EMERGING MARKETS DEBT
Knight Capital - June 30th 2011
Alfredo Viegas 203-930-7180
No ‘hard’ definition or rule
World Bank definition: a country with a gross national income per head between $975 and $11,905*
50 countries in the broader benchmarks**
Source: * World Bank, as of June 2010 ** S&P Investable and S&P Frontier benchmarks combined
World GNI per capita
Low ($975 or less)
Lower middle ($976 - $3,855)
Upper middle ($3,856 - $11,905)
No Data
High ($11,906 or more)
GNI Per Capita 2008*
Emerging Markets Debt – GeographyWhat is an “Emerging Market Country?”
2
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Market cap (float adjusted)
Market cap (full market)
GDP at market rates
Exports
GDP at PPP
Energy consumption
Foreign exchange reserves
Land mass
Population
Emerging Developed
Source: BofA Merrill Lynch Global Equity Strategy, BP, CIA World Factbook, IMF World Economic Outlook, MSCI, as of June 2010
Emerging Markets already important
Emerging Markets Debt – Present day…Emerging Markets are important…
3
Once upon a time…
• We may take the current world environment as status quo… but that is a mistake. Economies Rise & Fall
• Global economic leadership is expected to look very different in 40 years…
Emerging Markets Debt – History and FutureTimes change and Economies Rise and Fall…
4
Too important to ignore (84% of world’s population, 23% of world’s GNI)*
Strong growth relative to developed economies
Diversification advantages
Premium returns achieved as economies emerge
Economic / market developments reduce risk of crises
Emerging Markets Debt – Why Invest?Too Important to ignore…
5
Source: Schroders as of December 2009Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell.
Mat
uri
ty
Time
Sub-Saharan Africa IndiaChina
Egypt Brazil
Malaysia
Mexico
Czech/Hungary/Poland
S. Korea
IsraelTaiwan
Hong Kong/Singapore G7
Frontier markets deregulation
Emerging markets Premium growth (5%-7%)
Established growth(3%-5%)
Mature economies(2%-3%)
Russia
Emerging economies characterized by strong economic growth
Emerging Markets Debt – Why Invest?That’s where the growth is!
6
Source: UBS estimates, IMF, Haver, CEIC. Data as of January 2011Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell.The data includes some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. There is no guarantee that any forecasts or opinions will be realized.
GDP growth has come from Emerging and Frontiers markets not Developed
0%
100%
200%
300%
400%
500%
600%
700%
Kaz
akhs
tan
Rus
sia
Mon
golia
Chi
naN
iger
iaU
krai
neR
oman
iaS
lova
kIn
done
sia
Gha
naB
ulga
ria Iran
Cze
chU
AE
Est
onia
Vie
tnam
Jord
anB
razi
lLi
thua
nia
Latv
iaIn
dia
Per
uS
ri La
nka
Col
ombi
aH
unga
ryT
urke
yS
Afri
caC
hile
Ken
yaP
olan
dT
haila
ndP
hilip
pine
sM
oroc
coV
enez
uela
Pak
ista
nM
alay
sia
S. A
rabi
aLe
bano
nB
angl
ades
hB
otsw
ana
Tan
zani
aE
gypt
Kor
eaD
evel
oped
Mex
ico
Tai
wan
Arg
entin
a
Cumulative change in USD GDP, 2000-2010E (%)
Emerging Markets Debt – Why Invest?Emerging Market Economies have had extraordinary growth…
Emerging Markets
Frontiers
Developed
7
Emerging Markets Debt – Growth to continue?This is the chart that should really scare you…
0
5
10
15
20
25
30
35
40
45
Ge
rma
ny
Sw
itze
rla
nd
Au
stra
lia
Sw
ed
en
Ne
the
rla
nd
s
Ca
na
da
Fra
nce
Italy
Ire
lan
d
US
A
Jap
an
UK
Sp
ain
Gre
ece
So
uth
Ko
rea
Cze
ch R
ep
ub
lic
Po
lan
d
Sin
ga
po
re
Hu
ng
ary
Po
rtu
ga
l
Ta
iwa
n
Bra
zil
Ho
ng
Ko
ng
Ma
lays
ia
Arg
en
tina
Ch
ile
Ru
ssia
Tu
rke
y
Ve
ne
zue
la
Ch
ina
Me
xico
Pe
ru
Th
aila
nd
Ind
ia
Ph
ilip
pin
es
Sri
La
nka
Ind
on
esi
a
Hourly Labor Costs in US$, 2010
Source: EIU estimates, as of June 2010Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell.
Low labor costs
8
4.74.3
2.72.0
5.1
2.63.2
2.73.2
3.8 4.0
1.5
4.8
1.7 1.6
0.4
4.8
1.5
4.4
1.3 1.5
2.9
2.0 2.1
-0.4
-1.6
-0.3
1.7
-1.5-1.0
-2.9
-0.5-0.1
-1.4 -1.6
0.5
-4
-3
-2
-1
0
1
2
3
4
5
6
China Brazil Korea Taiwan India SA Russia Mexico Malaysia Indonesia Turkey Thailand
Consumption Gross domestic investment Net external demand
2011(F) contribution to real GDP growth for major emerging markets
Emerging Markets growth expected to continue to be internally driven
%
Source: JP Morgan, Economics Team estimates, as of October 2010The data includes some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. There is no guarantee that any forecasts or opinions will be realized.Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell.
Emerging Markets Debt – Growth to continue?The growth should start shifting to internal consumption…
9
0
50
100
150
200
250
300
350
400
450
500
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
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00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
e
20
11
e
20
12
e
20
13
e
20
14
e
20
15
e
20
16
e
20
17
e
20
18
e
20
19
e
20
20
e
BRICs Euro Area US
Source: Euromonitor, Morgan Stanley Research. As of December 2010The data includes some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. There is no guarantee that any forecasts or opinions will be realized.Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell.
BRIC - Household Disposable Income over US$10,000 (Millions)
BRICs consumer has become a driving force in the global economy
Emerging Markets Debt – Growth to continue?The growth should start shifting to internal consumption…
10
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Jan 03 Feb 04 Mar 05 Apr 06 Jun 07 Jul 08 Aug 09 Sep 10
Developed Emerging (Top 25)
Monthly motor vehicle sales (millions)
Emerging consumers more important than developed consumers
0% 50% 100% 150% 200% 250%
Online travelFragranceChocolate
Grape wineJuice
CosmesticsHealthcare
CoffeeLife insurance
Air trafficDairy
Internet
AutoBottled water
DisposablePC
Sports shoes
Mobile phoneInternet
BeerOnline gameFixed phone
BicyclePork
Instant noodle
Penetration rate / consumption per capita, China as % of world average
GDP per capita (PPP):
China = 57% of world Avg.
Emerging Markets Debt – Growth to continue?The growth should start shifting to internal consumption…
11
Socialization of Private Debts is an uncertain strategy…• Sovereign Policy is fully in “experimental stage” -- we think this suggests Sovereign UNDERPERFORMANCE
12
Emerging Markets Debt – EM’s got their sh!t togetherMedium term: core imbalances remain and policy responses remain unorthodox
Political Imperative remains to ‘kick the can’ to the next guy…
Emerging Markets Debt – 2011 EM a safe haven…This Time it IS Different – Deficits, Unsustainable Debt & Demographics
13
Advanced and Emerging Economies: Cyclically Adjusted Primary Balance (CAPB), Primary Balance (PB), and Government Debt, 2007–14(In percent of GDP)
•Advanced economies face large primary deficits even adjusting for the cycle•Debt and deficit problems are centered in the advanced economies•Primary balances (ex interest expense) are forecasted to remain negative and continue to increase debt accumulation
Source: IMF
Emerging Markets Debt – Fiscal sanityEmerging Market Countries do not have the debt hangover problem…
Private and public sector debt/GDP% of GDP
0
50
100
150
200
250
300
350
400
Jap
an
Po
rtu
ga
l
UK
US
A
Ne
the
rla
nd
s
Sp
ain
Fra
nce
Gre
ece
Ge
rma
ny
So
uth
Ko
rea
Hu
ng
ary
Th
aila
nd
Ind
ia
Ch
ina
Bra
zil
Po
lan
d
Cze
ch R
ep
ub
lic
Tu
rke
y
Arg
en
tina
Ind
on
esi
a
So
uth
Afr
ica
Ru
ssia
Me
xico
Private sector debt Public sector debt
Emerging economies generally have very low levels of debt
Source: ING. Data to December 2009 Countries mentioned are shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell.
14
Household debt as a % of GDP
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
Ger
man
y
US
A
UK
Rus
sia
Tur
key
Cze
ch
Hun
gar
y
Pol
an
d
Cro
atia
S. A
fric
a
Arg
en
tina
Per
u
Col
om
bia
Mex
ico
Bra
zil
Chi
le
Phi
lippi
ne
s
Indo
nes
ia
Indi
a
Tha
ilan
d
Chi
na
Sou
th K
ore
a
Hon
g K
on
g
Mal
aysi
a
Tai
wan
Latin America13.4%
Emerging Europe28.8%
Mature Markets85.6%
Emerging Asia32.4%
Source: Morgan Stanley as of April 2010Data to December 2009. Countries mentioned are shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell.
Emerging economies never took on debt the way developed markets did
Emerging Markets Debt – Fiscal sanityHouseholds in Emerging Markets also hold much less debt…
15
% of Population over 65 EU-27 Dependency Ratio is worrisome…
•Population demographics in the G-7 are very unfavorable, distinctly different from post WW2 when demographic trends were positive•The number of people 65 or older will increase by 90% by 2035, to 20% of the population•By 2060 the problem in developed economies, such as the EU-27 will be particularly worrisome…
Emerging Markets Debt – 2011 an inflection year?This Time it IS Different – Difficult Demographics
16
77 78
63
2223 22
37
78
0
10
20
30
40
50
60
70
80
90
Population Land Naturalresources
GDP
Emerging Markets Developed Markets
Resources and demographics
% World’s total
Source: CSIS and World Economic OutlookThe opinions stated in this presentation include some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee that any forecasts or opinions will be realized.
Percentage of population over retirement age
%
4 4 45 5
6 68
10
1314
89
1112
1315
17
20
2426
27
0
5
10
15
20
25
30
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Developing economies Advanced economies
Long term prospects are favorable to Emerging Markets
Emerging Markets Debt – Demographics & Resources Unlike the Developed world…
17
Emerging Markets Debt – 2011 G-7 debt spiral?This Time it IS Different – Destructive Debt Dynamics…
18
•Unprecedented adjustments are required across the G-7•The status quo is not an option•Under current and future pressures on public finances public debt would spiral out of control in the absence of meaningful fiscal adjustment
General Government Net Debt Scenario Under 2010 Policies(In percent of GDP)
Source: IMF
These figures DO NOT INCLUDE entitlements!
Emerging Markets weighting in MSCI All Country World Index ( ~ $40 Trillion)
Source: MSCI Barra Research. Data to December 31, 2010
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Emerging Markets’ weighting has increased significantly over recent years – over $7 Trillion
Emerging Markets Debt – The Equities storyThis has become rather well known by now…
19
0.0
0.2
0.4
0.6
0.8
1.0
1.2
0 10000 20000 30000 40000 50000
Emerging Markets 37%
Developed Markets 63%
Global economy (Share of GDP)2
1Source: Factset, MSCI, data shown for December 2009 using MSCI World and MSCI EM indices (MSCI AC World)2Source: Goldman Sachs, Global Economics Paper No:204 as of September 20103Source: IMF, Factset, MSCI, data shown for 2009Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell.
Ratio of market capitalization to GDP3
Emerging Markets 15%
Developed Markets 85%
Global stock markets1
Capitalization/GDP (Dec 09)
GDP Per capita (09)
Australia
UK
Japan
GermanyEmerging Markets
Canada US
Emerging Market stock markets under-represented relative to size of economies
(19% by 2011 and 31% by 2030)²
(49% by 2011 and 59% by 2030)²
Emerging Markets Debt – The Equities storyBut it is still by no means finished growing…
20
Performance (Net US$) %
-100
-50
0
50
100
150
200
250
300
350
400
Dec-00 May-02 Oct-03 Apr-05 Sep-06 Feb-08 Jul-09 Dec-10
MSCI World Index MSCI EM index
MSCI Emerging Markets Index Performance 2001-2010
Source: Factset, Performance Net TR (US$), as of December 2010Performance shown is past performance. Past performance is not necessarily a guide to future performance. The value of investment can go down as well as up and is not guaranteed.
MSCI EM MSCI World
MSCI EM versus MSCI World
2001 -2.6% -16.8% +14.2%
2002 -6.2% -19.9% +13.7%
2003 +55.8% +33.1% +22.7%
2004 +25.6% +14.7% +10.9%
2005 +34.0% +9.5% +24.5%
2006 +32.2% +20.1% +12.1%
2007 +39.4% +9.0% +30.4%
2008 -53.3% -40.7% -12.6%
2009 +78.5% +30.0% +48.5%
2010 +18.9% +11.8% +7.1%
2001-2010 +337.0% +25.6% +311.4%
Annual Returns Net (TR) US$
Outperformed in 9 out of the last 10 years
Emerging Markets Debt – The Equities storyNevertheless… it has had a good run over the past 10 years.
21
Emerging Markets External Debt – 2010 Record Year
WALL OF MONEY… IFC says $825Bn in 2010… 2011 to exceed $1T ?
EM Equity in the 5th inning… EM Debt in the 2nd inning ?Global EM equity allocation = 6% - according to GS => 18% which means $4TEM Debt allocation <2% - PIMCO suggests should be over 20% => over $6T according to EPFR in 2010 >$40Bn inflow in US EM bond funds alone…
Record SUPPLY in 2010 likely to be matched in 2011…454 deals in 2010 through end November, $610mn avg size for $279B in supply Corporate deals => Majority of supply 385 or 85% of supply or $201B
22
Growth in local market issuance
Source: Merrill Lynch – December 2010
Total universe by sector
LOCAL DEBT
85%
Corporate Debt
31%
Govt. Debt
54%
Govt. Debt
6%
Corporate Debt
9%
EXTERNAL DEBT
15%
Emerging Market Debt TOTAL over US$9 trillion
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
2001 2002 2003 2004 2005 2006 2007 2008 2009
Local Government Local Corporate External Government External Corporate
US
$ bi
llio
nEmerging Markets Debt – Knight FocusWe participate primarily in the EXTERNAL DEBT segment
23
1990 – Brady Plan --- the start of the asset class $170Bn issued ($148Bn Latam)
Today 42 countries, over $9 Trillion market with only 6.5% of original Brady bonds left
EM External Debt Segment is $1.5 Trillion - US High Grade is $2.2 Trillion - US High Yield is $500 Bn
Other products include local bonds, rates, FX and capital markets.
Economic / market developments reduce risk of crises
Emerging Markets Debt – Knight FocusExternal Debt – What, How and Why…
24
A Barbell Approach to Uncertainties… 1) UNDERWEIGHT SOVEREIGNS• Sovereign ‘ceiling’ pierced definitively in Euroland… a “Berlin Wall Moment” ?
• Sovereign credit quality already much improved – now over 60% investment grade… what’s left?!?
Emerging Markets Debt – 2011 how to positionWe Prefer to own Corporate Issuers in 2011 & Avoid selective sovereigns…
25
Underweight Sovereigns with “GAP Risk” and high debt ratios• Investor memories are short-term -- the next global crisis is likely to trigger the same SELLS across the board…
Emerging Markets Debt – 2011 how to positionWe Prefer to own Corporate Issuers in 2011 & Avoid selective sovereigns…
26
EM Corporates used to trade through sovereigns… & they outperform…
Within the EM Corporate Universe focus in on EVENTS & Special Situations…• Focus on the alpha… where the space is not yet crowded…
• Since 2005 there has been over $1.7T issued in EM corporate Eurobonds, with over 1,000 distinct issuers…
• Majority of EM fixed income assets and specialistsare focused on sovereign issuers
Emerging Markets Debt – 2011 how to positionWe Prefer to own Corporate Issuers in 2011
27
-
50
100
150
200
250
300
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
e20
11f
US
D$
Bn
-
200
400
600
800
1,000
1,200
1,400
Spr
ead
(bp)
Private Credit Flows (USD$Bn)
EMBI Spread (bp)
Correlation of Private FDI Flows with EMBI spread is 0.73
Over 60% of EMBI now Investment Grade… meaning increased UST risk
Out of Index positioning key factors:
Corporates: 10 – 25% Mostly BB or better (Rate Risk)
Single “B” – Esoteric Sovereigns
EMBI+ ↑ 3.2% EMBIG ↑ 3.7% Vene + Mex Contributers Turkey + Argie Laggerds
Second Half 2011 – Timing, Trends and Threats…EM Fixed Income: External Spreads Dynamics… Flows & Composition
Source: IIF, Bloomberg; Knight Research
28
Emerging Markets Debt – 2011 how to positionWe Prefer to own Corporate Issuers in 2011
A Barbell Approach to Uncertainties… 2) OVERWEIGHT EM Corporates• Corporate Balance sheets are stronger, have greater transparency & SHOULD TRADE THROUGH SOVEREIGNS
•CS Indices: EMCI (EM Corporate Bond) SBI (EM Sovereign Bond Index) & LUCI (US Liquid High-grade Index)•Average quality of EMCI is “BBB/BBB+” while SBI average quality is “BBB-/BBB” & LUCI is about “A-”•Consequently, we see scope here for EMCI to tighten over 50bp THROUGH SBI Index.•YTD EMCI z-spreads are unchanged at +316bp while SBI z-spreads are wider by about 8bp to +267bp. Historical tights for SBI spreads were z+175bp & for EMCI were z+275bp. Hence, we continue to see scope for outperformance
29
Emerging Markets Debt – How Knight Makes $We are an agency broker.
PRINCIPAL MODEL• Trade for yourself• Conflicts of Interest• Utilize and motivate
staff to prioritize Firm over Client
BROKERAGE
• Traditional Agency• Principal
INVESTMENT BANK
Capital Markets
Consulting/Advisory
ASSET MANAGER
Asset Management
CustodyThe
Tra
ditio
nal A
genc
y M
odel
Uni
vers
al In
vest
men
t Ban
k
+ =CLIENT MODEL• Pure Agency
(Bonfire analogy)
• Mitigate Market Impact
• Provide Value-AddedResearch and Ideas
• Independent• Variable Cost• Low Margin/
Low Risk
30
Emerging Markets Debt – Agency BrokerThe Actors.
31
Emerging Markets Debt Q & A
32
Question: What would you advise your client to do with $10mn?
Greece 30 year bond
GGB 4.6 @ $43 – YTM 11%
Venezuela 30 year bond
VENZ 7 @ 58 -- YTM 12.4%
5 Year Chinese Corporate Issuer
Initially rated “BB” & 6.25% couponNow trading at 50 with fraud allegations
10 Year Kazakhstan Nat’l Oil Co.
KZOKZ 7 @ 110 -- YTM 5.5%
33
a) Hedge Fund b) Insurance Account c) Distressed Investor d) EM Mutual Fund
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