Managing Risk in Emerging Markets Patricia Perez Coutts, CFA Senior - PowerPoint PPT Presentation

Global Equity Client Name Managing Risk in Emerging Markets Patricia Perez ‐ Coutts, CFA Senior Vice President and Portfolio Manager, Westwood International Advisors CFA Society Montreal: Emerging Markets Luncheon, Feb 4, 2015 For Professional Use Only ‐ Not for Public Distribution 181 Bay Street ● Suite 2450 ● Toronto, ON ● M5J 2T3 ● www.westwoodgroup.com

“All countries are risky; the Emerging “All countries are risky; the Emerging Markets are those where this is priced in” Markets are those where this is priced in” ‐ Dr. Jerome Booth ‐ Dr. Jerome Booth Investor, Economist, and Author* Investor, Economist, and Author* * Emerging Markets in an Upside Down World: Challenging Perceptions in Asset Allocation and Investment (The Wiley Finance Series), 2014 1

WIA Client Service Agenda I. Defining Risk • Categories of Risk • Risk Exposures II. Managing Risk through Fundamental Analysis • Our Approach • Alternative Measures of Risk III. Stock Examples 2

Defining Risk 1. Loss of Capital – downside risk 2. Relative Underperformance (versus benchmark and peers) 3. Volatility 3

Categories of Risk • Liquidity Market • Breadth Short ‐ term and Long ‐ term • Macroeconomic environment Economic • Inflation GDP • • Rule of law: rights and freedoms Political • System of government Stability • • Balance of payments • Current account balance Currency Capital mobility • • External debt financing 4

Risk Exposures – Endogenous and Exogenous Financial Risks Non-financial Risks Equity Markets Regulations Interest Rates Legal Exchange Rates Company Taxes Credit Markets Accounting Operations Commodity Prices Model Liquidity Risk Source: CFA Institute: Risk Management, 2015 5

Assessing Risk through Fundamental Analysis How does a company manage risk for future return potential? • Qualitative Analysis Business model o Management track record o Competitive landscape o Shareholder rights o • Quantitative Analysis Financial statements o Return ratios (ROE, ROIC, CFROI, o etc.) Drivers of return: sales growth, o operating margins, asset turns 6

Our Approach As bottom ‐ up, fundamental investors, we attempt to incorporate all possible risks into our calculations for COE (Cost of Equity) / WACC (Weighted ‐ Average Cost of Capital) assumptions. • Define RFR (Risk ‐ free rate) – 10yr • Market Beta • Equity Risk Premium – CDS spread Inflation differential • • Idiosyncratic risk 7

Alternative Measures of Risk Standard deviation / Variance • Tracking error • Sharpe Ratio • Sortino Ratio • Downside Capture • 8

Stock Examples Stock Examples

Commercial International Bank of Egypt Cost of Equity (COE) and Equity Risk Premium (EQRP) 30 COE EQRP 25 20 15 10 5 0 Price History (in local currency) Return on Common Equity 60 35 30 45 25 20 30 15 10 15 5 0 0 Source: *Bloomberg, Factset, Jan 2015 9

Copa Holdings (Panama) Weighted Average Cost of Capital (WACC) and Equity Risk Premium (EQRP) 16 WACC EQRP 14 12 10 8 6 4 2 0 Price History (in local currency) Return on Invested Capital 200 20 15 150 10 100 5 50 0 0 Source: *Bloomberg, Factset, Jan 2015 10

Thai Union Frozen Weighted Average Cost of Capital (WACC) and Equity Risk Premium (EQRP) 10 WACC EQRP 8 6 4 2 0 Price History (in local currency) Return on Invested Capital 25 14 12 20 10 8 15 6 10 4 2 5 0 0 Source: *Bloomberg, Factset, Jan 2015 11

Summary 1. How do we define Risk? 2. Managing risk as investors 3. Emerging Markets – past perceptions and misconceptions 12