december 15, 2005
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www.institutional.alliancebernstein.com
December 15, 2005
Corporate Governance as a Component of Equity Risk
IIF Indian Banks Symposium, Mumbai
Manish SinghaiAlliance Capital Management (S) LtdCIO, Asia ex-Japan Markets
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Sources of Risk in the Emerging Markets Are Changing
Single-Stock Risk Attribution**
Through December 31, 2004*Standard deviation of monthly returns of the MSCI Emerging Markets Index minus the standard deviation of monthly returns of the MSCI World Index; gross dividends re-invested, in US dollars; data annualized, shown on a rolling three-year basis.**Decomposition of single-stock risk by the following factors: global equity, emerging-market equity, global industry, local industry, country and stock-specific. The charts above isolate the country and company-specific factors of the decomposition. Numbers shown on a rolling three-year basis.Source: MSCI, Bernstein and Alliance Capital
10
15
20
25
30
90 92 94 96 98 00 02 04
Excess Equity Volatility*Emerging Minus
Developed Markets
0
2
4
6
8
10
12
14
16
18
97 98 99 00 01 02 03 04
(%)
Country Company Specific
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30
40
50
90 92 94 96 98 00 02 04
(%) (%)
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EM Company Risk Still Higher than Developed Markets’
Through December 31, 2004*Annualized average of monthly standard deviation of single-stock returns in US dollarsSource: MSCI, Bernstein and Alliance Capital
Average Annual Single-Stock Volatility(Rolling One Year)*
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20
40
60
80
100
120
88 90 92 94 96 98 00 02 04
38.6%
21.7%
(%)
DevelopedEmerging
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How to Best Assess Emerging Markets Equity Risk?
Strong “on-the-ground” fundamental research is critical to understanding balance-sheet risk and better pinpointing outperformance potential
A systematic approach evaluates risks associated with the quality of corporate governance
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Research Results Are Tangible
Emerging MarketsAsia
Emerging MarketsEMEA
Emerging MarketsLatin America
Past performance is no guarantee of future results. Annualized returns in US dollars. The rating system is based on the stocks tracked by Alliance Capital research analysts. The degree to which such internal research is utilized may vary between strategies. “1”-rated stocks are believed to be among the best in their sector; “3”-rated stocks are believed to be among the worst in their sector. The returns are based on an equal-weighted average of the returns of the equity research team’s individual ratings and are rebalanced bi-weekly. The rating system is proprietary to Alliance Capital and is not indicative of the performance of any Alliance Capital portfolio.Source: MSCI and Alliance Capital
Alliance Capital Analysts’ RatingsAnnualized Returns (Nov 1999–Dec 2004)
25.3%
2.7%
(6.5)%
27.2%
12.6%
2.3%
20.8%14.2%
(10.3)%“1” Rated “3” Rated
MSCI EM
ASIA
MSCIEM
EMEA
MSCI EM
LatinAmerica
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Analysis of Corporate Governance Can Be Revealing
The quality of corporate governance—both in developed and emerging markets—tends to affect risk and valuation, and it is correlated to key variables for investors, particularly:
Returns
Corporate fundamentals
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Corporate Governance Shown to Help Performance
US: Relative Annualized PerformanceBetter vs. Poorer Corporate Governance*
1990–1999
8.5%
5.4%
Market-CapWeighted
EqualWeighted
*Difference between the returns of theoretical portfolios with better and poorer corporate governance based on an attribution estimate of the pure impact of corporate governance. Corporate governance is measured by the Governance Index (G) as developed by Paul A. Gompers (Harvard Business School), Joy L. Ishii (Department of Economics at Harvard University) and Andrew Metrick (Department of Finance, The Wharton School, University of Pennsylvania) in a study titled “Corporate Governance and Equity Prices” (February 2003). The universe of the study is drawn from the Standard & Poor’s 500 Index as well as the annual lists of the largest corporations as published by Forbes, Fortune and BusinessWeek. The universe tracked more than 93% of the total market capitalization of the combined New York Stock Exchange, American Stock Exchange and Nasdaq markets. Main data source for the study is the Investors Responsibility Research Center (IRRC) database. Sample period is September 1990 to December 1999. The portfolios were reset in September 1990, July 1993, July 1995 and February 1998, which are the periods after new data on G became available. Better governance portfolios include the top decile of the studied universe ranked by G. Poorer governance portfolios include the bottom decile of the studied universe ranked by G.Source: Corporate Governance and Equity Prices (February 2003) by Gompers, Ishii and Metrick
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Corporate Governance and Fundamentals Are Correlated
US: Corporate Fundamentals’ Incremental BenefitBetter vs. Poorer Corporate Governance*
1990–1999
16 b.p.
39 b.p.
51 b.p.
ROE Net ProfitMargin
Sales Growth
*Corporate governance is measured by the Governance Index (G) as developed by Paul A. Gompers (Harvard Business School), Joy L. Ishii (Department of Economics at Harvard University) and Andrew Metrick (Department of Finance, The Wharton School, University of Pennsylvania) in a study titled “Corporate Governance and Equity Prices” (February 2003). The universe of the study is drawn from the Standard & Poor’s 500 Index as well as the annual lists of the largest corporations as published by Forbes, Fortune and BusinessWeek. The universe tracked more than 93% of the total market capitalization of the combined New York Stock Exchange, American Stock Exchange and Nasdaq markets. Main data source for the study is the Investors Responsibility Research Center (IRRC) database. Sample period is September 1990 to December 1999. The portfolios were reset in September 1990, July 1993, July 1995 and February 1998, which are the periods after new data on G became available. Better governance portfolios include the top decile of the studied universe ranked by G. Poorer governance portfolios include the bottom decile of the studied universe ranked by G. Regressions for net-profit margin, ROE and sales growth on G measured in the previous year and the book-to-market ratio. Data shown represent the mean values for the analyzed period.Source: Corporate Governance and Equity Prices (February 2003) by Gompers, Ishii and Metrick
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Our Tools Gauge Quality of EM Corporate Governance
In-depth tools assess quality of corporate governance by analyzing issues related to:
Information disclosure
Management access and fair disclosure
Accounting
Shareholder value creation
Board and shareholder structure
Capital management
Ethics and social responsibility
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Tools Provide Systematic Approach to Rating Stocks
Emerging-market stocks rated “A”, “B” and “C” according to the quality of corporate governance
Directional analysis integral part of the rating system(+, neutral, –)
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Top-Rated Companies Are Less Volatile…
Alliance Capital Emerging Markets UniverseAnnualized Average
2002–2004
15.9%17.7%
21.5%
“A” Rated “B” Rated “C” Rated
Standard Deviation Beta
Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. Beta is measured against the MSCI Emerging Markets Index.Source: MSCI and Alliance Capital
1.0 1.1
1.6
“A” Rated “B” Rated “C” Rated
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…Boast Higher Valuations…
Alliance Capital Emerging Markets UniverseAverage
2002–2004Price/Earnings Price/Book
Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. Average price/earnings was calculated using Windsor methodology, which capped P/Es at 200 and –200; average price-to-book was calculated using Windsor methodology, which capped price-to-book at 10 and –10.Source: MSCI, Worldscope and Alliance Capital
2.8×
2.2× 2.1×
“A” Rated “B” Rated “C” Rated
15.7×13.6× 13.6×
“A” Rated “B” Rated “C” Rated
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14% 13%
22%
“A”Rated
“B”Rated
“C”Rated
…Make Better Use of Capital…
Alliance Capital Emerging Markets UniverseAnnualized Average
2002–2004
Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. Annualized return on equity was calculated using Windsor methodology, which capped ROE at 100 and –100; annualized payout ratio was calculated using Windsor methodology, which capped the ratio at 100; annualized capital expenditures to sales was calculated using Windsor methodology, which capped the capex/sales ratio at 200 and –200.Source: MSCI, Worldscope and Alliance Capital
ROE
21% 20% 18%
“A”Rated
“B”Rated
“C”Rated
41%36%
31%
“A”Rated
“B”Rated
“C”Rated
Payout Ratio Capex/Sales
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…And Tend to Outperform Their Lower-Rated Peers
Alliance Capital Emerging Markets UniverseAnnualized Returns
2002–2004
Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. Annualized returns measured on an equal-weighted basis. The degree to which stocks in each category are utilized will vary. The returns presented above do not represent the performance of any Alliance Capital portfolio.Source: MSCI and Alliance Capital
32.2% 30.1% 29.5%
“A” Rated “B” Rated “C” Rated
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Top-Rated Companies Are Well Distributed by Region…
Corporate Governance RatingsDistribution by Region*
2002–2004
*Chart shows the average percentage distribution of companies rated “A”, “B” and “C” according to Alliance Capital’s proprietary corporate governance system by domicile.Source: Alliance Capital
Asia Latin AmericaEMEA
30.5%
60.6%
9.2%
“A” Rated “C” Rated“B” Rated
45.0%
47.5%
7.5%
26.8%
70.0%
3.2%
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…and by SectorCorporate Governance RatingsPercentage Distribution by Sector*
2002–2004
*Chart shows the average percentage distribution of companies rated “A”, “B” and “C” according to Alliance Capital’s proprietary corporate governance system by sector.Source: Alliance Capital
0% 10% 20% 30% 40% 50% 60% 70% 80%
Utilities
Telecommunications
Materials
Technology
Industrials
Healthcare
Financials
Energy
Consumer StaplesConsumer Discretionary
“A” Rated
“C” Rated
“B” Rated
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Improving Governance a Harbinger of Outperformance
38%
31%
A+ RatedStocks
A, A– RatedStocks
Alliance Capital Emerging Markets UniverseAnnualized Returns (2002–2004)
Stocks in this analysis are rated “A”, “B” and “C” by our analysts according to our proprietary corporate governance rating system. Stocks rated A are perceived to have better corporate governance, while stocks rated C are perceived to have poorer corporate governance. A plus (+) rating indicates an improving corporate governance outlook, while a neutral rating reflects a steady outlook and a minus (–) rating suggests a deteriorating outlook. Annualized returns measured on an equal-weighted basis. The degree to which stocks in each category are utilized will vary. The returns presented above do not represent the performance of any Alliance Capital portfolio.Source: MSCI and Alliance Capital
39%
24%
B+ RatedStocks
B, B– RatedStocks
38%
23%
C+ RatedStocks
C, C– RatedStocks
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Tools Can Enhance Bottom-Up Stock Selection
Annualized Performance: 2002–2004
Annualized returns calculated on an equal-weighted basis in US dollarsSource: MSCI and Alliance Capital
30.5%
MSCI Emerging
Markets Index
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Tools Can Enhance Bottom-Up Stock Selection
Annualized Performance: 2002–2004
Annualized returns calculated on an equal-weighted basis in US dollarsPast performance is no guarantee of future results. The rating system is based on the stocks tracked by Alliance Capital research analysts. The degree to which such internal research is utilized may vary between strategies. “1”-rated stocks are believed to be among the best in their sector; “3”-rated stocks are believed to be among the worst in their sector. The rating system is proprietary to Alliance Capital and is not indicative of the performance of any Alliance Capital portfolio.Source: FactSet, MSCI and Alliance Capital
30.5%36.5%
MSCI Emerging
Markets Index
Alliance Capital Analysts’
“1” Rated Stocks
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Tools Can Enhance Bottom-Up Stock Selection
Annualized Performance: 2002–2004
30.5%36.5%
44.4%
MSCI Emerging
Markets Index
Alliance Capital Analysts’
“1” Rated Stocks
“1” Rated Stocks with CG
Rating of A+Annualized returns calculated on an equal-weighted basis in US dollarsPast performance is no guarantee of future results. The rating systems are based on the stocks tracked by Alliance Capital research analysts. The degree to which such internal research is utilized may vary between strategies. “1”-rated stocks are believed to be among the best in their sector based on our fundamental analysis; “A+” rated stocks are perceived to have the best corporate governance with a positive outlook. The fundamental and corporate-governance rating systems are proprietary to Alliance Capital and are not indicative of the performance of any Alliance Capital portfolio. The returns presented above do not represent the performance of any Alliance Capital portfolio.Source: FactSet, MSCI and Alliance Capital
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Enhancing our Tools: A More Selective Rating System
Rating system recently expanded to “A”, “B”, “C” or “D” according to quality of corporate governance
Enhanced format instrumental to help us detect potential “false” improvements in governance
Sharpened focus on management compensation, capital management, shareholders’ rights, social responsibility and ethics better identifies good corporate governance behavior
“D” rated stocks will not be owned by any portfolio
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Enhancing our Tools: Introducing Country Ratings
Tools check whether country-specific investment environment protects minority shareholders by focusing on:
Investment framework
Enforcement
Shareholder activism
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Country Rating Scores Vary Within Region
Alliance Capital Country Rating Scores*
As of March 31, 2005*The country rating system considers whether the national framework adequately protects minority shareholders by posting a series of questions that result on a score between –2 and +2. Countries with higher scores are believed to have more investor-friendly regulatory and institutional frameworks.Source: Alliance Capital
EMEA Asia Latin America
Czech Republic 1 China 0 Argentina –1
Egypt –1 Hong Kong 1 Brazil –1
Hungary 1 India 1 Chile 1
Israel 2 Indonesia –2 Mexico 0
Poland 0 Malaysia 0 Venezuela 0
Russia –2 Philippines –2
South Africa 2 Singapore 2
Turkey 0 South Korea 0
Taiwan –1
Thailand –1
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What We Have Learned
Systematic approach to measuring quality of corporate governance can minimize risk and add value to investors
Constant checks of tools help avoid pitfalls
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