Subject: Correction: The Rohatyn Group - Emerging Markets: Down But Definitely Not Out
From: "TRG Management" <[email-masked]>
To: <[email-masked]>
Date: Thu, 9 Feb 2012 19:17:40 -0600 (CST)

TRG Management LP discovered a data error within the 2012 and 2013 economic and inflation forecast in figure 20 on page 16.  We have corrected the numbers in the table and are providing a clean copy of the report for your convenience.  Please note that the numbers quoted in the body of the paper and the conclusions of the white paper were not affected. We apologize for this inconvenience.

Emerging Markets: Down But Definitely Not Out

The year 2011 provided a stark reminder that investing in emerging markets is not always the same as investing in emerging economies.  It was also a good illustration of how asset price behavior can at times dissociate from economic and financial fundamentals.   For the year, the MSCI emerging market equity index declined 20.5% compared with a slightly positive return for the S&P500.  The poor performance of emerging market assets was not limited to equities.  The ELMI+ index of emerging market currencies declined 5.2% and contributed about a quarter of the total equity losses measured in US dollars.  Finally, while total returns for emerging market hard currency bonds (EMBI) outperformed all other EM assets, the average spread of emerging sovereign bonds over US Treasuries rose 50 basis points to end the year at 426 basis points.

The underperformance of emerging markets relative to developed markets in 2011 can be traced to the interaction of three factors.  First, a heavy “technical position” which was created in the run up from 2009-2011 and which led to record foreign inflows into emerging stock and local bond markets, making them and their currencies highly vulnerable to sudden sentiment shifts in global capital.  In a sense, emerging markets were victims of their own popularity as foreign holdings grew very large relative to the pools of available liquidity.  Second, a sharp increase in risk aversion starting in July 2011 which resulted from a worsening of the sovereign debt crisis in the Eurozone, the impact of the earthquake in Japan, fears of a US recession and a hard landing of the Chinese economy.  Finally, monetary policy tightening was implemented in most of the emerging economies in the first half of 2011, as their central banks struggled with inflationary pressures.

Late in 2011 and early in 2012, we have begun to see an improvement in all of these areas, making us more positive about the near and medium term investment outlook for EM assets.  As a result of ECB action, funding and liquidity conditions for Eurozone sovereigns and banks have improved.  In addition, short term indicators in China suggest that the economy is stabilizing at a less inflationary pace of growth.  In the US, the economy seems to be stabilizing at a moderate pace and the Fed has renewed its commitment to low rates until 2014.  For China, as for many other emerging countries, slower growth has caused inflation concerns to diminish, allowing for a relaxation of monetary policy.  Finally, as a result of strong outflows in the fourth quarter, technical positioning has become lighter at a time in the calendar year when investors are typically more willing to take on risk.

In reviewing emerging market economic and financial fundamentals, we conclude that, although there are somewhat fewer degrees of freedom than in 2008, emerging economies still display considerable ability to enact countercyclical policies and to weather the effects of slower growth in developed economies.  Solid fundamentals alone do not guarantee good asset performance but they diminish the probability of investment “tail” risks.

Looking ahead, the central question for investors is what factors explained the recent emerging market underperformance, and how these factors are shaping up for 2012 and beyond.  This brief paper explores these questions in some detail.  Please let us know if you have any comments or questions.

TRG Management LP
280 Park Avenue, 27th Floor
New York, NY 10017
+1 (212) 984-2900
[email-masked]
www.rohatyngroup.com

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