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Hedge funds UBS View Prefer Relative-value and Event-driven ° We expect hedge funds (HF) to offer positive asymmetric return characteristics due to active risk management and stop-loss strategies. On the active risk side of the equation, we have seen lower gross exposure and net-market exposure within the overall hedge funds group, with traders being cautiously positioned. With systemic risk at bay, we favor relative-value (RV ) and event-driven (ED) strategies. ¢ The inherent hedging in relative value is appealing. Credit relative-value managers should perform well in this environment of higher fixed-income volatility and increasing pricing anomalies created by central bank interventions and limited competition. ¢ While ED managers share some of the performance drivers, idiosyncratic bets reduce the correlation to markets. The real reason to own this strategy, however, is the potential for outsized returns in distressed, high-yield, and other credit investments as the Eurozone crisis plays out. A Positive scenario Prefer Equity long-short e Reduced uncertainty (e.g. resolution in Europe) lowers equities’ correlation and volatility. This helps bottom-up fundamental analysis and equity long/short managers the mast. Also, CEOs will likely make more corporate transactions that can be monetized by event-driven managers, and a clearer macroeconomic environment with more persistent trends would support CTA managers. ‘Negative scenario Prefer Trading (Global Macro + CTA) ° So far this year, the market has remained plagued by short-term reversals, due to central banks’ intervention and stimulus effects, an obstacle for trend-following managers. Still, if the European deleveraging (or fiscal cliff, China hard landing) is unmanaged, this could threaten risky assets. Trading can do well if such a scenario unfolds. Note: Scenarios refer to global economic scenarios (see slide 7). What we're Why it matters watching Global equity direction/ economic cycle The outlook for global equities is an important HF performance driver. The economic cycle impacts the strategies differently. Correlation Correlation is an important performance/alpha driver for equity long/short, the largest HF strategy by assets under management. Leverage Gross and net leverage are key to monitoring risk. Volatility The direction influences certain HF strategies (e.g. convertible arbitrage). Liquidity Important in particular for large, less nimble HFs, it enables them to enter and exit their strategies. Regulation Volcker rule, USCITS III/IV 2 UBS Recommendations Strategic (1 to 2 years) Recommendation: Active risk management is instrumental for capital preservation during adverse market conditions. At the moment, we therefore favor relative-value and event-driven strategies, since they are less correlated to equity markets and other risky assets than trading. Value proposition: Hedge funds should achieve robust performance over an extended horizon, while displaying limited volatility vis-a-vis equities and other risky assets. Hedge funds try to minimize downside losses in adverse market conditions (e.g. active risk management), which plays a crucial role in wealth appreciation. Similarly, hedge fund managers attempt to capture most of the upside of risky assets owning to valid value preposition. Performance, year-to-date Relative value Equity hedge Hedge Funds -2.0% -15% -1.0% 0.5% 0.0% 05% 1.0% 15% 20% 25% 30% 35% 4.0% 4.5% 5.0% 5.5% Source: HFRI, UBS, as of 31 Sep 2012 Note: Past performance is not an indication of future returns. For further information please contact ClO's asset class specialist Cesare Valeggia, cesare.valeggia@ubs.com Please see important disclaimer and disclosures at the end of the document. HOUSE_OVERSIGHT_025287