NOV. 26, 2012 INVESTOR EDUCATION

GLOBAL INVESTMENT COMMITTEE

Asset Class Review OVERVIEW

AUTHOR

Non-US Fixed Income

DAVID M . DARST , CFA

DESCRIPTION.

With more than $90 trillion of par value in bonds and notes outstanding as of the end of 2011, the non-US fixed income universe represents a large and diverse asset class spread across many countries, currencies, sectors, quality ratings, maturities, structures, and issue types, including sovereign, supranational, corporate and other securities. Non-US fixed income instruments include: (i) domestic bonds, sold by local issuers and traded in the currency and according to the regulations of local securities markets; (ii) Eurobonds, issued and traded in bearer form on a pan-national basis outside the jurisdiction of any single country; (iii) foreign bonds, issued by nonlocal borrowers in the currency and under the regulations of a specific foreign country; and (iv) global bonds, which are issued and traded simultaneously in the Eurobond and one or more foreign bond markets. Several types of foreign bonds include Yankee bonds (US-pay bonds issued in the US market and registered with the SEC), Dim Sum bonds (bonds issued in Hong Kong denominated in Chinese renminbi, rather than in the local currency, the Hong Kong dollar), Bulldog bonds (issued in the United Kingdom market), and Samurai bonds (issued in the Japanese market).

CHOICES.

The non-US fixed income markets may be accessed through: (i) outright purchase of fixed-coupon and/or floating-rate notes, bonds, certificates, and depository receipts, or through closed-end and open-end mutual funds, hedge funds, unit trusts, and exchange-traded funds; (ii) the interest rate and currency swap markets; (iii) derivative instruments such as options, futures and warrants; and (iv) various forms of leverage, repurchase agreements and special structures. Details about Brady bonds and other emergingmarkets issues are contained in the Morgan Stanley Smith Barney Asset Class Description for emerging-markets debt (dated June 25, 2012).

Chief Investment Strategist 212-296-6224 [email protected]

Non-US Fixed Income Advantages

Disadvantages

1. Responding to local as well as global monetary, fiscal, and currency policies; economic and inflation cycles; institutional forces and political developments; debt service, balance of payments, and foreign currency reserves conditions; non-US fixed income securities offer an expanded opportunity set of bond investment opportunities to protect against deflation or financial accidents. For example, during the decade of the 1990s, Japanese bonds returned 5.4% per annum in yen terms during a period when Japanese equities declined by a total of more than 75%.

1. During the 20th century, the world has experienced four different exchange rate regimes, during the last of which, floating exchange rates, the US dollar has experienced several major upward and downward cycles; as a result, the assumption of foreign currency exposure through non-US fixed income securities offers the possibility of significantly enhanced returns when foreign currencies appreciate against the US dollar, but also significantly reduced returns when foreign currencies depreciate against the US dollar. Due to the effects of various powerful counterbalancing forces in foreign exchange markets, it is alleged that unhedged non-US fixed income returns should be roughly equal to hedged non-US fixed income returns over the long term; however, in the short run, it is difficult to accurately forecast exchange rate movements due to: (i) the effects of official intervention; (ii) portfolio and direct investment flows; (iii) money supply, interest rates, economic growth, productivity and inflation differentials; (iv) technological innovation and labor-force flexibility; and (v) political and geopolitical developments.

With their returns a function of coupon income, coupon reinvestment, capital value changes, default rates, and currency gains or losses, non-US fixed income securities provide a relatively predictable series of scheduled coupon and final maturity payments and tend to generate long-term nominal returns in excess of those available on short-term instruments.

Investing outside of national borders may ultimately rescue, or wipe out, portfolio values. While the 20th century began and ended in an atmosphere of globalization and reduced barriers to the free flow of goods, people, and capital, several at times lengthy periods in the intervening years were marked by embargos, high tariffs, competitive currency devaluations, armed conflict, hyperinflation, debt repudiation, or economic depression, resulting in severe losses for investors in certain non-US bond issues.

Offering the potential to discover inefficiencies in international capital markets and to capture alpha (excess return) through active portfolio management, non-US fixed income securities may enhance returns and reduce risk: (i) in the short run, on an opportunistic basis (with the optimal scenario featuring declining indigenous foreign interest rates and an appreciating currency versus the investor’s base currency); or (ii) in the long run, independent of whether the foreign currency is owned on a hedged or unhedged basis.

As individual capital markets around the world have become more integrated through gains in computing, social networking, broadcasting, and communications technology, the Internet, financial innovation, and convergence in economic, fiscal, monetary, exchange rate, and inflation policies, the correlations of returns between non-US and US fixed income securities may exhibit a tendency to rise over time and thus reduce their portfolio diversification benefits.

When expressed in unhedged foreign-currency terms, many non-US bond markets may reduce the volatility of overall portfolio returns because they exhibit lower standard deviations of returns than the standard deviations of returns of US bond markets. (Due to the added volatility contributed by foreign currency fluctuations, when expressed in US dollar terms, non-US fixed income securities exhibit higher standard deviations of returns than those of US fixed income securities.)

Non-US fixed income securities are subject to many of the same bond-inherent risks as US fixed income securities, including market risk, default or credit risk, reinvestment risk, prepayment risk, and systemic risk.

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Please refer to important information, disclosures and qualifications at the end of this material.

Due in part to the influence of unhedged currency movements, the correlations of returns are low between non-US fixed income securities and US equity, emerging markets equity, private equity, high yield bonds, real estate, and cash, and moderately high between international fixed income securities and US fixed income securities and hedge funds. (Hedging the foreign currency risk in international fixed income securities tends to increase their correlations of returns with the returns of US bonds and those of several other asset classes.) 5.

Investing in non-US fixed income securities may involve lower trading liquidity and higher costs for such functions as: (i) information gathering, research, monitoring, valuation, custody, and reporting; (ii) custody, transfer, and settlement; (iii) transactions in local securities and foreign exchange markets; (iv) withholding taxes and other duties; and (v) hedging expenses. 5.

Source: The Art of Asset Allocation, 2nd Edition, by David M. Darst (McGraw-Hill, 2008); Triumph of the Optimists: 101 years of Global Investment Returns, by Elroy Dimson, Paul Marsh, and Mike Staunton; The Handbook of Fixed-Income Securities, Sixth Edition, ed. by Frank J. Fabozzi; Organization for Economic Cooperation and Development (oecd.org); Bank for International Settlements (bis.org); J.P. Morgan Global Government Bond Index (jpmorgan.com).

J.P. Morgan GBI Global Ex. US Government Bond Index – Price Performance Price Performance From Inception in December 31, 1987 to 2012YTD (Price in US Dollars)

(1)

600

500

400

300

200

100

0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

(1)

Note: (1) Data are as of October 31, 2012. Source: Bloomberg.

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Please refer to important information, disclosures and qualifications at the end of this material.

J.P. Morgan GBI Global Ex. US Government Bond Index – Monthly and Annual Total Returns (% in US Dollars) (1) From Inception in December 31, 1987 to 2012YTD YEAR

JAN

FEB

MAR

APR

MAY

JUN

JUL

AUG

SEP

OCT

NOV

DEC

2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988

1.70 -0.13 0.08 -4.19 4.05 -1.63 1.80 -1.84 0.16 1.88 -2.51 -0.39 -2.96 -1.52 0.64 -4.09 -2.13 2.24 0.66 1.33 -2.56 3.76 -1.70 -3.91 3.72

-1.27 0.58 0.19 -3.92 2.75 2.52 -0.66 0.29 -0.09 1.29 0.34 -0.46 -1.45 -3.66 1.45 -1.18 0.23 2.93 -0.31 1.27 -1.08 -0.24 -2.86 0.69 0.74

-1.11 0.43 -2.20 2.35 3.82 0.25 -1.24 -1.49 1.54 0.50 0.41 -4.03 3.28 0.18 -1.40 -0.62 0.23 8.38 0.83 2.87 -1.36 -7.92 -1.52 -2.91 3.64

1.63 3.97 -0.33 0.49 -3.80 1.11 3.06 1.49 -4.58 1.44 3.92 0.00 -4.25 -0.17 2.25 -1.89 -0.26 1.85 0.49 2.90 0.95 1.87 0.23 1.09 -0.31

-1.09 -0.66 -1.58 4.39 -1.57 -2.34 2.33 -2.87 1.06 4.73 3.52 -0.52 0.99 -1.74 0.04 3.36 0.25 2.19 -1.44 1.51 4.12 -0.42 3.97 -5.79 -1.53

-0.06 0.44 1.96 0.19 0.36 -0.82 -1.38 -1.20 0.13 -1.86 5.88 -1.48 2.72 -2.75 -0.29 1.14 0.71 0.51 2.28 -1.83 4.16 -2.96 2.17 0.77 -5.34

1.03 2.56 4.65 2.01 0.03 3.43 0.67 -0.96 -0.89 -2.62 0.64 2.51 -2.69 3.34 0.34 -2.53 2.79 0.95 0.39 -0.38 1.99 3.29 5.12 6.92 -1.00

1.08 1.85 2.16 2.31 -2.58 1.82 0.83 1.88 2.46 -0.86 1.63 4.64 -1.66 0.39 2.74 0.50 0.72 -5.17 -0.55 3.84 4.49 1.89 -0.37 -4.79 -2.04

1.79 -2.88 3.23 2.78 -1.43 2.73 -0.57 -2.10 1.72 6.45 0.61 0.41 -0.29 1.74 6.67 2.66 0.01 3.17 1.87 1.66 -1.75 5.81 1.01 3.29 2.90

-0.92 0.80 2.00 0.02 -1.67 1.76 1.04 -2.10 3.50 -0.19 -0.12 0.16 -2.10 -0.22 3.74 2.32 1.96 0.69 2.72 -0.40 -3.70 1.03 6.91 -0.52 7.39

-2.03 -6.17 3.88 3.35 2.82 3.14 -1.64 4.84 2.02 0.41 -1.05 -2.04 -1.62 -1.73 -2.30 1.31 0.88 -1.98 -0.54 -3.36 2.28 1.40 0.81 3.60

1.03 3.06 -5.84 8.18 -0.69 -2.20 1.02 1.88 4.84 5.74 -3.16 4.28 -0.13 2.78 -0.91 -0.58 1.18 -0.04 1.27 -0.15 7.35 0.67 2.58 -1.86

FULL (1) YEAR 2.74 5.91 6.78 3.94 11.39 11.30 6.84 -9.24 12.04 18.63 22.09 -3.59 -2.47 -6.17 18.28 -3.77 5.27 21.12 4.93 14.53 1.59 15.91 15.61 -2.48 1.78

Notes: (1) Data are as of October 31, 2012. Source: Bloomberg.

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees, or sales charges, which would lower performance. Past performance is no guarantee of future results. J.P. Morgan GBI Global Ex. US Government Bond Index measures the total, principal, and interest returns of government bonds in each market and can be reported in different currencies. By including only traded issues available to international investors, the Index provides a realistic measure of market performance.

Morgan Stanley Smith Barney Global Investment Committee – Asset Class Reviews 1.

Gold

2.

Managed Futures

10/31/11

3.

US Equity

11/28/11

4.

US Cash and Cash Equivalents

9/12/11

1/3/12

5.

Master Limited Partnerships

1/23/12

6.

Publicly Traded Real Estate Shares and REITs

2/27/12

7.

High Yield Fixed Income

3/26/12

8.

US Investment Grade Fixed Income

4/23/12

9.

Inflation-Indexed Securities

5/21/12

10.

Emerging Markets Fixed Income

6/25/12

11.

Hedge Funds

7/30/12

12.

Emerging Markets Equity

8/27/12

13.

Commodities

9/24/12

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Please refer to important information, disclosures and qualifications at the end of this material.

Morgan Stanley Smith Barney Global Investment Committee – Asset Class Reviews 14.

Non-US Equity

10/22/12

15.

Non-US Fixed Income

11/26/12

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Please refer to important information, disclosures and qualifications at the end of this material.

Disclosures This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This is not a research report and was not prepared by the Research Departments of Morgan Stanley & Co. Incorporated or Citigroup Global Markets Inc. The views and opinions contained in this material are those of the author(s) and may differ materially from the views and opinions of others at Morgan Stanley Smith Barney LLC or any of its affiliate companies. Past performance is not necessarily a guide to future performance. The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors. Morgan Stanley Smith Barney is involved in many businesses that may relate to companies, securities or instruments mentioned in this material. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or warranty with respect to the accuracy or completeness of this material. Morgan Stanley Smith Barney has no obligation to provide updated information on the securities/instruments mentioned herein. The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Morgan Stanley Smith Barney recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and 6

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other issuers or other factors. Estimates of future performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Smith Barney does not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. 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These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies. Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate. An investment in an exchange-traded fund involves risks similar to those of investing in a broadly based portfolio of equity securities traded on an exchange in the relevant securities market, such as market fluctuations caused by such factors as economic and political developments, changes in interest rates and perceived trends in stock and bond prices. Investing in an international ETF also involves certain risks and considerations not typically associated with investing in an ETF that invests in the securities of U.S. issues, such as political, currency, economic and market risks. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economics. For specifics and a greater explanation of possible risks with ETFs¸ along with the ETF’s investment objectives, charges and expenses, please consult a copy of the ETF’s prospectus. Investing in sectors may be more volatile than diversifying across many industries. The investment return and principal value of ETF investments will fluctuate, so an investor’s ETF shares (Creation Units), if or when sold, may be worth more or less than the original cost. ETFs are redeemable only in Creation Unit size through an Authorized Participant and are not individually redeemable from an ETF. Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets. The indices are unmanaged. An investor cannot invest directly in an index. 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