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State Association of County Retirement Systems Fall Conference November 13-16, 2007

State Association of County Retirement Systems Fall Conference November 13-16, 2007. Table of Contents. Section I The Case for Emerging Markets in 2004 Section II The Case for Emerging Market Debt in 2007

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State Association of County Retirement Systems Fall Conference November 13-16, 2007

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  1. State Association of County Retirement Systems Fall Conference November 13-16, 2007

  2. Table of Contents • Section I The Case for Emerging Markets in 2004 • Section II The Case for Emerging Market Debt in 2007 • Section III Understanding Emerging Market Countries as the New, Powerful Institutional Investor

  3. Section I The Case for Emerging Markets in 2004

  4. Cartography and Investment Topography

  5. Cartography and Investment Topography • In 2004, two definitions were useful in dividing the world and setting investment strategies and asset allocation targets: • Developed Markets • Emerging Markets

  6. What is a Developed Market? The implication is: • A nation that is industrialized (e.g., a well-developed manufacturing sector), has substantive infrastructure, and a well-developed service sector • A nation that has a per capita income higher than $9,655 • A nation that has universal education and significant health indicators on infant mortality, life expectancy, and literacy

  7. What is an Emerging Market? The official definition: • An economy with low-to-middle per capita income as defined by the World Bank (i.e., less than $9,656 minimum GNP per capita) • Investable market cap is low relative to its most recent Gross Domestic Product (GDP)

  8. What is an Emerging Market? The implication is: • It is a nation that is in rapid transition, increasing in size, activity, or level of sophistication • It is a nation that is making an effort to change and improve its economy, as well as provide an infrastructure in order to become a developed nation

  9. Cartography and Investment Topography (2004) • Like nature, nations gradually or glacially evolve from emerging to developed • And a few move back • What contributes to a successful evolution is a complex question as tectonic plates shift slowly • Why does it matter from an investment perspective?

  10. Opium and Tea Trades History of World GDP Share Surprise! India and China were the leaders in terms of GDP market share until surpassed by the U.S. in the early 20th century. Source: Angus Maddison (2001) the World Economy: A Millennial Perspective, Table B-20

  11. Rates of Growth of World GDP Per Capita So why are they just surpassing their prior per capita growth in the 20th century? Source: Angus Maddison (2001) the World Economy: A Millennial Perspective, Table B-22

  12. Rates of Growth of World GDP Per Capita …and now racing ahead at an unprecedented pace Source: Angus Maddison (2001) the World Economy: A Millennial Perspective, Table B-22

  13. Developed, Emerging, or Hegemon? • A highly evolved nation with overwhelming demographics does not always graduate to a developed nation

  14. Cartography and Investment Topography (2004) • Economists and investors are always seeking to develop a set of metrics to identify a country’s future status • That is, which countries will move from: • Emerging to Developed to something else • However, there is no defined set of rules to determine who will and will not evolve • Are there catalysts?

  15. Benchmarks as Investment Topography • Current industry practice is to construct portfolios using benchmarks as maps or guides • Are our current maps pre-Columbus, seismic sensors, or GPS?

  16. A View of Our World in the Pre-Columbus Era • Fortunately, early investors did not use maps for guides or they might not have gotten there

  17. A View of Our World from the English Colonies • Where would the U.S. be if our forefathers only focused on investing in the original 13 colonies and didn’t think about the frontier?

  18. A View of Our World After the Louisiana Purchase • Or called it quits after Napoleon sold us the Louisiana Purchase?

  19. So, What is the Lesson? • Historically, the most successful investors have sought future rather than past growth • Would you have invested in the Erie Canal? • If you are the typical institutional investor, probably not!

  20. Cartography and Investment Topography • State of the art today…very Americentric • Very benchmark-aware • Average U.S. plan sponsor holds the following portfolio: • 40 – 50% U.S. Equity • 15 – 20% Non-U.S. Equity • 15 – 30% Fixed Income • 0 – 15% Alternatives

  21. Market Capitalization Weights As Maps Select Developed and Emerging Markets as of 2004 • Constructing an investment map for tomorrow and today’s portfolio based on benchmarks is investing in the rearview mirror Source: RIMES Online

  22. 2004 Outlook Five Year Projected Growth Rates of Select Developed and Emerging Markets • As an investor seeking to grow assets, wouldn’t you seek future rather than historical growth? Source: National Governments, Consensus Economics, Economist Intelligence Unit, Datastream

  23. Benchmarks as Investment Maps Capitalization Weights within the MSCI ACWI Free 5 Year Cumulative Projected Real GDP Growth 1Source: RIMES Online 2Source: National Governments, Consensus Economics, Economist Intelligence Unit, Datastream

  24. S&P 500 Index vs. Nominal GDP Growth • Developed markets are positively correlated with domestic GDP growth but emerging markets may not be Source: Nominal GDP Growth data provided courtesy of Bureau of Economic Analysis (BEA)

  25. Section II The Case for Emerging Market Debt in 2007

  26. Cartography and Investment Topography

  27. Asset Allocation with Possibly the Wrong Map % anticipating an increase in allocations By Asset Class % anticipating a decrease in allocations Source: JPMorgan Asset Management

  28. Emerging Market Metamorphosis • We all read about global liquidity and its sources but generally don’t ponder its implications Source: JPMorgan

  29. Emerging or Developed? France Thailand

  30. Emerging or Developed? London Morocco

  31. Emerging Market Metamorphosis Trivia • Approximately 25% of the total number of world cranes is situated in one single city. Which city is it? • Up until 1998, the trophy for the tallest building has been in developed countries, mainly the United States. Currently how many of the top ten tallest buildings are in developed countries? • True or False. In 2005, more space missions have been launched by developed countries than emerging countries? • Of the top 40 countries by growth in manufacturing output, how many are emerging markets? • How many of the world’s top five billionaires are EM country nationals and who currently leads that list?

  32. Emerging Market Debt Metamorphosis • Emerging markets have witnessed a major transformation as evidenced by key economic variables Source: Goldman Sachs, IMF

  33. Emerging Market Debt Metamorphosis • Current accounts have transformed from deficits to strong surpluses in the last decade Source: JPMorgan, Bloomberg, PIMCO

  34. Emerging Market Debt Metamorphosis • Substantial foreign reserves make emerging market countries less vulnerable to external shocks Source: JPMorgan

  35. Emerging Market Debt Metamorphosis • Inflation rates in emerging economies are converging toward those of developed economies Source: PIMCO

  36. Emerging Market Debt Metamorphosis • The majority of emerging market countries have moved toward a floating exchange rate Source: JPMorgan, PIMCO

  37. Emerging Market Debt Metamorphosis Emerging Market Universe Credit Quality Composition Russia Upgrades México Upgrades Korea graduates out of the index • Structural reforms and fundamental improvements are reflected in credit ratings Source: JPMorgan

  38. Emerging Market Debt Metamorphosis Source: S&P, JPMorgan Source: S&P, JPMorgan • Favorable rating trends have extended beyond sovereign debt

  39. Emerging Market Debt Metamorphosis • Growth prospects for emerging markets remain strong Source: JPMorgan, Goldman Sachs, PIMCO

  40. Emerging Market Metamorphosis • The correlation between economic activity in the large developed economies and total global growth has fallen, as emerging countries have become more important growth engines of the global economy Source: IMF, PIMCO

  41. Implications for the Investment Opportunity • Is emerging market debt the new “safe haven” as opposed to U.S. credit? How much is too much in emerging markets? What is true growth?

  42. Section III Understanding Emerging Market Countries as the New, Powerful Institutional Investor

  43. Cartography and Investment Topography

  44. Cartography and Investment Topography • Western financial markets create acronyms based on: • Economics • Liquidity and capital flows • Organizational structures • In era of vast change in size and influence of liquidity pools, important and instructional to reconsider basic assumptions • EMEA (Europe, Middle East and Africa) and MENA (Middle East, North Africa) are examples of this • Context of discussion centered on changing missions of World Bank, IMF, IFC (e.g., in North/South dialogues migrating to South/South investment)

  45. Our Investment Topography • Definition: • Europe, the Middle East, and Africa, usually abbreviated to EMEA, is a regional designation used for government, marketing, and business purposes. It is particularly common amongst North American based companies, who often divide their international operations into the following regions: • The Americas, being North and South America (AMER) • North America (NORAM) • Europe, the Middle East, and Africa (EMEA) • Asia Pacific and Japan (APAC or APJ) • Brazil, Russia, India, and China (BRIC) • Increasingly, companies are separating their Eastern European business from the rest of Europe, and refer to the EEMEA (Emerging Europe, Middle East, and Africa) region as separate from the European region

  46. New Investment Topography • Definition: • The term MENA, for Middle East and North Africa • An acronym often used in academic and business writing • Generally covers an extensive region, extending from Morocco in northwest Africa, to Iran in southwest Asia • Generally includes all the Arab Middle East and North Africa countries, including Iran but not Turkey

  47. Our Investment Topography EMEA GDP (as % of world GDP) and Market Capitalization (as % of MSCI AC World Index Free) 1998 - 2007* * 2007 data is for the year to September. Source: MSCI and U.S. Department of Agriculture

  48. Changing Investment Topography EMEA Country GDP and Market Capitalization Growth (%) 2003 - 2007 Source: MSCI and U.S. Department of Agriculture

  49. Size and Shape of Capital Flows in Rapid Evolution

  50. Changing Destination of Capital Flows

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