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Top themes Thematic investment ideas from CIO Wealth Management Research April 2014

Rising capex Tech on sale Enhanced cash yields

Energy independence Credit alternatives

Eurozone rebound

Senior loans

ab

Capital securities


Contents

01 This month’s feature

03

Top themes

07 Thematic universe



09

US CIO Thematic Investment Committee

10 Disclosure

The visual aids below are used throughout this publication to help categorize themes in the context of portfolio integration and investment time horizon.

Portfolio context

Non-traditional

US equity

Commodities International equity

International fixed income US fixed income

Dear readers, Welcome to the second edition of Top themes, a new flagship thematic publication from CIO Wealth Management Research. This month, our investment theses remain strongly intact for each of the Top themes that we featured in the inaugural publication. In our view, the most attractive thematic investment opportunities continue to be those that are positioned to benefit from growth reaccelerating in the US and Europe and interest rates rising gradually over time. While there were no notable changes to our Top themes list, the recent tensions in Crimea and disappointing economic developments in China serve as a reminder to investors that geopolitical and policyrelated risks continue to deserve attention. The limited response in US financial markets thus far serves as a testament to the strength of the ongoing recovery and the resilience of the domestic economy. Accordingly, in this month’s feature article, we chose to elaborate upon our highest conviction US equity themes that are poised to benefit from an expanding US economy. On a final note, we’ve removed the investment theme “Attractive yields from emerging market corporates” from our Thematic Universe (starting on page 7). Bond valuations remain fair but we’ve become less optimistic on the return outlook for this asset class over the coming 6 months. Emerging market (EM) corporate fundamentals appear weaker, with indicators such as leverage ratios and rating trends deteriorating in recent quarters, and geopolitical risks are more prominent today. Additionally, we expect higher trending US Treasury yields to create headwinds for EM credit.

Investment time horizon

Stephen Freedman, PhD, CFA

Head of Cross Asset Strategy Long-term: Greater than 12 months Medium-term: 6 to 12 months Short-term: Less than 6 months

Please contact your financial advisor for copies of reports cited in this publication. This report was published on 24 March 2014.

Andrea Fisher Investment Strategist


Top themes

This month’s feature Investing in US growth and resilience About our feature Each month, we will use this feature article to focus on one or more of the top themes. Specifically, we will address changes to our list, shifts in investment rationale, or the relationship of several top themes to developments in the market.

With last year’s US fiscal drag taking a back seat, a central reason why we expect growth to accelerate is our view that capital expenditures (capex) should finally start gathering steam.

By Andrea Fisher; Stephen Freedman, PhD, CFA

The limited market impact of the recent uptick in geopolitical tensions and adverse weather conditions underscores the relative strength and resilience of the US economy. In spite of “uncertainties” surrounding Russia’s move into Crimea, China’s growth model, or the timing of the Fed’s first rate hike (all discussed in our latest House View publication), over the past few months the US has demonstrated not only that the recovery is sustainable but that its economy is a bright spot among developed and emerging countries. With US economic data now thawing after a bit of a “winter freeze,” we expect private-sector demand to drive robust growth, and in turn higher earnings and US equity prices, throughout the rest of year. Among our Top themes, there are three particular opportunities focused on US equities that take advantage of the pickup we expect in the business cycle and the overall greater resilience of the domestic economy: • Capex rising…finally • US Technology: secular growth on sale • North American energy Independence: reenergized

With last year’s US fiscal drag taking a back seat, a central reason why we expect growth to accelerate is our view that capital expenditures (capex) should finally start gathering steam. Capex has been notably lagging relative to prior cycles but we believe more convincing evidence surrounding the strength of the US economic expansion will act as the catalyst for corporate America to reengage this year. Already, improving sentiment is becoming visible; recent survey readings show notable increases in corporate capital spending plans (see figure below). This trend should benefit

Fig. 1: Rising capex intentions for small and large firms NFIB small business capex plans and Philly Fed 6-month capex forecast 40

40

30

35

20

30 25

10

20

0

15

–10

10

–20

5

–30

0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Philly Fed: 6 month capex forecast (lhs) NFIB small business capex plans (rhs)

Source: Federal Reserve Bank of Philadelphia, NFIB, as of 21 March 2014.

Top themes April 2014

1


Top themes

This month’s feature select cyclical areas of the US equity market, most prominently within the Industrials, Financials and Technology sectors.

The transformation underway within the energy industry is providing additional support to ongoing strength and resilience of the US economy.

The Technology sector is worth flagging on its own right. Tech stocks are a primary beneficiary of a rebound in capex, since corporations not only need to replace obsolete hardware and software but are also increasingly likely to expand their infrastructure. Enterprise spending accounts for the lion’s share of Tech revenues so a revival in capex should be a boon to earnings. In spite of brighter earnings prospects, tech stocks remain at attractive valuation levels. The sector is trading at a 3% discount to the market compared to its average 15% price/earnings ratio premium over the past 10 years. The transformation underway within the energy industry is providing additional support to ongoing strength and resilience of the US economy. With an abundance of inexpensive natural gas, the US has a clear opportunity to become less reliant on foreign oil (and thus less vulnerable to oil-related geopolitical risks) and achieve energy independence by the end of the decade. Though it’s a multi-year road to energy independence, the positive effects of robust drilling activity for oil and natural gas, infrastructure build-out, and widespread availability of reliable and affordable energy supplies are already positively impacting US economic. The energy sector has created 600,000 jobs in the US and the state of North Dakota, home of the Bakken shale gas field, experienced massive growth of 13.4% in 2012. Soon we expect the US will become a net exporter of natural gas, which should also create a competitive advantage for US companies in energyintensive industrial operations through relatively low energy costs. More specifically, Nicole Decker, our energy equity sector strategist, believes there are attractive investment opportunities in companies tied to North America’s energy transformation across a range of industries: energy and energy infrastructure, chemicals, auto parts, rails, engineering and construction, utilities.

Fig. 2: Total energy production and consumption, 1980–2040 Quadrillion Btu History

110

EIA projections

100 90

net imports

80 70 60 1980

1988

1996

2004

2012

Production Consumption Source: US Energy Information Administration, 16 Dec. 2013

2

April 2014 Top themes

2020

2028

2036


Top themes Our monthly selection of highest-conviction, actionable investment themes across the asset class spectrum.

Capex rising...finally

Opportunities in capital securities

Jeremy Zirin, CFA; David Lefkowitz, CFA; Matthew Baredes

Rebecca Clarke

Context

Context

The preconditions for a pickup in capiUS equities tal spending are in place. The nation’s

u  Global

recovery story

u  Medium-term

u  Portfolio

integration

We’ve identified a list of stocks that are poised to benefit from an upturn in capital spending. This stock basket can be a component of a diversified US large-cap portfolio with sector exposure to tech, industrials, and financials. u  Click here for full report

“US equities: Capex rising...finally,” 7 November 2013.

stock of plant and equipment is old and companies have access to low cost funding. The missing ingredient has been a need to ramp up production. But with Europe out of recession and US growth picking up, we believe companies will increasingly replace old equipment and invest in capacity additions. The recent uptick in capacity utilization underscores this need. In addition, a reflaring of macro risks is unlikely. Policy uncertainty continues to improve (the Fed is winding down asset purchases and federal budget battles have been deferred until at least March 2015) and the global financial system is much healthier. Finally, as interest rates rise we believe the marginal equity investor will become more growth-oriented and less focused on income, favoring companies that are prudently investing for growth.

Current capital stock is as old as it has been in 50 years Average age of fixed assets and consumer durable goods 23

5.0

22

4.8

21

4.6

20

4.4

19

4.2

18 4.0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

US fixed income u  Yield

enhancement

u  Medium-term

u  Portfolio

integration

This theme can be integrated into a US investment grade fixed income portfolio either through our recommended basket of single securities or through actively managed funds with blended exposure to capital and preferred securities. u  Click here for full report

“Subordinated bonds: Opportunities in financial sector capital securities,” 20 February 2014.

Capital securities describe the broader market of subordinated and junior subordinated debt which includes preferred shares. Capital securities as a market category describe securities which combine characteristics of equity and debt. They are typically structured as institutional issues of larger size and denomination than retail issues such as preferred shares. Similar to preferred shares, they serve as a source of capital for issuers on the depletion of common equity. We see some advantages for institutional capital securities over retail preferred shares due to the greater size and scope of this market, and its enhanced liquidity characteristics. In our view, financial sector capital securities will outperform the broader investment grade bond market over the coming months, boosted by attractive yields and improving issuer fundamentals. Banks, insurers and large-cap diversified financials are holding record levels of liquid assets and employing less leverage. Further, regulatory changes since the financial crisis are causing US and European banks to adapt their capital bases to new, stricter requirements. The broader capital securities market will likely benefit from the changing rules as they will be more likely to be called at their first call date and replaced with new compliant securities. We see this transitional period as an opportunity to benefit from the significantly higher yield and shorter duration of capital securities relative to US investment grade securities.

Fixed assets, le Consumer durable goods, right Source: Bureau of Economic Analysis, UBS CIO WMR, as of 24 February 2014

Top themes April 2014

3


Top themes Our monthly selection of highest-conviction, actionable investment themes across the asset class spectrum.

Favor Eurozone equities within Europe Andrea Fisher; Stephen Freedman, PhD, CFA

North America energy independence: reenergized Nicole Decker, David Lefkowitz, CFA

Context Non-US equities

u  Global

recovery story

u  Medium-term

u  Portfolio

integration

Passive or actively managed Eurozone equity funds are available. For higher-beta exposure, consider actively managed options with exposure to Eurozone small- and mid-caps. Given our negative view on the EUR/USD, consider hedged exposure. u  Click here for full report

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

We believe Eurozone equities present an attractive opportunity to participate in the region’s economic recovery. Our expectation for an improving domestic economy, re-accelerating 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 accelerating global economy.

Context

The Eurozone recovery is being supported by fewer fiscal headwinds, rebounding consumer confidence, and favorable 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.

u  Portfolio

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

US equities

u  Equity

growth and

income u  Long-term

integration

We have identified a list of stocks that are poised to benefit from positive trends related to North America’s burgeoning energy independence. u  Click here for update

“North America Energy Independence: Reenergized” 22 January 2014

North America continues to make progress in achieving greater energy independence. We expect greater self-sufficiency by the end of the decade and that the US will soon be a net exporter of natural gas. Relatively inexpensive natural gas will likely create a competitive advantage for the US and will bolster energy-intensive petrochemical and materials sectors. Trends – such as robust drilling activity for oil and natural gas, infrastructure build-out, and widespread availability of reliable and affordable energy supplies – are driving opportunities for investors. Technologies for extracting oil and gas are driving improved well productivity (see chart) and reducing costs. More oil and gas pipelines and processing plants are needed. The US will construct several LNG export facilities before the end of the decade. For the year ahead, we see opportunities in energy providers and advantaged energy consumers across several industry sectors: energy infrastructure, chemicals, auto and steel manufacturers, and utilities.

New oil wells are more productive Average first-month oil production (barrels per day) 600 500 400 300 200 100 0 Bakken

Eagle Ford

Niobrara

March 2013 March 2014 Source: Energy Information Administration, UBS CIO WMR

4

April 2014 Top themes

Permian


Top themes Our monthly selection of highest-conviction, actionable investment themes across the asset class spectrum.

Tip-toeing out the yield curve

US senior loans

Barry McAlinden, CFA; Michael Crook, CAIA; Andrea Fisher

Barry McAlinden, CFA, Philipp Schoettler

Context

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 completing its large scale asset purchases – which means that rates on cash-like investments will remain near zero for the foreseeable future.

US fixed income u  Yield

enhancement

u  Long-term

u  Portfolio

integration

This idea applies to buyand-hold as well as to total return-oriented investors with significant cash holdings.

As an alternative to paltry cash rates, investors should venture further out the maturity spectrum into shorterterm 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 maturities of one to four years is far superior to cash-like alternatives.

u  Click here for full report

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

We project that the front end of the yield curve will remain steep Treasury yield, in % 5 4 3 2 1 0 0

5

10

15 maturity (years)

20-March 2014

6 months forecast 12 months forecast

Source: Bloomberg, UBS CIO WMR, as of 20 March 2014

20

25

30

Context

US fixed income u  Yield

enhancement

u Medium-term

u  Portfolio

integration

This theme can be integrated into a diversified fixed income portfolio as a complement to the high yield bond allocation. Loans are investible either through open and closed-end mutual funds or ETFs.

Senior loans (or leveraged loans) are issued by speculative-grade companies but have a senior secured status within a company’s capital structure. The same positive fundamental trends evident in the US high yield bond market also apply to loans, including improved balance sheets and debt maturity profiles. Loan coupon rates reset regularly based on 3-month USD LIBOR, which has historically allowed loans to perform well when interest rates rise. Even though LIBOR floors prevent coupons from resetting higher right away, their low duration and strong demand should provide loans with an advantage over government and IG corporate bonds as rates rise.

There has been an increase in aggressive types of issuance in the loan market such as covenant-lite deals. We view these trends as representative of a highly u  Click here for full report accessible market environment within “US senior loans the middle stages of the credit cycle, update,” 19 March 2014 rather than signaling an overheating market.

S&P/LSTA Loan Index spread Spread to maturity over LIBOR, in bps L+1800.00 L+1600.00 L+1400.00 L+1200.00 L+1000.00 L+800.00 L+600.00 L+400.00 L+200.00 L+.00

1997

1999

2001

2003

2005

2007

2009

2011

2013

Spread-to-maturity Pre-crisis average Source: S&P LCD, UBS CIO WMR, as of 14 March 2014

Top themes April 2014

5


Top themes Our monthly selection of highest-conviction, actionable investment themes across the asset class spectrum.

US technology: secular growth, on sale

Diversify bond portfolios into credit alternatives

Jeremy Zirin, CFA; David Lefkowitz, CFA; Bob Faulkner

Brian Nick; Andrea Fisher

Context US equities

u   Global

recovery story; attractive valuations

u  Medium-term

u  Portfolio

integration

This idea applies to buyand-hold as well as to total return-oriented investors with significant cash holdings. u  Click here for full report

“US technology: secular growth, on sale,”17 February 2014

We believe that the US tech sector is trading at an unjustified lower than normal valuation versus the broader market despite solid growth prospects. Historically, investors have been well served by buying the sector when it trades at the current valuation of 15x earnings. Since 1989, the median 12-month forward return at these valuation levels has been 18%. In addition, the sector’s free-cash-flow yield of 7% is the second highest in the US market and its total yield (dividends plus net share buybacks) is higher than that of the broader market. Earnings growth for the US tech sector will outpace the market over the next few years in our view, based on secular growth drivers such as mobility, cloud computing, online advertising and e-commerce. Cyclical factors are also becoming more favorable. Fading policy risks, continued labor market gains, rising capacity utilization, and a positive inflection in European profit growth should unleash pent up enterprise spending on IT equipment and services.

Context

The recent rise in US interest rates has created concern among investors that holding too large an allocation to fixed income may result in lower overall returns in the coming year. We agree with this assessment to an extent and believe investors should be prepared for a multi-year period of unusually low bond returns.

Non-traditional investments

u   Return

enhancement; diversification

u  Long-term

u  Portfolio

integration

Fixed income relative value, event driven, and credit long/short hedge fund, fund-of-fund (FoF), and liquid alternative investment managed strategies. u  Click here for full report

“Investment strategy insights: Diversify bond portfolios into credit alternatives,” 20 Feb 2014

While no single asset or asset class can be a true substitute for holding highquality fixed income, there are several ways to diversify portfolios away from interest rate risk. One option is to diversify a portion of a portfolio’s high-quality bond holdings into credit alternatives. Alternative strategies that hold both long and short positions in a variety of fixed income instruments generally carry a net long bias to credit risk but with little to no interest rate risk. We believe such strategies should outperform investment grade sovereign and corporate bonds this year and thus recommend including them in a diversified asset allocation.

Credit alts have outperformed bonds when rates are rising

Low valuations are bullish for tech stocks One-year forward returns based on the tech sector’s P/E since 1989, in %

HFRX FI-Credit vs. Barclays Agg. & 10-year UST yield

120

140

6.0

130

5.0

120

4.0

110

3.0

100

2.0

Attractive risk-reward

80 40

20%

18%

13%

0 –23%

–40

–50%

–80 < 15x Maximum

15–20x Median

20–30x

30–40x

Minimum

Source: Thomson Datastream, UBS CIO WMR, as of 19 February 2014

6

In %

April 2014 Top themes

> 40x

1.0

90 2004

2005

2006

2007

2008

2009

2010

Credit Alts vs. Barclays Aggregate (le) 10-year US Treasury yield (right) Source: UBS CIO WMR, HFR, Bloomberg, as of 28 Feb 2014

2011

2012

2013


Thematic universe Our thematic universe represents the full spectrum of investment themes we currently recommend and actively monitor.

Equity e-Commerce: beyond Amazon Explosive growth in e-Commerce has altered the retailing landscape and omni-channel companies will lead the way (long-term horizon). Full report: “US equities consumer discretionary e-Commerce: wrapping up the holiday season” top theme

Capex rising...finally

After lagging for the past few years, we believe the catalysts for a pick-up in capital expenditures (capex) are in place and recommend investing in companies that should benefit from the expected rebound (medium-term horizon). Full report: “US equities: Capex rising…finally”

Dividend investing – don’t overpay for yield While valuations for the highest dividend yielding stocks remain elevated and vulnerable in a rising interest rate environment, stocks with more moderate yields but historically high and consistent dividend growth are much more attractively valued and less interest rate sensitive (mediumterm horizon). Full report: “Dividend ruler stocks”

North American energy independence: reenergized top theme

Not only will North America achieve energy independence by the end of the decade, but we expect the US will soon be a net exporter of natural gas, which benefits select companies in oil and gas exploration and production, energy infrastructure, pipelines, chemicals, steel, utilities, and auto manufacturing sectors (long-term horizon). Full report: “North American energy independence: reenergized”

REITs vs Utilities – REITs have the power! As the economic recovery continues and interest rates are set to rise, we expect US REITs to outperform US utilities (medium-term horizon). Full report: “US equity markets: REITs vs. Utilities – REITs have the power!”

US housing: the long grind higher The recovery in the US housing market has additional upside and we identify companies that are exposed to this tailwind and offer attractive valuations (medium-term horizon). Full report: “US housing: the long grind higher”

Equal-weight investing Alternative weightings strategies have shown superior long-term performance and we believe that equal-weight investing is currently attractive (long-term horizon). Full report: “Investment strategy insights: boosting returns with alternative weighting strategies” top theme

Favor Eurozone equities within Europe

We expect Eurozone stocks to disproportionately benefit from improving earnings growth and an accelerating global economy, particularly relative to the broader European equity market (medium-term horizon). Full report: “Eurozone equities: growth lifts mid and small caps”

Financials – on the road to recovery The Financials sector is poised to outperform the broader market due to easing earnings headwinds, still attractive valuations, normalizing interest rates, and improving capital markets activity (long-term horizon). Full report: “CIO Highlighted Theme: Financials – on the road to recovery”

top theme

US technology: secular growth on sale

The US technology sector is attractively valued given its solid long-term earnings growth, improving cyclical outlook, accelerating cash distributions to shareholders and exposure to secular growth drivers (medium-term horizon). Full report: “US equities information technology: secular growth, on sale”

Water: thirst for investments Clean water supply is constrained and the growth in demand for food, energy, and consumer products will require substantial amounts of this resource, benefiting select companies with water exposure (long-term horizon). Full report: “Water: Old and new technological trends add potential”

Top themes April 2014

7


Thematic universe Our thematic universe represents the full spectrum of investment themes we currently recommend and actively monitor.

Fixed income top theme

Opportunities in capital securities

Financial sector capital securities are poised to outperform the broader investment grade bond market over the coming months, boosted by attractive yields and improving issuer fundamentals (medium-term horizon). Full report: “Subordinated bonds: Opportunities in financial sector capital securities” top theme

top theme

Tip toeing out the yield curve

Investors with excess cash holdings should consider picking up some extra yield by taking on select short term credit exposure up to four years in maturity (long-term horizon). Full report: “Fixed income: Tip toeing out the yield curve”

Non-traditional and commodities Diversify bond portfolios into credit alternatives top theme

Credit alternatives present an opportunity for investors – particularly conservative ones with large existing traditional bond portfolios –to potentially diversify away some of their interest rate risk and outperform investment grade sovereign and corporate bonds this year (long-term horizon). Full report: “Investment Strategy Insights: Diversify bond portfolios into credit alternatives”

8

April 2014 Top themes

US senior loans

Due to their floating-rate character, senior loans are an attractive alternative to more traditional fixed income segments in an environment of stable or rising rates (medium-term horizon). Full report: “US senior loans update”


US CIO Thematic Investment Committee US Thematic Investment Committee

Thematic universe

The themes selected for the top themes list and those featured in the Thematic Universe are selected and actively monitored by the US Thematic Investment Committee (TIC).

CIO Wealth Management Research actively recommends and monitors a broader range of investment themes, a number of which are not included in the top themes list. Top themes within the thematic universe may change from month to month. Non-inclusion may be based on factors such as: lower conviction than for current members of the top themes list, limited implementability, or narrowness of the theme (e.g. only affects a small number of stocks). Themes within the Thematic Universe may be selected on a monthly basis by the TIC for inclusion in Top themes, if they qualify. However, the entire Thematic Universe is actively monitored and recommended by CIO Wealth Management Research analysts and strategists.

Members of the US Thematic Investment Committee All members are analysts or strategists working for the CIO Wealth Management Research Americas (CIO WMR): Michael Crook Mike Dion Andrea Fisher Steve Freedman (Chair) David Lefkowitz Barry McAlinden Tom McLoughlin Brian Nick Mike Ryan Jon Woloshin Jeremy Zirin

Top themes The top themes list represents our highest-conviction, actionable investment themes that we believe an investor should consider in light of current or anticipated financial market trends. Thematic drivers may include emerging growth opportunities, misvaluations in capital markets or foreseeable developments in public policy, demographics, society, environment, and technology, to name a few. All investment themes originate from analysts within CIO Wealth Management Research. Top themes are selected on a monthly basis by the TIC based on the level of conviction about the themesâ&#x20AC;&#x2122; structural and tactical drivers, return and risk expectations, and implementability. Themes that are no longer designated as top themes will be noted in the thematic universe section of the report.

Top themes April 2014

9


Disclosures Emerging Market Investments Investors should be aware that Emerging Market assets are subject to, amongst others, potential risks linked to currency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regulatory and socio-political risk, interest rate risk and higher credit risk. Assets can sometimes be very illiquid and liquidity conditions can abruptly worsen. WMR generally recommends only those securities it believes have been registered under Federal U.S. registration rules (Section 12 of the Securities 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 securities 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 Education Notes “Investing in Emerging Markets (Part 1): Equities”, 27 August 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 defaulted. Sub-investment grade bonds are recommended only for clients with a higher risk tolerance and who seek to hold higher yielding bonds for shorter periods only. Nontraditional Assets Nontraditional asset classes are alternative investments that include hedge funds, private equity, real estate, and managed futures (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, performance 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 substantial 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 secondary 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 periodic pricing or valuation information to investors; (7) generally involve complex tax strategies and there may be delays in distributing tax information to investors; (8) are subject to high fees, including management fees and other fees and expenses, all of which will reduce profits.

10

April 2014 Top themes

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 agency. Prospective investors should understand these risks and have the 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.


Disclaimer Disclaimer 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 currently 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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Top themes April 2014

11

April 2014 UBS Themes  

Investment themes from UBS

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