Theme Investing. Capitalizing on global trends. August 2010 I emerging market equity. Introduction. Consumption

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1 insights Theme Investing Capitalizing on global trends August 21 I emerging market equity Please visit jpmorgan.com/institutional for access to all of our Insights publications. Authors Richard Titherington Portfolio Manager, Emerging Markets Infrastructure Fund Chief Investment Officer and Head of the Emerging Markets Equity Team Peter Kirkman Portfolio Manager, Global Consumer Trends Fund Global Equities Team Introduction Since 27, emerging market consumers have been outspending U.S. consumers. By 22, more than 5% of the population of Japan will be of retirement age. By 23, almost 6% of the world s population will live in towns and cities. In this paper, we look at how theme investing can help investors capitalize on these shifting patterns of globalization, demographics and urbanization, and examine how these trends are contributing to two of the key themes powering equity markets today consumption and infrastructure. Consumption The rise of the emerging market consumer Emerging market countries are set to dominate consumption in the future. In 27, emerging market consumers began to outspend their U.S. counterparts. 1 By 215, they are forecast to account for 37% of global consumption, 2 as rising incomes, growing middle classes and rapid economic growth spur demand. Exhibit 1: Emerging markets will dominate future consumption 12% 22% 1% 25 Forecast % 34% 1 Source: The Economist, April Source: Credit Suisse. 11% 6% 2% Source: Credit Suisse, Economics department research. 37% 26% U.S. Emerging Markets Japan Other Industrial Europe For institutional use only

2 Even during the financial crisis, emerging market consumers kept buying, helping to buffer many emerging economies from the global recession. Indeed, as Exhibit 2 shows, while sales of consumer goods in developed markets fell 14% between 27 and 29, demand in emerging markets kept growing, increasing 11%. Exhibit 2: Emerging market consumers kept buying through the crisis Change in consumer discretionary company sales (%) To developed markets To emerging markets Analysis based on 254 members of the MSCI All Country World Consumer Discretionary index. Source: Company reports, MSCI, Compustat, Worldscope, Bloomberg, J.P. Morgan. The potential market for companies seeking to sell to emerging market consumers is huge: populations already vastly outstrip those in the developed world and are growing much faster. In India and China, hundreds of millions of people will enter the middle classes in the coming decades. 3 Exploiting the consumption theme Theme investing provides the opportunity to exploit the rising power of the emerging market consumer, as well as offering a new way to benefit from the trends driving more mature western markets. Investors should be looking to avoid short-term fads, instead seeking to profit from persistent, long-term trends with the ability to produce sustainable returns. For example, Starbucks effectively created a new category, convincing millions of people that they needed to buy a cup of hot milk with a shot of espresso every day creating a spending habit that had not previously existed. Spotting these trends early provides a durable source of returns for investors. 3 Source: The world turned upside down in the Economist, 17 April First break all the rules: The charms of frugal innovation in The Economist, April 17, Some of the trends we believe will shape the consumer landscape in the coming decades include: Aspirational demand By 23, two billion people are forecast to move from the lower- to the middle-class income bracket, changing buying patterns around the globe as people aspire to higher standards of living. One way of accessing this trend is through western companies selling into emerging markets. Most of the world s biggest brands are owned by western companies, and as wealth levels rise in developing markets their inhabitants aspire to own these branded goods. However, the aspiration trend is not only about luxury goods. As emerging markets develop, their citizens often aspire to what those in the developed world regard as basic necessities. In China, for example, only 6% of babies wear disposable diapers, compared with 9% in the UK. With 4 million babies in China, the growth potential for diaper companies selling into the market is considerable. Demographics One of the benefits of using demographic trends to assess investments is their predictability. Demographic factors are rational and quantifiable drivers of economic change. Aging populations drive changes in buying patterns, transforming the economy of a country and opening up new revenue streams. In the introduction, we noted that more than 5% of the Japanese population will be of retirement age by 22. Theme investors can use this information to predict changing consumption patterns. Companies that produce hip replacements and other musculoskeletal solutions, for example, can be expected to experience much faster growth and increased revenue streams as populations age. Health and wellness Health and wellness is an observable trend across the globe. In developed markets, people want to live as long as possible and look as good as they can, boosting demand for products perceived as offering lifestyle improvements. In the U.S., sales of organic food have increased from under USD 4 billion to almost USD 16 billion in the past ten years, reflecting the trend for healthier eating. In emerging markets, meanwhile, meeting basic sanitary needs remains a key challenge. Tissue paper, for example, 2 Theme Investing: Capitalizing on global trends

3 is a growth market in China, as is shampoo. In India, companies offering innovative, low-cost water purification systems and heart monitoring equipment are providing solutions to some of the country s most pressing health problems. 4 Infrastructure The emerging markets building boom Driven by many of the same forces that are powering the consumption theme changing demographics, globalization, urbanization infrastructure is becoming an increasingly important emerging market theme, creating opportunities for investors as governments and companies build the roads, power stations and ports needed to support the next phase of growth. China, for example, is currently building 57 new airports, and is developing the world s largest, fastest, most technologically sophisticated rail network at a cost of USD 3 billion. In Brazil, meanwhile, up to USD 5 billion of investment is estimated to be needed to improve infrastructure before the 214 World Cup, while USD 15 billion will be invested in Rio de Janeiro ahead of the 216 Olympic Games. Urbanization placing a strain on emerging market cities by 23, almost 6% of the planet s inhabitants will live in towns and cities. 5 Emerging urban populations are projected to grow between 133% and 15% faster than current overall population growth, with more than 35 million people equivalent to half the population of Europe moving to urban areas between 21 and 215. The urbanization trend is being driven by the industrialization of emerging nations. People are lured from the countryside to urban centers by the prospect of better wages and improved quality of life. This in turn increases demand for goods, leading to further industrialization and creating more jobs the virtuous circle of emerging market development. In 1975 the United Nations estimated that only three cities had a population of more than ten million people: Tokyo, New York and Mexico City. By 25, that number had risen to 2, and by 225, the UN estimates the total will be 29. Of these, 24 will be in the emerging world. By 25, emerging market city dwellers are expected to make up 83% of the world s urban population. 5 Urbanization means emerging markets have readily available labor forces, keeping wage costs cheap and allowing companies to expand rapidly key competitive advantages in the global marketplace. However, the influx of new inhabitants places a strain on basic services in the cities public transport, roads, electricity, water creating a pressing demand for investment in infrastructure. The need for new infrastructure is driven by rapid industrialization and urbanization. The United Nations anticipates that 5 Source: United Nations. Exhibit 3: Urbanization: 35 million people headed for the cities in the next five years Percent Source: World Bank, January 28. Emerging regions rural population Emerging regions urban population Total change from prior five year period urban population J.P. Morgan Asset Management 3

4 Globalization investment needed to sustain growth Meanwhile, growing demand for emerging market exports has overstretched local infrastructure, which is already weak in many cases as a result of years of underinvestment. Emerging economies have a pressing need for increased capacity if they are to maintain and extend their competitive advantage. As a result, investment in power stations, airports, railways and other infrastructure has become a key priority for regional businesses and governments, with spending projected to reach USD 21.7 trillion over the next decade. 6 Many emerging market countries have undergone meaningful economic and structural reforms over the past decade, increasing their ability to fund large infrastructure investments. In contrast to the majority of developed markets, the pace of expenditure in emerging markets has only been quickened by the financial crisis, as many governments have used infrastructure investment as a means of stimulating economic growth. Exhibit 4: Infrastructure spending is projected to grow USD (billion) 2, 1,8 1,6 1,4 1,2 1, Middle East Latin America Eastern Europe Asia Africa Source: Morgan Stanley Research. Accessing the infrastructure theme Infrastructure investment creates a virtuous circle, allowing for greater industrialization and urbanization, which then drives the need for further investment. As a result, companies with exposure to the infrastructure theme are typically growing faster than the broader market. For investors, the infrastructure theme offers broad opportunities across multiple emerging market sectors from construction companies to utilities, from airport operators to financing providers in a tangible growth area. For example, the construction of a new highway in an emerging market country creates multiple investment opportunities, benefiting companies in diverse industries: the commodity producers who provide the raw materials, the construction contractor and the highway tollbooth operator, among many others. Theme Investing Within a Portfolio The twin themes of consumption and infrastructure inform and enhance each other. By boosting employment and improving economic capacity, infrastructure spending increases wealth and stimulates consumption. In turn, robust consumption contributes to economic stability, providing governments and businesses with the means to invest in infrastructure. Within a portfolio, too, the consumption and infrastructure themes complement each other: emerging market consumption is a long-term secular trend, as seen in the financial crisis when strong domestic demand helped to insulate emerging economies from global trade winds. Infrastructure, meanwhile, is also a structural theme, but offers greater cyclical exposure. Both themes offer strong growth potential for investors with long-term investment horizons who are prepared to take on higher risk in pursuit of higher returns. To take full advantage of the many opportunities offered by theme investing, bottom-up management is vital particularly in inherently inefficient emerging markets. A top-down manager who allocates to the industrial engineering sector, for example, will not fully capture the many cross-sector opportunities offered by the infrastructure theme. Instead, it is important to find a bottom-up manager capable of scrutinizing individual companies and discovering those that truly offer the ability to benefit from shifting economic trends, whatever sector or country they fall in. Theme investing at a glance Seeks to capitalize on structural shifts in the global economy Taps into the growing spending power of the emerging market consumer Benefits from rising global demand for infrastructure Provides access to truly long-term investment opportunities 6 Source: Morgan Stanley. 4 Theme Investing: Capitalizing on global trends

5 Richard Titherington, Managing Director, is the Chief Investment Officer and Head of the Emerging Markets Equity Team. An employee since 1986, Richard transferred to the Pacific Regional Group in He was appointed as a managing director in April 21 and appointed head of the global emerging markets business in December 21. Prior to 1994 Richard was a U.S. and international pension fund manager, working in the UK until he transferred to Hong Kong in Before joining the firm, Richard spent two years as an analyst with UKPI in London. Richard obtained an M.A. in politics, philosophy and economics from Oxford University. Peter Kirkman, Managing Director, is a global portfolio manager in the Global Equities Team in New York. An employee since 21, Peter was previously the chief investment officer and the senior portfolio manager of the Fleming Japan Team. Before joining the firm, he was the senior portfolio manager of Japan Equities at the Trust Company of the West (TCW) in London and a portfolio manager in Japan Equities at Prudential UK. Peter holds a B.Sc. (Hons) in accountancy from the University of East Anglia and an M.Phil. in management studies from Cambridge University. He is also an associate of the U.K. Society of Investment Professionals (ASIP). FOR PROFESSIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Any forecasts, figures, opinions or investment techniques and strategies set out, unless otherwise stated, are J.P. Morgan Asset Management s own as at August 21. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. They may be subject to change without reference or notification to you. The views contained herein are not to be taken as an advice or recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate and investors may not get back the full amount invested. Both past performance and yield are not necessarily a guide to future performance. Exchange rate variations may cause the value of investments to increase or decrease. Investments in smaller companies may involve a higher degree of risk as they are usually more sensitive to market movements. Investments in emerging markets may be more volatile and therefore the risk to your capital could be greater. Further, the economic and political situations in emerging markets may be more volatile than in established economies and these may adversely influence the value of investments made. Real estate and infrastructure investing may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector. Real estate and infrastructure investing may be subject to risks including, but not limited to, declines in the value of real estate, risks related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by borrower. You should also note that if you contact J.P. Morgan Asset Management by telephone those lines could be recorded and may be monitored for security and training purposes. J.P. Morgan Asset Management is the brand for the asset management business of J.P. Morgan Chase & Co. and its affiliates worldwide. The above communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, and JPMorgan Asset Management Marketing Limited which are regulated by the Financial Services Authority; in other EU jurisdictions by JPMorgan Asset Management (Europe) S.à r.l. Issued in Switzerland by J.P.Morgan Suisse S.A., which is regulated by the Federal Banking Commission; and in the United States by J.P. Morgan Investment Management Inc., which is regulated by the Securities and Exchange Commission. 27 Park Avenue, New York, NY JPMorgan Chase & Co. IM_INS_EME_THEMEINVESTING jpmorgan.com/institutional