RETHINKING RISK & RETURNS 2017 MID-YEAR INVESTMENT OUTLOOK

RETHINKING RISK & RETURNS 2017 MID-YEAR INVESTMENT OUTLOOK BlackRock Investment Institute Kate Moore Chief Equity Strategist July 2017 FOR INSTITUTIONAL AND PROFESSIONAL INVESTOR USE ONLY NOT FOR PUBLIC DISTRIBUTION MKTG0717A-225066-668835

Key themes for the second half of the year SUSTAINED EXPANSION We see the world in a synchronized and sustained economic expansion that is slower than previous cycles RETHINKING RETURNS Structurally lower growth and interest rates mean that past valuations may not be a good guide to the future RETHINKING RISK Low market volatility is not a warning sign itself, but likely a normal feature of the benign economic and financial backdrop For illustrative purpose only. 2

Shifting from acceleration to sustained, above-trend expansion G7 BlackRock Macro GPS suggests upside surprises BlackRock Macro GPS for G7 nations, 2015-2017 A synchronised expansion Change in BlackRock GPS for G7 nations, 2017 YTD REAL GDP GROWTH (%) 2.5 2.0 Global economy transitioning from rapid acceleration & catch-up to a phase of sustained expansion Strength has broadened from the US to the rest of the world CHANGE (PERCENTAGE POINTS) 0.5 0.4 0.3 0.2 0.1 0-0.1-0.2 1.5 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17-0.3 Italy US UK France Japan Canada Germany GPS 12m Forward Consensus Sources: BlackRock Investment Institute with data from Consensus Economics, June 2017. Notes: The GPS (blue line) shows where the 12-month consensus GDP forecast may stand in three months time. Consensus forecasts are measured by Consensus Economics. G7 country components are weighted by country GDP. The green line shows the current 12-month economic consensus forecast for G7 economies. The GPS builds on existing nowcasting models that exploit the information from dozens of macroeconomic indicators to forecast GDP growth including realized activity, employment, sentiment and survey data. It draws on a wider set of information sources by incorporating proprietary big data insights from BlackRock s Scientific Active Equity team. These include micro insights, such as consumer behavior captured through internet searches, and macro insights such as country business sentiment measured through the text-mining of corporate managers conference calls. Other big data inputs include online job postings, inflation chatter, satellite images, e-invoicing and traffic patterns. 3

Bond supply is coming back The removal of central bank accommodation threatens to cause a spike in the term premium G3 net debt issuance excluding central bank purchases, 2007-2017 3 1.5 PROJECTION NET ISSUANCE ($ TRILLION) 2 1 0 1.0 0.5 0.0 TERM PREMIUM (%) -1 2007 2009 2011 2013 2015 2017 2019 U.S. Eurozone Japan Term premium -0.5 Sources: BlackRock Investment Institute with data from Thomson Reuters and Morgan Stanley, June 2017. Notes: The bars show net government bond issuance for the US, eurozone and Japan, net of central bank purchases via quantitative easing programs, projections for 2018/19 are from Morgan Stanley. The term premium is based on BlackRock calculations with 2018/19 based on a model that explains the term premium factoring in the global savings glut and IMF projections of the current account. 4

Equity valuations appear less stretched in a cross-asset framework Equities may be cheaper than they look U.S. equity valuation, 1988-2017 100% 80% CHEAP PERCENTILE 60% 40% 20% EXPENSIVE 0% 1988 1992 1996 2000 2004 2008 2012 2016 Earnings yield Earnings yield spread to real bond yields Sources: BlackRock Investment Institute with data from MSCI and Thomson Reuters, June 2017. Notes: U.S. equities are represented by the MSCI U.S. Equity Index. Absolute valuation is based on earnings yield (the inverse of 12-month forward price/earnings ratio). Valuation relative to bonds is based on earnings yield minus U.S. real bond yield (U.S. 10-year Treasury yield minus U.S. core CPI inflation). Valuations are shown in percentiles, for example the current U.S. absolute earnings yield is in the 18th percentile. This means the earnings yield has only been equal or lower than the current value for 18% of the time since 1988. 5

Low volatility regimes are normal, not exceptional Macro & Markets Exhibit Persistent Volatility Regimes S&P 500 realised monthly volatility, 1950-2017 30% SINCE 1872, WE HAVE BEEN IN A LOW-VOLATILITY REGIME OVER 80% OF THE TIME 20% VOLATILITY 10% 0% 1950 1960 1970 1980 1990 2000 2010 Volatility Sources: BlackRock Investment Institute with data from Robert Shiller, June 2017. Notes: Volatility is calculated as the annualized standard deviation of monthly changes in the S&P 500 index over a rolling twelve-month period. We calculate two historic states or regimes for volatility, a high-volatility regime and a low- volatility regime; the line plots the average level of volatility during each regime based on data from 1871 to 2017. The estimate of historic regime is based on an expectation-maximization algorithm using a Markov-Switching regression model. Regime 6

Equity vulnerability is reduced when earnings drive market returns An improving global earnings outlook Not exactly a comeback Equity earnings momentum, 2011-2017 World technology stocks price and earnings, 1996-2017 50 40 30 STRONG REVISIONS IN EVERY MAJOR REGION 600 500 Tech bubble ANNUAL CHANGE (%) 20 10 0-10 -20 INDEX (1996=100) 400 300 200 100-30 11 12 13 14 15 16 17 U.S. Eurozone Emerging Markets Japan 0 96 00 04 08 12 16 Price Index 12m Forward Earnings Sources: BlackRock Investment Institute with data from MSCI and Thomson Reuters, June 2017. Notes: The lines represent the 12-month change in analysts 12-month forward earnings estimates. Equity markets are represented by the respective MSCI index for that region. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute with data from MSCI and Thomson Reuters, June 2017. Notes: The lines are based on the MSCI All-Country World Technology Index. Earnings represented by the aggregate 12-month forward earnings estimate. It is not possible to invest directly in an index. Past performance is no guarantee of future results. 7

European equities are now consensus but not crowded The European recovery has been broad-based Eurozone composite PMI and % of Eurozone countries with PMI above the historic mean, 2005-2017 Finally a turn in earnings European equity earnings per share estimates, 2010-2017 65 120 115 PMI INDEX 60 55 50 45 40 35 2005 2007 2009 2011 2013 2015 2017 % of countries with PMI > historic mean (RHS) 100 80 60 40 20 0 % OF COUNTRIES ANNUAL EARNINGS PER SHARE ESTIMATE (in ) 110 105 100 95 90 2011 2017 85 2012 2014 2010 2015 80 2013 2016 75 09 10 11 12 13 14 15 16 17 Eurozone Composite PMI Sources: BlackRock Investment Institute with data from Thomson Reuters, June 2017. Notes: The green area represents the percentage of Eurozone countries where the current PMI level is above the historic mean. The blue line represents the Eurozone Composite PMI. Sources: BlackRock Investment Institute with data from MSCI and Thomson Reuters, July 2017. Note: The lines show the yearly path of expected annual earnings for firms in the MSCI Europe Index based on an aggregate of analyst earnings estimates. 8

A sustained recovery in EM earnings should drive greater flows Earnings upswing provides market footing EM vs. DM relative earnings and relative equity market performance, 2007-2017 150 140 EM equity inflows have resumed, but remain well below previous highs Cumulative flows in to EM equity funds, 2007-2017 200 2017 IS THE FIRST POSITIVE YEAR OF EM EQUITY FLOWS SINCE THE TAPER TANTRUM INDEX 130 120 110 100 EM EARNINGS ARE OUTPACING DM USD BILLION 150 100 50 TAPER TANTRUM 90 0 80 70 '07 '09 '11 '13 '15 '17-50 '07 '09 '11 '13 '15 '17 Relative Earnings (12m trailing) Relative Performance Sources: BlackRock Investment Institute with data from Thomson Reuters, 23 rd June 2017. Notes: Purple line represents the 12m trailing earnings per share of the MSCI Emerging Markets Index relative to the MSCI World Index. Green line represents the relative performance of the same indices. It is not possible to invest directly in an index. Past performance is no guarantee of future results. Sources: BlackRock Investment Institute with data from EPFR, 21 st June 2017. Notes: The line represents cumulative flows in to EM equity funds including mutual funds and exchange-traded products. Taper tantrum refers to May 21 st 2013, when Fed Reserve Chairman Ben Bernanke first mentioned the possibility of tapering the Federal Reserve s monetary expansion. 9

We believe the Value and Momentum factors can co-exist Gradually rising yields should support Value Relative performance of global Value and U.S. 10 year Treasury yield, 2016-2017 Stable economic backdrop is positive for Momentum Relative performance of Momentum, 1992-2017 104 102 2.75 2.50 250 GLOBAL FINANCIAL CRISIS INDEX 100 98 96 94 2.25 2.00 1.75 1.50 YIELD (%) RELATIVE PERFORMANCE 200 150 100 RECESSION TECH BUBBLE DRAWDOWNS OF GREATER THAN 10% 92 1.25 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Jul 17 Value vs. World U.S. 10 Year Yield (RHS) Sources: BlackRock Investment Institute with data from Thomson Reuters, July 2017. Notes: The orange line represents the relative performance of MSCI World Enhanced Value vs. MSCI World, rebased to 100 at the start of 2016. It is not possible to invest directly in an index. Past performance is no guarantee of future results. 50 1992 1997 2002 2007 2012 2017 Sources: BlackRock Investment Institute with data from MSCI, June 2017. Notes: The line shows the performance of the MSCI ACWI Momentum Index relative to the MSCI ACWI Index, by dividing the former by the latter and rebasing to 100 at the start of 2012. Areas in blue show periods of drawdowns, or peak-to-trough declines, of more than 10%, based on weekly data. 10

Central bank policy mistake is a key risk for the second half of 2017 The Fed is paving the way for a post-qe world Projected composition of Federal Reserve balance sheet As technical limits loom on the horizon, the ECB is being forced to deviate away from the capital key Deviation from capital key of ECB PSPP QE purchases, 2015-2017 5 PROJECTION 3% LIABILITIES ($ TRILLION) 4 3 2 1 % DEVIATION AWAY FROM CAPITAL KEY 2% 1% 0% -1% 0 2005 2010 2015 2020 2025-2% Portugal Germany Spain Italy France Currency in circulation Reserve balance Other May 2015 May 2016 May 2017 Sources: BlackRock Investment Institute with data from the Federal Reserve, New York Fed, June 2017. Notes: Our projections follow the New York Fed s liability-related assumptions: a minimum size of $500 billion reserve balance and that currency in circulation grows in line with nominal GDP forecasts. Reserve balances decline from $1.86 trillion to $500 billion from now to 2020 then grow in line with nominal GDP. Forward looking estimates may not come to pass. Sources: BlackRock Investment Institute with data from the ECB, June 2017. Notes: The bars represent the % deviation away from the capital key in monthly asset purchases as part of the ECB s public sector purchase programme. The capital key is a structure that the ECB use to determine the proportion of bonds bought from each country, based on relative country GDP. 11

Politics not quite as usual U.S. Key Fed meetings 19-20 Sept., 12-13 Dec Debt ceiling and 2018 budget Summer/autumn 2017 Potential tax reform 2017-2018 Mexico Start of NAFTA renegotiation Summer 2017 North Korea Missile and nuclear tests China 19 th Party Congress Autumn 2017 Attempts to rein in credit South China Sea disputes ME European Union Key ECB meetings 20 July, 7 Sept., 26 Oct. 14 Dec. Source: BlackRock Investment Institute, July 2017. Germany Federal elections 24 Sept. Italy General elections before 20 May 2018 UK Brexit negotiations Ongoing Middle East Syria and Yemen proxy wars Saudi economic transformation Future of Iran nuclear deal 12

Take risk where you are being rewarded Risk and reward BlackRock five-year asset return assumptions in USD, Q2 2017 8% ANNUALIZED RETURN ASSUMPTION 6% 4% 2% 0% Global ex- U.S. gov. bonds U.S. cash U.S. Treasuries U.S. investment grade U.S. TIPS U.S. high yield EM debt ($) US large cap US small cap Global ex- US large cap EM equity Sources: BlackRock Investment Institute and BlackRock Solutions, May 2017. Notes: This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Representative indexes used are: Barclays Global Aggregate Treasury Index ex U.S. (Global ex-u.s. gov. bonds), Citigroup 3-Month Treasury Bill Index (U.S. cash), Barclays Government Index (U.S. Treasuries), Barclays U.S. Credit Index (U.S. investment grade), Barclays U.S. Government Inflation-Linked Bond Index (U.S. TIPS), JP Morgan EMBI Global Diversified Index, (EM debt $), Barclays U.S. High Yield Index (U.S. high yield), MSCI USA Index (U.S. large cap), MSCI USA Small Cap Index (U.S. small cap), MSCI World ex USA Index (Global ex-us large cap) and MSCI Emerging Markets Index (EM equity). Indexes are unmanaged and used for illustrative purposes only. They are not intended to be indicative of any fund or strategy's performance. It is not possible to invest directly in an index. 13

BII Market views over a three-month time horizon Equities Positive on momentum and value stocks in a sustained expansion Like EM, Japan and Europe as global growth picks up Neutral on U.S. stocks Like U.S. investment grade credit Fixed Income Commodities / FX Neutral on EMD and Asia fixed income Reflationary outlook challenges U.S. government bonds, prefer TIPS. Improving growth and tight valuations leave us negative on European sovereigns and credit Oil prices rangebound around current levels, as supply / demand rebalancing is delayed U.S. dollar to strengthen moderately in the medium term Source: BlackRock. As of July 2017. Subject to change. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular. 14

Disclaimers This material is prepared by BlackRock and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of July 2017 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain forward-looking information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. This material is issued for Institutional Investors only (or professional/wholesale investors as such term may apply in local jurisdictions) and does not constitute investment advice or an offer or solicitation to purchase or sell in any securities, BlackRock funds or any investment strategy nor shall any securities be offered or sold to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. BlackRock Capital Market Assumptions This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class assumptions are passive, and do not consider the impact of active management. All estimates in this document are in U.S. dollar terms unless noted otherwise. Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations to all the asset classes and strategies. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, or tax advice. The outputs of the assumptions are provided for illustration purposes only and are subject to significant limitations. Expected return estimates are subject to uncertainty and error. Expected returns for each asset class can be conditional on economic scenarios; in the event a particular scenario comes to pass, actual returns could be significantly higher or lower than forecasted. Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making an investment decision. The model cannot account for the impact that economic, market, and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact future returns. BlackRock 5-year asset return and long-term volatility assumptions Five-year and long-term equilibrium annualised return assumptions are in geometric terms. Return assumptions are total nominal returns. Return assumptions for all asset classes are shown in unhedged terms, with the exception of global ex-us treasuries. We use long-term volatility assumptions. We break down each asset class into factor exposures and analyse those factors' historical volatilities and correlations over the past 15 years. We combine the historical volatilities with the current factor makeup of each asset class to arrive at our forward-looking assumptions. This approach takes into account how asset classes evolve over time. Example: Some fixed income indices are of shorter or longer duration than they were in the past. Our forward-looking assumptions reflect these changes, whereas a volatility calculation based only on historical monthly index returns would fail to capture the shifts. We have created BlackRock proxies to represent asset classes where historical data is either lacking or of poor quality. Expected return estimates are subject to uncertainty and error. Expected returns for each asset class can be conditional on economic scenarios; in the event a particular scenario comes to pass, actual returns could be significantly higher or lower than forecasted. The geometric return, sometimes called the time-weighted rate of return, takes into account the effects of compounding over the investment period. The arithmetic return can be thought of as a simple average calculated by taking the individual annual returns divided by the number of years in the investment period. Index returns are for illustrative purposes only and do not represent any actual fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. 15

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