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Investing in Emerging Markets: A Strategic Opportunity Javier Murcio Deputy Portfolio Manager & Senior Sovereign Analyst

Investing in Emerging Markets: A Strategic Opportunity

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Investing in Emerging Markets: A Strategic Opportunity. Javier Murcio Deputy Portfolio Manager & Senior Sovereign Analyst. Over the past decade, emerging markets countries have demonstrated well-documented improvements in critical macroeconomic measures: - PowerPoint PPT Presentation

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Page 1: Investing in Emerging Markets:  A Strategic Opportunity

Investing in Emerging Markets: A Strategic OpportunityJavier MurcioDeputy Portfolio Manager & Senior Sovereign Analyst

Page 2: Investing in Emerging Markets:  A Strategic Opportunity

Progress on Macro Economic Fundamentals

2

Over the past decade, emerging markets countries have demonstrated well-documented improvements in critical macroeconomic measures:

… a decrease in foreign debt ratios,

… an increase in foreign exchange reserves,

… and more credible monetary policies.

Source: Standish and JP Morgan as of September 30, 2011.* Market cap weighted averages for countries in the J.P. Morgan Government Bond Index - Emerging Markets(GBI-EM) Global Diversified.

Foreign Debt (% of Exports)*

0%30%60%90%

120%150%180%

Foreign Exchange Reserves (US$ bn)*

-$10

$40

$90

$140

$190

CPI (% YOY)*

05

1015202530

Page 3: Investing in Emerging Markets:  A Strategic Opportunity

EM Currencies: No More Pegs

Emerging markets currency valuations are driven by supply-demand conditions. We believe core balance – the sum of current account balance and net foreign direct investment – is the most conservative measure of such conditions.

As global economic activity slowed down, core balances in emerging markets deteriorated significantly in 2008, albeit from a very high level.

Core balances improved significantly in 2009, and we expect them to stay at supportive levels at least for the next couple of years.

3

EM Core Balance (Weighted Average of All Countries in the JPM GBI-EM Global Diversified Index)

2007 2008 2009 2010 2011F 2012F0.0

0.5

1.0

1.5

2.0

2.5

3.0

% o

f GD

P

Source: Standish as of September 30, 2011.

Page 4: Investing in Emerging Markets:  A Strategic Opportunity

EM Currencies: No More Pegs

The improved balance of payments of EM economies is already conspicuously manifesting itself in the rebounding foreign exchange reserves.

4

Source: Thomson Reuters Datastream, Standish as of July 31, 2011.

Combined Foreign Exchange Reserves of Brazil, Indonesia, Russia, and Turkey

Jan-0

1Ju

l-01

Jan-0

2Ju

l-02

Jan-0

3Ju

l-03

Jan-0

4Ju

l-04

Jan-0

5Ju

l-05

Jan-0

6Ju

l-06

Jan-0

7Ju

l-07

Jan-0

8Ju

l-08

Jan-0

9Ju

l-09

Jan-1

0Ju

l-10

Jan-1

1Ju

l-11

0

200

400

600

800

1000

1200

US

D b

illion

Page 5: Investing in Emerging Markets:  A Strategic Opportunity

5

EM: No Longer Highly Indebted

Source: International Monetary Fund, World Economic Outlook Database as of September 30, 2011

Fiscal prudence has helped to reduce indebtedness, improving sovereign risk.

Debt ratios have improved significantly and emerging markets are no longer subject to the vagaries of external financing.

This is a big contrast with the direction of developed economies’ leverage.

Debt as Percentage of GDP

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20160

20

40

60

80

100

120 Advanced economies - public sector debtEmerging and developing economies - public sector debtEmerging and developing economies - foreign debt

Page 6: Investing in Emerging Markets:  A Strategic Opportunity

Relative Resilience: Growth in EM Continues to Outpace Developed Economies

Emerging markets debt was literally the last “domino” to fall as the global financial crisis intensified in late 2008 due to: Improved creditworthiness of most emerging markets sovereign issuers; Positive growth differentials relative to G-3.

For the same reasons, we believe emerging markets debt should be well supported going forward.

6

Source: International Monetary Fund (IMF) World Economic Outlook (WEO) September 30, 2011. F = Forecast

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

F20

12F

2013

F20

14F

2015

F20

16F

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0 WorldEmerging and Developing EconomiesUnited States

Rea

l GD

P a

nnua

l % c

hang

e

IMF World Economic Outlook

Page 7: Investing in Emerging Markets:  A Strategic Opportunity

Relative Resilience: Growth in EM Continues to Outpace Developed Economies

According to an IMF study, the share in World GDP accounted for by Emerging Markets will exceed that of the Developed World within the next few years.

The superior growth of Emerging Markets and the development of a middle class in these countries has implications for world trade, deployment of savings (for example in pensions) etc. These are also likely to produce a virtuous cycle, as these countries develop more trading links and also invest in each other.

7

Source: International Monetary Fund as at 30 April 2011

Shares of World GDP Shifting

0

10

20

30

40

50

60

70

80

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Advanced economies Emerging and developing economies

Page 8: Investing in Emerging Markets:  A Strategic Opportunity

8

Ratings Quality Continues to Improve

Source: Standard and Poor's as at 30 September 2011

After a return to significantly more upgrades than downgrades in 2010, year to date, upgrades and downgrades from S&P are more balanced this year.

One downgrade reflects the changed methodology of S&P, placing a greater emphasis on political risk and other downgrades are mainly on the back of fiscal deterioration

Of the upgraded countries, two attained investment grade (Colombia and Uruguay), while Indonesia was upgraded to one notch below investment grade.

2007 2008 2009 2010 2011 YTD0

2

4

6

8

10

12

14Up Down

Ratings Upgrades vs. Downgrades

Page 9: Investing in Emerging Markets:  A Strategic Opportunity

9

Ratings Quality Continues to Improve

The trend to upgrade EM countries to investment grade continues.

Index Weights by Rating

Aug-06

Nov-06

Feb-07

May-07

Aug-07

Nov-07

Feb-08

May-08

Aug-08

Nov-08

Feb-09

May-09

Aug-09

Nov-09

Feb-10

May-10

Aug-10

Nov-10

Feb-11

May-11

Aug-11

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%Investment Grade BB B Residual

Source: JP Morgan as at 30 September 2011

Page 10: Investing in Emerging Markets:  A Strategic Opportunity

EM Bond Fund Flows

Flows had been significant until the recent episode of risk aversion, but they have begun to recover.

10

Cumulative Flows into External and Local EM Bond Funds

Source: Emerging Portfolio.com as of November 10, 2011

-2000

0

2000

4000

6000

8000

10000

12000 external local blended

Page 11: Investing in Emerging Markets:  A Strategic Opportunity

EM Bond Fund Flows

Both external debt and local currency debt have benefited, although with higher yields and the possibility of currency appreciation, local currency vehicles have benefited more.

11

Monthly Flows into External and Local EM Bond Funds

Source: Emerging Portfolio.com as of November 30, 2011

Dec-1

0

Jan-1

1

Feb-1

1

Mar-1

1

Apr-1

1

May-1

1

Jun-1

1Ju

l-11

Aug-1

1

Sep-1

1

Oct-11

Nov-1

1-2000

-1500

-1000

-500

0

500

1000

1500

2000

2500

3000

external local$mm

Page 12: Investing in Emerging Markets:  A Strategic Opportunity

New Face of Emerging Markets Debt

● Market capitalization: $811 billion

● Issuers: sovereign

● Average rating: BBB+ (S&P)

● Return drivers: (1) local currencies; (2) local bond yields

● Investor base: predominantly local

12

Market capitalization of emerging markets local-currency-denominated debt has quadrupled in the last five years and now represents approximately two thirds of the total EMD universe.

*UST = US TreasurySource: JP Morgan as of September 30, 2011.

Europe – Ex Russia

Local Bonds (JPMorgan GBI-EM Global Diversified)

Asia29.3%

-26.0%

Russia8.4%

Latin America26.3%

Middle East/Africa10.0%

Page 13: Investing in Emerging Markets:  A Strategic Opportunity

EM Local-Currency Debt: Unique and Potentially Attractive Sources of Returns EM local-currency bonds enjoy two distinct sources of returns 1) currency, or the local cash

yield plus changes in the spot rate, and 2) duration, or the extra return that local bonds earn relative to local cash – a currency hedged bond return.

Assuming a modest appreciation of EM currencies, we believe EM local-currency bonds have the potential to generate double-digit returns on an annual basis.

13

Source: JP Morgan, Standish as of November 30, 2011

GBI-EM Global Diversified: Currency and Duration Returns

Nov-02

May-03

Nov-03

May-04

Nov-04

May-05

Nov-05

May-06

Nov-06

May-07

Nov-07

May-08

Nov-08

May-09

Nov-09

May-10

Nov-10

May-11

Nov-11

100

125

150

175

200

225

250

275

300

325 Total Return Currency Return Duration Return

US

$ R

etur

n In

dex

Page 14: Investing in Emerging Markets:  A Strategic Opportunity

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Mar-09

Sep-09

Mar-10

Sep-10

Mar-11

Sep-11

5

6

7

8

9

10

Yie

ld, %

EM Local-Currency Debt: Unique and Potentially Attractive Sources of Returns We believe the steady positive local duration returns (suggesting that local bonds have

outperformed currency forwards) reflect the positive term premium of local yield curves. Bond managers, however, can use currency forwards to invest in countries where the currency is attractive, but not prospective duration returns. In several EM countries, inflation-linked bonds are also available.

14

Source: JP Morgan as of September 30, 2011

GBI-EM Global Diversified: Yield to Maturity

Page 15: Investing in Emerging Markets:  A Strategic Opportunity

New Face of Emerging Markets Debt

Market capitalization: $436 billion

Issuers: sovereign and quasi-sovereign

Average rating: BB+ (S&P)

Return drivers: (1) spreads over UST*; (2) UST* yields

Investor base: predominantly foreign

15

Emerging markets debt (EMD) consists of two distinct asset classes: local-currency-denominated bonds and dollar-denominated bonds.

The two asset classes are different in their country composition, creditworthiness, return drivers, and investor bases, yet both are fairly liquid.

*UST = US TreasurySource: JP Morgan as of September 30, 2011.

US$-Denominated Bonds (JPMorgan EMBI Global)

Asia17.9%

Europe- Ex Russia20.1%

Russia10.1%

Latin America44.5%

Middle East/Africa7.5%

Page 16: Investing in Emerging Markets:  A Strategic Opportunity

EM US$-Denominated Debt: Risk/Return Profile

We believe that given the improvement in the weighted average credit quality of the asset class to BB+, at current levels sovereign spreads may offer more than adequate compensation for the potential credit losses.

Our research suggests that historically BBs outperform other rating categories over the complete credit cycle.

16

Source: JP Morgan as of November 30, 2011

JPM EMBI Global: Spreads Over US Treasuries

May-02

Nov-02

May-03

Nov-03

May-04

Nov-04

May-05

Nov-05

May-06

Nov-06

May-07

Nov-07

May-08

Nov-08

May-09

Nov-09

May-10

Nov-10

May-11

Nov-11

0

100

200

300

400

500

600

700

800

900

1000

bps

Page 17: Investing in Emerging Markets:  A Strategic Opportunity

Important Information

17

This is a financial promotion and is not intended as investment advice. The information provided within is for use by professional investors and should not be relied upon by retail investors.All information relating to Standish Mellon Asset Management Company LLC (Standish) has been prepared by Standish for presentation by BNY Mellon Asset Management International Limited (BNYMAMI). Any views and opinions contained in this document are those of Standish at the time of going to print and are not intended to be construed as investment advice. BNYMAMI and its affiliates are not responsible for any subsequent investment advice given based on the information supplied.This document may not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorised.

This document should not be published in hard copy, electronic form, via the web or in any other medium accessible to the public, unless authorised by BNYMAMI to do so. No warranty is given as to the accuracy or completeness of this information and no liability is accepted for errors or omissions in such information. To help us continually improve our service and in the interest of security, we may monitor and/or record your telephone calls with us.This document is issued in the UK, mainland Europe (excluding Germany) by BNY Mellon Asset Management International Limited. BNY Mellon Asset Management International Limited, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Services Authority.

In Germany, this document is issued by WestLB Mellon Asset Management Kapitalanlagegesellschaft mbH, which is regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht. WestLB Mellon Asset Management was formed as a 50:50 joint venture between The Bank of New York Mellon Corporation and WestLB AG. If WestLB Mellon Asset Management Kapitalanlagegesellschaft (WMAM KAG) receives any rebates on the management fee of investment funds or other assets, WMAM KAG undertakes to fully remit such payment to the investor, or the Fund, as the case may be. If WMAM KAG performs services for an investment product of a third party, WMAM KAG will be compensated by the relevant company. Typical services are investment management or sales activities for funds established by a different investment management company. Normally, such compensation is calculated as a percentage of the management fee of the respective fund, calculated on the basis of such product’s fund volume managed or distributed by WMAM KAG. The amount of the management fee is published in the prospectus of the respective fund. Any compensation paid to the WMAM KAG does not increase the management fee of the relevant fund. A direct charge to the investor is prohibited. The information given herein constitutes information within the meaning of § 31 sub-section 2 WpHG (German Securities Trading Act). In Dubai, United Arab Emirates, this document is issued by the Dubai branch of The Bank of New York Mellon, which is regulated by the Dubai Financial Services Authority.If this document is used or distributed in Hong Kong, it is issued by BNY Mellon Asset Management Hong Kong Limited, whose business address is Level 14, Three Pacific Place, 1 Queen's Road East, Hong Kong. BNY Mellon Asset Management Hong Kong Limited is regulated by the Hong Kong Securities and Futures Commission and its registered office is at 6th floor, Alexandra House, 18 Chater Road, Central, Hong Kong.

In Singapore, this document is issued by The Bank of New York Mellon, Singapore Branch for presentation to professional investors.  The Bank of New York Mellon, Singapore Branch, One Temasek Avenue, #02-01 Millenia Tower, Singapore 039192. Regulated by the Monetary Authority of Singapore.If this document is used or distributed to intermediaries in the United States of America, it is issued by Dreyfus Investments, a division of MBSC Securities Corporation, located at 200 Park Avenue, New York NY 10166, USA. MBSC Securities Corporation is a member of FINRA. The products outlined are not available to US Persons.

BNY Mellon Asset Management International Limited, BNY Mellon Global Management Limited (BNY MGM), Standish and any other BNY Mellon entity mentioned are all ultimately owned by The Bank of New York Mellon Corporation.

CP7588-03-11-2011 (3M)

Page 18: Investing in Emerging Markets:  A Strategic Opportunity