Emerging Fixed Income A New Dawn Simon Lue-Fong March 2007 I Lima
Table of contents 1. The Changing Landscape
Emerging USD Bonds have had a spectacular ride But where next? EMERGING USD BOND SPREADS SINCE 1999 1200 Brazil Devaluation (Jan 99) 1000 Ecuador Default (Aug 99) Argentina Default (Dec 01) 800 600 Argentina Restructuring (Jun 05) 400 200 0 Index : JP Morgan EMBI Global Diversified Source : Bloomberg 3 01/01/99 01/05/99 01/09/99 01/01/00 01/05/00 01/09/00 01/01/01 01/05/01 01/09/01 01/01/02 01/05/02 01/09/02 01/01/03 01/05/03 01/09/03 01/01/04 01/05/04 01/09/04 01/01/05 01/05/05 01/09/05 01/01/06 01/05/06 01/09/06
The Emerging Market opportunity set has changed The future is Local Bonds USD BOND S LOCAL CURRENCIES LOCAL CURRENCIES AND BONDS PAST FUTUR E 4
.reflecting the reality of asset class growth High growth in Local Bonds versus stagnation in USD Bonds MARKET VALUE USD MILLIONS SINCE 2003 700000 600000 500000 400000 300000 200000 100000 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Emerging Local Bonds Emerging USD Bonds Indices : JP Morgan GBI-EM Broad Diversified and JP Morgan EMBI Global Diversified Source : JP Morgan 5
as local debt issuance rises versus external debt issuance This pattern is expected to accelerate GROWTH IN DOMESTIC AND EXTERNAL GOVERNMENT DEBT FROM 1999-2005 350 300 250 % 200 150 100 50 0-50 Mexico Poland Colombia Hungary Brazil Domestic Debt External Debt Source : Institute of International Finance 6
Emerging Local Bonds are investment grade EMERGING LOCAL BONDS UNIVERSE 1 Middle East/Africa 10% Latin Am erica 24% As ia 37% Europe 29% Yield: 6.58% Duration: 4.27 years Average rating: BBB+ Source & Notes 1 JP Morgan GBI-EM Broad Diversified Index as of end-october 2006 7
in addition to being well diversified EMERGING LOCAL BONDS COUNTRY WEIGHTS 1 Peru Chile Russia Slovakia Colombia Indonesia Turke y Czech Turke y Tha ila nd Hunga ry Malaysia South Africa Poland Me xic o India China Brazil 0 2 4 6 8 10 (%) Source & Notes 1 JP Morgan GBI-EM Broad Diversified Index as of end-october 2006 8
Table of contents 2. A Twofold Tale
Emerging Market fundamentals have improved dramatically
Strong economic growth is occurring... And is unlikely to be derailed ECONOMIC ACTIVITY INDICATORS (ADVANCED) Source: Pictet 11
which contributes to Improving government finances EMERGING ECONOMIES FISCAL BALANCES (% of GDP) Source: JP Morgan 12
Vulnerability to external shocks is falling reflecting Improving external accounts EXTERNAL DEBT SERVICING AS % OF RESERVES Source: Pictet 13
Meanwhile policies converge A move to inflation targeting and floating FX regimes Instrument Target Adoption Date Asia Korea Headline CPI 2001 Philippines Headline CPI 2002 Thailand Core CPI 2000 Europe Czech Republic Headline CPI 1998 Hungary Headline CPI 2001 Israel Headline CPI 1997 Poland Headline CPI 1998 Turkey Headline CPI 2005 70% of emerging market central banks target inflation Since 1996, 19 emerging market countries have moved to a floating FX regime Latin America Chile Headline CPI 1999 Colombia Headline CPI 1999 Brazil CPIA (broad) 1999 Mexico Headline CPI 2001 Peru Headline CPI 2002 Africa South Africa Headline CPI 2000 Source: JP Morgan, September 2006 14
enabling the improving credit trend to continue MOODY S SOVEREIGN CREDIT CHANGES 1999-2006 Upgrade Poland Hungary Korea Mexico Thailand Slovenia Hungary Malaysia Mexico Trinidad & Tobago Israel Brazil Barbados Fiji Russia Romania Ukraine Bulgaria Slovakia Kazakhstan Dom Rep South Africa Lithuania Russia Romania Bahrain Pakistan Ukraine Mexico Kuwait Qatar Malaysia Korea Czech R Estonia Hungary Kazakhstan Latvia Poland Slovakia Slovenia India Lithuania Russia Romania Jordan Bahrain Pakistan Ukraine China Indonesia Argentina Thailand Macau Tunisia Saudi Arabia Bulgaria Moldova UAE Malaysia Bulgaria Brazil Venezuela (2 notches) Romania India Ecuador Romania Qatar South Africa Slovakia Mexico Brazil Saudi Arabia Russia Turkey Trindad & Tobago Vietnam Argentina Slovakia Tunisia Bahrain Botswana Jordan Kuwait Mauritius Oman Qatar Saudi Arabia UAE India Kazakhstan Mongolia Turkmenistan Bosnia Bulgaria Lithuania Romania Slovenia Trinidad Fiji Hong Kong Indonesia Macau Papua NG Brazil Chile Honduras Nicaragua Paraguay Suriname Downgrade Columbia Ecuador Kazakhstan Argentina Ukraine Argentina Lebanon Ukraine Moldova Brazil Uruguay Moldova (x2) Venezuela Bolivia Jamaica Paraguay Venezuela Nicaragua Dom Rep (x2) Belize Dom Rep Philippines Belize Lebanon Philippines Belize Lebanon 1999 2000 2001 2002 2003 2004 2005 to 31/10/2006 Source: Bloomberg (October 2006) Credit changes opposite to the previous credit change for a single country indicated thus 15
An extremely favourable supply and demand dynamic is at work
A Structural shift is in motion Demand for Emerging Local Bonds outstrips supply 17 Switch to Local Financin g Demand Supply Local Pension Funds Foreign Pension Funds EM LOCAL MARKETS
Emerging Markets are at the forefront of pension reform MAP INDICATING COUNTRIES WHERE PENSION REFORM HAS OCCURRED Source: www.fiap.cl 18
...growing pension funds absorb local supply easily Leaving little for other investors SELECTION OF LATIN AMERICAN COUNTRIES PENSION FUNDS ADMINISTERED (USD MILLIONS) 90,000 80,000 70,000 60,000 Chile Mexico 50,000 40,000 30,000 20,000 10,000 Colombi a Peru 0 Jun. 1999 Dec. 1999 Jun. 2000 Dec. 2000 Jun. 2001 Dec. 2001 Jun. 2002 Dec. 2002 Jun. 2003 Dec. 2003 Jun. 2004 Mar.2005 Sep. 2005 Mar.2006 Sep. 2006 Source: www.fiap.cl 19
Emerging Local Bonds will be a fact of life Pension Funds are starved of cashflow.
Table of contents 3. A Compelling Investment Case
Emerging Local Bonds are high returning ANNUALISED RETURNS SINCE END-2001 S&P 500 4.26% Global Bonds 4.88% High Grade Bonds 6.52% Russell 2000 10.22% Asia Local Bonds 9.83% High Yield Bonds 10.56% Commodities 10.88% Emerging USD Bonds 13.35% Emerging Local Bonds 16.10% Emerging Equities 24.22% 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% Annualized historical data : 31.12.2001 31.10.2006 Source : JP Morgan / HSBC / Bloomberg 22
and are well diversified with other asset classes Correlations (Monthly 31.12.01-31.08.06) Emerging Local Bonds Asia Local Bonds Emerging USD Bonds Commodities Global Bonds High Grade Bonds High Yield Bonds Emerging Equities S&P 500 Russell 2000 Emerging Local Bonds 1.00 0.52 0.49 0.19 0.21 0.35 0.43 0.45 0.22 0.25 Asia Local Bonds 1.00 0.41 0.20 0.35 0.37 0.15 0.33 0.11 0.09 Emerging USD Bonds 1.00 0.05 0.46 0.51 0.59 0.51 0.41 0.33 Commodities 1.00-0.02-0.01-0.03 0.31 0.00 0.10 Global Bonds 1.00 0.65 0.00-0.24-0.40-0.36 High Grade Bonds 1.00 0.39-0.03-0.13-0.03 High Yield Bonds 1.00 0.54 0.53 0.57 Emerging Equities 1.00 0.77 0.78 S&P 500 1.00 0.82 Russell 2000 1.00 Historical data : 31.12.2001 31.10.2006 Source : JP Morgan/HSBC/Bloomberg 23
in addition to being well diversified within the asset class Correlations (Monthly 31.12.01-31.08.06) Asia Europe LatAm ME/Africa Asia 1.00 0.19 0.17 0.42 Europe 1.00-0.11 0.28 LatAm 1.00 0.19 ME/Africa 1.00 Historical data : 31.12.2001 31.10.2006 Source : Bloomberg 24
while the level of risk compares favourably Emerging Local Bonds Asia Local Bonds Emerging USD Bonds Commodities Global Bonds High Grade Bonds High Yield Bonds Emerging Equities S&P 500 Russell 2000 Sharpe Ratios 1.46 1.48 1.46 0.72 0.44 0.62 1.49 1.18 0.14 0.44 Historical data : 31.12.2001 31.10.2006 Source : Bloomberg 25
Principal components of return are split between Bonds and FX With bond returns outweighing FX returns and with lower volatility CUMULATIVE RETURNS SINCE END-2001 100 90 80 70 60 50 40 30 20 10 0 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Bonds FX Annualized historical data : 31.12.2001 31.10.2006 Source : JP Morgan 26
Speaker Simon Lue-Fong Head of Global Emerging Debt Fixed Income team Simon Lue-Fong joined Pictet Asset Management in 2005 as a Senior Investment Manager and Head of Global Emerging Debt with responsibility for investment management, product development and client relations. He has been an investment manager since 1991. His first role was managing Global Bonds and Currencies. In 1996 he set up an Emerging Markets Debt business in external debt and local currency at Fischer Francis Trees & Watts. Before joining Pictet, he worked for Standard Asset Management and INVESCO in their respective Emerging Markets Debt teams. Simon graduated from Bournemouth University with a BA (Hons) degree in Finance. 27