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Investment grade corporate bonds Preference: overweight Current global spread (24 Oct): 150bps (last month: 173bps) UBS View Spread target (6-month): 140bps ¢ Given the recent rally in investment grade (IG) bonds, spreads have approached fair levels, in our view and are likely to trade more or less sideways in the coming 6 months. Still, IG bonds will likely continue to outperform government bonds, offering low volatility and stable income. ¢ We lower our spread target from 170bps to 140bps due to the improved global macro and risk environment after recent central bank action and the pickup in economic data. IG bonds remain supported by our outlook for sluggish but positive global growth, ongoing investor appetite for income- generating assets, and expected negative net issuance. ¢ Non-financial corporates: While total yields are at record lows, the pickup over government bonds and money market rates is still attractive. Aggressive re-leveraging by companies looks unlikely. ¢ Financial corporates: Due to regulatory challenges, spreads are expected to remain above past averages. US banks are in a more favorable position than their European peers as they are better capitalized and earnings have been strong recently. US financial spreads are thus likely to tighten further. 4 Positive scenario Spread target (6-month): 130bps ¢ Global growth accelerates more forcefully than expected. This could compress spreads closer to pre-crisis levels. Soreads for Financials are likely to remain elevated due to regulatory challenges. However, in this case, rising benchmark yields would likely lead to slightly negative IG returns over six months. & Negative scenario Spread target (6-month): 380bps ¢ Main risks include a sharp slowdown of the US economy (e.g. the "fiscal cliff"). Also, risks in the Eurozone persist (e.g. Greek exit, Spain/Italy getting cut off from private funding). Still, we would be unlikely to see spread levels reached in 2009, given companies’ superior balance sheet positions. European financial issuers would be most at risk. Note: Scenarios refer to global economic scenarios (see slide 7) What we're watching Why it matters Core market yields Developed market sovereign yields are only expected to increase gradually. A sudden rise and high volatility would hurt IG credit. Key dates: 8 Nov, ECB rate decision; 11 Dec, US Fed rate decision Corporate fundamentals Robust corporate earnings and low leverage on corporate balance sheets should help prevent defaults. Key dates: US "earnings season" (ongoing) New issuance As companies continue to deleverage, net negative supply on the IG market should support higher prices. 2 UBS Recommendations Tactical (6 months) e We keep an overweight in IG corporate over government bonds. e In Europe, internationally diversified companies from non-financial sectors offer a low but stable income stream for conservative investors. e Financials in the US are in a better position than their European peers. e We recommend bonds from the lower IG rating segments (BBB and A) over higher- rated issuers. Strategic (1 to 2 years) e We prefer corporate over sovereign assets given how much more robust companies are compared to the structural weakness of public finance in many countries. Yield spreads 700 bps 600 500 400 300 200 100 0 2005 2006 2007 2008 2009 2010 2011 2012 — EUR Investment Grade —USD Investment Grade Source: Bloomberg, UBS, as of 16 Oct 2012 Note: Past performance is not an indication of future returns. For further information please contact ClO’s asset class specialist Philipp Schdttler, philipp.schoettler@ubs.com Please see important disclaimer and disclosures at the end of the document. HOUSE_OVERSIGHT_025273