II December 2013 GEM Equity Strategy Outlook 2014 • Much of the relative value resides in the financial sector, where EM price-to-book valuations appear very low relative to ROE both in absolute terms and relative to their historical relationship. We believe that this shift is due mainly to a very high level of investor scepticism about the level of potential NPLs in the BRIC markets in particular, which is entirely rational in our view. By contrast, DM financials are trading in line with their historic valuation/return relationship. • The majority of non-financial sectors within GEM have margins which have underperformed their DM peers; the overall ROE for EM non- financial stocks is now below the level of DM non-financials, based on an aggregate margin which has now almost converged with DM, having historically been much higher. • There is a pronounced polarisation of valuations within the EM universe on an ROE versus P/BV basis between sectors both in absolute terms (Figure 2) and relative to DM (Figure 3). where valuations and returns are more closely correlated. Financials and Energy stocks have extremely low valuations, while the Healthcare and Consumer Staples sectors appear very expensive. We identified this gap as the biggest reason to be bearish EM one year ago because it is driven by aversion towards those sectors which face the most severe structural challenges, and nothing has changed in the past twelve months. 'Figure 2: EM - PrBV (x) versus RoE (%) 4.5 - 4.0 33 3.0 2.5 o. 2.0 - 2.5 mOust 1.0 03 Miles Healt1/4aft • ♦ sosterish Consumer Staples Consumer • Finarmars • fnergy Telco 4IT 5 10 ROE (%) 15 20 25 tarot Onto* O&M arCOTD•Ig Amara LP iFigure 3: DM - P/BV (x) versus RoE (%) 40 - 33 30 IT 23 2.0 • 13 1.0 OS 0.0 S TOco RIaltioa • ri Whits Lis Energy SHORT 10 15 20 25 RC* (%) San bank* int Scants. Rim* LP Bette, governance and For growth necessary to unlock yalue. in EM equiti