EFTA01089722

For marketing purposes only UBS CIO WM Global Investment Office External Version CIO monthly video For smartphone users: scan the code with an app like "scan" UBS CIO Monthly Extended July 2012 Published Please see important disclaimer and disclosures at the end of the document. The content of this publication reflects the view of UBS Wealth Management & Swiss Bank's Chief Investment Office (ao). The relative asset 29 June 2012 class preferences in this publication refer to an investment horizon of 6 months following the publication date - if not indicated differently - and will be updated on a monthly basis. The preferred investment themes have a time frame of either 3-12 months or >12 months since inception, as indicated. The information does not constitute UBS financial research and therefore may not reflect or be fully aligned with the views of UBS Research expressed in other publications. The statutory regulations regarding the independence of financial research are not applicable to this publication. Investments may be subject to jurisdictional and regulatory restrictions and may therefore not be available - please discuss the availability and appropriateness of specific investments with your client adviser. EFTA01089722 Table of Contents Section 1 Base slides 3 Section 2 Asset class views 12 2.A Equities 13 2.B Fixed income 23 2.0 Foreign exchange 30 2.D NTAC: Commodities, Listed real estate, Hedge funds and Private equity 34 t EFTA01089723 Section 1 Base slides *UBS EFTA01089724 Summary "With the global • Economy The successful formation of a Greek government after the June 17 elections has reduced economy the risk of an imminent Greek exit from the Eurozone. However, the Euro debt crisis continuing to persists, and further reform and consolidation efforts in Spain and Italy are needed. In the US, economic data weakened recently, but it remains in line with our forecast of moderate muddle through, growth of around 2% in 2012. The Fed extended "Operation Twist" until the end of the year and is ready to do more if the economic situation deteriorates materially. Meanwhile, we believe that Chinese activity data is showing signs of stabilization and inflation remains low. We expect US corporate the Chinese economy to gradually pick up in the second half of 2012. bonds offer the • Equities Despite our relatively positive outlook for US and Chinese economic growth, ongoing best risk return." Eurozone issues keep us neutral on global equities. We think US companies are better positioned than their European peers, and thus keep our longer-standing preference for US equities. US earnings are relatively robust and the recovery of the domestic economy continues to support revenues. Furthermore, we keep a moderate overweight in emerging market (EM) equities as valuations are attractive and we expect growth to accelerate in the second half of the year. In the near term EM currency weakness remains a risk factor. • Fixed Income High grade government bond yields remain extremely low due to ultra-expansive monetary policy and ongoing investor concerns over global growth. While we expect yields to only rise very gradually in the near term, we continue to see better investment opportunities in other fixed income segments. US high yield remains our favorite asset class, given attractive valuations and a favorable default outlook. We also keep our overweight recommendations on investment grade and EM bonds. • Commodities We avoid broad commodity exposure as we see further price weakness ahead. While the worst of the oil sell-off is likely behind us, we see no reason for higher prices in the near term and expect roll costs to weigh on positions. • Foreign Exchange In light of the ongoing Eurozone troubles, we continue to prefer the US dollar over the euro. We also prefer the Canadian dollar, given its relatively good growth dynamics, a possible rate hike, and relatively high short rates. UBS 3 Please see important disclaimer and disclosures at the end of the document. EFTA01089725 Cross-asset preferences Most preferred Least preferred Portfolio weights • US • Europe Commodities 3% Liquidity Real Estate 10% • Western winners from EM Hedge Funds/ 5% High Grade Bondf growth private Equity 10% 6% • High quality dividend yields My Grade Equities • Event-driven and relative value Corp0rateS seitrihta USA Bonds 9% hedge funds 10% High Yield • Natural gas growth gainers Bonds 6% Emerging Markets Bonds Levities 6% Europe • US high yield • Developed market 20% EmMa Equities Equities Other 9% • Global investment grade credit government bonds 6% Fixed income • Event-driven and relative value hedge funds Note: Portfolio weights are for an advisory • EM corporate bonds client with a "EUR moderate" profile. For portfolio weights related to other risk profiles • USD • CHF please contact your client advisor. • GBP • EUR • CAD • Agriculture Commodities • Energy $ Recent upgrades ta Recent downgrades UBS 4 Please see important disclaimer and disclosures at the end of the document. EFTA01089726 Reference portfolio Tactical asset allocation deviations from benchmark* Currency allocation underweight neutral overweight underweight neutral overweight Cash USD Equities total EUR US GBP Eurozone JP‘f UK 3 CHF cr Japan Switzerland SEK EM NOK Other CAD NZD Government bonds -a AUD c Corporate bonds (IG) High yield bonds • new old EM bonds (USD) Commodities total Precious metals Energy * Please note that the bar charts show total portfolio preferences and thus can Base metals be interpreted as the recommended deviation from the relevant portfolio Agricultural benchmark for any given asset class and sub asset class. Listed Real Estate Also note that the implementation in advisory or discretionary products might slightly deviate from the 'unconstrained' asset allocation shown above, ■ new old depending on benchmarks, currency positions and for other implementation Source: UBS CIO considerations 4re UBS Please see important disclaimer and disclosures at the end of the document. EFTA01089727 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 models Developed world government bonds offer a comparatively small cushion that pay sustainable dividends offer an attractive income stream in a against future interest rate hikes and many face increasing credit risk. We low yield world. Historically, dividends have made a substantial expect select bonds of supranational or national agencies, sub-national contribution to total returns, and we expect this to remain the case in governments, multinational corporates, and covered bonds to the current environment. outperform 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 Asian economies are also well positioned to continue to outpace their balance sheets provide support to US high yield corporate bonds. Current Western peers in the years ahead. We have identified companies from a yield spreads of roughly 660 basis points still price in a much more dire variety of sectors in Europe, the US and Japan which have significant economic outcome than we expect. Historically, US high yield bonds have exposure to the rapidly growing emerging regions. We believe a delivered similar returns to US equities with lower volatility. We continue diversified portfolio of these companies will reward investors seeking to believe that US high yield corporate bonds represent a more favorable to profit from the robust demand growth in emerging economies. risk/return potential than equities and expect total returns of • Natural gas growth gainers approximately 7% over the next 6 months. 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 Recent economic data has shown signs of improvement, but growth in long term. We have examined the dynamics of the global market and most developed markets remains muted. In this environment, less the various components of the gas value chain, and identified the areas directional hedge fund strategies, such as relative value and event driven, we see as the most significant beneficiaries currently. These include should offer above average returns. producers in Europe and Asia, suppliers of infrastructure, services and related machinery, and Master Limited Partnerships (MLPs) in the US, • EM corporates: a growing asset class (sourced from global that offer both attractive yields and growth. government bonds - CIO UW) Given our relatively constructive current view on risk, we regard EM corporate debt as more attractive than EM sovereign debt due to its higher overall yield. Over a 6-month horizon, we expect EM corporate bonds to outperform US Treasuries and deliver total returns of close to 8% p.a. cat UBS 6 Please see important disclaimer and disclosures at the end of the document. EFTA01089728 Global economic outlook - Summary Key questions Global growth expected at just under • Can emerging markets (EM) continue to offset developed market (DM) weakness to buoy global 3% in 2012 growth? Kest GDP growth in '- 2011 20121 2013F 2011 20121 20131 • What are the risks of near-term faltering of the US economic recovery? America US 1.7 2.1 2.6 3.1 21 1.7 • When is the European economy likely to return to sustainable economic expansion? Canada 2.4 2.1 2.4 2.9 2.1 23 wan 2.7 2.0 9.8 65 52 65 Allaolractik Japan 2.5 2.0 -0.3 0.2 05 CIO View (Probability: 60%*) alraI 2.1 3.7 3.5 3.4 1.6 25 Dina 92 8.2 0.5 5.4 3.0 4.0 • Global economic activity remains moderate; the growth impulse stems largely (some 80%) from the EM bide 6.5 6.0 7.0 7.8 69 7.0 region. As expected, China started to ease monetary policy. The country is better placed than other EM Europe Eundone 1.5 -0.4 0.4 2.7 2.3 2-0 Gonnany 3.1 IA 1.1 2.5 1.7 IS and particularly DM countries to counter growth weakness with further monetary and fiscal stimuli. Thus, Nate 1.7 0.3 0.4 2.1 2.5 22 we expect EM growth to stabilize soon and pick up in 2H 2012. tatr 0.5 •18 0.2 2.9 3.4 3.9 Spain 0.7 -1.6 -1.3 3.1 1.9 1.9 • US economic indicators have on balance been disappointing recently, especially data related to business UK 0.7 02 1.3 9.5 2.8 1.9 fixed investment and employment growth. Thus, we lowered our 2Q 2012 real GDP growth forecast to an Switzerland 2.1 1.3 1.7 0.2 -0.4 t.4 Rum 43 3.8 3.7 8.5 9.5 69 annualized rate of 1.5% from 2%. We still expect growth slightly above 2% in 2H 2012. We think that the World 32 2A 3.3 3.9 3.0 3.0 risk that the Fed will take measures in addition to the extension of "Operation Twist" is still significant. Source: UBS CIO, as of 28 June 2012 • Large parts of Western Europe are in recession or stagnation. We expect the economies of the Eurozone In developing the OO economic forecast. CIO economists and the UK to show mild improvement in 2H 2012. Still, economic activity is likely to remain very sluggish worked in collaboration with economist employed by UBS Investment Research. Forecasts and estimates are current despite support from lower oil prices and less rigorous fiscal austerity. The Bank of England may support only as of the date of this publication and may change the UK economy by increasing its amount of bond purchases soon. The probability that the ECB will take without notice. further action to support the economy has risen significantly. Global economic momentum is X Positive scenario (Probability: 15%*) deteriorating (UBS GDP tracker) • The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity. 14 95 12 • Growth in Western Europe is marginally positive (Eurozone stagnates) in 2012 and the US economy May 10 grows moderately above trend. 8 6.3% Negative scenario (Probability: 25%*) 6 4 • There are three key downside risks to the global economy: 1. a significant escalation of the Eurozone 3.1% 2 debt crisis; 2. a sharp fiscal contraction in the US, and 3. a sharp deceleration of the Chinese economy. Each 0 1.0% one of these risks could precipitate a significant downturn of the global economy. .2Jan Jan Jan Jan Jan Jan Jan Jan .4 OS 06 07 08 10 11 12 13 Key dates •6 —Global —DM — EM• 2 July USA: ISM manufacturing PMI for June Source: Bloomberg, UBS ao, as of 22 June 2012 5 July Eurozone: ECB press conference • DM= developed markets, EM = emerging markets 24 July Eurozone: purchasing managers indices (PMI), July estimates Note: Past performance is not an indication of future returns. 22-25 July China: HSBC flash manufacturing purchasing managers index (Jul) ••scenario probabilities are based on qualitative assessment. UBS For further information please contact CIO economist Dirk Faltin, 7 Please see important disclaimer and disclosures at the end of the document. EFTA01089729 Key financial market driver 1- Eurozone crisis Key questions Bottoming in Eurozone leading • What is the way forward for Eurozone banks? indicators (PMI) in June? • What is the most likely course of events in Spain, Italy and Portugal? 65 • In what direction will the economy and the ECB go? 60 CIO View (Probability: 65%•) Austerity and weak growth 55 • Support for the banking sector is a major political agenda item, and the request for external support for 50 Spanish banks can be seen as the starting point for greater European support and oversight for banks, to 45 be discussed at the upcoming European Council. 40 • Greece's debt remains unsustainable, but the risk of a euro exit over the next six months has diminished 35 after the 17 June elections, which have produced a viable government coalition. The Troika may only 30 accept moderate adjustments to the second Greek package. Portugal is likely to receive an increased 06 07 08 09 10 11 12 bailout package and is unlikely to default in 2012. Progress on reforms and consolidation in Spain and Italy — Manufacturing —Services —Composite is most crucial for the near-term development of the crisis. Risk premiums would rise strongly on any failure to meet deficit targets; we expect bond risk premiums to remain elevated for Spain and Italy over Source: Bloomberg, UBS CIO, as of 21 June 2012 (estimates) the next six months. • Following stagnation in 1Q 2012, economic surveys are commensurate with a quarterly GDP contraction of around 0.3% at present. Business survey evidence points to a general wait and see mode. The risk to the outlook for a stabilization of economic growth in the second half of 2012 is skewed to the downside. The ECB remains on hold, but the bar to support the economy and markets has been lowered substantially. We Yield of Spanish and Italian 10-year see a significant probability of policy action in early July, including the possibility of a rate reduction. bonds over German Bunds (in bps) Despite all the talk about political measures to support growth and increased tolerance for budget 6C0 slippages, there is practically no leeway for fiscal stimuli. The near-term growth impact of any fiscal measure will at best be marginal, in our view. SW 7f Positive scenario (Probability: 15%•) Return to macro stability 41:0 • Bond yields are contained, as peripheral countries' budgets stay on track and economic activity recovers 3120 faster than expected. Greece fully complies with the austerity plans and receives further support. Market confidence is restored, and economic growth stagnates in 2012. 240 11 Negative scenario (Probability: 20%•) Major shock ico • Major shocks could include Spain being pushed into a full IMF/EU program, possibly by a rating cut to junk, enhancing pressure also on Italy; serious political disagreement in core countries (for instance after 0 Dutch elections, etc.); a possible Portuguese default; a Greek euro exit or a major external growth shock. 01/2011 04/2011 07/2011 10/2011 01/2012 0402012 — Italy — Spain Key dates Source: 1)85 CIO, Bloomberg, as of 18 June 2012 5 July ECB press conference Note: Past performance is not an indication of future returns. 9-10 July Eurogroup/ECOFIN-Meeting Scenario probabilities are based on qualitative assessment. 24 July Eurozone purchasing manager indices (PMI), July estimates UBS For further information please contact CIO analyst Thomas Wacker, CIO economist Ricardo Garcia, and 8 Please see important disclaimer and disclosures at the end of the document. EFTA01089730 Key financial market driver 2 - US policy Key questions US moderate growth to continue • Will the economic outlook deteriorate? Will QE3 become necessary? US real GDP and its components, quarter-over-quarter annualized in % • How will the election outcome change fiscal policy deliberations? • Can politicians find an agreement to avoid sharp fiscal contraction in early 2013 ("fiscal cliff")? 8% 6% CIO View (Probability: 65%*) No QE3, political gridlock and some fiscal tightening 4% • The economy stays on a moderate growth path, coupled with stable core PCE inflation close to the Fed's 2% target of 2%. UBS forecasts real GDP growth of 1.5% in 2Q 2012 (consensus: 2.1%) and 2.3% in 3Q 2012 0% 2% (consensus: 2.4%), with some downside risk due to rising uncertainty. The Fed has decided to extend so -4% called "Operation Twist' until the end of the year. More near-term monetary easing is still possible, but it -6% is currently not our central scenario. -8% • In the elections, Republicans will likely lose seats in the House overall, but retain a majority; we also -10% 12% expect them to win a narrow majority in the Senate. Obama will likely retain the White House. Such an Q12036 QI 2007 Q12008 QI 2009 QI 2010 Q12011 QI 2012 electoral outcome would confirm the existing gridlock between Republicans and Democrats. =Consumption • Gemmemai real estate investment =Capitalexpenstoures =Residential investment • Against the backdrop of ongoing political gridlock, we expect only moderate fiscal tightening of about hventonts =Net Exports • Government — Real GDP Mel annual1444) 0.9% of GDP in 2013. The government will likely let unemployment benefits and the payroll tax cut expire, but postpone income tax hikes and sequestration spending. Source: Thomson Datastream, UBS OO, as of 20 June 2012 $ Positive scenario (Probability: 10%*) No QE3, Democratic sweep and more fiscal tightening • Propelled by ultra-expansive monetary policy and improved confidence, cyclical forces surmount the structural hindrances and thus growth accelerates. More rapid growth leads to higher inflation, and the Fed responds by tightening monetary policy sooner. US fiscal cliff at year-end 2012 • The improved economic outlook raises the odds for an Obama re-election and makes it harder for Fiscal effects of change in provisions under current law, USD billion annualized Republicans to win a majority in the Senate. US fiscal consolidation efforts are facilitated by faster rising tax collections. A Democratic stronghold leads to some tax hikes and limited spending cuts. Fiscal policy 1Q13 2Q13 3Q13 4Q13 GYZ013 tightens by about 1.2% of GDP in 2013. -60 -68 -76 -76 -70 N Negative scenario (Probability: 25%*) QE3, political dysfunction and huge fiscal tightening -16 -16 -16 -17 -16 • Structural hindrances dominate and weigh on the cyclical recovery, thus growth weakens or turns -38 -58 -58 -65 -55 negative. The Fed embarks on QE3, most likely in the form of agency MBS and Treasury purchases. -164 -156 -137 -172 -157 • Weaker economic conditions raise the odds for a larger Republican majority in Congress, but Obama 0 -374 -125 -29 -132 remains President. The debt limit is reached earlier and the Treasury runs out of money before year-end. -94 -114 -114 -114 -109 The political gridlock becomes dysfunctional, thus fiscal policy tightens by USD 600 billion (3.7% of UBS -34 -34 -34 -34 -34 estimate of 2013 GDP) in 2013 ("fiscal cliff"). The US credit rating is downgraded. -27 -27 -27 -27 -27 - - 34 40O Key dates Source: Goldman Sachs, UBS OO, as of 20 June 2012 2 July ISM manufacturing PMI for June Scenario probabilities are based on qualitative assessment. 6 July Nonfarm payrolls and unemployment rate for June Note: Past performance is not an indication of future returns. 6 Nov US Presidential and Congressional elections UBS For further information please contact US economist Thomas Berner, 9 Please see important disclaimer and disclosures at the end of the document. EFTA01089731 Key financial market driver 3 - China growth outlook Key questions First interest rate cut since 2008 • When will the economy bottom out? • What economic policy responses can we expect to support the economy ahead? • How significant is the contagion risk from a possible downturn in the Eurozone? CIO View (Probability: 70%*) Modest policy easing to support growth in 2H12 • The latest economic data suggest that economic activity is showing signs of stabilization, albeit at a comparatively low level. However, we have yet to see meaningful pick-up in activity. We think that policy measures to support the economy should have more visible effect on activity in the second half of the 3 year. • To this effect, the People's Bank of China (PBoC) has recently cut interest rates by 25bps - the first such move since late 2008. With investment demand still sluggish, we don't expect the measure to have a significant near-term effect on growth. Still, the cut confirms the leadership's commitment to support the 0 2 3 8 r. co o o economy. Importantly, with the rate cut, measures were announced to increase the banks' ability to set e o • $ k e interest rates, which should bolster private household spending power in the future. .a 5 5 i .a 2 — 1-year lending rate — I -year deposit rate • The rate reduction took place against a backdrop of falling price inflation. Thus, inflation is no obstacle for further measures to ease monetary policy. However, at this point we don't expect further rate cuts this Source: Bloomberg, UBS CIO, as of 18 Jun 2012 year; especially since increased interest rate flexibility should contribute to an easing of monetary conditions ahead. If anything, we think the PBoC may implement more reductions in banks' reserve requirement rates to ensure sufficient liquidity provisions. Thus, we think the real focus has to be on the Pick-up in infrastructure investment fiscal policy measures now, including possibly an acceleration of infrastructure investments, measures to 6: support consumer spending and selective relaxation in the property market (while keeping home-purchase restrictions intact). 50 7; Positive scenario (Probability: 20%*) Higher-than-expected growth 40 Year.on.yeat %, • Chinese GDP grows above 8.5% in 2012. For this we would probably need to see stronger-than-expected 30 fiscal and monetary policy support from the government. A speedy improvement in the Eurozone debt 2C crisis could also lead to this positive scenario. 11 Negative scenario (Probability: 1O%*) Hard landing 10 • Chinese GDP growth 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. Other risks include a sharp decline in Chinese residential property prices —which would slow investment growth, a large-scale default of local 1C government debt, or a surge in inflation that forces the PBoC to significantly tighten monetary policy. 05 06 07 08 09 10 11 12 F xed asset investment —Infrastructure Key dates -Peal estate development -Manu'actv 1 Jul Manufacturing purchasing managers index (Jun) 13 Jul Fixed asset investment, industrial production (Jun), 2Q12 GDP Source: Bloomberg, UBS CIO, as of 18 Jun 2012 11-15 Jul New bank lending, M2 (Jun) Note: Past performance is not an indication of future returns. • Scenario probabilities are based on qualitative assessment. 22-25 Jul HSBC flash manufacturing purchasing managers index (Jul) cat UBS For further information please contact CO analyst Gary Tsang, Glenda Yu, S Patrick Ho, Please see important disclaimer and disclosures at the end of the document. EFTA01089732 Section 2 Asset class views 4 UBS EFTA01089733 Section 2.A Asset class views Equities 4 uss EFTA01089734 Equities overview Preferences (6 months) Global equity markets - Key points • We keep an overall neutral allocation to equities (see summary on slide 3). • The US remains our preferred developed market. The domestic economy is expected to continue to US grow. This should underpin earnings growth for US companies. With labour costs in check, profit margins z Canada should stay around the current high levels. EMU • We keep our overweight position on EM equities. Monetary easing in key countries continues, and Ifi relatively attractive valuations remain key supporting factors. However, near-term economic and currency UK weakness remains a major concern for investors — especially those domiciled in hard currency regions (e.g. Switzerland USD, EUR). Until year-end, we expect some growth acceleration and therefore stay overweight. Sweden • The UK remains a preferred market. It offers a solid earnings outlook compared to other European markets. Moreover, the valuation is attractive at a trailing P/E ratio close to 10. Australia Hong Kong • We keep our negative stance on Eurozone equities. The economy remains very weak affecting earnings growth negatively. The sovereign debt crisis remains a major risk (see page 8). a. Japan • We remain cautious on Australian equities. The earnings prospects are still being revised down by Singapore analysts. The domestic economy is moving at two speeds with the strong part getting its impulse from the mining sector. We maintain a small underweight. Fa Global EM • We keep a moderate underweight in Swiss equities, as valuation looks expensive relative to world • new old equities. The negative earnings impact of the strong Swiss franc should ease further in coming quarters. Note. Preference in hedged terms (excl. currencies) Global equity sectors - Key points neutral ++ • Consumer Staples and Healthcare remain preferred among defensive sectors, as their long-term Consumer Discretionary earnings prospects are very solid. Both sectors also offer strong balance sheets, exposure to favorable demographic trends and emerging markets. Consumer Staples • We keep our negative view on Telecom and Utilities. Both sectors suffer from weak revenue growth Energy as well as margin pressure. Financials • Within cyclical sectors, we keep our preference for IT due to a solid earnings outlook and strong corporate balance sheets. Moreover, we reiterate our neutral allocation to Industrials. Healthcare • Valuations are high and earnings expectations are optimistic for Consumer Discretionary. However, Industrials we reduce our Underweight as we become more positive on the sector in the US. • Following the latest oil price decline and a good relative performance, we have reduced our IT overweight on Energy. However, the earnings outlook remains solid and valuation is very attractive. Materials While Materials are not expensive, we are neutral, as margins remain under pressure. Telecom • The earnings outlook for US and Asian Financials is solid, which leads us to be neutral on Financials from a global perspective. However, we maintain our underweight on Eurozone Financials, where Utilities sovereign indebtedness and bank capitalization remain major concerns. • new old Source: UBS CIO. as of 28 June 2012 UBS For further information please contact OO asset class specialists Markus Irngartinger, or Carsten Schlufter 13 Please see important disclaimer and disclosures at the end of the document. EFTA01089735 US equities Preference: overweight S&P 500 (27 June): 1,332 (last month: 1,319) Recommendations UBS View S&P 500 (6-month target): 1,430 Tactical (6 months) • US firms on average show more resilient earnings than their global and especially European peers. • We have adopted a neutral allocation Modest domestic economic growth supports US companies' revenue and thereby earnings growth. About between defensive and cyclical sectors. two thirds of revenues are generated in the US. • Among defensives, we still like Consumer • While profit margins are slightly higher than their average over the last 30 years, we expect them to hold Staples, while IT is a preferred cyclical up in coming quarters. Pressure from rising wages on margins is rather muted. So company earnings are sectors. We also like Energy. forecast to develop in line with revenues. • We are cautious on Materials, where we • In the next six months, we forecast the price-to-earnings ratio (P/E) of the S&P 500 to rise to about 14.0x expect margin pressure to continue, as realized earnings from slightly above 13.0x currently. well as Telecom and Utilities, due to high • The combination of expected moderate earnings growth and an expansion of the valuation multiples valuations. make the US one of our preferred equity markets. Strategic (1 to 2 years) 71 Positive scenario • We like medium-sized US companies, S&P 500 (6-month target): 1,580 which should benefit from robust • An accelerating US and global economy reduces risks to company earnings. Investors begin to shift funds earnings growth in the long term (see into more cyclical sectors such as Industrials and Materials in light of better growth prospects. In this also slide 21). scenario, we would expect earnings to grow by around 10% in the next 12 months, and the trailing P/E multiple to expand to around 15x. Our sector stance in the US 11 Negative scenario S&P 500 (6-month target): 1,115 Sectors US • The US slides into a recession and corporate earnings fall by around 15% over the coming 12 months. Consumer Discretionary Coupled with an escalation in the Eurozone debt crisis, we would expect the PIE multiple to contract towards 12.0x trailing earnings. Consumer Staples Note: Scenarios refer to global economic scenarios (see slide 7) Energy Financials 4 What we're watching Why it matters Healthcare 4 Business sentiment The ISM is a leading indicator for US manufacturing and services. Key dates: 2 July, ISM manufacturing; 5 July, ISM non-manufacturing Industrials 4 The Fed The direction of monetary policy and hints on further quantitative easing can IT influence equities. Key date: 11 July, minutes from June FOMC meeting Materials Labor market Improvement in the labor market is key for domestic consumption. Key date: 6 Telecom July, US labor market report for June Utilities Earnings reports Earnings season in the US, with 60% of the S&P 500 companies reporting in July. Source: U8S CIO, as of 28 June 2012 Key date: 9 July, Alcoa, first major earnings report in July 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. EFTA01089736 Eurozone equities Preference: underweight Euro Stoxx (27 June): 217 (last month: 215) Recommendations UBS View Euro Stoxx (6-month target): 223 Tactical (6 months) • The crisis in the Eurozone will remain the main driver in the coming months. After the elections in • We continue to recommend defensive Greece, progress on the reform program will be closely monitored. Spain and Italy will also remain in the sectors. We like Consumer Staples and spotlight with levels of government bond yields too high for being sustainable. Healthcare. • With the sovereign debt crisis dragging on we expect the Eurozone market to stay highly volatile in • We also like the Energy sector, where the valuation is very attractive. coming months. • Because of risks stemming from the • Economies in peripheral countries increasingly feel the burden of austerity. The economic weakness sovereign debt crisis, we keep a cautious affects company earnings negatively. Analysts' earnings growth forecasts (consensus) for 2012 have come stance on Financials — especially Banks down to about 3% for this year, but we see this as still too high against the weak economic backdrop. and diversified Financials. • All in all, the ongoing risks stemming from the sovereign debt crisis lead us to the view that Eurozone equities will underperform other major markets. Strategic (1 to 2 years) • For investors with a multiyear horizon, X Positive scenario Euro Stoxx (6-month target): 275 we believe there are attractively valued opportunities in core Europe (see also • Global economic growth reaccelerates and Eurozone growth shows clear signs of bottoming out, slide 21). enabling 2-4% earnings growth over the rest of the year. The trailing PIE ratio could re-rate to 12x from the current reading close to 10x. Our sector stance in the Eurozone JI Negative scenario Euro Stoxx (6-month target): 165 Sectors Eurozone • Europe slides into a deep recession, and the debt crisis leads to severe pressure on Spain and Italy. In a Consumer Discretionary SI major crisis, earnings could fall by 10% to 15% from current levels until year-end, and the trailing PIE ratio Consumer Staples could drop to 8.5x by the end of 2012. Note: Scenarios refer to global economic scenarios (see slide 7) Energy Financials SI What we're watching Why it matters 73 Healthcare Growth indicators Economic growth indicators provide information on the development of a Industrials potential Eurozone recession. Key dates: 2 July, Final PMI manufacturing IT Eurozone, Germany, France for June; 24 July, Flash PMI Eurozone, Germany, France for July; 25 July, IFO business climate Germany Materials Policy action Decisions by European politicians and the ECB affect the course of the debt crisis. Telecom Key dates: 5 July, ECB meeting Earnings season Earnings reports of the Euro Stoxx companies. Key dates: Mid July until mid Source: U8S CIO, as of 28 June 2012 August Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialist Markus Irngartinger, 15 Please see important disclaimer and disclosures at the end of the document. EFTA01089737 UK equities Preference: overweight FTSE 100 (27 June): 5,524 (last month: 5,266) Recommendations UBS View FTSE 100 (6-month target): 5,785 Tactical (6 months) • We continue to like UK equities relative to global ones. An expected improvement in the global economy • We like the Energy sector due to over the coming quarters should support UK companies as 70% of revenues are generated abroad. attractive valuations; Consumer Staples • Energy is the largest sector of the UK market. While the oil price eased sharply over the past months, we is another preferred sector Because of expect it to stabilize in the second half of 2012. An attractive valuation of the energy sector at 6.5x trailing its defensive qualities. earnings provides some buffer for earnings volatility going forward. • Approaching the end of the patent cliff • Profitability of UK banks is reasonable. They are less affected by the sovereign debt crisis than their should remove some uncertainty on the Eurozone peers. While the recent easing of collateral requirements by the Bank of England is supportive in Healthcare sector and enable a re- the short-term, the profitability of the domestic operations could be negatively affected by the rating. implementation of the ring-fencing bank reform by 2015. Strategic (1 to 2 years) • UK equities' P/E, at about 10.0x trailing, indicates attractive value relative to global equities. Based on our • As commodity-related sectors, Energy 12-month forward earnings growth estimate of about 5% and the P/E multiple slightly expanding to 10.3x, and Materials should benefit from we expect UK equities to show good returns over the next six months. robust demand in emerging markets. • The UK market's 4% dividend yield 71 Positive scenario FTSE 100 (6-month target): 6,650 provides a good income stream. • Continued global growth and strong demand from emerging markets should support demand for commodities, helping the Materials and Energy sectors to lead the market higher. The market could re-rate UK market trades at a P/E-discount to a P/E multiple of close to 12.0x, and we would expect earnings growth of 5-8% over 12 months. (based on realized earnings) II Negative scenario FTSE 100 (6-month target): 4,400 • A global recession drags UK earnings down by 15-20%. The market's defensive characteristics would only 30 partly offset its strong exposure to commodity-related sectors. We would expect the trailing P/E multiple to 25 drop towards slightly below 9x. 20 Note: Scenarios refer to global economic scenarios (see slide 7) 15 What we're watching Why it matters 10 Growth indicators Business survey indicators provide information on the economic development in 5 the UK. Key date: 2 July, PMI manufacturing for June; 4 July, PMI services for June; 0 01.90 01_92 01.94 01.96 01.911 01.00 01.02 01.04 01.06 01.0B 01.10 01.12 Commodity prices Energy and Materials together are about 30% of the UK market by market capitalization. Developments in commodity prices affect earnings estimates. — FiSt 100(941:46PA — WatIrmuedM Policy action Loose monetary policy by the Bank of England (BoE) supports equities. Key date: Source: Thomson Reuter; UBS CO, as of 21 lune 2012 05 July, 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. EFTA01089738 Swiss equities Preference: underweight Recommendations SMI (27 June): 5,997 (last month: 5,818) UBS View SMI (6-month target): 6,200 Tactical (6 months) • Swiss listed companies generate a high share of profits in economies outside Switzerland. Consequently, • We favor companies with a strong and the Swiss equity market is affected by the recent weakening in global growth. broad foothold in emerging markets, as • Swiss companies try to mitigate concerns on the global economic prospects by maintaining tight cost well as innovative companies able to controls. This should allow to maintain relatively robust operating margins in 2012. market their products and services • While the Swiss franc remains overvalued, we expect the currency impact to gradually become less of a efficiently and globally. drag. In fact, at current exchange rates, Swiss companies' earnings would show some positive currency • We continue to favor large caps. translation effects by end 2012, compared to the previous year. Strategic (1 to 2 years) • Still, the PE-ratio of the market is relatively high compared to the global average, indicating less • We like stocks paying high and attractive value. The SMI is trading at about 12.8x realized earnings. We are thus more cautious on the sustainable dividends. ability of the market to deliver further multiple expansion in a challenging market environment. As a • Moreover, we favor leaders in regards result, we maintain a small underweight stance on Swiss equities. to the two key Swiss success factors: 'I Positive scenario innovation and globalization. SMI (6-month target): 6,900 • Eurozone economic growth reaccelerates meaningfully, providing relief to Swiss financials as well as Swiss exporters. Defensive sectors would likely be left behind in a relief rally. In this scenario, we would Swiss market trades at a PIE-premium expect the equity market P/E to re-rate to 14x and earnings to grow by 5% over the next six months. (based on realized earnings) JI Negative scenario SMI (6-month target): 5,075 4. • The sovereign debt crisis re-escalates, leading to further downside for Swiss financials and the export- focused Industrials and Materials sectors. In this scenario, corporate earnings could drop by 5-10% over 35 the next six months and we would expect the P/E to contract significantly, toward 11.5x. Note: Scenarios refer to global economic scenarios (see slide 7) 28 What we're watching Why it matters 21 Economic indicators Key announcement dates of domestic economic indicators: 2 July, PMI manufacturing; 27 July, KOF Swiss leading indicator 1,1 Monetary and economic Key Swiss/European monetary policy dates that can impact Swiss equities: 2 July, 7 policy SNB meeting; 5 July, ECB Governing Council meeting 2003 2005 2007 2009 2011 Corporate results Key corporate announcement dates that could move the market: 5 July, Barry — MSCI Switzerland realeed Pit — NISCIWorid realeed ME Callebaut; 12 July, Partners Group; 16 July, K0hne+Nagel; 17 July, Georg Source: Thomson Reuters, UBS CIO, as of 25 June 2012 Fischer & SGS; 19 July, Actelion; 20 July, Sulzer 25 July, Rieter & Lonza; 26 Note: Past performance is not an indication of future returns. July, ABB, CS Group, Logitech & Sika UBS For further information please contact CIO's asset class specialist Stefan Meyer, 7 Please see important disclaimer and disclosures at the end of the document. EFTA01089739 Japanese equities Recommendations Preference: neutral 1 Topix (27 June): 745 (last month: 721) UBS View Topix (6-month target): 780 Tactical (6 months) • The earthquake in Japan and recent • We expect earnings growth of about 45% over the coming 12 months. This exceptional high growth is floods in Thailand have impacted mainly due to the two natural disasters last year, as well as tax regulation changes which caused a Japanese earnings negatively. A recovery number of one-time losses to be booked in the fiscal year that ended in March 2012. from these disasters should benefit auto • In our base case scenario, we see only limited scope for an additional earnings boost from the local and industrial stocks in particular. economic recovery, given the slowing in export markets. Japanese companies are expected to continue • We prefer companies that continue cost their cost reduction efforts to counter the impact of a strong yen. reduction initiatives to maintain price • The Japanese government has started implementing its JPY 18tn recovery budget in 4Q 2011, and we competitiveness during the period of yen expect the budget to boost Japanese GDP by 1-1.5% in FY2012. strength. • Mainly due to the earnings rebound, we expect the TOPIX trailing PIE to drop from around 16.5x to 14x Strategic (1 to 2 years) - 14.5x by year end; still the earnings rebound should provide some room for moderate price increases. • A weaker USDJPY may drive Japanese companies' earnings recovery beyond a A Positive scenario Topix (6-month target): 900 technical recovery from natural disasters. • A rapidly aging population and the lack • Stronger global demand and stabilizing European markets provide an additional boost to earnings, and of a powerful and stable government also lead to improved risk taking. Falling risk aversion is likely to lead to a weaker yen, providing further remain negative for the country's longer- upside to earnings. TOPIX target is based on 16.0x trailing PIE. term economic prospects. 11 Negative scenario Topix (6-month target): 600 • Faltering global growth leads to weak exports, triggering negative earnings surprises. A strengthening Japanese realized earnings likely to USDJPY below 75 in response to rising risk aversion might provide an additional drag on the economy and recover going forward earnings. We would then expect the P/E ratio to contract to 13.5x, even if earnings show no recovery. as Note: Scenarios refer to global economic scenarios (see slide 7) 75 65 What we're watching Why it matters 55 JPY and exports The exchange rate is an important factor for the Japanese equity market, and 45 central bank intervention is a key swing factor. Japan's trade balance could be in 35 deficit and may impact USDJPY rates. Key date: 09 July, Japanese trade 25 75 balance BoJ's monetary policy The Bank of Japan's (Bel) additional commitment to its asset purchase program, board meeting which is currently JPY 65tn in size, would lead to a weaker yen, in our view. Key 1988 1990 1992 1994 1996 1998 2000 2CO2 211 2086 2008 2010 2012 date: 12 July, BoJ policy meeting — Topa 12entoolipcloarnrss poi two Source: Thomson Reuters, UBS CIO, as of 21 June 2012 Note: Past performance is not an indication of future returns. irS UBS For further information please contact CIO asset class specialist Toru Ibayashi, Please see important disclaimer and disclosures at the end of the document. EFTA01089740 Emerging market equities Preference: overweight Recommendations 1 MSCI EM (27 June): 913 (last month: 907) UBS View MSCI EM 6-month target: 1,000 Tactical (6 months) • Currency weakness hurt emerging market (EM) equity performance in US-dollar terms year-to-date. We • In Asia, we expect Chinese equities to expect EM FX to appreciate against the USD from current levels over a six-month horizon. benefit as the Chinese economy avoids a • As expected, China has started to ease monetary policy. We believe there is also room to do more on the hard landing. In Latin America, we prefer fiscal side, helping to support China's economic growth outlook for the second half of 2012 and into 2013. Brazil and Mexico. The 2Q GDP numbers are expected to represent the low point in the current cycle. Strategic (1 to 2 years) • Given the above, in our base case, we see scope for some multiple expansion for the MSCI EM Index, • Structural factors (e.g. stronger fiscal from the current 10.3x realized price-to-earnings ratio to closer to 11x over the next six months. We expect position, more favorable demographics) earnings growth of around 10% over the next 12 months. should continue to support stronger • Within EM, we believe that Asia is best positioned for economic growth in the second half of 2012. In economic growth than in the developed emerging Asia, we prefer China. In Latin America, we prefer Brazil and Mexico. Central and Eastern economies. Europe remains the most vulnerable region, and we remain neutral on Russia. • Strategically, we would advise a tilt in EM 7/ Positive scenario portfolios toward cash-rich and faster- MSCI EM (6-month target): 1,190 growing Asia. • The outlook for the global economy improves, boosting EM's ability to grow more strongly in 2013. Stronger economic growth leads to earnings growth of 15%. Investor confidence improves, leading to a better P/E multiple of 12.5x trailing earnings. More cyclical Korea and Taiwan would benefit. SI Negative scenario MSCI EM (6-month target): 730 Emerging market country preferences • Serious negative developments (e.g. a further deterioration of the Eurozone crisis, the US fiscal cliff, or a Chinese hard landing) hit trade and thus the economic prospects of emerging markets. In this case, we Current most Current least would expect a 25% decline in earnings. More defensive Malaysia would do better, whereas more cyclical preferred markets preferred markets Korea and Taiwan would underperform. We assume, however, that the market would also be expecting Brazil Hungary some recovery in earnings for 2013, helping the PIE multiple to recover to 9.5x trailing earnings. China Indonesia Note: Scenarios refer to global economic scenarios (see slide 7) Mexico Poland What we're watching Why it matters We currently have a neutral view on the Emerging market Investors are trying to figure out which emerging market central banks still have remaining emerging equity markets in the monetary policy room to ease monetary policy and where rates may be heading up. Inflation MSCI EM index. data due for Russia (4-9 July), Brazil (7 July), China (9 July), Mexico (9 July), India (13 July), South Africa (18 July). Oil prices & EM FX Recent declines in oil prices are helping to reverse some of the inflationary impact of earlier rises, but the exchange rate matters, too. UBS For further information please contact OO asset class specialist Costa Vayenas, 9 Please see important disclaimer and disclosures at the end of the document. EFTA01089741 Asian equities (ex-Japan) Preference: overweight Recommendations 1 MSCI Asia ex-Japan (27 June): 469 (last month: 466) UBS View MSCI Asia ex-Japan (6-month target): 515 Tactical (6 months) • The region continued to show high volatility last month, with its P/BV temporarily close to 2008 lows. • We prefer Hong Kong banks, Singapore • Hong Kong and Singapore markets' domestic fundamentals remain solid. Hong Kong should benefit high-dividend stocks and Chinese from China's gradual recovery in 2H 2012, while Singapore's economy is rebounding and corporate insurance and consumer plays. balance sheets and earnings remain solid. After the rate cut early June, we expect China to have more • We are concerned about India's inflation policies to support growth in 2H 2012. China is our most preferred market, while Indonesia is least pressure, but we see opportunities in the preferred in the region. We are more concerned about Indonesia's fiscal deficit, since the fuel price hike power and banking sectors. did not happen. Domestic problems for Indonesia include current account deficits, potential capital Strategic (1 to 2 years) outflows, bottomed-out inflation and hiccups in economic and market reforms, in our view. • Rising consumption is the long-term trend • We expect 10% earnings-per-share growth over 12 months for the MSCI Asia ex-Japan, which trades on in Asia ex-Japan that we expect will 11.6x 12-month trailing earnings. We expect this multiple to expand slightly in the next six months, as the continue to play out. current earnings downgrade cycle is approaching its end. Nevertheless, MSCI Asia ex-Japan is likely to see • In China, sectors that contribute to further volatility in the near term due to global macro risk factors. improved labor productivity or deliver goods and services for the elderly should 71 Positive scenario MSCI Asia ex-Japan (6-month target): 610 benefit from demographic changes • More supportive monetary and fiscal policy, stable inflation, sustained domestic demand growth, and an (ageing population and decelerating improved global growth outlook should lead to a better earnings outlook. We would expect earnings population growth). growth of 15% and a PIE based on realized earnings of 14x. JI Negative scenario MSCI APAC ex-Japan (6-month target): 380 Asia ex-Japan country preferences • A hard landing in China with a global recession leads to negative earnings revisions for 2012. In this scenario, earnings could fall 20% over 12 months and the P/E could fall to about 10.5x. Current most Current least Note: Scenarios refer to global economic scenarios (see slide 7) preferred markets preferred markets What we're watching Why it matters China Indonesia Growth Both HK and Singapore's GDP growth disappointed, raising concerns about the growth momentum in the region. Investors should focus on whether growth We currently have a neutral view on the will re-accelerate in the near term. Key dates: 3 July, HK retail sales; 13 remaining emerging equity markets in the July, SG retail sales; 17 July, SG exports MSCI Asia ex-Japan index. Policy responses Some other countries in the region have structural issues due to fuel subsidies (e.g. Indonesia) and fiscal deficits (e.g. India). Policy responses often come on an ad hoc base. UBS For further information please contact CO asset class specialist Patrick Ho, Please see important disclaimer and disclosures at the end of the document. EFTA01089742 Equity styles Regional differentiation UBS View Prefer value and large caps in Europe, mid caps in US • Within Europe, look for value • We recommend that investors look for value opportunities in Europe: The cheapest stocks within each opportunities within each sector, but be sector are at extreme relative valuations, which should begin to normalize. Within Financials, however, investors should limit their direct exposure to the Eurozone debt crisis. We assess the cheapness of a stock aware of the higher-risk Financials. • In the US, there are opportunities in value by looking at its price-to-earnings and price-to-book ratios relative to its peers. names that also show strong growth. • We believe US mid caps will outperform large caps. US economic data is forecast to stabilize and GDP growth should be resilient in the second half of 2012. Greater domestic sales exposure reduces earnings • Within Europe, avoid small caps and instead rotate into large caps. risk coming from Europe. In Europe, we prefer large over small caps in the current very challenging • In the US, prefer mid caps to large caps economic environment. • High quality dividend paying stocks provide a real and stable income stream to investors during the while GDP growth is above 2%. current low yield environment. Furthermore, they give exposure to the long term potential of equity Strategic (1 to 2 years) markets while also providing some support in declining markets. • We expect value strategies to outperform $ Positive scenario Prefer value, low quality and small caps the market significantly over the long term. • Leading indicators continue to move higher, and risks related to the Eurozone debt crisis subside. In this • Mid-cap stocks provide attractive case, add deep cyclical value (cheap price/book, price/earnings) regardless of sector, with high beta and opportunities over the longer term. high leverage. In such an environment, small- and mid-cap stocks should also perform well, but a dividend strategy would be too defensive to outperform the market. European earnings revisions fell hard N Negative scenario Prefer quality and large caps last year, but the down cycle might be • The global economic picture deteriorates markedly. In this case, buy high-quality growth companies and be ending (net revisions, in %; MSCI large caps. Do not look for value opportunities, but be as defensive as possible with your equity exposure. Europe) )0% Look to high-quality, dividend-paying stocks for yield. 20% Note: Scenarios refer to global economic scenarios (see slide 7). 10% What we're watching Why it matters 0% -10% Earnings revisions - see Watch for signs of continued improvement in earnings revisions (aggregated chart from stock level). An improved earnings outlook would cause investors to add -20% (3-month moving more risk, allowing multiples to expand and triggering the outperformance of -30% average upgrades vs. value stocks. -40% downgrades) -50% 40% US and Eurozone PMIs If PM's stabilize or improve, value stocks should outperform as there is no longer Jun.05 Jun.06 Jun.07 Jun.08 Jun.09 Jun.10 Jun.11 Jun.12 justification to pay the high price for earnings stability (quality). Key dates: 2 Source: FactSet, UBS CIO, as of 27 June 2012 July, PMI Manufacturing Eurozone; 2 July, US ISM Manufacturing Note: Past performance is no indication for future returns. itS UBS For further information please contact CIO's asset class specialist Christopher Wright, Please see important disclaimer and disclosures at the end of the document. EFTA01089743 Section 2.B Asset class views Fixed income *UBS EFTA01089744 Bonds overview Preferences (6 months) Government bonds - Key points short duration neutral long duration • Government bond yields of major developed markets started to rise from their historical lows ahead of Greek elections, in particular with hopes of more Eurozone integration (e.g. Eurobonds or a European USD bank deposit guarantee). The new Greek government has at least eased concerns of an imminent and disorderly Greek exit helping yields in their short term rise. However, further central bank easing, EUR (DE) including the extension of Operation Twist (OT) until end of 2012 by the Fed limited the further upside potential in yields over the coming months. GBP • Our expectations for bond yields over the coming 6 months remain a marginal rise. Despite recent setbacks in global growth, the world economy remains in expansion mode. However, OT will keep longer yields low for longer. Also short-term downside risks to bond yields cannot be excluded; Spain has CHF returned to the spotlight, and challenges in Italy's adjustment programs remain. Given current division among European leaders, the mutualization of debt is unlikely to be resolved soon. CAD • On a relative basis, we prefer German and Swiss bonds, over those in the US and UK, where bond yields could rise faster due to a sounder economic outlook. In particularly in the US, the cyclical recovery looks AUD comparatively more robust. • Declining growth momentum, extension of Operation Twist by the Fed and a rising likelihood of a rate ■ new r old cut by the ECB, are likely to keep yields on extraordinary low levels, for the time being. Thus we suggest a neutral duration position at this stage. undemeight neutral overv,eight Corporate and emerging market bonds - Key points Bonds total • We maintain our preference for corporate credit (both investment grade and high yield) as well as emerging market bonds, keeping overweight positions in all three segments. Government • Investment grade (IG) corporate bonds showed remarkable resilience in the latest downturn. The asset bonds class is likely to outperform government bonds in the coming six months, with higher liquidity and lower Investment volatility than HY bonds. We see the highest return potential in the lower-rated IG segment (BBB and A). grade • US corporate bonds of lower credit quality (high yield, HY) remain fundamentally supported by solid corporate bonds balance sheets and a benign US growth outlook. Given the low risk of default losses, valuations are attractive at an effective yield of 7.5%. For US HY, we expect high single-digit total returns in the next six High yield bonds months. US senior loans are an attractive alternative to traditional fixed income assets. • Emerging market bonds should continue to benefit from better fundamentals than those of developed Emerging markets over the medium term. Valuations remain attractive, and the potential for spreads to trend lower market bonds should more than offset the gradual increase in US Treasury yields in the quarters ahead. We continue to prefer increasing exposure to corporate bonds while keeping existing investments in sovereign bonds. ■new old Sconce: U8S OD, as of lune 1r 2012 cat UBS For further information please contact CIO's asset class specialist Achim Peijan, and CIO's asset class specialist Daniela Steinbrink Mattel 23 Please see important disclaimer and disclosures at the end of the document. EFTA01089745 US rates Duration preference: neutral US 10-year (29 June): 1.6% (last month: 1.7%) Recommendations UBS View US 10-year (6-month forecast): 1.8% Tactical (6 months) • US 10-year yields have recovered slightly from their June 15, 2012 lows after a reduction of political risks • Declining growth momentum, extension in the Eurozone. However, Treasury yields remain near historical lows due to the extension of Operation of Operation Twist by the Fed and a rising Twist (OT) coupled with recent setbacks of domestic economic data. likelihood of a rate cut by the ECB, are • We expect a marginal rise in yields since the US economy remains on a moderate cyclical growth path likely to keep yields on extraordinary low with the housing market having bottomed out. Additionally the diminished near-term risk of a Greek exit levels, for the time being. Thus we from the Eurozone following elections supports a gradual rise in Treasury yields. suggest a neutral duration position • However, over a six-month horizon, the extension of Operation Twist (OT) until the end of 2012 by the tactically. Federal Reserve (Fed) will limit the upside potential in yields. As of late, the probability of even more stimulus in the form of quantitative easing from the Fed has risen substantially and markets have pushed Strategic (1 to 2 years) out the first rate hike expectation into 2015. Additionally, structural obstacles from the pending US fiscal • Yields have significant upside potential consolidation will also limit the upside potential for yields. Further, the US economy seems more vulnerable over the next couple of years given the to possible spillover effects of increased political uncertainties in the Eurozone. current extraordinarily low levels —of real interest rates in particular. Thus clients 71 Positive scenario for US bonds US 10-year (6-month range): 1.5-1.7% with a longer time horizon should focus • The European debt crisis further re-escalates. The resulting contagion would intensify the current flight to on bonds with short and medium quality, with Italian and Spanish spreads above 550 basis points to the Bund (our base case). maturities • With the increased likelihood of further quantitative easing, the risk is that yields would stay low or fall lower. USD 10-year yields and forecasts JI Negative scenario for US bonds US 10-year (6-month range): 23-2.9% • If the EU leaders indicate serious commitment towards more fiscal integration, and US growth proves 5% more sustainable with a rapidly improving labor market, then yields could rise. • Recently, market expectations regarding future rate hikes by the Fed have pushed out a first rate hike 4% into 2Q 2015. Any re-pricing into 2014 or 2013 will result in higher yields. 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 labour market determines it's stance on quantitative easing and is key for yields. Key dates: 31 July, Federal Open Market 1% Committee meeting Labor market Key focus of the Fed, judged in part based on estimates of the non-accelerating 0% inflation rate of employment. Key date: 6 July, US non-farm payrolls Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Inflation expectations Current yields reflect low real interest rates, but rather normal inflation forecasts uS 10Y expectations. If inflation expectations decline, the risk of a deflationary spiral would exist, leading to more downside risk for long maturity yields. Source' Bloomberg, ties OO, as of June IV' 2012 Note: Past performance is not an indication of future returns US presidential election The US presidential election will guide fiscal spending for the coming years. UBS For further information please contact CIO's asset class specialist Daniela Steinbrink Mattel 24 Please see important disclaimer and disclosures at the end of the document. EFTA01089746 European rates Duration preference: neutral EUR (DE) 10-year (29 June): 1.6% (last month: 1.4%) Recommendations UBS View EUR (DE) 10-year (6-month forecast): 1.7% • We believe the reasons for the recent rise in Bund yields are numerous: First, signs of more Eurozone Tactical (6 months) integration (e.g. European bank deposit guarantee) combined with the recapitalization of Spanish banks. • Long term Bund yields would fall lower, Second, the firm commitment of central banks to act if downside risks materialize (possible quantitative in case of rising Euro zone break up easing by the BoE and a higher probability of a ECB rate cut) and finally, Greek election results met probability. In contrast if Germany would expectations. However, this rise was muted given the extension of Operation Twist, weak global / German need to support the periphery further, data and Spain's return to the spotlight. Bund yields would rise. We expect the • Over a three- to six-month horizon, we expect growth momentum to remain subdued but still in positive market to oscillate between these two territory; we should have more information on how Spain and Italy are handling their adjustment cases and recommend to stay neutral on programs. Also, the new pro-memorandum Greek government should limit safe haven inflows, and thus limit short-term downside risks to yields. duration tactically. • In the UK, economic data continues to be mixed as the recovery continues but is prone to external shocks. Strategic (1 to 2 years) The recent liquidity provision announcement by the BoE has confirmed these concerns. • Yields have significant upside potential • In Switzerland, yields have traded range bound owing to conflicting economic data. The SNB stressed over the next couple of years. Thus clients increased downside risks to the economy and stands ready to act. However, we believe Swiss yields will with a long time horizon should focus on gradually normalize. bonds with short and medium maturities. $ Positive scenario for German bonds 10-year Bund yield (6-month range) 1.1-1.3% • The European debt crisis re-escalates. The resulting contagion would intensify the current flight to quality. • The economic recovery fails to gain momentum in the second half of the year. Credit demand fails to EU 10-year yields and forecasts improve further as some of the recent European Central Bank (ECB) data indicates. The ECB cuts rates. • Further quantitative easing by the Fed would be supportive for Bunds and speaks for lower yields. 5% JI Negative scenario for German bonds 10-year Bund yield (6-month range) 1.9-2.3% • A moderate Eurozone economic recovery kicks in, supporting debt-burdened Eurozone countries in their a% efforts to fulfill austerity commitments and thus reducing the demand for safe-haven assets. Alternatively, Germany gives additional guarantees and the Eurozone moves towards a transfer union. 3% Note: Scenarios refer to global economic scenarios (see slide 7) What we're watching Why it matters Elections/EU fiscal The EU Summit will show if newly elected governments will change the dynamics consolidation in the Eurozone. Central banks The revival of the SMP program by the ECB would reduce the yields in the periphery. Their assessments of the current economic situation can give hints of further rate cuts or quantitative easing measures. Key dates: 5 July, ECB rate Jun-09 Jun-10 Jia)-11 Jun-12 Jun-13 forecasts UK 10Y decision; 31 July, Fed FOMC meeting Germany 10Y — Sweetland t0Y Economic variables Credit conditions (ECB bank lending survey). Key date: 14 August Eurozone GDP Q2 Source. Bloomberg. MS OO, as of lune 1r 2012 Note: Past performance is not an indication of future r Eurozone yield spreads The level of yield spreads to German bonds influences the level of German Bund yields due to safe-haven flows. UBS For further information please contact CIO's asset class specialist Daniela Steinbrink Maffei, or Sebastian Vogel, or Nina Gotthelf, Please see important disclaimer and disclosures at the end of the document. EFTA01089747 Investment grade corporate bonds Preference: overweight Recommendations Current global spread (26 June): 225bps (last month: 225bps) UBS View Spread target (6-month): 170bps Tactical (6 months) • We expect investment grade (IG) corporate bonds to achieve a total return of around 3% over the next • We still see room for tighter yield spreads; six months. Our spread target of 170bps is based on our benign economic outlook, ongoing investor the return outlook compares very appetite for income-generating assets and expected negative net issuance. This target spread is still above favorably to government bonds. its 15-year average of 130bps. • Internationally diversified companies from • Non-financial corporates: While total yields are at record lows, the pickup over government bonds and non-financial sectors offer a stable and money market rates is attractive. Aggressive re-leveraging by companies looks unlikely in the current relatively safe income stream for environment. Credit quality should remain good and non-financials continue to deliver a stable income. conservative investors. • Financial corporates: Due to regulatory challenges, spreads are expected to remain above past averages. • We recommend bonds from the lower IG Total returns could outpace non-financials, but volatility will be considerably higher. rating segments OM and A) over higher- • Overall, IG corporate bonds remain a preferred asset class, providing an attractive yield pickup. The asset rated issuers. class offers relatively low volatility and a benign total return outlook. We expect lower-rated issuers (BBB Strategic (1 to 2 years) and A) to outperform higher-rated ones. • We prefer corporate over sovereign assets given companies' robustness compared to A Positive scenario Spread target (6-month): 140bps the structural weakness of public finance • Global growth accelerates more forcefully than expected. This could compress spreads to closer to pre- in many countries. crisis levels. Spreads for Financials are likely to remain elevated due to regulatory challenges. However, in this positive case, rising benchmark yields would limit total returns to 1-2% over six months. Yield spreads JI Negative scenario Spread target (6-month): 400bps 700 • Even if US economic growth falters, and the European recession turns out to be worse than currently 600 expected, we believe we would be unlikely to see the spread levels reached in 2009, given companies' 500 superior balance sheet positions. European financial issuers would be most at risk in this scenario. Note: Scenarios refer to global economic scenarios (see slide 7) 400 300 What we're watching Why it matters 200 100 Core market yields Developed market sovereign yields are only expected to increase gradually. A sudden rise and high volatility would hurt IG credit. Key dates: 1 August 0 Federal Open Market Committee meeting 2005 2006 2007 2008 2009 2010 2011 2012 —EUR Investment Grade —USD Investment Grade Corporate fundamentals Good corporate earnings and low leverage on corporate balance sheets should help prevent defaults. Source: Bloomberg, UBS CIO, as of 26.1une 2012 Note: Past performance is not an indication of future returns. New issuance As companies continue to deleverage, net negative supply on the IG market should support higher prices. UBS For further information please contact CIO's asset class specialist Philipp Schattler, 26 Please see important disclaimer and disclosures at the end of the document. EFTA01089748 High yield corporate bonds Preference: iiven% right Spread USD HY (26 June): 660bps (last month: 660bps) Recommendations UBS View USD HY spread target (6-month): 525bps Tactical (6 months) • US high yield (HY) bonds continue to offer attractive value; we expect high single-digit total returns over • US high yield corporate bonds offer an the next six months. We stick to our spread forecast of 525bps based on an ongoing recovery of the US attractive return outlook and should be economy, robust company balance sheets, rising earnings, and ongoing investor appetite for higher- overweighted. yielding assets. US HY bonds remain our preferred asset class. • We prefer US over European issuers given • Fundamental factors remain supportive. Despite the recent uptick in defaults, in the absence of a the poorer economic outlook in Europe renewed US recession only a very gradual increase is to be expected. We forecast a modest rise in the and the increasing proportion of trailing default rate to 3.5% at the end of the year from 3.1% in May. A heavy load of new issuance in the peripheral and financial issuers in the first three months of the year means that HY companies will be faced with a lower risk of failed European HY universe. refinancing going forward (e.g. in case of an unexpected economic slump). • Inflows into HY mutual funds have been • We acknowledge that ongoing risk aversion could still cause spreads to widen somewhat in the short run. strong so far in 2012, but new issuance has Investors who are able and willing to hold on to their HY position will likely benefit over 6 months. cooled down a bit in April and May. Strategic (1 to 2 years) 21 Positive scenario USD HY spread target (6-month): 450bps • We expect US defaults to remain at below- • In the positive economic scenario, a rally in high yield bonds and a return to pre-crisis spreads of about average levels for longer. Significant re- 400bps is likely. Benchmark yields would also rise, limiting HY returns to around 10%. European HY leveraging is unlikely in the medium term. outperforms the US. • We believe US high yield corporate bonds NI Negative scenario USD HY spread target (6-month): 1,200bps will provide good returns for absolute • A global recession is a major risk for high yield bonds. Based on the more robust state of the corporate return-oriented investors, as well as sector, we would not expect spreads to widen to 2008/09 peak levels above 2,000bps. Although short-term relative to other fixed income segments. spikes are likely, due to liquidity suddenly drying up, we would expect a quick return to the "usual" Yield spreads recession-level spread of around 1,200bps. 2.500 bps Note: Scenarios refer to global economic scenarios (see slide 7) 2,000 What we're watching Why it matters 1.500 Credit quality/ As long as corporate earnings increase and balance sheets remain backed by high default cycle cash levels and low debt ratios, the default rate will remain below its 5% long- 1.000 term average. 500 New issuance For now, favorable conditions in the primary market have mainly been used for refinancing. More aggressive issuance activities should be monitored. 0 Bank lending standards Bank lending provides an important source of funding. US banks relaxed 2005 2006 2007 2008 2009 2010 2011 2012 — EUR High Yield — USD ugh Yield standards slightly in 2Q. Key dates: early-July, ECB bank lending survey; late-July, Fed Senior Loan Officer Survey Source: Bloomberg, lies CO, as of 26 June 2012 Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialist Philipp SchOttler, 27 Please see important disclaimer and disclosures at the end of the document. EFTA01089749 Emerging market bonds Preference: overweight EMBI Global / CEMBI spread (27 June): 388bps 430bps (last month: 410bps / 440bps) Recommendations UBS View EMBI Global I CEMBI spread target (6-month): 340bps / 350bps Tactical (6 months) • Emerging market (EM) bond spreads are currently higher than implied by fundamentals, and we think • EM corporate bonds are particularly they offer attractive returns even against a more challenging global backdrop. attractive due to favorable valuation, • The probability remains significant, though, that negative headlines out of the Eurozone or a weakening solid fundamentals, and their relatively global growth outlook will put short-term pressure on EM bond prices. However, given EM sovereigns' short duration. We advise clients to focus better average fundamentals, and EM corporates' solid profit growth outlook and low leverage ratios, we on investment grade bonds in the current think that periods of price weakness should offer attractive entry points. environment. We continue to like • Although we revised our spread targets (to 340bps from 300bps for sovereigns, and to 350bps from selected sovereign bonds. 310bps for corporates), we continue to expect spreads to trend gradually lower over the next six months, • Please refer to our EM bond list for more than offsetting the moderate rise in US Treasury yields we expect in the quarters ahead. specific guidance. Strategic (1 to 2 years) 71 Positive scenario EMBI Global / CEMBI spread target (6-month): 290bps I 290bps • EM bonds are attractive for longer-term • Yield stability in Europe's core markets and higher-than-expected growth in the US would provide a investors looking for higher yields. favorable backdrop for EM fixed income spreads. In such an environment, issuers of lower credit quality • Local markets in Asia offer interesting would likely fare better. Average spreads could tighten to below 300bps in such an environment. opportunities for longer-term investors JI Negative scenario EMBI Global / CEMBI spread target (6-month): 525bps I 700bps because of a supportive currency outlook. • An environment of escalating risk aversion in Europe, deteriorating EM funding markets, weakening global growth prospects, and lower commodity prices could impact EM credit negatively. Liquidity in Room for tightening emerging market bonds could dry up and spreads could spike. Spreads of EM bonds over US Treasuries (in bps) Note: Scenarios refer to global economic scenarios (see slide 7) 620 500 What we're watching Why it matters 400 Core market yields The direction of US Treasury and German Bund yields are important for EM fixed 300 income spreads, especially for USD- and EUR-denominated bonds. Key dates: 1 August US ISM & FOMC rate decision 200 Capital flows The European debt crisis may lead to further periods of outflows and weaker 100 prices, which could offer attractive entry levels for investors. 0 Jun-09 Dec-09 Jun-I0 Dec-10 Jun-11 Dec-11 Monetary policy cycles Monetary policy easing remains a key topic for local currency bonds. We look for — Emerging market soreseign bonds IEMBI GlobaO central bank policy announcements in key markets such as Brazil, Indonesia, — Emerging market corporatebends (CEIABI Broad) Malaysia, Mexico, Poland, South Africa, and Turkey. Key policy rate announcement dates: 29 June, Colombia; 4 July, Poland; 5 July, Source: JP Morgan, LIBS CIO, as of 27 June 2012 Malaysia; 11 July, Brazil; 12 July, Indonesia; 19 July, Turkey Note: Past performance is not an indication of future returns. UBS For further information please contact CIO's asset class specialist Michael Bolliger, and Kilian Reber, 28 Please see important disclaimer and disclosures at the end of the document. EFTA01089750 Section 2.0 Asset class views Foreign exchange *UBS EFTA01089751 Foreign exchange overview Preferences (6 months) Foreign exchange — Key points underweight neutral overweight • EUR: Greek election results reduce the near-term euro break-up risk. Now starts a difficult period with USD re-negotiation of the Greek austerity program. Also Spanish yields, which have reached hard to sustain highs, need to be addressed. As the crisis carries on and hurts growth prospects for Europe well into 2013 EUR we recommend to keep euro short positions. The risk for either an ECB rate cut or an extension of bond GBP purchase program by ECB as well as the increasing risks to the banking system are weighing on the euro. WV • The extension of Operation Twist in response to weakening growth outlook in the US has its pros and cons for the USD. Global risk aversion and search for alternatives to the euro is supporting the greenback CHF currently. The clear commitment of the Fed to respond with more stimulus to European contagion and SEK the approaching fiscal cliff is limiting the upside potential for the USD. • The CAD has increased in attractiveness recently due to weaker spot rates, while good growth dynamics NOK in Canada still lead to rate hike expectations. We continue to recommend an overweight. CAD • We keep the overweight position in the GBP. The BoE eased monetary conditions for the banking NZD system to protect the UK financial market against contagion effects spilling over from the continent. Apart from this, we think the pound remains well supported, because valuation is cheap and investors are AUD seeking liquid alternatives to the euro. al new mold • EURCHF is currently trading at the low end of our expected range of 1.20-1.25, and we therefore keep an underweight position in the CHF. The 1.20 EURCHF floor prevents any CHF appreciation and the SNB Source: UBS C1O. as of 22.06.2012 has clearly shown in May that it is willing and can protect the floor; we expect the SNB to continue in this. • Sweden and Norway stand out for their lower debt-to-GDP ratios and current account surpluses. The NOK appreciated recently, due to safe haven inflows. We stay neutral as the appreciation potential is now limited. The SEK is very sentiment-driven and should profit in the medium term. • Longer-term debt issues and weak competitiveness of major exporters are hurting the Japanese economy. Therefore the Bank of Japan and Ministry of Finance will maintain an expansive policy and continue to try weaken the WY. However, current positive growth dynamics are supportive of the JPY. • For commodity currencies, the AUD and NZD weakened within ranges from March to May. We expect another bout of weakness over the next three months together with increasing European troubles. • We expect the CNY to appreciate 3% against the USD, moving towards 6.15 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. Our most preferred emerging market currencies are currently MXN, ZAR, PLN, ZAR, KRW and CNY. UBS For further information please contact 00 's asset class specialist Thomas Flury, 30 Please see important disclaimer and disclosures at the end of the document. EFTA01089752 G10 currencies UBS View see UBS FX forecasts, below-right Recommendations • The negative momentum on the EUR is likely to persist. The growth outlook has deteriorated in the last Tactical (6 months) couple of months to a point, which challenges the fiscal austerity efforts seriously. • Long USD, GBP and CAD • The USD profits from European troubles, but the upside remains limited by expansive fed policy • Short EUR, and CHF • The GBP is resuming its uptrend despite stimulus measures by the Bank of England. The main reason is Strategic (1 to 2 years) the need for diversification of the EUR and better current economic indicators. • We recommend investors diversify from • The AUD seems to have found a bottom, and should recover on the back of better risk sentiment. We large USD and EUR exposures into minor believe the CAD remains one of the most attractive currencies. currencies. Structural financing issues • The SNB has shown that it will defend the CHF-floor. EURCHF will remain in the 1.20-1.25 range. weigh on each of the major currencies. 71 Positive scenario FX targets: EURUSD >1.35 / EUR.IPY 120 • The best diversifiers based on long-term macroeconomic fundamentals are the • Eurozone economies avoid a material contraction and financial market conditions recover. EURUSD CAD and the SEK. The AUD, NOK and CHF should trade above 1.40 in this case. Yen weakness could develop, since hopes for global growth would should only be added at better entry make the carry-trade role of the yen more prominent. levels. Negative scenario FX targets: EURUSD <1.20 / EURIPY 100 • European growth outlook deteriorates further with continued recession in 2013. The euro could rapidly UBS CIO FX forecasts fall below 1.20. A European debt default cascade is a tail risk for the single currency. Risk aversion would 25-06-12 3M 6M 12M PPP lead to an extended USD and JPY rally. EURUSD 1.2485 1.22 1.28 1.32 1.31 USD1PY 79.88 83 85 90 80 Note: Scenarios refer to global economic scenarios (see slide 7) USDCAD 1.0296 0.98 0.94 0.94 0.94 AuDuSD 0.9993 0.97 1.00 1.05 0.75 What we're Why it matters GBPUSD 1.S548 1.56 1.65 1.70 1.69 watching NZDUSO 0.7851 0.75 0.79 0.83 0.60 USDCHF 0.9617 0.99 0.95 0.93 1.01 Chinese growth We expect Chinese growth to land softly and then recover. Should China disappoint us WAG* 1.2006 1.21 1.21 1.23 1.32 with a hard landing, then we have a problem. Risk unwinding will support USD and JPY GBPCHF 1.4947 1.55 1.56 1.58 1.71 EURWY 99.74 101 109 119 105 versus risk takers currencies. EURGI3P 0.8026 0.78 0.78 0.78 0.77 EURSEK 8.8133 8.65 8.55 8.40 8.86 European With Greek elections out of the way, the main focus lies on Spain and on potential ECB EURNOK 7.40 8.57 7.492 7.40 7.40 sovereign crisis, rate cuts. Any improvement in Spain should support the euro, a rate cut would probably Source: Thomson Reuters, UBS 00, as of 25.06.2012 ECB policy hurt it. Key dates: ECB Meetings on 5 July and 2 August Note: Past performance is not an indication of future returns. US growth and Will the Fed add QE to current Operation Twist programs? How will presidential Fed policy elections change political powers in Washington? Keys to address long-term financing response issues. Key dates: 1 August FOMC meeting; 6 November, US Presidential elections irS UBS For further information please contact CIO's asset class specialist Thomas Flury, 31 Please see important disclaimer and disclosures at the end of the document. EFTA01089753 EM currencies UBS View For current exchange rates and CIO forecasts see table Recommendations Tactical (6 months) • With the risk of a Greek Eurozone exit subsiding, we think selected emerging market (EM) currencies • Several EM currencies look attractive at look attractive over the medium term against the USD and JPY and some even against the EUR. current levels; we advise investors to • Global growth prospects remain intact, also due to recent policy easing in China, and the risk of a gradually increase their exposure to our broader European crisis remains contained, in our view. Over the medium term, this will likely support EM preferred EM currencies, using the yen currencies. However, further bouts of volatility remain likely in the months ahead, since negative headlines and the USD as funding currencies. Our from Europe will likely continue to weigh on investor sentiment. preferred EM currencies are CNY, IDR, • Our tactical and strategic recommendations list our preferred currencies. For now, we remain cautious on KRW, SGD, MXN, ZAR, CZK, and PLN. the Brazilian real, Hungarian forint, Indian rupee, and Turkish lira. Strategic (1 to 2 years) 79 Positive scenario > 7% outperformance of EM FX against G4 currencies over a 6-month horizon • We recommend EM currencies backed by stable fundamentals as a strategy to • Macroeconomic data comes in stronger than expected and contagion risks in Europe subside further. EM exchange rates could appreciate swiftly against G4 currencies (USD, EUR, JPY, GBP). diversify currency exposure. • Our favorites include the Chilean peso, JI Negative scenario > 4% depreciation of EM FX across regions against USD over a 6-month horizon Czech koruna, Polish zloty, Chinese • Global growth prospects suffer a prolonged deterioration and the European debt crisis intensifies renminbi, Korean won, Malaysian ringgit further. EM exchange rates could see a significant although likely temporary, sell-off across regions. and Singapore dollar. Should growth concerns return to the fore, we expect export-oriented EM countries (e.g. most Asian economies) to welcome currency weakness in order to cushion economic growth. UBS CIO EM FX forecasts 27.06.2012 3-month 6-month 12-month Note: Scenarios refer to global economic scenarios (see slide 7) Americas USDBRL 2.07 2.10 1.95 115 What we're watching Why it matters USDMXN 13.8 12.7 12.5 12.3 Inflation dynamics Inflation dynamics are important to forecast central bank policy rate decisions. Asla in EM Monetary easing typically weighs on EM currencies, while rate hikes tend to be USDCNY 6.37 6.30 6.25 6.15 USDINR 57.1 53.0 54.0 55.0 supportive. Key policy rate announcement dates: 29 June, Colombia; 4 July USDIDR 9'480 9300 9'200 9'000 Poland; 5 July, Malaysia; 11 July, Brazil; 12 July, Indonesia; 19 July, Turkey USDKRW 1157 1'130 1'110 1'050 European sovereign Setbacks in sentiment will likely lead to bouts of EM currency depreciation and USDSGD 1.28 1.24 1.23 1.22 crisis elevated volatility across regions, providing attractive entry points for investors. EMEA EURPLN 4.25 4.35 4.15 4.00 US growth Growth in the US is key for risk sentiment, growth prospects in EM, and US EURHUF 286 305 285 310 monetary policy decisions. Positive surprises tend to support EM currencies. Key EURCZK 25.9 26.0 25.0 24.3 dates: 1 August, US ISM & FOMC rate decision USDTRY 1.81 1.75 1.78 1.78 USDZAR 8.43 7.90 7.75 7.50 USDRUB 32.9 33.5 32.0 31.0 Source: Bloomberg, UBS CIO, as of 27 June 2012 Note: Past performance is not an indication of future returns.1 UBS For further information please contact CIO's asset class specialists Michael Bolliger, or Teck-Leng Tan, 32 Please see important disclaimer and disclosures at the end of the document. EFTA01089754 Section 2.D Asset class views NTAC: Commodities, Listed real estate, Hedge funds and Private equity *UBS EFTA01089755 Commodities overview Commodities - Key points Preferences (6 months) • Broadly diversified commodity indices, which declined by about 10% in May, found some support in underweight newel ovemeight June. The sideways move was visible across all commodity sectors, with gold (precious metals) Commodities total delivering a temporary price uptick after the May US nonfarm payroll release. • Despite signs of price stabilization, diversified commodity indices are likely to decline in the PictiOtif coming weeks. Sluggish economic activity should put upward pressure on most commodity Metal, inventories. To mitigate inventory buildups, lower prices are required, in our view. Production cuts for cyclical commodities need to be incentivized, while demand needs a push. Energy • The starting point for gold (precious metals) remains challenging, with supply likely to outpace demand this year. However, the chance of further monetary easing (QE3) by the Fed - which is not our Base Metals base case - is an upside risk to the gold price. Given the weak fundamental situation combined with the substantial QE3 risk we maintain our neutral position. Agricultural • Easing geopolitical tensions related to Iran and further inventory builds in crude oil shifted the markets attention to sluggish demand growth. With muted incremental crude oil consumption, crude oil prices are likely to remain under pressure. But as production cuts are likely to kick in, downward ■ new old price momentum should slow meaningfully. OPEC production cuts of up to 0.5 mbpd are needed in Source: U8S CIO. as of 22 June 2012 the coming months, and should allow the Brent price to stabilize in the USD 80.5 - 90/bbl range (WTI Note: Past performance is not an indication of future returns. with a USD 12/bbl discount). But a sideways move in crude oil is not good enough to be long the commodity. The Brent forward curve has joined WTI and moved into contango as well. Hence, we keep our underweight position. • With regards to base metals, prices have room to soften in the very short run (4-6 weeks). Copper prices are likely to decline to USD 6,600/mt in order to weigh on scrap supply and compensate for deteriorating Chinese import volumes. But the price decline in copper and other base metals should be short lived. Fiscal and monetary easing in China provide the basis for an acceleration in base metal demand and should keep prices largely flat on a 6-month horizon. Moreover, metals like aluminum and nickel are already trading deeply into the production cost curve, which we regard as unsustainable over the long run. We keep a neutral position on base metals until we see further confirmation of a pickup in Chinese economic activity. • The outlook for ample supply in agricultural commodities, especially for corn, should still weigh on the grain complex towards the end of the year. Some short-term price support from dry US Midwest weather conditions in recent weeks is not altering our negative stance. Soft commodities are also battling with higher inventories, which will not bode well for prices in 3Q 2012. UBS For further information please contact Clo's asset class specialists Dominic Schnider, or Giovanni Staunovo, Please see important disclaimer and disclosures at the end of the document. EFTA01089756 Precious metals Recommendations Preference: neutral 1 Gold (25 Jun): USD 1,573/oz (last month: USD 1,573/oz) UBS View (gold) 6-month target: USD 1,650/oz Tactical (up to 6 months) • The price outlook for gold is largely tied to quantitative easing by the Fed. Although the probability has • In case of a conversion into gold, investors increased on weak US data, our base case still calls for no QE. Hence, current prices run on thin ice, in our should hold the position and target re- conversion at the original strike level. Over view. In the absence of any monetary stimulus, the gold market is likely to be oversupplied by more than three months, we regard strike levels 400 tons this year. around USD 1,460-1,520/oz as attractive. • Physical demand out of Asia remains lackluster. With the USDINR trading at a record high, the world's With option volatility on the rise, the risk second-largest gold market, India, is likely to witness a steep decline in jewelry consumption and a rather reward for selling volatility has improved. firm increase in scrap supply. Central bank buying, estimated at 300 tons (7% of total demand) in 2012, will not be enough to clear the market. Right incentives — i.e. temporary price setbacks — are needed to Strategic (1 to 2 years) • The risks for debt monetization in the motivate enough demand, before prices should manage to rebound towards USD 1,650/oz in 6 months. developed world and double-digit wage • The negative stance from a absolute return perspective, should not overshadow the relative growth in China and India, the two largest attractiveness of the yellow metal. The higher probability of QE3 by the Fed poses an upside risk to the gold markets, should ensure a steady rise gold price. Hence, we maintain our neutral position. in demand for gold and platinum over time. Physically backed ETF positions allow A Positive scenario 6-month target: USD 1,920/oz investors to participate effectively in • Additional quantitative easing measures by the US Fed and the ECB are implemented, or inflation higher prices. Positive real interest rates accelerates sharply in emerging markets. This would drive the gold price towards USD 1,920/oz again. present a threat to this view. JI Negative scenario 6-month target: USD 1,250/oz • A liquidity crisis would curtail financial demand and weigh on the gold price. A similar impact would Gold in INR terms and Indian gold come from deflationary pressure (positive real rates), or a combined Chinese and Indian hard landing. demand 300 SW What we're watching Why it matters Standardized to 100 250 400 Physical demand/supply Further INR weakness in the coming months should determine jewelry demand 2C0 from India. The health of coin and bar demand should be visible in the World 300 ISO Gold Council mid-August release. After the drop in PGM production, 200 ice keeping an eye on South African PGM output is a must. 100 SO Flows & rates To judge gold-related financing deals, we track gold export/import between 0 0 /an-013 Jan-09 Jan.10 Unit Jan -12 Hong Kong and China. In addition we follow the latest uptick in ETF gold mirdes pall 'waned/demand • in tons 0b0 —Gad in USD termini holdings and futures positions in gold to proxy investment demand strength. Gcld in MI Inn OW From an opportunity-cost perspective (real interest rate standpoint), we also Source: WGC, Bloomberg, UM GO, as of 19 June 2012 look at the upcoming meetings of the ECB on 5 July and Fed on 1 August. 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, Please see important disclaimer and disclosures at the end of the document. EFTA01089757 Energy Brent (25 Jun): USD 91/bbl (last month: USD 109/bbl) Recommendations Preference: underweight 1 UBS View (crude oil) Brent 6-month target: USD 100/bbl Tactical (6 months) • A combination of renewed economic concerns about the Eurozone, easing geopolitical tensions between • We foresee further short-term weakness Iran and the West, and further inventory builds in crude oil triggered a sharp decline in the Brent crude oil although less pronounced than the past price to USD 92/bbl and USD80/bbl for WTI. month —we expect Brent to stabilize in • We think the crude oil market is oversupplied, which is likely to push up OECD crude oil inventories to 62 days of consumption in the coming months. While it seems that Saudi Arabia has slightly reduced its the range of USD 80.5 - 90/bbl in the next production in May from 10.1 mbpd in April, the country could be in a wait-and-see position for longer. 3 months. Production cuts and a pick up in First, the EU/US sanctions on Iran take effect at the end of June/early July, and bring some additional supply emerging market demand should push uncertainty. Second, Saudi Arabia also sees the need for lower prices in the short run to support economic Brent crude oil above current levels. activity in the developed world. But to prevent inventories from swelling too strongly, additional Strategic (1 to 2 years) production cuts of up to 0.5 mbpd (0.55% of global demand) are needed in the coming months. • After the demand slump in 1H 2012, we • So what should investors do at current levels? Although downward momentum in crude oil prices is likely to fade, a sideways move should still lead to negative investment returns in the short run. The Brent expect Brent crude oil to trade at USD forward curve flipped into contango from backwardation, which is deteriorating the risk reward payoff of 110/bbl in 12 months. This higher price the energy sector. Hence, we currently maintain our underweight position. level for 2013 reflects our expectation that economic activity should provide price 71 Positive scenario Brent 6-month target: USD 140-180/bbl support in 2013. Thus, three-year crude oil • Iranian oil exports gets subject to a complete embargo, or military interventions affect crude oil supply futures contracts at USD 90/bbl remain for via the Strait of Hormuz. Alternative OPEC supply routs would not be in a position to compensate for such us mispriced and an attractive investment a supply shortfall. In order to curb demand, prices would need to spike towards USD 180/bbl. II Negative scenario solution for strategy-oriented crude oil Brent 6-month target: USD 75-80/bbl • Economic growth in the developed world contracts, thereby triggering a 0.5% to 1% decline in world investors. crude oil consumption. Although to a lesser degree, fading Iranian tensions and no supply cuts by OPEC would allow crude oil inventories to build firmly and push Brent prices down towards USD 80/bbl. OECD crude oil industry inventories on the rise What we're watching Why it matters 65 Days of consumption Iran tensions Resurfacing Iranian tensions could cause prices to spike higher, but an escalation is less likely, in our view. The focus is on remaining Iranian exports (currently around 60 1.6mbpd versus 2.4 mbpd in 2011). Supply US crude oil supply has come in strongly — reaching 6.4 mbpd. Further supply 55 growth would not bode well for WTI crude oil. We also look at oil supply related to 50 Sudan, Syria and Yemen, which caused a 0.5 mbpd decline in global crude oil production capacity. It seems that these production capabilities will remain offline for a longer period - potentially until 2014. 45 Mn Feb Ma' Apr May Jun Jul Aug Sep Ocl Nov Dec Oil market reports Key dates: 12 July, IEA Medium Term Oil market report. Another round of range 2007.2011 —2012 —average 2037-2011 (EIMEA/OPEC) downward revisions to demand, like in June, is not expected. The latest forecast Source: EIA UBS CIO as of 19 June 2012 changes to demand have been meaningful. 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, Please see important disclaimer and disclosures at the end of the document. EFTA01089758 Base metals Current (last month): copper USD 7,317/mt(7792); nickel USD16,528/mt(16833); aluminumUSD 1,825/mt(1989) Recommendations Preference: neutral 1 UBS View 6-month target: copper: UDS 7,400/mt nickel: USD 18,000/mt; aluminum: USD 2,200/mt Tactical (3-6 months) • With the exception of aluminum, base metal prices stabilized broadly in June. But we see room for • From a timing perspective, building up somewhat lower prices in the short run (4-6 weeks). Deteriorating industrial activity in Asian countries, exposure to base metals is not yet weak US data and the Euro-zone crisis remain a price burden for the sector in the early part of 3Q12. advised. While we still expect higher • To weigh on scrap supply and compensated for lower Chinese copper imports, copper prices are likely to prices over the next 6-12 months, the decline towards USD 6600/mt, in our view. For the rest of the base metals, prices could move deeper into short-term downside risks should offer the cost curve of production. When it comes to aluminum and nickel, however, prices have already investors better entry points, particularly declined deeply into the production cost curve. In both cases supply cuts could come quicker and limit the for copper. That said, existing aluminum price downside from current levels. and nickel positions should be kept. • In addition, supply uncertainty related to aluminum and nickel needs to be considered as well. Strategic (>1 year ) Indonesia's new regulations on ore exports could jack up Chinese import costs by around 20% in the • Rising energy and labor costs provide the coming quarters. We think such an increase would be meaningfully, as 60% of China's nickel pig iron (NPI) backdrop for base metal prices to trend production and 80% of China's bauxite imports depend on Indonesia. higher. The strongest performance is • The reason why base metals overall should trade at current levels or higher in six months from now, likely to come from zinc and lead, where relates to China. We think the People's Bank of China has made the right monetary policy steps to achieve existing mine capacity is expected to peak stronger credit activity and higher sequential GDP growth in 2H 2012. With this fairly balanced risk reward in 2014. Environmentally challenged base on a six-month horizon, we maintain our neutral position. metals, like tin, should be in line with the $ Positive scenario sector average. For nickel and aluminum, • China eases monetary policy aggressively, by pushing credit growth beyond 20% y/y. Additional QE in ample production capacity should lead to the US paired with stable European and Japanese demand would allow the sector to rally by around 25%. an underperformance in the long run. SI Negative scenario Due to its high current price versus • Chinese monetary conditions remain behind the curve, resulting in an economic hard landing. A severe production costs, copper should lag too. escalation of the Eurozone crisis (deep recession/global impact) could also bring prices close to 2009 levels. Heavy industrial activity in China, with high commodity use, slumped What we're watching Why it matters 25 i Cumulative year-on-year values, in % Demand The latest uptick in Chinese imports, driven by technical factors, do not 20 reflect stronger end demand. The June figures (on 10 July) should give some clarity. That said, the attractiveness to import from an arbitrage perspective I5 SHFE to LME has improved. Interest for physically backed copper ETFs needs to be tracked as exchange inventories are structurally low. 10 Supply Copper supply has room to improve in 2H 2012 from poor mine output in 1H 5 2012. Fading supply disruptions and capacity additions put copper at risk. 0 Indonesia's new export rules could have a positive one-off impact on aluminum Feb-99 Feb-02 Feb-05 Feb-08 Feb-11 and nickel. — Light industryrata added Heavy Monty value added Economic data/forward People's Bank of China meeting, Chinese economic data (especially IP and loan curve growth by financial institutions) Key dates: 11-15 July Source: Bloomberg, UBS OO, as of 18 lune 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, Please see important disclaimer and disclosures at the end of the document. EFTA01089759 Agriculture Current (25 June) (last month): Soybeans, USD 14.79/bu (USD13.82/bu); Corn, USD 6.09/bu(USD 5.79/bu); Recommendations Preference: underweight 1 Wheat USD 6.91/bu (USD 6.80/bu) Tactical UBS View 6-month target: Soybeans, USD 13.5/bu; Corn, USD 5.10/bu; Wheat USD 6.00/bu • The forward curve in corn already factors • Besides the overall commodity price backdrop, prevailing dry weather conditions in the US have been in a steep decline by the end of the year, price supportive for the grains and added to firmer prices. thereby mitigating the expected negative • While weather-related news flows might support grain prices in the short run (downward revisions in return. With lower corn prices, wheat grain yield estimates, especially corn), the 6-12 month price outlook remains negative. Global corn should come under pressure as well. Most inventories should grow beyond 10% in 2012/13. We think this will more than compensate for firmer agricultural commodities are generally wheat fundaments (lower inventory estimates) in the coming months. For soybeans, current price levels well supplied, so unless the weather sufficiently factor in the poor supply figures seen in recent months. This would be especially true, if South surprises on the downside, we expect American planting gets a boost due to soybeans' relative price improvement. further weakness. • A strong supply backdrop for Brazilian coffee along with a weaker BRL has kept coffee prices under Strategic pressure. For 2012/13, Brazilian coffee and sugar exports are likely to increase by 12% and 2% yly • Strategic agricultural positions are not respectively, and keep the global market well supplied in 2012. Cotton prices saw some bouts of strength, recommended at present. Our return but demand has yet to work off high inventory levels at 74-75mn bales. With ample inventories and outlook for the grains stands at -7.5% to economic conditions at risk, renewed price weakness is likely. - 5% over the next 12 months. Although the softs have a positive return outlook 71 Positive scenario Soybeans 6-month USD 16/bu over the same period, investors should • Lower acreage and yield figures for the US can tighten the supply backdrop until 1Q 2013 (until the new bide their time. Short-term price setbacks South American crop comes). On the demand side, higher soybean use for bio diesel in Argentina and of 10% or more are still likely over the strong Chinese imports (improvements in crush margins) are catalysts for prices to rally. next two to three months. JI Negative scenario Soybeans 6-month USD 12/bu • Unexpected Chinese government stock sale of soybeans and deteriorating crushing margins for soybean Global corn surplus as % of demand to oil/meal production, would leave soybean prices vulnerable to a price correction. advance towards 5-year high What we're watching Why it matters ' USDA WASDE report US corn yields could be at risk in the upcoming WASDE release. Key date : 11 8°, (monthly) July 2012 4% Grains stock report Corn and soybean inventories could be lowered vs. current estimates, reflecting 0% I - (quarterly) the strong export activity in corn during March-May and higher soybean crushing -4% during the same period. Key date: 28 September 2012 -8% USDA crop progress Dry weather conditions in the US has impacted the crop conditions (rating), 2009/10 2010/11 2011/12 2012/13E (weekly, Monday) which deteriorated in recent weeks. oCorn la Soybeans ',Wheat COT (weekly, Friday) Investors have scaled back their long exposure in corn. At the present speed, net Source: USDA, UBS CIO, as of 18 June 2012 positions would close in on zero over the next two months. 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. Please see important disclaimer and disclosures at the end of the document. EFTA01089760 Listed real estate Preference: neutral UBS Global Index DTR (28 June): 1,375 (last month: 1,320) Recommendations UBS View UBS Global Index DTR (6-month target): 1,400 Tactical (6 months) • A slight positive monthly performance has been driven by rebounds in the higher beta markets, • We maintain our neutral stance towards respectively Hong Kong, Japan and Singapore. listed real estate after a good performance • Listed real estate is still attractively valued on different earnings ratios and trade on a slight discount to year-to-date and due to a relative less NAV. Earnings yields over 5 year swap rate are attractive currently attractive, yet the flattening of interest attractive valuation compared to global curves has come to a halt and we see less support from it in the future. equities. Going forward returns are limited • Little supply of commercial space across the globe leads vacancy rates to gradually decline and low by subdued revenue growth. However, we capitalization rates in core markets support capital values. Also rental yields remain attractive compared to still expect listed real estate to stay high grade bond yields. However, further significant capital appreciation is unlikely. This is especially due a comparatively attractive in a low growth, slow down in rental income as economic growth is subdued. Hence, future performance is limited. low rates environment. • Although slightly reduced, we maintain our preference for US REITs due to stable fundamentals and like Australia as a conservative play. We slightly overweight Hong Kong, stay neutral towards Singapore, but Strategic (1 to 2 years) maintain a slight underweight in Japan as fundamentals remain unconvincing. • A cyclical slowdown in rents limits growth, but attractive refinancing conditions are 71 Positive scenario UBS Global Index MR (6-month target): 1,500 supportive. We see potential for higher • Improving macroeconomic data in the US, positive economic surprises in Europe followed by monetary payout ratios in the US and Asia, while easing in China help to increase growth prospects that support rental income growth, while refinancing Europe has to consolidate balance sheets. costs remain low in a low inflation environment. Real estate offers a comparatively attractive yield. 11 Negative scenario UBS Global Index DTR (6-month target): 1,300 Preference (6 months) • The US growth path disappoints investor expectations and causes the comparatively high valuation levels Our market preferences for listed real estate• there to correct, significantly affecting global real estate. Furthermore, a more severe recession in Europe neutral + ++ triggers a tightening of credit standards, making listed real estate more dependent than ever on bank North America financing at a time when credit markets are already fragile. Real estate underperforms global equities because the correlation between the availability of credit and short-term performance is high. Continental Europe Note: Scenarios refer to global economic scenarios (see slide 7) UK What we're watching Why it matters Japan Capitalization rates andWe do not expect capitalization rates to decrease much from now. Rental yields Hong Kong rental yields have already been pushed down by decreasing bond yields; we see a diminishing Singapore support from the interest curve, which has significantly flattened in the past. Australia Transaction volumes and Global commercial real estate transaction volumes are down year-on-year due to Old • New future rental growth in a lack of product in core markets and constraints on debt financing. Global rental direct markets growth has softened and very modest growth will feature major markets overall. • This is our relative preference within the global real estate sector based on UBS Global Real Estate Index domestic total return, which is not the overall sector view Credit markets and Lending conditions have been a little tightened. However, well financed listed Source: UBS CIO, as of 26 June 2012 financing costs companies have still good access to credit, while others are more restricted. 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. EFTA01089761 Hedge funds Recommendations UBS View Prefer Relative value and Event-driven Strategic (1 to 2 years) • We expect hedge funds (HF) to offer positive asymmetric returns characteristics vs. the S&P 500 due to • Active risk management is instrumental for active management and stop-loss strategies. (HF were down 1.9% in May 2012 vs MSCI world at —8.5%) capital preservation during adverse market • Decelerating global growth prospects, the next leg in the ongoing Eurozone crisis, is challenging mostly conditions. At the moment, we therefore equity long-short managers, who are net-long the market. While event-driven managers share some of favor relative value and event-driven the performance drivers, idiosyncratic bets (event) reduce the exposure to markets. The real reason to own strategies, since they are less hinged to this strategy, however, is the potential for out-sized return in distressed, high yield and other credit equity markets and other risky assets than investments as the Eurozone crisis plays out. The inherent hedging in relative-value should remain trading is. appealing. Credit relative-value managers should perform well in this environment of higher fixed income • Value proposition: Hedge funds should volatility and increasing pricing anomalies created by central bank interventions (OT2) and limited achieve robust performance over an competition. extended horizon, while displaying limited volatility vis-a-vis equities and other risky 7/ Positive scenario Prefer Equity long-short assets, in general. Hedge funds minimize • A reduction of uncertainty (e.g. resolution in Europe) lowers equities' correlation and volatility. This downside losses in adverse market helps bottom-up fundamental analysis and equity long/short managers the most. Also, CEOs will likely conditions (e.g. active risk management) make more corporate transactions that can be monetized by event-driven managers, and a clearer and play a crucial role in wealth macroeconomic environment with more persistent trends would be supportive for macro managers appreciation, since there is less ground to regain in the recovery phase and Negative scenario Prefer Trading (Global Macro + CTA) ultimately greater chances for superior long-term returns. • A 2011-type scenario in which hedge fund managers get whipsawed through the year with risk-on and risk-off circumstances, driven by a multitude of political interventions, is difficult to anticipate. That would Performance (year-to-date) impact long-short managers, event-driven, and to a lesser extent global macro managers. 4. eve etly Note: Scenarios refer to global economic scenarios (see slide 7) bind?" What we're watching Why it matters Global equity direction The outlook for global equities becomes an important HF performance driver. !Odin U / economic cycle The economic cycle impacts the strategies differently. MA Wit Correlation Correlation among pair-stocks; an important performance/alpha driver for equity long/short, the largest HF strategy by assets under management. Hid? Futil Leverage Gross and net leverage are key to monitoring risk. 4444 AS% M% 10% 15% :pa ma 30% 35% 44% Volatility The direction influences certain HF strategies (e.g. convertible arbitrage). Liquidity Particularly for large HF that are less nimble to enter and exit their strategies Source: MERL UBS OO, as of 18 June 2012 Regulation Volcker's rule, USCITS III/IV Note: Past performance is not an indication of future returns. *UBS For further information please contact CIO's asset class specialist Cesare Valeggia, 40 Please see important disclaimer and disclosures at the end of the document. EFTA01089762 Private Equity Prefer small/mid-cap buyout in US / emerging markets; Recommendations UBS View distressed debt in Europe Strategic (1 to 2 years) • We prefer small-/mid-cap buyouts in North • Private equity deals in today's volatile and uncertain markets are conservatively financed, with an average America given the better economic equity cushion of 40%. We like mid-market buyout strategies, which offer long-term exposure to attractive outlook vs Europe, higher transaction corporate assets and which rely less on large bank debt syndications. certainty and more attractive entry prices. • Our house view sees large parts of Europe in a stagnation, and business owners are reluctant to sell their • Investors looking for downside protection companies, reducing PE deal flow in the region significantly. We therefore prefer North America, which and stability during economic will see continuous (albeit suboptimal) growth, and emerging markets, which show positive fundamentals. uncertainties can consider large-cap • Prices for PE transactions have corrected by around 10% this year, although they are still 20% above the buyouts in the US, which offer exposure attractive levels seen during the successful years between 2000 and 2004. However, significant dry powder to large, diversified companies at more and high cash positions at corporations keep competition high and hinder prices from falling much further. attractive prices. • In Europe, the crisis and ongoing 71 Positive scenario Prefer small-/mid-cap buyout and secondaries deleveraging have led to attractive opportunities for special situations. We • An abating Eurozone debt crisis and improved business confidence would increase deal flow and exit thus recommend investing in distressed opportunities for private equity managers, but would also increase entry prices. In such a positive scenario, debt to benefit from the macroeconomic we would perceive commitment strategies to secondary funds as attractive for building exposure to an adjustment process and selling pressure invested private equity portfolio. for many European banks. 11 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 markets, which offer an attractive way to and company owners' willingness to sell. At the same time, it would offer attractive opportunities within capture superior long-term growth and distressed strategies and lower entry prices for long-term private equity investors. provide access to small/mid-cap companies Note: Scenarios refer to global economic scenarios (see slide 7) not available through the stock market. What we're watching Why it matters Private equity deals continue to be defensively Credit markets Availability of leverage and credit spreads are important signs of the health of financed amidst economic uncertainty buyout markets. Small/mid caps are currently financed at 4.3x EBITDA (vs 4.6x for large-caps) and are more attractive given their lower reliance on bank financing in a period of ongoing bank deleveraging. Capital overhang We track deal/exit activity to understand the pressure to invest, future price dynamics and draw-down profiles for investors. More than USD 930bn of un- invested capital and expiring investment periods will keep prices elevated. Purchasing prices (Enterprise Price multiples offer valuable insight into private company valuations. YTD .:Ikof h sla d — Ina.' value / EBITDA) May 2012, buyouts occurred at 8.1x, down from 8.8x seen in 2011. Large-cap Source: S&P, UBS OO, as of May 2012 buyouts have come down 10% from the peak last year to 8.6x. Note: Past performance is not an indication of future returns. UBS For further information please contact OO's asset class specialist Stefan Bragger, Please see important disclaimer and disclosures at the end of the documen Note: We emphasize the equal importance of fund manager selection and the commitment strategy. Please note that private equity is an illiquid asset class 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 UM CO private equity recommendations. Private equity is only suitable for qualified investors (> USD Sm investable assets). EFTA01089763 Contact list UBS WM Global Chief Investment Officer Alexander Friedman Global Head of Investment Mark Haefele Global Investment Office Themes / UHNW Asset Allocation Advisory Asset Allocation Discretionary Simon Smiles Mark Andersen Mads Pedersen Kiran Ganesh Karsten Ba er Walter Edelmann James Purcell Achim Peijan Markus Um artin er, CFA Christopher Wright Philipp Scheittler Oliver Malitius Matthias Uhl Regional Chief Investment Officers Regional CIO Europe Regional CIO Asia-Pacific Regional CIO Emerging Markets Regional CIO Switzerland Andreas Hofert Yon hao Pu Jor e Mariscal Daniel Kalt UBS 42 EFTA01089764 Disclaimer This document has been prepared by UBS AG, its subsidiary or affiliate ("UBS"). The Information is intended as a general market commentary and provided solely for marketing and information purposes. Opinions expressed herein are those of UBS Wealth Management & Swiss Bank's Chief Investment Office. 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