investing in emerging markets: a strategic opportunity

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


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

0Progress on Macro Economic Fundamentals1Over the past decade, emerging markets countries have demonstrated well-documented improvements in critical macroeconomic measures:

a decrease in foreign debt ratios,

an increase in foreign exchange reserves,

and more credible monetary policies.

Source: Standish and JP Morgan as of September 30, 2011.*Market cap weighted averages for countries in the J.P. Morgan Government Bond Index - Emerging Markets(GBI-EM) Global Diversified.Foreign Debt (% of Exports)*0%30%60%90%120%150%180%Foreign Exchange Reserves (US$ bn)*-$10$40$90$140$190CPI (% YOY)*0510152025301

EM Currencies: No More Pegs Emerging markets currency valuations are driven by supply-demand conditions. We believe core balance the sum of current account balance and net foreign direct investment is the most conservative measure of such conditions.As global economic activity slowed down, core balances in emerging markets deteriorated significantly in 2008, albeit from a very high level. Core balances improved significantly in 2009, and we expect them to stay at supportive levels at least for the next couple of years.

2EM Core Balance (Weighted Average of All Countries in the JPM GBI-EM Global Diversified Index)Source: Standish as of September 30, 2011.2

EM Currencies: No More Pegs The improved balance of payments of EM economies is already conspicuously manifesting itself in the rebounding foreign exchange reserves.

3Source: Thomson Reuters Datastream, Standish as of July 31, 2011.Combined Foreign Exchange Reserves of Brazil, Indonesia, Russia, and Turkey34EM: No Longer Highly IndebtedSource: International Monetary Fund, World Economic Outlook Database as of September 30, 2011Fiscal prudence has helped to reduce indebtedness, improving sovereign risk.Debt ratios have improved significantly and emerging markets are no longer subject to the vagaries of external financing.This is a big contrast with the direction of developed economies leverage.Debt as Percentage of GDPRelative Resilience: Growth in EM Continues to Outpace Developed EconomiesEmerging markets debt was literally the last domino to fall as the global financial crisis intensified in late 2008 due to: Improved creditworthiness of most emerging markets sovereign issuers; Positive growth differentials relative to G-3.For the same reasons, we believe emerging markets debt should be well supported going forward. 5Source: International Monetary Fund (IMF) World Economic Outlook (WEO) September 30, 2011. F = ForecastIMF World Economic Outlook5Relative Resilience: Growth in EM Continues to Outpace Developed EconomiesAccording to an IMF study, the share in World GDP accounted for by Emerging Markets will exceed that of the Developed World within the next few years. The superior growth of Emerging Markets and the development of a middle class in these countries has implications for world trade, deployment of savings (for example in pensions) etc. These are also likely to produce a virtuous cycle, as these countries develop more trading links and also invest in each other.6Source: International Monetary Fund as at 30 April 2011Shares of World GDP Shifting010203040506070801980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120122013201420152016Advanced economiesEmerging and developing economies67Ratings Quality Continues to ImproveSource: Standard and Poor's as at 30 September 2011After a return to significantly more upgrades than downgrades in 2010, year to date, upgrades and downgrades from S&P are more balanced this year. One downgrade reflects the changed methodology of S&P, placing a greater emphasis on political risk and other downgrades are mainly on the back of fiscal deteriorationOf the upgraded countries, two attained investment grade (Colombia and Uruguay), while Indonesia was upgraded to one notch below investment grade. Ratings Upgrades vs. Downgrades8Ratings Quality Continues to ImproveThe trend to upgrade EM countries to investment grade continues.Index Weights by RatingSource: JP Morgan as at 30 September 2011

EM Bond Fund FlowsFlows had been significant until the recent episode of risk aversion, but they have begun to recover.9Cumulative Flows into External and Local EM Bond FundsSource: Emerging as of November 10, 2011

EM Bond Fund FlowsBoth external debt and local currency debt have benefited, although with higher yields and the possibility of currency appreciation, local currency vehicles have benefited more.10Monthly Flows into External and Local EM Bond FundsSource: Emerging as of November 30, 2011New Face of Emerging Markets DebtMarket capitalization: $811 billionIssuers: sovereignAverage rating: BBB+ (S&P)Return drivers: (1) local currencies; (2) local bond yieldsInvestor base: predominantly local11Market capitalization of emerging markets local-currency-denominated debt has quadrupled in the last five years and now represents approximately two thirds of the total EMD universe.*UST = US TreasurySource: JP Morgan as of September 30, 2011. Europe Ex RussiaLocal Bonds (JPMorgan GBI-EM Global Diversified)Asia29.3%-26.0%Russia8.4%Latin America26.3%Middle East/Africa10.0%11

EM Local-Currency Debt: Unique and Potentially Attractive Sources of ReturnsEM local-currency bonds enjoy two distinct sources of returns 1) currency, or the local cash yield plus changes in the spot rate, and 2) duration, or the extra return that local bonds earn relative to local cash a currency hedged bond return.Assuming a modest appreciation of EM currencies, we believe EM local-currency bonds have the potential to generate double-digit returns on an annual basis.

12Source: JP Morgan, Standish as of November 30, 2011GBI-EM Global Diversified: Currency and Duration Returns12

EM Local-Currency Debt: Unique and Potentially Attractive Sources of ReturnsWe believe the steady positive local duration returns (suggesting that local bonds have outperformed currency forwards) reflect the positive term premium of local yield curves. Bond managers, however, can use currency forwards to invest in countries where the currency is attractive, but not prospective duration returns. In several EM countries, inflation-linked bonds are also available.

13Source: JP Morgan as of September 30, 2011GBI-EM Global Diversified: Yield to Maturity13New Face of Emerging Markets DebtMarket capitalization: $436 billionIssuers: sovereign and quasi-sovereignAverage rating: BB+ (S&P)Return drivers: (1) spreads over UST*; (2) UST* yieldsInvestor base: predominantly foreign14Emerging markets debt (EMD) consists of two distinct asset classes: local-currency-denominated bonds and dollar-denominated bonds. The two asset classes are different in their country composition, creditworthiness, return drivers, and investor bases, yet both are fairly liquid.*UST = US TreasurySource: JP Morgan as of September 30, 2011. US$-Denominated Bonds (JPMorgan EMBI Global)Asia17.9%Europe- Ex Russia20.1%Russia10.1%Latin America44.5%Middle East/Africa7.5%14

EM US$-Denominated Debt: Risk/Return ProfileWe believe that given the improvement in the weighted average credit quality of the asset class to BB+, at current levels sovereign spreads may offer more than adequate compensation for the potential credit losses.Our research suggests that historically BBs outperform other rating categories over the complete credit cycle.15Source: JP Morgan as of November 30, 2011JPM EMBI Global: Spreads Over US Treasuries15Important Information16This is a financial promotion and is not intended as investment advice. The information provided within is for use by professional investors and should not be relied upon by retail investors.All information relating to Standish Mellon Asset Management Company LLC (Standish) has been prepared by Standish for presentation by BNY Mellon Asset Management International Limited (BNYMAMI). Any views and opinions contained in this document are those of Standish at the time of going to print and are not intended to be construed as investment advice. BNYMAMI and its affiliates are not responsible for any subsequent investment advice given based on the information supplied.This document may not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorised.This document should not be published in hard copy, electronic form, via the web or in any other medium accessible to the public, unless authorised by BNYMAMI to do so. No warranty is given as to the accuracy or completeness of this information and no liability is accepted for errors or omissions in such information. To help us continually improve our service and in the interest of security, we may monitor and/or record your telephone calls with us.This document is issued in the UK, mainland Europe (excluding Germany) by BNY Mellon Asset Management International Limited. BNY Mellon Asset Management International Limited, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Services Authority.In Germany, this document is issued by WestLB Mellon Asset Management Kapitalanlagegesellschaft mbH, which is regulated by the Bundesanstalt fr Finanzdienstleistungsaufsicht. WestLB Mellon Asset Management was formed as a 50:50 joint venture between The Bank of New York Mellon Corporation and WestLB AG. If WestLB Mellon Asset Management Kapitalanlagegesellschaft (WMAM KAG) receives any rebates on the management fee of investment funds or other assets, WMAM KAG undertakes to fully remit such payment t