Global Equities Fragmentation in the Global Village"

Global Equities Fragmentation in the Global Village" Virginie Maisonneuve Head of Global and International Equities, Global and International Portfolio Manager June 2012 For Professional Investors or Advisors Only Schroder International Selection Fund is referred to as Schroder ISF throughout this presentation

Framing Our Investment Decisions: World Shaping Trends

Super Cycle Demographics Climate Change Fragmentation In The Global Village

Fragmentation in the Global Village: A Structural Rise in Volatility?

Investing in an Increasingly Volatile World: Growing fragmentation within the global village Global village: The widening, deepening and speeding up of worldwide interconnectedness in all aspects of contemporary life Facilitated by technology Increasing trade and capital flows Fragmentations Adds complexity to the dynamics of globalisation and investment analysis May materialize in conflicts, drive economic divergence or add confusion to decision-making processes May create unpredictable patterns of volatility contrary to the usual sector / region / country lines?

Global Village: Growing trade and capital flows Multinational co. earnings vs listing (half of S&P 500 revenue now from overseas) Global exports 1948-2010, USD Insert - Leading economies by trade in goods Trillions 25 20 15 10 5 Imports (Billion USD) 1800 1600 1400 1200 1000 800 600 400 200 0 France United States Japan Netherlands Germany China Exports 80 280 480 680 880 1080 1280 (Billion USD) 0 1948 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Services Goods Source: World Trade Organization

Global Village: the iphone, a Symbol Growing trade and capital flows : designed in California, assembled in China Sum of Its Parts Value of iphone 3G $178.96 components and labor* *Estimates do not total 100% due to rounding Source: Rassweiler Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell. Source: Image Courtesy of Apple

Global Village: Social/cultural dimension International media: CNN now available to >2bn people in >200 countries Communications technology: mobile penetration almost 80%, >4000 tweets per second Rise of the global community: shared culture and values 90 Global Mobile and Internet Penetration 80 70 60 50 40 30 The widening, deepening and speeding up of worldwide interconnectedness in all aspects of contemporary life. 20 10 0 199019911992199319941995199619971998199920002001200220032004200520062007200820092010 Source: World Bank, World development indicators 2009 Internet - World Mobile - World

Fragmentation in the Global Village: Emergence of new fragmentations Economic fragmentation Social Fragmentation Political fragmentation Attention Fragmentation

Economic growth: 20 year Perspective, the Birth of a New World Contribution to global growth by group and region, 1973-2009 Contribution to Global Growth (in percent) 12 10 8 6 4 2 0 World Advanced economies Emerging market economies United states G-7 China, India and Brazil 1973-1985 1986-2007 2008-2009 Source: Brookings Institution, Emerging Markets, p 34-35 Notes: Share contributions are derived by dividing world GDP growth by group/region growth. Growth is calculated suing PPP exchange rates

Economic Fragmentation: Convergence becomes divergence Economic divergence in highly connected and relatively homogenous units New phase for Europe? Unemployment rates 1 25 20 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 2012 Spain Ireland Greece Germany Portugal 10-year Govt. bond yield spreads over Bunds, % 10-year Govt. bond yield spreads over Bunds, % 50 45 40 35 30 25 20 15 10 5 Greece debt swap completed 0 Jan 09 Sep 09 May 10 Jan 11 Sep 11 May 12 Italy Greece Ireland Spain Portugal 1 Source: Thompson Datastream, Schroders. Updated May 15, 2011 2 Source: Thompson Datastream, Schroders. Updated May 22,, 2011

Economic Fragmentation: Convergence becomes divergence Source: Economist http://www.economist.com/blogs/dailychart/2010/12/europes_economies

Economic Fragmentation and Competitiveness: Salary versus productivity in manufacturing - % change 2005-2009 40% HIGHER UNIT LABOUR COST Salary per unit labour input Italy 30% 20% Germany 10% UK Spain US Greece Korea LOWER UNIT LABOUR COST Poland 0% -20.00% -10.00% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% Output per unit labour input Source: OECD Statistics, extracted 1/6/2012. N.B. Unit labour input in most cases equals hours worked, but equals persons employed for some countries including the United States, United Kingdom and Poland. Japan is excluded because the most recent data points are for 2007.

Global Competitiveness: Europe, China and the USA. Is Tennessee the new Guangdong? Source: Oxford Economics, OECD. Unit Labour Costs: 2008 = 100 350 Europe: currency issue? Exchange rate adjusted unit labour costs 1.1 300 250 1 0.9 0.8 Euro adopted 200 0.7 150 0.6 100 0.5 0.4 50 0.3 0 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 0.2 1993 1998 2003 2008 US Germany China Greece Italy Portugal Spain China: still competitive but decreasingly

Global Competitiveness: The US Adjustment Falling US labour costs boost corporate profits Private wages and unit labour costs decelerate QoQ annualised growth rate, 12 month centred moving avg US profits versus wages % of GDP 14% 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% Feb 1950 Aug 1953 Feb 1957 Aug 1960 Feb 1964 Aug 1967 Feb 1971 Aug 1974 Feb 1978 Aug 1981 Feb 1985 Aug 1988 Feb 1992 Aug 1995 Feb 1999 Aug 2002 Feb 2006 Aug 2009 61% 60% 59% 58% 57% 56% 55% 54% 53% 52% Corporate profit Employee compensation Source: GaveKal, US Bureau of Economic Analysis

Global Competitiveness: while Chinese corporates adapt to higher costs Operating profit margin 34 21 32 30 28 26 24 22 20 19 18 17 16 20 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 15 MSCI China (LHS) S&P 500 (RHS) ource: Bloomberg

Economic Fragmentation: Working Towards a New Equilibrium? Deleveraging the developed world and growing EM domestic consumption Current account balance % of GDP 12 10 8 6 4 2 0-2 -4-6 -8 2011 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 China United States Source: IMF

Political Fragmentation: Recent elections in Europe France: 2012 presidential election UK: 2010 general election First hung parliament since 1974. Italy: Nov 2011 Greece: 2012 parliamentary election Spain: 2011 general election Hungary: Jan 2012 Netherlands: April 2012 Far-right candidate Marine Le Pen wins 18% of first round vote, beating previous record for Front National. Election dominated by anti-immigrant rhetoric. Silvio Berlusconi forced to resign; technocratic government of entirely unelected officials formed by economist Mario Monti. Will remain in office until next elections in 2013. Failure to form a government to replace technocratic caretaker government. Far-right Golden Dawn wins 7% of the vote, entering parliament for the first time with 21 seats. Stable majority government formed but remaining voters polarised with separatist parties gaining ground. New constitution enshrines anti-democratic principles, endangers EU/IMF bailout. Government collapses during budget talks. Belgium Political instability with multiple government changes 2007-11. Finland: 2011 parliamentary election Populist/nationalist True Finns win 19% of vote to become third largest party in parliament.

Political Fragmentation: The rise of extremists movements in Europe: expression of social grievance? Rising extremism - Marine Le Pen support rate in France Rising tension among EU countries Source: Guardian

Political Fragmentation:

Social Fragmentation: Income inequality and the skill premium Rising income inequality due to skill premium in the global labor market Richest 1% in the US earn 25% of all income (up from 13% in the early 1980s) Emerging markets remain highly unequal; China has seen the biggest increase in Gini coefficient Financial crisis has aggravated problem: low-skilled workers far more likely to be unemployed The skill premium in the US 1 Unemployment rate in 2010 (%) Median weekly earnings in 2010($) 1.9 2.4 Doctoral degree Professional degree 1,550 1,610 45 Gini coefficient in the developed world 2 United States 4.0 Master s degree 1,272 United Kingdom 14.9 9.2 10.3 7.0 5.4 Bachelor s degree Associate s degree Some college, no degree High school diploma Less than a high school degree 444 712 626 767 1,038 Average : 8.2% Average : $782 35 Germany Japan 25 France 1980 1985 1990 1995 2000 200 Italy 1 Source: Bureau of Labor Statistics, Current Population Survey 2 Source: IMF (2008), Rising Income Inequality: Technology, or Trade and Financial Globalisation? Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell.

Social Fragmentation: Distribution of financial wealth in the United States, 2009 Bottom 88 percent 7% of financial wealth Top 1 percent 43% of financial wealth Source: G. William Domhoff, Wealth, Income and Power

Social Fragmentation: Income gains at the top dwarf those of the low-and middle-line households, 1979-2007 Percentage change in after-tax income since 1979 +281% +95% +25% +16% Source: CBPP calculations from congressional budget office data. www.mybudget360.com

New Dimensions of Loyalty and Conflict: Belonging to a community but which one? Traditional religious, ethnic and tribal divides remain salient Now overlaid by new dimensions of group identity and notions of community Technology provides the means to bypass and challenge established structures e.g. Middle East Number of ethnic conflicts starting in a given year 14 12 Fall of the Soviet Union and Yugoslavia 10 8 6 4 2 0 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Cederman et al (2008), Ethnic Armed Conflict dataset.

Attention Fragmentation: Information overload Many professionals now own 5 6 connected devices, meaning constant distractions Average # of Connected Devices Owned Studies suggest there is an optimal amount of information, beyond which we make worse decisions Overloaded investors lose sight of long-term trends: average holding period has fallen from 7 years to 7 months since 1970s Tablet owners ebooks owners Portable game player owners 5 5 6 Short-termism causes excessive volatility and poor performance Portable media player owners 5 Netbook owners 4 Source: The Nielsen Company

Fragmentation Leads to Higher Equity Market Volatility Volatility remains high Earnings risk at a 70-year high 80 70 60 50 40 30 20 10 0 00 01 02 03 04 05 06 08 09 10 11 300% 250% 200% 150% 100% 50% 0% 40 44 47 51 55 59 62 66 70 74 77 81 85 89 92 96 00 04 07 11 VIX Index 3 Week Average Rolling 5-Yr Std Deviation of Y/Y EPS Growth for SP 500 Source: CBOE, Morgan Stanley Research, as at 31th May 2012 Source: BofA ML US Equity & Quant Strategy, as at 30 September 2011

Fragmentation Leads to Higher Equity Market Volatility Volatility remains high 2011 Sector Performance has rotated violently 80 70 60 50 40 30 20 10 0 00 01 02 03 04 05 06 08 09 10 11 31-Dec-10 17-Mar-11 17-Mar-11 2-May-11 2-May-11 4-0ct-11 4-Oct-11 28-Oct-11 28-Oct-11 21-Nov-11 Materials (4.97)% 12.75% (32.24)% 25.01% (13.63)% Financials 1.36% 7.01% (30.96)% 21.45% (15.20)% Energy 8.67% 6.58% (27.76)% 25.20% (8.93)% Industrials 0.93% 10.20% (27.59)% 19.54% (9.65)% Consumer Discretionary (1.71)% 9.86% (19.43)% 16.35% (9.75)% Information Technology (2.02)% 7.68% (14.31)% 14.50% (7.47)% Telecommunication Services 1.30% 9.11% (14.05)% 10.22% (6.94)% Utilities (1.58)% 7.92% (12.66)% 7.75% (6.50)% Health Care 0.78% 12.28% (12.47)% 9.91% (6.96)% Consumer Staples (2.45)% 11.45% (8.65)% 9.01% (4.92)% MSCI World 0.32% 9.17% (21.98)% 16.81% (9.65)% VIX Index 3 Week Average Best performing sectors Source: CBOE, Morgan Stanley Research, as at 31th May 2012 The last two periods of rotation were especially short: 4 weeks each Source: BofA ML US Equity & Quant Strategy, as at 30 September 2011 26

Conclusion The new Fragmentations in the global village are on going, long term themes They contribute to rising macro risk as the world attempts to find a new equilibrium in a shifting economic growth environment And makes fundamental investing into quality growth companies more compelling

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