after its meeting on January 31st. The euro also benefited as the market waited for whether the European Central Bank’s meeting on February 2, 2006 would raise borrowing costs as Europe’s economy strengthened. During the second quarter, stronger than expected core Consumer Price (“CPI”) coupled with statements from U.S. Federal Reserve Chairman Bernanke calling recent increases in inflation measures an “unwelcome development”, led investors to speculate that the U.S. Federal Reserve might raise rates 50 basis points rather than the previously expected 25. The increased rate speculation helped the U.S. dollar reach an eight-week high of 1,2479 against the euro. On June 29th, the U.S. Federal Reserve raised rates 25 basis points and suggested it may be nearing the end of its 2-year cycle of rate increases as the statement announcing their decision indicated that slowing economic growth “should help to limit inflation pressures”. As a result, the U.S. dollar reversed once again and weakened during the last two days of the month. During the third quarter, fighting broke out between Israel and Hezbollah causing a sharp reversal in the weakening U.S. dollar trend. The U.S. dollar rallied as fighting in the Middle East escalated sending the currency higher against the Japanese yen and euro. Unfortunately, most of the gains disappeared as investors focused on interest rates after U.S. Federal Reserve Chairman Bernanke stated that “moderation” in the economy was under way. On October 13th, the dollar rose to its highest level against the Japanese yen this year and the strongest level versus the euro since July, after a government report showed U.S. retail sales excluding gasoline increased in September. On October 31st however, the U.S. dollar had given up most of its gains from earlier in the month and dropped to its lowest level in five weeks against the euro and Japanese yen after a survey of purchasing managers showed business declined and a report revealed U.S consumer confidence unexpectedly fell for the month. The data provided evidence of a slowdown in the world’s largest economy, increasing speculation that the U.S. Federal Reserve may cut borrowing costs early in 2007 reducing the appeal of dollar-denominated assets. Near the end of the year the U.S. dollar tumbled to a 20-month low against the euro and approached a three-month low versus the Japanese yen. The year ended as higher European interest rates helped the euro reach a record high against the Japanese yen on December 29th and caused the Japanese yen to fall to its lowest level since 1998 versus the British pound.
The Partnership posted losses in all sectors.
Trading in the metals sectors was the least unprofitable for the Partnership. At the beginning of the year, the loss in metals was primarily due to the weakness in both gold and aluminum. Gold which recently had a strong inverse relationship with the U.S. dollar came under pressure as the U.S. dollar strengthened. Aluminum sustained losses as supply increases in Shanghai (among other factors) put pressure on the market. A decrease in the Institute for Supply Management Non-Manufacturing Business Activity Index in the beginning of the second quarter initially caused base metal prices to fall, while precious metals continued to appreciate. Gold prices rose in the middle of the second quarter as crude oil surged, and then dipped with the strengthening of the U.S. economy. Gold prices continued to fall early in the third quarter as the U.S. dollar strengthened, reducing the metal’s appeal as an alternative investment. The cumulative effects of severe price action in the currencies and fixed income markets along with the market impact of Hurricane Katrina led gold to under perform. However, gold futures for December delivery closed at $475.80 on September 29th, the highest since January 1988. November 29th, was also a record day as gold reached $506.70, the highest price for a most-active contract since December 1987. Even though the metals sector had gains at the end of the year, that was not enough to offset the combined losses in other sectors.
The agricultural sector proved to be the second least unprofitable for the Partnership. Early in the year there was forecasted a drought season in Brazil which positively effected soy bean prices near term. Through the middle part of the year, there was no discernable trend in agricultural commodities due to the fact of the increased volatility in the market. Coffee returns rose after flooding caused by Hurricane Katrina placed bean inventories at risk in New Orleans, the second largest coffee port in the U.S. Sugar was an important commodity in the last quarter with the European Union intentionally limiting the supply of white sugar in London and rising Brazilian demand for ethanol made from cane. However, the European Union was forced to cut sugar prices 36% after the World Trade Organization ruled that the Euro nations were illegally subsidizing prices. The year ended with coffee trading being a very significant part of this sector due to the fact that on December 9th Brazil, the world’s largest coffee grower, announced its 2006-2007 crop would increase by 43.6 million bags which was less that what was expected.
The energy sector also posted losses for the Partnership. The bull market trend did continue through the beginning of the year as commodity prices surged to a 24-year high due to signs of growing global demand for energy-related goods. However, as it appeared that global demand for oil would peak to a record 86.4 million barrels a day in the 4th quarter, an Energy Department report informed investors of an unexpected surge in supplies because of increased productivity in refineries. Natural gas prices retreated from record highs set in September, which resulted when Hurricanes Katrina and Rita struck the Gulf Coast. The year ended with a dramatic fall in prices as a result of private and government forecasters calling for warmer than normal temperature across the country for the beginning of January. Predictions stated that demand in the Midwest, where natural gas is the major heating fuel, will be 20 percent lower than normal on average and in the Northeast, where 80 percent of the nation’s heating oil is used, will be 13 percent lower than normal on average. Crude oil’s surge at the end of December also hindered performance as the pricing dispute between Russia and the Ukraine disrupted shipments of natural gas to Europe and raised concerns that Russia is not a reliable energy supplier.
Stock indices and interest rate futures was the fourth least profitable sector for the Partnership. Losses occurred in the beginning of the year resulting from a sell off in world equity markets, as stocks weakened because of high energy prices. In addition, stocks dropped as American International Group Inc., the world’s largest insurer, lost its top credit rating. Japanese stocks rallied in the third quarter on the news that the European Central Bank upgraded its assessment of the Japanese economy, citing improved business confidence and greater company investments however; gains were limited as the majority of the world’s equity markets weakened due to record oil prices, caused by Hurricanes Katrina and Rita. Interest rate futures having losses that were directly related to the fixed income sector as the European, Japanese and U.S. bond markets sold off. The catalyst for the dramatic move higher in world interest rates was the cumulative effect of increases in both energy prices and inflation expectations. During the second quarter, Japan’s government bond yields experienced record lows because of anticipated economic slowdowns for two main reasons; the projection that the demand for regional goods would wane because of a slowing U.S. economy and record high oil prices were expected to take a serious toll on the nation. Sector’s gains in the third quarter were limited as the majority of the world’s equity markets weakened during the quarter on concerns of record oil prices, caused by Hurricanes Katrina and Rita. The year ended with limited performance in the European fixed-income market volatility caused by changing expectations as to whether or not the European Central Bank rate hike was a single increase or the beginning of a series of further moves.
Trading in currencies was the least profitable for the Partnership. Loss in the beginning of the year was directly related to the strength of the U.S. dollar against most major currencies. The recent dollar strength began when Federal Reserve Chairman Alan Greenspan predicted that the deficit in the U.S. current account, the broadest measure of trade, may shrink. However, the second quarter ended with a widening spread between the two-year U.S. Treasury note and the German schatz (two-year note), along with the rally of the U.S. dollar against the Japanese yen. In the third quarter, China revalued its yuan for the first time in a decade. The currency sector continued to suffer as the U.S. dollar rallied against the Euro, Swiss franc and British pound, but offset in part by gains in the Japanese yen and Brazilian real. The year ended with the U.S. dollar reversing its strengthening to the Japanese yen because of the apparent Federal Reserve signals that it was closer to ending its rate-hiking cycle. The sector also incurred losses from weakness in the British pound as it weakened on expectations that the Bank of England may have to cut rates.
The energy sector had the highest gains for this Partnership. The upward trend in crude oil prices and related products continued in their secular bull market trend, in a very volatile fashion. Colder than expected winter months, rising demand out of Asia, supply disruptions in Iraq, fears of worldwide terrorism, an active hurricane season in the U.S., and unrest in Nigeria, all seem to have contributed to supporting high prices throughout the year. The end of the year did witness a pull back from the all time highs in energy prices, possibly due to U.S. heating oil perceptions regarding the weather in the U.S. Northeast.
Stock indices and interest rate futures posted the second highest gains for the Partnership. Stock indices had strong gains in the beginning and end of the year. The re-election of President Bush and the lack of any terrorist activity during the U.S. elections may have combined to decrease the uncertainty that had plagued the world equity markets. U.S., European and Japanese stocks rallied after the U.S. election and energy prices decreased. Early gains for the interest rate
futures may have been based upon the U.S. Federal Reserve’s accommodating interest rate policy being maintained. Interest rates in the European Central Bank community experienced a certain amount of downward pressure, due to a terrorist attack in Spain, which may have dampened confidence in local communities. German interest rates fell as bond prices rose after a report that German business confidence unexpectedly dropped to a nine month low as consumers curtailed their spending activity. The hawkish stance of the U.S. Federal Reserve combined with the expected concretionary effect of higher energy prices helped to push long-term interest rates lower and flatten the yield curve. The year ended on increased volatility in the currency and energy sectors which seemed to spill over to the debt markets and thereby may have negatively affected the Partnership’s performance.
The currency sector posted the third highest profit for the Partnership. The weakening U.S. dollar continued to decline as it has for over a year and the Partnership was well positioned to capitalize on its U.S. dollar positions against other currencies. The strengthening in the U.S. dollar in mid-year attributed to losses. The U.S. dollar weakened again in October. As a result of the U.S. dollar’s weakness, many currency markets were able to break out of their well-established trading ranges. The U.S. dollar’s decline, which seems to have resulted from the uncertainty surrounding the outcome of the U.S. election, led to profitable currency trades for the Partnership. December marked the third consecutive annual decline of the dollar against both the euro and the yen.
Agricultural sector posted gains for the Partnership. The best performers in the sector were corn, soybeans and soybean oil. The price of cotton continued to move lower due to the World Trade Organization’s ruling in June that U.S. subsidies to U.S. farmers are illegal, paving the way for increased cotton planting in other countries. The only notable gain was in coffee, as prices rose to a four year high on expectations that global demand was outpacing production, mainly because Brazil, the world’s top grower, harvested a small crop.
The metals sector was the most unprofitable for the Partnership. Prices of base metals consolidated within certain ranges as the market weighed information that China’s appetite for metals may be saturated as that country seems to be attempting to rein in rapid domestic growth. Precious metal prices fell steeply in the beginning of the second quarter as investors liquidated long positions which had been a hedge against the negative real rate of return environment in the U.S. The sector ended the year unprofitable as trading in the metals sector was mixed as the U.S. dollar’s instability and economic data reports influenced trading. Gold hurt the metal sector’s performance as it suffered its biggest decline in more than a year after trading near record highs. Gold’s decline was possibly due to speculation over the prospects of continued dollar weakening. The largest loss occurred in silver.
Variables Affecting Performance
The principal variables that determine the net performance of the Partnership are gross profitability from the Partnership’s trading activities and interest income.
During all periods set forth above “Selected Financial Data”, the interest rates in many countries were at unusually low levels. The low interest rates in the United States (although higher than in many other countries) negatively impacted revenues because interest income is typically a major component of the Partnership’s profitability. In addition, low interest rates are frequently associated with reduced fixed income market volatility, and in static markets the Partnership’s profit potential generally tends to be diminished. On the other hand, during periods of higher interest rates, the relative attractiveness of a high risk investment such as the Partnership may be reduced as compared to high yielding and much lower risk fixed-income investments.
The Partnership’s Brokerage Commissions and Administrative Fees are a constant percentage of the Partnership costs (other than the insignificant currency trading costs which are not based on a percentage of the Partnership’s assets allocated to trading or total) and the Profit Shares payable to the Advisor based on the new Trading Profits generated by the Partnership excluding interest and after reduction for a portion of the Brokerage Commissions.
Unlike many investment fields, there is no meaningful distinction in the operation of the Partnership between realized and unrealized profits. Most of the contracts traded by the Partnership are highly liquid and can be closed out at any time.
Except in unusual circumstances, factors-regulatory approvals, cost of goods sold, employee relations and the like-which often materially affect an operating business have virtually no impact on the Partnership.
Liquidity; Capital Resources
The Partnership borrows only to a limited extent and only on a strictly short-term basis in order to finance losses on non-U.S. dollar denominated trading positions pending the conversion of the Partnership’s U.S. dollar deposits. These borrowings are at a prevailing short-term rate in the relevant currency.
Inflation by itself does not affect profitability, but it can cause price movements that do so.
The Partnership’s assets and open positions are generally highly liquid.
The Partnership changes its positions and market focus frequently. Consequently, the fact that the Partnership realized gains or incurred losses in certain markets (gold, stock indices, currencies, etc.) in the past is not necessarily indicative of whether the Partnership will do so in the future.
(The Partnership has no off-balance sheet arrangements or tabular disclosure of contractual obligations of the type described in Items 3.03(a)(4) and 3.03(a)(5) of Regulation S-K.)
Item 7A:
Item 7A: Quantitative and Qualitative Disclosures about Market Risk
Introduction The Partnership is a speculative commodity pool. The market sensitive instruments held by it are acquired for speculative trading purposes and all or substantially all of the Partnership’s assets are subject to the risk of trading loss. Unlike an operating company, the risk of market sensitive instruments is integral, not incidental, to the Partnership’s main line of business.
Market movements result in frequent changes in the fair market value of the Partnership’s open positions and, consequently, in its earnings and cash flow. The Partnership’s market risk is influenced by a wide variety of factors, including the level and volatility of interest rates, exchange rates, equity price levels, the market value of financial instruments and contracts, the diversification effects among the Partnership’s open positions and the liquidity of the markets in which it trades.
The Partnership, under the direction of JWH®, rapidly acquires and liquidates both long and short positions in a wide range of different markets. Consequently, it is not possible to predict how a possible future market scenario will affect performance, and the Partnership’s past performance is not necessarily indicative of its future results.
Value at Risk is a measure of the maximum amount which the Partnership could reasonably be expected to lose in a given market sector. However, the inherent uncertainty of the Partnership’s speculative trading and the recurrence in the markets traded by the Partnership of market movements far exceeding expectations could result in actual trading or non-trading losses far beyond the indicated Value at Risk or the Partnership’s experience to date (i.e., “risk of ruin”). In light of the foregoing as well as the risks and uncertainties intrinsic to all future projections, the inclusion of the quantification in this section should not be considered to constitute any assurance or representation that the Partnership’s losses in any market sector will be limited to Value at Risk or by the Partnership’s attempts to manage its market risk.
Quantifying the Partnership’s Trading Value at Risk Quantitative Forward-Looking Statements
The following quantitative disclosures regarding the Partnership’s market risk exposures contain “forward-looking statements” within the meaning of the safe harbor from civil liability provided for such statements by the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). All quantitative disclosures in this section are deemed to be forward-looking statements for purposes of the safe harbor, except for statements of historical fact.
The Partnership’s risk exposure in the various market sectors traded by JWH® is quantified below in terms of Value at Risk. Due to the Partnership’s mark-to-market accounting, any loss in the fair value of the Partnership’s open positions is directly reflected in the Partnership’s earnings (realized or unrealized) and cash flow (at least in the case of exchange-traded contracts in which profits and losses on open positions are settled daily through variation margin).
Exchange maintenance margin requirements have been used by the Partnership as the measure of its Value at Risk. Maintenance margin requirements are set by exchanges to equal or exceed the maximum loss in the fair value of any given contract incurred in 95% to 99% of the one-day time periods included in the historical sample (approximately one year, generally) researched for purposes of establishing margin levels. The maintenance margin levels are established by dealers and exchanges using historical price studies as well as an assessment of current market volatility (including the implied volatility of the options on a given futures contract) and economic fundamentals to provide a probabilistic estimate of the maximum expected near-term one-day price fluctuation.
In the case of market sensitive instruments which are not exchange-traded (almost exclusively currencies in the case of the Partnership), the margin requirements for the equivalent futures positions have been used as Value at Risk. In those rare cases in which a futures-equivalent margin is not available, dealers’ margins have been used.
100% positive correlation in the different positions held in each market risk category has been assumed. Consequently, the margin requirements applicable to the open contracts have been aggregated to determine each trading category’s aggregate Value at Risk. The diversification effects (which would reduce the Value at Risk estimates) resulting from the fact that the Partnership’s positions are rarely, if ever, 100% positively correlated have not been reflected.
The Partnership’s Trading Value at Risk in Different Market Sectors The following table indicates the average, highest, and lowest trading Value at Risk associated with the Partnership’s open positions by market category for the fiscal year 2006. During the fiscal year 2006, the Partnership’s average capitalization was approximately $1,050,574,066. During the fiscal year 2005, the Partnership’s average capitalization was approximately $1,266,792,130.
December 31, 2006
December 31, 2005
Material Limitations on Value at Risk as an Assessment of Market Risk
The face value of the market sector instruments held by the Partnership is typically many times the applicable maintenance margin requirement (maintenance margin requirements generally ranging between approximately 1% and 10% of contract face value) as well as many times the capitalization of the Partnership. The magnitude of the Partnership’s open positions creates a “risk of ruin” not typically found in most other investment vehicles. Because of the size of its positions, certain market conditions - unusual, but historically recurring from time to time - could cause the Partnership to incur severe losses over a short period of time. Even comparatively minor losses could cause MLAI to further deleverage or terminate the Partnership’s trading. The foregoing Value at Risk table - as well as the past performance of the Partnership - gives no indication of this “risk of ruin.”
Non-Trading Risk
Foreign Currency Balances; Cash on Deposit with MLPF&S
The Partnership has non-trading market risk on its foreign cash balances not needed for margin. These balances (as well as the market risk they represent) are generally immaterial.
The Partnership also has non-trading market risk on the approximately 90-95% of its assets which are held in cash at MLPF&S. The value of this cash is not interest rate sensitive, but there is cash flow risk in that if interest rates decline so will the cash flow generated on these monies. This cash flow risk is generally immaterial.
Qualitative Disclosures Regarding Primary Trading Risk Exposures
The following qualitative disclosures regarding the Partnership’s market risk exposures through the joint venture - except for (i) those disclosures that are statements of historical fact and (ii) the descriptions of how the Partnership manages its primary market risk exposures - constitute forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. The Partnership’s primary market risk exposures as well as the strategies used and to be used by MLAI and JWH® for managing such exposures are subject to numerous uncertainties, contingencies and risks, any one of which could cause the actual results of the risk controls for the Partnership and for the trading conducted through the joint venture to differ materially from the objectives of such strategies. Government interventions, defaults and expropriations, illiquid markets, the emergence of dominant fundamental factors, political upheavals, changes in historical price relation­ships, an influx of new market participants, increased regulation and many other factors could result in material losses as well as in material changes to the risk exposures and the risk management strategies of the Partnership. There can be no assurance that the Partnership’s and joint venture’s current market exposure and/or risk management strategies will not change materially or that any such strategies will be effective in either the short- or long-term. Investors must be prepared to lose all or substantially all of the value of their investment in the Partnership.
The following were the primary trading risk exposures of the Partnership as of December 31, 2006, by market sector.
Currencies.
The Partnership trades a large number of currencies. However, the Partnership’s major exposures have typically been in the U.S. dollar/Japanese yen, U.S. dollar/Swiss Franc, U.S. dollar/Euro and U.S. dollar/ British pound positions. The Partnership does not anticipate that the risk profile of the Partnership’s currency sector will change significantly in the future. The currency trading Value at Risk figure includes foreign margin amounts converted into U.S. dollars with an incremental adjustment to reflect the exchange rate risk of maintaining Value at Risk in a functional currency other than U.S. dollars.
Interest Rates.
Interest rate movements directly affect the price of derivative sovereign bond positions held by the Partnership and indirectly the value of its stock index and currency positions. Interest rate movements in one country, as well as relative interest rate movements between countries, materially impact the Partnership’s profitability. The Partnership’s primary interest rate exposure is to interest rate fluctuations in the United States, Europe and Japan. However, the Partnership also takes positions in the government debt of smaller nations - e.g., Canada and Australia.
Stock Indices.
The Partnership’s primary equity exposure is to liquid global equity index price movements. As of December 31, 2006, the Partnership’s primary exposures were in the Nasdaq E-mini, Nikkei (Japan) and Eurostoxx 50 stock indices. The Partnership is primarily exposed to the risk of adverse price trends or static markets in the major U.S., European and Asian indices.
Energy.
The Partnership’s primary energy market exposure is to natural gas and oil price movements. Oil prices can be volatile and substantial profits and losses have been, and are expected to continue to be, experienced in these markets.
Metals.
The Partnership’s primary metals market exposure is to fluctuations in the price of gold. JWH® also trades silver and base metals such as aluminum and copper, Gold prices can be volatile, and JWH® has from time to time taken substantial gold positions.
Agricultural Commodities.
The Partnership’s primary agricultural commodities exposure is to agricultural price movements, which can be directly affected by severe or unexpected weather conditions. Sugar and coffee accounted for a large portion of the Partnership’s commodities exposure as of December 31, 2006. In the past, the Partnership has had material market exposure to grains and live cattle and may do so again in the future. However, MLAI anticipates that JWH® will maintain an emphasis on grains, coffee, sugar, and meats in which the Partnership has historically taken its largest agricultural positions.
Qualitative Disclosures Regarding Non-Trading Risk Exposure
The following were the only non-trading risk exposures of the Partnership as of December 31, 2006.
Foreign Currency Balances.
The Partnership’s primary foreign currency balances are in Japanese yen, Euro and British pounds.
U.S. Dollar Cash Balance
The Partnership hold U.S. dollars only in cash at MLPF&S. The Partnership has immaterial cash flow interest rate risk on its cash on deposit with MLPF&S in that declining interest rates would cause the income from such cash to decline.
Qualitative Disclosures Regarding Means of Managing Risk Exposure
Trading Risk
MLAI has procedures in place intended to control market risk, although there can be no assurance that they will, in fact, succeed in doing so. While MLAI does not itself intervene in the markets to hedge or diversify the Partnership’s market exposure; MLAI may urge JWH® to reallocate positions in an attempt to avoid over-concentrations. However, such interventions are unusual. Except in cases in which it appears that JWH® has begun to deviate from past practice and trading policies or to be trading erratically, MLAI basic risk control procedures consist simply of the ongoing process of monitoring JWH® with the market risk controls being applied by JWH® itself.
Risk Management
JWH® attempts to control risk in all aspects of the investment process - from confirmation of a trend to determining the optimal exposure in a given market, and to money management issues such as the startup or upgrade of investor accounts. JWH® double checks the accuracy of market data, and will not trade a market without multiple price sources for analytical input. In constructing a portfolio, JWH® seeks to control overall risk as well as the risk of any one position, and JWH® trades only markets that have been identified as having positive performance characteristics. Trading discipline requires plans for the exit of a market as well as for entry. JWH® factors the point of exit into the decision to enter (stop loss). The size of JWH®’s positions in a particular market is not a matter of how large a return can be generated but of how much risk it is willing to take relative to that expected return.
To attempt to reduce the risk of volatility while maintaining the potential for excellent performance, proprietary research is conducted on an ongoing basis to refine the JWH® investment strategies. Research may suggest substitution of alternative investment methodologies with respect to particular contracts; this may occur, for example, when the testing of a new methodology has indicated that its use might have resulted in different historical performance. In addition, risk management research and analysis may suggest modifications regarding the relative weighting among various contracts, the addition or deletion of particular contracts for a program, or a change in position size in relation to account equity. The weighting of capital committed to various markets in the investment programs is dynamic, and JWH® may vary the weighting at its discretion as market conditions, liquidity, position limit considerations and other factors warrant.
JWH® may determine that risks arise when markets are illiquid or erratic, which may occur cyclically during holiday seasons, or on the basis of irregularly occurring market events. In such cases, JWH® at its sole discretion may override computer-generated signals and may at times use discretion in the application of its quantitative models, which may affect performance positively or negatively.
Adjustments in position size in relation to account equity have been and continue to be an integral part of JWH®’s investment strategy. At its discretion, JWH® may adjust the size of a position in relation to equity in certain markets or entire programs. Such adjustments may be made at certain times for some programs but not for others. Factors which may affect the decision to adjust the size of a position in relation to account equity include ongoing research, program volatility, assessments of current market volatility and risk exposure, subjective judgment, and evaluation of these and other general market conditions.
Non-Trading Risk The Partnership controls the non-trading exchange rate risk by regularly converting foreign currency balances back into U.S. dollars at least once per week and more frequently if a particular foreign currency balance becomes unusually high.
The Partnership has cash flow interest rate risk on its cash on deposit with MLPF&S in that declining
interest rates would cause the income from such cash to decline. However, a certain amount of cash or cash equivalents must be held by the Partnership in order to facilitate margin payments and pay expenses and redemptions. MLAI does not take any steps to limit the cash flow risk on the cash held on deposit at MLPF&S.
Item 8:
Item 8: Financial Statements and Supplementary Data
Selected Quarterly Financial Data
ML JWH Strategic Allocation Fund L.P.
Net Income by Quarter
Eight Quarters through December 31, 2006
(1) Includes Minority Interest
The financial statements required by this Item are included in Exhibit 13.01.
The supplementary financial information (“information about oil and gas producing activities”) specified by Item 302(b) of Regulation S-K is not applicable.
Item 9:
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There were no changes in or disagreements with the independent registered public accounting firm on accounting and financial disclosure.
Item 9A:
Item 9A: Controls and Procedures
Merrill Lynch Alternative Investments LLC, the General Partner of ML JWH Strategic Allocation Fund L.P., with the participation of the General Partner’s Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the design and operation of its disclosure controls and procedures with respect to the Partnership as of the end of the period covered by this annual report, and, based on their evaluation, have concluded that these disclosure controls and procedures are effective. Additionally, there were no significant changes in the Partnership’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Item 9B:
Item 9B: Other Information
Not Applicable
PART III
Item 10:
Item 10: Directors,Executive Officers and Corporte Governance
10(a) and 10(b) Identification of Directors and Executive Officers:
As a limited partnership, the Partnership itself has no officers or directors and is managed by MLAI. Trading decisions are made by JWH on behalf of the Partnership.
The managers and executive officers of MLAI and their respective business backgrounds are as follows:
Benjamin C. Weston
Chief Executive Officer and President
Robert D. Ollwerther
Chief Operating Officer and Manager
Barbra E. Kocsis
Chief Financial Officer
Robert M. Alderman
Vice President and Manager
Andrew B. Weisman
Manager
Benjamin C. Weston was born in 1954. Mr. Weston is the Chief Executive Officer, President and a Manager of MLAI and Head of MLAI’s Hedge Fund Development and Management Group at Merrill Lynch where he is responsible for all hedge fund investment activities for Merrill Lynch worldwide. Mr. Weston joined Merrill Lynch from Indeman Capital Management (IDM), a hedge fund incubation business formed in 2003 with the backing of Ritchie Capital Management and Azimuth Trust. Before founding IDM, Mr. Weston worked as a consultant for Ritchie Capital which he joined in September 2002 from Credit Suisse First Boston where he was a Managing Director and Head of the Funds Development Group. The Funds Development Group developed and launched a series of market-leading hedge funds, including three that today rank in the world’s 50 largest funds. Until 2000,
Mr. Weston served on the Management Committee of CSFB’s Fixed Income Division and was Head of the Leveraged Capital Services Group, which advised a select group of hedge funds on global market strategy, optimal investment expression and risk management. Prior to transferring to CSFB in 1996, Mr. Weston was Co-Head of Credit Suisse Financial Products in the Americas (CSFP) and a Member of the Executive Board from 1990 to 1995. Before founding CSFP in New York in 1990, Mr. Weston held various senior management positions from 1983 to 1990 at Bankers Trust including Head of the Capital Markets Group in London, Head of the Equity Derivatives business in Europe and Head of the bank’s equity businesses in Asia from Hong Kong. Mr. Weston started his career at JP Morgan in 1978 where he worked in the Funding Services Group in New York and London. Mr. Weston received a Bachelor of Arts in International Studies from Miami University in 1976 and a Master of Arts in International Affairs with Honors in Economics from The Johns Hopkins School of Advanced International Studies
Robert D. Ollwerther was born in 1956. He is Chief Operating Officer for and a Manager of MLAI. He is responsible for Finance, Operations, Technology and Administration for the Fund and other MLAI products which invest in hedge funds. He has over 20 years of experience in the securities industry. He began his career with Coopers & Lybrand, CPAs. Since joining Merrill Lynch in 1981, he has primarily served in finance positions in the U.S. and abroad, including Chief Financial Officer for Europe, the Middle East and Africa, Chief Financial Officer for Latin America and Canada, Chief Financial Officer of Global Equity Markets, Director of Institutional and International Audit and Manager of Merrill Lynch Financial Reporting. He holds a Bachelor of Science in accounting from Fairfield University and a Master of Business Administration from New York University, and is a Certified Public Accountant.
Barbra E. Kocsis was born in 1966. She is Chief Financial Officer for MLAI. She is also a Director within the Merrill Lynch Global Private Client Global Infrastructure Solutions group. Prior to that, she was the Fund Controller of MLAI. Before coming to MLAI, Ms. Kocsis held various accounting and tax positions at Derivatives Portfolio Management LLC from May 1992 until May 1999, at which time she held the position of accounting director. Prior to that, she was an associate at Coopers & Lybrand in both the audit and tax practices. She graduated cum laude from Monmouth College in 1988 with a Bachelor of Science in Business Administration - Accounting and is a Certified Public Accountant.
Robert M. Alderman was born in 1960. He is Managing Director of Merrill Lynch Global Private Client, and a Vice President and a Manager of MLAI. He is responsible for coordinating a global sales effort and managing the retail product line, which includes hedge funds, private equity opportunities, managed futures funds and exchange funds. Prior to re-joining Merrill Lynch and the International Private Client Group in 1999, he was a partner in the Nashville, Tennessee-based firm of J.C. Bradford & Co. where he was the Director of Marketing, and a National Sales Manager for Prudential Investments. Mr. Alderman first joined Merrill Lynch in 1987 where he worked until 1997. During his tenure at Merrill Lynch, Mr. Alderman has held positions in Financial Planning, Asset Management and High Net Worth Services. He received his Master of Business Administration from the Carroll School of Management, Boston College and a Bachelor of Arts from Clark University.
Andrew B. Weisman was born in 1959. He is Manager of MLAI and is head of HFDMG’s Consolidated Investment Analytics group. Mr. Weisman joined Merrill Lynch in August 2005. From April 2002 to July 2005, Mr. Weisman was a partner and director of research for Stradivarius Capital Management, and from January 1998 until April 2002, he served as Chief Investment Officer of Nikko Securities International. Mr. Weisman holds a Master of International Affairs and a Bachelor of Arts from Columbia University.
As of December 31, 2006, the principals of MLAI had no investment in the Partnership, and MLAI’s general partner interest in the Partnership was valued at $8,204,766.
MLAI acts as the sponsor, general partner or manager to eight public futures funds whose units of limited partner or member interests are registered under the Securities Exchange Act of 1934: ML Select Futures I L.P., ML John W. Henry & Co. / Millburn L.P., ML Absolute Plus Management Global Commodity FuturesAccess LLC, ML Appleton FuturesAccess LLC, ML Aspect FuturesAccess LLC, ML Cornerstone FuturesAccess LLC, ML Winton FuturesAccess LLC and the Partnership. Because MLAI serves as the sponsor, general partner or manager of each of these funds, the officers and managers of MLAI effectively manage them as officers and directors of such funds.
(c) Identification of Certain Significant Employees:
John W. Henry & Company, Inc. is the trading advisor of the Partnership. Were JWH®'s services no longer to be available to the Partnership, the Partnership would, in all likelihood, dissolve.
(d) Family Relationships:
None.
(e) Business Experience:
See Item 10(a) and (b) above.
(f) Involvement in Certain Legal Proceedings:
None.
(g) Promoters and Control Persons:
Not applicable.
Code of Ethics:
MLAI and Merrill Lynch have adopted a code of ethics, as of the end of the period covered by this report, which applies to the Partnership’s (MLAI’s) principal executive officer and principal financial officer or persons performing similar functions on behalf of the Partnership. A copy of the code of ethics is available to any person, without charge, upon request by calling 1-877-465-8435.
Nominating Committee:
Not applicable. (Neither the Partnership nor MLAI has an audit committee.)
Audit Committee: Audit Committee Financial Expert:
Not applicable. (Neither the Partnership nor MLAI has an audit committee.) There are no listed shares of the Partnership or MLAI.
Section 16(a) Beneficial Ownership Reporting Compliance:
Not applicable.
Item 11:
Item 11: Executive Compensation
The officers of MLAI are remunerated by Merrill Lynch in their respective positions. The Partnership does not itself have any officers, directors or employees. The Partnership pays Brokerage Commissions to an affiliate of MLAI and Administrative Fees to MLAI. MLAI or its affiliates may also receive certain economic benefits from holding certain of the Partnership's U.S. dollar Available Assets in offset accounts, as described in Item 1(c) above. The managers and officers receive no “other compensation” from the Partnership, and the managers receive no compensation for serving as managers of MLAI. There are no compensation plans or arrangements relating to a change in control of either the Partnership or MLAI.
Item 12:
Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Security Ownership of Certain Beneficial Owners:
Not applicable (The Units are non-voting limited partnership interests. The Partnership is managed by MLAI, its general partner).
(b) Security Ownership of Management:
As of December 31, 2006, MLAI owned 46,719 Unit-equivalent general partnership interests, which was 1.04% of the total Units outstanding.
(c) Changes in Control:
None.
(d) Securities Authorized for Issuance Under Equity Compensation Plans:
Not applicable.
Item 13:
Item 13: Certain Relationships and Related Transactions
(a) Transactions between Merrill Lynch and the Partnership
All of the service providers to the Partnership, other than JWH®, are affiliates of Merrill Lynch. Merrill Lynch negotiated with JWH® over the level of its advisory fees and Profit Share. However, none of the fees paid by the Partnership to any Merrill Lynch party were negotiated, and they are higher than would have been obtained in arm's-length bargaining.
The Partnership pays indirectly Merrill Lynch through MLPF&S and MLAI substantial Brokerage Commissions and Administrative Fees, respectively, as well as bid-ask spreads on forward currency trades. The Partnership also pays MLPF&S interest on short-term loans extended by MLPF&S to cover losses on foreign currency positions.
Within the Merrill Lynch organization, MLAI is the direct beneficiary of the revenues received by different Merrill Lynch entities from the Partnership. MLAI controls the management of the Partnership and serves as its promoter. Although MLAI has not sold any assets, directly or indirectly, to the Partnership, MLAI makes substantial profits from the Partnership due to the foregoing revenues.
No loans have been, are or will be outstanding between MLAI or any of its principals and the Partnership.
MLAI pays substantial selling commissions and trailing commissions to MLPF&S for distributing the Units. MLAI is ultimately paid back for these expenditures from the revenues it receives from the Partnership.
(b) Certain Business Relationships:
MLPF&S, an affiliate of MLAI, acts as the principal commodity broker for the Partnership.
In 2006, the Partnership expensed: (i) Brokerage Commissions of $61,808,517 to the Commodity Broker, which included $21,431,431 in Consulting Fees paid by the Commodity Broker to JWH®; and (ii) Administrative Fees of $2,687,327 to MLAI. In addition, MLAI and its affiliates derived certain economic benefit from possession of the Partnership's assets, as well as from foreign exchange and EFP trading.
See Item 1(c), “Narrative Description of Business - Charges” and “- Description of Current Charges” for a discussion of other business dealings between MLAI affiliates and the Partnership.
(c) Indebtedness of Management:
The Partnership is prohibited from making any loans, to management or otherwise.
Item 14:
Item 14: Principal Accountant Fees and Services
(a) Audit Fees
Aggregate fees billed for professional services rendered by Deloitte & Touche LLP in connection with the audit of the Partnership’s consolidated financial statements as of and for the year ended December 31, 2006 were $74,857.
Aggregate fees billed for these services for the year ended December 31, 2005 were $65,500.
(b) Audit-Related Fees
There were no other audit-related fees billed for the years ended December 31, 2006 or 2006 related to the Partnership.
(c) Tax Fees
Aggregate fees billed for professional services rendered by Deloitte Tax LLP in connection with the tax compliance, advice and preparation of the Partnership’s tax returns for the year ended December 31, 2006 were $153,000.
Aggregate fees billed for these services for the year ended December 31, 2005 were $153,500.
(d) All Other Fees
No fees were paid to Deloitte and Touche LLP or Deloitte Tax LLP during the years ended December 31, 2006 or 2005 for any other professional services in relation to the Partnership.
Neither the Partnership nor MLAI has an audit committee to pre-approve principal accountant fees and services. In lieu of an audit committee, the managers and the principal financial officer pre-approve all billings prior to the commencement of services.
PART IV
Item 15:
Item 15: Exhibits and Financial Statement Schedules
Page
1. Financial Statements:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Statements of Financial Condition as of December 31, 2006 and 2005
Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Changes in Partners’ Capital for the years ended December 31, 2006, 2005 and 2004
Consolidated Financial Data Highlights for the year ended December 31, 2006
Notes to Consolidated Financial Statements
6-12
2. Financial Statement Schedules:
Financial statement schedules not included in this Form 10-K have been omitted for the reason that they are not required or are not applicable or that equivalent information has been included in the financial statements or notes thereto.
3. Exhibits:
The following exhibits are incorporated by reference or are filed herewith to this Annual Report on Form 10-K:
Designation:
Description
1.01
Form of Selling Agreement among the Registrant, MLAI, MLPF&S and JWH®.
Exhibit 1.01:
Is incorporated herein by reference from Exhibit 1.01 contained in Amendment No. 2 to the Registration Statement (File No. 33-80509) filed on April 23, 1996, on Form S-1 under the Securities Act of 1933 (the "Registrant's Registration Statement").
3.01(i)
Certificate of Limited Partnership of the Registrant.
Exhibit 3.01(i):
Is incorporated herein by reference from Exhibit 3.01 contained in the Registrant's Registration Statement.
10.01
Form of Joint Venture Agreement among the Registrant, MLAI, MLPF&S and JWH®.
Exhibit 10.01:
Is incorporated herein by reference from Exhibit 10.01 contained in the Registrant's Registration Statement.
10.02
Form of Customer Agreement between the Registrant's joint venture with JWH® and MLPF&S.
Exhibit 10.02:
Is incorporated herein by reference from Exhibit 10.02 contained in the Registrant's Registration Statement.
10.03
Foreign Exchange Desk Service Agreement among Merrill Lynch Investment Bank, MLAI, MLPF&S and the Partnership.
Exhibit 10.03:
Is incorporated herein by reference from Exhibit 10.03 contained in the Registrant's Registration Statement.
10.04
Joint Venture Agreement Amendment among JWH® and the Partnership.
Exhibit 10.04:
Is incorporated herein by reference from Exhibit 10.04 contained in the Registrant’s Form 10-K for the fiscal year ended December 31, 2001, filed on March 30, 2002.
10.05
Form of Subscription Agreement and Power of Attorney (included as Exhibit C to the Prospectus).
Exhibit 10.05:
Is incorporated herein by reference from Exhibit 10.05 contained in the Registrant's Registration Statement.
10.06
Form of Investment Advisory Contract among the Registrant's joint venture with JWH®, MLAI, and MLPF&S.
Exhibit 10.06:
Is incorporated herein by reference from Exhibit 10.06 contained in the Registrant's Registration Statement.
10.07
Form of Custody Agreement among the Registrant's joint venture with JWH® and MLPF&S.
Exhibit 10.07:
Is incorporated herein by reference from Exhibit 10.07 contained in the Registrant's Registration Statement.
10.08
Form of Limited Liability Company Operating Agreement.
Exhibit 10.08:
Is incorporated herein by reference from Exhibit 10.08 contained in the Registrant’s Form 10-K, for the fiscal year ended December 31, 1997, filed March 30, 1998.
10.09
Form of Amendatory Agreement.
Exhibit 10.09:
Is incorporated herein by reference from Exhibit 10.09 contained in the Registrant's Registration Statement.
13.01
2006 Annual Report and Report of Independent Registered Public Accounting Firm.
Exhibit 13.01:
Is filed herewith.
28.01
Prospectus of the Partnership dated March 31, 2006.
Exhibit 28.01:
Is incorporated herein by reference as filed with the Securities and Exchange Commission pursuant to Rule 424 under the Securities Act of 1933, Registration Statement (File No. 333-80509) on Form S-1, effective March 31, 2003.
31.01 and 31.02
Rule 13a-14(a)/15d-14(a) Certifications.
Exhibits 31.01 and 31.02
Are filed herewith.
32.01 and 32.02
Section 1350 Certifications.
Exhibits 32.01 and 32.02
Are filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed on March 29, 2007 by the following persons on behalf of the Registrant and in the capacities indicated.
(Being the principal executive officer, the principal financial and accounting officer and a majority of the managers of Merrill Lynch Alternative Investments LLC)
ML JWH STRATEGIC ALLOCATION FUND L.P.
2006 FORM 10-K
INDEX TO EXHIBITS
Exhibit
Exhibit 13.01
2006 Annual Report and Report of Independent Registered Public Accounting Firm.