INVESTMENT OUTLOOK 2014 World Views from the Ground: Dislocations & Opportunities

VIEWPOINT David Jiang, Chief Executive Officer

ECONOMIC OUTLOOK – POLITICS IS ALWAYS LOCAL Markus Schomer, Chief Economist

ASSET ALLOCATION – SUSTAINABLE EXPANSIONS LEAD TO SUSTAINABLE MARKETS Michael Kelly, Managing Director, Global Head of Asset Allocation

GLOBAL CREDIT AND FIXED INCOME OUTLOOK – HAVE WE REACHED  THE INFLECTION POINT IN THE FIXED INCOME JOURNEY? Steven Oh, Managing Director, Head of Global Credit and Fixed Income, Co-Head of Leveraged Finance

EQUITY OUTLOOK – OVERALL STRENGTH, POCKETS OF OPPORTUNITY Robin Thorn, Managing Director, Global Head of Equities

PRIVATE MARKETS – AN INTERESTING AGE CREATES DISLOCATION Talal Al Zain, Chief Executive Officer, PineBridge Investments Middle East, Co-Head of Alternative Investments

Harjit Singh Bhatia, Managing Partner and Chief Executive Officer, PineBridge Asia Partners

FT Chong, Managing Partner, PineBridge Structured Capital

Pierre Mellinger, Managing Director, President and Chief Executive Officer, Capital Management,

Head of Central and Eastern Europe

Steve Costabile, Managing Director, Global Head of Private Funds Group

BIOGRAPHIES

DISCLOSURE

CONTENTS

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INVESTMENT OUTLOOK 2014World Views from the Ground:  Dislocations & Opportunities

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PineBridge is a global asset manager with over 60 years of experience in emerging and developed markets, delivering innovative alpha-oriented strategies across asset allocation, equities, fixed income and alternatives.

What differentiates PineBridge is the integration of on-the-ground knowledge with analytical insights, bridging global and local capabilities to deliver innovative products and solutions that create value for clients.

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With the global economy appearing to be at an inflection point, I believe it is more important than ever to be clear and, in many cases brave, in communicating our thoughts on policy, economies and markets. Our investment partners around the world would expect nothing less. The PineBridge Investment Outlook 2014: World Views from the Ground: Dislocations & Opportunities contains the bold views of our foremost experts on the global economy – including equities, credit and fixed income and private markets. We briefly review developments in the past year, and we throw our thinking forward, taking into account factors such as potential policy developments, investor sentiment and risks.

It is clear that six years since the global economic crisis erupted – and following a rebound in global equities and then a huge policy-driven rally in global credit markets –  the world is still coming to grips with a new economic reality. You will see the word “rebalancing” several times in this piece: China is in the midst of it, with domestic demand finally coming through to help GDP growth find a bottom; Eurozone fiscal positions are slowly improving, which  could allow austerity to be eased; and the United States  may finally get the investment-led growth rebound it has been waiting for. 

And therein lies the greatest source of uncertainty – policymaking. Our firm view is that politics is always local.  Markets will almost certainly turn on the words and  actions of central bankers and policymakers in 2014. Predictions are always difficult, but such scenarios make them even harder. However, this should prove worthy of  a truly global multi-asset class investment manager. Since PineBridge became independent, we have transformed the firm to compete in the changing investment landscape and strengthened our capabilities as a next-generation investment manager. With our geographic footprint, we are focused on generating alpha where we see opportunities for growth and utilizing our global presence and on-the- ground teams to deliver customized solutions to our clients.  I very much hope that you will find the PineBridge Investment Outlook 2014 interesting, and that this will be just one of many contacts that we have over the next year. Wishing you success and prosperity in 2014. Sincerely yours, 

 David JiangChief Executive Officer, PineBridge Investments

VIEWPOINT

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ECONOMIC OUTLOOK Politics is Always Local

Extricating ourselves from the post-2008 economic policy mix seems harder than imagined. That is both the lesson of 2013 and our key insight for 2014. Just as politics weighed on the pace of economic growth in the last 12 months, so it will limit the extent of the increasingly sustainable global recovery in 2014. So understanding local politics will give insight into local economics.

In the US, the Federal Reserve tried and failed to taper its massive asset purchase program; in China, the government tried and failed to reduce the economy’s dependence on exports; in many emerging economies, governments failed to recognize the danger of speculative capital inflows financing growing current account deficits. Policy makers’ responses proved ineffectual. US politicians turned the US fiscal crisis into a game of brinkmanship and eurozone politicians failed to reverse the contraction in bank lending. Meanwhile, politicians in developing economies struggled to maintain the pace of reform and correct policy imbalances, triggering a sharp summer sell-off.

As a global asset manager with on-the-ground investment professionals across the globe, we have viewed these political shortcomings with keen interest in the past year, just as they will inform our actions in 2014. 

Most notably, US politicians have been particularly ineffectual in 2013. Given the importance of the US to the global economy, the Republicans and Democrats are playing a game of high stakes over the funding of the US government budget that concerns us. Three times the US Congress has taken the world’s largest economy to the brink of default – threatening to unleash a 2008-style market meltdown, which could spread rapidly through a global financial system that relies on US Treasuries for collateral. 

So the US has a key challenge for 2014 – to unleash this pent-up demand in the business sector. Political uncertainty has stalled that process, but we still expect investment spending to accelerate by the middle of 2014. Congress looks set to flirt with chance once more, after doing little more than kick the can down the road during its fiscal battle in October. It  is not hard to see why businesses are unwilling to invest and hire. We anticipate that US GDP growth will step up to 2.6%  in 2014, from a more moderate 1.7% pace in 2013, allowing the Federal Reserve to begin the high-wire act of normalizing monetary policy without hurting financial markets.   

Turning to Europe and Japan, the key challenge for politicians in these economies remains in rebalancing economic policy. In 2013, the eurozone suffered from tight fiscal policy and insufficient monetary easing. In 2014, we believe austerity will likely ease, as most budgets are on an improving trend and monetary policy is likely to become more accommodative. But the main roadblock to faster growth is the ongoing contraction in bank loans. European 

Central Bank (ECB) rate cuts may not be enough to unclog the lending channel. Rather, banks must raise more capital in the next 12 months, which suggests a faster recovery is not likely until 2015. We believe that European GDP growth is likely to maintain the 1.2% average recorded since the recession ended last spring. 

Japan’s economy rebounded strongly in 2013, lifted by a dramatic increase in monetary policy stimulus and the expansion of fiscal spending, under the banner of “Abenomics”. The real challenge for Prime Minister Abe’s government is the consumption tax hike planned for early 2014, which constitutes the first step towards reducing the country’s massive fiscal imbalance. We believe growth is likely to be cut in half in 2014 and Japan’s growth prospects in the coming years will depend more on the Federal Reserve than the Bank of Japan (BOJ). We expect the eventual tightening of US monetary policy will trigger another round  of export-boosting yen weakness.

The other Asian economies face their own rebalancing challenge. China is furthest ahead, after successfully engineering a soft landing in 2013, stabilizing GDP growth at 7.5%. We do not believe growth will slow further from here. On the contrary, a pickup in global growth should boost Chinese exports, which stalled in the second half of 2013. Looking ahead, the government is likely to use periods of stronger growth in the coming years to pare back total social financing, the key driver of credit growth in the country,  pro-cyclically deleveraging the economy. 

Despite continued disinflation, central banks have been on the sidelines, while fiscal policy has been mildly stimulating, cushioning the export sector’s ongoing weakness. Growth  in 2014, projected at 2.9% for these countries, will improve only modestly from the prior year’s performance.

As we move into 2014, the drivers for stronger business activity, which we envisioned would already be boosting US GDP, remain in place. Rising capacity utilization suggests that slowing productivity gains are increasing the need for businesses to invest.

Many of the developed Asian economies, such as Singapore, and more-developed emerging economies, like Taiwan and South Korea, will also benefit as stronger global growth boosts recovery speeds.

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India and Indonesia face tougher challenges in 2014, largely the result of politicians’ missed opportunities in the previous year. Both countries have run relatively wide current account deficits. In India, persistent, large fiscal shortfalls have driven the deficit. Further complicating the necessary policy response, both countries face elections in 2014, which will slow the process of fiscal and monetary contraction. So, both are likely to lag in 2014’s global recovery phase. We expect the politicians’ failures will continue to slow growth in 2014, against broader improving global trend.

Economies in the Middle East and North Africa (MENA) face  a different set of policy challenges in 2014. While economies such as Egypt are struggling to stabilize their political systems, others, such as the Gulf Cooperation Council economies, must accelerate the process of reducing their dependence on oil exports through continued diversification and moving towards promotion of services and manufacturing. We expect economic growth across the region will increase moderately during the year, helped in part by higher oil production and concur with the IMF’s forecast of 3.8%  real GDP growth for 2014 (up from 2.1% in 2013).1 

In Turkey, on the fringes of the MENA region, we believe growth will moderate slightly in 2014 to 3.5% (from 3.8% in 2013), again in line with IMF forecasts, as the politicians work to address the wide current account deficit. Financial tightening due to the country’s deficit is slowing growth, but currency depreciation and government investment are serving to offset this. In the medium term, we expect politicians will take action to address the deficit, allowing this expanding nation of 75 million people, with an average age of 28, to achieve its potential for consumption-led economic growth.

Elections and the World Cup dominate Brazil’s 2014 outlook. The elections are likely to slow the necessary policy 

adjustment process. Brazil’s widening current account deficit has been the result of an overheating economy, which can be addressed with orthodox policy tightening. Banco Central do Brasil’s decisive interest rate hikes have slowed growth and should shrink its external imbalances. But, as one might expect, the upcoming October elections are pushing Brazil’s budget deeper into deficit again. After the poll, however, fiscal policy is likely to tighten again and reverse the pre-election boom. As a result, Brazil’s economy is likely to remain more volatile than its neighbors. Even so, growth is likely to pick  up substantially in 2014 from the prior year’s pace. 

Mexico’s prospects are more closely tied to the US.  We believe a pickup in GDP growth north of the border will likely boost growth in Mexico’s industrial sector. We also expect accommodative monetary policy should add to next year’s rebound in business spending. The country’s main challenge is President Pena Nieto’s ambitious reform agenda, which he promises will increase the country’s  long-term growth prospects. While it may not bear fruit  in the near term, successful implementation will positively impact investor sentiment.

Yet, delayed decisions to correct US fiscal imbalances, to end overly restrictive policy in Europe and to rebalance deficits in developing economies, will weigh on the pace of recovery. Nevertheless, we expect global GDP growth to accelerate from its moderate 2.6% pace in 2013, to 3.2% in 2014. Developed world economies will enjoy the stronger relative improvement, although growth will not be strong enough to close the still sizable output gap. Many developing world economies, meanwhile, are operating closer to, and in some cases already above, their potential capacity. That suggests the growth pickup in Asia, Latin America and Eastern Europe will have a stronger impact on consumption and business spending and, therefore, corporate profits     

So rather than returning to relative economic simplicity, 

2014 will be another year when politics dominates economic fundamentals. The foundations of a strong and sustained global recovery are in place.

In the longer term, a growing young population, increasing consumption and rising budget expenditure should overcome policy challenges in many of these countries, creating promising conditions for investment.

1: IMF World Economic Outlook October 2013: Transitions and Tensions.

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ASSET ALLOCATION Sustainable Expansions Lead to Sustainable Markets

Out with the old and in with the new. While the policy hangover from 2008 remains, the headwinds of the financial crisis are beginning to fade.

While growth may or may not accelerate, market participants should increasingly recognize that the slow pace of growth is sustainable and exceeds the speed at which economies stall. We’re getting familiar with a 2% pace, fiscal drags are dissipating and the US has achieved significant fiscal de-leveraging despite modest growth.

In the year ahead, few identifiable risks will compete with 2013’s US fiscal cliff (although this funding battle is not completely resolved), Europe’s lingering recession or fears of a hard landing in China. But this promise of better economic times is not universally uplifting – often it’s better to travel than to arrive. As confidence in a sustainable outlook rises, so the Federal Reserve will become less accommodative. Quantitative Easing (QE) will stop, to be replaced by extended forward guidance. We are not big believers that words alone (extending forward guidance on when zero interest rate policy will end) will prove very effective – yet it should, at least, drive home the message that the end of QE will not coincide with the beginning of policy rate hikes.

After five years of worrying about relapse risks, we believe 2014 will be the year when markets begin to worry less about these risks and focus more on where the opportunities lie.

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some say that when the fed’s Qe ends, so too will the rallies in risk assets. we are not in that camp. the rally in stocks since 2009 has not meaningfully outdistanced the expansion in earnings. while most risk asset prices will initially stall as Qe comes to an end, the fed will most likely time this withdrawal of financial liquidity to coincide with stronger economic fundamentals, which should reboot earnings growth. Higher earnings should, eventually, overcome slower liquidity growth. After all, if there is any doubt about the sustainability of the expansion, the federal reserve will surely err on the side of caution to secure a positive result. furthermore, at a global level, just as the federal reserve withdraws financial liquidity, the bank of Japan (boJ) looks set to partially offset this by accelerating its own Qe program.

while having favored liquid risk assets by serving as a bridge to better times, Qe had a much more pronounced effect on treasury rates by suppressing the rates curve. but by amplifying the tail end of the 30-year bull market in us treasuries, Qe helped to over-extend its lifespan. Markets like us treasuries and Japanese government bonds (Jgb) are huge. despite some back-up in rates in 2013, we believe these large markets remain overpriced relative to most growth assets. As a result, the appearance of sustainable economic growth threatens the “relapse risk premium” that still exists in these risk-free rates. the boJ is more likely to succeed in suppressing the rates backup for another year than the fed, since the boJ will continue its Qe program, whereas the fed will rely on words alone. in the context of rallying stock markets, us treasury rates began a stair step pattern higher in 2013. this will most likely continue in 2014 at the longer end of the yield curve, despite continued policy attempts to keep nominal interest rates below inflation (financial repression).

in the last innings of the search for yield, steady income producing core real estate outperformed more opportunistic real estate. core infrastructure outperformed more opportunistic infrastructure. High dividend paying stocks outperformed growth stocks. these income producing sub-asset classes were “couponized” and began tracking bonds quite closely. like the rates curves, these couponized sub-asset classes improved through May and then began to deteriorate thereafter. we see that deterioration continuing in 2014. As such, we believe it is time to focus more on growth and less on current income.

when the us large cap stock market bubble burst in 2000, despite rapidly falling prices in this large segment of the capital markets, rotation out of us large cap stocks propelled many other asset classes higher (us small cap stocks, real estate, commodities, emerging market stocks, etc.). As confidence grows that the fed will end monetary accommodation only once sustainable growth is firmly established, thereby facilitating rising prices for risk assets, declining prices in risk free rates should lead to a flight from safety, which helps to propel growth assets higher. this passing of the baton should offset much of the impact on growth assets from the wind down of Qe.

in witnessing the evolution of our Capital Market Line research, we have been describing this cycle as “moving out”. overnight us dollar based liquidity has gradually shifted out on the risk curve in the years since the crisis. similarly, credit spreads have improved from 2009 to 2012, listed equity risk premiums have from 2009 to 2013 and, now, 2014 and beyond looks poised to deliver improvements in illiquid assets. risk premiums for private equity, private credit and timber remain very attractive. while improvement in fundamentals can still lead toward modest increases in listed equity, without Qe, stock market appreciation is likely to be much less robust than in 2013. rotation away from bonds should partially offset the impact on stocks from the end of Qe. earnings gains could then drive a modest appreciation in stock prices. commodities still face an extended period of slowing infrastructure growth in emerging markets, colliding with accelerating supply growth for many industrial commodities. with slower appreciation ahead for most liquid risk assets, the opportunity cost will not be as great for those considering the initial J-curve effects of illiquid investments. As a result, we believe 2014 will be a good time to utilize one’s illiquidity budget.

While our colleagues will each highlight opportunities in their asset classes in the following pages, the asset allocation team’s  picks for 2014 are:

• MEXICAN PRIVATE ASSETS: A furious policy spell is paving the way toward favorable asset class performances across the board in 2014 and beyond. While Mexico’s listed markets have anticipated many of these benefits in the past 18 months, private markets have not. While still favoring Mexican listed equity as a relative out-performer, opportunities in private credit, equity and infrastructure look very attractive.

• JAPAN EQUITY: Only in Japan can a consensus be reached to redistribute part of the earnings gains from currency depreciation into higher wages. Implementation of wage increases (after a long period where they stagnated) should largely offset the impact  of consumption tax rises in the spring of 2014. At a time when the Bank of Japan plans to extend, if not accelerate, QE throughout 2014, Abenomics is still a glass three quarters full. This positive backdrop should drive a continuing rally in the Topix.

• EUROPEAN CREDIT: With recession bottoming out, European banks still disintermediating themselves and the European Central Bank needing to respond  to very low inflation, the outlook should continue to improve for European credit.  Given today’s elevated euro, such positions should be hedged  

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GLOBAL CREDIT AND FIXED INCOME OUTLOOK Have we Reached the Inflection Point in the Fixed Income Journey?

We can, metaphorically, look across the fixed income markets as a long-term sojourn across a craggy mountain range that involves extended periods of climbs and descents. The path is not always smooth and is punctuated by a series of smaller hills. Over the past 30 years, we have enjoyed walking downhill on a path of descending interest rates, though we have often encountered obstacles along the way. However, the secular bull market is coming to an end, as we find ourselves at the bottom of the mountains, and the next phase of our journey will certainly require a more arduous climb upward.

We arrived at this current inflection point in spring 2013 and, just as we commenced our climb, we found ourselves in an interim rest camp, Camp Quantitative Easing (QE), which was generously funded by the largess of central bankers and US politicians. Camp QE allowed us to postpone the upcoming climb (in interest rates) and perhaps map out a less steep route in the process. However, we must be prepared to leave camp at a moment’s notice in 2014, as our benefactors could pull their support. Even if we stay in Camp QE for the entire year, we will most certainly not be welcome to remain in this peaceful sanctuary in 2015. In fact, we fully expect to meet the dogs of short-term rates in 2015, so we will need to get a head start to protect our portfolios.

One of the key philosophical questions on a long journey  is whether it is the pathway and experiences along the way that make a journey successful or the final destination, and can the two be separated. The investment corollary relates to time horizons in measuring our approach and performance. As we reflect on 2013 through the end of November (the time of writing), the market appears to have arrived at a point that we would have largely predicted at the beginning of the year. Intermediate interest rates have risen by roughly 75 basis points (bps), up from unsustainably low levels, and credits spreads have compressed slightly. While our expectations were along these lines, as noted in our 2013 outlook, the market has, historically, rarely produced stable coupon level returns,  and only the ongoing Federal Reserve intervention has allowed this more benign environment to persist. In addition, while the destination may be close to what we predicted at the onset, the path itself has been treacherous and full of short-term volatility. 

In May, the Fed surprised investors by guiding that it might withdraw monetary stimulus later in the year, resulting in a temporary sell off of both risk-free and risk assets. Then, when market expectations fully discounted a September taper, the Fed surprised investors again when it continued the current level of purchases. This highlighted the Fed’s anxiety about the inability of US politicians to properly address fiscal issues. This concern is likely to remain as the outlook for a comprehensive agreement is dim. The fact that 2014 will include mid-term elections should not be overlooked, as they will set the stage for possible change in this political dynamic. Markets are likely to continue to be focused on the politics of debt and the budget as 2014 begins. The ultimate impact these events have on the US economy will go a long way in determining market performance as the new year unfolds. On the surface, 2014 is shaping up to be similar to 2013. There is slight upward pressure on the intermediate part of the yield curve and anchored short-term rates, but political and global growth headwinds are dampening overall upward pressure. While most credit spreads appear to be close to fair value, there is room for additional compression if we steer toward a more bullish part of the credit market cycle.  

No matter what the outcome, we do not anticipate our uphill climb to be as steep as the downward path we have experienced. So, for the foreseeable future, we will be in a “relatively” lower rate and lower inflation environment, compared with the 10 years preceding the financial crisis. The uphill pathway will be lined with political discourse, slow global growth, low inflation and poor quality of employment. While directionally the normalization of rates will produce an increase in base rates, the shape of change will be more gradual steps on an upward path.

FIGURE 1: 10 YEAR TREASURY BOND YIELD HISTORY

15.00 %

11.25

7.50

3.75

02013200920041994 199919891984

Source: Bloomberg. Data as of 12 November 2013

However, in 2015 and beyond a secular shift lies before us. The yield curve will flatten due to normalization of short-term rates, in addition to the full impact of the withdrawal of QE that has supported intermediate rates. While we do not expect this shift to take place until 2015, the market moves in anticipation of future events, so the looming question is when and how does one position portfolios in 2014 for the events of 2015 and beyond.

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So, what tools should we pack for the uphill climb?  As a manager that invests across fixed income, we tend  to look across the spectrum when analyzing dislocations  and opportunities. 

whether it is via investment grade corporates, bank loans and high yield bonds, or EM corporate and EM sovereign debt. However, as the yield curve steepens, institutions with longer-term liabilities may find it increasingly appealing to match assets more closely to these liabilities. While the credit markets are becoming more accommodating, we are still in the relative early stages of a bullish market, so credit spreads have additional room to compress to offset the negative impact of rising rates. But the risks are not asymmetric and a steeper uphill climb than expected in rates would be more painful than the benefits of a flat terrain.  So preparing for an arduous path in 2014 would prudent.

TREASURY MARKET AWAITS TAPERINGThe US Treasury market forms the base of much of the fixed income market and, as such, is its “stake in the ground.” Treasury market volatility, which reigned supreme in 2013, should be no different in 2014. Given that the US economy is only now approaching “escape velocity,” inflation remains stubbornly low and fiscal policy remains in paralysis, the Fed has obviously concluded it is premature to reign in its asset purchase program. The recent deceleration in the personal consumption expenditures (PCE) deflator as shown in Figure 2, is very worrisome for the Fed and its future trajectory, in our view, will provide the most important clue about when tapering will commence. We think that tapering is unlikely unless we see the PCE deflator, which currently stands at 1.2%, rise above 1.5%. Our view is that, at some point in 2014, the Fed will take its first step toward reducing its asset purchase program, but we expect no rate hike until at least the second half of 2015. 

We believe the Treasury market has largely priced in tapering, thanks to over-deterministic Fed communication. 2013’s rise in the 10-year Treasury bond yield was roughly equivalent to what the Fed’s own research showed the impact of quantitative easing to be on this part of the yield curve. We expect the future trajectory of US long-term interest rates to resemble a staircase, with a period of discrete jumps – like we saw in May to August 2013 – followed by long periods of consolidation, similar to what we are currently experiencing. As we enter 2014, the Treasury market could remain in a consolidation phase unless one of two things happens: 1) PCE inflation rises to 2% or higher or 2) meaningful progress is made on the fiscal policy front, which will set the stage for better growth. In the meantime, we expect the 10-year Treasury bond yield to remain in a 2.75% to 3.25% range, which we believe is fair value, based on the current 1.8% to 2.0% US trend growth and 1.1% to 1.3% PCE inflation.

While tapering monthly asset purchases should only have  a modest impact on the level of longer-term yields (25bps  to 40 bps) given the already steep curve, the impact on the yield curve’s front-end could be significant. Investors would view any reduction in asset purchases as the beginning of  a rate tightening cycle, thus leading to pressure on the  front-end and a bearish flattening of the Treasury curve. 

FIGURE 2: FED FAVORITE INFLATION MEASURE HAS DECELERATED NOTICEABLY OVER THE PAST TWO YEARS

Source: Bloomberg. Data as of September 2013

-1.25

1.25

3.75

-2.50

0

2.50

5.00

2004 2005 2006 2007 20102008 20112009 2012 2013

%

Generally, we believe that continuing to shift exposure toward credit spread rather than duration is the prudent approach toward managing risk and return

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Another potential source of volatility for the Treasury market in 2014 could be waning foreign demand for US Treasuries. Foreigners sold US Treasury bonds on a net basis in 2013 and, notably, participated in auctions reluctantly. Another government shutdown and/or debt ceiling showdown could really hurt the safe haven status of US Treasuries and further dampen foreign demand.

INVESTMENT GRADE’S GOOD FUNDAMENTALSAs 2014 begins, further battle in Congress over the US budget is likely to make credit markets volatile; although the Fed’s ongoing monetary actions should continue to support them. It remains to be seen if Democrats and Republicans will strike a deal that gives the Fed sufficient confidence to begin tapering its monthly asset purchases. As whatever deal reached likely will not expire until after the mid-term elections in November, the stage should be set for a range bound market. In this eventuality, markets will continue to be overtly attuned to economic releases and  a possible reduction in Fed accommodation.  

Credit market behavior has been relatively range bound  in 2013, as the option-adjusted spread (OAS) of the Barclays Credit Index maintained a range of approximately 30 bps, despite the rise in interest rates. We expect more of the same in 2014, as investors balance the scope and pace of Fed accommodation with overall economic conditions. 

Credit market supply for 2013 hit records, given the strong liquidity conditions. September was the largest month for investment grade credit supply ever recorded. Looking ahead to 2014, we expect market conditions to maintain the same access to issuers and generate similar numbers. 

Nevertheless, warning signals come with this abundant supply, as issuers use much of the proceeds to finance more shareholder friendly activities. Thus, these conditions call for greater questioning of issuers’ corporate management, leverage and overall event risk. 

At the sector level, we continue to believe in an overweight in Financials. While the sector has already outperformed, we think this outperformance will continue. Included in our outlook for 2013 was a similar recommendation when the OAS of the Financial sector was 27 bps cheap to the overall Barclays Credit Index. The Financial sector now stands in line with the overall index in spread terms, but we still think it will move to trade tighter against Treasuries than the  index as a whole. Specifically, much of this move is likely  to occur as the spread between senior and subordinated  debt continues to compress.  

Our outlook incorporates ongoing fiscal concerns and their continued impact on the economy, as well as the duration and size of monetary support. For 2014 and beyond, these are the key factors that will influence markets. Enduring Federal Reserve support is likely to temper market disruption. Nevertheless, the failure to address the serious fiscal issues facing the US and other developed world economies means that debt levels will continue to grow and exert downward pressure on economic growth and interest rates.

GROWTH IN EMERGING MARKETS DEBT TO CONTINUEIt is a sad state of affairs when an emerging markets (EM) investment team’s biggest concern for the year ahead lies outside of its own jurisdiction, yet there is no easy way to predict how EM will fare. Herd mentality, rather than economic fundamentals, increasingly drives markets and in 2014 the herd will follow the lead of sentiment regarding the likelihood of the US Fed reducing its monthly bond purchases. Ironically, we would probably have been more optimistic about EM if the Fed had started to reduce these purchases in September, as markets had already discounted the first wave of tapering, if not more. 

In 2014, investment grade bonds are likely to continue to benefit from a relatively good fundamental outlook, reasonable valuations and a strong technical environment supported by abundant liquidity.

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Effectively, the combination of weaker exchange rates and higher yields created value and squeezed the short positions. Refreshingly, market forces were working as they should, allowing currencies to find a new equilibrium. This event was a great showcase for the vast improvements in the institutional frameworks of many emerging economies over the last decade. Flexible exchange rates acted as an absorber of the initial shock and the independence of central banks allowed them to react faster to changing circumstances. Without that, these adjustments would have become entrenched in the economy and eventually caused weaker economic growth.

The whole premise of an economic crisis in EM seems, in  our opinion, a little farfetched. Above all, the starting point for most emerging economies is much different than it was 10 to 15 years ago, when EM crises were the norm. 

as shown in Figure 3. Admittedly we shared the markets’ concerns about the sharp weakening of China’s economy in the first half of 2013, and this will continue to be a feature of much debate in years to come, but once again the Chinese leadership has showed willingness to avoid a crash landing in the world’s second largest economy. Further, there is growing confidence that the new leadership will act more decisively to make structural reforms than the previous regime. More than anything, EM needs stable economic growth in China as the economy rebalances from investment-led to consumption-driven expansion, and the new leadership appears willing to deliver 7% growth over  the next 12 months.

So, how should we position ourselves in EM given the uncertainties? A scenario of low interest rates for longer from a prolonged period of accommodative US monetary policy should be sweet music to the ears of EM investors. Obviously, one should expect some volatility, but we are comfortable with the investment outlook for EM, following last summer’s rigorous test of investor positions and believe remaining investors will stay invested. A decline in market volatility might even encourage some investors to reengage in EM local currency debt as the August 2013 sell-off left some issues trading at attractive levels. 

For the first time in many years we had to defend EM as an attractive investment choice during the summer, as fears rose of massive outflows. The uncertainty culminated in August – when market liquidity was at its thinnest – and led to a sharp devaluation in a range of EM currencies. Policymakers reacted in an exemplary fashion, in the sense that they allowed the initial currency adjustment to take place according to the slightly weaker fundamentals (weaker growth outlook combined with large current account deficits in a few countries). However, as exchange rates began to overshoot and currencies risked moving the economies to inferior market equilibriums, central banks stepped into the market by gradually raising interest rates – thereby offering higher yields to medium-term investors in domestic debt, while punishing speculators shorting the currencies. 

The EM of today has much lower public debt levels and is not only in a much better fiscal position but also outshines most advanced economies,

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In the sovereign arena, financial markets will have to focus on sustainable growth and country selection will be as important as ever. Historically, EM spreads widen during periods of unexpected US interest rate hikes, which is a scenario we do not think likely in 2014. With this in mind, we are positive about emerging markets and believe EM local currency debt will regain investor popularity, following some years in the shadow of spread products.

As for EM corporate bonds, investors endured a volatile 2013, but, despite the slightly negative returns, they are still on track to surpass 2012’s record US $330 billion in primary issuance. 2012’s issuance occurred against a backdrop of double digit returns (21.1% in high yield and 13.2% in investment grade) so, despite anemic returns versus other risk asset classes in 2013, there is still clearly strong demand for EM corporate bonds. Given that only around US $80 billion of bonds needed refinancing in 2012, over US $200 billion of new money/allocations has flowed into the asset class, despite the headline grabbing outflows in the summer.

But this is an outlook for 2014, so why focus on 2013 events? The simple reason is that we expect 2014 to be very similar to 2013, with technical factors largely dictating overall returns. 

FIGURE 3:  PUBLIC SECTOR DEBT – GDP IN EMERGING AND DEVELOPED MARKETS

120 US

EUROZONE

LATAM

CEE+TR

DEV. ASIA

%

100

80

60

20

40

02000 2002 2004 2006 2008 2010 2012 2014 F 2016 F 2018 F

Source: IMF WEO, Commerzbank Research. Data as of 30 August 2013

The retail outflows and sudden questioning of the growth trajectory in the broader EM asset class triggered the sharp downward price moves in EM corporates in May/June (down 7% in four weeks from 22 May). Corporate fundamentals deteriorated slightly between the end of 2012 and the second quarter of 2013, but nothing like the quantum the market priced in during this period. We are now seeing a recovery in risk profiles from the second quarter trough. The correction in the summer has actually placed the asset class in a better position for the inevitable QE taper, whenever that comes,  as many marginal, non-dedicated EM investors exited during this volatility.

So, with fundamentals expected to be relatively stable and valuations still compelling on a relative value basis versus developed market peers, we expect another year of robust demand for the asset class. Consequently, the level of corporate issuance will be the key driver of spread performance, rather than fundamentals or default levels. If there is insufficient supply from new issues to meet the expected demand, we will see the currently dysfunctional secondary market getting squeezed and spreads compressing accordingly. Volatility will be omnipresent given the uncertain global macro backdrop, QE withdrawal etc., but this is now firmly a mainstream fixed income asset class with a large component of institutional investors. We believe it will continue to grow in size and importance.

GLOBAL LEVERAGED FINANCE TO OUTPERFORMIn 2013, US and European leveraged finance assets proved among the best performers within global fixed income. Last year’s call for a coupon total return year was interesting, since we have rarely seen one before. 2013 should meet our expectations, though it did not involve steady prices and coupon clipping. The path was rugged due to rumors of tapering at Camp QE. With yields in the asset class remaining range bound and spreads grinding tighter in the latter half of the year, 2014 is shaping up to be another benign year from a credit quality and default perspective. We expect returns in 2014 to be positive, but unlikely to exceed 2013. However, both high yield bonds and loans will likely remain favored asset classes and outperformers in fixed income. 

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Demand has been strong over the past three years, leading to record levels of issuance for both high yield bonds and leveraged loans. Issuers have taken advantage of the demand to term out their capital structures at historically low interest rates. With only 13.2% of the entire leveraged finance universe (bonds and loans) maturing through 2016, we have difficulty imagining a materially higher default environment unless there is a severe macro shock. So  the fundamental outlook is benign in the near term.

That said, the level of exuberance in leveraged finance is raising concern among some market observers. With record volumes of new issuance in both the high yield and loan markets, coupled with a declining trend in underwriting standards, another potential default cycle could be brewing. However, if one examines the facts more closely, most market issuance has been refinancing of existing issuers rather than introduction of new, unproven companies that typically represent the bulk of defaults. With the exception of lingering pre-financial crisis leveraged buyouts such as TXU Energy, there are limited debt maturities over the next two years so default rates should remain benign. Corporate liquidity positions remain in excellent status and lower overall debt servicing costs are enhancing cash generation. Barring an exogenous shock, such as a major military conflict, the credit markets should remain relatively benign in 2014. However, if this receptive environment continues unabated for an extended period of time and the market cycle tilts further into a  bull market, we will eventually set the stage for a more painful fall.  

Many of last year’s macro event risk scenarios have turned out better than expected. That leaves investors to focus  on US economic statistics and their impact on the Federal Reserve’s QE program. Europe continues to muddle through, but there are signs of green shoots and strong European credit performance reflects a shift away from crisis concerns. Moderately higher interest rates seem more a question of when rather than if. So long as that remains the backdrop, leveraged finance should remain  a relative, if unspectacular, leader in fixed income. On a relative risk-adjusted return basis, we prefer loans over high yield bonds. But on an absolute basis, bonds could  still outperform in 2014 if the benefit of the higher coupon continues to be accommodated for a longer period by Fed 

policies. And as Europe starts its path toward a potential recovery, the European credit markets are likely to  continue to outperform the US. 

SUMMARYWe view 2014 as an extremely important year for fixed income portfolio positioning as the US is likely to withdraw its monetary stimulus and set the stage for an eventual rise in short-term interest rates, probably in 2015. Some of this transition’s negative impact occurred in 2013 when rates made their initial stair step up. As a result, 2014’s next step should be a less painful shift, representing gradual rather than dramatic change. As we chart our long-term route up the mountain, the preferred path for 2014 is lined with more credit-oriented exposure in the form of investment grade corporate credit, high yield and bank loans, as well as emerging market corporates and local currency. But watch your footing and be prepared to make adjustments as the road will not be smooth  

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EQUITY OUTLOOK  Overall Strength,  Pockets of Opportunity

In last year’s issue of our Investment Outlook, we put forward our overall positive view on equities and explained why we thought that the elusive “alpha” would be found, as active investing, once again, would pay off. We also urged investors not to generalize by treating global emerging markets (GEM) as one monolithic block or focusing on only the four most talked about EM countries behind the BRICs (Brazil, Russia, India and China) acronym. The US was described as our favored developed market going into 2013 and we also argued that we should see increased capital spending, as well as a pickup in merger and acquisition (M&A) activities.

Most of those points turned out to be worth paying attention to, though with some caveats. Using the S&P 500 Index as a proxy, at the time of writing, US stocks had (in USD-terms) outperformed Europe and Japan year-to-date (YTD) but not by a very wide margin, and we could certainly label 2013 as a “tale of two halves.” For example, the US stock market outperformed Europe by over 10% in the first half of the year, but has since given back much of its lead.

This is a good sign, as it typically means that the world is healing when the US, considered the “safe haven,” lags the more cyclical European market. We could be on track for a synchronized global growth environment that is not just dependent on the US economy as the engine.

Given that positive backdrop, it has been interesting to observe that there has not really been a considerable uptick in companies investing in future growth initiatives, as capital spending and the expected M&A boom have not yet occurred. When this does happen, however, we believe that it will lead to a self-sustaining economic recovery, which will benefit equity markets.

In our 2013 write up, we gave a region-by-region outlook from our global team. For 2014, we will focus on the areas where our local teams see the greatest opportunity and which we believe investors might have overlooked. So  we will look at how investors can capitalize on eurozone stabilization (and eventual recovery), the “Chinese Dream” and how to keep the overall equity party/rally going.

THE EQUITY PARTY IS NOT OVERFor the first time in three years, global growth is accelerating and the recovery has a broad base. The slowing EM growth compared with developed markets (DM) does  not have to be a bad thing, given the relative size difference of the economies, as well as the positive effect that slower  EM growth can have on inflation.

In our view, this more stable backdrop will (finally!) unleash investing in the future, as CEOs dare to lengthen their time horizons. The aggregated free cash flows of US corporations compared to GDP are still close to record highs. Pent up demand in Europe is considerable, as net new business investment to GDP is the lowest in 20 years and Europe 

remains far short of historical profitability and earnings levels. In 2014, we should see a significant uptick in capital spending, as well as more M&A (admittedly, something  we expected already for 2013).

This better economic outlook, sustained by an investment cycle, will likely lead to higher interest rates. 

Figure 4 shows the dramatic shift out of long-only equity funds and into bond funds. If you look very closely, you can see that there is actually a small reversal towards the end  of the graph, but this is just the beginning of the trend – there is a LOT more to go.

We are not suggesting that these lines will meet any time soon, but we think the direction is clear and that it will support equities for a long time. This will be the case until new information makes us change our economic and corporate outlook, or until equity markets perform beyond expected fundamentals and become too expensive. 

In both the US and Europe, we expect to see less fiscal tightening in 2014 compared to 2013, which should give a measurable boost to GDP growth rates. For Japan, we do not know how many arrows Prime Minister Abe has in his quiver, but we do know that he will keep trying to find new ones if the first ones do not hit their targets (inflation and growth).

Interest rates rising due to a better growth outlook is music to the ears of equity investors and it is about time that our asset class attracted attention.

Source: ICI Organization. Data as of November 2013

FIGURE 4:  THE FIVE-YEAR PREFERENCE FOR BONDS OVER STOCKS IS STARTING TO REVERSE

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A different way of assessing the valuation of equities can be to relate their price to assets that often are bought by investors in times of risk and uncertainty, such as gold. Figure 5 illustrates how risk-averse investors have been  and also indicates how under-exposed many asset owners are to equities, compared to (perceived) lower risk assets like bonds and gold.

EMERGING EUROPEIf you want exposure to things that are looking up in Europe, look no further than emerging Europe. Within that region, we believe economies and companies are solid and ready to benefit from increased exports and investments. 2013 has been a year of mixed performance for emerging European equities. For the first part of the year, investors stayed away from the Central Europe 3 (CE3) – Czech Republic, Poland and Hungary – due to the lack of visibility on the economic outlook for developed Europe. Flows from foreign investors have been slow to return, as political and structural changes are still causing uncertainty. Czech elections, Polish pension reform and Hungarian mortgage concerns have kept investors from deploying capital. As we gain more clarity on these issues into 2014, we expect fund flows to return to emerging Europe as a way to play the European recovery theme.

In Russia, the focus is now on sustainable growth, financial stability and bringing down inflation as a way to sustain real income growth. Investors did not look to Russia in 2013,  as it has been seen as a proxy play on Chinese growth, due to its commodity exports. Headlines on various social and political items have also not been helpful. However, we believe that 2014 can be a good year for the Russian equity market. Despite negative headlines, we see the government pushing through a tremendous amount of reform that should catch investor attention. This includes the usage of Euroclear (European clearing house) for local shares, International Financial Reporting Standards (IFRS) for accounting, higher payout ratios from state companies, tax reforms for hard-to-recover onshore reserves and offshore projects, lower tariffs for state companies that would allow them to focus on efficiency and lower inflation and potentially lower interest rates leading to lower mortgage rates and more real income for the end consumer. Higher dividend yields and positive earnings revisions show the positive momentum from these reforms.

After a strong 2012, the Turkish stock market faced headwinds in 2013, as investors worried about people rioting in the streets and the anticipated effects of US tapering. After meeting major Turkish banks in September 2013, we believe that they will have fully re-priced their loans books by the beginning of 2014, after a weak period for the banks towards the end of 2013. 2014 will be a year of elections, so we do not expect to see any tough reforms that suddenly curb growth and eliminate the current account deficit. Instead, we think that the politicians will try to slow consumer lending only marginally in the short term and focus on the medium and long-term issues. As we approach the middle-to-end of the first half of 2014, we will most likely have more clarity on politics and US tapering, but investors would want to be positioned ahead of this.

THE CHINESE DREAM2014 will mark the beginning of the Chinese Dream era. The Chinese Dream refers to a philosophy promoted by President Xi Jinping that seeks to improve people’s livelihoods and their chances for prosperity, while also strengthening the nation’s military and societal construction. The Chinese Communist Party believes that the Chinese Dream is about prosperity, collective effort, socialism and national glory. With slowing 

Source:  BofA Merrill Lynch European Strategy, Bloomberg.  Data as of November 2013

FIGURE 5:  GLOBAL EQUITY, PRICED IN GOLD, IS RISING FOR THE FIRST TIME IN 10 YEARS

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2003 2005 2007 2009 2011 2013

Equities, priced in gold, breaking out of their 

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slow down after three decades of rapid growth, the country’s problems are already well publicized and well known. There are definitely investment opportunities in China now, given that expectations are low and the valuation on Chinese equities is extremely attractive at only single digit forward earnings multiples. Overall, we believe Chinese equities are just too cheap to be ignored by investors in 2014. But targeted stock selection will be key, since a return to previous hyper growth rates is unlikely, as the economy  is dealing with its debt burden.

SUMMARYLooking forward to 2014, we would certainly encourage investors to embrace areas that will benefit from a more broad-based global recovery. This means not forgetting about EM Europe as DM Europe finds its footing, seeking opportunities arising from the Chinese Dream and  finding the beneficiaries of corporations extending their investment horizons. 

Even if the “great rotation” from bonds to equities does  not come to pass, we believe a subtle rotation is more  than enough to keep equity markets celebrating as we move from the Chinese zodiac year of the Snake into  the year of the Horse  

growth and rising debt levels, the new leadership, under President Jinping and Premier Li Keqiang, has every incentive to change. This new government is serious about reforms  and is ready to focus on the quality and composition of economic growth. We have already seen the implementation of some liberalization measures over the past few months, and more far-reaching economic reforms in the area of government administration, banking, fiscal budgets, land/household registration, resource pricing, etc. are expected to be unveiled and implemented in 2014 and beyond.

We are optimistic that these reforms will gradually address many of the deep rooted structural issues that have started to threaten the sustainability of Chinese growth. For example, the recent opening of the Shanghai Free Trade Zone is a significant event that illustrates how China can further deepen its integration with the rest of the world. In the Free Trade Zone, for the first time, the government would open the market for financial services, such as RMB capital account opening, foreign private banks, foreign asset managers, interest rate liberalization and so on. Just like  the Shenzhen Special Economic Zone marked the transition of China to a socialist market economy in 1978, the Shanghai Free Trade Zone might as well represent a WTO 2.0 entry  for China in 2013. 

Despite reforms and the broad economic slowdown, there are still a lot of industries, such as mass consumption, e-commerce and environment-related sectors that should continue to grow exponentially in the coming years in China, due to low penetration and policy support from the government. Investors should look beyond the broad macro picture and search for bottom-up investment opportunities. For example, Macau’s gaming revenue has grown 700%+ over the past ten years to US $38 billion, and it is expected  to double again over the next five years. Online consumer shopping’s compound annual growth rate has exceeded 70% over the past four years, and the overall size of the Chinese online shopping market will overtake the US by the end of this year. While it is true that China will likely continue to 

FIGURE 6: GAMING REVENUE – MACAU VS. THE LAS VEGAS STRIP

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2005 2006 2007 2008 2009 2010 2011 2012

Source:  LVCVA & Macau Gaming Inspection and Coordination Bureau.  Data as of 30 September 2013

This is the make or break moment for the Chinese Dream.

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PRIVATE MARKETS  An Interesting Age  Creates Dislocation

Exceptional political and economic disruption in the past five years has created asset price dislocation and, in spite of a gradual global economic recovery, sources of disquiet remain. Among other issues, the US Federal budget battle and likely withdrawal of quantitative easing have the potential to spark turmoil in financial markets. While valuations in public markets have broadly recovered from their post financial crisis lows, anomalies persist in some private markets. Indeed, ongoing flux in some parts of the world continues to disrupt valuations in some private markets as we enter 2014.

The bottom up view from our regional offices across the globe is that these sources of uncertainty continue to present some attractive opportunities in private markets. This belief holds true for small and mid-market companies in both developed and emerging markets, as well as niches such as structured capital, regional real estate, private credit and secondary markets.

DEVELOPED MARKETS: SMALL AND MIDDLE MARKET FUNDS MOST ATTRACTIVEIn developed markets, one of the most enduring dislocations since the financial crisis has been the banks’ more discriminating lending policies. For some time now, we have advocated investing in private equity funds that depend less on leverage, instead focusing on improving their portfolio companies’ operations, especially in small and mid-market buyout funds. In the five years since the 2008 crisis, these funds have tended to outperform and we expect the trend to continue into 2014 and through the foreseeable market cycle. 

NORTH AMERICAWhile headlines of mega buyouts dominate the US market, small and mid-sized buyout funds have actually generated the highest returns over the years. These funds (valued at less than US $2 billion in assets) have outperformed their larger counterparts over the five-year horizon to March 20132, according to the most recent Preqin data. Over the past two decades, small and middle market buyout funds have generated a median multiple of 1.47x and an internal rate of return (IRR) of 12.6% – by contrast large buyout funds have achieved a multiple of 1.34x and a 9.9% IRR3. Looking forward, we believe small and middle market funds will continue to offer the strongest value proposition.

EUROPE

As Europe emerges from recession, its member states do not share the same rates of recovery. The North is clearly more resilient and will likely provide a strong deal pipeline going forward. Additionally, opportunities are opening up in some peripheral countries that were not present six months ago. In our view, specialist regional managers will have the keenest edge going forward as the “one-size-fits-all” model does not apply to Europe. 

PRIVATE CREDIT AND SECONDARY MARKETS: SOURCES OF FINANCE IN FLUXPrivate credit and the secondary markets are likely to see strong deal flow in 2014 and beyond as sources of finance remain in flux. Within private credit, the opportunity set for specialized lenders will widen with direct lending, rescue financing and more bespoke capital transactions contributing to a robust pipeline over the coming years. In the secondary markets, innovative solutions for sellers constrained by regulatory changes, liquidity and portfolio rebalancing needs will provide deal flow. 

PRIVATE CREDITWithin developed markets, increased capital requirements for holding illiquid, non-traded debt instruments makes lending to small and mid-market companies prohibitively expensive for many financial institutions. These companies, shut off from the syndicated loan and bond markets, have found private credit a vital source of financing over the past five years as bank credit has become scarce. In emerging markets, these mid-sized companies have historically been poorly served by the banks and relatively under-developed capital markets, but we are also seeing the emergence of a more institutionalized private credit market in Asia, focused  on providing financing.

Providers of private credit to small and mid-market companies in both developed and emerging markets are able to achieve wider spreads and higher absolute interest rates than those available in liquid credit markets. They also 

The European small and middle market space remains attractive. Europe has never been one integrated market, and regional differences in terms of economic health are more pronounced than ever in the wake of the financial crisis.

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benefiting from tighter covenants, significant collateral  rights and, in some cases, equity participation offering attractive opportunities to investors of these strategies.

SECONDARY MARKETS

Over this period, funds raised an aggregate US $2.2 trillion  in commitments. Institutions that over-committed or  over-diversified in these vintage years are actively managing their portfolios and pursuing rebalancing strategies through the secondary market in an effort to achieve target portfolio goals. As a result, we expect these transactions to continue to provide a substantial baseline of deal activity.    

There are also other emerging sources of transaction volume. Despite improving conditions for private equity realizations and the increased exit activity witnessed this year, a significant amount of outstanding net asset value remains locked in “tail-end” funds. PineBridge estimates that this opportunity set, which includes funds within or past their ewxtension periods, comprises over 1,300 funds representing US $140 billion in net asset value (NAV). Naturally, these funds have a lower ratio of distributions to capital invested than their peers. The global financial crisis delayed the exit timelines for many of these investments, and existing investors in these funds are increasingly seeking ways to monetize the reported NAV. Consequently, we expect to see an increasing number of fund restructurings that provide liquidity solutions for tail-end portfolios. 

In addition, secondary activity is growing in emerging markets. As primary capital continues to flow into these regions, secondary deal flow will inevitably increase as primary assets mature. We expect to see significant deal flow over the next several years.

Source:  ThomsonOne/Venture Economics, Preqin, and secondary advisors.Data as of May 2013

FIGURE 7:  SECONDARY SUPPLY – CAPITAL RAISED BY PRIVATE EQUITY FUNDS GLOBALLY

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244

Vintage Years

Over 1,300 funds representing  US $140 bn in NAV are within or past extension periods

US $2.2 tn in  PE commitments between 2005 – 2010

US $bn

2:  Preqin Private Equity Performance Update Q1 2013. Horizon returns  for buyout funds by size through March 2013.

3:  Preqin Private Equity Performance as of December 31, 2012.  The data is presented net of management fees and carried interest.

We continue to see strong secondary deal flow in funds raised during the commitment surge between 2005 and 2010.

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EMERGING MARKETS: PLAYING CATCH UPIn emerging markets, the degree of dislocation varies significantly from one market to another. In parts of the Middle East and Africa, dislocations continue, while in some Asian countries optimism remains high. Generally, economic growth has exceeded the global average over the past few years. In addition, economic reform and increased domestic demand in emerging market regions have led to an improved private investment environment over recent years. As a result, we believe that the most attractive theme for private equity often arises primarily from the need for companies to adopt international business practices, but that dislocation in its various forms may sometimes serve to influence asset prices.

LATIN AMERICAAs a region, Latin American countries still have low private equity penetration rates. For example, despite being Latin America’s second largest economy, with a favorable investment framework for private investments, Mexico’s private-equity-to-GDP penetration rate is still one of the lowest in the region. But the country’s strong macroeconomic fundamentals, local investment skills  and private equity-friendly institutional investors have set  the stage for what we believe will be an inflection point  in Mexican private equity. Similar to other markets,

Private equity managers can create value by, among other operational enhancements, institutionalizing family businesses, consolidating fragmented industries and regionalizing operations, and improving corporate governance. Nevertheless, investing in a nascent private equity market such as Mexico brings challenges.

Beyond Mexico, the Andean economies of Chile, Peru and Colombia are growing healthily, and companies are becoming more familiar with the role of PE firms and 

growth, providing a fertile environment for private equity.  In Brazil, the destination of most of the capital raised in Latin America in the last seven years, most of the dry powder (about 85% in our estimation) has been directed to the larger sized companies, whereas, there are many attractive small and medium-sized companies. Moreover, the value add from institutional managers to these companies could be extremely meaningful. These companies exhibit strong growth characteristics where private markets can provide a solution in the form of private equity and credit to foster further growth in years to come.

CENTRAL AND EASTERN EUROPE In 2014, the region’s continued economic development, and the gradual economic recovery in neighboring Western Europe, should create promising conditions for businesses to improve their operations and profitability. An ecosystem of suppliers and service providers is emerging as large companies have entered the region. For example, the need  to produce, supply and transport automotive components has spawned new businesses in Shipping, IT Support, Personnel Outsourcing and Multi-Modal Warehouse/Logistics centers.

High employment is boosting consumer demand for high quality goods and services. In turn, this is driving growth in the retail sector, ranging from convenience stores to online platforms. Along with new commerce comes the associated infrastructure, shopping malls, strip malls, supermarket chains and discount stores. Logistics is also expanding, from privatized courier and postal services to delivery solutions. 

Other attractive sectors include Health Care (from  diagnostic to specialized treatment) and Education Services. The government is disengaging itself from what it sees as non-core activities while the population increases its standard of living and demands a higher quality of services.

Mexico’s best opportunities are in the small and middle market deals, where the scarcity of growth capital from banks is creating opportunity.

In summary, private equity can play a part as Central and Eastern Europe’s economies catch up with their Western neighbors.

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MIDDLE EAST AND NORTH AFRICAWith combined GDP of over US $2 trillion and annual GDP growth outlook of mid-single digits, the Middle East, North Africa (MENA) and Turkey are increasingly fertile ground for private market activity. In a similar way to other emerging markets, growing domestic demand is combining with the prospect of transforming businesses.

High rates of economic growth are fostering the development of local small and medium-sized enterprises, which have substantial financing requirements. Investors  and business owners need to access growth capital to  seize opportunities ahead of competitors. 

Most of the region’s private companies remain family-owned and family-run, with limited institutionalization and organizational systems constraining their ability to capture opportunities before others. Many business owners with promising prospects look to experienced institutional investors to act as agents of change, driving institutionalization and realizing growth opportunities.

Additionally, the region is benefiting as new leaders invest significantly in infrastructure as a first step towards achieving their goals for economic diversification. Finally, regional commonalities of culture, social values, language and business are creating opportunities for expansion. For example, well-managed service businesses in Turkey have tremendous expansion potential into the Gulf Cooperation Council (GCC), while GCC-based energy and related service companies are well-positioned to tap the developing energy markets in North Africa, Turkey and Northern Iraq. 

From a private equity perspective, growth investments  in partnership with businesses benefiting from these  regional trends appear promising. These include Business Services, Social Infrastructure and Industrial and Manufacturing companies. 

Additionally, Real Estate offers real opportunities. Sectors benefiting from the GCC’s economic growth, including Logistics and Warehousing, Education, Health Care and retail offer attractive income yields. Furthermore, limited access to growth capital in the region is creating attractive conditions for sale-and-leaseback transactions.

Selling their properties and leasing them back over the long-term offers corporates a practical way of unlocking dormant capital that is invested in their operational real estate assets and channeling it back into their core business. 

Investing in existing buildings with high-quality tenants  on long-term leases appeals to a broad spectrum of real estate investors because it offers a favorable blend of  low risk and stable long-term yield. The key is to focus  on sale-and-leasebacks with top-tier companies, within industries that are supported by positive regional macroeconomic fundamentals.

SUB-SAHARAN AFRICAToday, seven out of the 10 fastest growing economies in the world are found in Sub-Saharan Africa. In addition to the rapid growth the region is experiencing, the region also possesses attractive demographics and a rapidly urbanizing population, which should support this growth going forward. There are over 1 billion people in Africa, of which 876 million are living in Sub-Saharan Africa at a median age of 18.4 This number is expected to triple over the next few decades, which will fuel higher consumer demand and keep economic growth rates attractive. Moreover, from both a political and economic perspective, life in Africa is improving. More than half the countries in Sub-Saharan Africa hold open elections and many political leaders realize the need to keep monetary policies balanced. In fact, the IMF forecasts that 2014 will mark the first time in reported history that inflation will dip below the GDP growth rate, with inflation falling under 5%. 

These strong fundamentals set the stage for what is an exciting outlook for Sub-Saharan Africa in the coming decades. That said there are also obstacles to overcome in the region for it to achieve its full potential. While capital markets continue to develop, the majority of the region is comprised of over 10 million small-and-medium enterprises 

Sale-leasebacks are gaining popularity among owner-occupiers in the GCC region as companies look to free up their capital towards high-return growth opportunities.

4:  Source: http://databank.worldbank.org  Sources: United Nations World Population Prospect; McKinsey Global

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(SMEs) that find access to financing difficult or, at best, very expensive. These local businesses, in most cases, are also family-run and need help in managing and expanding to meet growing consumer demand throughout the region. The shortage of finance and management skills has the potential to stifle growth in the region. Private equity, however, can help by providing both growth capital and the expertise to improve operations. Private investment has already begun to bear fruit in some sectors of the Sub-Saharan African economy. The Telecom sector, for example, has expanded rapidly over the past decade, making it the world’s fastest growing mobile market.5 Ten years ago there were 16 million people connected to phone lines. Today, over half the population is connected with over 550 million phone line connections, which has prepared the way for Africans to use mobile banking more widely than the citizens of most developed nations. Such opportunities exist in various sectors. As  Sub-Saharan Africa’s secular growth story unfolds, Financial Services, Real Estate, Agriculture and Infrastructure  provide similarly attractive investment opportunities. 

While African private equity investment is still in its infancy, and private investment in the region is among the lowest  in the world, more investors are seeking to take advantage  of the growth prospects that Sub-Saharan Africa offers.

ASIAAlthough economic growth rates have moderated from  their peaks a couple years ago, the pace of growth in developing and emerging Asian countries is projected to  be among the highest in the world. We believe the long- term fundamentals in these economies remain intact and the current investment environment offers an attractive entry point at optimal valuations. 

Even under a more balanced yet slower-growing economy, growth/expansion capital will predominate in China. However local private equity managers have revised their investment approach and are seeking to add more value to their portfolio companies through operational 

improvements. In addition, there is an anticipation that buyout will also gain some traction through outbound M&A activities, as well as through consolidation and rationalization of highly-fragmented industries, populated  by thousands of young and mismanaged companies.  With the Chinese government exercising greater control over credit expansion, yet rising demand for debt supporting premium pricing, private credit strategies  have the potential to be attractive in the near future. With respect to sectors, Consumer, Health Care, Financial Services, Agriculture and Environmental Services are  the most attractive. 

In the case of India we believe growth equity, and to a lesser extent buyouts, in the small and middle market segment offer the most attractive investment opportunities. We are also seeing the emergence of credit-oriented, special situation-like funds looking to target over-leveraged Indian corporates, and borrowers that do not have access to traditional sources of debt financing. This segment of the market has the potential to deliver attractive risk-adjusted returns with good downside potential. 

In the case of South East Asia, some of the best returns  are expected to come from the small and mid-market, given the significantly larger number of target companies and their need for growth capital. The majority of deal flow will be in the form of minority growth investments, with some potential for control buyout deals particularly in Malaysia and Singapore.

The private equity market in Asia continues to mature.  While minority growth equity investments remain most prevalent, we are also witnessing a growing diversity of deal types like platform strategies, i.e. consolidation, growth buyouts, cross-border M&A and take-privates. Across the region, a majority of attractive deal flow is in Health care, Consumer Goods and Services, Media, Precision Engineering, IT/Software Services, Infrastructure Support Services and Environment Protection Businesses. 

5: African Emergence – The Rise of the Phoenix. KPMG, 2012

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SUMMARYWe believe private markets are poised to deliver strong returns and significant liquidity over 2014 and the foreseeable future, provided the investment and capital markets remain stable and modest global economic growth continues. Against a global investment environment preoccupied by the winding down of quantitative easing, private markets present opportunities in developed and emerging regions. Small and mid-market buyout funds standout in developed markets while the credit squeeze  is creating attractive risk-adjusted returns for providers  of capital. The faster growing emerging markets also present attractive situations as they catch up with the recovering developed markets. 

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MR. JIANG was appointed as Chief Executive Officer of PineBridge Investments in March 2012. In this capacity, he is responsible for directing PineBridge Investments’ strategies on a worldwide basis. Mr. Jiang also chairs the firm’s Executive Committee. Mr. Jiang is an experienced investment management executive with approximately 20 years of investment experience. Prior to his appointment with PineBridge, Mr. Jiang spent nearly eight years as CEO of Asia-Pacific for BNY Mellon Asset Management, during which time he built a business of over US $50 billion in AUM engaging in active strategies across Equities, Fixed Income, and Alternatives. During his tenure as  Global Head of Passive and ETF at BNY Mellon, Mr. Jiang added over US  $100 billion of reported AUM, globally. Further, at BNY Mellon Corporation, Mr. Jiang also served as Co-Head of the bank’s Sovereign Advisory Board, overseeing its growth in sovereign wealth funds and central banks around the world. Previously, he was a Senior Portfolio Manager at Franklin Portfolio Associates, where he managed more than US  $4 billion in US and International equity portfolios and over US $500 million in long-short hedged portfolios. He has a unique international perspective, having held senior executive positions in Tokyo, London, Hong Kong, Shanghai, San Francisco and New York.  Mr. Jiang also has experience as a direct investor in several start-up companies.  Mr. Jiang earned his Master’s degree from Harvard University and holds a Bachelor’s degree from Georgetown University.

DAVID JIANG Chief Executive OfficerPineBridge InvestmentsNew York

BIOGRAPHIES

MR. AL ZAIN is Chief Executive Officer for PineBridge Investments’ Middle East and North Africa region. He is responsible for managing the firm’s investment activities and relationships within the region. Mr. Al Zain is also a member of PineBridge’s Executive Committee. He has joint management responsibility for PineBridge’s alternative investments capabilities, as Co-Head of Alternative Investments. Prior to joining PineBridge, Mr. Al Zain was the Chief Executive Officer of Bahrain Mumtalakat Holding Company, the sovereign wealth fund and investment arm for the Kingdom of Bahrain. He was also a founding board member of Mumtalakat. Prior to joining Mumtalakat, Mr. Al Zain spent 18 years with Investcorp as Managing Director and Co-Head of Placement and Relationship Management. Before that he was Vice President of Private Banking International and Head of Investment Banking Middle East with The Chase Manhattan Bank, Geneva as well as a corporate banker  for Citibank Corporate Banking Division in Bahrain. He holds a Bachelor of Business Administration from Oglethorpe University as well as a Master of Business Administration  in Finance from Mercer University, Atlanta.

TALAL AL ZAINChief Executive Officer PineBridge Investments Middle East,Co-Head of Alternative Investments PineBridge InvestmentsBahrain

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MR. BHATIA was appointed to head PineBridge Investments’ Asia Partners in July 2012. In this role, the regional private equity teams based in Mumbai, Seoul, Shanghai and Hong Kong work closely with him to maximize opportunities with respect to the existing private equity portfolio and formulate strategies for new funds in the region. Mr. Bhatia has nearly 40 years of broad management experience across private equity, distressed asset investing, corporate finance and investment banking. His extensive credentials include building and leading the Asian private equity businesses at Credit Suisse as Chairman, CS Private Equity Asia Partners and General Electric as President, Asia Pacific, and Corporate Financial Services as well as at Deutsche Bank and State Bank of India in senior investment banking, international finance and corporate lending roles. He received a Bachelor’s of Science degree in physics, chemistry and mathematics from the Ewing Christian College, India. He also earned a Master of Commerce degree in commerce and management from the University of Allahabad, India and an MBA in Management Studies from the University of Delhi, India. He is also a Certified Associate of Indian Institute of Bankers.

HARJIT SINGH BHATIAManaging Partner and Chief Executive Officer PineBridge Asia Partners PineBridge InvestmentsSingapore

MR. CHONG joined PineBridge in 1999. He has worked in buyouts and corporate finance since 1981, and is or has served as a Board Director of numerous companies including Sodecia North America, Field Turf, Fresh Direct, Faith Media, Tensar and Talyst. From 1994 to 1998, he was Executive Vice President for Business Development for the GT Group, an Asian conglomerate headquartered in Jakarta, Indonesia. In the early 1990s, he was CFO of Dynadx Technologies, a start-up company that developed and marketed an out-of-home advertising technology. From 1981 to 1989 he was head of the US $3 billion U.S. leveraged finance group at Swiss Bank Corp. Mr. Chong received a BS in Chemical Engineering from the University of Malaya and an MBA from Columbia Business School.

FT CHONGManaging PartnerPineBridge Structured Capital PineBridge InvestmentsNew York

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MR. KELLY joined the firm in 1999 and is responsible for asset allocation and manager selection. This includes managing our investment process and expanding our capabilities for Dynamic Asset Allocation strategies, pension fund advisory, and retail orientated asset allocation vehicles. The asset allocation team serves as OCIO for pension funds as well as the US high net worth channel, participates on the Asset/Liability committees of Asian insurance companies, and manages Dynamic Asset Allocation strategies for institutional accounts as well as lifestyle funds for individual investors. The team has provided strategic advice for corporate, trade group, and government pension plans. Mr. Kelly serves as a rotating member of the Executive Committee is a permanent member of the Illiquid Council and Senior Management Committee, and Chairs the firm’s Proxy Committee. Prior to PineBridge Investments, he spent 15 years with JP Morgan Investment Management in various equity research and portfolio management roles while chairing the US Asset Allocation Committee. Prior to JP Morgan he spent several years in research at Alan Greenspan’s economic consulting firm, Townsend-Greenspan & Co. His investment experience began in 1980. Mr. Kelly received an MBA from the Wharton Graduate School  of Business and is a CFA charterholder.

MICHAEL KELLY CFAManaging Director Global Head of Asset Allocation PineBridge InvestmentsNew York

MR. COSTABILE joined the firm in 2000 and is the Managing Director of the Private Funds Group. Mr. Costabile brings his in-depth knowledge of private funds to PineBridge Investments and has played a significant role in the successful growth of four product lines: Pine street LLC (securitizations), PSP I (Secondaries), the PEP Program, and the Credit Opportunities funds. Mr. Costabile serves on the Developed Markets Fund Investment Committee, Secondaries Investment Committee and Asia Private Equity Investment Committee. His current responsibilities include overseeing all private funds’ investments in the developed and many emerging markets, as well as sourcing, due diligence, monitoring product development, and marketing. Mr. Costabile’s private equity investing and valuation experience dates back to 1990. Previously, from 1997 to 2000, Mr. Costabile was a Vice President at Credit Suisse First Boston (CSFB) in the Private Funds Group, with a focus on investments on behalf of CSFB and third party investors. Prior to that, he was the Senior Investment Officer of Alternative Investments for the Commonwealth of Massachusetts  and the Assistant Director of Venture Capital for the Commonwealth of Pennsylvania. In both positions, Mr. Costabile focused on private equity fund investments. He received both  a BSBA and a MBA from Duquesne University. He is also a CFA charterholder and holds  a Series 7 license.

STEVEN COSTABILE CFAManaging Director Global Head of Private Funds GroupPineBridge InvestmentsNew York

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MR. MELLINGER joined the firm in 1998. Based in Warsaw, he has overall responsibility for the firm’s private equity activity in Central and Eastern Europe. Mr. Mellinger has extensive experience in investments, finance, and management spanning more than 30 years, including more than 20 years in direct investments. Prior to joining the firm, he was Co-Head of the Financial Institutions Team at EBRD, where he played a leading role in establishing the department and, in particular, and its equity portfolio. Prior to EBRD Mr. Mellinger was a Director, Head of Business Development, and Deputy General Manager of the mortgage bank with Banque Sovac, a US $10 billion total balance sheet consumer finance, leasing, and mortgage finance affiliate of Lazard Freres. Mr. Mellinger’s previous experience includes a position as a senior officer at the French Minister of Finance in charge of export, credit finance, and financial relations with Central and Eastern Europe. Mr. Mellinger, a graduate of the French Ecole Nationale d’Administration, holds a degree in Economics from Paris University, a Law Degree from La Sorbonne, and a degree in Political Science from Institute d’Etudes Politiques of Paris.

PIERRE MELLINGERManaging Director, President and Chief Executive Officer Capital Management Head of Central and Eastern EuropePineBridge InvestmentsWarsaw

MR. OH is responsible for coordinating and overseeing the firm’s Global Credit and Fixed Income Strategies. Mr. Oh also co-manages the Leveraged Finance Group and portfolios.  Prior to joining PineBridge Investments and its affiliates in 2000, Mr. Oh’s leveraged finance investment experience includes serving as Head of High Yield and Special Situation Investments at Citadel Investments, Head of Leveraged Finance at Koch Capital, and Vice President in High Yield and Distressed Debt Trading at BancAmerica Securities. Other prior positions include Manager in Ernst & Young’s Restructuring and Reorganization and Strategy Consulting Groups. Mr. Oh received a BS in Finance and Management from the Wharton School at the University of Pennsylvania and an MBA in Finance from the Kellogg School of Northwestern University. Mr. Oh is a CFA charterholder and has Series 7 and Series 63 licenses.

STEVEN OH, CFAManaging Director, Head of Global Credit and Fixed Income,Co-Head of Leveraged FinancePineBridge Investments Los Angeles

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MR. THORN joined the firm in 1998 and is now responsible for managing the firm’s Fundamental and Quantitative Equity teams. Mr. Thorn joined PineBridge Investments as Co-Portfolio Manager of the Global/International portfolios and Portfolio Manager focused on the health care sector. In 2000, he became Global Head of Equity Research, followed by additional responsibilities as Head of European Equities (2003), Head of US Equities (2006) and assumed the role of Head of all Developed Markets in 2007. In the fourth quarter of 2010, the Emerging Markets Equities group was added to his responsibilities. During his tenure with the firm, Mr. Thorn helped develop and implement the firm’s equity process and online knowledge-sharing tools for equity investing globally. Prior to joining the firm, Mr. Thorn was a global health care portfolio manager with SE Banken Fonder (SEB Asset Management) in Sweden. Mr. Thorn holds an MS in Economics and Business Administration from the Stockholm School of Economics with majors in Financial Economics and Economical Steering/Planning.

ROBIN THORN Managing Director, Global Head of EquitiesPineBridge InvestmentsNew York

MR. SCHOMER joined the firm in 1996 and is responsible for providing economic forecasts, analysis and commentary for all groups of PineBridge Investments. He is a member of various strategy committees and responsible for coordinating the PineBridge Investments interest rate and currency strategies. Mr. Schomer transferred to the U.S. in 2002 from the firm’s London office, where between 1996 and 2001 he also managed various fixed income portfolios. Prior to joining PineBridge Investments, he was a Fixed Income Analyst at Commerzbank in Frankfurt, Germany. Mr. Schomer holds degrees in Economics from the University of Bonn in Germany and the University of East Anglia, in the UK. He  also studied at the London School of Economics and is a CFA charterholder.

MARKUS SCHOMER CFAManaging Director, Chief EconomistPineBridge InvestmentsNew York

PineBridge Investments is a group of international companies that provides investment advice and markets asset management products and services to clients around the world. PineBridge Investments is a registered trademark proprietary to PineBridge Investments IP Holding Company Limited.

READERSHIP: This document is intended solely for the addressee(s) and may not be redistributed without the prior permission of PineBridge Investments. Its content may be confidential. PineBridge Investments and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part.

OPINIONS:

Any opinions expressed in this document may be subject to change without notice. We are not soliciting or recommending any action based on this material.

RISK WARNING:

All investments involve risk, including possible loss of principal. Past performance is not indicative of future results. If applicable, the offering document should be read for further details including the risk factors. Our investment management services relate to a variety of investments, each of which can fluctuate in value. The investment risks vary between different types of instruments. For example, for investments involving exposure to a currency other than that in which the portfolio is denominated, changes in the rate of exchange may cause the value of investments, and consequently the value of the portfolio, to go up or down. In the case of a higher volatility portfolio, the loss on realization or cancellation may be

DISCLOSUREvery high (including total loss of investment), as the value of such an investment may fall suddenly and substantially. In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved.

Information is unaudited, unless otherwise indicated, and any information from third party sources is believed to be reliable, but PineBridge Investments cannot guarantee its accuracy or completeness.

PineBridge Investments Europe Limited is authorised and regulated by the Financial Conduct Authority (“FCA”). In the UK this communication is a financial promotion solely intended for professional clients as defined in the FCA Handbook and has been approved by PineBridge Investments Europe Limited. Should you like to request a different classification, please contact your PineBridge representative.

Approved by PineBridge Investments Ireland Limited. This entity is authorised and regulated by the Central Bank of Ireland. In Australia, this document is intended for a limited number of wholesale clients as such term is defined in chapter 7 of the Corporations Act 2001 (CTH). The entity receiving this document represents that if it is in Australia, it is a wholesale client and it will not distribute this document to any other person whether in or outside of Australia. In Hong Kong, the issuer of this document is PineBridge Investments Asia Limited, licensed and regulated by the Securities and Futures Commission (“SFC”). This document has not been reviewed by the SFC. PineBridge Investments Asia Limited holds a Representative

Office license issued by the Central Bank of UAE and conducts its activities in the UAE under the trade name PineBridge Investments Asia Limited – Abu Dhabi. This document has not been reviewed by the Central Bank of UAE nor SFC. In UAE, this document is issued by PineBridge Investments Asia Limited – Abu Dhabi Representative Office.

PineBridge Investments Singapore Limited is licensed and regulated by the Monetary Authority of Singapore (the ”MAS”). In Singapore, this material may not be suitable to a retail investor and is not reviewed or endorsed by the MAS.

PineBridge Investments Middle East B.S.C.(c) is regulated by the Central Bank of Bahrain as a Category 1 investment firm. This document and the financial products and services to which it relates will only be made available to accredited investors of PineBridge Investments Middle East B.S.C. (c) and no other person should act upon it. The Central Bank of Bahrain takes no responsibility for the accuracy of the statements and information contained in this document or the performance of the financial products and services, nor shall it have any liability to any person, an investor or otherwise, for any loss or damage resulting from reliance on any statement or information contained therein.

Last updated 01 June 2013

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