WEEKLY GUIDANCE FROM OUR I NVESTMENT STRATEGY COMMITTEE. Jim Sweetman Senior Global Alternative Investment Strategist

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1 WEEKLY GUIDANCE FROM OUR I NVESTMENT STRATEGY COMMITTEE Jim Sweetman Senior Global Alternative Investment Strategist Asset Group Overviews Equities... 4 Fixed Income... 5 Real Assets... 6 Alternative Investments... 7 April 16, 2018 Why Alternatives Can Be Powerful Portfolio Diversifiers» Alternative investments have provided enhanced diversification benefits over the latest U.S. market cycle (three and five years). When added to equity portfolios in recent years, alternative investments have outperformed other equity diversifiers such as fixed income and commodities.» The first-quarter financial-market turmoil reversed the recent positive-performance trend for hedge funds. Yet, hedge funds outperformed U.S. equities, commodities, and fixed-income classes (broadly speaking) during the quarter. What it may mean for investors» As the U.S. economic expansion matures, we continue to see an improving environment for alternative investments, which may be better positioned to dampen volatility through short exposure and identify distinctive alpha-generation opportunities independent of broader equity directionality. Many who invested solely in the U.S. equity markets since the financial crisis saw their portfolios outperform more diversified portfolios. In fact, for the nine years since U.S. equity markets bottomed on March 9, 2009, the Dow Jones Industrial Average was up 287%, the S&P 500 Index had gained 312%, and the NASDAQ Composite Index had increased by 496% (through March 9, 2018). While diversification may have hampered an investor s absolute return since the financial crisis (assuming they invested 100% of their portfolio in U.S. equities), Wells Fargo Investment Institute (WFII) believes that allocating investments across broad asset classes is the blueprint to potentially deliver optimal risk-adjusted returns aligned with an investor s goals. An integral component of our asset allocation guidance is including alternative investments (along with equities, fixed income, and real assets). As many investors know, alternative investment strategies include hedge funds, private equity, private debt, managed futures, commodities and private real assets (including private real estate) and can help qualified investors potentially mitigate risk and pursue distinctive alpha-generating (excess returns) opportunities in their portfolios. Before we look ahead, let s review how alternative investments have performed in the latest market cycle. While many headlines would lead one to believe that alternative investments have underperformed, we find that not to be the case. As Chart 1 shows, comparing a hypothetical portfolio of 100% U.S. large-cap equities with three hypothetical portfolios with a 60% equity allocation and a % allocation to different 2018 Wells Fargo Investment Institute. All rights reserved. Page 1 of 9

2 Why Alternatives Can Be Powerful Portfolio Diversifiers asset classes (alternative investments, fixed income and commodities) for the past three years ( ) yields compelling results in favor of alternative investments. Chart 1 shows that a 60/ portfolio including equities and alternative investments outperformed similar portfolios holding equities and fixed income, and equities and commodities. Chart 1. Cumulative three-year portfolio returns through December 31, 2017 Source: MPI Stylus. April 11, For illustrative purposes only. Equities are represented by the S&P 500 Index. Fixed income is represented by the Bloomberg Barclays U.S. Aggregate Index. Commodities are represented by the Bloomberg Barclays Commodity Index. Alternatives are represented by an equal allocation to the HFRI Fund Weighted Index, Cambridge Private Equity Index, and NCREIF Property Index. The performance of the 60/ that includes alternative investments becomes more compelling over the past five years ( ). This supports our view that alternative investments have actively participated on the upside while offering diversification benefits and downside protection over this period. Chart 2. Cumulative five-year portfolio returns through December 31, 2017 Source: MPI Stylus. April 11, For illustrative purposes only. Equities are represented by the S&P 500 Index. Fixed income is represented by the Bloomberg Barclays U.S. Aggregate Index. Commodities are represented by the Bloomberg Barclays Commodity Index. Alternatives are represented by an equal allocation to the HFRI Fund Weighted Index, Cambridge Private Equity Index, and NCREIF Property Index Wells Fargo Investment Institute. All rights reserved. Page 2 of 9

3 Why Alternatives Can Be Powerful Portfolio Diversifiers As the U.S. economic expansion matures, we continue to see an improving environment for alternative investments. Late-cycle dynamics such as rising interest rates, rising inflation, and increasing volatility illicit the need for selectivity within an investor s equity and credit exposure. We believe that these dynamics favor beta-mitigating strategies, such as the Equity Hedge and Relative Value strategies. During the first quarter, we saw 10-year Treasury note yields rise, a continued increase in forwardlooking inflation expectations, and 23 daily moves of +/- 1% for the S&P 500 Index (versus only 8 last year). Table 1 shows that, during the first quarter, alternative investments (specifically, hedge funds) provided downside protection and outperformed equities, fixed income and commodities allowing investors to benefit from the diversification benefits of this asset class while also enhancing returns. Table 1. First-quarter performance of hedge funds versus equities, fixed income, and commodities Source: Bloomberg, April 11, Past performance is no guarantee of future results. An index is unmanaged and not available for direct investment. In the current market environment, we remain constructive on less-liquid strategies across the private capital spectrum, specifically private equity buyouts with a focus on small- and mid-sized U.S. companies and buyouts focused on companies in developed European countries. For example, the U.S. small- and mid-sized buyout strategy offers investors the combination of a larger investable universe (more than 115,000 private companies, compared to 4,0 public companies), less public information, significant scope for improvement in EBITDA (earnings before interest, taxes, depreciation, and amortization), and generally lower valuations that we believe will translate into higher expected returns. We also favor private debt strategies that can capitalize on illiquidity to deliver cash yields and total returns at a premium to those available in the public or broadly syndicated debt markets. Given the underlying illiquidity, managers of private debt strategies are able to be patient (avoid being a forced buyer or seller), to originate credit, and to often react quickly in times of market dislocations Wells Fargo Investment Institute. All rights reserved. Page 3 of 9

4 EQUITIES Stuart Freeman, CFA Co-Head of Global Equity Strategy U.S. Small Cap Equities U.S. Large Cap Equities U.S. Mid Cap Equities Developed Market Ex-U.S. Equities Emerging Market Equities Strong cyclical stock outperformance a harbinger of continuing expansion The stock market is well-known as a leading indicator for the economy. Its cycle tends to precede that of broad economic data. Over the past year, cyclical market sectors have meaningfully outperformed defensive ones by roughly 19 percentage points (see chart below). This would tend to be favorable for the U.S. economy and stocks. Historical data from 1984 to today suggests that when cyclical stocks outperform defensive equities by percentage points over a year, the S&P 500 Index has increased by an average of 10.7% during the following year (ranging between -25.3% and +28.1%). In only 2 of 22 instances (9% of the time) did a recession take hold over the next 12 months. Those two instances were tied to the 2001 recession. Overall, however, yearover-year gross domestic product (GDP) growth in the following year was 0.5%-2.2% in 4 instances (the 0.5% year included two quarters of the 2001 recession), 2.2%-3.9% in 10 instances, and 3.9%-5.6% in 8 of the 22 cases. The average year-over-year GDP growth was 3.3%. One chart below plots the ranges of S&P 500 Index performance following similar cyclical-market behavior. In 14 of 22 instances, the S&P 500 Index increased between 8.7% and 25.7%. While every cycle has its own idiosyncrasies, history points toward continuing expansion ahead.» Recent outperformance of cyclical stocks over defensive ones signals more expansion and additional market upside ahead.» We favor the cyclical Consumer Discretionary, Financials, and Industrial sectors (as well as one rather defensive sector Health Care). Cyclical versus defensive outperformance Twelve-month forward S&P 500 (Percentage points) Index change (%)* Percentage outperformance/underperformance of cyclical versus defensive stocks Cyclical Defensive -80 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 Sources: S&P Capital IQ, Wells Fargo Investment Institute. April 11, * Following percentage point cyclical outperformance Wells Fargo Investment Institute. All rights reserved. Page 4 of 9

5 FIXED INCOME Brian Rehling, CFA Co-Head of Global Fixed Income Strategy Bank-loan yields are increasing U.S. Taxable Investment Grade Fixed Income U.S. Short Term Taxable Fixed Income U.S. Intermediate Term Taxable Fixed Income Most U.S. Long Term Taxable Fixed Income High Yield Taxable Fixed Income Developed Market Ex.-U.S. Fixed Income Emerging Market Fixed Income Bank-loan investments provide investors with a variable income stream, based on an interest rate that floats over a benchmark, such as the three-month London Interbank Offered Rate (LIBOR). Bank loan floating-rate debt is generally below-investmentgrade. While bank loans can help reduce a portfolio s interest-rate sensitivity, they also can increase exposure to credit risk. The average price of the S&P/LSTA Leveraged Loan Index was approximately $98.63 last week. As bank loans are callable at or above par, there appears to be limited priceappreciation upside for bank loans. Instead, investors should expect coupon-like returns, barring any significant credit events or economic downturns. The yield of the S&P/LSTA Leveraged Loan Index recently stood at 5.12%, the highest level in more than 20 months. We expect bank-loan yields to continue increasing as the Federal Reserve (Fed) raises rates. Mind the risk While the added yield potential may be attractive, we are concerned that some investors may not fully appreciate the risks entailed with bank-loan investments in the current market environment. We recommend that investors: Avoid the reach for yield: Investors who use bank loans to enhance portfolio yield need to understand that significant credit risk can be present in these investments. Watch for weakening covenants: Issuers have been able to offer new loans with fewer investor protections. These covenant-light deals could prove problematic should default trends begin to reverse and move higher. Recognize the asymmetric risk/return profile: The prices of bank loans are unlikely to move much above 100. Yet, significant downside risks remain. We currently have an unfavorable high-yield debt position. Within the high yield class, we are neutral on bank loans. Generally speaking, bank loans can provide investors with an opportunity to invest in a different asset class one that can add diversification to a high-yield-debt allocation.» We see limited upside in bank-loan prices returns are likely to be commensurate with current yield (absent a risk-off event).» A more aggressive Fed than expected could lead to higher current bank-loan yields, while a more dovish Fed could disappoint bank-loan investors.» Bank loans can help to diversify a high-yield portfolio Wells Fargo Investment Institute. All rights reserved. Page 5 of 9

6 REAL ASSETS Austin Pickle, CFA Investment Strategy Analyst Commodities Private Real Estate Public Real Estate It is easier to build strong children than to repair broken men. --Frederick Douglass Full throttle oil bullishness likely will shift oil prices into reverse Oil has been stuck in neutral since its January peak. A number of headlines recently have influenced returns: record U.S. oil production, trade-war concerns, fears of reinstated Iranian sanctions, Middle East tensions, and the perceived resolve of OPEC (Organization of the Petroleum Exporting Countries) to continue its oil-production quota. In this noisy environment, the smart money (money managers) is nearly as bullish on oil as it has ever been. Only 7% of all money-manager oil futures positions are held short (bets of falling oil prices). In other words, 93% of the smart money is betting on oil prices to rise. Typically, the smart money does a good job at guessing the direction of oil prices, reducing short positions as oil prices rise and adding short positions as oil prices fall. But at extreme levels, it often has paid to go against the smart money consensus. Today s 7% short level is at a near-historic extreme. The chart below illustrates this relationship. West Texas Intermediate (WTI) oil prices are shown in the top panel and the percentage of money managers short crude-oil futures is shown in the bottom panel. Today s extreme short positioning by money managers is consistent with past peaks in WTI prices, as shown by the yellow box highlights. With the smart money essentially all-in on oil prices, we believe that oil s next move is likely lower (barring fears of a significant supply disruption, such as escalating Middle East tensions).» Money managers are extremely bullish on oil (as measured by the percentage of short positions).» Today s extreme short positioning is consistent with past peaks in oil prices. Oil prices versus managed money short positions Oil price (U.S. dollars/barrel) Managed money shorts (%) WTI oil price Managed money shorts (as % of all managed money open interest) Oil price (U.S. dollars/barrel) Managed money shorts (%) Sources: Bloomberg, U.S. Commodity Futures Trading Commission (CFTC), Wells Fargo Investment Institute. Data: December 1, 2015 April 6, Top panel daily data. Bottom panel weekly data Wells Fargo Investment Institute. All rights reserved. Page 6 of 9

7 ALTERNATIVE INVESTMENTS Justin Lenarcic Global Alternative Investment Strategist Private Equity Hedge Funds-Macro Hedge Funds-Event Driven Hedge Funds-Relative Value Most Hedge Funds-Equity Hedge Early signs of tighter lending conditions for lower-rated borrowers Financing (lending) conditions will become an increasingly important topic as the credit and economic cycles mature. While the recent increase in the LIBOR-OIS spread may illicit fears of financial stress, much of this spread widening can be attributed to an increase in short-dated U.S. Treasury issuance and repatriation of foreign earnings. 1 In short, financing conditions currently remain loose (accommodative). Yet, we believe that it is safe to expect tighter lending conditions over the next 24 to 48 months driven by normalization of interest rates and by the need for banks and other financial institutions to improve the credit quality of their balance sheets late in the economic cycle. One metric we use to gauge lending conditions is the percentage of CCC-rated issuers that are able to access primary markets (banks) for loans. This is then related to the default cycle, as defaults tend to accelerate roughly two years after primary lending slows. We believe that the most recent default cycle, which began in late 2014 and peaked in March 2017, ended prematurely due to historically low interest rates and the ability of challenged borrowers to amend and extend their debt. Yet, the next default cycle may be more normal, and we already are seeing early signs of reduced financing access for CCC-rated borrowers. These developments will be important for Long/Short Credit, Distressed Debt, and Private Debt strategies in the coming quarters.» While financial conditions generally remain loose, or accommodative, we are seeing early signs of tightening for lower-rated borrowers.» Typically, a reduction in access to bank lending is a precursor to a default cycle. It also provides an attractive opportunity for Relative Value, Event Driven, and Private Debt strategies. As lending conditions tighten, defaults may increase Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not suitable for all investors and are only open to accredited or qualified investors within the meaning of U.S. securities laws. Percentage accessing primary market Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-12 Mar-16 Mar Default rate CCC issuers able to access primary market (%, 12 month average) High Yield credit default rate (reverse) Source: Bank of America, April LIBOR is the London Interbank Offered Rate (the reported average rate that banks charge each other for short-term funding). OIS is the Overnight Indexed Swap rate, and it closely resembles the fed funds rate Wells Fargo Investment Institute. All rights reserved. Page 7 of 9

8 Risks Considerations Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions. Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is suitable only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing. Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund. HFRI Strategy Definitions HFRI Fund Weighted Composite Index. A global, equal-weighted index of over 2,000 single-manager funds that report to HFR Database. Constituent funds report monthly net-of-all-fees performance in U.S. Dollars and have a minimum of $50 Million under management or a 12- month track record of active performance. The HFRI Fund Weighted Composite Index does not include Funds of Hedge Funds. HFRI Equity Hedge (Total) Index. Equity Hedge: Investment Managers who maintain positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. EH managers would typically maintain at least 50% exposure to, and may in some cases be entirely invested in, equities, both long and short. HFRI Event Driven (Total) Index. Maintains positions in companies currently or prospectively involved in corporate transactions of a wide variety including mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated and frequently involve additional derivative securities. Exposure includes a combination of sensitivities to equity markets, credit markets and idiosyncratic, company-specific developments. Investment theses are typically predicated on fundamental (as opposed to quantitative) characteristics, with the realization of the thesis predicated on a specific development exogenous to the existing capital structure. HFRI Macro (Total) Index. Encompass a broad range of strategies predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard-currency, and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top-down and bottom-up theses, quantitative and fundamental approaches and longand short-term holding periods. Although some strategies employ RV techniques, Macro strategies are distinct from RV strategies in that the primary investment thesis is predicated on predicted or future movements in the underlying instruments rather than on realization of a valuation discrepancy between securities. In a similar way, while both Macro and equity hedge managers may hold equity securities, the overriding investment thesis is predicated on the impact movements in underlying macroeconomic variables may have on security prices, as opposed to EH, in which the fundamental characteristics on the company are the most significant are integral to investment thesis. HFRI Relative Value (Total) Index. Strategy is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Managers employ a variety of fundamental and quantitative techniques to establish investment theses, and security types range broadly across equity, fixed income, derivative or other security types. Fixed income strategies are typically quantitatively driven to measure the existing relationship between instruments and, in some cases, identify attractive positions in which the risk adjusted spread between these 2018 Wells Fargo Investment Institute. All rights reserved. Page 8 of 9

9 instruments represents an attractive opportunity for the investment manager. RV position may be involved in corporate transactions also, but as opposed to ED exposures, the investment thesis is predicated on realization of a pricing discrepancy between related securities, as opposed to the outcome of the corporate transaction. Additional Index Definitions Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market. Bloomberg Barclays US Aggregate 10+ Year Bond Index is composed of the Bloomberg Barclays US Government/Credit Index and the Bloomberg Barclays US Mortgage-Backed Securities Index, and includes Treasury issues, agency issues, corporate bond issues, and mortgage-backed securities with maturities of 10 years or more. Bloomberg Barclays US Treasury Index includes public obligations of the U.S. Treasury with a remaining maturity of one year or more. Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Bloomberg Commodity Index is a broadly diversified index comprised of 22 exchange-traded futures on physical commodities and represents 20 commodities weighted to account for economic significance and market liquidity Cambridge Private Equity Index is an end-to-end calculation based on data compiled from 1,152 U.S. private equity funds (buyout, growth equity, private equity energy and mezzanine funds), including fully liquidated partnerships, formed between 1986 and MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of 23 developed markets including the United States. NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market. NCREIF Property Index is a quarterly time series composite total rate of return measure of investment performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only. Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 00 Index, which represents approximately 8% of the total market capitalization of the Russell 00 Index. S&P 500 Index is a capitalization-weighted index calculated on a total return basis with dividends reinvested. The index includes 500 widely held U.S. market industrial, utility, transportation and financial companies. The S&P/LSTA (Loan Syndications and Trading Association) U.S. Leveraged Loan 100 Index measures the performance of 100 large loan facilities meeting specific inclusion criteria. The index is modified market value-weighted and is fully rebalanced semi-annually. In addition, the index is reviewed weekly to reflect pay-downs and ensure that it continually maintains 100 loan facilities. Index returns and other statistics are calculated daily as described in S&P Dow Jones Indices Fixed Income Mathematics Methodology An index is unmanaged and not available for direct investment. General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR Wells Fargo Investment Institute. All rights reserved. Page 9 of 9