Transcript
Page 1: Emerging Markets: Opportunities and Challenges in Public Equity Investing

Knowledge. Experience. Integrity.

CALLAN INVESTMENTS INSTITUTE

Research

April 2016

Emerging Markets

Opportunities and Challenges in Public Equity Investing

The last few years have been challenging for emerging market equities. In 2015, the MSCI Emerging

Markets Index declined 14.9% and underperformed developed markets for the third straight year, dragged

down by weak commodity prices, the slowing global economy, and the U.S. Fed interest rate hike in

December. Looking ahead, Callan’s 2016 capital market projections forecast a 10-year outlook for emerg-

ing market equities of 7.6% annualized return and a sizable 27.9% risk (standard deviation).

We assembled a group of Callan’s experts to discuss this challenging yet exciting asset class, of which it

might be said, “When it was good, it was very, very good, and when it was bad it was horrid.” Our experts

included Ho Hwang, Andy Iseri, and Lyman Jung of our Global Manager Research group. (Their full biog-

raphies can be found at the end of the paper.)

Ho HwangVice President, Global Manager Research

Andy Iseri, CFASenior Vice President, Global Manager Research

Lyman JungVice President, Global Manager Research

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Are emerging markets a safe place to invest? What are the associated risks?

Andy Iseri Statistically,emergingmarkets(definedbyMSCI)experiencehighervolatilitythandevelopedmarkets,

as seen in Exhibit 1. Coupled with relatively high correlation to other equity markets, an allocation to

emerging markets typically leads to heightened volatility for the overall equity structure.

Thereareothersignificantrisks,includingnaturalresourcepricedeclines,theslowdowninChina,cur-

rencyrisk,risinginterestrates,andnon-financialrisks.(Pleasesee“Section1:DetailedDiscussionof

Emerging Market Risks” in the Appendix for a deeper dive into these various risks.) However, emerging

marketequitiesstillplayanimportantroleinwell-diversifiedinstitutionalportfolios.

Sources: MSCI, Callan PEP

2015 Emerging Markets Performance CommentaryIn 2015, the appreciation of the U.S. dollar materially impacted performance on the U.S. dollar-de-

nominated MSCI Emerging Markets Index. Many currencies declined by double digits on a percent-

age basis against the U.S. dollar amid global growth concerns. The local currency version for the

MSCI Emerging Markets Index was down 5.8% in 2015 (compared to -14.6% for the U.S. dollar

version), so currency alone cost the Index nearly 900 basis points. All sectors declined in the asset

class, led by Materials (-21.6%), Utilities (-20.8%), and Telecom (-19.6%). The best performing sec-

tor was Health Care at a dismal -5.2%. From a style and market cap perspective, growth outper-

formed value stocks by more than 700 basis points, and small cap bettered mid/large cap stocks by

800 basis points for the year.—Lyman Jung

0%

10%

20%

30%

40%

13.2 – MSCI Emerging Market

9.7 – MSCI World

91 07 08 09 10 11 12 13 14 15989796959493 9992 06050403020100

Exhibit 1

Rolling 12 Quarter

Standard Deviation

for 25 Years ended

December 31, 2015

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3Knowledge. Experience. Integrity.

China• Fell 8% as the central government’s pursuit of the anti-corruption

campaign continued • TheCentralBankcuttheinterestratefivetimesandannounceda

surprise devaluation of the renminbi

Hungary• Best-performing emerging market (+36%); boosted by Prime

Minister Victor Orban’s economic reforms• Improving economic prospects and a potential return to invest-

ment grade debt rating helped gains

Russia• Among the few bright spots, Russia was one of only two emerging

market countries that was positive, up 4% for the year• The ruble fell 20% against the U.S. dollar, so the rally was much

less impressive in U.S. currency• Russian stocks rebounded after steep losses in 2014, helped by thecentralbankcuttingtheinterestratefivetimesin2015

Indonesia• Declined by more than 19% as growth slowed despite the govern-

ment’s economic stimulus plan • Rupiah fell 10% against the U.S. dollar

Brazil• Equities were down more than 41% as the economy plunged into

recession• Hamperedbyhighinflation,highunemployment,lowcommodity

prices, and political uncertainty amid continued fallout from the Petrobras investigation

Turkey• Down32%despitebenefitingfromloweroilprices• Lira fell 20% against the U.S. dollar

2015 Emerging Market Highlights

Greece

• Worst-performing emerging market (-61%) as the country’s debt crisis continued

• Its potential withdrawal from the euro zone and continued auster-ity measures hampered returns

India• Fell 6% in dollar terms as the excitement over reforms and eco-

nomic improvements waned over the year• Currency was also a headwind as it fell 5% against the U.S. dollar

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Callan Periodic Table of Investment Returns: Emerging Markets

Are we truly tapping into emerging market growth by investing in indices? What are your thoughts on alternative emerging market products?

Ho Hwang Investments in emerging markets continue to enable investors to capitalize on the growing economies

within developing markets. According to MSCI economic exposure data, the MSCI Emerging Markets

Index has consistently derived approximately 80% of its revenues from emerging markets over the past

fiveyears.(See“SectionII:ADeeperDiveIntotheMSCIEmergingMarketsIndex”intheAppendix for

a detailed discussion of this Index.) Two breeds of products centered on emerging market consumption

areslowlybubblingup:directandindirectemergingmarketconsumerstrategies.Althoughbothproducts

seek to capture the burgeoning emerging market middle class and focus on consumer-related sectors,

they have differentiated investable universes.

Sources: Callan, The FTSE Group, MSCI, Russell

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

FTSE Emerging

SC

34.8%

FTSE Emerging

SC

53.8%

Russell 3000

-37.3%

FTSE Emerging

SC

117.2%

Russell Emerging Mkts SC

28.1%

Russell 3000

1.0%

FTSE Emerging

SC

25.2%

Russell 3000

33.6%

Russell 3000

12.6%

Russell 3000

0.5%

Callan Emerging Mkt Style

34.3%

Russell Emerging Mkts SC

43.9%

MSCI World ex US

-43.6%

MSCI Emerging Mkts SC

113.8%

MSCI Emerging Mkts SC

27.2%

MSCI World ex US

-12.2%

Russell Emerging Mkts SC

24.2%

MSCI World ex US

21.0%

FTSE Emerging

1.6%

MSCI World ex US

-3.0%

Russell Emerging Mkts SC

33.7%

MSCI Emerging Mkts SC

42.0%

FTSE Emerging

-52.9%

Russell Emerging Mkts SC

96.6%

FTSE Emerging

SC

25.8%

MSCI Emerging Markets

-18.4%

MSCI Emerging Mkts SC

22.2%

Russell Emerging Mkts SC

5.3%

FTSE Emerging

SC

1.5%

MSCI Emerging Mkts SC

-6.8%

Russell Emerging Markets

33.4%

Russell Emerging Markets

40.9%

Callan Emerging Mkt Style

-53.3%

Russell Emerging Markets

83.8%

Russell Emerging Markets

21.7%

Callan Emerging Mkt Style

-18.5%

Callan Emerging Mkt Style

19.6%

FTSE Emerging

SC

2.3%

MSCI Emerging Mkts SC

1.0%

Russell Emerging Mkts SC

-8.9%

FTSE Emerging

33.1%

MSCI Emerging Mkts IMI

39.8%

MSCI Emerging Markets

-53.3%

FTSE Emerging

82.6%

MSCI Emerging Mkts IMI

19.9%

FTSE Emerging

-19.0%

Russell Emerging Markets

18.8%

MSCI Emerging Mkts SC

1.0%

Russell Emerging Mkts SC

-0.3%

FTSE Emerging

SC

-10.5%

MSCI Emerging Mkts SC

33.0%

FTSE Emerging

39.7%

MSCI Emerging Mkts IMI

-53.8%

MSCI Emerging Mkts IMI

82.4%

FTSE Emerging

19.8%

Russell Emerging Markets

-19.4%

MSCI Emerging Mkts IMI

18.7%

Callan Emerging Mkt Style

34.3%

Callan Emerging Mkt Style

-1.1%

Russell Emerging Markets

-12.8%

MSCI Emerging Markets

32.2%

MSCI Emerging Markets

39.4%

Russell Emerging Markets

-55.5%

MSCI Emerging Markets

78.5%

Callan Emerging Mkt Style

19.4%

MSCI Emerging Mkts IMI

-19.5%

MSCI Emerging Markets

18.2%

Russell Emerging Markets

0.0%

Russell Emerging Markets

-1.7%

Callan Emerging Mkt Style

-13.7%

MSCI Emerging Mkts IMI

31.7%

Callan Emerging Mkt Style

39.1%

MSCI Emerging Mkts SC

-58.2%

Callan Emerging Mkt Style

77.3%

MSCI Emerging Markets

18.9%

Russell Emerging Mkts SC

-25.3%

FTSE Emerging

17.9%

MSCI Emerging Mkts IMI

-2.2%

MSCI Emerging Mkts IMI

-1.8%

MSCI Emerging Mkts IMI

-13.9%

MSCI World ex US

25.7%

MSCI World ex US

12.4%

Russell Emerging Mkts SC

-59.5%

MSCI World ex US

33.7%

Russell 3000

16.9%

FTSE Emerging

SC

-27.1%

Russell 3000

16.4%

MSCI Emerging Markets

-2.6%

MSCI Emerging Markets

-2.2%

MSCI Emerging Markets

-14.9%

Russell 3000

15.7%

Russell 3000

5.1%

FTSE Emerging

SC

-63.3%

Russell 3000

28.3%

MSCI World ex US

8.9%

MSCI Emerging Mkts SC

-27.2%

MSCI World ex US

16.4%

FTSE Emerging

3.5%

MSCI World ex US

-4.3%

FTSE Emerging

-15.2%

See page 15 in the

Appendix for the standard

Callan Periodic Table

of Investment Returns,

which may provide useful

additional context.

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5Knowledge. Experience. Integrity.

The direct products gravitate to emerging market small cap companies, while the indirect strategies veer to

multi-national, developed market, large cap companies. Both direct and indirect strategies have performed

well (albeit having short track records) and offer beta around 0.80 relative to the MSCI Emerging Markets

Index.Despitethefavorablerisk/returnprofile,theseproductsmaypotentiallyhaveoverlapriskwithother

asset classes given their investable universe and subsequently disrupt the non-U.S. equity structure. As

such, both direct and indirect products may not be ideal for a core allocation, but viable for an opportunistic

mandate.

What about frontier markets?

Ho Hwang Frontier markets—countries with investable stock markets that are less established than those in the

emerging markets—are directly tied to their local economies. They are not a viable option to get indirect

exposure to emerging markets, considering only about 7% of revenues (MSCI Frontier Markets Index)

stem from emerging markets. (See Exhibit 11 in the Appendix.) Frontier markets offer a unique risk/

returnprofileduetotheirlowcorrelationtoothernon-U.S.equities.

Therearetwotypesoffrontiermarketstrategies:pureandhybridproducts.Similartodirectandindirect

emerging market products, pure and hybrid frontier market strategies are differentiated by the investable

universe. The pure products solely focus on frontier markets, whereas the hybrid portfolios utilize both

emerging and frontier markets. Because the hybrid products also invest in emerging markets, they may be

anoptionforinvestorsseekingemergingmarketexposurewithfrontiermarketflexibility.

What are some of the non-financial reasons to invest in emerging markets?

Andy Iseri Weoftendiscuss theeconomicandfinancial rationales foremergingmarket investing.But thereare

somenon-financialconsiderationswheninvestinginemergingmarkets,andperhapsforemostamong

these is the demographical shift taking place in these markets.

The vast majority of the world’s population live in emerging and frontier markets. The world has approxi-

matelysevenbillionhumans:China’spopulationtotalsmorethan1.3billion,India’sisover1.2billion,and

the U.S. has a mere 300 million. If an investor wants exposure to consumers, emerging markets should be

their focus. Not only is the current population tilted to emerging economies, so too is the trend of population

growth. Exhibit 2 shows past and projected population statistics for select countries and regions.

Sources: Richard Hokenson, United Nations

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

50 30 35 40 45 50858075706560 9055 25201510050095

Pop

ulat

ion

(mill

ion)

Brazil China Europe India Russia U.S.

Present day (2016)

Exhibit 2

Past and Projected

Population Statistics

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This chart depicts the population of least, less and more developed economies by age bracket. As

time marches on and people age, areas with downward-sloping bars will see increases in working-age

populations.

Perhaps more important than total population is the working-age population. Many developed countries

face aging populations. A shrinking workforce relative to a growing retired population spells trouble.

Strong future economic growth requires a growing workforce, and trends favor emerging markets. As

time marches on, populations in these economies are not only larger, but younger. These less-devel-

oped economies will have ample working-aged people for years to come. People in more developed

countries do live longer—although that poses a different set of issues for pension plans.

Is a diversified global emerging market strategy better than local specialists?

Ho Hwang Although country/regional specialists provide local expertise, global emerging market strategies in gen-

eralhavethefollowingdistinctiveadvantages:cost,regionalallocation,cross-countrystockselection,

and risk management. Unlike global emerging market strategies, a structure with local specialists can

be expensive as it requires multiple managers (i.e., Asia, Europe and Middle East, and Latin America)

to gain full emerging market exposure. Further, these local strategies may also have higher vetting and

monitoring costs considering their regional locations. Additionally, a structure with regional managers

underutilizes alpha opportunities from country and regional allocations.

Country and regional performance dispersion is wide within emerging markets (Exhibit 4).Thefive-yearreturn difference between the best-performing country (United Arab Emirates) and the worst-performing

country (Greece) was 46%. Regionally, emerging Asia beat emerging Latin America by roughly 13%.

Global emerging market strategies are better positioned to capture this performance gap relative to local

specialists because regional allocation, stock selection, and risk management processes are holistically

managed to construct optimal portfolios. Conversely, with regional strategies asset owners would be

Exhibit 3

Population of Least,

Less, and More

Developed Economies

by Age

Least Developed Less Developed More DevelopedP

opul

atio

n (m

illio

n)

0

100

200

300

400

500

600

0–4 100+95–9990–9485–8980–8475–7970–7465–6960–6455–5950–5445–4940–4435–3930–3425–2920–2415–910–145–9

Age brackets

Source: World Economic Forum

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7Knowledge. Experience. Integrity.

responsible for top-down decisions and execution. To simplify this process, plans may adopt a static

regional allocation. Unfortunately, such a structure would mute alpha opportunity and quite possibly

heighten risk given the country/regional performance dispersion. Moreover, company valuation and risk

assessment across countries and regions are limited with local specialists due to their narrow universe,

which may lead to sub-optimal stock selection and unintended risk exposure. Although we recognize that

country or regional specialists have local insights, top-down considerations have the potential to derail

stock selection.

EM Latin America

-11.4%

-4.8%-0.8%

-14.4%

All EmergingMarkets

EM Europe and Middle East EM Asia

Exhibit 4

Five-Year Regional

Performance

(U.S. Dollars)

Sources: Callan, MSCI

Five-Year Country

PerformanceGreece

Brazil

Colombia

Chile

Peru

Russia

Turkey

Poland

Czech Republic

South Africa

Hungary

All Emerging Markets

Egypt

Indonesia

Malaysia

Mexico

India

Korea

Taiwan

Thailand

China

Qatar

Philippines

United Arab Emirates

-33%

13%

11%

5%

1%

0%

-20%

-14%

-14%

-13%

-12%

-9%

-9%

-8%

-6%

-5%

-5%

-4%

-3%

-3%

-2%

-2%

-2%

-1%

Sources: Callan, MSCI

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How do you construct an emerging market structure?

Lyman Jung Aswithmostassetclasses,Callanadvocates forabalanceddiversifiedapproachwhenconstructing

an emerging market structure. We believe it is sub-optimal for an overall structure to be exposed to

significantbiasesrelativetotheassumptionsusedinassetallocationstudiesunlessthosebiasesare

intended and supported by sound investment principles. Many factors should be considered, including

overall and component style factors, market capitalization, and sector, country, and currency exposures.

Factors can have different levels of importance in emerging markets relative to developed. For example,

the impact of style (value/growth) is generally less pronounced in emerging markets than in developed

markets or single-country strategies. Country exposure has a heightened effect relative to developed

markets.

Callan also pays close attention to return patterns and performance predictability. For example, an

emerging market manager with a quality growth philosophy may display strong growth characteristics;

however, the manager’s performance pattern exhibits downside protection and as such may be appro-

priate as a standalone manager. Managers in a multi-emerging markets structure should complement

each other as far as style, fundamental vs. quantitative investment processes, and top-down vs. bottom-

up managers, while close attention is paid to their return patterns.

Country or regional specialists can also be utilized, as they may offer specialized local research into

less-covered areas. In this case, plan sponsors would have to manage the allocations to each special-

ist while individual managers would focus on stock selection since they lack the ability for cross-border

investing. Use of specialists will lead to an increased number of managers.

Passive implementation may have a place in the overall non-U.S. equity structure—perhaps in a core/

satellite approach where the passive sleeve is the structure’s anchor and the satellite manager may be

a high active share, high tracking error, conviction-driven manager where risk can be afforded. Callan

advocatesforactivemanagementinlessefficientassetclassessuchasemergingmarkets.Historyhas

shown that active management over longer time periods generally outperforms the MSCI Emerging

Markets Index and adds value (Exhibit 5). A “batting average” of rolling three-year outperformance when

considering various fee hurdles is shown in the Appendix, Exhibit 12.

Exhibit 5

Rolling 12-Quarter

Excess Return

relative to MSCI

Emerging Markets

20 Years ended

December 31, 2015

Source: Callan

-10%

0%

10%

20%

07 08 09 10 11 12 13 14 15989796 99 06050403020100

Callan Emerging Markets Style (10th–90th percentile) Median

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Is environmental, social, and governance (ESG) investing appropriate for emerging markets?

Andy Iseri Our current approach to ESG investing, which is similar to how we approach all aspects of investing,

is to gather information, conduct research, gain broad knowledge, and assist our clients in making an

informed decision that is right for them.

ESG investing in emerging markets offers risks and opportunities. There is opportunity that emerging

countries “leap-frog” togreener,moreenergy-efficienteconomies.Therearealso risks thatdataand

corporatefilingsare less robustand less reliablegiven less-developed (albeit improving)accounting

and reporting standards.

Emerging markets represent approximately 10% of the global investment universe for public equity. Is this a reasonable allocation?

Ho Hwang A strategic 10% weight to emerging markets within a public equity allocation is reasonable, considering

suchexposurewouldbeinlinewithitsmarketcapitalizationinthepublicequityuniverse(definedbythe

MSCI ACWI IMI). Historical emerging market exposure for the global universe is shown in the Appendix,

Exhibit 13. Although Callan’s 10-year return forecasts point to higher returns from emerging markets

relative to other equity asset classes, they are accompanied by higher risk (volatility), which can lead to a

less-favorablerisk/returnprofile.Despitesucharisk/returnprofile,thecurrentvaluationspreadbetween

developed and emerging markets may create an opportunity for a tactical emerging market overweight.

Investors should also take note of the assumptions used in their asset-allocation and asset-liability stud-

ies. Any deviation from these assumptions would constitute “assumption risks.”

For Further Reading

To learn more about emerging markets and related topics, see the following research on Callan’s website:

• ThePeriodicTableCollection:RankingsofAssortedIndicesandStrategies

• 2016 Capital Market Projections

• Global Equity Benchmark Review

• Going Global? (charticle)

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AppendixSection 1: Detailed Discussion of Emerging Market (EM) Risks

Natural Resources: Investors face daily headlines about the price of oil and other commodities. Dramatic

price declines have put a strain on many resource-producing countries. Several EM governments rely on

oil revenue to fund their budgets. This can affect entire societies as funding for social programs becomes

challenged. Notable resource-producing EM countries include Russia, United Arab Emirates, Brazil, and

Mexico. EM oil producers include Saudi Arabia, Iran, Iraq, and Kuwait. “Lower for longer” is a threat to both

economicandsocialstability,aswellastocorporateprofits, forproducers.Theoil/commodityenviron-

ment isnotbadforallcountries.Countriesthatareconsumersoftheseresourcesdirectlybenefitfrom

lower prices. Emerging and frontier countries topping this list include China, India, South Korea, Taiwan,

Thailand, and Poland. The natural resources environment is an area of both risks and opportunities.

China Slowdown: Another story topping the news is the slowdown in China. China was considered the

driver of global economic growth until 2011. Since then, China’s year-on-year GDP growth (Exhibit 6) fell

from 12% to estimates of about half of that. This slowdown has broadly affected commodity producers

and exporters to China. China’s slowdown coincides with an economic shift from focusing on manufactur-

ing to services and consumers. Along with corruption and market reforms, the eventual outcome of these

dynamic forces is uncertain.

-5%

0%

5%

10%

15%

1980 2010 2015199519901985 20052000

GD

P G

row

th

U.S. Growth China GrowthExhibit 6:

GDP Growth

U.S. and China

Sources: Callan, statisticstimes.com

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11Knowledge. Experience. Integrity.

Currency: Non-U.S. exposure for U.S.-based investors includes the investment security and the currency

it is denominated in. Simply put, if a currency goes up (U.S. dollar weakness or foreign currency strength)

it helps returns, if a currency goes down (U.S. dollar strength or foreign currency weakness) it detracts.

Currency risk from emerging market exposure has been heightened by the recent rise in the U.S. dollar.

As central banks around the globe balance their mandates for economic stability, employment, and com-

petitiveness, currency volatility has increased to the detriment of U.S. dollar-based investors. Exhibit 7 shows the relative performance of MSCI EM Local Currency to the standard U.S. dollar-denominated index

to highlight the currency effect to U.S. dollar-based investors. Currency effect has been generally nega-

tive since 2011. The question facing investors is whether the dollar’s upswing is largely done—or if there’s

more to come.

Rising U.S. Interest Rates: Conventional wisdom says that the U.S. Federal Reserve is in a tightening

phase. Strong economic growth relative to the rest of the world has most investors expecting a contin-

ued path to higher interest rates in the U.S. For emerging countries this poses two problems. First, as

globalassetsseekhigher-yieldinglow-riskassets,capitalflowstotheU.S.fromothercountries—including

emergingmarkets.Manyemergingeconomiesrelyonforeigninvestmenttofundgrowth—capitaloutflows

from those countries risks the slowing of investment. A second risk to emerging markets from higher U.S.

interest rates concerns external debt. Many governments, corporations, and banks in emerging markets

tookadvantageoflow-costU.S.dollar-denominatedfinancing.Itisestimatedthatover$4trillioninU.S.

dollar-denominated debt exists in emerging markets. As U.S. interest rates rise, capital leaves, and emerg-

ing currencies devalue, servicing this debt could be problematic. Countries facing the highest external debt

challenges include Brazil, Turkey, and South Africa.

Non-Financial Risks: The sources of risk when investing in any country are too numerous to list, but

investors should consider things like shareholder rights, rule of law, corruption, etc. Some key risks and

country ratings for 2015 are shown in Exhibit 8.

-13.4%

3.2%

2006

-6.2%

1.4%

-5.5%

4.9%

20142013201220112010200920082007 2015

10.3%

4.5%

-6.6%

-9.4%

Sources: Callan, MSCI

Exhibit 7

Calendar Year Relative Returns of MSCI EM (unhedged) to MSCI EM Local Currency

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Source: World Economic Forum

Judicial independence

1-7 (best)

Property rights

1-7

Favoritism in decisions of government

officials 1-7

Organized crime

1-7

Strength of auditing and

reporting standards

1-7

Soundness of banks

1-7

Regulation of securities exchanges

1-7

Protection of minority

shareholders’ interests

1-7

Strength of investor protection 0–10 (best)

Brazil 3.6 4.0 2.6 3.9 5.2 6.1 5.4 4.7 5.3

Chile 5.2 5.0 4.0 5.5 5.2 6.3 5.3 4.6 6.3

China 4.0 4.5 4.1 4.7 4.4 5.0 4.4 4.1 5.0

Colombia 2.8 3.9 2.6 2.8 4.5 5.8 4.0 4.1 8.3

Czech Republic 3.9 4.0 2.6 5.0 4.9 5.9 4.4 4.1 5.0

Egypt 4.0 3.6 3.7 3.5 3.8 4.2 3.5 3.5 3.7

Greece 3.7 3.9 2.6 5.5 4.3 2.8 3.7 4.3 5.3

Hungary 4.0 3.7 2.4 4.9 5.2 4.8 4.4 4.1 4.3

India 4.2 4.1 3.4 4.0 4.2 4.3 4.3 4.1 6.3

Indonesia 3.9 4.3 3.9 4.2 4.6 5.1 4.5 4.6 6.0

Malaysia 4.9 5.3 4.5 5.2 5.7 5.7 5.5 5.3 8.7

Mexico 3.2 4.0 2.7 2.7 5.0 5.6 4.8 4.3 5.7

Morocco 3.5 4.9 3.5 5.7 5.0 5.6 4.5 4.3 4.7

Pakistan 3.8 3.3 2.6 3.0 4.3 4.8 4.5 4.0 6.3

Peru 2.5 3.5 2.7 3.1 5.0 5.8 4.8 4.3 7.0

Philippines 3.6 4.3 3.1 4.7 5.1 5.5 4.6 4.5 4.3

Poland 4.1 4.3 3.1 5.6 4.9 5.4 4.9 4.0 6.0

Qatar 6.0 6.0 5.6 6.7 6.0 6.3 5.9 6.0 4.3

Russia 2.9 3.3 2.8 4.2 4.1 4.0 3.7 3.5 4.7

South Africa 5.4 5.6 2.6 4.3 6.7 6.5 6.4 6.1 8.0

South Korea 3.5 4.2 2.9 4.3 4.4 3.9 3.7 3.4 6.0

Taiwan 4.2 5.7 4.1 5.8 5.7 5.7 5.4 5.1 6.3

Thailand 3.8 4.1 2.8 4.5 5.1 5.7 5.0 4.9 7.7

Turkey 3.1 4.6 3.2 4.4 4.8 5.7 4.6 4.3 6.3

UAE 5.6 5.5 5.3 6.8 5.5 5.9 5.5 5.3 5.0

Exhibit 8: Key Risks by Country

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13Knowledge. Experience. Integrity.

Section 2: A Deeper Dive Into the MSCI Indices

Thesignificanceofcountryofdomicileforcompaniesisdiminishingduetoglobalization.Assuch,MSCI

has developed a methodology to calculate the economic exposure of the underlying constituent companies

by segregating their revenues based on geographic distribution. The following exhibits provide the regional

economic exposure for the various indices. The economic exposure for the MSCI Emerging Markets Index

hasbeenconsistentoverthepastfiveyears(Exhibit 9). In 2010, 81% of the Index was economically tied

to emerging markets, which declined only by 2% in 2015 to 79%. As the engine of growth in emerg-

ing markets, China is the biggest revenue contributor with 37% in 2015, which increased by 13% from

24% in 2010. Interestingly, the Emerging Markets Small Cap Index (Exhibit 10) has a similar economic

exposureprofile,with83%ofrevenuescomingfromemergingmarkets.Theeconomicexposureforthe

MSCI Frontier Markets Index (Exhibit 11) hasevolvedoverthepastfiveyears.In2010,58%ofrevenue

was driven by frontier markets. In 2015, it jumped to 80%, suggesting some economic convergence within

frontier markets.

7.2%

Developed Markets

57.9%

80.3%

9.7%12.0%

Frontier MarketsEmerging Markets Other Countries

20.4% 6.9% 5.6%

80.9% 79.6%

2010 2015

17.6%

Developed Markets

1.4% 1.5% 2.3%15.4%

Frontier MarketsEmerging Markets Other Countries

80.9% 78.9%

2.0%

13.6%

Developed Markets

1.2% 1.3% 2.0%15.6%

Frontier MarketsEmerging Markets Other Countries

81.1% 83.2%

2.0%

Exhibit 11

Economic Exposure for the MSCI Frontier Markets Index

Exhibit 9

Economic Exposure for the MSCI Emerging Markets Index

Exhibit 10

Economic Exposure for the MSCI Emerging Markets Small Cap Index

Sources: Callan, MSCI

Page 14: Emerging Markets: Opportunities and Challenges in Public Equity Investing

14

0%

4%

8%

12%

16%

20152006 2010200920082007 2014201320122011

11.0% 10-Year Average Emerging Market Exposure

Sources: Callan, MSCI

Exhibit 13

Emerging Markets

Exposure within

MSCI ACWI IMI

for 10 Years ended

December 31, 2015

Section 3: Other Exhibits

Fee Hurdle 0.70% 0.75% 0.80% 0.85% 0.90% 0.95% 1.00% 1.05% 1.10% 1.15%Median 65% 65% 63% 63% 61% 58% 56% 56% 56% 51%

45th Percentile 74% 71% 71% 71% 70% 69% 69% 68% 68% 65%

40th Percentile 81% 81% 80% 79% 79% 76% 76% 74% 74% 73%

35th Percentile 91% 91% 90% 90% 88% 86% 84% 84% 84% 84%

30th Percentile 99% 99% 99% 98% 96% 96% 96% 96% 95% 94%

25th Percentile 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

AverageAnnualizedExcessReturn–MedianManager:1.45%

Exhibit 12

Batting Average of

3-Year Periods Where

Peer Group Median

Manager Beats the

Benchmark by More

than Typical Fee Hurdles

The median manager in Callan Emerging Markets Broad peer group had an average annualized excess

return of 1.45%.

Source: Callan

Page 15: Emerging Markets: Opportunities and Challenges in Public Equity Investing

15Knowledge. Experience. Integrity.

Sources: Barclays, MSCI, Russell, Standard & Poor’s

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

MSCI Emerging Markets

32.6%

MSCI Emerging Markets

39.8%

Barclays Aggregate

5.2%

MSCI Emerging Markets

79.0%

Russell 2000

Growth

29.1%

Barclays Aggregate

7.8%

MSCI Emerging Markets

18.6%

Russell 2000

Growth

43.3%

S&P 500 Growth

14.9%

S&P 500 Growth

5.5%

MSCI EAFE

26.3%

MSCI EAFE

11.2%

Barclays Corp High

Yield

-26.2%

Barclays Corp High

Yield

58.2%

Russell 2000

26.9%

Barclays Corp High

Yield

5.0%

Russell 2000 Value

18.1%

Russell 2000

38.8%

S&P 500

13.7%

S&P 500

1.4%

Russell 2000 Value

23.5%

S&P 500 Growth

9.1%

Russell 2000 Value

-28.9%

Russell 2000

Growth

34.5%

Russell 2000 Value

24.5%

S&P 500 Growth

4.7%

S&P 500 Value

17.7%

Russell 2000 Value

34.5%

S&P 500 Value

12.4%

Barclays Aggregate

0.5%

S&P 500 Value

20.8%

Russell 2000

Growth

7.0%

Russell 2000

-33.8%

MSCI EAFE

31.8%

MSCI Emerging Markets

19.2%

S&P 500

2.1%

MSCI EAFE

17.3%

S&P 500 Growth

32.8%

Barclays Aggregate

6.0%

MSCI EAFE

-0.8%

Russell 2000

18.4%

Barclays Aggregate

7.0%

S&P 500 Growth

-34.9%

S&P 500 Growth

31.6%

Barclays Corp High

Yield

15.1%

S&P 500 Value

-0.5%

Russell 2000

16.3%

S&P 500

32.4%

Russell 2000

Growth

5.6%

Russell 2000

Growth

-1.4%

S&P 500

15.8%

S&P 500

5.5%

S&P 500

-37.0%

Russell 2000

27.2%

S&P 500 Value

15.1%

Russell 2000

Growth

-2.9%

S&P 500

16.0%

S&P 500 Value

32.0%

Russell 2000

4.9%

S&P 500 Value

-3.1%

Russell 2000

Growth

13.3%

S&P 500 Value

2.0%

Russell 2000

Growth

-38.5%

S&P 500

26.5%

S&P 500

15.1%

Russell 2000

-4.2%

Barclays Corp High

Yield

15.8%

MSCI EAFE

22.8%

Russell 2000 Value

4.2%

Russell 2000

-4.4%

Barclays Corp High

Yield

11.8%

Barclays Corp High

Yield

1.9%

S&P 500 Value

-39.2%

S&P 500 Value

21.2%

S&P 500 Growth

15.1%

Russell 2000 Value

-5.5%

S&P 500 Growth

14.6%

Barclays Corp High

Yield

7.4%

Barclays Corp High

Yield

2.5%

Barclays Corp High

Yield

-4.5%

S&P 500 Growth

11.0%

Russell 2000

-1.6%

MSCI EAFE

-43.4%

Russell 2000 Value

20.6%

MSCI EAFE

7.8%

MSCI EAFE

-12.1%

Russell 2000

Growth

14.6%

Barclays Aggregate

-2.0%

MSCI Emerging Markets

-1.8%

Russell 2000 Value

-7.5%

Barclays Aggregate

4.3%

Russell 2000 Value

-9.8%

MSCI Emerging Markets

-53.2%

Barclays Aggregate

5.9%

Barclays Aggregate

6.5%

MSCI Emerging Markets

-18.2%

Barclays Aggregate

4.2%

MSCI Emerging Markets

-2.3%

MSCI EAFE

-4.9%

MSCI Emerging Markets

-14.6%

Callan Periodic Table of Investment Returns Annual Returns for Key Indices Ranked in order of Performance

Page 16: Emerging Markets: Opportunities and Challenges in Public Equity Investing

16

Biographies

Ho Hwang is a vice president and a non-U.S. equity investment consultant in the Global Manager

Research group. Ho joined Callan in 2012. He is responsible for research and analysis of non-U.S.

equity investment managers and assists plan sponsor clients with non-U.S. equity manager searches.

Ho regularly meets with investment managers to develop an understanding of their strategies, prod-

ucts, investment policies and organizational structures. Prior to joining Callan, Ho worked as a senior

investment analyst for Progress Investment Management Company. Ho earned a BA in Economics from

University of California at Davis.

Andy Iseri, CFA, is a senior vice president and a non-U.S. investment consultant in Callan’s Global

Manager Research group. He is responsible for research and analysis in the non-U.S. and global asset

class including developed and emerging equity, issues surrounding currency management, as well as

matters related to ESG investing. He oversees manager searches, conducts on-site visits, and attends

finalistinterviews.Andyisashareholderofthefirm.PriortojoiningCallan,Andyspentsixyearsselecting

and evaluating domestic and international equity managers for the California State Teachers’ Retirement

System.Prior to that,Andymanagedandtradeddomesticfixed incomeassetsatCalSTRS.Healso

assisted in the plan’s currency, securities lending and credit enhancement programs. Before joining

CalSTRS’ investmentdivisionAndywasaSeniorAccountant in theplan’sbenefitaccountinggroup.

Andy earned a BS in Business Administration - International Business at California State University,

Sacramento. He belongs to CFA Institute, CFA Society of Sacramento, and earned the right to use the

Chartered Financial Analyst designation.

Lyman Jung is a vice president and a non-U.S. equity investment consultant in Callan’s Global Manager

Research group. He is responsible for research and analysis in the non-U.S. and global asset classes

including developed and emerging markets. In this role, Lyman meets regularly with investment manag-

ers to develop an understanding of their strategies, products, investment policies and organizational

structures. Prior to Lyman’s current role, he was the Operations Manager for the group where he man-

aged the group’s analyst team and coordinated search workflow. His responsibilities also included

qualitative and quantitative analysis of investment managers and the production of research and client

reports. Lyman earned his B.A. in Economics from the University of California, Los Angeles and is a

Level III candidate in the CFA Program.

Page 17: Emerging Markets: Opportunities and Challenges in Public Equity Investing

17Knowledge. Experience. Integrity.

Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to be reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational pur-poses only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of this report is your sole responsibility. You should consult with legal and tax advisers before applying any of this information to your particular situation. Reference in this report to any product, service or entity should not be construed as a recommendation, approval, affiliation or endorsement of such product, service or entity by Callan. Past performance is no guarantee of future results. This report may consist of statements of opinion, which are made as of the date they are expressed and are not statements of fact. The Callan Investments Institute (the “Institute”) is, and will be, the sole owner and copyright holder of all material prepared or developed by the Institute. No party has the right to reproduce, revise, resell, disseminate externally, disseminate to subsidiaries or parents, or post on internal web sites any part of any material prepared or developed by the Institute, without the Institute’s permission. Institute clients only have the right to utilize such material internally in their business.

If you have any questions or comments, please email [email protected].

About Callan

Callanwas foundedasanemployee-owned investment consultingfirm in1973.Ever since,wehave

empowered institutional clients with creative, customized investment solutions that are uniquely backed

by proprietary research, exclusive data, ongoing education and decision support. Today, Callan advises

onmorethan$1.8trillionintotalassets,whichmakesusamongthelargestindependentlyownedinvest-

mentconsultingfirmsintheU.S.Weuseaclient-focusedconsultingmodeltoservepublicandprivate

pensionplansponsors,endowments,foundations,operatingfunds,smallerinvestmentconsultingfirms,

investmentmanagers,andfinancialintermediaries.Formoreinformation,pleasevisitwww.callan.com.

About the Callan Investments Institute

The Callan Investments Institute, established in 1980, is a source of continuing education for those in

the institutional investment community. The Institute conducts conferences and workshops and provides

published research, surveys, and newsletters. The Institute strives to present the most timely and relevant

research and education available so our clients and our associates stay abreast of important trends in the

investments industry.

© 2016 Callan Associates Inc.

Page 18: Emerging Markets: Opportunities and Challenges in Public Equity Investing

Corporate Headquarters

Callan Associates600 Montgomery Street Suite 800San Francisco, CA 94111800.227.3288 / 415.974.5060www.callan.comTwitter:@CallanAssocFollow us on LinkedIn

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