North America Europe Asia-Pacific CFA Society, Victoria September 30, 2010 Arjun Divecha Proprietary information not for distribution beyond intended recipient.
Overview San Francisco Boston London Zurich Singapore s Edge: Success Factors: Motivation/Focus: Stability: Current Scale: Montevideo We blend proven traditional judgments with innovative quantitative methods, to find undervalued securities and markets. Discipline, value orientation, investment research, risk control, size limitation. Private partnership founded in 1977; investment management is our only business. has a low turnover of investment professionals. Sydney Rotorua $101 billion of assets under management: Equities: $90 billion ($61 billion non-u.s.) Fixed Income: $12 billion Absolute Return*: $9 billion Asset Allocation*: $35 billion More than 100 investment professionals and over 500 employees worldwide. * Asset allocation and absolute return assets are accounted for within underlying strategies and should not be double-counted. Represents assets from both GIPS and non-gips compliant firms. There are two GIPS compliant firms. The first is Grantham, Mayo, Van Otterloo & Co. LLC ( ), an independent investment adviser registered under Investment Advisers Act of 1940. s accounts are managed by investment management offices in Boston, MA and Berkeley, CA. has total assets of $92,957,357,614. The second firm is defined as UK Limited. UK was established to manage mandates primarily for UK and other European clients. UK is authorized and regulated by the Financial Services Authority in the United Kingdom. UK firm assets are $3,177,620,310. Source: As of 7/31/10 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 1
Agenda Should emerging markets trade at a discount, parity or premium to developed markets? Themes within emerging markets domestic demand Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 2
Emerging Markets Should emerging markets trade at a discount, parity or premium to developed markets?
Annual Real Return Over 7 Years 7-Year Asset Class Return Forecasts* As of July 31, 2010 12% - Expected Value Added - Real Return (Asset Class Index) Stocks Bonds Other 10% 9.2% 8% 6.5 % Long-term Historical U.S. Equity Return 7.9% 1.8% 6.4% 3.7% 7.5% 1.5% 6% 4% 3.7% 2.3% 4.3% 4.3% 2% 0% 1.8% 1.9% 1.9% 1.8% 0.1% 6.1% 4.1% 2.3% 2.0% 5.5% 1.1% 0.1% 2.9% 1.3% 1.1% 3 3 0.9% 1.4% 0.9% 2 0.9% 1.4% 0.4% 0.2% -0.3% -0.8% 6.0% -2% U.S. equities (large cap) U.S. equities (small cap) U.S. High Quality Int'l. equities (large cap) Int'l. equities (small cap) Equities (emerging) U.S. Bonds (gov't.) Int'l. Bonds (gov't.) Bonds (emerging) Bonds (inflation indexed) U.S. treasury (30 days to 2 yrs.) Managed Timber Estimated Range of 7-Year Annualized Returns ±6.5 ±7.0 ±6.0 ±6.5 ±7.0 ±10.5 ±4.0 ±4.0 ±8.5 ±1.5 ±1.5 ±5.5 *The chart represents real return forecasts 1 for several asset classes and an estimate of net value expected to be added from active management. These forecasts are forwardlooking statements based upon the reasonable beliefs of and are not a guarantee of future performance. Actual results may differ materially from the forecasts above. 1 Long-term inflation assumption: 2.5% per year. 3 Alpha transported from management of global bonds. 2 Alpha transported from management of global equities. Source: Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 4
Emerging Markets Valuations Price/Earnings Price/Normalized Earnings 3 Price/Sales 14.9 14.5 14.9 14.8 Price/Book Shiller Price/Earnings 30 25 20 15 10 5 Jan-93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 4 3 2 1 Jan- 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 40 30 20 10 0 Jan-93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 50 40 30 20 10 0 Jan- 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 3 Yield 2.0 1.9 17.7 17.4 2 1 1.5 1.4 2 1 1.7 1.6 0 Jan-93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 25 20 15 10 IBES Price/Earnings Jan-93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 5 Jan-93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 13.1 12.7 0 Mean Value Discount Z-Score Price/Earnings 14.9 14.5 3.1 % 0.1 Price/Book 1.9 2.0-3.7 % -0.2 Price/Normalized Earnings 14.8 14.9-0.8 % 0.0 Shiller Price/Earnings 17.7 17.4 1.9 % 0.1 Price/Sales 1.4 1.5-8.2 % -0.5 Yield 1.6 1.7 2.1 % 0.1 IBES Price/Earnings 12.7 13.1-2.7 % -0.1 Source: IFC, MSCI, IBES, EcoWin, As of 7/31/10 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 5
What Drives P/E Ratios? Going Back to the First Principles The Gordon growth model Price = Earnings / (Risk Premium Growth). Price/Earnings = 1 / (Risk Premium Growth). In short, P/E is driven by Risk Premium and Growth. Thus, Risk, Growth, Profitability, and Corporate Governance are the things that matter. Let s look at the drivers of each. Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 6
If Things Get REALLY BAD, Who can write a check to save themselves? Country Region Current Account Balance Budget Balance Foreign Reserves Gov't. Debt Overall Rank China Asia 4.1-2.6 43.8 16.9 1 Taiwan Asia 8.8-3.1 87.2 32.5 2 Korea Asia 3.0-2.0 28.0 23.5 3 Russia EMEA 5.2-3.9 29.4 6.3 4 Thailand Asia 6.6-3.6 49.5 45.9 5 Chile LatAm -0.1-2.2 13.3 6.1 6 Peru LatAm -1.8 0.2 24.4 24.8 7 Indonesia Asia 1.5-2.2 10.8 27.4 8 Malaysia Asia 13.0-5.3 40.9 53.7 9 Philippines Asia 3.9-3.7 25.1 58.7 10 Mexico LatAm -1.2-1.0 10.0 37.7 11 Hungary EMEA -0.3-3.9 35.7 78.0 12 Poland EMEA -3.0-3.0 19.1 46.5 13 Israel EMEA 2.4-4.1 29.6 78.4 14 Colombia LatAm -1.6-3.9 9.8 45.8 15 Brazil LatAm -2.7-1.8 13.1 60.0 16 Czech Republic EMEA -3.3-5.4 21.1 34.1 17 Germany Developed 4.5-5.2 6.5 72.1 18 Turkey EMEA -4.8-4.5 14.8 46.3 19 India Asia -1.6-5.5 15.9 58.0 20 Japan Developed 3.2-7.8 20.3 189.3 21 South Africa EMEA -5.0-6.3 12.3 29.5 22 Italy Developed -2.4-5.1 7.2 115.2 23 Ireland Developed -0.7-19.0 1.0 57.7 24 United Kingdom Developed -1.1-10.3 3.3 68.1 25 France Developed -2.4-8.4 6.7 77.5 26 United States Developed -3.2-8.8 0.8 52.9 27 Spain Developed -4.7-9.9 2.2 53.2 28 Portugal Developed -8.0-7.8 0.0 76.9 29 Greece Developed -7.2-9.9 1.9 113.4 30 Source: Datastream, World Factbook, As of 6/30/10 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 7
Risk: The Lost Decades Are Over Vulnerability index* levels * Vulnerability Index = External Debt/GDP + Budget Balance/GDP + Credit/GDP + Current Account/GDP. Source: UBS, Haver As of 10/09 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 8
Risk Premium Has Come Down Substantially Even in This Crisis Emerging sovereign debt spread over treasuries 1600 1400 Less Fear in Times of Panic 1200 1000 800 600 400 200 0 Jan-90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: J.P. Morgan As of 10/14/09 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 9
Risk: Intra-Emerging Trade Is Reducing Dependence on Exports to the West $1,500,000 Intra-Emerging Markets Trade Has Exploded ($U.S. Millions) $1,000,000 $500,000 $0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 40% Emerging Exports to Other Emerging Countries (As a % of Total Exports) 35% 30% 25% 20% 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Source: World Bank As of 2008 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 10
Growth: Demographics Play an Important Role 90 80 70 Dependency Ratios* Why Emerging Markets Now Developed Emerging 60 50 40 30 20 10 0 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 * Percent of non-working to working people. Source: United Nations Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 11
Growth: Demographics the Next 10 Years Starting demographics vs. changes Improving Demographics Deteriorating Demographics 65 Philippines Peru Israel Egypt India Japan Argentina Saudi Arabia Mexico South Africa France Italy World UK But Not All Emerging Countries Have Improving Demographics 60 Worse Starting Demographics 55 Malaysia Germany Morocco U.S. Brazil Indonesia Turkey Spain Australia 50 Chile Hungary Czech Republic 45 Thailand China Poland All Countries with Improving Demographics Are Emerging Countries Russian Federation 40 Republic of Korea Singapore 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 35 30 Better Starting Demographics Source: UN As of 10/09 12
Savings Rate (GDP Weighted) % Non-Working to Working Growth: Savings Rates Are Tied to Demographics 35 30 Emerging Markets Average Savings Rate (GDP Weighted) Demographics (Percent Non-Working to Working) 80 75 70 25 65 20 60 15 55 10 50 Dec-80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 Source: EIU, United Nations As of 12/31/06 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 13
Real Return 1900-2000 Growth: But Does High GDP Growth Translate to High Stock Returns? Dimson and Marsh findings from 1900-2000 8% 7% 6% South Africa U.S. UK Australia Sweden 5% 4% Germany France Spain Japan 3% Belgium Italy 2% 1% Return = 7.2% 1.0*(Per Capita GDP Growth) R 2 =.13 0% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% Real Per Capita GDP Growth 1900-2000 Source: Dimson & Marsh Triumph of the Optimists Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 14
Return on Equity (%) Profitability in Emerging Markets Has Converged with Developed 18 16 14 MSCI World Return on Equity 12 10 8 6 4 Emerging Markets Return on Equity 2 0 Jan-93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Source: MSCI As of 9/30/09 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 15
Why Profitability Has Converged Since the Tequila/Asia/Russia/Argentina/Brazil crises of the 90s, most countries (with the prominent exception of China) have opened their capital accounts and allowed their currencies to float. The same crises forced these countries to abandon industrial policy, allowing capitalism to work. Corporate governance has improved dramatically since the 90s. Globalization of trade AND finance has forced standardization of corporate governance. Figured out that they can get richer by getting a higher P/E than by stealing this year s earnings. Generational shift to Western educated managements. Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 16
Should Emerging Markets Trade at a Discount or Premium? In the 90s, the answer was easy. Now it s not as clear 1.5 1.0 0.5 Emerging Average Discount = 20% Emerging P/E Relative to U.S. P/E Ratio Emerging P/E vs. U.S. 0.0 Jan-93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 1.5 1.0 0.5 Emerging Average Discount = 24% Emerging P/BK vs. U.S. Emerging P/BK Relative to U.S. 0.0 Jan-93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Source: MSCI, S&P, As of 6/30/10 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 17
Pulling It All Together With most emerging markets running good economic policies, actual and perceived risk has come down. Growth will likely stay strong, based on demographics and other factors. Profitability has converged with developed markets and is likely to stay that way. As a result, there s a plausible case that emerging markets should trade at parity to developed markets in the medium term and at a HUGE premium in the short term (if Jeremy s Emerging Emerging Bubble thesis is correct). Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 18
Emerging Markets Themes within emerging markets domestic demand
Indices Are Skewed towards Globally Sensitive Companies Commodity Producers and Exporters IFC EM Universe Classification by Investable Market Cap Domestic Demand 46% Commodities/ Exporters 54% Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 20
Exports Have Been the Main Driver of Growth Components of emerging market growth over last 10 years 3.5 3.0 Gross Exports 2.5 Gross Capital Formation 2.0 Consumption 1.5 1.0 Jun-99 00 01 02 03 04 05 06 07 08 09 Source: As of 12/31/09 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 21
Emerging Markets Contribution to GDP Growth (% Y/Y) Consumption Has Become a Larger Part of Growth 10% Emerging Markets Growth by Category 8% 6% 4% 2% 0% -2% -4% -6% Consumption Did Not Go Negative in 2008 00 01 02 03 04 05 06 07 08 09 10 Consumption Fixed Investment Net Exports Overall GDP Source: Haver, CEIC, IMF, USB Estimates. As of 5/13/10 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 22
Savings Rate Savings Rate Savings Rate Savings Rate Savings Rates Drop Dramatically When GDP/Capita Reaches the $3,000 to $10,000 Range We ve seen this in developed markets at a similar stage of development 26 Portugal 45 Japan 24 22 20 40 35 18 16 14 30 25 12 0 10,000 20,000 30,000 40,000 50,000 20 0 10,000 20,000 30,000 40,000 50,000 GDP/Capita GDP/Capita 80 60 40 20 0-20 Greece 0 10,000 20,000 30,000 40,000 50,000 GDP/Capita 34 32 30 28 26 24 22 20 Australia 0 10,000 20,000 30,000 40,000 50,000 GDP/Capita Source: Bloomberg, World Bank, Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 23
MSCI Weighting And 50% of Emerging Countries Now in the Sweet Spot of Shifting from Savings to Consumption GDP per Capita Source: Bloomberg, World Bank, Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 24
Household with Air Conditioning/100 Cameras Per 100 People Refridgerator Penetration The Relationship between Income and Consumption Is Not Linear 10.00 1.00 0.10 0.01 Per-capita round-trip air travel HK Singapore Malaysia Thailand Indo, Phil, Cambodia China India, other Asian countries Korea New Zealand USA Brunei Australia Japan Per-capita GDP (US$) 0 10,000 20,000 30,000 40,000 50,000 100 90 80 70 60 50 40 Malaysia China 30 Thailand 20 Philippines 10 0 Indonesia India Korea Taiwan Singapore Japan HK y = 22.99ln(x) - 147.6 R² = 0.943 Disposable income per capita (US$) Australia 0 5,000 10,000 15,000 20,000 25,000 30,000 100 120 90 80 70 60 50 China Taiwan Korea Japan HK Singapore 100 80 60 Thailand Malaysia China Taiwan Korea Singapore HK Japan 40 30 Malaysia 40 Philippines 20 10 0 Thailand Philippines Disposable income per capita (US$) Indonesia India 0 5,000 10,000 15,000 20,000 25,000 30,000 20 0 Indonesia India Disposable income per capita (US$) 0 5,000 10,000 15,000 20,000 25,000 30,000 Source: Bloomberg, World Bank, Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 25
And Penetration Rates in Emerging Markets Are Still Very Low 500 Passenger Cars (Per 1,000 People) $8,000 Health Expenditure (Per Capita) 400 300 200 100 0 100 80 60 40 20 0 Brazil China Brazil China Colombia India Indonesia Korea Rep. Personal Computers (Per 100 People) Mexico Turkey Russia U.S. Euro Area UK Colombia India Indonesia Korea Rep. Malaysia Mexico Thailand Turkey Russia U.S. Euro Area UK $6,000 $4,000 $2,000 $0 35 30 25 20 15 10 5 0 Brazil China Brazil China Colombia India Indonesia Korea Rep. Malaysia Mexico Thailand Turkey Russia U.S. Euro Area UK Fixed Broadband Internet Subscribers (Per 100 People) Colombia India Indonesia Korea Rep. Malaysia Mexico Thailand Turkey Russia U.S. Euro Area UK Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 26
Million If Current Trends Persist, the Emerging Middle Class Will Increase by around 500 Million People in the Next 5 Years 600 Emerging Markets New Consumer in 5 Years (2010-2015) 500 400 300 200 463 70% of Europe Population 100 0-100 -200-300 80-400 -370-500 Less than $6,000 (Below Middle Class) $6,000 < Middle Class < $30,000 More Than $30,000 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 27
The Third Wave? Relative performance of domestic, export and commodity sectors in Emerging Markets 2.3 2.1 1.9 First Wave Exporters Did Well 1.7 1.5 1.3 1.1 0.9 0.7 Second Wave Commodity Producers Did Well Will Domestic Sectors Be Third Wave? Commodity Domestic Exporters 0.5 Dec-94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Source: As of 3/31/10 Proprietary information not for distribution to the public. Copyright 2010 by LLC. All rights reserved. 28
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