New world order INVESTMENT INSIGHTS IN BRIEF. Growing population, smaller world. Connecting you with our global network of investment professionals

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1 PORTFOLIO DISCUSSION CAPTURING GLOBAL GROWTH THROUGH ACTIVELY MANAGED EQUITY STRATEGIES October 13 Connecting you with our global network of investment professionals IN BRIEF A rising middle class in developing countries is sparking new demand for consumer goods, infrastructure and housing. So as the world s economies and capital markets become more integrated, emerging markets will act as a key driver of global growth. A company s country of domicile often has little to do with where it generates revenue. European and U.S. corporations see a growing share of their revenue coming from emerging markets. In the U.S. and Canada, hydraulic fracturing has unlocked new supplies of oil and natural gas, delivering valuable cost savings to industrial and energy sectors and creating new growth prospects in the reindustrialization of North America. Active equity managers are well positioned to capture these global growth opportunities, especially as correlations among stocks subside and investors focus on fundamentals. Innovative technology has created a smaller, more interconnected world. The exchange of goods, culture and ideas is remarkably widespread. Transportation has become more efficient. Communication is easier. Vast urbanization is creating new jobs and bolstering disposable income, lifting millions of people out of poverty and generating waves of new consumers. In the next five years, the middle class of emerging markets is expected to grow by 39 million people, a figure larger than the total population of the U.S. Meanwhile, the U.S. is experiencing a different form of transformation, as the world s largest consumer of energy has started to produce more oil than it imports. For equity investors, the growth opportunities created by these broader economic trends have coincided with decreasing global correlations among equities, setting the stage for active managers to outperform. Growing population, smaller world As the global economy and capital markets become increasingly integrated, emerging markets should play an ever more important role as a driver of growth. The United Nations in 12 estimated that each day about 18, people in developing countries move from rural communities to urban centers. When the population of new arrivals is added to the existing urban population, it equates to the creation of one new New York City about every two months. These migration patterns from rural to urban areas should create a significant and sustained demand for and supply of highways, housing, utilities, public transportation, water treatment and energy. Overall economic growth should pick up. If urbanization and economic FOR INSTITUTIONAL/WHOLESALE OR PROFESSIONAL CLIENT USE ONLY NOT FOR RETAIL DISTRIBUTION

2 PORTFOLIO DISCUSSION: Title Copy Here expansion together lift wages and living standards, this should further boost the consumption of both basic materials and luxury goods (Exhibit 1). Emerging market consumers are an essential component of global growth EXHIBIT 1: SHARE OF GLOBAL NOMINAL CONSUMPTION 35 U.S. consumption % of global EM consumption % of global Source: FactSet, Compustat, Russell, J.P. Morgan Global Economics Research, J.P. Morgan Asset Management. Foreign sales as a percentage of total sales is calculated as an unweighted average of individual index constituent companies reported sales figures and does not capture all index members due to differences in reporting practices; data as of September, 13. Though emerging market economies have expanded rapidly over the past decade, they are poised for continued growth that will far outpace that of developed economies. A February 13 OECD forecast projected that non-oecd (emerging market) economies would expand at an average annual rate of 6.9% between 12 and 17 and 5.1% between 18 and. That compares with OECD GDP growth of 2.1% and 2.3%, respectively. Still, investors have become increasingly concerned about the relative slowdown in emerging markets, focusing especially on China s retreat from a % annual growth rate for much of the past decade to an estimated 7.5% GDP increase this year. In recent months, both emerging market equity and bond funds have experienced significant outflows, largely the result of the sudden backup in U.S. interest rates and emerging market debt spreads. Despite the macroeconomic shifts, however, it is hard to deny the powerful potential of the emerging market consumer amid a rapidly growing middle class. For example, 14 million cars were sold in China last year, 9 million of which were from companies listed in developed markets. In portfolio construction, opportunities to capture the ascent of the emerging market consumer exist in both the emerging and developed worlds. As corporations have become increasingly multinational, a company s country of domicile often has little to do with where it derives its revenue. European companies generate approximately one-third of their revenues from their activities in emerging markets, more than double the level of revenues that they generate from the United States. This important trend has accelerated in recent years (Exhibit 2). Companies domiciled in the U.S. also have seen an increasing amount of their revenues come from foreign sales (Exhibit 3). Europe: Sales exposure to emerging markets has increased at a very high rate EXHIBIT 2: EUROPEAN CORPORATE EARNINGS % of total revenues Emerging markets North America Source: Morgan Stanley Research; data as of May 31, 12. Shown for illustrative purposes only U.S. companies have increased their foreign sales EXHIBIT 3: FOREIGN SALES, % OF TOTAL SALES 35 Mega Cap (Russell Top ) Large Cap (Russell ) Small Cap (Russell ) Source: FactSet, Compustat, Russell, J.P. Morgan Global Economics Research, J.P. Morgan Asset Management. Foreign sales as a percentage of total sales is calculated as an unweighted average of individual index constituent companies reported sales figures and does not capture all index members due to differences in reporting practices; data as of September, New World Order: Capturing global growth through actively managed equity strategies

3 Globalization has enhanced the value of brand equity, as rising disposable incomes in emerging markets have sparked demand for global recognized brands. Companies that are already household names in Europe and the U.S. are expanding their operations to take advantage of the growing wealth in emerging markets. For example, in its third fiscal quarter report, Starbucks Corp. reported a 29% year-over-year increase in net revenues for China/Asia-Pacific, primarily due to 523 net new store openings over the past 12 months and a 9% increase in comparable store sales. The international expansion of developed world companies underscores their belief that emerging market consumers will propel future sales growth, a trend that will continue to redefine the global economic landscape. Meanwhile, in the U.S., a classic growth story is taking shape. An abundant supply of low-cost natural gas may give U.S. companies an important competitive advantage in the global market EXHIBIT 4: NATURAL GAS PRODUCTION Cubic meters (trillions) 5 Other EIA forecast 5 Shale gas Source: J.P. Morgan, EIA. Forecasts are from the EIA Annual Energy Outlook 13. The reindustrialization of North America Although in recent years the technology sector has been a main driver of U.S. economic expansion, growth is now taking shape in new industries. Most dramatically, advancements in horizontal drilling and hydraulic fracturing have unlocked oil and natural gas supplies trapped in shale formations across the U.S. At the end of May 13, U.S. domestic crude-oil production exceeded imports for the first time in 16 years. The increase in domestic production helped the U.S. meet 88% of its energy needs in February 13, the highest monthly rate since By 17, the International Energy Agency estimates, the U.S. will have overtaken Saudi Arabia as the world s leading oil producer. For U.S. refiners, domestically produced crude oil is cheaper than foreign oil, and the boom in domestic production has allowed them to improve margins and regain their competitive edge against international refining companies. The benefits of increasing domestic oil and gas production are also galvanizing growth across a range of industries. Globally, natural gas prices are among the least expensive in the U.S., largely because of the increased supply from shale extraction (Exhibit 4). For U.S. chemical manufacturers that use natural gas to make plastic and polymers, cheaper natural gas prices dramatically lower their costs relative to international rivals, providing the U.S. manufacturers with an enormous competitive advantage. U.S. railroad companies are also experiencing a growth revival as the increased activity in the industrial and energy sectors has led to more freight traffic. Reindustrialization is also animated by the relative patterns of wage growth in the U.S., China and Mexico, leading to the return of a significant number of manufacturing jobs to North America. As wage growth has been relatively stagnant in the U.S., with the average monthly wage rising from $2,942 in 1 to $3,885 in 12, it has soared in China (of course, from a fraction of the base), from $74 in 1 to $348 in 12. In Mexico, the average monthly wage increased only modestly, from $352 in 1 to $455 in 12. With the average monthly wage just $7 higher in Mexico than in China, more companies are moving manufacturing jobs back to North America. Identifying the individual companies that are best positioned to benefit from the reindustrialization of North America will help investors capitalize on this economic trend. We believe that a bottom-up, fundamental approach to portfolio construction, despite recent headwinds, will be the best way to capture the longer-term growth opportunities created by the shifting global economy. Falling equity correlations bolster actively managed equity strategies Equity correlations spiked following the 8 financial crisis and again at the height of Europe s debt crisis as macro drivers dominated flows and portfolio performance. During these periods of high equity correlations, individual company fundamentals are largely ignored as investors hide in perceived J.P. Morgan Asset Management 3

4 PORTFOLIO DISCUSSION: Title Copy Here safe-haven markets until the smoke clears, then add risk back to their portfolios when market sentiment turns positive again. Active management tends to add value over time, but performance can be cyclical. Given the challenges that actively managed strategies have confronted during the past five years, many investors have chosen passive equity strategies that are designed simply to track the performance of an index. However, although these passive strategies may seem to offer more diversification because of the large number of stocks they hold, they could potentially leave investors with unintended exposures, particularly when a specific sector or group of sectors is significantly overvalued. In addition, given that country of domicile is becoming less reliable as an indicator of the source of profits, passive equity strategies can result in unintentional country or regional exposures. For example, passively investing in emerging markets typically leads to significant commodity exposure and less access to consumer and urbanization trends (Exhibit 5). To be sure, even as emerging economies have provided exciting growth and investment opportunity, the historically cyclical nature of their success and persistent disparities within the asset class often leads to unwelcome volatility. For this reason, long-term investment success depends upon the careful monitoring of the disparate group of countries and companies that make up the emerging markets (Exhibit 6). Actively managed emerging market equity strategies deliver alpha EXHIBIT 6: MEDIAN EXCESS RETURN FROM ACTIVE MANAGERS Source: evestment, simple weighted median performance of active managers; returns are in USD terms; data as of December 31, In U.S. markets, the correlations of stocks have retreated, and investors have renewed their focus on fundamentals, which should serve to bolster actively managed U.S. equity strategies (Exhibit 7, next page). In the past year, the U.S. stock market has demonstrated greater breadth and diminished outperformance of mega-cap stocks, an advantage for active management. In addition, some of the tail risks that have been catalysts for recent market volatility and higher correlations are subsiding, as a financial crisis emanating from Europe appears much less likely now than it did a year ago (YTD) Passively investing in emerging market stocks does not provide exposure to key economic trends EXHIBIT 5: INDEX COMPOSITION BY SECTOR: MSCI EM VERSUS S&P 5 Commodities Materials Energy Consumer-oriented Consumer Healthcare 7 MSCI EM Countries MSCI EM S&P MSCI EM S&P Top five countries Bottom 16 countries Source: Bloomberg, FactSet, MSCI; data as of May 31, New World Order: Capturing global growth through actively managed equity strategies

5 Equity correlations have pulled back from peak levels EXHIBIT 7: LARGE-CAP EQUITY CORRELATIONS Great Depression/WWII Cuban Missile Crisis OPEC Oil Crisis 1987 Crash Sovereign Debt Crisis Lehman Bankruptcy Tech Bust/9-11 Average = 26.9% Sept. 13 = 36.7% Source: Empirical Research Partners LLC, Standard & Poor s, J.P. Morgan Asset Management. Capitalization-weighted correlation of top 75 stocks by market capitalization, daily returns, 1926 June, 13. Data as of September, 13. Chart is shown for illustrative purposes only. Over the longer term, we look to invest in U.S. companies that: serve large addressable markets in which a change is under way enjoy sustainable competitive advantages show positive price momentum We think stocks that own these characteristics should outperform the broader market over time. As we assess global growth prospects, we see significant investment potential in the emerging market consumer and, more generally, in a newly empowered middle class, driving demand for infrastructure, energy, housing and consumer goods. We believe the reindustrialization of North America has only just begun and will in coming years galvanize growth in a wide range of industries and sectors. Across the spectrum, we are strong believers in the potency of active equity management. As the world economy evolves, actively managed equity strategies can help investors manage new and unexpected risks and access longer-term growth opportunities. J.P. Morgan Asset Management 5

6 PORTFOLIO DISCUSSION: Title Copy Here AUTHORS George Iwanicki Managing Director, Macro Strategist Emerging Market Equities Jonathan M. Sherman Head of U.S. Equity Growth, Small Cap Client Portfolio Manager Team James M. Connors Client Portfolio Manager U.S. Equity Robert C. LeDoux Client Portfolio Manager Emerging Markets NOT FOR RETAIL DISTRIBUTION: This communication has been prepared exclusively for Institutional/Wholesale Investors as well as Professional Clients as defined by local laws and regulation. The opinions, estimates, forecasts, and statements of financial markets expressed are those held by J.P. Morgan Asset Management at the time of going to print and are subject to change. Reliance upon information in this material is at the sole discretion of the recipient. Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as advice or a recommendation relating to the buying or selling of investments. Furthermore, this material does not contain sufficient information to support an investment decision and the recipient should ensure that all relevant information is obtained before making any investment. Forecasts contained herein are for illustrative purposes, may be based upon proprietary research and are developed through analysis of historical public data. J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication may be issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited which is authorised and regulated by the Financial Conduct Authority.; in other EU jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Switzerland by J.P. Morgan (Suisse) SA; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in India by JPMorgan Asset Management India Private Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited; in Australia by JPMorgan Asset Management (Australia) Limited; in Brazil by Banco J.P. Morgan S.A.; in Canada by JPMorgan Asset Management (Canada) Inc., and in the United States by J.P. Morgan Investment Management Inc., JPMorgan Distribution Services Inc., and J.P. Morgan Institutional Investments, Inc. member FINRA/ SIPC. 27 Park Avenue, New York, NY JPMorgan Chase & Co. II_New World Order: Capturing global growth FOR INSTITUTIONAL/WHOLESALE OR PROFESSIONAL CLIENT USE ONLY NOT FOR RETAIL DISTRIBUTION jpmorganinstitutional.com