SUB-PRIME - WHAT WILL FUTURE HISTORIANS SAY?

LIAM HALLIGAN Chief Economist

CITY WIRE WEALTH MANAGER RETREAT

OCTOBER 2011

WHAT THE IMF SAID

“The improved resilience may be seen in fewer bank failures and more consistent credit provisions. Consequently, the commercial banks may be LESS VULNERABLE today to credit or economic shocks …”

“There is a growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors … has helped make the banking system, and the overall financial system MORE RESILIENT …”

INTERNATIONAL MONETARY FUND Global Stability Report, April 2006

WHAT THE CHINESE SAID

“There is money everywhere ….. You can get liquidity from the market every second, for anything you want ...

… That means people are investing in assets with no idea of the risks they are taking … ”

ZHU MIN, Peoples’ Bank of China DAVOS, Jan 2007

WHAT OUR “LEADERS” SAID

“Today’s decisions won’t solve the crisis immediately … but we’ve begun the process by which it will be solved”

“There is no disagreement that we need action by our government, a recovery plan that will help jumpstart the economy”

GORDON BROWN London G-20 Summit, April 2009

BARACK OBAMA President-Elect, January 2009

REALLY …?

LESSONS WE THOUGHT WE HAD LEARNT

“We used to think you could spend your way out of recession and increase employment by boosting government spending. I tell you, in all candour, that that option no longer exists ….

JIM CALLAGHAN, UK Prime Minister Labour party conference 1976

… and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step ...”

5 QE is a historic turning-point - big impact on global investment landscape

BERNANKE’S “SUPPORTIVE MEASURES”

•  Responding to sub-prime, US has TRIPLED monetary base in less than 3 years, as has UK - totally unprecedented

•  Designed to “tackle deflation”, QE is a back-door bank bail-out - and more to come

•  QE has alarmed international investors and creditor governments - resulting “flight to tangibles” has bid-up soft and hard commodities

•  Dollar weakness means yuan up 12% V USD over 12 months - strengthens Chinese oil demand

“To think output and income can be raised by increasing the quantity of money is rather like trying to get fat by buying a larger belt …”

“It is a most misleading thing to stress the quantity of money, which is only a limiting factor, not the operative factor.”

JM Keynes, Letter to FDR, 1933

HISTORIC LESSONS IGNORED

WESTERN MONETARY POLICY - LET ‘EM ROLL

UK FISCAL POLICY – AN AUSTERITY OF ACTION

•  There is much talk of austerity in the UK - but the actual figures, which the media rarely look at, show that government spending is still rising

•  Inflation - and higher expected inflation - will ultimately make non-indexed gilts much harder to sell once the props have gone

“CUTS, WHAT CUTS” ?

UK is spending more than ever - “austerity” is largely about political positioning

•  This is true even after allowing for inflation

•  Britain’s gilt issuance was £150bn+ in 2009/10 and 2010/11 and will be £125bn+ in 2011/12 - this is 6x to 8x recent annual averages

•  Gilts market is being propped up by QE, buying by state-controlled banks & regulatory requirements - this cannot go on forever

•  Then there is the “currency overlay” issue - why buy long-term instruments denominated in a currency that is being deliberately debased?

SOME PERSPECTIVE ON “THE CUTS”

UK GOVERNMENT DEL SPENDING

•  Osborne "paying down the deficit” - but what about the debt?

After 5 years of austerity, spending will be to 2005 levels, but with twice as much debt

•  DEL spending (not including benefits and debt interest) is falling - but only set to return to 2005 levels in real terms, so hardly draconian

•  UK net public debt £581bn in 2008, set to be £940bn in 2011 - and £1,500bn+ by 2015/16, even if “austerity” fully implemented

•  Osborne is not implementing TME cuts - and a zero deficit anyway signals that the problem has “peaked”, not that the problem has ended

•  The debt reality is worse than numbers above seeing as 2011 debt including “interventions” is £2,270bn (Sept 2011) - which is 150% of GDP

•  Then add public sector pensions (£1,100bn+), PFI (£400bn+) and other off-balance-sheet niceties

220% 91% 71%

72% 66% 18% 10%

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WHAT IS THE WESTERN END-GAME?

QE/debt situation raises big currency overlay issues for Western investors

STATE DEBT (% GDP)

JAPAN USA UK

INDIA BRAZIL CHINA RUSSIA

“DEVELOPED MARKETS” STATE DEBT (% GDP) •  After both WWI & WWII, Western debt crises were only resolved by “soft default” of inflation and debasement

•  Post-War debts marked a peak, but in current situation, demographics means Western liabilities are set to rocket further

•  Inflation and debasement look like the only way out this time too - not least because the problem is worse

Western debts at levels not seen since

WWI and WWII

•  The EMs, in contrast, have far lower debts and far fewer age-related liabilities

•  EMs have 75% of the world’s currency reserves, while the G7 (minus Japan) has only 7%

•  This suggests EM currencies will rise over the medium-term, while those in DM will fall – should be kept in mind by long-term institutional investors

GORDON AND FRIENDS “SAVE THE WORLD”

“G20 has an unshakeable commitment to work together to restore jobs & growth …”

“G20 will work to deliver a stronger regulatory framework for the financial sector …”

•  But protectionist dangers have risen - note recent bill in US Congress - and we’re further than ever from Doha trade round •  Global economy is now facing first outright failure of a multi-lateral trade negotiation since the Smoot-Hawley tariffs of the 1930s

•  Bank balance sheets remain weighed down with undisclosed debts - acting as serious blockage to new credit and, ultimately, economic recovery

•  It took until mid-2010, 2 years into “sub-prime”, for serious discussion on structural banking reform – but resulting policies were seriously watered-down in face of lobbying

Far from policy co-ordination, international debate is becoming more fractious

PASS THE BUCK - IT’S “THEIR FAULT”

•  Fashionable, and convenient, to blame “sub-prime” fiasco on “global imbalances”

•  Crisis is, apparently, unrelated to Western hubris, unchecked securitization, lack of regulatory oversight and political weakness

•  “They” made us do it - far-flung Eastern economies produced what the world wanted, then forced us to borrow (!)

•  “Davos consensus” is that “something must be done” about global imbalances

•  This view is misguided - global capital flows are lifeblood of progress and must be allowed to continue

•  “Global imbalances” thesis - tawdry form of Western self-pity and blame-shifting

•  Could be used to justify deeply damaging capital controls and protectionism

“Global imbalances” thesis confuses the symptoms and causes of our predicament

THE FUTURE IS NOW

SHARE OF GLOBAL GDP STOCK (%, $ PPP TERMS) •  As EMs outpace West, they are accounting for fast-growing share of global economy

•  … this trend accelerated and accentuated by impact of sub-prime on Western growth …

CONTRIBUTION TO GLOBAL GDP GROWTH (%, $ PPP)

•  BRICs have already eclipsed EU/US in terms of PPP-adjusted share of world GDP ….

•  During 1990s, G7 drove world economy - home to more than 40% of global growth

•  Between 2000 and 2008, BRICs grabbed the baton, their share of world growth rising to 45% - more than twice the G7

•  IMF estimates BRIC growth share will be FIVE TIMES that of G7 during 2008/14

Economic power was shifting eastward - and sub-prime has speeded that up

EMERGING MARKETS MUCH LESS EXPOSED

SHARE OF GLOBAL EXPORTS ($ TERMS)

•  EMs are much, much less indebted than “advanced” Western nations - in terms of both private and public debt

•  This reality will widen growth differential and hasten the on-going West-to-East growth shift.

•  So they can lever-up over next 3-5 years as Westerns firms, consumers and governments will, in general, be forced to “de-lever”

•  BRICs’ fast-growing exports mean big external surpluses – these four EMs now boast for 44% of world currency reserves

•  G7 countries have only 19% of reserves, falling to 8% if you exclude Japan

•  In world of systemic risk, reserves let you stabilize banking systems, defend currencies and boost growth without using more leverage

PUBLIC/PRIVATE DEBT (% SHARE OF GDP)

The ratings agencies are wrong (again) - risks are more acute in the West than the East

•  EMs account for ever growing share of global economy •  Accounted for ALL global growth in 2009/10 - and big share in 2011/15 •  “Productivity gap” rapidly closing, so wealth differences also narrower

… from “indebted-to- unimpaired”

FIRMS

•  West issuing debts and de-basing currencies •  Inflation now looming - sky-high gold price •  Many EMs have abundance of real, tangible assets •  These offer returns and inflation hedge

… from “deficit-to- surplus”

COUNTRIES

… from “intangible

-to-tangible” ASSETS

Investors following

“West-to-East” GROWTH …

… amidst on-going

“SEARCH FOR YIELD”

INVESTMENT FLOWS ARE STARTING TO SHIFT …

•  Post sub-prime, advanced nations far more indebted •  BRICs have half of total global reserves •  EMs have trade surpluses and strong fiscal position •  Less exposed than West to systemic risk

•  Western firms now weighed-down by debt-service and deleveraging •  Global investors will seek firms able to win share of expanding markets •  BRIC firms have far fewer aged-related liabilities

•  As Western societies age, “search for yield” gets more desperate •  Post sub-prime regulation will limit high-return strategies •  EMs offer more growth/better margins •  Anti-EM prejudices now starting to fade

•  EMs have 2/3rds of world population, 1/2 of stock of PPP GDP, lion’s share of growth - yet account for only 1/5th of global portfolio investment

•  As EM capital markets deepen, and funds migrate from West “post sub-prime”, this share could rapidly rise – from 1/5th to 1/3rd

EM share of portfolio investment will rise - but nothing important happens in a straight line

“NOUGHTIES” …. BUT NICE

•  The “noughties” - 2000-09 – were widely seen as disastrous decade for equities

•  During the same period, MSCI EM index of leading emerging markets rose 102% in dollar terms - annual gain of 7.2%.

•  China’s Shanghai Composite gained 191% during “noughties” - an 11.2% annual increase - while India’s Sensex 30 rose 226% - 12.4% pa

•  Brazil’s Bovespo Index up 314% in dollar terms during 2000-2009 - 15.1% a year - while Russian RTS index piled on 724%, an annual 23.3%

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MSCI EM S&P 500

The emerging markets beat the West and Russia beat all the other emerging markets

•  The S&P500 fell 25%, an average annual 2.4% loss, while the FTSE lost 24%

•  The Russian market has been volatile - but around a strong upward trend. And volatility and risk are not the same

RUSSIAN PROSPERITY FUND Fundamental Value Strategy

Blue Chip Focus

1996 Launch – $1.3bn AUM Weekly liquidity

Main Strategies

Investment Approach

•  Long-only - bottom-up, “buy and hold” philosophy, no leverage •  Fundamental value - Analyze, understand, monitor, stand by our convictions •  Thorough in-house research - extensive company visits (500+ per year) •  Unique network - strategic, political and corporate governance involvement for >15 years •  Active investor - on company boards representing > 30% of AUM during 2010

•  Leading Manager of Russian assets - outperformed market/peers since 1996 (US$ 4.3bn AUM) •  Specialized - Russia/CIS-focused, with consistent, 27-strong, Moscow-based investment team •  Vigilant - actively identifies and mitigates corporate governance risks •  Top-class client base – leading international institutions, SWFs, private banks and family offices

Fund returns as of 31 Sept 2011,

in US dollars and net of PCM fees

Investment Manager

PROSPERITY QUEST FUND Restructuring Strategy 2nd Tier & Below Focus

1999 Launch – $ 480m AUM Monthly liquidity

40% annualized return 53-fold rise since 1999 Fund

Index RTS 2: 9-fold rise, 23% p.a. MSCI RU: 2-fold rise, 13% p.a.

PCM - A HIGHLY-FOCUSED MANAGER

15

22% annualized return 21-fold rise since 1996 Fund

RTS: 7-fold rise, 15% p.a. MSCI RU: 3-fold rise, 12% p.a. Index

PQF yielded 44% a year 1999/2009 - with no leverage - world’s best fund

World’s Best Performing Funds, Dec 99 – Dec 09

TOP THREE FUNDS OF THE DECADE

Source: Morningstar Data – via Morningstar Direct Main PCM Funds, 2010 – StateStreet

•  Russia-focused funds took 5 of top-10 slots in all asset classes, 2000-2009

•  Prosperity Quest Fund returned 3,604% during the “noughties”, Prosperity Cub Fund was up 1,828% and Russian Prosperity Fund posted 1,605% so PCM was placed 1st, 2nd and 3rd

•  These world-beating returns, in dollars and net of PCM fees, used no leverage.

•  RPF offers weekly liquidity while PQF and PCF have monthly liquidity terms. We have never gated any client in any way

•  Since 2008 pull-back, PCM funds have continued their out-performance - easily beating the RTS and other Russia-funds in 2009 and 2010

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Main PCM Funds, 2010

10 Year Return Country

1. Prosperity Quest Fund 3,604 % Russia

2. Prosperity Cub Fund 1,828 % Russia

3. Russian Prosperity Fund 1,605 % Russia

4. East Capital Ryssland 1,565 % Russia

5. Xing Hua Fund 1,493 % China

6. RBC Global Precious Metals 1,380 % Canada

7. ZZ2 1,297 % Europe

8. SBI Magnum Sect. Umbrella Contra 1,230 % India

9. Anshun Securities Investment Fund 1,203 % China

10. URALSIB First Fund 1,126 % Russia

2009 2010

Russian Prosperity Fund 194 % 48 %

Prosperity Cub Fund 204 % 52 %

Prosperity Quest Fund 142 % 60 %

RTS Index 129 % 23 %

RUSSIA RANKS WELL AMONG BRICS

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BRIC countries compared, 2010/11

•  Some argue Russia shouldn’t be included among BRIC group of leading EMs

•  Yet Russia has highest BRIC GDP/capita, 2nd biggest reserves and lowest debts

•  Odd to exclude Russia but not surprising, given lingering “iron curtain of the mind”

•  EMs are widely perceived to be more risky - but they are systemically much stronger than the West

•  As the US, UK and now the Eurozone go for wholesale currency debasement, investors need to consider the impact on their asset allocation

•  Most big EMs have currencies that are likely to rise over an institutional investment horizon

China and India have mass,

cheap labour forces …

Brazil and (especially) Russia have resources …

Intra-BRIC growth

synergies are enormous …

… biggest synergy could

be CHINA & RUSSIA …

Russia remains “out of favour” – but that’s the real investment opportunity

RUSSIA Brazil India China

GDP ($bn) 1,688 1,511 1,367 5,365 GDP/cap ($) 11,578 9,210 1,124 3,999

Public debt 10.1 42.7 78.4 15.7 Budget Balance 0.0 + 1.1 - 6.5 - 3.1

Current Acc Balance + 4.4 - 2.9 - 2.2 + 6.2 FX Reserves 520 260 287 2,454

Reserves/Imports ratio 2.0 1.2 0.7 2.3

THE STATE’S ROLE •  Despite perceptions, Russia’s judiciary & corporate governance are much improved •  Amid explicit official recognition, definite steps being taken to tackle corruption •  Government has deliberately put this issue at top of domestic political agenda

---------------------------- •  Government’s first job is to “do no harm” - bureaucracy/regulation are being cut •  Legal framework, while still patchy, has many “investor-friendly” aspects •  State is also promoting infrastructure development - set to intensify given 2014 Winter Olympics & 2018 World Cup

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WHAT DO YOU KNOW ABOUT THE WORLD’S BIGGEST COUNTRY

•  Government spending only 20% of GDP •  Mass privatization in the 1990s - and on-going sell-offs •  Modernization driven by “Invisible Hand” - not top-down

•  Russian service sector, from nothing, now 30% of GDP •  Retailing, telecom, financial services adding value •  High-tech industry still small, but showing real promise

.. WITH BIG COMPARATIVE ADVANTAGES …

•  Unmatched resource endowment, going way beyond oil/gas •  World class supplies of metals, timber and soft commodities •  Strong human capital too - Canadian/Australian/Nordic model

RUSSIA IS A MARKET ECONOMY …

… DEVELOPING A GLOBAL FINANCIAL CENTRE

•  Government seriously engaged in IFC project •  Moscow superbly located between London and Hong Kong •  PCM has leading role in reform process

PCM finds and backs top modernizing entrepreneurs – benefitting our funds

… THAT IS DIVERSIFYING FAST AND ….

•  Real “modernization” being driven by firms restructuring, consolidating & diversifying corporate Russia.

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ECONOMY IS GROWING PRETTY WELL

•  The Russian economy grew by real terms 4% in 2010 and 3.7% during H1 2011

•  Steady recovery since 2008 - all-sector PMI consistently above 50 points

•  Manufacturing contributed 43% of growth in Q211, with trade’s share at 16% - both back at pre-crisis levels.

•  Between 2000 and 2010, GDP/head rose 9-fold, with each Russian becoming on average x3/x9 richer than their Chinese/Indian counterparts

Russian/Chinese PMI

As PMI China has recovered,

so has PMI Russia

Despite severe GDP contraction in 2009, Russia has recovered quite quickly

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DEMAND IS STRONG – INFLATION IS UNDER CONTROL

•  Ruble now “hard currency within it’s own borders” •  Lack of “dollar flight” helped re-boot credit markets •  Reserves recovered from $360bn to $530bn

HEADLINE NUMBERS - pointing North

•  H1 2011 GDP growth of 3.7% •  Industrial production up 6.8% January-August •  Serious drought Q3 2010 - so Q3 2011 “base effects”

CREDIT EXPANSION - Pro-growth •  Credit is growing at 20% per annum •  But from low base - personal credit around 5% of GDP

CURRENCY - Much more secure

FISCAL STRENGTH - Russia well-placed •  Budget Surplus of 2.4% of GDP Jan-Aug 2011 •  Total sovereign debts of 9% of GDP •  2011 budget assumes $93 average oil price

INFLATION DANGER?

•  During H1 2011, price pressures quite high •  Worst drought in 50 years in summer 2010 and food still 35% of basket - CPI hit 9.6% •  So CBR raised rates twice to 8.25%

•  2011 harvest looks good - grain haul of 90m+ tons, up from 61m in 2010 •  Russia set to export 20m+ tons this year •  In H2, adverse base effects turned benign •  CPI actually fell in August - driven by food •  End-August YTD inflation was 5.4% •  CBR 2011 target of 7.5% looks do-able •  Would be new post-Soviet low

•  Danger of higher spending in Q4 pre-election period - could provoke inflation. •  Huge reserve build-up (via heavy oil taxation) means stimuli often funded by cash - certainly not by QE-style “money-printing”

Economy has kept expanding despite sluggish demand in US and Western Europe

•  Retail sales up 5.8% January-August •  Fixed capital investment up 7.9% in Sept

VIRTUOUS CIRCLE - Investment & Consumption

PCM PHILOSOPHY - IN BEN WE TRUST

“In our experience, Graham’s ideas are applicable in Russia, just as elsewhere”

PCM’s success since 1996 has come about because we’ve kept our focus squarely on the companies - on cash-generation, on “value triggers”, on the quality of the management and potential for future productivity gains … in a market subject to so much “top-down” noise, and judged almost entirely from that perspective by international investors, we’ve spent the last 15 years being relentlessly “bottom-up”.

Mattias Westman, PCM Founding Partner

“Investment is most intelligent when it is most business-like”

“It is amazing to see how many capable businessmen operate on Wall Street with complete disregard of all the sound principles through which they have gained success in their own under-takings …. yet every corporate security may best be viewed, in the first instance, as an ownership interest in, or a claim against, a specific business enterprise …”

Benjamin Graham, 1949

21 “If you follow Graham, you will profit from folly, rather than participate in it” – WARREN BUFFET

Graham’s ideas work in Russia - but few investors bother to look beyond the

“top-down noise” …

SOVIET “PRODUCTION UNIT” WESTERN-STYLE COMPANY TRANSITION PHASE

State companies

Wireline

Oil

Power Utilities

Industrials

Wireless

Retail & Consumer Goods

TIME

Investment Goods/Serv

VALU

E

•  Productivity gains driven by transition of Soviet-era assets AND fast growth of de novo private sector

•  Restructuring and consolidation continue even during slow growth - not reliant on commodity prices

•  PQF “special situations” strategy focuses on restructuring/consolidation, but “fundamental value” strategy of RPF, also exploits such opportunities

•  Soviet production units were run inefficiently, but full of potential value as lots of previous capex

•  Better products, staff cuts and other RESTRUCTURING gains led to huge margin growth in some firms but still a long way to go

•  Domestic demand driving CONSOLIDATION of many sectors - eg. retail/consumer and power

RESTRUCTURING AND CONSOLIDATION - PCM’S “EDGE”

Capture value during Transition

22

QUEST

RPF

SHAREHOLDER GAINS

SOURCES OF SHAREHOLDER GAINS IN RUSSIA/CIS

3) RESTRUCTURING

•  Massive productivity growth during “transition” process

•  Largely driven by restructuring of previously state-owned assets

•  Soviet production units were run badly, but full of potential

•  Better products, staff cuts and other efficiencies have driven large shareholder gains

4) CONSOLIDATION

•  During mass privatization each factory/shop/oilfield became a free-standing legal entity.

•  Efficiency gains as fragmented economy consolidates

•  Process well underway but still scope for large upside

•  Second major source of PCM out-performance

2) COMMODITIES

•  Unmatched commodity wealth underpins Russian economy

•  Increasingly valuable as world population expands and growing demand from EMs

•  Resource-base being used to build stability - big forex reserves

•  Source of fiscal strength and shareholder value

1) ECONOMIC GROWTH

•  Russia’s “transition” has sparked long-term “catch-up” trend

•  Economic growth of 5% per annum over last ten years

•  Double-digit annual rises in construction and investment

•  One of Europe’s largest retail markets - Russians are x3/x10 wealthier than Chinese/Indians

Buying Russian “blue-chips” & ETFs give exposure mainly to 1) & 2)

RTS UP 800% AUG 2001 TO AUG 2011

PCM funds gives exposure to 1), 2), 3) & 4)

PCM FUNDS UP 1,300% - 2,500% OVER SAME PERIOD

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BETA

BETA

ALPHA

ALPHA

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AUGUST WAS A WICKED MONTH - AS WAS SEPTEMBER

Recent pull-back needs to be seen in context - which news wires rarely provide

•  Russian market down 23% YTD, but that’s the same as other emerging markets.

•  Ruble has held up pretty well, as has the oil price

•  Russia earnings CAGR 2011-2013 still 27%, even after late-summer downgrade

•  Valuations now extremely attractive

Russia V other EMs, Sept 2011

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Russian Prosperity Fund Prosperity Quest Fund RTS Index S&P 500

“Eyes on the horizon”

•  The Russian market is immature and volatile and lack of domestic institutional investors adds to this volatility - so levering is unwise

•  But volatility and risk are different. Over a longer-term investment period, tremendous value being created in Russia

•  By focusing on and helping to catalyze such value-creation, PCM funds have gained disproportionately …

Equity Index

YT-end Sept

10 yr-end Sept

P/E 11 Sept

Russia RTS - 24% +816 % 4.6x Brazil Bovespa - 25% + 560% 9.4x China Shanghai B - 16% + 271% 13.0x India Sensex - 20% + 510% 14.0x MSCI EM - 24% +330% - MSCI World - 14% +28% - S&P500 - 9% + 15% 12.2x

RUSSIA IN 1999

•  Russia now totally different place to 1999 - but valuations similar after “forced selling” of 2008, subsequent earnings growth and recent pull-back

•  Economy now far better – not least fiscal and external balances, forex reserves, wages and inflation

•  Corporate governance still tough, but also much improved since 1999 - and now no danger of Communist revaunchism

•  Best firms will gain from on-going restructuring of Soviet-era assets and general consolidation - a process targeted by PCM

•  In addition, higher incomes mean that Russia now among Europe’s very largest retail markets, leading to robust FDI as savvy investors compete for market share

RUSSIA IN 2011

VALUATIONS SAME AS 1999, BUT ECONOMY SO MUCH BETTER

25

Valuations back at “transition era” levels despite the massive progress that Russia has made

GDP $196bn

GDP per capita $1,346

Average wage $64/month

Sovereign debt 162% of GDP

Foreign exchange reserves (ex. gold) $7bn

Average oil price $17/bbl

Annual inflation 86%

RTS P/E Ratio (1999) 6.0x

GDP $1,850bn

GDP per capita $10,578

Average wage $805/month

Sovereign debt 10% of GDP

Foreign exchange reserves (ex. gold) $500bn

Average oil price $111/bbl

Annual inflation 8.5%

RTS P/E Ratio (2011) 4.6x

STRONG EARNINGS, MORE SHARE SALES IN THE PIPELINE

26 Biggest wave of privatization since the “voucher-auctions” of mid-1990s

Min Econ Privatization List 2012-15

Relative RTS valuation •  Russian market now displays an interesting

combination of low valuations and high earnings. •  In the wake of “sub-prime”, some EM equity

indices rose “too-far, too-fast” - but Russia has received little “hot money”

•  “Russia discount” is a symptom of high earnings, as well as foreign portfolio investor distaste.

•  In 2010, Russian IPOs totaled $5.5bn - involving companies from Mail.ru to Mostotrest

•  This was much better than 2008 & 2009 but still way below $36bn raised in 2007, when Russia was biggest source of LSE foreign listings

•  “New wave” of privatization - to which government is now committed - could be favorable for medium-term investment outlook

RUSSIA

Brazil

India China

U.S.

5.0

10.0

15.0

12.0% 14.0% 16.0% 18.0% 20.0% 22.0% 24.0% 26.0%

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E

2011-2013E Earnings CAGR

Russia - high earnings & low valuation

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THE CRUDE REALITY

Crude realities augur badly for the West, so mainstream opinion tries to deny

•  In early Sept, EIA altered global oil use forecasts, keeping 2011 the same, but lowering 2012 to 89.6 mbpd - still 2% annual rise and an all-time high

•  Global oil use now 15% up on 10 years ago. IEA sees 99.1 mbpd usage by 2015, another 15% rise, this time in 5 years

•  Even in 2009, historic slowdown, global oil use fell just 2%, then grew 4% the following year.

DEMAND-SIDE RELENTLESS

SUPPLY-SIDE UNREST Source: Energy Information Agency (US Gov), BP Statistical Review 2011

2010

2011 (Old)

2011 (New)

2012 (Old)

2012 (New)

2015F

US GDP

growth (%) 3.0 2.4 1.5 2.6 1.9 -

World oil use

(m barrels/day) 87.3 88.2 88.2 89.8 89.6 99.1

•  On the supply side, EIA sees short term deficit of 0.7mbpd in Q3 2011 and 1.4mbd for Q4 2011

•  Looking forward, credit-crunch has cut investment in exploration and well-development

•  Oil markets showing more interest in problems at Ghawar, Cantarell and other giants fields

•  OPEC politics turned upside-down by “Arab Spring” - Saudi budget now balances at $114 average

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MARKET OUTLOOK - FUNDAMENTALLY STRONG

•  Many low-levered firms, robust during crisis •  Acceleration of consolidation/restructuring gains •  Best returns often from non-energy names

3) ECONOMY - Recovering well

•  GDP growth of 4% in 2010 - inflation subdued •  Continued expansion - 3.7% growth in H1 2011 •  Another big trade surplus and still fiscally strong

2) TECHNICAL - RTS set to gain

•  GEM weighting remains low - upgrades to come •  Russia still to benefit from post sub-prime EM shift

1) COMPANIES - Getting better

4) STRATEGIC - Russia well-placed

•  On-going demand for commodities, metals, minerals •  Large and fast-growing consumer market •  Symbiotic relationship between Russia and China •  Investors increasingly seeking “tangible assets”

“Another “Minsky moment?”

In the event of “Lehman II”, Russian market looks much stronger than 2008

•  Starting valuations lower •  Much less levered “hot-money” in the market •  Company balance sheets more robust

•  Far lower dollar-denominated debt to service •  Russians now saving in rubles, not dollars •  Ruble now “under-valued”, not “over-valued”

•  Oil not pumped-up by speculative money •  Previous drop from $149 to $32 per barrel •  “Worst case” scenario now from $100 to $60 •  OPEC politics transformed since 2008 •  Middle East producers now higher spenders

•  Global investors now more pro-EM •  QE/Western debts mean more investor demand for markets/currencies backed by tangibles

Main value drivers still in place - and market looks a lot more robust than 2008

2010 P/E 4.6x

2010 P/E 9.4x

RUSSIA

BRAZIL

•  Liquidity under-reported - fragmented exchanges, lots of OTC

•  PCM trades less liquid names beyond exchanges via unrivalled network

•  Also liquidity from strategic sales, often at market premium

•  PCM open-ended funds never gated Lower-tiers

“DEEP VALUE”

PCM gives exposure to deep value plays while tackling genuine risks

•  Economy strong - despite skepticism •  6% annual growth 2000-10 •  10 years of external surpluses •  World’s 3rd largest forex reserves •  Very low economy-wide leverage •  Commodities only 20% of GDP

•  Putin/Medvedev extended privatization to ports, power utilities, railways …

•  13% basic rate of income tax •  State owns 35% of oil industry -

lowest of any major crude exporter •  2003 Yukos case was a “one-off” - to

rein-in then over-powerful oligarchs

•  Main danger of investing in Russia - but focus of PCM efforts/expertise

•  15 years’ on-the-ground experience of spotting, avoiding and fighting abuses

•  PCM on many boards •  Runs Investor Protection Association •  Ability to tackle governance, plus

impact on valuations, - big part of PCM investment opportunity

Macro Risks

OVER-STATED

Liquidity Risks

OVER-STATED

Additional “Lower-Tier Discount”

“Russia Risk Discount” •  Macro risks •  Political risks •  Liquidity •  Corporate governance

RISKS AND “THE RUSSIA DISCOUNT”

29

Political Risks

OVER-STATED

Corporate Governance Risks

GENUINE

•  Perceived risks drive discount - mostly overstated •  PCM well-placed to deal with genuine governance dangers

30

CORPORATE GOVERNANCE IS MUCH BETTER, BUT STILL TOUGH

BIG IMPROVEMENTS IN CORPORATE

GOVERNANCE

OPERATIONAL

•  Restructuring and consolidation mean firms now less complex

•  Clearer structures also make companies easier to manage

•  Also easier for investors/creditors to understand - brings improved access to capital.

TAX CODE/LEGAL •  From 2002, new tax code banned “transfer pricing” - led to drastic cut in minority abuse

•  Enforcement more efficient and consistent - especially since 2004

•  Corporate case law now helping to stabilize property rights

PRIVATIZATION •  Privatization has helped align shareholder/manager interests

•  Managers now motivated by value-creation, not speculative gains or “empire-building”

•  Privatization has helped root-out state-sector corruption

INVESTOR/PEER PRESSURE

•  Russian BoD appointments made by proportional representation

•  Managers mindful of IPO/trade sale, takeovers and arbitration

•  Increasing impatience with firms harming Russia’s reputation

It’s getting better ... but problems remain … which requires “active” investment

Governance Improvement Drivers 1996-2011

31

15 YEARS OF SHAREHOLDER ACTIVISM

POLICY ACTIVISM •  POWER SECTOR: In 2002, PCM made detailed proposals on how to reform and restructure Russia’s Soviet-era power sector

•  Invited to policy meetings with Putin and appointed to UES Advisory Committee and heavily influenced the privatization and unbundling of Europe’s biggest power sector

------------------------------

•  DIVIDEND LAW: PCM sued Surgut in 2003 over manipulation of “net profit”, which resulted in lower dividends on preferred share

•  Court case highlighted loophole - and our lobbying efforts led to change in Russian statute to include proper net profit definition

------------------------------

•  IFC CORP GOVERNANCE CTTE: PCM founded Investor Protection Association - main lobby group for Russian minorities

•  In 2011, Kremlin asked PCM’s Alexander Branis to lead official Corporate Governance Advisory Group. Committee meets weekly and has pivotal role creating crucial legislation

Corporate governance improving - but big premium on being a local, specialized manager

SUCCESS: GAZ

SUCCESS: ATF

SUCCESS: DIXY

SUCCESS: LAFARGE

CURRENT DISPUTE: TGK 2

2011: PCM successfully sued GAZ in a regional court over unpaid dividends. The automaker appealed, lost again, and then paid-up. GAZ is controlled by Oleg Deripaska, one of Russia’s richest men

2007: Unicredit buys 3rd biggest Kazakh bank, holds EGM diluting pref shareholders. PCM, holds of 9% of prefs, lobbies Kazakh ministers and LSE - then cuts deal to sell prefs back to ATF for 450% gain

2006-2011: As board member of leading Russian food-retailer, PCM pushed for consolidation, helping to facilitate and finance acclaimed Dixy-Victoria merger

1999: PCM begins building big stake in Voskresensk Cement, majority-owned by Lafarge. PCM sues Lafarge for unjustified royalty payments to subsidiary. Lafarge eventually offers VTO at big premium

2008 onward: Owner of newly-privatized genco refuses to honour agreed MTO, resulting in protracted legal action by minorities, initiated and driven by PCM - including in Russia’s Supreme Arbitrage Court

------------------------------

FDI INVESTORS WAY AHEAD OF PORTFOLIO INVESTORS

32

•  Russia was second only to China among large EMs in terms of FDI in 2006-09, attracting gross $359bn accroding to UN data.

•  By end of 2009, Russia’s FDI stock was 12 times larger than at the turn of the millennium and FDI/head during this period was 2x Brazil, 4x China and 9x India.

•  UN says Russia’s FDI stock 2005-2009 was: 31% primary (oil, gas, mining and agriculture) 38% secondary (manuf, utilities, construction) 31% services (retail, telecoms, real estate)

•  FDI investors piling-in, seeking market share •  WTO accession - likely 2012 - will accelerate trend

•  Enel, E.On & Fortum have all made $5bn+ investments •  $2bn by Renault, $1bn by Peugeot-Citroen, $1.5bn by VW •  $2bn by Societe General, $6bn by BP, $6bn by Eni •  $5bn by Boeing, $500m by John Deere •  $800m by Unilever, $600m by P&G, $700m by Ilim •  $1bn by Cisco Systems, $4bn by Ikea + Volvo, Toyota, Samsung, Tetrapak, Arcelor, Axa …

FDI across the BRICs $bn

FDI investors know more than portfolio investors, and a lot more than the media

THE WESTERN PRESS – AUTHORITATIVE, BUT WRONG

33

•  The Western press treats Russia as “different” – focusing on espionage and geo-politics, while practically ignoring the business story

•  Even the Financial Times and Wall Street Journal portray Russia in terms of lingering Cold War cliches – barely reporting evidence of rapid commercial and economic progress

•  The Economist has been consistently wrong - long predicting that Russia’s post-Communist economy would collapse into chaos, leading to mass protests and social unrest

•  Such lurid reporting has stymied the flow of portfolio investment into Russia – helping to generate the under-valuation which is part of today’s investment case

•  Russia is no investment utopia – but business environment is no worse than other large EMs and in some cases is much better

FUTURE HISTORIANS’ VERDICT

•  Western world CAUSED sub-prime - the lack of regulatory oversight and, above all, the wild policy response to crisis, will make historians wince

•  We have tried to solve a problem of too much debt by taking on yet more debt while QE is a “back-door bail-out” of banks that are basically bust, and should fold

•  The UK is now close to insolvency - recovery from which will take a generation

•  Bank loses have been passed on to governments, and now sovereign debts are being monetized - which will ultimate lead to massive currency realignment

•  Sub-prime and resulting loss of faith in Western markets/institutions will speed shift of centre of economic gravity from West to East

•  EMs are less risky than DMs - it is difficult for Westerners to admit, but investment should not be an emotional business

GRIM REALITY WHAT TO DO

•  Big banks have “captured” government - this stranglehold must be broken

•  Volcker rule was a good step forward, but was heavily diluted - and UK has followed suit

•  “Glass-Steagall” no panacea - must also rein-in securitization and impose counter-cyclical reserve requirements - but would be a start

•  Force banks to “fess-up” losses, so credit markets can reboot - if not, no real recovery

•  Remember what happened to “Sunny Jim” – and prepare for inflation

•  Diversify your portfolio - “go where the growth is” and to countries with surpluses and currencies that are likely to rise

•  Investors should look, above all, at countries with low debts and tangible assets - assets that “governments can’t print more of”

APPENDIX

PCM monthly net flow of funds, 2010 and 2011

•  Net subscriptions were $370m in 2010 •  This year, global sentiment has been far more negative,

but up until the end of August, PCM has still seen net inflows of $170m so far during 2011

•  Interest and demand are growing, not only in Europe and the US, but also the Middle East and Asia - in particular among FOs, pension funds and SWFs

36

-50

0

50

100

150

200

Jan-

10

Feb-

10

Mar

-10

Apr-

10

May

-10

Jun-

10

Jul-1

0

Aug-

10

Sep-

10

Oct-

10

Nov-

10

Dec-

10

Jan-

11

Feb-

11

Mar

-11

Apr-

11

May

-11

Jun-

11

Jul-1

1

Aug-

11

THE WORLD’S BIGGEST RUSSIA/CIS-FOCUSED MANAGER

•  PCM was launched in 1996 with $28m AUM

•  15 years on, we control $4,500m of assets in Russia, Ukraine, Georgia and Central Asia - the largest Russia/CIS-focused asset manager in the world

•  The RTS remains some 35% below is pre-crisis peak, but PCM AUM is close to all-time high - driven by on-going net inflows and strong outperformance

Source: State Street

Steady subscriptions during 2010 and 2011 - despite poor global investor sentiment

$370m net inflows in 2010

$170m net inflows so far

in 2011

37

INSTITUTIONAL, STABLE - BUT DIVERSIFYING - CLIENT BASE

PCM CLIENT-BASE - BY TYPE (AUG 2011) BY ORIGIN (AUG 2011)

•  PCM’s 1996 launch was built on Nordic money and Scandinavia still accounts for a large share

•  Almost half our money now comes from Western Europe (including Switzerland) and we also have many prestigious clients across North America

•  Our client-base is diversifying into the Middle East and Asia - and we work on behalf of a growing number of sovereign wealth funds.

WESTERN EUROPE

SCANDINAVIA

NORTH AMERICA

MIDDLE EAST

JAPAN/ASIA

OTHER

46%

32%

14%

4%

3%

1%

Institutions Sovereign Entities FOs & (U)HNWIs Asset Managers Private Banks Pension Funds Insurers Foundations Other

Source: State Street

Sticky, institutional money - which has been consciously allocated to Russia

•  PCM never chases retail money and the funds we manage derive entirely from outside Russia

•  All our clients are institutions or quasi-institutions that have made a conscious commitment to Russia - rather than a generic BRIC or EM fund. Many “core clients” know Russia well - and have been with us for a decade or more.

•  As a result, our money is “sticky” - and lots of PCM investors use market pullbacks to increase their allocation.

Fund AUM Strategy Description

1996 Russian Prosperity

Fund

Fundamental value - Shareholder activism $1,366m Open-ended,

Weekly Liquidity

2010 Prosperity Quest II

Restructuring - Shareholder activism $142m Closed-ended

2006 Prosperity Voskhod

Fund

Restructuring - Shareholder activism $345m Closed-ended

Listed on AIM

2007 Prosperity Russian

Domestic Fund

Fundamental value - Domestic focus $277m Closed-ended

Listed on AIM

1999 Prosperity Quest Fund

Restructuring - Shareholder activism $477m Open-ended in 2003,

Monthly Liquidity

2008 Sovereign Wealth

Mandate

Fundamental value - Blue-chip and mid-

cap bias Not Disclosed

QU

EST R

estructuring Strategy

Bespoke vehicle

1998 Prosperity Cub Fund

Fundamental value - Shareholder activism $157m Open-ended,

Monthly Liquidity

KEY PCM FUNDS – 1996/2011

1999/2005/2007 New Russian Generation

Restructuring Power-sector focus Strategic holdings

$621m Closed-ended

Derives from Quest Power 1999 & Prosperity Aurora 2005

38

QUESTION AND ANSWER

SESSION