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The Emerging Market fixed income opportunity
1. The Emerging Market
fixed income opportunity
Madrid Perspectives Event
17 January 2013
Steve Ellis
Portfolio Manager
Fixed Income
This presentation is for investment professionals only and
should not be relied upon by private investors.
2. Evolution of the EM Debt asset class
Today: A strategic component of asset allocation
Emerging market Hard currency Rise of the Corporate issuance
Sovereign local Domestic yield Hard currency
restructuring yield curve EM corporate exceeds sovereign
market issuance curve extension debt buybacks
(Brady Bond Plan) development debt market issuance
EM DEBT MARKET
1990s 2000s
Why invest in emerging market bonds?
EM bonds have demonstrated a resilience and passed a second stress test as the Eurozone crisis has not resulted in a
deterioration of EM fundamentals.
EM countries account for almost 72% of the contribution to global growth and growing at four times that of DMs.
EM fixed income asset class continues to grow with total EM debt outstanding across sovereign, corporates, and local
markets approaching $8 trillion
EM is attractive to DM markets on a risk-adjusted basis with EM local yields remaining attractive to DM yields, offering
over 4% pick-up on a relative basis in nominal terms and 2.5% on a real basis to comparable government bonds
Who invests in emerging market bonds?
Pension funds: $1.7 trillion
Insurance companies: $2.7 trillion
Sovereign Wealth Funds: $4.3 trillion
Source: FMR, BofA Merrill Lynch, September 2012
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3. EM Debt and currency markets at a glance
The best-performing asset class of the last decade on an absolute and risk-adjusted basis
A beneficiary of the search for yield among investors and a diversification away from debt-laden
developed markets
A way to benefit from emerging economic growth without the higher volatility levels associated with
equity investment
Stable government policies have combined with well-managed economic growth to drive the
performance of emerging market debt
This is an ongoing story: emerging market fundamentals are forecast to go on improving, while
developed-world governments face slower growth and large deficits
Frontier markets offer the opportunity to benefit from genuine ‘emergence’ - when some of the best
capital gains can be made
However, most of the return from emerging market debt comes from income/carry
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4. Sovereigns have recently issued predominantly in the
local market
Sovereigns now issue more frequently in the domestic market (87% of total sovereign issuance).
With local term structures shifting lower, governments have more incentive to issue locally (FX risk is
borne by investors and not by the government).
Local pension funds’ AUM (US$ 1.7trn) and insurance companies’ AUM (US$ 2.7trn) haven risen
dramatically which causes a natural bid for local currency debt.
Net issuance in local currency debt in 2012 has been low.
GBI-EM gross issuance (US$ bn)
Source: Fidelity Worldwide Investment, Bond Radar, J.P. Morgan, official sources.
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5. Corporates issue more frequently in hard currencies
New issue market in the external EM market has been dominated by corporate supply
Share of corporate issuance in hard currencies is almost back to 2007 peak levels
Corporate issuance is equally split across regions: Asia (41%), EMEA (29%) and LATAM (30%)
Total outstanding EM corporate debt stands at US$2.9trn of which approximately one third is in
investable hard currency bonds
Hard currency issuance (US$ bn)
Source: Fidelity Worldwide Investment, Bond Radar, J.P. Morgan, official sources, Sept 2012
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6. If you like EM equities, you should love EM debt...
EM external debt was the best-performing asset class of the last 18 years on an absolute and risk-
adjusted basis.
EM Hard Currency debt has offered better risk-adjusted returns than most DM asset classes over the
last three years.
EM local markets and corporates have experienced higher volatility due to FX moves and corporate
defaults, but still have impressive Sharpe Ratios.
Cumulative performance (rebased 31.12.1993=100) Sharpe Ratios
Source: Fidelity Worldwide Investment, Datastream, as at 31/07/2012. Rebased to
31.12.93 – first date of availability for JPM EMBIG data. US listed property is the Source: Fidelity Worldwide Investment, J.P. Morgan,
FTSE/NAREIT EQUITY REITS $ Index. 31/07/2012
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7. Higher quality higher returns higher inflows
Continued strong inflows into EM dedicated funds with inflows of US$32.6bn YTD.
Hard currency funds experienced the largest inflows with ~61% of total inflows YTD.
Flows into global EM funds are >90% of total flows as compared to regional dedicated funds.
EMBI Global vs EM Hard Currency Fund EM Fund Flows (US$ bn)
Flows (US$ bn)
Source: Fidelity Worldwide Investment,
Source: Fidelity Worldwide Investment, J.P. Morgan, December 2012 Credit Suisse, EPFR Global, December 2012
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8. Where do we go from here?
EM growth momentum is picking up. PMI data supportive going forward
Alpha is portable in EM. Three alpha sources: Credit, Rates and FX
FX looks like an attractive alpha source for 2013 with PMIs now ticking higher
EM FX has underperformed other EM assets due to the weak global growth backdrop and central
bank currency wars
EM PMIs now ticking higher High correlation between EMFX returns and
global PMIs
Source: Fidelity Worldwide Investment, Bloomberg,
Source: Fidelity Worldwide Investment, Bloomberg, December 2012 J.P. Morgan, December 2012
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9. How much more can spreads tighten?
EM spreads over treasuries are close to pre-global financial crisis levels
Appetite for yield, and the lack of spread products due to QE likely to encourage further spread
tightening. Investors likely to be pushed further down the risk spectrum
Some obvious threats are: default rates rising / pick up in volatility caused by some tail risk event. But
as we shall see, there are other risks
Index spreads over UST (bps)
Source: Fidelity Worldwide Investment, Bloomberg, December 2012
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10. Key risks in EM Debt
Heavy refinancing needs in H1 2014.
Unintended consequences of QE with increasing inflation and asset bubbles.
Increase in UST yields from record lows (Great Rotation).
EM HY refinancing needs (US$ bn) Inflation projections, CPI (%)
Source: Fidelity Worldwide Investment, ING, Oct 2012. Source: Fidelity Worldwide Investment, Credit Suisse.
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11. EM Debt:
Three opportunity sets
USD EM Hard Currency EM Local Currency EM Corporate
Market Capitalization $579* $1535* $265*
(billion$) *JP Morgan EMBI Global *JP Morgan GBI-EM Broad Diversified *JP Morgan CEMBI Broad Diversified
Investability Highly investable Wide variability: from highly Still very much a primary
investable to fully market but investablility
uninvestable
continues to grow as issuer
base broadens
Foreign Exchange Risk No Yes No
# of Issuers 55 16 372
Quality BBB- A- BBB
Analytical Approach Top down & Bottom Up Top Down Bottom-Up
FF Emerging Market Debt Fund FF Emerging Market Inflation-
Launched January 2006 linked Bond Fund
AUM: $1178m Launched November 2011
Fidelity fund range: Managed by Steve Ellis AUM: $110m
Managed by Andy Weir
Two existing funds
Two proposed new funds FF Emerging Market Local FF Emerging Market Corporate
Currency Debt Fund Debt Fund
Proposed launch March 2013 Proposed launch March 2013
Managed by Steve Ellis Managed by Andrei Gorodilov
Source: JP Morgan, 31/12/2012
FIL Limited fund AUM as at 30/11/2012
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13. Steve Ellis
EM Portfolio Manager
Investment Experience
Commence managing FF-Emerging Market Debt Fund November 5, 2012
Goldman Sachs Asset Management
Emerging Markets Local Currency Debt and FX, 2006– 2012
Portfolio Manager
Lehman Brothers
2001-2006
Steve Ellis Global Head of Local Market Strategy
Fund Manager
Based in London
Investment Experience ING Barings
1997-2001
19 years Global Research, Fixed Income Strategist
Education
Bristol University, BSc (Hons)
Economics NatWest
1993-1997
Economist
Source: FIL Limited, November 2012
* Local Currency EM Bond pilot launched 3rd September 2012
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14. Dedicated EM sovereign research analyst,
trader and Asian PM
Andressa Tezine Paul Greer Eric Wong
EM Research Analyst EM Trader Portfolio Manager
• Since 2005, Andressa worked for • Prior to joining Fidelity Paul was at • Prior to joining Fidelity Paul was Portfolio
Pinebridge Investments as the Head of Pinebridge Investments since 2006 as Manager at BlackRock where he
Research for the Emerging markets Fixed Head of Fixed Income and Listed Equity managed over $18 billion of emerging
Income Trading market bonds since 2002.
• From 1996-2005 Andressa worked for • Prior to that Paul worked at the Bank of • He was responsible for generating alpha
ABN AMRO in Sao Paulo (1996-2005), Ireland Global Markets in Dublin in by country selection, curve relative value
Brazil as a Treasury Senior Economist Wholesale FX and Money Market and new issues participation
operations since 2001.
• From 1995-1996 she worked at Banco • Developed and launched exchange traded
Itamorati as an Economics Analyst • He traded credit, rates and was a principal funds for emerging market corporates and
dealer emerging market high yield
• She started her career in the Treasury
department at Unibanco (1993-1995). • He gained his FSA Securities and • Collaborated with research desk to
Financial Derivatives qualification in 2003. enhance existing investment models and
• Education:
developed new trading strategies to
• Education
– Universidade Sao Paulo, Economics provide high capacity alpha to portfolios.
– The Queen’s University of Belfast
– Universitat Pompeu Fabre in • Education
Barcelona , MSc in Economics & – Bachelors degree with Honours
– BA, Economics with minors in
Management
– 2.1 Electrical and Electronic Computer Science & Spanish
Engineering
– Stanford University
Source: FIL Limited, November 2012
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15. EM Debt coverage across the fixed income team
Andrew Wells
Global CIO of Fixed Income & ISG
Andy Howse Juan Landazabal Olivier Szwarcberg Sabita Prakash David Buckle Rob Middleton
Team Leader - Portfolio Managers & European Product Head of Trading Head of Credit & Structured Research Head of Asian Fixed Income Head of Quantitative Research Head of FI Investment Operations
Portfolio Investment Trading Credit & Structured Asia – Fixed Income Quantitative Investment
Management Directors Research Research Operations
Steve Ellis Andrew Falco Kristian Atkinson Fred Kam Marton Huebler Paul Wood
Portfolio Manager
Investment Director -TBH Senior Trader Senior Credit Analyst Senior Credit Analyst Quantitative Analyst Head of Trading & Research Operations
Ian Fishwick Kevin Loo Naomi Haynes Gita Bal Katsumi Ishibashi Claudio Ferrarese Sifa Clark
Portfolio Manager Product Manager Senior Trader Senior Credit Analyst Senior Credit Analyst Quantitative Analyst Trading and Data Projects
Tim Foster Stuart Rumble Duncan Fraser Dierk Brandenburg Torquil Macleod Liam Kelly Gary Willis
Portfolio Manager Product Manager Senior Trader Senior Credit Analyst Senior Credit Analyst Quantitative Research Associate Trade Support
Andrei Gorodilov Aran Gordon Lars Salmon Stuart Collings Nitesh Kathuria Arezou Philsouph Jane O’Brien
Portfolio Manager Product Manager Senior Trader Senior Credit Analyst Research Associate Quantitative Developer Research Support
Peter Khan Constance de Wavrin Andrew Martin John Davy Dylan Ngai Joe Hanmer Kathryn Barrow
Portfolio Manager Product Manager Trader Senior Credit Analyst Research Associate Investment Graduate Research Support
Rick Patel David Lagrange Robbie Taylor Michael Dolan Nishan Pradhan Oliver Fawcett
Portfolio Manager Competitor Fund Analyst Trader Senior Credit Analyst Research Associate Head of PMS
David Simner Tobias Bracey Paul Greer Martin Dropkin Fan Zhang Quentin Lafosse
Portfolio Manager Product Specialist Trader Senior Credit Analyst Research Associate PMS Analyst
Jeremy Church Paola Delgado Richard Meachin Tiago Parente Jenny Lee (Maternity Leave) Christopher Ellinger
Assistant Portfolio Manager Product Specialist Graduate Junior Trader Senior Credit Analyst Credit Analyst PMS Analyst
Rahul Kathuria Ario Emami-Nejad Federico Wynne Asia-Investment Directors Katie Tutcher
Product Specialist Junior Trader Credit Analyst PMS Analyst
Portfolio Management Namrata Nanda Sanjeev Desai Andressa Tezine Gregor Carle Tim Craigen
Product Specialist Trade Support Sovereign Analyst Investment Director Head of Analytics
Ian Spreadbury Tristan Cooper Trista Cheung Konstantinos Korrovesis
Portfolio Manager Sovereign Analyst Associate Investment Director Senior Analytics Specialist
Andy Weir Jonathan Neve Asia Richard Homer
Portfolio Manager Credit Research Associate Investment Operations Analytics Specialist
Investment professionals
Bryan Collins Simoni Mittal Maria Abbonizio Camille Florentin
Portfolio Manager with full or partial Credit Research Associate Head of Investment Operations Junior Analytics Specialist
EM debt responsibility
Eric Wong Rebecca Motta Henry Mak Ashley-Anne Berry
Portfolio Manager Credit Research Associate Senior Manager, Investment Services Change Management Junior Analytics Specialist
Patrick Haller Asia - Trading Tara Lally Farshad Safaei
KEY: London Based Investment Graduate Change Manager Application Developer
Hong Kong Based
India Based Hiroki Hashimoto Freddy Wong Sabina Awan Business Change
Investment Graduate Trader Senior Change Analyst Management
Tokyo Based
Those in bold report Stephen Bramley Tae Ho Ryu Jack Adamson Virginia Galloway
directly to A Wells Investment Graduate Associate Trader Business Management Graduate Business Change Manager
Quan Yuan Jonathan Kok
Investment Graduate FI Associate
Source: FIL Limited, 01/01/2013 Jasmina Koleva
Credit Research Associate
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16. EM Debt
How we add value
Summary:
The EM team focuses on the management of emerging market external, local and corporate bonds
and currencies.
Leveraging the broader research resources available throughout Fidelity Worldwide Investment
They seek to generate alpha from solid credits with strong fundamentals.
The investment philosophy reflects the fact that alpha is portable so they construct optimal portfolios
with a mix of emerging market instruments that reflects Fidelity Worldwide Investment’s view on
emerging markets.
This is achieved through a combination of fundamental and quantitative modeling techniques that are
the backbone of the investment process
Portfolio Analytics
Client Guidelines Portfolio Managers
Quantitative Portfolio
Portfolio Sovereign
Modeling Management
Management Currency
Trading
Source: FIL Limited, November 2012
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17. Sources of potential alpha
External, local, FX, corporates
External debt Local rates FX Corporates
Evaluate country balance Inter-country rate levels & FX valuation Fundamental
sheets yield curve research/corporate market
Are we being adequately Identifying value in local debt Short term- Fundamental analysis-
compensated? Country /risk selection Investor positioning Credit analysis
Analyse- Value Sentiment Corporate governance
Economic growth FX rates Risk appetite Technical analysis-
Balance of payments FX risk Medium term- Liquidity
Political environment Security’s fair value Growth Yield curve
Government transparency Research inflation breakeven vs. Monetary Sovereign analysis-
Financial system inflation Fiscal Business environment
Fiscal policy Evaluate yield curve Current account Regulatory environment
Level of debt/composition Capital account FX controls
Security selection- Long term-
Relative value PPP
Productivity
Trade
Demographics
Source: FIL Limited, November 2012
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18. Overview of our EM Bond investment process
Top-down analysis
to screen countries’ creditworthiness
EMD Macro
HeatMap
Local Rates External Debt
Local FX Scorecard
Scorecard Scorecard
Bottom-up analysis using quant tools
to rank important drivers of alpha
The EMD team at FIL are fundamental investment managers, but use “HeatMaps” and “Scorecards” to
assist in data screening and portfolio construction.
Stage 1:
The HeatMap ranks countries’ creditworthiness, using factors such as fiscal solvency, balance of
payments and growth dynamics.
Stage 2:
The Scorecards then help the EMD team decide how best to express a particular view on a country:
i.e. via FX, duration, or external debt (or a mixture). The scorecards are a powerful way of combining
valuation metrics and trading rules to identify alpha opportunities in EM.
Source: FIL Limited, 30/11/2012
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19. FF Emerging Market Debt Fund Performance
Annual Performance in % Performance (%) as of October 31, 2012
Fidelity Funds JP Morgan Active
Emerging Market Debt EMBI Global Return
2007 4.6 6.3 (1.7)
2008 -19.5 -10.9 (8.7)
2009 45.6 28.2 17.4
2010 10.8 12.0 (1.2)
2011 3.1 8.5 (5.4)
YTD 2012 16.1 15.7 0.5
Ranking in Global Emerging Bond** Universe
1 year 26 of 117 1st quartile
3 years 45 of 69 3rd quartile
5 years 14 of 60 1st quartile
Source: FIL Limited as of 31/10/2012. Performance is gross and net of fees and in US Dollar terms. Calculation basis is NAV-NAV with
gross income reinvested.
**Source: Morningstar *Inception 1/23/2006
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19
20. EM credit quality has been improving
EM have proven resilient as the Euro debt crisis has not resulted in any significant deterioration of EM
fundamentals.
Average public debt-to-GDP ratio at 34%, and fiscal deficits currently average only 2.2% of GDP, broadly
unchanged from 2007.
EMBI universe is predominantly Investment Grade (63%) and the average rating has stabilised at Baa2/BBB.
EM sovereigns have experienced 194 upgrades (vs.154 downgrades) across 54 countries by the three rating
agencies since the start of the global financial crisis.
DM sovereigns on the other hand experienced only 15 upgrades (vs.132 downgrades) during the same
period.
% of EMBIG market capitalization by ratings bucket
Source: Fidelity Worldwide Investment, J.P. Morgan.
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21. Risk-return trade-off is most favourable in Credit Markets
Source: Fidelity Worldwide Investment, Credit Suisse.
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22. Default risks in Emerging Markets
EM corporate default rate bottomed at 0.74% in September 2011 but has since increased to 4.09%.
Total EM default rates remained below 3%.
EM default cycles have been decreasing over the past decade in magnitude and length, but timing the
default cycle remains important.
Speculative grade corporate and total EM default rates (%)
In the 2001-2003 cycle, EM speculative grade The EM corporate default rate
defaults peaked at 30.85% with US$41bn of bottomed at 0.74% in September ‘11
defaults recorded over the period. versus 2.08% in November ‘10. But, it
has since increased to 4.09% in Oct ’12.
The more recent 2008/09 cycle witnessed
US$29bn worth of corporate defaults. Given the
growth of the outstanding corporate bond market
the default rate peaked at 13.87%.
Source: Fidelity Worldwide Investment, ING.
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23. 1YR EMBIG total return scenarios
Base case (moderate growth upturn)
EMBIG yield (as of 14 Nov) 4.68%
Losses from defaults per yr ‐0.5%
Probability 70% EMBIG Spread change (%) ‐20% from 302 to 242 (DTS= 1687 )
10y UST yields (bp change) 15 from 1.59 to 1.74 (IR dur= 7.1 )
Expected 1y total return % 6.5%
Bear case (fiscal cliff / EU implosion)
EMBIG yield (as of 14 Nov) 4.68%
Losses from defaults per yr ‐2.0%
Probability 15% EMBIG Spread change (%) 50% from 302 to 453 (DTS= 1687 )
10y UST yields (bp change) ‐50 from 1.59 to 1.09 (IR dur= 7.1 )
Expected 1y total return % ‐2.2%
Bull case (QE continues / EM allocations increase)
EMBIG yield (as of 14 Nov) 4.68%
Losses from defaults per yr ‐0.5%
Probability 15% EMBIG Spread change (%) ‐50% from 302 to 151 (DTS= 1687 )
10y UST yields (bp change) 10 from 1.59 to 1.69 (IR dur= 7.1 )
Expected 1y total return % 11.9%
1y EMBIG weighted expected total return 6.0%
Source: Fidelity Worldwide Investment.
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24. Objectives
Mission statement:
“Quantitative screening of Emerging Market
data to identify alpha opportunities in order to
assist fundamental portfolio construction”
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25. FIL’s EM Interface
HeatMap and Scorecards are networked-based. Available to all in FIL.
All models are
available at the
click of a button
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26. EM Investment Approach
HeatMaps: Quant screen to rank countries
Sovereign “HeatMaps” are utilised to determine the creditworthiness of individual countries
This is based on the analysis of specific factors and sub-factors
– (e.g. growth, inflation, fiscal, balance of payments, banking and credit and the political environment)
Source: FIL August, 2012
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27. Summary of Investment Process
FIL’s quant models have been built with the purpose of trying to express a view on an EM country in
the most optimal way.
FIL EM team start by scanning the HeatMap, and looks for countries with solid fundamentals. The
team then uses the scorecards to identify the best way to express a view: FX / rates / external debt.
The quant models are used by other Portfolio Managers within FIL. There are no silos at FIL!
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28. FF Emerging Market Debt Fund
Current investment guidelines
At least two-thirds of portfolio in dollar denominated sovereign/quasi sovereign
Interest Rate Duration: Within +/- 20% of benchmark duration
Stand alone maximum allocations:
– Corporate bonds: 20%
– Emerging Market Equity: 20%
– Local Currency Debt: 20%
– Combination of all three: not to exceed one-third of portfolio
Maximum Country overweight: 10%; large countries will typically not have zero allocation
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29. FF Emerging Market Debt Fund :
Portfolio Characteristics
Portfolio Characteristics as 31/08/2012 Risk/Return Characteristics as 31/12/2012
Fund Index 3 Yr
Duration 7.08 7.16 Beta 1.11
Yield to Worst (YTW) 4.10 3.81 Alpha ‐0.28
Ave. Maturity 13.04 12.56 R‐Squared 0.86
Ave. Coupon 6.32 6.66 Annualised Standard Deviation 7.83
Spread Duration 7.23 7.33 Sharpe Ratio ‐ Portfolio 1.33
OAS 273 257 Sharpe Ratio‐Comparative Benchmark 1.89
DTS 1612 1602 Annualised Tracking Error 3.00
Ave. Bond Price 116.91 118.67 Information Ratio ‐0.74
Number of Holdings 224 330
Number of Issuers 111 93
Average Rating BB+ BB
Source: FIL Limited, 31/12/2012,
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31. FF Emerging Market Debt Fund
Top 10 active o/w holdings
Description Relative Risk Weight
(CHILE) Republic of Chile 3.73%
(PDVSA) Petroleos De Venezuela S 1.58%
(ADGB) Emirate of Abu Dhabi 1.58%
(T) United States of America 1.36%
(WIT) United States of America 1.10%
(SLOVEN) Republic of Slovenia 0.83%
(ARGBON) Argentine Republic 0.83%
(BHRAIN) Kingdom of Bahrain 0.78%
(SLOVAK) Slovak Republic 0.73%
(ALRSRU) Alrosa Finance Sa 0.67%
Source: FIL Ltd, 31/12/2012
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32. Important information
This information is for Investment Professionals only and should not be relied upon by private investors. It must not be reproduced or circulated without prior permission. This
communication is not directed at, and must not be acted upon by persons inside the United Kingdom or the United States and is otherwise only directed at persons residing in
jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Research professionals include both analysts and associates.
Fidelity/Fidelity Worldwide Investment means FIL Limited and its subsidiary companies. Unless otherwise stated, all views are those of Fidelity.Top security holdings are those
securities in which the largest percentage of the fund’s total assets are invested. Holdings in different securities issued by the same company are listed separately and any exposure
achieved by derivatives is not shown. This means that the data may not always represent the total exposure of the portfolio to any given company. A full list of holdings, including
derivatives is available on request. Reference in this document to specific securities should not be construed as a recommendation to buy or sell these securities, but is included for
the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. The research and
analysis used in this documentation is gathered by Fidelity for its use as an investment manager and may have already been acted upon for its own purposes. Fidelity only offers
information on its own products and services and does not provide investment advice based on individual circumstances. Fidelity, Fidelity Worldwide Investment, the Fidelity
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bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity are generally more sensitive to
interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuer's ability to make interest payments and to repay the loan at maturity.
Default risk may therefore vary between different government issuers as well as between different corporate issuers. The investment policy of this fund means it can be more than
35% invested in Government and public securities. These can be issued or guaranteed by other countries and Governments. For a full list please refer to the fund's prospectus.We
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