Global Investment Committee Views & Valuations

Transcription

1 Global Investment Committee Views & Valuations December

2 Global Investment Committee Outlook European recession, but no global or US recession given ongoing central bank ease and US fiscal policy progress Earnings expectations to stabilize Slowing inflation in both developed and developing countries Global policy: challenged in developed economies, robust options in developing ones Modest US trade-weighted dollar strength; broad developed country currencies weak to developing country currencies, especially Asia For an in-depth explanation of our conclusions, please ask your Financial Advisor for the recent publication, Global Investment Committee Monthly Source: Morgan Stanley Smith Barney Global Investment Committee. Thomson Financial, DataStream. Data as of December

3 Tactical Asset Allocation Weightings Global Cash Global Bonds Short Duration Bonds Developed Sovereign Bonds Corporate and Securitized Bonds Inflation-Linked Securities High Yield Bonds Emerging Market Bonds Global Equities US Large Caps, US Growth, Emerging Markets Japan US Mid and Small Caps, Asia-Pacific ex Japan, Canada, and Europe Global Alternative/ Absolute Return Investments Managed Futures and Commodities REITS Hedge Funds, Real Estate, and Private Equity* Under Equal Over Source: Morgan Stanley Smith Barney Global Investment Committee. Data as of November 9, * Market weight only; no tactical weights The tactical asset allocation weightings above are based on the GIC Level 3 models (for investors with $20 million or more in Investable assets) 3

4 Tactical Asset Allocation Reasoning: Global Bonds Global Bonds Short Duration Government Relative Weight Within Bonds Underweight Underweight We recently reduced our exposure. With yields extremely low in many markets, relative performance will lag over any reasonable holding period except in an environment of negative returns on risk assets. The price of safety is very expensive in perceived safe-haven markets. We see better value elsewhere. Investment-Grade Corporates Inflation-Linked Securities High Yield Emerging Markets Overweight Underweight Underweight Overweight We recently increased our exposure. These securities offer an attractive combination of high credit quality and yields that are somewhat above those on safe-haven government bonds. In the US, securitized bonds are benefiting from the Federal Reserve s Quantitative Ease 3 (QE) purchases. With breakeven rates a bit above their long-term averages, we see better value elsewhere. We recently reduced our exposure. Yields are near record lows; further upside seems limited. The yield spread is above its long-term trend line. Source: Morgan Stanley Smith Barney Global Investment Committee. Data as of December 3,

5 Tactical Asset Allocation Reasoning: Global Equities and Global Alternative / Absolute Return Investments Global Equities Relative Weight Within Equities U.S. Overweight We recently increased our exposure. At the capitalization level, our preference is large caps; at the style level, our preference is growth against a backdrop of decelerating earnings growth. Relative-valuation readings also support this positioning. Developed Markets ex U.S. Underweight At the regional level, we recently increased our exposure to the Europe ex UK region, eliminating our underweight position. We are market weight Canada and the Asia Pacific ex Japan region (predominantly Australia) and underweight Japan, where challenges to economic growth appear to be structural as well as cyclical. Emerging Markets Overweight Policymakers focus has generally shifted away from containing inflation and toward supporting growth, and there is more scope for policy support than in the developed economies. Global Alternative / Absolute Return Investments Relative Weight Within Alternative Investments REITs Underweight Further upside seems limited against a backdrop of slowing global economic growth. For US real estate investment trusts, the dividend yield spread versus the S&P 500 dividend yield is well below its long-term average. Commodities Overweight We recently increased our exposure. Prior rounds of the Fed s QE have been associated with higher commodity prices, especially in the precious-metals sector. Still, much depends on China s economic performance. Managed Futures Overweight As a partial hedge against a less favorable outcome than our base case, we remain tactically overweight. This asset class often provides protection during extended periods of adverse financial market conditions. Source: Morgan Stanley Smith Barney Global Investment Committee. Data as of December 3,

6 Strategic and Intermediate-Term Return and Volatility Assumptions The intermediate-term return estimates have a seven-year horizon and assume that current market levels will converge to equilibrium conditions over this time period. The strategic assumptions are long-term estimates (20+ year horizon) of performance characteristics for various asset classes and sub-asset classes. They are predicated on the time-tested relationships between the fundamental drivers of the financial markets and the return potential of each asset class. For more information, please ask your Financial Advisor for our Strategic Asset Allocation: Return, Risk and Correlation Estimates paper. Annualized Global Cash Benchmark Index Intermediate- Term Return (%)E Annualized Strategic Return (%)E Volatility (%) Global Cash 90-Day U.S. Treasury Bill Global Bonds Short Duration BC Global Treasury (1 3 Year) Government BC Global Agg. Gvt/Gvt-Related BC Global Agg. Corporate / Securitized Corporate / Securitized High Yield BC Global High Yield Emerging Markets JPM EMBI Global Equities U.S. Russell Developed Markets ex U.S. MSCI World ex U.S. IMI Emerging Markets MSCI Emerging Markets IMI Global Alternative / Absolute Return Investments REITs FTSE EPRA / NAREIT Global Commodities DJ / UBS Commodity Inflation-Linked Securities BC Global Inflation-Linked Source: Morgan Stanley Smith Barney Investment Strategy as of December 31, Volatility estimates are based on data from January 1990 through December Note: Strategic and intermediate estimates are for illustrative purposes only and are not indicative of the future performance of any specific investment. 6

7 How to Read the Charts The following charts show relative historical valuations for each asset class for a given time period The vertical axis shows the range for that valuation metric over the given time period The horizontal axis shows the cumulative percent, or the percentage of time that the valuation metric has been equal to, or less than, the level on the vertical axis The black dot represents the respective valuation metric for each asset class on December 31, 2011, which is the date when our intermediate-term return estimates were calculated (see prior page) The green dot represents the current level of the respective valuation metric for each asset class Intermediate-term return is our 7-year return estimate for the relevant asset class The historical line shows the range of observations over the given period and their corresponding cumulative percent for each asset class 7

8 U.S. Cash Yields As of November 30, 2012, cash yields have been lower only 7% of the time since Yield (%) Historical Yields Yield as of December 31, 2011 Current Yield 9.0 Intermediate-Term Return Estimate: 0.7% % 20% 40% 60% 80% 100% Cumulative Percent Source: Morgan Stanley Smith Barney Global Investment Committee, FactSet. Data as of November 30, Note: The cash yields are not inflation-adjusted for this time period. The benchmark index we selected is 90-Day U.S. Treasury Bill. 8

9 Global Short Duration Bond Yields As of November 30, 2012, global short duration bond yields have been lower only 0.4% of the time since Yield (%) Historical Yields Yield as of December 31, 2011 Current Yield Intermediate-Term Return Estimate: 1.7% % 20% 40% 60% 80% 100% Cumulative Percent Source: Morgan Stanley Smith Barney Global Investment Committee, FactSet. Data as of November 30, Note: The benchmark index we selected is Barclays Capital Global Aggregate 1 3-Year (hedged). Citi WGBI 1 3-Year (hedged) is used prior to September 2000, due to lack of data availability. 9

10 Global Government Bond Yields As of November 30, 2012, global government bond yields have been lower only 0.4% of the time since Yield (%) Historical Yields Yield as of December 31, 2011 Intermediate-Term Return Estimate: 2.3% Current Yield % 20% 40% 60% 80% 100% Cumulative Percent Source: Morgan Stanley Smith Barney Global Investment Committee, FactSet. Data as of November 30, Note: The benchmark index we selected is Barclays Capital Global Treasury (hedged) 10

11 Global Investment Grade Corporate Bond Spreads As November 30, 2012, global investment grade corporate bond spreads have been wider 46% of the time since Spread (%) Historical Spreads Spread as of December 31, 2011 Current Spread Intermediate-Term Return Estimate: 4.8% % 20% 40% 60% 80% 100% Cumulative Percent (%) Source: Morgan Stanley Smith Barney Global Investment Committee, Yield Book. Data as of November 30, Note: This reflects the Corporate / Securitized Bonds asset class. The benchmark index we selected is Citi World Broad Investment Grade (BIG) Corporate (hedged). We determine the period under review based on data availability for the benchmark indices. In this case, the options adjusted spread for Citi World Broad Investment Grade Corporate (hedged) is not available prior to December

12 Global High Yield Bond Spreads As of November 30, 2012, global high yield bond spreads have been tighter 45% of the time since Spread (%) Historical Spreads Spread as of December 31, 2011 Current Spread Intermediate-Term Return Estimate: 6.7% % 20% 40% 60% 80% 100% Cumulative Percent (%) Source: Morgan Stanley Smith Barney Global Investment Committee, FactSet. Data as of November 30, Note: The benchmark index we selected is Barclays Capital Global High Yield (hedged). Citi High Yield Index (hedged) is used prior to August 2000, due to lack of data availability. We determine the period under review based on data availability for the benchmark indices. In this case, the options adjusted spread for Global Investment Grade Corporate Bonds (Citi WorldBIG Corporate) is not available prior to December 1998, and we use the same time frame here in order to compare bond spreads over a consistent time period. 12

13 Emerging Markets Bond Spreads As of November 30, 2012, emerging markets bond spreads have been tighter 23% of the time since 1998; however, spreads are experiencing a secular decline due to the rerating of the asset class. Spread (%) Historical Spreads Spread as of December 31, 2011 Current Spread Intermediate-Term Return Estimate: 6.6% % 20% 40% 60% 80% 100% Cumulative Percent (%) Source: Morgan Stanley Smith Barney Global Investment Committee, Yield Book. Data as of November 30, Note: The benchmark index we selected is Citi Emerging Market Sovereign Bond Index (ESBI). We determine the period under review based on data availability for the benchmark indices. In this case, the options adjusted spread for Global Investment Grade Corporate Bonds (Citi WorldBIG Corporate) is not available prior to December 1998, and we use the same time frame here in order to compare bond spreads over a consistent time period. 13

14 U.S. Equities Forward P/E Ratio As of November 30, 2012, U.S. equities forward P/E ratio has been lower only 17% of the time since Fwd P/E Historical Fwd P/E Fwd P/E as of December 31, 2011 Current Fwd P/E Intermediate-Term Return Estimate: 10.5% % 20% 40% 60% 80% 100% Cumulative Percent (%) Source: Morgan Stanley Smith Barney Global Investment Committee, FactSet, IBES, and DataStream. Data as of November 30, Note: The benchmark index we selected is Russell MSCI USA Index is used prior to January 2002, due to lack of data availability. 14

15 Developed Markets ex U.S. Equities Forward P/E Ratio As of November 30, 2012, developed markets ex U.S. equities forward P/E ratio has been lower only 10% of the time since Fwd P/E Historical Fwd P/E Fwd P/E as of December 31, 2011 Current Fwd P/E Intermediate-Term Return Estimate: 9.8% 0% 20% 40% 60% 80% 100% Cumulative Percent (%) Source: Morgan Stanley Smith Barney Global Investment Committee, IBES and DataStream. Data as of November 30, Note: The benchmark index we selected is MSCI World ex U.S. 15

16 Emerging Markets Equities Forward P/E Ratio As of November 30, 2012, emerging markets equities forward P/E ratio has been lower only 23% of the time since Fwd P/E Historical Fwd P/E Fwd P/E as of December 31, 2011 Current Fwd P/E Intermediate-Term Return Estimate: 15.0% % 20% 40% 60% 80% 100% Cumulative Percent (%) Source: Morgan Stanley Smith Barney Global Investment Committee, IBES and DataStream. Data as of November 30, Note: The benchmark index we selected is MSCI Emerging Markets. 16

17 REITs AFFO Yield Spreads As of December 7, 2012, REITs AFFO yield spreads over BBB corporate bonds have been tighter 65% of the time since Spread (%) Historical Spreads Spread as of December 31, 2011 Current Spread Intermediate-Term Return Estimate: 8.8% (1.0) (2.0) 0% 20% 40% 60% 80% 100% Cumulative Percent (%) Source: Morgan Stanley Smith Barney Global Investment Committee, Citi Research, FactSet. Data as of December 7, Note: REITs AFFO (adjusted funds from operations) is a measure of a REIT s residual cash flow after expenses and expenditures. The benchmark index we selected is the Citi Investment Research Hunter Express. We determine the period under review based on data availability for the benchmark indices. In this case, the inception date of the Citi Investment Research Hunter Express Index is March

18 U.S. 10-Year Inflation-Linked Securities Implied Inflation As of November 30, 2012, U.S. 10-year inflation-linked securities implied inflation has been lower 72% of the time since Historical Implied Inflation Implied Inflation (%) Implied Inflation as of December 31, 2011 Current Implied Inflation Intermediate-Term Return Estimate: 3.2% % 20% 40% 60% 80% 100% Cumulative Percent (%) Source: Morgan Stanley Smith Barney Global Investment Committee, FactSet. Data as of November 30, Note: Implied inflation is a measure of the market s expectation of future inflation. In the case of U.S. inflation-linked securities, it is calculated by comparing the yield of a nominal U.S. Treasury bond to the yield of a U.S. inflation-linked security. The benchmark indices we selected to calculate implied inflation are Federal Reserve Benchmark 10-Year Inflation-Indexed and Federal Reserve Constant Maturity 10-Year Yields. We determine the period under review based on data availability for the benchmark indices. In this case, data availability for the Federal Reserve Benchmark 10-Year Inflation-Indexed is January

19 Index Definitions 90-Day U.S. Treasury Bill Index: Short-term obligations issued by the United States government. Barclays Capital Global Aggregate 1 3 Year Index (hedged): This index tracks fixed-rate, short-term debt of investment-grade countries. Currency exposure is hedged to the U.S. dollar. Citi World Government Bond Index (WGBI) 1 3 Year (hedged): This index is composed of short-term sovereign debt with minimum ratings of Baa3/BBB-. Currency exposure is hedged to the U.S. dollar. Barclays Capital Global Treasury Index (hedged): This index provides a broad-based measure of the global sovereign debt markets. Currency exposure is hedged to the U.S. dollar. Citi World Broad Investment Grade (BIG) Corporate Index (hedged): This index comprises investment-grade securities with minimum ratings of Baa3/BBB-. The securities have a minimum maturity of one year and a fixed coupon. Currency exposure is hedged to the U.S. dollar. Barclays Capital Global High Yield Index (hedged): This index provides a broad-based measure of the global high yield fixed income markets. Currency exposure is hedged to the U.S. dollar. Citi High Yield Index (hedged): This index captures the performance of below-investment-grade debt issued by corporations domiciled in the U.S. or Canada, including cash-pay and deferred-interest securities. All the bonds are publicly placed, have a fixed coupon, and are nonconvertible. Currency exposure is hedged to the U.S. dollar. Citi Emerging Market Sovereign Bond Index (ESBI): This index includes Brady bonds and U.S.-dollar-denominated emerging market sovereign debt issued in the global, Yankee, and Eurodollar markets, excluding loans. Russell 3000 Index: This index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market. MSCI USA Index: This free-float adjusted capitalization-weighted index measures the equity market performance of companies domiciled in the United States. MSCI World ex U.S. Index: This free-float adjusted capitalization-weighted index measures the equity performance of companies throughout the world, excluding the U.S. MSCI Emerging Markets Index: This free-float adjusted capitalization-weighted index measures the equity market performance in the global emerging markets. Citi Investment Research Hunter Express: This index is a weighted average of the AFFO yields of REITs covered by Citi Investment Research. AFFO (adjusted funds from operations) is a measure of a REIT s residual cash flow after expenses and expenditures. Federal Reserve Benchmark 10-Year Inflation-Indexed: This index tracks the yields of U.S. inflation-indexed securities with a ten year maturity. The U.S. Treasury interpolates the yield at this constant maturity from the daily yield curve for Treasury inflation protected securities in the over-the-counter market. Federal Reserve Constant Maturity 10-Year Yields: This index tracks the yields of nominal U.S. Treasury bonds with a constant maturity of ten years. The U.S. Treasury interpolates the yield at this constant maturity from the daily yield curve for non-inflation-indexed Treasury securities. 19

20 Index Definitions Barclays Capital Global Aggregate Government/Government Related Bond Index (hedged): This index provides a broad-based measure of the global sovereign debt markets. Currency exposure is hedged to the US dollar. Barclays Capital Global Aggregate Corporate and Securitized Index (hedged): This index is a broad-based measure of the global investment-grade, fixed-rate corporate debt markets as well as the securitized component that includes mortgage-backed securities, asset-backed securities and commercial mortgage-backed securities. Currency exposure is hedged to the US dollar. JP Morgan Emerging Market Index (local currency, unhedged): This index tracks debt issued in local currencies by emerging market governments. FTSE EPRA/NAREIT Global Index: This index reflects general trends in real estate equities worldwide. Relevant real estate activities are defined as the ownership, disposure, and development of income-producing real estate. Dow Jones / UBS Commodity Index: A broad-based index of commodities futures contracts. Barclays Capital Universal Government Inflation-Linked Bond Index (unhedged) - This index combines the Barclays Capital World, Euro and Emerging Market government indices to measure the performance of the major developed and emerging government inflation-linked bond markets. 20

21 Disclosures This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This is not a research report and was not prepared by the Research Departments of Morgan Stanley & Co. LLC or Citigroup Global Markets Inc. The views and opinions contained in this material are those of the author(s) and may differ materially from the views and opinions of others at Morgan Stanley Smith Barney LLC or any of its affiliate companies. Past performance is not necessarily a guide to future performance. The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors. Morgan Stanley Smith Barney is involved in many businesses that may relate to companies, securities or instruments mentioned in this material. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security / instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or warranty with respect to the accuracy or completeness of this material. Morgan Stanley Smith Barney has no obligation to provide updated information on the securities / instruments mentioned herein. The securities / instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor s individual circumstances and objectives. Morgan Stanley Smith Barney recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities / instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors. Estimates of future performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Smith Barney does not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Smith Barney is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material. Morgan Stanley Smith Barney and its affiliates do not render advice on tax and tax accounting matters to clients. This material was not intended or written to be used, and it cannot be used or relied upon by any recipient, for any purpose, including the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Each client should consult his/her personal tax and/or legal advisor to learn about any potential tax or other implications that may result from acting on a particular recommendation. This material is primarily authored by, and reflects the opinions of, Morgan Stanley Smith Barney LLC, Member SIPC, as well as identified guest authors. Articles contributed by employees of Citigroup Global Markets Inc. Member SIPC or one of its affiliates are used under license from Citigroup Inc. International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies. Alternative investments which may be referenced in this report, including private equity funds, real estate funds, hedge funds, managed futures funds, and funds of hedge funds, private equity, and managed futures funds, are speculative and 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 and risks associated with the operations, personnel and processes of the advisor. 21

22 Disclosures (cont d) Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention. Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond s maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate. Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio. Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax (AMT). Typically, state tax-exemption applies if securities are issued within one s state of residence and, if applicable, local tax-exemption applies if securities are issued within one s city of residence. Treasury Inflation Protection Securities (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation by tracking the consumer price index (CPI). While the real rate of return is guaranteed, TIPS tend to offer a low return. Because the return of TIPS is linked to inflation, TIPS may significantly underperform vs. conventional U.S. Treasuries in times of low inflation. Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment. Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. Investing in smaller companies involves greater risks not associated with investing in more established companies, such as business risk, significant stock price fluctuations and illiquidity. Stocks of medium-sized companies entail special risks, such as limited product lines, markets, and financial resources, and greater market volatility than securities of larger, moreestablished companies. Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected. Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations. Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets. The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. The indices selected by Morgan Stanley Smith Barney to measure performance are representative of broad asset classes. Morgan Stanley Smith Barney retains the right to change representative indices at any time. REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited diversification and sensitivity to economic factors such as interest rate changes and market recessions. Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. 22

23 Disclosures (cont d) Principal is returned on a monthly basis over the life of a mortgage-backed security. Principal prepayment can significantly affect the monthly income stream and the maturity of any type of MBS, including standard MBS, CMOs and Lottery Bonds. Yields and average lives are estimated based on prepayment assumptions and are subject to change based on actual prepayment of the mortgages in the underlying pools. The level of predictability of an MBS/CMO s average life, and its market price, depends on the type of MBS/CMO class purchased and interest rate movements. In general, as interest rates fall, prepayment speeds are likely to increase, thus shortening the MBS/CMO s average life and likely causing its market price to rise. Conversely, as interest rates rise, prepayment speeds are likely to decrease, thus lengthening average life and likely causing the MBS/CMO s market price to fall. Some MBS/CMOs may have original issue discount (OID). OID occurs if the MBS/CMO s original issue price is below its stated redemption price at maturity, and results in imputed interest that must be reported annually for tax purposes, resulting in a tax liability even though interest was not received. Investors are urged to consult their tax advisors for more information. Hypothetical Performance General: Hypothetical performance should not be considered a guarantee of future performance or a guarantee of achieving overall financial objectives. Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets. Hypothetical performance results have inherent limitations. The past performance shown here is simulated performance based on benchmark indices, not investment results from an actual portfolio or actual trading. There can be large differences between hypothetical and actual performance results achieved by a particular asset allocation. Actual performance results of accounts vary due to, for example, market factors (such as liquidity) and client-specific factors (such as investment vehicle selection, timing of contributions and withdrawals, restrictions and rebalancing schedules). Clients would not necessarily have obtained the performance results shown here if they had invested in accordance with any GIC asset allocation, idea or strategy for the periods indicated. Despite the limitations of hypothetical performance, these hypothetical performance results may allow clients and Financial Advisors to obtain a sense of the risk / return trade-off of different asset allocation constructs. Indices used to calculate performance: The hypothetical performance results in this report are calculated using the returns of benchmark indices for the asset classes, and not the returns of securities, fund or other investment products. Indices are unmanaged. They do not reflect any management, custody, transaction or other expenses, and generally assume reinvestment of dividends, accrued income and capital gains. Past performance of indices does not guarantee future results. Investors cannot invest directly in an index. Performance of indices may be more or less volatile than any investment product. The risk of loss in value of a specific investment is not the same as the risk of loss in a broad market index. Therefore, the historical returns of an index will not be the same as the historical returns of a particular investment a client selects. Fees reduce the performance of actual accounts: None of the fees or other expenses (e.g. commissions, mark-ups, mark-downs, advisory fees) associated with actual trading or accounts are reflected in the GIC asset allocation strategy or ideas. Fees and/or expenses would apply to clients who invest in investments in an account based on these asset allocations, and would reduce clients returns. The impact of fees and/or expenses can be material. Investing in the market entails the risk of market volatility. The value of all types of securities may increase or decrease over varying time periods. This Analysis does not purport to recommend or implement an investment strategy. Financial forecasts, rates of return, risk, inflation, and other assumptions may be used as the basis for illustrations in this Analysis. They should not be considered a guarantee of future performance or a guarantee of achieving overall financial objectives. No Analysis has the ability to accurately predict the future, eliminate risk or guarantee investment results. As investment returns, inflation, taxes, and other economic conditions vary from the assumptions used in this Analysis, your actual results will vary (perhaps significantly) from those presented in this Analysis. The assumed return rates in this Analysis are not reflective of any specific investment and do not include any fees or expenses that may be incurred by investing in specific products. The actual returns of a specific investment may be more or less than the returns used in this Analysis. The return assumptions are based on historic rates of return of securities indices, which serve as proxies for the asset classes. Moreover, different forecasts may choose different indices as a proxy for the same asset class, thus influencing the return of the asset class. Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom. Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, sale, exercise of rights or performance of obligations under any securities / instruments transaction. 23

24 Disclosures (cont d) This material is disseminated in Australia to retail clients within the meaning of the Australian Corporations Act by Morgan Stanley Smith Barney Australia Pty Ltd (A.B.N , holder of Australian financial services license No ). Morgan Stanley Smith Barney is not incorporated under the People's Republic of China ("PRC") law and the research in relation to this report is conducted outside the PRC. This report will be distributed only upon request of a specific recipient. This report does not constitute an offer to sell or the solicitation of an offer to buy any securities in the PRC. PRC investors must have the relevant qualifications to invest in such securities and must be responsible for obtaining all relevant approvals, licenses, verifications and or registrations from PRC's relevant governmental authorities. Morgan Stanley Private Wealth Management Ltd, which is authorized and regulated by the Financial Services Authority, approves for the purpose of section 21 of the Financial Services and Markets Act 2000, content for distribution in the United Kingdom. Morgan Stanley Smith Barney is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. Morgan Stanley Smith Barney material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney Morgan Stanley Smith Barney LLC. Member SIPC. 24