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Investing in Emerging Markets: A Strategic Opportunity

Investing in Emerging Markets: A Strategic Opportunity. Javier Murcio Deputy Portfolio Manager & Senior Sovereign Analyst. Over the past decade, emerging markets countries have demonstrated well-documented improvements in critical macroeconomic measures:

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Investing in Emerging Markets: A Strategic Opportunity

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  1. Investing in Emerging Markets: A Strategic Opportunity Javier MurcioDeputy Portfolio Manager& Senior Sovereign Analyst

  2. Over the past decade, emerging markets countries have demonstrated well-documented improvements in critical macroeconomic measures: … a decrease in foreign debt ratios, … an increase in foreign exchange reserves, … and more credible monetary policies. Foreign Debt (% of Exports)* 180% 150% 120% 90% 60% 30% 0% Foreign Exchange Reserves (US$ bn)* $190 $140 $90 $40 - $10 CPI (% YOY)* 30 25 20 15 10 5 0 Progress on Macro Economic Fundamentals Source: Standish and JP Morgan as of September 30, 2011. * Market cap weighted averages for countries in the J.P. Morgan Government Bond Index - Emerging Markets(GBI-EM) Global Diversified.

  3. EM Currencies: No More Pegs EM Core Balance (Weighted Average of All Countries in the JPM GBI-EM Global Diversified Index) • Emerging markets currency valuations are driven by supply-demand conditions. We believe core balance – the sum of current account balance and net foreign direct investment – is the most conservative measure of such conditions. • As global economic activity slowed down, core balances in emerging markets deteriorated significantly in 2008, albeit from a very high level. • Core balances improved significantly in 2009, and we expect them to stay at supportive levels at least for the next couple of years. Source: Standish as of September 30, 2011.

  4. EM Currencies: No More Pegs Combined Foreign Exchange Reserves of Brazil, Indonesia, Russia, and Turkey • The improved balance of payments of EM economies is already conspicuously manifesting itself in the rebounding foreign exchange reserves. Source: Thomson Reuters Datastream, Standish as of July 31, 2011.

  5. EM: No Longer Highly Indebted Debt as Percentage of GDP • Fiscal prudence has helped to reduce indebtedness, improving sovereign risk. • Debt ratios have improved significantly and emerging markets are no longer subject to the vagaries of external financing. • This is a big contrast with the direction of developed economies’ leverage. Source: International Monetary Fund, World Economic Outlook Database as of September 30, 2011

  6. Relative Resilience: Growth in EM Continues to Outpace Developed Economies IMF World Economic Outlook • Emerging markets debt was literally the last “domino” to fall as the global financial crisis intensified in late 2008 due to: • Improved creditworthiness of most emerging markets sovereign issuers; • Positive growth differentials relative to G-3. • For the same reasons, we believe emerging markets debt should be well supported going forward. Source: International Monetary Fund (IMF) World Economic Outlook (WEO) September 30, 2011. F = Forecast

  7. Advanced economies Emerging and developing economies 80 70 60 50 40 30 20 10 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Relative Resilience: Growth in EM Continues to Outpace Developed Economies Shares of World GDP Shifting • According to an IMF study, the share in World GDP accounted for by Emerging Markets will exceed that of the Developed World within the next few years. • The superior growth of Emerging Markets and the development of a middle class in these countries has implications for world trade, deployment of savings (for example in pensions) etc. These are also likely to produce a virtuous cycle, as these countries develop more trading links and also invest in each other. Source: International Monetary Fund as at 30 April 2011

  8. Ratings Quality Continues to Improve Ratings Upgrades vs. Downgrades • After a return to significantly more upgrades than downgrades in 2010, year to date, upgrades and downgrades from S&P are more balanced this year. • One downgrade reflects the changed methodology of S&P, placing a greater emphasis on political risk and other downgrades are mainly on the back of fiscal deterioration • Of the upgraded countries, two attained investment grade (Colombia and Uruguay), while Indonesia was upgraded to one notch below investment grade. Source: Standard and Poor's as at 30 September 2011

  9. Ratings Quality Continues to Improve Index Weights by Rating • The trend to upgrade EM countries to investment grade continues. Source: JP Morgan as at 30 September 2011

  10. EM Bond Fund Flows Cumulative Flows into External and Local EM Bond Funds Source: Emerging Portfolio.com as of November 10, 2011 • Flows had been significant until the recent episode of risk aversion, but they have begun to recover.

  11. EM Bond Fund Flows Monthly Flows into External and Local EM Bond Funds Source: Emerging Portfolio.com as of November 30, 2011 • Both external debt and local currency debt have benefited, although with higher yields and the possibility of currency appreciation, local currency vehicles have benefited more.

  12. Local Bonds (JPMorgan GBI-EM Global Diversified) Europe – Ex Russia - 26.0% Russia 8.4% Asia 29.3% Latin America 26.3% Middle East/Africa 10.0% New Face of Emerging Markets Debt • Market capitalization of emerging markets local-currency-denominated debt has quadrupled in the last five years and now represents approximately two thirds of the total EMD universe. • Market capitalization:$811 billion • Issuers: sovereign • Average rating:BBB+ (S&P) • Return drivers:(1) local currencies; (2) local bond yields • Investor base:predominantly local *UST = US Treasury Source: JP Morgan as of September 30, 2011.

  13. EM Local-Currency Debt: Unique and Potentially Attractive Sources of Returns GBI-EM Global Diversified: Currency and Duration Returns Source: JP Morgan, Standish as of November 30, 2011 • EM local-currency bonds enjoy two distinct sources of returns 1) currency, or the local cash yield plus changes in the spot rate, and 2) duration, or the extra return that local bonds earn relative to local cash – a currency hedged bond return. • Assuming a modest appreciation of EM currencies, we believe EM local-currency bonds have the potential to generate double-digit returns on an annual basis.

  14. EM Local-Currency Debt: Unique and Potentially Attractive Sources of Returns GBI-EM Global Diversified: Yield to Maturity Source: JP Morgan as of September 30, 2011 • We believe the steady positive local duration returns (suggesting that local bonds have outperformed currency forwards) reflect the positive term premium of local yield curves. Bond managers, however, can use currency forwards to invest in countries where the currency is attractive, but not prospective duration returns. In several EM countries, inflation-linked bonds are also available.

  15. US$-Denominated Bonds (JPMorgan EMBI Global) Russia Europe- Ex Russia 10.1% 20.1% Asia 17.9% Latin America 44.5% Middle East/Africa 7.5% New Face of Emerging Markets Debt • Emerging markets debt (EMD) consists of two distinct asset classes: local-currency-denominated bonds and dollar-denominated bonds. • The two asset classes are different in their country composition, creditworthiness, return drivers, and investor bases, yet both are fairly liquid. • Market capitalization: $436 billion • Issuers:sovereign and quasi-sovereign • Average rating:BB+ (S&P) • Return drivers:(1) spreads over UST*; (2) UST* yields • Investor base: predominantly foreign *UST = US Treasury Source: JP Morgan as of September 30, 2011.

  16. EM US$-Denominated Debt: Risk/Return Profile JPM EMBI Global: Spreads Over US Treasuries Source: JP Morgan as of November 30, 2011 • We believe that given the improvement in the weighted average credit quality of the asset class to BB+, at current levels sovereign spreads may offer more than adequate compensation for the potential credit losses. • Our research suggests that historically BBs outperform other rating categories over the complete credit cycle.

  17. Important Information CP7588-03-11-2011 (3M) 16 This is a financial promotion and is not intended as investment advice. The information provided within is for use by professional investors and should not be relied upon by retail investors. All information relating to Standish Mellon Asset Management Company LLC (Standish) has been prepared by Standish for presentation by BNY Mellon Asset Management International Limited (BNYMAMI). Any views and opinions contained in this document are those of Standish at the time of going to print and are not intended to be construed as investment advice. BNYMAMI and its affiliates are not responsible for any subsequent investment advice given based on the information supplied. This document may not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorised. This document should not be published in hard copy, electronic form, via the web or in any other medium accessible to the public, unless authorised by BNYMAMI to do so. No warranty is given as to the accuracy or completeness of this information and no liability is accepted for errors or omissions in such information. To help us continually improve our service and in the interest of security, we may monitor and/or record your telephone calls with us. This document is issued in the UK, mainland Europe (excluding Germany) by BNY Mellon Asset Management International Limited. BNY Mellon Asset Management International Limited, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Services Authority. In Germany, this document is issued by WestLB Mellon Asset Management KapitalanlagegesellschaftmbH, which is regulated by the BundesanstaltfürFinanzdienstleistungsaufsicht. WestLB Mellon Asset Management was formed as a 50:50 joint venture between The Bank of New York Mellon Corporation and WestLB AG. If WestLB Mellon Asset Management Kapitalanlagegesellschaft (WMAM KAG) receives any rebates on the management fee of investment funds or other assets, WMAM KAG undertakes to fully remit such payment to the investor, or the Fund, as the case may be. If WMAM KAG performs services for an investment product of a third party, WMAM KAG will be compensated by the relevant company. Typical services are investment management or sales activities for funds established by a different investment management company. Normally, such compensation is calculated as a percentage of the management fee of the respective fund, calculated on the basis of such product’s fund volume managed or distributed by WMAM KAG. The amount of the management fee is published in the prospectus of the respective fund. Any compensation paid to the WMAM KAG does not increase the management fee of the relevant fund. A direct charge to the investor is prohibited. The information given herein constitutes information within the meaning of § 31 sub-section 2 WpHG (German Securities Trading Act). In Dubai, United Arab Emirates, this document is issued by the Dubai branch of The Bank of New York Mellon, which is regulated by the Dubai Financial Services Authority. If this document is used or distributed in Hong Kong, it is issued by BNY Mellon Asset Management Hong Kong Limited, whose business address is Level 14, Three Pacific Place, 1 Queen's Road East, Hong Kong. BNY Mellon Asset Management Hong Kong Limited is regulated by the Hong Kong Securities and Futures Commission and its registered office is at 6th floor, Alexandra House, 18 Chater Road, Central, Hong Kong. In Singapore, this document is issued by The Bank of New York Mellon, Singapore Branch for presentation to professional investors.  The Bank of New York Mellon, Singapore Branch, One Temasek Avenue, #02-01 Millenia Tower, Singapore 039192. Regulated by the Monetary Authority of Singapore. If this document is used or distributed to intermediaries in the United States of America, it is issued by Dreyfus Investments, a division of MBSC Securities Corporation, located at 200 Park Avenue, New York NY 10166, USA. MBSC Securities Corporation is a member of FINRA. The products outlined are not available to US Persons. BNY Mellon Asset Management International Limited, BNY Mellon Global Management Limited (BNY MGM), Standish and any other BNY Mellon entity mentioned are all ultimately owned by The Bank of New York Mellon Corporation.

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