CIO Wealth Management Research May 2014 The dog that barks?€¦ · 2 ubs house view may 2014 Just...

Investment Strategy Guide US EditionCIO Wealth Management Research

May 2014

Also inside Keep your eye on the fundamentals

UBS HouseView

The dog that barks?

2 ubs house view may 2014

a message from the regional Cio

Dear reader,Periodic pullbacks within equity markets are fairly common following extended rallies, so the most recent stretch of volatility doesn’t come as all that much of a surprise. Still, this pullback hasn’t exactly followed form. Although both cyclical and growth stocks lead the way lower, credit spreads remained unchanged and European peripheral yields reached new post-crisis lows. It would therefore appear that there is more at work here than just the standard equity market correction.

So in this month’s Feature article we consider the impact that shift-ing perceptions about central bank policy actions may be having on assorted financial markets. We find that while monetary policy may add to volatility, the overall mix is broadly appropriate given the differ-ing dynamics across regions: the Fed is gradually moving to normalize policy as inflation begins to rise; the ECB continues to explore more accommodative measures as deflation threats linger.

The Focus article likewise delves into recent market re-pricing, but fo-cuses a bit more directly on the fundamentals factors that are likely to drive directional moves going forward. While we remain mindful of geopolitical risks, we recommend that investors continue to over-weight risk assets amid improving growth prospects and still fair valu-ation levels. We therefore retain a preference for US and Eurozone equity markets – as well as more credit-sensitive sectors within fixed income markets.

Sincerely,

Mike Ryan, CFAChief Investment Strategist, WMARegional CIO, Wealth Management US

tACtICAl pREFEREnCES 1

feature 2the dog that barks?by Alexander S. Friedman

pREFERREd InvEStMEnt vIEwS 10

Month In REvIEw 11

At A GlAnCE 11

GlobAl EConoMIC oUtlooK 12

ASSEt ClASSES ovERvIEw 14equitiesfixed incomeCommoditiesforeign exchange

In FoCUS 20Keep your eye on the fundamentalsby Stephen Freedman

top thEMES 22major advances in cancer therapeutics

favor eurozone equities within europe

tip-toeing out the yield curve

KEy FoRECAStS 24

dEtAIlEd ASSEt AlloCAtIon 25

pERFoRMAnCE MEASUREMEnt 32

AppEndIx 35

pUblICAtIon dEtAIlS 39

Contents

may 2014 ubs house view 1

Tactical preferencesDespite geopolitical uncertainties, we expect the global economy to accelerate this year, providing support to US and Eurozone equities as well as high yield bonds.

OverweightUnderweight

Cash

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d income Commodities Non traditional Foreign exchange

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US Muni Corp* Corp Markets Markets Total Total USD EUR GBP JPY CHF Other

taCtiCal asset alloCation

Legend

Overweight: Tactical recommendation to hold more of the asset class than specified in the moderate risk strategic asset allocation (see page 25) Underweight: Tactical recommendation to hold less of the asset class than specified in the moderate risk strategic asset allocation (see page 25) Neutral: Tactical recommendation to hold the asset class in line with its weight in the moderate risk strategic asset allocation (see page 25)

*investment grade corporates are overweight in tax-exempt portfolios but underweight in taxable portfolios, where we prefer municipal bonds.

note: tacticaL time horizon is approximateLy six months

3) Commodities We upgrade commodi-ties to neutral amid supply-side tail risks.

1) Equities We maintain a prefer-ence for the Us and the eurozone.

2) Fixed income We prefer high yield corporate bonds and, in taxable portfolios, municipal bonds.

Asset ClassesTactical asset allocation

this month


Just over a year ago, the International Monetary Fund (IMF) called inflation “the dog that didn’t bark” in reference to the remarkably stable rates of consumer price inflation in the wake of the 2008-09 financial crisis. One year later, that dog remains silent. But as any dog owner knows, assuming it stays that way can be a bold assumption.

It is important that investors do not become complacent in the face of changing funda-mentals. In both the US and the Eurozone, inflationary dynamics are becoming more chal-lenging, albeit in different ways.

The recent sell-off in equities has left the MSCI World equity index down 2.5% from its April peak. It has caused pain for equity investors and appears attributable to a combina-tion of style rotation and a rise in geopolitical uncertainty. However, the overall scale of the move should come as no surprise in an asset class with a weekly standard deviation of 2.7%.

To the extent investors are surprised by volatility in the equity market, it illustrates how ac-customed to, and perhaps dependent on, the central bank-sponsored low-volatility envi-ronment they have become. In the years ahead, central bank policy will remain critical, and monitoring how central banks respond to changing inflationary dynamics will be key to assessing the financial market outlook.

In the US, continued improvement in employment data has reduced spare capacity in the labor market, which suggests we should see greater inflation and capital expenditures this year. The market’s focus on rising Fed rates is likely to intensify and should result in higher Treasury yields and a stronger US dollar.

Meanwhile, the Eurozone’s flirtation with deflation has, in our view, transformed the per-ceived limits of European Central Bank (ECB) policy, similar to when the Outright Mone-tary Transactions (OMT) program was announced during the 2012 sovereign debt crisis. At the most recent ECB press conference, President Mario Draghi opened the door to an asset purchase program should inflation expectations become unhinged. This willingness to consider quantitative easing, which now seems implicitly supported even by the Ger-man Bundesbank, provides an additional layer of “insurance” to the Eurozone’s economic growth and corporate health.

The dog that barks?

Alexander S. FriedmanGlobal Chief Investment OfficerWealth management

Inflation has remained remarkably stable in the wake of the 2008-09 financial crisis.

Inflationary dynamics are now becoming more challenging, albeit in different ways across regions.

US employment data suggests we should see higher inflation this year. The market’s focus on rising Fed rates should result in higher Treasury yields and a stronger US dollar.

The Eurozone’s flirtation with deflation has transformed the perceived limits of ECB policy.

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As a result, we view the recent financial market weakness as a buying opportunity. We will, of course, continue to monitor the situation in Ukraine closely and would review our position in the event of a sustained rise in energy prices or prolonged supply disrup-tion. But, for investors, attempting to anticipate geopolitical developments and trade risk premiums is likely to prove a losing strategy. We consider it best to invest based on fundamental economic developments and react, as necessary, to geopolitical events as they occur.

A remarkable absence of inflation (or deflation) in the aftermath of the financial crisisThe problems of high inflation are obvious – a vicious circle can take hold whereby prices and wages feed off each other. The ensuing inefficiency in setting real wages can nega-tively affect real consumer spending, which forces businesses to devote more time to managing changing prices and less to producing goods and services. The overall impact is slower real growth and a stagflation-like environment.

The costs of deflation may not be as evident in the near term, and for consumers the idea of falling prices might even sound attractive. Just last week the Polish central bank gover-nor commented that he was pleased with the country’s current rate of inflation (0.7%) because it stimulates consumption. But over the long haul, the impact is quite the oppo-site – consumers defer purchases in anticipation of lower future prices and companies es-chew investment due to concerns that debt levels could grow in real terms. This causes the economy to contract and leads to a debt-deflationary downward spiral, with unem-ployment rising and numerous negative real-world effects.

In both cases, the inflationary and deflationary dynamic feeds on itself, and once expecta-tions are embedded they can be very difficult to dislodge. It took the so-called “Volcker Shock” to remove the US’s high inflation expectations in the 1970s, with the US Federal Reserve raising base interest rates from 10% to 20% in a period of less than 12 months in 1979-80. And the Abenomics project in modern Japan is, in effect, an effort to unhinge a deflationary mind-set that has taken hold in the country after decades of extremely low inflation or deflation.

Conversely, if a central bank can keep inflation expectations stable, it is much easier to keep inflation itself stable. And since the Volcker Shock and the subsequent shift to

Fig. 1: Inflation expectations have been firmly anchored for decades

Source: Bloomberg, as of 15 April 2014

University of Michigan 5–10 year ahead yoy inflation expectations survey (%)

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> Both high inflation and deflation are problematic

> In both cases, the dynamic feeds on itself, and embedded expectations are difficult to dislodge

> Thankfully, the forces of deflation and inflation have offset each other almost perfectly


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inflation-targeting regimes at many other central banks, inflation-fighting credentials have been affirmed, generally helping to set inflation expectations low and steady. We can see this most clearly in the US and in the University of Michigan survey of long-run inflation expectations. For more than two decades, the public’s expectation for inflation five to 10 years into the future has remained in a comfortable 2.5% to 3.5% range (see Fig. 1). This is consistent with the c.2% rate of inflation that most major central banks consider to be ideal for stability and maximum employment.

The financial crisis should have made things a lot more difficult, as financial markets seized up and credit contracted, threatening a damaging deflationary spiral. At one point, Treas-ury Inflation Protected Securities implied that financial markets expected deflation in the US for the 10 years subsequent to December 2008. But, both realized inflation and infla-tion expectations actually have proved remarkably steady. The unprecedented expansion in central bank balance sheets meant the forces of deflation and inflation offset each other almost perfectly.

It has all proved eerily stable, hence the IMF’s reference to “the dog that didn’t bark.” To-day, however, inflationary dynamics are becoming more challenging, on the upside in the US and on the downside in the Eurozone. Central bank responses to these changing re-gional dynamics will largely determine the direction of markets in the years ahead.

US inflationary pressures are steadily risingJust over a year ago I wrote a CIO letter about inflation in which I pointed out that it was unlikely to rise sharply in the US because the unemployment rate (at the time 7.8%) was too high.

Since then, the economy has added around 2.4 million jobs. Labor market slack has dimin-ished and economic growth going forward will feed more quickly into inflation. Quite how quickly this happens is a major source of debate within the Fed. On the one hand, the unemployment rate remains high and may underestimate spare capacity if we account for potential workers who have dropped out of the labor force but could return in a buoy-ant economy. But demographics in the US suggest aging baby boomers may not return. And, some leading indicators, such as the number of small businesses reporting difficulty in filling their job openings (see Fig. 2), the overtime hours being worked, and their high number of temporary workers, tell a story that suggests there may not be so much spare capacity in the US workforce.

Fig. 2: Signs of diminishing slack in the US labor market


NFIB survey of small business job openings deemed ‘hard to fill’

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> An increasing number of small businesses are finding job openings hard to fill

> However, inflationary dynamics are becoming more challenging

> US labor market slack has diminished and economic growth going forward will feed more quickly into inflation

> However, if a central bank can keep inflation expecta-tions stable, it is easier to keep inflation itself stable


Precisely where the non-accelerating inflation rate of unemployment (NAIRU) lies remains a topic of much debate. The Fed as a committee believes it lies close to 5.5%, but some of its members think, as we do, that it could be half to a full percentage point higher. With no proof forthcoming, the Fed must react nimbly to economic data, and the lack of clarity about NAIRU contributed to its decision to no longer focus purely on the unemployment rate as a measure of labor market slack.

Considering a broad range of economic indicators is particularly important in the context of the massive expansion of the Fed balance sheet in recent years. It has not translated into inflation since the vast majority of funds have simply ended up as reserves on the bal-ance sheets of commercial banks – stuck in the financial system due to the unwillingness of banks to expand lending aggressively and the relatively muted corporate demand for loans.

In the absence of stronger loan demand, this “blockage” is likely to persist and prevent loose monetary policy from generating meaningful inflation. But this dynamic could change quickly if the labor market is found to contain little slack and wages go on rising. In this scenario, companies would turn to investing in capital rather than labor, drawing some of the banks’ excess reserves into the real economy through higher loan demand. This would boost real economic growth – the US has ample scope, and needs, to expand investment – and we favor those sectors exposed to growing business spending, such as banking and technology. But, if this situation unfolds, the Fed will need to respond quickly to avoid dislodging inflation expectations.

We believe the Fed is unlikely to face this scenario in 2014 and that it remains somewhat biased toward dovish policy – we note that the Federal Open Market Committee (FOMC) took the unusual move of hosting a video conference this month to ensure that steps to eliminate its 6.5% unemployment threshold were not misconstrued as hawkish. But with consumer price inflation set to approach 2% by the end of this year and likely accelerate through 2015 on the back of stronger economic data, the attention on the rising Fed rates can only increase and translate, in our view, into a stronger US dollar and higher Treasury yields. As a result, we advise shifting fixed income allocations away from high grade bonds, which are less insulated against interest rate rises, and toward credit and loans, which offer, respectively, a credit spread to provide insulation and a floating rate. We con-tinue to hold a neutral stance on the duration, and note that as we get closer to policy

Fig. 3: Eurozone inflation has reached dangerously low levels


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> We believe NAIRU could be a half to a full percentage point higher than the Fed's estimate

> Any downward shock risks expectations of low-and-stable inflation becoming dislodged

> Attention on rising Fed rates will likely translate into a stronger US dollar and higher Treasury yields

> If the labor market is found to contain little slack, companies would turn to investing in capital


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normalization, short-dated bonds are (in a relative sense) likely to react most sharply to changes in Fed policy.

Equities need not suffer in this environment. Interest rate rises, in isolation, won’t benefit equity multiples, but if accompanied by higher growth, greater capital expenditure, and stronger corporate earnings, they should not preclude markets from trending modestly higher, in line with earnings growth. And, historically, rising inflation has proved positive for equity markets (as one might expect since equities are a claim on future incomes), pro-vided it remains in low-and-stable territory, e.g. below c.4%. We are keeping an over-weight allocation to US equities.

The Eurozone is flirting with deflationThe dynamics in the Eurozone are different than those in the US. Unemployment hovers considerably higher at 11.9%. The ECB balance sheet has been contracting for close to two years as banks repay the emergency long-term refinancing operation (LTRO) funds they received during the 2011-12 crisis. And loans are shrinking for a second year. Con-sumer price inflation has fallen from 2.7% year-over-year at the beginning of 2012 to just 0.5% this March (see Fig. 3).

We believe March is likely to mark the bottom of the downward trend for inflation. A relatively warm winter and a late Easter probably played a role in lessening inflation in March, a situation that should reverse in April. But with inflation already so low, any downward shock risks expectations of low-and-stable inflation expectations becoming dislodged, as happened in Japan in the 1990s.

As I mentioned earlier, when it comes to asset prices, a central bank’s response to inflation may matter more than the rate itself. And we believe the Eurozone’s flirtation with defla-tion has transformed the perceived limits of ECB policy in a way similar to the announce-ment of the OMT during the 2012 sovereign debt crisis.

In the past month, Draghi has opened the door to the possibility of an asset purchase program to stimulate loan growth and prices, should inflation expectations become un-hinged. At this stage it is unclear precisely what assets the ECB would be willing, or al-lowed, to buy. And if inflation rebounds in line with our expectation, an asset purchase program is unlikely. But for the pricing of risky assets in the Eurozone, the perceived limits

Fig. 4: The strength of the Euro is a key contributor to weak Eurozone inflation


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> The strength of the euro sits at odds with the ECB's price stability mandate

> Draghi has opened the door to the possibility of an asset purchase program

> The dynamics in the Eurozone are different than those in the US

> Equities need not suffer in this environment; histori-cally, rising inflation has proved positive for markets


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of policy are crucial – we learned this during the 2008 financial crisis. The fact that Jens Weidmann, president of the typically hawkish Bundesbank, is willing to acknowledge that an asset purchase program is “not generally out of the question” shows just how far potential ECB policy has come.

This shift in ECB thinking should serve to underpin equity multiples in the region, increas-ing our confidence in the region’s market, which we remain overweight. We also remain underweight the euro. Draghi’s statement over the weekend that “the strengthening of the exchange rate requires further monetary stimulus“ was perhaps the most explicit ex-ample yet that the governing council feel the strength of the euro sits at odds with their price stability mandate. Local services prices in Germany, France, and Italy are all actually rising at a comfortable rate of 1.5-2.0%, but the strength in the euro is leading to very low headline rates of inflation, due to falling import prices (see Fig. 4). Regardless of whether the ECB elects to act, we expect the currency to weaken as expectations of mon-etary policy divergence between the Eurozone and the US increase this year.

Deflationary forces from AsiaOf course, global factors also influence inflation and we cannot neglect the situation in Asia in this regard.

China has acted as a deflationary force on the global economy since ascending to the World Trade Organization, as its cheaply manufactured goods replaced those of devel-oped markets in consumer baskets. Life for developed market central banks became al-most universally easier since inflation stayed contained despite strong economic growth.

This deflationary dividend appeared to be coming to an end in recent years – China’s unit labor costs in USD terms have climbed by 60% since 2007, due to a combination of a ris-ing currency and wages, and its market share growth has slowed. For the developed world, this need not mean inflationary forces, as production is shifted to other producers. Since 2010, China has lost market share in, for example, clothing production to the likes of Vietnam and Bangladesh.

And China’s transition to a less investment-oriented economy could mean that it actually continues to provoke deflation in the rest of the world as it reduces its reliance on energy-intensive and commodity-demand growth. The energy-hungry aluminium and steel mills

Fig. 5: Overcapacity in China has resulted in producer price deflation


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> The shift in ECB thinking should serve to underpin equity multiples in the region, increasing our con-fidence in the market

> China recently reported PPI at -2.3% year over year

> We remain underweight the euro


historically used to meet growth targets are now being forced to cut production and be-come more profit sensitive. Overcapacity has caused producer price deflation, most re-cently reported at -2.3% year over year, for the past two years (see Fig. 5).

Finally, we believe Japan will also act as a deflationary force. Its economic data was rela-tively strong in the first quarter, in our view due in large part to greater consumer demand for big-ticket items such as cars ahead of April’s consumption tax hike. Economic growth should slow in its wake, and we believe the government will once again lean on the Bank of Japan to weaken the yen in order to stimulate growth. While inflationary for Japan, such intervention will reduce import prices for Japanese goods and impose a deflationary drag on the rest of the world.

ConclusionOverall, inflation worldwide is likely to remain contained, even if growth improves in de-veloped markets. However, it must not be ignored. Dynamics are changing and diverging, and central bank responses to these shifts will prove a key driver of markets in the years ahead.

I have obviously spent a lot of this letter discussing inflation as an economic phenomenon, and examining its influence on developed market central bank policy. This is important for our portfolio positioning. But, I should acknowledge that inflation is a very real phenom-enon faced by some individuals. This is particularly true in emerging markets like Brazil, Turkey, and India that have suffered from years of underinvestment. Ironically, however, protecting against inflation is easier in these countries than in developed markets since real interest rates are positive in local currency.

In the developed world, real interest rates remain in negative territory in most currencies. While we expect them to rise in the years ahead, they are unlikely to reach pre-crisis norms. Structural factors such as relatively low investment rates in developed markets, ex-cess savings in emerging markets, and aging populations in asset-rich countries will con-tinue to suppress them.

The best way of protecting against inflation, we believe, is to invest in assets. Such a strat-egy particularly pertains to wealthy individuals, since rising asset prices may influence in-flation perceptions more than the prices of other goods included in economists’ inflation baskets.

Equities, which represent claims on the future income produced by the real assets of a business, should rise over time in tandem with overall prices. We advise investors to review their strategic asset allocations to ensure they have adequate exposure to shares and lim-ited exposure to cash.

Asset allocation summaryWe maintain a preference for equities as an asset class, in particular in the US and the Eu-rozone. In both regions we expect earnings growth to drive prices higher in the months ahead, with only limited potential for multiple expansion. We have reduced the scale of our underweight position in UK equities due to tentative signs of stabilizing earnings mo-mentum, and after c.3% relative underperformance in the past month.

In fixed income, we advocate shifting allocations away from government bonds and to-ward global investment grade and US high yield credit, where we believe spreads still pro-vide more-than-adequate compensation for default risks.

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> The best way of protecting against inflation is to invest in assets

> Overall, global inflation is likely to remain contained, but it must not be ignored


In last month’s letter I discussed “investing through uncertainty,” and uncertainty persists today, particularly with respect to developments in the Ukraine. In the past month, events in eastern Ukraine have increased the probability of the West taking stronger sanctions against Russia, and the probability of a disruption to energy supplies to Europe has in-creased, with Russia and Ukraine in open dispute over gas payments.

We stand by the view that the crisis should not affect the global outlook unless it results in oil prices rising by USD10-20/bbl over a prolonged period. In such a scenario, consumer and business confidence would be adversely affected, real economic activity would slow, and we would likely review our overweight positions in risky assets. That said, we continue to assign a low, if increased, probability to such a scenario, but are increasing our position in commodities from underweight to neutral against the backdrop of this uncertainty, which should lead energy markets to continue reflecting a higher-than-usual geopolitical risk premium.

Finally, in foreign exchange, we prefer those major currencies likely to see interest rate hikes in 2015, relative to those where central banks hold an easing bias. We are over-weight the US dollar and the British pound, relative to the Japanese yen, euro, and Swiss franc.

Thank you for reading this letter.

Sincerely,

Alexander S. FriedmanGlobal Chief Investment OfficerWealth Management

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Preferred investment vieWsas of 16 april 2014

Asset Class Most preferred least preferred

Equities • Us • eurozone • Us small and mid caps• Us technology • Us capex • north american energy independence• Cancer therapeutics ()

• UK ()

bonds • Us high yield• investment grade credit1 • Capital securities • Us senior loans

• Government bonds ()

Foreign exchange

• Usd• gBP

• eUr • Chf• JPy

Alternative investments

• Credit alternatives to diversify bond portfolios

Cash • tiptoeing out the yield curve

recent upgrades recent downgrades

1 municipal bonds preferred in taxable portfolios, investment grade corporates in tax-exempt portfolios.


At a glanceEconomy

The US economy continues to recover from its weather-induced soft patch. The latest ISM leading indicator, as well as employment and retail data, suggest that the US is on track for GDP growth of around 3% this year – the fastest growth rate since 2005. This would allow the Federal Reserve to phase out its quantita-tive easing (QE) program by 4Q14 and start hiking rates by mid-2015. Meanwhile, the European Central Bank (ECB) maintains an easing bias as deflationary threats persist, and the successful return of Greece to the capital market highlights the improved sentiment toward the region. Meanwhile, geopolitical risks continue to trouble certain emerging economies.

Equities Positive economic news keeps us confident in our constructive outlook for equi-ties in 2014. We believe that the recent weakness in equity prices, partly due to increased tensions in Ukraine, presents a buying opportunity, and we are main-taining our overweight in global equities over bonds. Our preferred equity mar-kets are the US and the Eurozone where earnings growth will likely drive prices higher in the months to come. UK equities have underperformed global equities so far in 2014, and we are reducing the size of our UK underweight position in light of tentative signs of earnings stabilization in certain sectors.

Fixed income Investor demand for developed market corporate bonds, both from the invest-ment-grade (IG) and high-yield (HY) segments, remains strong. We believe that this is warranted given robust corporate balance sheets, good funding conditions, and solid economic growth that are keeping default rates low. We recommend overweight positions in US HY funded by underweights in Government bonds, which will likely suffer from gradually rising rates. Within emerging markets, valu-ations look appealing however the credit cycle is still deteriorating. As a result, we recommend a neutral allocation.

Commodities

We are increasing our position in commodities from underweight to neutral against the backdrop of increased geopolitical uncertainty in Ukraine, which should lead en-ergy markets to continue reflecting a higher-than-usual geopolitical risk premium in the near term. That being said, based purely on supply-and-demand factors, our to-tal return estimate for commodities remains negative over the next six months.

Foreign exchange

While the Fed continues to taper its QE program, several ECB officials have ac-knowledged QE as a legitimate policy option for the monetary union. We expect this divergence in the monetary policy outlook to weaken the euro against the US dollar in the coming months. Likewise, the Bank of Japan is likely to provide fur-ther stimulus in the summer months to come closer to its 2% inflation goal. We are therefore underweight the yen and the euro against the US dollar. Finally, the British pound offers upside against the Swiss franc as the British economy contin-ues to be persistently strong.

month in review

After their slow but steady grind higher this year, US markets were less predictable in April following a wide momentum sell-off in bio-tech and internet names. While the protracted winter was ex-pected to affect Q1 earnings, the economy continued to expand, with manufacturing, unemploy-ment, and consumer confidence all showing improvement. On the policy landscape, decidedly dovish Janet Yellen reiterated her patient approach to interest rate hikes, as investors sought greater clarity around the timeline.

After a disappointing year, Emerging Markets bounced back slightly while turmoil in Ukraine continued to weigh on sentiment. The killing of pro-Russian protes-tors in a military operation by Kiev sparked off harsh rhetoric from Russia. Meanwhile international pressure on Putin mounted as the UN rejected the Crimean referen-dum and the Parliamentary Assembly of the Council of Europe passed a resolution stripping Russia of voting rights.

The Chinese government re-sponded to weak data with light stimulus and Afghanistan held elections which marked an impor-tant test for the government as it prepared for the withdrawal of US forces this year. Venezuelan oppo-sition leaders expressed readiness to try to resolve months of violent civil unrest. Meanwhile in Nigeria a bus station bombing – attrib-uted to a militant Jihadist group Boko Haram – killed 71, while in South Korea, a ferry carrying high school students capsized, with nearly 300 people still unac-counted for.



Eurozone in the focus Ricardo Garcia, CFA

CIo vIEw Probability: 60%

Moderate growthThe Eurozone economy is set to grow at approximately 0.3–0.4% sequentially in coming quarters. The ECB retains an easing bias but is not in a hurry to ease, despite low inflation and neutral monetary conditions. We expect a grand coalition in the European parliament, with non-mainstream parties gaining more seats.

poSItIvE SCEnARIo Probability: 20%

Strong growth and fiscal stabilization

Bond yields converge closer than expected as peripheral countries consolidate their budgets and economic activity recovers faster. France and Italy follow a credible reform path at a faster pace and political risks fade further.

nEGAtIvE SCEnARIo Probability: 20%

Major shock

Political uncertainty and negative bank stress-test results rattle Italian bonds, while persistent deficit overshoots threaten Spain. Spain or Italy requires funding support; Eurozone disinflation or deflation persists; Portugal requi-res a debt restructuring; and France experiences a massive fiscal slippage. The severity of economic sanctions on Russia increases.

Key finanCial marKet drivers

Global economic outlook thomas berner, cfa; ricardo garcia, cfa; gary tsang

US data confirmed a solid rebound in economic growth as adverse weather conditions faded, putting fears of a more severe downturn to rest. While 1Q14 real GDP growth will likely be sub-par, we expect growth to reaccelerate to annualized 3+% in the remainder of the year. We expect the Eurozone recovery to continue at a moderate speed and consumer price inflation to rise again after hitting a low point of 0.5%. The ECB will likely only react with minor unconven-tional policy actions but abstain from another rate cut. Chinese growth data remained lacklus-ter, but the government’s policy reaction will likely boost growth moderately going forward.

Robust US expansion thomas berner, CFA


Robust expansionWe expect US growth to be robust in 2014, driven by stronger private-sector demand. Inflation will likely stay below the Fed’s target of 2% over the next six months. The Fed’s QE3 will likely last until 4Q14, with a tapering of USD 10bn per meeting, and ultimately total USD 1.62tr.


Strong expansion

US real GDP growth accelerates persistently to around 4%, propelled by an expansive monetary policy, a rapidly fading fiscal drag, strong investment in housing, improved business and consumer confidence, and subsiding China hard-landing and Ukraine geopolitical risks. The Fed halts QE3 earlier and raises policy rates sooner than mid-2015.


Growth recession

US growth momentum fades as Fed stimulus is curtailed, the Eurozone crisis reescalates, China’s growth decelerates significantly, or the Ukraine geopolitical tension intensifies. Real GDP growth deteriorates, raising the fiscal deficit and leading to more aggressive bond-buying by the Fed.

China growth to moderateGary tsang


More policy response to stabilize growthDisappointing growth in 1Q14 has prompted more policy support. The measures will help cushion the downside risks to cyclical growth. While small-scale credit events are likely in 2014, we do not see the situation developing into a systemic event.


Growth acceleration

Annual growth accelerates past 8% as a result of more substantial fiscal, monetary, and credit policy support from the government, or a strong pickup in external demand.


Sharp economic downturn

Annual growth falls below 6% as the government heavily reins in shadow banking with tight liquidity, property prices rapidly rise or decline, and demand for Chinese exports plunges.

real gdp growth in % Inflation in %2013 2014f 2015F 2013 2014f 2015F

Us 1.9 3.0 3.2 1.5 1.9 2.4Canada 1.6 2.6 3.1 0.9 1.6 2.2Brazil 2.3 2.3 2.0 5.9 6.2 6.0Japan 1.6 1.5 1.2 0.3 2.7 1.8australia 2.4 3.0 3.2 2.4 2.9 2.4China 7.7 7.5 7.0 2.6 2.7 3.0india 4.7 5.7 5.3 9.5 7.6 6.4eurozone -0.4 1.1 1.5 1.4 1.0 1.5UK 1.8 2.8 2.7 2.6 2.0 2.0switzerland 2.0 2.1 2.4 -0.2 0.2 0.7russia 1.3 1.5 2.0 6.8 6.1 5.4World 2.5 3.2 3.4 2.9 3.1 3.2

gloBal groWth exPeCted to Be 3.2% in 2014

Key dates

> 1 may 2014

ISM manufacturing The manufacturing PMIs should continue to re-

bound, confirming that any earlier softness was weather-induced and supporting our view that growth will accelerate over the year.

> 2 may 2014

US jobs report Nonfarm payrolls should confirm a trend-like gain

of around 200,000, with the unemployment rate gradually falling further despite a rebound in the participation rate. We look for average hourly earnings inflation to trend higher soon, as labor market conditions continue to tighten.

> 8 may 2014

ECb policy decision Despite a drop in inflation, the ECB has held its

refinancing rate at 0.25% although Mario Draghi repeated that any unusual measures would be considered by the Governing Council. There continues to be intense speculation that the ECB could suspend SMP, or cut the deposit rate sub-stantially at one of the upcoming meetings.

> 13 may 2014

US retail sales Retail sales rose 1.1% in March, with auto sales in

particular showing significant rebound as con-sumption rose after weather-induced weakness, further bolstering the economic outlook. We ex-pect further solid gains going forward.

> 15 may 2014

US CpI Even though March CPI edged higher at a faster

clip, it likely doesn’t mark a watershed moment for inflation in the near term. Either way, we expect CPI inflation to accelerate over the course of the year.

> 17 may 2014

portugal exits bailout program Greece’s successful bond issue raised the prob-

ability that like Ireland last year, Portugal might not need a cautionary credit line when exiting its three-year bailout program in May.


Source: Reuters EcoWin, IMF, UBS CIO WMR, as of 15 April 2014. Please see disclaimer in appendix.


Equities

Emerging Markets We are holding a neutral position in EM equities. The consensus expecta-tion is for EM earnings to grow by 11% over the next 12 months. We are more cautious, however, and expect around 9%. The weakness in EM earnings is currently counterbalanced by relatively attractive valuations on a historical basis and relative to developed market valuations. This matters for longer-term investors, but is not a short-term trigger. We do not foresee a material rerating of EM equities over the next six months, but expect the P/E multiple of the MSCI EM index to stay close to its current level of about 11.6x based on realized earnings. We prefer China, Mexico, South Korea, and Taiwan over Malaysia, Thailand, and Turkey.

MSCI EM (index points, current: 1000) six-month target

House view 1050

Positive scenario 1170

Negative scenario 820

asset Classes overvieW

Jeremy Zirin, CFA; David Lefkowitz, CFA; Stephen Freedman, PhD, CFA; Markus Irngartinger, PhD, CFA

Eurozone

We have an overweight position on Eurozone equities but recommend that investors seek to hedge the risk of a declining euro. The region’s economic growth momentum, combined with an uptick in global manu-facturing, bodes well for the Eurozone corporate earnings outlook. Trailing earnings have already improved in recent months. We prefer the consumer discretionary sector as it offers good revenue and earnings growth and generates high free cash flow. Financials offer attractive valuations and superior earnings growth. Utilities are cheap and earnings will return to growth. Our least preferred sectors are Consumer Staples, Materials and Telecom.

EURo Stoxx (index points, current: 314) six-month target

House view 330

Positive scenario 380


Japan

We have a neutral stance on Japanese equities. We believe corporate earnings growth will start to slow as the effect of the yen’s weakness peters out. Following an estimated 55% earnings growth for FY2013 (end-ing March 2014), earnings growth for FY2014 should slow down to 10%. The consumption tax hike in April and the end of some stimulus measures will be a drag in the current quarter. Should inflation decline considerably, the Bank of Japan is likely to increase its monetary policy stimulus. Overall, we forecast the Topix to move in line with global equity markets.

topIx (index points, current: 1,167) six-month target

House view 1,210

Positive scenario 1,400


UK

We have an underweight stance on UK equities relative to global equities. The UK’s overall earnings dynamics lag those of global markets. The strong pound is a drag on earnings given the high proportion of FTSE 100 sales generated abroad. The UK’s valuation discount to global equities is in line with that of the past 15 years. The UK market is more defensive than global equities, with defensive sectors accounting for 50% of the UK market versus 35% for global equities. Thus, UK equities will likely benefit less from the global recovery. Investors could benefit from the UK’s do-mestic recovery by investing in UK mid-cap companies.

FtSE 100 (index points, current: 6,542) six-month target

House view 6,740


Negative scenario 5,700

Positive economic news keeps us confident in our constructive outlook for equities in 2014. We believe that the recent weak-ness in equity prices, partly due to increased tensions in Ukraine, presents a buying opportunity and we are maintaining our overweight in global equities over bonds. Our preferred equity markets are the US and the Eurozone. US equities are well-supported by robust earnings growth. The Eurozone’s trailing earnings per share (EPS) have started to rise on the back of a brighter economic backdrop for the region. UK equities have underperformed global equities so far in 2014, and we are re-ducing the size of our UK underweight position in light of tentative signs of earnings stabilization in certain sectors. While UK large-caps’ trailing EPS continue to lag those of developed markets, the UK materials sector is showing signs of improve-ment in earnings. We are neutral on emerging market equities. Their valuations are currently at a discount relative to their own history and to global equities, but so far a trigger to unlock their valuations is missing.

global equities

We now include six-month price targets for each of the regional equity markets covered by CIO WMR strategists in this report, including the US. This time frame aligns with the horizon for our tactical asset allocation recommendations. Price target updates will be provided on a monthly frequency in this publication and on an ad hoc basis as market conditions dictate. Current targets are as of 15 April 2014.



US Equities overview US equities have modestly retreated from their recent highs as concerns over geopolitical risks in Ukraine, decelerating growth in China, and a rotation out of a select group of prior “market darlings” have outweighed more positive fundamental domestic developments. We believe improv-ing domestic economic growth prospects as the weather improves and pent-up demand is vented will be the key for further US equity market advances. From this perspective, the most recent data has been encour-aging. Improving manufacturing and small business sentiment, rebound-ing labor market data and retail sales, and an uptick in bank lending activ-ity all signal that our expectation for US growth to accelerate in 2014 remains on course.

S&p 500 (index points, current: 1,843) six-month target

House view 1,950


Negative scenario 1,600

US SectorsDefensive sectors have outperformed on a relative basis over the past few weeks, benefiting from the market pullback and the rotation out of momentum stocks. Furthermore, the high yielding Utilities sector has been the top-performing sector year-to-date driven by increased home heating demand and the decline in interest rates. Interestingly, year-to-date, outside of the outperformance of Utilities and underperformance of the Consumer Discretionary sector, the remaining eight sectors all

After reaching a new nominal all-time high of 1890 on 2 April 2014, the S&P 500 slid 4% over the next 7 trading days. A 4% pullback is not terribly uncommon, even during bull markets. However, the decline “felt” more extreme to many investors since market volatility has been quite low over the past 12-18 months and because select market segments (high growth and high momentum) suffered declines far steeper than the broad market index. Fundamentally however, core US equity market drivers remain healthy. We anticipate that corporate earnings will continue to advance, monetary conditions remain accom-modative despite the Fed’s well telegraphed “tapering” of asset purchases, and market valuations are fair. We favor small- and mid-caps and cyclical sectors most levered to a pickup in capital spending, such as Technology, Industrials, and Financials.

Us equities

have performed broadly in line with the S&P 500 index. Going forward, we look for cyclical sectors to regain market leadership and for Utilities to meaningfully lag as domestic growth improves and interest rates likely head higher from current levels.

US Equities – sizeSmaller size segments typically lead the market higher during rallies and decline more than large-caps during sell-offs. The recent pullback has not been an exception. Somewhat high valuations relative to long-term averages left both small- and mid-caps vulnerable to a shift in investor risk appetite. But importantly, the fundamental rationale for our over-weight stance in small- and mid-cap stocks has not changed. Much faster earnings growth for smaller US companies and our positive view on equity markets remain the primary drivers underpinning our preference for smaller US size segments. Other fundamental factors such as low high-yield bond yield spreads to Treasuries (Fig. 1), also provide an attractive fundamental backdrop for small- and mid-cap stocks.

US Equities – styleGrowth styles suffered last month as investors rotated out of momentum stocks and into more defensive and value-oriented stocks. This rotation appears overdone, in our view. While there are pockets of high growth and momentum segments where valuations may have become extended, growth stocks in the aggregate are not expensive. The Russell 1000 Growth Index currently trades at a 23% valuation premium (based on price to forward consensus earnings) to the Russell 1000 Value Index. This compares favorably to its long-term average premium of 45%. As economic growth picks up over the next few months, we expect growth stocks to regain market leadership.

Fig. 1: Gains in high yield benefit small caps

Source: Federal Reserve, Bloomberg, UBS CIO WMR, as of 15 April 2014

High yield spread vs. small/large cap performance In %

112

108

104

100

96

116

2

4

6

8

10

0

Russell 2000 relative to Russell 1000 (le) CIO WMR ForecastHigh yield spread over 10yr Treasury bond yield (right), inverted

2010 2011 2012 2013 2014

Source: FactSet, UBS CIO WMR, as of 16 April 2014Note: 2014 and 2015 are CIO WMR forecasts.

80

110

100

90

120

130

140

2012 2013 2014E 2015E

Fig. 2: Earnings growth should accelerate over next two years

S&P 500 EPS

$103.786.0%

$110.396.4%

$120.008.7%

$129.007.5%


Fixed income


Thomas McLoughlin; Barry McAlinden, CFA; Achim Peijan, PhD, CEFA; Philipp Schoettler; Thomas Wacker, CFA

The interest rate backdrop has been benign with the 10-year Treasury yield locked in a fairly tight trading range of 2.6% – 2.8% since early February. Meanwhile, corporate credit spreads have tightened toward multi-year lows and have shown resiliency against the recent equity volatility. These goldilocks conditions are unlikely to persist in fixed income as we look for the Fed’s shift toward a fully qualitative forward guidance to result in higher interest rate volatility. In addition, recent economic data releases suggest that the US cyclical recovery remains on track. This backdrop should result in rising rates, leading higher quality fixed income segments to give back some recent gains. We maintain a preference for credit sensitive segments, namely HY bonds, which offer the greatest spread compression and higher coupon income. For taxable portfo-lios, we maintain an overweight position in municipal bonds relative to IG corporates as technicals should remain favorable in the tax-exempt sector.

Emerging Market bonds

We retain a neutral preference for both EM sovereign bonds and EM corporate bonds denominated in USD. From a valuation perspective, both segments are fair to slightly expensive relative to fundamentals, in our view. The fragile economic recovery and financial vulnerabilities pose headwinds for lower-rated sovereign and corporate issuers. Corporate credit indicators such as leverage ratios and rating trends have weakened in recent quarters. Within sovereign bonds, we prefer sovereign issuers with current-account surpluses or manageable small deficits, coupled with attractive valuations.

EMbI / CEMbI SpREAd (Current: 323bps / 330bps) Six-month target

House view 330bps / 350bps

Positive scenario 285bps / 300bps

Negative scenario 450bps / 520bps

Government bonds

US Treasury yields fell across the curve over the past month. A decisive rebound in US growth was overshadowed by mounting fears of an es-calating stand-off between Russia and Ukraine as well as still ailing Chinese growth. The 10-year rate fell to 2.6% and the 2-year rate to 0.4%. Despite these developments, we continue to expect rates to trend higher going forward. US growth will likely reaccelerate to annualized 3+% in the remainder of the year, but with inflation only moderately rising from its low levels we are not worried about a shift toward more aggressive fed rate hike expectations. The Chinese government’s policy reaction to lackluster growth will likely prevent further deterioration. In Ukraine, we expect further escalation in the form of broader sanctions, but we don’t foresee a full-blown military confrontation. In this scenario we expect upward pressure on rates to emerge again and we therefore maintain our 10-year rate forecast of 3.2% in six months.

US 10-yEAR yIEld (Current: 2.7%) Six-month target

House view 3.2%

Positive scenario 3.3–3.9%

Negative scenario 2.0–2.8%

US high yield Corporate bonds

We hold an overweight position in US HY, even as spreads are close to post-crisis lows. Our six-month spread target of 350bps will provide some price cushion to help offset the drag from rising benchmark rates, and we forecast coupon-driven six-month returns of 2-3%. We expect the default rate to remain well below 2% (ex-TXU) through 2014, supported by our constructive economic outlook, solid corporate fundamentals, and favorable funding conditions. US corporates remain in a middle stage of the credit cycle that entails gradual re-leveraging and incrementally tighter spreads.

USd hy SpREAd (Current: 375bps) Six-month target

House view 350bps

Positive scenario 300bps

Negative scenario 900bps

US Investment Grade Corporate bonds

We are overweight investment grade (IG) corporate bonds in tax-exempt portfolios but underweight in taxable portfolios where we prefer munici-pal bonds. The parallel fall in benchmark yields and corporate spreads since the beginning of the year have turned IG corporate bonds into one of the best-performing asset classes year-to-date with total returns of 3.5%. IG bonds had a better 1Q14 than major equity markets or govern-ment bonds. Although the fundamental and economic backdrop for IG credit remains constructive, IG will remain sensitive to rising rates. IG spreads have declined to 103bps, only slightly above our six-month target of 100bps. We look for weakness in IG prices to be offset by coupon income, with our six-month return projection at only 0-1%. Lower-rated IG segments (BBB) should offer better return potential than higher-rated issuers and short/intermediate maturities outperform longer maturities.

US IG SpREAd (Current: 103bps*) Six-month target

House view 100bps

Positive scenario 85bps

Negative scenario 350bps

*data based on Barclay’s Corporate aggregate indexes.



Additional US taxable fixed income (TFI) segmentsAgency bonds

Within our US TFI allocation, we are underweight agency debt to the same degree as Treasuries. Within the agency market, we are ambivalent on callable bonds versus bullets (i.e., non-callable bonds) because we think the incremental spread is roughly commensurate with the incremental risk. In bullets, we find the best relative value around the two- to three-year area of the yield curve because it offers the best expected carry and roll- down. In callables, we like 5yr finals with 3mo lockouts and 1x calls.

Current agency benchmark spread of +15bps over 5-year UST (versus +25bps last month)

Mortgage-Backed Securities (MBS)

We have a neutral recommendation for the mortgage sector within our US TFI allocation, which represents a relative overweight to Treasuries and agencies. Our reasoning here is that the additional spread that mortgage securities offer generates relative total return outperformance potential in the medium term, assuming our Treasury rate and Fed tapering projec-tions are correct. We prefer higher coupon pass-throughs versus lower coupons because they offer relatively more protection from duration ex-tension risk (i.e., they are relatively less responsive to rising interest rates).

Current MBS spread of 124bps to blend of 5-year and 10-year Treasuries (versus +123bps last month)

Treasury Inflation-Protected Securities (TIPS)

Real yields are lower since the beginning of the year due to temporary weakness in the US economic data, but real yields rose in line with nominals following the March Fed meeting. We expect real yields to continue this rising trend along with the ongoing economic recovery and the phase-out of quantitative easing, so we believe the real yield component of TIPS will suffer in the coming months. While we see some value in TIPS relative to matched maturity nominal Treasuries on a breakeven inflation basis, we believe a tactical investor will find better entry points to buy inflation pro-tection in the medium to longer term. Within our US fixed income alloca-tion, we remain underweight TIPS by the same magnitude as Treasuries.

Current 10-year breakeven inflation rate of 2.20% (2.14% last month)

preferred Securities

Preferreds remain well bid and the solid price-driven performance we saw earlier in the year has continued mostly uninterrupted with preferreds up 8.3% YTD. Fundamentals remain sound and the direction of fund flows has been positive. We believe the performance trajectory is now unsustain-able and expect prices to pare back some gains as interest rates rise. Further credit spread compression is possible for preferreds, which can help support prices in a rising rate environment; however demand conditions could weaken should investors become concerned again about the long duration. Given their income advantage, we look for preferreds to outperform US IG corporate bonds where we only expect flattish returns over the next 6 to 12 months.

Current spread of +240bps over 10-year UST (+244bps last month)

Municipal bonds

Year-to-date, municipals (+4.7%) are outpacing the total returns for both US Treasury securities (+2.2%) and IG corporate bonds (3.5%). We attribute the stronger performance in large part to three factors. First, tight new issuance has provided support to prices. Second, on the demand side, net cash inflows to muni funds have occurred on a weekly basis since the middle of January. Third, for the moment, the muni market has resisted its propensity to overreact to adverse credit developments among a rela-tively small number of borrowers. We continue to believe munis are at-tractive on an after-tax basis.

Current AAA 10-year muni-to-Treasury yield ratio: 87.8% (last month: 91.5%)

non-US developed Fixed Income

Year-to-date, bond yields in most of the major non-US developed markets have moved in line with the US. Eurozone peripheral sovereign bonds have rallied, in some countries pushing yields down to their lowest levels since the global financial crisis began, and Greece was able to sell bonds to the market for the first time since 2010. While this is good news, in our view the lower yields on peripheral bonds have reduced their attractiveness. In the months ahead, we expect Japanese and Eurozone bond yields to rise by somewhat less than Treasury yields. However, we also expect the dollar to gain against both the yen and euro, hurting returns on non-US devel-oped fixed income when measured in dollar terms.

CIo wMR interest rate forecasts

Americas 15-Apr-14 3 mths 6 mths 12 mths End 14

Usd 3m libor 0.2 0.3 0.3 0.5 0.4

Usd 2y treas. 0.4 0.5 0.7 1.0 0.8

USD 5Y Treas. 1.6 1.9 2.1 2.4 2.2

Usd 10y treas. 2.6 3.0 3.2 3.4 3.3

Usd 30y treas. 3.5 4.0 4.1 4.2 4.1

Source: Bloomberg, UBS CIO WMR, as of 15 April 2014

HY spreads staying steady

Source: BofAML, UBS WMR, as of 14 April 2014

S&P 500 Index (le) and HY Index spread (right, in reverse), in bps

SPX Index (le)HY OAS (right)

350

375

400

425

450 1725

1775

1825

1875

1925

Dec-13 Jan-14 Feb-14 Mar-14



Commodities

precious metalsHawkish comments by Fed Chair Janet Yellen brought the gold price under pressure in March. We believe the Fed’s monetary policy normalization could weaken gold further in the coming months. We therefore like to reiterate our negative price stance with a forecast of USD 1,250/oz and USD 1,050/oz over a 6- and 12-month period. The risk to our view relates to stronger Indian demand from changes in import restrictions. With lower gold prices, we expect silver to be burdened as well. Mine strikes in South Africa which started on 23 January are still ongoing, with no resolution in sight. Signs of supply stress in platinum and palladium should soon emerge and give both metals an attractive return outlook over the coming 3–6 months.

Gold (Current: USD 1,302/oz) six-month target

House view USD 1,250/oz

Positive scenario USD 1,500/oz

Negative scenario USD 900/oz

Crude oil Supply availability of crude oil is ample with solid production gains in North America and Iraq. Moreover, we see room for additional Iranian crude oil to find its way to the market once the international sanctions on Iran are lifted. Excess supply in the range of 0.3–0.5mbpd should allow crude oil prices to trade from USD 100–105/bbl in 6–12 months. That said, the commodity still faces geopolitical tail risks due to the Ukrainian-Russian crisis.

bREnt (Current: USD 109.3/bbl) six-month target

House view USD 105/bbl

Positive scenario USD 130–165/bbl

Negative scenario USD 80–90/bbl

base metals The outlook for base metals is receiving support from China’s infrastruc-ture-led stimulus measures. Together with accelerating industrial produc-tion in the developed world, the sector should be in a position to deliver 5–10% returns from here onward. Given the structural challenges in China and a rather strong supply side, there is little upside beyond a one-off move. We favor supply-constrained base metals like nickel, zinc, and lead.

Commodities Dominic Schnider, CFA, CAIA; Giovanni Staunovo; Thomas Veraguth

The decline of broadly diversified commodity indices, like the DJ UBS Index (TR), from early March highs came to a halt and started to reverse partially in recent weeks. Stronger agricultural commodity prices have more than offset weaker energy and precious metal prices, whereas base metal prices were largely stable. Our total return estimate for the asset class remains nega-tive (around –2% to –3%) over the next six months, driven by lower energy, precious metals, and agricultural prices. However, the Ukrainian-Russian crisis and abnormal weather patterns create upside risks in the near term.

AgricultureWeather-related supply concerns for the grains and lower-than-expected inventories for corn and soybeans in the US have supported prices. We believe the conditions for the US harvest in 2H14 will remain solid. Ample area allocation for soybeans and sufficient supply prospects for corn should allow US stock-to-use ratios to increase toward the end of the year. Tightness in other agricultural commodities, like US cotton, is also expected to ease with less Chinese imports (change in the reserve pur-chasing program) and an excess supply allowing a buildup of inventories ex-China. The risk to our view on the grains relates to the El Niño weather pattern, with drier weather in Southeast Asia, Australia, and West Africa, and excessive rains in South America. We believe this makes wheat es-pecially vulnerable, similar to other agricultural commodities, like coffee, that have already been affected by this year’s weather extremes.

other asset classes

listed real estateListed real estate has performed slightly below global equities so far this year. That said, renewed concerns about economic growth, lower interest rates, and a flattening interest-rate curve have supported the asset class. The latter has eased concerns about future property values and debt costs. The market has remained range-bound since May 2013, but we see a short-term rebound in Asian property based on valuations. We expect the recent outperformance of US listed real estate to fade.

FtSE EpRA/nAREIt developed tR USd (Current: 3,870)

six-month target

House view USD 4,020

Positive scenario USD 4,240

Negative scenario USD 3,600

and other asset classes



USd We expect the USD to strengthen versus the EUR, with EURUSD reaching 1.24 next year. The Fed’s normalization of monetary policy – in contrast to many other central banks – should be beneficial for the dollar. The Fed will be able to normalize policy as data continues to suggest that Q1 2014 saw weaker economic activity due to weather and not a funda-mental slowdown. However, a sharp rebound of the broad USD will not occur, in our view, until investors start to prepare for a hike in the fed funds rate, which we still only expect in Q3 of 2015.

EUR The euro remains near recent highs, even after Mario Draghi, President of the ECB, suggested that the common currency is excessively strong. An improving economic outlook, as well as capital flows into peripheral countries’ sovereign debt markets, has kept the euro supported. However, with the latest inflation data showing prices rose just 0.5% y/y, such cur-rency strength could cause disinflation. Various ECB governors have sug-gested considering quantitative easing or negative interest rates to counter such strength. We expect when such policies are implemented – likely later this year – EURUSD will fall quickly.

Gbp Inflation in the UK has fallen just as in many countries, but CPI remains at 1.6% y/y, not far from target. This small drop takes some pressure off of the Bank of England, but we still expect that it will hike rates in the same time frame as the Fed, long before the ECB or Swiss National Bank. Economic momentum in the UK remains solid and labor markets continue to improve, including a surprise drop in unemployment to 6.9%. So long as the BoE remains comfortable with the exchange rate, we expect the pound to appreciate further against the continental currencies and to keep steady against the dollar over the next year.

Jpy The BoJ failed to offer hope of any additional monetary stimulus at its early April meeting, triggering a drop in USDJPY. However, we expect it will have to take additional measures in June or July to remain on track achieving its 2% inflation target and we therefore remain underweight the yen. We maintain our target of 110 in a year with steady movement upward in light of weakness in forward-looking indicators and low infla-tion in Japan. We think the BoJ would move aggressively if USDJPY fell below 100.

ChF EURCHF will continue to trade in a small range between 1.21-1.25, in our view, in spite of better economic momentum in Switzerland than the

Eurozone. Inflation is very subdued, making it challenging for the SNB to remove the EURCHF floor. We remain bullish on USDCHF and expect the pair to trade up to close to parity within the year largely on the back of the dollar’s gain relative to the euro. This dollar strength may material-ize slowly after a cold winter, and with the Fed unlikely to hike rates until at least the middle of 2015.

other developed market currencies Many smaller G10 currencies have struggled. In spite of solid funda-mentals, the Swedish krona (SEK) and Norwegian krone (NOK) have come under pressure. The SEK has dropped on the risk that the Riksbank would cut rates due to low inflation. We think the SEK should recover relative to the EUR from an improving Swedish economy. The NOK has recovered slightly against the EUR due to improving manufacturing and home prices, yet the Norges bank is far from hiking. Fed rate hikes will probably push the Australian and New Zealand dollar down over the next year, but this is a bigger risk for the AUD as the central bank re-mains on hold and data mixed. Finally, we expect a slow recovery in the beleaguered Canadian dollar, as demand and labor markets improve and the Bank of Canada moves away from its dovish stance.

Foreign exchangeKatie Klingensmith; Thomas Flury

The dollar entered April on an upswing, benefiting from suggestions that the Federal Reserve might hike rates early in 2015. Coupled with comments from European Central Bank officials regarding monetary easing, the EURUSD dropped. However, the Fed’s clarification that unemployment is still too high, along with mixed US economic data, brought the dollar under pressure again. Equity market losses failed to lift the Greenback, which is unsurprising given that the recent sell-off was not associated with broad risk aversion. We continue to expect gains in the dollar; however, it is likely only once US economic data rebounds more convincingly and markets focus on the first rate hike. As we expect this focus to come just when the ECB and Bank of Japan are easing policy, widening yield differentials should lift the dollar.

UbS CIo Fx forecasts16-apr-14 3m 6m 12m PPP*

eUrUsd 1.384 1.34 1.28 1.24 1.30

UsdJPy 102.3 105 107 110 81

UsdCad 1.100 1.10 1.07 1.05 0.99

aUdUsd 0.935 0.88 0.88 0.85 0.76

gBPUsd 1.679 1.65 1.65 1.62 1.67

nZdUsd 0.860 0.83 0.83 0.78 0.61

UsdChf 0.880 0.92 0.96 0.99 1.00

eUrChf 1.217 1.23 1.23 1.23 1.30

gBPChf 1.476 1.51 1.58 1.60 1.67

eUrJPy 141.5 141 137 136 105

eUrgBP 0.824 0.81 0.78 0.77 0.78

eUrseK 9.096 8.80 8.60 8.40 8.57

eUrnoK 8.250 8.40 8.20 8.00 8.40

source: thomson reuters, UBs Cio Wmr, as of 16 april 2014note: Past performance is not an indication of future returns.*PPP = Purchasing Power Parity


Keep your eye on the fundamentalsThe recent volatility on the stock market has left the S&P 500 in slightly positive territory year-to-date. However, this envi-ronment has been associated with deep intra-market disloca-tions, which has made it feel more painful for many investors than it would appear on the surface. Indeed, certain seg-ments of the market that had performed well through the be-ginning of this year have come under significant pressure re-cently, including parts of the IT sector, biotechnology and small-cap growth stocks (see Fig. 1). More generally speaking, across global financial markets previous winners are being sold off, while losers, including emerging market equities, are receiving strong bids.

This raises two related questions, namely whether this change in market leadership a) is set to continue, and b) should be viewed as an early signpost for a directional change in the stock market, i.e., the end of the bull market. We believe that the key to answering these questions is to focus on the still solid fundamental earnings and valuation picture. We con-clude that the recent volatility and market rotations represent

a temporary consolidation and that at an index level, most prior trends should resume over the course of our six-month tactical time horizon. Our recommended tactical positioning, therefore, continues to reflect a preference for equities over bonds, for cyclical over defensive equity sectors, for growth over value stocks and for small caps over large caps.

Fundamental picture still intactWe started off the year with the basic thesis of a global eco-nomic recovery led by developed nations, in particular the US and Europe. This thesis remains in place. While the unusually harsh winter affected economic data in the US and led some observers to question the strength of the US growth picture, more recent data releases appear to confirm our more san-guine view (see Fig. 2). Consumer confidence keeps improv-ing and has reached post-recession highs, thus supporting re-tail sales. Industrial production growth accelerated to an annual rate of 3.8% during the first quarter, leading industrial capacity utilization to rise to levels last seen in early 2008. As highlighted in Alex Friedman’s lead article, the labor market is tightening further with, for instance, weekly jobless claims reaching new lows. Credit conditions continue to improve, supported, in particular, by steady growth in commercial lending by smaller banks. And, finally, we are seeing the first signs of the much awaited capital expenditure recovery.

Turning to overseas markets, the Eurozone seems to have started 2014 on very solid footing, helped by thawing credit conditions and led by Germany, thereby leaving its recession further behind. In China, where growth expectations have come down since the beginning of the year, we remain confi-dent that renewed policy support will cushion further down-side risk and avoid a hard landing scenario.

Against this macro backdrop, we believe US first quarter earn-ings will prove reasonably supportive for the market. S&P 500 earnings-per-share (EPS) growth likely slowed to 4-5% after a 9% rise in the fourth quarter. However, the weather-induced slowdown is well anticipated and bottom-up consensus ex-pectations have been managed down to roughly flat growth for the quarter, leaving room for upside surprises. Looking forward, and in line with our economic projections, we ex-pect a pick up in earnings growth rates as the year progresses and forecast 2014 EPS growth of 9% followed by 7% in

in focus

Keep your eye on the fundamentals

Stephen Freedman, phd, CFAHead of Cross-Asset StrategyCIO Wealth Management Research


in foCUs

2015. With valuations, as measured by the price-earnings ra-tio, in line with the long-term average, the stock market is neither cheap nor expensive. Under these circumstances, we believe that it is reasonable to expect stock price appreciation in line with earnings growth both in the US and in the Eurozone.

Meanwhile, bond markets should continue to face pressure against the backdrop of the Fed’s tapering of asset purchases, which should drive bond yields progressively higher during the course of the year, as discussed in Alex Friedman’s article.

Remain mindful of geopolitical risksWhile the fundamental backdrop remains supportive for risk taking, we continue to monitor the situation in Ukraine care-fully. It remains our view that crisis will not spill over and af-fect global markets, unless the energy supply is impacted. Our emerging markets team published an updated assessment of the relevant scenarios last week. They concluded that a mild sanctions regime remains the most likely outcome. However,

they did increase the probability of further escalation to 45%. We therefore believe that the crisis can be expected to keep energy prices elevated in the near term, despite supply and demand fundamentals that would point to lower prices.

Investment conclusions: upgrade risk assetsIn view of all the aspects described above, we have opted to increase our recommended tactical position in risk assets and reduce US fixed income. We are closing the commodity un-derweight position, which we opened in January and has worked against us. While supply and demand considerations still argue for lower commodity prices, the Ukraine crisis poses an increasing risk to such a position. The commodity upgrade is funded by reducing US equities and US fixed income. Note, however, that in portfolios that exclude commodities alto-gether (and where they cannot be upgraded), we would rec-ommend upgrading risk assets by adding to international eq-uities at this stage, while reducing US fixed income.

Fig. 2: Improving fundamentals for consumer and industry

Source: Bloomberg, CIO WMR, as of 16 April 2014

US capacity utilization in %; US Consumer Confidence

80

60

40

20

0

140

120

100

160

80

75

70

65

60

85

Consumer Confidence, Conference Board (1985=100, le scale)US capacity utilization, in % (right scale)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 201220112010 2013

Fig. 1: Large intra-market shis despite range-bound market

Source: Bloomberg, CIO WMR, as of 16 April 2014

Russell 2000 relative to Russell 1000; Russell 1000 Growth relative toRussell 1000 Value; S&P 500 index; all normalized at 31 Dec. 2013=100

9897969594

102101100

99

103

US small relative to large-cap equities S&P 500US Growth relative to Value

Dec-13 Jan-14 Feb-14 Mar-14


While there have been some major advances in cancer therapies in recent years, many forms of cancer remain without cures, making it an important therapeutic opportunity for biotech-nology and pharmaceutical compa-nies. We believe that we are now at the threshold of discovery and com-mercialization of many novel break-through cancer therapies.

The scientific knowhow and advances made over the last decade, including the human genome project, have laid the basis for new cancer treatments. Today, many pharmaceutical and biotechnology companies are testing promising novel cancer drug candi-dates in late-stage clinical trials. We believe a number of these new cancer treatments in development will be suc-cessful and reach the market within the next two years, which could translate into a multibillion dollar sales potential for the companies developing them.

To take advantage of this opportunity, we recommend targeted equity expo-sure in biotech and pharma companies with a fairly high probability of clinical success and new drugs in develop-ment. Given the recent sell-off, we believe now is a particularly attrac-tive time to invest in such companies from a risk-return perspective. Finally, we do not believe that threats of Congressional legislation to address the exorbitant prices of oncology and other specialty drugs is likely to result in pricing pressure on pharma or bio-tech companies during the next few years, especially for unique drugs for underserved medical conditions, such as many forms of cancer.

Portfolio context We believe Eurozone equities present an attractive opportunity to participate in the region’s economic recovery. Our expectation for an improving domestic economy, reaccelerating global growth, and solid earnings growth in 2014 are among the key drivers behind our constructive call on Eurozone equities. Compared to more defensive Swiss and UK equity markets, the Eurozone should disproportionately benefit from an accel-erating global economy.

The Eurozone recovery is being sup-ported by fewer fiscal headwinds, re-bounding consumer confidence, and fa-vorable monetary conditions. In addition, an uptick in global manufacturing should help drive double-digit earnings growth. Profit margins in the Eurozone, especially the periphery, remain at depressed levels and have significant room for improvement.

Mid- and small-cap equities (SMIDs) are a particularly attractive way to play an improvement of the economic environ-ment in the Eurozone. SMIDs are more biased to cyclical sectors and the recover-ing peripheral countries compared to the broader market which should lead to su-perior sales and earnings growth.

Top themes

uEarnings growth potential

uMedium-term horizon (6–12 months)

uportfolio integration

this theme can be inte-grated into a Us equity portfolio through our recommended basket of single securities.

uFull report

“major advances in can-cer therapeutics” 14 april 2014

Major advances in cancer therapeuticsJerry Brimeyer

uGlobal recovery story

uMedium-term horizon (6–12 months)


investors can gain expo-sure through passive or actively managed eurozone equity funds. for higher-beta expo-sure, consider active op-tions with exposure to eurozone small- and mid-caps. given our negative view on the eUr/Usd, consider hedged exposure.

uFull report

“european equities: Growth lifts mid and small caps,” 13 January 2014

Favor Eurozone equities within EuropeAndrea Fisher, Stephen Freedman, PhD, CFA

Highlights from our monthly selection of highest conviction investment themes across the asset class spectrum

Us equity

Portfolio context

non-Us equity


US fixed income

As the post-crisis economic recovery gains traction, many investors continue to hold an unusually large amount of cash and remain reluctant to redeploy assets into high quality fixed income.

While longer-term Treasury yields are set to gradually rise from current levels, interest rates on the short end of the curve remain fairly well-anchored. The Fed remains committed to keeping short-term rates low – even after com-pleting its large scale asset purchases – which means that rates on cash-like investments will remain near zero for the foreseeable future.

As an alternative to paltry cash rates, buy-and-hold investors should venture further out of the maturity spectrum into short-term credit instruments. In doing so, investors can obtain some of the safety, or low volatility, associated with cash while also taking advantage of a relatively steep Treasury yield curve. The yield attainable on bonds with ma-turities of one to four years is far supe-rior to cash-like alternatives.

Portfolio context

The investment themes highlighted in this

section are among our highest conviction

thematic recommendations. The full list of

most preferred themes (see below) is

discussed in our new monthly publication

entitled “Top themes.” Top themes

• Capex rising...finally

• Diversify bond portfolios into credit alternatives

• Favor Eurozone equities within Europe

• Major advances in cancer therapeutics

• North American energy independence: reenergized

• Opportunities in financial sector capital securities

• Tiptoeing out the yield curve

• US senior loans

• US technology: secular growth, on sale

Ask your Financial Advisor for a copy

of this publication.

uyield enhancement

ulong-term horizon (>12 months)


With short-end yields sensitive to fed tighten-ing expectations, we recommend this strategy primarily for buy-and-hold investors.

uFull report

“US fixed income: Tip-toeing out the yield curve,” 21 January 2014

tiptoeing out the yield curveBarry McAlinden, CFA; Michael Crook, CAIA, Andrea Fisher

ab

Eurozone rebound

Enhanced cash yields

Capital securities

Thematic investment ideas from CIO Wealth Management ResearchApril 2014

Top themes

Senior loans

Credit alternatives

Energy independence

Tech on sale

Rising capex

Cancer therapeutics

Highlights from our monthly selection of highest conviction investment themes across the asset class spectrum

Top themes

We project that the front end of the yield curve will remain steep

Source: Bloomberg, UBS CIO WMR, as of 15 Apr 2014

Treasury yield, in %

12 mo. forecast

maturity (years)

15-Apr-146 mo. forecast

00.5

11.5

22.5

33.5

44.5

0 5 10 15 20 25 30


Key foreCasts

6-month forecast

asset class taa1 Change Benchmark value4

m/m perf.2 in % house view

Positive scenario

negative scenario

equities –

Usa S&P 500 1862 1.2% 1950 2200 1600

eurozone – euro stoxx 320 3.6% 330 380 260

UK ftse 100 6584 0.9% 6740 7500 5700

Japan – topix 1167 0.2% 1210 1400 970

switzerland – smi 8323 2.6% 8500 9200 7600

emerging markets – msCi em 1003 6.9% 1050 1170 820

bonds

Us government bonds 10yr yield 2.6 0.2% 3.20% 3.3-3.9% 2.0-2.8%

Us Corporate bonds3 – spread 103 bps 1.2% 100 bps 85 bps 350 bps

Us high yield bonds – spread 375 bps 1.0% 350 bps 300 bps 900 bps

emerging markets Bonds(Sovereign/Corporate)

– spread319 bps/ 308 bps

2.3%/ 3.3%

330 bps/ 350 bps

285 bps/ 300 bps

450 bps/ 520 bps

other asset cLasses

Commodities dJUBs er index 137 1.6% na na na

listed real estate – ePra/nareit dtr 3899 3.5% 4020 4240 3600

currencies Currency pair

Usd – na na na na na

eUr – eUrUsd 1.38 -0.7% 1.28 1.20 1.40

gBP – gBPUsd 1.68 0.9% 1.65 na na

JPy – UsdJPy 102 0.9% 105 110 100

Chf – UsdChf 0.88 1.1% 0.92 na na

source: UBs Cio Wmr, Bloomberg1 taa = tactical asset allocation, 2 month-on-month performance. 3 investment grade corporates are overweight in tax-exempt portfolios but underweight in taxable portfolios, where we prefer municipal bonds.

past performance is no indication of future performance. Forecasts are not a reliable indicator of future performance.

overweight

neutral

Underweight

Key foreCastsas of 16 april 2014



detailed asset alloCation

investor risk profile

conservative moderately conservative

moderate moderately aggressive

aggressive

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cash 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

q fixed income 69.0 -2.0 -0.5 67.0 57.0 -3.0 -1.0 54.0 46.5 -3.5 -1.0 43.0 41.0 -3.5 -1.0 37.5 33.0 -3.5 -1.0 29.5

q us fixed income 62.0 +2.0 -0.5 64.0 51.0 +1.0 -1.0 52.0 40.5 -0.5 -1.0 40.0 34.0 -0.5 -1.0 33.5 26.0 -1.5 -1.0 24.5

Us gov’t 7.0 -3.0 4.0 5.5 -4.0 1.5 4.0 -4.0 0.0 3.5 -3.5 0.0 2.0 -2.0 0.0

q Us municipal 50.0 +0.5 -0.5 50.5 39.0 +0.5 -1.0 39.5 30.0 +0.5 -1.0 30.5 24.0 +0.5 -1.0 24.5 17.0 -2.5 -1.0 14.5

Us ig Corp 4.0 +0.5 4.5 3.5 -0.5 3.0 3.0 -2.0 1.0 2.5 -2.5 0.0 2.0 -2.0 0.0

Us hy Corp 1.0 +4.0 5.0 3.0 +5.0 8.0 3.5 +5.0 8.5 4.0 +5.0 9.0 5.0 +5.0 10.0

int’l fixed income 7.0 -4.0 3.0 6.0 -4.0 2.0 6.0 -3.0 3.0 7.0 -3.0 4.0 7.0 -2.0 5.0

int’l developed markets 6.0 -4.0 2.0 4.0 -4.0 0.0 3.0 -3.0 0.0 3.0 -3.0 0.0 2.0 -2.0 0.0

emerging markets 1.0 +0.0 1.0 2.0 +0.0 2.0 3.0 +0.0 3.0 4.0 +0.0 4.0 5.0 +0.0 5.0

q Equity 16.0 +2.0 -0.5 18.0 27.0 +3.0 -0.5 30.0 34.5 +3.5 -1.0 38.0 45.0 +3.5 -1.0 48.5 55.0 +3.5 -1.0 58.5

q US Equity 9.0 +1.5 -0.5 10.5 15.0 +2.0 -0.5 17.0 20.0 +2.5 -1.0 22.5 26.0 +2.5 -1.0 28.5 31.0 +2.5 -1.0 33.5

q Us large cap growth 2.5 +0.5 -0.5 3.0 4.5 +1.0 5.5 6.0 +1.0 -0.5 7.0 8.0 +1.0 -0.5 9.0 9.5 +1.0 -0.5 10.5

Us large cap value 2.5 -1.0 1.5 4.5 -1.5 3.0 6.0 -2.0 4.0 8.0 -2.0 6.0 9.5 -2.0 7.5

q Us mid cap 3.0 +1.0 4.0 4.0 +1.0 -0.5 5.0 5.0 +1.5 -0.5 6.5 7.0 +1.5 -0.5 8.5 8.0 +1.5 -0.5 9.5

Us small cap 1.0 +1.0 2.0 2.0 +1.5 3.5 3.0 +2.0 5.0 3.0 +2.0 5.0 4.0 +2.0 6.0

International Equity 7.0 +0.5 7.5 12.0 +1.0 13.0 14.5 +1.0 15.5 19.0 +1.0 20.0 24.0 +1.0 25.0

int’l developed markets 4.0 +0.5 4.5 7.0 +1.0 8.0 8.5 +1.0 9.5 11.0 +1.0 12.0 14.0 +1.0 15.0


p commodities 4.0 +0.0 +1.0 4.0 4.0 +0.0 +1.5 4.0 4.0 +0.0 +2.0 4.0 5.0 +0.0 +2.0 5.0 5.0 +0.0 +2.0 5.0

non-traditional 11.0 +0.0 11.0 12.0 +0.0 12.0 15.0 +0.0 15.0 9.0 +0.0 9.0 7.0 +0.0 7.0

hedge funds 11.0 +0.0 11.0 12.0 +0.0 12.0 10.0 +0.0 10.0 3.0 +0.0 3.0 0.0 +0.0 0.0

Private equity 0.0 +0.0 0.0 0.0 +0.0 0.0 5.0 +0.0 5.0 6.0 +0.0 6.0 7.0 +0.0 7.0

Private real estate 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

“Wmr tactical deviation” legend: overweight Underweight neutral “Change” legend: p Upgrade q Downgrade *Refers to moderate-risk profile. 1the current allocation column is the sum of the strategic asset allocation and the tactical deviation column.

Detailed asset allocation taxable with non-traditional assets

Source: UBS CIO WMR and WMA AAC, 16 April 2014. See appendix for information regarding sources of strategic asset allocations and their suitability, investor risk profiles, and the interpretation of the suggested tactical deviations from the strategic asset allocations.





aggressive

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cash 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

q fixed income 80.0 -2.0 -0.5 78.0 66.0 -3.0 -1.0 63.0 54.5 -3.5 -1.0 51.0 44.0 -3.5 -1.0 40.5 33.0 -3.5 -1.0 29.5

q us fixed income 72.0 +2.0 -0.5 74.0 58.0 +2.0 -1.0 60.0 47.0 +0.5 -1.0 47.5 36.0 -0.5 -1.0 35.5 26.0 -1.5 -1.0 24.5

Us gov’t 8.0 -3.0 5.0 7.0 -4.0 3.0 5.0 -5.0 0.0 3.0 -3.0 0.0 2.0 -2.0 0.0

q Us municipal 58.0 +0.5 -0.5 58.5 45.0 +0.5 -1.0 45.5 35.0 +1.0 -1.0 36.0 26.0 -0.5 -1.0 25.5 16.0 -3.5 -1.0 12.5

Us ig Corp 4.0 +0.5 4.5 3.0 +0.5 3.5 3.0 -0.5 2.5 2.0 -2.0 0.0 1.0 -1.0 0.0

Us hy Corp 2.0 +4.0 6.0 3.0 +5.0 8.0 4.0 +5.0 9.0 5.0 +5.0 10.0 7.0 +5.0 12.0




q Equity 16.0 +2.0 -0.5 18.0 30.0 +3.0 -0.5 33.0 40.5 +3.5 -1.0 44.0 51.0 +3.5 -1.0 54.5 62.0 +3.5 -1.0 65.5

q US Equity 9.0 +1.5 -0.5 10.5 18.0 +2.0 -0.5 20.0 23.0 +2.5 -1.0 25.5 29.0 +2.5 -1.0 31.5 36.0 +2.5 -1.0 38.5



q Us mid cap 2.0 +1.0 3.0 5.0 +1.0 -0.5 6.0 6.0 +1.5 -0.5 7.5 7.0 +1.5 -0.5 8.5 9.0 +1.5 -0.5 10.5

Us small cap 1.0 +1.0 2.0 3.0 +1.5 4.5 3.0 +2.0 5.0 4.0 +2.0 6.0 5.0 +2.0 7.0




p commodities 4.0 +0.0 +1.0 4.0 4.0 +0.0 +1.5 4.0 5.0 +0.0 +2.0 5.0 5.0 +0.0 +2.0 5.0 5.0 +0.0 +2.0 5.0




Detailed asset allocationtaxable without non-traditional assets







aggressive

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cash 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

q fixed income 68.0 -2.0 -0.5 66.0 56.0 -3.0 -1.0 53.0 46.5 -3.5 -1.0 43.0 39.0 -3.5 -1.0 35.5 33.0 -3.5 -1.0 29.5

q us fixed income 60.0 +2.0 -0.5 62.0 49.0 +1.0 -1.0 50.0 40.0 +0.0 -1.0 40.0 32.5 -1.0 -1.0 31.5 26.0 -1.5 -1.0 24.5

q Us gov’t 47.0 -4.5 -0.5 42.5 36.0 -6.5 -1.0 29.5 28.0 -8.5 -1.0 19.5 19.5 -9.5 -1.0 10.0 13.0 -10.0 -1.0 3.0

Us municipal 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

Us ig Corp 9.0 +2.5 11.5 7.0 +2.5 9.5 5.0 +3.0 8.0 4.0 +3.0 7.0 2.0 +3.0 5.0

Us hy Corp 4.0 +4.0 8.0 6.0 +5.0 11.0 7.0 +5.5 12.5 9.0 +5.5 14.5 11.0 +5.5 16.5




q Equity 17.0 +2.0 -0.5 19.0 28.0 +3.0 -0.5 31.0 34.5 +3.5 -1.0 38.0 42.0 +3.5 -1.0 45.5 53.0 +3.5 -1.0 56.5

q US Equity 10.0 +1.5 -0.5 11.5 16.0 +2.0 -0.5 18.0 20.5 +2.5 -1.0 23.0 24.0 +2.5 -1.0 26.5 31.0 +2.5 -1.0 33.5



q Us mid cap 2.5 +1.0 3.5 4.0 +1.0 -0.5 5.0 5.5 +1.5 -0.5 7.0 6.0 +1.5 -0.5 7.5 8.0 +1.5 -0.5 9.5

Us small cap 1.5 +1.0 2.5 2.0 +1.5 3.5 3.0 +2.0 5.0 3.0 +2.0 5.0 4.0 +2.0 6.0




p commodities 4.0 +0.0 +1.0 4.0 4.0 +0.0 +1.5 4.0 4.0 +0.0 +2.0 4.0 5.0 +0.0 +2.0 5.0 5.0 +0.0 +2.0 5.0

non-traditional 11.0 +0.0 11.0 12.0 +0.0 12.0 15.0 +0.0 15.0 14.0 +0.0 14.0 9.0 +0.0 9.0

hedge funds 11.0 +0.0 11.0 12.0 +0.0 12.0 10.0 +0.0 10.0 8.0 +0.0 8.0 3.0 +0.0 3.0

Private equity 0.0 +0.0 0.0 0.0 +0.0 0.0 5.0 +0.0 5.0 6.0 +0.0 6.0 6.0 +0.0 6.0

Private real estate 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0


Detailed asset allocation non-taxable with non-traditional assets



Detailed asset allocation non-taxable without non-traditional assets





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lloca

tion1

cash 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

q fixed income 78.0 -2.0 -0.5 76.0 65.0 -3.0 -1.0 62.0 55.0 -3.5 -1.0 51.5 46.0 -3.5 -1.0 42.5 36.0 -3.5 -1.0 32.5

q us fixed income 69.0 +2.0 -0.5 71.0 57.0 +2.0 -1.0 59.0 47.0 +0.5 -1.0 47.5 38.0 -0.5 -1.0 37.5 29.0 -1.5 -1.0 27.5

q Us gov’t 55.0 -4.5 -0.5 50.5 42.0 -6.5 -1.0 35.5 32.0 -8.0 -1.0 24.0 23.0 -9.0 -1.0 14.0 13.0 -10.0 -1.0 3.0

Us municipal 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

Us ig Corp 10.0 +2.5 12.5 8.0 +3.5 11.5 6.0 +3.0 9.0 4.0 +3.0 7.0 3.0 +3.0 6.0

Us hy Corp 4.0 +4.0 8.0 7.0 +5.0 12.0 9.0 +5.5 14.5 11.0 +5.5 16.5 13.0 +5.5 18.5




q Equity 18.0 +2.0 -0.5 20.0 31.0 +3.0 -0.5 34.0 41.0 +3.5 -1.0 44.5 50.0 +3.5 -1.0 53.5 59.0 +3.5 -1.0 62.5

q US Equity 10.0 +1.5 -0.5 11.5 18.0 +2.0 -0.5 20.0 23.0 +2.5 -1.0 25.5 28.0 +2.5 -1.0 30.5 33.0 +2.5 -1.0 35.5



q Us mid cap 3.0 +1.0 4.0 5.0 +1.0 -0.5 6.0 6.0 +1.5 -0.5 7.5 7.0 +1.5 -0.5 8.5 9.0 +1.5 -0.5 10.5

Us small cap 1.0 +1.0 2.0 2.0 +1.5 3.5 3.0 +2.0 5.0 4.0 +2.0 6.0 4.0 +2.0 6.0




p commodities 4.0 +0.0 +1.0 4.0 4.0 +0.0 +1.5 4.0 4.0 +0.0 +2.0 4.0 4.0 +0.0 +2.0 4.0 5.0 +0.0 +2.0 5.0




In order to create the analysis shown, the rates of return for each asset class are combined in the same proportion as the asset allocations illustrated (e.g., if the asset allocation indi-cates 40% equities, then 40% of the results shown for the allocation will be based upon the estimated hypothetical re-turn and standard deviation assumptions shown below).

You should understand that the analysis shown and assump-tions used are hypothetical estimates provided for your gen-eral information. The results are not guarantees and pertain to the asset allocation and/or asset class in general, not the performance of specific securities or investments. Your actual results may vary significantly from the results shown in this report, as can the performance of any individual security or investment.

Portfolio AnalyticsThe portfolio analytics shown for each risk profile’s bench-mark allocations are based on estimated forward-looking return and standard deviation assumptions (capital market assumptions), which are based on UBS proprietary research. The development process includes a review of a variety of factors, including the return, risk, correlations and historical performance of various asset classes, inflation and risk pre-mium. These capital market assumptions do not assume any particular investment time horizon. The process assumes a situation where the supply and demand for investments is in balance, and in which expected returns of all asset classes are a reflection of their expected risk and correlations regardless of time frame. Please note that these assumptions are not guarantees and are subject to change. UBS has changed its risk and return assumptions in the past and may do so in the future. Neither UBS nor your Financial Advisor is required to provide you with an updated analysis based upon changes to these or other underlying assumptions.

Risk Profile ==>> conservative

moderately conservative

moderate

moderately aggressive

aggressive

Taxable with non-traditional assets

estimated return 4.4% 5.1% 5.9% 6.4% 7.0%

estimated risk 5.6% 7.4% 9.6% 11.5% 13.5%

Taxable without non-traditional assets


estimated risk 5.4% 7.5% 9.5% 11.5% 13.5%

Non-taxable with non-traditional assets


estimated risk 5.5% 7.4% 9.5% 11.4% 13.4%

Non-taxable without non-traditional assets


estimated risk 5.4% 7.5% 9.5% 11.4% 13.5%

Asset Class Capital Market Assumptions

Annual total return Annual risk

Us Cash 2.5% 0.5%

Us government fixed income 2.2% 4.3%

Us municipal fixed income 2.9% 4.7%

Us Corporate investment grade fixed income 3.5% 5.9%

Us Corporate high yield fixed income 5.6% 11.7%

international developed markets fixed income 4.0% 9.0%

emerging markets fixed income 4.9% 9.1%

Us large Cap equity 7.5% 16.8%

Us mid Cap equity 8.4% 19.6%

Us small Cap equity 8.6% 21.8%

international developed markets equity 8.5% 19.7%

emerging markets equity 10.0% 25.5%

Commodities 6.4% 18.9%

hedge funds 6.2% 6.7%

Private equity 11.8% 24.4%

Private real estate 8.5% 11.8%


Additional Asset Allocation ModelsUS taxable Fixed Income Allocation, in %

benchmark CIo wMR tactical deviation2 Current allocation3

allocation1 previous Current

treasuries 25.0 -7.0 -7.0 18.0

Treasury Inflation Protected Securities (TIPS) 19.0 -7.0 -7.0 12.0

agencies 11.0 -6.0 -6.0 5.0

agency mortgage-Backed securities 13.0 0.0 0.0 13.0

investment grade Corporates 13.0 3.0 3.0 16.0

high-yield Corporates 14.0 9.0 9.0 23.0

Preferred securities 5.0 8.0 8.0 13.0

International Developed Markets (Non-US) Equity Module, in %

benchmark CIo wMR tactical deviation2 Current allocation3


emU / eurozone 28.0 +10.0 +10.0 38.0

UK 20.0 -10.0 -10.0 10.0

Japan 19.0 +0.0 +0.0 19.0

australia 7.0 +0.0 +0.0 7.0

Canada 9.0 +0.0 +0.0 9.0

switzerland 8.0 +0.0 +0.0 8.0

other 9.0 +0.0 +0.0 9.0

source: UBs Cio Wmr, as of 16 april 2014

International Developed Markets (Non-US) Fixed Income Module, in %

benchmark wMR tactical deviation2 Current allocation3


emU / eurozone 42.0 -10.0 -10.0 32.0

UK 9.0 +25.0 +25.0 34.0

Japan 32.0 -10.0 -10.0 22.0

other 17.0 -5.0 -5.0 12.0


1 The benchmark allocation refers to a moderate risk profile. For the second and third tables on this page, it represents the relative market capitalization weights of each country or region. 2 see “deviations from strategic asset allocation or benchmark allocation” in the appendix for an explanation regarding the interpretation of the suggested tactical deviations from benchmark. the

“current” column refers to the tactical deviation that applies as of the date of this publication. the “previous” column refers to the tactical deviation that was in place at the date of the previous edition of the investment strategy guide or the last investment strategy guide Update.

3 the current allocation column is the sum of the benchmark allocation and the tactical deviation columns.





Additional Asset Allocation ModelsUS Equity Industry Group Allocation, in %

s&p 500 cio wmr tactical deviation2 CurrentBenchmark Numeric symbol allocation3

allocation1 Previous Current Previous Current

Consumer Discretionary 11.9 +0.0 +0.0 n n 11.9

auto & Components 1.2 +0.0 +0.0 n n 1.2

Consumer services 1.8 +0.0 +0.0 n n 1.8

media 3.5 +0.0 +0.0 n n 3.5

retailing 4.1 +0.0 +0.0 n n 4.1

Consumer, durables & apparel 1.3 +0.0 +0.0 n n 1.3

Consumer Staples 9.9 -2.0 -2.0 – – – – 7.9

food, Beverage & tobacco 5.3 -0.5 -0.5 – – 4.8

food & staples retailing 2.4 -1.0 -1.0 – – 1.4

household & Personal Products 2.2 -0.5 -0.5 – – 1.7

energy 10.5 -1.0 -1.0 – – 9.5

financials 16.2 +2.0 +2.0 ++ ++ 18.2

Banks 6.1 +0.5 +0.5 + + 6.6

Diversified Financials 5.0 +1.0 +1.0 + + 6.0

insurance 2.8 +0.5 +0.5 + + 3.3

real estate 2.3 +0.0 +0.0 n n 2.3

healthcare 13.1 +0.0 +0.0 n n 13.1

hC equipment & services 4.2 +0.0 +0.0 n n 4.2

Pharmaceuticals & Biotechnology 8.9 +0.0 +0.0 n n 8.9

Industrials 10.7 +2.0 +2.0 ++ ++ 12.7

Capital goods 8.1 +1.0 +1.0 + + 9.1

Commercial services & supplies 0.6 +0.0 +0.0 n n 0.6

transportation 2.0 +1.0 +1.0 + + 3.0

information technology 18.5 +2.5 +2.5 +++ +++ 21.0

Software & Services 10.3 +1.0 +1.0 + + 11.3

technology hardware & equipment 6.1 +1.0 +1.0 + + 7.1

semiconductors 2.1 +0.5 +0.5 + + 2.6

materials 3.5 +0.0 +0.0 n n 3.5

telecom 2.5 -1.0 -1.0 – – 1.5

utilities 3.2 -2.5 -2.5 – – – – – – 0.7

source: s&P, UBs Cio Wmr, as of 16 april 2014The benchmark allocation, as well as the tactical deviations, are intended to be applicable to the US equity portion of a portfolio across investor risk profiles.1 The benchmark allocation is based on S&P 500 weights.2 see “deviations from Benchmark allocations” in the appendix for an explanation regarding the interpretation of the suggested tactical deviations from benchmark. the “current” column refers to

the tactical deviation that applies as of the date of this publication. the “previous” column refers to the tactical deviation that was in place at the date of the previous edition of the investment strategy guide or the last investment strategy guide Update.

3 The current allocation column is the sum of the S&P 500 benchmark allocation and the CIO WMR tactical deviation columns.


The performance calculations shown in Table A commence on 25 January 2013, the first date upon which the Investment Strategy Guide was published following the release of the new UBS WMA strategic asset allocation (SAA) models. The performance is based on the SAA without non-traditional as-sets for a moderate risk profile investor, and the SAA with the tactical shift (see detailed asset allocation tables where the SAA with the tactical shift is referred to as “current alloca-tion”). Performance is calculated utilizing the returns of the indices identified in Table B as applied to the respective allo-cations in the SAA and the SAA with the tactical shift. For ex-ample, if US Mid Cap Equity is allocated 10% in the SAA and 12% in the SAA with the tactical shift, the US Mid Cap Equity index respectively contributed to 10% and 12% of the results shown. Prior to 25 January 2013, CIO WMR published tactical asset allocation recommendations in the Investment Strategy Guide using a different set of asset classes and sectors. The performance of these tactical recommendations is reflected in Table C.

The performance attributable to the CIO WMR tactical devia-tions is reflected in the column in Tables A and C labeled “Excess return,” which shows the difference between the performance of the SAA and the performance of the SAA with the tactical shift. The “Information ratio” is a risk- adjusted performance measure, which adjusts the excess returns for the tracking error risk of the tactical deviations.

Tactical Asset Allocation Performance Measurement

Specifically the information ratio is calculated as the ratio of the annualized excess return over a given time period and the annualized standard deviation of daily excess returns over the same period. Additional background information regarding the computation of the information ratio figures provided be-low are available upon request.

The calculations assume that the portfolios are rebalanced whenever changes are made to tactical deviations, typically upon publication of the Investment Strategy Guide on a monthly basis. Occasionally, changes in the tactical deviations are made intra-month when warranted by market conditions and communicated through an Investment Strategy Guide Update. The computations assume portfolio rebalancing upon such intra-month changes as well. Performance shown is based on total returns, but does not include transaction costs, such as commissions, fees, margin interest, and interest charges. Actual total returns adjusted for such transaction costs will be reduced. A complete record of all the recom-mendations upon which this performance report is based is available from UBS Financial Services Inc. upon written re-quest. Past performance is not an indication of future results.

Table A: Moderate Risk Profile Performance Measurement (25 January 2013 to present)

SAA SAA withtactical shift

Excessreturn

Information ratio

(annualized)

Russell 3000stock index

(total return)

barclays CapitalUS Aggregate bondindex (total return)

25 January 2013 to 31 March 2013 0.79% 0.83% 0.04% +0.9 5.59% 0.11%

31 march 2013 to 28 June 2013 -2.18% -2.14% 0.04% +0.3 2.69% -2.33%

28 June 2013 to 30 september 2013 3.60% 3.86% 0.26% +2.4 6.35% 0.57%

30 september 2013 to 31 december 2013 3.05% 3.23% 0.18% +2.9 10.10% -0.14%

31 december 2013 to 31 march 2014 2.44% 2.38% -0.06% -0.3 1.97% 1.84%

31 march 2014 to 16 april 2014 0.32% 0.14% -0.18% -3.0 -0.89% 0.68%

Since inception (25 January 2013) 8.17% 8.46% 0.29% +0.5 28.31% 0.70%

source: Cio Wmr, as of 16 april 2014

PerformanCe measUrement



Table B: SAA for moderate risk profile investor, and underlying indices (all figures in %)

25 Jan 2013 to present

US Large Cap Growth (Russell 1000 Growth) 7.0

US Large Cap Value (Russell 1000 Value) 7.0

US Mid Cap (Russell Mid Cap) 6.0

US Small Cap (Russell 2000) 3.0

International Dev. Eq (MSCI EAFE) 10.0

Emerging Markets Eq. (MSCI EMF) 7.5

US Government Fixed Income (BarCap US Agg Government) 5.0

US Municipal Fixed Income (BarCap Municipal Bond) 35.0

US Investment Grade Fixed Income (BarCap US Agg Credit) 3.0

US Corporate High Yield Fixed Income (BarCap US Agg Corp HY) 4.0

International Dev. Fixed Income (BarCap Global Agg xUS) 4.0

Emerging Markets Fixed Income (50% BarCap EM Gov and 50% BarCap Global EM (USD)) 3.5

Commodities (Dow Jones-UBS Commodity Index) 5.0

source: Cio Wmr

The performance calculations shown in Table C, which start on 25 August 2008 and end on 24 January 2013, have been provided for historical information purposes only. They are based on prior SAAs (referred to as benchmark allocations) with non-traditional assets for a moderate risk profile investor, and on prior SAAs with tactical shifts as published in the Investment Strategy Guide during the same time period. Performance is calculated utilizing the returns of the indices identified in Table D as applied to the respective allocations in the SAA and the SAA with the tactical shift. See the discus-sion in connection with Table A, previous page, regarding the meanings of the “Excess return” and “Information ratio” col-umns and how the “Information ratio” column is calculated.

Tactical Asset Allocation Performance Measurement

From 25 August 2008 through 27 May 2009, the Investment Strategy Guide had at times published a more detailed set of tactical deviations, whereby the categories “Non-US Developed Equities” and “Non-US Fixed Income” were fur-ther subdivided into regional blocks. Only the cumulative rec-ommendations at the level of “Non-US Developed Equities” and “Non-US Fixed Income” were taken into account in cal-culating the performance shown in Table C opposite. Prior to 25 August 2008, WMR published tactical asset allocation rec-ommendations in the “US Asset Allocation Strategist” using a less comprehensive set of asset classes and sectors, which makes a comparison with the subsequent models difficult.


Tactical Asset Allocation Performance MeasurementTable C: Moderate Risk Profile Performance Measurement (25 August 2008 to 24 January 2013)

benchmark Allocations (SAA)

benchmark Allocation (SAA)

with tactical shift

Excessreturn

Information ratio(annualized)

Russell 3000stock index

(total return)

barclays CapitalUS Aggregate bondindex (total return)

25 Aug 08 to 31 Dec 08 -16.59% -15.64% 0.96% +2.0 -29.00% 3.33%

2009 Q1 -5.52% -5.45% 0.07% +0.3 -10.80% 0.12%

2009 Q2 11.18% 11.37% 0.18% +1.0 16.82% 1.78%

2009 Q3 10.44% 11.07% 0.63% +2.1 16.31% 3.74%

2009 Q4 2.99% 3.30% 0.31% +1.1 5.90% 0.20%

2010 Q1 2.74% 2.56% -0.18% -0.9 5.94% 1.78%

2010 Q2 -4.56% -4.87% -0.31% -1.4 -11.32% 3.49%

2010 Q3 8.34% 7.99% -0.35% -2.1 11.53% 2.48%

2010 Q4 5.18% 5.17% -0.01% -0.1 11.59% -1.30%

2011 Q1 3.23% 3.15% -0.08% -0.4 6.38% 0.42%

2011 Q2 0.62% 0.47% -0.16% -0.9 -0.03% 2.29%

2011 Q3 -7.65% -8.56% -0.90% -2.5 -15.28% 3.82%

2011 Q4 4.66% 4.39% -0.27% -0.8 12.12% 1.12%

2012 Q1 5.89% 5.41% -0.48% -2.3 12.87% 0.30%

2012 Q2 -1.59% -1.57% 0.02% +0.2 -3.15% 2.06%

2012 Q3 4.18% 4.08% -0.10% -1.1 6.23% 1.59%

2012 Q4 0.69% 0.65% -0.04% -0.7 0.25% 0.21%

01 Jan 13 to 24 Jan 13 2.17% 2.20% 0.03% +2.5 5.19% -0.23%

25 Aug 08 to 24 Jan 13 24.86% 24.10% -0.76% -0.1 31.81% 30.76%

source: Cio Wmr

Table D: SAAs for moderate risk profile investor, and underlying indices (all figures in %)

25 Aug 2008 to 23 Feb 2009 24 Feb 2009 to 24 Jan 2013

US Large Cap Value (Russell 1000 Value) 12.5 US Large Cap Value (Russell 1000 Value) 11.0

US Large Cap Growth (Russell 1000 Growth) 12.5 US Large Cap Growth (Russell 1000 Growth) 11.0

US Small Cap Value (Russell 2000 Value) 2.0 US Mid Cap (Russell Midcap) 5.0

US Small Cap Growth (Russell 2000 Growth) 2.0 US Small Cap (Russell 2000) 3.0

US REITs (FTSE NAREIT All REITs) 1.5 US REITs (FTSE NAREIT All REITs) 2.0

Non-US Dev. Eq (MSCI Gross World ex-US) 10.5 Developed Markets (MSCI Gross World ex-US) 10.0

Emerging Markets Eq. (MSCI Gross EM USD) 2.0 Emerging Markets (MSCI Gross EM USD) 2.0

US Fixed Income (BarCap US Aggregate) 30.0 US Fixed Income (BarCap US Aggregate) 29.0

Non-US Fixed Income (BarCap Global Aggregate ex-USD) 8.0 Non-US Fixed Income (BarCap Global Aggregate ex-USD) 8.0

Cash (JP Morgan Cash Index USD 1 month) 2.0 Cash (JP Morgan Cash Index USD 1 month) 2.0

Commodities (DJ UBS total return index) 5.0 Commodities (DJ UBS total return index) 5.0

Alternative Investments (HFRX Equal Weighted Strategies) 12.0 Alternative Investments (HFRX Equal Weighted Strategies) 12.0

source: Cio Wmr



aPPendix

Global Investment process and Committee descriptionThe UBS investment process is designed to achieve replica-ble, high quality results through applying intellectual rigor, strong process governance, clear responsibility and a culture of challenge.

Based on the analyses and assessments conducted and vet-ted throughout the investment process, the Chief Investment Officer (CIO) formulates the UBS Wealth Management Investment House View (e.g., overweight, neutral, under-weight stance for asset classes and market segments rela-tive to their benchmark allocation) at the Global Investment Committee (GIC). Senior investment professionals from across UBS, complemented by selected external experts, debate and rigorously challenge the investment strategy to ensure consistency and risk control.

Global Investment Committee CompositionThe GIC is comprised of 13 members, representing top mar-ket and investment expertise from across all divisions of UBS:

• Alex Friedman (Chair)• Mark Andersen• Mark Haefele• Andreas Höfert• Jorge Mariscal• Mads Pedersen• Mike Ryan• Simon Smiles• Tan Min Lan• Themis Themistocleus• Larry Hatheway (*)• Bruno Marxer (*)• Curt Custard (*)• Andreas Koester (*)(*) Business areas distinct from Chief Investment Office/Wealth Management Research

Investment CommitteewMA Asset Allocation Committee descriptionWe recognize that a globally derived house view is most ef-fective when complemented by local perspective and applica-tion. As such, UBS has formed a Wealth Management Americas Asset Allocation Committee (WMA AAC). WMA AAC is responsible for the development and monitoring of UBS WMA’s strategic asset allocation models and capital mar-ket assumptions. The WMA AAC sets parameters for the CIO WMR Americas Investment Strategy Group to follow during the translation process of the GIC’s House Views and the in-corporation of US-specific asset class views into the US-specific tactical asset allocation models.

wMA Asset Allocation Committee CompositionThe WMA Asset Allocation Committee is comprised of six members:

• Mike Ryan • Michael Crook • Stephen Freedman • Richard Hollmann (*)• Brian Nick • Jeremy Zirin(*) Business areas distinct from Chief Investment Office/Wealth Management Research


Sources of strategic asset allocations and investor risk profilesStrategic asset allocations represent the longer-term allocation of assets that is deemed suitable for a particular investor. The strategic asset alloca-tion models discussed in this publication, and the capital market assump-tions used for the strategic asset allocations, were developed and ap-proved by the WMA AAC.

The strategic asset allocations are provided for illustrative purposes only and were designed by the WMA AAC for hypothetical US investors with a total return objective under five different Investor Risk Profiles ranging from conservative to aggressive. In general, strategic asset allocations will differ among investors according to their individual circumstances, risk tolerance, return objectives and time horizon. Therefore, the strategic as-set allocations in this publication may not be suitable for all investors or investment goals and should not be used as the sole basis of any invest-ment decision. Minimum net worth requirements may apply to alloca-tions to non-traditional assets. As always, please consult your UBS Finan-cial Advisor to see how these weightings should be applied or modified according to your individual profile and investment goals.

The process by which the strategic asset allocations were derived is de-scribed in detail in the publication entitled “UBS WMA’s Capital Markets Model: Explained, Part II: Methodology,” published on 22 January 2013. Your Financial Advisor can provide you with a copy.

Explanations about Asset Classesdeviations from strategic asset allocation or benchmark allocationThe recommended tactical deviations from the strategic asset allocation or benchmark allocation are provided by the Global Investment Commit-tee and the Investment Strategy Group within Wealth Management Re-search Americas. They reflect the short- to medium-term assessment of market opportunities and risks in the respective asset classes and market segments. Positive / zero / negative tactical deviations correspond to an overweight / neutral / underweight stance for each respective asset class and market segment relative to their strategic allocation. The current al-location is the sum of the strategic asset allocation and the tactical devia-tion.

Note that the regional allocations on the International Equities page are provided on an unhedged basis (i.e., it is assumed that investors carry the underlying currency risk of such investments). Thus, the deviations from the strategic asset allocation reflect the views of the underlying equity and bond markets in combination with the assessment of the associated currencies. The detailed asset allocation tables integrate the country pref-erences within each asset class with the asset class preferences stated earlier in the report.

Scale for tactical deviation charts

Symbol Description/Definition Symbol Description/Definition Symbol Description/Definition

+ moderate overweight vs. benchmark – moderate underweight vs. benchmark n neutral, i.e., on benchmark

++ overweight vs. benchmark – – underweight vs. benchmark n/a not applicable

+++ strong overweight vs. benchmark – – – strong underweight vs. benchmark

source: Cio Wm research

aPPendix


aPPendix

nontraditional Assetsnontraditional asset classes are alternative investments that in-clude hedge funds, private equity, real estate, and managed fu-tures (collectively, alternative investments). Interests of alternative investment funds are sold only to qualified investors, and only by means of offering documents that include information about the risks, perfor-mance and expenses of alternative investment funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alternative investment fund is speculative and involves significant risks. Specifically, these investments (1) are not mutual funds and are not subject to the same regulatory requirements as mutual funds; (2) may have performance that is volatile, and investors may lose all or a substan-tial amount of their investment; (3) may engage in leverage and other speculative investment practices that may increase the risk of investment loss; (4) are long-term, illiquid investments; there is generally no second-ary market for the interests of a fund, and none is expected to develop; (5) interests of alternative investment funds typically will be illiquid and subject to restrictions on transfer; (6) may not be required to provide pe-riodic pricing or valuation information to investors; (7) generally involve complex tax strategies and there may be delays in distributing tax infor-mation to investors; (8) are subject to high fees, including management fees and other fees and expenses, all of which will reduce profits.

Interests in alternative investment funds are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agen-cy. Prospective investors should understand these risks and have the

AppendixEmerging Market InvestmentsInvestors should be aware that Emerging Market assets are subject to, among others, potential risks linked to currency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regula-tory and sociopolitical risk, interest rate risk and higher credit risk. Assets can sometimes be very illiquid and liquidity conditions can abruptly wors-en. WMR generally recommends only those securities it believes have been registered under Federal US registration rules (Section 12 of the Se-curities Exchange Act of 1934) and individual State registration rules (commonly known as “Blue Sky” laws). Prospective investors should be aware that to the extent permitted under US law, WMR may from time to time recommend bonds that are not registered under US or State securi-ties laws. These bonds may be issued in jurisdictions where the level of required disclosures to be made by issuers is not as frequent or complete as that required by US laws.

For more background on emerging markets generally, see the WMR Edu-cation Notes “Investing in Emerging Markets (Part 1): Equities,” 27 Au-gust 2007, “Emerging Market Bonds: Understanding Emerging Market Bonds,” 12 August 2009 and “Emerging Markets Bonds: Understanding Sovereign Risk,” 17 December 2009.

Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns with the highest credit ratings (in the investment grade band). Such an approach should decrease the risk that an investor could end up holding bonds on which the sovereign has de-faulted. Subinvestment grade bonds are recommended only for clients with a higher risk tolerance and who seek to hold higher-yielding bonds for shorter periods only.

financial ability and willingness to accept them for an extended period of time before making an investment in an alternative investment fund and should consider an alternative investment fund as a supplement to an overall investment program.

In addition to the risks that apply to alternative investments generally, the following are additional risks related to an investment in these strategies:

• Hedge Fund Risk: There are risks specifically associated with investing in hedge funds, which may include risks associated with investing in short sales, options, small-cap stocks, “junk bonds,” derivatives, distressed securities, non-US securities and illiquid investments.

• Managed Futures: There are risks specifically associated with investing in managed futures programs. For example, not all managers focus on all strategies at all times, and managed futures strategies may have mate-rial directional elements.

• Real Estate: There are risks specifically associated with investing in real estate products and real estate investment trusts. They involve risks as-sociated with debt, adverse changes in general economic or local mar-ket conditions, changes in governmental, tax, real estate and zoning laws or regulations, risks associated with capital calls and, for some real estate products, the risks associated with the ability to qualify for favor-able treatment under the federal tax laws.

• Private Equity: There are risks specifically associated with investing in private equity. Capital calls can be made on short notice, and the failure to meet capital calls can result in significant adverse consequences in-cluding, but not limited to, a total loss of investment.

• Foreign Exchange/Currency Risk: Investors in securities of issuers located outside of the United States should be aware that even for securities denominated in US dollars, changes in the exchange rate between the US dollar and the issuer’s “home” currency can have unexpected effects on the market value and liquidity of those securities. Those securities may also be affected by other risks (such as political, economic or regula-tory changes) that may not be readily known to a US investor.


Chief Investment Office (CIO) Wealth Management Research is published by Wealth Management & Swiss Bank and Wealth Management Americas, Business Divisions of UBS AG (UBS) or an affiliate thereof. In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein does not constitute a personal recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could result in materially different results. We recommend that you obtain financial and/or tax advice as to the implications (including tax) of investing in the manner described or in any of the products mentioned herein. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness (other than disclosures relating to UBS and its affiliates). All information and opinions as well as any prices indicated are current only as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using different assumptions and/or criteria. At any time, investment decisions (including whether to buy, sell or hold securities) made by UBS AG, its affiliates, subsidiaries and employees may differ from or be contrary to the opinions expressed in UBS research publications. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and options trading is considered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in FX rates may have an adverse effect on the price, value or income of an investment. This report is for distribution only under such circumstances as may be permitted by applicable law.

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Version as per January 2014.

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Disclaimer

aPPendix


publication details

publisherUBS Financial Services Inc.

Wealth Management Research

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New York, NY 10019

This report has been prepared by UBS Financial

Services Inc. (“UBS FS”) and UBS AG. Please see

important disclaimers and disclosures at the end

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This report was published

on 21 April 2014.

lead authors Alexander S. FriedmanMike Ryan

Authors (in alphabetical order)Matt BaredesThomas BernerJerry BrimeyerRebecca ClarkeMichael CrookRobert FaulknerAndrea FisherThomas FluryStephen FreedmanRicardo GarciaPatrick HoMaryam KhanMarkus IrngartingerKatie KlingensmithDavid LefkowitzBarry McAlindenThomas McLoughlinKathleen McNamaraBrian NickAchim PeijanJames RhodesBrian RoseCarsten SchlufterDominic SchniderPhilipp SchoettlerGiovanni StaunovoAlexander StiehlerGary TsangThomas VeraguthThomas WackerJonathan WoloshinHenry WongGlenda YuJeremy Zirin

EditorCLS Communication, Inc.

project Management Paul LeemingAlessandra Gonzalez

desktop publishingGeorge StilabowerCognizant Group – Basavaraj Gudihal, Srinivas Addugula, Pavan Mekala

and Virender Negi

Sections of this report were originally published outside the US and have been customized for US distribution.

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