MACQUARIE GLOBAL INVESTMENTS Emerging …...6F Adding emerging market equities to a balanced...

MACQUARIE GLOBAL INVESTMENTSEmerging markets

Summer 2012

1 An intuitive approach to investing 2 Emerging markets: what’s in a name? 3 Economic growth and sharemarket gains: unrelated? 3.1 GDP growth does not mean sharemarket gains 3.2 Why is this the case? 4 Economic development follows a discernable path 4.1 We have been here before 4.2 Catch-up growth 4.3 Industrialisation 4.4 Urbanisation 4.5 Consumption 4.6 The ‘Middle-Income Trap’ 4.7 Key transition: from investment to consumption 5 Unintended consequences 5.1 Food and energy inflation 5.2 Political upheaval 6 Building on Australian equity foundations 6.1 Australia: investing from a position of strength 6.2 The opportunity 6.3 The benefits 7 Investment implications 8 Appendix 8.1 Glossary 8.2 Bibliography 8.3 End Notes

Contents

Table of figures

1A World’s economic centre of gravity 2A The emerging markets of the world 3A China sharemarket gains and GDP growth 3B Shanghai: then and now 3C Equity returns and GDP growth 1900–2002 3D Average cross-correlation of major asset classes (rolling three year) 4A World population and GDP, AD1 to 2008 4B GDP by Country: China has come a long way 4C GDP per person: China has a long way to go 4D Income and Urbanisation, 1700–2009 4E Share of world fixed capital stock, 1980–2050 4F China’s coal consumption 4G China urban and rural population, 1950–2050 4H New York vs. China top 10 city growth rates

4I Slowing growth at a key threshold 4J Failing to catch up to the US 4K The progress of emerging economies 4L Investment driven model: the tipping point 5A Food prices, China imports and middle class Income 5B Share of food spending as per cent of total expenditures 5C Top 20 wheat importing countries (2011 estimate) 6A Australian dollar / US dollar exchange rate 6B What world equity markets offer 6C Share of global GDP 6D Share of global market capitalisation 6E Australian equity market diversification 6F Adding emerging market equities to a balanced portfolio

(five years)

Macquarie Global Investments Emerging Markets

1 An intuitive approach to investing

Being well positioned at times of significant change is one of the few things the Rockefellers, Gates, Hursts and Vanderbilts have in common. Dynastic wealth is the other and it was created in large part by being well positioned when the economy of their times underwent a profound shift. Having the insight to see this and do something about it, each of them invested in industry-defining businesses.

Today we are also witnessing a profound change in global economic affairs. The stuttering developed economies and the growing emerging markets are together shifting the global economic centre of gravity.

Understanding what drives these changes and how their effects will be felt is of key importance, which is not as difficult as it may seem. With intuition, an eye for history and good advisers, these waters are navigable.

■ By intuition, we mean our understanding of human behaviour. At its most basic level the significant growth of emerging markets is driven by human needs and wants; the farmer who wants a better life for his family moving to the city, and the Government ensuring this can happen for the hundreds of millions of farmers like him.

■ By history, we mean the example set by now-developed economies. The development path facing the emerging markets is not unprecedented. We only need to look at the first half of the 20th century to see the rapid and sustained development of western economies such as Germany, the UK and the US. Drawing on history, academic studies and current economic thinking, we can see where a country is placed along its development path, understand how it got there and indentify the challenges and opportunities it may face in the future.

■ By advisers, we mean your financial adviser. This paper does not provide investment recommendations, but aims to help you assess your approach to investing in emerging markets with your financial adviser, considering the risks and opportunities this poses to your portfolio.

In this paper we aim to provide the foundation for an investor to assess the opportunities and risks of the rise of the emerging markets.

Craig Swanger BFS Global Business Director

“The dramatic modernisation of the Asian economies ranks alongside the Renaissance and the Industrial Revolution as one of the most important developments in economic history.” — Larry SummersUS economist and former Director of the White House National Economic Council (2009–2011)

i. The average location of economic activity across the Earth is calculated by (Quah, 2011) using geographic population distribution and national GDP figures.

2007

Figure 1A World’s economic centre of gravity1

1980–2007 Extrapolated to 2050

Research from the London School of Economics allows us to plot the global economic centre of gravity.i There was a time when we would mark the map somewhere in the Atlantic, between the US and Europe. The last time this mark would have been accurate was in the early 1980s.

Today, we would mark a place somewhere near Cairo, as the vast economies of the emerging markets such as India and China continue to grow. By 2050 this map will focus on South-Western China.

Macquarie Global Investments Emerging Markets1

2 Macquarie Global Investments Emerging Markets

2— Emerging markets: what’s in a name?What do we mean when we say ‘emerging markets’? It depends who you ask. It used to be that development economists and politicians divided the world into ‘North and South’ or ‘First, Second and Third World’. These were replaced by ‘developing countries’ until this too was replaced with ‘emerging markets’.

2 Emerging markets: what’s in a name?

There are three common approaches to defining the emerging markets:

1. mnemonic: selects countries with strong growth prospects and applies a catchy brand eg. ‘BRIC’

2. dynamic: where a list of countries is maintained, with names added or removed as conditions change

3. arbitrary: these are either unhelpfully circular, ‘countries that are not yet developed’, or are built for another purpose, for example, IMF classifications.


3G “Global Growth Generators”

Coined by Citigroup, this term is used to tag those countries, regions, cities, sectors, firms, products or asset classes that they consider likely to thrive in the globally integrated economy. Members are characterised by high growth rates and returns to investment over the coming decades.

7% Club

Coined by Standard Chartered, this list refers to economies growing at seven per cent annually. At this rate of growth a country would double in size every decade and more than quadruple in a generation.

MSCI Emerging Markets Indices

An equity market index covering more than 2,600 securities in 21 markets. Country inclusion is adjusted annually, taking into account each country’s economic development, size, liquidity and market accessibility.

Dow Jones Emerging Market Indices

An equity market index aiming for breadth and ‘investability’. At its broadest, the index covers 35 countries, with many sub-indices matching countries selected in other groupings eg. the ‘Dow Jones BRIC Indices’.

S&P Emerging Broad Market Index

An equity market index covering approximately 2,500 large, mid and small cap equities. Country inclusion is adjusted annually and takes into account a range of factors including: macroeconomic conditions, political stability and legal property rights.

CIVETS

Used by the Economist Intelligence Unit and initially, HSBC, to group a second tier of big emerging markets (Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa). The acronym has the added advantage of also being a small catlike mammal found in Asia and Africa.

Next 11

A group of 11 countries identified by Goldman Sachs as those likely to follow the BRICs in becoming the world’s largest economies in this century. The ‘Next 11’ is selected based on macroeconomic stability, political maturity, openness of trade and investment policies, and education quality. These countries lack the scale of the BRICs, but as a source of new demand and growth, they could surpass the G8.

MIST

Coined, once more, by Goldman Sachs, this list is made up of Mexico, Indonesia, South Korea and Turkey. These countries share large populations and markets, big economies (approximately one per cent of global GDP), and all are members of the G20.

FTSE Emerging Market Indices

An equity market index covering approximately 1,600 large, mid and small cap securities listed in ‘advanced emerging’ and ‘secondary emerging’ countries. FTSE groups countries into Developed (25), Advanced Emerging (nine), Secondary Emerging (13) and Frontier (25) markets.

BRICs

Perhaps the most famous emerging market grouping currently in use. The BRICs refer to Brazil, Russia, India and China and were grouped based on their prospects for economic growth on a massive scale. First coined by Goldman Sachs’ head of research, Jim O’Neil in 2001, it has gone from finance buzz-word to a powerful block in world affairs . Indeed, in 2009 developed countries declared the broader G20 was the premier economic forum, replacing the G8.

EAGLEs

Coined by BBVA Research2, ‘Emerging and Growth-Leading Economies’ includes all emerging economies, whose expected contribution to world’s GDP in the next 10 years is expected to be larger than the average of the G7 economies, excluding the US. A dynamic list of countries.

2 Emerging markets: what’s in a name?

Investment implications

These various mnemonics and acronyms have several shortcomings:

■ GDP does not relate consistently to sharemarket growth (see Section 3)

■ the economic position of a country changes, but the acronym does not

■ the dynamics of companies and industry can overwhelm country rankings.

A more intuitive approach is to look at the behavioural and societal changes underway in a region to assess which region is likely to be of economic or financial interest. Once identified, we can consider the best company, industry, country or commodity to take advantage of those changes.

Figure 2A The emerging markets of the world3

Number of lists on which each country appears

Low 1 2 3 4 5 6 7 8 High



3— Economic growth and sharemarket gains: unrelated?It is easy to assume that faster economic growth will translate into higher equity returns. So it is interesting to look at the experience in China, where strong growth has not always been associated with strong equity returns. This demonstrates that when it comes to investing in emerging markets, the obvious approach is not always the best.

3.1 GDP growth does not mean sharemarket gains

China’s GDP growth has averaged close to 10 per cent per year for each of the decades starting 1980, 1990 and 2000. It recently surpassed Japan as the world’s second largest economy. It would be easy to assume that buying Chinese equities would give an investor exposure to this significant growth.

However, simply buying and holding the equity index in Shanghai or Hong Kong would have resulted in widely diverging returns even over 10 year periods – as shown in Figure 3A.

Academic evidence

Across many global markets and economies, there is no conclusive evidence that fast economic growth necessarily results in strong equity market gains. A study by the University of Florida5 found that countries with the highest real equity market returns had among the lowest real GDP per capita growth rates.

This corroborates research by the London Business School, which showed similar findings for developed economies over the 20th century6, and a paper from Stanford University which came to similar conclusions for developing economies.7

Figure 3A China sharemarket gains and GDP growth4

GDP Hong Kong Shanghai

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Figure 3C Equity returns and GDP growth 1990–20025

Real GDP growth per person (per cent pa) Real equity return (per cent pa)

Figure 3B Shanghai: Then and Now

Shanghai, 1990 versus 2010

1990

Shanghai, 1990 versus 2010

2010

Shanghai: Then and Now (refer to Figure 3B)

Standing in Shanghai’s Pudong district on a crisp dawn in 1990, you would find yourself surrounded by marshy conditions. Back then, the soft ground supported few buildings taller than the fire station. Stand there today and there is no need to consider protective footwear. The marshland has been drained, countless skyscrapers test the record books and two metro lines, an international airport and a magnetically levitating high-speed train connect what is now China’s financial centre to the world.


Investment implications: Investing in emerging markets is not as simple as picking the next fast growing economy

We are not suggesting that emerging markets equities are a poor investment. In fact, many major emerging market equity markets have performed better than developed markets during the past decade. India’s equity market index (the SENSEX) gained 5.9 per cent pa since 2000 compared to the Australian ASX200 which gained 4.7 per cent pa in the same period.

What the research does say is that investing in emerging markets is not as simple as picking the next fast growing economy. As we have seen, many factors influence equity returns in different ways than they effect the economy. These factors can operate at regional, economy-wide, industry and company levels.

A passive investment strategy where one selects an equity market index based on an estimate of likely economic growth of that country/region, is unlikely to be the most efficient way of profiting from opportunities in emerging markets. You need to assess valuations and entry points, and be prepared to be out of some markets at times. For most of us that means selecting an active manager to address those factors. Consider:

■ the potential for less efficient trading markets. This increases the chance of mispriced stocks, but also increases the potential for an active manager to add value

■ the degree to which all major asset class prices move together has increased during the past decade, as shown in Figure 3D. This suggests that the passive approach of investing in major asset class indexes may provide less diversification than it once did

■ companies of a sufficient size are global enterprises now. Companies such as Danone, Nestle and L’Oreal all derive well over a third of their sales from emerging markets. So, an investment in India’s equity market ignores companies that may profit from operations in India, but are listed in another market. An active approach can identify such companies and provide exposure to this growth as well.

3.2 Why is this the case?

Strong economic growth is undoubtedly a force for good. People that live in countries with higher incomes enjoy a longer lifespan and lower infant mortality rates, amongst other benefits. So how can it be that strong economic growth benefits a country’s citizens but not necessarily the owners of capital, ie. shareholders?

■ Innovation – unless the innovation comes from an existing company with strong pricing power, such as a monopoly, it generally results in productivity improvements and higher income for consumers, rather than earnings and share price appreciation.

■ Creative destruction – innovation destroys as well as creates value. So while economy-wide productivity and GDP growth both benefit from innovation, the positive and negative effects of disruptive innovation are felt unevenly at the industry and company level.

■ Dilution – fast growth businesses may be financed by issuing additional equity. This does not boost the returns of existing shareholders and has been estimated to reduce returns by as much as two per cent per year.8

■ Location – not all companies that profit from a market are listed there – Colgate-Palmolive which now has 50 per cent of its sales in emerging markets. It has been estimated by BNP Paribas that more than 20 per cent of the revenues of companies in the Dow Jones Industrial Average come from emerging markets.9

■ Financial market psychology – the extent to which the sharemarket is driven by rational participants or herding behaviour changes over time. Investors can move as a group into the sharemarkets of high growth countries, causing them to be overvalued. Subsequent returns can often be disappointing, regardless of economic strength.

■ Capital controls and political risk – these risks may pose challenges to moving money into a country to invest in an opportunity, or moving money out of the country to realise profit.

0.60

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Figure 3D Average cross-correlation of major asset classes (rolling 3 year data)10


4— Economic development follows a discernable path“The world economy is rebalancing. Some of this is new. Some represents a restoration.…Asia accounted for over half of world output for 18 of the last 20 centuries. We are witnessing a move towards multiple poles of growth as middle classes grow in developing countries…”— Robert Zoellick, President of the World Bank11


4.1 We have been here before

Restoration not revolution

For centuries, global GDP was dominated by population. Multiply low productivity by a large enough population and a country will lead the world in economic size. Indeed, as recently as 1820, China’s economy was estimated to have been larger than Western Europe and the US combined.12

The rapid and sustained development of the West saw economies with smaller populations, such as Germany, the UK and the US, vault ahead during the 19th and 20th centuries, as productivity advanced significantly. Now, as emerging market nations start a similar economic development project, we see the rapid return of the most populous nations as leading economic powers – such as India and China.

A long way to go

However, economic output per person shows that the journey has only just begun. There remains a vast gap in standards of living between developed and emerging market nations.

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Figure 4C GDP per person: China has a long way to go12 USA China India Remaining countries

4 Economic development follows a discernable path

For most of human history, economic growth and improvements in living standards have moved at a very gradual pace. The rapid, sustained growth experienced in modern times is relatively rare.

Commencing in the 18th century, the Industrial Revolution marked a pronounced improvement in productivity per person, while the Agricultural Revolution enabled a step rise in the rate of population growth.

The path of rapid economic development has been far from uniform between nations, driving the rise and fall of empires and dynastic wealth. It is these differences between economies that drive the risks and opportunities to which we now turn our attention.

Figure 4A World population and GDP, AD1 to 200812

GDP ($Million total) Population (‘Million total) GDP per capita

World population and GDP, AD1 to 2008

GDP ($m total) Populaton (’Millions total) GDP per capita

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1000AD■ GUNPOWDER IS INVENTED IN CHINA■ LEIF ERICSON LANDS IN NORTH AMERICA■ HUTU ARRIVED IN RAWANDA


4.2 Catch-up growth

If a relatively poor country is going to close the gap with more developed nations, how does it do it, and how difficult is the process? There are a variety of development models and historic examples provided by developed countries that were once considered poor. Provided other factors are equal, poorer countries should grow more quickly than richer countries, because they can follow the lead of developed nations and achieve ‘catch-up growth’. Countries within the standard of living frontier, marked out by the US GDP per person (see Figure 4C) can move towards the frontier by importing or imitating technology. Countries at the frontier, however, can only grow by pushing out the frontier itself – a far more difficult task.

Japan’s Meiji period of industrial revolution (1868–1912) provides one such example of ‘catch-up growth’. However, the most prominent current example is China. When comparing the development path of urbanisation and income, the similarities are striking (see Figure 4D).

Some of the clear advantages enjoyed by many emerging markets are:

■ fixed asset stock – developing economies can borrow know-how and skip to the latest technology. Developed economies, on the other hand, have aging / outdated infrastructure, which requires more expensive reinvestment or innovation to move forward.

■ human capital – developing nations can reap huge gains by simply moving the underemployed from agriculture to manufacturing. Developed nations, typically with a higher proportion of their workforce in the service sector, must innovate to enhance productivity from already high levels. This is a far more difficult and expensive process than borrowing ‘know–how’.

■ domestic savings – improving incomes lead to higher savings rates in a generally younger workforce for developing economies. Developed nations struggle against the drain on savings from depreciation of their higher fixed asset levels and a generally older workforce with lower saving rates, or even dis-saving.ii

■ institutions and policies – efficient financial institutions, functioning property rights and rule of law, flexible labour markets and non-traded sectors support faster growth. The advantage of catch-up economies is that, inefficient institutions and poor policies harm growth less when the country is a long way from the productivity frontier. This means mistakes are less costly, for a time.

It is not all smooth sailing

While the above advantages make the job of economic development sound easy, it is far from the case. Virtually all of the ‘advantages’ are a reflection of a very low starting point. Social, health and political issues often hold back or derail development.

Even the apparently simple task of skipping to the best technology can be difficult. What constitutes best practice is not a static concept – catch-up growth eventually reaches an inflection point, after which a difficult transition is required.

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Figure 4D Income and urbanisation, 1700–200913

Trying to pick winners

We do not have to look far for illustrations of the evolving nature of ‘best practice’. If you were picking a mass transit system for your developing nation, simply following a developed nation’s lead would be a confusing affair.

Depending on the era, your people could be zipping around on trams, queuing in their cars, piling into the subway, avoiding a monorail or, once again, being encouraged back onto trams and buses.

ii. As an increasing share of the population draws on savings in retirement.


4.3 Industrialisation

The physical capital of a country is a key component to catch-up growth. This is due to the technology embodied in the physical machinery, and its effect on improving productivity per worker and ultimately, economic output and average incomes.

In terms of share of the world’s productive assets (such as ports, rail or electricity, factories and equipment), China is far behind the US.

At present, they are the world’s largest manufacturer, despite having less fixed assets. This is because they can substitute labour for machinery. As a consequence, China currently produces slightly more than the US – but uses nine times as many people to do so.14

The central government is planning for a more industrialised future.iii Every year for the next 40 years, China is expected to add nearly $US4 trillion in fixed assets.15 This is equivalent to the entire fixed asset base of Australia being added every eight months, for 40 years.

During this phase of the development process, investment driven demand is more significant than consumption driven demand. As investment demand tends to be more commodity and energy-intensive than consumption driven demand, China’s energy need is immense. While China is actually leading the world in the installation of renewable energy, there simply are not enough solar panels, wind turbines or even nuclear power plants with construction capacity to meet the increased requirement.

Consequently, China’s already significant coal consumption is set to increase. China currently consumes 40 per cent of the world’s coal and it is projected to pass 50 per cent within ten years.

China currently produces slightly more than the US, but uses nine times as many people to do so.14

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China is rising rapidly to be the world’s manufacturerShare of world fixed capital stock, 1980-2050, CEPII

Source: World Bank databank, extracted November 2010.

China India

Figure 4E Share of world fixed capital stock, 1980–205015

US Japan Germany China India

Figure 4F China’s coal consumption16

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Source: Energy Intelligence Agency (EIA), International Energy Statistics Nov 2009. Projection: EIA, World Energy Projection System Plus 2010.

PROJECTED

iii. The country’s 12th Five Year Plan, approved by the National People’s Congress on 14 March, dedicates 7 trillion Yuan ($US1 trillion) for spending for urban infrastructure alone, according to Chinese news agencies.

Investment implications: To invest in China’s growth, you don’t need to invest in China

We believe investors can profit from developing markets, such as China, without investing in the domestic assets of those countries. The opportunities available during the industrialisation phase provide a good example. Profits may flow to international firms that learn how to access the opportunities that exist as a result of the enormous demand outstripping domestic supply. Firms that could benefit include the providers of resources, equipment, technology and services, such as logistics, engineering and construction.


4.4 Urbanisation

The productivity improvements that result from converting a workforce from an agricultural to an industrial focus are accompanied by broader societal and infrastructure impacts. As the population moves from country to city, the energy needs, infrastructure requirements and consumption patterns change.

From rural to urban

China’s 48 per cent urbanisation rate is well below Western economies, which have rates closer to 80 per cent.17 Those making the move to cities are attracted by better job opportunities and higher incomes. This urbanisation has also been associated with a rapid improvement to per capita income levels (shown earlier in Figure 4C). During the next 20 years, 600 million people around the world are expected to shift from low social economic status to the middle class. Of that number, half are in China.

As pronounced as it is, this trend is not new or unique. The same trends were seen in the US around the turn of the 19th Century, resulting in a comparable shift from 30 per cent of the population living in cities, to more than 60 per cent by the 1950s.18

Similarly, this shift occurred in Europe in the mid 19th Century. At that time, we saw a move in the urban population from roughly 30 per cent of the total population to 60 per cent over a 30 year period.

As China follows this path, the economy will require resources to build the cities, transport, technology and logistics to connect them, as well as the energy to power them. We believe the vast size of the population making this transition will have a profound impact on global demand for many key resources, services and markets.

We have done much of this before

If we compare the growth of New York’s population during its major urbanisation period, with the expected growth rate of the top 10 Chinese cities during the next 50 years, we find that New York grew at a far greater rate (see Figure 4H). Tokyo’s growth was even faster.

While the pace and task itself are not unprecedented, the sheer number of people involved certainly are. If the expected growth rates of China’s urban population are achieved, China will require the construction of approximately 40 billion square meters of floor space, according to global consultancy McKinsey. That is the equivalent of 10 cities the size of New York, including all the roads, rail, housing, water, sewerage, power, hospital, schooling, retail and commercial buildings and so on. In short, this would be a construction project of a scale never before attempted.

During the next 20 years as China’s population moves from country to city, building needs alone are estimated to require the equivalent of 10 cities the size of New York.

Investment implications: Invest in global sectors, not specific countries

Once again, the providers of natural resources, logistics and construction services can benefit from these developments. However, there is also a variety of other sectors which may profit, including urban planning, technology and service providers, health care equipment and pharmaceutical providers, water services and technologies, energy technology including alternative energy, private infrastructure owners, and specialist property experts such as retail property specialists.

China Urban and Rural Population, 1950-2050 China Urban and Rural Population, 1950-2050

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Figure 4G China urban and rural population, 1950–205019

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Figure 4H New York vs. China top 10 city growth rates20

New York population 1870–1950, versus index of top 10 Chinese cities, 1950–2025

New York China top 10 cities

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New York versus top 10 Chinese citiesNew York population 1870-1950, versus index of top 10 Chinese cities, 1950-2025

Source: New York - US Census Bureau. China – ‘Preparing for China’s Urban Billion’, McKinsey Global Institute, March 2009.

SHANGHAI, BEIJING AND THE OTHER TOP 10 CHINESE CITIES ARE EXPECTED TO GROW AT 2.1%PA FROM AN AVERAGE 2.8M TO AVERAGE 10M

NEW YORK GREW AT 3.6%PA FOR 60 YEARS FROM 1.5M TO 8M


4.5 Consumption

China’s growing middle class

As residents achieve the higher incomes that initially attracted them to the cities, their spending patterns begin to change. Consumption is boosted by these new urban residents as they rent apartments, shop in markets and eat in restaurants.

Urbanisation and the accompanying higher income per person results in a large increase in demand for consumer goods, food, services and the raw materials required to produce them.

We would typically expect to see changes in both the share of income spent on particular categories and also changes in the types of purchases within those categories. We know this because the US made this transition in the late 1930s, France during the 1950s and Japan in the early to mid 1960s.

■ As incomes rise, spending and consumption shift from essentials to more discretionary purchases.

■ Data from the US indicates that the volume of consumption dedicated to food follows rapid growth as income levels rise, but reaches a plateau where further income rises have little effect.

■ Transport follows a more linear path of increased consumption following higher income.

■ More discretionary items, such as recreation, show an accelerating increase in consumption as incomes rise ie. the more money you have, the more you spend on recreation.

As income levels rise, spending patterns change. The impact on demand for complex carbohydrates and protein are already being felt.

Implications for global markets

A shift from industrial to more consumption and services driven growth increases demand for imports. If this is accompanied by rising real wages (exceeding productivity growth) then household wealth will improve as costs rise for local exporters. These factors shift the balance away from local exporters, and in favour of global exporters who can access an increasingly wealthy Chinese consumer.

A transformation of emerging economies from export and investment driven growth to consumption driven growth will have profound consequences. These include:

1. increased world prices of consumer goods relative to investment goods

2. lower commodity prices – as investment demand tends to be more commodity and energy-intensive than consumption demand (other things being equal).

This process is country specific and not all emerging markets are at the same stage in their economic development. The global impact of such shifts should be staggered, as not all economies make the transition at the same time. For instance, production and demand in India is likely to be quite commodity-intensive for the foreseeable future.21

Investment implications: Invest in predictable consumer spending patterns

Farmland is the most direct asset class providing exposure to the benefits of the increased demand for food. As this is not always easy to access, another option is the equity (private or listed) in companies which provide inputs to the farming sector. As an example, these companies can be involved in the manufacture of fertilizer, farming equipment such as tractors, watering systems and technology providers.

Other discretionary consumer spending categories that are likely to benefit from this shift to middle class consumption include luxury goods manufacturers and retailers, or some leisure and travel service providers.


4.6 The ‘Midde-Income Trap’

There comes a point in a developing economy’s path where growth slows markedly. This slowdown is referred to as the ‘middle-income trap’.22 Previously rapidly growing economies reach a point of slower growth, and fail to achieve the same standard of living as the leading economy.

The causes are debated. It may be that the slowing of growth comes as the advantages of a ‘catch-up’ economy expire. Or, that policies and political institutions which are effective for early stage development are not appropriate for advanced stages of development.

Of the evidence that does exist, a study23 by Barry Eichengreen of the University of California, Berkeley, Donghyun Park of the Asian Development Bank and Kwanho Shin of Korea University found that several key indicators were associated with significant growth slowdowns (that is, falling by at least two per cent per annum). The main indicators were: income per person reaches $US16,740 per annum (in 2005 prices); and income per person reaches 57 per cent of the average income of people in the world’s leading nation at the time. The research found that the loss of momentum is mostly due to economic maturity. In particular the productivity gains stemming from workers moving from rural to urban jobs in factories and offices diminishes as the pool of rural workers is exhausted.

Figure 4I Slowing growth at a key threshold24

Growth rate before reaching income threshold Growth rate after reaching income threshold

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4.6 The ‘Midde-Income Trap’

Past experience

Figure 4K shows the GDP growth path of various countries relative to the US. We have aligned each selected nation’s development path based on the year they hit the GDP threshold associated with the middle income trap. While each country reached this threshold at different times, they all experienced a similar effect of slowing growth.

It is interesting to observe that the Asian economies which have reached the threshold (Taiwan, Hong Kong and Japan) all show a more rapid growth in the ‘catch-up’ phase than that of the selected European countries (Germany, France, Italy and Belgium). All, however, exhibit the same plateau after reaching the threshold.

Current progress

Few countries, even in the ‘long list’ of all emerging economies identified in Section 2, exceed these thresholds. Those that do are the oil-rich economies of the Middle-East. On the growth based measures, the majority of countries classified as emerging markets are yet to reach the theoretical inflection point – but they are on track.

Figure 4J Failing to catch up to the US24

Actual: United States Belgium France Italy Germany Japan Hong Kong Taiwan

Projections: China India

Figure 4K The progress of emerging economies24

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CHINA 1,324MINDIA 1,157MINDONESIA 240MBRAZIL 199MPAKISTAN 181MBANGLADESH 154MNIGERIA 149MRUSSIA 140MMEXICO 111MPHILIPINES 98MTURKEY 77MSOUTH AFRICA POPULATION 49M

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4.7 Key transition: from investment to consumption

Rebalancing

A centrally planned economy focused on investment-driven development can achieve rapid economic growth, especially if they are in the ‘catch-up’ phase. Dubbing these as ‘miracle years’, as commentators often do, forgets historic precedent and ignores the pitfalls of investment driven growth.

When investments are chosen by a decisive central government, capital can be quickly deployed to projects. When an economy is operating at efficiency levels well below the most productive economies of the world, it is relatively easy to choose new productive projects in which to invest eg. electrification. The task for the central planner is relatively easy.

As an economy advances, the obviously productive investments become less plentiful and the path less clear. The risks of the central planner picking uneconomic projects increases, especially if market signals are distorted.

The risks are twofold:

1. uneconomic projects represent a misallocation of capital that will slow growth versus efficiently allocated capital

2. any debt used to fund such growth risks becoming non-performing, further slowing growth.

Can there be too much investment driven growth?

Many of the levers used to accelerate growth in the early years of development can lead to distortions that inhibit development later. Policies aimed at subsidising investment in infrastructure and manufacturing, do so at the expense of household savings. This is relevant, as rising household wealth is key to developing a consumer society, vibrant service sector and robust domestic demand. These policies can include:

■ undervalued currency – reduces real household wages by raising the cost of imports, while subsidising producers of tradable goods

■ excessively low interest rates – households (mostly depositors) fund the borrowing costs of borrowers (mostly manufacturers)

■ repressed wage growth – directly subsidises employers at the cost of households.

With distorted market indicators there is little to guide the assessment of new projects. The longer these distortions last, the higher the risk of accumulating uneconomic investments and non-performing loans.

The tipping point is very hard to see and the temptation is to keep doing what has worked in the past. Michael Pettis, of the Carnegie Endowment, identifies economies that have mistimed this transition as; the USSR (during the 1950s–60s), Asian tigers (1980s–90s), and Japan (1970s–80s).25


These are historic observations and reminders that trends do not continue indefinitely. However, beware the warnings from some who are using the slowdown of China’s GDP growth to claim China’s progress is coming to an end. If China’s growth were to fall six per cent per annum for the next 10 years, that would still represent the addition of $US3.94 trillion to China’s economy. This is more than the US$3.90 trillion added in the past 10 years, while growth has been 10 per cent per annum.

As we saw earlier, valuations were one reason for sharemarket returns and economic growth to diverge. If economic growth were to fall below the level expected by the market, then prices based on those incorrect growth assumptions may fall. While a broad equity index may fall on such news, individual securities and sectors may be affected to different extents.

Figure 4M Investment driven model: the tipping point

DEVELOPMENT MECHANISM

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Navigating the shift to consumption

Rebalancing from investment to consumption-driven growth involves reversing many of the above policies. Allowing interest rates to rise, letting the currency appreciate, and wages to grow faster than productivity will achieve two things:

1. improve household income and savings (wealth) leading to increased consumption

2. increase costs and lower competitiveness of the export sector, leading to lower current account surpluses.


5— Unintended consequencesOne of the most famous metaphors in economics is the ‘invisible hand’, coined by Adam Smith, who argued that each person, seeking only his own gain, “is led by an invisible hand to promote an end which was no part of his intention”26 – that end being the public interest. This is a rare example of a positive unintended consequence. It is more common, certainly prudent, to consider negative unintended consequences. In this section we consider some of the far reaching and unexpected impacts of the rise of emerging markets.


5.2 Political upheaval

One of the most poignant insights from recent history is the role of rising food prices in political unrest and revolution. The impact of emerging markets on global food demand was shown in Figure 5A. It is one of several important drivers of the global food price inflation currently in effect.

Food price volatility

In years past, single factors such as adverse weather caused agricultural commodity price spikes. Now, trends on both sides of the demand and supply equation are driving prices. Put simply: Each night, 219,000 additional people join the global dinner table

1. emerging markets are starting to consume more beef, which in turn consume grain

2. the US is turning grain into ethanol

3. the EU is banning genetically modified crops, potentially limiting productivity advances

4. global policymakers continue to subsidise small farmers, when what the world needs is Brazilian-style high technology and big agriculture.

When the global price of rice doubles, a bowl of rice costs twice as much as it did whether you are in New York or New Delhi. While the price change may be the same globally, the impact is felt unequally. Americans spend less than 10 per cent of their income in the supermarket.28 For them, a doubling of food prices is an annoyance. However, the poorest two billion people in the world spend 50 per cent to 70 per cent of their income on food.28 For these people, soaring prices are a significant blow.

Figure 5B Food spending as per cent of total expenditures29

= 10%

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Each night, 219,000 additional people join the global dinner table28

5.1 Food and energy inflation

We expect one of the most globally significant areas to be impacted by emerging market development is the rapid increase in the demand for complex carbohydrates and protein. Meat, milk, grains and oil seeds have already come under pressure as supply struggles to meet the demand from China in particular, but also from India.

The “Green Revolution”, which spanned the 1940s to the 1970s, greatly improved productivity, however, there is not enough arable land adjacent to transport infrastructure available to produce food and ship it to urban populations in the volumes now being demanded. The result is higher food prices.

Food and energy are typically the two largest categories of spending for the average consumer and therefore have the greatest impact on inflation measures. Higher inflation means higher interest rates, which is typically bad news for equities. Inflation also erodes the real value of retirement savings as the higher inflation rises, the less those retiring can buy with their savings.

Figure 5A Food prices, China imports and middle class Income27

Food price index China’s food imports volumes (adjusted) Middle class expenditure and projection (RHS)

Source: Food Price Index – UN Food Administration Organisation (FAO), May 2011. Middle class expenditure - McKinsey & Company and Wharton University, 2011. Food imports - US Department of Agriculture, May 2011.

Middle class in China & India driving global food prices

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5.2 Political upheaval

The breakdown of government stabilisation efforts

Almost half of the top 20 wheat importers in 2010 were Middle Eastern countries: Egypt (one), Algeria (four), Iraq (eight), Morocco (17), Yemen (15) and Saudi Arabia (18) Why is this the case?

Many of these countries relied on food subsidies to ensure stability. Since the cold war major governments of the world have used cheap grains, along with other enticements, to exert influence over small nations. During this time many Arab countries established a system of bread subsidies.30

Cheap grains may have kept the population stable, but it hollowed out the agriculture sector in each country. This drove the ever increasing need to import wheat, as local providers could not afford to produce at such low prices.

When the global grain prices reached record highs, these governments could no longer afford the subsidies, nor were there many local producers capable of meeting demand.

By 2010 Egypt was subsidising bread by approximately $US3 billion annually.30 A 2008 move to militarise bread production and distribution was too late for the April 6 protests in Al-Mahalla al-Kubra. These protests proved an early sign of the wider unrest.

Increasing competition for land and the prospect of further food price volatility will heighten the risks of political instability. The events of the ‘Arab Spring’ (2011 political unrest in MENA nations) may spread beyond the Middle East and North Africa (MENA) region in years to come.

Figure 5C Top 20 wheat importing countries (2011 estimate)32

Political unrest

= 10 PANAMA DRY BULK CARRIERS

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By understanding how societal trends may impact asset markets, investors can manage risks and pursue opportunities. Having looked at the impact of emerging markets on inflation and political upheaval through the transmission mechanism of energy and food prices, we can start to identify opportunities.

The best hedges against inflation risk are generally those that will increase in value with the rise of food or energy prices. Assets that hold reserves of these resources or have additional production capacity may benefit, for example oil exploration, oil and gas producers and farmland. Assets offering less direct hedging include inflation-linked bonds, some types of property and equities where the company has the ability to increase prices faster than the increase in their cost of inputs.

“There are only seven meals between civilization and anarchy.”– Josette Sheeran (UN World Food Program)31


6— Building on Australian equity foundationsThe Australian economy and sharemarket survived the Global Financial Crisis better than many of our developed market peers. In light of this it might be an obvious question to ask; ‘why bother assessing emerging markets or international investing in general?’


6.1 Australia: investing from a position of strength

The past decade of investing internationally has been underwhelming for Australian investors. Witness the broad world index in Australian dollars compared to the Australian equity market; where international equities averaged -5.1 per cent per annum for Australian investors during the past decade.33 Much of this has been due to the strengthening the Australian dollar. Looking at international equities in US dollar terms over the same period, they averaged 1.8 per cent per annum if you exclude the effect of the rising Australian dollar. With the Australian dollar near multi-decade highs it may be worth considering using that purchasing power to buy assets overseas.

Over the long term the contribution to foreign investment returns, positive or negative, from currency movements, will decline because of relative inflation rates. In that context it is the underlying investment that matters most, not the currency.

Figure 6A Australian dollar / US dollar exchange rate35

19811971 1991 2001 2011

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6.2 The opportunity of international investing

Australian equities offer limited diversification

While justifiably the envy of many investors and citizens around the world, the Australian economy is relatively small and the equity market is very concentrated. Just two sectors, finance and mining, make up nearly two thirds of the index.

Our market is limited in the sense that the Australian market represents 2.7 per cent of the global equity markets. While we have many world-leading companies (such as the mining industry), other sectors (like healthcare, information technology and the heavy industry) are very small. Only 41 of 1,803 global companies with market capitalisation greater than $AU5 billion are Australian.

While some of the companies benefiting from this phase of the emerging market growth story are Australian, many are not. As personal incomes grow and demand shifts, a different set of companies and sectors will profit. Luxury brands such as L’Oreal are actively targeting and already profiting from the developing middle class in the emerging markets. Australia has less than 0.4 per cent of the world’s population, accounts for less than two per cent of global GDP and has just under three per cent of global market capitalisation. Fast growing emerging markets are already disrupting the global economic order. Their continued growth will increase the global opportunity set more quickly than Australian growth.

Figure 6B What world equity markets offer33

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6.2 The opportunity of international investing

That diversification is declining

Holding approximately 200 Australian stocks represented by the index delivers less diversification than it used to.

To illustrate, holding the shares of 200 companies may seem like a good way to spread one’s risk. However, if those companies were mostly mining and finance sector stocks, your portfolio would be dominated by the risks of just two sectors. You would have no alternative should those sectors underperform.

The diversification ratio shown in Figure 6E measures the number of independent factors driving returns. Macquarie analysis shows that the Australian equity market, while dynamic, is experiencing a long term reduction in diversification. Essentially, the companies on the ASX are behaving more and more alike.

We are not alone

This trend is not just an Australian phenomenon. The MSCI’s world, European and US indices show a similar trend.37 This has been attributed to globalisation, where the increasing interconnectedness of economies and markets is eroding the diversification once available.

This does not mean geography no longer matters. It means we have to work harder and reach further to achieve the diversification we once may have taken for granted.

Relative size of sector in the world index compared to the Australian index

20052003 2007 2009 2011

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Figure 6C Share of global GDP34

Figure 6D Share of global market capitalisation35

Figure 6E Australian equity market diversification36


6.3 The benefits of international investing

Adding emerging markets can enhance portfolio risk and return

Adding the emerging markets asset class to a balanced portfolio can offer an enhanced risk and return profile, but it depends on how it’s implemented.

The way in which you gain exposure matters. Figure 6F illustrates this. It shows the five year return and risk (volatility) of a balanced portfolio, in which more is invested in emerging markets investments over time, changing its risk and return.

The red series shows the effect of adding progressively more of an emerging markets equity index investment. In this instance a modest improvement in annual returns is accompanied by a significant increase in risk.

The blue series shows the effect of adding progressively more of a leading actively managed emerging markets equity fund. In this instance, the increase in risk is smaller and the return improvement more significant, when compared to the index approach.

Figure 6F Adding emerging market equities to a balanced portfolio (five years)3

Balanced Portfolio with varying allocation to an emerging markets manager Balanced Portfolio with varying allocation to an emerging markets index

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By adding additional sources of return that do not move in the same way as our domestic markets, we can improve the risk return profile of an Australian equity dominated portfolio.


7— Investment implications


7 Investment implications

The world’s economic centre of gravity is shifting towards the emerging markets. Both the growth of those markets and the crises of the developed economies have accelerated this trend in recent years.

■ History has provided a guide to economic development. Developed economies have shown us the path and pitfalls faced by countries attempting to move from low to higher income status. This is not lost on those emerging economies, which enjoy several advantages in following the developed economies before them.

➔ In this case, Figure 4K will be of enduring interest – as we see the emerging markets plot their own course alongside their European and Asian developed market peers.

■ While many countries have been able to transition from low to middle income, relatively few have carried on to high income. This pattern may have been caused by the middle income trap and the precarious transition between investment and consumption driven growth.

➔ In this case, Figure 4M will be of enduring interest – as we see the emerging markets improve their standard of living and how close they get to the leading nation’s level of wealth.

■ It is evident that the relationship between economic growth and sharemarket gains is not as simple as intuition would suggest. In fact, the impact can be felt very far afield, with political unrest linked through food prices to the growth of the emerging market middle class.

The recent economic performance of these markets is good, yet experience suggests there will be setbacks. As developed world economies lurch from crunch to crisis, the wealth gap is closing fast. This is good news for hundreds of millions of people and will represent important opportunities for the diligent investor.

Specific items worth considering:

1. While the growth prospects may be strong, investors may have already priced in these growth expectations, making the share valuation somewhat steep. You may want to consider the relative value of stocks with real estate and/or commodities.

2. When considering the risk of specific countries, remember that some companies listed in developed markets derive significant proportions of their income from the emerging markets.

3. Owners of natural resources may benefit from the emerging market’s urbanisation and the rise in middle class. As demand for increasingly scarce supplies grows, they could benefit through higher prices as emerging market governments compete to meet the needs of their people.

4. This could be particularly true for food supplies, as governments do everything possible to avoid the social implications of food shortages.

5. Suppliers to natural resource owners such as heavy machinery providers, fertilizer manufacturers and logistics providers could also benefit from this growing demand.

6. The development of emerging markets can be accessed at many stages, from consumer staples (in the early stages), transportation (in the middle income phase), and recreation and luxury goods as consumer driven growth begins to dominate.

7. In terms of risks, inflation is key. Volatility in the short-term may likely be higher, but in the longer term, the development of these markets may lead to shortages of natural resources, including food – and this could lead to inflation. Inflation erodes wealth, particularly investments in cash deposits and fixed interest. Inflation hedges can include natural resource assets that can profit from higher inflation caused by higher resource prices, inflation-linked bonds, some forms of property and equities, where the company has the ability to increase prices faster than the increase in their cost of inputs.


8— Appendix


8.1 Glossary

Angus Maddison Angus Maddison was a world scholar on quantitative macroeconomic history, including the measurement and analysis of economic growth and development. In 1995 he published GDP estimates for 56 countries as far back as 1820. In 2001 he released an estimate for world output in the year 1AD. The figures preceding 1820 are based on unofficial records and should be treated as educated guesses.

Correlation A statistical measure of how two values move in relation to each other. This measure ranges between -1 and +1. Perfect positive correlation (value of +1) implies that as one value moves, either up or down, the other security will move in the same direction. Alternatively, perfect negative correlation (value of -1) means that if one value moves in either direction the value that is perfectly negatively correlated will move in the opposite direction. If the correlation is 0, the movements of the securities are said to have no correlation; they are completely random.

Diversification Diversification is a risk management technique that mixes a wide variety of investments within a portfolio. The rationale is that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment within the portfolio.

Diversification ratio The diversification ratio measures the number of independent effective risk factors driving returns. It is calculated by dividing the weighted-average volatility of the individual securities by the volatility of the portfolio. In Figure 6E we have divided the weighted-average volatility of all ASX 200 companies (adjusted throughout time) by the volatility of the ASX200 index.

GDP Gross Domestic Product is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products.

Globalisation The steady decline in importance of national boundaries and geographical distance as constraints on the mobility of a variety of economic and social factors. The economic factors include: people, goods and services, capital, technology and ideas.

International Geary-Khamis dollars A hypothetical unit of currency that has the same purchasing power that the US dollar had in the US at a given point in time. It is widely used in economics .

Meiji Period The period when Japan was ruled by the emperor Meiji Tenno, marked by the modernization and westernization of the country. Literally: “enlightened government”.

PPP This is a conversion applied to GDP figures which makes allowances for the lower prices of non-traded services in poorer countries. Specifically, the purchasing power parity conversion factor is the number of units of a country’s currency required to buy the same amounts of goods and services in the domestic market as US dollar would buy in the US.


Bernstein, William, and Arnott, Robert, “Earnings Growth: The Two Percent Dilution”, Financial Analysts Journal, September 2003.

Brown, L. R. (2011, May/June). The New Geopolitics of Food. Foreign Policy.

Buiter and Rahbari, “Global growth generators: Moving beyond emerging markets and BRICs”, Citigroup and Centre for Economic Policy Research, April 2011.

Choueifaty and Coignard, “Toward Maximum Diversification,” Fall 2008, Journal of Portfolio Management.

Ciezadlo, A. “Let Them Eat Bread”, Foreign Affairs, March 2011.

Eichengreen, B., Park, D., & Shin, K. (2011). When Fast Growing Economies Slow Down: International Evidence And Implications For China. Cambridge, MA: NATIONAL BUREAU OF ECONOMIC RESEARCH.

Dimson, Marsh, Staunton, “Economic Growth and Global Investment Returns”, London Business School, November 2005.

Henry, Kannan, “Growth and Returns in Emerging Markets”, Stanford University, June 2006.

International Monetary Fund Institute. (1999). Working Paper: Currency and Banking Crises: The Early Warnings of Distress. IMF Institute.

Liu, J. M. China: growth, urbanisation and mineral resource demand. Canberra.

Macroeconomic Assessment Group - BIS. (2010). Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements. Basel: Bank for International Settlements.

McKinsey Global Institute, “Preparing for China’s Urban Billion”, March 2009.

National Bureau of Economic Research. (2011). When Fast Growing Economies Slow Down: International Evidence and Implications for China. NBER.

Pettis, M. (2009). Sharing the Pain: The Global Struggle Over Savings. Washington, DC: Carnegie Endowment for International Peace.

Quah, D. (2011). The Global Economy’s Shifting Centre of Gravity. London: London School of Economics and Political Science and John Wiley & Sons Ltd.

Reinhart, C. R. (2008). This Time is Different: A Panoramic View of Eight Centuries of Financial Crises. National Bureau of Economic Research.

Ritter, Jay R., “Economic Growth and Equity Returns” (November 1, 2004), University of Florida

Smith, A. (1776). The Wealth of Nations. London: W. Strahan and T. Cadell.

UBS. (2011). Emerging Economic Comment: If China Is So Productive, How Come I Made All My Money In Brazil? (Part 1).

U.S. Energy Information Administration (EIA), “Annual Energy Outlook 2011”, September, 2011.

Zoellick, R. (2010). The End of the Third World? Modernizing Multilateralism for a Multipolar World. Woodrow Wilson Center for International Scholars.

8.2 Bibliography


8.3 End notes

1. (Quah, 2011)

2. Banco Bilbao Vizcaya Argentaria.

3. Source: Macquarie, August 2011.

4. Macquarie analysis. Source: World Bank databank, extracted June 2011. Source: Bloomberg, Shanghai Composite (AUD), Hang Seng Index (AUD), extracted August 2011.

5. Ritter, Jay R., “Economic Growth and Equity Returns” (November 1, 2004), University of Florida. Dimson, Marsh, Staunton, “Economic Growth and Global Investment Returns”, London Business School, November 2005.

6. Dimson, Marsh, Staunton, “Economic Growth and Global Investment Returns”, London Business School, November 2005.

7. Henry, Kannan, “Growth and Returns in Emerging Markets”, Stanford University, June 2006.

8. (Bernstein, 2003)

9. Source: “Buttonwood: All in the same boat”,The Economist, 10 September 2011.

10. Macquarie analysis, September 2011. Asset classes include, index exposures to Australian property, Australian equities (large, mid and small capitalization), bonds (both Australian and global government and corporate), infrastructure, private equity, 10 hedge fund sub-indices, Timber, Farmland, and Emerging Market equities.

11. (Zoellick, 2010)

12. Macquarie analysis. Source: Angus Maddison dataset (in 1990 PPP based International Geary-Khamis dollars)

13. (Liu)

14. Source: HIS Global Insight, quoted in “China noses ahead as top goods producer”, Financial Times, 13 March 2011.

15. Source: CEPII, 2011.

16. Source: Energy Intelligence Agency (EIA), “International Energy Statistics”, November 2009. Projection: EIA, Annual Energy Outlook 2011, DOE/EIA-0383(2011), AEO2011 National Energy Modelling System, and “World Energy Projection System Plus (2011).

17. Europe averages 75 per cent while North America averages 80 per cent urban population. (Source: UN Population Division; EIU.)

18. Source: US Census Bureau, 1993.

19. United Nations, “World Urbanization Prospects: The 2009 Revision”, accessed May 2011.

20. New York: US Census Bureau. China: ‘Preparing for China’s Urban Billion’, McKinsey Global Institute, March 2009.

21. Buiter and Rahbari, “Global growth generators: Moving beyond emerging markets and BRICs”, Citigroup and Centre for Economic Policy Research, April 2011.

22. Study by Barry Eichengreen, University of California, Berkeley, Donghyun Park, the Asian Development Bank and Kwanho Shin, Korea (University National Bureau of Economic Research, 2011).

23. (National Bureau of Economic Research, 2011)

24. Analysis: Macquarie. Data Source: Alan Heston, Robert Summers and Bettina Aten, Penn World Table Version 7.0, Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania, May 2011.

25. Source: Michael Petis, “China Rebalancing”, CFA Australia Investment Conference, 11 August 2011.

26. (Smith, 1776)

27. Source: Food Price Index – UN Food Administration Organisation (FAO), May 2011. Middle Class expenditure – McKinsey & Company and Wharton University, 2011. Food Imports – US Department of Agriculture, May 2011.

28. (Brown, 2011)

29. Source: USDA, Economic Research Service, “International Evidence on Food Consumption Patterns”, October 2003.

30. (Ciezadlo, 2011)

31. Source: “The Silent Tsunami—the Globalization of the Hunger Challenge”, Josette Sheeran, UN World Food Program, Keynote address delivered at the Peterson Institute. May 2008.

32. Source: USDA estimate, 2011.

33. Source: MSCI World Ex Au (AUD), July 2001 to July 2011. Data via Bloomberg, accessed August 2001.

34. Source: World Bank databank extracted August 2011.

35. Source: Bloomberg, August 2011.

36. Source: Diversification Ratio was developed by Choueifaty, “Methods and Systems for Providing an Anti-Benchmark Portfolio, May 2006, USPTO. Analysis of the Australian market by Macquarie, August 2011.

The diversification ratio measures the number of independent effective risk factors driving returns. It is calculated by dividing the weighted-average volatility of the individual securities by the volatility of the portfolio.

37. Source: “The Most Diversified Portfolio”, TOBAM, All About Alpha, 27 March 211.


This document does not constitute financial product advice and should not be relied upon as such. The information in this document is for discussion purposes only and is not an offer or solicitation to purchase or sell any securities or financial product. None of the information in this document takes into account any person’s personal objectives, financial situation or needs and you must determine whether the information is appropriate in terms of your particular circumstances. We recommend you obtain financial, legal and taxation advice before making any financial investment decision.

The information contained in this document is strictly confidential. If you are not the intended recipient, you may not disclose or use the information in this document in any way. No liability is accepted for any unauthorised use of the information contained in this document.

This document is not to be distributed to any person or corporation by the recipient. Macquarie Group is the owner of the copyright material in this document unless otherwise specified. Macquarie Group Limited and its worldwide affiliates and subsidiaries accept no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this document and/or further communication in relation to this document.

This document has been prepared based on information believed to be accurate at the time of the preparation of this document. Subsequent changes in circumstances may occur at any time and may impact the accuracy of the information in this document. Some of the information in this document and the figures that have been quoted, and or used within it, have yet to be confirmed and finalised and consent has not been obtained from all relevant stakeholders. It is important to note that to this extent the document may not be accurate or complete and some of the information could be subject to amendments.

This document incorporates third party information from sources believed to be reliable. The accuracy of such information (including all assumptions) has not been independently verified by Macquarie and Macquarie cannot guarantee its accuracy or completeness. Except as required by law, Macquarie and its respective directors, officers, employees, agents and consultants make no representation or warranty as to the accuracy or completeness of the information contained in this document.

Any forecasts contained in this document are predictive in character and therefore no undue reliance should be placed on the forecast information. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The actual results may differ substantially from the forecasts and some facts and opinions may change without notice on the basis of changing market conditions.

Past performance is no indication of future performance.

Other than Macquarie Bank Limited ABN 46 008 583 542 (MBL), none of the entities referred to in this document (nor Macquarie Global Investments) is an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities (and Macquarie Global Investments) do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that entity, unless noted otherwise.

Macquarie Global Investments is an operating division of the Macquarie Group’s Banking and Financial Services Group.


For more information, please contact:

1800 214 616

Macquarie Professional Series GPO Box 2912, Brisbane QLD 4001

[email protected]

macquarie.com.au/professionalseries

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