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Bonds overview Government bonds - Key points ¢ Government bond yields of major developed markets started to rise from their historical lows ahead of Greek elections, in particular with hopes of more Eurozone integration (e.g. Eurobonds or a European bank deposit guarantee). The new Greek government has at least eased concerns of an imminent and disorderly Greek exit helping yields in their short term rise. However, further central bank easing, including the extension of Operation Twist (OT) until end of 2012 by the Fed limited the further upside potential in yields over the coming months. ° Our expectations for bond yields over the coming 6 months remain a marginal rise. Despite recent setbacks in global growth, the world economy remains in expansion mode. However, OT will keep longer yields low for longer. Also short-term downside risks to bond yields cannot be excluded; Spain has returned to the spotlight, and challenges in Italy's adjustment programs remain. Given current division among European leaders, the mutualization of debt is unlikely to be resolved soon. ¢ On a relative basis, we prefer German and Swiss bonds, over those in the US and UK, where bond yields could rise faster due to a sounder economic outlook. In particularly in the US, the cyclical recovery looks comparatively more robust. ¢ Declining growth momentum, extension of Operation Twist by the Fed and a rising likelihood of a rate cut by the ECB, are likely to keep yields on extraordinary low levels, for the time being. Thus we suggest a neutral duration position at this stage. Corporate and emerging market bonds - Key points ¢ We maintain our preference for corporate credit (both investment grade and high yield) as well as emerging market bonds, keeping overweight positions in all three segments. ¢ Investment grade (IG) corporate bonds showed remarkable resilience in the latest downturn. The asset class is likely to outperform government bonds in the coming six months, with higher liquidity and lower volatility than HY bonds. We see the highest return potential in the lower-rated IG segment (BBB and A). e US corporate bonds of lower credit quality (high yield, HY) remain fundamentally supported by solid balance sheets and a benign US growth outlook. Given the low risk of default losses, valuations are attractive at an effective yield of 7.5%. For US HY, we expect high single-digit total returns in the next six months. US senior loans are an attractive alternative to traditional fixed income assets. e Emerging market bonds should continue to benefit from better fundamentals than those of developed markets over the medium term. Valuations remain attractive, and the potential for spreads to trend lower should more than offset the gradual increase in US Treasury yields in the quarters ahead. We continue to prefer increasing exposure to corporate bonds while keeping existing investments in sovereign bonds. 36 UBS Preferences (6 months) short duration neutral USD EUR (DE) GBP JPY CHF CAD AUD Bnew old underweight neutral Bonds total long duration overweight Government bonds Investment grade corporate bonds High yield bonds Emerging market bonds Bnew Source: UBS CIO, as of June 19% 2012 For further information please contact CIO's asset class specialist Achim Peijan, achim.peijan@ubs.com and CIO's asset class specialist Daniela Steinbrink Mattei, old 23 daniela.steinbrinkmattei@ubs.com Please see important disclaimer and disclosures at the end of the document. HOUSE_OVERSIGHT_024158