HOUSE_OVERSIGHT_014606.jpg

Exhibit 91: EM Local Debt Currencies and Developed Market Interest Rates Rising global interest rates would be a headwind to EM local debt. % 1/1/2016 = 100 1.2 Average G3 10-Year Rate 34 EM Local Debt FX (Right, Inverted) 96 1.0 r 98 0.8 00 0.6 02 04 0.4 06 0.2 08 0.0 10 Jan-16 Apr-16 Jul-16 Oct-16 Data through December 31, 2016. Source: Investment Strategy Group, Bloomberg, Datastream. Exhibit 92: S&P Goldman Sachs Commodity Total Return Index Commodities generated their first double-digit return since 2009. Annual Returns (%) 60 40 20 _ I I _IL ti Bp gis Return: 11% LIL 1 hi | | "t 1 | | -60 1980 §=1984 =©1988 §=61992, 1996 )=— 2000) 2004 = 2008 )=— 2012S 2016 -20 -40 Data through December 31, 2016. Source: Investment Strategy Group, Bloomberg. represent a headwind this year (see Exhibit 91). Meanwhile, any boost to emerging market exports from the modest pickup in global growth we expect is likely to be dwarfed by ongoing US trade policy uncertainty, European political risk and China fears. Lastly, an acceleration of recent outflows from EMLD markets could magnify these risks, particularly since 60% of the cumulative inflows into the asset class since 2004 are experiencing losses at current market levels. Although the number of concerns is large, so is the risk premium of the asset class. As previously seen in Exhibit 76, the currencies in the EMLD index are 15% undervalued. From this starting point, the asset class could deliver attractive total returns if US trade policy proves to be more benign than feared and China worries abate. Considering this balance of risks, our central case calls for low single-digit returns. While positive, this return is not sufficient to justify a tactical long position in EMLD in our view, given the still considerable downside risks discussed above. Emerging Market Dollar Debt Emerging market dollar debt (EMD) returned 10% in 2016, capping a surprising four-year period of outperformance that has greatly benefited from stable US rates and dollar strength. But the prospects for a fifth year of upside are questionable for several reasons. First, EMD’s almost seven-year duration is a liability in a rising-rate environment. This is particularly true now that the Federal Reserve has resumed tightening policy, a fact evident in EMD’s 4.3% drop in response to increasing rate hike expectations late last year. Second, with spreads standing near two-year lows, there is scope for spread widening based on US and European policy uncertainty and renewed China growth fears. Third, countries accounting for 37% of EMD— including Mexico, China, South Africa and Brazil—have negative outlooks from at least two rating agencies, raising the potential for downgrades.!” A potential default by Venezuela and its national oil company could also sour sentiment, as could unfavorable tariffs or trade restrictions from the new US administration. Finally, the backup in interest rates we expect could raise funding costs for EM corporate issuers, which could also heighten concerns about spillover into EMD. Indeed, a recent stress test by Standard & Poor’s revealed that EM corporate borrowers— who must repay $200 billion per year through 20201*°—are twice as susceptible to downgrades as US corporates if dollar funding costs rise by a third.17? Based on the above, we do not recommend a tactical position in EMD at this time. Outlook | Investment Strategy Group 73 HOUSE_OVERSIGHT_014606