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INVESTOR PRESENTATION \\ STRICTLY CONFIDENTIAL
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EMERGING SOVEREIGN GROUP, LLC
National Association of College and University Business Officers
February 8, 2013
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For further information, please contact:
Stephen L. Guillette
(212) 813-4600 | [email protected]
THIS PRESENTATION AND THE INFORMATION CONTAINED HEREIN SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF ANY OFFER TO BUY WHICH MAY ONLY BE MADE AT THE TIME A QUALIFIED OFFEREE RECEIVES A CONFIDENTIAL PRIVATE OFFERING MEMORANDUM
(“CPOM”) DESCRIBING THE OFFERING AND RELATED SUBSCRIPTION AGREEMENT AND IN THE CASE OF ANY INCONSISTENCY BETWEEN THE DESCRIPTIONS OR TERMS IN THIS DOCUMENT AND THE CPOM, THE CPOM SHALL CONTROL. SECURITIES SHALL NOT BE OFFERED OR SOLD IN ANY
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GROUP, LLC (“ESG”) MAKES NO EXPRESS WARRANTY AS TO THE COMPLETENESS OR ACCURACY NOR CAN IT ACCEPT RESPONSIBILITY FOR ERRORS APPEARING IN THE DOCUMENT. ANY PROJECTIONS, MARKET OUTLOOKS OR ESTIMATES IN THIS DOCUMENT ARE FORWARD LOOKING
STATEMENTS AND ARE BASED UPON CERTAIN ASSUMPTIONS. OTHER EVENTS WHICH WERE NOT TAKEN INTO ACCOUNT MAY OCCUR AND MAY SIGNIFICANTLY AFFECT THE RETURNS OR PERFORMANCE OF ESG FUNDS. ANY PROJECTIONS, OUTLOOKS OR ASSUMPTIONS SHOULD NOT BE
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Executive Summary
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Executive Summary
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
The world is in the midst of a global deleveraging crisis. The crisis began in the USA, moved to Europe and will soon be in China.

The European crisis is far from over. Europe will have:
1.
Negative GDP growth
2.
Five countries soon in the “ECB Hospital”
3.
Little to no progress on the fiscal side
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
China will soon be Act III in the global deleveraging crisis. China will no longer enjoy a healthy trade surplus. China remains at the
“Nexus” of the global liquidity cycle.

While the US has been given a pass due to its reserve currency status and the more pressing problems in Europe and China, the
debt problems in the US will soon move to the forefront of investor’s minds.

China, Japan, and EM will begin to look inward to focus on their own problems. The continually shortening maturity profile of US
debt makes the US even more vulnerable.
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
Emerging Markets are considered by most investors to be the one bright spot on the globe yet returns have trailed the troubled
developed world. Most EM investors use flawed EM investment products and fail to benefit from the enormous dispersion
between winners and losers.

EM equities are not cheap.
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EUROPE
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Executive Summary
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 Europe represents just another step in the global deleveraging crisis that began in the US and will eventually have implications for
Asia and broader emerging markets.
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 The Eurozone was designed to fail given it lacks any economic rationale. The break up of a monetary union which condemns most
of its members to recession and surging unemployment is not a tail risk but an inevitability.
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 The economic outlook remains bleak given the continued toxic combination of fiscal austerity, contracting bank lending, soaring
unemployment, uncompetitive exchange rate, and structural rigidities.
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 Without growth, it is virtually impossible to resolve a debt problem without restructuring.
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 The German solution is the promise of debt mutualization after years of austerity and structural reforms in the periphery for which
there is no socio-political consensus. We do not believe this will ever happen.
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 Social and political tensions in the periphery continue to grow with almost daily demonstrations against austerity and rising support
for radical political parties.
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 The European policy response has constantly remained behind the curve and while LTROs and promises of renewed ECB bond
buying have reduced the risk of a complete collapse of the financial system, there has been no meaningful change to long-term
sustainability of public finances, the banking sector, nor any impact on private credit growth.
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 We believe that spreads will reach new highs and the Eurozone will look very different 1-2 years from now.
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Previous Spikes in Public Debt/GDP Have Always Resulted in a Surge in Sovereign Default
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Previous to the early-1900s, under the gold standard, high debt levels were mainly reduced through default.
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Since the advent of fiat currencies, a combination of inflation and default has been used to reduce debt.
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Current levels of debt have always resulted in a surge of inflation and/or default.*
SOVEREIGN DEFAULTS & INFLATION
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45
40
35
30
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15
10
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1826
1830
1834
1838
1842
1846
1850
1854
1858
1862
1866
1870
1874
1878
1882
1886
1890
1894
1898
1902
1906
1910
1914
1918
1922
1926
1930
1934
1938
1942
1946
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
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90
Total public debt/GDP
world average
(% right axis)
80
70
60
50
40
30
20
Percent of countries in
default or restructuring
(% left axis)
Percent of countries
with annual
inflation over 20%
(% left axis)
Source: Carmen Reinhart
*There can be no assurance that this trend will continue
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Multi-Decade Surge in Developed Economies Debt
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Developed market economies have seen a rapid increase in debt since the 1970s when major currencies became completely
floating and the world ended centuries of currency regimes backed by precious metals.
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The surge in debt in Eurozone countries since the inception of the common currency has been particularly rapid, with many
peripherals seeing debt levels triple or quadruple.
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GOVERNMENT PLUS FINANCIAL DEBT TO GDP
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Spain
PIIGS
UK
Italy
US
EU
France
Source: DB, BIS, Bloomberg
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Eurozone – Ill Conceived Monetary Union
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The Eurozone is particularly vulnerable to a deleveraging cycle because it has locked itself into an ill conceived monetary union.
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In the three decades leading up to the introduction of the Euro, significant and continuous currency adjustment was needed for
the vast majority of the members of the EU against Germany.
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As the chart below shows, the current most problematic Eurozone countries – Greece, Portugal, Italy and Spain – were the
countries with the weakest pre-Euro currencies.
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EUROZONE CURRENCIES DEPRECIATION VERSUS DEM SINCE USD/GOLD CONVERTIBILITY WAS ABANDONED
AND DURING THE 1990S
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Source: Deutsche Bank
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Degree of Required Fiscal Adjustments is Extreme
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Average primary balance required to stabilize the public debt/GDP ratio at 2007 level
(% of GDP)
NEVER BEFORE IN
OBSERVABLE
Over
5yrs
Over
10yrs
Over
20yrs
Primary balance
in 2011
Austria
5.1
3.0
2.0
-0.1
France
7.3
4.3
2.8
Germany
5.5
3.5
Greece
5.4
Ireland
11.8
ECONOMIC HISTORY
HAVE SO MANY
COUNTRIES HAD SO
MUCH DEBT.
THE ADJUSTMENTS
TO
PRIMARY FISCAL
BALANCES JUST TO
BRING DEBT BACK TO
2007 LEVELS ARE
EXTREME.
FOR EXAMPLE,
PORTUGAL WILL NEED
TO AVERAGE A 5.7%
PRIMARY SURPLUS FOR
EACH OF THE NEXT 5
YEARS TO STABILIZE
DEBT/GDP AT 2007
LEVELS, WHILE THE
LARGEST PRIMARY
SURPLUS OVER THE LAST
10 YEARS HAS BEEN
1%.
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Largest primary
balance 20002010
2.0
-2.2
-1.1
0.4
-0.7
0.3
2.1
2.8
CU
1.5
-3.0
-1.0
2.7
5.4
2.2
-9.2
-0.7
4.8
5.1
3.4
2.5
-0.5
2.3
4.1
10.1
6.4
4.5
-8.0
-4.9
-2.4
Netherlands
6.7
3.7
2.3
-3.4
0.4
2.3
Portugal
5.7
3.1
1.8
-4.4
-1.8
1.0
Spain
6.1
2.9
1.3
-4.3
0.1
2.8
UK
10.6
5.8
3.5
-7.6
-2.2
3.0
US
8.1
4.3
2.4
-7.1
-2.6
3.1
Italy
Japan
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Average primary
balance 20002010
NA
2.4
Source: IMF
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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ECB Action Has Previously Only Provided Temporary Relief
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There has been an endless procession of summits over the past two and a half years proposing “Grand Plans” to resolve the crisis.
All of these plans have failed and only last minute emergency measures by the ECB have prevented the situation in the Eurozone
from completely unraveling.
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Previous episodes of ECB bond purchases and liquidity injections initially triggered sharp moves lower in periphery yields, similar
to the recent rally, but failed to have a lasting impact.
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We believe the latest version of ECB bond buying, with its strict conditionality, will be no more effective.
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SPANISH 10 YEAR SPREAD VERSUS GERMANY
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Source: Bloomberg
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Eurozone Still Far from Medium-term Sustainability
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The ECB’s OMT program provides one leg of support for a sustainable Eurozone but much more needs to be done. Most of the
remaining legs have low probability of positive outcome.
Core Europe governments
and voters remain supportive
despite growing contingent
liabilities and actual costs to
budgets
Germany and markets allow
for slower pace of fiscal
austerity in periphery and
France
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Social rejection of austerity
and reform remains
manageable
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Banking Union – Agreement
on common supervision leads
to common deposit
guarantee and bank
resolution mechanisms
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Banks, especially in periphery,
complete deleveraging,
provide credit to economy
Fiscal Union - Countries to
give up significant
sovereignty over budgets
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Greece remains in Euro.
Depends on both EU writing
checks and survival of weak
coalition government
Spain achieves fiscal
consolidation, restrains
independence movement in
Catalonia, completes
cleanup of banking system
Eurozone only sustainable with a
return to solid growth, falling
unemployment and sustainable
debt trajectories
ECB/ESM provide credible
lender of last resort role
Italy elections produce strong
reform minded government
French government
implements strong structural
reforms
Supportive global growth
over coming years
There can be no assurance that any or all of these scenarios will materialize.
PAGE | 9
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Eurozone Had Stopped Functioning as a Monetary Union
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Despite the common currency, government bond markets in the periphery are becoming increasingly de-integrated from the
rest of the Eurozone as foreign ownership plummets to pre-Euro levels.
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GOVERNMENT MARKETABLE DEBT, FOREIGN HOLDERS (% OF TOTAL)
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Source: Eurostat, Morgan Stanley Research
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Europe 2013 and Beyond
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1) Weak GDP growth at best
2) Five countries to enter the “ECB Hospital”
3) Austerity Kills the patient
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4) Non-existent fiscal improvement
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Growth Outlook for Europe Remains Bleak
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Spreads in Europe have rallied, fuelled by promises of ECB bond buying and a global search for yield that is creating a growing
credit bubble.
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However, the growth outlook for Europe remains bleak due to the toxic combination of fiscal austerity, contracting bank lending,
soaring unemployment, non competitive exchange rate, and structural rigidities.
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Without growth, it is virtually impossible to resolve a debt problem without restructuring.
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The Eurozone is expected to enter recession in 2013 with the ongoing deep recessions in the periphery to continue.
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MUCH OF EUROZONE FACES MANY YEARS OF STRUCTURAL LOW GDP GROWTH
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US – “weak recovery”
Germany – “booming economy”??
UK
France
Euro Area
Spain
Italy
IMF Forecasts
Source: IMF
There can be no assurance that low GDP will materialize as forecasted.
PAGE | 12
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Eurozone Economic Data Continues to Deteriorate
EUROZONE UNEMPLOYMENT
%
% yoy
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EUROZONE CONSUMER CONFIDENCE
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EUROZONE INDUSTRIAL PRODUCTION
EUROZONE RETAIL SALES
% yoy
Source: Bloomberg
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Growth Forecasts Have Consistently Proved Far Too Optimistic
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As shown below, actual GDP growth has fallen far short of consensus forecasts in 2011 and 2012. We expect that to be the case
in 2013 as well.
ITALY- YOY REAL GDP
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SPAIN - YOY REAL GDP
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FRANCE- YOY REAL GDP
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Source: Deutsche Bank
There can be no assurance that growth estimates will materialize.
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Growing Social Tensions
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Some estimates of turnout for independence demonstration in Barcelona were over one million.
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Source: El Pais
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Political Risk Growing
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In the recent Catalonia elections in Spain, a far left pro-independence and anti-austerity party more than doubled its votes to
become the second largest party in the regional parliament.
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In Italy, Berlusconi is back and his party is rising in the polls ahead of the February 24 elections based on a anti-Europe, antiausterity platform. The anti-establishment Five Star Movement has become a major political force.
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In Greece, the left wing, anti-austerity Syriza party is now leading the polls. The neo-Nazi Golden Dawn party is rising strongly and
is now polling 13% support.
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SHARE OF SUPPORT FOR NON-MAINSTREAM POLITICAL PARTIES
(LAST ELECTION BEFORE CRISIS BEGAN IN 2010-PRESENT)
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Source: Credit Suisse
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Spain – Past the Point of No Return
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It is hard to be bullish about a country where people of working age are leaving in growing numbers and
whole regions may vote to secede.
SPAIN NET MIGRATION
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SHOULD CATALONIA BECOME INDEPENDENT?
Source: INE, population nowcast
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Source: Goldman Sachs
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EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Greece – Still a Very Significant Risk
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Greece will likely, once again, fail to meet the conditions of the bailout loans.
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Greece has already implemented more austerity than any other country on an IMF program ever, and the weak coalition
government is unlikely to be able to muster the political will to do what is being asked of it.
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The far left Syriza is now leading opinion polls with the neo Nazi Golden dawn party rising to third. Combined, they now have 45%
support.
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LATEST POLL – SUPPORT FOR GREEK POLITICAL PARTIES
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Source: VPRC
PAGE | 18
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Spain: Entering a Greek Like Vicious Circle
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
Despite never ending austerity measures, the Spanish fiscal deficit looks likely to once again miss the official target by a wide
margin.

The deficit target for 2012 has already been revised twice, from 4.6% to 5.3% of GDP and then to 6.3%. It will likely be around
8.0%.

The fiscal/economic outlook in Spain looks increasingly similar to Greece where austerity led to a sharp contraction in the
economy, which resulted in overshooting of fiscal deficit targets and required further austerity.
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SPANISH BUDGET DEFICIT EVOLUTION
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2011 2012
2011 2012
2011 2012
2011 2012
Revisions to 2011 during 2012
Changes to projected deficit
during 2012
Source: IGAE, Spanish Finance Ministry, J.P. Morgan
PAGE | 19
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Short-Term Fiscal Austerity May Kill the Patient
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We are highly skeptical that the Eurozone policymakers will implement medium-term reforms needed to make the Eurozone a
sustainable monetary union.

The argument may end up being irrelevant with a strong possibility of short-term austerity killing the patient.
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AUSTERITY ONLY MAKING THE PROBLEM WORSE
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Source: Goldman Sachs
There can be no assurances that estimated percentages will come to fruition.
PAGE | 20
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Despite Austerity, Debt Levels Continue to Grow
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Despite years of austerity, the Euro area is still far from achieving sustainable primary surpluses of the size required to stabilize debt
levels.
GOVERNMENT DEBT
%GDP
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Source: IMF
There can be no assurances that the estimated metrics will materialize..
PAGE | 21
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Austerity Combined with Private Sector Deleveraging Creating a Perfect Storm
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
Fiscal austerity alone of the magnitude required to stabilize debt levels in Europe would be painful.

When combined with deleveraging of the highly indebted private sector, a perfect storm is created.
…..AND AS A RESULT ARE REDUCING THEIR BALANCE SHEETS
EURO AREA BANKS ARE HIGHLY LEVERAGED….
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Source: Goldman Sachs
PAGE | 22
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Austerity Combined with Private Sector Deleveraging Creating a Perfect Storm

Even when credit is available, it is prohibitively expensive in the periphery.

This has not been corrected, as promised, by Draghi’s OMT.
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THE CORE-PERIPHERY LENDING GAP
SME LOAN RATES, 1-5 YEARS
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Source: IMF
PAGE | 23
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
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Greece Will Need Further Debt Restructuring

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The debt trajectory for Greece, announced in a second bailout in March, has already soared way beyond even the worst case
scenarios, requiring a third bailout just eight months later.
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EVOLUTION IN PROJECTIONS FOR GREEK GOVERNMENT DEBT
% OF GDP
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C
A
N
l
ia
t
n
O
B
U
E
E
E
E
E
E
E
E
Source: Moody’s
There can be no assurances that the estimated metrics will materialize..
PAGE | 24
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
e
t
u
b
tri
Complacency Returns
s
i
tD

Whether or not the Eurozone becomes a functional and sustainable monetary union will ultimately be decided by politicians and
not central bankers.

Politicians will need to ignore electoral calendars and make long term commitments to highly unpopular structural reforms of
their domestic economies and cede significant sovereignty over their economies, budgets, and banking systems to European
institutions.

Northern European governments will need to convince their taxpayers to accept years of fiscal transfers to Southern European
countries in the name of European unity.

However, once again, with market pressure easing, complacency has returned to Eurozone capitals.

Progress on negotiations over reforms such as fiscal and banking union, touted as vital to save the Eurozone just a few short
months ago, have come to a standstill.

The first and easiest step towards banking union (common bank supervision) will likely be delayed until 2014, at the earliest.
Greater fiscal union is now seen as a “medium-term” goal.

Politicians now claim that the Eurozone crisis is over and the ECB, without buying a single bond, has relieved them of any need
to make urgent progress on structural reforms. We believe that they are, once again, mistaken.
G
S
E
n
o
C
e
d
fi
C
A
N
l
ia
t
n
O
B
U
o
D
-
o
N
Source: Moody’s
PAGE | 25
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
e
t
u
b
tri
The Developed World’s Debt Crisis is Ridiculous
SPAIN 10YR BOND YIELD*
8
O
B
U
7.5
7
6.5
6
5.5
5
n
o
C
4.5
G
S
E
e
d
fi
o
N
C
A
N
l
ia
t
n
o
D
-
s
i
tD
* Updated as of: 1/8/2013
Source: Bloomberg
PAGE | 26
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Europe
e
t
u
b
tri
The Developed World’s Debt Crisis is Ridiculous
FRANCE 10YR BOND YIELD*
3.4
3.2
O
B
U
3
2.4
2.2
N
l
2
n
o
C
1.8
G
S
E
e
d
fi
ia
t
n
o
N
C
A
2.8
2.6
o
D
-
s
i
tD
 The next trade: short these countries in absolute yield – not in spread.
* Updated as of: 1/8/2013
Source: Bloomberg
PAGE | 27
e
t
u
b
tri
CHINA
G
S
E
n
o
C
e
d
fi
ia
t
n
N
l
C
A
O
B
U
o
D
-
o
N
s
i
tD
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
Executive Summary
s
i
tD
 While the world is obsessed with Europe, we believe that China will move to the forefront of investors’ minds over the next 1-3 years.
 Much like the US and Europe, we believe that China will soon be dealing with the fallout from a credit bust.
o
N
• China has engaged in highly wasteful investment and credit expansion in the past decade.
o
D
-
• Between 2000 and 2008, China funded investment with huge FX inflows, but those inflows have stopped.
• In 2012, China sustained investment through a rapid expansion of off-balance sheet financing, which is very risky.
O
B
U
• Unless massive inflows resume, China will be forced to increase risks in off-balance sheet assets, print massively, or face a hardlanding.
C
A
 Any China focused strategy needs to appreciate the five different paths that China can go down.
G
S
E
n
o
C
e
d
fi
ia
t
n
N
l
PAGE | 29
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
Trade Surplus as a Share of GDP Investment
NET EXPORT AS A SHARE OF GDP
0.08
CHINA’S HEFTY TRADE
SURPLUSES ARE A THING
0.07
OF THE PAST.
O
B
U
0.06
e
d
fi
0.02
n
o
C
N
l
ia
t
n
0.03
o
N
C
A
0.05
0.04
o
D
-
s
i
tD
0.01
G
S
E
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Net Export as a Share of GDP
Source: CEIC
PAGE | 30
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
Deposit Growth Slows Dramatically
s
i
tD
YOY % CHANGE IN CHINA’S DEPOSITS
30%
28%
26%
24%
22%
20%
18%
16%
14%
G
S
E
12%
n
o
C
nt
e
d
fi
ial
O
B
U
-
Do
o
N
DEPOSIT GROWTH HAS
SLOWED DRAMATICALLY.
IN 2009, CHINA HAD
PLENTY OF “DRY
POWDER” WITH WHICH
C
A
-N
WHILE STILL IN THE LOW
DOUBLE-DIGITS, CHINA’S
TO IGNITE A
“STIMULATIVE”
BOOM IN
PROPERTY AND
INFRASTRUCTURE.
THIS IS
NOT SO TODAY.
10%
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: CEIC
PAGE | 31
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
China’s Trade Surplus No Longer Generates Naturally Abundant Liquidity
s
i
tD
 In the past, Chinese stimulus programs were easily funded out of the abundance of liquidity created by China’s trade surpluses
and consequent FX reserve accumulation.
o
N
 Today, with FX reserves stagnating, the liquidity to fund any stimulus program would have to be created by the PBOC, which
would likely result in CNY weakness, an accelerated reduction of FX reserves, and potentially high inflation.
CHINA’S FX INFLOW
(BARS) IS NO LONGER
DRIVEN BY TRADE
SURPLUSES (LINE).
ia
t
n
FX RESERVES ARE
NOW
MAINLY DRIVEN BY
CAPITAL FLOWS, LARGELY
IN THE FORM OF “HOT
MONEY.”
G
S
E
n
o
C
N
l
e
d
fi
C
A
O
B
U
o
D
-
CHINA’S FX RESERVES ARE
NOW STAGNATING (AND
LIKELY HEADING INTO
REVERSE).
PAGE | 32
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
Economic Rebalancing is a Myth
s
i
tD
 Efficient, wealth-creating investment should generate the productivity enhancements, jobs, and income,
to naturally facilitate the “hand-off” to consumption. This is not happening in China.
CHINA’S “GROWTH”
IS
FAR TOO RELIANT ON
HIDDEN SUBSIDIES TO FIXED
ASSET INVESTMENT AND
INEFFICIENT SOE’S.
HALTING
SUCH POLICIES
IN ORDER TO REBALANCE
THE ECONOMY WOULD
NECESSITATE A LENGTHY
PERIOD OF MUCH LOWER
GROWTH.
POLITICAL REALITIES
SUGGEST THIS IS UNLIKELY.
G
S
E
n
o
C
e
d
fi
C
A
N
l
ia
t
n
O
B
U
o
D
-
o
N
PAGE | 33
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
China’s Growth Model: “If You Build it, They Will Come”
s
i
tD
CEMENT CONSUMPTION PER CAPITA VS. GDP PER CAPITA
EACH
SET OF SYMBOLS
REPRESENTS A NATION’S
DEVELOPMENT PATH OVER
TIME.
CHINA’S
PATH
KOREA’S
PATH
BY THIS METRIC, THE RATE AT
WHICH CHINA IS BUILDING
BO
U
C
A
THINGS RELATIVE TO ITS
GROWTH IN INCOMES IS
UNPRECEDENTED IN
MODERN ECONOMIC
HISTORY.
SOMEDAY BE ABLE TO
PRODUCTIVELY UTILIZE ALL
THE INFRASTRUCTURE,
PROPERTY AND INDUSTRIAL
CAPACITY, THE DEBT WITH
WHICH IT WAS FINANCED
NEEDS TO BE SERVICED
TODAY.
G
S
E
n
o
C
e
d
fi
SPAIN’S
PATH
N
l
ia
t
n
EVEN IF, AS THE BULLS
ARGUE, CHINA MIGHT
o
D
-
o
N
Source: J.P. Morgan Calculations
PAGE | 34
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
Funding Past Malinvestment Requires Ever Larger Doses of New Credit

o
D
-
CONVERSION OF INCREMENTAL DEBT INTO INCREMENTAL
ONE UNIT OF NEW
FINANCING IN 2006 CREATED
1.16 UNITS OF ADDITIONAL
GDP IN 2007.
140%
120%
TODAY,
88%
77%
60%
ADDITIONAL CREDIT
PRODUCES LESS THAN HALF A
UNIT OF NEW
GDP.
G
S
E
n
o
C
U
C
A
100%
EACH UNIT OF
e
d
fi
0%
1
o
N
116%
2003
81%
N
l
71%
ia
t
n
40%
20%
BO
GDP1
105%
80%

s
i
tD
Credit growth has become much less efficient in generating new GDP, as increasing portions go to the rolling of principal and
accumulating interest on past debts.
2004
38%
2005
2006
2007
2008
2009
44%
2010
50%
37%*
2011
2012
Incremental Nominal GDP / Prior Year’s Total Social Financing. Source: PBOC, World Bank
Ever-expanding credit growth is required to both fund past malinvestments and ensure continued new investment at levels
sufficient to meet government GDP targets.
* 2012 estimate assumes 10% growth in nominal GDP and 16% growth in social finance, which are the 1H growth rates.
PAGE | 35
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
The Explosion of Grey Market Financing and Risks
s
i
tD
 Rapid rise in wealth management products (WMPs) and other shadow financing (see below)
 Through WMPs, credit risks have shifted from banks to millions of corporations and households.
 WMPs, with three to six month maturity, finance multi-year projects.
o
D
-
 Banks put some of their worst assets in WMPs, but investors assume there is no risk.
O
B
U
GROWTH IN WMPS AND SHADOW FINANCING
60
50
40
30
20
n
o
C
10
E
SG
C
A
N
l
ia
t
n
e
d
fi
o
N
0
2011
WMPs as % of GDP
2012
Shadow Banking Assets as % of GDP
Source: Fitch, BAML
PAGE | 36
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
The Explosion of Grey Market Financing and Risks
s
i
tD

Contrary to the assumption of many investors, WMPs are legally not guaranteed by the banks.

Banks are beginning to default on WMPs, which they have sold on behalf of third parties.

In a panic, it is generally impossible to roll all of the underlying assets in WMPs back on banks’ balance sheets unless the PBOC
drastically reduced RRR.

A panic in WMPs can easily lead to a run on the banks.
G
S
E
n
o
C
e
d
fi
C
A
N
l
ia
t
n
O
B
U
o
D
-
o
N
Source: 21CBH.com
PAGE | 37
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
China
e
t
u
b
tri
A Fiscal Solution or a Foreign Bailout of China’s Financial System is Impossible
s
i
tD

Total Assets in the Chinese banking system in excess of 300% of GDP, or 150% of US GDP.

In the five years to end-2012, China’s banking system assets will have grown by USD 14T, equivalent in size to the entire US
commercial banking system.
o
D
-
o
N
BANKING SYSTEM ASSETS AS A PERCENTAGE OF GDP (END 2011)
O
B
U
450%
400%
350%
300%
79%
250%
200%
421%
373%
150%
on
100%
50%
0%
G
S
E
C
A
Shadow Banking
C
ia
t
n
e
d
fi
328%
N
l
240%
192%
180%
144%
117%
112%
106%
94%
76%
Source: PBoC, CEIC, World Bank
PAGE | 38
e
t
u
b
tri
US
G
S
E
n
o
C
e
d
fi
ia
t
n
N
l
C
A
O
B
U
o
D
-
o
N
s
i
tD
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
US
e
t
u
b
tri
Executive Summary
s
i
tD
 Fed QE has the effect of dramatically shortening the average maturity of US debt. Financing a debt load of 70% of GDP (and
rising) at 3-year average maturity would be viewed as highly irresponsible anywhere else.
o
N
 This irresponsible fiscal behavior is made temporarily possible by large scale, price-insensitive buying of US assets by global central
banks.
o
D
-
 However, the ability of foreign central banks to “recycle” of excess liquidity, thereby accommodating Fed printing, is coming to an
end as the EM world’s Balance of Payments surplus has effectively disappeared.
O
B
U
 Fed QE has been effective in pushing inflation breakevens higher (thereby lessening debt loads in real terms). The bond rally is the
result of a sharp decline in real yields, which are poised to head sharply higher as the “global recycling” game comes to an end.
N
l
C
A
 US yields are not suppressed because “we are like Japan.” US yields are trading well (and unsustainably) through the growth rate
in nominal GDP, which is running at a steady 4%. By contrast, low JGB yields were justified by flat-lining nominal GDP.
G
S
E
n
o
C
e
d
fi
ia
t
n
PAGE | 40
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
US
e
t
u
b
tri
The Limit to the Fed Backstop: Treasury’s Funding Stance is Becoming Highly Unstable
s
i
tD

Let us say Treasury issues USD 100bn in 30-year bonds. The Fed then “issues” USD 100bn in excess reserves (overnight deposits) at
0.25% and uses the proceeds to purchase USD 100bn in 30-year bonds. On a consolidated basis the US Government has funded
itself via the issuance of overnight debt.

As the US Treasury has endeavored to lengthen the average maturity of its debt outstanding, a seemingly prudent policy at
generational lows on interest rates, Fed QE policies have more than offset those efforts.
O
B
U
AVERAGE MATURITY OF US TREASURY MARKETABLE DEBT
G
S
E
C
on
N
l
ia
t
n
e
d
fi
C
A
o
D
-
o
N
Fed QE has pushed the
average maturity of the US
debt outstanding to a mere
three years – lower than
anything seen in peripheral
Europe.
Fed QE policies are creating
a massive “rollover risk.”
Any Fed attempt to step up
QE purchases to cap yields in
the face of waning interest on
the part of foreign central
banks will risk a run on the
Dollar.
Source: Federal Reserve, US Treasury, calculations by Encima Global.
PAGE | 41
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
US
e
t
u
b
tri
The Exorbitant Privilege: US Treasuries Afloat Upon a Sea of “Ink-Money”
s
i
tD

How long can the US government expect to fund patently irresponsible fiscal deficits at near-zero interest rates? As long as
global central banks remain willing and able to act as the marginal buyers, regardless of the rates on offer.

Fully half of the outstanding supply of US Treasuries has now been monetized by global central banks (including the Fed).
o
D
-
o
N
P roport ion of Treasuries O ut st anding Held by G lobal C ent ral Banks
O
B
U
(Including Fed Holdings)
C
A
60.0
N
l
52.5
45.0
n
e
id
37.5
G
S
E
C
f
n
o
tia
60.0
52.5
45.0
37.5
30.0
30.0
22.5
22.5
15.0
15.0
95
Source: Hav er Analytics
00
05
10
PAGE | 42
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
US
e
t
u
b
tri
The Machinery of Global Liquidity Recycling is Breaking Down
s
i
tD
 Global reserve accumulation has been the accommodating factor for excess US credit growth pre-crisis and Fed QE post-crisis,
creating the illusion of a money-printing “free lunch” for the US.
o
N
 But as higher EM inflation erodes competitiveness and liquidity-destroying local credit busts unfold, EM’s ability to sustain the
process is coming to end.
o
D
-
 With global partners becoming unable to further accommodate Fed money printing, the inflationary effect on the Dollar and US
long yields will start to reveal itself.
O
B
U
BRICKS* FX RESERVE ACCUMULATION (Y/Y)
50%
ia
t
n
30%
20%
n
o
C
10%
e
d
fi
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
0%
2002
G
S
E
C
A
N
l
40%
-10%
* Brazil, Russia, India, China, Korea, Singapore
Source: Haver Analytics / ESG Calculations
PAGE | 43
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
US
e
t
u
b
tri
The Yield Decline is Solely a “Real Rate” Phenomenon




s
i
tD
As inflation expectations ratchet higher with each spin of the Fed printing press, so to do real yields push to more negative levels.
A clean break above 2.50% in the 10-year breakeven would be a big event technically.
Barring a complete meltdown in Europe, it is hard to see nominal yields trading lower when breakeven inflation rates are
breaking out to the topside.
The Fed floor under the breakeven inflation rate should also broadly serve as a floor on nominal yields.
O
B
U
o
D
-
o
N
US 10YR REAL RATES (TIPS) VERSUS THE 10YR INFLATION BREAKEVEN
G
S
E
n
o
C
e
d
fi
ia
t
n
N
l
C
A
Treasury buyers are locking
in a decade of -0.77% real
returns – hardly a sustainable
strategy.
PAGE | 44
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
US
e
t
u
b
tri
If the US were “Becoming Japan” Rates Would Not be Trading through
Nominal GDP
JAPAN POST-CRISIS NGDP
GROWTH = 0%
US POST-CRISIS NGDP
GROWTH = 4%
SEE THE SIMILARITIES?
NEITHER DO WE!
G
S
E
n
o
C
e
d
fi
ia
t
n
N
l
C
A
O
B
U
-
Do
o
N
s
i
tD
US nGDP = 4%
US 10y Note = 1.6%
10y less nGDP = -2.4%
10y JGB = 0.8%
Japan nGDP = -0.5%
10y less nGDP = +1.3%
PAGE | 45
e
t
u
b
tri
EM
G
S
E
n
o
C
e
d
fi
ia
t
n
N
l
C
A
O
B
U
o
D
-
o
N
s
i
tD
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
EM
e
t
u
b
tri
Executive Summary
s
i
tD
 The EM consumer should be the focus for investors.
 Traditional avenues of EM investing FAIL!
 EM growth and increased EM consumerism does not equal returns – stock picking does!
 EM Universe filled with big winners and big losers and exciting dispersion.
O
B
U
 EM equities are not cheap. They are expensive.
G
S
E
n
o
C
e
d
fi
C
A
N
l
ia
t
n
o
D
-
o
N
PAGE | 47
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
EM
e
t
u
b
tri
Domestic Demand is the “Sweet Spot” of Emerging Market Equities
s
i
tD
 ESG believes that global consumption growth will come predominantly from emerging markets.
o
N
 ESG believes that emerging markets are now positioned at the beginning of an exciting credit cycle.
HOUSEHOLD DISPOSABLE INCOME OVER US$10,0001
2020e
2019e
2018e
2017e
2016e
2015e
2014e
2013e
2012e
2011e
2010e
2009
2008
2007
2006
2005
2004
2003
2002
e
d
fi
1996
1993
1992
G
S
E
1991
0
n
o
C
1995
50
1994
100
o
D
-
C
A
ia
t
n
2000
150
Euro Area
N
l
1999
200
1998
250
1997
300
O
B
U
US
Number of Households
(Millions)
350
BRICs
2001
400
(1) Source: Euromonitor, Morgan Stanley Research. Forward projections are Euromonitor Estimates. Note: data end-2009; 2010 data not finalized as of August 2011.
(2) Source: IMF IFS, Central Bank data, BofA Merrill Lynch Global Research estimates.
There can be no assurance that estimated regional growth will materialize.
PAGE | 48
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
EM
e
t
u
b
tri
Domestic Demand is the “Sweet Spot” of Emerging Market Equities
s
i
tD
MISALLOCATION OF CAPITAL

ESG believes that traditional emerging market vehicles do not provide adequate exposure to the exciting emerging market
consumer sector.

Indices and many long-only vehicles1:

Dominated by megacaps

Significant commodity and export-related exposure

Underweight niche emerging market growth opportunities which are driven by domestic demand
Top 10 Holdings of MSCI Emerging Markets Index
(EEM)
Name
Samsung Electronics
3.12%
Description
Global
Exporter
Petrobras
2.63%
Commodity
Vale
2.11%
Taiwan Semiconductor
1.90%
on
China Mobile
en
fid
C
A
Name
N
l
tia
Commodity
Global
Exporter
Top 10 Holdings of Brazil Bovespa Index
(IBOV)
Weighting Description
PetroChina
China Construction
Bank
Industrial &
Commercial BoC
10.19%
Commodity
10.14%
Name
Weighting Description
Vale
10.93%
Commodity
Bank
Petrobras
10.22%
Commodity
9.81%
Bank
OGX
5.46%
Commodity
Bank of China
9.77%
Bank
Itau Unibanco
4.54%
Bank
China Life Insurance
China Petroleum &
Chemical
6.46%
Insurer
BM&F Bovespa
3.49%
Exchange
6.30%
Commodity
Banco do Brasil
3.29%
Bank
PDG Realty
3.26%
Homebuilder
Gerdau
3.10%
Commodity
Chinese Telco
1.76%
Commodity
America Movil
1.41%
Telco
Ping An Insurance
5.40%
Insurer
China Construction Bank
1.30%
Bank
4.97%
Commodity
Itau Unibanco
Industrial & Commercial
Bank of China
1.29%
Brazilian Bank
China Shenhua Energy
Agricultural Bank of
China
3.59%
Bank
Banco Bradesco
3.02%
Bank
1.11%
Bank
China Merchants Bank
2.72%
Bank
Usiminas
2.66%
Commodity
SG
E
Weighting
O
B
U
Top 10 Holdings of Hang Seng China
Enterprises Index (HSCEI)
1.82%
Gazprom
(1)
o
D
-
o
N
C
As of Q1 2012; Source: Bloomberg.
Composition of top 10 holdings in the respective regional indices are subject to change over time.
PAGE | 49
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
EM
WIDE DISPERSION BETWEEN WINNERS AND
LOSERS CREATES A ROBUST ENVIRONMENT FOR
STOCK SELECTION
ESG Universe of EM Domestic Demand
Stocks
(MSCI EM: 19% 2010)
# of Stocks
400
300
 In 2011, 417 stocks were down greater
than 20%, while there were 343 stocks
that were positive.
227
61
100
250
150
# of Stocks
>100%
36
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(1) Source: ESG Internal Analysis, Bloomberg; The information contained herein
has been prepared by Emerging Sovereign Group. The dispersion data
analysis is based on the "universe" of stocks that are primarily, emerging
market domestic demand focused names, which trade more than a total of
$5mm a day, on a rolling six month daily average basis.
(2) Through 09/30/12
ial
>25% & <50%
50
o
N
>0% &<25%
180 Losers
68
55
57
<0% & >-10%
<-10% & >-20%
<-20%
(MSCI EM: -18.3% 2011)
181
76
627 Losers
150
109
101
250
350
417
450
>100%
550
450
350
# of Stocks
 Opportunities exist to generate returns
on both sides of the portfolio (long and
short).
CU
A
N
-
50
BO
>50% & <100%
o
D
-
343 Winners
50
f
n
o
155
136
-
 Growing dispersion presents an exciting
opportunity for fundamental stock
picking.
s
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579 Winners
200
100
 It is not surprising that some EM hedge
funds have struggled in the past 12
months as the market has not behaved
in a directional manner.
e
t
u
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ESG UNIVERSE OF EMERGING MARKET DOMESTIC DEMAND STOCKS - PERFORMANCE DISPERSION IN 2010 , 2011 & 20121
>50% & <100%
>0% &<25%
<0% & >-10%
<-10% & >-20%
<-20%
(MSCI EM: 12.2% 20122)
577
351
747 Winners
236
250
150
>25% & <50%
118
42
328 Losers
50
50
105
124
84
120
150
>100%
>50% & <100%
>25% & <50%
>0% &<25%
<0% & >-10%
<-10% & >-20%
<-20%
PAGE | 50
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
EM
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Keys to Hedge Fund Success in EM
s
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 Focus on 3 to 1 return to risk opportunities – eliminate everything else.
 Low net – let stock picking drive returns!
 Limit country exposures – let stock picking drive returns!
 No FX risk – let stock picking drive returns!
O
B
U
 Only analyzable businesses / Commodity stocks are unanalyzable
o
D
-
o
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 Focus on individual long and shorts. Indices add no alpha and create commodity and market cap mismatches.
 Exclusively liquid stocks – Liquidity in EM is king!
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PAGE | 51
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
EM
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Long | Short Equity Risk Management: The “Matrix” Approach¹
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MATRIX AND NET PORTFOLIO MANAGEMENT
1000 Stocks = ESG Universe
o
D
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450 Stocks = ESG Matrices
O
B
U
o
N
C
A
“1 Matrix”
LOWER BOUND
100
n
o
C
ial
75
fid
t
n
e
-N
3 to 1 +/-
UPPER BOUND
50
25
1 to 1 +/-
1 to 3 +/-
0
 At a score of 75: the average upside/downside ratio is 3 to 1
G
S
E
 At a score of 25: the average upside/downside ratio is 1 to 3
(1) The Matrix Approach is included to illustrate ESG’s current intended approach to risk management. This approach and the parameters set forth herein may be adjusted at any time in ESG’s discretion.
PAGE | 52
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Private Fund Risk and Other Disclosures
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The products described herein are unregistered private investment funds commonly called “hedge funds” (each, a “Private Fund”). Private Funds,
depending upon their investment objectives and strategies, may invest and trade in many different markets, strategies and instruments (including
securities, non-securities and derivatives) and are NOT subject to the same regulatory requirements as mutual funds, including requirements to provide
certain periodic and standardized pricing and valuation information to investors. There are substantial risks in investing in a Private Fund, including risks
associated with limited or no regulatory oversight. You should note that:
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o
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 A Private Fund represents a speculative investment and involves a high degree of risk.
Investors must have the financial ability,
sophistication/experience and willingness to bear the risks of an investment in a Private Fund. An investor could lose all or a substantial portion of
his/her/its investment.
o
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-
 An investment in a Private Fund is not suitable for all investors. An investment in a Private Fund should be discretionary capital set aside strictly for
speculative purposes. Only qualified eligible investors may invest in a Private Fund.
O
B
U
 A Private Fund’s prospectus or offering documents are not reviewed or approved by federal or state regulators and its privately placed interests are
not federally or state registered.
C
A
 An investment in a Private Fund may be illiquid and there are significant restrictions on transferring or redeeming interests in a Private Fund. There is no
secondary market for an investor’s investment in a Private Fund and none is expected to develop. Substantial redemptions within a limited period of
time could compel a Private Fund to liquidate its securities positions more rapidly than otherwise would be desirable, which could adversely affect the
value of the distribution proceeds and the value of the remaining interests in a Private Fund.
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l
 The net asset value of a Private Fund may be determined by its administrator or a pricing committee retained by the Private Fund in consultation with
its manager or advisor in certain cases. Certain portfolio assets may be illiquid and without a readily ascertainable market value. Since the value
assigned to portfolio securities affects a manager’s or advisor’s compensation, the manager’s or advisor’s involvement in the valuation process
creates a potential conflict of interest. The value assigned to such securities may differ from the value a Private Fund is able to realize. Instances of
mispriced portfolios, due to fraud or negligence, have occurred in the industry.
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 A Private Fund may trade in commodity interests and futures, may execute a substantial portion of trades on foreign exchanges, and/or may invest in
credit instruments, real estate, alternative or non-traditional assets or other instruments, each of which involve specified risks as disclosed in such Private
Fund’s offering documents and which could result in a substantial risk of loss. Commodities and futures prices may be highly volatile and are difficult to
predict.
G
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 A Private Fund may use derivative financial instruments, including, futures, swaps, options, credit default swaps and credit default indices, both for
hedging and speculative purposes. The use of derivative instruments involves a variety of material risks, including the high degree of leverage often
embedded in such instruments and the possibility of counterparty non-performance as well as of material and prolonged deviations between the
actual and the theoretical value of a derivative instrument.
PAGE | 53
EMERGING SOVEREIGN GROUP, LLC (“ESG”)
Private Fund Risk and Other Disclosures (cont.)
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 A Private Fund’s manager or advisor has total trading authority over a Private Fund. The death or disability of the portfolio manager or advisor, or their
departure, may have a material adverse effect on a Private Fund.
s
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 A Private Fund may use a single advisor or employ a single strategy, which could mean a lack of diversification and higher risk.
 A Private Fund may involve a complex tax structure, which should be reviewed carefully, and may involve structures or strategies that may cause
delays in important tax information being sent to investors.
o
N
 A Private Fund’s fees and expenses which may be substantial regardless of any positive return will offset such Private Fund’s trading profits. If a Private
Fund’s investments are not successful, these payments and expenses may, over a period of time, deplete the net asset value of a Private Fund.
o
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 A Private Fund and its managers/advisors and their affiliates may be subject to various potential and actual conflicts of interest.
 A Private Fund may employ investment strategies or techniques aimed to reduce the risk of loss which may not be successful.
O
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U
 A Private Fund may not be required to provide periodic pricing or valuation information to investors.
 A Private Fund may employ leverage. The more leverage used, the more likely a substantial change in value may occur, either up or down.
N
l
C
A
The above summary is not a complete list of the risks, tax considerations and other important disclosures involved in investing in a Private Fund and is
subject to the more complete disclosures in such Private Fund’s offering documents, which must be reviewed carefully prior to making an investment.
ia
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These Materials have been distributed by TCG Securities, L.L.C., a limited purpose broker/dealer registered with the US Securities and Exchange
Commission (“SEC”) and member of the Financial Industry Regulatory Authority (“FINRA”). Related financial products and services are only available to
investors deemed to be “qualified purchasers” as defined in Section 2(a)(51) of the Investment Company Act of 1940, as amended, and “accredited
investors” as defined in Regulation D of the 1933 Securities Act, as amended.
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PAGE | 54