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December 15, 2005. IIF Indian Banks Symposium, Mumbai. Corporate Governance as a Component of Equity Risk. Manish Singhai Alliance Capital Management (S) Ltd CIO, Asia ex-Japan Markets . Sources of Risk in the Emerging Markets Are Changing. Excess Equity Volatility*

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December 15, 2005

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December 15 2005

December 15, 2005

IIF Indian Banks Symposium, Mumbai

Corporate Governance as a Component of Equity Risk

Manish Singhai

Alliance Capital Management (S) Ltd

CIO, Asia ex-Japan Markets


Sources of risk in the emerging markets are changing

Sources of Risk in the Emerging Markets Are Changing

Excess Equity Volatility*

Emerging Minus Developed Markets

Single-Stock Risk Attribution**

Country

Company Specific

(%)

(%)

(%)

Through December 31, 2004

*Standard deviation of monthly returns of the MSCI Emerging Markets Index minus the standard deviation of monthly returns of the MSCI World Index; gross dividends re-invested, in US dollars; data annualized, shown on a rolling three-year basis.

**Decomposition of single-stock risk by the following factors: global equity, emerging-market equity, global industry, local industry, country and stock-specific. The charts above isolate the country and company-specific factors of the decomposition. Numbers shown on a rolling three-year basis.

Source: MSCI, Bernstein and Alliance Capital


Em company risk still higher than developed markets

EM Company Risk Still Higher than Developed Markets’

Average Annual Single-Stock Volatility

(Rolling One Year)*

(%)

Emerging

Developed

38.6%

21.7%

Through December 31, 2004

*Annualized average of monthly standard deviation of single-stock returns in US dollars

Source: MSCI, Bernstein and Alliance Capital


How to best assess emerging markets equity risk

How to Best Assess Emerging Markets Equity Risk?

  • Strong “on-the-ground” fundamental research is critical to understanding balance-sheet risk and better pinpointing outperformance potential

  • A systematic approach evaluates risks associated with the quality of corporate governance


Research results are tangible

“1” Rated

“3” Rated

Research Results Are Tangible

Alliance Capital Analysts’ Ratings

Annualized Returns (Nov 1999–Dec 2004)

Emerging MarketsAsia

Emerging MarketsEMEA

Emerging MarketsLatin America

25.3%

27.2%

20.8%

14.2%

12.6%

2.7%

2.3%

MSCI EM ASIA

MSCI EMLatinAmerica

MSCIEMEMEA

(6.5)%

(10.3)%

Past performance is no guarantee of future results. Annualized returns in US dollars. The rating system is based on the stocks tracked by Alliance Capital research analysts. The degree to which such internal research is utilized may vary between strategies. “1”-rated stocks are believed to be among the best in their sector; “3”-rated stocks are believed to be among the worst in their sector. The returns are based on an equal-weighted average of the returns of the equity research team’s individual ratings and are rebalanced bi-weekly. The rating system is proprietary to Alliance Capital and is not indicative of the performance of any Alliance Capital portfolio.

Source: MSCI and Alliance Capital


Analysis of corporate governance can be revealing

Analysis of Corporate Governance Can Be Revealing

  • The quality of corporate governance—both in developed and emerging markets—tends to affect risk and valuation, and it is correlated to key variables for investors, particularly:

    • Returns

    • Corporate fundamentals


Corporate governance shown to help performance

Corporate Governance Shown to Help Performance

US: Relative Annualized Performance

Better vs. Poorer Corporate Governance*

1990–1999

*Difference between the returns of theoretical portfolios with better and poorer corporate governance based on an attribution estimate of the pure impact of corporate governance. Corporate governance is measured by the Governance Index (G) as developed by Paul A. Gompers (Harvard Business School), Joy L. Ishii (Department of Economics at Harvard University) and Andrew Metrick (Department of Finance, The Wharton School, University of Pennsylvania) in a study titled “Corporate Governance and Equity Prices” (February 2003). The universe of the study is drawn from the Standard & Poor’s 500 Index as well as the annual lists of the largest corporations as published by Forbes, Fortune and BusinessWeek. The universe tracked more than 93% of the total market capitalization of the combined New York Stock Exchange, American Stock Exchange and Nasdaq markets. Main data source for the study is the Investors Responsibility Research Center (IRRC) database. Sample period is September 1990 to December 1999. The portfolios were reset in September 1990, July 1993, July 1995 and February 1998, which are the periods after new data on G became available. Better governance portfolios include the top decile of the studied universe ranked by G. Poorer governance portfolios include the bottom decile of the studied universe ranked by G.

Source: Corporate Governance and Equity Prices (February 2003) by Gompers, Ishii and Metrick


Corporate governance and fundamentals are correlated

Corporate Governance and Fundamentals Are Correlated

US: Corporate Fundamentals’ Incremental BenefitBetter vs. Poorer Corporate Governance*

1990–1999

*Corporate governance is measured by the Governance Index (G) as developed by Paul A. Gompers (Harvard Business School), Joy L. Ishii (Department of Economics at Harvard University) and Andrew Metrick (Department of Finance, The Wharton School, University of Pennsylvania) in a study titled “Corporate Governance and Equity Prices” (February 2003). The universe of the study is drawn from the Standard & Poor’s 500 Index as well as the annual lists of the largest corporations as published by Forbes, Fortune and BusinessWeek. The universe tracked more than 93% of the total market capitalization of the combined New York Stock Exchange, American Stock Exchange and Nasdaq markets. Main data source for the study is the Investors Responsibility Research Center (IRRC) database. Sample period is September 1990 to December 1999. The portfolios were reset in September 1990, July 1993, July 1995 and February 1998, which are the periods after new data on G became available. Better governance portfolios include the top decile of the studied universe ranked by G. Poorer governance portfolios include the bottom decile of the studied universe ranked by G. Regressions for net-profit margin, ROE and sales growth on G measured in the previous year and the book-to-market ratio. Data shown represent the mean values for the analyzed period.

Source: Corporate Governance and Equity Prices (February 2003) by Gompers, Ishii and Metrick


Our tools gauge quality of em corporate governance

Our Tools Gauge Quality of EM Corporate Governance

  • In-depth tools assess quality of corporate governance by analyzing issues related to:

    • Information disclosure

    • Management access and fair disclosure

    • Accounting

    • Shareholder value creation

    • Board and shareholder structure

    • Capital management

    • Ethics and social responsibility


Tools provide systematic approach to rating stocks

Tools Provide Systematic Approach to Rating Stocks

  • Emerging-market stocks rated “A”, “B” and “C” according to the quality of corporate governance

  • Directional analysis integral part of the rating system(+, neutral, –)


Top rated companies are less volatile

Top-Rated Companies Are Less Volatile…

Alliance Capital Emerging Markets Universe

Annualized Average

2002–2004

Standard Deviation

Beta

Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. Beta is measured against the MSCI Emerging Markets Index.

Source: MSCI and Alliance Capital


Boast higher valuations

…Boast Higher Valuations…

Alliance Capital Emerging Markets Universe

Average

2002–2004

Price/Earnings

Price/Book

Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. Average price/earnings was calculated using Windsor methodology, which capped P/Es at 200 and –200; average price-to-book was calculated using Windsor methodology, which capped price-to-book at 10 and –10.

Source: MSCI, Worldscope and Alliance Capital


Make better use of capital

…Make Better Use of Capital…

Alliance Capital Emerging Markets Universe

Annualized Average

2002–2004

Payout Ratio

Capex/Sales

ROE

Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. Annualized return on equity was calculated using Windsor methodology, which capped ROE at 100 and –100; annualized payout ratio was calculated using Windsor methodology, which capped the ratio at 100; annualized capital expenditures to sales was calculated using Windsor methodology, which capped the capex/sales ratio at 200 and –200.

Source: MSCI, Worldscope and Alliance Capital


And tend to outperform their lower rated peers

…And Tend to Outperform Their Lower-Rated Peers

Alliance Capital Emerging Markets Universe

Annualized Returns2002–2004

Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. Annualized returns measured on an equal-weighted basis. The degree to which stocks in each category are utilized will vary. The returns presented above do not represent the performance of any Alliance Capital portfolio.

Source: MSCI and Alliance Capital


Top rated companies are well distributed by region

Top-Rated Companies Are Well Distributed by Region…

Corporate Governance Ratings

Distribution by Region*

2002–2004

Asia

Latin America

EMEA

3.2%

7.5%

9.2%

26.8%

30.5%

45.0%

47.5%

60.6%

70.0%

“C” Rated

“A” Rated

“B” Rated

*Chart shows the average percentage distribution of companies rated “A”, “B” and “C” according to Alliance Capital’s proprietary corporate governance system by domicile.

Source: Alliance Capital


And by sector

…and by Sector

Corporate Governance Ratings

Percentage Distribution by Sector*

2002–2004

“A” Rated

Consumer Discretionary

“B” Rated

“C” Rated

*Chart shows the average percentage distribution of companies rated “A”, “B” and “C” according to Alliance Capital’s proprietary corporate governance system by sector.

Source: Alliance Capital


Improving governance a harbinger of outperformance

Improving Governance a Harbinger of Outperformance

Alliance Capital Emerging Markets Universe

Annualized Returns (2002–2004)

Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. A plus (+) rating indicates an improving corporate governance outlook, while a neutral rating reflects a steady outlook and a minus (–) rating suggests a deteriorating outlook. Annualized returns measured on an equal-weighted basis. The degree to which stocks in each category are utilized will vary. The returns presented above do not represent the performance of any Alliance Capital portfolio.

Source: MSCI and Alliance Capital


Tools can enhance bottom up stock selection

Tools Can Enhance Bottom-Up Stock Selection

Annualized Performance: 2002–2004

MSCI Emerging Markets Index

Annualized returns calculated on an equal-weighted basis in US dollars

Source: MSCI and Alliance Capital


Tools can enhance bottom up stock selection1

Tools Can Enhance Bottom-Up Stock Selection

Annualized Performance: 2002–2004

MSCI Emerging Markets Index

Alliance Capital Analysts’ “1” Rated Stocks

Annualized returns calculated on an equal-weighted basis in US dollars

Past performance is no guarantee of future results. The rating system is based on the stocks tracked by Alliance Capital research analysts. The degree to which such internal research is utilized may vary between strategies. “1”-rated stocks are believed to be among the best in their sector; “3”-rated stocks are believed to be among the worst in their sector. The rating system is proprietary to Alliance Capital and is not indicative of the performance of any Alliance Capital portfolio.

Source: FactSet, MSCI and Alliance Capital


Tools can enhance bottom up stock selection2

Tools Can Enhance Bottom-Up Stock Selection

Annualized Performance: 2002–2004

MSCI Emerging Markets Index

Alliance Capital Analysts’ “1” Rated Stocks

“1” Rated Stocks with CG Rating of A+

Annualized returns calculated on an equal-weighted basis in US dollars

Past performance is no guarantee of future results. The rating systems are based on the stocks tracked by Alliance Capital research analysts. The degree to which such internal research is utilized may vary between strategies. “1”-rated stocks are believed to be among the best in their sector based on our fundamental analysis; “A+” rated stocks are perceived to have the best corporate governance with a positive outlook. The fundamental and corporate-governance rating systems are proprietary to Alliance Capital and are not indicative of the performance of any Alliance Capital portfolio. The returns presented above do not represent the performance of any Alliance Capital portfolio.

Source: FactSet, MSCI and Alliance Capital


Enhancing our tools a more selective rating system

Enhancing our Tools: A More Selective Rating System

  • Rating system recently expanded to “A”, “B”, “C” or “D” according to quality of corporate governance

  • Enhanced format instrumental to help us detect potential “false” improvements in governance

  • Sharpened focus on management compensation, capital management, shareholders’ rights, social responsibility and ethics better identifies good corporate governance behavior

  • “D” rated stocks will not be owned by any portfolio


Enhancing our tools introducing country ratings

Enhancing our Tools: Introducing Country Ratings

  • Tools check whether country-specific investment environment protects minority shareholders by focusing on:

    • Investment framework

    • Enforcement

    • Shareholder activism


Country rating scores vary within region

Country Rating Scores Vary Within Region

Alliance Capital Country Rating Scores*

EMEAAsiaLatin America

Czech Republic 1China 0Argentina–1

Egypt–1Hong Kong 1Brazil–1

Hungary 1India 1Chile 1

Israel 2Indonesia–2Mexico 0

Poland 0Malaysia 0Venezuela 0

Russia–2Philippines–2

South Africa 2Singapore 2

Turkey 0South Korea 0

Taiwan–1

Thailand–1

As of March 31, 2005

*The country rating system considers whether the national framework adequately protects minority shareholders by posting a series of questions that result on a score between –2 and +2. Countries with higher scores are believed to have more investor-friendly regulatory and institutional frameworks.

Source: Alliance Capital


What we have learned

What We Have Learned

  • Systematic approach to measuring quality of corporate governance can minimize risk and add value to investors

  • Constant checks of tools help avoid pitfalls


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