EFTA01089678

UBS CIO WM Global Investment Office CIO monthly video For smartphone users: scan the code with an app like "scan" UBS CIO Monthly Extended November 2012 Published This report has been prepared by UBS AG. Please see important disclaimers and disclosures at the end of the document. Past performance is no indication of future performance. 25 October 2012 The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication. EFTA01089678 Table of Contents Section 1 Base slides 2 Section 2 Asset class views 11 2.A Equities 12 2.B Fixed income 22 2.0 Foreign exchange 29 2.D NTAC: Commodities, Listed real estate, Hedge funds and Private equity 33 EFTA01089679 Section 1 Base slides *UBS EFTA01089680 Summary • Economy "Global growth Global growth is showing broad-based signs of improvement, supported by decisive is showing monetary policy from the world's major central banks. In the US, the housing market recovery continues and the labor market remains on a modest uptrend. This has helped broad-based improve the sentiment of US consumers, and consumption remains the most important contributor to US GDP growth. Growth has also begun to pick up in key areas of the signs of emerging markets, including China and Brazil. While the Eurozone economy remains weak, we expect Q3 2012 to mark the bottom, and that growth will begin to get "less bad" from improvement." Q4 2012. • Equities Equity markets have been supported by central bank action and the recent improvements in economic data. Our preferred markets remain the US and Emerging Markets (EM). Investor funds have started to flow back into EM, as economic data is improving and inflation remains under control. Canada and Australia remain our least favored regions due to falling earnings. • Fixed Income US high yield bonds remain supported by strong corporate fundamentals, modest economic growth, and the broad demand for yield-generating assets. Given this, we see potential for further spread tightening. Meanwhile, benchmark rates are expected to rise gradually on better economic data, while short rates remain ultra-low. While investment grade corporate bond spreads are approximately fair value, we continue to view their absolute yields as attractive. • Commodities We keep a neutral stance on commodities. Increased global liquidity has pushed prices up over the last few months, however, for a more sustained price increase we likely need to see further evidence of an acceleration in global growth. • Foreign Exchange We remain underweight the Japanese yen. The Japanese economy continues to weaken against its peers, leading to rising pressure for the Bank of Japan to engage in further quantitative easing. We have closed our preference for the Canadian dollar following its recent strength, and therefore close our offsetting short CHF position. UBS 3 Please see important disclaimer and disclosures at the end of the document. EFTA01089681 Cross-asset preferences Most preferred Least preferred Portfolio weights • US • Canada Commodities Liquidity • Western winners from EM • Australia Real Estate 5% 10% High Grade 5% Bonds growth Hedge Funds Private Equity 7% Equities • High quality dividend yields 10% Inv Grade Corporates • Event-driven and relative value Bonds Equities USA hedge funds 10% 9% High Yield Bonds • Natural gas growth gainers 6% Emerging Market; Bonds • US high yield • Developed market Equities 3% Equities Other • Global investment grade credit government bonds Europe 21% EmMa Equities 6% 6% Fixed income • EM corporate bonds • Event-driven and relative value Note: Portfolio weights are for an advisory hedge funds client with a "EUR moderate" profile. For portfolio weights related to other risk profiles please contact your client advisor. • GBP • JPY • Emerging markets (7I) Foreign exchange Commodities $ Recent upgrades y Recent downgrades UBS Please see important disclaimer and disclosures at the end of the document. EFTA01089682 Recommended tactical asset allocation Tactical asset allocation deviations from benchmark* Currency allocation underweight neutral overweight underweight neutral overweight Cash USD Equities total EUR US Eurozone GBP vl a UK JPY = W a Japan CHF EM SEK Other NOK Bonds total CAD Government bonds N c Corporate bonds (IG) NZD o co High yield bonds AUD EM bonds (USD) ■ new old Commodities total N Precious metals * Please note that the bar charts show total portfolio preferences and thus can ao be interpreted as the recommended deviation from the relevant portfolio -0 Energy o benchmark for any given asset class and sub asset class. E Base metals o The UBS Investment House view is largely reflected in the majority of UBS L.) Agricultural Discretionary Mandates and forms the basis of UBS Advisory Mandates. Note Listed Real Estate that the implementation in Discretionary or Advisory Mandates might slightly deviate from the "unconstrained' asset allocation shown above, depending on ■ new old benchmarks, currency positions and for other implementation considerations. Source: UBS CIO WM Global Investment Office - as of 25.10.2012 UBS Please see important disclaimer and disclosures at the end of the document. EFTA01089683 Preferred themes • High quality dividend yields (sourced from existing European • Government bond alternatives (sourced from government bonds - and UK equities) CIO UW) High quality companies with geographically diversified business Developed world government bonds offer a comparatively small cushion models that pay sustainable dividends offer an attractive income against future interest rate hikes and many face increasing credit risk. We stream in a low yield world. Historically, dividends have made a expect selected bonds of supranational or national agencies, sub-national substantial contribution to total returns, and we expect this to remain governments, multinational corporates, and covered bonds to outperform the case in the current environment. government bonds. We recommend switching out of government bonds into these alternatives. • Western winners from emerging market growth (sourced from existing equity holdings) • US high yield corporate bonds (sourced from government bonds — Emerging economies continue to grow faster than developed CIO UW) economies. With little need to deleverage and repair balance sheets, Positive economic growth, robust corporate earnings and healthy balance Asian economies are also well positioned to continue to outpace their sheets provide support to US high yield corporate bonds. Current yield Western peers in the years ahead. We have identified companies from spreads of 540 basis points still price in a more dire economic outcome a variety of sectors in Europe, the US and Japan which have significant than we expect. Historically, US high yield bonds have delivered similar exposure to the rapidly growing emerging regions. We believe a returns as US equities with lower volatility. We continue to believe that diversified portfolio of these companies will reward investors seeking US high yield corporate bonds represent a more favorable risk/return to profit from the robust demand growth in emerging economies. potential than equities and expect mid single digit returns over the next 6 months. Senior loans are exposed to similar positive fundamentals, and • Natural gas growth gainers (sourced from existing equity offer an attractive, floating rate alternative to US high yield. holdings) Natural gas is a relatively clean source of energy, and we think it will • The place to be in Hedge Funds benefit from continued substitution for other energy sources over the Growth in most developed markets remains muted. In this environment, long term. We have examined the dynamics of the global market and less directional hedge fund strategies, such as relative value and event the various components of the gas value chain, and identified the driven, should offer above average returns. areas we see as the most significant beneficiaries currently. These • EM currencies: An underappreciated asset class (sourced from include producers in Europe and Asia, suppliers of infrastructure, government bonds - CIO UW) services and related machinery, and Master Limited Partnerships (MLPs) The currencies of emerging countries, collectively as an asset class and in the US, that offer both attractive yields and growth. measured using total returns (i.e. including interest received), have the • EM corporates: a growing asset class (sourced from global potential to contribute positively to the longer-term returns of a well- government bonds - CIO UW) diversified portfolio. We believe that this is especially relevant now that Given our relatively constructive current view on risk, we regard EM the developed world is settling into an extended period of very low corporate debt as more attractive than EM sovereign debt due to its interest rates. higher overall yield. Over a 6-month horizon, we expect EM corporate bonds to outperform US Treasuries and deliver total returns of close to 4%. = New theme UBS 6 Please see important disclaimer and disclosures at the end of the document. EFTA01089684 Global economic outlook - Summary Key questions Global growth expected to be around 3% in • What are the prospects for the global economy in 4Q 2012 and 1Q 2013? 2012 and 2013 • What are the risks that the US economic recovery will falter in the near term? • When is the European economy likely to emerge from contraction? 00si GOP rowth • What is the near-term outlook for the Chinese economy? 20n 2011F 2013E 2011 2012F 2013E Anialkas US 1.a 2.1 1_3 3.1 2.1 1.7 Canada 2.0 2.0 1_3 2.9 2.0 23 Waal 2.7 IS 03 6.5 5.4 63 CIO View (Probability: 75%) Sluggish expansion Asla/PactfIc Aryan MASSY 09 2.1 23 33 2.0 12 03 3.0 00 1.7 0.3 23 • Global economic activity has shown signs of improvement over the last month - albeit from a low base. Importantly, Chna 9.3 7.5 72 5.4 25 16 nth) 65 5.5 6.5 60 7.5 7.0 the .IPM global composite PMI (a survey measuring economic activity) rose significantly to 52.5 in September from 50.9 (wog. EurOZOOe 1.5 .0.1 0.2 2.7 2.1 1.9 in August. The increase was driven by improvements in both manufacturing and service sector activity. Thus, the GOMW9 3.1 0.9 1.1 25 1.7 1.5 Force 1.7 02 01 2.1 2.0 1.3 global manufacturing PMI rose marginally to 48.9 from 48.1, while the services PMI jumped two index points to 54. nor 0.5 -2.1 42 29 33 2.7 • Geographically, improvements were concentrated in the emerging markets and the US. Indeed, we think that Span UK OA 0.9 •1a .0-3 1.0 3.1 AS 25 2.7 2.7 2.3 downside risks in the US have diminished lately and we expect the moderate recovery to continue ahead. Chinese data Sxtualvd 1.9 1.1 La 0.2 0.5 1.2 RUSS. 0.3 3.11 3.7 05 5.1 &II are still mixed, but we think that an improvement in the economic momentum is in the cards in 4Q. In the EMU and World 3.2 2.7 3.1 3.9 2.9 3.0 UK, recent PMI surveys deteriorated but we still expect the EMU to improve gradually in coming quarters. Overall, we expect the moderate improvement in global economic activity to continue ahead. A key driver here is the latest wave Source: UBS CO, as of 24 October 2012 of ultra-expansionary monetary policy. Downside risks have diminished somewhat in recent months. We expect Greece In developing the CIO economic forecasts, CIO economists to stay in the euro this year and sign a new memorandum in November. In the US modest fiscal tightening is expected worked in collaboration with economists employed by UBS with the Fed mitigating downside growth risks. The risk of an idiosyncratic slowdown in Asia has declined as the latest Investment Research. Forecasts and estimates are current Chinese data confirms that the economy has bottomed." only as of the date of this publication and may change • Global consumer price inflation peaked in summer 2011 and has since fallen gradually. Base effects and rising without notice. commodity prices since June may push up the global headline rate of inflation in coming months. 76 Positive scenario (Probability: 10%•) Services and manufacturing diverging Return to long-term trend • The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity. (Global PMis, 3-month moving averages) • Growth in Western Europe turns decisively positive by early 2013 and the US economy grows above trend. 65 & Negative scenario (Probability: 1S%*) Recession 60 • There are three key downside risks to the global economy: 1) a significant escalation of the Eurozone debt crisis; 2) a 55 sharp fiscal contraction in the US, and 3) a sharp deceleration of the Chinese economy. Each of these risks could so precipitate a significant downturn of the global economy. 45 —Manufacturing —Services 40 — Composite — No-change line Key dates TBA Troika report on Greece 35 2 Nov Nonfarm payrolls and unemployment rate for October 08 09 10 11 12 6 Nov US presidential and congressional elections Source: Bloomberg, UBS CIO, as of September 2012 8 Nov The 18th National Congress of the Communist Party of China Note: Past performance is not an indication of future returns. 22-23 Nov European Council •Scenario probabilities are based on qualitative assessment. UBS For further information please contact CIO economist Dirk Faltin, and CIO economist Ricardo Garcia, 7 Please see important disclaimer and disclosures at the end of the document. EFTA01089685 Key financial market driver 1- Eurozone crisis Key questions Purchasing managers indices point to • What do we expect from the economy and EC8 policy? ongoing contraction in 3Q • Can Spain and Italy continue to tap the primary market if they ask for a support program? • How much more support will Greece receive and will it be able to stay in the Eurozone next year? 65 60 CO View (Probability: 70%*) Austerity and weak growth 55 50 • We think the Eurozone economy troughed in 3Q. We expect flattish growth in 4Q 2012 and 1Q 2013 (in line with 45 consensus). Beyond this, uncertainties regarding the debt crisis and continuing fiscal austerity efforts will likely keep 40 the pace of recovery subdued. The ECB is still in easing mode but after announcing a conditional bond purchasing 35 program, it would take a marked worsening of the debt crisis and/or a worsening of economic data to trigger any 30 further policy action. 25 • There is political pressure on Spain to apply for official financial support (OMT by the ECB and direct support from 07 08 09 10 11 12 the EFSF/ESM). However, the government may hesitate until market pressure rises and/or clear political benefits are on — Manufacturing —Services offer. We think that Italy will have to apply for an aid package similar to Spain's. We see a high probability of Spain —Composite — No-change line being downgraded to junk by at least one rating agency. Source: Bloomberg, UBS, as of October 2012 • OMT bond purchases in the secondary market will focus on maturities of up to three years and countries will be expected to maintain their funding profiles by also issuing longer-dated bonds. Hence, longer yields should stay elevated as bondholders remain concerned about countries' ability and willingness to implement necessary reforms, and about the de-facto subordination to ECB holdings and official loans. The central banking supervision at the ECB is Yield of Spanish and Italian 10-year bonds unlikely to be ready by January 2013, meaning that direct bank recapitalization through the ESM remains unavailable. over German Bunds (in bps) • We think Greece will not exit the euro in 2012 but will sign a new memorandum by November, although further delay is possible. We think that Greece's failure to meet targets may trigger a cut-off from funding by early 2013 and 700 a possible gradual exit later. Portugal and Ireland should remain on track with their bailout packages, Cyprus will 600 likely get a new package and Slovenia may ask for help soon. 500 $ Positive scenario (Probability: 15%•) Return to macro stability • Bond yields are contained as peripheral countries' budgets stay on track and economic activity recovers faster than 400 expected. Greece complies with the new austerity plans and market confidence is restored. 300 N Negative scenario (Probability: 15%*) Major shock • Major shocks include Spain and Italy being fully cut off from bond markets, i.e. requiring all new funding through 200 EFSF/ESM/IMF loans, with European rescue funds only able to cover them until the end of 2013; resistance from core 100 countries against the ECB program and further support; a Portuguese default; a Greek euro exit before the end of 2012; or a major external shock. 0 03.2011 0612011 092011 122011 03/2012 062012 09/2012 Key dates —Italy —Spain TBD Troika report on Greece 8 Nov ECB press conference Source: UBS, Bloomberg, as of 16 October 2012 12 Nov Eurogroup meeting Note: Past performance is not an indication of future returns. 15 Nov Eurozone GDP 3Q: first estimate • Scenario probabilities are based on qualitative assessment. 22 Nov Eurozone composite purchasing managers index 22-23 Nov European Council UBS For further information please contact CIO analyst Thomas Wacker, CIO economist Ricardo Garcia, and Please see important disclaimer and disclosures at the end of the document. EFTA01089686 Key financial market driver 2 - US economic outlook Key questions US growth to pick up throughout 2013 • Is the nascent growth recovery sustainable? Will the Fed stimulus boost growth? US real GDP and its components, quarter-over-quarter • How will the election result change fiscal policy deliberations? annualized in % • Can politicians find an agreement to avoid a sharp fiscal contraction in early 2013 (i.e. the "fiscal cliff')? 8% grqamutikeed CCO View (Probability: 70%*) Moderate expansion 4% • The economy stays on a moderate growth path but the unemployment rate comes down only very gradually - the 2% September report exaggerated the pace of improvement. Core personal consumption expenditure (PCE) inflation stays 096 -2% 11J- slightly below or close to the Federal Reserve's target of 2%. UBS forecasts real GDP growth of 2.0% in 3Q 2012 (consensus: 1.8%) and 1.6% in 4Q 2012 (consensus: 1.9%). The Fed has added considerable stimulus: it extended -6% Operation Twist and its interest rate forward guidance, indicated that it will stay highly accommodative even after the 8% recovery strengthens, launched an open-ended agency mortgage-backed securities (MBS) purchase program of USD 10% 12% 40bn per month, and shows a strong easing bias tied to the state of the labor market. The Fed actions effectively QI QI QI Q1 QI Q1 01 Q1 mitigate downside growth risks, but they are unlikely to dramatically boost growth. 2006 2007 2008 2009 2010 2011 2012 2013 • In the elections, Republicans will likely lose seats in the House on a net basis but retain a majority; we expect them Consumption 0Cormierciel real estate imestment • Capitalexpemitures 0Residential investment to be even with Democrats in the Senate. Obama will likely retain the White House. Such an electoral outcome would Inventories Net Exports • Gerrerivrent — Real GDP (gAi ant1":0940 prolong the existing gridlock between Republicans and Democrats. • Due to the ongoing political gridlock, we expect modest fiscal tightening. The government will likely let Source: Thomson Datastream, UBS, as of 15 October 2012 unemployment benefits phase out and payroll tax cuts expire, but postpone income tax hikes and sequester spending cuts. Such a decision would lower the federal deficit by 0.7% of GDP, with a likely lower real GDP growth impact as households could buffer the income loss with lower savings. Budget impact of US fiscal cliff in 2013 Cumulative budget effects of fiscal cliff components, in % of 71 Positive scenario (Probability: 10%*) Strong expansion UBS estimate of 2013 GDP • Propelled by expansive monetary policy and a fading Eurozone crisis, growth accelerates persistently above 3.0%. This leads to higher inflation and the Fed responds by halting QE3 and raising rates sooner. • The better economic outlook raises the odds of an Obama reelection and makes it harder for Republicans to gain seats in Congress. Faster-rising tax collection and a Democratic stronghold leads to some tax hikes and limited spending cuts. Fiscal policy tightens by about 1.2% of GDP in 2013. Negative scenario (Probability: 20%*) Growth recession • US fiscal deleveraging and an escalating Eurozone crisis weigh on the cyclical recovery. Falling profit margins weigh on business capital expenditures. Real GDP growth deteriorates much further. The Fed massively purchases agency MBS and Treasuries under its QE3 program. $ e $ .$5 ‘tb e t • The debt limit is reached earlier and the Treasury runs out of money before year-end. Political gridlock becomes c seif e ,c,* 4p.c.F.s4` elit i .1 xpe- dysfunctional, thus sending the country over the 'fiscal cliff," with fiscal policy tightening by e o- USD 607 billion (32% of UBS estimate of 2013 GDP) in 2013. The US credit rating is downgraded. i Fat * A .) Key dates Note: AMT = Alternative Minimum Tax, ACA = Affordable Care 30 Oct Conference Board consumer confidence Act 1 Nov ISM manufacturing purchasing managers index for October Source: CBO, UBS, as of 9 October 2012 2 Nov Nonfarm payrolls and unemployment rate for October " Scenario probabilities are based on qualitative assessment. 6 Nov US presidential and Congressional elections Note: Past performance is not an indication of future returns. UBS For further information please contact US economist Thomas Berner, 9 Please see important disclaimer and disclosures at the end of the document. EFTA01089687 Key financial market driver 3 - China growth outlook Key questions Nascent rebound in domestic commodity • What are the drivers for a modest sequential growth recovery? prices • What is our policy expectation? • How strongly will the recently announced infrastructure projects boost growth? CIO View (Probability: 70%*) Stabilization in economic momentum • We continue to expect a sequential recovery in the growth momentum in the current quarter. Inventory reductions should be less of a drag on growth and the government is rolling out more investment plans. At the same time, political uncertainty should diminish after the power handover in November. We think that real GDP will grow 7% y/y in 4Q (consensus: 7.7%) before improving mildly to 7.3% in 1Q 2013 (consensus: 7.9%). • Indicators measuring inventory levels have fallen recently, showing that the destocking cycle is well advanced. In addition, domestic prices for some major raw materials appear to have bottomed out, which should support a mild rebound in production activity in the coming months. However, this may not be sustainable without a genuine recovery in final demand. • While the government has recently announced trillions of infrastructure investment projects, the spending will span Atte-10 Oen10 Aott11 Oct.1t AD8.12 Oet.12 several years and the source of funding remains unclear. In addition, real estate investment growth is likely to stabilize —Ste* —Cement —Coal but not rebound strongly in the months ahead. We therefore do not expect a sharp rise in investment growth. Fiscal Source: CEIC, Wind, UBS, as of 15 October 2012 support measures should help to stabilize economic growth, but are unlikely to result in a strong growth boost. • The 18th National Congress of the Communist Party of China will be held on 8 November, which is exactly the same date as in the previous leadership handover in 2002. With the transition of the senior Communist Party leadership Investment staying supportive to growth taking place in this meeting, political uncertainties should be reduced. Execution of policy easing measures could improve, although a substantial new stimulus is unlikely in the near term. In terms of monetary policy, we do not 60 expect any interest rate cut for the rest of the year, but a reserve requirement cut is still possible to manage liquidity. 50 Growth rate lac. ley 3foiriai 71 Positive scenario (Probability: 20%*) Higher-than-expected growth 40 • Chinese GDP grows above 7.7% in 2012. This would require more effective fiscal and monetary policy support from the government and possibly also a fast improvement in the Eurozone debt crisis. 30 Negative scenario (Probability: 10%*) Hard landing 20 • Chinese GDP grows below 6%, i.e. a hard landing of the economy. This could be triggered by a global financial crisis/recession, causing a slump in Chinese exports, or domestic policy staying adrift during the leadership transition 10 period. Other risks include a sharp movement in residential property prices, or a surge in inflation that forces the PBoC 0 to significantly tighten monetary policy. (10) Key dates 2006 2007 2006 2009 2010 2011 2012 1 Nov Manufacturing purchasing managers index (October) — Infrastructure —Real estate development 8 Nov The 18th National Congress of the Communist Party of China — Manufacturing 9 Nov Consumer price inflation, industrial production, fixed-asset investment (October) 10-15 Nov New bank lending, M2 (October) Source: Bloomberg, UBS, as of 15 October 2012 Note: Past performance is not an indication of future returns. " Scenario probabilities are based on qualitative assessment. UBS For further information please contact 00 analyst Gary Tsang, Glenda Yu, S Patrick Ho, 10 Please see important disclaimer and disclosures at the end of the document. EFTA01089688 Section 2 Asset class views *LBS EFTA01089689 Section 2.A Asset class views Equities UBS EFTA01089690 Equities overview Global equity markets - Key points Preferences (6 months) • We keep an overall neutral allocation to equities (see summary on slide 3). underweght neutral Prenseght • We keep our preference for US equities. Resilient company earnings still speak for an overweight quit. LOW stance. Continued economic growth should underpin earnings also in 2013. USA • We keep our neutral stance on Eurozone equities. Value is attractive compared to global equities. - Canada However, due to the recession in several countries the earnings dynamics remains weak. In addition, uncertainty as to when and under what conditions Spain will sign a memorandum of understanding keeps EMU us from taking a more positive stance. UK • We have an overweight position in EM equities. Monetary easing as well as fiscal stimulus in key I Switzerland countries, coupled with relatively attractive valuations, are supporting factors. Economic activity is likely to Sweden improve gradually over the coming quarters, supporting company earnings. • We keep our negative stance on Canadian equities. Corporate earnings continue to decline, showing Australia a weak development relative to the global trend. In addition, valuation is not compelling. Hong Kong • We are cautious on Australian equities. Realized earnings continue to come down for the market. a Japan • We are neutral on Swiss equities. Companies show solid earnings growth, which is expected to hold up Singapore better than in other regions. Although the Swiss franc is still overvalued, the weakening to the USD and related currencies since this summer provides additional earnings support. 3 Global EM H • We keep our neutral view on UK equities. In the UK the earnings dynamics lags behind other markets. ■ new old Also, the recent strengthening in the pound is a drag for earnings measured in local currency terms. Note: Preference in hedged terms (en/. currencies) undeMtght neutral overweight Global equity sectors - Key points • We keep our overweight in Consumer Staples. Among the defensives it offers good earnings growth Consumer Discretionary prospects due to its geographically diversified revenue generation. Consumer Staples • We reiterate our preference for global IT due to a superior growth outlook and as we are in the Energy seasonally strong second half year. With healthy balance sheets and good cash flows, sector valuation is in line with the overall market, while we believe it deserves a larger premium. Financials • We continue to like Healthcare as it offers solid long-term earnings prospects with low volatility and Healthcare strong balance sheets. We reiterate our underweight in Telecoms, where we expect ongoing weak Industrials revenue growth as well as margin pressure. • We are negative on Consumer Discretionary as earnings expectations may be too optimistic. With leading indicators in major regions still deteriorating, we keep our underweight in Industrials. We have Materials concerns over weak manufacturing momentum leading to increased earnings revisions. Telecom • The earnings outlook for US and Asian Financials is solid. We are neutral globally on Financials. While Utilities the ECB's OMT program reduces tail risk for Financials, it has limited impact on sector earnings. ■ new old Source: UBS UBS For further information please contact CIO asset class specialists Markus Irngartinger, or Carsten Schlufter 13 Please see important disclaimer and disclosures at the end of the document. EFTA01089691 US equities Preference: overweight S&P 500 (24 Oct): 1,409 (last publication: 1,433) Recommendations UBS View S&P 500 (6-month target): 1,460 Tactical (6 months) • We keep our preference for US equities relative to other developed equity markets. Earnings continued • We continue to like IT. The sector trades to hold up better than in other regions during the recent economic slowdown. Continued economic at the lowest valuation multiples seen since the early 1990s. Product launches growth should allow companies to show mid single digit earnings growth over the coming 12 months. support superior earnings growth. • The US central bank's (Fed) very pro-growth oriented policy stance is a clear advantage for the local • Industrials are preferred as they benefit equity market the recent introduction of additional quantitative easing (QE 3) is positive for riskier assets. from a pick up in manufacturing activity. • We still expect some potential for re-rating over the coming 6 months, in terms of increases in the price- • Consumer Staples is our preferred to-earnings ratio (P/E). defensive sector offering the best • The debate around the fiscal cliff implies increased uncertainty over the coming months. However, we combination of dividend growth and think that a 20% discount compared to the long-run PE-average provides some cushion, and our base case attractive valuation. assumes that politicians will finally achieve a compromise to avoid economic contraction. • We are still cautious on Telecoms, due to high valuations, as well as Materials, where margins remain under pressure. A Positive scenario S&P 500 (6-month target): 1,700 • An accelerating US and global economy reduces risks to company earnings. Investors begin to shift funds Strategic (1 to 2 years) • We like medium-sized US companies, into more cyclical sectors such as Industrials and Materials in light of better growth prospects. In this which are expected to show good longer scenario, we would expect earnings to grow by around 10% in the next 12 months, and the trailing P/E term earnings growth. multiple to expand to around 16x. SI Negative scenario S&P 500 (6-month target): 1,250 Our sector stance in the US • The US slides into a recession and corporate earnings fall over the coming 12 months. If this were coupled Sectors US with an escalation of the Eurozone debt crisis, we would expect the PIE multiple to contract towards 12.5x Consumer Discretionary trailing earnings. Consumer Staples 71 Note: Scenarios refer to global economic scenarios (see slide 7) Energy Financials What we're watching Why it matters Healthcare bi Business sentiment The ISM is the key indicator for US manufacturing and services. Key dates: 1 Industrials 71 Nov, ISM manufacturing; 5 Nov, ISM non-manufacturing IT 71 The Fed Hints on further quantitative easing can influence equities. Key date: 11 Nov, Materials minutes of Fed meeting (of 24 October) Telecom Labor market Utilities 4 Improvement in the labor market would support stronger consumption. Key date: 2 Nov, US labor market report for October Source: UN Note: Past performance is not an indication of future returns. UBS For further information please contact CIO asset class specialist Markus Irngartinger, 14 Please see important disclaimer and disclosures at the end of the document. EFTA01089692 Eurozone equities Preference: neutral Euro Stoxx (24 Oct): 247 (last publication: 247) Recommendations UBS View Euro Stoxx (6-month target): 249 Tactical (6 months) • We keep our neutral stance on Eurozone equities. While the sovereign debt crisis remains a risk factor • We continue to recommend defensive (see slide 8), the conditional bond buying program by the ECB (OMT) and the introduction of the ESM have sectors like Consumer Staples and Healthcare. We also like the Energy significantly reduced downside risks. sector. • Near-term we might see volatility increasing as politicians wrangle about the steps needed to provide a • We are negative on Industrials and more lasting solution to the debt crisis (setup of a single banking regulator, solving the banking related Consumer Discretionary as industry problems in Spain, etc. ). We think that attractive valuations sufficiently compensate for those risks. sentiment remains subdued. • The weak economic environment with recessions in the southern countries continues to weigh on • We remain cautious on Financials — corporate earnings. Consensus expectations (bottom up) of about 10% to 15% earnings growth in 2013 is especially Banks and diversified too high, in our view. In contrast, we forecast just about 3-5% earnings growth next year. Financials. The need for recapitalization remains a major concern. 7 Positive scenario Euro Stoxx (6-month target): 320 Strategic (1 to 2 years) • Global economic growth reaccelerates and Eurozone growth shows clear signs of bottoming out, • We have a preference for stocks paying enabling mid-single-digit earnings growth over the next six months. The trailing P/E ratio could re-rate to high-quality dividends. about 14.5x from its current reading of about 11.7x. • We like companies with high exposure NI Negative scenario Euro Stoxx (6-month target): 200 to rapidly growing emerging markets. • The debt crisis leads to renewed pressure on Spain and Italy. However, downside risks are expected to be Our sector stance in the Eurozone less severe now, after the ECB has put its new bond-buying program in place. • Earnings could fall about 5% to 10% from current levels over the coming six months, and the trailing P/E Sectors Eurozone ratio could drop to a level around 10x over a six-month period. Consumer Discretionary Note: Scenarios refer to global economic scenarios (see slide 7) Consumer Staples Energy What we're watching Why it matters Financials Growth indicators Healthcare 2/ Economic growth indicators provide information on the development of a potential Eurozone recession. Key dates: 2 Nov, final PMI manufacturing, Industrials EMU; 6 Nov, final PMI services EMU; 22 Nov, flash PMI manufacturing, IT EMU, France and Germany; 23 Nov, Ifo business sentiment index, Materials Germany Telecom Policy action Utilities Decisions by European politicians and the ECB affect the course of the debt crisis Key dates: 8 Nov, ECB meeting Source: UBS Note: Past performance is not an indication of future returns. *UBS For further information please contact CO's asset class specialist Markus Irngartinger, IS Please see important disclaimer and disclosures at the end of the document. EFTA01089693 UK equities Preference: neutral FTSE 100 (24 Oct): 5,805 (last publication: 5,768) Recommendations UBS View FTSE 100 (6-month target): 5,850 Tactical (6 months) • We keep our neutral stance on UK equities. Earnings have continued to disappoint, showing one of the • The UK offers an attractive 4% dividend weakest dynamics within our market universe. Commodity related sectors show steep earnings declines, yield. We still like companies with high which is expected to moderate only in a lagged fashion to stabilizing commodity prices. The Healthcare quality income streams. sector suffers from company specific issues which affect earnings also negatively. • We like Consumer Staples in the UK. The • With the oil price expected to trade down over the next 3 months, earnings of companies in the energy sector - comprising about 20% of the market — should remain depressed over the coming quarters. Within sector should provide steady earnings financials, law suits related to mis-selling of insurance related products represent a special risk factor. growth through its exposure to • Recent strengthening of the British pound is also a headwind for the competitiveness of UK companies, emerging markets. as earnings measured in the local currency are negatively affected. Strategic (1 to 2 years) • The PE of UK equities looks attractive at first sight. But over the past 10 years, UK equities traded on average at a discount to global equities. • The UK market's close to 4% dividend yield provides a good income stream. 71 Positive scenario FTSE 100 (6-month target): 7,000 • Companies with pricing power are • A fast strengthening in global growth and recovering demand from emerging markets leads to fast rising expected to deliver superior earnings commodity prices, helping the Energy and Materials sectors to lead the market higher. The market could growth. re-rate to a PIE multiple of 13.0x, and we would expect earnings growth of 5-10% over 12 months. Negative scenario FTSE 100 (6-month target): 4,750 UK market trades at a P/E discount, based on realized earnings • A global recession drags UK earnings down by 15-20% over 12 months. The market's traditionally defensive characteristics would only partly offset its strong exposure to commodity-related sectors. We 2.1 would expect the trailing PIE multiple to drop towards 10x. Note: Scenarios refer to global economic scenarios (see slide 7) What we're Why it matters watching 12 Growth indicators Business survey indicators provide information on economic development in the UK. Key date: 1 Nov, PMI manufacturing; 5 Nov, PMI services 9 Commodity prices Energy and Materials together comprise about 30% of the UK market according 6 to market capitalization. Developments in commodity prices affect earnings 2003 2006 2009 2012 estimates. — FTSE100 maltte094 PASCINeort0roaleed9h Policy action Loose monetary policy by the Bank of England supports equities. Key date: Source: Thomson Reuters, UBS, as of October 24, 2012 8 Nov, Bank of England policy meeting Note: Past performance is not an indication of future returns. UBS For further information please contact CIO asset class specialist Markus Irngartinger, 16 Please see important disclaimer and disclosures at the end of the document EFTA01089694 Swiss equities Preference: neutral SMI (24 Oct): 6,627 (last publication: 6,540) Recommendations UBS View SMI (6-month target): 6,700 Tactical (6 months) • We stay neutral on Swiss equities relative to global ones. Swiss companies are internationally well • We favor large caps over small caps. diversified, with about 2/3 of revenues generated in the US and in emerging markets. This provides the • We like stocks paying high and basis for solid revenue and earnings, despite economic weakness in Europe. sustainable dividends. • Swiss companies are trying to mitigate concerns about global economic prospects and a strong Swiss • Within defensives, we favor the franc using tight cost controls. This should protect operating margins. Healthcare and Consumer Staples • While the Swiss franc remains overvalued, the currency is not longer a drag. In fact, after depreciating sectors. since summer versus the USD and related currencies, Swiss companies' earnings will show positive currency • Among the cyclical companies, we translation and margin effects. prefer those with a broad emerging- • Especially in an environment of low economic growth we like the properties of decent earnings growth, solid balance sheets and a reasonable valuation. markets exposure and/or cheap valuation, including insurers. 7i Positive scenario SMI (6-month target): 7,500 Strategic (1 to 2 years) • Eurozone economic growth is reaccelerating considerably, providing further relief to Swiss financials as • We favor leaders in regards to the two well as Swiss exporters. Defensive sectors would likely be left behind in a strong global relief rally. In this scenario, we would expect the equity market P/E to be re-rated to 15x and earnings to grow by 5% over key Swiss success factors: innovation and the next six months. globalization. Negative scenario SMI (6-month target): 5,600 Swiss market relative to world • The global economy slides into a recession. Despite being less dependent on the global business cycle, equities Swiss companies will also feel the drop in global demand. In this scenario, corporate earnings are likely to drop slightly over the next six months and we would expect the PIE to contract toward 12.0x. Note: Scenarios refer to global economic scenarios (see slide 7) What we're watching Why it matters Economic indicators Key announcements of domestic economic indicators: Nov 1, Manufacturing 1 PMI index; Nov 30, KOF Swiss leading indicator; Monetary and economic Key Swiss monetary policy dates that could impact Swiss equities: Nov 1, SNB policy meeting Corporate news Key corporate announcement dates: Oct 30, Geberit, Oerlikon, Straumann & UBS; Oct 31, Lonza & Sika — SMt reatzedP4 — MSC! vivid iNitted Source: Thomson Reuters, UBS, as of October 24, 2012 Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialist Stefan Meyer, 17 Please see important disclaimer and disclosures at the end of the document. EFTA01089695 Japanese equities Topix (24 Oct): 743 (last publication: 743) Recommendations Preference: neutral 1 UBS view Topix (6-month target): 756 Tactical (6 months) • Japanese value stocks have under- • We expect earnings growth of about 25% over the upcoming 12 months. A relatively high growth rate performed growth stocks by more than still reflects last years sharp decline caused by two natural disasters. Still, the earnings recovery has 20% for the last four months. We see this disappointed so far. Earnings growth continues to slow down and is expected to move toward a more as an overreaction to concerns on the normal single-digit growth in 2013. slower global economy, and recommend • The government started implementing its JPY 18 trillion recovery budget in Q4 2011; we expect it to picking some value stocks with high boost GDP by 0.5-1.0% in FY2012, and about 0.5% in 2013. dividend yields. • However, we see only limited scope for an additional earnings boost from the local economic recovery. • We prefer companies that are using cost- Slowing export markets also curtail the outlook. June quarter-earnings results revealed emerging market reduction initiatives to maintain price competitiveness during periods of yen demand was below expectation, capping earnings growth. strength. • We expect the TOPIX trailing P/E to drop to around 13.5x from 15.0x over the coming months, mainly due to the earnings recovery; this provides room for moderate price increases only. Strategic (1 to 2 years) • A weaker USD-JPY rate may drive 74 Positive scenario Topix (6-month target): 970 Japanese companies' earnings recovery beyond a technical recovery from natural • Stronger global demand and stabilizing European markets lead to improved risk-taking. Falling risk disasters. Japanese exporters and aversion is likely to lead to a weaker yen, providing an additional increase in earnings. We expect 10-15% companies owning international EPS growth in FY2013 and the TOPIX target is based on 16.0x trailing P/E. operations would benefit from such a 11 Negative scenario Topix (6-month target): 575 development. • Faltering global growth leads to weak exports, triggering negative earnings surprises. USD-JPY rate Japanese realized earnings likely to strengthening to below 75 and potential economic conflicts with China might serve as an additional drag recover further going forward on earnings. We would then expect the P/E ratio to contract to 13.0x and earnings to fall during the 9$ upcoming six months. 85 75 Note: Scenarios refer to global economic scenarios (see slide 7) 65 55 What we're watching Why it matters 45 JPY and exports The exchange rate is an important factor for the Japanese equity market. Japan's trade balance could be in deficit and may impact USD-JPY rates. Key date: Nov 15 21, Japanese trade balance to Boils monetary policy If the Bank of Japan makes additional commitments to its asset-purchase 1968 1990 1992 1994 1996 1998 2003 2002 2004 2036 2033 2010 2012 board meeting program, which is currently JPY 70 trillion in size, it would lead to a weaker yen, — 11., MOWS toning!. per 1h.le in our view. Key date: Oct 30, BoJ policy meeting Source: Thomson Reuters, UBS, as of October 22, 2012 Note: Past performance is not an indication of future returns. *UBS For further information please contact 00 asset class specialist Toru lbayashi, 18 Please see important disclaimer and disclosures at the end of the document. EFTA01089696 Emerging market equities MSCI EM (24 Oct.): 995 (last publication: 990) Preference: overweight Recommendations 1 UBS View MSCI EM 6-month target: 1,040 Tactical (6 months) • The downward revisions to the emerging market GDP growth forecasts appear to be coming to an end. • Within emerging markets, we have a We expect emerging market GDP growth to accelerate to 5.3% in 2013 from this year's 4.7%. preference over six months for the large • Monetary policy in the US, the Eurozone, and Japan remains supportive. One implication of these low equity markets, Brazil, China and South interest rate policies, we believe, will be to enhance emerging market (EM) equity returns in USD by Korea. We expect an acceleration of supporting EM currencies more broadly against the USD over the next six months. I growth into 2013 in Brazil and South • In our base case, we see the P/E multiple of the MSCI EM Index staying around the current level of 11x Korea, and a stabilization in the case of trailing (i.e. realized) earnings over the next six months. Over the next 12 months, we expect EM earnings China. We see relatively less upside for growth of around 11% (slightly below consensus). more defensive Malaysia. We believe that • Over the past month, structural reforms that will have longer-term benefits were announced in India South Africa and Indonesia are expensive. (retail sector), Russia (energy sector) and Mexico (labor market). This highlights that the emerging The ECB's announcement that it stands economies have options to improve the competitiveness of their economies, if they choose to do so. ready to buy the bonds of compliant Eurozone governments has lessened the 71 Positive scenario MSCI EM (6-month target): 1,325 tail risks for the smaller European • The outlook for the global economy improves, boosting EM's ability to grow more strongly in 2013. This emerging equity markets (Turkey, stronger economic growth leads to earnings growth of 15%. Investor confidence improves, leading to a Hungary, Poland), but their equity markets better P/E multiple of 14x trailing earnings. If oil prices rose too, Russia would benefit in this scenario. are susceptible to setbacks. Negative scenario MSCI EM (6-month target): 800 Strategic (1 to 2 years) • A significant escalation in the Eurozone, a sharp fiscal contraction in the US, and a rapid deceleration in • Strategically, we would advise that EM Chinese growth could each hit EM's economic prospects. In such a scenario, we would expect a 20% decline portfolios tilt toward cash-rich and faster- in earnings over six months. More defensive Malaysia would do better, whereas more cyclical South Korea growing Asia. and Russia would underperform. We assume, however, that the market would also be expecting some recovery in earnings for 2014, helping the P/E multiple to recover to 10x trailing earnings. Note: Scenarios refer to global economic scenarios (see slide 7) Country preferences within emerging markets (relative to MSCI EM) What we're watching Why it matters Current most Current least Emerging market Investors are trying to figure out which emerging market central banks still have preferred markets preferred markets monetary policy room to ease monetary policy and where rates may be heading up. Inflation Brazil Indonesia data is due for Russia (6 Nov), Brazil (7 Nov), China (9 Nov), India (14 China Malaysia Nov) and South Africa (21 Nov). South Korea South Africa Food and oil prices The prices of grains and oil are higher than this time last year. For now, negative output gaps should counterbalance some of this inflationary pressure. UBS For further information please contact CIO asset class specialist Costa Vayenas, 19 Please see important disclaimer and disclosures at the end of the document. EFTA01089697 Asian equities (ex-Japan) MSCI Asia ex-Japan (24 Oct): 518 (last publication: 510) Recommendations UBS view MSCI Asia ex-Japan (6-month target): 545 Tactical (6 months) • The Fed's implementation of QE3 provides • China released a set of positive data for September. While the headline 3Q GDP number only met support to Asia ex-Japan equities. In expectations at +7.4% YoY (consensus +7.4%, prior +7.6%), the higher frequency data was better. conjunction with improving growth Industrial production of +9.2% YoY (consensus +9.0%, prior +8.9%), retail sales of +14.2% YoY prospects we see good near term upside. (consensus +13.2%, prior +13.2%), and fixed asset investment of +20.5% (+20.2% consensus, prior +20.2%) all came in higher. • Should economic growth surprise to the upside, more defensive markets such as • Chinese H-Shares are up almost 10% in the last month, while the S&P 500 is within 0.4 index points of Singapore and Malaysia are likely to where it was a month ago. Valuations of MSCI China remain extremely attractive as the market underperform. Instead, higher beta, continues to price in a hard landing scenario, although sentiment is clearly turning. In India, the export-oriented markets like South Korea, government has proposed several key economic reforms, but there are implementation risks and Taiwan, Hong Kong and China are likely to consensus GDP forecasts still have downside risk, while Indonesia's economic momentum is on track. take advantage from a strengthening in • We expect 12.8% earnings-per-share growth over 12 months for the MSCI Asia ex-Japan. It trades on global growth. 11.0x 12-m forward earnings and 1.6x price-to-book. We expect a stable earnings multiple in the next six Strategic (1 to 2 years) months. Economic growth should stabilize and earnings downgrades come to an end toward the end of • Consider a portfolio mix of high yield 2012. stocks largely found in Singapore, Taiwan 7 Positive scenario MSCI Asia ex-Japan (6-month target): 670 & HK, complemented by growth-oriented • More supportive monetary and fiscal policy, stable inflation, sustained domestic demand growth, and an stocks in the rest of Asia. improved global growth outlook lead to a better earnings outlook. In such a scenario, we expect Country preferences within Asia ex earnings growth of 15% and a trailing P/E of about 15.0x. Japan (relative to MSCI Asia ex Japan) NI Negative scenario MSCI Asia ex-Japan (6-month target): 400 c‘•?,e.eivit • A hard landing in China with a global recession leads to negative earnings revisions for 2012. In this China scenario, Asia ex-Japan could trade down to about 10.5x realized earnings. Hong Kong India What we're watching Why it matters Indonesia Politics Leadership in China is set to change, resulting in a newly defined future Korea economic policy. The US Presidential elections have implications on the Malaysia outcome of the Fiscal Cliff.Key dates: Nov 6, 57tl ' US Presidential Philippines Elections; Nov 8, 18th Communist Party Congress Singapore Policy responses Some other countries in the region have near-term macroeconomic issues due Taiwan to fiscal and current account deficits, as well as hiccups in market and economic Thailand reforms. Policy responses often come on an ad-hoc basis. Other, • new old UBS For further information please contact CIO asset class specialist Kelvin Tay, 20 Please see important disclaimer and disclosures at the end of the document. EFTA01089698 E quity styles UBS view Prefer mid caps in US, large caps in Europe Regional differentiation • In the US, we prefer mid caps to large • We believe that medium-sized companies (mid caps) will outperform large caps in the US. US economic caps. Moderate economic growth should data is forecast to stabilize and then show moderate economic growth in the second half of 2012 and into support their earnings generation. 2013. The greater domestic sales exposure of US mid caps reduces the earnings risk coming from Europe. • In the US, there are opportunities in value • In Europe, we prefer companies with a large market capitalization (large caps) over ones with a small one names that also show strong growth. (small caps) in the current very challenging economic environment. Small caps generate more sales in • Within Europe, we avoid small caps and Continental Europe than large caps. Thus, they are more negatively affected by weak domestic demand. instead rotate into large caps. Small caps also have a more cyclical earnings exposure than large caps. • Globally, high-quality dividend paying stocks promise to provide a real and stable income stream to Strategic (1 to 2 years) investors in the current low-yield environment. Furthermore, they give exposure to the long-term potential • We expect value strategies to outperform of equity markets while tending to suffer less in declining markets. the European market over a multi-year time horizon. 7 Positive scenario Prefer value, low quality and small caps • Mid-cap stocks provide attractive • Leading indicators continue to move higher, and risks related to the Eurozone debt crisis subside. In this opportunities over the longer term. case, add deep cyclical value (cheap price/book, price/earnings) regardless of the sector, with high beta and high leverage. In such an environment, small and mid-cap stocks should also perform well. A dividend strategy would be too defensive to outperform the market. Avoid small caps and favor large caps in Europe NI Negative scenario Prefer quality and large caps DJ STOXX small over large and business • The global economic picture deteriorates markedly. In this case, buy high-quality growth companies and confidence large caps. Do not look for value opportunities, but be as defensive as possible with your equity exposure. 13 10 Look to high-quality, dividend-paying stocks for yield. 6 12 Note: Scenarios refer to global economic scenarios (see slide 7). 0 1.1 What we're watching Why it matters (10) 10 (15) Earnings revisions — see Watch for signs of improvement in earnings revisions (aggregated from stock Large caps (20) chart level). An improved earnings outlook would cause investors to add more risk — 09 outperforming (26) (3-month moving influencing our preferences among equity styles. 08 I (30) average upgrades vs. (35) 07 (40) downgrades) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 US and Eurozone PM's PMIs are important for earnings generation and preferences for value, growth - Smal cap over Wye cap - ELcoaxeCustness. women (ft) and size. Key dates: Nov 2, PMI manufacturing Eurozone (final); Nov 1, US ISM manufacturing Source: Thomson Reuters, UBS, as of September 29, 2012 Note: Past performance is no indication for future returns. 443 UBS For further information please contact CIO's asset class specialist Christopher Wright, 21 Please see important disclaimer and disclosures at the end of the document. EFTA01089699 Section 2.B Asset class views Fixed Income *UBS EFTA01089700 Bonds overview Preferences (6 months) Government bonds - Key points shoe duration neutral long duration • We expected government bond yields to move towards slightly higher ranges over the next 6 months, USD as seen in late 2011/early 2012. This is likely to have a slightly negative effect on most developed government bond prices, and is likely to result in a total return around zero over this period. EUR (DE) • Price fluctuations in the month ahead could originate from developments in the Eurozone and the US. They include the Troika report on Greece, Spanish local elections/referendum and the possible delayed GBP request for additional ECB support in Europe. In the US, the extent of the fiscal cliff is dependent on the election outcome and the results from the debates in the subsequent lame duck session of congress. IDv While we expect the full cliff to be avoided, it poses a significant downside risk to domestic growth. • Overall, we suggest keeping the duration close to neutral, as we expect global growth to remain CHF lackluster and central banks to continue supporting bond markets. CAD Corporate and emerging market bonds - Key points AUD • We maintain a preference for investment-grade (IG) and US high-yield (HY) corporate credit. A strong (US) corporate sector, the ongoing moderate recovery of the US economy, determined central bank • new old support and a strong technical backdrop are likely to further support credit segments. undemeight neu:ra overweight • Investment-grade corporate bonds have achieved a total return of more than 10% so far this year, at remarkably low volatility. While absolute returns will likely be moderate in the next six months (1-2%), Bonds total the asset class should continue outperforming government bonds, offering higher liquidity than HY bonds. We see the highest return potential in the lower-rated IG segments (BBB and A). • US corporate bonds of lower credit quality (HY) remain fundamentally supported by solid balance Government bonds sheets and a benign US growth outlook. Given the low risk of default losses, valuations are attractive at an effective yield of above 6%. For US HY, we expect mid single-digit total returns in the next six months. Investment grade US senior loans are an attractive alternative to traditional fixed income assets. Corporate • Emerging market (EM) bonds should continue to benefit from better fundamentals than those of bonds developed markets over the medium term. However, valuations have now moved towards a fair level for High yield sovereign bonds (in USD) and we take profits on selected sovereign bond issuers. For EM corporate bonds bonds in USD, there is still some potential for spreads to trend lower in the quarters ahead, and we continue to Emerging recommend this area as a CIO-preferred theme. market bonds ■ new old Source: UBS CIO WM Global Investment Office UBS For further information please contact CO's asset class specialists Achim Peijan, and Daniela Steinbrink Mattel, 23 Please see important disclaimer and disclosures at the end of the document. EFTA01089701 US rates Duration preference: neutral US 10-year (24 Oct): 1.8% (last month: 1.8%) Recommendations UBS view US 10-year (6-month forecast): 2.0% • US 10-year yields traded largely sideways within a narrow range. Improving domestic economic and sentiment data Tactical (6 months) was balanced by concerns of the elections/fiscal cliff weighing on the US economy. However, both the ECB and the • Weak global growth momentum, ongoing Fed have provided substantial and credible backstops that significantly reduce tail risks. This reduces the flight to bond market support from central banks quality and the risk discount placed on Treasuries in the event of a re-escalation of the European debt crisis. This and the lingering euro crisis are likely to represents a clear floor with little chance of retesting the historical lows of July (-1.4%). In addition, the Fed's keep yields at extraordinarily low levels for willingness to fall behind the curve in support of the domestic labor market will increase inflation expectations over the medium term. This implies steeper yield curves. some time. Tactically, we suggest a neutral • In addition, the credible and conditional central bank backstops have already improved sentiment and should help duration position. to kick-start growth if politicians provide the necessary tailwinds. Yields will then return to their slightly higher, previously stable ranges over a six-month horizon (1.8%-2.1%). Strategic (1 to 2 years) • At the same time, US yields should be capped, as the US economy continues to be vulnerable to spillover effects • Yields have significant upside potential from the Eurozone. Structurally weak growth which will be dampened by the upcoming US fiscal consolidation, will add to volatility and limit the increase in yields. over the next couple of years given the extraordinarily low current levels of real 7l Positive scenario for US bonds US 10-year (6-month range): 1.4-1.6% interest rates in particular. Thus clients • US fiscal deleveraging beyond our expectations weighs on the cyclical recovery and is a drag on yields. with a longer time horizon should focus • A re-escalation of the European debt crisis burdens yields. Implementation risks in the ECB framework remain, given on bonds with short and medium that Italy and Spain have not yet made the necessary application, which will result in the peripheral spread widening. At the same time, Greece is likely to announce a second debt restructuring and leave the Eurozone next year. maturities. • The labor market fails to recover, increasing the likelihood of even more MBS purchases or alternative measures, and yields stay low or fall further. USD 10-year yields and forecasts N Negative scenario for US bonds US 10-year (6-month range): 2.1-2.5% 5% • If the ECB buying of short-dated Spanish and Italian sovereign bonds increases risk appetite, it would reduce the flight to quality more substantially and this represents an upside risk to our forecasts. 4% strotA • If EU leaders make progress toward increased fiscal integration, and US growth recovers with a rapidly improving labor market, then yields could rise more significantly. Note: Scenarios refer to global economic scenarios (see slide 7) 3% - What we're watching Why it matters 2% Fed policy The Fed's assessment of the labor market determines its stance on quantitative easing and is key for yields. Key dates: Nov 2, NFP; Dec 11 Fed FOMC meeting 1% • Inflation expectations Current yields do not reflect low real-interest rates, but rather normal inflation 0% expectations. Inflation expectations increased on the back of the latest Fed action, Oct-09 Oct-10 Ott-11 Oct-12 Oct-13 leading to more upside risk for long maturity yields. forecasts US 10Y US presidential The US presidential election will guide fiscal spending for the coming years. election/Fiscal cliff & debt Source: Bloomberg. UBS, as of October IS, 2012 ceiling Note: Past performance is not an indication of future returns. UBS For further information please contact CO's asset class specialist Daniela Steinbrink Mattei, 24 Please see important disclaimer and disclosures at the end of the document. EFTA01089702 European rates Duration preference: neutral EUR (DE) 10-year (24 Oct): 1.6% (last month: 1.6%) Recommendations UBS view EUR (DE) 10-year (6-month forecast): 1.8% • Bund yields have trended sideways over the month, lacking a directional trigger. Markets still await Tactical (6 months) crucial developments in Spain, Greece and the extent of the US fiscal cliff, and have not fully reflected • If the ECB were to intervene with massive mixed but stabilizing fundamentals. However, when compared to the all-time lows witnessed in August amounts in the peripheral bond markets, (-1.2%), yields are still trading at decisively higher levels. This is supported by the ECB announcement to Bund yields would rise more significantly. act as a lender of last resort by intervening in the secondary markets with unlimited and conditional But, for the time being, we expect only government bonds purchases. In addition, the open-ended Fed stimulus hinging on the labor market contributed to improving sentiment. This provides a cap for short-term peripheral yields and a floor for moderate interventions that do no Bund yields. meaningful harm to Germany's credit • Over a six-month horizon, we expect yields to trend slightly higher, returning to previously higher ranges. quality. We recommend staying neutral on The central bank backstops have already improved confidence and resulted in convergence between the duration tactically. periphery and the core. This speaks for slightly better growth prospects and thus slightly higher yields. • However, growth is still structurally weak, and short-term uncertainties (US elections, fiscal cliff, Spain) Strategic (1 to 2 years) remain. Consequently, short-term downside risks persist around year end. The ECB, however, will limit the • Yields have significant upside potential spread from widening, providing a bottom to Bund yields as well. over the next couple of years. Thus clients • In the UK, economic data stabilized and we expect the BoE to extend quantitative easing in November. with a long time horizon should focus on • In Switzerland, yields rose only slightly owing to mixed economic data. The Swiss National Bank stands ready to act. With much negative news priced in, we believe Swiss yields will gradually start to normalize. bonds with short and medium maturities. A Positive scenario for German bonds 10-year Bund yield (6-month range): 1.2-1.5% EU 10-year yields and forecasts • Implementation risks in the ECB framework remain, in particular the need for Italy and Spain to apply for aid. At the same time, Greece may announce a second debt restructuring and is likely to leave the 5% Eurozone in 2013. • US fiscal deleveraging beyond our expectations weighs on the cyclical recovery and is a drag on yields. • Further non-standard policy measures by the Fed are supportive for Bunds and speak for lower yields. NI Negative scenario for German bonds 10-year Bund yield (6-month range): 1.8-2.3% • A moderate Eurozone economic recovery kicks in. Spain and Italy are ahead on their austerity commitments without needing ECB support. This reduces safe-haven inflows, driving Bund yields higher. Alternatively, Germany gives additional guarantees and the Eurozone moves towards a transfer union. Note: Scenarios refer to global economic scenarios (see slide 7) What we're watching Why it matters 0% - Political risks and fiscal cliff The US fiscal cliff, Greek negotiations, Spanish local elections and Spain delaying its Oct-09 Oct-10 Oct-11 Oct-t2 Oct-13 application for assistance add to policy uncertainty. forecasts UK 10Y Central banks Key dates: Nov 8, ECB; Dec 11, Fed FOMC meeting Germany 10y — SwizerLand 10Y Economic variables Credit conditions (ECB bank lending survey) Source: Bloomberg. UBS, as of October IS, 2012 Eurozone yield spreads The level of yield spreads to German bonds influences the level of German Bund yields due Note: Past performance is not an indication of future returns. to safe-haven flows. UBS For further information, please contact CIO's asset class specialist Daniela Steinbrink Mattei, Sebastian Vogel, or Nina Gotthelf, 25 Please see important disclaimer and disclosures at the end of the document. EFTA01089703 Investment grade corporate bonds Preference: overweight Current global spread (24 Oct): 150bps (last month: 173bps) Recommendations UBS View Spread target (6-month): 140bps Tactical (6 months) • Given the recent rally in investment grade (IG) bonds, spreads have approached fair levels, in our view • We keep an overweight in IG corporate and are likely to trade more or less sideways in the coming 6 months. Still, IG bonds will likely continue to over government bonds. outperform government bonds, offering low volatility and stable income. • In Europe, internationally diversified • We lower our spread target from 170bps to 140bps due to the improved global macro and risk companies from non-financial sectors environment after recent central bank action and the pickup in economic data. IG bonds remain offer a low but stable income stream for supported by our outlook for sluggish but positive global growth, ongoing investor appetite for income- conservative investors. generating assets, and expected negative net issuance. • Financials in the US are in a better position • Non-financial corporates: While total yields are at record lows, the pickup over government bonds and than their European peers. money market rates is still attractive. Aggressive re-leveraging by companies looks unlikely. • We recommend bonds from the lower IG • Financial corporates: Due to regulatory challenges, spreads are expected to remain above past averages. US banks are in a more favorable position than their European peers as they are better capitalized and rating segments (BBB and A) over higher- earnings have been strong recently. US financial spreads are thus likely to tighten further. rated issuers. Strategic (1 to 2 years) 71 Positive scenario Spread target (6-month): 130bps • We prefer corporate over sovereign assets • Global growth accelerates more forcefully than expected. This could compress spreads closer to pre-crisis given how much more robust companies levels. Spreads for Financials are likely to remain elevated due to regulatory challenges. However, in this are compared to the structural weakness case, rising benchmark yields would likely lead to slightly negative IG returns over six months. of public finance in many countries. la Negative scenario Spread target (6-month): 380bps • Main risks include a sharp slowdown of the US economy (e.g. the "fiscal cliff"). Also, risks in the Yield spreads Eurozone persist (e.g. Greek exit, Spain/Italy getting cut off from private funding). Still, we would be 700 unlikely to see spread levels reached in 2009, given companies' superior balance sheet positions. European bps 600 financial issuers would be most at risk. Note: Scenarios refer to global economic scenarios (see slide 7) 500 What we're watching Why it matters 400 Core market yields Developed market sovereign yields are only expected to increase gradually. A 300 sudden rise and high volatility would hurt IG credit. Key dates: 8 Nov, ECB 200 rate decision; 11 Dec, US Fed rate decision 100 Corporate fundamentals Robust corporate earnings and low leverage on corporate balance sheets 0 2005 2006 2007 2008 2009 2010 2011 2012 should help prevent defaults. Key dates: US "earnings season" (ongoing) — (UR hvelment Grade —USD Investment Grade New issuance As companies continue to deleverage, net negative supply on the IG market Source: Bloomberg, UBS, as of 16 Oct 2012 should support higher prices. Note: Past performance is not an indication of future returns. et) UBS For further information please contact CIO's asset class specialist Philipp Schottler. 26 Please see important disclaimer and disclosures at the end of the document. EFTA01089704 High yield corporate bonds Preference: overweight Spread USD HY (24 Oct): 540bps (last month: 573bps) Recommendations Tactical (6 months) UBS View USD HY spread target (6-month): 475bps • US high yield corporate bonds offer an • We reiterate our spread target of 475bps based on still robust corporate fundamentals, a favorable attractive return outlook and should be technical backdrop and the commitment of major central banks to provide strong monetary support. In overweighted. particular, the Fed's buying of mortgage-backed securities (MBS) is likely to provide further support for the • We prefer US over European issuers given credit universe. the increasing proportion of peripheral • Thus, US high yield (HY) bonds continue to offer attractive value although spreads tightened and financial issuers in the European HY considerably in Q3. We think the recent rally has been justified in light of the favorable default outlook universe and the poorer economic outlook and central bank action. The ongoing slow recovery of the US economy, healthy company balance sheets, in Europe. robust earnings, and strong investor appetite for yield assets continue to push spreads lower. US HY thus • Inflows into HY mutual funds have been strong so far in 2012. New issuance was remains our preferred asset class. strong in Q3. • Despite the recent uptick in defaults, in the absence of a renewed US recession, we expect the default rate to remain stable at 3.5% until the end of the year. A heavy load of new issuance so far this year means Strategic (1 to 2 years) that HY companies will be faced with a lower risk of failed refinancing going forward (e.g. in case of an • We expect US defaults to remain at below- unexpected economic slump). average levels for longer. Significant re- leveraging is unlikely in the medium term. 70 Positive scenario USD HY spread target (6-month): 400bps • We believe US high yield corporate bonds • Even in the positive economic scenario, spreads are unlikely to tighten to pre-crisis lows of below 300bps will provide good returns both relative to due to lower liquidity and a generally higher risk premium after the financial crisis. Benchmark yields other fixed income and for absolute return-oriented investors. would rise, limiting HY returns to around 7%. European HY outperforms the US. II Negative scenario USD HY spread target (6-month): 1,000bps Yield spreads • A global recession is the major risk for high yield bonds. Based on the robust state of the corporate 7.509 sector, we would not expect spreads to surpass "usual" recession levels around 1,000bps. Although short- term spikes are possible due to liquidity suddenly drying up, we expect a quick normalization. ZOOD Note: Scenarios refer to global economic scenarios (see slide 7) 1800 What we're watching Why it matters LOW Credit quality/ US earnings were roughly flat in 2Q compared to 1Q. A modest pickup is expected in 2H. default cycle Balance sheets are backed by high cash levels and low debt ratios. Against this backdrop 500 the default rate will likely remain below its long-term average. New issuance For now, favorable conditions in the primary market have mainly been used for 0 2005 2006 2007 2008 2009 2010 2011 2012 refinancing. More aggressive issuance activities should be monitored. — CUR 160 Meld —USD high Meld Bank lending standards Bank lending provides an important source of funding. US banks relaxed standards Source: Bloomberg, U8S, as of 16 Oct 2012 further in early 3Q. Key dates: late October, US Fed Senior Loan Officer Survey Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialist Philipp Sch0ttler, 27 Please see important disclaimer and disclosures at the end of the document. EFTA01089705 Emerging market bonds Preference: neutral EMBI Global/CEMBI spread (24 Oct): 281bps I 334bps (last month: 292bps /363bps) Recommendations UBS View EMBI Global/CEMBI spread target (6-month): 275bps/290bps Tactical (6 months) • Current spread levels of EM sovereign bonds are roughly in line with fundamentals. We think valuations • EM corporate bonds are particularly of EM corporate bonds are more attractive than valuations of EM sovereign bonds. Additionally, the attractive due to their favorable gradual recovery in EM we expect over coming quarters should support the performance of EM corporate valuations, solid fundamentals, and bonds relative to EM sovereign bonds. Corporate bonds tend to outperform sovereign bonds during relatively short duration. We advise periods of accelerating growth. clients to focus on investment grade • However, absolute returns of EM bonds will be lower than in the past, we think, as the room for spreads bonds in the current environment. We to tighten further has become more limited. We expect total returns of less than 2% for EM sovereigns recommend taking profit on selected EM and close to 4% for EM corporate bonds over the next six months. sovereign bonds. Please refer to our EM • Negative headlines from the Eurozone or global growth fears might put renewed short-term pressure on bond list for issuer- and bond-specific EM bond prices. We think that periods of price weakness offer attractive entry points. guidance. 7I Positive scenario EMBI Global/CEMBI spread target (6-month): 235bps/230bps Strategic (1 to 2 years) • Yield stability in Europe's core markets and higher-than-expected growth in the US would provide a • EM bonds are attractive for longer-term favorable backdrop for EM fixed-income spreads. In such an environment, issuers of lower credit quality investors looking for higher yields. would likely fare better. Average spreads could tighten to below 240bps in such an environment. • Local markets in Asia offer interesting NI Negative scenario EMBI Global/CEMBI spread target (6-month): 555bps/750bps opportunities for longer-term investors because of a supportive currency outlook. • An environment of renewed escalating risk aversion in Europe, deteriorating EM funding markets, weakening global growth prospects, and lower commodity prices could impact EM credit negatively. EM sovereigns relatively expensive Liquidity in emerging market bonds could dry up and spreads could spike. compared to EM corporates Note: Scenarios refer to global economic scenarios (see slide 7) Spreads of EM bonds over US Treasuries, in bps 630 What we're watching Why it matters S00 Core market yields The direction of US Treasury and German Bund yields are important for EM fixed income spreads, especially for USD- and EUR-denominated bonds. 400 Key date: Dec 6, European Central Bank meeting 303 103 Capital flows The European debt crisis may lead to further periods of outflows and weaker prices, which could offer attractive entry levels for investors. 100 0 Monetary policy cycles Monetary policy easing remains a key topic for local currency bonds. We look for 0k1439 Apr-10 Old-10 Apr-11 0k1-11 Apr-12 central bank policy announcements in key markets. Key policy rate — burgh] market sovereign teal (Val Gtbd) announcement dates: Nov 11, Indonesia; Nov 20, Turkey; Nov 22, South Africa; — bdergig matt capdate tot (CUM Brod0 Nov 30, Mexico Source: JP Morgan, UBS, as of IS October 2012 Note: Past performance is not an indication of future returns. UBS For further information please contact Co's asset class specialist Michael Bolliger, and Kilian Reber, 28 Please see important disclaimer and disclosures at the end of the document. EFTA01089706 Section 2.0 Asset class views Foreign Exchange *UBS EFTA01089707 Foreign exchange overview Foreign exchange - Key points Preferences (6 months) • The ECB's announcement of Outright Monetary Transactions (OMT) has reduced tail risk in the Eurozone underweight neutral overweight considerably, while the Federal Reserve announcing a new round of potentially unlimited asset purchases USD at their September 13 meeting has weakened the USD. Given that the ECB action was EUR-positive and the Fed action USD-negative, EURUSD has jumped considerably, but since then moved little. EUR • We believe the risks to the pair are now more balanced, and see a range between EURUSD 1.28-1.35 for GBP the months ahead. A Spanish ESM/OMT request would be EUR positive. While the US elections and US fiscal cliff could lead to short term USD strength, we see the USD weaker over the next 6 months. JPV • The CAD remains supported by better growth dynamics in Canada and QE in the US. However, we believe CHF the recent appreciation against the USD could see a near-term setback and we close the overweight. • We keep the overweight position in the GBP despite the current asset purchasing program by the Bank of SEK England (BoE), which we believe will be terminated in November. The GBP remains well supported given the recent rebound in economic data, the expectation of a stronger economy in 2013 and because NOK investors are seeking liquid alternatives to the EUR, the USD and the JPY. CAD • EURCHF has traded higher in our 1.20-1.23 range recently and we continue to see the pair in that range. The SNB protects the downside, while a strong upside move is also limited by a potential flare-up in the NZD euro crisis and reserve unwinding of the SNB at some point. Given this balance, we have decided to close AUD the underweight in the CHF. • Sweden and Norway stand out for their lower debt-to-GDP ratios and current account surpluses. Both the ■ new old SEK and NOK have appreciated on diversification and safe-haven inflows, but economic data in both countries has become weaker recently, which led to a setback in the SEK. A rate cut in Sweden cannot be Source: UBS CIO WM Global Investment Office ruled out, but seems to be priced in already. • Longer-term debt issues and weak competitiveness of major exporters are hurting the Japanese economy and PMIs have disappointed. We therefore think the Bank of Japan and Ministry of Finance will maintain an expansive policy bias and continue trying to weaken the JPY. We are underweight WY. • For commodity currencies, the AUD and NW continue to trade at the top of their well established ranges. We got the expected rate cut in Australia and expect another cut by year end. Do not buy AUD above AUDUSD 1.00. We have a preference for the NZD over the AUD. • We maintain a positive medium-term view on emerging market (EM) currencies. This is supported by higher short-term rates which provide an attractive yield pick-up relative to developed market currencies as monetary policies are expected to remain loose for longer. We think investors should increase EM FX exposure across regions. Lower tail risks in Europe should be especially supportive of the higher-yielding currencies in EMEA and Latin America. • Our most preferred emerging market currencies are currently the MXN, ZAR, PLN, KRW and SGD.We expect the CNY to appreciate 2% against the USD, moving towards 6.20 over the coming 12 months. Internationally marketable instruments (such as CNH, the offshore version of the Chinese currency traded in Hong Kong) have similar appreciation potential. UBS For further information please contact CIO asset class specialist Thomas Flury, 30 Please see important disclaimer and disclosures at the end of the document. EFTA01089708 G10 currencies UBS View See table for current exchange rates and CIO forecasts Recommendations Tactical (6 months) • We believe the risks to the EURUSD currency pair are now more balanced, as tail risks on the European • We continue to have a preference for the side have been considerably reduced. GBP and keep the short in the JPY. • The GBP trended higher despite stimulus measures by the Bank of England. The main reason is the need for diversification out of the EUR and USD and decisive UK policy making. We maintain an overweight Strategic (1 to 2 years) after the strong rebound of economic data in 3Q 2012 which we expect to persist into 2013. • We recommend that investors diversify • The CAD remains supported by better growth dynamics. However in the short term, around the US from large USD and EUR exposures into elections and fiscal cliff debate, a setback cannot be ruled out. We also remain underweight in the AUD. minor currencies. Structural financing • The SNB has shown that it can defend the CHF floor. With EUR tail risk reduced the CHF likely recovers issues weigh on all the major currencies. together with the EUR against most other currencies. Thus we close the CHF underweight. • The best diversifiers based on long-term • We expect stronger policy intervention in Japan to weaken the JPY over the coming months. macroeconomic fundamentals are the CAD and the SEK. The AUD, NOK and CHF 7 Positive scenario FX targets: EURUSD >1.35 / EURJPY 115 should only be added at better entry • The announcement of unlimited QE in the US, as well as a stronger-than-expected acceleration of global levels. The GBP also remains attractive. growth or further European integration would be EURUSD positive. EURUSD should trade above 1.35 in this case. Yen weakness should come as the Bank of Japan intervenes to weakens its currency. NI Negative scenario FX targets: EURUSD <1.25 / EllItlPY 90 • The European growth outlook deteriorates further with continued recession in 2013. The euro could rapidly fall below 1.25. A European debt-default cascade (possibly triggered by a disorderly Greece euro UBS CIO FX forecasts exit) is a tail risk for the single currency. Risk aversion would lead to an extended USD and JPY rally. Note: Scenarios refer to global economic scenarios (see slide 7) 24.10.12 3M 61.4 1214 PPP EURUSD 1.294 1.30 1.32 1.34 1.30 What we're watching Why it matters UMW 79.75 so 82 B6 79 MOW 0.991 0.94 0.94 0.92 098 Chinese growth We expect China to land softly and then recover. Should China disappoint with a AUDUSO 1.0322 0.97 1.00 1.05 0.74 G8PUSD 1.601B 1.65 1.68 170 1.69 hard landing, then risk-unwinding would support USD and JPY vs. risk-taker N2DUSD 08136 0.78 080 083 0.60 currencies. In the base case, a Chinese recovery should support the AUD in the MCI* 09346 0.93 0.92 0.92 1.03 medium term, but a dip below parity is likely in the short term. EURO* 1.2097 1.21 121 1.23 1.33 European sovereign The main focus lies on the Spanish application for ESM/ECB support, which would G8PCHF 1.4974 1.54 1.54 136 1.73 crisis, ECB policy be EUR positive; a rate cut (not expected) would hurt the EUR. Key date: Nov 8, EUFUPY 10327 104 108 115 102 ECB meeting EURG8P 08079 0.79 0.79 0.79 0.77 EUPSEK 8.6577 8.20 8.00 8.00 886 US growth and Fed What will the Fed do once Operation Twist ends at year end? How will the EURNOK 7.4373 7.30 720 720 8.53 policy response presidential elections change political power in Washington? Key dates: Nov 6, US presidential elections; Dec 12, FOMC meeting Source: Thomson Reuters, U85, as of 15 October 2012 Note: Past performance is not an indication of future returns. *UBS For further information please contact ao asset class specialist Thomas Flury, 31 Please see important disclaimer and disclosures at the end of the document EFTA01089709 Emerging market currencies UBS View See table for current exchange rates and ao forecasts Recommendations Tactical (6 months) • We continue to like emerging market (EM) currencies over a medium term horizon. We think monetary • Several EM currencies look attractive at policies of major central banks will remain loose for longer whereas the easing cycle in several emerging current levels and we advise investors to markets is over. This should support EM currencies relative to major currencies (USD, EUR, and JPY). Long keep existing holdings for further gains term investors should therefore diversify into EM currencies using surplus exposure to these currencies. while increasing exposure to our • In Europe, both the Polish zloty (PLN) and the Turkish lira (TRY) have supportive fundamentals in the preferred EM currencies (KRW, SGD, MYR, long-term and could benefit from inflows into their fixed-income market which offers attractive yield MXN, TRY, PLN, ZAR), using the JPY, USD, relative to G4 currencies. Due to structural reasons we remain cautious on the Hungarian forint (HUF). and EUR for funding. • The South African rand (ZAR) is currently attractively valued, but Investors should be willing and able to Strategic (1 to 2 years) tolerate bouts of volatility due to the current strikes and a cyclical slowdown of the economy. • We recommend EM currencies backed by • In Asia, we like the Korean won (KRW), the Singaporean dollar (SGD) and the Malaysian ringgit (MYR) as stable fundamentals as a strategy to all three countries have a strong economy and should benefit from increasing liquidity and a recovering diversify currency exposure. Chinese economy. • Our favorites include the Chilean peso, Mexican peso, Czech koruna, Polish zloty, • In Latin America, the Mexican peso (MXN) remains attractively valued, despite its recent rally. Chinese renminbi, Korean won, Malaysian A Positive scenario > 5% outperformance of EM FX against G4 currencies over a 6-month horizon ringgit, and Singapore dollar. • Macroeconomic data comes in stronger than expected and contagion risks in Europe subside further. EM UBS CIO EM FX forecasts exchange rates could appreciate swiftly against major currencies (USD, EUR, and JPY). 24.10.2012 3-month 6-month 12.month I Negative scenario > 5% depreciation of EM EX across regions against USD over a 6-month horizon Americas USDBRL 2.02 1.95 1.90 1.85 • Global growth prospects suffer a prolonged deterioration and the European debt crisis intensifies. EM USDMXN 12.9 12.7 12.5 12.3 exchange rates could see a significant, although likely temporary, sell-off across regions. Asia Note: Scenarios refer to global economic scenarios (see slide 7) USDCNY 6.25 6.30 6.30 6.20 USDINR 53.6 53.0 54.0 55.0 What we're watching Why it matters USDINR 9,615 9,400 9,400 9,400 USDKRW 1,103 1,100 1,080 1,050 Inflation dynamics Inflation dynamics are important to forecast central bank policy rate USDSGD 1.22 1.21 1.20 1.19 in EM decisions. Monetary easing typically weighs on EM currencies, while rate hikes EMEA tend to be supportive. Key policy rate announcement dates: 11 Nov, EURPIN 4.12 4.30 4.15 3.90 Indonesia; Nov 20, Turkey; Nov 22, South Africa; Nov 30, Mexico EURHUF 280 290 300 300 EURC2K 24.9 26.0 25.0 24.3 European sovereign crisis Setbacks in sentiment will likely lead to bouts of EM currency depreciation, USDTRY 1.80 1.75 1.75 1.72 providing attractive entry points for longer term investors. USD2AR 8.66 8.20 7.90 7.80 Growth Growth in the US, Europe, and China is key for risk sentiment, growth USDRUB 31.1 33.0 32.0 31.0 prospects in EM. Key date: Dec 6, European Central Bank meeting Source: Bloomberg, UBS, as of 15 October 2012 Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialists Michael Elolliger, or Teck Leng Tan, 32 Please see important disclaimer and disclosures at the end of the document. EFTA01089710 Section 2.D Asset class views NTAC: Commodities, Listed real estate, Hedge funds and Private equity 4UBS EFTA01089711 Commodities overview Commodities - Key points Preferences (6 months) • The impact of new quantitative easing (QE) measures on commodity prices is losing strength, as broadly uncrAe ght newal overweight diversified commodity indices have not been advancing anymore on a month-on-month basis. Investors have started to reflect on the underlying economic challenges that motivated the easing decisions by Commodities key central banks. With global economic growth barely accelerating, the asset class will struggle to total appreciate firmly over the coming months. We therefore advise investors to have only low single digit return expectations for commodities warranting a neutral stance. Precious Metals • Gold is less depending on economic growth, however the metal could be a beneficiary of ample liquidity provided by central banks. But ebbing QE news flow at a later stage (6-12 months) might challenge the necessary investment demand inflows to balance the market. Hence, we stay neutral Energy on precious metals. • The return outlook of the energy sector remains not compelling in 4Q12 and we stay neutral. Global crude oil supply should expand firmly and surpass incremental demand in 4Q12. We think this will bring Base Metals Brent crude oil prices temporarily towards USD 95/bbl while WTI should slide towards USD 78/bbl in 4Q12. However, a weaker USD due to QE3, ongoing social turmoil in the Middle East and North Africa and the risk that Iranian tensions have the potential to heat up after the US presidential elections are Agricultural likely to keep the oil price at around USD 105-110/bbl in 6 months. In addition, demand growth from EM countries in 1Q13 could start to gather pace. ■ new old • Base metal prices should hold their ground, with China's growth deceleration coming to an end. So we keep our neutral stance. That said, it is too early to call for a strong extension of the liquidity Source. WS CIO WM Global Investment Office driven price rally seen until now, despite the RMB 1 trillion in infrastructure approvals by the NDRC (National Development and Resource Commission) in rail, highways, ports and other infrastructure projects. Many of the announced projects are already part of the 12th 5-year plan. The incremental demand impact of speeding up investments should therefore be rather muted this time compared with previous stimulus packages. Besides that, China's steel intensity for one unit of RMB of investment (FAI) has halved over the last 5 years. • A 15% increase in grain prices remains our base case for 4Q12, with room for prices to top out in 1Q13. Demand rationing in case of corn and soybeans is still needed to limit the damage done to global inventories by lower supply. The quarterly stock and the monthly WASDE report by the USDA are reiterating the critical conditions of US grain inventories. The softs, on the other hand, should remain under pressure due to ample South American production and export activity. That said, the sub-sector already weakened quite a bit, which will limit the downside in the short run and we remain neutral. UBS For further information please contact CIO's asset class specialists Dominic Schnider, or Giovanni Staunovo, 30 Please see important disclaimer and disclosures at the end of the document. EFTA01089712 Precious metals Gold (24 Oct): USD 1,702oz (last month: USD 1,764/oz) Recommendations Preference: neutral 1 UBS View (gold) Gold 6-month target: USD 1,8751oz Tactical (up to 6 months) • Although it is possible for gold to test its • So far we saw inflows into gold of around 4 million ounces via physically backed ETFs since Bernanke's all-time high in the next three months, we speech at Jackson Hole. We expect this trend to continue and to lead to an undersupplied market, with are aware that the metal has already financial demand also finding its way into gold futures and physical gold bars and coins. appreciated firmly ahead of the QE3 • Additional demand support comes from central banks, which are likely to further increase their foreign announcement, which requires an ever reserve allocation to the yellow metal. At the same time the drag from India's jewelry demand is set to fade growing amount of investment demand with an already lower base in 2H11 and a stabilizing Indian rupee. to hold the current upward trajectory. • Securing sufficient investment demand to push prices sharply higher is different from securing the Strategic (1 to 2 years) needed demand over a long period of time, and along these lines we see less support for the price over a 6- • To protect investors' portfolios from month perspective. Secondly, from a portfolio perspective we currently prefer to take some risk off the unorthodox monetary policy measures, table instead of on, and we thus maintain our neutral stance on gold. holding gold exposure is a viable and attractive strategy. Alternatively, we 71 Positive scenario 6-month target: USD 2,2501oz recommend palladium as well as • Unorthodox monetary policy measures by the Fed start to weaken the USD persistently. Moreover, the platinum. Structural supply issues with risk of a Eurozone breakup intensifies, which triggers a tidal wave of investment demand for gold. regard to platinum and a reduction in II Negative scenario 6-month target: USD 1,450/oz Russian stock sales of palladium speak in • A hard landing of China and India or the Fed backing off from the recent monetary policy favor of PGM exposure, despite higher volatility. announcements would be a key drag on the yellow metal. The latter would have the strongest impact. What we're watching Why it matters Money created per hour (in mn USD) Physical demand/supply In the months ahead, with the festive season in India starting and monsoon activity having improved considerably, supporting rural incomes, Indian physical demand is likely to pick up. Key dates: World Gold Council mid- November release. Mining activity in South Africa is unlikely to return to normal in the coming months. Hence, we are closely tracking mining news from South Africa, including the aggregated PGM IP numbers to assess the overall situation. Investment flow In order to see the gold price reaching our target, investment inflows into physically backed ETFs need to continue. To gauge investor interest in gold US0 11 Wu. WrgV god read rigued al LISO ?MAU) Monetary policy (sector) a build-up in futures positions is likely to materialize as well. hn Key dates: 2 Nov US payrolls; 8 Nov ECB meeting, 12 Dec Fed meeting Source: WGC, Bloomberg, UBS, as of Oct. 2012 Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialists Dominic Schnider, or Giovanni Staunovo, 3S Please see important disclaimer and disclosures at the end of the document. EFTA01089713 Energy Brent (24 Oct): USD 109/bbl (last month: USD 111/bbl) Recommendations Preference: neutral 1 UBS View (crude oil) Brent 6-month target: USD 105.110/bbl Tactical (6 months) • Growing fear over an escalation of the Syrian civil war, involving Turkey, allowed crude oil prices to move • OPEC is in a good position to balance the higher again. While Syria's crude oil exports already dropped to near zero due to international sanctions, oil market, which should limit the price the oil market's concerns relate to the Kirkuk-Ceyhan oil pipeline (Iraq-Turkey - capacity of 0.4mbpd) and weakness. Along with central banks' the crude exports from the Turkish port of Ceyhan, around 70km from the Syrian border. support and with the geopolitical risks • Though we believe that Syria and Turkey are not interested in a military confrontation, a stop of crude oil remaining, we believe that the potential flows from Iraq via Turkey would curb global incremental crude oil supply in 4Q12 by more than 50%. It downside for the oil price has declined, would also tighten up the market balance in early 2013 and put additional pressure on the structurally low thereby warranting allocation. spare capacity in the crude oil market. • In the absence of a further escalation, which remains our base case, ebbing news related to Syria-Turkey is Strategic (3-5 years) likely to ease supply concerns. This should keep the market focus on weak demand growth and strong • We regard the long end of the forward crude oil output from North America, allowing the Brent price to temporarily reach USD 95/bbl. curve in crude oil as mispriced. To satisfy • A weaker USD, reduced economic tail risk for Europe, ongoing social turmoil in the Middle East and emerging market demand in the long run, North Africa and the risk that the Iranian topic heats up again after the US presidential elections are likely prices around USD 90-95/bbl are unlikely to keep the Brent price around USD 105-110/oz in 6 months. to secure the needed investments to keep supply growing adequately. This gives A Positive scenario Brent 6-month target: USD 140-180/bbl strategically oriented crude oil investors • Iranian oil exports are subject to a complete embargo, which would drain another 0.5-0.75 mbpd of the opportunity to build up some long- global crude oil supply. Alternatively, a military confrontation that affects crude oil supply via the Strait of term crude oil exposure over the next Hormuz would be the ultimate supply shock, requiring crude oil to be rationed on a large scale. three to five years. NI Negative scenario Brent 6-month target: USD 75-80/bbl • Political tensions lead to a breakup of the Eurozone or intensify the economic contraction. At the same time, the Fed is not successful in promoting growth. Supply-wise, a restoration of Iranian exports and no Petroleum demand in selected markets supply cuts by OPEC would push oil inventories firmly up and weaken Brent prices towards USD 80/bbl. Year-on-year change - in mbpd 1.2 What we're watching Why it matters 0.8 Alm- The biggest risk related to a potential military confrontation is an Israeli air strike 0.4 ic rigg ci OO OO Iran tensions on nuclear facilities in Iran. A preemptive strike could easily destabilize the region 0.0 even further and threaten global crude oil supply. MI7 -0.4 Changes in the US gasoline blending mandate with ethanol (made from corn) -4: ;Ice I; Supply -0.8 o' might fuel higher crude oil prices as spare capacity increases slides further. SI) c V in US crude oil supply progress (room to grow by 1.3 mbpd from 2011 to 2013) is a 47. Oa a V n3 _c • • •O- vital offsetting factor to supply outages seen in the MENA region. 3 L9 Demand Most of China's demand growth seems to be related to stock building (strategic • 2012E •2013E and by refineries). If this is true, the import should stay on the weak side y/y. Oil market reports Key date: 13 Nov, IEA Oil market report Source: UBS, as of Oct. 2012 Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialists Dominic Schnider, or Giovanni Staunovo, 36 Please see important disclaimer and disclosures at the end of the document. EFTA01089714 Base metals Current (24 Oct) (last month): Copper USD 7,81S/mt (8,271); Nickel USD 16,336/mt (18,351); Recommendations Preference: neutral 1 Aluminum USD 1,912/mt (2,079) Tactical (6 months) UBS View 6-month target: Copper. USD 8,800/mt Nickel: USD 19,000/mt; Aluminum: USD 2,100/mt • We reiterate that the strong uptick in • After the swift uptick in prices, base metals have been under renewed pressure. The initial price strength base metal prices is skating on thin ice, in - a simple catch up with Chinese prices triggered by a shift in demand expectations - is losing strength. our view. Real activity has yet to follow • In order to continue the price rally, a firm increase in final metal demand is needed. Since global and support prices over a longer time economic growth is far from seeing such a demand uptick in industrial activity during 4Q12, we think that period. 50% of the upside potential on a prices are likely to trade only sideways in the coming months before trending higher in 1Q13. 6-month horizon is likely to be behind us, • Loose monetary policy is a good precondition for activity to pick up, but not a guarantee after so many making only copper and nickel attractive, rounds of monetary stimulus. We therefore look east to China. Although industrial activity growth in China is likely to bottom out, the upcoming leadership change in the country (November 2012 to March 2013), with +10% expected return. will likely delay a bigger investment program into 1Q13. The latest stimulus program will probably prevent Strategic (2 years) Chinese IP from decelerating even further, but will not lift it meaningfully higher. • Although the strongest performance • On a single commodity level, we favor copper and nickel. For nickel, short-term supply issues due to a should be visible in zinc and lead, with slower ramp up of new and existing projects have temporarily brought the market closer to balance than existing mine capacity expected to peak initially expected. Furthermore, we should see higher Chinese stainless steel demand with stabilizing in 2014/15, the recent price strength housing activity and a demand pick up in stainless steel related products. makes such an investment unattractive • With regards to copper, we expect import activity to remain strong, as seen in the import figures for now, based on timing. Given a September. Overall, the copper market should remain undersupplied, which could widen if financial structurally solid supply side, investors demand is finding some store of value in the metal. We think this puts structurally low LME inventories at should avoid aluminum and nickel. A risk and should push the metal price towards USD 8,800/mt or higher over six months. firmer supply side should also limit the 71 Positive scenario upside in copper. • China eases monetary policy aggressively, pushing credit growth to 20% y/y. In the US the Fed is able to lift GDP growth via QE3 and the ECB puts an effective backstop to declining industrial activity. Net speculative copper position at Negative scenario Comex are far from being overstretched • To passive Chinese authorities keep GDP growth on a constant deceleration path. A severe escalation of 80 the Eurozone crisis (room for a break-up) triggers a setback in investment activity — including in Germany. In thousand contracts 60 40 What we're watching Why it matters 20 China's growth deceleration should come to an end. But hard economic activity 0 Demand indicators, especially for China, have yet to catch up with the increase in prices. (20) Hence, the current base metal market is already reflecting considerable growth (40) goodwill that is in need of a demand confirmation by China, the US or Europe. (60) Copper output continues to undershoot market expectations and should be (80) Supply watched closely, as investment activity in mines increased sharply. For zinc, Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11 prospects for mine closures have been delayed and should keep the market Long positions Short positions — Net long position oversupplied. Economic data/forward Chinese economic data — trade data, CPI, IP and loan growth by financial Source: Bloomberg, UBS, as of Oct. 2012 curve Note: Past performance is not an indication of future returns. institutions. Key date: 10-15 Oct UBS For further information please contact CIO's asset class specialists Dominic Schnider, or Giovanni Staunovo, 37 Please see important disclaimer and disclosures at the end of the document. EFTA01089715 Agriculture Current (24 Oct) (last month): Soybeans, USD 15.17/bu (16.12); Corn, USD 7.54/bu (7.44); Recommendations Preference: neutral 1 Wheat USD 8.84/bu (8.87) Tactical UBS View 6-month target: Soybeans: USD 17.0/bu; Corn: USD 9.0/bu; Wheat USD 9.5/bu • Despite the recent setback in corn prices, • Major US supply surprises on the grains side are rather unlikely in the near term as harvesting is in full risk-seeking investors should still hold on swing. However, we think that demand is unlikely to drop as quickly as the USDA expects. According to the to long positions in corn. Demand latest USDA grain stocks and WASDE reports, feed demand remained surprisingly resilient in 3Q12. To rationing is still required to limit the drag effectively ration demand, especially on the feed side, in an environment of critically low US corn and on inventories. The expected return soybean stocks, higher prices are still required. For wheat, global production estimates were further target for a long position in corn stands lowered due to production losses in Australia, EU, Russia for 2012/13, which likely keeps prices supported in at 15%. the near term. We expect corn and soybean prices to appreciate by 15% in the coming months. Strategic • On the other side, the sorts are likely to remain well supplied, which should keep prices under pressure. • Our expected return outlook for grains Improved export activity of coffee and strong stock selling from Vietnam in 4Q12 should weigh on coffee stands at around -10% over the next 12 prices in the short-term. For sugar, higher production from Brazil and other producers should continue to months. With grain prices not far below burden prices in the near term, but also offer buying opportunities on a 12-month perspective. historical highs, the supply side is highly • Aggregating the above points, the risk/reward for being long across the entire sector is not a given. We likely to expand meaningfully in 2013/14 and pressurize prices at a later stage. On therefore reiterate our neutral sector stance. the soft side, 3Q12 does not offer the 21 Positive scenario Corn 6-month USD 10/bu; Soybeans 6-month USD 19/bu right timing to build up positions. • With a reduced probability of El Nino, the yield potential for South American crops is likely to be lower. Any deterioration in South American supply prospects would require additional demand to be rationed. NI Negative scenario Corn 6-month USD 6/bu Soybeans 6-month USD 12.5/bu US grains stocks continue to drop, • A change of the US ethanol-gasoline blending mandate would be a game changer. Increases in planted demand remains resilient acreage combined with a steep decline in US demand for exports and feed would weigh on prices. Values in mn tons so Lt. What we're watching Why it matters 70 60 Revisions in acreage and yield estimates for the US crops remain a topic. Demand 50 USDA WASDE report estimates are important, too, as they are key drivers behind inventory levels at 40 (monthly) 30 the end of the year. Key date: 9 Nov 20 The latest stocks data is not correctly reflecting the demand for Jun-Aug'12 as it 10 US grains stock report 0 contains both old and new crop stock figures. We expect stocks as of 1 Dec to lst Sep'10 1st Seel' 1st Sep'12 Jun- Jun- Jun- (quarterly) reflect the true demand picture. Key date: Jan 2013 Aug'10 Aug•I I Aue'12 USDA crop progress Faster US grain harvests than usual have been exerting downward pressure on Stodts Demand • Corn aWheat O5o)13ean (weekly, Monday) prices in the short run, which have reversal potential at a later stage. Source: USDA, UBS, as of Oct. 2012 COT (weekly, Friday) Investors' net long positions in grain futures are still at high levels, but stable Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialists Dominic Schnider, or Giovanni Staunovo, 38 Please see important disclaimer and disclosures at the end of the document. EFTA01089716 Listed real estate Preference: neutral UBS Global Index DTR (24 Oct): 1,490 (last month: 1,500) Recommendations UBS View UBS Global Index DTR (6-month target): 1,600 Tactical (6 months) • Since July global listed real estate has again performed well. Despite the good performance the asset class • We continue to be neutral global listed remains slightly attractive based the high dividend yield and implied property yield compared to bonds. real estate recommending to have Asia has been the strongest performer and Europe has outperformed the US year-to-date as tail risk was exposure to the Hong Kong, Singapore reduced by the ECB launching the OMT. QE3 is not an imminent performance driver but provides a support and Australia markets. The asset class is for capital values going forward and helps to keep interest levels low. overall slightly attractive on relative • Due to the current search for yields, listed real estate companies are able to refinance their investments at valuation and the current low interest lower yields with longer maturities. The implied property yields to bonds and earnings yields over five-year rate is supportive, but the uncertain swap rates are even more attractive due to low interest rates offering good opportunities within the global real estate space. environment warrants a neutral stance. • Low to decent supply of commercial surfaces helps to push vacancy rates down which in turn increases Strategic (1 to 2 years) the rent. We further see capital appreciation as possible in the light of overall stable fundamentals. • Real estate is supported by several factors • Asia remain the positive performance generators in our view as this is the more cyclical market, whereas in the long term. We anticipate a gradual Australia is supported by high dividend yields. Overall Europe remains comparatively weak, while the UK increase in payout ratios coupled with and the US have already priced in some market improvements. portfolio optimizations and ongoing cost- cutting. A weak economy limits strong 70 Positive scenario UBS Global Index DTR (6-month target): 1,650 rental growth, but low supply supports • Improving fundamentals maintain listed real estate in fairly valued territory, despite stronger high occupancy rates keeping rents up. performance as occupancy rates grow faster than expected and rental income accelerate. Ongoing reflationary monetary policies across the world help to maintain favorable spreads between rental yields and bonds, maintaining real estate as a comparatively attractive asset class. Refinancing costs remain low. Preference (6 months) 11 Negative scenario UBS Global Index DTR (6-month target): 1,300 Our market preferences for listed real estate• • US, European and Chinese growth rates disappoint investor expectations and cause the comparatively high valuation levels in the US to partially correct. Furthermore, a more severe recession in Europe triggers - neutral +4 a tightening of credit standards and cuts real estate companies from the capital market, making listed real North America estate more dependent than ever on bank financing. Real estate underperforms global equities. Cont'l Europe Note: Scenarios refer to global economic scenarios (see slide 7) UK What we're watching Why it matters Japan Corporate bond yields This is one of the best indicators for listed real estate as a low yield helps reduce Hong Kong financing costs. A steep yield curve is furthermore a signal that the overall economic environment is improving. Both are currently supportive. Singapore Rental yield and capital The rental yield is usually inflation linked, as the upcoming supply is currently low Australia appreciation this pushes up the occupancy rates and thus increasing the rents. Capital Old • New appreciation is expected to be stable to positive. Overall are both supportive. This is our relative preference within the global real estate sector based on UBS Global Real Estate Index domestic total Credit markets and Lending conditions are still challenging for developers and private investors. return, which is not the overall sector view financing costs Public companies by contrast have very good access to credit and capital. Source: UBS, as of 16 October 2012 Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialist Thomas Veraguth, 39 Please see important disclaimer and disclosures at the end of the document. EFTA01089717 Hedge funds UBS View Prefer Relative-value and Event-driven Recommendations • We expect hedge funds (HF) to offer positive asymmetric return characteristics due to active risk Strategic (1 to 2 years) management and stop-loss strategies. On the active risk side of the equation, we have seen lower gross • Recommendation: Active risk exposure and net-market exposure within the overall hedge funds group, with traders being cautiously management is instrumental for capital positioned. With systemic risk at bay, we favor relative-value (RV ) and event-driven (ED) strategies. preservation during adverse market • The inherent hedging in relative value is appealing. Credit relative-value managers should perform well conditions. At the moment, we therefore in this environment of higher fixed-income volatility and increasing pricing anomalies created by central favor relative-value and event-driven bank interventions and limited competition. strategies, since they are less correlated to • While ED managers share some of the performance drivers, idiosyncratic bets reduce the correlation to markets. The real reason to own this strategy, however, is the potential for outsized returns in distressed, equity markets and other risky assets than high-yield, and other credit investments as the Eurozone crisis plays out. trading. • Value proposition: Hedge funds should 71 Positive scenario Prefer Equity long-short achieve robust performance over an • Reduced uncertainty (e.g. resolution in Europe) lowers equities' correlation and volatility. This helps extended horizon, while displaying bottom-up fundamental analysis and equity long/short managers the most. Also, CEOs will likely make limited volatility vis-à-vis equities and more corporate transactions that can be monetized by event-driven managers, and a clearer other risky assets. Hedge funds try to macroeconomic environment with more persistent trends would support CA managers. minimize downside losses in adverse SI Negative scenario Prefer Trading (Global Macro + CTA) market conditions (e.g. active risk • So far this year, the market has remained plagued by short-term reversals, due to central banks' management), which plays a crucial role in intervention and stimulus effects, an obstacle for trend-following managers. Still, if the European wealth appreciation. Similarly, hedge fund deleveraging (or fiscal cliff, China hard landing) is unmanaged, this could threaten risky assets. Trading managers attempt to capture most of the can do well if such a scenario unfolds. upside of risky assets owning to valid Note: Scenarios refer to global economic scenarios (see slide 7). value preposition. What we're Why it matters Performance, year-to-date watching Global equity direction/ The outlook for global equities is an important HF performance driver. The economic cycle economic cycle impacts the strategies differently. Correlation Correlation is an important performance/alpha driver for equity long/short, the largest HF strategy by assets under management. Leverage Gross and net leverage are key to monitoring risk. Volatility The direction influences certain HF strategies (e.g. convertible arbitrage). Liquidity Important in particular for large, less nimble HFs, it enables them to enter and exit their strategies. Source: HFRI, UBS, as of 31 Sep 2012 Regulation Volcker rule, USCITS III/IV Note: Past performance is not an indication of future returns. UBS For further information please contact OO's asset class specialist Cesare Valeggia, 00 Please see important disclaimer and disclosures at the end of the document. EFTA01089718 Private equity Prefer small-/mid-cap buyouts in US/emerging markets; Recommendations UBS View distressed debt in Europe Strategic (1 to 2 years) • In Europe, the ongoing deleveraging has • Global volume has continued its downward trend since Q4 2010, falling by -20% quarter-by-quarter led to attractive opportunities for special in Q3 2012, with a drastic decline in Europe of -46%, the third lowest quarter since 2001. However, private situations. We thus recommend pursuing equity withstood the negative environment as global activity grew by +13% in Q3, and the US posted less liquid investment strategies with a its strongest quarter since Q3 2007. The importance of private equity in emerging markets continues to preference for debt to benefit from the grow, now accounting for 13% of global activity, strongly driven by Asia, but increasingly also by Africa. macroeconomic adjustment process and • We prefer buyout strategies in North America, given reasonable valuations, liquid debt markets and our selling pressure for many European banks. house view of economic outperformance vs. Europe. Emerging markets offer compelling opportunities for • We prefer small-/mid-cap buyouts in North PE investors, especially outside the main hubs (China, Brazil), which have become expensive. Distressed America given the better economic strategies which focus on acquiring complex illiquid loan positions from banks in Europe are also attractive. outlook vs. Europe, higher transaction certainty and more attractive entry prices. a Positive scenario Prefer small-/mid-cap buyout and secondaries • Investors looking for downside protection during economic uncertainty can consider • An abating Eurozone debt crisis and improved business confidence would increase deal flow and exit large-cap buyouts in the US, which offer opportunities for private equity managers, but would also increase entry prices. In such a positive scenario, exposure to large, diversified companies we would perceive commitment strategies to secondary funds as attractive for building exposure to an at more attractive prices and are invested private equity portfolio. supported by liquid debt markets. Negative scenario Prefer distressed debt • We advise investors make an ongoing • A renewed escalation of the debt crisis would significantly impact deal activity, the availability of debt allocation to private equity in emerging and company owners' willingness to sell. At the same time, it would offer even more attractive markets, which offer an attractive way to capture superior long-term growth and opportunities within distressed strategies and lower entry prices for long-term private equity investors. gain access to small-/mid-cap companies Note: Scenarios refer to global economic scenarios (see slide 7) unavailable on the stock market. What we're watching Why it matters The US has seen its strongest quarter since Credit markets In HI 2012, leveraged loan issuance, an important ingredient of PE activity, Q3 2007, while sentiment in Europe remains dropped 17% y/y in the US, but over 41% in Europe. The US debt market is weak se much deeper than Europe, raising over EUR 153bn of leveraged debt, while 40 Europe achieved only EUR 16bn in 1H 12 at less attractive conditions. i Exit activity Exit activity is an important indicator for the health of the PE market and a key y return driver for investors. Despite the difficult macro environment, 3 0 distributions from portfolio sales (USD 69bn) have held up, and grew 20% yoy. 01 02 03 OA 01 02 03 01 01 Pt 03 MO NW 3051 1070 2011 2011 2011 20.. 2012 2012 2011 Sector activity Transactions in consumer discretionary and in energy & utilities remain the —N “ruga, Pa* most preferred sectors for private equity investors in 2012. Source: S&P, UBS CO. as of October 2012 Note: Past performance is not an indication of future returns. UBS for further information please contact CIO's asset class specialist Stefan Bragger, Please see Mpcgtant disclaimer and disclosures at the end of the document. 41 Note: We emphasize the equal importance of fund manager selection and the commitment strategy. Please note that private equity is an illiquid asset dais and must be held at least until the end of the fund (10. years). Please note that UBS might not have a product available which reflects our UBS CIO private equity recommendations. Private equity is only suitable for qualified investors (a USO Sm investable assets). EFTA01089719 Contact list UBS WM Global Chief Investment Officer Alexander Friedman UBS WM Head of Investment Mark Haefele UBS WM Global Investment Office Themes / UHNW Asset Allocation Advisory Asset Allocation Discretionary Alternative Investments Simon Smiles Mark Andersen Mads Pedersen Andrew Lee Kiran Ganesh Karsten Ba er Christophe de Montrichard James Purcell Achim Pei-an Walter Edelmann Christopher Wright Philipp Schöttler Markus Urn artin er, CFA Oliver Malitius Matthias Uhl UBS WM Regional Chief Investment Officers (CIO) Regional CIO Asia-Pacific Regional CIO Europe Regional CIO Asia-Pacific (South) Regional CIO Emerging Markets Regional CIO Switzerland Andreas Höfert Yon hao Pu Kelvin Ta Jor e Mariscal Daniel Kalt UBS 42 EFTA01089720 Disclaimer UBS CIO WM Research is published by Wealth Management & Swiss Bank and Wealth Management Americas, Business Divisions of U8S AG (U8S) or an affiate thereof. h certain counties UBS AG is referred to as UBS SA. 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