Newsletter January 2013

2012 was a really good year for stock markets, which benefitted investors worldwide. The German stock market index, the DAX, gained nearly 30%, enjoying its best year since 2003. The world's largest stock market, the US, also had a good year, with gains of close to 10% for the Dow Jones and the broader S&P. The sentiment that it was a good year for stock markets set in gradually throughout the year, and it was not until the autumn that it became a more widespread view.

At the same time, money continued to flow into bond funds, as many investors who are not yet fully convinced that it is possible to make money from shares continued to put their faith in this asset class. The market for corporate bonds also continued to exhibit strong growth throughout the year, which means that there is plenty of money that could potentially find its way into the stock markets.

Our markets in Eastern Europe had a rela-tively good year, with Turkey as a clear leader, with an increase of as much as 61.9% measured in dollar terms. However, Estonia and Poland also had a good year, with impressive gains of 41% and 34.1% respectively.

The great exceptions during 2012, all of which posted negative returns, were Ukraine (-38.8%), Kazakhstan (-12.9%), Slovakia (-9.1%) and Serbia (-0.1%). Russia ended the year with an increase of 10.5% – not bad at all, but worse than we had expected.

Several of our markets in Asia had a strong year. Thailand and the Philippines were the best performers here, with the markets gaining 45.6% and 42.0% respectively. China posted a 22.4% gain for the year.

After five years of turbulence on world financial markets, we believe that 2013 will be characterised by a relative calm. In our outlook for 2013, we call this “the start of a return to normal behaviour.” There are good conditions for better economic growth in most large world economies, and at the same time, interest rates will remain low. The FED has said that it will continue to keep interest rates low to keep

unemployment in check. In addition, interest rates will most likely be lower than inflation, which means that, to secure its value, money should seek out tangible assets, and this creates a favourable situation for shares and property.

We also believe that investors will seek out smaller markets during the year. Just as with shares, the big companies will post gains first, and then come the small companies once investors feel secure in the upward trend. And there is a real possibility that the same pattern will occur for stock markets on a global basis, and in that case, the relatively smaller emerg-ing markets will benefit. These markets are also enjoying fundamentally low valuations. All of this means we can look to 2013 with confidence.

Peter Elam HåkanssonChairman and Head of Public Equity investment team

Written onboard flight QR 301 (Qatar Airways) from Colombo to Doha

1

New year, new opportunities

Aeroflot: Former Soviet airline now soaring Page 2

Critical reform increases the opportunities for China investors Page 3

ALSO Of intereSt SUBSCriBe

Subscribe to the Newsletter atwww.eastcapital.com/newsletteralso available in Swedish

Phot

o: E

mil

Hol

mst

röm

, Eas

t Cap

ital

In 2013, interest rates will most likely be lower than inflation. This creates a favourable situation for shares and property. One of Moscow's fastest growing areas is Moscow City.

January 2013

Aeroflot: Former Soviet airline now soaringThe days when stepping onto an Aeroflot plane was a risk to your life are long gone. The aviation giant of the former Soviet Union has transformed into one of the most modern and profit-able airlines in the world, positioned to tap into growth both internationally and domestically.

In the Soviet era, Aeroflot was the national carrier and at one point in time the largest airline in the world. Following the collapse of the Soviet Union, Aeroflot – which was founded in 1923 – was split into 300 regional airlines. Some now carry the flag of countries that broke away from the Soviet Union, like Uzbekistan Airways, Air Moldova and Lithu-anian Airlines. The part that was taken over by the Russian state retained the name Aeroflot. But that is probably where the similarities end.

Aeroflot has gone through enormous changes over the past decade. Soviet-built aircrafts have been replaced with Western-made jets, flight routes have been extensively restructured and the entire company has been modernised – and made effective. Today, Aero-flot is one of the most profitable airlines in the world, not least thanks to its fuel-efficient aircraft fleet, which is the newest in Europe.

”I believe we are doing a very good job in terms of cost structure. Aeroflot is the most efficient operator in terms of both total operat-ing costs, and fuel and staff cost on a stand-alone basis,” said Giorgio Callegari, the former director of Alitalia that stepped in as head of strategy of Aeroflot’s management team in 2011. He was talking to East Capital’s investors in Moscow late last year.

East Capital is the third largest owner of Aeroflot after the state, which still controls 51% of the shares, and Russian billionaire Alexander Lebedev. It's not only low costs that sparked East Capital's investment in Aeroflot, but its growth prospects, both in Russia and abroad.

“During the first ten months of 2012, in comparison with the same period of 2011, Aeroflot increased the number of carried passengers by 25.9%. We are not only growing, but we are also growing efficiently,” Callegari said.

”Russia still has a low number of fliers compared to other countries. Trips per capita in Russia was 0.3 in 2010, compared to 1.1 in Europe – where there are also very competi-tive services offered by high-speed trains – and 3.0 in the US,” he said. “The forecasted CAGR

for 2008-2017 is around 8%. That is an amazing growth rate and it is also amazing because it has been able to withstand slowdowns.”

That domestic growth, in addition to the potential for international growth offer Aero-flot the opportunity to put its name among the world's major airlines again.

”The geographical position of Moscow means that planes from New York do not need to go down to, for example, Frankfurt and then go up again to reach India,” he said.

“Compared to Air France and Turkish Airlines we can offer a shorter travel time and hence also a lower cost. This is true not only for the traffic between New York and India, but also for the traffic between Europe and Asia,” said Giorgio Callegari.

Emil Holmström

The Turkish stock market was one of the big winners in 2012, thanks to the economy’s soft landing. The good news is that growth will be even stronger in 2013. But, the stock market may not be able to match its 2012 performance.

Last year, the Turkish economy performed strongly, with growth of between 3 and 3.5%. This year's outlook is even better.

“Most analysts believe that growth in 2013 will land at around 4%,” said East Capital's chief economist, Marcus Svedberg. “We believe it can be even higher”.

“When consumption in Turkey starts to grow again, historically we have seen that it

has a tendency to grow very strongly,” Sved-berg said, but added, “then we in turn again get the problems with the current account deficit, which is Turkey's eternal Achilles heel”.

Inflation in Turkey is currently around 6.5%.

“It is lower compared to earlier in 2012, but as growth is now increasing, inflation will follow,” Svedberg explained. “Moreover, the Turkish Central Bank started to cut interest rates, which stimulates credit growth and increases pressure on inflation.”

The Turkish market performed well through-out last year, but was particularly strong in November, when the rating agency Fitch upgraded its rating to “investment grade”.

It seems highly likely that in 2013 one of the other rating agencies will also raise Turkey's credit rating.

“If Turkey gets its second credit rating increase it means that more capital will flow into the country next year. Many large funds are not allowed to invest in a country until it has received two investment grades,” Svedberg said. “In addition to providing support for the bond market, it will also have a positive effect on the stock market and the currency.”

In terms of the Turkish stock market in 2012, the banks and financial companies gained the most.

Karl Lans

Turkey looking good for 2013, but risks remain

Aeroflot currently has one of the most modern aircraft fleets in the world.

Phot

o: K

irill

Naum

enko

January 2013

Currently, 100 million Chinese live illegally in cities. Soon they might be able to register where they really live.

Phot

o: K

arin

e H

irn,

Eas

t Cap

ital

Despite the serious public deficit and debt issues in the EU and US, 2012 turned out to be a good year for equi-ties, in particular in emerging mar-kets. Emerging market equities gained +15.1% outperforming developed market equities which were up +13.2%. EM equity funds saw four consecutive months of inflows at the end of 2012, and ended the year with USD 51 bn of new money, compared to USD 34 bil-lion in redemptions during 2011.

As for Chinese equities, 2012 started off strong during the first quarter. We then saw a 15% decline in May on renewed concerns for the Euro area. Chinese equities traded sideways during the summer, and then in the run-up to the leadership change and with improving economic growth figures, equities rallied almost 22% during the last four months to end 2012 with a full year increase of 22.4%. The rest of emerging Asia equity markets also produced strong returns. Thailand and the small Philip-pine market were the best performers with a full year gain of 45.6% and 42.0%, India was up 22.0% and Korea +18.6%. Indonesia, 2011's star, were among the weakest markets during 2012, with a gain of 6.1%. Despite the strong performance during 2012 in emerging Asia, the potential for further gains remains high. Valu-ation levels remain low, the region trades at an average P/E multiple of 11x and P/B* of 1.7 and the corporate sector continues to grow fast.

Why hukou reform mattersChina went through a smooth leadership tran-sition when Hu Jintao handed over the party leadership to Xi Jinping and the important standing committee was replaced with a new generation of elite party officials.

Another important but less publicised event in China during 2012 was the announcement by the government that the reform of the household registration system – called hukou – will be accelerated. China’s leading planning agency the NDRC, said the government will speed up household registration reform and set policies so that rural immigrants can turn into legally registered urban residents “in an orderly manner, without delay”. There is still no time table for when the hukou reforms will start.

Historically, the hukou has been an impor-tant tool for the government to control popula-tion movement. Without the permission of the government or an employer, a person was not allowed to relocate. In recent years, with a growing number of migrant industrial workers, the main obstacle preventing hukou reform has been financial. The organisation and funding of healthcare, schools and other social services for migrant workers presents a major challenge to China’s growing cities.

Violent protests in places like Tunisia, Egypt, Libya, and Syria seem to have spurred China’s Communist Party to take proactive measures to prevent social disorder at home. The Party rec-ognises that the creation of a permanent urban underclass could result in political instability, and that spending more on social services for migrants is of critical importance. Today, the urban share of China’s 1.3 billion population has reached 51%, while at the same time over 100 million urban residents lack the rights to social services because they do not have a hukou for the place where they reside.

Recently, it became public that the nDrC and ten other ministries are working on a draft 10-year urbanisation development plan, which may involve the construction of more than 20 urban clusters, 180 new cities and over 10,000 towns.

So during 2013, and in the next few years, we expect the number of migrant workers qualifying for and being granted hukou in China’s cities to accelerate. This in turn will

Critical reform increases the opportunities for China investors

require increased transfer payments to the cities from the central government in Beijing. Almost half of local government revenues today come from Beijing so the transfer system is already in place.

This reform has important implications from an investment perspective. Not only will the migration from the countryside to cities continue in huge numbers for years to come, but a large number of migrants already in cities without a hukou will be granted one. This means a huge boost to spending on social services and infrastructure, a boost to social welfare and security and a resulting boom for all kinds of consumption. The hukou reform will also give an even greater boost to the already buoyant property market, as it will remove one important barrier for migrant families to buy an apartment.

Our investments in China’s real estate developers turned out to be among the best performers during 2012 and the hukou reforms should add to an already strong underlying demand in the coming years.

* P/B stands for the price-to-book ratio of the company. P/B shows how shares are priced relative to the company's assets.

Gustav Rhenman Portfolio manager

This information shall not be regarded as an offer, solicitation or recommendation for an investment. This publication is not directed at you, if we are prohibited by any law of any jurisdiction from making this information available to you and is not intended for any use which would be contrary to local law or regulation. Every effort has been made to ensure the accuracy of the information herein, but it may be based on unaudited or unverified figures and sources. East Capital can under no circumstances be answerable for the totality or correctness of the information, or for direct or indirect loss that can occur as a result of mistakes or discrepancies therein. Historic yields are no guarantee for future yields. Fund units can go up or down in value, and investors may not get back the amount invested. Full information such as simplified prospectus, prospectus and financial reports can be obtained free of charge from East Capital.

End of year rally in Eastern Europe

Most equity markets in Eastern Europe rallied at the close of the year on the back of a greater appetite for risk and belief that the US would not go off the fiscal cliff.

Turkey and Poland were the strongest of the larger index markets. Turkey gained 7.5%, clos-ing 61.9% up over the year. Poland was up 9.2%, ending the year with gains of 34.1%.

The Russian market was also strong in December, advancing 6.3% – but the yearly gain was a relatively modest 10.5%. The Hungarian market was the only one in negative territory in December, dropping 2.2% but nevertheless rising 18% over the year, supported by the HUF appreciating over 10%. Several of the smaller markets in Southeastern Europe, which started to perform during 2H12, were among the best performers in December. Romania, Serbia and Slovenia gained 11.3%, 10.6% and 9.7% respec-tively. The end of year rally even spread to two of the year’s biggest underperformers, Ukraine and Kazakhstan, which gained 4.9% and 4% respectively.

Asian equity markets gained in December on the back of improving economic indicators both from Chinese manufacturing and con-sumer demand in the US. That was despite fears over the potential for the US to go over the fiscal cliff. In China, the CPC’s new lead-ers pledged to maintain growth and promote urbanisation, leading to positive projections for the country’s economic performance in 2013.

In December, the Hong Kong market rose 2.9%, Singapore 4.0%, while Korea gained 3.3% and Taiwan 1.6%. Chinese retail sales growth was the strongest since March 2012. Industrial production accelerated for a third month. The Chinese housing market was well supported with many developers reporting contract sales growth of 40-50% year-on-year. In other parts of Asia, South Korea’s December inflation figure was the lowest for four months, even though industrial output and current-account surplus gained more momentum. In Singapore, manufacturing output growth remained slow, mainly due to a weak electronics sector, and inflation dropped to 3.6% year-on-year.

Market comments, December

Box 1364, 111 93 Stockholm SwedenTel +46 8 505 88 505 Fax +46 8 505 88 508

funds@eastcapital.comwww.eastcapital.com

January 2013

Asian markets defy fears

Funds NAV (28.12.2012) December (%) 2012 (%)USD EUR SEK USD EUR SEK USD EUR SEK

East Capital Russian Fund 1177.57 +4.8 +3.1 +2.4 +14.1 +11.9 +8.0

East Capital Baltic Fund 44.24 +4.9 +3.2 +2.5 +21.8 +19.4 +15.3

East Capital Eastern European Fund 34.40 +5.4 +3.6 +3.0 +20.6 +18.3 +14.2

East Capital Balkan Fund 11.02 +8.0 +6.2 +5.6 +32.0 +29.4 +24.9

East Capital Turkish Fund 10.03 +7.6 +5.8 +5.1 +62.5 +59.4 +53.9

East Capital (Lux) Russian Fund, Class A 80.17 79.17 +4.8 +3.0 +14.1 +11.9

East Capital (Lux) Eastern European Fund, Class A 63.11 69.36 +5.4 +3.6 +20.3 +17.9

East Capital (Lux) China East Asia Fund, Class A 219.79 90.76 +2.1 +1.5 +15.0 +11.0

East Capital (Lux) China Fund, Class A 127.94 88.62 +1.3 +0.7 +12.6 +8.7

East Capital Explorer NAV (31.12.2012) Closing price (31.12.2012)

East Capital Explorer (ECEX) SEK 78/EUR 9.13 SEK 49.00 (corr. to EUR 5.70)

East Capital Explorer provides a liquid exposure to unique investment opportunities across the whole region of Eastern Europe through listing on nASDAQ OMX Stockholm. For more information and subscription of financial reports, please visit the website: www.eastcapitalexplorer.com

Follow our news feeddirectly on the webwww.eastcapital.com

Or follow us onFacebook

and Twitter