pine bridge out look

8/10/2019 Pine Bridge Out Look

1/56

INVESTMENTOUTLOOK 2015 Divergent Paths : Investing in anUnsynchronized World


2/56

CONTENTS

2015


3/56

3 E C O

N O M I C O

U T L O O K

U N S

Y N C H R O

N I Z E D

B U S I N E

S S C Y C L

E S

M a r k

u s S c h o m

e r M a n

a g i n g D i r

e c t o r, C h

i e f E c o n o

m i s t

1 V I E

W P O I N T

D a v i d J

i a n g C

h i e f E x e c u

t i v e O f

c e r

1 1 A S S

E T A L L O

CA T I O N

Q E G O E

S G L O BA

L A N D E U

R O P E S S

E C O N D C

HA N C E

M i c h a e l J. K e l

l y M a n a g

i n g D i r e c t o

r, G l o b a l H

e a d o f A s s

e t A l l o c a t i

o n

1 7 G L O B

A L C R E D I T

A N D F I X E D

I N C O M E

A T T H E F I X E

D I N C O M E

C R O S S R OA

D S

S t e v e n O h

M a n a g i n g D i r

e c to r, G lo b a l

H e a d o f C r e d

i t a n d F i x e d I n

co m e

2 7 E Q U I T I E S

FOCU S ON F

UN DAMEN TAL S

An i k Sen Ma

nag ing D irec tor, In ter im

G lo ba l Head o f Equ i t ies

35 PRIVATE MARKETS A CONSTANT FLOW OF OPPORTUNITIES Talal Al Zain Regional CEO, MENA, Co-Head of Alternative Investments FT Chong Managing Director, Head of PineBridge Structured Capital Pierre Mellinger President and CEO, Head of Central Europe Private Equity

Steven Costabile Managing Director, Global Head of Private Funds Group


4/56

PINEBRIDGE | INVESTMENT OUTLOOK 2015

PineBridge believes that differences of opinion not onlymake markets, but they foreshadow substantial movesahead of time. As a multi-asset rm, we nurture debateacross investment teams and jurisdictions globally. Suchdebate hones in on our internal differences of opinion andassists with the development of our well-rounded views.

PineBridge is a global asset managerwith over 60 years of experience inemerging and developed markets,delivering innovative alpha-oriented

strategies across asset allocation,equities, xed income and alternatives.

What differentiates PineBridge is theintegration of on-the-ground knowledge withanalytical insights, bridging global and localcapabilities to deliver innovative productsand solutions that create value for clients.

Any opinions, projections, forecasts and forward-looking statementspresented are valid only as of the date indicated and are subject to change.


5/56


NAVIGATING GLOBAL MARKETS WILL BE NO EASYFEAT IN THE COMING YEAR, WITH THE BEGINNING OTHE US RATE RISE CYCLE NOW UPON US, EMERGINGECONOMIES DIVERGING IN THEIR GROWTH TRENDSAND GEOPOLITICAL RISKS AT EVERY TURN. IT IS ATSUCH TIMES THAT NEXT GENERATION INVESTMENTMANAGERS CAN DISTINGUISH THEMSELVES.

We are living in a world where companies operate in morecountries, supply chains cross continents, and governmentpolicies are more coordinated. In this globally integratedeconomy, events in one part of the world have implicationsin another. Local insights into important links of the economicchain become critical to making investment decisions.

To deliver alpha during turbulence and uncertainty, wemust have conviction in our investment decisions, basedon investment insights from a platform that has strategicpresence in terms of geography, sector and asset class.When combined with speed, teamwork and processes thatapply the latest portfolio techniques to balance risk andreturn, such insights can deliver consistent alpha. The PineBridge Investment Outlook 2015 draws upon theanalytical skills of our on-the-ground teams. While ourbroad view is that 2015 will provide a last hurrah forliquidity-led securities markets as the US Federal Reservepasses the baton of Quantitative Easing to its Japanese andEuropean counterparts, we believe that investors shouldbuild up long-term positions in direct investments.

It is also clear that growth can no longer be taken for grantedin the emerging markets. In our outlook, we contrast countriesthat are likely to proceed with economic reforms with thoselikely to take longer. This process normally requires short-term political pain for long-term economic gain. In-depthpolitical and economic analysis is important because markets

tend to provide immediate rewards for governments that endurethis process.

I believe 2015 is shaping up to be a pivotal year. I thereforevery much hope that you will nd these insights interestingand thought-provoking.

Sincerely,

David JiangChief Executive Ofcer, PineBridge Investments


6/56

PineBridge Forecasts 2014(e)* 2015(e) 2016(e)

Global GDP 3.1% 3.6% 3.9%

Developed Economies 1.7% 2.1% 2.4%

Emerging Economies 4.2% 4.8% 5.1%

GLOBAL GDPFORECAST 2015

* EstimatedSource: PineBridge Investments. Data as of November 2014.

3.6%


7/56


8/56

Unconventional monetary policy was instrumental inpreventing an even deeper and more damaging nancialcollapse in 2009. Yet the record of central banks using

Quantitative Easing (QE) to boost growth and ination hasbeen mixed at best. The policy has had serious side effectstoo. Easy monetary policy boosted capital markets returns.But a greater proportion of those returns accumulated tohigher income earners, which has exacerbated incomeinequality in times of stagnant wage growth.

Global Rate Hike CycleLed by the US Federal Reserve, a number of major centralbanks are set to start the long process of normalizingmonetary policy, the rst pillar of our 2015 outlook. Themain driver is not the need to catch up with acceleratingination or with booming jobs markets. Rather, the gradualnormalization in economic conditions for household andbusinesses allows for a measured removal of what wasalways considered an emergency monetary policy setting.

Not all countries are far enough along the recovery path toafford such a monetary stimulus withdrawal. Hence, the startof the global rate hike cycle will split the global economyinto two camps: one where central banks follow the FederalReserve towards a more neutral monetary policy setting;and one where weak growth forces central banks to keeprates lower for longer.

Emerging Markets ReformThe emerging markets (EM) reform cycle is the second pillar ofour 2015 outlook. The main catalysts are elections that broughtto power new, more business-friendly governments in countrieslike India and Indonesia. They were elected on a promise toimplement reforms to boost agging economic growth.

Mexico has already enacted sweeping reforms that will openits energy sectors to foreign investment. More countries willfollow. Peer pressure may even prompt Brazils re-elected

President Dilma Rousseff into bolder, much-needed reforms.Some will not follow, of course. So the reform cycle will splitemerging markets into two groups. Countries implementingstructural reforms will raise expectations of strongereconomic growth. Those where governments lack thatcourage will likely experience disappointing growth.

PINEBRIDGE | INVESTMENT OU TLOOK 2015


9/56

US, EU and Japan: UnsynchronizedEconomic growth can only thrive when nancial systemsare robust. The US took drastic action following the 2008nancial market crisis. QE boosted asset prices. Thegovernment injected capital directly into the biggest banksunder the Troubled Asset Relief Program (TARP) and the2009 stress-tests forced banks to raise more private capital.

The measures worked. Condence was restored in the USbanking sector and loan activity started growing in 2010. An

improving banking system is a necessary condition to fuel therebound in business investment that is driving the strongerUS growth trend. With capacity-utilization approaching thehighs of the previous business cycle, companies need toborrow and invest to maintain productivity and protability.

Augmented by falling energy prices, the pick-up in job creationis boosting household incomes and should boost consumerspending. Housing activity has become more volatile, but therecovery in sales and construction should continue in 2015.Politics will diminish in importance. Divided governmentmeans the pace of new legislation will remain slow. At thisstage of the business cycle, political inaction is a welcomeprospect. We expect overall US GDP growth will top 3% in 2015.

US vs. EU vs. JapanForecast GDP Growth Rates 2015

US EU Japan3.1% 1.1% 1.1%

Source: PineBridge Investments. Data as of November 2014.

The comparison with Europe is stark. Bank lending isstill contracting, adding to the headwinds from scalausterity. At least Eurozone average budget decits areback below 3% of GDP, so little additional scal tighteningis required. The ECB has been very active in cutting rates,offering additional liquidity and starting a small assetpurchase program. However, the game changers werethe Banks Asset Quality Review and the establishmentof the Single Supervisory Mechanism to oversee thelargest Eurozone banks. Both measures should signalthe all-clear to increase lending to the private sector.

Added to that are the boost to exports from a weaker euroand the possibility of a Eurozone-wide scal stimuluspackage. Still, more serious improvements in the Eurozonegrowth trend will take longer to emerge. We expect a 1.1%growth rate in 2015. That is not particularly buoyant, but itis an improvement from essentially zero growth in the pastthree years. It should take the pressure off the ECB and allowthe Bank to undo extreme measures such as negative depositrates that banks have started to pass on to their accountholders. However, Eurozone policy normalization is not onthe cards until 2017.

Japans recovery was severely disrupted in early 2014when the government prematurely pivoted from aggressivegrowth- and ination-boosting policy stimulus to sudden scalcontraction, which pushed the economy back into recession.It took the authorities longer than expected, but the Bank ofJapan (BOJ) eventually increased its asset purchase programand the government abandoned ideas of a further tax increasein 2015. That and the sharply weaker yen should pull theeconomy out of recession. Similar to the Eurozone, we expectonly a moderate improvement in Japanese economic growthto 1.1% after barely growing at all in 2014.

PINEBRIDGE | INVESTMENT OUT LOOK 2015


10/56

A Vote for ChangeElections may not dominate like last year, but some stillwarrant attention. The highlight is the UK Parliamentaryelections in May. They could end the current coalition andrestore the Conservatives to one-party power; that wouldincrease the odds of the UK leaving the European Unionin 2017 after a promised referendum.

Other elections with regional implications are the JuneAssembly elections in Turkey, which will determine theinuence new President Recep Tayyip Erdogan has overthe next prime minster. Voters in Finland (April), Portugal(October) and Spain (December) will pass judgment onthe current state of the Eurozone recovery. Argentines(October) have a chance to change the direction theircountry is going; Canadians go to the polls in the samemonth. Finally, general elections are planned thoughnot yet scheduled in Thailand where the militarygovernment intends to restore democratic power.

India vs. China:Reasons for ReformWhat will differentiate prospects in emerging markets is thedegree to which governments embrace economic reforms toboost economic growth.

In 2014, Indian and Indonesian voters rejected incumbentswho lacked the courage to tackle vested interests thatwere hindering economic growth. Now Indian Prime MinisterNarendra Modi and Indonesian President Jokowi look likelyto ease business regulation and to use scal reform tostimulate investment and consumption. Both realize theyhave to accelerate the rate of growth to improve livingstandards. While elections were the catalyst for change,2015 will be about formulating and implementing reforms.We do not expect a big bang, but look for a series of smallsteps that will improve the efciency of the bureaucracy andreduce subsidies that stie business activity. We expect botheconomies to post stronger growth rates in 2015.

Chinas leaders are also betting on economic reforms.President Xi Jinpings government is experimenting with

free trade zones, looking at state-owned enterprise (SOE)reform and at ways to open up access to the countrys capitalmarkets. Yet Chinas reforms are not focused on acceleratingeconomic growth, but on managing the structural slowdown.



11/56

Chinas nancial system has gorged on cheap credit since2008. Deleveraging without causing a crisis is the leadershipsgreatest challenge. The task will dene Xi Jinpings presidency.We believe China has sufcient control over the main economiclevers to avoid a hard landing. Even so, GDP growth will continueto slow in the coming years as the country moves from aninvestment-led growth model to one based on consumptionand services. China will continue to outperform most othereconomies in the region, even though we project its growthto slow to 7.3% in 2015 and 7% by 2016.

The Slow Growth of ChinaThe Slow Growth of China

2012 2013 2014 2015 20167.7% 7.7% 7.4% 7.3% 7.0%


CHINAS REFORMS ARE NOT FOCUSEDON ACCELERATING ECONOMIC GROWTH,BUT ON MANAGING THE STRUCTURALSLOWDOWN

Mexico vs. Brazil:Courage Can Win ElectionsReforms may also be a key differentiator in Latin America.Mexico demonstrated that politicians who show courage byembracing reforms can win elections. Unfortunately, Brazilshowed politicians campaigning for the status quo can win too.

Mexico started the reform trend in 2012 when voters returnedthe Institutional Revolutionary Party (PRI) to power. It hadpreviously run Mexico for 70 years until 2000. Unhappy withthe rate of economic improvement, Mexicans sent a messagethat party history is irrelevant as long as leaders promotereforms that promise to lift economic growth. The case ofMexico is particularly exciting; one of its key reform pillars isthe opening of the countrys energy sector to foreign investment.That is expected to increase oil production dramatically in thecoming years. As a result, we are looking for a sustainedimprovement in Mexicos underlying growth potential.For 2015, we project an improvement to 3% growth andwe expect at further acceleration though the end of 2016.

Brazilians did not vote for change in 2014. Rather than

embracing a new approach, Brazilians may hope thatre-elected President Dilma Rousseff interprets her victoryas a vote of condence that she is the better candidate toimplement reforms, not as afrmation of past policies. Brazilmust reduce its stubbornly high rate of ination, which wouldallow real interest rates to fall and stimulate investment.Success will not be fast and the risk of policy error remains.We do not expect Brazils recession to stretch into 2015, butgrowth is likely to remain below 2% insufcient to addressthe countrys income inequality.



12/56

Russia vs. Turkey:Geopolitics in ActionThe simmering Russian/Ukraine conict was bound tohamper economic prospects in Eastern Europe. Sanctionspushed Russia to the brink of recession and hurt Eurozonegrowth prospects too. Capital ight and declining oil priceshave exacerbated the economic crisis in Russia. This shouldcreate sufcient incentives to resolve the conict peacefully.

But Europe must also re-engage with Russia. It mustrestore the mutually-benecial relationship between theprovider of energy and the providers of capital goods. It willtake time to heal the economic wounds. We expect Russiaseconomy to grow barely above 1% in 2015.

WE EXPECT RUSSIAS ECONOMYTO GROW BARELY ABOVE 1% IN 2015

The crisis is a good example that integration must gobeyond trade. The EU would be well-advised to involveRussia more in shaping Europes future. Integrationand inclusion are lessons Turkey needs to learn too.An important way to demonstrate sustainable politicalstability to investors is the smooth and peaceful transitionof democratic power. Turkey risks losing that condence.Erdogan, who headed Turkeys government for eleven years,was recently elected to the hitherto ceremonial post ofPresident of the Republic. He is now trying to reshape theofce by claiming many of the powers reserved for the primeminister. Maintaining political stability will be key for Turkeyto realize its true growth potential. We expect the countrysgrowth trend will remain moderate at around 3% in 2015.

MENA: Oil and PoliticsPolitical instability and volatile oil prices dominate ourMiddle East and North Africa outlook. The decline in oilprices is hitting oil producers disproportionately in theMiddle East where governments rely more on oil revenuesto nance scal spending. Large sovereign wealth fundsinsulate many of the Gulf Cooperation Council (GCC)economies. The decline in oil revenues threatens generouswelfare systems and ambitious infrastructure programs.The main risk is increased geopolitical risk, but it may

also accelerate the process of diversifying the economiesfurther towards manufacturing and services. Assuming oilprices stabilize around US $80, GCC economies should seegrowth accelerating back to 4% in 2015 from 2.5% in 2014.

Africa: Fundamentals andInfrastructure SpendingThe early development stage and the benets of strongpopulation growth insulate many Sub-Saharan countries fromthe more volatile macro environment in other emerging marketregions. Yet more needs to be done to attract investment.

The decline in commodity prices is a net negative headwindfor the region, although South Africa is one of the mainbeneciaries of falling oil prices. Slowing ination is openingthe door for rate cuts in 2015, which could provide a muchneeded stimulus. Overall GDP growth in the region shouldreaccelerate to 5.5% in 2015.



13/56

Global Outlook: US LeadsStronger global growth and pre-emptive rate increasesare good for stocks, good for the US dollar and good forcorporate bonds.

Our global outlook centers around the improving US growthtrend that allows the Federal Reserve to begin normalizingpolicy rates. We expect US policy rates to reach 1% by theend of 2015 and 2% in the following year. Central banks incountries experiencing similar improvements will follow suit.

Canada and the UK are the obvious examples. The changesin interest rate differentials will boost exchange rates versuscountries were central banks leave rates lower for longer.

US Federal Fund Rates2013 2014 2015 20160.25% 0.25% 1% 2%


That growth backdrop supports further appreciation of theUS dollar and offers further upside for equities. Structuralreforms in emerging markets promise the same. In the shortterm, markets are also likely to reward ECB and BOJ policystimulus with higher asset prices.

US Yields Up10-year US Treasury yield forecasts

2014 H1, 2015 H2, 20152.32% 2.50-2.75% 3.00-3.25%

Source: PineBridge Investments. Data as of 19 November 2014.

Bond yields are likely to rise next year. It is hard to imagineanother conuence of the events that drove yields lowerin 2014. However, low ination and abundant liquidity pointto only moderate upside risk. Benchmark 10-year US bondyields should trade between 2.50% and 2.75% in the rsthalf of the year and rise less than the shorter end of theUS Treasury yield curve. By year-end, we expect 10-yearyields to trade around 3%.

We are still early in the global business cycle. Leverageratios are low and household debt-to-income ratios havenot turned up again. Hence, the rst phase of the global ratehike cycle should not raise default rates in the corporatesector. Rate hikes are a reflection of growing confidencein the recovery. Structural reforms will make that condenceand growth sustainable.



14/56

THE AGGREGATE SIZE OF THE THREE LARGESTCENTRAL BANK BALANCE SHEETS (FED, ECB,BOJ) ARE PLANNED TO SURGE FROM US $9TRILLION TO US $11 TRILLION BY MARCH 2016.

CENTRAL BANKBALANCE SHEETS

TO INCREASE

Source: Haver, Federal Reserve, Bank of Japan, World Bank, Trading Economics. Data as of November 2014.


15/56

MACROWHENBUSINESSCYCLES

DEVIATE

WITH THE QUANTITATIVE EASING BATON HAVING BEEN PASSEDFROM THE FEDERAL RESERVE TO THE BANK OF JAPAN ANDTHE EUROPEAN CENTRAL BANK, 2015 IS POISED TO BE YETANOTHER YEAR WHERE FUNDAMENTALS TAKE A BACK SEATTO SURGING LIQUIDITY.

ASSET

ALLOCATION

Falling commodity prices will hurt many emerging andfrontier markets, herding excess liquidity into strengtheningdeveloped markets.

The biggest surprise for 2015 will be the revival of Europe andthe leadership of its markets. Japan, Mexico and India are alsopoised to do quite well. While it lasted, Fed-led QuantitativeEasing (QE) helped US markets outperform their fundamentals.

With the Fed now having ended QE, US equities are stilllikely to outperform most emerging markets, yet shouldunderperform their strengthening US fundamentals. Beyond2015, most central banks will begin grappling with how andwhen to normalize their policies. At that point, an era will havepassed. We will have come to the end of liquidity-led markets.

So 2015 is one last hurrah, the grand nale before we shiftregimes into a low nominal return world with rising volatilityand ination for years to come. This makes 2015 an importantyear to begin rebuilding allocations to private markets asprotection from volatility and from less favorable public markets.

AUTHOR :

Michael J. Kelly Managing Director, Global Head of Asset Allocation



16/56

The US Economy may Lead,yet European Markets havethe Greatest Pent-Up PotentialAs we ring out the old and ring in the new, we are nostalgicabout bidding farewell to Ben Bernankes unconventionalmonetary program. The Professor may have lost sleep studyingthe struggle that economies suffered as they attempted to pullthemselves out of the Depression, but he was fortunately theright leader at the right time. This is not to say that it was not

the right time for him to leave the party. Too much of a goodthing often turns out to be not so good. So farewell US-styledQE, and thank you Ben Bernanke.

QE HAS BEEN SHOWN CAPABLE OFOVERWHELMING OTHERWISE POORECONOMIC FUNDAMENTALS

By now, all of us know far more about the impact of QE onnancial markets than when it was taken mainstream by theFederal Reserve in November 2008. We may still debate itsimpact on economies, yet its favorable intermediate-term

impact on nancial markets should now be clear.QE has been shown capable of overwhelming otherwisepoor economic fundamentals, initially powering marketshigher before eventually reviving fundamentals themselves.While global excess liquidity should be fungible, it appearsnonetheless to make its biggest splash closest to its pointof origin, and then on deserving opportunities elsewhere.In that light, we were not surprised that US markets werethe best performing major markets while Fed-led QE lasted.

As investment pragmatists with an intermediate-termperspective, we factor in QEs favorable impact on high-endconsumer spending as it creates jobs, even though otherswill dismiss this impact given longer-term inequality.We watched QEs potency as a lifeline to fragile nancialstructures as it paved the way towards renancing andextending lower-quality debt. With a longer lag, QE eventuallyresuscitated business condence in the US which is nowadding a second leg to employment growth and revivingbusiness spending.

We concur that US fundamentals are now the strongest into2015. Yet we still expect US markets to under perform theirstrengthening fundamentals as the performance-enhancingimpact of Fed-led QE fades.

Markets Driven by more than QEThe chart opposite illustrates that central banks have notbeen the only force contributing to global excess liquidity,but they have clearly been a large and easy source to track.Even though the Feds balance sheet will likely remain ona plateau for quite some time to come, the Bank of Japan(BOJ) and European Central Bank (ECB) are revving up theirown QE programs.

The world will witness and be impacted by very rapid growth inthese two balance sheets throughout 2015. The aggregate sizeof the three largest central bank balance sheets (Fed, ECB andBOJ) is planned to surge from US $9 trillion at present to overUS $11 trillion by March 2016. Such expansion will far exceednominal global GDP growth, contributing to yet another yearwhere fundamentals take a back seat to liquidity growth.

Only now are markets gaining comfort that the end of theFeds QE program is not the end of global QE.



17/56

0

3

6

9

12

15

20

21

22

23

24

25

80 84 88 92 161208040096

%%

Sources: Haver, Federal Reserve, Bank of Japan, World Bank, TradingEconomics, PineBridge Investments. Data as of 27 October 2014.Note: Gross savings are calculated as gross national income less totalconsumption, plus net transfers. Estimates are based on World BankGDP and demand forecasts. Source for 2015 and 2016 Gross NationalSavings / Global GDP.

NORMAL SOURCES OF LIQUIDITY HAVE SURGEDSIMULTANEOUSLY POST-CRISIS

Global Savings/Global GDP (Left Scale)

FED+ECB+BoJ/Global GDP (Right Scale)

Global savings have also outpaced global GDP, exacerbatingtodays liquidity-fed markets. Here, it is not as easy to sketchthe path forward. What we do know is that there have beentwo waves that have explained the step-up in global savings.The rst wave occurred in the wake of the 1998 Asian nancialcrisis. Asian companies, governments and individuals increasedtheir savings once their economies had revived. Fed chairmanBen Bernanke labeled this a global savings glut, but that wasbefore the latest crisis struck.

The second wave followed the current crisis, with Europeanausterity joining Asian frugality, while global businessprioritized protability and liquidity-restoration over internalgrowth. Global slack has discouraged companies fromreinvesting. Firms have nurtured a keen focus on generatingever-higher protability and repatriating cash to shareholders.China has also throttled down the growth rate of its state-ledinvestment faster than consumerism has emerged, addinganother source of global savings. Fortunately, each yearof global growth has picked away at this global slack.

In the US, both major contributors to slack (capacity utilizationand the unemployment rate) should cross from too loose to tootight in 2015. The outlook for business spending has recentlybegun to revive. European austerity is fading and Chinasconsumer economy will eventually bear fruit beyond 2015.It is likely that the global savings glut is poised to dissipateslowly, yet the timing is hard to call. What is clear is thatcentral bank liquidity will surge at least one more year.

Such a backdrop leads us to once again emphasize a followthe money approach as we assess our top picks for 2015.



18/56

TOPIX and Economy to StrengthenThe BOJs second attempt at QE paid off immediately for theTOPIX in 2013, before being questioned during 2014 as policymakers erred in prematurely implementing scal austeritywith a consumption tax. As we look into 2015, fundamentalsare beginning to revive just as the monetary thrust has beenenhanced and given more time to work. Japans energy billhas skyrocketed since its nuclear plants were shuttered. Thelower price structure of energy will have a strong benecialimpact on Japan. In our view, both the TOPIX and Japans

economy will continue to strengthen throughout 2015.

WE THINK THE BIGGEST SURPRISE IN2015 WILL BE THE REVIVAL OF EUROPEAND THE LEADERSHIP OF ITS MARKETS

Clearly Russian trade sanctions and uncertainty over gassupplies had an unfavorable impact on Europes economyin 2014. Yet we are a bit surprised that most economistsattribute Europes near-double dip to these forces. The realculprit that choked off Europes fragile recovery was theplunge in bank lending that preceded the ndings of the

Asset Quality Review (AQR). While necessary for privatecapital to come back into European nancials and for theseinstitutions to trust each other in order to reboot interbanklending, the impending stress-test led banks to shed assetsrelative to their capital positions.

With the AQR behind us, its benets can now be realized.Combined with the ECBs expanding QE program, we thinkthe biggest surprise in 2015 will be the revival of Europe andthe leadership of its markets. Of course, one needs to hedgeeuro currency exposures, just as one should hedge yenexposures when investing in Japan as both QE programswill weigh heavily on each currency.

2015 TOP PICKS EUROPEAN STOCKSEconomic revival and beginning of ECBs liquidity impact.

JAPANESE STOCKSQE tailwind, focus on stocks in JPX 400.

MEXICAN ASSETSMexican moment will survive, its oil story is volume-led.

INDIAN ASSETSImproving business climate.

TIMBERThe one real asset which has not been couponized.

MID-MARKET DIRECT LENDINGPost GFC witch-hunt and related penalties will not stoplending recovery, yet will dampen its magnitude.

USDDivergent monetary policies have long legs ahead.



19/56

Commodity Price Declinesare Pro-GrowthCommodity prices came down hard in 2014. Markets initiallyworried that this was a sign of weakening global demand.Like the growth of central bank balance sheets, we seecommodity supply cycles as quite visible, long-lasting andeasy to analyze. The only uncertainty is often the timingof when the supply tsunamis hit. We have been anticipatingtheir arrival for at least two years, cautious on commodity-exporting regions and countries. But even we were surprisedby the extent to which these supply curves all came aboutin unison. Whether one focuses on oil, gas, iron ore or copper,the cure to high commodity prices proved once again to behigh commodity prices.

As condence grows that these widespread price declineswere supply-led, the focus will shift next to their impact.We are in the camp that believes that supply-led declinesin commodity prices are unmistakably pro-growth butnot for everyone.

Just as the commodity super-cycle redistributed country-level income and wealth, and led to the emergence orsubmergence of middle classes, a long-lasting decline incommodity prices also raises the prospect of reshufingthese decks . At present, the winners are more clear to usthan the losers. We place Japan, India, Europe and muchof Asia in the beneciary camp.

The ripple effect of falling commodity prices will depressinflation indices in the near term, yet the commoditysuper-cycle from 2002 to 2010 witnessed rising commodityprices coexisting with disinflation. Given the massiveincreases in central bank balance sheets post-crisis, we seeno reason that falling commodity prices cannot also coexistwith re-ination. We do not see too much of a delay on risinginterest rates or the emergence of real assets. Yet that isa story for 2016 and beyond.



20/56

US UNEMPLOYMENT THESIGNAL FOR FED RATE RISES

5.5%

Source: PineBridge Investments. Data as of November 2014


21/56

GLOBAL CREDITAND FIXED

INCOME

WHEN THE FINANCIAL CRISIS BROKE, MONETARY POLICYMAKERTRAVELLED THE SAME TURBULENT ROUTE. THEY REDUCEDINTEREST RATES TO THE LOWEST LEVELS EVER RECORDEDAND INTRODUCED UNORTHODOX POLICIES TO KEEP THEGLOBAL ECONOMY ALIVE.

As we head into 2015, economies and the central bankpolicies that guide them have arrived at a crossroads. Theyare seeking to part ways but may nd it difcult to do so.

While each country would like to chart its own distinctcourse, the global economy and capital markets areinterconnected so they cannot separate fully. Will theUS recovery lift Europe and other global economies?Or will the weaker links weigh down on the US? Pullingin different directions while remaining connected maynot get us very far from where we currently stand.

The net result will be a attening of the yield curve with globalinterest rates remaining lower for longer. This will extend thecredit cycle and broadly provide support for credit risk assets.However, within each component area, there will be greaterdifferentiation among countries, sectors and issuers as we moveaway from the beta stage of the cycle toward alpha distinctions.

AUTHOR :

Steven Oh Managing Director, Global Head of Credit and Fixed Income



22/56

One Way or AnotherAs economies head in different directions, central bankpolicy makers will pursue divergent policies that will resultin different impacts on the various xed income markets.

The Federal Reserve has already exited its QuantitativeEasing (QE) program and is poised for rate normalizationby increasing short-term policy rates. The EuropeanCentral Bank (ECB) and Bank of Japan (BOJ) face entirelydifferent circumstances, so have different paths to take.

Both are beset by deationary threats and will increasetheir stimulative measures in an effort to resuscitatetheir fragile economies. While growth rates in emergingmarkets (EM) remain generally favorable to those of thedeveloped markets (DM), the pace of growth is slowing.The divergence in economic growth and policy decisionsis growing between regions and countries.

Relative demand for US Treasuries should put a ceilingon intermediate and longer-term rates, resulting in aattening yield curve over the next two years. Divergingpolicy actions should also result in a stronger US dollarand softer commodity prices. The interconnectivity betweenthe dollar and commodities will spill over into emergingmarket debt as Fed policy actions will weigh on investorappetite for such assets.

In 2014, we witnessed a similar drag-down effect as10-year Treasury yields declined during the year. Wehad anticipated a relatively benign, range-bound rateenvironment with indications that 2015 would be the yearwhen the yield curve shifted toward a new equilibrium.2015 will still be that transition year, although we expectthe new equilibrium to ultimately settle at lower levelsthan in prior cycles as we move toward a secular phaseof relatively lower global growth and lower ination.

The credit cycle is also approaching its own crossroads aswe transition from an extended recovery period towardsa bullish phase and eventually another downturn. Theremoval of QE also comes at a time of reduced marketliquidity. The current credit cycle has additional roomto run its course, so although we expect default ratesto increase from current lows, they should remain wellbelow their historical average in the year ahead.

These crossroads represent both change and uncertainty.The xed income markets will enter a new transitionperiod with the potential for greater short-term volatility.In the end, policy divergence across interlinked marketscould leave us not too far from where we start the year.



23/56

US Treasuries:Flattening Yield Curve2014 serves as a stark reminder of just how connectedglobal nancial markets have become. Even thoughthe US economy made progress, US Treasuries cavedin to the gravitational pressure exerted by a precipitousdrop in European government bond yields. The fall indeveloped market government bond yields was largelytriggered by the free fall in Eurozone ination.

US Consumer Price Index

EU Consumer Price Index

% y/y % y/y

-1

0

1

2

3

4

5

-3

-2

-1

0

1

2

3

4

5

6

00 02 03 04 06 07 08 10 11 12 14

INFLATION AND DEFLATIONUS consumer prices are rising as Europe flirts with price falls.

Source: BLS, Eurostat. Data as of November 2014.

The Fed has inextricably linked future policy action toeconomic data. We believe the single best indicator ofFed rate rise action is wage inflation (as measured bythe employment cost index). History shows that wagepressures begin to accelerate once the unemploymentrate dips below 5.5% and we are approaching that point.

THE SINGLE BEST INDICATOR OF FEDRATE RISE ACTION IS WAGE INFLATION

2yr/10yr Treasury Yield Curve

US Unemployment Rate

0

%Bps

0

2

4

6

8

10

12

90 93 95 97 00 02 04 07 09 11 14 16

-100

-50

50

100

150

200

250

300

UNEMPLOYMENT DOWN, RATES UPThe correlation between yield curve shape and the unemploymentrate is strong. US unemployment at 5.5% could trigger normalization.

Source: Bloomberg. Data as of November 2014.



24/56

The market remains at odds with US policymakers over thepace of rate hikes, indicated by the infamous dots graphsplotting Fed board member projections. We believe the paceof Fed rate hikes will be slow, at least in 2015. We expect onlythree 25 basis points rate hikes during the year, all in thesecond half.

Diverging monetary policy should also set the stage forcontinued decoupling in G7 bond yields. Yet at the margin,this dynamic also puts a lid on how high US yields can rise,especially in longer tenors. Our highest conviction is a nominalcurve attener.

Europe: Running to Stand StillWe expect growth in Europe to remain sub-par and thatEurozone ination will be below the ECBs 2% target, therebyrequiring more ECB support. With this background and in theabsence of any material aid from scal policies, the ECB willhave no option than to continue its accommodative monetarypolicy and further balance sheet expansion.

We expect European rates to stay low with Bunds remainingrange-bound, favoring flattening positions as investors

move further out in the curve as they search for positiveyields. The periphery should continue to perform as themarket positions itself for sovereign QE. However, we doanticipate some differentiation. For example, Ireland andSpain should outperform Italy and Portugal thanks to theirbetter fundamentals.

IRELAND AND SPAIN SHOULDOUTPERFORM ITALY AND PORTUGALTHANKS TO THEIR BETTERFUNDAMENTALS

The divergence of global monetary policy and the globalizationof term premium will remain dominant themes through 2015and beyond. The aggressive easing invoked by the ECB andBOJ are multi-year strategies.



25/56

Developed Market InvestmentGrade: Tighter SpreadsDeveloped economy growth will remain fragile and anemicin the face of high sovereign debt levels, challengingdemographic and structural conditions, and an ever-growingregulatory burden. Interest rates are likely to remain low.

Central bank efforts boosted asset prices and risk appetite inrecent years. They also created an environment of relativelylow volatility. Strong central bank support is likely to remainand will temper any uptick in market volatility.

Despite a more challenging environment driven by anincrease in mergers and acquisitions (M&A) and othershareholder-friendly activities, investment grade creditwill prove resilient as access to receptive markets shouldcontinue. The credit cycle has turned but it is not likely toimpact markets signicantly for some time. Supply wasrobust in 2014 and most forecasts are that it will continueto be in 2015. The ability of companies to issue debt andto access markets will hinge largely on market conditions,which should ultimately remain receptive despite volatility

caused by central bank uncertainty.

The magnitude of the expected increase in volatilityfollowing the end of US QE and its impact on investmentgrade markets depends on a number of factors. Amongthem is the timing and nature of what we expect to be amore aggressive ECB as it institutes its own form of QE.

In our view, current conditions are similar to that of 2004when ination was not a major concern and the Fed wasnot viewed as behind the curve on raising rates. The Fedembarked on a measured approach to rate increases, whichled to a atter yield curve and relatively strong xed incomereturns in the spread sectors.

2015 will kick off with uncertainty and anticipation asinvestors predict the Feds path and that of additionalmeasures overseas. As the year progresses, we expecta range-bound rate environment to continue. Even if thereare some weak periods, spreads are likely to remain tightas investors continue their search for yield in an environmentwhere it is hard to nd.

SPREADS ARE LIKELY TO REMAIN TIGHT ASINVESTORS CONTINUE THEIR SEARCH FOR

YIELD IN AN ENVIRONMENT WHERE IT ISHARD TO FIND



26/56

Emerging Markets:Reforms Boost for GrowthThe main theme for 2015 will be structural reform but, apartfrom Mexico and India, the starting point for the marketsexpectations for signicant reforms is very low leaving roomfor plenty of upside surprise. What is to say that Indonesiawill not be next to follow the reform agenda or even Brazil?

The external backdrop is likely to remain the main driver ofemerging market returns for some time to come. Yet it hasbecome increasingly clear over the last 12 months that EMinvestors can distinguish between unjustied fear of a totalUS rate normalization-related meltdown (as per 2013 andthe taper tantrum) and the idiosyncratic country are-upswhich dominated EM returns in 2014.

On a total return basis, the recovery by EM hard currencybonds during 2014 was nothing short of remarkable.Effectively, that rebound will cap the potential for anothersurprise beta outperformance in 2015. Instead, the focuswill be on alpha generation from country selection andfrom timing a re-entry into local bond markets which offer

attractive yields with equally volatile exchange rates.

%EM FX Index

Source: J.P. Morgan, Bloomberg, PineBridge Investments.Data as of 14 November 2014.

EM CURRENCIES TO OFFER VALUE ONCEGROWTH RECOVERS

EM FX has been on a depreciation trend since 2011but may be reaching the bottom.

FX Appreciation

FX Depreciation

0

1

2

3

4

5

6

7

8

9

10

83

93

103

113

123

133

03 04 05 06 07 08 09 10 11 12 13 14

EM GDP growth, yoy

EM FX Index



27/56

The US dollar may strengthen for some time to come andwith it USD-based EM spread products, unless currencyadjustments by EM countries pay dividends in the formof improved terms of trade.

A number of countries such as India, Indonesia and Turkeyhave seen considerable improvements in their currentaccounts. Although further improvements are needed, themarket has turned its focus to other issues, partly becauseEM inows have been led by institutional investors with alonger investment horizon than the retail-dominated outowsof 2013. We expect this trend to continue in 2015 especiallyas the post-election political situation has improved in manyEM countries. The drive towards reforms will determine eachcountrys attractiveness to foreign investors.

Downside risks to the EM outlook remain centered aroundthe ability of the Chinese economy to grow above 7.0%without additional targeted policy measures. Failure to doso will increase the risk that a number of EM countrieswill lose a reliable anchor for their commodity exports.That could lead to a secular drop in commodity prices. Thesecondary effect of this on ination and a renewed exibilityin monetary policy may counterbalance some of the effectsof the stronger US dollar. Ultimately, EM countries will needto substitute some of their reliance on external support witha more focused drive toward structural reform.

EM COUNTRIES WILL NEED TO SUBSTITUTESOME OF THEIR RELIANCE ON EXTERNALSUPPORT WITH A MORE FOCUSED DRIVETOWARD STRUCTURAL REFORM

Exchange rates in a number of large EM countries havefallen by 25-40% versus their 2012 averages the sort ofadjustment we would expect in a currency crisis. Luckily, thefalls have occurred in an orderly fashion thanks to the worldof exible exchange rates and independent central banks. Wewould anticipate weaker currencies to boost export growthwith a 6-9 month lag, eventually enabling these currencies torecover some lost ground. Once economic reform and growthcombine in a sufcient number of EM countries, we expectmore demand for EM assets and thus for EM currencies. Thisdemand could be a second half of 2015 phenomenon or mayspillover into 2016 as investors wait for rmer evidence.



28/56

EM Corporates: Divergingfrom EM SovereignsFor EM corporate xed income, 2014 was another relativelypredictable year in terms of trends in fundamentals (stableto mildly positive), and technicals and supply (a third straightyear of record gross issuance of over US $300 billion). Yet totalreturns exceeded all expectations at over 7.5% for InvestmentGrade and more than 6.8% for the broad index.

We expect a similar scenario to play out in 2015. The recentgeneric trends in fundamentals and supply will be maintainedbut, as always, forecasting EM corporate returns is an inexactscience. We are not sitting on the fence, merely reecting thetough ask of setting convictions in a complex asset class splitbetween Investment Grade and High Yield, and spread across48 countries, 500 issuers and 40 plus industry sectors.

Yet there are some convictions we can be clear about.Generic EM corporate default rates will remain benign.Spreads are still attractive on a relative value basis versusdeveloped market credit. The EM versus DM growth differentialis still in place and the asset class has a low sensitivity to

US Treasuries. So, in an environment where US Treasuryrates do not suddenly spike aggressively and the search forhigh quality risk assets continues, we expect demand forEM corporates to remain every bit as strong as it has overthe past three years.

A major supporting factor for the asset class has been thestrong demand from institutional investors. These investorshave accounted for more than 80% of the overall growth ofthe EM corporate market which is now worth US $1.7 trillion(15% of the total global credit market).

We have a favorable outlook for EM corporate xed income in2015. The relative value attraction remains. The investor basecontinues to broaden and deepen. Demand remains strong forthe predominantly Investment Grade asset class. We anticipatethat the EM corporate component will continue to becomeless correlated with EM local markets and EM sovereign hardcurrency. It should converge more with its developed marketcredit peers. With global multi-sector solutions in demand,EM corporate xed income will be viewed as an integral partof the global xed income universe.



29/56

Leveraged Finance:History Doesnt Repeat Itselfbut it Often RhymesIt is widely accepted that corporate credit spreads run incredit cycles. They generally follow economic cycles. Thecycle eventually leads to tighter monetary conditions andresulting in slower economic growth.

Every cycle has its peculiarities and the current one is as

peculiar as they come. It started with the 2008 credit crisis,matured during a period of extraordinary monetary policyconditions and now sits in one of the lowest interest rateenvironments in modern economic history. We are now overve years past the credit spread peak. Normally, that wouldsuggest that this cycle is fairly advanced. However, monetarypolicy is likely to remain accommodative, global economicgrowth rates are neither strong nor synchronized, and yieldcurves are being distorted by 10-year G7 rates that remainanchored around 2%.

We believe the current credit spread environment exhibitsmid-cycle economic conditions with late-cycle creditspreads. Credit spread levels have tightened back to historicaverages. We anticipate a minor increase in defaultsover the next 2-3 years, edging back towards the historicaverage of around 4%. Defaults will likely concentrate inthe lower rating tier and result from the natural aging ofover-leveraged companies unable to renance maturingdebt and in industries experiencing secular shifts. Creditspreads appear to have room to absorb moderate increasesin interest rates or default rates.

In the current economic environment, range-bound spreadsand continued low default rates should result in returns thatare in line with the coupon yield of the asset class. We expectrelatively attractive returns versus other xed income assetclasses, with the occasional short bout of volatility.

THE CURRENT SPREAD CREDITENVIRONMENT EXHIBITS MID-CYCLE ECONOMIC CONDITIONS WITHLATE-CYCLE CREDIT SPREADS

Leveraged nance covers a broad space in the US andEuropean Leveraged Loans and High Yield sectors. It hasseen a large increase in issuance since the credit crisis. Webroadly favor leveraged loans in the current phase of thecredit cycle due to their higher priority in corporate capitalstructures and their oating rate coupons. High yield bondsmay well outperform leveraged loans on an absolute basis butleveraged loans are likely to have better risk-adjusted returns.

There are still areas of value within High Yield, specicallyin the single B rating tier. This area has attractive yield,lower duration and a historically better default experience

than lower-rated credit. We also favor the US over Europe,given the relative disparity in economic outlook.



30/56

OIL PRICE PERBARREL CONTINUES

DOWNWARD TREND

Source: Bloomberg. Data as of 1 December 2014.

JANUARY 2014US $110.00 PER BARREL

DECEMBER 2014US $69.50 PER BARREL


31/56

EQUITIES

THE LONG PERIOD OF RE-RATING DUE TO QUANTITATIVE EASING HARAISED THE VALUATION OF DEFENSIVE STOCKS. FURTHER EASINIS BY NOW LARGELY DISCOUNTED. COMPANY FUNDAMENTALS WIAGAIN DRIVE THE MARKET.

Our global equity outlook remains positive, although tingedwith caution as we enter 2015. Areas of change include thesharply lower price of oil, the easing of regulatory reform,

divergent macro-economic growth prospects and the likelihoodthat fundamentals will play a larger role in equity marketreturns as the US Federal Reserve ends Quantitative Easing(QE). In terms of fundamentals, we are generally encouragedby company management teams continuing to focus on marginimprovement and on shareholder value creation throughcapital return and strategic M&A.

The oil price decline has the potential to affect global andregional equity markets signicantly. Oversupply relative toglobal economic growth and a strong US dollar have pushedoil price forecasts down by 15-20% for 2015. If sustained, lowergasoline prices could bolster global consumer demand.

Easing regulatory reform could also benet equity markets.We are now at the latter stages of re-regulation of the bankingsystem following the global nancial crisis. This has broughtin new capital and liquidity requirements, new regulatorysupervisory bodies and testing procedures. US loan bookshave been expanding and thus supporting US growth.

European banks still await good quality loan demand whiledealing with the ongoing need to build capital and reserves,despite the end of the Asset Quality Review (AQR). Away from

the US, structural reform in many economies is a commontheme as newly elected governments continue to tackle,to varying degrees, high rates of unemployment, slowereconomic growth and persistent geopolitical tension.

Finally, fundamentals are expected to play a signicantlylarger role in equity market returns than over the past threeyears. Equity markets have, to a large extent, factored inmonetary easing by the Bank of Japan (BOJ) and furtheraction by the European Central Bank (ECB) early in 2015.Together with the ending of US monetary easing, thiswill likely signal a limited opportunity for high returnsfrom further reductions in equity market risk premium.

We expect equity volatility to rise in the coming year asthe market re-focuses on company earnings and growthexpectations, given the arguably high valuations comparedto pre-2008 crisis levels of defensive stocks with relativelystable earnings and the comparatively low valuations ofcyclical stocks.

AUTHOR :

Anik Sen Managing Director, Interim Global Head of Equities



32/56

Fundamentals and ReformWE HAVE A GENERALLY POSITIVEOUTLOOK FOR GLOBAL EQUITIESAS WE EXIT 2014, THOUGH WEREMAIN FOCUSED ON SEVERALAREAS OF CAUTION.

From a high level, many investment considerations arelittle changed in the US, Europe, China and Japan. TheUS continues to show steady growth despite the end ofQuantitative Easing (QE). Europe continues to rely on theEuropean Central Bank (ECB) while awaiting structuralreform. Chinas growth rate remains on a deceleratingpath and the Bank of Japan (BOJ) continues in its resoluteattempt to re-inate the economy. Tensions in the MiddleEast, Russia and Ukraine continue.

The sharp oil price decline, however, is a major change andhas the potential to affect global equity markets signicantlyin 2015. The sustainability and volume of US shale oil andnon-OPEC production growth have the potential to causeoil markets to be in an oversupplied position relative todemand. The strength of the US dollar is being driven bydivergent central bank paths and is having an impact oncommodity markets. Indeed, many forecasters have recentlyreduced their 2015 crude oil forecasts by 15-20%. If theseforecasts hold, cheaper oil could be a helpful tailwind forthe US consumer and therefore important to the outlookfor sustained global growth.

US GROWTH LEADERConsumer spending may be a drag for much of the restof the world, but it looks on a steady track for the US, drivenby continued job growth, credit availability improvements,low oil prices and the potential for modest governmentspending increases.



33/56

US$/barrel

75

8085

90

95

100

105

110

115

120

125

0

1000000

2000000

OIL PRICES HEAD SOUTH

Brent Crude dropped sharply from July 2014.

Source: Factset Futures. Data as of November 2014.

04/13 07/13 10/13 01/14 04/14 07/14 10/14

Volume (b/d)

Settlement Price

Markets will also benefit as we inch toward the end ofmuch-needed nancial system re-regulation. New capitaland liquidity ratios have been established and largely met.

New supervisory bodies and procedures have been instituted,though much remains to be achieved in terms of creating alevel global regulatory playing eld. US banks have regainedthe condence to expand their loan books, especially to small-and medium-sized businesses that are vital to the health ofthe economy as the main employers. The end of the AssetQuality Review (AQR) in Europe was a similar llip but theunderlying economic weakness and the continuing need tobuild capital and reserves will likely restrain bank lending.

Lastly, the inection in US monetary easing is likely to drivechange in markets. Contracting risk premiums, and earningsrevisions to a lesser degree, have driven strong equityreturns over the past three years. Looking ahead, theopportunity for high returns from a further reduction inmarket risk premium is limited. With greater reliance onfundamental factors for positive share price appreciation,idiosyncratic risk is likely to result in greater stock andindustry-level volatility, and signicantly lower returns.

IDIOSYNCRATIC RISK IS LIKELY TORESULT IN GREATER STOCK ANDINDUSTRY-LEVEL VOLATILITY, ANDSIGNIFICANTLY LOWER RETURNS

In such an environment, we see three positive signals incorporate behavior that make us favorable towards equitymarkets. Firstly, corporate governance is noticeably strongerwith greater alignment of management compensation toshareholder value creation, attention to balance sheetsand the return of excess capital.

Secondly, management teams globally are focused on margins,

which have increased appreciably over the past decade. Finally,management teams are now more willing to consider strategicoptions to change their business growth potential throughdivestment and acquisition.



34/56

The US: Global Growth LeaderWe continue to back the US expansion that, while modest,will continue to lead global growth. Consumer spending maybe a drag for much of the rest of the world, but it looks toremain on a steady track in the US, driven by continued jobgrowth, credit availability improvements, low oil prices andthe potential for modest government spending increases.

The spending boost from lower gasoline prices is a strongspur for increased consumer spending in other areas. This

is helpful for the domestic economy and should offset somereected pressures from the stronger US dollar. Corporatetax reform and approval of the Keystone pipeline are headlineinitiatives that could help business condence in the face offurther global growth concerns.

-5% 0% 5% 10% 15% 20% 25%

Energy

Telecom

Discretionary

Industrials

Materials

Financials

S&P500

Staples

Tech

Utilities

Health Care

US EQUITIES STRONG IN 2014

Defensives drove the market last year. 2015 may be mutedif cyclicals do not lead.

Source: PineBridge Investments, Bloomberg.Data as of November 2014.

-2.3%

3.9%

4.5%

7.4%

7.6%

9.9%

11.0%

12.1%

17.6%

19.2%

22.3%

Europe: Policy andReform UncertaintyWe take a skeptical view in the short term. While thereis little doubt about the aims or intents of the ECB, wesee limited benet from potential future actions giventhat the market is already anticipating such actions andstructural limitations.

Beyond the ECB, the member states of the European Union(EU) have generally failed to make much progress and theneed for structural reform remains. The banking systemhas made positive strides, though credit expansion will behindered as banks continue to build capital and reservesby a lack of quality credit demand.

Assessmentof Order Books

40

60

80

100

120

140

160

180

200

Q410

Q111

Q211

Q311

Q411

Q112

Q212

Q312

Q412

Q113

Q213

Q313

Q413

Q114

Q214

Q314

EUROPEAN ORDER BOOKS STABILIZECompanies are feeling more positive about their prospects,particularly exporters.

Source: Eurostat. Data as of November 2014.

FranceGermanyItaly

NetherlandsSpainUK



35/56

US over EuropeHeading into 2014, the market expected a synchronizedeconomic expansion. However, clear divergent trends thendeveloped between the US and Europe. In the US (along withCanada and Mexico), purchasing manager indices (PMIs)indicated expansion for most of the year. However, EuropeanPMIs peaked and subsequently contracted in many key marketsin the second half.

This dynamic inuenced global markets, as evidenced

by the relative outperformance of defensive sectors suchas healthcare, information technology and utilities.Furthermore, the common theme between leaders andlaggards within sectors has been their cyclical exposureto areas like capital expenditure and construction.

The market is again forecasting a European expansion as weenter 2015, based on company management commentary andstabilizing order books. Recent euro weakness should also helpexporter order books to grow. However, we believe that there isa risk to EU and potentially broader equity markets if economicweakness continues and the cyclical outlook deteriorates.ECB actions are critical to maintaining a stable outlook in theabsence of structural reform. Additionally, modest earningsgrowth and lack of further re-rating of defensive sectors meanthat they have limited ability to lead the market in 2015.

As a result, we remain overweight in the US market where wecontinue to nd opportunities in domestic-exposed cyclicaland growth stocks.

Japan: Monetary and FiscalReforms Driving ChangeWe are bullish on the united front of scal, monetary andcorporate reforms that Japan has orchestrated to stimulateits long-dormant economy. In particular, we highlight theincreased equity allocation of government pension assetsinto the high return on equity (ROE) JPX-Nikkei Index 400as a critical piece of the program.

We also believe there is substantial market upside shouldcompanies achieve protability closer to their global peers.Pressure from organizations such as Institutional ShareholderServices will help. Shareholders are now more preparedto vote against CEO nominations if protability lags certainlevels. Additional yen weakness has also improved thecompetitive position for exporting companies.

Global Emerging Markets:Reforms Drive OpportunityWe are attracted to markets where economic reforms aretaking place, notably India and Mexico. We also look formarkets where improved political stability and attractive realGDP growth provide the ability for consumers and companiesto lengthen their spending horizons. In addition to India andMexico, this list includes Indonesia, China, Malaysia, thePhilippines, Turkey, Poland and Colombia.



36/56

China: Potential to Re-Rateas Xi-nomics Take HoldIn China, we look for companies that can drive earningsgrowth despite the decelerating macro economy. Enteringyear two of Xi-nomics reform, we see value created bybetter capex discipline, cost control, asset restructuringand mixed ownership working its way into state-ownedenterprises. Given current modest market valuations, thereis potential for equities to re-rate as protability and returnson equity improve. That said, volatility will likely persist asinvestors continue to focus on headline macro news andpolicy responses.

India: A Decisive Vote for ChangeThe market outlook is very positive, driven by Prime MinisterModis initiatives to unshackle the business environmentfrom the rules and regulations that hindered growth in thepast. We are positive on globally competitive companiesthat will thrive and look warily on those that have enjoyedprotectionism and may now see their fortunes deteriorate.We expect the market re-rating to continue as economic

growth accelerates and lower oil prices support reduceddecit spending.

Turkey: Infrastructure BoostTurkish companies currently conrm a strong outlook. GDPgrowth should be in the 3-4% range with ination lower thanlast year. Big infrastructure projects are going ahead. A thirdbridge over the Bosphorus is being constructed, along withconnecting roads to the new airport and Istanbul. Additionally,a road tunnel is being dug and the subway is being extended.The lower oil price is also helping Turkey.

Mexico, Colombia and Peru:Reform Critical to OurBullish StanceWe are bullish on Latin America as the whole region isshowing GDP growth. In Mexico, we anticipate a positiveimpact from structural reforms. Foreign direct investment(FDI) will benet from the rst round of energy bids early inthe year. Infrastructure-linked investment opportunities willbe plentiful and there is a long list of companies coming to

the Mexican Stock Exchange.

Peru and Colombia are also benetting from investment, withspending passing 30% of GDP in both countries. Colombias 4Ginfrastructure projects will have the same economic impactas the 2010 oil bonanza. Much of that oil money is now beingrecycled to rebuild the roads between major cities, a projectwe estimate is worth up to 3% of GDP. In Peru, a variety ofinfrastructure and investment projects have pushed up ofcialinvestment gures, from agribusiness to mining, ports andtourism, putting them into a select group in Latin America.

For Brazil, we await news from the new finance ministerJoaquim Levy on the steps that will be taken to address thescal situation, price anomalies and a potential investmentrating downgrade. While we expect volatility in the short term,we remain invested in agribusiness as exporters benet froma weaker real.



37/56


38/56

GLOBAL SEARCH FORNEW SOURCES OF

YIELD AND GROWTH


39/56

PRIVATE MARKETS WILL BENEFIT FROM INCREASED OPPORTUNITIEACROSS DEVELOPED, EMERGING AND FRONTIER MARKETS WHICWILL DRIVE DEAL ACTIVITY IN 2015.

Fragile optimism has ourished into buoyant condencesince the crisis, despite continued signs of economicdislocation and lingering inefciencies in capital markets.Asset prices continue their rapid ascent with no imminentend in sight, boosted by the actions of central banks, eventhough GDP forecasts are tepid at best.

However, we believe GDP and asset prices will begin toconverge as developed markets lead the improvement ingrowth momentum. Emerging markets will also graduallycast off the regulatory and political impediments that haveheld back growth rates in past years. In turn, we expect thisto produce a rich market for investing.

PRIVATE

MARKETS

AUTHORS :

Talal Al Zain Regional CEO, MENA, Co-Head of Alternative InvestmentsFT Chong Managing Director, Head of Structured CapitalPierre Mellinger President and CEO, Head of Central Europe Private EquitySteven Costabile Managing Director, Global Head of Private Funds Group



40/56

Developed Markets DeleverageThe impact of regulation and deleveraging on bank lendingpolicies continues to be one of the most enduring impedimentsto growth in developed markets. Seven years on, the largestLeveraged Buyout (LBO) funds are nding it difcult to levertheir portfolios in a meaningful way, as banks continue toshow reluctance (or restraint) to gearing at previous highs.As such, many of these funds have been unable to matchtheir pre-crisis performance averages.

We believe this picture will persist and continue to advocateinvestments in unlevered funds with value-added propositions,relying on improvements in operational performance. Ourview suggests such funds provide investors with higherreturns, shorter holding periods and better J-curve mitigation,particularly in the small-to-mid-end of the market. Ourconviction in the growth prospects of smaller companiesis vindicated by the facts. Since the crisis, small to mid-sizefunds have outperformed their larger counterparts. Weexpect that trend to continue.

The outlook for private equity managers with buyout strategiesremains encouraging, fueled by stabilizing and improvingmacroeconomic conditions and buoyant equity markets.Despite recent worrying levels of volatility, share prices haverebounded as central banks continue to provide reassuranceregarding interest rates. Growth prospects will continue toimprove. Consumer condence in the US recently reacheda seven year peak as unemployment rates fell to their lowestsince 2008. Lower petrol prices can only help.

Investors interest in private equity (PE) has bettered as well.Deal activity is expected to see a sustained pick-up asa result. There is a sizable amount of dry powder readyto be put to work, in excess of US $400 billion globally inthe buyout market alone1, with much of this in developedmarkets. Exit activity should flourish. The initial publicoffering (IPO) market remains attractive. Meanwhile, manycompanies have amassed sizable cash reserves and arekeen to put this money to work by participating in mergersand acquisitions (M&A).

1 Source: Preqin. Data as of November 2014.

North America: Robust MiddleMarket ActivityAppetite in the North American market for companiesvalued between US $25 million and US $1 billion remainsstrong. The market is being driven by the availability oflow-cost credit, the abundance of private equity dry powderand long average holding periods in the wake of thenancial crisis.

Activity levels will remain robust across the middle marketwhich constitutes the core of private equity activity andaccounts for a growing majority of transactions. Thestrength in middle market activity has raised privatecompany valuations to post-nancial crisis highs. However,appetite among private equity funds and lenders will persistas fundraising and market liquidity remain healthy and thegrowth outlook for middle market companies remainsfavorable. Consequently, private equity fund distributionswill also remain elevated as heightened exit activity worksto relieve pent-up portfolio inventory.



41/56

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

00 01 02 03 04 05 06 07 08 09 10 11 12 13

Year of Investment

A GROWING US UNIVERSEUS private equity portfolio inventory by deal year.

Source: PitchBook. Data as of December 2013.

Pre 00

00-04

05-08

09-13

From a credit standpoint, banks will continue to servea shrinking role in middle market lending, just as wepredicted last year. Less-regulated institutional funds

including credit funds, nance companies and businessdevelopment companies (BDCs) will ll the growing void.

We continue to view the middle market as an opportunityto achieve wider spreads and higher absolute interest ratesrelative to those available in liquid credit markets. We areencouraged by sustained low default rates and the modestfirming in yields seen in late 2014. Given deep liquidity,heightened competition among lenders and the persistenceof borrower-friendly terms and covenants, we predictcontinued strength in new issuance and in refinancingmarkets, with relatively low levels of opportunities fordistressed private equity and credit investors.

Europe: Replacing the BanksIt is likely the European Central Bank (ECB) will expand itsbalance sheet to approximately 1 trillion, levels last seenin 20122. This move highlights the ECBs strong commitmentto promoting European growth. Even so, European small andmid-market companies are having to adapt to an environmentwhere banks are no longer the dominant source of lending,nor able to provide substantial new nancing. Alternatives arecurrently slim, especially for projects such as internationalexpansion and add-on acquisitions.

As a result, European small and medium-size enterprises(SMEs) are embracing private lenders as a viable providerof capital. This is a substantial change as managementteams and owners are traditionally wary of this new typeof debt providers in 2015.

Recovery rates vary substantially across the Eurozone.The North, including the Nordics, UK, Benelux and German-speaking Europe, has remained visibly more resilient. Webelieve the bulk of deal pipeline will come from these countries.

Additionally, activity in Southern Europe is expected to pickup this year as reforms take hold and fears of a crisis-relapse fade. Southern entry prices remain attractive.Barring further scares, privat e equity activity shouldincrease rapidly in countries such as Spain, France andItaly as the region begins to see its rst strong capital-raising since the downturn. This increase in activity shouldhave a direct positive effect on Southern Europe, wherea number of succession-driven sales have been delayedas sellers could not obtain their targeted valuations.

2 Source: European Central Bank. Data as of October 2014



42/56

Private Credit andSecondary MarketsActivity levels in the secondary market are forecast tocontinue unabated in 2015, thanks to cheap sources offinance. Private credit markets look positive too as thefavorable macroeconomic environment continues to driveactivity. Within private credit, aggressively structuredtransactions and a greater use of leverage will createopportunity sets for institutional lenders. Direct lending,rescue nancing and more bespoke capital transactionswill contribute to a robust pipeline over the coming years.

In the secondary market, regulatory pressure still weighsheavily on sellers, notably banks and other financialinstitutions. However, we believe this will lead to innovativesolutions and greater diversity and liquidity in the marketfor bespoke transactions and special situations, when pairedwith the return of the mega funds chasing mega deals.

Private CreditIn North America, private lenders can structure loans withstrict covenants and enforceable collateral rights in orderto take possession of assets or the equity of companies in theevent of stress, whereas the holders of liquid leveraged loansand high yield bonds have no such power. Companies in thesmall and middle markets have been amenable to these termsas they have few alternative funding sources and want to avoiddilutive equity nancing.

Credit issuance volumes have risen substantially in recentyears, resulting in looser underwriting standards. We nowexpect an increase in distressed inventory and, as such,expect to increase weightings to dedicated managers inthis space.

In Western Europe, the bank pullback has hit the SME sectorseverely, creating ample opportunities for European privatecredit managers. European banks may also shed substantialamounts of assets in the secondary markets, creatingpotential for additional opportunity.

Mid-sized EM companies have historically been poorly servedby banks and relatively under-developed capital markets.However, the emergence of a more institutionalized privatecredit market focused on providing nancing in both LatinAmerica and Asia has created alternative funding opportunitiesto support growth for small and middle market businesses.



43/56

Secondary MarketsActivity in the secondary market will remain buoyant, fueledby Volcker rule regulations and record amounts of dry powder.The market is growing in size and scope. It is increasinglyseen as a viable channel for limited partners (LPs) to managetheir exposure to the private equity market. Aside fromthe mega transactions and large auctions advertised in thenancial news, non-traditional transactions such as fundrestructurings and asset carve-outs continue.

A key event for future activity will be implementation of theVolcker rule with a deadline of July 2015. Secondary buyers willcontinue to step in and facilitate the carve-out of banks captiveprivate equity investments that used to be signicant driversof market activity. The inux of fresh assets will have a positiveeffect, increasing diversity in an otherwise mature market. Buta greater number of funds with signicant unrealized valueremaining are also reaching the end of their pre-agreed life-span. General partners (GPs) will continue to unload some ofthese tail-end funds through the secondary markets to easetime pressure and accelerate returns for investors.

Small and mid-market fund stakes and the lower prolesof their underlying companies present the best value today.The attractiveness of these assets reects their lack of relianceon leverage and the smaller pool of suitable buyers, thuspricing in this segment remains more in line with previousyears. Overall, future returns for secondaries are still forecastto compare favorably with other private market asset classeswhen measured over an appropriate length of time.

Another subset of secondary investing that receives littleattention is emerging market secondaries. The EM privateequity strategies that have matured over the last decadeare just beginning to draw interest from a small group ofsophisticated secondary buyers. Pricing for these assetsoften equates to a comparatively attractive risk/rewardprofile for buyers with the on-the-ground resources toassess and evaluate these opportunities. With a currentEM secondary pipeline of over US $4 billion, we expect themarket for these types of transaction to continue its growthin the near term.

0

10

20

30

40

50

60

70

01 02 03 04 05 06 07 08 09 10 11 1312

Capital Raised(US $ billion)

SECONDARY SUPPLY

Capital raised by private equity funds in EM.

Source: EMPEA. Data as of Q3 2014.

Other

Latin AmericaSub-SaharanAfrica

Emerging Asia



44/56

Emerging MarketsActivity levels vary greatly from market to market and,therefore, emerging market performance and opportunitymust be reviewed on a case-by-case basis. Asia, andSouth-East Asia in particular, continue to grow much moreaggressively than the rest of the world as fears of a Chinahard landing recede. While growth is anticipated to slow fromheightened levels of the past, we believe that the driversof future growth are more balanced than ever before.

Meanwhile, we are also seeing ample opportunities forgrowth and investment in Sub-Saharan Africa, Latin Americaand the Middle East. With experience, institutionalizationand improved performance continuing to unfold across theemerging market private equity landscape, investors areonce again showing a renewed desire to put capital to workin several key emerging market countries.

0

200

600

800

1,000

1,200

0

10

20

30

40

50

09 10 11 1312 14Q1-Q3

Number of DealsUS $ billions

Source: Emerging Markets Private Equity Association.Data as of November 2014.

EMERGING MARKETS GAINING FAVOR

2014 total PE volumes will likely top those of the two previous years.

Total Capital Invested (US $B)

Number of Deals

Worlds Ten Fastest Growing Economies 1

Annual Average GDP Growth %2001-2010 2011-2015

Angola 11.1 China 9.5China 10.5 India 8.2Myanmar 10.3 Ethiopia 8.1Nigeria 8.9 Mozambique 7.7Ethiopia 8.4 Tanzania 7.2Kazakhstan 8.2 Vietnam 7.2

Chad 7.9 Congo 7.0Mozambique 7.9 Ghana 7.0Cambodia 7.7 Zambia 6.9Rwanda 7.6 Nigeria 6.8

Source: The Economist, IMF, The Lion Kings, Print Edition, 6 January 2011.1 Excluding countries with less than 10m population and Iraq and Afghanistan.

CEE: Less CompetitionEquals More OpportunitiesAt 1.5%, GDP growth in Central Europe is projected to outpacethe EU forecast average of 1.1% for 2015, driving furtherincreases in disposable income and private consumption.This is likely generate investment opportunities in sectorssuch as consumer goods, nancial services, healthcare,specialty retail and media.

Yet Central European markets remain under-penetratedby private equity when compared to the European average.This trend will be further reinforced by lower volumes ofprivate equity capital being allocated to funds in the regionin the near term.

The already high level of capital scarcity in Central Europeis likely to amplify. That should lead to a highly attractive

investment environment for funds that remain active in theregion. In essence, we should see a less competitive privateequity environment and lower ingoing valuation multiplescompared to other regions of the world.



45/56

THE ALREADY HIGH LEVEL OFCAPITAL SCARCITY IN CENTRALEUROPE WILL AMPLIFY

Moreover, pension reform in Poland has signicantly limitedthe ability of local pension funds to invest in listed equities. Themove is forecast to reduce the number of Polish IPOs, meaningthat entrepreneurs will view private equity as an increasinglyattractive and viable option for growth equity nancing.

The Warsaw Stock Exchange has been an attractive nancingroute over the years for many successful regional companies.They will now be seeking alternative sources of nancing,thus generating more private equity opportunities, particularlyfor growth capital investors.

Central Europe has evolved into a key trading partner,manufacturing base and service supplier for primaryEuropean markets. It has solidied its reputation as anindustrial hub and taken advantage of borderless marketaccess and overall lower corporate tax rates. Educationlevels are high and the region has a long tradition oftechnical and engineering training. When combined with

exible labor markets, these skill sets create interestinginvestment opportunities in industries such as specialtymanufacturing, engineering services and outsourcing.

We expect Central European industrial production to growstrongly in 2015 and beyond. Consolidation and growth inkey industries will allow companies to expand internationallyand to become regional leaders.

Latin America: Reformist BoostLatin American private markets continue to evolve, providinga wide range of investment opportunities from early stage growthequity to private credit. A growing number of mid-size companieswith limited sources of nancing are turning to private creditmanagers and specialized credit alternatives.

Openness to private equity from local families and entrepreneurswill increase. Yet country dynamics are likely to have an impactin 2015 as different political and economic cycles occur in Brazil,

Mexico, Colombia, Chile and Peru. Recent changes in regulationwill likely aid this process, especially in low penetration marketssuch as Mexico, Colombia and Peru. In Mexico, we expect to seethe rst wave of private investments triggered by the energy andtelecom reforms. Such changes will attract international privateequity players, alongside local capital.

The Brazilian situation is more challenging, at least in thenear term. We struggle to see an immediate solution to thedifcult macroeconomic, social and political challenges.Over a mid-to-long-term outlook, private equity rms arewell positioned to take advantage of better pricing andimprovements to underlying companies, particularly thosein the small-and mid-market, where the need for operationalefciencies, growth capital and succession planning are mostprevalent, and where access to public markets is scarce.

Mid-sized companies in Latin America are usually family-runand have corporate governance, decision-making processesand systems which are generally suboptimal. Involvementof an institutional investor can help them improve in theseareas and create value. Institutional capital and insights mayassist in expansion, while mitigating challenges associatedwith high growth companies, such as management teamissues, culture and systems. For succession issues, havinga hands-on, third party nancial investor with a pre-denedpath for exit in 4-5 years aligns the current owners and makesfor a smoother transition.

Access to the public markets by mid-sized companies in LatinAmerica has always been scarce and that, in part, creates theopportunity or need for private capital to step in and ll in thegap between new enterprises financed by friends, familyor angel investors, and larger public companies.



46/56

Sub-Saharan AfricaPrivate equity is a crucial part of the capital markets of Africaand the continent is, and will continue to be, an importantpart of the global economic landscape.

Sub-Saharan Africas (SSA) growth is expected to reach 5.8%in 2015. Africas biggest economy, Nigeria, will grow 7.3%this year. Yet SSAs high GDP gures can undersell the trueextent of growth in nancial services, agribusiness, logisticsand fast-moving consumer goods where revenue growth

rates far outstrip those of productivity. Governments in SSAare continuing political and pro-business reforms, nurturingfurther direct investment as demand for capital is now prominent.

Demographics are the key contributor to sustained growthin consumption. The middle class has expanded over the lastdecade. The African Development Bank estimates that Africasmiddle class population is now 313 million, about 30% of thecontinents total. The average age in Africa is a sprightly19, just half the average age in China. The combination ofgrowth and youthfulness is a tangible demographic dividend.Urbanization is another signicant economic driver as urbanpopulations tend to have higher incomes and consume moregoods and services. As such, the growth being witnessedin SSA is likely a long-term secular trend.

The PE climate is maturing fast, making Africa the numberone investment destination for international investors.The number and volume of deals is rising quickly. Thetotal number of deals was US $1.2 billion in 2011 and US$1.6 billion in 2012. In 2013, values hit US $3.2 billion. Thattrend has continued in 2014 and will do so for the next fewyears. Investment opportunities are many as information isasymmetric, entry valuations remain relatively low comparedto other regions and strong fundamentals remain in place.

Middle East and North Africa:Oil Price ConcernsThe main topics that will shape the Middle East and NorthAfrica (MENA) region in 2015 will be oil prices, Egyptsupswing and strong consumer spending. The new supportlevel of oil prices will determine government expenditure andtrade balance across oil importing and exporting countriesthroughout the region.

Foreign investors have raised their appetite towardsinvesting in Egypt as a result of the improved political andsecurity situation. Encouraging indicators of growth suggesta remarkable pick-up in economic development over thenext two to three years. The Gulf Cooperation Council (GCC)countries have proclaimed that sufcient aid will be madeavailable to Egypt.

Consumer spending will continue to grow in the MENAregion, supported by a sizable population with high levelsof disposable income, specically in the GCC countries.We expect disposable income to continue its strong growthtrajectory until 2018, driving total private consumption.

Saudi Arabia is the second-largest retail market in MENA, just behind Egypt. Its rapidly rising p

pine bridge out look

Documents