Prudential Fixed Income

1st Quarter Outlook January 2013

PRUDENTIAL FIXED INCOME

Sector Snapshot 2012

January 2013

Sector performance during 2012… Sector (Benchmark) Sector

2012 Index Returns Returns (%)

Comments Comments

US Investment Grade Corporate Bonds Barclays Capital US Corporate Investment Grade Index

9.82

Impressive performance, led by banks and financials, was supported by solid fundamentals and strong demand.

European Investment Grade Corporate Bonds iBoxx Euro Corporate Index (Unhedged in Euros)

13.57

Performance was driven by supportive technicals which outweighed Europe’s negative fundamental backdrop.

US High Yield Merrill Lynch US High Yield Master II Constrained Index

15.55

Solid, double-digit returns as investors sought the higher yields and attractive valuations of non-investment grade bonds in a low default environment.

European High Yield Merrill Lynch Euro Currency High Yield ex-Financials – 2% constrained (Hedged to USD)

25.53

Surprisingly strong returns despite recessionary concerns.

US Senior Secured Loans Credit Suisse Leveraged Loan Index

9.43

Solid returns supported by increasing CLO participation.

European Senior Secured Loans Credit Suisse Western European Leveraged Loan Index (Hedgedto USD)

10.80

Substantial returns during a ‘quiet’ year with little new issuance and ongoing refinancing concerns.

Emerging Markets US-Dollar Denominated Sovereign Debt JP Morgan Emerging Markets Bond Index Global Diversified

17.44

Among the best performing asset classes in 2012, surpassing most developed market bond returns and matching returns on EM equities.

Emerging Markets Local Debt JP Morgan Government Bond Index-Emerging Markets Global Diversified (Unhedged in USD)

16.76

Currency appreciation and declining local rates boosted performance.

Emerging Markets Corporate Bonds JP Morgan Corporate Emerging Markets Bond Composite Index

15.01

Returns in this asset class were driven by attractive yields and valuations, despite rising supply.

Municipal Bonds Barclays Capital Municipal Bond Index

6.78

Strong technicals drove another year of solid tax-exempt municipal bond performance.

US Treasury Bonds Barclays Capital US Treasury Bond Index

1.99

Not surprisingly, US Treasuries underperformed spread sectors as yields remained range bound, with intermediate yields declining only slightly for the year.

Mortgage Backed Securities Barclays Capital US MBS - Agency Fixed Rate Index

2.59

Outperformed Treasuries despite record low consumer mortgage rates, as the Fed launched another round of agency mortgage bond purchases.

Commercial Mortgage-Backed Securities Barclays Capital CMBS: ERISA Eligible Index

9.66

Limited supply and improvement in the commercial real estate environment led to strong returns.

US Aggregate Bond Index Barclays Capital US Aggregate Bond Index

4.22

Strong performance in the US Corporate sector drove returns.

Other strong performers in 2012 were non-agency residential mortgage backed securities due to improved views in housing.

See Notice Page for important disclosures.

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Our Global View

January 2013

Still Not Too Late For Bonds… Although the broad fixed income indices paint a pretty bland picture of 2012―the Barclays Capital Aggregate Bond Index returned 4.2%—it was a bright year for the spread sectors. Investment grade corporate and CMBS returns were both just under 10%, while high yield bond and emerging markets debt returns pushed well into the teens. The combination of low growth and inflation, combined with high demand from pension funds, retail investors, and of course, the Federal Reserve, was a formula for low U.S. Treasury rates, and narrowing spreads across fixed income sectors. Although tensions in Europe flared during the year, they declined over most of the second half, as is detailed in the column to the right (OMTs Continue to Buoy Confidence). This not only allowed yields on peripheral debt to decline, but also created a tailwind for spread product globally as contagion fears abated. While the media focused in the final weeks of the year primarily on the so-called 'fiscal cliff,' markets largely shrugged it off as investors appeared to correctly assume that, in the final analysis, the cliff would be smoothed to a more manageable slope.

So What’s Different This Year? There have been signs of improvement in the U.S. economy―especially the housing market—which, all else equal, would likely translate into higher interest rates. But all is hardly equal with fiscal consolidation accelerating in the world’s largest two economic zones―the U.S. and Europe. In addition to the modest tax increases coming on stream in the U.S. this year, spending cuts are likely to come in fairly short order as part of the imminent battle, and inevitable subsequent bargain, to lift the debt ceiling. In the case of Europe, deficit reduction will probably continue to bite in 2013. This is a plus for the bond market as lower government spending and higher taxes may not only curtail growth but also reduce debt issuance. Japan could also come to the fore in 2013. In the wake of the recent political sea change, monetary, and quite possibly fiscal, stimulus appear likely to be significantly increased.

2012 May Not Repeat Itself But It Sure Does Rhyme... Similar to last year, we believe demand for fixed income is likely to remain strong. Retail investors continue to flock to fixed income, seeking the income of bonds with less volatility than stocks. Pension funds, for their part, have continued to implement liability driven investment, or LDI, strategies, increasing allocations to fixed income, and extending duration. And last but not least, there’s the Fed, which enters 2013 buying a potent mix of U.S. Treasuries and mortgages at a rate of roughly $85 billion a month. What’s The Bottom Line? In a world where demand for bonds remains strong, but developed country deleveraging tends to both constrain growth and reduce supply, we believe the overarching theme

in fixed income will continue to be the search for yield. Long Treasury rates are likely to remain relatively low and range bound, while spread sectors will offer incremental yield and the potential for additional return as spreads continue to narrow. Meanwhile, the Fed’s aggressively accommodative posture is likely to exert modest downward pressure on the dollar, boosting the returns of foreign developed, and developing, bond markets and currencies.

OMTs Continue To Buoy Confidence The confidence effects from the Outright Monetary Transactions (OMTs), announced by the European Central Bank (ECB) in September, continued to buoy peripheral assets throughout the final quarter of 2012. This framework envisages secondary bond market purchases by the ECB of sovereigns undergoing a European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) adjustment program. The OMT program effectively establishes the ECB as a ‘lender of last resort’ for select sovereigns. Nevertheless, the success of this policy framework will only be as sustainable as the policies pursued under the associated adjustment program. Despite several upward revisions, Spain is likely to have overshot its fiscal deficit target again in 2012. The European Commission estimates the deficit will reach 8% of GDP, well above the 6.3% of GDP target and only marginally below the 2011 outcome. Despite these impending slippages, Spain has been receiving numerous high-level reassurances that no additional fiscal belt tightening is needed, at least in 2013, to secure a sovereign bailout. Although markets seem poised to greet an eventual bailout with applause, comprehensive and ambitious policies are vital to ensure debt sustainability over the longterm. Besides a possible bailout of Spain, the upcoming parliamentary elections in Italy could be another key event in the first quarter. The political landscape remains fluid and outcomes are difficult to gauge. While far from complete, fiscal adjustment reached an advanced stage in Italy in 2012. Hopefully, this will mitigate political risks.

The Bottom Line—Headline driven volatility notwithstanding, Treasury yields are likely to remain relatively low and range bound, while spread product remains biased to outperform. Global bond markets—both developed and emerging—should outperform as investors incrementally move abroad in search of return.

Sources of data on this page: Barclays Capital as of 12.31.12, and The Federal Reserve.

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Q1 2013 Sector Outlook

U.S. and European Corporate Bonds Corporate bonds delivered impressive results in Q4 and 2012. For the full year, U.S. corporate bonds returned +9.82% and European corporate bonds +13.57%. U.S. corporates posted +734 bps in excess return over U.S. Treasuries as spreads narrowed 93 bps during the 12 months. European corporate bond spreads narrowed 156 bps to 134 bps over swaps. Key factors driving the corporate bond rally last year remain in place as we enter 2013—historically attractive spread levels and accommodative central bank policies designed to keep interest rates low. Investors searching for yield turned to the corporate bond markets last year, and we believe the trend is likely to continue as long as rates remain low and credit fundamentals fairly healthy. Record level new issue activity in the U.S. was generally met with equally strong demand with little, and sometimes negative, concessions as the year came to a close. Although still quite strong, the fundamentals for many U.S. industrial companies appear to have peaked for this stage of the credit cycle. Cash flow and debt coverage remain solid, but leverage has begun to creep higher as flatter revenue and earnings are pushing more industrial corporate managers to adopt shareholder-friendly activities, such as share buybacks and special dividends. Conversely, many large financial institutions, particularly U.S. money center banks, have continued to build capital levels, reduce leverage, and improve their credit profiles. As a result, the finance sector outperformed all other corporate industries in Q4 and full-year 2012, and is expected to perform well in the coming year. In Europe, corporate bond performance in Q4 was driven primarily by supportive technicals, which outweighed the region’s negative fundamental backdrop. During the quarter, higher beta, BBB-rated bonds, UK banks, and issuers in peripheral countries were top performers. New issuance was in full flow in Q4 with demand far outweighing supply, and concessions getting smaller. We still favor financials over industrials given their wider spread levels and improving credit metrics. We are finding modestly attractive value across the industrial sector, but are cautious on select commodity and steel companies that may be pressured by slower global growth, as well as companies initiating share buyback programs and acquisitions, which may weaken their credit profiles. We are overweighting BBBrated issues, especially those with shorter maturities, and look to increase exposure to long-term corporates, which should benefit from growing demand from pension accounts. We still favor Build America Bonds, particularly index-eligible issues that are supported by strong demand and lack of supply.

In global portfolios, we still prefer U.S. over European issues, especially given the recent outperformance of Euro bonds and the lingering downside risks given the region’s weak economic prospects. Key risks to our overall positive outlook include the deepening recession in Europe, slower global economic growth, event risk in the industrial sector, and uncertainty regarding the outcome of the U.S. budget debates.

OUTLOOK: Positive given historically healthy fundamentals, attractive spreads, and strong demand. Still favor select U.S. money center banks.

Leveraged Finance High yield bonds delivered double-digit returns in 2012 with U.S. high yield bonds up +15.55% and European high yield issues a surprising +25.53%. The underlying theme boosting performance was, in our view, investors’ continuous thirst for yield in a record-low interest rate environment. In the U.S., investors were met with relatively stable credit fundamentals. The European high yield market, which is comprised primarily of B and BB-rated issuers (2/3 are BB-rated), benefited primarily from strong investor demand, despite ongoing recessionary concerns. In Q4, nearly all high yield sectors posted positive returns with metals and mining, telecommunications, and financial issuers leading the market higher. For the full year, building and construction, driven by Chinese property companies, and financials, particularly foreign banks, were the top performers. Both the U.S and European high yield markets posted record levels of new issuance. In the U.S., a majority of the new supply was used to refinance existing debt, leaving net supply manageable. In Europe, the size of the high yield market expanded nearly 50%, as issuers moved from the senior secured loan market to the high yield market and a number of downgraded issues entered the universe. Both the U.S. and European senior secured loan markets posted solid returns, albeit less than high yield bonds. U.S. loans registered +9.43% in return, supported in part by a pickup in CLO issuance, while European loans rose +10.80%. Despite the strong rally this year, we believe high yield bonds still offer good value in the current environment. Although the average yield on the broad U.S. high yield market closed the year at a new all-time low of 6.2%, the asset class still offers 548 bps in spread over similar-maturity U.S. Treasuries, an attractive level relative to periods with similar, low default rates.

Sources of data on this page: U.S. and global corporate bonds, Barclays Capital; European corporate bonds, Markit iBoxx; High yield returns, Merrill Lynch; High yield spreads, JP Morgan; Bank loan returns, Credit Suisse.

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Q1 2013 Sector Outlook

With regard to fundamentals, we do not expect much balance sheet or margin improvement in U.S. companies after several years of steady progress, while weaker global growth may begin to weigh down certain sectors, especially in Europe. Nevertheless, we look for U.S. defaults to remain lower than the historical average over the next few years. Conversely, in Europe, we believe loan defaults could rise to the 4% to 5% range. In addition, quality trends for some new issues have weakened, and shareholder-friendly leveraging transactions are on the rise. In this environment, we continue to focus on issuers that we believe are better positioned to withstand a protracted slowdown in the global economy. We prefer issuers in defensive sectors, such as gaming, cable, and healthcare, but are also finding value in select cyclical credits whose yield levels are commensurate with underlying risks. Individual issue selection is key, especially in the primary market where underwriting standards have begun to weaken. We remain wary of issuers prone to shareholder-friendly leveraging transactions. We also continue to find value in shortermaturity issues, especially those that may benefit from an early tender.

OUTLOOK: Positive longer term. Valuations and technicals are supportive but we expect short-term volatility to remain high due to earnings uncertainty and macroeconomic concerns.

Emerging Markets Debt The Emerging Markets Debt (EMD) asset class delivered strong performance in 2012, surpassing developed market bond returns and matching the return of emerging markets equities. Hard currency sovereign debt led Q4 and 2012 with returns of +2.8% and +17.44%, respectively. For the 12 months, EM corporate bonds returned +15.01%, EM local currency bonds (hedged) +8.94%, and EM FX +7.45%. The modest return of local rates reflects market expectations for fewer interest rate cuts going forward, while EM FX was volatile most of the year due to broader global concerns. Key themes supporting EMD in 2013 include: Positive Growth Prospects: Economic growth in emerging countries remains well above that of developed countries. Current estimates peg EM economic growth at close to 5.5% in 2013. Stronger growth, improving balance of payments positions, and stricter fiscal policies have contributed to the steady rise in EM sovereign credit ratings, a sharp contrast to a decidedly lower quality trend in developed countries. Today, more than 60% of EM countries are rated investment grade quality, up from 37% just ten years ago.

Sources of data on this page: JP Morgan 2013 Emerging Market Debt Outlook.

In 2013, identifying those countries with positive trajectories that are more resilient to developed market spillover, geopolitical tensions, and country specific political risks will be key. Regionally, Asia should benefit from stabilizing growth in China, while select Latin American commodity-exporting countries and Middle East/African countries should continue to offer value. We remain guarded on Eastern Europe given its close ties to the Euro zone. Notably, this should be a supportive environment for EM corporates and quasisovereigns, which currently offer good value relative to sovereigns spreads. Deepening Sponsorship: The steady improvement in EM credit quality, combined with relatively attractive valuations, has attracted a deepening sponsorship. It is estimated that over $80 billion was allocated to dedicated EM fixed income mandates in 2012, with many investors making strategic, long-term investments in the asset class. Investors’ risk appetite and sentiment should play an increasing role in determining whether higher-yielding, lower-rated countries, which dominated in 2012, will continue to outpace betterquality sovereigns in the coming year. New Entrants Expand the Opportunity Set: Thirteen new countries entered the major EMD sovereign bond indices since 2009, with five additions in 2012. These ‘frontier’ countries are generally smaller, mineral-rich, and fastgrowing—like Angola, Zambia, Mongolia, and Bolivia—and can offer tactical opportunities. The EM corporate universe also registered strong growth with issuance surpassing that of sovereign debt. In-depth fundamental research will continue to be essential to screen out those issuers with questionable political and governance risk, and to uncover value opportunities. More Supportive Climate for Local Bonds and EM FX: We believe local bonds are poised to deliver solid returns in 2013 as policymakers focus on supportive growth practices while keeping inflation in check. Many investment grade EM countries have steep yield curves and are likely to converge to developed market rates over time. Medium term, we believe EM FX should offer attractive returns given the prospect for stronger growth, better flows, and higher yields. Near term, FX could exhibit volatility in response to deliberate interventions to stem currency appreciation or in response to central bank rate cuts to counteract slowing growth. We believe the key to profiting from FX and local rates is identifying fundamental value weighed against policy risk and risk sentiment. In EM hard currency sovereign debt, we still favor a barbell approach: shorter-duration, higher-yielding issuers, such as Venezuela, where credit concerns are compensated with very high yields, combined with longer-term securities from investment-grade countries with steep yield curves, such as Mexico, Russia, and South Africa.

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Q1 2013 Sector Outlook

Although the idiosyncratic risk and election calendar for EM countries appears manageable, several risks could develop. Elections in Malaysia (Parliament) and Argentina (Congress) could impact the markets if the opposition parties appear to be gaining, or ultimately win. Also in Argentina, there may be a final ruling regarding the decade-long ‘holdout’ bond recovery case, the results of which are binary. In Venezuela, President Chavez’s health issues could result in a regime change, which may impact fundamentals. In the Ukraine, balance of payments weakness could lead to an FX crisis— currency devaluation, in addition to an IMF program, may be needed to anchor credibility.

OUTLOOK: Positive given strong demand and attractive valuations.

outcome is known, we expect heightened volatility in the municipal marketplace. On a more positive note, the municipal market’s technical picture should improve as the positive effects of January 1st reinvestments support the market. In addition, absent any cap on deductions, demand should rise in response to higher investment income taxes associated with the Affordable Care Act, and higher individual income tax rates in 2013. In addition, state tax revenues continue to improve overall, and many state and local governments have taken steps to control spending and shore up their budgets. Longer term, the ability and willingness of states to address unfunded pensions and other retirement benefits remain a concern.

OUTLOOK: Neutral given uncertainty regarding potential tax-reform.

Municipal Bonds Municipal bonds outperformed U.S. Treasuries on the long end in both Q4 and 2012, delivering another year of strong performance. Investment grade issues returned 6.78% and high yield municipal bonds +18.14%. For the year, the 10year Municipal/Treasury yield ratio ended close to where it began, at 98.6%, while the 30-year Municipal/Treasury yield ratio declined from 123% to 96.5%, reflecting the strong performance of long-term securities. The municipal yield curve flattened, with the spread between 2-year and 30-year securities narrowing 67bps during the 12 months. Taxable municipal bonds, including Build America Bonds (BABs), also delivered strong annual returns of +12.50%, due in part to their scarcity value. Municipal returns in 2012 were driven by a solid technical backdrop with investor demand and reinvestment proceeds often outpacing available supply. Municipal bonds, particularly non-investment grade bonds, offered investors an attractive, higher income alternative in an ultra-low interest rate environment. Annual issuance was robust, totaling $373 billion, although over half this amount reflects municipalities refinancing their debt at lower rates, rather than net new issuance. The market's technical backdrop faltered toward year-end in light of growing uncertainty regarding U.S. budget negotiations and the potential impact on tax-exempt bonds if deductions and exemptions (including municipal income) are capped at 28%. The year-end budget deal did not include a cap on municipal income, but it did include an increase in personal income tax rates to 39.6% from 35% for individuals making more than $400,000. Higher income taxes are generally viewed as a positive for the tax-exempt market. However, we expect tax-exemption to remain in focus as part of any broader tax reform debate in 2013, and until the final

U.S. Governments U.S. Treasury yields rose marginally in Q4 but still closed the year at levels largely in-line with year-end 2011. During the 12 months, the U.S. Treasury yield curve flattened at the front end of the curve, while the back of the curve steepened. Twoyear yields ended relatively flat at 0.25%, 5-year yields declined 11 bps to 0.72%, and 30-year yields rose 6 bps to 2.95%. As we enter 2013, market conditions still point to a low, range-bound interest rate environment. Investors continued to seek the safety of government bonds going into year-end in the event tax increases and spending cuts take effect next year and curb economic growth. In addition, in mid-December the Fed committed to extending its Treasury bond-buying program to support the bond market. The Fed plans to buy approximately $45 billion of U.S. Treasuries per month until the unemployment rate improves (to a 6.5% target), and as long as inflation stays low (under 2.5%). During Q4, swap spreads appeared to reach a bottom in November, then widened marginally from historically tight levels as the LIBOR rate decline abated, and demand for U.S. Treasury collateral picked up. The swap spread curve steepened year-over-year. We are currently neutral on 2-year swap spreads and expect 5- to 30-year spreads to widen marginally given healthy demand for U.S. Treasuries (which may increase further as a result of new central clearing regulations and margin requirements), potentially better funding rates, and lower supply. U.S. government agency bonds outperformed U.S. Treasuries again in Q4, delivering +94 bps excess return for the full year. Agency bonds continued to benefit from low net supply and

Sources of data on this page: Municipal bonds: Barclays Capital; US Governments: Bloomberg and Barclays Capital.

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Q1 2013 Sector Outlook

strong investor demand for high quality bonds. We are currently neutral on agencies relative to U.S. Treasuries.

OUTLOOK: Negative on lower coupon agency mortgages relative to U.S. Treasuries.

OUTLOOK: Underweight U.S. Governments in favor of more attractive spread sectors.

Structured Product Mortgages Agency mortgage-backed securities (MBS) delivered +2.59% in return in 2012, outperforming similar-maturity U.S. Treasuries by +91 bps. Nominal and option-adjusted spread valuations reached their tightest levels of the year in September as the Federal Reserve launched a new MBS purchase program. The Fed announced plans to purchase $40 billion agency MBS per month, in addition to reinvesting principal and interest on its existing MBS and agency debt portfolio, until conditions in the labor market improve. By linking the MBS purchase program to targets in unemployment and inflation, the Fed has now changed its purchase language to be more conditional than time-specific, which creates some uncertainty for MBS investors. Net supply of MBS is expected to remain negative, which may keep spreads firm and investors on the sidelines, as the Fed will remain the most significant buyer. Lower coupon mortgages strongly outperformed higher coupons in the second half of the year given Fed purchases and rising prepayments across the coupon stack. MBS investors reduced higher coupon exposure as consumer mortgage rates remained at record lows and refinancing activity from the Home Affordable Refinance Program (HARP) remained elevated. Although higher coupons have cheapened, prepayment risk remains a concern as the Obama administration begins its second term and housing policy changes may again take shape. Going forward, we expect primary versus secondary mortgage spreads to continue to narrow from the wide levels seen in September. The Fed has drawn attention to this wide spread gap, which may pressure banks to lower consumer mortgage rates, providing another refinancing opportunity for creditworthy borrowers. At this time, we recommend underweighting lower-coupon mortgages versus U.S. Treasuries and, for active multi-sector strategies, underweighting mortgages versus more attractive spread sectors. We favor modestly reducing some higher coupon underweight positions, if appropriate specified pools can be found. We expect prepayment speeds in the middle of the coupon stack to remain elevated, while higher coupon prepayments may be close to peaking according to our proprietary models, unless housing policy changes spur additional refinancing activity.

Non-agency residential mortgage bonds (RMBS) continued their significant rally in Q4, while commercial mortgagebacked security (CMBS) spreads tightened and consumer asset-backed security (ABS) spreads were stable. We are constructive on ‘top of the capital structure’ collateralized loan obligation (CLO) tranches. In the coming quarter, we look for low spread volatility on high-quality ABS and CMBS, while riskier securities, such as non-agency RMBS, should trade directionally with the broader fixed income spread markets, but with a positive skew. CMBS: High-quality CMBS spreads of varying vintages rallied 10 to 50 bps in Q4, but nonetheless continue to offer good value as a high-quality, short duration trade. Certain themes should continue into 2013 including: 1) Strong investor demand for new issues; 2) More relaxed credit underwriting standards for CMBS loans from conservative, post-financial crisis standards; 3) Stabilizing commercial real estate values; and 4) Historically high, but stable, delinquencies in CMBS loans issued in 2006 and 2007. CMBS issuance in 2013 is projected to be about $50 billion, which roughly matches the size of issues expected to roll-off. Fannie Mae and Freddie Mac are projected to originate an additional $50 billion of bonds backed by multi-family properties. Overall, we believe CMBS spreads remain attractive for well-researched bonds (i.e., bonds with sufficient enhancement relative to loan loss assumptions). ABS: Spreads on credit cards and auto ABS were stable in Q4 and are likely to remain so as we enter 2013. Collateral trends (losses and delinquencies) have also been stable. In 2013, we expect consumer credit to move modestly with the direction of the economy. We favor these securities as defensive, lower spread volatility investments. We continue to find value, as a front-end carry investment, in fundamentally strong, off-the-run senior ABS tranches. RMBS: Prices rallied sharply again in Q4, with seasoned subprime bonds up 3% to 5%. Supporting the rally was an improved view on the housing sector, better capital treatment by banks, and net negative supply (about $200 billion annually). Distressed mortgages are the key headwind. About four million mortgages are seriously delinquent nationwide, or about 8% of all mortgages, which has created a shadow inventory of possible homes for sale. In addition, credit remains restricted as about 90% of all mortgages are originated into government programs. Nonetheless, RMBS still trades at positive spreads, even in adverse scenarios. We

Sources of data on this page: Mortgages and Structured Product: Barclays Capital. Source of data for CLOs: Prudential Fixed Income.

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Q1 2013 Sector Outlook

believe well-enhanced bonds offer value for investors who can withstand price volatility for long-term results. CLOs: AAA-rated CLO spreads tightened in both the primary and secondary markets in Q4. Primary (‘CLO 2.0’) spreads compressed about 8 bps in Q4 to L+139 bps, while secondary amortizing CLOs tightened 15 bps to L+120 bps. While spreads have tightened, in our opinion, they continue to offer solid value. The new issue market is particularly compelling as only a small number of investors participate and debtfriendly terms can often be negotiated into the governing documents. In Q4, about $23 billion of CLOs were issued across 43 deals, bringing total annual issuance to nearly $55 billion in 120 CLOs. In Q4, underlying CLO collateral, comprised of corporate senior secured bank loans, continued to benefit from strong credit performance and low default rates. Although default rates may increase slightly this year, we do not believe they will have a material effect on CLO performance, particularly senior tranches, given credit enhancements, pool diversity, and the low amount of troubled loans. Despite a robust new issue calendar in early 2013, we expect continued spread compression due to strong demand by insurance companies, banks and asset managers. More than 40 CLOs are expected to be priced during the first six weeks of the year. Annual issuance is projected at approximately $65 billion.

OUTLOOK: Non-agency RMBS continues to offer value, but can be subject to price volatility, especially in ‘riskoff’ market environments. Constructive on top of the capital structure CLO tranches.

Source of data on this page: Prudential Fixed Income.

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Q1 2013 Sector Outlook

Notice Prudential Fixed Income is a unit of Prudential Investment Management, Inc. (“PIM”), a registered investment adviser and a Prudential Financial company. Prudential, the Prudential logo and the Rock symbol are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. These materials represent the views, opinions and recommendations of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered and to such person’s advisers is unauthorized, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of Prudential Fixed Income is prohibited. Certain information contained herein has been obtained from sources that Prudential Fixed Income believes to be reliable as of the date presented; however, Prudential Fixed Income cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Prudential Fixed Income has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. Past performance is not a guarantee or a reliable indicator of future results. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. Prudential Fixed Income and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of Prudential Fixed Income or its affiliates. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or strategies for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions. Conflicts of Interest: Prudential Fixed Income and its affiliates may have investment advisory or other business relationships with the issuers of securities referenced herein. Prudential Fixed Income and its affiliates, officers, directors and employees may from time to time have long or short positions in and buy or sell securities or financial instruments referenced herein. Prudential Fixed Income affiliates may develop and publish research that is independent of, and different than, the recommendations contained herein. Prudential Fixed Income personnel other than the author(s), such as sales, marketing and trading personnel, may provide oral or written market commentary or ideas to Prudential Fixed Income’s clients or prospects or proprietary investment ideas that differ from the views expressed herein. Additional information regarding actual and potential conflicts of interest is available in Part 2 of PIM’s Form ADV. Performance for each sector is based upon the following indices: US Investment Grade Corporate Bonds: Barclays Capital US Corporate Investment Grade Index European Investment Grade Corporate Bonds: iBoxx Euro Corporate Index High Yield Bonds: Merrill Lynch US High Yield Master II Constrained Index European High Yield Bonds: Merrill Lynch Euro Currency High Yield ex-Financials 2% Constrained (Hedged to USD) US Senior Secured Loans: Credit Suisse Leveraged Loan Index European Senior Secured Loans: Credit Suisse Western European Leveraged Loan Index (Hedged to USD) Emerging Markets USD Sovereign Debt: JP Morgan Emerging Markets Bond Index Global Diversified Emerging Markets Local Debt (Hedged to USD): JP Morgan Government Bond Index-Emerging Markets Global Diversified Composite Hedged USD Emerging Markets Corporate Bonds: JP Morgan Corporate Emerging Markets Bond Global Broad Diversified Index Emerging Markets Currencies: JP Morgan Emerging Local Markets Index Plus Municipal Bonds: Barclays Capital Municipal Bond Indices US Treasury Bonds: Barclays Capital US Treasury Bond Index Mortgage Backed Securities: Barclays Capital US MBS - Agency Fixed Rate Index Commercial Mortgage-Backed Securities: Barclays Capital CMBS: ERISA Eligible Index US Aggregate Bond Index: Barclays Capital US Aggregate Bond Index

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