31st Dec 2021

What We Are Reading - Volume 2.095

The enclosed 2.095 version includes interesting set of reports by Credit Suisse on India outlook for H1 2022, ESG – megatrend in investing
by Motilal Oswal, Morningstar’s Outlook 2022 , Jefferies Greed & Fear, Fidelity’s insights on correlation of returns of Technology stocks and
Inflation, Goldman Sach’s report on Metaverse, Banking trends in India BCG, COP25 and its implications by Mckinsey and Macquire’s
outlook on global Lithium markets.

• India outlook H1 2022 Credit Suisse

• ESG – Megatrend in investing Motilal Oswal
• Ideas from investment expert Morningstar
• Greed & Fear Jefferies
• Could Technology’s leadership be over? Fidelity Investments
• Framing the future web - Metaverse Goldman sachs
• Miniaturization of Banking ticket sizes BCG
• COP26 Mckinsey
• Lithium Market outlook Macquarie
Global CIO Office
Research

Equities

India outlook H1 2022

Research Alert | Investment horizon: 12 months | Produced for first dissemination 21.12.2021, 17:09, UTC

As we head into 2022, the world’s major central banks Policy normalization and global growth disappointment
have started prioritizing inflation control over growth After the significant acceleration in global GDP growth that
acceleration. Unwinding of monetary policy support we have seen in 2021, albeit from the very low base of 2020,
and reduction in fiscal support in the upcoming year consensus expectations speak in favor of yet another year of
may have negative repercussions for global growth as strong GDP growth – 4.4% in 2022 versus the three-year
well as equity valuations. Having said that, Indian equi- average of 3.1% in the pre-pandemic world. On the other
ties might experience some near-term de-rating but – hand, policy support by central banks across the world (except
thanks to the improved macroeconomic fundamentals for China, mainly due to the worries of a property market
and corporate balance sheets – valuation multiples are slowdown) has started waning. Of late, key policymakers in
unlikely to revert to pre-pandemic levels, in our view. major economies have started prioritizing inflation control over
Rather, given the substantial improvement in corporate growth acceleration; thus, as we approach 2022, risks to
global growth forecasts are slowly building up, in our view. In
fundamentals, the Indian equity market should continue
addition, cost of capital may see a gradual rise, leading to a
to command a higher valuation premium, relative not
higher expected risk premium for equities as an asset class,
only to its historical average but also other markets.
compared to the previous two years. Hence, the investment
Hence, despite the record-high valuation premium for
case in 2022 for equities purely hinges on whether earnings
the Indian market, our House View remains neutral on
growth – including buybacks – will be sufficient to withstand
Indian equities. the twin blows of some macroeconomic slowdown and a
higher interest rate environment.
Jitendra Gohil
Head of India Equity Research
Our global Investment Committee believes earnings growth
Premal Kamdar
in 2022 should be sufficiently high to deliver moderate returns
Equity Research Analyst – India Research
and equities as an asset class remain attractive. Despite an
expected higher interest rate environment, real interest rates
Actionable ideas: Moderate overweight in domestic should still remain in negative territory for longer. Hence, any
cyclical and selected mid-cap stocks valuation contraction in 2022 should be limited and we may
While higher interest rates may lead to some growth worries, not see a sharp decline in valuation multiples. Nevertheless,
we are reasonably confident that India’s gross domestic the Omicron variant of the coronavirus is fast spreading and
product (GDP) growth should accelerate in the next two years, could lead to a macroeconomic slowdown and consequently
compared to pre-COVID levels. We believe that selected do- hurt earnings growth. Hence, as a risk reduction step in the
mestic cyclical and mid-cap stocks will benefit materially from face of changing circumstances, the Investment Committee
the GDP growth acceleration. Please refer to the table at the in an ad-hoc meeting on 21 December decided to move eq-
end of this Alert for a list of our preferred stocks. uities overall to a neutral allocation (and thus close the over-
weight allocation) in a portfolio context.

Important information and disclosures are found in the Disclosure appendix: CS does and seeks to do business with companies covered in its research reports. As a result,
investors should be aware that CS may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision.
Resilience of Indian equities has improved P/E premium may not revert to historical average levels
In the past eight weeks, consensus expectations of global While it is a consensus view that the Indian equity market is
growth for 2022 have come down by 10 bp to 4.4%, while overvalued, we believe that a higher-than-historical-average
in the same period expectations for India’s FY 2023 growth P/E premium for Indian equities is justified. Our constructive
have been revised upward by 60 bp to 7.6%. Over the past outlook is based on our expectation of a faster acceleration
few years, we have been highlighting how the structural ap- in India’s macroeconomic environment. As shown in Figure
peal of the Indian economy has improved materially and why 2, compared to pre-COVID years (2017, 2018 and 2019),
the country is in a sweet spot. This view is also validated by GDP growth for the next two years (2022 and 2023) could
Indian equity market’s impressive returns, even in USD terms, see an acceleration of 116 bp versus much slower or decel-
since the beginning of 2020 when the pandemic started erated GDP growth expected in peer group countries. India
(MSCI India total USD returns: +39.8% versus +17.9% for was growing below potential due to several growth headwinds
MSCI Ex-Asia Japan as of 17 December). Even in the long stemming from the implementation of the goods and services
term, the Indian market has proved to be a good wealth cre- tax (GST) and insolvency code, the introduction of the Real
ator, with the MSCI India Index delivering 3-, 5-, 10-, and Estate (Regulation and Development) Act, 2016, demoneti-
20-year compound annual growth rates (CAGRs) of 15.5% zation, etc. Given its improving digital penetration, attractive
(17.8%), 14.1% (16.8%), 10.2% (14.3%) and 13.1% demographic profile, economic reforms, formalization of the
(15.7%) in USD (INR) terms versus the MSCI Asia ex-Japan economy and favorable government policies, we believe India
Index’s CAGRs of 11.6%, 11.1%, 8.3%, and 10.1%, respec- could surprise on the upside in the coming years.
tively (data as of 17 December 2021).
Figure 2: GDP growth acceleration vs. pre-COVID period
Figure 1: MSCI India valuation premium versus MSCI Asia India’s GDP growth is expected to accelerate the fastest among
ex-Japan Index peers in the next two years
MSCI India valuation premium may fall from stretched levels, but 7.0% 150 bp

may not revert to historical levels 5.0%

116 100 bp
12 months forward valuation premium
100% 3.0%
50 bp
90% 48
1.0% 36
80% 78% 0 bp
11 10
0 3 5
-1.0% -2
70%

60% -50 bp
-3.0%
50%
44% -100 bp
40% -5.0%

30% -128
-7.0% -150 bp
*India Malaysia Thailand Brazil Indonesia Philippines Russia Taiwan South Korea China
20%
Avg. GDP growth pre-COVID (2017,18,19) Avg. GDP growth for the next 2Y (2022-23)
10% Accleration of GDP growth in bp (RHS)

0%
Dec-11 Dec-13 Dec-15 Dec-17 Dec-19 Dec-21 Note: *Fiscal year ending March. Last data point:
India's P/E prem. wrt MSCI EM Avg. 10 yr. premium (MSCI EM) 17/12/2021. Source: Bloomberg, Credit Suisse
Last data point: 17/12/2021. Historical performance indica-
tions and financial market scenarios are not reliable indicators Macro momentum likely to accelerate
of current or future performance. Source: Bloomberg, Credit In our view, consensus forecasts currently underestimate In-
Suisse dia’s medium-term GDP growth potential. We expect GDP
growth to surprise on the upside driven by a sharp improve-
ment in the real estate sector, significant investments in in-
With the government-initiated reforms – digital adoption and
frastructure debottlenecking over the past few years, the in-
infrastructure debottlenecking, etc. – the structural macro
troduction of production-linked incentives (PLI) schemes,
outlook for India has improved further. However, the key
higher-than-expected tax collections by the government, and
question on investors’ minds is how long India’s relative valu-
rising private capex spending. We also note that the hiring
ation can sustain and if this improved outlook is fully priced
outlook has materially improved after several years and this
in. Indian equities currently command a 12-month forward
may have a good rub-off effect on growth.
P/E premium of 78% versus the MSCI Emerging Markets
Index, which is much higher than the 44% average for the
past 10 years. While India may see some valuation deteriora- On the other hand, India’s start-ups are benefiting from strong
tion, we do not anticipate it to fall back to historical average foreign inflows, which are currently even higher than inflows
levels anytime soon given India’s superior and improving fun- into India’s listed companies (Figure 3). India’s FY 2022 and
damentals versus peers coupled with the improving domestic FY 2023 consensus GDP growth forecasts have been revised
inflows, including retail inflows that are still at a nascent stage. upward in the past few weeks. We see further scope for up-
ward revisions as government spending could accelerate fur-
ther – provided the Omicron variant of COVID-19 does not
lead to a material loss of economic activities. While we expect
the Reserve Bank of India (RBI) to tighten liquidity conditions
gradually and hike rates by 50–75 bp in FY 2023, the overall
macroeconomic momentum should sustain. Our macro equity market to continue to command a higher-than-historical
strategy team believes that consensus is underestimating In- average valuation and a relatively high P/E premium versus
dia’s FY 2023 and long-term GDP growth expectations and peers.
we may see some upward revisions once the past reforms
start showing results.
Figure 5: Indian corporate leverage has been declining
Indian corporates have de-levered materially
Figure 3: Private equity investments continue to outpace
BSE500 Index
public fundraising 3.5 1.9 2.0
3.4
The surge in private equity investments continues, giving impetus 3.4
3.2
to growth 3.0
1.5 3.1 3.2
1.6
2.9 1.4
$bn 2021 : Data annualised from 1st 3Q data 2.5 1.3 1.2 1.2 1.23
1.2
60
2.4 1.2

2.0
50 0.9

0.8
40 1.5
1.5
1.4
30 1.0 0.4
FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22'e FY23'e

20 ND/EBITDA Div Yield (%, RHS)

10
Last data point: 17/12/2021. Historical performance indica-
tions and financial market scenarios are not reliable indicators
0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 of current or future performance. Source: Bloomberg, Credit
Private Equity Deals Public Offerings
Suisse
Last data point: 30/09/2021. Historical performance indica-
tions and financial market scenarios are not reliable indicators
of current or future performance. Source: VCCEdge, Credit Figure 6: Consensus EPS growth among the fastest
Suisse India to see one of the highest accelerations in earnings growth
Consensus EPS growth (MSCI Indices)
30.0%

24.2%
Figure 4: ROA comparison (India vs. regional peers) 25.0%

India’s ROA is higher relative to regional peers, and it may accel- 20.0%
17.4%
15.8%
erate further 15.0%
15.3%
12.8% 13.5%
10.0% 10.4%
Consensus ROA (MSCI Indices) 10.0%
6.0% 180 bp 6.8% 6.7%
155 5.0% 4.2%
3.0% 2.2% 2.3%
5.0% 150 bp
0.6%
4.0% 120 bp 0.0%
-1.7% -1.0%
3.0% 108 90 bp -5.0%

2.0% 60 bp -10.0% -7.3%

64
Phillippines India* Indonesia China Thailand Malaysia Taiwan S Korea Russia
1.0% 30 bp

0.0% 22 0 bp Pre-Covid (EPS CAGR 2015-19) EPS CAGR (2022E-24E)

-1.0%
-28
-30 bp Note: *Fiscal year ending in March. Last data point:
-2.0% -60 bp
-59 17/12/2021. Historical performance indications and financial
-3.0% -86 -90 bp
Taiwan India* Thailand Phillippines Malaysia Indonesia China market scenarios are not reliable indicators of current or future
Avg. ROA Pre-COVID (2017,18,19) Avg. ROA for the next 2Y (2022-23)
Acceleration of ROA in bp (RHS)
performance. Source: Bloomberg, Credit Suisse
Note: *Fiscal year ending in March. Last data point:
17/12/2021. Source: Bloomberg, Credit Suisse Bottom-up analysis of Nifty constituents paints a re-
silient picture
Compared to the last five-year average, the Nifty index is
India’s corporate fundamentals have improved and may currently trading at a 9.3% higher valuation or 20.1 (as of
become even better 17 December), and at the peak, the valuation touched 22.8
As Figure 4 illustrates, India commands a much higher relative times in October. However, looking at the Nifty constituents
return on assets (ROA). Valuation is largely related to the and their respective valuation premiums/discounts, we believe
level and acceleration of ROAs as well as growth, and India that about 30% of these constituents, which account for 35%
ranks among the top countries in terms of these three param- of the Nifty index weight, still offer valuation expansion poten-
eters. Moreover, corporate financial leverage has come down tial. On the other hand, we expect about 24% of the Nifty
materially, as shown in Figure 5. In terms of growth, the Nifty constituents (15% in weights) to have a high probability of
EPS (Figure 6) is expected to accelerate materially in the valuation contraction. We also note that 38 out of 50 Nifty
next couple of years, much higher than countries in its peer companies (around 76% of the overall Nifty Index weight)
group. Given these fundamental shifts, we expect India’s will likely see ROE expansion in the next two years versus
the pre-COVID three-year average. Lastly, we also note that panies to do better, and given our expectation of higher GDP
several companies having high valuations were added to the growth, domestic cyclicals such as private banks and large
Nifty index over the past three years. Going ahead, we may public sector banks are our preferred segments. Given our
see more new-age or internet-based companies getting added expectation of a sharp improvement in the hiring outlook and
to the index. Thus, valuation may naturally look much higher wage growth next year, we turn constructive on selected auto
than the historical average as India is experiencing an accel- companies.
eration in the start-up revolution.
Within fixed income, prefer medium-duration bonds
Figure 7: Potential changes in the valuation of Nifty con- While we expect headline inflation to remain largely above
the 4% target but below the upper end of the inflation toler-
stituents, in our view
ance range of 6%, we believe the RBI will have to remove
We expect 30% (~35% in weights) of Nifty constituents to see excess liquidity gradually from the system. We expect the
valuation upgrades versus 24% (15%) valuation downgrades
RBI to raise rates by 50–75 bp in 2022 and unwind excessive
Sector weights in
the Nifty 50 index liquidity support gradually over the next few quarters. We will
Financials 13% 20% 4% 37%
also keenly monitor the trajectory of core inflation, which is
IT 18% 18%

Energy 11% 2% 13%

running at 6%, and wholesale price index (WPI) inflation,
Consumption 3% 3% 5% 11% which recently came in at 14.2%, the highest since 1991.
Auto 3% 2% 5%

Industrials 4% 4%

Pharma
USD/INR may remain range-bound, but could trade
3% 1% 3%

Metals 3% 3%
with a downward bias near term
Cements 1% 1% 0% 3% Omicron worries, higher inflation and expectations of tighter
Telecom 2% 2% monetary policies globally were the key factors that led to a
Utilities 1% 1% 2%
sharp depreciation of the INR against the USD. Moreover,
Chemicals

Valuation expansion
1%

No change Valuation contraction

1%
the recent selling of Indian equities by FPIs may have added
to downward pressure on the INR. Amid rising global head-
Last data point: 17/12/2021. Historical performance indica- winds, we expect the INR to continue to trade with a down-
tions and financial market scenarios are not reliable indicators ward bias in the near term. Nevertheless, we do not expect
of current or future performance. Source: Bloomberg, Credit significant downside as India’s domestic fundamentals remain
Suisse favorable. A combination of the improved fiscal position,
healthy foreign exchange reserves and a surplus balance-of-
payments position should protect the significant downside.
Moderate overweight position in selected mid-caps
Thus, the performance of USD/INR over the medium term
Given our constructive view on the macro outlook and the
could remain range-bound, in our view.
structural investment opportunities emerging in India, we
continue to maintain a moderate overweight position in mid-
caps. In the mid-cap space, several structural themes are Conclusion and risks to our view
emerging, which we believe should offer better alpha-gener- Our positive case for Indian equities in the medium term is
ation opportunities relative to their large-cap peers (see the largely based on our view that Indian corporate fundamentals
table at the end of this Alert for a list of our preferred picks). have improved materially over the past couple of years, not
Moreover, financialization of savings and higher internet pen- just relative to pre-COVID levels but also relative to other
etration can lead to higher retail inflows into the mid and small- emerging markets. If the government continues its reform
cap sector, while large caps may remain susceptible to foreign momentum, India may continue to attract higher foreign direct
portfolio investor (FPI) selling in the near term. We expect investment (FDI) inflows, and at the same time, financialization
the hiring outlook to improve materially for several sectors, of savings and robust corporate balance sheet may support
from information technology (IT) to financial services, and this a revival in capex spending. Nevertheless, the Indian macro
should support our constructive view on staffing companies. economy continues to remain vulnerable to fast-changing
India’s exports will likely see a material pick-up given favorable geopolitical equations, global macro shocks, and India’s ex-
government policies and the RBI’s bias toward keeping the cessive dependence on oil imports. Moreover, the recovery
INR weaker, in our view. Hence, we believe after the recent is not broad-based yet and the government might have to al-
correction, the chemical and pharma active pharmaceutical locate higher spending toward subsidies, including for food,
ingredient (API) sector should be back in favor in 2022. We fertilizer, and another less impactful spending especially in
continue to remain constructive on a housing market recovery light of the fast-spreading Omicron virus and ahead of the
and also believe the companies with expertise in financing several important state elections early next year. Also, in the
developers will benefit the most next year apart from pure- near term, the spread of Omicron could lead to some near-
play developers. term growth worries; we however do not expect the govern-
ment to announce any stringent lockdowns. Nevertheless, it
could hurt sentiments and delay the recovery process should
Prefer domestic cyclicals within large caps
any renewed contagion overwhelm healthcare facilities.
While we continue to avoid recommending highly valued
companies, we believe certain companies and sectors offer
valuation expansion potential. Ahead of the Union Budget
2022, we expect infrastructure, cement and industrial com-
 Thematic | December 2021
Company name

hfy
Sustainability
NEW MANTRA OF INTEGRATED INVESTING

ESG: The Megatrend in Investing

10 December 2010 1
 Thematic | 15 December 2021
Thematic | Sustainability

Sustainability
Our previous report on Environmental, Social, and Governance: The megatrend
Sustainability
in investing
We published our first report on ESG (Sustainability- Expanding Horizons) in June
2017.What we saw as a significant emerging trend back then has gained remarkable
acceptance amongst investors in the past 5 years and is now evolving as a megatrend in
investing.

 While the roots of Environmental, Social, and Governance (ESG) date far back to
1970’s, it has gained significant ground in the last decade – especially since the
launch of the 17 Sustainable Development Goals (SDGs) by the United Nations
Organization (UNO) in 2015. The size of sustainable assets grew multifold at a CAGR
of ~11% between 2016 and 2020 and stood at USD35.3t in 2020. The sustainable
investment share in global AUM rose to 36% in 2020 (from 28% in 2016).
Proportion of sustainable investing assets relative to total managed assets (USD)
Global sustainable investing assets Total managed assets

Canada is the market with

22.9t
the highest proportion of 30.6t 35.3t
sustainable investment 27.9 % 33.3 % 35.9 %
assets at 62%, followed by
Europe (42%), Australasia
(38%), the United States 81.9t 91.8t 98.4t
(33%) and Japan (24%)
2016 2018 2020
Source: GSIR 2020, MOFSL

 The emerging markets (EMs) currently have a negligible share in the sustainable
asset pool, mainly due to the emerging state of the capital markets and
Asia (ex Japan) has less than economy. Going forward, the rising adoption of stewardship codes in these
1% share in the sustainable markets, along with a focus on governance reforms and improved ESG
asset pool
disclosure, may help boost the share of such assets allocated to them. India is
also likely to see a higher allocation of funds in the form of sustainable
investments in the coming years.
Why has investing in ESG become so critical?
 Global warming and climate change have emerged as the world’s greatest risks
today. Countries across the globe have set targets to achieve carbon neutrality
The International Energy and are working towards achieving these targets and walking the path to a more
Agency (IEA) in its latest
report, Net Zero by 2050- A
sustainable future.
Roadmap for the Global  Companies are already experiencing the financial consequences of failing to act
Energy Sector, has on sustainability as many countries have implemented regulations such as
advocated that no new Oil carbon taxes and penalties. Moreover, the Financial and Banking sectors have
and Coal projects should be
integrated ESG rules into their funding criteria. The only way stakeholders can
commissioned to achieve
carbon neutrality by 2050 avoid poor lending conditions and exclusion from the capital markets is to show
evidence of having developed robust sustainability and ESG strategies.

15 December 2021 3
 Thematic | Sustainability

 Investors, especially foreign institutions (FIs), have included sustainability and

ESG criteria into their portfolio strategies. Investors have realized that investing
in companies with a robust and convincing ESG strategy positively affects
returns and reduces the investment risk, generating sustainable and better long-
term financial returns.

India’s ESG journey in the nascent stage

The NITI Aayog annually  India is trailing with regard to sustainability performance and ranks 120th out of
reports the SDG India Index,
165 countries in terms of total progress towards achieving all SDGs, as per the
which evaluates progress of
states and union territories UN Sustainable Development Report 2021. Recently with India committing to a
on social, economic and 2070 deadline to achieve net-zero emissions, the progress towards sustainability
environmental parameters should gather pace in the coming years.
Snapshot of India’s sustainability performance
SDG Index Rank SDG Index Score Spillover Score

120/165 60.1 98.9

Source: UN Sustainable Development Report 2021. MOFSL

AUM of ESG funds in India (INR)  The regulatory push has, over the years, shaped the governance landscape in
India. Sustainability has also been introduced to Corporate India through
regulations. Regulatory steps such as the introduction of stewardship codes for
institutional investors and the Business Responsibility and Sustainability
Reporting (BRSR) framework – which would be applicable for the Top 1,000
listed companies, by market capitalization, from FY23 (voluntarily in FY22) – are
certain key steps in the direction of improving governance standards and ESG
disclosures for companies.
ESG investing in India to grow multifold
 The size of ESG investments in India from a global sustainability AUM
perspective is currently negligible, but it has been growing significantly. Even
domestically, the aggregate AUM in ESG funds as of 30th November 2021 was
just ~0.3% of the MF industry AUM.
Source: MOFSL  However, COVID-19 has further accelerated demand for sustainable investing. 7 of
10 ESG funds in India have been launched since January 2020. ESG funds witnessed
strong inflows, with aggregate AUM jumping to INR123.2b in November 2021, from
INR26.3b in November 2019, reflecting a ~4.7x jump over a two-year period.
As per the latest portfolios,
there was a more than 50%  Since most of the ESG funds have started recently, it would be premature to
median overlap between evaluate their performance with benchmark indices. In developing regions, given
the ESG portfolios and the nascent stage of the capital markets, the outperformance of ESG funds
NIFTY100 and an around should be sharper as the gap in practices between the ESG leaders and laggards
30% overlap with NIFTY50
is larger – and the same should apply to India. This is evident from the sharp
as well as the respective
flagship funds outperformance of the MSCI India ESG Leaders index v/s the MSCI India index
since its launch in 2007.

15 December 2021 4
 Thematic | Sustainability

How should investors approach ESG investing?

 There is no fixed approach to ESG investing. Based on the objectives and
constraints, investors have to decide which strategy or combination of strategies
is best suited for them in the long run and implement these.
 Investors could choose between a more direct approach to ESG investing by
initiating an ESG fund, implementing a style/strategy of ESG investments, such
as negative screening or theme-based investing. Another approach is ESG
integration, which systematically includes ESG parameters in investment analysis
and decisions.
 Investors may also choose between (a) the top-down approach – which is more
passive and depends on the framework/index/ratings provided by agencies or
(b) the bottom-up approach – a more active and customized approach wherein
the investor would have to create their own framework for ESG evaluation
based on the objective of the fund/firm.
 ESG investing has a learning curve, which grows with experience and time.
Investors’ knowledge, expectations, goals, and experience in ESG usually vary.
Hence, their approaches differ, and they face different types of challenges and
leverage different kinds of opportunities.

How can Indian investors ride this megatrend?

 Investors who wish to ride this wave would have to go back to the drawing
board and sketch a fresh strategy that fits their investment objectives and goals.
Here are some of the strategies that investors could employ:

Identifying the Trends born Identifying hidden Lowering the Identify agile
long-term ESG from regulatory and future ESG overall portfolio and flexible
leaders actions risks ESG risk businesses

Themes arising out Businesses in Focus on Monitoring Actively engaging

of government transition directionality interest of foreign with portfolio
policies institutions companies

 Identifying the long-term ESG leaders – Identifying the long-term ESG leaders
within a sector or from an overall market perspective is a simple strategy likely
to work in the long term.
 Themes arising out of government policies – Government policies have played a
pivotal role in shaping the ESG trend in India and would continue to do so in the
future. Monitoring sectors and businesses that may be impacted by government
policies may generate good investment ideas.
 Trends born from regulatory actions – Regulatory actions can change the
fortunes of companies and even the industries in which they operate. This may

15 December 2021 5
 Thematic | Sustainability

not only result in higher operational cost but also pose existential questions.
Moreover, some of these trends could have a compounded impact, potentially
even surpassing geographies. Understanding existing and potential regulatory
actions should help investors to devise their investment strategies better.
 Businesses in transition – Businesses that are undergoing a transition – such as
In FY18, China imposed the transition towards a greener fuel mix or a more sustainable business model,
shutdowns and severe and change in ownership – could lead to a palpable change in the ESG rating of a
restrictions on coal-fired company. This theme could generate good investment ideas.
power plants and other
 Identifying hidden and future ESG risks – Investors should look at ESG risks that
polluting industries to
reduce its carbon footprint. are not as obvious and may not be relevant today, but would be relevant in the
The Chinese businesses future, as the portfolios are constructed for the long term. Understanding such
operating in these sectors risks could help investors decide on the sectors/businesses to exclude or cap in
were adversely impacted. their portfolios.
However, this benefited
Indian manufacturers in  Focusing on directionality – Investors should regularly review their ESG
sectors such as Metal and rankings/scores or the ratings of stocks under their coverage. They should focus
Specialty Chemicals as on companies that are showing major changes in their ESG rankings/scores or
supply constraints meant a ratings and understand the reason for the change. Both positive and negative
surge in the prices of the
directionality are evidence of a material change in ESG practices and should
commodities manufactured
influence investors’ portfolio decisions.
 Lowering the overall portfolio ESG risk – While an asset manager should not
have restrictions on investing in a particular sector or company, if the
investment comes with a higher risk, it should have a higher IRR expectation.
Regular monitoring and the reduction of the portfolio ESG risk without
compromising on returns is a strategy that could help investors reduce risk and
outperform the indices.
 Monitoring the interest of foreign institutions – Foreign institutions’ declining
The FI shareholding has interest could be a sign that a business has a weak ESG profile – as more and
been reducing incessantly in
ITC and BHEL, over the past
more investors are implementing ESG in their portfolios and aligning their
five years, and both the portfolios accordingly. Also, the increasing interest of foreign institutions may be
stocks have an indicator of improving ESG practices. Domestic institutions (DIs) have also
underperformed the indices begun implementing ESG practices in their portfolio, so this trend is also likely to
on a three-year and five-
be applicable for domestic funds going forward.
year basis
 Identifying agile and flexible businesses – Businesses that are dynamic and
flexible, with management that is receptive to the changing business and
sustainability landscape, are likely to outrun their peers in the ESG race despite
their size and experience. This approach could help identify winners and future
ESG leaders for investors.
 Actively engaging with portfolio companies – Investors must use their ESG
experience and actively engage with these companies. They must guide them in
the right direction and regularly monitor the progress of the businesses on ESG
parameters, and push them to implement better practices. This strategy would
benefit investors as the ESG performance of the entire portfolio improves with
the improving ESG practices of the portfolio companies.

15 December 2021 6
 Thematic | Sustainability

Overview of ESG

What is ESG?
Environmental, Social, and Governance is an integrated term used in the capital
markets to evaluate corporate behavior. Investors are increasingly applying these
non-financial factors to their analysis processes to identify material risks and growth
“The greatest threat to our opportunities. ESG has, over the years, evolved from Socially Responsible
planet is the belief that
Investment (SRI), which has gained worldwide prominence over the years. ESG
someone else will save it”
– Robert Swan, Author propounds an underlying philosophy of the larger good without overlooking the
financial or economic viability.

ENVIRONMENTAL SOCIAL GOVERNANCE

Considers company’s Examines how the company Considers implementation of
performance as steward of the manages its relationships with good practices in areas such as
natural environment its employees, customers and leadership, executive pay,
other stakeholders audits, internal controls and
shareholder rights.

What is ESG investing?

ESG investing is a holistic approach to incorporating critical environmental, social,
and governance factors in the investment analysis and decision-making process for
an organization. ESG investments include different investment styles, some of which
are as follows:

 Negative screening (or exclusions): This excludes investments in companies

whose business activities do not meet client-specific values. The common
objectives of this approach are to align portfolios with moral and ethical values
and mitigate ESG risks – e.g. alcohol, tobacco, and arms and ammunition.
 Norms-based Investing: Norms-based investing involves the screening of
investments against the minimum standards in business practices based on
international norms. Such norms include, but are not limited to, the United
Nations Global Compact Principles, the Universal Declaration of Human Rights,
the UN SDGs, and The OECD Guidelines for Multinational Enterprises.
 Thematic investing: This seeks to identify the structural trends which are able
to generate long-term growth. It involves creating a portfolio based on a macro-
trend by gathering a collection of companies under the trend that would
generate superior returns vis-à-vis the market over the long term. It enables
investments in long-term trends or themes such as food, climate, and education.
 Responsible investing: This is the recognition of the fact that long-term
sustainable returns are dependent on stable, well-functioning, and well-
governed social, environmental, and economic systems.

15 December 2021 7
 Thematic | Sustainability

 Value-based investing: This is an investment philosophy by which investors

seek to invest in environmentally conscious companies. They seek positive
returns through sustainable and ethical practices.
 Impact investing: This type of investing refers to investments in companies,
organizations, and funds with the intention to generate an intentional and
identifiable social and environmental impact alongside financial returns.
 Green investing: This involves investing in activities that may be considered
good and friendly for the environment directly or indirectly.
 External tilting: This involves favoring overweight companies with the strongest
ESG characteristics (such as ESG ratings or pillar scores and carbon emission
intensities) based on third-party data (such as from MSCI, Sustainalytics, and
S&P Global).
 Mission-related investing: This refers to investments done by foundations
and/or organizations to achieve their philanthropic goals.
 ESG integration: This involves the inclusion of ESG parameters in investment
analyses and investment decisions.

Exhibit 1: ESG investment styles

SCREENING BASED
Negative Screening

PRINCIPLE BASED
Norm based | Responsible Investing | Mission Related |
Green Investing | Impact Investing

OPPORTUNITY BASED
Thematic | Value Based | External Tilting

IMPLEMENTATION BASED
ESG Integration

Source: MOFSL

15 December 2021 8
 Thematic | Sustainability

Why is ESG investing important?

 Global warming and climate change have emerged as the greatest risks to
modern civilization. Commitments towards decarbonization are indispensable
not only from a business standpoint but also from the perspective of the survival
of the human species.
 According to the European Green Deal, by 2050, all member states will have to
Making net zero emissions achieve net-zero emissions. With the Biden administration taking over, the US
a reality hinges on a has also committed to achieving the net-zero emissions target by 2050. China
singular, unwavering focus
has pledged to achieve carbon neutrality by 2060.
from all governments
working together with one  India, the world’s third largest greenhouse gas emitter at the 26th Conference of
another, and with Parties (COP-26) in Glasgow announced that it will achieve net-zero emissions by
businesses, investors and 2070. Further, India has committed to raise its non-fossil energy capacity to 500
citizens GW by 2030, reducing 1 billion tons of projected emissions from now till 2030
– Net Zero by 2050, IEA
and achieving carbon intensity reduction of 45 per cent over 2005 levels by
2030.

Case Study: How non-alignment to the principles of sustainable lending led to

redemption of green bonds
 SBI drafted an in-principle agreement with Adani Ports in 2014 for a USD1.0b facility for financing
the thermal coal mine in Carmichael, Australia.
 SBI has managed to raise ~USD800.0m through green bonds since 2018.
 Carmichael has drawn strong criticism from climate campaigners because of the potential carbon
emissions that would be produced by the mine. Several investors like Amundi, BlackRock, and
Storebrand ASA raised concerns on SBI funding the project due to non-alignment with ESG
principles.
 Amundi divests the exposure in green bonds issued by SBI from its Planet Emerging Green One
Fund and several other investors made the issue ineligible and others warned for redemption.
 With the opposition to the project, SBI is reticent to disburse the funds for the project. The final
decision on whether to disburse the funds is yet to be made.
Source: MOFSL, Reuters

 Companies are already experiencing the financial consequences of failing to

In India, Green Tax is levied implement sustainability measures – as many countries have introduced
on older vehicles, for both regulations, such as carbon taxes and penalties, and the Financial and Banking
private and commercial
sectors have integrated ESG rules into their funding criteria. The only way
vehicles. This varies from
state to state. For example, stakeholders can avoid poor lending conditions and exclusion from the capital
in Maharashtra, private markets is to show evidence of having developed robust sustainability and ESG
vehicles aged more than 15 strategies.
years and commercial
vehicles aged more than 8
years have to pay the
Green Tax

15 December 2021 9
 Thematic | Sustainability

Case Study: How not meeting emission norms increased the operational cost
 In the United States, OEMs are subject to substantial civil penalties if they fail to meet federal
CAFE standards. These penalties are calculated at USD5.5 for each tenth of a mile below the
required fuel-efficiency level for each vehicle sold in a model year in the U.S. market up to and
including the 2021 model year vehicles.
 Beginning with the 2022 model year vehicles, the rate is expected to increase to USD14.0 and
will be followed by index-linked annual increases thereafter.
 Since 2010, JLR has paid total penalties of USD46.0m for its failure to meet CAFE standards. In
addition, as of 31st March 2021, a provision of GBP75.0m was held to face the possible fine from
European and UK regulators for failing to meet emission reduction targets.
Source: Tata Motors Annual Report FY21, MOFSL

 Investors, especially FIs, have included sustainability and ESG criteria into their
portfolio strategies. Investors have realized that investing in companies with a
robust and convincing ESG strategy positively affects returns and reduces the
investment risk, generating sustainable, long-term financial returns. As
illustrated in Exhibit 7, the S&P 500 ESG index outperformed S&P 500 over a
five-year period.

Exhibit 2: S&P 500 ESG v/s S&P 500 (Nov 2016–Nov 2021)
The outperformance by S&P
500 ESG index over S&P 500 S&P 500 Rebased S&P 500 ESG Index Rebased
has become more palpable
240
since Jan 2020

200

160

120

80
Jul-17

Jul-18

Jul-19

Jul-20

Jul-21
Mar-17

Mar-18

Mar-19

Mar-20

Mar-21
Nov-16

Nov-17

Nov-18

Nov-19

Nov-20

Nov-21

Source: Bloomberg, MOFSL

Case Study: How responsible investing can result in social impact and also generate
superior returns
 Founded on the principles of responsible healthcare investing, Quadria Capital is one of Asia’s
largest private healthcare investors. By leveraging its financial capital, operational capabilities,
and ESG systems, Quadria has been able to develop a sustainable and profitable business model
that creates equitable healthcare access and affordability.
 Quadria has also influenced its portfolio companies to become ESG-compliant, which helped
them do business with global healthcare companies. Ultimately, this resulted in significant social
impact while generating superior double-digit annual profit growth for Quadria – reflecting the
important fact that responsible investing does not have to come at the expense of financial
returns.
Source: AVPN-Oliver Wyman Analysis, MOFSL

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 Thematic | Sustainability

Global ESG journey

 While ESG might seem like a new trend, its roots, in the form of sustainable
investing were planted decades ago; however, ESG as a concept has ascended
quickly in the past decade. The first socially responsible mutual fund, Pax World
Fund, was launched in the US in 1971, which remains investible to date.
Exhibit 3: Milestones in the evolution of responsible investments

1971
Launch of Pax World
Fund, the first socially
responsible mutual fund
1980s in the US 1989
Widespread Valdez Principles (later
disinvestment from South renamed CERES Principles)
Africa in protest of formed following Exxon

1990 apartheid 1998 Valdez oil spill 1999

UK publishes the first Launch of Dow Jones
Launch of Domini 400
Corporate Governance Sustainability Indices
Social Index, one of the
first socially responsible Code
indices 2003 2006
Glaxo SmithKline cuts Launch of Principles
cost of AIDS drugs in for Responsible
developing countries Investing (PRI)
amid pressure from
campaigners and
2008
World Bank issues
shareholders *SUSTAINABLE
first labelled green
bond DEVELOPMENT GOALS
2015 2017 The Sustainable
Development Goals
United Nations sets Launch of Climate
(SDGs) provide a
the Sustainable Action 100+, the largest
globally agreed
Development Goals ever corporate
framework to make the
(SDGs) 2019 engagement by
investors world more sustainable
Number of PRI by 2030. The PRI's SDG
signatories reach Investment case
2,500 outlines five ways in
which the SDGs are
relevant to investors.

Source: PRI, MOFSL

 As a concept, ESG was introduced in 2004 with the launch of The UN Global
Compact (UNGC). UNGC was launched with the aim to integrate ESG
philosophies into the capital markets.
 One of the reasons why ESG has become ubiquitous in the past decade can be
attributed to The United Nations Organization (UNO) formulating 17 Sustainable
Development Goals (SDGs) in 2015, which were adopted by 193 countries. SDGs
are Global Goals that have become the basis of sustainable development for
countries, businesses, and investors.
 India has also aligned itself with the SDGs, and its convergence with the national
development agenda is reflected in the motto of “Sabka Saath Sabka Vikaas.”
Based on the evidence from the SDG India index, which measures progress at
the sub-national level, the country has developed a robust SDG localization
model centered on adoption, implementation, and monitoring at the state and
district levels.

15 December 2021 11
 Thematic | Sustainability

Exhibit 4: UN Sustainable Development Goals

Source: United Nations, MOFSL

 ESG investing has since shown tremendous growth; the share of sustainable
investments in global AUM rose to 36% in 2020 from 28% in 2016.
 Europe has been a traditional leader in ESG assets, driven by its pension-fund
US and Europe continue to focus on sustainable investing and strong regulatory push. However, we saw the
represent more than 80% of
US and Canada catching up with developed European counterparts, with
global sustainable investing
assets during 2018 to 2020 sustainable assets growing 42% and 48%, respectively, between 2018 and 2020.
Canada now has 61.8% of its AUM invested in sustainable assets.
 Asia (ex-Japan) has minuscule share (<1%) in the sustainable asset pool, largely
due to the emerging state of the capital markets and economy. Going forward,
the rising adoption of stewardship codes in the Asian markets, with a focus on
governance reforms and improved ESG disclosure, may help boost the share of
such assets allocated to the region. For example, in Japan, governance reforms
and an emphasis by the Government Pension Investment Fund have helped
enhance ESG strategies to 24.3% of AUM from virtually nothing seven years ago.

Exhibit 5: Proportion of sustainable investing assets relative to total managed assets (USD)
Global sustainable investing assets Total managed assets

22.9t 30.6t 35.3t

27.9 % 33.3 % 35.9 %

81.9t 91.8t 98.4t

2016 2018 2020

Source: GSIR 2020, MOFSL

15 December 2021 12
 Thematic | Sustainability

Exhibit 6: Growth in sustainable investing assets by region in local currency (2014–20)

Growth Per Period (%) Compound
Annual Growth
Growth Growth Growth
2014 2016 2018 2020 Rate (CARG)
2014-16 2016-18 2018-20
2014-2020 (%)
Europe• (EUR b) €9,885 €11,045 €12,306 €10,730 12 11 -13 1
United States (USD b) $6,572 $8,723 $11,995 $17,081 33 38 42 17
Canada (CAD b) $1,011 $1,505 $2,132 $3,166 49 42 48 21
Australasia* (AUD b) $203 $707 $1,033 $1,295 248 46 25 36
Japan (JPY b) ¥840 ¥57,056 ¥231,952 ¥310,039 6,692 307 34 168
* Europe and Australasia have enacted significant changes in the way sustainable investment is defined in these regions
Source: GSIR 2020, MOFSL

 Principles for Responsible Investment (PRI), one of the leading proponents of

The AUM under PRI has
responsible investing, has developed six voluntary and aspirational principles for
increased at ~21.7% CAGR
since its inception in 2006 responsible investing. By implementing these, signatories contribute to
developing a more sustainable global financial system. The number of PRI
signatories has grown to 3,826 in 2021 (from 63 in 2016), with AUM currently at
USD121.4t.

Exhibit 7: PRI growth (2006–21)

Source: PRI, MOFSL

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 Thematic | Sustainability

India’s ESG journey

The evolving regulatory landscape

 India is at a nascent stage in its ESG journey. It ranks 120th among 165 countries
in its total progress towards achieving all 17 SDGs (as per the UN Sustainable
Development Report 2021), worse than even some of its SAARC counterparts
such as Sri Lanka, Nepal, and Bangladesh. India has a long road ahead to
achieving its sustainability targets. NITI Aayog, the Indian government’s premier
think tank, has been entrusted with the task to coordinate and monitor progress
on SDGs. NITI Aayog has been working closely with the government to
implement the schemes to achieve these SDGs.

Exhibit 8: Key regulatory milestones in India

2007 2008 2009 2010 2011

The RBI advises Launch of S&P ESG Ministry of Department of MCA publishes
commercial banks India Index Corporate Affairs Public Enterprises National Voluntary
on CSR, (MCA) publishes CSR (DPE) issues CSR Guidelines on Social,
sustainability and guidelines guidelines for Environmental
non-financial CPSEs and Economic
disclosure Responsibilities of
Business (NVGs)

2012 2013 2014 2015 2016

SEBI mandates BRR MSCI India ESG Landmark CSR law: RBI includes social SEBI publishes green
for top 100 listed Leaders Index 2% of average net infra and renewable bond guidelines
companies profits of the energy in priority
preceding three years sector lending (PSL) IBA publishes NVGs
BSE launches for CSR spending for banks for Responsible
Greenex and Financing
Carbonex BRR mandatory for
top 500 companies

2017 2018 2019 2020 2021

Kotak Committee on BSE publishes guidance MCA revises NVGs SEBI mandates SEBI launches
Corporate document on ESG to align with SDGs stewardship code BRSR framework
Governance disclosures with ESG which will be
monitoring mandatory for Top
IRDA, PFRDA* 1000 listed
mandates stewardship companies from
code FY23 onwards

Source: CRISIL, MOFSL

15 December 2021 14
 Thematic | Sustainability

 At the recently concluded COP-26, India announced that it will achieve net-zero
emissions by 2070. Further, India has committed to raise its non-fossil energy
capacity to 500 GW by 2030, reducing 1b tons of projected emissions from now
till 2030 and achieving carbon intensity reduction of 45 per cent over 2005 levels
by 2030.
 Over the years, governance has been introduced in Corporate India via a
regulatory push. Similar to governance, sustainability has also been introduced
via regulations. In 2011, the government announced the National Voluntary
Guidelines on Social, Environmental, and Economic Responsibilities of Business
(NVGs). The NVGs contain nine broad principles to be adopted by companies as
a part of their business practices. In 2012, SEBI introduced Business
Responsibility Reporting (BRR) for the Top 100 entities based on these NVGs,
providing a basic framework for sustainability reporting for companies.
 In 2014, MCA amended the Companies Act, 2013, to make it mandatory for
companies to spend 2% of their average net profits of the past three years
More than half of the CSR towards CSR activities, making India the only country to legally mandate
spends in FY20 were towards Corporate Social Responsibility. While introduced as a mandate, Indian
education, hunger, poverty, companies have embraced the idea of giving back to society and undertaken CSR
healthcare, and rural
development activities in spirit and not just to tick the checkbox. Spends have not been made
in areas where companies would reap direct benefits but in areas that would
lead to the upliftment of society or the country as a whole.
 In June 2017, The SEBI Committee on Corporate Governance was formed under the
Chairmanship of Mr. Uday Kotak (Kotak Committee) – this initiative was aimed at
improving the corporate governance standards of listed companies in India and
implementing some of the global best practices. Of the total 81 recommendations
made by the Committee, SEBI accepted 40 proposals without modifications,
accepted 15 with modifications, rejected 18, and referred 8 to other regulatory
bodies.
 The regulatory push was then directed at the stewardship responsibilities of
What is stewardship?
Stewardship is an ethic that institutional investors. The Insurance Regulatory and Development Authority of
embodies the responsible India (IRDA) mandated the implementation of stewardship and fiduciary obligations
planning and management for insurance companies in 2017 and the Pension Fund Regulatory and
of resources. The concepts Development Authority (PFRDA) did the same for pension funds in 2018. In 2020,
of stewardship can be
applied to the environment SEBI directed mutual funds and all categories of AIFs to adopt stewardship code,
and nature, economics, including monitoring ESG risks in relation to their investments in listed equities.
health, property,  In 2019, the NVGs structure was revised and replaced by the National Guidelines
information, theology, on Responsible Business Conduct (NGRBC), primarily to align NVGs with the
cultural resources etc.
SDGs – NGRBC places the responsibility for the adoption of the principles on the
- Wikipedia
board. BRR was also made mandatory for the Top 1,000 listed companies.

15 December 2021 15
 Thematic | Sustainability

Exhibit 9: Formats for BRSR reporting

BRSR ‘Comprehensive’ BRSR ‘Lite’

 This is a comprehensive format been  This format is kept easier, to enable

developed for large/listed entities. all companies to adopt and
 This will be mandatory for the top encourage, unlisted companies to
1000 listed companies, by market begin sustainability reporting.
cap, from FY23 and voluntarily from  The adoption of BRSR Lite will be
FY22. voluntary for such companies.
Source: MOFSL
 Recently, SEBI made it mandatory for the Top 1,000 listed companies, by market
capitalization, to file Business Responsibility and Sustainability Reporting (BRSR)
from FY23 (voluntarily in FY22). BRSR is set to be the single source of
sustainability-linked or non-financial information for companies in India and
would replace the existing BRR framework. Under BRSR, the reporting format
has been revamped to include quantitative and qualitative information in a
standardized manner – some disclosures are mandatory and some are voluntary
in nature.

ESG investing in India

 While the size of ESG investments in India from a global sustainability AUM
perspective may be negligible, it has been growing significantly. Even
domestically, aggregate AUM in ESG funds as of 30th November 2021 was just
~0.3% of the MF industry AUM.

Exhibit 10: ESG funds in India – facts in numbers

9 ESG Portfolios Reviewed

123.2b Aggregate AUM as on

30 November 2021

~0.3% ESG Funds AUM as a % of

MF Industry’s AUM

169 Unique Portfolio Stocks

Source: MOFSL

15 December 2021 16
 Thematic | Sustainability

 However, COVID-19 has further accelerated the demand for sustainable

investing. 7 of 10 ESG funds in India currently have been launched since January
2020. ESG funds witnessed strong inflows, with aggregate AUM jumping to
INR123.2b in November 2021, from INR26.3b in November 2019, reflecting a
~4.7x jump over a two-year period.
 A few ESG indices have also come up now in the country, namely MSCI India ESG
India, launched in 2007, and NSE100 ESG Sector Leaders index / S&P BSE 100
ESG index, launched in 2017.
 Since most of the ESG funds have started recently, it would be premature to
evaluate their performance with benchmark indices. However, early trends
suggest the performance of the ESG funds has been in line with the benchmarks,
and the outperformance is not evident yet.
 One of the reasons the funds have generated market returns could be due to a high
degree of overlap with the benchmark. As per the latest portfolios, there was a
more than 50% median overlap between the ESG portfolios and NIFTY100 and an
around 30% overlap with NIFTY50 as well as the respective flagship funds.

Exhibit 11: ESG funds in India

Name of the Fund Launch Date/Inception AUM (INR b)
SBI Magnum Equity ESG Fund * May-18 44.9
Avendus India ESG Equity Fund Feb-19 $
Quantum India ESG Equity Fund – Regular Jul-19 0.5
AXIS ESG Equity Fund Feb-20 21.2
ICICI Prudential ESG Fund Oct-20 17.7
Mirae Asset ESG Sector Leaders ETF Nov-20 1.7
Quant ESG Equity Fund Oct-20 0.3
Kotak ESG Opportunities Fund Dec-20 17.5
Aditya Birla SL ESG Fund Dec-20 11.2
Invesco India ESG Equity Fund Mar-21 8.1
*Re-categorized as ESG thematic scheme in May 2018
$ Latest portfolio not available Source: MOFSL

 Globally, historical evidence suggests ESG funds have outperformed their

benchmarks over the long term. The same should be applicable even for the Indian
In line with the global trend, markets – if the ESG principles and practices are implemented in spirit. In the
the outperformance of MSCI developing markets, given the nascent stage of the capital markets, we believe the
India ESG Leaders index outperformance of the ESG funds should be sharper – as the gap in practices
compared to MSCI India
between the ESG leaders and laggards is larger. This is evident from the sharp
index, has been accentuated
since January 2020 outperformance of the MSCI India ESG Leaders index v/s the MSCI India index.

15 December 2021 17
 Thematic | Sustainability

Exhibit 12: MSCI India ESG Leaders v/s MSCI India (cumulative index performance – net
returns in USD)

Source: MSCI,MOFSL

A closer review of the ESG portfolios shows a higher concentration of asset

7 of the 8 companies that
managers showing a preference for Private Sector lenders and IT Services.
form a part of most ESG
funds are from IT Services or Companies in IT Services are global leaders with mature business practices and
Private Sector lending generally good governance standards. Private Sector lenders work under the
RBI’s close lens, and most practices are regulated and institutionalized, leading
to better governance practices. Both of these sectors also have high institutional
shareholding, and as a result, the push from investors has necessitated the
implementation of global best practices. Furthermore, the overall sector-level
ESG risk is lower for these businesses, resulting in the preference for them.
Exhibit 13: Most owned stocks by ESG funds in India (based on latest portfolio of 9 ESG funds)

Tata Consultancy Services 8

HDFC Bank 8
Kotak Mahindra Bank 7
Infosys 7
Housing Development Finance Corporation 7
Wipro 6
ICICI Bank 6
Divis Laboratories 6
Titan Company 5
Info Edge (India) 5
Axis Bank 5
Avenue Supermarts 5
Tech Mahindra 4
State Bank of India 4
SBI Cards & Payment Services 4
Larsen & Toubro 4
Indraprastha Gas 4
ICICI Lombard General Insurance Company 4
Hindustan Unilever 4
Colgate-Palmolive (India) 4
Bharti Airtel 4
Bajaj Finance 4

Source: MOFSL

15 December 2021 18
 Thematic | Sustainability

Key trends evolving in ESG

Global trends

 Shift towards ESG integration: One of the most interesting trends in recent
times has been the shift from negative/exclusionary screening towards ESG
integration. The PRI defines ESG integration as “the explicit and systematic
inclusion of ESG issues in investment analysis and investment decisions.”
Sustainability-themed investing has also shown good traction since 2016.

Exhibit 14: Global growth in sustainable investing strategies (asset value in USD b)

Source: GSIR 2020, MOFSL

 COVID-19 impacting ESG practices: COVID-19 has speeded up certain sustainability

trends that are likely to continue in the near future. (a) Response to the medical and
mental health of employees and workers, (b) flexibility in commuting, and (c) aiding
the distribution of essential and life-saving commodities were all indicators of
corporate behavior in a difficult time. Even on the environmental front, trends such
as virtual meetings and work-from-home, accentuated by COVID-19, would result in
a lower carbon footprint in future.
While corporate travel is  ESG investing in emerging markets to grow: Multiple factors are likely to drive
expected to pick- up
significantly in the second
higher investments in EMs in the near future. The regulatory push has resulted
half of 2021, total spend in in the better reporting of sustainable data and, thus, improving practices. As a
Q4 2021 is projected to only result, this has improved the coverage of EM companies among ESG score
reach 25%–35% of providers. EMs needs capital, and the number of environmental projects
2019 levels
requiring funding is increasing. These factors are likely to result in higher inflows
-Deloitte
in EMs towards ESG in the near future.

15 December 2021 19
 Thematic | Sustainability

 Regulations influencing ESG activities: Regulatory actions towards the

“We cannot solve our implementation of stewardship codes by institutional investors would mandate
problems with the same them to monitor the ESG activities of businesses they invest in and thus push
thinking we used when we
created them”
corporates towards better ESG practices. Also, regulations such as Green Tax
– Albert Einstein and fines/penalties for violating environmental regulations would increase the
operational costs for businesses, pushing them to adopt more sustainable
practices.
 Standardization of ESG reporting: Currently, companies have the option to
choose between at least 10 reporting frameworks for ESG reporting. However,
the world is moving towards the standardization of ESG reporting, similar to the
standardization of financial reporting achieved through the implementation of
IFRS. In September 2020, Carbon Disclosure Projects (CDP), the Climate
Disclosure Standards Board (CDSB), Global Reporting Initiatives (GRI),
International Integrated Reporting Council (IIRC), and the Sustainability
Accounting Standards Board (SASB) co-published a shared vision for more
comprehensive reporting and a joint Statement of Intent to drive this goal. In
November 2020, IIRC and SASB announced their intent to merge into a new
unified organization named the Value Reporting Foundation; on 9th June 2021,
this merger was officially completed.

Exhibit 15: Sustainability reporting frameworks

Sustainability Reporting Frameworks

 Global Reporting Initiative (GRI)  Climate Disclosures Standards
 Integrated Reporting framework (IR)  Board (CDSB)
 Task Force on Climate-related  United Nations Environment
Financial Disclosures (TFCD) Programme Finance Initiative
 Carbon Disclosure Project (CDP)  Business Responsibility and
 Dow Jones Sustainability Index (DJSI) Sustainability Reporting (BRSR)
 United Nations Principles for
Responsible Investment (UN PRI)
Source: MOFSL

 Higher focus on ‘S’ in ESG: The corporate reporting of ‘social’ factors has
What is Alternative data? failed to keep up with ‘environmental’ and ‘governance’ disclosures, even in the
Alternative data refers to developed markets. As already discussed above, COVID-19 has accelerated some
data used to obtain insight
of the ESG practices. The discussions around workers’ rights, diversity, human
into the investment
process. It is the rights, customer engagement, employee well-being, and community relations
information about a have only become stronger. As a consequence, we expect ESG frameworks
company that is published across the world to assign a higher weight to ‘S’.
by sources outside of the  Alternative data sources: Alternative data is becoming a useful resource in
company, which can
provide unique and timely ESG investing. Technologies such as Artificial Intelligence (AI), satellite data, and
insights into investment big data could help investors identify the hidden risks and opportunities that
opportunities may be missing from traditional ESG disclosures.

15 December 2021 20
 Thematic | Sustainability

Trends in India
 India trails in terms of global standards for ESG: India is currently a laggard
in each of the three parameters of ESG, not only in comparison with developed
countries but also some developing peer countries. India must commit to a
carbon neutrality target and work towards it. India’s labor and worker laws and
practices are primitive and need to be aligned with global standards. On the
governance front as well, India has a long road ahead, some of which could be
attributed to legacy issues, short-termism, skill gaps, and inflexibility to change
at both the corporate and investor levels. While the country is moving in the
right direction, it needs to act quickly and align with global ESG standards.

Exhibit 16: Snapshot of India’s sustainability performance

SDG Index Rank SDG Index Score Spillover Score

120/165 60.1 98.9

Source: UN Sustainable Development Report 2021. MOFSL

 Migration from BRR to BRSR: The existing BRR requires companies to respond
Under BRSR, the reporting to a list of standardized questionnaires, which provide only an overview and the
format has been revamped steps undertaken by the company towards sustainability. The BRR framework
to include quantitative and does little in terms of data and renders it difficult to measure the progress
qualitative information in a
standardized manner; some
towards sustainability goals and draw comparisons between companies. The
disclosures are mandatory proposed BRSR framework, which would be mandatory from FY23 for the Top
and some are voluntary in 1,000 listed companies, is a welcome step in this direction.
nature  Government policies shaping the ESG landscape: Government initiatives such as
Pradhan Mantri Jan Dhan Yojna, the scheme towards financial inclusion;
Pradhan Mantri Ujjwala Yojna, which seeks to substitute harmful cooking fuels
with LPG; Bharat VI emission norms; and the Ethanol Blending Policy are some of
the key policy changes by the government driving the ESG agenda. The
implementation of these policy changes has meant that India is set to meet its
Paris Agreement commitments ahead of 2030. We believe government policies
will continue to shape the ESG landscape in India.
 Evolving governance landscape: Over the years, capital market regulator SEBI
and the government have worked in tandem to implement several regulations
to improve governance and financial reporting standards to bring them on par
with those of the developed economies. Policy changes such as the introduction
of the Companies Act 2013, adoption of Ind-AS, the Insolvency and Bankruptcy
Code, stewardship codes for institutional investors, and the amendment to the
LODR are some key initiatives in the past decade that have improved the
governance landscape in the country. Indian businesses still have a long way to
go in meeting the global standards of governance. However, this is underway,

15 December 2021 21
 Thematic | Sustainability

and we believe regulations would continue to drive India Inc. towards better
governance practices.
 Challenges related to investing in smaller companies: The existing BRR and the
proposed BRSR frameworks are mandatory only for the Top 1,000 companies.
Given that sustainability disclosures are not mandatory, asset managers would
have to travel the extra mile to evaluate ESG performance and not pass up these
opportunities due to the lack of disclosures. Managers would have to innovate
and get creative while looking at these businesses. For example, one could look
at the public records of the state pollution control board to see if a company has
been fined in the past, reflecting non-compliance with local emission norms and
therefore higher environmental risk.

15 December 2021 22
For Financial Advisers & Their Clients
Page 2 of 19 2022 Outlook | December 2021

Page 2 of 19

Page 2 of 19

Page 2 of 19
Foreword by the Global Chief Investment Officer
Welcome to our 2022 Outlook!

This document has been created to highlight the most important issues facing investors, share insights
from our current research, and help you make better investment decisions as we enter 2022. It has
been compiled by our investment leaders and draws on the work of our global team.

Globally, Morningstar Investment Management now runs over 150 portfolios, which are all united by
our investment principles and a common methodology. As we look ahead, it is important to remember
that the future holds a wide range of possible outcomes and is characterised by unyielding complexity
that continually defeats those who seek to make confident forecasts. Fortunately, our role as investors
is not to forecast the future, but rather to construct portfolios that empower people to reach their goals
whatever the economic and market conditions.

Let’s not forget about the entire purpose of investing, which is to let our money work for us. It is an
active decision to put money aside (delayed gratification) to boost our purchasing power and/or fund
our desired future lifestyle. Ultimately, it is to help you achieve your goals.

Therefore, we start with the objectives of investors. We have identified four key objectives that are
especially relevant as we enter 2022 and sorted them into a 2 x 2 grid. Each of these objectives are
addressed in a separate section of this document to cover the current challenges facing investors. We
offer practical insights drawn from our own research and expressed in the portfolios that we manage.
This enables investors to focus on the objective and solutions that are most pertinent to them.

Underlying this outlook is the understanding that returns to investors will be determined by both the
cashflows generated by the assets in which we invest and the price paid to acquire those assets. A
fundamentally attractive asset can become an unattractive investment when purchased at a high price
and, equally, a fundamentally weak asset can provide the most attractive returns when bought at a
sufficiently low price. The importance of this dual focus when undertaking investment analysis tends to
be lost in markets characterised by excessive optimism or pessimism. As investors become increasingly
focused on the future path of prices, confident of either a continuation of the past or a sharp reversal,
many forget that most paths lie between these two outcomes.

It is for this reason that we adopt a granular, fundamental and valuation-driven approach to investing,
acknowledging that expensive markets can provide opportunities, and cheap markets may be a source
of threats. In every situation, the right approach is to view the future probabilistically and think long
term.

Dan Kemp, Global Chief Investment Officer

 Page 3 of 19 2022 Outlook | December 2021

Page 3 of 19

Growing a Client’s Portfolio with

Page 3 of 19

High-Conviction Positioning
Page 3 of 19

Investors are entering 2022 with stocks at or near all-time highs—up over 100% from the market bottom in the U.S., for example. Kickstarted
by an unprecedented fiscal and monetary stimulus and sustained by rising investor exuberance—e.g., special purpose acquisition company
(SPACs), IPOs, and meme stocks—sharp gains across risk assets such as equity and credit have left investors with only a small number of
investment opportunities. That requires an increasingly focused approach to portfolio construction.

Global Equity Markets – Evolution of Our Return Expectations

14%
(Nominal % per year, before inflation, USD)

12%
Valuation-implied return expectations

10%
8%
6%
4%
2%
0%
We like ex-US equity markets. -2%
2016 2017 2018 2019 2020 2021
US Equity UK Equity Europe ex UK Equity
Japan Equity Pacific ex Japan Equity EM Equity

Equity Sectors
8%
(Nominal % per year, before inflation, USD)
Valuation-implied return expectations

7%
6%
5%
4%
3%
2%
1%
We like cyclical sectors. 0%

Fixed Income Markets

(Nominal % per year, before inflation, USD)

7%
Valuation-implied return expectations

6%
5%
4%
3%
2%
1%
0%

We like emerging market bonds.

Source for all three charts: Morningstar Investment Management, calculated 31 October 2021. Information is based on expectations, is indicative and presented for illustrative
purposes only. Past performance is not a reliable indicator of future results. An investment cannot be made directly in an index.
Page 4 of 19 2022 Outlook | December 2021

Page 4 of 19

When
Page assessing the
4 of 19 number of attractive asset-class opportunities, we tend to look at the percentage of assets that trade above their fair
return, which is the return we expect to realise when the asset is trading at fair value.
Page 4 of 19

The number of assets that are fairly valued based on our valuation models has declined since last year. For instance, in March 2020, 57% of
all country-equity markets that we track traded at a discount to their intrinsic value, and that has fallen to only 6% of all country markets as of
the end of October (see exhibit presented below).

In this context, it is prudent to recall Warren Buffet’s guidance: “Opportunities come infrequently. When it rains gold, put out the bucket, not
the thimble.” During the height of the pandemic-induced sell-off last March, we were in an environment where opportunities were plentiful,
and a very targeted approach wasn’t required. Today, the situation is different. Investors ought to take a more measured approach to
constructing their portfolios: i.e., put out the thimble, and save the proverbial bucket for a period with heavier rain.

Exhibit Number of opportunities has been dwindling (% of country with a valuation implied above fair return)

Source: Morningstar Investment Management calculation, as of October 31, 2021.

Because of the scarcity in opportunity out there, the work that our global investment team does to uncover the opportunities presenting the
best potential reward for risk becomes more critical. Looking ahead to 2022, we are highlighting three investment ideas for investors to
consider in their portfolios.

1) The Recovery Play: Relative Value in Energy and Financials

While there are a number of headwinds on the horizon, not least uncertainty about inflation and the emergence of a resistant COVID-19
variant, the global economy is poised to continue its recovery, fueled by the normalisation of economic activity globally.

At current prices, global equities look expensive overall, according to our analysis, both in absolute terms and relative to international
markets. However, there are pockets where we continue to see opportunity. These opportunities tend to cluster in more cyclical (or
economically sensitive) areas of the market—including energy and financials, which have both done exceptionally well recently.

× Energy Stocks: Despite recent strength, we continue to believe integrated energy companies with diversified business models and
strong balance sheets provide significant potential upside for investors. The global energy sector has survived its darkest days, which
saw a negative oil price at one point. Additionally, the longer-term transition towards cleaner energy remains broadly on track despite
some concerns about the profitability of clean energy. This development is particularly interesting when we consider climate-change
risk, with European energy companies making a meaningful pivot toward renewables.
Page 7 of 19 2022 Outlook | December 2021

Page 7 of 19

Page 7 of 19

Protecting a Client’s Portfolio from Drawdown

Page 7 of 19

Investing is all about taking risk. To achieve our investment objectives and enable investors to meet their goals, we need to assess the
investment environment and take what we deem appropriate risks. Sometimes the opportunity set will be rich, and we will be able to build
robust portfolios that should comfortably meet an investor’s investment objectives. Other times, that’s not the case. Our analysis hints that the
path ahead could be a little rocky at times, but we must accept some risk to achieve goals.

We must accept the odd setback

on our investing journey.

Every drawdown is unique, but

they usually recover.

Following a long expansion, we

should expect higher risk.

Source for all three charts: Clearnomics, Standard & Poors, CBOE and Morningstar Investment Management, as of 7 December 2021. Information is indicative and presented for
illustrative purposes only. Past performance is not a reliable indicator of future results. An investment cannot be made directly in an index.
Page 8 of 19 2022 Outlook | December 2021

Page 8 of 19

“Risk
Page 8 of is
the Price You Pay for Good Returns”
19
Calling drawdowns good or bad is somewhat flippant. Of course, no drawdown is good for an investor. This is especially the case for investors
Page 8 of 19
with shorter time horizons.

In fact, risk aversion can be a rational response, as people often fail to appreciate the danger of negative compounding. The common
message is that compounding is a beautiful thing, however it is more powerful on the downside than the upside. Consider various scenarios.
If the market were to sell off by 20% tomorrow, you need to make 25% to get back to square. If it falls by 50%, you need to earn 100%.
Avoiding losses matters because losing less means you require less to bounce back.

That said, failing to take calculated risks is a risk itself. Or, said simply: we must ensure that we take enough risk to meet our objectives. This
side of the coin is just as important, as goal attainment is the key reason most people invest. This is also the main focus of our investment
approach—we need to ensure we are being rewarded for the risks we take.

Tomorrow versus Yesterday

In the last decade it has been a relatively simple task to invest in a very risk-focused way and still achieve healthy returns above the inflation
rate.2 Even in the extreme market event in March 2020, we were afforded the opportunity to buy assets at prices that could deliver
exceptional long-term returns—enabling us to be confident that we could deliver on our promises to investors.

However, the opportunity set has clearly narrowed. Equity markets have become more expensive on almost every measure, with some parts
of the market moving to what we’d consider quite extreme levels. The same can be said for traditionally defensive assets, with bonds trading
at levels that could lead to significant capital losses, especially with economic growth remaining a tailwind and inflation at levels not seen for
many years.

Faced with these risks, the key is to assess a portfolio relative to the corresponding goals and risk tolerance of the investor, whilst also
acknowledging the investing environment we operate in. Regarding the investment environment, we foresee a wide range of potential
outcomes, expecting the next year (and decade) to look quite different from the last.

This is both an opportunity and a threat—it presents an opportunity for us to add value for investors by navigating the series of setbacks
ahead, but it’ll require a different approach from that taken over the last decade. We are heading into a time when broad market exposure
(passive investing) could easily fall short of historical averages and may fail to meet absolute return objectives, making it difficult for investors
to achieve their goals. In this sense, we don’t expect an easy ride for the average investor.

Defending in a Low Interest Rate Environment

Perhaps the biggest dilemma for risk-sensitive investors resides in traditional fixed income. Holdings in “defensive assets” such as bonds offer
poor return prospects, on our analysis, creating a true challenge for risk management.

We don’t paint with a broad brush here, still selectively investing in pockets of the bond market for their defensive characteristics and/or
return potential. However, many fixed income markets are expensive (especially so in corporate high-yield bonds), where we carry an
underweight overall position. This is quite different from the last 30 years, where bonds have played the dual role of return generator and
diversifier in portfolios. We are therefore balancing what is left of their defensive characteristics against low absolute yields while also
looking for more defensive characteristics from the growth holdings in our portfolios.

2
In our own research, using Australian data, over the last 10 years a typical 60/40 portfolio (60% in stocks and 40% in bonds) achieved a return of at least CPI +3.5% during 96% of rolling three-year

periods since the start of 2010, well above the 62% of rolling three-year returns if we take the analysis back to 1970.
Page 9 of 19 2022 Outlook | December 2021

Page 9 of 19

The9 Goal
Page Must Still be to Avoid Permanent Loss of Capital
of 19
Importantly not all drawdowns are equal. Volatility provides investment opportunities—the ability to get set in assets with significant upside.
Page 9 of 19
As investing great Bill Miller says, “volatility is the price you pay for returns” and accepting volatility will be necessary for most investors. The
way we approach risk is to consider the potential for two types of drawdowns: 1) valuation-induced drawdowns, and 2) volatility-induced
drawdowns. We embrace volatility, within reason, but want to avoid valuation-induced sell-offs.

When you look at the exposure in our multi-asset portfolios, this difference between volatility and valuation becomes evident. We have a
decent tolerance for holding assets with economically sensitive cashflows, even if these assets tend to have higher core volatility. Our
exposure to energy stocks is a good example. They present reasonably high core volatility, but that can usually be recouped with time. See
the chart below for the volatility of the global energy sector, where the range of outcomes really starts to skew to the upside over long
timeframes—this is a “good” volatility tradeoff in our view.

Exhibit The Range of Outcomes for Energy Stock is Wide in the Short Term, But Narrows Over Time
80%

60%
Forecast Likely Range % p.a.
(99% Confidence Interval)

40%

20%

0%

-20%

-40%

-60%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years

Source: Morningstar Investment Management, calculated in US$ in Nominal Terms as of 30 November 2021. Forecasts are indicative and presented for illustrative purposes only.

Valuation-based drawdowns (paying too much for an asset) can be more enduring and may not be fully recouped—even over the long term.
Equities that go bankrupt or bonds that default are extreme examples. These are the drawdowns our process seeks to avoid where capital can
be permanently impaired.

So, how can an investor both protect and earn? We believe the best pathway is to identify the assets with the greatest reward-for-risk and
size them appropriately to manage total portfolio risk. Today, the most attractive holdings are concentrated in cyclical areas of the market,
despite their higher volatility, so we employ portfolio construction techniques to offset or temper the cyclical risk, including defensive sector
exposures.

Our analysis has shown some of the most attractive assets include emerging-markets debt, consumer-staples stocks, healthcare, and utilities
companies. These are all attractive as replacements for growth assets in an array of different environments we might face, especially where
the opportunity set is diminished and the potential for a risk event is elevated. Analysis we have recently carried out shows that each of the
asset classes named above have inviting downside- and upside-capture ratios against the S&P 500, presenting particularly attractive
asymmetry between the two in the significant market scenarios we have run.3

3
Emerging-markets debt presents with not just inversely-related downside capture (positive return when the S&P is negative), but also surprisingly large upside capture. Similarly, US consumer staples

stocks and healthcare stocks both show low downside captures (consumer staples nearly as low as the fixed-income asset classes) while ranking among the top upside captures.
Page 11 of 19 2022 Outlook | December 2021

Page 11 of 19

Page 11 of 19

Protecting a Client’s Portfolio from Inflation

Page 11 of 19

When it comes to the most insidious risks facing investors, inflation may well top the list. Its impact on portfolios doesn’t appear until
investors compare gains to the climbing cost of living. To achieve any meaningful progress toward financial goals, investors need to clear the
inflation hurdle.

We view inflation as investors,

not economists.

Portfolios need to be robust

against a wide range of scenarios.

We acknowledge modern risks,

including the large debt burden.

Source for all three charts: Clearnomics, Morningstar Investment Management, as of 30 November 2021. Where information is based on expectations/estimates/forecasts, this
information is indicative and presented for illustrative purposes only.
Page 12 of 19 2022 Outlook | December 2021

Page 12 of 19

Beating
Page 12 of 19Inflation
is Investing 101
For many years, clearing the inflation hurdle hasn’t been difficult. With a stable supply-and-demand balance, the cost of living has broadly
Page 12 of 19
risen at a predictable, modest pace. Meanwhile, falling rates, expanding valuations, and individual company successes have fueled broad-
market gains at a rate well above historical norms.

But when inflation does materialise, particularly at higher levels, its impact can be widespread devastation. Investors with shorter time
horizons, who typically have greater exposure to bonds, are particularly vulnerable. A significant portion of the total return generated from
bonds comes from income, which, for most bonds, is predetermined (hence the term “fixed” income). As inflation rises, the “fixed” income
delivered by the bond is worth less. In response, investors may sell bonds, driving prices down and further hurting returns.

Among investors with shorter-term horizons are retirees, who no longer generate wages that could potentially rise to inflation-adjusted levels.

But it’s not just the bond investor who faces risk during periods of inflation. While equity markets aren’t subject to the same “fixed”-income
conundrum, their total return can also be in jeopardy; their dividend payments are worth less, and their earnings can suffer from higher input
costs, particularly if they are not in a position to pass along higher prices to their consumers. As earnings come under pressure, so can their
ability to generate inflation-beating returns.

Even high-flying growth stocks aren’t immune to inflation. In fact, growth stocks have historically shown greater vulnerability to inflation than
their value brethren. The explanation involves the expectations around earnings: as inflation rises, so do interest rates, which means investors
expecting higher earnings from growth companies discount them back to present day with a more punishing level of interest rates.

This leaves us with two questions as we enter 2022:

1. If inflation is inconsistent—and unpredictable—how do you protect your portfolio from it?
2. If you could predict it, given that both bonds and stocks are vulnerable to it, is there anything you can do to protect against it anyway,
even if you could see it coming?

On the first point, you don’t need to know with certainty that inflation is coming. We view portfolio construction as an exercise of probability,
weighing one market environment against another. We build portfolios for a range of environments and rarely make binary calls on particular
outcomes.

Fortunately, our research suggests that many of the assets best suited for inflation protection are also relatively well priced. These assets
include:
• Short-duration bonds or cash (fixed payments have very short durations and thus can reset as rates rise)
• Equities that are positively correlated to inflation, such as energy stocks
• High-quality companies with high degrees of pricing power that can pass along rising input costs

However, there are also sources of protection we don’t like. For example, inflation-protected bonds (including Treasury Inflation-Protected
Securities or TIPS) are a common go-to source; however, these are less attractively priced, in our view. The same applies to high-yield bonds
and floating-rate bonds, both of which benefit from improving credit profiles during inflationary periods but are also unattractively priced. As
a result, we have limited exposure to these asset classes, despite their inflation-protection properties.
Page 13 of 19 2022 Outlook | December 2021

Page 13 of 19

Key13Takeaways
Page of 19 Regarding Inflation
Inflation is a well-known risk facing investors and we take it seriously. In 2022, as always, we believe inflation is worth protecting against, but
Page 13 of 19
we caution investors away from trying to predict inflation outcomes with precision.

The key is to understand how each asset may help in different inflation outcomes, assessing the total portfolio impact and whether it will
deliver on its objective. It’s worth noting that some assets that have been in vogue for the past few years—especially U.S. growth stocks—
strike us as not only overpriced but also as vulnerable in an inflation shock.

Those considerations above aside, over the past several decades inflation has been more a specter in investors’ minds than an actual reality
they need to face, and today’s market could very well prove to be more of the same. It’s for that very reason that we think along the lines of
probability rather than forecasts and account for a range of market environments. In the end, if inflation once again fails to materialise as a
real threat, we do not believe our portfolios will be at a disadvantage; the driving thrust of their positioning is valuations, not inflation.

Marta Norton, Chief Investment Officer, Americas

Page 14 of 19 2022 Outlook | December 2021

Page 14 of 19

Page 14 of 19

Letting Your Money Work for You into Later Life.

Page 14 of 19

One of the primary motives of investing is to fund a comfortable retirement, with a 2020 Morningstar Behavioural Research survey
(https://www.morningstar.com/lp/mining-for-goals) showing that retirement remains the number-one goal among individuals. So, while
retirement planning remains a foundational pillar of the financial advice industry, we’d broaden it out as making your money work for you.
This is a timely and relevant topic, as it is no secret that income generation is getting harder, with several trade-offs and potential pathways
to navigate.

Lower interest rates have made

retirement funding complex.

Income and total return

approaches can both make sense.

Goal attainment should be your

north star when investing.

Source for all three charts: Clearnomics, Bloomberg, Morningstar Investment Management as of 7 December 2021. Information is indicative and presented for illustrative purposes
only. Past performance is not a reliable indicator of future results. An investment cannot be made directly in an index.
Page 15 of 19 2022 Outlook | December 2021

Page 15 of 19

The15Modern
Page of 19 Dilemma for Retirees & Income Generators
The last decade has been a good one for investors of all types and sizes, with record-low volatility and record-high prices for most asset
Page 15 of 19
classes. For retirees, though, it has been a period of declining cash rates, declining bond yields, and declining dividend yields. This remains
one of the great challenges for investors trying to live off their assets in 2022, as income is so much harder to attain.

This might be about to change, with some expecting interest rates to rise. We note that we aren’t in the business of predicting interest rates,
although the general consensus is that the most likely direction for interest rates is up. Our expertise is to build portfolios that can handle
different possibilities, which is really a matter of portfolio robustness. In this regard, higher interest rates would have obvious implications for
asset prices, with retirees particularly sensitive given their typically higher weighting to bonds. This is a double-edged sword, however, as
higher rates would cause bond price losses in the near term, but it could make income generation easier in a forward-looking context.

The harsh reality is that we are presented with a perfect storm against retirees—an environment that is low yielding and generally
unattractive, with rising inflation reducing their purchasing power. This requires a selective approach to empower investor success and
presents a modern dilemma to solve.

What Approach is Best for 2022?

Many timeless questions carry special weight in 2022. For instance, are retirees better positioned by focusing on a selective-income approach
or a total-return approach in an environment of low current yields and higher risk? We did some interesting research on this in early 2021 and
found that both approaches can still be effective, although both carry risks, too. 4 The same learnings are applicable in 2022, though starting
yields are slightly lower again and risks slightly higher.

Exhibit Three Measures Retirees Should Understand

Source: Morningstar Investment Management, for illustrative purposes only.

• With a total-return approach in 2022, you would seek to accumulate further gains, then sell part of the portfolio periodically to meet the
withdrawal needs. The obvious risk is that markets are expensive, so if you sell down assets that aren’t rising (or worse, falling), you’ll
have a higher likelihood of running out of money. This is a risk many would like to avoid, especially those exposed to sequencing risk (the
risk of a big decline early in your retirement wiping out a big part of your nest egg). Ordinarily, this would incline many towards an
income approach, but the common mantra remains that “there is no alternative” (TINA).

4
Using U.S. data, we looked at 163 rolling periods, comparing the two approaches for a) income stability, b) the source of withdrawals, and c) the likely ending account value. We found that there is no

best choice that works for everyone, with an income approach generally effective for (a) and (b), but less clear for (c). We also noted taxation and behavioral elements and highlighted the modern

challenge of lower starting yields.

Page 16 of 19 2022 Outlook | December 2021

Page 16 of 19

Page 16 of 19
• The income approach requires a selective approach in 2022, as a focus on cash-flow generation requires you to typically tilt portfolios
Page 16 of 19
toward asset classes with higher current income, such as high-dividend stocks and emerging-markets debt. However, some of the
popular income assets can carry meaningful downside risk, and some exhibit no growth in income (a risk in the face of rising inflation).
For example, we don’t believe longer-dated bonds are an area that will serve income-hungry investors in 2022. We think yield chasing is
a cardinal sin when it is taken to the extreme, moving up the risk curve without a thorough understanding of what you own and why you
own it. Patience is key, as 4%+ yields are difficult, if not impossible, to obtain in 2022 without accepting meaningful risk.

Natural Sources of Cashflow in 2022

Some assets naturally lend themselves to stable income generation, and we see some attraction in these asset classes heading into 2022.
The aim is for:
• Income growth,
• Some capital growth to keep up with inflation,
• Durability. Dividend cuts are an issue to avoid and technological obsolescence must be considered. ESG (environmental, social,
governance) risks must also be assessed.

We look for these characteristics across our entire portfolio range, not just income-focused strategies, because natural income sources are a
return driver with relatively reliable outcomes. For example, banks are a popular source for income and are an area we generally find
attractive heading into 2022, represented in many portfolios. We note that banking income isn’t always natural, with durability a nuanced
issue — capital adequacy is important, with debt issues to consider and excess capital that can cause overdistributing — but it does offer
relative value.

When it comes to robustness, defensive equity sectors such as consumer staples and healthcare are also areas that we believe offer natural
income sources. The yields aren’t high in absolute terms as we enter 2022, but they do help offset cyclical risk and provide durability. As you
can see, selectivity is key for those wanting to live off their income in the current environment.

Key Takeaways for Living Off Your Assets

As was the case in recent years, 2022 is likely to be a difficult environment for passive-income generation, with low rates and expensive
assets a common challenge. Arguably, this year’s environment is even worse, with higher inflation eroding the purchasing power of your
income.

This requires careful navigation. On one hand, your primary role is to maintain your purchasing power with an inflation-beating portfolio that
is robust and can handle different environments. On another, it makes sense to capture natural income sources, helping you with the three
measures of retirement success: 1) cashflow stability, 2) source of withdrawals, and 3) likely ending account value.

We seek to do all of the above in the portfolios we manage, including some that are specifically targeted with inflation-beating or income-
targeted objectives.

Mike Coop, Chief Investment Officer, Europe Middle-East & Africa

23 December 2021

Omicron update
Verbier
There is a whiff of déjà vu in the air with habitual travellers like GREED & fear seeking to move before borders
are closed. Still if Omicron is making headlines, and resulting in escalating restrictions being announced by
governments as the number of cases climb, the base case remains that it is more infectious but less lethal.

This conclusion continues to be supported by the evidence from South Africa where the variant was first
identified. Cases are already falling there on a seven-day average basis. The 7-day average daily new case
count in South Africa rose from 258 in early November to a peak of 20,791 on 17 December and has since
declined to 17,440 (see Exhibit 1). While the rise in hospitalisations remains very small relative to the recent
surge in cases, the number of Covid patients in ICU has risen from 230 in late November to 613, compared
with 1,808 at the start of September (see Exhibit 2)

Exhibit 1: South Africa 7-day average daily new Covid cases and deaths
Daily cases 7dma Daily deaths 7dma (RHS)
21,000 600

18,000 500
15,000
400
12,000
300
9,000
200
6,000

3,000 100

0 0
Aug-20

Aug-21
May-20

May-21
Sep-20

Sep-21
Oct-20

Nov-20

Oct-21

Nov-21
Jun-20

Jun-21
Apr-20

Jul-20

Apr-21

Jul-21
Mar-20

Mar-21
Jan-21
Dec-20

Dec-21
Feb-21

Source: National Institute for Communicable Diseases (NICD)

Exhibit 2: South Africa hospitalised Covid patients in ICU

2,000 Currrently hospitalised Covid patients in ICU
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
10-Nov

24-Nov
17-Nov
1-Sep

8-Sep

6-Oct

1-Dec

8-Dec
3-Nov
20-Oct

27-Oct
15-Sep

13-Oct
22-Sep

29-Sep

15-Dec

22-Dec

Source: National Institute for Communicable Diseases (NICD)

Meanwhile Britain remains a good test case of herd community. The good news here is that the number of
cases over the past week has seemingly stabilised at around the 90,000 level before rising again to a record
106,122 on Wednesday (see Exhibit 3). But that may reflect the population exercising self-restraint since the
streets of London went from being remarkably crowded to empty in the week following GREED & fear’s recent
arrival there, most particularly in areas where people normally go to offices. As for hospitalisations, the
number of hospitalised Covid patients has risen only from 7,182 in early December to 8,008 on Tuesday (see
Exhibit 4). Meanwhile, 70% of the total UK population have been fully vaccinated with 46% having taken the
booster jab.

Exhibit 3: UK daily new Covid cases

110,000 UK daily new Covid cases 7-day mov. avg.

100,000
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21
Source: UK Health Security Agency

Exhibit 4: UK Covid patients in hospital

40,000 UK Covid patients in hospital 4,500
35,000 Patients in mechanical ventilation beds (RHS) 4,000

30,000 3,500
3,000
25,000
2,500
20,000
2,000
15,000
1,500
10,000 1,000
5,000 500
0 0
Oct-20

Oct-21
Aug-20

Sep-20

Aug-21

Sep-21
May-20

May-21
Nov-20

Nov-21
Jun-20

Jun-21
Apr-20

Jul-20

Apr-21

Jul-21
Mar-21
Feb-21
Dec-20

Dec-21
Jan-21

Source: UK Health Security Agency

In the global context, Covid cases are now rising again with the Centers for Disease Control and Prevention
(CDC) estimating this week that 73% of new American cases last week were Omicron (see Exhibit 5). The 7-
day average daily Covid case count globally has risen from 403,923 in mid-October to 705,253, while average
daily deaths have remained broadly flat at 6,698 (see Exhibit 6). As for America, the 7-day average daily new
Covid case count has risen from 64,182 in late October to 161,261, with average daily deaths running at 1,223
(see Exhibit 7). Daily new cases in New York State surged to a record 28,924 on Tuesday (see Exhibit 8).
Exhibit 5: Share of sequenced Covid-19 cases in the US

0.76% 0.88% 0.85% 0.99% 0.79% 1.34% 1.36% 1.66% 0.25% 0.03% 0.44% 0.12%
100%
90%
26.64%
80%
70%
60%
87.00%
50% 99.24% 99.12% 99.15% 99.01% 99.21% 98.66% 98.64% 98.34% 99.70% 99.28%
40%
30%
20%
10% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.05% 0.68% 12.56% 73.24%
0%

13-Nov

20-Nov

27-Nov
2-Oct

9-Oct

4-Dec
6-Nov
16-Oct

23-Oct

30-Oct

11-Dec

18-Dec
Omicron Delta Others
Note: CDC estimates for latest two weeks. Source: Centers for Disease Control and Prevention (CDC)

Exhibit 6: World 7-day average daily new Covid cases and deaths

Source: Johns Hopkins University

Exhibit 7: US 7-day average daily new Covid cases and deaths

300,000 Daily new cases, 7dma Daily new deaths, 7dma (RHS) 4,000
3,500
250,000
3,000
200,000
2,500
150,000 2,000
1,500
100,000
1,000
50,000
500
0 0
Aug-20

Aug-21
May-20

Sep-20

May-21

Sep-21
Oct-20

Nov-20

Oct-21

Nov-21
Jun-20

Jun-21
Apr-20

Jul-20

Apr-21

Jul-21
Mar-20

Mar-21
Jan-21
Dec-20

Dec-21
Feb-21

Source: CDC
Exhibit 8: New York State daily new Covid cases

30,000 New York State daily new Covid cases 7-day mov. avg.

25,000

20,000

15,000

10,000

5,000

0
Aug-20

Aug-21

Sep-21
May-20

Sep-20

May-21
Nov-20

Oct-21
Oct-20

Nov-21
Jun-20

Jun-21
Apr-21
Apr-20

Jul-20

Jul-21
Mar-20

Mar-21
Jan-21

Dec-21
Dec-20

Feb-21
Source: New York State Department of Health

Meanwhile, Omicron has yet to hit much of Asia as can be seen in the lack of cases in the likes of India and
Indonesia. There have so far been only 213 Omicron cases reported in India and 5 in Indonesia. The 7-day
average daily new Covid cases in India and Indonesia have declined by 98.3% and 99.6% respectively from
their peak reached in May and July to 6,768 and 204 (see Exhibits 9 & 10). This reflects the reality that borders
in most of Asia remain all but closed. Indonesia, for example, is still imposing a quarantine requirement of 10
days.

If the empirical evidence so far is that Covid is following the usual path of a pandemic, where variants become
less lethal but more infectious, victory cannot be guaranteed until the global vaccination rate is much higher.
It is currently 48% (see Exhibit 11). There is also still the contentious issue of where the virus originated from.
GREED & fear has an open mind on this point. But clearly if the virus did not originate from nature the normal
rules may not apply.

Exhibit 9: India and Mumbai 7-day average daily new Covid cases

400,000 10,000
Nationwide Mumbai (RHS) 9,000
350,000
8,000
300,000
7,000
250,000 6,000
200,000 5,000
150,000 4,000
3,000
100,000
2,000
50,000 1,000
0 0
Aug-20

Aug-21
Sep-20

Sep-21
May-20

May-21
Oct-20

Nov-20

Oct-21

Nov-21
Jun-20

Jun-21
Apr-21
Jul-20

Jul-21
Mar-21
Jan-21
Dec-20

Dec-21
Feb-21

Source: Ministry of Health and Family Welfare

Exhibit 10: Indonesia and Jakarta 7-day average daily new Covid cases

55,000 Indonesia daily new Covid cases, 7dma 14,000

50,000
12,000
45,000 Jakarta daily new Covid cases, 7dma (RHS)
40,000 10,000
35,000
30,000 8,000
25,000 6,000
20,000
15,000 4,000
10,000
2,000
5,000
0 0
Aug-20

Aug-21
Sep-20
May-20

May-21

Sep-21
Oct-20

Oct-21
Nov-20

Nov-21
Jun-20

Jun-21
Apr-21
Apr-20

Jul-20

Jul-21
Mar-20

Mar-21
Jan-21

Dec-21
Dec-20

Feb-21
Source: Ministry of Health

Exhibit 11: Share of population fully vaccinated against Covid-19

Singapore 87
China 85
Korea 82
Spain 81
Japan 78
Malaysia 78
Canada 77
Australia 76
Italy 74
Sweden 72
France 72
Germany 70
UK 69
EU 68
Netherlands 67
Brazil 66
Taiwan 65
Thailand 63
Israel 63
Hong Kong 61
USA 61
World 48
Philippines 41
India 40
Indonesia 39
Pakistan 28
South Africa 26 (%)
0 10 20 30 40 50 60 70 80 90
Note: Data as of 21 December 2022. Source: Our World in Data

Meanwhile, Omicron has hit the cyclical trade of late as can be seen both in the recent decline in the oil price,
now down 13% from this year’s peak in late October (see Exhibit 12), and in downgrades for near-term US GDP
growth. Jefferies’ US chief economist Aneta Markowska now expects US real GDP to grow by only an
annualised 1.5% QoQ in 1Q22, down from the previous forecast of an annualised 6.9% made in November (see
Jefferies research What's Next? Outlook Refresh Post FOMC & Omicron, 17 December 2021).

There is also the issue of Democrat Senator Joe Manchin almost singlehandedly blocking the passage of the
Build Back Better bill through the Senate. All 50 Republican Senators oppose it. As mentioned here last week
(see GREED & fear - Inflation and politics, 16 December 2021), he has been given significant political cover for
this stance by the publication on 10 December of the CBO report estimating the true cost of this proposed
legislation at an enormous US$5tn (see CBO report: “Budgetary Effects of Making Specified Policies in the Build
Back Better Act Permanent”, 10 December 2021).
Exhibit 12: Brent crude oil price
90 (US$/bbl)

80

70

60

50

40

30

20

10
2015 2016 2017 2018 2019 2020 2021
Source: Bloomberg

This latest development has raised fears of fiscal cliffs facing America in 2022. Still if GREED & fear had to
bet on it, the view would be that Omicron would no longer be making headlines in the Western world by the
end of January while the US Congress would, by then, be looking at another version of Build Back Better though
hopefully one with a better name.

With the end of the year approaching GREED & fear, who has been writing the forthcoming Asia Maxima
quarterly, will make some further adjustments to the portfolios. The weighting in Samsung Electronics in the
Asia ex-Japan long-only portfolio will be raised by one percentage point to 5%, with the investment paid for by
shaving the investment in MediaTek. While the investment in Geely Automobile will be removed and replaced
by electric vehicle battery maker Contemporary Amperex Technology (CATL) (see Exhibit 14).

As for the Asia Pacific ex-Japan relative-return portfolio, the weightings in Hong Kong, Korea and Taiwan will
be increased by 0.5ppt, 1.5ppts and 1ppt respectively. These will be paid for by reducing the weightings in
Australia and China by 1ppt each and shaving the weightings in Malaysia and Singapore by 0.5ppt each (see
Exhibit 13).
 Commentary

Could Technology’s Leadership Be Over?

Inflation, the economy, and sector fundamentals could
spell trouble for tech

I approach my research by looking at market data through a historian’s

lens. I believe historical patterns, when considered in the appropriate
context, can help investors build conviction about future trends.
Denise Chisholm This month, using history as a guide, I’m highlighting three recent
Director of Quantitative
developments that in the past have been associated with poor results
Market Strategy
for the technology sector.

Technology tends to struggle when inflation is high

Inflation had been exceptionally low for more than a decade before jumping recently. This
change may have important ramifications for sector performance, and technology looks
particularly vulnerable: Historically, the faster inflation has risen, the worse tech’s returns
have been relative to the overall market (Exhibit 1). By contrast, periods of declining or
slower-growing inflation have been associated with better relative results for the sector.

EXHIBIT 1: Large inflation increases have corresponded with technology underperformance.

Historical Tech Relative Performance (NTM) by Inflation Scenario, 1977–Present

5% 3.5%
1.9% 1.4%

0%

-2.2%
-5%

-10%
-10.2%

Q1 Q2 Q3 Q4 Top Decile
Historical Inflation Acceleration Tranche

Past performance is no guarantee of future results. NTM: next 12 months. Analysis based on top 3,000 stocks by
market capitalization. Inflation reflects core CPI (consumer price index.) Sources: FactSet, Fidelity Investments, as of
Aug. 31, 2021.
The tech sector has tended to underperform during inflationary periods regardless of the health
of the economy. Since 1962, technology has performed poorly relative to the broad market during
both inflationary economic booms and inflationary busts (also known as stagflation), as shown
in Exhibit 2. Conversely, tech has tended to outperform when inflation is negative and/or falling,
whether the economy has been strong or weak.

EXHIBIT 2: Tech often has trailed during inflationary periods, regardless of the state of the economy.
Historical Tech Sector Odds of Outperformance by Inflation and Growth Scenario (YoY), 1962–Present

80% 71%
67%

41%
40% 36%

0%
Inflationary Boom Inflationary Bust Disinflationary Boom Deflationary Bust
(Stagflation)

Past performance is no guarantee of future results. Analysis based on top 3,000 stocks by market capitalization. YoY: year over year.
Percentages refer to historical likelihood of quarterly outperformance in various scenarios. Inflationary boom: above-median real GDP
growth and inflation. Inflationary bust: above-median inflation, below-median real GDP growth. Deflationary bust: below-median inflation,
below-median real GDP growth. Disinflationary boom: below-median inflation, above-median real GDP growth. Inflation reflects core CPI.
Sources: FactSet, Fidelity Investments, as of Aug. 31, 2021.

Tech often lags after leading economic indicators peak

The state of the economic cycle also may present challenges for the technology sector. Earlier this
year, leading economic indicators (LEIs) surged to their biggest year-over-year improvement since at
least the late 1970s.1 It may seem counterintuitive, but in the past technology stocks have fared very
poorly after peaks in LEI growth. In fact, after previous top-decile leading indicator gains, technology
underperformed the broad market by an average of more than 10% in the ensuing 12 months
(Exhibit 3). The best time to buy tech has historically been when leading indicators have worsened,
because by the time LEIs peak, the sector’s cyclical outperformance has usually already happened.

Tech stocks have often underperformed after big margin gains

Powerful fundamentals have helped drive the technology sector’s performance in recent years,
as the growth in tech company profit margins reached the top decile of its historical range. In
the past, the sector has struggled after margins improved this much: When tech-sector margin
expansion has reached the top 10% of its historical range, technology stocks have underperformed
the market by an average of 0.7% over the next 12 months (Exhibit 4).1 Now with outsized
improvements in the rear-view mirror, the tech sector may face a headwind.

Could Technology’s Leadership Be Over? | 2

 EXHIBIT 3: Technology has underperformed dramatically after the biggest gains in leading indicators.
Average Relative NTM Performance by Prior LEI Composite Change Tranche, 1977–Present

8%
5.9%
4.7%
4% 2.4%
1.9%

0%

-4% -2.9%

-8%

-10.4%
-12%
Bottom Decile Q1 Q2 Q3 Q4 Top Decile
Historical LEI Composite Tranche

Past performance is no guarantee of future results. NTM: next 12 months. LEI: leading economic indicators composite. Analysis based on
top 3,000 stocks by market capitalization. Sources: FactSet, Haver, The Conference Board, Fidelity Investments, as of Aug. 31, 2021.

Given the strong historical connection between inflation and technology returns, I continue to closely
track inflation expectations, which historically have been modest leading indicators of future inflation.
Furthermore, with technology valuations drifting toward the top quartile of the sector’s historical range
and creating another potential headwind, earnings growth will be a critical factor to watch over the next
year. These dynamics aside, technology has been a beneficiary of slower global growth and lower interest
rates this cycle, as the sector’s earnings growth has outpaced the broader market against this backdrop.
In times of stress, these quasi-defensive qualities may offer a natural buffer to current headwinds.

EXHIBIT 4: Margin expansion for the sector remains near historic highs.
Technology EBIT/Sales Ratio (% Change Year over Year)

20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 2021

Past performance is no guarantee of future results. Analysis based on top 3,000 stocks by market capitalization. EBIT: earnings before
interest and taxes. Sources: FactSet, Fidelity Investments, as of Aug. 31, 2021.

Could Technology’s Leadership Be Over? | 3

 EQUITY RESEARCH | December 10, 2021 | 12:12 AM EST

Framing the Future of Web 3.0

METAVERSE EDITION

In our view, the global Internet is in the middle to late innings of the innovation curve of Web 2.0
(the shift from desktop to mobile computing & from local to cloud storage) and the “leaders” of this
wave of the Internet are now firmly established. In framing the next wave of computing (Web 3.0),
we see the potential for dramatic shifts in industry structure (decentralized, more
local/niche/targeted) that could impact current investor perceptions of platform moat/strength,
industry input costs, possible headwinds to monetization driven by personalization and potential for
shifting media & commerce trends. One element of Web 3.0 that has recently captured media &
investor attention is the “Metaverse” – a term that has taken on many meanings but with common
themes around virtual and immersive experiences, online communities and the creator economy. In
the report, we examine how the gaming/media landscape has already shown some key elements as
to how the Metaverse might evolve and how themes such as decentralized web activity & virtual
experiences could become hallmarks of many of the next wave of computing in Web 3.0.

Eric Sheridan Michael Ng, CFA Lane Czura Alexandra Steiger Alex Vegliante, CFA Katherine Campagna
+1 917 343-8683 +1 212 902-8618 +1 917 343-8682 +49 69 7532-3097 +1 212 934-1878 +1 212 902-1151
[email protected] [email protected] [email protected] [email protected] [email protected] [email protected]
Goldman Sachs & Co. LLC Goldman Sachs & Co. LLC Goldman Sachs & Co. LLC Goldman Sachs Bank Europe SE Goldman Sachs & Co. LLC Goldman Sachs & Co. LLC

The Goldman Sachs Group, Inc.

Goldman Sachs Americas Technology

Framing the Transition to Web 3.0

In our view, the global Internet is in the middle to late innings of the innovation curve of
Web 2.0 (the shift from desktop to mobile computing & from local to cloud storage) and
the “leaders” of this wave of the Internet are now firmly established. The defining
characteristics of a Web 2.0 “leader” are scale of users, utility-like nature of
mobile/desktop applications/services (if not a family or ecosystem of apps) & low to no
distribution costs (companies have gained broad based familiarity with some turning into
verbs). As seen in the figure below, we see dramatic shifts in the industry trends in Web
3.0 (decentralized, more local/niche/targeted, etc) that could impact current investor
perceptions of platform moat/strength, industry input costs, possible headwinds to
monetization driven by personalization and potential for shifting media and commerce
trends as we transition to Web 3.0.

Exhibit 1: Evolution of Decentralized Web

Source: Company data, Data compiled by Goldman Sachs Global Investment Research

10 December 2021 2
Goldman Sachs Americas Technology

So what form might “Web 3.0” take? We lay out a few key principles:

n Likely more control by the user of their data (including data residing on-device);
n Likely a more micro focus - a mean reversion on scale (either in end market being
tackled or in relationship between the platform and the user);
n The rise of individual as creator & creator monetizing their content more directly
with “fans”;
n Increasingly decentralized (with the possible breakdown of the mobile operating
system/app store distribution model over the next 5-10 years ); &
n Flexibility (if not innovation) on payment mechanisms aimed at a mix of themes,
including decentralized privacy and anti-establishment.

As with any new wave of computing, in our opinion, the disruption that it causes is likely
to be more impactful on current industry dynamics than outside forces (e.g., potential
regulation).

10 December 2021 3
Goldman Sachs Americas Technology

What is the Metaverse?

In the early ‘90s, Neal Stephenson first coined the phrase “Metaverse” in his science
fiction novel, Snow Crash. Decades later, industry investor/analyst Matthew Ball raised
awareness around the phrase “Metaverse” in a series of essays that was focused on
the present/future of Epic Games (owner of Fortnite). Both of these thinkers have set a
benchmark of themes which investors could envision key elements of the industry
shifting from Web 2.0 to Web 3.0. Large tech platforms (which benefited from the rise of
mobile computing apps) now look toward augmented reality as the next computing
platform shift. Along those lines, repositioning key consumer/enterprise offerings to
evolving media consumption applications (gaming, avatars, attending sports/concerts,
exercise) seems like the next logical shift in consumption patterns that will likely drive
platform unit economic shifts and create new leader/laggard status among industry
players.

One interesting aspect of this evolution is the inter-connectivity of such a computing

landscape and the possible erosion of the walled garden elements of the mobile
computing wave. While there remain key friction points to solve such as hardware form
factor (especially cost curve), broadband connectivity and mass appeal use cases, most
investors and tech operators (probably most notable is Mark Zuckerberg’s focus at Meta
Platforms and the broader gaming industry) are planning and investing toward platform
evolution in this direction.

Over the past 12 months, the term Metaverse began to gain traction shortly after
Roblox’s direct listing in March and more meaningfully saw higher levels of Google
Search interest during the Q3 ‘21 earnings season as various management teams
discussed elements of their business within the future Metaverse. More significantly,
Meta Platforms (formerly Facebook) changed its name to reflect CEO Mark Zuckerberg’s
vision of Meta’s role within the Metaverse. That said, the term has taken on many
forms/definitions with commonalities/themes around virtual experiences,
interoperability, creator community, immersive, and many other elements.

Exhibit 2: Metaverse Google Search Interest

120

100
FB name change
to Meta
80

60

40

20

RBLX Direct Listing

0
Nov-19
Dec-19
Jan-20

Jun-20

Nov-20
Dec-20

Jun-21
Feb-20

Jan-21
Feb-21
Mar-20

Jul-20

Mar-21

Jul-21
Oct-19

Apr-20

Oct-20
Aug-20

Apr-21
Sep-20

Aug-21
Sep-21
Oct-21
May-20

May-21

Google Trends (https://www.google.com/trends)

Source: Google Trends, Data compiled by Goldman Sachs Global Investment Research

10 December 2021 4
Goldman Sachs Americas Technology

Similar to elements within Web 2.0 around the iPhone/iOS, we view augmented reality
& virtual reality as technology enabling the Metaverse whereby services, content, and
more are all layered on top and accessed/consumed through the mergence of virtual
3-D and physical experiences. However, below we outline how US internet & gaming
companies are defining the term.

Meta Platforms

CEO of Meta Platforms, Mark Zuckerberg views the Metaverse as a successor to

mobile internet that will:

(1) Elevate physical world experiences. Through mixed reality and physical-world
experiences, the Metaverse will magnify the feeling of presence. Currently, there are
multiple use cases of AR (including Spark AR) that serve as a template for the future of
Metaverse applications, specifically how businesses have utilized AR to enable
consumers to virtually see how certain furniture fits within their home or try on
makeup/glasses. In the future, Zuckerberg envisions a world in which many physical
objects (e.g., TV, computers, etc.) can simply be holograms designed by creators and
consumers will use AR glasses to optimize the physical world and VR to be fully
submerged in the virtual world.

(2) Be co-created & built responsibly. Similar to a lot of other US TMT companies,
Zuckerberg believes that many entities will work together to build the Metaverse
(including businesses, creators, policymakers, entrepreneurs, etc.) with integrity, safety,
and privacy at the center of its foundation. To support this framework, open standards
and interopability are also core to the Metaverse with new forms of governance likely to
emerge.

Zuckerberg believes the Metaverse is coming within the next 10 years, but expects that
in the near-term, consumers will first experience the Metaverse through 2D apps, citing
examples within commerce (buying physical or digital products) or entertainment
(hosting a mixed-reality experience with consumers buying a ticket for in-person or
virtual event). Similar to what we saw with the mobile internet, consumer adoption of
AR & VR will be a driving factor in business opportunities.

In order to better understand the timeline around the Metaverse opportunity, we look at
eMarketer data to assess what current penetration rates are and forward growth
assumptions for both AR and VR. While AR represents a larger opportunity when
compared to VR, we highlight that penetration rates still remain low with AR users
expected to be ~28% of the US population and VR users at ~18% in 2021. We also note
that AR numbers are likely to be inflated as they include any individual that experiences
AR content as least once per month via any device (e.g., anyone with an Apple/Android
device who uses an AR feature in the app, such as AR in Snapchat). With the pandemic
removing a lot of physical experiences, the AR and VR market saw strong growth in
2020. Going forward, we expect that technological advances (such as 5G, edge
computing) coupled with more use cases (beyond gaming, social media, entertainment)
are likely to drive consumer adoption. That said, the low penetration rates in the next 2
years are a key indicator around the timing of the Metaverse opportunity.

10 December 2021 5
Goldman Sachs Americas Technology

Exhibit 3: US Augmented Reality Users Exhibit 4: US Virtual Reality Users

(mm, 2019-2023E) (mm, 2019-2023E)

120 35% 70 25%

100 30% 60
20%
25% 50
80
15%
20% 40
60
15% 30
10%
40
10% 20
5%
20 5% 10 35%

0 0% 0 30% 0%
2019 2020 2021E 2022E 2023E 2019 2020 2021E 2022E 2023E
25%
AR Users (mm) YoY Growth Penetration VR Users YoY Growth Penetration

Source: eMarketer, Data compiled by Goldman Sachs Global Investment Research Source: eMarketer, Data compiled by Goldman Sachs Global Investment Research

Roblox

CEO of Roblox, David Baszucki, views the Metaverse as a virtual universe that is
persistent and shared where platforms connect people from different realms of life and
enables them to communicate in a new way through the combination of technology and
high-fidelity communication, borrowing from mobile gaming and the entertainment
industry. Baszucki has often referred to Roblox as a human co-experience that
predicates on the following fundamentals: identity, social, immersive, low friction,
variety, anywhere, economy, and civility.

Epic Games

CEO of Epic Games, Tim Sweeney, envisions the Metaverse as an expansive,

communal, & virtual world where people can interact with brands, intellectual
properties, and each other with experiences spanning across all categories (beyond
gaming). Similar to others, Sweeney believes that individuals will build the Metaverse
through user-generated content and there must be a free & fair economy in which all
users can partake, make money, and be rewarded. Additionally, every participant (from
an individual to a brand to a major developer) must participate on equal terms. Aside
from the underlying technology, Sweeney believes that opening up walled gardens and
applying industry standards and laws will be pivotal to the Metaverse.

Niantic Labs

CEO of Niantic Labs, John Hanke, has labeled the Metaverse as a “dystopian
nightmare” (link) and is focused on building a better reality by enhancing the physical
world through augmented reality, which he has labeled as “real-world Metaverse” in an
effort to differentiate it from the virtual video game version. At the core of Hanke’s
thesis is data, information, services, and interactive creations where digital meets
physical. To Hanke, the key technical challenges in achieving his goal are synchronizing
millions of users globally (“shared state”) and tying these users to the physical world,
which he believes represents the larger challenge of the two.

10 December 2021 6
Goldman Sachs Americas Technology

Nvidia

CEO of Nvidia Jensen Huang has defined the Metaverse as a 3D extension of the
internet today and expects the virtual economy to be much larger than the real-world
economy. In an effort to build the Metaverse, Huang is focused on the Omniverse at
Nvidia which is a platform centered on collaboration and simulation, enhancing existing
workflows by creating virtual worlds. As an example, Ericsson has partnered with Nvidia
using the Omniverse to build virtual cities that replicate physical cities in an effort to
accurately simulate 5G cells and the environment, optimizing for performance and
coverage.

What is the cost?

Looking back at the shift from Web 1.0 to Web 2.0, there were various cost components
tied to Web 2.0 that all built on Web 1.0. Similarly, there will be significant costs tied to
Web 3.0 that build upon Web 2.0 infrastructure. Given the complexity involved in
quantifying the investments needed, we look at Meta Platforms’ recent segment
disclosures for Facebook Reality Labs as a way to better understand what level of costs
are required to support the build-out of the Metaverse.

With Meta’s last earnings report, management announced plans to break out reporting
by two separate segments, Family of Apps and Facebook Reality Labs which will include
augmented and virtual reality related hardware and software content. Management
guided Facebook Reality Labs to be a $10bn headwind to total consolidated EBIT in
2021.

More specifically, Meta intends to invest in:

n Data center infrastructure. Over the past decade, Meta has invested ~$17bn
against 14 data centers in the US and ~$4.1bn against 4 data centers internationally,
amounting to ~$21.3bn. Meta’s President of Infrastructure & Data Centers, Tom
Furlong, has stated that they have 48 active buildings and another 47 buildings
under construction, signaling 70 additional buildings in the coming years.
n Further iterations of VR and AR Products + Content. In 2014, Facebook acquired

10 December 2021 7
Goldman Sachs Americas Technology

Oculus for ~$2bn as its first foray into virtual reality products. From 2014 to 2016,
Meta had invested $250mm into VR content and committed an additional ~$250mm
to fund future content projects. During the 2017 Connect event, CEO Mark
Zuckerberg commented that it plans to invest $3bn+ over the next decade against
VR products. Since then, Meta Platforms has meaningfully accelerated its
investments, purchasing 6 VR content studios in the past 2 years.
n Hiring talent. As of March 31, 2021, roughly 10,000 employees have been focused
on building out Meta’s augmented and virtual reality efforts, representing nearly 1/6
of Meta’s employee base. During the last earnings call, management announced
their goal to double this by hiring an additional 10,000 employees in Europe for its
Facebook Reality Labs segment over the next five years.
n Responsibility. In late September 2021, Meta announced plans to invest ~$50mm
in several global partnerships over the next two years in order to ensure Metaverse
related products are being developed responsibly. To date, Meta has announced ~18
partnerships that are focused on ensuring responsibility across a few key ares:
economic opportunity, privacy, safety & integrity, and equity & inclusion.
n Content Creators. During the 2021 Connect event, Meta announced that it will
create a ~$150mm fund to help train and develop the next generation of creators.
Specifically, these investments will focus on Metaverse creators’ skillset,
high-quality training content, increasing global access to Meta technologies, and
responsible research. In addition to Meta’s ~$150mm VR/AR learning fund for
creators, Meta has also recently announced a ~$10mm creator fund to support
Horizon. Meta will distribute these funds through community competitions offering
up to ~$10k for the top 3 winners, its Creator Accelerator Program which will launch
in early 2022, and partnerships for funded opportunities.

That said, we take a look at other public companies investing against Metaverse as
well as funding within the private markets and provide an illustrative scenario analysis
around the total potential spend against this opportunity in the coming years. Looking
at the underlying holdings of the META ETF, we calculate the market cap of each
company and apply a percentage to the total market cap of ~$12,500tn. In addition, we
look at the private market across gaming, online games, augmented reality, and virtual
world categories - during 2021, ~$10.4bn of capital has been raised so far across 612
deals (up from ~$5.9bn in 2020). As can be seen in Exhibit 5, there are a range of
potential outcomes with ~$135bn of investments at the low end to ~$1.35tn at the
high end - however, we view the more likely scenario as ranging from ~$135-700bn
based on our assumption that Meta Platforms investments over the next three years
(as a percentage of market cap) will be the largest.

10 December 2021 8
Goldman Sachs Americas Technology

Exhibit 5: Illustrative scenario Analysis Around Levels of Investments ($bn)

% of Market Cap
1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
$ 10 $ 135 $ 260 $ 384 $ 509 $ 634 $ 759 $ 884 $ 1,008 $ 1,133 $ 1,258
$ 20 $ 145 $ 270 $ 394 $ 519 $ 644 $ 769 $ 894 $ 1,018 $ 1,143 $ 1,268
$ 30 $ 155 $ 280 $ 404 $ 529 $ 654 $ 779 $ 904 $ 1,028 $ 1,153 $ 1,278
Private Funding

$ 40 $ 165 $ 290 $ 414 $ 539 $ 664 $ 789 $ 914 $ 1,038 $ 1,163 $ 1,288
$ 50 $ 175 $ 300 $ 424 $ 549 $ 674 $ 799 $ 924 $ 1,048 $ 1,173 $ 1,298
$ 60 $ 185 $ 310 $ 434 $ 559 $ 684 $ 809 $ 934 $ 1,058 $ 1,183 $ 1,308
$ 70 $ 195 $ 320 $ 444 $ 569 $ 694 $ 819 $ 944 $ 1,068 $ 1,193 $ 1,318
$ 80 $ 205 $ 330 $ 454 $ 579 $ 704 $ 829 $ 954 $ 1,078 $ 1,203 $ 1,328
$ 90 $ 215 $ 340 $ 464 $ 589 $ 714 $ 839 $ 964 $ 1,088 $ 1,213 $ 1,338
$ 100 $ 225 $ 350 $ 474 $ 599 $ 724 $ 849 $ 974 $ 1,098 $ 1,223 $ 1,348
META ETF top holdings include: NVDA, MSFT, RBLX, U, ADSK, SE,AMZN,TCTZF, TSM, AAPL, SNAP, QCOM, FSLY, INTC, SNEJF, TTWO, MTTR, GOOG, COIN, AMD, NET, ADBE, EA. Date as of 12/8/2021.

Source: Company data, Goldman Sachs Global Investment Research, FactSet

What are the potential use cases and TAM?

Current State of Virtual Reality: Examining Oculus

In March 2014, Meta Platforms acquired Oculus for $2.4bn as a way to gain a footprint
in the virtual reality landscape. Following the acquisition, Meta Platforms launched
Oculus Rift (the first consumer model) in March 2016 at a starting price of $599,
followed by Oculus Go in May 2018 (with a starting price of $199). In May 2019, Meta
Platforms debuted Oculus Quest which would replace Oculus Rift for a starting price of
$399. Since then, Meta Platforms released a new version of Oculus Quest, with a
starting price of $299, the lowest price within the competitive landscape. As can be
seen below, Oculus Quest 2 (which will later be renamed to Meta Quest 2) has resulted
in significant YoY growth rates for Meta Platforms’ payments & other revenue
segment, whereby consumer hardware represents the vast majority based on our
estimates.

10 December 2021 9
Goldman Sachs Americas Technology

Exhibit 6: Consumer VR Competitive Landscape Exhibit 7: Meta Platforms Payments & Other Revenue
$mm, Q1 ‘19 - Q3 ‘21

$1,000 250%
$900
Oculus 2 Launch 200%
$800
$700
150%
$600
$500 100%
Oculus 1
$400 lauch
50%
$300
$200
0%
$100
$- -50%
1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21

Payments & Other Revenue YoY Growth

*Sony has announced a second version of Playstation VR but has not yet disclosed the price Source: Company data, Goldman Sachs Global Investment Research
point

Source: Company data, Goldman Sachs Global Investment Research

The Gaming Industry: Setting the Stage for What’s Ahead

Prior to COVID-19, video games were already starting to blur the lines between virtual
and physical events & activities as demonstrated by in-game events in Fortnite and
Roblox (e.g., Star Wars: The Rise of Skywalker, DJ Marshmello concert, Weezer album
debut), professional eSports players partnering with celebrities on Twitch (e.g., Drake
and Ninja playing Fortnite), and Take-Two’s online casino in Grand Theft Auto where
gamers could gamble real money. As a result of these in-game events and activities,
these key franchises saw user base expansion and increased levels of engagement,
consumption, and ultimately monetization. And on the other hand, these events allowed
content creators to connect with the next generation in a new forum that boasts high
levels of engagement.

During COVID-19, social restrictions placed an importance on the need to have virtual
events and connections, resulting in the social acceptance of virtual existence. During
the pandemic, video games, streaming platforms, and communication apps allowed
consumers to digitally connect with one another, with cancelled in-person graduations
ceremonies, weddings, and many other significant life events taking place via Minecraft,
Roblox, and other platforms. These examples demonstrated the many use cases video
game platforms can offer. Prior to COVID-19, many of the platforms were more in an
experimental phase in terms of integrating live events. During COVID-19, we saw a
wave of consumers creating their own virtual worlds in an effort to replicate physical
worlds. Coming out of COVID-19, we are now seeing platforms invest in a greater sense
of presence and individuality (e.g., gamer’s avatar connecting directly with an artist in
Roblox) in an effort to further blur the lines between virtual and physical existence.

Large and Growing Market Makes Gaming an Attractive Platform to Connect with
Others

The video games market was approximately $175bn in 2020, marking a 13% 3-year
CAGR (2017-20), and is projected to grow at an 8% 3-year CAGR (2020-23), according to

10 December 2021 10
Goldman Sachs Americas Technology

Newzoo (see Exhibit 8). Within the global games market, mobile is the largest
segment at ~$94bn in 2021 and has realized a 25% CAGR (2013-19), making it the
fastest growing platform (i.e., faster than PC and console), well above overall industry
growth of 11% over the same time period. In addition, we note that the global player
base is estimated to grow to ~3.22bn by 2023 (according to Newzoo) from 2.03bn in
2015 driven by a growing installed base of smartphones, the rollout of 5G, and a new
generation of gamers adapting mobile games coupled with a growing number of
high-quality games made for mobile. We note that COVID-19 accelerated many of the
long-term tailwinds as many consumers turned to video games as a way to connect
with others virtually.

Exhibit 8: Global Games Market Exhibit 9: Global Players

$bn, 2013-2023E bn, 2015-2023E

3.22
3.09
2.96
2.81
2.64
$61
2.49
$57
2.33
$55
2.17
$51
2.03
$44
$42 $43
$43 $40
$33 $37
$32 $35
$30 $35
$30 $33
$30 $32 $113
$32 $94 $103
$31 $86
$29 $61 $69
$56
$43
$25 $32
$18

2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2023E

Mobile PC Console 2015 2016 2017 2018 2019 2020E 2021E 2022E 2023E

Source: Newzoo, Data compiled by Goldman Sachs Global Investment Research Source: Newzoo, Data compiled by Goldman Sachs Global Investment Research

Breaking Down Walled Gardens Unlocks the Digital Transformation and

Monetization of Long-Tailed Engagement

Looking back on the history of video games, traditional games were typically purchased
with an upfront fee of ~$60 with players only allowed to play with others based on the
player’s platform (e.g., Xbox vs. Playstation). In 2017, Fortnite was released as a
free-to-play Battle Royale game that was cross-platform (by Sep 2018), which opened up
the addressable market and drove a myriad of competitive and social elements given
the ability to play with other players regardless of the platform - all of these elements
allowed Epic Games to create an ecosystem in which they can promote live services
(e.g., monetize skins that have no direct impact on game play) and host virtual events
(e.g., Ariana Grande) for gamers to connect with each other as well as the artist. Since
then, the business model across video game companies has transformed from physical
unit sales for premium games to in-game content (events, competitions, skins, etc.)
layered on top of premium games and monetized through various forms (premium,
in-game purchases, advertising, battle/season passes), which has led to the rise of
virtual currency. Furthermore, live streaming platforms (e.g., Twitch) and eSports have
also driven long-tail engagement around key gaming franchises as an additional way to
interact with other gamers, further strengthening the community and expanding the
economic opportunity (through tips, sponsorship, advertising, etc.). Over time, AAA
publishers have increasingly focused on developing in-game content to drive
engagement and ultimately monetization - as can be seen below, the vast majority of

10 December 2021 11
Goldman Sachs Americas Technology

AAA publishers has seen an increasing mix towards digital revenues (vs. physical).

Exhibit 10: Digital Bookings by AAA Publishers

%, 2019-2023E

100%
95%
90%
85%
80%
75%
70%
65%
60%
55%
50%
2019 2020 2021E 2022E 2023E

ATVI EA TTWO

Source: Company data, Goldman Sachs Global Investment Research

Next Generation of Users Places Importance on Social Elements and Virtual

Worlds Within Gaming

Looking at how the next generation of users spends their digital time in 2020 across the
US, UK, Spain, online video and social media both represent ~26% of screen time at
~45 minutes, with gaming falling closely behind at ~22% of screen time or ~38
minutes. However, when looking at the top apps by time spent, Fortnite and Roblox rank
first and second with more than an hour and a half spent in the games, both of which
are open environment multi-player games, signaling the value the younger generation
places on social elements and virtual worlds within gaming.

Exhibit 11: Time Spent by App Category Exhibit 12: Time Spent by App
%, 2020 minutes, 2020

Fortnite 98
5%
Roblox 96
26% TikTok 75
21%
YouTube Kids 68

YouTube 64

Zoom 50

22% Minecraft 49
26%
Disney Plus 46

Instagram 44

SnapChat 39
Online Video Social Media Gaming Communication Education

Source: Data compiled by Goldman Sachs Global Investment Research, Qustodio Source: Data compiled by Goldman Sachs Global Investment Research, Qustodio

Emergence of Virtual Experiences and Widespread Gamer Adoption Highlights the

Opportunity Ahead

Looking at Roblox specifically, the company currently has ~47mm DAUs with
expectations to grow to ~78mm by 2024 consuming ~2.6 hours per DAU per day of
“experiences”. Roblox monetizes its user base through the sale of its virtual currency,
Robux (R$), which can be used to enhance game experiences, customize a player’s

10 December 2021 12
Goldman Sachs Americas Technology

avatar, or acquire development resources. Developers are compensated in Robux, which

can be exchanged for fiat currency or spent back into the platform. As laid out in
Goldman Sachs initiation, Roblox’s platform includes content developed by individual
creators and video game studios, as well as non-endemic businesses such as film/TV
studios (e.g., Warner Bros, Netflix) and musical artists (e.g., Lil Nas X) demonstrating
the use cases for non-gaming general entertainment.

Exhibit 13: Roblox DAUs (mm) and Hours per DAUs

90.0 3.0
80.0
2.5
70.0
60.0 2.0
50.0
1.5
40.0
30.0 1.0
20.0
0.5
10.0
0.0 0.0
2019 2020 2021 2022 2023 2024

DAUs Hours per DAU

Source: Company data, Goldman Sachs Global Investment Research

According to a survey conducted by Newzoo, consumers view the ability to choose their
avatar’s physical appearance as a key feature in terms of driving overall enjoyment
within the metaverse, followed by free content funded by advertisers & sponsors, and
ability to create content for other players. These are all elements that Roblox has been
investing behind in order to enhance the users’ virtual experience.

10 December 2021 13
Goldman Sachs Americas Technology

Exhibit 14: Metaverse features and benefits

Ability to choose your avatar's physical appearance 5.32

Free content funded by advertisers & sponsors 5.26

Ability to create content for other players (cosmetics, art, mini-

games) 5.23

Ability to jump from one game to the next without leaving a game
world 5.22

Special credits so you can buy items in one game, and take them
into others 5.22

Access to player created content (cosmetics, art, mini-games) 5.2

Ability to buy decorations/pets for your avatar's house 5.18

Ability to buy outfits for your avatar to wear 5.11

Ability to watch movies, or TV shows whilst in the game world 5.08

Ability to buy real-life products whilst in the game world 5.07

Q: How good or bad do you think each of the following content and features would be, in terms of your overall enjoyment? [Mean score out 7]

Source: Newzoo, Data compiled by Goldman Sachs Global Investment Research

10 December 2021 14
Goldman Sachs Americas Technology

Investing in Virtual Identity Through User-Generated Avatars

While the Roblox marketplace (where gamers can purchase clothing accessories and
simulated gestures for their avatar) only represents ~25% of total revenue, Roblox is
investing heavily in the avatar marketplace by improving fidelity (e.g., layered clothing,
facial animations, photorealistic skin meshes) in an effort to enhance the feeling of
presence & individuality among the gamer base. Despite representing the minority of
revenue, avatars are a key element of the Roblox experience as 20% of users change
their avatars daily - the more personalized a gamer’s avatar is, the more engaged they
are, the more invested they are in the platform, and the more time they spend.

Exhibit 15: Roblox Avatar Timeline

Source: Company reports, Goldman Sachs Global Investment Research

Prior to 2019, Roblox developed all content sold within the avatar marketplace in-house.
Roblox then shifted to a user-generated content (UGC) model in 2019, which it trialed
with a select group of Roblox developers. Notably, Roblox experienced a 250% increase
in avatar marketplace transactions upon turning the avatar marketplace over to the
developer community. Currently, the marketplace is open to ~500 developers who
release ~350 items per week representing ~65% of all 3D avatar item sales. Going
forward, Roblox plans to continue to invest behind UGC items by opening new items to
UGC creation including layered clothing and avatar body & faces. Following that, Roblox
will enable every new item type on the platform to be UGC and will also look to open up
the current closed list of ~500 developers to all users (similar to how anyone can
develop a Roblox experience). Over the long-term, management envisions a fully
decentralized model whereby various brands and creators can build their own stores to
sell virtual goods to consumers to further build out their virtual identity and beyond that,
management also envisions a world in which consumers can virtually buy anything that
you could in real life (e.g., pets, art, houses, cars, etc.) further expanding one’s identity
within the Metaverse.

Exhibit 16: UGC Drives Avatar Marketplace Spend

Source: Company data, Goldman Sachs Global Investment Research, Company reports

10 December 2021 15
Honey, I shrunk the loans !
Miniaturization of banking ticket sizes and
the embedded future of banks: What does it
mean for the winners of tomorrow?

Saurabh Tripathi, Senior Partner

MINT ANNUAL BANKING CONCLAVE, DEC 2021

 Lending in India is poised for data driven transformation
• Transactions will increasingly get digitized and available
in bank statements.
• Aggregators will give access to machine readable bank
stmnt. and other data to any lender of customer's choice
• OCEN will create transparent competition on price and
customer experience on digital platforms

3
Key
India's embrace of open stack implies that, similar to
payments, a significant share of customer interactions for
lending will shift to digital platforms with customer traffic
• More frequent, context specific, low-ticket loans
messages • Embedded banking

.
Banks need to prepare for this new reality in 3 ways:
• Master AI to draw real time credit insights from lots of
data
• Develop muscles for managing partnerships with digital
platforms
• Upgrade tech stack to keep pace with digital platforms
Shrinking of loan tickets size has started … it is just the beginning

Average ticket size

(INR in '000)
Property Loans Business loans Personal loans
942 267
2,658

645
2,295 181
1,984 697
1,779
118
87
305
FY18 FY19 FY20 FY21 FY18 FY19 FY20 FY21 FY18 FY19 FY20 FY21

SME (Small) loans SME (Micro) loans

5,892 5,667 860 883 834

5,266
4,661
415

FY18 FY19 FY20 FY21 FY18 FY19 FY20 FY21

Source: FIBAC Trends and Benchmarks; BCG analysis

 Small tkt high velocity lending like BNPL are poised to take off

BNPL User base BNPL disbursements

BNPL expected to surpass credit card base by FY26 BNPL market expected to grow 15x by FY26

User base (Mn.) BNPL Disbursals (INR 000'Cr)

80-100 356
75

33
13 24
FY21 FY26 FY21 FY26

Credit card BNPL BNPL

Source: Expert discussions, BofA GLOBAL RESEARCH, Secondary Research & BCG Analysis
We witnessed this disruption in payments in last 5 years
UPI platform has miniaturized ticket size and exploded volume of transactions
Digital Transaction volume (in lakhs) &
Average Ticket size (ATS) in INR

34,430
61,569

11,265

.
1,386
Jul-2016

Jul-2017

Apr-18

Jan-19

Apr-19

Jan-20

Apr-20

Jan-21
Oct-18

Oct-19

Oct-20
Jul-18

Jul-19

Jul-20

Mar-21
Apr-2016

Oct-2016

Jan-2017

Apr-2017

Oct-2017

Jan-2018

Digital Transaction Volume Average ticket size

Source: RBI, BCG Analysis
Digital Transactions include UPI, NEFT and IMPS
With QR codes, majority of P2M txn data will be digital in 5 years
Digital transaction data is machine readable and deployable in lending algorithms

POS devices growth stagnated while Bharat QR and UPI QR are witnessing exponential growth
since Dec’20 …
No. of POS devices (in lakhs) No. of UPI QR codes (in lakhs) No. of Bharat QR codes (in lakhs)

+3% +45%
1,070 1,092 +65% 51 53
49
4.6 4.7 4.7 4.7 4.5 4.5 4.6 4.6 4.8 978 982 1,018 49
925
876
806 40
752 35 36
32 34

.
Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug-
20 21 21 21 21 21 21 21 21 20 21 21 21 21 21 21 21 21 20 21 21 21 21 21 21 21 21

Source: RBI, Secondary Research, BCG Analysis

In 3 years, Aggregator and OCEN will disrupt lending like UPI has
done to payments in 5 years
Aggregator Open Credit Enablement Network (OCEN)

Account Lender
Banks (customer's Borrower
aggregator choice)

One time/
Consent

Periodic
MF house Digital platform with
LSP1
heavy customer traffic
Single API to connect
Insurance to all lenders
Account
OCEN
Aggregator
Pre-defined
Income tax application
APIs APIs APIs APIs protocols

GST Borrower Lender 4 Lender 5

Lender 1 Lender 2 Lender 3

Access to standard format machine readable all accounts Real time competition amongst lenders based on price
txn data to any lender instantly with customer consent transparency, speed of response, and customer experience

1. LSP – Loan service provider

India's embrace of open stack has profound implications for banks
Across products, 3rd party digital intermediaries to anchor bank's client interface

Consent

Transactor Borrower Saver

Payment Loans Personal finance
management (PFM)

Payment Service Loan Service Neo-banks/Investment

providers providers advisors

Account
Data P1 P2 P3 L1 L2 L3 N1 N2 N3
Aggregator

UPI OCEN API

.
Data
The embedded future: Banking Services will be originated on non-bank
platforms

Retail Digital Payments Unsecured Digital Lending Savings Account Opened Digitally
(Volume) (Volume%) (Volume)

20%
25%
35%
55%

75%
90%
95%
80%
75%
65%
45%

25%
5%
FY21 FY26e FY21 FY26e H1FY22 FY26e
% On Bank Platform % On Third Party Platform
Large range of potential partners to consider for customer acquisition

Fin Tech, Alternate Digital model

Industry E-commerce
Insurance & lending & Neo with Offline
Investment Platforms players
Banks Partners

Airlines
Retailers
Telcos
Chinese new age banks have led the way in partnering with platforms

Open bank partnership model Growth boosted

Products Own or partners’ platforms

Ping An’s own Ping An Pocket

platforms Bank APP
~39%1
Ping An’s own Customers acquired
products
Partners’ 2C from partners’
platforms platforms as of total
customers of retail
business

.
Partners’(other bank) Partners’ 2B
products platforms

1. By 2020, data from Ping An press release and public reports

Source: Annual reports; Company websites; Ping An Open Bank whitepaper; BCG analysis
In Summary: Key principles to consider in partnerships

Customer Advance analytics Tech to match Partnership

Experience and AI partner tech business unit
• Design capabilities • Quick decisions • Modular • Value based deal
negotiation
• Seamless e2e journey • Straight through • Micro services

.
processing enabled • Align risk appetite,
ops, tech,
• Test and learn
• Co-creation of
customer experience
 COP26 made net zero a
core principle for business.
Here’s how leaders can act
Momentum has shifted: net-zero commitments are the norm. But demand
for solutions and systems to meet them outstrips the supply. To respond,
businesses should focus on five fundamentals.

by Harry Bowcott, Daniel Pacthod, and Dickon Pinner

© Theasis/Getty Images

November 2021
 Even as COP26 delegates conclude negotiations, Why do we say so? Because many of the net-
it is clear that the climate commitments launched in zero commitments made in Glasgow came from
Glasgow will reshape the agenda for global business. coalitions of the stakeholders—governments,
Hopes were high that COP26 would be where the financial institutions, companies, multilateral
world delivered action on the goals of the Paris organizations, and others—who must participate
Agreement. Debate will go on about whether official if systemic problems are going to be solved. For
talks accomplished enough. To focus only on those example, the transition to clean shipping would
developments, though, is to miss the other story require customers to request the service, shipping
that unfolded during COP26, as public-, private-, companies to invest in vessels that run on zero-
and cross-sector pledges signaled that the emissions fuels, fuel producers to make more
|direction of travel is toward net zero. And in of those fuels, and banks to provide capital for
hundreds of conversations in Glasgow, executives these endeavors. And when these activities are
told us and our colleagues that they expect an coordinated, they shift the entire operating context
acceleration of climate action across the real for companies.
economy: at the system level, throughout
industries, and within organizations. CEOs can get ahead of such shifts by joining
coalitions that exist now, such as the Mission
Our conversations made something else apparent, Possible Partnership. COP26 also saw new
too: net-zero commitments are outpacing the commitments from groups such as the Glasgow
formation of supply chains, market mechanisms, Financial Alliance for Net Zero (GFANZ). CEOs who
financing models, and other solutions and structures see a pressing and unmet need for cross-sector
needed to smooth the world’s decarbonization effort may wish to organize a coalition. They might
pathway. For businesses, these conditions will also choose to engage the public sector in setting
create opportunities to innovate and to lead rules that favor a more orderly net-zero transition.
coordinated action by industry peers, value-chain
partners, capital providers, and policy makers. They
also introduce added risk that commodity prices will Companies can gain advantage
spike. With these opportunities and risks in mind, from translating net-zero pledges
we offer a look at five fundamental considerations into net-zero plans
that can help executives define an effective net-zero In many instances, net-zero commitments are
program for the next few years. running ahead of companies’ own plans to meet
them. Relatively few businesses have yet to make
clear, detailed plans for how they will achieve net
Commitments to systemic change zero. That must be what leaders focus on now;
mean that net zero is now an investors and regulators expect them to do so. UK
organizing principle for business chancellor of the exchequer Rishi Sunak reiterated
Coming out of COP26, many observers will focus at COP26 that the Treasury would require UK-listed
on whether the commitments made there imply a companies to release net-zero plans by 2023. It
temperature increase of greater than 1.5°C. That is only a matter of time before regulators and
analysis is important; it helps show how much supervisors elsewhere follow that example.
more must be done to cut emissions and adapt to
warming. For executives, it also matters that the Until then, leaders who put convincing net-zero
aims of countries and companies are converging on plans in place can distinguish their companies
1.5°C targets. The net-zero imperative is no longer from peers. To put that another way: the basis
in question—it has become an organizing principle of competition has changed, and there is now a
for business. premium on sound net-zero planning and execution.

2 COP26 made net zero a core principle for business. Here’s how leaders can act
Such plans will vary in their specifics, of course, but COP26. GFANZ brought together more than 450
well-formed ones will feature certain elements: institutions, representing $130 trillion of financial
assets (40 percent of the global total), that promised
— emissions targets for Scopes 1, 2, and 3 (the to align their portfolios with net-zero goals. To put
hardest to meet); these should include long-term that in perspective, McKinsey analysis indicates
targets, as well as near-term goals for 2025 and that a net-zero transition would require $150 trillion
2030, all aligned with science-based mitigation of capital spending, two-thirds of it in developing
trajectories or sector-specific trajectories from economies. While there is justifiable debate about
credible authorities what the GFANZ pact might mean in terms of capital
investment—and far more capital will probably be
— a strategic view of climate risks and needed—the commitment shows that capital is
opportunities for each part of the company’s starting to form.
portfolio, covering both competitive dynamics
and environmental exposures Deploying sufficient capital quickly enough
to achieve net zero is now the challenge. At a
— an assessment on the spending of transition system level, focus should be on scaling markets
capital that will be required to reduce emissions, and institutions that can channel money into
especially from existing emissions-intensive decarbonization and adaptation. This involves
assets, coupled with a credible stance on the scaling voluntary carbon markets, restructuring
use of high-quality carbon credits multilateral development banks, developing
country platforms, and creating futures markets
— a program for building capabilities to monitor for green commodities.
external conditions, make decisions about how
to update the company’s plan, and implement it At the company level, leaders will need capital to
decarbonize their holdings and to build businesses
Plans take time to prepare—but business conditions that serve the growing markets for zero-emissions
are changing quickly, as we explain below. goods and services. Companies that own
Companies should not wait to act. Most can make carbon-intensive assets might work with financial
no-regrets moves even while drawing up their long- institutions that have net-zero goals on securing
term agendas. Start with straightforward moves funds to retrofit or retire these assets responsibly.
that are sure to generate value; investing in energy Except when dealing with the most carbon-
efficiency, for example, usually does. intensive assets, this approach may deliver
greater emissions reductions than divesting
Explaining the company’s plan to stakeholders assets or taking them private.
is important, too. Leaders will want an investor-
relations and external-engagement program that
puts the company on the front foot by explaining Securing green(er) materials will
how they see the future, what they are doing now, mitigate risk amid shortages and
and what they will do next. price volatility
Extreme weather won’t be the only climate-related
threat to supply chains in the years ahead. One
The money to finance the transition is consequence worries many: as demand increases
forming; markets and institutions are for materials with low emissions intensity, such as
needed to channel capital green steel, production capacity may not expand
Financial institutions have been at the forefront of quickly enough to keep pace, at least in the near
the drive to net zero, and they continued leading at term. For example, McKinsey analysis suggests that

COP26 made net zero a core principle for business. Here’s how leaders can act 3
 shortages of high-quality iron ore could constrain plans. A company’s first impulse may be to disclose
production of zero-emissions steel. only the required minimum, but it can be beneficial
to describe performance more openly. This would
Or consider potential shortfalls in the supply of involve closer monitoring of value chains—an
climate technologies. Zero-emissions trucks are approach that digital technology can enable. The
one example. A report from Road Freight Zero, a experience of leading companies suggests that
cross-industry coalition that is part of the Mission sustainability management will be the next frontier
Possible Partnership, and McKinsey indicates that for digital transformation.
projected growth in sales of zero-emissions trucks
in Europe won’t be enough to put the continent’s Distributed sensing and computing technologies
road-freight sector onto a 1.5°C pathway.1 lend themselves well to value-chain management—
and lowering emissions represents one of the
Executives will want to prepare now for tightening thorniest value-chain issues we have witnessed.
supplies and for upward pressure on their costs. At each point in a company’s value chain, cost
Some businesses are locking in purchasing increases could result as suppliers and business
contracts for commodities such as green steel. It partners reduce their emissions. Digital systems for
may also be possible to hedge the gap in price tracking and tracing goods could help reveal where
between conventional materials and zero-emissions emissions are concentrated so that companies can
substitutes—though this would require trading take steps to lessen them.
capabilities that few companies outside the financial
sector now possess. Digital technologies also have powerful applications
within a company’s own operations. Research by
For makers of steel, cement, and other materials, McKinsey and the World Economic Forum on 90
growing demand for zero-emissions goods technically advanced factories around the world
constitutes an opportunity, which can be met shows that digital transformations had boosted
only if they decarbonize their base of installed sustainability performance at roughly two in every
assets. Doing so will take significant capital, as three facilities.2
noted above, as well as technology and time. Until
these companies actually achieve net zero, they
might pursue other ways of satisfying customers’ Investments in resilience can protect
demands for green materials. One stopgap people and companies from physical
approach involves securing high-integrity carbon climate hazards
credits from nature-based projects. Further warming will have physical consequences,
and warming is set to continue. The Sixth
Assessment Report of the Intergovernmental Panel
Measurement and disclosure are on Climate Change concluded that further changes
unavoidable; using digital to create to the Earth’s systems are locked in, no matter how
cost and price transparency can much more warming takes place. What’s more,
have benefits multiple climate-modeling efforts based on
Financial institutions and governments are asking COP26 pledges suggest that continued warming
companies to disclose more information about their will raise temperatures to more than 1.5°C above
exposures to climate risks and their climate-action preindustrial levels.

1
Road Freight Zero: Pathways to faster adoption of zero-emission trucks, World Economic Forum, October 2021, weforum.org.
2
Francisco Betti, Enno de Boer, and Yves Giraud, “Lighthouses unlock sustainability through 4IR technologies,” September 27, 2021, McKinsey.com.

4 COP26 made net zero a core principle for business. Here’s how leaders can act
 The physical hazards posed by climate change
have manifest humanitarian impacts. For example,
in scenario-based analysis for Race to Resilience, Notwithstanding any debate about whether COP26
a campaign led by the UN High-Level Climate was a success, the general direction for business
Champions, McKinsey found that in a 2.0°C world, has been established. Momentum has shifted
roughly a billion more people would be exposed to toward net zero, providing businesses with a new
climate hazards than in a 1.5°C world.3 In a scenario organizing principle. The transition to net zero will be
where 1.5°C of warming occurs by 2030, almost complicated. The best leaders can hope for is that
half the world’s population could be exposed to a it will be relatively orderly, rather than punctuated
climate hazard related to heat stress, drought, flood, by sudden, unexpected shifts. And in any case, the
or water stress. And compared with high-income basis of competition will change as stakeholders
nations, lower-income countries have larger shares reward companies that exhibit high levels of
of the population that are likely to be exposed to at preparedness—not for sheer strategic uncertainty
least one climate hazard. but for the bounded volatility that the transition is
certain to bring.
Companies, too, could experience more frequent
interruptions as physical risks from climate hazards Courageous leadership will therefore help
increase. But by building greater resilience, they companies navigate the transition. Leaders will
can improve their ability to maintain business need to cut through the noise and articulate a
continuity—which can be a source of confidence, North Star for their company’s future, supported
not to mention competitive advantage. Indeed, by a detailed plan to get there. Focusing on the five
using the same warming scenario described above, fundamentals described in this article can help them
the McKinsey Global Institute estimated that achieve the clarity of thought that will be required to
downstream electronics companies could lose up plan effectively.
to a third of annual revenue if their supplies of chips
were disrupted for five months.4

3
“Protecting people from a changing climate: The case for resilience,” November 8, 2021, McKinsey.com.
4
“Could climate become the weak link in your supply chain?,” McKinsey Global Institute, August 6, 2020, McKinsey.com.

Harry Bowcott is a senior partner in McKinsey’s London office, Daniel Pacthod is a senior partner in the New York office, and
Dickon Pinner is a senior partner in the Bay Area office.

COP26 made net zero a core principle for business. Here’s how leaders can act 5
 21 December 2021 Global

EQUITIES Lithium Market Outlook

Lithium prices soared 1-4x in 2021 Demand growth offsets supply response
600%

500% Key points

400%
 Strong underlying demand for lithium, primarily from the electric vehicle
300% market has pushed spot lithium prices to record levels.
200%  We continue to expect prices to peak in mid-2022 but have upgraded our
100% peak spodumene assumption by ~100% to reflect the strength in prices.
0%  Our CY22E regional lithium prices rise 3-18% and we lift CY23-CY25E
prices by 12%-22% to reflect the higher peak.

Source: Bloomberg, Macquarie Research, December 2021 Event

• We are upgrading our lithium price outlook to reflect further tightening in
Spodumene prices have outperformed other supply/demand fundamentals and strength in spot prices, which have pushed
lithium prices in 2021
well ahead of our previous peak price assumptions.
Spodumene (US$/t) - CFR Spod / LCE
2,500 13.0% Spot price rise continues despite supply response
12.0%
2,000 11.0% • Supply side response fails to curb price rises: Lithium production rates
10.0%
1,500 9.0%
have increased over 2021, with solid increases from spodumene producers in
8.0% Western Australia and rising production from South America. However, the
1,000 7.0%
increase has failed to supress spot lithium prices.
6.0%
500 5.0%
• EV sales have remained strong through the 2HCY21: Macquarie’s Global
4.0%
0 3.0% EV tracker reported strong growth in EV sales with sequential increases in
battery electric vehicle sales in the US, China and Europe. November sales
Source: Bloomberg, Macquarie Research, December 2021 implied EV penetration rates of 28% for Europe, 20% in China and 5% in the
US with YTD rates of ~20%, ~15% and ~4% for Europe, China and the US.

Upgrading lithium price outlook

• Spodumene set to remain in short supply: Despite several new projects
securing funding, we do not see material volume from new spodumene
producers until CY24E. We now expect spodumene prices to remain elevated
compared to carbonate and lift our CY22E, CY23E and CY24E price forecasts
by 71%, 68% and 47%, respectively. We also adjust our long-term
spodumene/carbonate ratio, which drives a 7% lift in our longer-term price for
spodumene to US$910/t (real).

• Chinese prices approaching the peak: Domestic Chinese lithium carbonate

prices are trading at significant premiums to regional lithium carbonate prices.
We have upgraded our CY22E Chinese carbonate prices by 36-40% and lift
CY23-CY24E prices by 14-20%. We note that our 1HCY22E forecasts are 2-
3% above spot prices for carbonate and ~10% higher for hydroxide.
Analysts • Lag in regional prices reducing: Spot prices for key regional markets in
Macquarie Securities (Australia) Limited Asia, South America, North America, and Europe continue to lag movements
Hayden Bairstow +61 439 889 321
[email protected]
in Chinese domestic prices, although the time lag appears to be shortening.
We now expect the peak for regional lithium prices to occur in 3QCY22E, 3-6
Jon Scholtz +61 400 036 617 months later than the peak in Chinese prices.
[email protected]
• Peak prices expected to fall short of spot peak in China: We note that our
Andrew Bowler +61 448 433 736
[email protected] peak price assumptions for the key regional markets are expected to fall ~20%
short of the domestic Chinese lithium prices, largely due to the regional pricing
Austin Yun, CFA +61 457 429 116
[email protected] lag. Our base case assumes global lithium carbonate and hydroxide prices
become aligned by CY24E as spot price liquidity continues to improve.

Please refer to page 11 for important disclosures and analyst certification, or on our website
www.macquarie.com/research/disclosures.
Macquarie Research Lithium Market Outlook

Supply side response fails to curb price rises

• Lithium production rates have increased over 2021, with solid increases from spodumene producers in
Western Australia and rising production from South America. Both Albemarle (ALB US, Not Rated) and
SQM (SQM US, Not Rated) have increased volumes of brine while Greenbushes and Pilbara Minerals
(PLS AU, Outperform) have ramped up production over the course of the last year.

• We expect significant supply growth over the next 2-3 years, largely from the incumbent producers. ALB
is commissioning an expansion at its Salar de Atacama project in Chile while SQM has also guided to
increased volumes over the next two years. The ramp up of the Kemerton and Kwinana lithium
hydroxide plants over the next two years are expected to underpin strong volume growth at
Greenbushes.

Fig 1 Spodumene and brine supply has responded to rising Fig 2 We expect spodumene to dominate supply growth
prices since the beginning of 2020 (LCE Equ.) over the next five years (LCE Equ.)

160.0 Spodumene (kt) Brine (kt) 1,800.0 Spodumene (kt) Brine (kt)

140.0 1,600.0

1,400.0
120.0
1,200.0
100.0
1,000.0
80.0
800.0
60.0
600.0
40.0
400.0
20.0 200.0

0.0 0.0

Source: Company data, Macquarie Research, December 2021 Source: Company data, Macquarie Research, December 2021

EV sales have remained strong through the 2HCY21

• Macquarie’s Global EV tracker reported strong growth in EV sales with sequential increases in battery
electric vehicle sales in the US, China, and Europe. November sales implied EV penetration rates of
27.5% for Europe, 19.5% in China and 5.1% in the US with YTD rates of ~20%, ~15% and ~4% for
Europe, China and the US, respectively.

Fig 3 Global plug-in sales in key markets

Source: Autodata, CAAM, KBA, CCFA, OFV, Macquarie Research, December 2021

21 December 2021 2
Macquarie Research Lithium Market Outlook

Fig 4 Global electric vehicle sales market penetration assumptions

Source: Autodata, CAAM, KBA, CCFA, OFV, Macquarie Research, December 2021

• Our demand forecasts assume global EV market penetration rates rise to 26% by CY30E and 58% by
CY40E. We estimate current market penetration rates are 4% globally, well below the penetration rates
in Europe and China. Total global vehicle sales are estimated to have fallen to around 80m units in
CY20.

Fig 5 Global vehicle sales outlook Fig 6 Global BEV sales and penetration

Source: Company data, Macquarie Research, December 2021 Source: Company data, Macquarie Research, December 2021

Accelerated targets brighten the outlook

• Several key global automakers have accelerated targets to shift towards battery electric vehicles (BEV).
The most significant of these was Toyota, which lifted its 2030 BEV sales target from 2.0m units to 3.5m
units. Within this target, Toyota is expanding its battery capacity to 280GWh, up from 200GWh
previously, with its key Lexus brand expected to be full BEV by 2035.

Fig 7 Battery electric vehicle ambitions – 2030 targets

Source: Company data, Macquarie Research, December 2021

21 December 2021 3
Macquarie Research Lithium Market Outlook

Lithium market remains in deficit

• We estimate that the strong demand from the electric vehicle has more than offset the rise in
spodumene and brine supply, with the market swinging from a surplus in 2020 to a deficit in 2021. The
increased supply in 2022 should slightly loosen market fundamentals, although we expect deficits to
remain over the next year.

Fig 8 We believe the lithium market is now likely in a perpetual deficit

Lithium market Surplus/(Deficit) (kt LCE) Asia Lithium Carbonate (US$/t) Asia Lithium Hydroxide (US$/t)

100.0 30,000

0.0
25,000

(100.0)
20,000

(200.0)
15,000
(300.0)

10,000
(400.0)

5,000
(500.0)

(600.0) 0
CY20 CY21e CY22e CY23e CY24e CY25e CY26e CY27e CY28e CY29e CY30e

Source: Bloomberg, Company data, Macquarie Research, December 2021

• A widening deficit remains our base case in the medium term, with the speed at which new entrants can
enter the market presenting a key risk to our base case. In the longer term, the market deficit starts to
widen significantly from 2027E, suggesting that more new sources of supply will be required to meet the
shortfall.

Fig 9 Macquarie global lithium market supply/demand outlook

Y/E December CY20 CY21e CY22e CY23e CY24e CY25e CY26e CY27e CY28e CY29e CY30e

Supply (kt)
Spodumene 210.0 317.3 373.2 426.0 498.6 674.2 869.7 959.4 1,006.9 1,056.1 1,067.6
Brine /Clay 184.0 232.7 323.2 388.5 437.0 469.7 496.9 514.9 544.3 568.1 592.9
Recycling 0.0 0.0 0.0 0.0 0.0 0.0 26.0 42.0 58.0 74.0 90.0
Total Supply 393.9 550.0 696.4 814.5 935.6 1,143.9 1,392.6 1,516.3 1,609.2 1,698.2 1,750.5
Demand (kt)
Chemical/industrial 134.1 147.5 154.9 162.7 170.8 179.3 188.3 197.7 207.6 218.0 228.9
EV battery 126.2 295.3 395.7 518.3 658.3 822.9 1,012.1 1,214.6 1,433.2 1,648.2 1,730.6
Consumer battery 57.5 60.2 62.3 65.0 67.8 70.7 72.6 74.5 76.6 78.7 80.9
ESS (fixed) battery 6.9 45.7 66.6 80.8 95.8 109.7 129.1 145.2 161.3 177.4 193.5
Other 24.3 25.5 26.0 26.6 27.1 27.6 28.2 28.7 29.3 29.9 30.5
Total demand 349.0 574.3 705.5 853.4 1,019.8 1,210.3 1,430.3 1,660.7 1,907.9 2,152.1 2,264.3
Balance
Surplus/(Deficit) (kt) 45.0 (24.3) (9.1) (38.9) (84.2) (66.4) (37.7) (144.4) (298.8) (453.9) (513.8)
Source: Bloomberg, Company data, Macquarie Research, December 2021

21 December 2021 4
Macquarie Research Lithium Market Outlook

Spot prices continue to surge, particularly in China and spodumene

• Spot lithium carbonate prices in China have soared in 2HCY21. After a four-month period of
consolidation, which saw regional lithium carbonate prices catch up to Chinese prices, the spot China
lithium carbonate prices have more than doubled since the middle of the year. Regional prices have
also started to move higher but continue to lag the Chinese prices.

• Chinese spot lithium prices rose significantly in the 1HCY21 before stabilising around RMB80,000/t from
April – August. However, since then the rise in spot prices has been significant, moving beyond
RMB200,000/t for lithium carbonate prices. Current spot prices are RMB215,000/t for technical grade
carbonate and RMB235,500/t for batter grade lithium carbonate.

Fig 10 Chinese spot lithium prices have started to rise after Fig 11 Spodumene and Chinese lithium prices have
a four month consolidation period outperformed in CY21
Asia LCE (US$/t) US LCE (US$/t) Chile LCE (US$/t)
35,000 600%
Europe LCE (US$/t) China LCE (US$/t)

30,000 500%

25,000 400%

20,000 300%

15,000 200%

10,000 100%

5,000 0%

Source: Bloomberg, Macquarie Research, December 2021 Source: Bloomberg, Macquarie Research, December 2021

• Only spodumene prices have outperformed the Chinese domestic prices, rising nearly 500% in CY21,
driven largely by an emerging spot market for spodumene. We note that spot spodumene prices have
significantly outperformed regional lithium carbonate prices. Spodumene is now equivalent to 12% of
the Asia lithium carbonate price, compared to our long-term assumption of 7.5%

• Lithium hydroxide price performance in China have been mixed in 2021 compared to carbonate prices.
Earlier in the year, strong demand for LFP batteries saw lithium carbonate trade at a premium to
hydroxide. The hydroxide premium was re-established during the middle part of the year before a
discount to carbonate resumed in the past few months.

Fig 12 Hydroxide now at a discount to carbonate in China Fig 13 Spodumene price has outperformed carbonate

China LiOH (RMB/t) China LCE (RMB/t) 99.5% Spodumene (US$/t) Asia LCE (US$/t)
Hydroxide Premium (%) 2,500 25,000
250,000 160%

140% 2,000 20,000

200,000
120%
1,500 15,000
150,000 100%

80%
1,000 10,000
100,000 60%

40%
50,000 500 5,000
20%

0 0% 0 0

Source: Bloomberg, Macquarie Research, December 2021 Source: Bloomberg, Macquarie Research, December 2021

21 December 2021 5
Macquarie Research Lithium Market Outlook

Upgrading spodumene price outlook to a peak of US$2,500/t

• We are upgrading our spodumene price forecasts the reflect a combination of the tightening
supply/demand fundamentals and the emerging spot market, which could see sustained decoupling
from lithium carbonate prices compared to longer-term ratios as spot market volumes increase. Marking
our forecasts to market drives a 62% lift in our 4QCY21 assumption and we also upgrade our CY22E,
CY23E and CY24E spodumene prices by 71%, 68% and 47%, respectively.

• Our CY25E and CY26E prices rise 30% and 15%, respectively, largely due to the higher peak price and
expected delays as new entrants enter the market. Our longer-term price is upgraded 7% from
US$850/t to US$910/t as we continue to expect spodumene prices to trade above historical long-term
averages compared to regional lithium carbonate prices. We note that our long-term spodumene price
is equivalent to 7.0% of our Asia Lithium Carbonate prices.

• Several spodumene projects are now assessing the potential to be developed as fully integrated
operations, constructing lithium sulphate or lithium hydroxide conversion plants in conjunction with the
spodumene mine. This is likely to limit the amount of potential third-party volumes that could become
available, particularly in the short to medium term.

Fig 14 Upgrading price outlook for spodumene

Y/E December 4QCY21e CY22e CY23e CY24e CY25e CY26e Long-term

Old forecasts (US$/t) – CFR 1,140 1,385 1,155 1,048 995 940 850
New forecasts (US$/t) - CFR 1,845 2,363 1,940 1,540 1,295 1,078 910
Change 62% 71% 68% 47% 30% 15% 7%
Source: Bloomberg, Macquarie Research, December 2021

• The decoupling of spodumene compared to lithium carbonate as spot price volumes increase should
enable spodumene to hit a new quarterly average peak of US$2,500/t in 2QCY22E. We note that our
peak price assumption is lower than the recent third spot sale completed by PLS but in our view is more
reflective of average realised prices likely to be achieved over a three month period.

• Longer term, we maintain a relationship between lithium carbonate and spodumene but have increased
our ratio from 6.5% to 7.0%. Over the past two years, spodumene prices have traded on an average
ratio of 6-8% to China domestic prices but has risen from an average of 5% vs the Asia lithium
carbonate price to over 12% recently.

• We believe this partially reflects the lag that regional lithium carbonate prices see compared to Chinese
domestic prices. Our long-term regional lithium carbonate prices are in line with the Chinese domestic
prices after adjusting for VAT, hence our long-term spodumene ratio is 7.0% for both regional and
Chinese domestic carbonate prices.

Fig 15 We now expect spodumene prices to hit a new peak Fig 16 We expect spodumene prices to outperform
of US$2,500/t in mid-2022 carbonate prices over the next two years

Spodumene (US$/t) - Spot Spodumene (US$/t) - Macq forecast Spodumene / China LCE Spodumene / Asia LCE
3,000 14.0%

2,500 12.0%

10.0%
2,000
8.0%
1,500
6.0%
1,000
4.0%

500 2.0%

0 0.0%

Source: Bloomberg, Macquarie Research, December 2021 Source: Bloomberg, Macquarie Research, December 2021

21 December 2021 6
Macquarie Research Lithium Market Outlook

Regional prices have started to rise

• Regional lithium prices have historically lagged Chinese domestic prices for lithium carbonate. During
the middle of this year regional prices started to catch up to the Chinese domestic lithium price, which
had stabilised for 3-4 months.

• However, in the past few months Chinese domestic prices have significantly outperformed and are now
trading at over US$30,000/t (VAT adjusted). Regional Asia lithium carbonate prices have recently
started to respond, and are now trading just below US$20,000/t. Other regional prices have also started
to move higher with the normal 3-6 month lag.

Fig 17 Regional carbonate prices have lagged the China Fig 18 Asia prices have maintained a premium to other
carbonate price (VAT adjusted) regional prices
Asia LCE (US$/t) US LCE (US$/t) Chile LCE (US$/t) 100% US LCE (US$/t) Chile LCE (US$/t)
35,000
Europe LCE (US$/t) China LCE (US$/t) Europe LCE (US$/t) China LCE (US$/t)
80%
30,000
60%
25,000
40%

20,000 20%

15,000 0%

(20%)
10,000
(40%)
5,000
(60%)

Source: Bloomberg, Macquarie Research, December 2021 Source: Bloomberg, Macquarie Research, December 2021

• We have upgraded our short-term lithium prices to reflect the current strength in spot prices. Marking to
market spot prices drives upgrades of 9-35% for 4QCY21E, which translates to upgrades of 3-10% to
our CY21E annual price forecast. The stronger spot prices drive an 18% upgrade to our CY22E Asia
lithium carbonate price with other regional spot prices lagging hence is upgraded only 3-8%.

• In CY23E and CY24E, the continued emergence of a spot market is likely to see most lithium contracts
being priced on shorter term periods, which we expect will remove the variability between regional
prices over time.

• We have equalised our regional lithium carbonate prices from the end of CY24 as we believe the spot
market emergence will see regional prices trade broadly in line. We have not upgraded our long-term
lithium carbonate price for Asia but make modest adjustments to our long-term regional prices for North
America, South America, and Europe to bring them in line with our Asia price of US$13,000/t.

Fig 19 Upgrading regional lithium prices and equalising regional prices by the end of CY24
Y/E December 4QCY21e CY22e CY23e CY24e CY25e CY26e Long-term

Old forecasts (US$/t)

Asia Lithium Carbonate 13,500 18,500 17,750 16,125 15,250 14,500 13,000
North America Lithium Carbonate 13,370 18,315 17,575 15,965 15,100 14,360 12,900
South America Lithium Carbonate 12,150 17,388 17,395 15,803 14,945 14,210 12,700
Europe Lithium Carbonate 12,830 17,575 17,220 15,643 14,795 14,070 12,600
New forecasts (US$/t)
Asia Lithium Carbonate 18,164 21,875 21,250 19,250 17,250 15,375 13,000
North America Lithium Carbonate 15,594 18,933 19,750 19,150 17,250 15,375 13,000
South America Lithium Carbonate 13,219 17,988 19,750 19,150 17,250 15,375 13,000
Europe Lithium Carbonate 16,227 18,933 19,750 19,150 17,250 15,375 13,000
Change
Asia Lithium Carbonate 35% 18% 20% 19% 13% 6% 0%
North America Lithium Carbonate 17% 3% 12% 20% 14% 7% 1%
South America Lithium Carbonate 9% 3% 14% 21% 15% 8% 2%
Europe Lithium Carbonate 26% 8% 15% 22% 17% 9% 3%
Source: Bloomberg, Macquarie Research, December 2021

21 December 2021 7