january 2012 market commentary

global investment committee

Global Investment Committee Investment Ideas for 2012 analysis

authors

T

jeff applegate

he Global Investment Committee attributes fitting to the times. This report (GIC) believes policy disarray on presents what we believe to be the best both sides of the Atlantic has tipped the investment ideas for 2012. These ideas Euro Zone into a recession, with the include global equities, fixed income US soon to follow. Still, while regional and alternative/absolute return asset economies are linked by trade and finance classes that are consistent with the GIC’s more than ever, the global view of the global economy economy will likely avoid and markets. The order of recession due to emergthe ideas is not indicative We tap the global ing market (EM) growth. of preference. resources of Despite the headwinds to The areas of opportunity Morgan Stanley EM exports that may be that interest us in 2012 Smith Barney caused by sluggish outare varied. Five of our to formulate the looks for the developedideas target high-quality market (DM) economies, income generation in a best investment both Morgan Stanley and low interest rate environideas for the Citi economists expect GDP ment: dividend aristocrats, coming year. growth in EM countries to investment-grade credit, exceed 5% in 2012. short-duration bonds, prerefunded municipal securities Given a slower-than-desired growth forecast, the GIC enters 2012 with a and master limited partnerships. Bemore cautious stance toward risk asyond those, emerging market equities also offer higher dividend yields than sets than in recent years. Still there are always investment opportunities that their DM peers. Our preference for offer attractive valuation, portfolio diverthe emerging markets continues with sification, income generation and other “global gorillas,” or DM companies 

Chief Investment Officer

david darst, cfa

Chief Investment Strategist

hernando cortina, cfa Equity Strategist

john dillon

Chief Municipal Bond Strategist

kevin flanagan

Chief Fixed Income Strategist

edward m. kerschner, cfa* Senior Strategy Consultant

jonathan mackay

Senior Fixed Income Strategist

dan nelson

Head of Portfolio Strategy and Research Group

charles reinhard

Deputy Chief Investment Officer

douglas schindewolf

Director of Tactical Asset Allocation

andrew slimmon

Head of Morgan Stanley Smith Barney Applied Equity Advisors

* Edward M. Kerschner is not an employee of Morgan Stanley Smith Barney. He is a paid consultant and a member of the Global Investment Committee. His opinions are solely his own and may not necessarily reflect those of Morgan Stanley Smith Barney or its affiliates.

market commentary / global investment committee

with considerable business exposure and growth potential in the emerging markets. We also highlight an important secular theme: water—a finite resource that is not always available where it is needed, especially in the fast-growing urban centers of EM countries. Finally, we believe that good risk management starts with portfolio diversification. Thus, we have included managed futures, which, as an asset class, have low correlations with global stocks and bonds. 2011 PERFORMANCE REVIEW. Before turning to our ideas for 2012, let’s review how our 2011 ideas fared. It’s important to keep in mind that while we quote indexes, actual returns may have varied based upon the specific investment vehicles employed. All returns are reported as of Dec. 30, in US dollars (See Table 1). The past year was a challenging one for equities, and our 2011 equity-related ideas were not spared. In a period in which global equities, as measured by the MSCI All Country World Index, returned -4.3%, our equity ideas—resource-rich countries, emerging market equities, global gorillas, water and alternative energy—all posted negative returns. Global real estate investment trusts posted a return slightly below that of global equities. The bestperforming idea for 2011 was TIPS and WIPS, which represent US and non-US inflation-linked securities—and ended up 11.7% on a total return basis. High yield bonds came in second best, with a 7.2% total return. Now let’s review our ideas for 2012. US LARGE-CAP GROWTH. This selection incorporates our preference for US equities in terms of market capitalization and style. Large-cap stocks tend to be more defensive than mid- and small-cap stocks and typically outperform them in adverse market conditions. Moreover, from a valuation perspective, large-cap stocks appear historically cheap relative to mid- and small-cap stocks.

2 | january 2012

A similar line of reasoning augurs well for growth stocks over value stocks. By historical standards, value stocks appear expensive relative to growth stocks. The ratio of the price/earnings (P/E) multiple of the Russell 1000 Value Index to that of the Russell 1000 Growth Index, our benchmark, is nearly 0.8 versus a three-decade average of 0.7, indicating that growth remains cheap relative to value (see Chart 1, page 3). Furthermore, during the periods of declining corporate earnings that accompany recessionary episodes, growth stocks—companies that can deliver relatively stable earnings growth regardless of the economic backdrop or those that can generate above-average earnings growth—typically perform better. DIVIDEND ARISTOCRATS. This investment is defined by our benchmark, the S&P 500 Dividend Aristocrats Index. This index comprises 42 large-cap, blue-chip companies that have raised dividend payouts annually for at least 25 years. Companies in the index have solid franchises in the health care, consumer products and materials sectors. In a period of record-low money-market and bond yields, dividend-paying equities can offer an attractive source of income. GLOBAL GORILLAS. We believe that investment in large, DM companies with outsized exposure to the emerging markets—we call them “global gorillas”— is another way to capture the growth from those markets. The EM economies now account for up to 80% of global GDP growth, a contribution that we believe is likely to be maintained for the foreseeable future. One way to capitalize on the growth in emerging economies is via established multinationals that have strong businesses in countries with a rapidly expanding middle class—such as China, India and Brazil, all of which are expected to see

Table 1: A Recap of 2011’s Best Ideas Results may vary depending on the strategies used. From Dec. 3, 2010, through Dec. 30, 2011, the total return on the MSCI All Country World Index was -4.3%; the Barclays Capital Global Aggregate Bond Index, 6.1%; and US Treasury Bills, 0.2%. Total Return (%)*

1

Emerging Market Equities MSCI Emerging Markets Index

2

Emerging Market Currencies Morgan Stanley Foreign Currency Emerging Markets Index -7.5

3

Global Gorillas S&P Global 100 Index

-2.2

4

Resource-Rich Countries MSCI Australia MSCI Canada MSCI Norway

-6.5 -9.1 -2.1

5

Commodities Dow Jones-UBS Commodity Index

-8.5

6

Global Real Estate Investment Trusts FTSE EPRA/NAREIT Global Index -5.7

7

TIPS and WIPS Barclays Capital World Government Inflation-Linked Index 11.7

8

High Yield Bonds Barclays Capital High Yield Index (B3+/B- or >)

7.2

9

Water ISE Water Index

-1.2

10

Alternative Energy WilderHill New Energy Global Index

-15.9

-33.5

*Dec. 3, 2010 through Dec. 30, 2011 Source: Bloomberg as of Dec. 30, 2011

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

market commentary / global investment committee

increases in consumer spending at an 8% annual rate over the next 10 years according to Euromonitor International, a market research firm. Our benchmark for the global gorillas is the S&P Global 100 Index. EMERGING MARKET EQUITIES. Emerging market economies are on much better footing than their developedmarket counterparts, thanks mainly to robust domestic demand in the developing economies. Many EM countries do not face the debt burdens that are creating problems for developed countries, allowing for more fiscal policy flexibility. Meanwhile, as inflationary pressure has dissipated the monetary-tightening cycle has come to an end and policymakers have started to ease. Finally, from a valuation standpoint, the MSCI Emerging Markets Index, our benchmark appears cheap relative to its history and to the developed markets. In addition, EM equities in aggregate have higher dividend yields than DM equities. Thus, we maintain our constructive long-term outlook for this asset class. INVESTMENT-GRADE CREDIT. We believe the very strong balance sheets of investment-grade companies will enable them to better withstand a slowdown in economic growth than at any point in recent history. A historically wide spread—or yield advantage versus low risk-free rates—and significantly lower volatility relative to other risk assets make a compelling case for investment-grade corporate bonds. Our benchmark is the Barclays Capital US Aggregate Corporate Investment Grade Index. SHORT-DURATION BONDS. Given the potential for a recessionary backdrop and concerns about ongoing financial risks stemming from Europe, we have increased our allocation to safe-haven assets. Short-duration fixed income offers favorable yields relative to cash.

Chart 1: In Large-Cap US Stocks, Growth Has More Value

2.0 1.8 1.6

By historical standards, value stocks appear expensive relative to growth stocks. The ratio of the price/earnings multiples of the Russell 1000 Value Index to the Russell 1000 Growth Index, our benchmark, is nearly 0.8 versus a three-decade average of 0.7, indicating that growth is cheap relative to value.

Ratio of Price/Earnings Multiples of the Russell 1000 Value Index to the Russell 1000 Growth Index

1.4 1.2 1.0 0.8

Average

0.6 0.4 0.2 0.0

’79 ’81 ’83 ’85 ’87 ’89 ’91 ’93 ’95 ’97 ’99 ’01 ’03 ’05 ’07 ’09 ’11

Source: Thomson Financial, FactSet as of Dec. 30, 2011

Moreover, the defensive properties of this asset class should reduce volatility in diversified portfolios during turbulent periods. Our benchmark is the Barclays Capital Global Treasury 1-3 Years Index (hedged to the US dollar). HIGH-QUALITY MUNICIPAL BONDS. The confluence of relative value versus US Treasuries, wide credit spreads, a historically steep yield curve and the expectation of continued low default rates suggests that high-quality municipal bonds should perform well in the coming year. We define “high quality” as bonds rated “A” or better. In addition, we prefer to keep to maturities of 15 years or less. Specific points of value include A-rated general-obligation bonds, which trade at spreads that are more than double the long-term average of essential-service revenue bonds. We believe there is also opportunity in prerefunded bonds, which are generally backed by an irrevocable escrow of US government bonds and have been trading at relative-value levels well in excess of the historical average. Bonds

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

with above-market coupons are also favored for income maximization and their defensive qualities. Our benchmark is the Barclays Capital AMT-Free Intermediate Continuous Municipal Index. WATER. Water may be the most important commodity story of the 21st century as declining supply and rising demand combine to create the “perfect storm.” Current global water-usage levels are unsustainable. While the scarcity of freshwater is most acute in Africa and western Asia, scarcity also has become an economic constraint in major economies such as China, India and Indonesia, as well as in the commercial centers of Australia and the western US. Indeed, urbanization may cause the demand for water to increase five-fold beyond the essential water requirement needed for personal hygiene, cooking and cleaning. Moreover, this does not include water used in power generation or other industrial activities that typically accompany urbanization. Finally, climate change is shrinking the available supply.

january 2012 | 3

market commentary / global investment committee

In the face of progressively growing demand for water, companies are investing in ways to increase water availability (see Chart 2). Our benchmark is the ISE Water Index. MANAGED FUTURES. Managed futures— funds and accounts that can take both long and short positions in futures contracts and options on futures contracts in the global commodity, interest rate, equity and currency markets—generally have low correlations of returns with stocks, bonds and other alternative asset classes, including hedge funds (see Table 3, page 5). These diversification benefits have the potential to lower the standard deviation of returns and improve the risk-reward profile of investment portfolios. What’s more, managed futures have historically performed well during adverse equity market conditions. Our benchmark is the CASAM CISDM CTA Equal-Weighted Index.

Chart 2: Spending Growth in the Global Water Industry

MASTER LIMITED PARTNERSHIPS. Master limited partnerships (MLPs)—limited partnerships that trade on a securities exchange—offer the tax benefits of the limited-partnership structure and the liquidity of publicly traded securities. MLPs are concentrated in natural-resource industries such as oil, natural gas and minerals extraction, and they are attractive to yield hunters for their usually robust quarterly dividend payouts. That yield has helped to lift recent years’ total returns on MLPs well above the total returns on the S&P 500 (see Chart 3, page 5). As with real estate investment trusts, MLPs have a special status in the US tax code: They avoid state and federal corporate income taxes and must generate and pay out 90% of their income from producing, transporting and/or processing natural resources. Our benchmark for this investment is the Alerian MLP Index.

The global water industry is expected to undergo substantial transformation in the near future. Businesses will need to make further investments in water technology, and utilities will need to devote more money to water infrastructure.

Forecast Compound Annual Growth Rate, 2010 to 2016 10% 8 6 4 2 0

6.5%

7.8%

Capital Expenditures Water- and Wastewateron Water Infrastructure Treatment Equipment Sales to Industrial Water Users

Source: Global Water Intelligence as of March 2010

Table 2: Here are our best ideas for 2012, given our outlook for a challenging year ahead: Idea (benchmark)

1

US Large Cap Growth (Russell 1000 Growth Index)

2

Dividend Aristocrats (S&P 500 Dividend Aristocrats Index)

3

Global Gorillas (S&P Global 100 Index)

4

Emerging Markets Equities (MSCI Emerging Markets Index)

5

Investment Grade Credit (Barclays Capital US Aggregate Corporate Investment Grade Index)

6

High Quality Municipal bonds (Barclays Capital AMT-Free Intermediate Continuous Municipal Index)

7

Short-Duration Bonds (Barclays Capital Global Treasurys 1 to 3 years Index)

8

Water (ISE Water Index)

9

Managed Futures (CASAM CISDM CTA EqualWeighted Index)

9.4%

8.6%

Total Capital Expenditures on Desalination

Total Capital Expenditures for Water Reuse

10

Master Limited Partnerships (Alerian MLP Index)

Source: MSSB Investment Strategy

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

market commentary / global investment committee

Table 3: Asset Class Correlation Matrix (1990 to 2010)

To improve diversification, investors seek asset classes with little or no correlation to the asset classes they already hold. For instance, managed futures have a very low correlation or even a slight negative correlation with most asset classes. That makes managed futures potential diversifiers for multi-asset class portfolios.

US$ US$ High Non-US Investment- Yield Bonds (US$ US LargeCash Grade Bonds Bonds hedged) Cap Stocks

DevelopedCountry Emerging Commodities Commodities Non-US Market Managed Hedge (Dow Jones(S&P Stocks Stocks Futures Funds UBS Index) GSCI Index)

1.00

0.08

-0.07

0.13

0.06

-0.06

-0.09

0.05

0.15

0.02

0.06

0.08

1.00

0.24

0.67

0.15

0.11

0.01

0.22

0.09

0.04

0.00

-0.07

0.24

1.00

0.05

0.60

0.54

0.59

-0.14

0.46

0.29

0.14

0.13

0.67

0.05

1.00

0.07

0.04

-0.04

0.19

0.03

-0.11

-0.17

0.06

0.15

0.60

0.07

1.00

0.73

0.69

-0.13

0.49

0.29

0.14

-0.06

0.11

0.54

0.04

0.73

1.00

0.73

-0.05

0.52

0.44

0.24

-0.09

0.01

0.59

-0.04

0.69

0.73

1.00

-0.08

0.65

0.39

0.22

Managed Futures

0.05

0.22

-0.14

0.19

-0.13

-0.05

-0.08

1.00

0.21

0.16

0.14

Hedge Funds

0.15

0.09

0.46

0.03

0.49

0.52

0.65

0.21

1.00

0.38

0.31

0.02

0.04

0.29

-0.11

0.29

0.44

0.39

0.16

0.38

1.00

0.90

0.06

0.00

0.14

-0.17

0.14

0.24

0.22

0.14

0.31

0.90

1.00

Cash US$ InvestmentGrade Bonds US$ High Yield Bonds Non-US Bonds (US$ hedged) US Large-Cap Stocks DevelopedCountry Non-US Stocks Emerging Market Stocks

Commodities (Dow JonesUBS Index) Commodities (S&P GSCI Index)

Source: MSSB Investment Strategy, Citi Investment Research & Analysis, Bloomberg, Barclays, Hedge Fund Research as of Dec. 31, 2010

Chart 3: In Recent Years, MLPs Have Beat the S&P 500 1,300 1,100 900 700 500 300 100 -100

Master limited partnerships (MLPs) offer limited-partnership tax benefits and the liquidity of publicly traded securities, as well as usually robust quarterly dividend payouts. That yield has helped to lift the total return on MLPs well above the total return on the S&P 500 since 1996.

Alerian MLP Index Total Return S&P 500 Index Total Return

Jan. 1, 1996 = 100

1995

1997

1999

2001

2003

2005

2007

2009

2011

Source: Thomson Financial, FactSet as of Dec. 30, 2011

1,300 1,100 900 700 500 300 100

Alerian MLP Total Return Index S&P 500 Total Return Index

Jan. 1, 1996 = 100

Please refer to important information, disclosures and qualifications at the end of this material. 1995

1997

1999

2001

2003

2005

2007

2009

2011

january 2012 | 5

market commentary / global investment committee

Index Definitions MSCI ALL COUNTRY WORLD INDEX This is a free-float-adjusted market-capitalization index that is designed to measure equity-market performance in the developed and emerging markets. barclays capital global aggregate bond indexThis index measures a wide spectrum of global governments, government-related agencies and corporate and securitized fixed income investments. MSCI EMERGING MARKETS INDEX This is a free-float-adjusted, market-capitalization index designed to measure equity market performance in the global emerging markets. MORGAN STANLEY FOREIGN CURRENCY EMERGING MARKETS INDEX This index measures the change in value of a basket of emerging market currencies versus the US dollar. S&P GLOBAL 100 INDEX This market-capitalization-weighted index includes 100 large-cap companies whose businesses are global in nature and that derive a substantial portion of their operating income, assets and employees from multiple countries.

6 | january 2012

msci australia index This index is a freefloat-adjusted marketcapitalization index that is designed to measure equity market performance in Australia. msci canada index This index is a freefloat-adjusted marketcapitalization index that is designed to measure equity market performance in Canada. MSCI NORWAY INDEX This index is a freefloat-adjusted marketcapitalization index that is designed to measure equity market performance in Norway. DOW JONES-UBS COMMODITY INDEX This index comprises futures contracts on 19 physical commodities. These include energy, industrial metals, precious metals and agricultural commodities. FTSE EPRA/NAREIT GLOBAL REAL ESTATE INDEX The index has diverse representation of publicly traded equity REITs and listed property companies in global markets. Stocks in the index are free-floatweighted to ensure that only the investable equities are included.

BARCLAYS CAPITAL WORLD GOVERNMENT INFLATION-LINKED INDEX The index measures the performance of the inflation-protected bond segment of the global bond market, including sovereign and quasisovereign issues. BARCLAYS CAPITAL HIGH YIELD INDEX This index provides a broad-based measure of the global high yield fixed income markets. ISE WATER INDEX The index comprises securities that derive a substantial portion of their revenues from the potable water and wastewater industry. The index uses a modified marketcapitalization-weighted methodology to create a more uniform weight distribution. WILDERHILL NEW ENERGY GLOBAL INDEX This index comprises companies worldwide that have innovative technologies and services that focus on the generation and use of cleaner energy, conservation and efficiency as well as advancing renewable energy generally. russell 1000 growth index This index measures the performance of the Russell 1000 companies with higher priceto-book ratios and higher forecasted growth rates. RUSSELL 1000 VALUE INDEX This index measures the performance of the Russell 1000 companies with lower priceto-book ratios and lower forecasted growth rates.

S&P 500 INDEX This capitalization-weighted index includes a representative sample of 500 leading companies in leading industries of the US economy.

$500,000 under management and at least a 12-month track record. The index, which goes back to 1980, is calculated using net performance and net asset value.

S&P 500 DIVIDEND ARISTOCRATS INDEX This equal-weighted index measures the performance of large-cap, blue-chip companies within the S&P 500 that have followed a policy of increasing dividends every year for at least 25 consecutive years.

ALERIAN MLP INDEX The Alerian MLP Index is a float-adjusted, capitalization-weighted index of the 50 most prominent energy master limited partnerships.

BARCLAYS CAPITAL US AGGREGATE COPORATE INVESTMENT GRADE INDEX This index represents securities that are investment grade, SECregistered, taxable and dollar denominated. BARCLAYS CAPITAL GLOBAL TREASURY 1–3 YEARS INDEX The Barclays Capital Global Treasury 1-3 years Index tracks the fixed-rate local currency government debt of investment grade countries. BARCLAYS CAPITAL AMT-FREE INTERMEDIATE CONTINUOUS MUNICIPAL INDEX This is a marketvalue-weighted index designed to replicate the price movements of medium-duration bonds with a nominal maturity of six to 17 years. CASAM/CISDM CTA EQUAL WEIGHTED INDEX This index reflects the average performance of commodity trading advisors (CTAs) reporting to the CISDM Hedge Fund/ CTA Database. In order to be included in the equally weighted index universe, a CTA must have at least

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

market commentary / global investment committee

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. Please refer to important information, disclosures and qualifications at the end of this material. 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 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. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Smith Barney is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material. Morgan Stanley Smith Barney and its affiliates do not render advice on tax and tax accounting matters to clients. This material was not intended or written to be used, and it cannot be used or relied upon by any recipient, for any purpose, including the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Each client should consult his/her personal tax and/or legal advisor to learn about any potential tax or other implications that may result from acting on a particular recommendation.

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

january 2012 | 7

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. 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. Master Limited Partnerships (MLPs) are limited partnerships or limited liability companies that are taxed as partnerships and whose interests (limited partnership units or limited liability company units) are traded on securities exchanges like shares of common stock. Currently, most MLPs operate in the energy, natural resources or real estate sectors. Investments in MLP interests are subject to the risks generally applicable to companies in the energy and natural resources sectors, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Alternative investments which may be referenced in this report, including private equity funds, real estate funds, hedge funds, managed futures funds, and funds of hedge funds, private equity, and managed futures funds, are speculative and entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/ or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds and risks associated with the operations, personnel and processes of the advisor. Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention. 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. Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio. Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax (AMT). Typically, state tax-exemption applies if securities are issued within one’s state of residence and, if applicable, local tax-exemption applies if securities are issued within one’s city of residence. Treasury Inflation Protection Securities’ (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation by tracking the consumer price index (CPI). While the real rate of return is guaranteed, TIPS tend to offer a low return. Because the return of TIPS is linked to inflation, TIPS may significantly underperform versus conventional U.S. Treasuries in times of low inflation. Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment. Investing in smaller companies involves greater risks not associated with investing in more established companies, such as business risk, significant stock price fluctuations and illiquidity. Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected. Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations. 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. They are shown for illustrative purposes only and do not represent the performance of any specific investment. The indices selected by Morgan Stanley Smith Barney to measure performance are representative of broad asset classes. Morgan Stanley Smith Barney retains the right to change representative indices at any time. REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited diversification and sensitivity to economic factors such as interest rate changes and market recessions. Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom. Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, sale, exercise of rights or performance of obligations under any securities/instruments transaction. Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. 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morgan stanley smith barney | january 2012

GWM6972493 6972493 MSSB 01/12