Global Funds Outlook on a roller coaster ride

BBVA Research - Global Funds Outlook 1Q19 / 1 Global Funds Outlook on a roller coaster ride February 2019

BBVA Research - Global Funds Outlook 1Q19 / 2 Main Takeaways Global Investment Funds (GIFs) flows have been on a roller coaster ride since the start of Q4 2018. An intense bout of volatility and risk aversion towards the end of last year led to a sharp pullback in portfolio flows from developed markets (DMs). Capital outflows concentrated mainly in Europe, in equity funds and, particularly, in those funds investing in most risky assets (High Yield and Leveraged Loans); while preference for high quality liquid assets jumped. Capital flight, last December, was triggered by heightened uncertainty in wake of cooling global growth, mounting protectionist threat, political and sector specific issues in the Eurozone (EZ) and the Fed s auto-pilot remark on quantitative tightening. In fact, our in-house risk-off indicator slipped into risk redemption territory twice in 4Q18, for the first time since 2015 (when concerns on China's hard landing escalated). This mood led the Fed to take a U turn in January, which, together with China`s stimulus and expectations of a truce on US-China trade negotiations, caused a positive twist in flows. Since the start of 2019, GIF flows to EMs have surged while DMs have seen a visible moderation in the pace of outflows. Furthermore, warning signals have since dissipated, as reflected in our Investment Mood Index. Assuming a soft landing in global growth and against the backdrop of a more dovish Fed, the outlook for EMs has recently improved. Looking ahead, our baseline scenario suggests EMs would continue to outperform DMs in attracting GIF flows over the short term (but at slower pace than in January), although hinged on Fed s future rate actions and progress on US-China trade dispute. Given that risks surrounding the global outlook continue to be tilted to the downside, a repetition of risk-off episodes cannot be ruled out in the coming months-quarters.

How have flows evolved over the past quarter and what is driving them? BBVA Research - Global Funds Outlook 1Q19 / 3

Jan-18 Feb-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 GIF flows to EM and DM (Weekly flows, 4w moving average, % AUM) BBVA Research - Global Funds Outlook 1Q19 / 4 Turning a corner in 2019 - Contrary to last year end, 2019 has, so far, seen a marked moderation in DM outflows and soaring inflows to EM 0.6 0.5 0.4 Dovish pivot by the Fed and the ECB Renewed hopes of a US-China trade deal in sight A step up in policy stimulus by China Rising likelihood of a "soft" Brexit 0.3 0.2 0.1 0-0.1-0.2-0.3 Global growth concerns China-US trade uncertainty Drop in oil prices Volatility spike and equity correction -0.4 EM DM Source: BBVA Research, EPFR

2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 1Q19 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21 What led the flows to pivot back upwards at start of this year after a dismal end to 2018? The Good, the Bad and the Ugly BBVA Research - Global Funds Outlook 1Q19 / 5 The Ugly Global growth outlook dented. Global manufacturing cycle lost steam in 2H18 consistent with slowing world trade. Weak global demand weighed on oil prices. Increasing probability of US recession in the next 12 months. The Bad Rising protectionist threat, China slowdown concerns, rising political and sector specific uncertainty in the EZ and a Fed on auto-pilot unnerved financial markets, triggering intense volatility and equity sell-off in Dec 2018 The Good Fed s dovish shift, narrowing US-China trade differences and a step up in policy stimulus by China has, so far, underpinned the positive turn in GIF flows World manufacturing PMI (Level ± 50) Developed market equity index and VIX (indices, 100: January 2015 and Vix, %) The Fed s dovish shift altered market expectations of Fed s rate hike trajectory 57 56 55 54 53 52 51 50 49 48 150 140 130 120 110 100 90 80 70 43 38 33 28 23 18 13 8 3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 DM EM GLOBAL VIX (rhs) S&P Eurostoxx Current DOTS, upper bound (old) Previous quarter Source: BBVA Research

Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 May-18 Jul-18 Nov-18 Jan-19 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 May-18 Jul-18 Nov-18 Jan-19 BBVA Research - Global Funds Outlook 1Q19 / 6 The recent change in Fed s stance supported EMs, which were struggling with rising global volatility EM FX and EM bond spread US 10Y bond and the USD (indices) (% and DXY index) 74 270 3.5 105 72 320 3 100 70 370 2.5 68 2 95 420 66 1.5 90 64 470 1 62 520 0.5 85 60 570 0 80 FX (EMCI) EMBI spread (rhs, inv) US 10Y DXY (rhs) Source: BBVA Research

Asia EM Europe EM EZ core US EM Asia EM Europe EM EZ core US EM BBVA Research - Global Funds Outlook 1Q19 / 7 Inflows to EMs this year have been driven mainly by a positive turn in common factors, while idiosyncratic factors remained supportive GIF flows across regions in 4Q18: common vs idiosyncratic factors (Monthly average,%, AUM) GIF flows across regions in January 2019: common vs idiosyncratic factors (Monthly average,%, AUM) EM EM DM DM US US Japan Japan EZ core EZ core EZ peripherall EZ peripherall Europe EM Europe EM LatAm -2-1 0 1 2 3 Asia EM -4-2 0 2 4 Common Idiosyncratic Total LatAm -2-1 0 1 2 3 Asia EM -2-1 0 1 2 Common Idiosyncratic Total *All comparative inferences across countries are based on inflows relative to each country s total assets under management (AUM). They are NOT based on actual USD flows, which tend to be significantly larger for the US than for any other economy Source: BBVA Research, EPFR

Jan-18 Feb-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 DM flow dynamics remain weak even in early 2019 despite moderating pace of outflows EZ leading the weakness BBVA Research - Global Funds Outlook 1Q19 / 8 Accumulated flows to DM (% of AUM from January 2018) 3.0% 2.0% Breakdown of monthly portfolio flows by DM region (% of AUM) 2.0% 4Q18 1Q19 1.0% 0.0% -1.0% -2.0% 1.5% 1.0% 0.5% -3.0% -4.0% -5.0% 0.0% -0.5% -6.0% -1.0% US Equity EZ Equity US Bonds EZ Bonds -1.5% Oct-18 Nov-18 Dec-18 Jan-19 US EZ Japan Source: BBVA Research, EPFR

Jan-18 Feb-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Jan-18 Feb-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 BBVA Research - Global Funds Outlook 1Q19 / 9 The tale of two halves for flows is evident in the recent rebound in high yielding assets at the expense of sovereign bonds and MMFs Flows to HY & Leverage loans (4w m.a. % of AUM) 0.50% Flows to Sovereign bonds & Money markets funds (4w m.a. % of AUM) 1.50% 1.25% 0.00% -0.50% -1.00% -1.50% -2.00% 1.00% 0.75% 0.50% 0.25% 0.00% -0.25% -0.50% -0.75% -1.00% -2.50% -1.25% Leverage Loans High Yield Sovereign Money Markets Source: BBVA Research, EPFR

Jan-18 Feb-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 BBVA Research - Global Funds Outlook 1Q19 / 10 During 4Q18, Asian funds led EMs in outperforming developed funds. However, the recovery in the 1Q19 seems to be broad-based Breakdown of monthly portfolio flows by EM region (% of AUM) 2.0% 4Q18 1Q19 GIF flows to EM (Cumulated flows since 2018 % AUM) 5% 4% 1.5% 3% 1.0% 2% 0.5% 1% 0.0% 0% -1% -0.5% -2% -1.0% Oct-18 Nov-18 Dec-18 Jan-19 LATAM ASIA EX JP-CH Emerging Europe LatAM EM Asia ex China EM Europe Source: BBVA Research, EPFR

Warnings from our risk-off indicator and its implications BBVA Research - Global Funds Outlook 1Q19 / 11

Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 BBVA Research - Global Funds Outlook 1Q19 / 12 Our risk-off indicator slipped into risk redemption territory twice in 4Q18, a strong signal ahead of Fed s U-turn in January Past episodes of financial market turmoil coincide well with our Risk Redemption alert Risk-off alerts (Colored areas indicate outbreaks) Investment mood index* (Above (below) zero = risk-on (risk-off) mood Lehman Brothers European Debt crisis Sharp drop in oil prices China EM turmoil Red October 2.0 1.5 Taper tantrum China yuan devaluation "Risk-on mood" 1.0 0.5 0.0-0.5-1.0-1.5-2.0 "Risk-off mood" Risk aversion Safe-haven Risk redemption (*) see annex for more details. Source: BBVA Research, EPFR The Risk aversion alert is based on asset price movements (rates and VIX); while the Safe-haven and Redemption alerts are contained within the Risk off alert but focus on abrupt movement in GIF flows: Safe haven is linked to abrupt movements from EM to DM assets, while Redemption is linked to overall reductions in GIF assets towards other (probably more liquid) assets

Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Investors preference has increasingly switched towards taking positions in EMs after the Fed s pause BBVA Research - Global Funds Outlook 1Q19 / 13 Investor appetite for DM vs EM (Indicator expressed as standard deviation from historical mean) Investor appetite for bonds vs equity (Indicator expressed as standard deviation from historical mean) 1.5 1.3 1.0 0.8 0.5 0.3 0.0 Taper tantrum China Trum p "Red October" Preference for EM 2.0 1.5 1.0 0.5 0.0 Preference for Equities Developed Markets -0.3-0.5-0.8-1.0-1.3 Preference for DM -0.5-1.0-1.5 Emerging Markets Preference for Bonds -1.5-2.0 Source: BBVA Research, EPFR The relative preference for EMs increased since October. However, EM funds continued to register outflows during 4Q, but to a lesser extent Fed s pause seems to have increased the appetite for EMs and especially for bonds, the assets that suffered the most during 4Q18

What s next? BBVA Research - Global Funds Outlook 1Q19 / 14

Main trends surrounding our economic and financial outlook BBVA Research - Global Funds Outlook 1Q19 / 15 Economic outlook Financial markets Central banks Assumptions on key risks Soft landing in global growth Downward revision of growth affecting mostly developed markets, more sizable in the EU Downward revision in oil prices based on mix of demand and supply factors Financial volatility to stay for a while (until 2Q19 while fears on key risks moderate). Low long-term rates on safe-haven flows. USD unlikely to appreciate sharply EM on the sidelines due to high volatility Central banks (including Fed) to stay dovish A step up in policy support by China More aware of the downside risks (sensitive to market turmoil) and more prudent on policy normalization: Altering the path of interest rates (Fed to pause earlier, ECB to delay the hiking cycle) But, no changes in the non-standard measures (balance sheet), for now Three key assumptions in our projections: Easing US-China trade tensions: Tariffs left unchanged, but structural issues remain Tail risks in Europe are eventually resolved (orderly Brexit; Italy) More dovish Fed (2 vs 3 hikes in 2019; data dependent ) ECB (refi-rate hike postponed to 2020), further room for EM central banks All in all, risks remain tilted to the downside Source: BBVA Research

Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Jun-18 Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 BBVA Research - Global Funds Outlook 1Q19 / 16 Portfolio flows outlook: With the most favorable environment already priced in, GIF inflows to EMs are unlikely to sustain for a long period Our baseline scenario suggests EMs would continue to outperform DMs in attracting GIF flows over the short term, although hinged on Fed s future rate actions and progress on US-China trade dispute That said, we think recent strong EMs attractiveness does not seem sustainable given that the most favorable environment is already priced in Portfolio flows to EM (% of AUM) 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% -6% Idiosyncratic Global Source: EPFR, BBVA Research

Mar-17 Jun-17 Sep-17 Dec-17 Jun-18 Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 BBVA Research - Global Funds Outlook 1Q19 / 17 Under a more favourable scenario with the Fed on a prolonged pause and lower volatility, the positive mood in EM could last till year end According to our sensitivity analysis, EMs could maintain the positive mood during almost the whole 2019 if: Portfolio flows to EM: baseline vs positive* scenario (% of AUM) 4% 1 Fed halts the tightening: no more rate hikes, and reduces the path of reduction of its balance sheet 3% 2% 1% 2 Volatility moves to lower levels than baseline 0% -1% -2% 3 Long-term US rates remain very subdued (slope very tight) -3% -4% Assumptions in baseline: VIX will remain hovering around 18%, Fed will increase fed funds rate two times by 25 bps each and will continue with BS normalization. The 10Y UST will end 2019 at around 3.3%. Assumptions in alternative: VIX will decrease to levels around 15% progressively, Fed will increase fed funds rate maximum once by 25 bps and the BS normalization will be slower. The 10Y UST will end 2019 around 2.90%. Alternative Baseline Source: EPFR, BBVA Research

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 BBVA Research - Global Funds Outlook 1Q19 / 18 What to watch this year: Trade issues and China slowdown as main global threats while leveraged loans as a potential source of concern 01 Could Trade tensions derail global economy? The approved tariff increase has already weighed on growth and the new round could hit harder 02 Are leveraged loans the new elephant in the room? The recent market mood curbed new issuances However, the maturities should not represent a short-term threat as they are concentrated between 2024-2025 03 Is China s credit outlook a hot potato? Non-financial debt continued to increase supported by targeted monetary easing. Market caution reflected in downward pressures on the stock market and currency Effect on GDP growth of approved US tariffs and retaliation (pp over two years, trade and financial/confidence channel) Portfolio flows to Leveraged Loans funds* (4w moving average, % of AUM) Non-Financial Debt (% of GDP) 3.0% 250 % of GDP 25 Europe -0.04 2.0% 200 20 15 US China World -0.20-0.10-0.07 1.0% 0.0% -1.0% -2.0% 150 100 50 0 10 5 0-5 -10-15 -0.25-0.20-0.15-0.10-0.05 0.00-3.0% D-09 D-10 D-11 D-12 D-13 D-14 D-15 D-16 D-17 D-18 Credit Gap (Rhs) Credit Trend Source: BBVA Research

Annex BBVA Research - Global Funds Outlook 1Q19 / 19

BBVA Research - Global Funds Outlook 1Q19 / 20 Glossary GIF Global Investors Funds: these are the funds covered by the EPFR database in the Country flows allocation, with amounts shown in millions of US Dollars. This database includes the flows in countrydenominated funds and the proportional amounts in global or supranational labelled funds AUM Assets under management in the EPFR database DM Developed markets included in our sample are Austria, Australia, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the US EM Emerging markets included in our sample are Argentina, Brazil, Chile, China, Colombia, Czech Republic, Hungary, India, Indonesia, Korea, Mexico, Peru, Philippines, Poland, Russia, Slovenia, South Africa, Thailand, Turkey and Venezuela