Transitioning Emerging Markets Equities

July 2015

Transitioning Emerging Markets Equities Operational and Risk Considerations

Abstract

Investment in emerging market (“EM”) equities has increased substantially over the

last 10 to 15 years as investors have sought out perceived growth and diversification

benefits. Along with these potential benefits come challenges associated with

investing and trading in these markets. In particular, there are many nuances

specific to trading EM equities which tend to result in higher transaction costs and

increased risk relative to trading in developed markets (“DM”). As such, managing

portfolio transitions involving EM equities requires a heightened level of attention to

both operational and investment risks. This paper identifies and discusses some of

what we believe are the most important considerations and implications from a cost

and risk perspective.

We begin with a brief overview of the current state of EM equities, including growth

in investment and trading volumes over the recent past. We then review some of the

operational aspects (e.g., account and market structure) from the perspective of

transitioning assets within these markets. Next, we examine trading costs, broken

down into key components, and discuss factors unique to EM equities which may

contribute to higher costs relative to developed markets.

Finally, we examine portfolio risk management techniques including execution timing

and optimization as well as some challenges related to foreign exchange (“FX”)

trading, managing market exposure and hedging. In this final section, we present a

quantitative comparison of volatility, liquidity and correlation between a sample of

EM and DM portfolios. This includes a statistical test of correlation stability. In

addition to higher volatility and greater uncertainty in liquidity, our findings suggest

that correlations between EM stocks are less stable than DM stocks, making it more

difficult to predict security-level tracking error and reduce risk during a (short-term)

transition event.

Portfolio Solutions

Strategy

Steve Fenty, CFA

Head of Strategy State Street Global Markets Portfolio Solutions +1 617 664 1546 [email protected]

Dan Constantine, CFA

State Street Global Markets Portfolio Solutions Strategy +1 617 664 4802 [email protected]

Glenn Cooper, CFA


Rick Zhan, CFA, FSA


STRATEGY RESEARCH

July 2015 PORTFOLIO SOLUTIONS 2

Table of Contents

I. Overview of Emerging Markets ............................................................................................................................ 3

II. Operational Aspects ............................................................................................................................................ 4

Account Opening Process ................................................................................................................................ 4

Cash Accounts & Foreign Exchange Trading .................................................................................................. 5

Other Operational Considerations .................................................................................................................... 6

III. Trading Costs and Considerations ..................................................................................................................... 7

IV. Portfolio Risk Management ................................................................................................................................ 9

Timing Risk and Tracking Error ........................................................................................................................ 9

Emerging vs. Developed – Correlation, Volatility & Liquidity.......................................................................... 10

Currency Risk ................................................................................................................................................. 13

Market Exposure / Hedging Considerations ................................................................................................... 14

V. Putting It All Together ........................................................................................................................................ 15

VI. Appendix .......................................................................................................................................................... 16

A1. Charts from IIF “Capital Flows to Emerging Markets” Papers ................................................................ 16

A2. EM Country Grids .................................................................................................................................... 17

A3. Box’s M Test of Correlation Matrix Equality ............................................................................................ 28

A4. Table 7 – EM Futures Contracts ............................................................................................................. 30

A5. Example of MSCI EM Exposure Options – MES Futures vs. EEM ETF ................................................. 31

References .......................................................................................................................................................... 32

SSGM Portfolio Solutions Strategy Team ........................................................................................................... 33

Disclaimers and Important Risk Information ....................................................................................................... 33

STRATEGY RESEARCH


32

46

0

10

20

30

40

50

60

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(bln USD) EEM Net Assets VWO Net Assets

0

1,000

2,000

3,000

4,000

5,000

6,000

201

4

201

3

201

2

201

1

201

0

200

9

200

8

200

7

200

6

200

5

200

4

200

3

200

2

200

1

200

0

(bln USD) MSCI EM Index Volume

sources: MSCI, FTSE, State Street Global Markets

CHART 1: Index Weights by Country

0% 5% 10% 15% 20% 25%

China - Hong Kong

Republic of Korea

Taiwan

Brazil

South Africa

India

Mexico

Russian Federation

Malaysia

Indonesia

Thailand

Turkey

Poland

Chile

Philippines

Qatar

Colombia

U.A.E.

Greece

Peru

Egypt

Czech Republic

Hungary

Pakistan

Morocco

MSCI EM FTSE Emerging

I. Overview of Emerging Markets

Markets may be categorized as developed, emerging or

frontier based on a variety of factors including economic

development, size and liquidity, and market accessibility1.

Two widely used benchmarks for EM equities are the

MSCI Emerging Markets Index and the FTSE Emerging

Index. Chart 1 to the right shows approximate weights by

country as of the end of December 2014 for each of these

indices. We note these two index providers’ resulting

classifications of countries as emerging are largely similar,

with the main exception that FTSE considers the Republic

of Korea to be a developed market.

Investment and trading in EMs has increased substantially

over the last 10 to 15 years. Based on research published

by the Institute of International Finance Research (“IIF”),

EM private capital flows have been markedly positive

every year thus far in the 21st century. And while

institutional investors’ allocation in percentage terms to

EM equities has declined over the last few years, private

capital equity inflows have held steadily positive at 600 bln

USD or more per year since 2010.2 Increased interest in

EM equities is also evident in the trading volumes of the two aforementioned indices and assets under

management of two of the most widely used EM ETFs, as shown in Charts 2 and 3 below3. Since 2005, trading

volumes in the MSCI EM Index have more than doubled and the combined AUM of the iShares MSCI EM ETF

(“EEM”) and Vanguard FTSE EM ETF (“VWO”) has grown from 10 bln USD to more than 75 bln USD.

CHART 2: EM ETF Assets CHART 3: EM Trading Volumes

1 source: MSCI press release “MSCI Announces Results of the 2014 Annual Market Classification Review” (June 10, 2014)

2 source: IIF paper “Capital Flows to Emerging Markets” (May 28, 2015); see Section A1 of Appendix for supporting exhibits

3 as of December 31, 2014; sources: Bloomberg, State Street Global Markets

STRATEGY RESEARCH


II. Operational Aspects

Operational risks are those associated with the structure, instruction and settlement of the transition. A

Transition Manager (“TM”) must pay special attention to operational aspects associated with EM equity and FX

transactions. Processes may be unique to each country/ market and include (but are not limited to) the following:

account opening procedures and timing;

operating structure of cash accounts and FX trading conventions in given currency;

settlement timing, delivery and funding requirements and exchange schedules / holidays.

Effective management of these operational aspects is critical to completing a restructure involving EM equities in

a timely and efficient manner. This includes the avoidance of costs associated with, for example, buy-ins and

penalties due to failed delivery, interest charges on overdraft balances, or losses due to non-execution (or

delays) where prefunding is required. In particular, multiple listings and settlement locations in the Asia-Pacific

region have serious implications due to short settlement cycles, strict buy-in practices and adverse time zone

factors.

ACCOUNT OPENING PROCESS4

The timeframe for opening accounts in EM countries is dependent upon each market’s documentation and

review practices. The account opening process is generally shorter (i.e., one to two days) in markets that do not

require documentation.

It may take longer to open accounts in “documentation markets” requiring submission and notarization of

paperwork showing proof of ownership, residence, legal structure, etc.5 The quality, accuracy and completeness

of the documentation may affect account opening timeframes – potentially resulting in delays if information is

missing or unclear. Regulators may request further clarification pursuant to their review of the paperwork

provided. Custodians may request that applications for opening new accounts are provided a week or more in

advance of the date on which the client wishes to have documentation submitted. The documentation review

and account opening process may then take up to 45 days to complete.

Investor registration is mandatory in the majority of EM countries and may require additional lead time as this

process can take weeks or even months to complete. A prime example is the Republic of Korea, where foreign

investors are generally required to apply for and obtain an Investment Registration Certificate (“IRC”) from the

Financial Supervisory Service (“FSS”) or Commission (“FSC”) in order to participate in domestic securities

markets.

4 source: State Street Investment Manager Guide revised July 1, 2015 (please note, this guide is updated from time to time)

5 In such markets, clients must often sign over authority to a sub-custodian or other third-party to take certain actions on their

behalf.

STRATEGY RESEARCH


Table 1 below shows estimated account opening timeframes (business days) for each country in the MSCI EM

Index. We note that these may vary by custodian, are subject to change due to market conditions and

requirements mandated by regulatory authorities, and do not incorporate additional time for investor registration.

TABLE 1: Account Opening Timeframes6

CASH ACCOUNTS & FOREIGN EXCHANGE TRADING

We highlight important distinctions between the operating structures of cash accounts for certain EM currencies.

For markets denominated as “on-book” (On-Book Markets), the custodian implements an operating structure for

cash accounts in the given currency, whereby the custodian opens and operates deposit accounts on its records

on behalf of clients. Under the operating structure in the remaining markets (Off-Book Markets), the custodian

may open deposit accounts on behalf of clients at selected sub-custodian banks. In an On-Book Market,

deposits and associated risk of insolvency loss are held with the custodian. In an Off-Book Market, deposits are

maintained and the client’s risk lies with the sub-custodian.

In an Off-Book Market, the TM must instruct the custodian for execution of FX transactions with the sub-

custodian rather than trading directly with a broker on behalf of the client. Such currencies where third party

trading is prohibited are often referred to as “restricted”. Since the TM does not have control over the exact

timing and execution of these foreign currency transactions, they may not align with the transition benchmark,

resulting in additional risk and potential tracking error. EM currencies that are restricted or operate generally as

Off-Book Markets include the following: CLP (Chile), CNY (China), COP (Colombia), EGP (Egypt), IDR

(Indonesia), INR (India), KRW (Republic of Korea), MYR (Malaysia), PEN (Peru), PHP (Philippines), PKR

(Pakistan) and TWD (Taiwan).7 In addition to restrictions on outside investors, clients that are domiciled within

certain EM countries may be subject to domestic controls which constrain their allocation to foreign investments

and / or the manner in which currency trading can be executed. For example, local EM companies may be

limited by or need regulatory approval from their own country in investing overseas, and could be required to

trade FX through an authorized onshore dealer. More detail on currency trading for each EM country is provided

in Section A2 of the Appendix.

6,7 sources: State Street Global Markets, State Street Investment Manager Guide revised July 1, 2015 (please note, this

guide is updated from time to time)

China ‒ Hong Kong

Greece

Hungary Indonesia

Mexico Brazil Republic of Korea * Chile

Philippines Czech Republic Malaysia Colombia

South Africa Egypt Peru Taiwan Qatar

Thailand Poland United Arab Emirates Turkey Russia India *

1-2 Days 3-5 Days 5-7 Days 7-10 Days 10-14 Days 2+ Weeks

* note, the account opening process may take more than a month for Republic of Korea (due to IRC requirements) and India

STRATEGY RESEARCH


Restricted currencies come with their own set of unique considerations requiring a deep understanding by the

TM to efficiently navigate. An account may be set up to have standing FX instructions in place with the custodian

to repatriate when transactions are executed in restricted foreign currencies. In the context of a transition,

particularly one involving EM equities, the use of standing instructions may present operational challenges and

inefficiencies. While the custodian may have a “typical” schedule for executing FX spot transactions for some of

these currencies (e.g., T+1 for net buys and settlement date for net sells), the timing may vary and custodians

settle gross in many cases. In fact, buying and selling cannot be netted in certain restricted markets. Also,

repatriation trades are often released in batches as trades are confirmed or matched periodically, at which time

there is no guarantee that all trades in a particular market have been received and booked. For instance,

assume that a group of buy trades in a given currency was released in the morning (local time) before a batch of

sells later in the day. The custodian may first execute an FX trade to cover the buys (without regard for the sells)

and subsequently repatriate the sale proceeds. In this case, in order to net buys and sells for FX purposes, the

TM would need to avoid the use of standing instructions. By initiating trades manually instead, a TM may be able

to reduce transaction costs by taking advantage of netting opportunities, while also having greater control over

the timing of FX executions.

OTHER OPERATIONAL CONSIDERATIONS

Settlement requirements vary by country in emerging markets. For example, some EM transactions settle

shorter than T+3 (e.g., Chile, India, South Korea, Taiwan, Turkey, UAE). South Africa continues to move toward

T+3 but still settles T+5. In Russia, settlement timing may vary from trade date to T+15, although a T+2 cycle

was recently introduced on the Moscow Exchange. Egypt has a different schedule for buys (T+2) and sells

(T+1). And while India is technically a T+2 market, direct custodial settlement requires that buys are effectively

settled on a T+1 basis. There are also countries that call for pre-funding to be arranged on purchases, such as

India and Taiwan. More detail on the settlement requirements for each EM country is provided in Section A2 of

the Appendix. The regulatory framework is often quite complicated and fluid (e.g., the Brazilian FX tax lasted for

approximately two years beginning in 2009). Many EM countries in Asia have very strict buy-in policies which

can result in suspension from exchange trading if violated. This is important because corporate actions often

cause changes in share holdings so a TM must be careful not to short sell securities. Additionally, exchange

trading hours and holidays within the trading horizon must be monitored and appropriately accounted for in

constructing a transition strategy, particularly when attempting to maintain cash neutrality. For example, the

Qatar Exchange as well as Egypt and U.A.E. exchanges operate Sunday through Thursday, and therefore a

transition scheduled to trade on a Friday may experience delays attributable to these markets.

In addition, certain EM countries may require additional information to be provided prior to or at the time of trading –

such as tax identification or registration numbers, standing settlement instructions, and even commissions – and may

require the set-up of special accounts in order for trades to be executed and booked correctly. This is often the case

for direct settle markets (i.e., no third party settlement) in EMEA and Latin America where investors must provide proof

of ID / registration in order to settle with local brokers.

STRATEGY RESEARCH


0

10

20

30

40

50

60

US Large Cap Global Developed(Ex-US)

Emerging

(bps) Sample Transition Costs

Taxes/Fees

FX Spread

Market Impact

Bid Ask Spread

Commissions

CN, MX, RU, TH, TR, PL, CZ, HU,

SA (39%)

BR, IN, MY, ID, QA, CO, UAE, PE, EG (23%)

KR, TW, CL, PH,

GR (38%)

MSCI EM Index Weights

IKs Allowed

IKs Prohibited

Other

III. Trading Costs and Considerations

Transitions involving EM equities are generally more expensive than those for DMs, as shown in the sample

transition costs by component in Chart 4 on the bottom left of this page8. There are several nuances unique to

an EM equity restructuring which may contribute to costs that are generally higher than DM transition events. On

the next page, we discuss potential contributors to higher costs. But first, we highlight considerations which are

somewhat unique to EMs related to in-kind transfers and depository receipts.

In developed and emerging markets alike, redemptions and contributions can generally be made “in-kind” (i.e., in

securities rather than cash) free of charge to the extent that the accounts involved are managed on a separate or

segregated basis and thus there is no change in beneficial ownership (“NCBO”). Such transfers may reduce

costs and expedite completion of a transition by reducing the amount of trading required to implement a

transition. In the case of a taxable account, in-kind transfers may potentially avert taxation from capital gains

associated with selling securities. However, for a transition involving redemptions or contributions in pooled

vehicles, commingled funds or Unit Trusts, assets are registered in the name of the fund. While this may not

present transferability issues in developed markets, in certain EM countries, any transfer represents a change of

beneficial ownership or “CBO”. Therefore, in-kind transfers may be administratively difficult, heavily taxed or

prohibited in some EM countries, resulting in increased transaction costs for an EM equity restructuring. In such

cases, a transition manager may be able to facilitate “on-market” cross trades (where regulations allow) with a

legacy or target commingled fund. These trades would be printed on the exchange but still afford the client

potential savings on some implicit costs such as bid ask spread and market impact. Chart 5 to the right below9

shows EM countries categorized based on whether in-kinds are allowed, prohibited or “Other” along with the

corresponding weights of each group within the MSCI EM Index. The “Other” category includes countries where

such transfers are cost- or administratively- prohibitive. For example, while in-kinds are technically permitted in

the Republic of Korea, Taiwan and Chile, they may be subject to regulatory restrictions and approval (or simply

may not reflect common market practice), and therefore can be difficult to implement.

CHART 4: Sample Transition Costs CHART 5: Index Weights by Country

8 source: State Street Global Markets Transition Management database for 2012–2014.

9 sources: “MSCI Global Market Accessibility Review” updated on June 11, 2015, State Street Global Markets

STRATEGY RESEARCH


An EM transition may also involve stocks where American or Global Depository Receipts (“ADRs” or “GDRs”) of

shares are available on global exchanges in addition to the local line. This presents yet another level of

complexity and additional cost consideration. The fungibility10

of ADRs or GDRs may allow a TM to use local

markets to potentially reduce opportunity costs by converting to the local line or accessing local line liquidity via

third party broker. The additional spread charged by brokers to convert ADRs or GDRs to local exchanges can

often be justified when accelerating the transition out of the legacy assets. For example, the local exchange

listing might show considerably higher liquidity as compared with the ADR, which could lead to trading the

position in a shorter time period and reducing the opportunity cost risk. Note, it may be preferable for the TM to

work with the target manager to see if the local line or depository receipt (whichever is held in the legacy

portfolio) is acceptable. Trading both sides (i.e., selling the ADR or GDR and buying the local line) is generally

more expensive than converting. Therefore, this strategy should only be used as a last resort, when the target

manager is not amenable to the ADR or GDR and converting to the local line is not practical.

In Table 2 below, we take a closer look at some of the factors that may contribute to higher costs for each component

previously identified in Chart 4.

TABLE 2: Components of EM Transition Costs

Commissions

Commission rates charged by TMs may be higher for EMs (relative to those for DMs) due to costs associated with

accessing local markets (via direct exchange membership or third party broker), maintaining trading desks that

understand the intricacies of each market, and increased operational trading risks in these markets (many of which are

discussed herein). Commissions charged by onshore third party brokers in some EMs and many frontier market

countries may be substantial. Further, an EM equity transition involving commingled funds may incur greater

commissions where securities for certain EM countries may not be transferred in-kind. These markets need to be

liquidated by the legacy manager and/or purchased by the target manager, thus reducing in-kind potential and

increasing costs.

Taxes and

Fees

EM countries, particularly in Asia, tend to charge higher taxes and other fees than DMs. This may include transaction

taxes on buys and/or sells, stamp duties and clearing/settlement fees. In the case of a commingled fund, double

payment of stamp duty may arise if a TM purchases securities with stamp duty – e.g., China H-shares traded in Hong

Kong. That is, the client would pay the stamp duty first on the purchase and then again on the contribution to the

commingled fund. One potential way to avoid paying double stamp duty is to contribute cash in lieu of securities for

target names in countries where this situation applies.

Equity Bid-

Ask Spreads

and Market

Impact

EM stocks and currencies tend to be less liquid than DM counterparts, resulting in higher bid-ask spreads and greater

potential for market impact. This highlights the importance of the pace of trading in EM equities – aggressive buying or

selling could result in excessive market impact while trading too passively opens the door to additional opportunity costs.

Volumes also tend to be more volatile, making it difficult to accurately predict implicit costs such as bid-ask spreads and

market impact. A TM with a global trading infrastructure has the ability to control the pace of trading and manage the

ebbs and flows of liquidity opportunities real-time during the wide range of EM trading hours.

FX Spreads

Some EM currencies do not have a liquid offshore FX market and therefore may require onshore trading. Investors may

be limited to a select group of local intermediaries able to transact onshore, and thus lose some control over the

execution, potentially leading to higher costs. Trading at the benchmark rate may be difficult or unattainable resulting in

further implementation risk. Currency shortages and lower liquidity may also lead to wider spreads.

10 “Interchangeability” – i.e., depository receipts may be converted to local shares or vice versa.

STRATEGY RESEARCH


IV. Portfolio Risk Management

Portfolio risks are those associated with the management, execution and performance of the transition.

Opportunity Costs are attributable to the actual timing risk due to tracking error between the portfolios during

the transition period. Market Impact represents the cost associated with accessing liquidity for larger orders.

Some of the important contributing factors to opportunity cost risk (i.e., timing of executions, correlations, and

country and currency risks) and market impact risk (volatility and liquidity) for EM transitions are discussed in the

sections below. We also review some options and considerations for obtaining or hedging EM equity exposure.

TIMING RISK AND TRACKING ERROR

During an EM transition, the portfolio is managed across three separate regions (APAC, EMEA and the

Americas) to account for the effect of time zone differences and market overlap. It can be particularly

challenging, and often impossible, to optimize trading and remain cash neutral across a vast array of time zones.

This requires close coordination between the TM and parties responsible for trading to identify periods of

advantageous volume and volatility characteristics within each market, and subsequently match purchase and

sale trades across several time zones while maintaining market exposure. In our experience, this is one of the

most important aspects of a transition and one that could be detrimental if overlooked. If the portfolio is

overexposed to the market and a general de-risking day prevails across the equity universe, the leverage in the

transition portfolio acts as a multiplier on the amount of the loss. For example, a 20% overexposure could cause

30 bps of tracking error in the event of a 1.5% average decline in the MSCI EM Index. Chart 6 below shows the

primary exchange trading periods for the countries in the MSCI EM index.

CHART 6: EM Trading Hours by Country11

11 as of June 30, 2015; gridlines represent 15 minute increments; sources: Bloomberg, State Street Global Markets

Brazil

Chile

Colombia

Mexico

Peru

Czech Rep

Egypt

Greece

Hungary

Poland

Qatar

Russia

South Africa

Turkey

UAE

China

India

Indonesia

Korea

Malaysia

Philippines

Taiwan

Thailand

Tokyo Stock Exchange London Stock Exchange New York Stock Exchange

CLOSE CLOSE CLOSEOPEN OPEN OPEN

STRATEGY RESEARCH


TMs typically utilize trade optimization techniques that consider characteristics such as security level volatility,

correlations and market liquidity in order to reduce tracking error between legacy and target portfolios. They

often consider volumes and security prices over some recent period (e.g., the last 30 or 60 days) to estimate

liquidity and construct a risk profile on which the trading strategy will be based. In DMs, one can reasonably

expect correlation, volatility measures and liquidity to be somewhat consistent with the historical period used.

However, this is less frequently the case with EM securities where the drivers of risk and return typically tend to

be more volatile.

For example, average daily volumes are less reliable for EM equities – that is, the average is typically based on a

more disparate sample of trading activity as compared to DMs, which tend to exhibit more consistent volumes.

Also, some EM countries place restrictions on foreign ownership – for example, by capping at a percentage of

free float or limiting access to non-voting shares only – particularly in industries that are strategic to their

economy. Such restrictions may affect a substantial portion of the equity market and further impact liquidity. To

the extent that there are different classes of securities – e.g., voting shares for locals and non-voting for foreign

investors – the liquidity between the two lines can be dramatically different. In such situations, a TM needs to

know the correct lines to trade and how to access liquidity in those securities as well as the fungibility of local and

foreign listed lines. Controlling the flow of information to the broader market is also paramount in achieving an

optimal execution outcome. This is especially true in trading EM securities that are highly illiquid and / or have a very

small free float.

Furthermore, factors such as political risk and non-normal return distributions can cause perceived correlations to

disappear during the actual transition period. While it is impossible to predict such events, a trading strategy that

allows real-time adjustments to the trading path can offer advantages (from an implementation cost perspective)

in the face of these unexpected circumstances.

We now present statistical comparisons between a sample EM and DM portfolio to illustrate the volatility, liquidity

and correlation dynamics noted above.

EMERGING VS. DEVELOPED – CORRELATION, VOLATILITY & LIQUIDITY

Correlations, returns and liquidity among EM stocks tend to be less stable than DM stocks, in general, making it

more difficult to predict tracking error and reduce risk during a transition event.

To test this assumption, we construct a representative sample emerging market equity portfolio consisting of the

top weighted stock within each of the 23 countries within the MSCI EM Index as of December 31, 2014. We then

remove the Egypt, Qatar and U.A.E. securities to reduce inconsistency in the returns data since these markets

trade on a Sunday through Thursday schedule. For comparison, we also produce a sample DM portfolio taking

the same approach but using the MSCI (Developed) World Index. We exclude Israel due to the same market

schedule issue noted above, as well as Austria and New Zealand which had the smallest representation in terms

of index weight. The resulting EM and DM sample portfolios each contain 20 names.

STRATEGY RESEARCH


Correlation: We use an extension of Box's M Test and the sample portfolios described above to examine the

stability of return correlation matrices over the period 2011 through 2014. Note, local returns are used based on

the assumption that currency exposure can largely be hedged away if desired. The test also relies on the

assumption that the joint distribution of stock returns is multivariate normal. While the distribution of equity

returns is a topic of debate, the normal distribution is generally accepted as a default when assessing the

characteristics of stock markets.

We first slice this 4-year period into non-overlapping sub-periods (to avoid autocorrelation) based on varying time

horizons (40, 45, 50, 60, 75 and 90 days). Since Box’s M statistic is designed to test the equality of variance-

covariance matrices, we first convert daily returns to standard scores within each sub-period, a technique

originated by Tang (1995). Testing the equality of the variance-covariance matrices of the standard scores is

equivalent to testing the equality of correlation matrices. For the returns of each adjacent pair of sub-periods, we

then test the null hypothesis that their covariance matrices are equal, using the F distribution and rejecting at a

significance level of 0.001. Table 3 and Chart 7 below summarize the results separately for the sample EM and

DM portfolios by time horizon. We find that from one period to the next, correlation matrices are generally less

stable for the sample EM portfolio. This can be ascertained from the % of “Stable” samples identified in the

various test horizons.

TABLE 3: Box M Test Results by Time Horizon (2011 – 2014) CHART 7: % Stable by Time Horizon

source: Bloomberg, State Street Global Markets (see also Section A3 of Appendix and References 2, 3, 8, 12, 14 and 15)

For a more detailed view of the Box M Test results, including Chi-Square and F-Statistics, see section A3 of the

Appendix.

Volatility: We calculate the annualized volatility of daily returns for 2011 through 2014 for each stock in the

sample EM and DM portfolios. Histograms based on these data points are shown in Charts 8 and 9 below, along

with the unweighted average for the stocks in each portfolio (gray dotted line). The sample EM stock returns

were approximately 3% more volatile per year on average than their DM counterparts over the 4-year

observation period.

Horizon

(days)

# of Pairs

Tested

#

Rejected # Stable

%

Stable

#

Rejected # Stable

%

Stable

40 25 21 4 16% 19 6 24%

45 22 22 0 0% 15 7 32%

50 19 17 2 11% 13 6 32%

60 16 12 4 25% 9 7 44%

75 12 10 2 17% 6 6 50%

90 10 9 1 10% 6 4 40%

Developed Marketsα = 0.001 Emerging Markets

0%

10%

20%

30%

40%

50%

40 45 50 60 75 90

% S

table

Horizon (Days)

EM DM

STRATEGY RESEARCH


1

6

7

3

2

1

0 5 10 15 20 25 30 35 40 45 50 55 600

1

2

3

4

5

6

7

8

Annualized Volatility of Daily Returns (%)

Num

ber

of S

tocks

Sample EM Portfolio

1

4

7

4

2 2

0 5 10 15 20 25 30 35 40 45 50 55 600

1

2

3

4

5

6

7

8

Annualized Volatility of Daily Returns (%)

Num

ber

of S

tocks

Sample DM Portfolio

2

11

2 2 2

1

0 5 10 15 20 25 30 35 40 45 50 55 600

2

4

6

8

10

12

20-Day ADV Coefficient of Variation (%)

Num

ber

of S

tocks

Sample DM Portfolio

2

4

3

2

3

2 2

1 1

0 5 10 15 20 25 30 35 40 45 50 55 600

2

4

6

8

10

12

20-Day ADV Coefficient of Variation (%)

Num

ber

of S

tocks

Sample EM Portfolio

Liquidity: In examining liquidity, we focus on daily value traded (in USD terms for consistency) during 2014 and

group this data into non-overlapping 20 trading day sub-periods. For each stock, we then calculate the

coefficient of variation (“CV”, standard deviation divided by mean) of the average daily volume across each of the

thirteen 20-day sub-periods. Given materially higher volumes on average for the DM securities relative to the EM

names, the CV provides a standardized measure of the volatility of liquidity that can be compared between the

sample EM and DM portfolios. Histograms based on the CVs for each stock are shown in Charts 10 and 11 for

the sample EM and DM portfolios, respectively. These charts also show the unweighted average CV for the

stocks in each portfolio. Liquidity for the sample EM stocks was approximately 7% more volatile on average than

their DM counterparts during 2014.

CHARTS 8 & 9: Volatility of Returns Histograms, Sample

EM & DM Portfolio Stocks (2011 – 2014)

CHARTS 10 & 11: 20-Day ADV Coefficient of Variation

Histograms, Sample EM & DM Portfolio Stocks (2014)

sources: Bloomberg, State Street Global Markets

Avg = 25.2

Avg = 28.1

Avg = 22.2

Avg = 28.8

STRATEGY RESEARCH


CURRENCY RISK

Currency risk may arise due to the potential variance between the executed FX rates and the FX rates used for

benchmark pricing (typically the published WM/Reuters 4PM London “fix”). To mitigate currency risk, a TM may

complete a portion of the FX trading on T-1 with the goal of trading at the benchmark pricing point (the

WM/Reuters 4PM London fixing on T-1), with residual FX trades executed once the final traded values are

known. While trading FX at the benchmark rate may be achievable for DM currencies, there is no market

mechanism whereby traders can execute at the WM fix in certain EM currencies. As discussed previously, this is

due to the inability of most investment and transition managers to trade onshore in many of the EM currencies.

Often times, they must rely upon the custodial FX process instead, and therefore relinquish control over the

timing of FX trades. In addition to this potential lack of control over the timing of FX trades, WM rates are often

stale for EM. This is particularly the case for Asian currencies where most FX trading occurs during local market

hours, well before 4pm London (see Chart 6). These challenges in executing FX trading at the benchmark rate

can result in a substantial amount of implementation cost in an EM equity transition.

EM currencies that are illiquid or non-convertible (e.g., due to capital controls of the local government) are often

traded as non-deliverable forwards (NDFs). A gain or loss on notional is calculated based on the difference

between the spot and (contracted) forward rates on settlement date and cash-settled in the counter currency

(typically USD). For a transition involving a substantial shift in allocation between countries or regions, NDFs

may be used to hedge the currency exposure to align with the target at or around the benchmark point. These

NDF hedging positions would then be unwound as physical currency repatriation trades are executed by the

custodian. However, as mentioned previously, FX trades in these markets are often executed automatically in

batches by custodians. For this reason, a TM may wish to avoid using the custodian’s standing FX instructions

for markets where NDFs are being used to hedge currency exposures. Alternatively, the TM could attempt

confirm the timing of such trades with the custodian in advance of execution, and align the unwinding of any NDF

currency hedging positions as closely as possible (i.e., on a best efforts basis). This strategy may reduce risk as

compared with simply waiting for the custodial FX process to be implemented, which may be a number of days

away from the benchmark point of the transition.

Example 1: Assume a transition involves net selling in Russian equities to be completed over a number of days.

The TM may wish to hedge currency exposure as close as possible to the benchmark point by selling RUB

forward. It is common practice for brokers to settle local Russian securities in USD, striking the FX as of the

trade date. In this case, the TM should make a best efforts attempt to line up the unwinding of the RUB NDF

hedge position with the broker's FX conversion of the physical security executions. A TM may also structure

executions such that residual trading in Russian securities is cash-matched in order to limit the need for RUB

NDF exposure.

STRATEGY RESEARCH


MARKET EXPOSURE / HEDGING CONSIDERATIONS

For broad EM exposure or hedging purposes, asset owners may consider using one of the following:

a liquid ETF such as EEM or VWO;

the mini MSCI EM Index Futures Contract – “MES”; or

a basket of local EM index futures.

EEM, VWO and the MES futures contract are priced in USD and include currency returns of the underlying

physical securities or cash index. While the ETFs provide currency exposure on the entire notional value of the

investment, a non-US client investing in MES futures would need to sell base currency and buy USD forward in

order to achieve unhedged returns in domestic terms, assuming that any underlying cash is held in the client’s

base currency. The MES futures contract trades on the NYF-ICE exchange between 8:00 PM (7:30 PM pre-

open) and 6:00 PM (NY time) with daily settlement at 4:00 PM (based on VWAP over the last minute). However,

as is the case for the two ETFs, the vast majority of liquidity is seen during US equity market hours. Therefore,

the ETFs and MES futures may not be ideal for hedging a large, short-term trade due to the timing difference

versus EM trading hours. This timing risk – as well as country risk derived from differences in exposure between

legacy and target portfolios – may be reduced if exposure is hedged using local EM (country-specific) futures.

While daily volumes in the MES futures contract continue to grow12

, a basket of local futures may provide more

liquidity for larger transactions. Note, investing in local futures for certain countries may not be feasible due to

lack of approval by home-country regulating authorities (i.e., CFTC for US investors), limited liquidity, and/or

taxes or other fees that make transacting inefficient or prohibitive. As a result, this alternative generally requires

the use of optimized proxies and tends to result in higher expected tracking error compared with the single USD-

priced contract. Also, unlike ETFs which (if unhedged) provide currency exposure on the entire notional value,

local futures require the use of FX forwards to achieve unhedged returns, assuming cash is held in the investor’s

base currency. This could lead to further transaction costs, tracking error, complexity, documentation

requirements and administrative burden. Sections A4 and A5 of the Appendix provide information on availability

and liquidity of futures by country and summarize two options commonly used to obtain or hedge MSCI EM

equity exposure. Below are some specific situations where using futures or ETFs may be beneficial in the

context of a transition.

Example 2: When trading in India, in addition to having funding in place on T+1 for buys, sell proceeds are not

typically received in base currency until SD+1 (T+3). For an EM transition with a high concentration in India,

futures may be used to maintain or hedge country exposures until such time that cash is available to spend.

12 Total value of open interest (open interest x contract value, USD): $3.0 bln as of 12/31/2011, $8.0 bln as of 12/31/2012,

$12.1 bln as of 12/31/2013, $16.0 bln as of 12/31/2014 (source: Bloomberg)

STRATEGY RESEARCH


Example 3: Country-specific ETFs are often used to gain exposure to markets in which local securities cannot

be purchased due to transferability, account opening or other issues (e.g., Brazil, India, Korea, Taiwan). For

example, a transition manager may purchase a passive Brazil ETF in place of the local securities – which cannot be

contributed in-kind to a target commingled fund – to gain exposure through the funding date; or a passive Korea ETF

may be used in a time-sensitive transition where the client did not have sufficient lead time to obtain an IRC and set up

the account to trade in local securities.

V. Putting It All Together

Market and operational risks are heightened when trading in Emerging Markets as compared to Developed

Markets. These risks highlight the importance of a thoughtful, strategic approach in transitioning EM equities.

Three key areas of focus are as follows:

Increased planning, project management and focus on operational aspects: A detailed project plan

and timeline should be developed well ahead of an EM transition, clearly outlining responsibilities and critical

juncture points. It should be shared amongst the key participants – including the custodian, outgoing and

incoming managers – so that each party is well versed in its roles and responsibilities. Often times, a TM

must begin coordinating with the custodian several weeks before commencement of an EM transition to

allow sufficient lead-time for account set up and opening of relevant markets in advance of trading. Special

attention should be paid to the operational structure and nuances of each market, including the regulatory

framework and transferability, FX markets, and settlement and delivery of securities.

Global coordination and risk management: Some TMs have teams located in different regions around

the world that understand the intricacies of each market. By maintaining a global presence, a TM is able to

monitor portfolios “round-the-clock” and ensure that trading is executed in line with local market liquidity.

Cash and currency management: During an EM transition, managing operational and portfolio risks

associated with currency and cash availability while remaining market-neutral across time zones requires

particular focus and expertise. From an operational perspective, a portion of FXs may need to be executed

in advance of equity trading to accommodate the pre-funding requirements of certain markets or hedge

currency exposure in restricted FX markets. A TM must also line up settlement timing among buys and sells

to avoid overdrafts. To this end, it may also be prudent to maintain a small cash balance throughout the

transition to act as a buffer in the event of an unexpected capital call. Given the operational constraints –

and limited control over the timing of spot FX transactions – strategic management of potential opportunity

costs associated with currency risk requires detailed knowledge of each spot and forward market.

To the extent that an EM equity restructure is not managed efficiently, the transition costs can erode some of the

perceived benefits of investing in EM in the first place (or moving to a new EM manager). An experienced TM

with global trading expertise possesses the resources necessary to address the operational challenges and

monitor portfolio risks – and reduce trading costs – associated with an EM equity restructure.

STRATEGY RESEARCH


VI. Appendix

A1. CHARTS FROM IIF “CAPITAL FLOWS TO EMERGING MARKETS” PAPERS13

13 Chart 6 sourced from paper dated May 28, 2015. Charts 3 and 39 sourced from paper dated May 29, 2014.

$ billion in Chart 6 and Chart 3 refer to USD.

STRATEGY RESEARCH


A2. EM COUNTRY GRIDS14,15

Country BRAZIL

Primary Exchange(s) BM&F Bovespa

Currency BRL (BRAZILIAN REAL)

Account Opening Process 3-5 Days.

Transferability Prohibited.

Settlement (Equities) T+3.

Market Charges (Buys) 0.035% EXCHANGE FEE - gross consideration

Market Charges (Sells) 0.035% EXCHANGE FEE - gross consideration

Currency Trading

On-Book Market, though generally trades are executed through client's custodian or sub-custodian.

Deliverable trades available only through certain counterparties and requires lead time (e.g., 2 days) for

account setup. Otherwise, traded as NDF offshore.

Other Trading Considerations CVM # and Bovespa # required at time of trade.

Country CHILE

Primary Exchange(s) Santiago Stock Exchange (SSE)

Currency CLP (CHILEAN PESO)


Transferability Difficult.


Market Charges (Buys) TBA when traded

Market Charges (Sells) TBA when traded

Currency Trading Off-Book Market. Unable to trade with third party dealers; FX's executed through client's custodian or sub-

custodian. Non-convertible. NDF only offshore.

Other Trading Considerations RUT # required at time of trade.

14 Timeframes for account opening process may vary by custodian, are subject to change due to market conditions and

requirements mandated by regulatory authorities, and do not incorporate additional time for investor registration,

documentation submission, and review by sub-custodians / local authorities.

15 sources: Bloomberg, State Street Global Markets, HSBC’s Emerging Markets Currency Guide 2015 (January 2015), Credit

Suisse Emerging Markets Currency Guide (January 2013), State Street Investment Manager Guide revised July 1, 2015,

“MSCI Global Market Accessibility Review” updated June 11, 2015

STRATEGY RESEARCH


Country CHINA - HONG KONG

Primary Exchange(s) Hong Kong Stock Exchange

Currency HKD (some stocks settle in USD) (HONG KONG DOLLAR)


Transferability Allowed.


Market Charges (Buys) STAMP DUTY: 0.1% of the consideration (rounded up to nearest dollar) / TRANSACTION LEVY : 0.003% of

the consideration / TRADING FEE : 0.005% of consideration

Market Charges (Sells) STAMP DUTY: 0.1% of the consideration (rounded up to nearest dollar) / TRANSACTION LEVY : 0.003% of

the consideration / TRADING FEE : 0.005% of consideration

Currency Trading On-Book Market. Generally able to execute with third party dealers. Freely convertible and deliverable.

Other Trading Considerations 0

Country COLOMBIA

Primary Exchange(s) Colombian Securities Exchange (BVC)

Currency COP (COLOMBIAN PESO)






Currency Trading

Off-Book Market. Unable to trade with third party dealers; FX's executed through client's custodian or sub-

custodian. Onshore relationship needed to trade spot (i.e., FX counterparty that has onshore entity) and

numerous supporting documents required. Non-convertible. NDF only offshore.

Other Trading Considerations NIT # required at time of trade.

Country CZECH REPUBLIC

Primary Exchange(s) Prague Stock Exchange

Currency CZK (CZECH KORUNA)




Market Charges (Buys) N/A

Market Charges (Sells) N/A


Other Trading Considerations

STRATEGY RESEARCH


Country EGYPT

Primary Exchange(s) Egyptian Exchange

Currency EGP (EGYPTIAN POUND)



Settlement (Equities) T+2 buys, T+1 sells.



Currency Trading Off-Book Market. Unable to trade with third party dealers; FX's executed through client's custodian or sub-

custodian. Not fully convertible or deliverable. NDF only offshore. EGP cannot be settled on a Friday.

Other Trading Considerations Exchange trading days are Sunday through Thursday.

Country GREECE

Primary Exchange(s) Athens Stock Exchange

Currency EUR (EURO)


Transferability Restricted.


Market Charges (Buys) 0.020% EXCHANGE FEE 0.0125% TRADING FEES

Market Charges (Sells) 0.020% EXCHANGE FEE 0.0125% TRADING FEES



Country HUNGARY

Primary Exchange(s) Budapest Stock Exchange

Currency HUF (HUNGARIAN FORINT)








STRATEGY RESEARCH


Country INDIA

Primary Exchange(s) Bombay Stock Exchange and National Stock Exchange

Currency INR (INDIAN RUPEE)



Settlement (Equities) T+2. See "Other Trading Considerations" below for additional settlement information.

Market Charges (Buys) SECURITIES TRANSACTION TAX: 0.125% on gross consideration (applies to buys and sells)

Market Charges (Sells) SECURITIES TRANSACTION TAX: 0.125% on gross consideration (applies to buys and sells)

Currency Trading


custodian. Spot available for purchase only, with an onshore entity and appropriate account setup. NDF only

offshore.


India is a T+2 market but trades need to be pre-matched on T+1 in order to settle as "Direct Custodial

Settlement (DCS)". Otherwise, they are converted to "Hand Delivery DVP" which may incur penalties by the

exchange. Institutional trades that fail to settle "DCS" may also attract negative attention from regulators. In

addition, unmatched trades on T+1 are subject to margin calls by the exchange. Margin is charged directly to

the local subcustodian which cannot extend credit to the client. Therefore, the client must maintain a positive

balance in order to meet any potential margin payments (which are refunded on T+3). Margin calls are

avoided if the custodian arranges for early pay in of INR proceeds (or delivery of stock for sell trades) on T+1.

However, prefunding the account ensures that the custodian can release instructions in time to pre-match on

T+1, avoiding any margin calls and meeting the DCS settlement process. In addition to having funding in

place on T+1 for buys, sell proceeds may not be received until SD+1 (or T+3) in base currency.

Country INDONESIA

Primary Exchange(s) Jakarta Stock Exchange

Currency IDR (INDONESIAN RUPIAH)




Market Charges (Buys) TRANSACTION LEVY : 0.04% of the consideration / VAT : 10% of commission

Market Charges (Sells) TRANSACTION LEVY : 0.04% of the consideration / VAT : 10% of commission / SALES TAX : 0.1% of

consideration

Currency Trading

On-Book Market, but generally trades through client's custodian or sub-custodian. Onshore relationship

needed to trade spot (i.e., FX counterparty that has onshore entity) and numerous supporting documents

required. NDF only offshore.


Any FX transactions (spots and forwards) which involve the sale of IDR with a value greater than USD

100,000 (per month) must be supported by documentation detailing the underlying securities transactions.

The value of IDR sold must not exceed the value of the underlying securities transactions. In addition, a

statement must be provided confirming the authenticity of the supporting documents. This information needs

to be available on the trade date.

STRATEGY RESEARCH


Country MALAYSIA

Primary Exchange(s) Kuala Lumpur Stock Exchange

Currency MYR (MALAYSIAN RINGGIT)




Market Charges (Buys) CLEARING FEE : 0.03% of the consideration (Max MYR1000) / CONTRACT STAMP DUTY : 0.1% on

consideration, mark up to nearest dollar (Max MYR200)

Market Charges (Sells) CLEARING FEE : 0.03% of the consideration (Max MYR1000) / CONTRACT STAMP DUTY : 0.1% on

consideration, mark up to nearest dollar (Max MYR200)

Currency Trading

On-Book Market, but generally trades through client's custodian or sub-custodian. Onshore relationship

needed to trade spot (i.e., FX counterparty that has onshore entity) and numerous supporting documents

required. Generally, NDF only offshore.


Country MEXICO

Primary Exchange(s) Mexican Stock Exchange

Currency MXN (MEXICAN PESO)






Currency Trading On-Book Market. Generally able to execute with third party dealers. Freely convertible. Fully deliverable spot

and forward offshore.

Other Trading Considerations No special tax IDs or registration numbers required at time of trade.

Country MOROCCO

Primary Exchange(s) Casablanca Stock Exchange

Currency MAD (MOROCCAN DIRHAM)






Currency Trading

On-Book Market. Generally able to execute with third party dealers but may trade through client's custodian

or sub-custodian in practice. Spot and forward markets trade deliverable. There are restrictions on the

offshore currency market.


STRATEGY RESEARCH


Country PAKISTAN

Primary Exchange(s) Karachi Stock Exchange and Lahore Stock Exchange

Currency PKR (PAKISTANI RUPEE)




Market Charges (Buys) 0.015% of principal

Market Charges (Sells) 0.025% of principal

Currency Trading



numerous supporting documents required. Not fully convertible. NDF only offshore.


Country PERU

Primary Exchange(s) Lima Stock Exchange

Currency PEN (PERUVIAN NEW SOL)






Currency Trading

On-Book Market. Deliverable currency but generally trades through client's custodian or sub-custodian.

Freely convertible. Deliverable spot through select FX dealers but not typically deliverable on a forward

basis.

Other Trading Considerations CAVAL # required at time of trade.

STRATEGY RESEARCH


Country PHILIPPINES

Primary Exchange(s) Philippine Stock Exchange

Currency PHP (PHILIPPINES PESO)


Transferability Difficult. It may be difficult for transition managers to utilize in-kind transfers in practice.


Market Charges (Buys)

SSCP : 0.01% on gross amount / VAT : 12% on local broker commission - 0.03% below PHP100,000,000,

0.018% from PHP 100,000,001 to PHP 500,000,000, 0.0096% from PHP500,000,00 to PHP1bil: 0.0048%

over PHP 1bil.

Market Charges (Sells)

SALES TAX: 0.5% of the consideration (Sells only) / SSCP : 0.01% on gross amount \ VAT : 12% on local

broker commission - 0.03% below PHP100,000,000, 0.018% from PHP 100,000,001 to PHP 500,000,000,

0.0096% from PHP500,000,00 to PHP1bil: 0.0048% over PHP 1bil.

Currency Trading

On-Book Market. Unable to trade with third party dealers; FX's executed through client's custodian or sub-


numerous supporting documents required. Generally NDF only offshore.


Country POLAND

Primary Exchange(s) Warsaw Stock-Exchange

Currency PLN (POLISH ZLOTY)




Market Charges (Buys) If traded OTC 1% stamp duty will apply

Market Charges (Sells) If traded OTC 1% stamp duty will apply



STRATEGY RESEARCH


Country QATAR

Primary Exchange(s) Qatar Exchange

Currency QAR (QATARI RIYAL)




Market Charges (Buys) 0

Market Charges (Sells) 0

Currency Trading On-Book Market. Generally able to execute with third party dealers but may trade through client's custodian

or sub-custodian in practice. Fully convertible and deliverable. QAR cannot be settled on a Friday.


Country REPUBLIC OF KOREA

Primary Exchange(s) Korea Stock Exchange

Currency KRW (KOREAN WON)

Account Opening Process

4-7 Days. Foreign investors are generally required to obtain an Investment Registration Certificate (“IRC”) in

order to participate in domestic securities markets which may result in substantial delays to the account set-

up process.

Transferability Difficult, Restricted.



Market Charges (Sells) TRANSACTION TAX (Sells only): 0.3% on KSE (rounded to nearest integer), 0.5% on OTC (Any amount less

than 1 KRW will be rounded down) \ WITHHOLDING TAX ON CASH DIVIDEND : 15%

Currency Trading


custodian. Typically, subcustodians automatically execute individual FXs (purchasing KRW) to cover each

equity buy trade in a given account. As a result, there may be multiple FXs with the same trade and value

dates rather than a single purchase of the total KRW vs. base currency. Onshore relationship needed to trade

spot (i.e., FX counterparty that has onshore entity) and numerous supporting documents required. Fully

convertible, but trades as NDF only offshore.


STRATEGY RESEARCH


Country RUSSIAN FEDERATION

Primary Exchange(s) Moscow Exchange

Currency RUB (RUBLE)



Settlement (Equities) TD to T+15 (Negotiable). The Moscow Exchange introduced T+2 settlement cycle in 2013.



Currency Trading

On-Book Market. Generally trades through client's custodian or sub-custodian. Need to provide a valid reason

(repatriation, funding of securities' trades, speculation, etc.) and have documentation and account onshore to

trade deliverable. Freely convertible.

Other Trading Considerations Most brokers will settle local Russian equity trades in USD.

Country SOUTH AFRICA

Primary Exchange(s) Johannesburg Stock Exchange

Currency ZAR (S. AFRICAN RAND)


Transferability Allowed. Transition managers are generally able to utilize in-kinds transfers in practice.

Settlement (Equities) T+5. The Johannesburg Stock Exchange has completed Phase 2 of 3 in moving from the current T+5

settlement cycle to T+3.

Market Charges (Buys) 0.25%


Currency Trading On-Book Market. Generally able to execute with third party dealers. Freely convertible ‒ although Central

Bank (SARB) may intervene ‒ and deliverable.


STRATEGY RESEARCH


Country TAIWAN

Primary Exchange(s) Taiwan Stock Exchange

Currency TWD (TAIWAN DOLLAR)


Transferability Difficult.

Settlement (Equities) T+2. See "Other Trading Considerations" below for additional settlement information.


Market Charges (Sells) SALES TAX : 0.3% (sells only)

Currency Trading



numerous supporting documents required. Not fully convertible. NDF only offshore.


Note, pre-funding needs to be arranged for buys. Also, proceeds move on settlement date (SD) for buys and

SD+1 for sells. Therefore, a transition manager must specify value date accordingly in sending FX

instructions ‒ i.e., SD to buy TWD (cover purchases) and SD+1 to repatriate sale proceeds.

Country THAILAND

Primary Exchange(s) The Stock Exchange of Thailand

Currency THB (THAI BAHT)




Market Charges (Buys) VAT: 0.0175% of Gross consideration (7% of local broker commission)

Market Charges (Sells) VAT: 0.0175% of Gross consideration (7% of local broker commission)

Currency Trading

On-Book Market. But generally trades through client's custodian or sub-custodian. Although the Thai Baht

(THB) is deliverable, the account must be appropriately set up as non-resident, so as to avoid potential

unwind (at the client’s risk) of a non-eligible trade. Therefore, it may be preferable to trade off-book unless

the account is set up correctly. Freely convertible. Fully deliverable spot and forward offshore.


STRATEGY RESEARCH


Country TURKEY

Primary Exchange(s) Istanbul Stock Exchange

Currency TRY (TURKISH LIRA)








Country UNITED ARAB EMIRATES

Primary Exchange(s) Abu Dhabi Securities Exchange (ADX), Dubai Financial Market (DFM)

Currency AED (UAE DIRHAM)






Currency Trading On-Book Market. Generally able to execute with third party dealers (may depend on custodian). Freely

convertible and deliverable. AED cannot be settled on a Friday.


STRATEGY RESEARCH


A3. BOX’S M TEST OF CORRELATION MATRIX EQUALITY

Box’s M is a common statistic used to test for homogeneity of covariance matrices in a MANOVA (multivariate

analysis of variance) analysis, which is the multivariate extension of the ANOVA (analysis of variance) test.

Under MANOVA assumptions, Box’s M can be used to test whether two or more covariance matrices are equal

(Mayers, 2013).

Following the convention used by Cho and Taylor (1987), Box’s M statistic is given by:

∑ ( ) | |

where

( )( )(∑

) and

∑ ( )

Where S1, S2, … , Sq are sample covariance / correlation matrices from q independent time horizons and S is the

pooled covariance/correlation matrix. n1, n2… nq are the number of observations in each population with

∑ . In our study, q = 2, ni = 40, 45, 50, 60, 75 or 90.

M has a χ2 distribution with

( )( )

degrees of freedom. However, a better estimate is proposed using the F

distribution (Stevens, 1992 / Zaiontz, 2014),

{

( )

where,

and ( )( )

( )(∑

( )

( ) )

( )( )

and

| |

and

The Null Hypothesis in our study is H0: Si = Si-1, for i = 2, 3... k where k is the number of pairs of matrices for a

given time horizon. That is, the consecutive period covariance / correlation matrices are statistically equal (or the

covariance / correlation in stock market returns is “stable” over two consecutive periods).

Under the F-distribution, ̃ ~ F(df1, df2). We set the critical significance level (α) at 0.001. Thus the null

hypothesis is rejected if Pr( ̃ > F) < α.

Tables 4 – 6 on the next page show results, including Chi-Square and F-Statistics, for 40, 60 and 90 day time

horizons.

STRATEGY RESEARCH


TABLE 4: Box M Test Results, 40 Day Time Horizon (2011 – 2014)

sources: MSCI, Bloomberg, State Street Global Markets





Time

PeriodPeriod I Period II Box's M F-Value P-Value Stable Box's M F-Value P-Value Stable Box's M χ2 P-Value Stable Box's M χ2 P-Value Stable

1 1/3/2011 ‒ 2/25/2011 2/28/2011 ‒ 4/22/2011 431.4350 1.4926 0.0000 NO 474.3559 1.6410 0.0000 NO 431.4350 318.3084 0.0000 NO 474.3559 349.9750 0.0000 NO

2 2/28/2011 ‒ 4/22/2011 4/25/2011 ‒ 6/17/2011 345.9066 1.1967 0.0277 YES 433.1152 1.4984 0.0000 NO 345.9066 255.2064 0.0180 YES 433.1152 319.5481 0.0000 NO

3 4/25/2011 ‒ 6/17/2011 6/20/2011 ‒ 8/12/2011 548.9203 1.8990 0.0000 NO 405.6242 1.4033 0.0001 NO 548.9203 404.9879 0.0000 NO 405.6242 299.2654 0.0001 NO

4 6/20/2011 ‒ 8/12/2011 8/15/2011 ‒ 10/7/2011 519.1857 1.7961 0.0000 NO 450.5835 1.5588 0.0000 NO 519.1857 383.0500 0.0000 NO 450.5835 332.4360 0.0000 NO

5 8/15/2011 ‒ 10/7/2011 10/10/2011 ‒ 12/2/2011 597.9932 2.0688 0.0000 NO 461.0841 1.5951 0.0000 NO 597.9932 441.1934 0.0000 NO 461.0841 340.1832 0.0000 NO

6 10/10/2011 ‒ 12/2/2011 12/5/2011 ‒ 1/27/2012 589.0636 2.0379 0.0000 NO 472.7241 1.6354 0.0000 NO 589.0636 434.6053 0.0000 NO 472.7241 348.7711 0.0000 NO

7 12/5/2011 ‒ 1/27/2012 1/30/2012 ‒ 3/23/2012 457.6815 1.5834 0.0000 NO 485.4925 1.6796 0.0000 NO 457.6815 337.6728 0.0000 NO 485.4925 358.1915 0.0000 NO

8 1/30/2012 ‒ 3/23/2012 3/26/2012 ‒ 5/18/2012 564.9422 1.9544 0.0000 NO 478.1353 1.6541 0.0000 NO 564.9422 416.8087 0.0000 NO 478.1353 352.7634 0.0000 NO

9 3/26/2012 ‒ 5/18/2012 5/21/2012 ‒ 7/13/2012 517.1739 1.7892 0.0000 NO 392.2174 1.3569 0.0005 NO 517.1739 381.5657 0.0000 NO 392.2174 289.3740 0.0002 NO

10 5/21/2012 ‒ 7/13/2012 7/16/2012 ‒ 9/7/2012 320.7964 1.1098 0.1332 YES 382.2399 1.3224 0.0013 YES 320.7964 236.6804 0.0998 YES 382.2399 282.0127 0.0007 NO

11 7/16/2012 ‒ 9/7/2012 9/10/2012 ‒ 11/2/2012 549.6219 1.9014 0.0000 NO 351.3150 1.2154 0.0186 YES 549.6219 405.5055 0.0000 NO 351.3150 259.1967 0.0117 YES

12 9/10/2012 ‒ 11/2/2012 11/5/2012 ‒ 12/28/2012 573.9146 1.9855 0.0000 NO 456.9175 1.5807 0.0000 NO 573.9146 423.4285 0.0000 NO 456.9175 337.1092 0.0000 NO

13 11/5/2012 ‒ 12/28/2012 12/31/2012 ‒ 2/22/2013 355.3241 1.2292 0.0136 YES 604.5138 2.0913 0.0000 NO 355.3241 262.1546 0.0084 YES 604.5138 446.0042 0.0000 NO

14 12/31/2012 ‒ 2/22/2013 2/25/2013 ‒ 4/19/2013 422.5262 1.4617 0.0000 NO 503.9338 1.7434 0.0000 NO 422.5262 311.7356 0.0000 NO 503.9338 371.7973 0.0000 NO

15 2/25/2013 ‒ 4/19/2013 4/22/2013 ‒ 6/14/2013 520.9080 1.8021 0.0000 NO 448.1205 1.5503 0.0000 NO 520.9080 384.3207 0.0000 NO 448.1205 330.6188 0.0000 NO

16 4/22/2013 ‒ 6/14/2013 6/17/2013 ‒ 8/9/2013 433.2892 1.4990 0.0000 NO 417.9121 1.4458 0.0000 NO 433.2892 319.6764 0.0000 NO 417.9121 308.3314 0.0000 NO

17 6/17/2013 ‒ 8/9/2013 8/12/2013 ‒ 10/4/2013 383.2651 1.3259 0.0012 YES 337.3875 1.1672 0.0497 YES 383.2651 282.7692 0.0006 NO 337.3875 248.9211 0.0340 YES

18 8/12/2013 ‒ 10/4/2013 10/7/2013 ‒ 11/29/2013 536.0569 1.8545 0.0000 NO 364.5866 1.2613 0.0064 YES 536.0569 395.4974 0.0000 NO 364.5866 268.9883 0.0037 YES

19 10/7/2013 ‒ 11/29/2013 12/2/2013 ‒ 1/24/2014 518.6305 1.7942 0.0000 NO 450.1732 1.5574 0.0000 NO 518.6305 382.6404 0.0000 NO 450.1732 332.1333 0.0000 NO

20 12/2/2013 ‒ 1/24/2014 1/27/2014 ‒ 3/21/2014 473.4079 1.6378 0.0000 NO 389.5703 1.3477 0.0006 NO 473.4079 349.2756 0.0000 NO 389.5703 287.4211 0.0003 NO

21 1/27/2014 ‒ 3/21/2014 3/24/2014 ‒ 5/16/2014 558.6685 1.9327 0.0000 NO 407.2158 1.4088 0.0001 NO 558.6685 412.1800 0.0000 NO 407.2158 300.4397 0.0000 NO

22 3/24/2014 ‒ 5/16/2014 5/19/2014 ‒ 7/11/2014 508.9309 1.7606 0.0000 NO 420.8497 1.4559 0.0000 NO 508.9309 375.4841 0.0000 NO 420.8497 310.4987 0.0000 NO

23 5/19/2014 ‒ 7/11/2014 7/14/2014 ‒ 9/5/2014 443.6020 1.5346 0.0000 NO 355.0571 1.2283 0.0139 YES 443.6020 327.2851 0.0000 NO 355.0571 261.9576 0.0086 YES

24 7/14/2014 ‒ 9/5/2014 9/8/2014 ‒ 10/31/2014 416.9776 1.4425 0.0000 NO 338.1099 1.1697 0.0474 YES 416.9776 307.6419 0.0000 NO 338.1099 249.4541 0.0323 YES

25 9/8/2014 ‒ 10/31/2014 11/3/2014 ‒ 12/26/2014 451.6714 1.5626 0.0000 NO 483.8021 1.6737 0.0000 NO 451.6714 333.2386 0.0000 NO 483.8021 356.9443 0.0000 NO

0 0 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0

Horizon = 40 Days Emerging Markets Developed Markets Emerging Markets Developed Markets

Time


1 1/3/2011 ‒ 3/25/2011 3/28/2011 ‒ 6/17/2011 319.8376 1.2515 0.0079 YES 345.7726 1.3530 0.0005 NO 319.8376 264.4017 0.0064 YES 345.7726 285.8415 0.0004 NO

2 3/28/2011 ‒ 6/17/2011 6/20/2011 ‒ 9/9/2011 620.6863 2.4288 0.0000 NO 405.7871 1.5879 0.0000 NO 620.6863 513.1057 0.0000 NO 405.7871 335.4540 0.0000 NO

3 6/20/2011 ‒ 9/9/2011 9/12/2011 ‒ 12/2/2011 685.6130 2.6828 0.0000 NO 367.7572 1.4391 0.0000 NO 685.6130 566.7790 0.0000 NO 367.7572 304.0156 0.0000 NO

4 9/12/2011 ‒ 12/2/2011 12/5/2011 ‒ 2/24/2012 434.8331 1.7015 0.0000 NO 364.6300 1.4268 0.0001 NO 434.8331 359.4656 0.0000 NO 364.6300 301.4304 0.0000 NO

5 12/5/2011 ‒ 2/24/2012 2/27/2012 ‒ 5/18/2012 299.6484 1.1725 0.0443 YES 383.0183 1.4988 0.0000 NO 299.6484 247.7117 0.0382 YES 383.0183 316.6316 0.0000 NO

6 2/27/2012 ‒ 5/18/2012 5/21/2012 ‒ 8/10/2012 420.5486 1.6456 0.0000 NO 272.6610 1.0669 0.2415 YES 420.5486 347.6569 0.0000 NO 272.6610 225.4019 0.2218 YES

7 5/21/2012 ‒ 8/10/2012 8/13/2012 ‒ 11/2/2012 405.9389 1.5885 0.0000 NO 274.9008 1.0757 0.2156 YES 405.9389 335.5795 0.0000 NO 274.9008 227.2535 0.1971 YES

8 8/13/2012 ‒ 11/2/2012 11/5/2012 ‒ 1/25/2013 426.7942 1.6701 0.0000 NO 381.3764 1.4923 0.0000 NO 426.7942 352.8200 0.0000 NO 381.3764 315.2743 0.0000 NO

9 11/5/2012 ‒ 1/25/2013 1/28/2013 ‒ 4/19/2013 330.1195 1.2918 0.0029 YES 334.9536 1.3107 0.0017 YES 330.1195 272.9015 0.0023 YES 334.9536 276.8977 0.0013 YES

10 1/28/2013 ‒ 4/19/2013 4/22/2013 ‒ 7/12/2013 375.2462 1.4684 0.0000 NO 334.5148 1.3090 0.0018 YES 375.2462 310.2065 0.0000 NO 334.5148 276.5349 0.0014 YES

11 4/22/2013 ‒ 7/12/2013 7/15/2013 ‒ 10/4/2013 504.6554 1.9747 0.0000 NO 370.3238 1.4491 0.0000 NO 504.6554 417.1859 0.0000 NO 370.3238 306.1374 0.0000 NO

12 7/15/2013 ‒ 10/4/2013 10/7/2013 ‒ 12/27/2013 546.8691 2.1399 0.0000 NO 347.7930 1.3609 0.0004 NO 546.8691 452.0829 0.0000 NO 347.7930 287.5117 0.0003 NO

13 10/7/2013 ‒ 12/27/2013 12/30/2013 ‒ 3/21/2014 392.7944 1.5370 0.0000 NO 295.3489 1.1557 0.0609 YES 392.7944 324.7132 0.0000 NO 295.3489 244.1575 0.0530 YES

14 12/30/2013 ‒ 3/21/2014 3/24/2014 ‒ 6/13/2014 464.6231 1.8181 0.0000 NO 373.4367 1.4613 0.0000 NO 464.6231 384.0922 0.0000 NO 373.4367 308.7107 0.0000 NO

15 3/24/2014 ‒ 6/13/2014 6/16/2014 ‒ 9/5/2014 404.4264 1.5825 0.0000 NO 334.7404 1.3099 0.0018 YES 404.4264 334.3291 0.0000 NO 334.7404 276.7214 0.0014 YES

16 6/16/2014 ‒ 9/5/2014 9/8/2014 ‒ 11/28/2014 332.1646 1.2998 0.0023 YES 300.4227 1.1756 0.0418 YES 332.1646 274.5921 0.0018 YES 300.4227 248.3519 0.0359 YES

0 0 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0


Time


1 1/3/2011 ‒ 5/6/2011 5/9/2011 ‒ 9/9/2011 375.3654 1.5782 0.0000 NO 424.8535 1.7863 0.0000 NO 375.3654 332.2355 0.0000 NO 424.8535 376.0374 0.0000 NO

2 5/9/2011 ‒ 9/9/2011 9/12/2011 ‒ 1/13/2012 469.8657 1.9755 0.0000 NO 408.7276 1.7185 0.0000 NO 469.8657 415.8776 0.0000 NO 408.7276 361.7644 0.0000 NO

3 9/12/2011 ‒ 1/13/2012 1/16/2012 ‒ 5/18/2012 335.3080 1.4098 0.0001 NO 379.5693 1.5959 0.0000 NO 335.3080 296.7808 0.0001 NO 379.5693 335.9564 0.0000 NO

4 1/16/2012 ‒ 5/18/2012 5/21/2012 ‒ 9/21/2012 372.8075 1.5674 0.0000 NO 271.4827 1.1414 0.0783 YES 372.8075 329.9715 0.0000 NO 271.4827 240.2890 0.0743 YES

5 5/21/2012 ‒ 9/21/2012 9/24/2012 ‒ 1/25/2013 381.3058 1.6032 0.0000 NO 328.1738 1.3798 0.0002 NO 381.3058 337.4934 0.0000 NO 328.1738 290.4663 0.0002 NO

6 9/24/2012 ‒ 1/25/2013 1/28/2013 ‒ 5/31/2013 270.8903 1.1389 0.0818 YES 295.2355 1.2413 0.0100 YES 270.8903 239.7647 0.0776 YES 295.2355 261.3126 0.0092 YES

7 1/28/2013 ‒ 5/31/2013 6/3/2013 ‒ 10/4/2013 335.7197 1.4115 0.0001 NO 287.3256 1.2080 0.0212 YES 335.7197 297.1452 0.0001 NO 287.3256 254.3116 0.0198 YES

8 6/3/2013 ‒ 10/4/2013 10/7/2013 ‒ 2/7/2014 393.0825 1.6527 0.0000 NO 293.0565 1.2321 0.0124 YES 393.0825 347.9169 0.0000 NO 293.0565 259.3840 0.0115 YES

9 10/7/2013 ‒ 2/7/2014 2/10/2014 ‒ 6/13/2014 340.2668 1.4306 0.0000 NO 345.2468 1.4516 0.0000 NO 340.2668 301.1698 0.0000 NO 345.2468 305.5776 0.0000 NO

10 2/10/2014 ‒ 6/13/2014 6/16/2014 ‒ 10/17/2014 385.7978 1.6221 0.0000 NO 356.4379 1.4986 0.0000 NO 385.7978 341.4692 0.0000 NO 356.4379 315.4829 0.0000 NO

0 0 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0


STRATEGY RESEARCH


A4. TABLE 7 – EM FUTURES CONTRACTS

There is not a liquid, broad-based index futures contract available for the remaining countries representing a total of

approximately 5% of the MSCI EM Index: Chile, Colombia, Czech Republic, Egypt, Greece, Hungary, Qatar, Peru, the

Philippines and United Arab Emirates.

Some futures may not have local regulatory approval – e.g., Russia RTS and Poland WIG20 index futures are still

pending approval by the Commodity Futures Trading Commission (CFTC) for U.S. investors as of April 2015 (source:

Katten “Foreign Listed Stock Index Futures and Options Approvals”, April 2015)

In certain cases, the account set-up documentation, margin and brokerage requirements may be cumbersome, making it

more difficult or even prohibitive to trade and clear them. For example, setting up an account to trade Bovespa futures

may require that clients complete documentation in triplicate which must be notarized by the Brazilian consulate.

Further, the account may be subject to pre-margin in BRL prior to trading and brokerage costs are much higher relative

to developed and other EM countries.

Futures*

Static HCN5 XUN5 KMU5 TWN5 BZQ5 AIU5 IHN5H-SHARES IDX FUT

Jul15

FTSE CHINA A50

Jul15

KOSPI2 INX FUT

Sep15

MSCI TAIWAN INDEX

Jul15

BOVESPA INDEX FUT

Aug15

FTSE/JSE TOP 40

Sep15

SGX CNX NIFTY

Jul15

HKD USD KRW USD BRL ZAR USD

50 1 500000 100 1 10 2

Liquidity 327,999 642,635 108,467 156,151 421,923 244,237 342,134

126,044 1,049,265 148,976 42,584 47,029 31,667 44,257

200,949 7,665 13,477,025 5,348 22,252 111,785 5,840

77,221 12,515 18,510,268 1,459 2,480 14,494 755

Pricing 12,253.00 11,927.50 248.50 342.50 52,739.00 45,769.00 8,534.00

612,650.00 11,927.50 124,250,000.00 34,250.00 52,739.00 457,690.00 17,068.00

Margin 65,200 1,540 9,337,500 1,540 15,508 26,637 880

N/A N/A N/A N/A N/A N/A N/A

Fair Value HSCEI XIN9I KOSPI2 TAMSCI IBOV TOP40 NIFTY

12,231.43 12,183.33 248.30 346.53 52,149.37 45,732.42 8,522.15

7/30/2015 7/30/2015 9/10/2015 7/30/2015 8/12/2015 9/17/2015 7/30/2015

24 24 66 24 37 73 24

7.226 82.026 0 4.266 54.791 481.097 20.006

0.187 0.190 1.530 0.770 13.629 6.804 8.000

12,225.73 12,102.85 249.00 342.44 52,825.07 45,882.27 8,547.60

0.2231% -1.4488% -0.1994% 0.0170% -0.1629% -0.2469% -0.1591%

Costs 1.00 2.50 0.05 0.10 5.00 1.00 0.50

1.00 2.50 0.50 0.10 5.00 1.00 0.50

0.8 2.1 2.0 2.9 0.9 0.2 0.6

0.8 2.1 20.1 2.9 0.9 0.2 0.6

0.4 20.1 0.0 7.0 4.6 0.5 14.1

Current Contract

Description

Currency

Multiplier

Last Price

Contract Value

Underlying Index

Last Index Level

Last Trading Date

Days Until Expiration

Dividends (Index Pts)

Interpolated STI (%)

Fair Value

Trading Commissions (bps)

Outright spread (idx pts)

Roll Spread (idx pts)

Outright (bps)

Roll (bps)

Rich (+) / Cheap (-) (%)

Open Interest (Aggregate)

ADV (5 Day)

Open Interest (mln local notional)

5 Day ADV (mln local notional)

Margin (Speculator)

Margin (Hedger)

Futures*

Static VEU5 ISU5 IKN5 IDON5 BCU5 KRSU5 A5Q5RTS INDEX FUTURE

Sep15

MEX BOLSA IDX FUT

Sep15

FTSE KLCI FUTURE

Jul15

SGX MSCI Indonesi

Jul15

SET50 FUTURES

Sep15

WIG20 INDEX FUT

Sep15

BIST 30 FUTURES

Aug15

USD MXN MYR USD THB PLN TRY

0.02 10 50 2 200 20 100

Liquidity 380,118 29,467 37,833 6,597 245,007 70,326 220,980

542,022 3,482 8,833 505 91,675 14,847 129,025

669 13,206 3,225 77 46,693 3,218 2,253

953 1,560 753 6 17,471 679 1,316

Pricing 87,950.00 44,817.00 1,705.00 5,810.00 952.90 2,288.00 101.98

1,759.00 448,170.00 85,250.00 11,620.00 190,580.00 45,760.00 10,197.50

Margin 11,829 27,000 4,000 550 11,400 N/A 900

N/A N/A N/A N/A 8,100 N/A N/A

Fair Value RTSI$ MEXBOL FBMKLCI MXID SET50 WIG20 XU030

902.88 44,794.01 1,717.05 5,787.25 968.48 2,272.09 100,427.55

9/15/2015 9/18/2015 7/31/2015 7/30/2015 9/29/2015 9/18/2015 8/31/2015

71 74 25 24 85 74 56

20.101 112.683 1.993 0 11.634 8.599 0

0.347 3.000 3.100 0.190 1.622 1.482 10.857

88,339.63 44,957.56 1,718.75 5,787.98 960.55 2,270.41 102.12

-0.4411% -0.3126% -0.8002% 0.3804% -0.7969% 0.7746% -0.1455%

Costs 10.00 5.00 0.50 5.00 0.10 1.00 0.03

10.00 1.00 0.50 5.00 0.10 1.00 0.03

1.1 1.1 2.9 8.6 1.0 4.4 2.5

1.1 0.2 2.9 8.6 1.0 4.4 2.5

136.4 0.5 2.8 20.7 1.3 5.2 23.5

* Figures are in local currency unless otherwise specified; represents snapshot of markets as of 07/06/2015 23:20

Source: State Street Global Markets, Bloomberg

Current Contract

Description

Currency

Multiplier

Last Price

Contract Value

Underlying Index

Last Index Level

Last Trading Date

Days Until Expiration

Dividends (Index Pts)

Interpolated STI (%)

Fair Value

Trading Commissions (bps)

Outright spread (idx pts)

Roll Spread (idx pts)

Outright (bps)

Roll (bps)

Rich (+) / Cheap (-) (%)

Open Interest (Aggregate)

ADV (5 Day)

Open Interest (mln local notional)

5 Day ADV (mln local notional)

Margin (Speculator)

Margin (Hedger)

STRATEGY RESEARCH


A5. EXAMPLE OF MSCI EM EXPOSURE OPTIONS – MES FUTURES VS. EEM ETF

Current Contract MESU5 ETF EEM

Descriptionmini MSCI Emg

Mkt Sep15Description

ISHARES MSCI

EMERGING

MARKETCurrency USD Currency USD

Multiplier 50 Replication Strategy Full

Open Interest (Aggregate) 393,878 Shares Outstanding (mln) 685

ADV (5 Day) 31,933 ADV (30 Day) 50,607,928

Open Interest (notional) 18,502,419,050 Volume Outstanding 26,290,026,000

Notional ADV (5 Day) 1,500,052,675 30 day ADV (Volume) 1,941,320,118

Last Price 939.50 Last Price 38.36

Contract Price 46,975.00 Last Close 38.43

Margin (Speculator) 2,035 Primary Exchange NYSE Arca

Margin (Hedger) 1,850 Country US

Last Index Level 940.83 NAV 38.63

Last Trading Date 9/18/2015 Premium /Discount % Discount: 0.7%

Days Until Expiration 65 B/A Spread vs. Mid (5 day, bps) 1.32

Dividends (Index Pts) 4.687 Expense ratio (%) 0.67

Interpolated STI (%) 0.31 Replication Strategy Full

Fair Value 936.67 Currency Hedged? N

Rich (+) / Cheap(-) (%) 0.3018% Securities Lending? Y

Outright spread (idx pts) 0.10 Shares/Unit 450,000.00

Roll Spread (idx pts) 0.05 Cash Value 17,262,000

Outright (bps) 1.1 Implied Liquidity 8,597,388

Roll (bps) 0.5 Creation Fee 7700

* Figures are in USD and reflect a snapshot of markets as of 7/15/2015 14:58 * Figures are in USD and reflect a snapshot of markets as of 7/15/2015 14:58

source: State Street Global Markets, Bloomberg source: State Street Global Markets, Bloomberg

Holding Period 1D 1W 1M 3M 6M 1Y 3Y 5Y

ETF (bps)

Avg. Dev. 0.0 -1.8 -9.4 -31.5 -62.3 -123.3 -346.3 -690.9Periodic TE 104.5 118.2 120.4 122.8 131.9 141.8 154.3 164.4Avg. ABS Dev. 74.1 84.9 90.0 95.9 112.2 149.8 349.6 694.0Bid/Ask vs. Mid 2.63 2.63 2.63 2.63 2.63 2.63 2.63 2.63Trading Comms. 5.21 5.21 5.21 5.21 5.21 5.21 5.21 5.21Mgmt Fees 0.26 1.29 5.58 16.75 33.50 67.00 201.00 335.00Total ETF Costs 8.10 9.13 13.43 24.59 41.34 74.84 208.84 342.84

Futures (bps)

Avg. Dev. 0.0 -1.8 -9.1 -31.2 -63.6 -131.3 -402.1 -738.1Periodic TE 102.7 114.6 117.3 123.2 132.4 144.8 170.3 183.1Avg. ABS Dev. 73.4 82.9 88.0 95.5 113.9 157.2 404.5 741.4Bid/Ask vs. Mid 2.13 2.13 2.13 2.13 2.66 3.73 7.98 12.24Spread vs. FV 0.46 2.32 10.06 30.18 30.18 30.18 30.18 30.18Trading Comms. 2.55 2.55 2.55 2.55 5.11 10.22 30.65 51.09Total FUT Costs 5.15 7.00 14.74 34.86 37.95 44.12 68.82 93.51

* Rolling time-periods, TE based on historical backtest period, Costs based on current market, All costs are indicative only

source: State Street Global Markets, Bloomberg

MSCI EM FUTURES2

ETF Notes

Pricing Currency USD USD USD Simulation Period: Sep 11 2009 ‒ Jul 14 2015

Total Return 23.35% 14.89% 14.46% Returns are net of estimated commissions, bid/ask spreads, and management fees (ETFs)

Annual Return 3.65% 2.40% 2.33% Futures backtest results assume rolls (2nd to front) occur 4 days prior to expiration

Annual σ 16.20% 22.80% 22.89% Annualized volatility (standard deviation) of daily returns assuming 260 valuation days per year

Annual TE - 1.45% 1.42% Rolling one-year tracking error

Annual TC (bps) - 13.94 7.84 T-Costs reflect estimated bid/ask & trading comms. only (ETF mgmt. fees, FUT spread vs. FV not included)

Source: State Street Global Markets, Bloomberg

Source: State Street Global Markets, Bloomberg Source: State Street Global Markets, Bloomberg Source: State Street Global Markets, Bloomberg

Backtest

Time-Horizon Comparison

Costs

Strategy

Futures* ETF*

Exchange

Pricing

Instruments Overview - MES Futures vs. EEM ETF

Creation Unit

Static

Liquidity

Costs

Margin

Liquidity

Static

Pricing

Fair Value

Fair Value

-10%

0%

10%

20%

30%

40%

50%

Sep-0

9

Dec-0

9

Mar-

10

Jun-1

0

Sep-1

0

Dec-1

0

Mar-

11

Jun-1

1

Sep-1

1

Dec-1

1

Mar-

12

Jun-1

2

Sep-1

2

Dec-1

2

Mar-

13

Jun-1

3

Sep-1

3

Dec-1

3

Mar-

14

Jun-1

4

Sep-1

4

Dec-1

4

Mar-

15

Jun-1

5

Index Futures ETF

8.1 9.1 13.424.6

41.3

74.8

0

20

40

60

80

100

1D 1W 1M 3M 6M 1Y

bp

s

Total ETF Costs

5.1 7.014.7

34.9 37.9 44.1

0

20

40

60

80

100

1D 1W 1M 3M 6M 1Y

bp

s

Total FUT Costs

-300

-250

-200

-150

-100

-50

0

50

100

150

1D 1W 1M 3M 6M 1Y

bp

s

+1 SD -1SD Avg. Dev

-300

-250

-200

-150

-100

-50

0

50

100

150

1D 1W 1M 3M 6M 1Y

bp

s

+1 SD -1SD Avg. Dev

STRATEGY RESEARCH


References

1. Bloom, D., Mackel, P., Wardle, C., Williams, M.T., Wang, J., Hernandez, M., Bunning, D., Chew, J. “HSBC’s

Emerging Markets Currency Guide 2015: An essential companion”. HSBC Global Research. (January

2015)

2. Cheung, Y-L., Ho, Y-K. “The Intertemporal Stability of the Relationships Between the Asian Emerging Equity

Markets and the Developed Equity Markets”. Journal of Business Finance & Accounting, 18(2).

3. Cho, D.C., Taylor, W.M. "The Seasonal Stability of the Factor Structure of Stock Returns". The Journal of

Finance. (VOL. XLII, NO. 5, December 1987, 1195–1211)

4. Collyns, C., Huefner, F., Koepke, R., Bykere, A., Farnham, S., Shaw, L., Tran, H., Gibbs, S., Tiftik, E.,

Nguyen, F., Mahmood, K., “Capital Flows to Emerging Markets”. Institute of International Finance (IIF).

(May 28, 2015)

5. Collyns, C., Huefner, F., Koepke, R., Mohammed, S., Tran, H., Gibbs, S., Tiftik. “Capital Flows to Emerging

Markets”. Institute of International Finance (IIF). (May 29, 2014)

6. Credit Suisse AG. “Emerging Markets Currency Guide: Helping You Find Your Way”. (Swiss Edition,

January 2013)

7. ICE Futures US, Inc. “White Paper: The Relationship Between MSCI Emerging Market Index, mini MSCI

Emerging Markets Index Futures and the iShares MSCI Emerging Markets ETF”. ICE Futures US mini MSCI

Index Futures: theice.com/products/Futures-Options/Financials/MSCI-Indexes

8. Mayers, A. "Introduction to Statistics and SPSS in Psychology Multivariate Analyses". Pearson Higher

Education. (July 25, 2013, 318–361)

9. MSCI Inc. “MSCI Global Market Accessibility Review”. (updated June 11, 2015)

10. State Street Corporation. “Investment Manager Guide.” (revised July 1, 2015)

11. Stevens, J. “Applied Multivariate Statistics for Social Sciences”. Lawrence Erlbaum Associates Publishers.

(2nd

Edition, 1992, 260-269).

12. Van De Graaff, J.D., Rosenzweig, K.M., Foley, K.M., DeWaal, G.A., Hennion, C.B. “Foreign Listed Stock

Index Futures and Options Approvals”. Katten (Katten Muchin Rosenman LLP). (April 2015)

13. Tang, G.Y.N. “The intertemporal stability of the covariance and correlation matrices of Hong Kong stock

returns”. Applied Financial Economics. (1998, 8, 359–365)

14. Zaiontz, Charles. "Box’s M Test Basic Concepts". Real Statistics Using Excel. http://www.real-

statistics.com/multivariate-statistics/boxs-test-equality-covariance-matrices/boxs-test-basic-concepts/ (2014)

STRATEGY RESEARCH


SSGM Portfolio Solutions Strategy Team

Steve Fenty, CFA Vice President, Head of Strategy +1 617 664 1546 [email protected]

Dan Constantine, CFA Vice President +1 617 664 4802 [email protected]

Glenn Cooper, CFA Vice President +1 617 664 2538 [email protected]

Rick Zhan, CFA, FSA Officer +1 617 664 5060 [email protected]

Notes and Definitions

State Street Global Markets is the marketing name and a registered trademark of State Street Corporation used for its financial markets

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Important Legal Information – Please Read

NAM

This communication is intended to provide generic background information about investments and investment strategies and does not take into account your individual needs and circumstances. Nothing in this communication should be construed as a solicitation, offer, recommendation or advice on the merits of acquiring or disposing of any particular investment or of participating in any specific trading strategy or in any other transaction or as investment, legal or tax advice. This communication does not provide any assessment of the value or prospects of any particular investment or issuer of investments. You should make your own assessment and evaluation of the communication in the light of your individual needs and circumstances. We also would remind you that past performance is no guarantee of future results.

The content of this communication is based on or derived from public information and data made available to us from a number of different sources, including third party sources. We, our affiliated companies and our and their directors and employees make no representation that the information and opinions contained in this communication comply with local accounting standards or are accurate, complete or up to date and hereby exclude all warranties, conditions and other terms, whether express or implied, in relation to such information and opinions and accept no liability, whether arising in contract, tort, including negligence, or for breach of statutory duty, misrepresentation or otherwise, for any losses, liabilities, damages, expenses or costs arising from or connected with this communication and the information and opinions expressed herein, provided, however that nothing herein shall limit or exclude liability for fraud or for any other liability to the extent that the same cannot be limited or excluded by applicable law. We also do not undertake and are under no obligation to update or keep current the information or opinions contained in this communication to account for future events.

You may only use and copy this communication for internal purposes and may not forward, amend or distribute the communication outside your immediate organization without our prior written consent. These terms are subject to any agreement between us governing the provision of the communication. This communication is not intended for distribution to, and may not be relied upon by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to applicable law or regulation.

United States. This communication is being distributed in the United States by State Street Bank and Trust Company.

Canada. This report, when made available in certain provinces of Canada, has been approved by State Street Global Markets Canada, Inc. (“State Street Global Markets Canada”), a member of the Investment Industry Regulatory Organization of Canada.

Please contact your sales representative for further information.

© State Street Corporation, 2015

EMEA

This document is for marketing and/or informational purposes only, it does not take into account any investor's particular investment objectives, strategies or tax and legal status, nor does it purport to be comprehensive or intended to replace the exercise of a clients own careful independent review regarding any corresponding investment decision. This document and the information herein does not constitute investment, legal, or tax advice and is not a solicitation to buy or sell securities or intended to constitute any binding contractual arrangement or commitment by State Street to provide securities services. The information provided herein has been obtained from sources believed to be reliable at the time of publication, nonetheless, we cannot guarantee nor do we make any representation or warranty as to its accuracy and you should not place any reliance on said information. State Street Global Markets hereby disclaims all liability, whether arising in contract, tort or otherwise, for any losses, liabilities, damages, expenses or costs arising, either direct or consequential, from or in connection with the use of this document and/or the information herein.

STRATEGY RESEARCH


Clients should be aware of the risks of participating in trading foreign exchange, equities, fixed income or derivative instruments or in investments in non-liquid or emerging markets. Derivatives generally involve leverage and are therefore more volatile than their underlying cash investments. Clients should be aware that products and services outlined herein may put their capital at risk. Further, past performance is no guarantee of future results and, where applicable, returns may increase or decrease as a result of currency fluctuations.

This communication is not intended for retail clients, nor for distribution to, and may not be relied upon by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to applicable law or regulation. This publication or any portion hereof may not be reprinted, sold or redistributed without the prior written consent of State Street Global Markets.

United Kingdom and European Economic Area. The products and services outlined in this communication are offered to Professional Clients or Eligible Counterparties in the United Kingdom and other Member States of the European Economic Area through either (i) State Street Bank Europe Limited or (ii) State Street Bank and Trust Company, London Branch, both of which are authorised by the Financial Conduct Authority of the United Kingdom and regulated by the Prudential Regulatory Authority or (iii) State Street Bank GmbH, London branch, which is authorised and regulated by the Bundesbank and German Financial Supervisory Authority (BaFin) and subject to regulation by the Financial Conduct Authority for the conduct of UK business, with each of the foregoing hereafter referred to as the “Distributor”. This communication is not intended for and must not be provided to retail investors. This communication is intended for distribution by the Distributor in the United Kingdom and other Member States of the European Economic Area with respect to which the Distributor has exercised passporting rights, where applicable, to provide cross-border services

This communication has not been prepared in accordance with the legal requirements designed to promote the independence of investment research, and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The information in this communication has been prepared to ensure that it is fair, clear and not misleading. However, the Distributor makes no representation as to the independence or impartiality of the information that is contained in this communication. The recipient should not view this communication as an objective report.

© 2015 State Street Corporation - All Rights Reserved

APAC

The information provided herein does not constitute investment advice and is not a solicitation to buy or sell securities. It does not take into account any investor's particular investment objectives, strategies or tax status. All material has been obtained from sources believed to be reliable but we make no representation or warranty as to its accuracy and you should not place any reliance on this information. Past performance is no guarantee of future results.

State Street has a foreign bank representative office in Thailand, restricted bank license in Brunei and an unregulated entity in Malaysia and the activities that are being discussed are carried out from off-shore.

The written materials do not constitute, and should not be construed as constituting:

an offer or invitation to subscribe for or purchase securities or futures in Thailand, Brunei or Malaysia or the making available of securities or futures for purchase or subscription in Thailand, Brunei or Malaysia;

the provision of investment advice concerning securities or futures; or

an undertaking by State Street to manage the portfolio of securities or futures contracts on behalf of other persons.

Australia. This communication is being distributed in Australia by State Street Bank and Trust Company ABN 70 062 819 630, AFSL 239679 and is intended only for wholesale clients, as defined in the Corporations Act 2001. Privacy: Please read our Privacy Statement at www.statestreet.com.au. Our Privacy Statement provides important information about how we manage personal information.

China. In China, State Street is not licensed within or carrying on business within China in relation to the products and services outlined in this document, and the activities that are being discussed are carried out from off-shore. The written materials do not constitute, and should not be construed as constituting an offer or invitation to subscribe for or purchase securities or futures in China or the making available of securities or futures available for purchase or subscription, a provision of investment advice concerning securities or futures, or an undertaking by State Street to manage the portfolio of securities or futures contracts on behalf of other persons in China.

Hong Kong. This communication is being distributed in Hong Kong by State Street Securities Hong Kong Limited and is intended only for professional investors as defined in the Securities and Futures Ordinance.

Japan. This communication is disseminated in Japan by State Street Global Markets (Japan) which is regulated by the Financial Services Agency of Japan as a financial instruments firm.

Singapore. This communication is being disseminated by State Street Bank and Trust Company, Singapore Branch (“SSBTS”) (UEN T01FC6134G), which holds a wholesale bank license by the Monetary Authority of Singapore. In Singapore, this communication is only distributed to accredited, institutional investors as defined in the Singapore Financial Advisers Act (“FAA”). Note that SSBTS is exempt from Sections 27 and 36 of the FAA. When this communication is distributed to overseas investors as defined in the FAA, note that SSBTS is exempt from Sections 26, 27, 29 and 36 of the FAA.

Taiwan: State Street is not licensed within or carrying on business within Taiwan and the activities that are being discussed are carried out from offshore.

The products and services may not be available in all jurisdictions. Please contact your sales representative for further information.

© State Street Corporation, 2015

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