Investing in emerging markets

A monthly guide to investing in emerging market financial assets 24 July 2019 – 5:00 pm GMT
August 2019 Chief Investment Office GWM
Investment Research

Summer ruminations

Equities: Credit: Currencies: Focus:

Move ahead of Best first-half Tide of easing lifts Brazil after
the market performance in a currencies pension reform:
decade The growth
agenda

This report has been prepared by UBS AG, UBS Financial Services Inc. (UBS FS), and UBS Switzerland AG.
Please see important disclaimers and disclosures at the end of the document.
Contents
Editorial
Investing in emerging markets Summer ruminations.................................................................................... 3

Editors-in-Chief
Global investment views.......................................................................... 5
Alejo Czerwonko
Michael Bolliger
Emerging market investment strategy
Carry on...................................................................................................... 6
Project management
Brennan Azevedo
Focus
Editors Brazil after pension reform: The growth agenda........................................... 8
Abe De Ramos
Equities
Editorial deadline Move ahead of the market ......................................................................... 9
23 July 2019
USD bonds strategy
Desktop Publishing Best first-half performance in a decade...................................................... 10
Srinivas Addugula*
Currencies
Contact Tide of easing lifts currencies..................................................................... 11
wmrfeedback@ubs.com
Emerging market electoral monitor...................................................... 12
Cover photo
UBS Emerging markets publications............................................................. 14

Important disclosure
* An employee of Cognizant Group. Please note there may be changes to our house view and tactical asset allocation
Cognizant staff provides support services strategies prior to the next edition of Investing in Emerging Markets. For all up-
to UBS. dated views, please refer to the latest UBS House View.

UBS CIO GWM August 2019  2

Editorial
Summer ruminations
The aggressive change in tone by major central banks, the
strong returns on risk assets so far this year, and the US-China
trade “truce” have shifted the focus of our recent client con-
versations. Up until June, a common question had centered
on whether the end of the current economic cycle was immi-
nent. But now that the US economy has clocked its longest
uninterrupted expansion in at least 165 years—a streak that
could well be extended—clients have a new set of concerns.
We address three of the questions we’ve been hearing most
frequently.
1. With equity markets at all-time highs, and with near-
ly USD 12 trillion of global bonds trading at negative
yields, is it still a good idea to put money to work?
First, we like to use our Liquidity. Longevity. Legacy. (3L)* ap-
proach as a starting point for addressing this question. We
developed this framework to help our clients align their assets
with their financial objectives over time. It helps them build a
clear plan that they can then use as a basis for decisions on
how to put their money to work.
Second, it’s important to recognize that, although cash is a
“safe” short-term holding, it is very risky to hold over the long
term. For example, since 2009, the purchasing power of cash
has declined more than 15%. In addition, 75 years of history
shows that, in spite of wars, presidential impeachments, revo-
lutions, geopolitical incidents, and market-moving tweets, re-
maining invested in a diversified portfolio of global stocks and
bonds has consistently paid off.
Investing even pays off in periods when stock markets are at
all-time highs. In our study using 75 years of data, we found
that, counterintuitively, buying at an all-time high does not
result in lower returns. Based on S&P 500 performance one,
two, and three years after setting an all-time high, the aver-
age return has been 11.9%, 22.5%, and 38.5%, respectively.
These averages are close to, or higher than, forward-looking
returns when markets are not at an all-time high. In addition,
all-time highs don’t mean that drawdown risks are higher; in-
vestors’ odds of suffering losses when entering the market at
a record high are surprisingly lower than at any other time.
There is therefore no reason to fear all-time highs.
* T imeframes may vary. Strategies are subject to individual client goals,
objectives and suitability. This approach is not a promise or guarantee
that wealth, or any financial results, can or will be achieved.
Mark Haefele
Alejo Czerwonko, Ph.D.
Chief Investment
Strategist
Officer
That said, given current valuations of global risk assets, inves-
tors do need to curb their expectations for future returns. We
anticipate the returns of a balanced equity-bond portfolio to
be more modest in the next 10 years than in the last decade,
particularly since fixed income returns are most likely going to
be uninspiring.
2. What’s the best way to deal with lump sums?
Many of our clients are in the enviable position of having re-
ceived large sums of cash from the sale of a company or a
large dividend payment, among other reasons. Deciding when
to put large sums to work can lead to the “paralysis by anal-
ysis” syndrome.
We have done work to help clients address this problem. We
conclude that putting the full amount to work immediately
can produce a significant edge over phase-in, dollar-cost-aver-
aging approaches. Since 1945, putting funds directly to work
in a 60% stock, 40% bond portfolio would have added an
average 4.4% to returns compared to a 12-month phase-in
strategy.
While moving funds quickly from cash into higher-return fi-
nancial assets is typically the most rational choice, we know it
can be emotionally difficult, and that it could involve a great
amount of short-term risk, especially if the amount represents
a large share of the family wealth. For ways to deal with lump
sums, we encourage you to take a look at our recent work,
which explores a variety of options for deploying cash and
strategies for systematic hedging for equity portfolios.
3. With global central banks easing monetary condi-
tions, this appears to be a good time for emerging mar-
ket assets. What opportunities do you see in this space?
Easier monetary policy in developed countries is pushing down
the yields of safer assets, and incentivizing capital flows into
higher-yielding emerging market assets. Central banks in de-
veloping economies have been quick to adapt to this new real-
ity, wasting no time to cut interest rates themselves. Ten of the
20 emerging markets central banks we track have already cut
rates in recent weeks, and more have indicated that they may
follow suit. This should lend support to their domestic econ-
UBS CIO GWM August 2019  3
Editorial
omies. And despite the wide-ranging cuts, emerging market to dispel market concerns about the company’s future. We
currencies have held their ground, suggesting this remains a think this trade has further room to run. The Focus section de-
favorable environment for carry strategies. scribes what we expect Brazilian policymakers to tackle next.

We have therefore increased the size of our overweight on a We hope this report helps address some of your most pressing
basket of high-yielding emerging market currencies (Indone- investment-related questions this summer.
sian rupiah, Indian rupee, South African rand) against a basket
of lower-yielding currencies (Australian, New Zealand, and Tai-
wanese dollars) in our FX strategy this month. The Currencies
section of this report provides more detail on our outlook for
the asset class.

Finally, we overweight emerging market equities versus US

government bonds in our US portfolios. Emerging markets are
attractively valued and are geared to the global recovery that
we expect in the second half of the year. Needless to say, trade
uncertainties remain a key risk to that environment. Please re-
fer to the Equities section of this report for more information.
Mark Haefele
Chief Investment Officer
Within our emerging market equity strategy, which continues
to favor China and Malaysia over Hong Kong and Thailand, we
have opened an overweight on Brazil versus an underweight
on Mexico. This trade has worked well since inception on 9
July thanks to the partial approval of pension reform in Brazil,
the sudden departure of Mexico’s finance minister, and recent
market pressure on Pemex after their new business plan failed
Alejo Czerwonko
Strategist

UBS CIO GWM August 2019  4

Global investment
views
Asset allocation
Lower trade tariff uncertainty following the G20 summit and
expectations for further easing from global central banks are sup-
porting risky assets. The G20 meeting between Presidents Xi Jin-
ping and Donald Trump has led to a truce, with tariffs on hold for
now. While this sets the scene for a restart to US-China dialogue,
neither side appears in a hurry to find a trade deal, and we expect
a prolonged ceasefire period. Amid signs of continued weakness
in global manufacturing and trade, and muted inflation expecta-
tions, global central banks have turned more dovish. We expect
the Federal Reserve to cut rates later this month, likely leading the
European Central Bank (ECB) to cut rates, too. A continued
low-interest-rate environment should be favorable for carry posi-
tions. Our tactical positioning continues to overweight equities
with a regionally selective approach. Given downside risks, we
also recommend an overweight to long-duration US Treasuries.
Equities
Preemptive Fed rate cuts create a supportive backdrop for stocks,
and, given low interest rates, equity valuations look attractive rel-
ative to bonds. While we still expect global economic growth to
stabilize in the second half, risks around China-US trade remain
elevated. Assuming our risk scenarios do not materialize, we
believe equities can advance moderately. We are closely monitor-
ing the current earnings season for further downside risks to the
earnings outlook. We have an overweight in Japanese, emerging
market, and US equities, and an underweight in international
developed market stocks. While international developed market,
emerging market, and Japanese equities are all heavily geared to
the global cycle, the first has priced in a macro recovery and
appears expensive, while the latter two have not and appear rela-
tively cheap. In addition, we prefer US stocks as they should
deliver superior profit growth in 2019 and 2020.
Bonds
This month we opened an overweight in US Treasury Inflation-Pro-
tected Securities (TIPS) against US government bonds. With the
Fed likely to cut rates to lift inflation expectations, this position
should benefit. By buying TIPS and selling government bonds, we
are effectively overweight market-implied inflation expectations,
which is exactly what the Fed is trying to raise. We continue to
overweight cash against US government bonds as the market
appears to be pricing in too many rate cuts. We also continue to
hold an overweight to US long-duration Treasuries, which should
help protect the portfolio against unanticipated equity market
weakness.
Foreign exchange
Easier monetary policy should support safe-haven currencies
where central banks have limited room to ease policy further. In
our FX strategy, we close our underweight in the CHF against
the EUR and the NOK. We keep our NOK overweight against the
CAD, while shifting the other position from CHFNOK to EUR-
NOK. Both positions aim to benefit from central bank diver-
gences. As the US and China agreed on a truce and Australia
has cut rates twice, downside risks to the AUD diminished. We
thus close our underweight in the AUD against the USD, and
shift our long GBP versus short AUD into a long GBP versus short
USD position. We increase our allocation to a basket of select
emerging market currencies versus pro-cyclical advanced econ-
omy currencies to profit from the attractive interest rate advan-
tage.
UBS CIO GWM August 2019  5
Emerging market
Jonas David, CFA
Strategist

investment strategy
Carry on
Emerging markets continued to deliver sound returns in recent
weeks, supported by the US-China truce and the dovish shift of
the Federal Reserve and the European Central Bank (ECB). This
pushed year-to-date returns above 11% in emerging market eq-
uities and fixed income. In the coming months, we expect the
benign global backdrop to last and are positioning accordingly.
At the same time, it’s important to put key drivers in perspective,
balancing between already optimistic investor expectations and
mixed fundamental conditions, especially in emerging econo-
mies where growth remains soft.
Monetary easing supportive of assets
Our expectation of imminent policy rate cut by the Fed and the
ECB later this year eases external pressure on emerging markets,
especially the fundamentally weaker ones. This support comes at
a critical point as it also allows central banks to ease monetary
policy amid subdued economic activity and contained inflation-
ary pressure. Among the major markets, India and Russia have
already cut policy rates in 1H19; Indonesia and South Africa fol-
lowed more recently. After the change in Turkey’s central bank
governor earlier in July, market observers will closely follow up-
coming announcements. In Brazil, the policy rate has been stable,
but rate cuts have become likely. Meanwhile, policymakers in Chi-
na use easier monetary and fiscal conditions to stabilize growth
and cushion the impact of trade tensions with the US.
At the same time, economic data in emerging markets is still
weak and a meaningful pickup is rather unlikely in the coming
months. In recent weeks, data releases continued to surprise to
the downside and forward-looking indicators like purchasing
managers’ indexes point to further headwinds. While there is lit-
tle growth impulse from the rest of the world for now, structural
reforms become even more important to boost growth prospects,
and we expect progress on that front in some markets, notably
South Africa and Brazil.
Global easing of financial conditions could brighten the outlook
for emerging markets in 2020, and we might see an inflection
point for growth-sensitive assets, but we think it’s too early to
anticipate this. In the current environment, we think it’s more at-
tractive to focus on carry investments.
Where do the risks lie?
Global central banks have now shifted to more dovish stances in
a preventive manner. Should major economies nonetheless see a
marked deterioration in economic outlook, the currently buoyant
mood would likely turn. One reason could be a renewed falter-
ing of trade talks between the US and China—we expect a frag-
ile truce to hold over the coming months. Idiosyncratic issues in
emerging markets persist as well, even if global factors are mask-
ing these for now.
Where to invest: Focus on fixed income opportunities…
In our view, the current environment is supportive of fixed income
in emerging markets amid the hunt for yield, and we see attrac-
tive opportunities both in hard-currency credit and in local-cur-
rency markets. Still, past volatility is an important reminder that
investors have to closely monitor growth-inflation dyanmics, the
outlook for central bank policy, commodity prices, and political
tensions.

Figure 1 Figure 2

Renewed monetary easing… …amid weak economic data in emerging markets

Policy rates in selected emerging markets, US Fed funds effective rate and future, in % EM economic data surprises (index)
8 40
7 30
6 20
5 10
4 0
3 –10
2 –20
1 –30
0 –40
Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Jan-18 Jul-18 Jan-19 Jul-19
US Fed funds effective rate Russia Indonesia Brazil Positive surprises
US Fed funds future - December 2019 India South Africa Negative surprises
Source: Bloomberg, UBS, as of 18 July 2019 Source: Citi, Bloomberg, UBS, as of 17 July 2019

UBS CIO GWM August 2019  6

Emerging market investment strategy
• Levering up a basket of emerging market bonds in …and relative value in equities
USD may magnify portfolio returns for a moderately higher In early July, we added an overweight position in Brazilian equi-
risk, but finding a suitable portfolio of bonds and an opti- ties against an underweight in Mexican equities to our emerging
mal financing strategy is not easy. Based on current market market equity strategy. In Brazil, the likelihood of a successful im-
conditions, we prefer a diversified, buy-and-hold basket of plementation of the social security reform has been increasing.
short-duration bonds from selected high yield and BBB rated We think this should have a robust impact on government ex-
issuers. We think not more than 40% of the portfolio should penses over the next 10 years and allow the broader reform agen-
be financed through a loan, and we recommend matching the da to progress. Apart from pension reform, potential tax reform
loan and portfolio duration. We expect this reference portfolio and pro-business measures also bode well for Brazilian equities.
to outperform an unlevered emerging market corporate bond Meanwhile, we remain cautious on Mexican equities. Tight fiscal
index in the coming years. and monetary policies, together with policy uncertainty, will con-
tinue to hurt investor sentiment and growth prospects.
• We also like an FX carry basket with a long position in select-
ed high-yielding emerging market currencies (Indonesian rupi-
ah, Indian rupee, and South African rand) funded with a short
position in low-yielding currencies (Australian, New Zealand,
and Taiwan dollars). This combination lowers the sensitivity of
the position to potential global headwinds, in particular trade
tensions and periods of USD strength that cannot be ruled
out.

• For experienced investors, selected frontier markets offer

opportunities. Given the high interest rate carry amid benign
global conditions and some domestic improvement, we think
the risk-reward looks attractive for local-currency fixed income
instruments in Egypt, Nigeria, and Kazakhstan. We recom-
mend a diversified exposure, but also emphasize that inves-
tors must have the ability to withstand periods of volatility and
significant setbacks.

Tactical asset allocation deviations from benchmark*

underweight neutral overweight Most Preferred Least Preferred

EM equities total •• China •• Thailand

•• Malaysia •• Hong Kong
Equities

EM Asia
•• Brazil () •• Mexico ()
EM LatAm
EM EMEA
EM sovereign bonds (USD) •• High yield sovereigns •• Investment grade sovereigns
EM sovereign bonds IG (USD) •• Leveraged basket of short-
Bonds in USD

EM sovereign bonds HY (USD) dated EM HY bonds (new)

•• GCC sovereign and quasi-
EM corporate bonds (USD)
sovereign bonds
EM corporate bonds IG (USD) •• Select LatAm corporates
EM corporate bonds HY (USD)
instruments

EM currencies / money market • Long EM carry basket (IDR, INR, ZAR) vs short
currency

EM FX AUD, NZD and TWD

Local

EM government bonds • Long ZAR vs short USD

Views • Long frontier carry basket (Egypt, Nigeria and
EM inflation-linked bonds Kazakhstan)

new old **Short-term recommendation (1–2 months)

Source: UBS, as of 18 July 2019. Green/Red arrows indicate new upgrades/downgrades. Grey up/down arrows indicate increase/reduction to existing positions.
* Please note that the bar charts show total portfolio preferences. Thus, it can be interpreted as the recommended deviation from the relevant portfolio benchmark for any given asset class and sub-asset
class. These charts were formulated at the Emerging Markets Investment Committee. These preferences are designed for global investors. For models that are tailored to US investors, please see our flag-
ship publication, UBS House View.

UBS CIO GWM  August 2019   7

Focus
Brazil after pension reform: The growth agenda
Brazil’s lower house of Congress finally approved the social security reform pro-
posal in the first round of voting in July. Although it may take around three
additional months before the bill can be signed into law, the most difficult part
of the process is over, as the various parties have debated all the pertinent items
and agreed on what would become the core of the reform.

Economic growth has been anemic in Brazil over the last decade, averaging just
1.2% a year. The pension reform’s approval is necessary for the country to achieve
higher levels of growth. But it cannot do so singlehandedly. In our view, the reform Ronaldo Patah Alejo Czerwonko, Ph.D.
momentum must continue and business conditions improve to fully restore con- Analyst Strategist
fidence and rejuvenate investment spending. The good news is that the adminis-
tration’s economic team appears to understand this necessity and is now working
on a series of initiatives toward this end.

• The “economic freedom law”: The government aims to improve Bra- Figure 1
zil’s position in rankings of economic freedom and ease of doing busi-
ness through a sweeping reduction of red tape and broad improvements
Brazil’s last decade has been plagued with
in public sector transparency to tame corruption. dissapointing and unstable growth
Average quarterly real GDP growth (y/y) and volatility of quarterly
• Tax reform: The current tax system is difficult to entangle even for corpora- GDP growth, in % from 2009–2018
tions. Although tax cuts are unlikely due to the country’s fragile fiscal situation, 9
lawmakers may opt to simplify the tax structure. Various proposals are under
Average quarterly real GDP growth
8 China
consideration, and the chances for reform to the tax regime are increasing. 7
India
(% y/y, 2009–2018)

Vietnam
6 Philippines
• Infrastructure investment framework: The Ministry of Economy has Indonesia Turkey
drawn up a bill to give investors greater legal certainty and reduce the 5 Singapore
Malaysia
risk that private businesses face in large construction projects and con- 4
South Korea Thailand
Poland
cessions. The bill also aims to create mechanisms for a quicker resolution 3 Chile Taiwan
of related financial problems. 2 Mexico
South Africa Czech Hungary
1
Brazil
• Reductions in energy costs: The economy minister, Paulo Guedes, has
0
vowed to sell the gas distribution companies that today are controlled by 0 1 2 3 4 5 6
the state oil giant Petrobras, thereby increasing competitiveness in the sector Volatility of Quarterly real GDP,
and reducing the cost of gas for industries and consumers. in % (St. Dev of 2009–2018)

Source: UBS, as of 16 July 2019.

• Privatization program: The government is keen to privatize state-
owned enterprises and is developing the narrative to gain public support
for such initiatives. The Ministry of Infrastructure estimates that privatiza-
tions and new concessions for airports, sea ports, railways, and highways
will attract over BRL 200 billion in investments.

• Increased trade: The South American trade bloc Mercosur and the Eu-
ropean Union recently announced a free-trade agreement, a potential-
ly significant boost for exporters in Brazil. Mercosur is also working on
trade agreements with Canada, Singapore, and South Korea. Guedes is
also eyeing a gradual, unilateral tariff reduction by Brazil that does not
require congressional approval.

We see a good chance that many of the above initiatives will be implemented
as the administration and a majority in Congress appear to have a pro-market
tilt. In this context, we think Brazilian assets can perform well. We have there-
fore opened an overweight in Brazilian equities versus an underweight in Mexican
equities within our emerging market strategy (see Equities section), and project
further appreciation of the Brazilian real against the US dollar, to 3.70 in three and
six months and 3.60 in 12 months. We also think investors can benefit from a
good number of bottom-up opportunities in USD-denominated Brazilian bonds.

UBS CIO GWM August 2019  8

Equities
Move ahead of the market

Emerging market (EM) equities have rebounded about 7% after falling 7.3%
in May, thanks to dovish global central banks and low bond yields. Economic
fundamentals are not supportive given softer manufacturing activity and a
deteriorating earnings growth outlook for 2019, but we expect activity to re-
cover in 2H19. Continued uncertainty around the global growth outlook will
likely weigh on near-term sentiment, but assuming our risk case for global
trade doesn’t materialize, equities offer an attractive potential upside.
Xingchen Yu Gabriela Soni, CFA
Strategist Strategist
At 13.3x 12-month trailing P/E, emerging market equities are trading at a
premium to their historical average, but still hold a 22% discount to their
developed market counterparts. They are primed to catch up to the rest Figure 1

of the world, having materially lagged year-to-date. We expect a recovery Emerging Markets Country Preference
in economic activity and less negative earnings revisions since global
environment has turned friendly for emerging countries to pursue economic China
India
reforms and easing measures. That said, investors need to remain braced for Indonesia
a bumpy ride toward any future US-China trade deal. South Korea

Asia
Malaysia
Philippines
Brazil and Mexico: moving in opposite directions Taiwan
We have opened an overweight in Brazilian equities versus an underweight Thailand
Hong Kong*
in Mexican stocks. We now assign a 90% probability that Brazil’s Congress Brazil
will finally pass the social security reform this year. This will have a positive
LatAm
Chile
impact on government expenses over the next 10 years and allow the Colombia
Mexico
broader reform agenda to progress. Apart from pension reform, potential Peru
tax reform and pro-business measures also bode well for Brazilian equities. Czech Republic
Hungary
Meanwhile, for Mexico, the economy appears on verge of a recession. Tight
EMEA

Poland
fiscal and monetary policies, together with policy uncertainty, will continue Russia
South Africa
to hurt investor sentiment and growth prospects. Turkey
underweight neutral overweight
The trade has already posted about 3.2% of total return since its inception
New Old
on 9 July. We would continue to expect high volatility, and the situation to
move in favor of our position. All positions unless noted are relative to MSCI EM.
*Hong Kong is not a constituent of MSCI EM.
Source: UBS CIO, as of 18 July 2019.
Our position and equity preferences
In our global portfolio, we remain overweight emerging market equities. At
a regional level, our most preferred markets are China, Malaysia, and Brazil, Figure 2

and we are underweight Hong Kong, Thailand, and Mexico. The overweight in Brazilian equities vs the
underweight in Mexican equities trade is off
Regarding our stock preferences, in Asia, our selections are aligned with
our strategy positioning, with a bias toward better-quality large-caps. From to a good start
a thematic perspective, we still like Asian companies that offer growth Index levels of MSCI Brazil and MSCI Mexico
at reasonable prices, financials, and cash flow leaders. By sector, we still 4,800 2,500
like financials and select internet and technology stocks, as we see strong 4,750 2,400
diversification benefits between growth and value. 4,700
2,300
4,650
Focusing on Latin America, the rising risk-free rate in Mexico makes the risk- 2,200
4,600
reward for local equities unattractive. Within Mexico, we see opportunities in 2,100
4,550
industries where companies can meet our Most Preferred criteria: 1) resilient 2,000
4,500
earnings and USD inflows to offset foreign-exchange volatility; 2) compelling
4,450 1,900
valuation and low regulatory risk; and 3) high dividend yields.
4,400 1,800
20 May 19 30 May 19 09 Jun 19 19 Jun 19 29 Jun 19 09 Jul 19
Within the Brazilian local equity market, we prefer a balanced selection of high-
MSCI Mexico
quality domestic cyclical names (financials, consumer discretionary, industrials) MSCI Brazil (rhs)
exposed to a pickup in economic growth, as well as some cheap domestic
Source: Bloomberg, UBS, as of 18 July 2019.
defensives (consumer staples, healthcare, telecom), as we believe they offer about
5% dividend yield and could serve as a buffer in a potential market correction.

UBS CIO GWM August 2019  9

USD bonds strategy
Best first-half performance in a decade
Jérôme Audran,
USD-denominated emerging market bonds have posted a double-digit CFA, FRM, Analyst
return this year. These gains are due to tighter credit spreads, lower US
benchmark rates, and the yield carry, and have been mostly driven by
more dovish central banks and the US-China trade truce. We expect low-
single-digit returns over the next six months as the effects of a slowing
global economy will likely be offset by accommodative liquidity conditions.
Using a diversified and selective investment approach, remains crucial.

Concerns about risks to global economic growth have receded after the US
and China reached a trade truce at the G20 meeting. Dovish statements
from the Federal Reserve and the European Central Bank have also raised
expectations of easier liquidity conditions.

Against this backdrop, high yield credits have outperformed their investment
grade peers, which makes sense as more accommodative monetary policy
benefits riskier issuers more by easing their access to the bond market and
lowering their funding costs.

We remain constructive, but expect more muted returns for the second half of
the year. Credit spreads are below historical averages and lower Treasury yields
already reflect expectations of easier-for-longer global monetary policies. This
caps the upside on the asset class, particularly in light of lingering macro and
political risks. However, the yield carry should more than offset the somewhat
higher bond yields we expect. Also, a dovish Fed and a likely resilient global
growth will sustain the risk appetite for emerging market assets, in our view.

The main risks to our positioning come from a continued rally in US bench-
mark rates or further deterioration in global growth.

UBS CIO GWM August 2019  10

Currencies
Tide of easing lifts currencies

Emerging market currencies have done well in recent weeks, helped

by a renewed trade truce between the US and China, indications of a
precautionary interest rate cut from the Federal Reserve at the end of
July, and the marked dovish shift in tone from the European Central
Bank. Amid lackluster economic growth, we continue to favor select
high-yielding emerging market and frontier market currencies.

Year-to-date, total returns for emerging market currencies, based on the Tilmann Kolb, CFA Jonas David, CFA
ELMI+ index, are roughly 3.8% in US dollar terms. The largest gains were Analyst Strategist
recorded starting the end of May, thanks to the favorable shift in the global
monetary backdrop, which we expect to last over the next few months. Figure 1

Latest drop in US benchmark yields a boon

However, activity in most emerging economies remains lackluster. Manufac-
turing PMIs are signaling contraction, while exports and industrial produc- for EM currencies…
tion are showing low levels of growth. The impulse from developed markets ELMI+, indexed to 100 on 17 July 2018 (lhs);
US Treasury 2-year yield, in % (rhs)
is also weak. In the coming months, some support should come from mone-
tary easing as central banks in emerging markets have ample room to follow 104 3.2

peers in advanced countries in cutting interest rates, given the currency ap-
preciation and contained inflationary pressure in many economies. Structural 102 2.8
reforms are another way to boost growth prospects, and we expect progress
on that front in some markets, notably South Africa and Brazil.
100 2.4

In this environment, we think global investors will renew their hunt for yield.
As both developed and emerging market central banks ease policy, the inter- 98 2.0
est rate differential offered by emerging markets should remain attractive. In
our global tactical asset allocation, we position for the favorable carry via a
long basket of select high-yielding currencies (Indonesian rupiah, Indian ru- 96 1.6
pee, South African rand), which should also benefit from structural reforms Jul-18 Sep-18 Nov-18 Jan-19 Mar-19 May-19

after political uncertainty has diminished. Funding this trade with low-yield- ELMI+
ing, cyclical currencies (Australian dollar, New Zealand dollar, Taiwan dollar) UST 2-year yield (rhs)
should lower the position’s sensitivity to global headwinds, in particular a Source: Bloomberg, UBS, as of 17 July 2019
potential renewed escalation in trade tensions or periods of USD strength.
Figure 2
With respect to individual currencies, we still favor the South African rand
over the US dollar. With President Cyril Ramaphosa’s government focusing ...overpowering lackluster economic data in
on structural reforms, we think the rand still has room to strengthen in the emerging markets
coming months. Industrial production growth (in % y/y, 3mma) and manufacturing
PMI (relative to 50-threshold), GDP-weighted
The global environment should similarly support frontier market assets. For 6
experienced investors, we again highlight our preference for local currency
5
exposure in Egypt, Nigeria, and Kazakhstan via short-term instruments, as
we also see some domestic improvements in these countries. We recom- 4
mend a diversified exposure, but we emphasize that investors must have the 3
ability to withstand periods of volatility and significant setbacks.
2

Where do the risks lie? Global central banks have now shifted to a more 1
dovish stance in a preventive manner. Should major economies nonetheless
0
see a marked deterioration in the economic outlook, the currently buoyant
mood would likely turn. One reason could be a renewed faltering of trade –1
talks between the US and China; we expect a fragile truce to hold over 2016 2017 2018 2019
the coming months. Idiosyncratic issues in emerging markets persist as well, PMI indicating expansion Industrial production
even if global factors are masking them for now. PMI indicating contraction

Source: Bloomberg, UBS, as of 24 July 2019

UBS CIO GWM August 2019  11

 What’s at stake?
Throughout 2019, voters will elect the president, half of
the representatives in the lower house, one-third of the
senate, governors of 22 out of the country's 23 provinces,
and the mayor of the City of Buenos Aires. Markets will
focus on the outlook for the October presidential race.
Argentina
Economic & policy backdrop Candidates & key trends Scenarios & implications
2.8 1.8
Mauricio Macri: Current president and member of Juntos por el Cambio With three months to go until the first round,
party. The poor macro backdrop has negatively affected his voter support the presidential race remains wide open. In our
GDP level, but this has improved in the last two months. baseline scenario, however, we expect
(y/y in %) -2.1 -2.1
incumbent President Mauricio Macri to be
48 38 Miguel Angel Pichetto: Longtime Peronist, senator for Río Negro reelected, and his currently policy mix to remain
25 23 province, and leader of the Senate majority. He joined forces with Macri in place. This includes fiscal consolidation efforts
Inflation
and will run as his vice-presidential candidate. He has developed strong toward a primary surplus, tight monetary policy
(year end in %)
relationships with Peronist governors over the years. to rein in inflation, and a cooperative relationship
with the IMF, as well as "willingness" to remain
Current account Maria Eugenia Vidal: Current governor of Buenos Aires province, running current on debt obligations.
(% of GDP)
-1.5 -1.9 for reelection. A key member of Macri's coalition, she remains among the
-4.9 -5.5 most popular politicians in the country. Kirchner's ticket does not represent continuity, in
our view. We see her odds of winning around
Cristina Fernandez de Kirchner: Former president and current senator 35% given that she is facing severe corruption
Budget balance -2.4
-3.6 for Buenos Aires province. Despite widespread corruption allegations allegations; Argentine economic numbers are set
(% of GDP) -6.1 -5.5
against her, she retains around 30% of voting intentions. She announced to look less dire in the coming months; the
in May that she will participate in the August primary elections, running as global macro and political backdrop is
vice president to presidential candidate Alberto Fernandez. supportive, with key partners the US, Brazil, and
'17 '18E '19E '20E Chile all backing policy continuity; and the fact
Alberto Fernandez: A political negotiator, his only election experience that incumbent presidents in Latin America have
The country's strict money base targets, together with a better was in 2000 when he ran for the local congress of the city of Buenos Aires. historically had a distinct advantage in winning
behaved peso, are leading to an improved inflation outlook. His ticket lost and he came in second, though he still secured a legislature reelections.
Month-over-month inflation came in at 2.7% in June which, seat. Fernandez was chief-of-staff for Nestor Kirchner and Cristina
although still high, represents the third consecutive month of Kirchner. He quit the role over disagreements with Cristina. He was a critic In our view, current Argentine asset prices
moderation relative to the even higher March print of 4.7%. of her second mandate, particularly relating to her more extreme policies. overestimate the likelihood of a return to
Fiscally, the government delivered its target primary deficit of Fernandez maintains good relations with many Peronist leaders and populism in the upcoming elections. We
2.7% of GDP in 2018, and has so far achieved additional savings segments of the private sector and the media. He led Sergio Massa’s maintain our favorable view of a number of
Emerging market electoral monitor

in 2019, approaching a primary fiscal balance. Amid tight
monetary and fiscal policy, economic activity will remain muted.
The primary sector will likely support overall activity as production Sergio Massa: Former chief-of-staff of Cristina Kirchner, former
stages a meaningful recovery from the depressed levels of 2018
due to drought conditions.
presidential campaign in 2015. Argentine US dollar-denominated bonds, though
we warn against making too large of an
allocation to the country. Our favorable view on
presidential candidate, and current congressman for Buenos Aires its electoral outlook is far from guaranteed, and
province. He ran in the 2015 presidential race and came in third with 23% Argentina's still-large twin deficits leave its assets
of the votes. He will run for congress for the Fernandez-Kirchner coalition. vulnerable to sharp changes in the external
financial environment in the near term. Longer
Roberto Lavagna: Former economy minister under Duhalde’s term, the country will continue to face economic
administration. Joined forces with Juan Manuel Urtubey, current governor and political challenges.
of Salta province, to run for president. In our view this ticket will feel the
squeeze of an increasingly polarized political race and will eventually be For investors overexposed to the country, the
pushed out. rally in Argentine assets in recent weeks provides
a good opportunity to reduce their allocations
Libertarian economists: A number of libertarian economists intend to and better manage risks.
run, with Jose Luis Espert leading the pack. They enjoy limited voter
support currently, but dent Macri's coalition numbers.

Google search trends Polling trends Social media following

A note on published polls: The majority of survey results published in the Facebook Twitter
local press and influencing the market lately are of questionable quality.
Most are based on landline phone interviews, often carried out by robots.
likes followers
In-person surveys are generally considered more trustworthy, but they are
costly to execute, and the few agencies running them don’t usually make
Mauricio Macri 4.4m 4.8m
the results publicly available, selling them privately instead. The small print
is key to assessing the believability of the surveys. Miguel Pichetto 5k 56k
Alberto Fernandez 97k 213k
Cristina Fernandez
2.4m 5.4m
de Kirchner
Roberto Lavagna 7k 153k

Source: Ministerio del Interior, Obras Publicas y Vivienda, La Nacion, UBS, as of July 2019

UBS CIO GWM August 2019  12

 What’s at stake? Economic & policy backdrop Candidates & key trends Scenarios & implications

October/November – Parliamentary elections
460 members of the Sejm (lower house) and 100 members
of the Senate (upper house); proportional representation
with 5% single party threshold (Sejm)
Sejm current composition:
Poland
5.1 Law and Justice (PiS): PiS is the main nationalist- Base case:
4.9 4.4 3.8
conservative party in Poland. It won an absolute majority We think the ruling Law and Justice is likely to remain in power.
GDP in 2015, and incumbent Prime Minister Mateusz Another outright majority is in the realm of possibility if smaller
(y/y in %) Morawiecki leads the party into this year's election. Its parties fail to cross the electoral threshold. Polls show a PiS vote
fiscal spending programs over the past years were well share of around 40%. Strong economic growth, low
2.5 2.7 received by large parts of the Polish population. unemployment, and past and planned social spending provide a
2.1
Inflation 1.1
supportive backdrop for campaigning.
(year end in %)
Civic Platform (PO): PO is the main opposition party,
headed by Grzegorz Schetyna. Given its liberal- A potential weakness may be the government’s ongoing
Current account 0.1 conservative focus, it is perceived as more business- disputes with the European Commission around the rule of law
(% of GDP) oriented than PiS. PO has a pro-European focus; the and judicial reform, especially if the opposition can link these
current president of the European Council, Donald Tusk, disputes with Poland’s standing in the EU. The Polish population
-0.6 -0.3 -0.6
is a cofounder of PO and served as prime minister of the is highly supportive of EU membership, also given its large
earlier PO-led government. economic benefits in the form of EU structural funds.
Budget balance
(% of GDP) -0.4
Wiosna: Formed only in early 2019 by Robert Biedroń, In the case of another PiS (or PiS-led) government, we don’t
the social-democratic Wiosna already comes in third place expect a change in the current policy direction. Catering to the
-1.5 -1.6 -1.6 in polls for the parliamentary election. Its platform is party’s base in terms social and socially conservative fiscal
'17 '18E '19E '20E based on increases in social spending, better priorities will likely persist, as will clashes with European
environmental protection, as well as pro-European and institutions over the rule of law. Over a multiyear horizon, the
Poland benefited from an impressive growth spurt in recent years, socially liberal values. new government may have to find a way to finance fiscally
allowing the government to boost fiscal spending while keeping expansive measures amid moderating economic growth.
the budget deficit contained. GDP growth should remain sound Kukiz'15: The right-wing political movement, led by
(2019: 4.4% y/y), thanks to solid private consumption; fiscal Paweł Kukiz, received more than 8% of the vote in the Alternative scenarios:
easing later this year supports this view. Still, high-frequency last general election, but saw some members of We think it is unlikely that any of the opposition parties can
economic data remains mixed, and additional Eurozone weakness parliament switch to other political groupings over the overpower PiS and become the strongest force in the Sejm.
would muddy the Polish outlook as well. Risks also persist with past years. It enjoys strong support from the younger However, the formation of a coalition for the European
Emerging market electoral monitor

regards to global trade and European politics. population. Parliament elections by several opposition parties may serve as a
Senate current composition:
blueprint for the Polish parliamentary election. Should the main
Polling trends (below): parties cooperate, the election may become contested. From a
Law and Justice consistently polls as the strongest party, market perspective, a change in power may be greeted with
with Civic Platform in second place. A number of parties some enthusiasm, as the deterioration in institutional quality
do not currently surpass the electoral threshold of 5%, may come to an end. However, different views and ideologies
which may decide over Law and Justice’s ability to reach within the coalition may also lead to frictions.
an absolute majority on its own. The Law and Justice-led
coalition won the European Parliament election in May,
achieving a better result than forecast by polls against the
European Coalition (a coalition of opposition parties),
helped by the successful mobilization of PiS voters.

Google search trends Polling trends Social media following

Facebook Twitter
likes followers
Mateusz
- 116k
Morawiecki
Grzegorz Schetyna 36k 185k

Robert Biedroń 532k 171k

Source: Sejm (sejm.gov.pl), Wikipedia, Google, UBS, as of July 2019

UBS CIO GWM August 2019  13

Emerging markets
publications

Investing in emerging markets

A monthly guide to investing in emerging market financial assets 24 July 2019 – 5:00 pm GMT
Monthly flagship 10 October 2018
Chief Investment Office GWM
Investment Research White Papers
August 2019 Chief Investment Office GWM

Investing in emerging markets

Investment Research

Thinking strategically
Including investment views across asset Thinking strategically about Emerging Markets
classes and regions about Emerging Markets Africa
Economic, social and financial market changes
over the last 20 years and investment implications
Cradle of Diversity
Russia
Summer ruminations Back at Global Center Stage

Equities: Credit: Currencies: Focus: Economy:

Latin America
Wait and see Best first-half
performance in a
decade
Tide of easing lifts
currencies
Brazil after
pension reform:
The growth
agenda
With great power
comes great
responsibility Beyond peak trade
Middle East
Prosperity beyond oil
This report has been prepared by UBS AG, UBS Financial Services Inc. (UBS FS), and UBS Switzerland AG. A previous version of this report displayed an incorrect version of the table in Figure 42.
Please see important disclaimers and disclosures that begin on page 18.

Asset class publications Regional investment themes

Currencies Long term investments (LTIs)
• EM FX Monthly including currency preferences Thematic investments with a 5yr+ investment horizon
• FX one-pagers (BRL, MXN, RUB, ZAR, TRY, CEE3, APAC)

UBS CIO GWM August 2019  14

Appendix
Non-Traditional Assets

Non-traditional asset classes are alternative investments that include hedge funds, private equity, real estate, and
managed futures (collectively, alternative investments). Interests of alternative investment funds are sold only to qualified
investors, and only by means of offering documents that include information about the risks, performance and expenses of alter-
native investment funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alterna-
tive investment fund is speculative and involves significant risks. Specifically, these investments (1) are not mutual funds and are
not subject to the same regulatory requirements as mutual funds; (2) may have performance that is volatile, and investors may
lose all or a substantial amount of their investment; (3) may engage in leverage and other speculative investment practices that
may increase the risk of investment loss; (4) are long-term, illiquid investments, there is generally no secondary market for the
interests of a fund, and none is expected to develop; (5) interests of alternative investment funds typically will be illiquid and sub-
ject to restrictions on transfer; (6) may not be required to provide periodic pricing or valuation information to investors; (7) gener-
ally involve complex tax strategies and there may be delays in distributing tax information to investors; (8) are subject to high fees,
including management fees and other fees and expenses, all of which will reduce profits.

Interests in alternative investment funds are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured
depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any
other governmental agency. Prospective investors should understand these risks and have the financial ability and willingness to accept
them for an extended period of time before making an investment in an alternative investment fund and should consider an alternative
investment fund as a supplement to an overall investment program.

In addition to the risks that apply to alternative investments generally, the following are additional risks related to an investment in these
strategies:

• Hedge Fund Risk: There are risks specifically associated with investing in hedge funds, which may include risks associated with
investing in short sales, options, small-cap stocks, “junk bonds,” derivatives, distressed securities, non-U.S. securities and illiquid
investments.
• Managed Futures: There are risks specifically associated with investing in managed futures programs. For example, not all managers
focus on all strategies at all times, and managed futures strategies may have material directional elements.
• Real Estate: There are risks specifically associated with investing in real estate products and real estate investment trusts. They involve
risks associated with debt, adverse changes in general economic or local market conditions, changes in governmental, tax, real
estate and zoning laws or regulations, risks associated with capital calls and, for some real estate products, the risks associated with
the ability to qualify for favorable treatment under the federal tax laws.
• Private Equity: There are risks specifically associated with investing in private equity. Capital calls can be made on short notice, and
the failure to meet capital calls can result in significant adverse consequences including, but not limited to, a total loss of investment.
• Foreign Exchange/Currency Risk: Investors in securities of issuers located outside of the United States should be aware that even for
securities denominated in U.S. dollars, changes in the exchange rate between the U.S. dollar and the issuer’s “home” currency can
have unexpected effects on the market value and liquidity of those securities. Those securities may also be affected by other risks
(such as political, economic or regulatory changes) that may not be readily known to a U.S. investor.

UBS CIO GWM August 2019  15

Appendix
UBS Chief Investment Office’s (“CIO”) investment views are prepared and published by the Global Wealth Management business of UBS Switzerland
AG (regulated by FINMA in Switzerland) or its affiliates (“UBS”).

The investment views have been prepared in accordance with legal requirements designed to promote the independence of investment research.
Generic investment research – Risk information:

This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other spe-
cific product. The analysis contained herein does not constitute a personal recommendation or take into account the particular investment objectives,
investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could result in
materially different results. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or
may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable
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UBS). All information and opinions as well as any forecasts, estimates and market prices indicated are current as of the date of this report, and are subject
to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result
of using different assumptions and/or criteria.

In no circumstances may this document or any of the information (including any forecast, value, index or other calculated amount (“Values”)) be used for
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UBS CIO GWM August 2019  16