July 2012

STEVEN KACZMAREKGENE D. BALAS, CFA631 574 2474Info@EastEndWealthManagement.comwww.EastEndWealthManagement.org

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Increased protein intake in emerging markets presents a number of investment opportunities, not only in agriculture

and related fields, but also in the medications used to treat the maladies that sometimes come with Western diets. There are many examples of Western diets being introduced into Asia in particular, but some of the dietary changes have already been made in markets that have already advanced somewhat, such as China, and other nations may follow.

China does serve as a useful model, however, to assess the impact of recent dietary changes on health. Some of these dietary changes may be healthy, but the incursion of fast foods and soft drinks into everyday cuisine might not be so advantageous. Additionally, some of the changes in lifestyles in China may not be just the result of dietary changes, but also the increased urbanization, which itself brings health problems related to a more sedentary lifestyle, increased stress and tobacco consumption, along with more pollution.

Let’s first discuss dietary changes – and all of the investment opportunities that go into food production, ranging from demand for farmland, farm equipment, fertilizer, and even water and irrigation systems, which are an important investment theme in their own right. Note that poultry and livestock production is much more agriculturally intensive than growing crops, so increased meat production greatly increases demand for grains beyond what a similar increase in a more vegetarian diet would require.

Then, we’ll examine the problems associated with Western style diets, including rising incidents of diabetes, obesity, cancer and hypertension, and tying this theme to improved access to health care in China that can stimulate demand for pharmaceuticals and medical devices used to treat these problems. We must stress that we are approaching this topic from the perspective of an investor and not as an ecologist or healthcare practitioner.

Let’s take a look at how diets are expected to change between now and 2019, and to put this into context, the UN estimates that the world population will grow by 11% during this period:

A few highlights from the OECD include, for overall agriculture production and consumption:

Production/Consumption - Production is projected to continue to increase but at a slower pace than before. This increase is expected to mainly come from non-OECD countries as they have the spare capacity to increase production in line with demand.

There are large differences in the growth in production between regions. Brazil’s growth in production is expected to be the fastest (40%). China and India are also projected experience significant production growth at 26% and 21% respectively. US and Canada’s growth is anticipated to be somewhere between 10-15%. The growth in the EU27 is expected to be much more muted at only 4%. Production in North Africa and the

From Farming to Pharmaceuticals: investment themes From changing Diets in emerging markets

Commodity Consumption Increase 2010 Compared to 2019 OECD Non OECD

Vegetable Oil 22% 33%

Protein Meals 9% 33%

Sugar (in raw sugar equivalent) 5% 23%

Butter 3% 31%

Poultry 14% 30%

Oilseeds 13% 21%

Wheat 10% 13%

Source: OECD/Food and Agriculture Organization of the United Nations (FAO)

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Middle East has fallen recently due to limited water availability. Production in Sub-Saharan Africa is expected to remain stagnant in per capita terms and grow at only 2.2%. Thus production will grow the fastest in Non-OECD countries.

For just meat: Almost 90% of the increase in production over the projection period is expected to come from developing countries, and 60% of meat consumption is by developing countries, which have 83% of the world’s population, highlighting the potential for meat consumption in the emerging world to catch up to that in the rest of the world. Growth in consumption will be slow among the OECD countries with an average increase in per capita consumption of 1.1% per year compared to 2.4% in developing countries.

What does this mean to investors? Well, let’s start by retracing the agricultural steps needed to produce this extra protein. We’ll focus on poultry, pork and beef, but note that poultry, unlike pork or beef, has no widespread cultural obstacles to its consumption in Asia.

Cornell University researcher David Pimentel did some environmental research on the environmental impacts of meat production of energy requirements to protein output, using data from the U.S. He notes that the 7 billion livestock animals in the United States consume five times as much grain as is consumed directly by the entire American population. And, each year an estimated 41 million tons of plant protein is fed to U.S. livestock to produce an estimated 7 million tons of animal protein for human consumption. For every kilogram of high-quality animal protein produced, livestock are fed nearly 6 kg of plant protein.

Animal agriculture is a leading consumer of water resources in the United States, Pimentel noted. Grain-fed beef production takes 100,000 liters of water for every kilogram of food. Raising broiler chickens takes 3,500 liters of water to make a kilogram of meat. In comparison, soybean production uses 2,000 liters for kilogram of food produced; rice, 1,912; wheat, 900; and potatoes, 500 liters. This means new investments in water projects. For example, China is spending $150 billion on the South-North Water Diversion Project, which will divert water from the Yangtze river to the parched north, and has an estimated completion date of 2050. Investment implications: water and irrigation systems.

Leo Horrigan, Robert S. Lawrence, Polly Walker at the Center for a Livable Future, Johns Hopkins Bloomberg School of Public Health authored a paper which appeared in Environmental Health Perspectives that described the use of fertilizer and pesticides needed for food production. They note that in 1998, the world used 137 million metric tons of chemical fertilizers, of which U.S. agriculture consumed about 20 million tons, or 15%. Between 1950 and 1998, worldwide use of fertilizers increased more than 10-fold overall and more than 4-fold per person.

Each year, the world uses about 3 million tons of pesticides (comprising herbicides, insecticides, and fungicides), formulated from about 1,600 different chemicals. Given the increased amount of crop production needed to produce this extra animal protein, we will need even more fertilizers and pesticides in the near future. Disease and pest resistant crops are big business, including the possible use of genetically modified crops. Investment implications: makers of fertilizers and pesticides and seed manufacturers.

The Johns-Hopkins researchers also noted that land planted in cereal grains produces 2-10 times as much protein for human consumption as land devoted to beef production; for legumes the ratio is anywhere from 10:1 to 20:1. As such, the land required for cultivation of animal proteins would see exponential growth versus that if there was not a dietary shift along with population growth. There’s also theme of increased agriculture devoted to biofuels which will add further to the demand for cropland. The FAO estimates that between now and 2030, the amount of arable land under cultivation will increase by 28% for irrigated land and 25% for rain-fed land, with growth of 12.6% in the emerging world. Increases in agricultural intensity – the increase in crop production per acre – will add further to total yields, so the amount of increased crop production is estimated to rise by between 57% and 64%. Investment implications: farm equipment.

Since China has already witnessed dietary changes take place in that country in recent years, it serves as a useful laboratory to see the effects of increased urbanization and higher animal protein consumption on health. Meat consumption itself is not necessarily the cause of health problems, but by measuring China’s increased meat consumption we can derive a proxy for a broader change in diets. Its meat consumption increased from 10 kg per person annually in the 1970’s to 45 kg currently (and might be expected to reach 60 kg in 2015 and 69 kg in 2030). As its diets became more Westernized, China has also seen an increase in diseases that accompany those diets. Leading into our second focus – that on health issues - consider these statistics that relate to health problems from China’s dietary changes:

A national survey conducted in 1994 showed that the prevalence of diabetes was 2.5%. These estimates were higher by a factor of approximately 3 than those reported in 1980. Since the 1994 study, diabetes has continued to surge: in 2001, the prevalence was 5.5%, the New England Journalism of Medicine reported. Part of this relates to obesity; while the prevalence of obesity is still lower in China than it is in the U.S., PBS Newshour reports that China’s obese population is growing 30 to 50 percent each year.

Meanwhile, a study that appeared in Current Hypertension Review demonstrated the rise in high blood pressure in China, which now is estimated to afflict 200 million people in that

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This information is intended to describe a general investment strategy and is not a recommendation to buy or sell any specific securities. The strategy discussed does not and should not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. Any investment carries risk, including the loss of principal. Any investment strategy discussed here or available through East End Wealth Management is not an obligation of a bank and is not guaranteed by the FDIC and may lose money. Some investments are not suitable for all investors. Past performance is not indicative of future results. We cannot guarantee that this information is accurate or complete. As with any investment strategy, you should thoroughly discuss your particular investment situation and with your financial representative and understand any investment recommendation that might be made before investing any money.

East End Wealth Management is registered as an investment advisor with the States of New York and Florida. East End Wealth Management only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements.

country. The study notes that since 1958 multiple national surveys have been carried out to estimate the prevalence of hypertension in China. With each passing decade the prevalence of hypertension rose significantly (5-11% in 1958, 7.7% in 1979, 11% in 1991, and 24-27% in 2000. Researchers primarily blame diet on the increase in hypertension.

Researchers also attribute dietary changes for a surge in cancer in China – breast cancer rates have increased by about a third in just the past ten years, China Daily reports. Of course, not all cancers are caused by diet by any means, but increased salty and fatty foods are blamed for some of the increase. For all cancer rates, the Ministry of Health and the Ministry of Science and Technology data show that the cancer death rate has increased 80% in the past thirty years, with diet following second only to smoking as being the causes in the surge.

As part of its means of providing a better healthcare, China is leading a drive to offer a universal health insurance plan to its citizens starting in 2011, with a $123 billion program to establish universal health care for the country’s 1.3 billion people. Now, China spends 4.5% of its GDP on healthcare, compared to 16% in the U.S. Under the plan, in 2012 90% of China’s citizens will be covered by a universal health-care system and health-care facilities will be upgraded, including construction of 30,000 hospitals, clinics, and care centers across the country.

Not only will pharmaceuticals be covered, but Businessweek reports that the market for medical devices in China is estimated to almost double in size between 2006 and 2014 to $28 billion a year. The magazine further notes that the number of cardiac patients in China is growing at a 20-30% annual rate, and the market for cardiovascular stents increasing by 40% annually. It reports that Chinese prefer foreign-made medical devices and medications, as they are perceived to be of higher quality than domestically-produced ones.

Pharmaceuticals will also likely see growth as well, though China manufactures many of the pharmaceuticals within its borders. However, IMS Health, in its IMS Health Market Prognosis of October 2009, China’s CAGR from 2009- 2013 is now projected at 23-26% for prescription sales. China is now the third largest pharmaceutical market in the world, after the United States and Japan, and ahead of Germany, France, Italy, and Spain. Reuters reports that China will be the number two drug market in 2015. It is also taking steps to bolster patent protection for foreign makers of pharmaceuticals, making it an important market for Western pharmaceutical makers. One risk, however, is government price controls and that some medications need to be on approved lists to be covered by the new universal health insurance program in China. There is, however, room for growth, as CNNMoney.com reports that the 15 biggest drug makers in the world derived just 0.9% of their combined sales from China in 2009.

While we’ve focused here on China, as it is leading other emerging markets, IMS also believes that other emerging markets, including Brazil, Russia, India will soon follow, along with other emerging markets from Eastern Europe to Latin America, Asia and Africa. IMS cites 17 emerging markets that will account for 50% of the global growth in pharmaceutical sales in the next five years. Murray Aitken of IMS recently told Reuters that he sees certain European drug manufacturers ahead of the pack in sales to emerging markets, noting that they are already more internationally focused than some U.S. drug makers and have more of an existing presence in emerging markets.

ETFs present viable ways to invest in these themes. At East End Wealth Management, we can discuss with you incorporating thematic investments such as these as part of a diversified portfolio. Not all investment themes are suitable for all investors, but by examining longer term trends, we can identify longer term investment opportunities.

BiograPhies

STEVEN KACZMAREK

gENE d. bAlAS, CfA

Steve is the President of East End Wealth Management. He has over 30 years of experience in trading and risk management in a wide range of markets. Most recently, Steve held the position of Managing Director at Legend Merchant Group. His background also includes the positions of Partner at Schonfeld Securities; a proprietary trading firm, NYMEX floor trader and Lieutenant, United States Army Reserve. Steve graduated New York University with a degree in Economics. As an active member of the investing, planning and trading community, Steve is a member of NAIFA and the Financial Planning Association. Locally, he is the Chairman of the Southampton Youth Board, focused on youth issues on the East End of Long Island.

Balas has over twenty years’ experience in investment management. He currently writes economic commentary for TheStreet.com’s RealMoney site. Previously, he was Director of Investments at Genworth Financial Asset Management. In this role, he performed forecasts on macroeconomic conditions and determined the influences of thematic drivers to develop investment strategy, He also headed the firm’s manager due diligence efforts. Prior to GFAM, Gene was Director, Investment Management & Guidance at Merrill Lynch & Co. In that role, he advised pension funds, endowments and foundations as to appropriate asset allocation strategy. In previous roles, he advised both institutional and individual investors on asset allocation and manager selection decisions, beginning his career in 1989. He has an MBA from Columbia Business School and a BBA in Finance from the University of Houston, where he attended on a full National Merit scholarship. He is a Chartered Financial Analyst.

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