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EMERGING MARKETS DEBT Knight Capital - June 30 th 2011 Alfredo Viegas 203-930-7180

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EMERGING MARKETS DEBT. Knight Capital - June 30 th 2011. Alfredo Viegas 203-930-7180. Low ($975 or less) Lower middle ($976 - $3,855) Upper middle ($3,856 - $11,905). No Data High ($11,906 or more). Emerging Markets Debt – Geography What is an “Emerging Market Country?”. - PowerPoint PPT Presentation

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Page 1: EMERGING MARKETS DEBT

EMERGING MARKETS DEBT

Knight Capital - June 30th 2011

Alfredo Viegas 203-930-7180

Page 2: EMERGING MARKETS DEBT

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

Page 3: EMERGING MARKETS DEBT

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

Page 4: EMERGING MARKETS DEBT

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

Page 5: EMERGING MARKETS DEBT

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

Page 6: EMERGING MARKETS DEBT

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

Page 7: EMERGING MARKETS DEBT

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

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oroc

coV

enez

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Pak

ista

nM

alay

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S. A

rabi

aLe

bano

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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

Page 8: EMERGING MARKETS DEBT

Emerging Markets Debt – Growth to continue?This is the chart that should really scare you…

0

5

10

15

20

25

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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

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ary

Po

rtu

ga

l

Ta

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n

Bra

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Ho

ng

Ko

ng

Ma

lays

ia

Arg

en

tina

Ch

ile

Ru

ssia

Tu

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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

Page 9: EMERGING MARKETS DEBT

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

Page 10: EMERGING MARKETS DEBT

0

50

100

150

200

250

300

350

400

450

500

19

91

19

92

19

93

19

94

19

95

19

96

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97

19

98

19

99

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00

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01

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02

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e

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e

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e

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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

Page 11: EMERGING MARKETS DEBT

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

Page 12: EMERGING MARKETS DEBT

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…

Page 13: EMERGING MARKETS DEBT

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

Page 14: EMERGING MARKETS DEBT

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

Page 15: EMERGING MARKETS DEBT

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

Page 16: EMERGING MARKETS DEBT

% 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

Page 17: EMERGING MARKETS DEBT

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

Page 18: EMERGING MARKETS DEBT

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!

Page 19: EMERGING MARKETS DEBT

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

Page 20: EMERGING MARKETS DEBT

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

Page 21: EMERGING MARKETS DEBT

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

Page 22: EMERGING MARKETS DEBT

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

Page 23: EMERGING MARKETS DEBT

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

Page 24: EMERGING MARKETS DEBT

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

Page 25: EMERGING MARKETS DEBT

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

Page 26: EMERGING MARKETS DEBT

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

Page 27: EMERGING MARKETS DEBT

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

Page 28: EMERGING MARKETS DEBT

-

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

Page 29: EMERGING MARKETS DEBT

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

Page 30: EMERGING MARKETS DEBT

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

Page 31: EMERGING MARKETS DEBT

Emerging Markets Debt – Agency BrokerThe Actors.

31

Page 32: EMERGING MARKETS DEBT

Emerging Markets Debt Q & A

32

Page 33: EMERGING MARKETS DEBT

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