Global Investment Committee Monthly - Morgan Stanley

global investment committeeaugust meeting summaryTactical Asset Allocation ReasoningGlobal BondsRelative WeightWithin BondsShort Duration Underweight The steep yield curve leads us to seek better value in longer-dated corporate bonds.GovernmentInvestment-Grade CorporatesHigh YieldUnderweightOverweightOverweightYields, which are not far from the historical lows reached during the financial crisis, are more likelyto increase than to decrease. This is our least-favored segment of the bond market.An expanding global economy, solid corporate profit growth and, in the US, above-average yieldspreads versus Treasuries lead us to favor this segment of the bond market.Under the assumption that the economic expansion remains on track, history suggests that theyield spread over Treasuries, which is a bit above its long-term average, is likely to decline.Emerging MarketsOverweightYield spreads versus US Treasuries are somewhat above their declining long-term trend line andinflation should peak before long. In addition, some currency appreciation seems likely.Global EquitiesUSDeveloped Markets ex USEmerging MarketsRelative WeightWithin EquitiesOverweightUnderweightOverweightThe policy mix in the US is likely to result in stronger economic growth relative to most otherdeveloped markets. We favor large-cap stocks at the capitalization level and growth at the stylelevel, based largely on favorable relative-valuation readings.At the regional level, we are market weight to Canada and the Asia Pacific ex Japan region(predominantly Australia) and underweight to Europe and Japan.This is our most-favored asset class on a one-year view; fundamental factors such as economic andearnings growth, government balance sheets and indebtedness remain favorable. Policymakers’efforts to prevent overheating and engineer “soft landings” in these economies may be coming to asuccessful end.Global Alternative/Absolute ReturnInvestmentsREITsCommoditiesRelative WeightWithin AlternativeInvestmentsOverweightOverweightIndustry tailwinds include an expanding global economy, limited new-property supply, banks’increased willingness to lend and an improved market for commercial mortgage-backedsecurities. Above-average dividend increases seem likely, given the combination of a relativelylow payout ratio and improving fundamentals.With global economic output at a record high and with particular strength in the emergingeconomies, the demand for most commodities should remain strong. Supply shortages could leadto price surges.Inflation-Linked Securities Underweight With the peak in inflation expectations likely behind us for this cycle, we see better value elsewhere.3 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryduring the second quarter. By contrast,the latest US auto-assembly schedulespoint toward increased motor-vehicleproduction in this quarter, which couldbe additive for GDP growth.Another important change in theeconomic outlook comes from a dropin energy prices. Crude oil is now tradingalmost $15 per barrel lower thanone month ago, and it is off more than$30 per barrel from the late-April peak.Higher energy prices played a negativerole in consumer spending in the secondquarter, as personal consumptionexpenditures rose a scant 0.1%, the worstperformance since the recession endedtwo years ago. Citi economists look tothe decline in energy prices to help boostpersonal consumption expenditures toa 1.9% reading in the third quarter with3.0% expected in the fourth quarter.The drop in market interest rates,and by extension mortgage rates, is apotential positive, too. The MortgageBankers Association Applications Indexrose 21.7% during the first weekof August—the highest reading in morethan two years (see Chart 6). Withinthis index, refinancings as a percentageof total mortgage applications movedup to 75.6%. As recently as mid April,that percentage was 58.5%. By loweringmonthly mortgage payments for borrowers,refinancings can potentially boostconsumer spending.EMPLOYMENT TAILWINDS? There isno question that the softening in labormarket conditions was a disappointingdevelopment during the early spring. TheChart 6: Lower InterestRates Spur MortgageApplications50%403020100-10-20-30-40Mortgage applications rose by nearly 22%in the last week and, of those, about threequarters were for refinancings. Refinancingsput more money in homeowners’ pockets,potentially enabling a higher level ofconsumer spending.Mortgage Bankers Association Mortgage Applications Index,Weekly Percent ChangeJan ’09 Jul ’09 Jan ’10 Jul ’10 Jan ’11 Jul ’11Source: Bloomberg as of Aug. 5, 2011Chart 7: US PayrollGrowth Is SlowlyRecoveringJob creation was off to a good start earlierthis year, but slipped in the spring, asevidenced by the number of employees onUS nonfarm payrolls. Lately, the payrollnumbers have been climbing.Employees on US Nonfarm Payrolls140 Million138136134132130128126124Shaded areas denote periods of recession.’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11Source: Bloomberg as of July 29, 20119 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summarypace of new job creation fell off considerablyas compared with earlier in the year,begging the question: Did this softeningreflect a lagging effect of the overall decelerationin economic activity, or was ita sign of a more sustainable trend? Whilethe expected pace of economic growthprobably will not produce a robust levelof new hiring, it should be sufficient tomaintain, if not build upon slightly, the117,000 gain in nonfarm payrolls recordedin July. That was noticeably better thanthe May-through-June average of 50,000(see Chart 7, page 9).Looking at the weekly jobless claimsdata, which are a leading economic indicator,it seems plausible that the lacklusterpayroll gains in May and June mayhave been a reflection of the rise in newclaimants from late February throughlate April (see Chart 8). During this time,claims rose by 103,000, but they havesince reversed course. Through the firstweek of August—the latest data available—totalclaims actually fell by 83,000,retracing a good portion of that increase.According to Citi economists, joblessclaims rise sharply during every recession“with no exceptions.” Thus, the latestdownward trend has been a welcomesign and could potentially be signalingthat the late spring’s performance will notbe duplicated in the months to come.Chart 8: Initial JoblessClaims Trend DownwardThe number of new unemploymentclaims has declined of late. If the declinecontinues, it would be a positive sign forthe labor markets.650 Thousand, Four-Week Moving Average625600 US Initial Jobless Claims575550525500475450425400375350Oct ’09 Jan ’10 Apr ’10 Jul ’10 Oct ’10 Jan ’11 Apr ’11Jul’11Source: Bloomberg, US Dept. of Labor as of July 29, 201110 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryTable 3: Earnings Forecasts for the Standard & Poor’s 500, MSCI All Country Worldand MSCI Emerging Markets IndexesS&P 500Consensus of Wall Street AnalystsMorgan Stanley Citi S&P 500 MSCI All Country World MSCI Emerging MarketsOperatingEPSYOYChangeOperatingEPSYOYChangeOperatingEPSYOYChangeOperatingEPSYOYChangeOperatingEPSYOYChange2010 $85.00 39% $85.49 38% $85.28 40% $23.97 45% $86.72 42%2011 $93.00 9% $98.00 15% $99.01 16% $27.42 14% $98.84 14%2012 $98.00 5% $105.00 7% $113.67 15% $31.44 15% $112.60 14%52-Week Forward $107.99 $30.10 $108.13Note: Citi estimates are before write-offs.Source: Citi Investment Research & Analysis, Morgan Stanley Research, Thomson Financial, Datastream as of Aug. 18, 2011INVESTING LARGE. In the US, we favorthe large-cap sector. The forward P/Esfor the Russell Midcap Index and theRussell 2000 Index, representing midcapand small-cap stocks, respectively,relative to that of the Russell Top 200Index, representing mega-cap stocks, arehigh by historical standards. This suggeststhat the largest US stocks are relativelyinexpensive. At the style level, we continueto favor growth stocks over value stocks.Here, too, the primary driver is relativevaluation. By historical standards, valuestocks are expensive relative to growthstocks, especially in the large-cap sector.Chart 9: Global EquitiesTrade at HistoricallyLow Valuation Levels302520151050MSCI All Country World Index 12-MonthForward Price/Earnings RatioGlobal equities appear to be attractivelyvalued based on forward earnings estimates.The price/earnings ratio is about 11 comparedwith a long-term average of 16.1987 1990 1993 1996 1999 2002 2005 2008 2011Source: MSCI, FactSet as of July 29, 2011AverageEmerging Markets May NeedDomestic DemandAlthough the emerging markets (EM)are plugged into the global economy weexpect their economies to remain muchstronger relative to those in the developedmarkets (DM). As such, we believe thatEM domestic demand should be ableto at least partly cushion any period ofreduced external demand.Once again, China’s market will bekey. China’s policy response followingthe 2008 credit crisis was the region’smost aggressive—a $586 billion stimuluspackage to boost domestic demand,from an economy that was one-third thesize of the US at that time. Now, withinflation still at high levels, we expectChina’s policymakers to try to institutemeasured fiscal expansion—includingsocial housing, consumer spending andurbanization projects — to boost domesticgrowth if DM demand slackens. Similarly,we think other EM governments such asSouth Korea, Indonesia, Malaysia andThailand will step up fiscal measuresto support their economies if necessary.FISCAL SUPPORT. Since much of theEM story rests on Asia’s shoulders, itis helpful to understand the particularsensitivity of Asia’s growth to changesin G-10 growth. According to ChetanAhya, Morgan Stanley’s Asia economist,if G-10 growth in 2012 were to fall by onepercentage point, GDP growth in Asiaex Japan would be between 6.4% and6.9%, which is considerably lower thanMorgan Stanley’s 7.8% base-case forecast.Overall, Morgan Stanley economistscontinue to forecast relatively stronggrowth for the EM economies with onlya moderate slowing of activity; their GDPestimates are 6.4% for 2011 and 6.1%for 2012.Inflation remains an issue in the developingeconomies, but Morgan Stanleyeconomists believe it may be peakingthis quarter. If so, the region is nearingthe end of monetary tightening. Clearly,falling commodity prices support theidea of a deceleration of inflation in thenear future. As such, we see the end ofpolicy tightening and lower inflationas a second-half positive catalyst forEM equities.MULTIPLE EXPANSION. In particular, webelieve that a decline in EM inflation willresult in an expansion of price/earnings(P/E) multiples from today’s below-averagelevels (see Chart 10, page 13). Currently,the 12-month forward P/E for the MSCI12 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryEmerging Markets Index is 9.5, which isin line with the low point reached during1998’s Asian financial crisis and justabove the trough P/Es of the stressed2002-to-2003 and 2008-to-2009 periods.In our view, the current forward P/E istoo low. It implies that EM earnings willdrop about 25% in the next 12 months,based on a 20-year average forward P/Eof 12.7. This valuation suggests that themarkets have priced in a bear-case scenariothat would include all of the following:Chinese growth that drops below5% versus market expectations of 9%, adouble-dip recession in the US and anacceleration of the sovereign debt crisisin Europe.SOLID GAINS. The consensus earningsper-shareexpectations for the MSCIEmerging Markets Index suggest gainsof 14% in 2011 and 14% in 2012. If theseestimates prove to be correct, they willprovide a solid foundation for equities. Assuch, EM equity valuations look attractiverelative to their history. Comparedwith developed markets, EM valuationsare equally compelling, with stocksnow trading at a discount of 15% to thedeveloped markets.Finally, we are also likely to see sustainedstrength in EM currencies longterm versus the US dollar and otherdeveloped-market currencies, whichshould provide a tailwind for US-basedinvestors. Thus, comparing these positivefundamentals against what is priced intothe market suggests that there are goodinvestment opportunities to be found inthe emerging markets.Chart 10: Valuationon Emerging MarketsEquities Takes a TumbleBecause of the recent declines, the forwardprice/earnings ratio for emerging marketequities is around 9. That implies a 25%decline in earnings that, in our view, is notlikely. The consensus earnings forecast is for15% growth.2422201816141210864MSCI Emerging Markets Index ConsensusForward Price/Earnings Ratio-1 Standard DeviationAverage+1 Standard DeviationPeriods of Market Stress’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11Source: FactSet, IBES, MSCI as of Aug. 8, 201113 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryFixed IncomeOutlook“Ease”y Does ItThe altered global growth outlook andturbulence in the equity markets createa new dynamic for global central-bankpolicy. During the first half of the year,the predominant focus was on tighteningin the emerging market (EM) countriesand an exit from easing strategies in thedeveloped markets (DM). The gravityof the recent turmoil is a reminder ofhow developments can escalate quicklyand take on a life of their own that is, attimes, not predicated by the fundamentals.Nevertheless, having navigated thepreviously unprecedented 2008-to-2009experience, central bankers now have aplaybook to utilize and will most likelyerr on the side of keeping policy loose.Within the emerging markets, themain focus is China. After going througha series of tightening maneuvers, suchas raising reserve requirements andactual increases in the policy rate, theMorgan Stanley Global Economics teamnow expects no further hikes this year.In fact, they believe “if downside risksto global growth increase substantially,the balance of risks would shift towardselective monetary easing.”From the DM standpoint, the EuropeanCentral Bank (ECB) has been thenotable outlier, raising its policy ratedespite ongoing stresses in the peripheralcountries. However, the ECB’s recentdecision to start purchasing the sovereigndebt of Spain and Italy raises an interestingpossibility of an unconventionalapproach in the future. Unlike the Fed’sChart 11: European PolicyRate Expectations Shifting5.0%4.54.03.53.02.52.01.51.00.50.0Euro Refi Rate May 16 Consensus ForecastCurrent Morgan Stanley Forecastmore aggressive asset-purchase program,the ECB has been far less ambitious interms of scope and in sterilizing thesepurchases. If the ECB needs to be moreproactive, it could follow the Fed’s QuantitativeEase (QE) methodology. In addition,their prior rate hikes this year givethem the wherewithal to reduce policyrates as a tool of stimulus, a rare positionamong the DM central banks. In fact,the Morgan Stanley Global Economicsteam now sees the ECB lowering ratesnext year (see Chart 11 and Table 4).THE FED SHIFTS GEARS. Given the recenteconomic and equity market challenges,The European Central Bank raised its policyrate twice this year. However, in responseto slowing growth and the sovereign debtcrisis in some euro-bloc nations, expectationsregarding the next move are shifting.’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11Source: FactSet as of Aug. 10, 2011Table 4: Morgan Stanley and Citi Policy Rate and Government Bond Yield ForecastsMorgan Stanley Current Rate 4Q11 4Q12Policy Rate (%)US 0.00–0.25 0.02 0.02Euro Zone 1.50 1.50 1.00Japan 0.10 0.05 0.05UK 0.50 0.50 1.00China 6.56* 6.56* 6.56*10-Year Government Bond Yield (%)US 2.27 2.10 2.25Euro Zone 2.37 2.00 2.75Japan 0.85 1.50 1.40UK 2.46 2.90 3.80Citi Current Rate 4Q11 4Q12Policy Rate (%)US 0.00–0.25 0.25 1.00Euro Zone 1.50 1.75 2.00Japan 0.10 0.10 0.10UK 0.50 0.50 1.00China 3.50** 3.75** 3.75**10-Year Government Bond Yield (%)US 2.27 3.25 3.85Euro Zone 2.37 2.95 3.75Japan 0.85 1.30 1.30UK 2.46 3.35 4.00*Morgan Stanley’s current and forecast policy rates use the one-year lending rate.**Citi’s current and forecast policy rates use the one-year deposit rate.Source: Morgan Stanley Research, Citi Investment Research & Analysis as of Aug. 18, 201114 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summarythe Fed is now back in the conversationand may consider further stimulus optionsbeyond its recent announcementthat economic conditions “are likely towarrant exceptionally low levels for thefederal funds rate at least through mid2013.” Prior to the downgrade, the recentspate of soft data had increased chattersurrounding the potential for QE3. Wedo not think the Fed was quite ready togo down that road yet but, as we foundout at the August Federal Open MarketCommittee (FOMC) meeting, thediscussion about additional monetarystimulus has moved to front and center.The Fed has outlined several familiaroptions: provide more precise guidanceabout the amount of time the fed fundsrate and its balance sheet would remainat current levels, reduce the 25-basispointrate of interest on excess reservesor enter into another round of QE.The parallels to this time last yearsurrounding the Fed, and, by extension,the US Treasury market, are intriguing.At the August 2010 FOMC meeting, thepolicymakers brought back their reinvestmentprogram, which ultimately led toChairman Ben Bernanke’s Jackson Holespeech and the November launch of QE2.This year, the FOMC voting membersimplemented the aforementioned fedfunds reference and downgraded theireconomic and inflation assessments,essentially paving the way for futurepolicy action. For the record, Bernankeis scheduled to be at Jackson Hole onAug. 26, which presents a similar opportunityfor him to offer more insights.WHAT DOWNGRADE? Standard & Poor’shad well telegraphed the possibility fora downgrade on US debt, and the Aug. 5announcement should not have been agreat surprise to the fixed income markets.The negative reaction was in theequity markets, resulting in a flight-toqualitytrade that sent Treasury pricessoaring. Still, though the downgradesplace the money and bond markets inuncharted territory, investors have notaltered their stance regarding the statusof US Treasuries as safe-haven assets.With global equity markets selling offin the wake of S&P’s announcement,Treasuries benefitted from a strongflight-to-quality trade, as well as a shiftin monetary policy from the Fed.Once risk markets stabilize, we believethat the Treasury yield curve could againsteepen, partially reversing the powerfulrally that has driven the 10-year yield downby more than 100 basis points. However,market activity underscores our beliefthat any rate increase would most likelybe capped as the focus shifts back to theslower pace of economic growth.Credit: Attractive ValueAmid VolatilityThough market liquidity seems fine,the risk-off trade is taking its toll on theweaker tiers of credit. The option-adjustedspread (OAS) on the Barclays Capital USAggregate Corporate High Yield Indexis roughly 150 basis points wider sincethe beginning of August. The spreadon the index is now 697 basis points, alevel we have not seen since the peak ofthe Greek crisis in the summer of 2010.The OAS on the Barclays Capital USAggregate Corporate Investment GradeIndex, at 197 basis points, is only 44 basispoints higher in the same period. Alltold, the high yield index is down 3.88%since the beginning of June. The yearto-datetotal return (as of Aug. 17) oninvestment-grade credit is now 6.35%,versus 2.07% for high yield.While we expect this current periodof volatility may persist until there isChart 12: Credit DefaultSwaps Costs Rise forSome G-10 Countries, Too180 Basis Points160 France UK Germany US140120100806040200Feb ’11 Mar ’11 Apr ’11 May ’11 Jun ’11Source: Bloomberg as of Aug. 8, 2011either a firmer response from the FederalReserve or European policymakers,we also believe there is a limit to theamount of additional spread wideningthat could occur. For example, the highyield market is pricing in a 6%-plus defaultrate 12 months from now. This isfar above the expected 12-month defaultrate of 2% to 3%. Granted, investorsshould be demanding a risk premiumgiven the elevated levels of uncertaintysurrounding the domestic growth outlook,the divisions in Washington andthe creeping peripheral sovereign debtcrisis in Europe, but we believe spreadsare overcompensating for default risk. Ifspreads continue to widen, we believeinvestors will become more attracted tothe strong fundamental underpinningsof credit at more attractive valuationsversus other risk assets.BACK TO FUNDAMENTALS. Over the comingweeks, the impact of the Standard& Poor’s downgrade of US debt shouldfade, and investors likely will focus attentionon incoming economic data andthe direction of yields on the bonds ofcountries on Europe’s periphery. Whilethe risks of a recession have increased,we still believe US economic activitywill rebound in the latter half of thisyear. Although it may take more marketpressure to get them there, we expectEuropean policymakers eventually willtake the necessary steps to put an endThough they are nowhere near the levelsfor Greece, Ireland or Portugal, the costs forcredit default swaps on some G-10 countries,notably France and Germany, are on the rise.Jul ’11 Aug ’1115 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryto the ongoing sovereign debt crisis.All told, we believe credit spreadshave reached attractive levels given aslow-but-positive growth outlook, solidcorporate fundamentals, positive technicalsand relative value versus risk-freerates. In our view, the sell-off has createdan opportunity to add exposure to bothinvestment-grade and high yield credit.EUROPEAN CENTRAL BANK STEPS IN. Inrecent weeks, contagion from Europe’speriphery has been dangerously close toenveloping the “softer core” as Spanishand Italian 10-year bond yields breached6% and the markets started to considerthe possibility that both countries wouldneed a bailout. Since the wealthiercountries would have to finance sucha bailout, there is increasing pressureon them, too. Prices for credit defaultswaps (CDS) on German and especiallyon French debt have been climbing inrecent weeks, while the CDS prices forUS and UK debt have essentially beenflat (see Chart 12, page 15).The problem with the bigger bailoutscenario is one of size; Spain has roughly€660 billion of debt outstanding whileItaly, the third-largest issuer of debtafter the US and Japan, has more than€1.6 trillion. A combined bailout of bothcountries would put a massive burden onthe stronger core countries of Europe,most notably France and Germany, and itwould undoubtedly call into question thefeasibility of maintaining the EuropeanMonetary Union.On Aug. 7, the European Central Bank(ECB) announced its intention to purchaseSpanish and Italian bonds in the secondarymarket through its Securities MarketProgram. Almost immediately, the yieldson Spanish and Italian bonds droppeddramatically and are now trading justbelow 5%. The ECB’s move essentiallybuys time for European politicians to enactsome of the recently proposed changes tothe European Financial Stability Facility(EFSF) that would enhance its abilityto tackle the debt crisis. The changesneed to be ratified by all European Unionparliaments. Once this is completed, theECB is expected to transfer its sovereignChart 13: Long-TermImprovement in DebtRatings for EmergingMarket Sovereign Bonds60%50403020100bond exposure to the EFSF, thus shiftingthe risk off its balance sheet.BOOSTING THE EFSF. Another issue iswhether the EU countries will agree toincrease the size of the EFSF. The facilitycurrently has a notional lendingcapacity of €440 billion; however, due toovercollateralization requirements thatare needed to maintain its AAA rating,the EFSF’s true lending capacity is only€260 billion. In our view, this capacityneeds to be raised significantly to quellconcerns that the facility is sufficientin size to help Spain and Italy if theirbond yields rise again, as well as to actas a capital backstop to European banks.Due to rising political pressure at home,Germany is currently against increasingthe size of the EFSF, although we believeits government will ultimately relent forthe greater good of the EU.Our base case remains that Europeanpolicymakers will overcome their differencesand agree to a policy response thateventually puts an end to the peripheralcrisis. We believe the ultimate end gamefor the EU will be greater fiscal union.The path to get there likely will be quitepainful and will include a restructuringof Greek sovereign debt, as well as thepossible restructuring of Portuguese andIrish debt. We maintain our view thatall peripheral European sovereign andcorporate debt should be avoided.During most of the last 12 years—exceptfor the 2008-to-2009 financial crisis—ratings agencies have been continuallyupgrading emerging markets’ sovereigndebt. More than half of the issuers haveinvestment-grade ratings.Percentage of Investment-Grade Bondsin the Citi Global Emerging Market Sovereign Bond Index1995 1997 1999 2001 2003 2005 2007 2009 2011Source: The Yield Book as of July 31, 2011Better Borrowers in theEmerging MarketsWhile investors have been riveted tothe decline in credit worthiness ofdeveloped-market (DM) sovereign debt,they have given little notice to the overallimprovement in emerging market (EM)sovereign debt. During most of the last12 years—except for the 2008-to-2009financial crisis—ratings agencies havebeen continually upgrading EM sovereigndebt. In aggregate, the EM debtmarket has climbed to BBB-, the lowestinvestment-grade rating, from BB.HIGHER RATINGS. More than half of thecountries in the Citi Global EmergingMarkets Sovereign Bond Index are nowamong the ranks of investment grade(see Chart 13). Recent upgrades includeBrazil, Columbia, Panama and Uruguay.Since 2009, however, spreads—in effect,the extra yield investors demandto own emerging market debt over USTreasuries—have not tracked the improvementin credit quality. According toMorgan Stanley’s Emerging MarketsFixed Income Strategy team, that suggestsEM bonds are undervalued.The current spread of EM debt to USTreasuries has increased 69 basis pointsto 375 since the end of July, accordingto the Barclays US Emerging MarketsBond Index. While that spread is belowthe 400-basis-point long-term average, it16 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryChart 15: GoldValuation SoarsThis chart plots the ratio of the gold price tothe price/earnings ratio for developed-marketequities. While the long-term average is 25,the current ratio is 109. That is an indicationthat the valuation of gold is stretched.Global Alternatives /Absolute ReturnInvestments OutlookWill Gold Continue to Shine?While most risk assets declined in July,commodity prices increased. The DowJones-UBS Commodity Index, our benchmark,was up by 3%. Then, in the firsthalf of August, commodities droppedalong with other risk assets, but by just3% (as of Aug. 16).The commodity garnering the mostattention these days is gold, which gained$285 per ounce in the first half of August,bucking the broader trend, and is up 26%for the year to date. Robert Buckland,global equity strategist for Citi InvestmentResearch & Analysis, points outthat, unlike most investments, gold ishard to value because it does not providea dividend or coupon payment thatcan be discounted into the future; it isonly worth what a purchaser will pay atthe moment.GOLD VERSUS EQUITIES. One interestingway of assessing the rise in gold is tocompare its price to an easier-to-valueasset class such as global equities (seeChart 15). With gold hovering around$1,800 per ounce, it is at a historic highrelative to the price/earnings ratio ofdeveloped-market stocks, using the MSCIWorld Index as a proxy. This comparisonsuggests that global stocks are thecheaper asset class by a wide margin.Hussein Allidina, head of commodityresearch at Morgan Stanley and a memberof the Global Investment Committee,recently made major upward revisionsto his forecast for gold in light of marketdevelopments. Still, he estimates that theper-ounce price for gold will average$1,624 in 2012, suggesting lower pricesnext year.120100806040200Gold Price Relative to the Price/Earnings Ratiofor the MSCI World IndexOVERWEIGHT COMMODITIES. Even withthe recent setbacks to the broader commoditiesmarket, we remain tacticallyoverweight to this asset class. With theglobal economy generating a record-highlevel of output—and the dominant rolebeing played by the more manufacturingintensiveemerging economies—the underlyingdemand for most commoditiesis likely to remain strong.We believe that most long-term investorswill be better served if they use vehiclesthat provide broad-based exposure to theasset class rather than those that targetsectors or individual commodities, whichtypically exhibit high volatility. For example,during July, the best-performing sectorwas precious metals, which increased byabout 10%; the worst-performing sectorwas “softs,” which decreased by about 2%.Among individual commodities, the bestperformer during July was silver, up by15%; the worst was cotton, down by 14%.Hedge Funds Gain asMarkets FallEven though the majority of equity marketsracked up losses in July, hedge funds, onaverage, delivered positive returns. TheHFRI Fund of Funds Composite Indexreturned 0.65%. The star sector for gainswas macro, as the HFRI Macro Indexclimbed 2.5%, reversing the back-to-backdeclines seen in the prior two months.Systematic trend followers in the macrosector made strong gains in fixed incomeand commodities, including preciousAverage 25’71 ’75 ’79 ’83 ’87 ’91 ’95 ’99 ’03 ’07 ’11Source: Citi Investment Research and & Analysis, Morgan Stanley Smith Barney as of Aug. 1, 2011metals, oil and agricultural products.Many long-term technical funds benefitedfrom positions in fixed income markets,as sovereign debt concerns triggered aflight to safety. Discretionary global macrofunds generally benefited from largermarket moves in interest rates, equitiesand foreign exchange. Emerging marketsmacro funds navigated July’s sharp reversalswell, deriving profits from bothstrategic positioning and tactical trading.RELATIVE VALUE. The HFRI RelativeValue Index finished the month flat, aspositive contributions from fixed incomeexposure and multistrategy creditfunds were offset by declines in yieldalternativeand convertible-arbitragestrategies. Within mortgages, prices fornonagency residential mortgage-backedsecurities rebounded from the sell-offexperienced during June to finish positivefor July. Mortgage-derivatives strategiesalso were profitable, as both agency andnonagency interest-only securities benefitedfrom stable prepayment speeds anda favorable interest rate environment. Theperformance of commercial mortgagebackedsecurities flagged due to uncertainmacroeconomic conditions, coupled withthe withdrawal of two preliminary bondratings by Standard and Poor’s.EVENT DRIVEN. The HFRI Event DrivenIndex posted a hair’s breadth loss—only 0.1%—as equity special situations,distressed and merger-arbitragestrategies faced declines. In the mergerarbitragesector, deal spreads widened in18 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryGlobal Investment CommitteeAsset Allocation ModelsThe Global Investment Committee (GIC) is made up of senior professionalsfrom Morgan Stanley Research, Morgan Stanley Smith Barney, Citi InvestmentResearch & Analysis and outside financial market experts. The committeeprovides guidance on investment allocation decisions through the creationand maintenance of various model portfolios.The GIC’s Asset Allocation Models shown on thefollowing pages represent its best thinking on strategicand tactical asset allocation. In these portfolios, thestrategic equity allocations are in proportion to theirshare of global market capitalization based on theMSCI All Country World Investable Market Index. Assuch, the strategic allocation to non-US stocks is morethan 50% of the total equity allocation.There are three sets of models designed to provideguidance for investors with less than $1 million (Level1), between $1 million and $20 million (Level 2) andmore than $20 million in investable assets (Level 3).Accordingly, the portfolio sets have varying levelsof allocations to traditional asset classes, liquidalternative investments and illiquid investments.The GIC constructs each set of portfolios on a scaleof increasing risk—that is, expected volatility—andexpected return. Each set consists of eight risktolerancelevels. In each case, model 1 is the least risky and is composed mostly of bonds. As the model numbers increase, the models introduce higher allocations to equities and thus, become riskier. Alternative/absolute return investments are present in all models and provide increased asset-class diversification.The GIC has also created and maintains strategicand tactical allocations for several other modelportfolios used in various advisory programs. Most of these model portfolios incorporate a homecountrybias toward the US. Under this subjectiveconstraint, the strategic equity allocations have a70%/30% split between US and non-US markets,and the strategic fixed income allocations have an80%/20% split.20 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryGlobal Investment CommitteeAsset Allocation Models for InvestorsWith Less Than $1 Million in InvestableAssets (Level 1) Tactical Changes Effective July 8, 2011Global Bondsand InflationlinkedSecuritiesGlobal Bonds, Global Equities and Alternative/Absolute Return InvestmentsGlobal Equities andAlternative/AbsoluteReturn InvestmentsModel Portfolios Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic TacticalGlobal Cash 30% 28% 15% 13% 10% 8% 8% 6% 5% 3% 3% 1% - - - -Global BondsInvestment Grade 60 63 55 46 42 32 30 20 21 11 6 2 - - - -Short Duration 15 12 15 13 10 8 7 5 5 3 2 0 - - - -Government/Government-Related29 23 25 16 21 11 15 5 10 0 2 0 - - - -Corporate &Securitized16 28 15 17 11 13 8 10 6 8 2 2 - - - -High Yield - - 2 4 3 5 5 7 6 8 8 8 - - - -Emerging Markets - - - - 2 3 4 5 5 6 6 3 - - - -Total Bonds 60 63 57 50 47 40 39 32 32 25 20 13 - - - -Total Cash & ShortDuration Bonds45 40 30 26 20 16 15 11 10 6 5 1 - - - -Global EquitiesUS Large - - 6 10 12 16 16 20 18 23 22 28 30 33 24 27Growth - - 3 6 6 10 8 12 9 14 11 17 15 20 12 16Value - - 3 4 6 6 8 8 9 9 11 11 15 13 12 11US Mid - - 2 3 2 3 2 3 4 5 4 5 4 4 4 4Growth - - 1 2 1 2 1 2 2 3 2 3 2 2 2 2Value - - 1 1 1 1 1 1 2 2 2 2 2 2 2 2Canada - - 1 1 1 1 2 2 2 2 2 2 3 3 3 3Europe - - 4 2 9 5 10 6 12 7 15 9 21 13 18 9Europe ex UK - - 3 1 6 2 7 3 8 3 10 5 14 7 12 5UK - - 1 1 3 3 3 3 4 4 5 4 7 6 6 4Developed Asia - - 3 1 4 1 6 2 7 2 9 3 12 4 11 4Japan - - 2 0 3 0 4 0 5 0 6 0 8 0 7 0Asia Pacific ex Japan - - 1 1 1 1 2 2 2 2 3 3 4 4 4 4US Small - - 2 3 2 3 2 3 2 3 4 5 4 4 6 6Growth - - 1 2 1 2 1 2 1 2 2 3 2 2 3 4Value - - 1 1 1 1 1 1 1 1 2 2 2 2 3 2World ex US Small - - 1 2 2 3 2 3 3 4 4 5 5 5 8 8Emerging Markets - - 2 5 4 10 5 12 6 14 8 17 11 20 16 25Total Equity - - 21 27 36 42 45 51 54 60 68 74 90 86 90 86Total US Equity - - 10 16 16 22 20 26 24 31 30 38 38 41 34 37Total Developedex US Equity- - 9 6 16 10 20 13 24 15 30 19 41 25 40 24Total DevelopedMarket Equity- - 19 22 32 32 40 39 48 46 60 57 79 66 74 61Total EmergingMarket Equity- - 2 5 4 10 5 12 6 14 8 17 11 20 16 25Global Alternative/Absolute Return InvestmentsREITs - - 2 3 2 3 3 4 4 5 4 5 5 6 5 6Commodities - - 2 5 2 5 2 5 2 5 3 6 5 8 5 8Inflation-LinkedSecurities10 9 3 2 3 2 3 2 3 2 2 1 - - - -Managed Futures - - - - - - - - - - - - - - - -Hedge Funds - - - - - - - - - - - - - - - -Private Real Estate - - - - - - - - - - - - - - - -Private Equity - - - - - - - - - - - - - - - -Total Alternative/Absolute ReturnInvestments10 9 7 10 7 10 8 11 9 12 9 12 10 14 10 1421 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryGlobal Investment CommitteeAsset Allocation Models for InvestorsWith $1 Million to $20 Million in InvestableAssets (Level 2) Tactical Changes Effective July 8, 2011Global Bondsand InflationlinkedSecuritiesGlobal Bonds, Global Equities and Alternative/Absolute Return InvestmentsGlobal Equities andAlternative/AbsoluteReturn InvestmentsModel Portfolios Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic TacticalGlobal Cash 25% 23% 13% 11% 8% 6% 5% 3% 3% 1% 2% 0% - - - -Global BondsInvestment Grade 65 68 55 46 40 30 30 20 20 10 6 1 - - - -Short Duration 15 12 12 10 7 5 5 3 2 0 3 0 - - - -Government/Government-Related32 26 28 19 21 11 16 6 12 2 2 0 - - - -Corporate &Securitized18 30 15 17 12 14 9 11 6 8 1 1 - - - -High Yield - - 2 4 3 5 4 6 5 7 6 6 - - - -Emerging Markets - - - - 2 3 3 4 4 5 4 2 - - - -Total Bonds 65 68 57 50 45 38 37 30 29 22 16 9 - - - -Total Cash & ShortDuration Bonds40 35 25 21 15 11 10 6 5 1 5 0 - - - -Global EquitiesUS Large - - 6 11 8 11 12 17 14 18 18 24 24 26 20 22Growth - - 3 7 4 7 6 10 7 11 9 14 12 16 10 13Value - - 3 4 4 4 6 7 7 7 9 10 12 10 10 9US Mid - - - - 2 3 2 3 4 5 4 5 4 4 4 4Growth - - - - 1 2 1 2 2 3 2 3 2 2 2 2Value - - - - 1 1 1 1 2 2 2 2 2 2 2 2Canada - - 1 1 1 1 1 1 1 1 2 2 3 3 2 2Europe - - 4 2 6 4 8 4 10 6 13 8 17 10 15 6Europe ex UK - - 3 1 4 2 5 2 7 3 9 4 11 6 10 3UK - - 1 1 2 2 3 2 3 3 4 4 6 4 5 3Developed Asia - - 2 1 4 1 4 1 6 2 7 2 10 3 7 2Japan - - 1 0 3 0 3 0 4 0 5 0 7 0 5 0Asia Pacific ex Japan - - 1 1 1 1 1 1 2 2 2 2 3 3 2 2US Small - - - - 2 3 2 3 2 3 4 5 4 4 6 6Growth - - - - 1 2 1 2 1 2 2 3 2 2 3 4Value - - - - 1 1 1 1 1 1 2 2 2 2 3 2World ex US Small - - 1 2 2 2 2 2 2 3 3 3 4 4 7 7Emerging Markets - - 2 5 3 9 4 10 5 12 7 15 9 17 14 22Total Equity - - 16 22 28 34 35 41 44 50 58 64 75 71 75 71Total US Equity - - 6 11 12 17 16 23 20 26 26 34 32 34 30 32Total Developedex US Equity- - 8 6 13 8 15 8 19 12 25 15 34 20 31 17Total DevelopedMarket Equity- - 14 17 25 25 31 31 39 38 51 49 66 54 61 49Total EmergingMarket Equity- - 2 5 3 9 4 10 5 12 7 15 9 17 14 22Global Alternative/Absolute Return InvestmentsREITs - - 2 3 2 3 3 4 4 5 4 5 5 6 5 6Commodities - - 2 5 2 5 2 5 2 5 3 6 5 8 5 8Inflation-LinkedSecurities10 9 3 2 3 2 3 2 3 2 2 1 - - - -Managed Futures - - 2 2 4 4 4 4 4 4 5 5 5 5 5 5Hedge Funds - - 5 5 8 8 11 11 11 11 10 10 10 10 10 10Private Real Estate - - - - - - - - - - - - - - - -Private Equity - - - - - - - - - - - - - - - -Total Alternative/Absolute ReturnInvestments10 9 14 17 19 22 23 26 24 27 24 27 25 29 25 2922 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryGlobal Investment CommitteeAsset Allocation Models for InvestorsWith $20 Million or More in InvestableAssets (Level 3) Tactical Changes Effective July 8, 2011Global Bondsand InflationlinkedSecuritiesGlobal Bonds, Global Equities and Alternative/Absolute Return InvestmentsGlobal Equities andAlternative/AbsoluteReturn InvestmentsModel Portfolios Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic TacticalGlobal Cash 25% 23% 13% 11% 8% 6% 5% 3% 3% 1% 2% 0% - - - -Global BondsInvestment Grade 65 68 55 46 40 30 30 20 20 10 6 1 - - - -Short Duration 10 7 7 5 7 5 5 3 2 0 3 0 - - - -Government/Government-Related33 27 30 21 21 11 16 6 12 2 2 0 - - - -Corporate &Securitized22 34 18 20 12 14 9 11 6 8 1 1 - - - -High Yield - - 2 4 3 5 4 6 5 7 6 6 - - - -Emerging Markets - - - - 2 3 3 4 4 5 4 2 - - - -Total Bonds 65 68 57 50 45 38 37 30 29 22 16 9 - - - -Total Cash & ShortDuration Bonds35 30 20 16 15 11 10 6 5 1 5 0 - - - -Global EquitiesUS Large - - 6 11 8 12 10 14 14 18 18 24 22 24 18 20Growth - - 3 7 4 7 5 8 7 11 9 14 11 14 9 12Value - - 3 4 4 5 5 6 7 7 9 10 11 10 9 8US Mid - - - - 2 2 2 3 2 3 4 5 4 4 4 4Growth - - - - 1 1 1 2 1 2 2 3 2 2 2 2Value - - - - 1 1 1 1 1 1 2 2 2 2 2 2Canada - - 1 1 1 1 1 1 1 1 2 2 3 3 2 2Europe - - 4 3 6 4 7 4 9 5 12 7 16 8 13 4Europe ex UK - - 3 2 4 2 5 2 6 2 8 3 11 4 9 2UK - - 1 1 2 2 2 2 3 3 4 4 5 4 4 2Developed Asia - - 2 1 3 1 4 1 5 2 7 2 9 3 7 2Japan - - 1 0 2 0 3 0 3 0 5 0 6 0 5 0Asia Pacific ex Japan - - 1 1 1 1 1 1 2 2 2 2 3 3 2 2US Small - - - - 2 2 2 3 2 3 2 3 4 4 6 6Growth - - - - 1 1 1 2 1 2 1 2 2 2 3 4Value - - - - 1 1 1 1 1 1 1 1 2 2 3 2World ex US Small - - 1 2 1 2 2 3 2 3 3 3 4 4 7 7Emerging Markets - - 2 4 3 8 4 9 5 11 6 14 8 16 13 21Total Equity - - 16 22 26 32 32 38 40 46 54 60 70 66 70 66Total US Equity - - 6 11 12 16 14 20 18 24 24 32 30 32 28 30Total Developedex US Equity- - 8 7 11 8 14 9 17 11 24 14 32 18 29 15Total DevelopedMarket Equity- - 14 18 23 24 28 29 35 35 48 46 62 50 57 45Total EmergingMarket Equity- - 2 4 3 8 4 9 5 11 6 14 8 16 13 21Global Alternative/Absolute Return InvestmentsREITs - - 2 3 2 3 3 4 2 3 2 3 2 3 2 3Commodities - - 2 5 2 5 2 5 2 5 3 6 5 8 5 8Inflation-LinkedSecurities10 9 3 2 3 2 3 2 3 2 2 1 - - - -Managed Futures - - 2 2 4 4 4 4 4 4 5 5 5 5 5 5Hedge Funds - - 5 5 8 8 11 11 11 11 10 10 10 10 10 10Private Real Estate - - - - - - - - 2 2 2 2 3 3 3 3Private Equity - - - - 2 2 3 3 4 4 4 4 5 5 5 5Total Alternative/Absolute ReturnInvestments10 9 14 17 21 24 26 29 28 31 28 31 30 34 30 3423 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryEndnotes1. The strategic allocationrefers to the long-terminvestment weightingsfor the major asset classesthat best fit an investor’sspecific circumstances, arisk profile including theirability and willingness totolerate risk, and returnobjectives, and that takeinto account the assetreturns, standard deviationsof returns, and correlationsof returns undervarying economic andfinancial conditions.2. The tactical allocationincorporates activedecisions to overweightor to underweight assetclasses in the near-termrelative to their strategicallocation based on: (i)the current and projectedfinancial and economicenvironment; (ii) evaluationsof risk in global assetmarkets; and (iii) otherfundamental, valuation,and psychological, technical,liquidity factors.3. The eight portfoliosdisplayed in the accompanyingmatrix are arrangedfrom left to right in ageneral progression fromconservative throughmoderate to aggressiverisk profiles.4. A conservative assetallocation risk profiletends to encompass: (i)relatively lower, or insome cases zero, levels ofexposure to equities andto investments outside theinvestor’s home countryand currency; and (ii)relatively higher levels ofexposure to cash, fixedincome, and investmentsinside the investor’s homecountry and currency.A conservative assetallocation risk profile stylemay generally be expectedto exhibit lower pricevolatility as measured bythe standard deviations ofannual returns from theportfolio and generallyseeks to generate asomewhat greaterproportion of its returnsfrom income as comparedwith capital gains.5. A moderate asset allocationrisk profile tendsto encompass: (i) relativelymoderate levels ofexposure to equities andto investments outside theinvestor’s home countryand currency; and (ii) relativelymoderate levels ofexposure to cash, to fixedincome and investmentsinside the investor’s homecountry, and to currency. Amoderate asset allocationrisk profile may generallybe expected to exhibitmoderate price volatilityas measured by the standarddeviations of annualreturns from the portfolioand generally seeks to generatea somewhat balancedproportion of its returnsfrom income as well asfrom capital gains.6. An aggressive assetallocation risk profiletends to encompass: (i)relatively higher levels ofexposure to equities andto investments outside theinvestor’s home countryand currency; and (ii)relatively lower, or income cases zero, levels ofexposure to cash, to fixedincome and investmentsinside the investor’s homecountry, and to currency.An aggressive assetallocation risk profile maygenerally be expectedto exhibit higher pricevolatility as measured bythe standard deviations ofannual returns from theportfolio and generallyseeks to generatea somewhat lowerproportion of its returnsfrom income as comparedwith capital gains.7. The cash/cashequivalent asset classmay include US dollarbasedshort-terminvestments as well asnon-US dollar-basedshort-term investments,and/or Exchange-TradedFunds (ETFs) or otherinstruments dedicatedto US and/or to non-UScash and cash equivalents.In a rising US dollarenvironment, the return toUS dollar-based investorsfrom unhedged non-USdollar investments willbe lower than US dollarreturns. In a falling USdollar environment, thereturn to US dollar-basedinvestors from unhedgednon-US dollar investmentswill be higher than USdollar returns.8. Fixed income holdingsmay be either taxable ortax exempt, depending onthe instrument and/or theinvestor’s current and futuretax status. As a matterof practice, many investorstend to hold certain typesof investments in theirtaxable accounts, such as:(i) tax-exempt municipalbonds; and (ii) assets thatgenerate a significantproportion of their totalreturn from long-termcapital gains. Similarly,many investors tend tohold certain other typesof investments in theirtax-deferred, tax-exempt,or low-tax accounts, suchas: (i) taxable bonds; (ii)assets that generate a significantproportion of theirtotal return in the form ofdividends, taxable interestincome, accredited incomeand/or short-term tradingprofits. It may thus behelpful for investors tomentally and/or computationallycombine the assetsheld in their taxable andtheir tax-exempt accountsto gain perspective on theoverall asset allocation oftheir investments.9. Duration is a measure ofthe average cash-weightedterm-to-maturity of abond. It is a frequentlyused measure of thesensitivity of a bond’s priceand the present value ofits cash flows relative tointerest rate movements.The specific desired durationof investment grade,high yield and emergingmarkets bond holdingswill usually be influencedby the investor’s interestrate expectations. Ina rising interest rateenvironment, investorsmay choose to generallyshorten the durationof their fixed incomeholdings, and in a fallinginterest rate environment,investors may choose togenerally lengthen theduration of their fixedincome holdings.10. Depending on theinterest rate environmentand other factors, certainfixed income securities,such as preferred stocksand convertible securitiestrading near their bondequivalent value, may beincluded within the fixedincome asset category.11. Global investmentgrade bonds include: (i)US dollar denominated ornon-US dollar denominatedUS Treasury securities;(ii) US dollar denominatedor non-US dollar denominatedUS Federal Agencyand other Governmentrelatedsecurities; (iii)many US dollar denominatedor non-US dollardenominated securitizedand/or mortgage-backedsecurities carrying investmentgrade quality ratingsfrom the major credit ratingservices; (iv) US dollardenominated or non-USdollar denominated corporateand/or municipalbonds carrying investmentgrade quality ratings fromthe major credit ratingservices; and (v) certainother US dollar denominatedor non-US dollardenominated instruments.For tax-related and/or other reasons, someinvestors may implementtheir investment gradebond exposure throughtax-exempt securities. Inperiods of deterioratingcredit conditions, investorsmay choose to improvethe credit quality of theirbond holdings by focusingon higher-rated sectorsof the global investmentgrade bond universe, andin periods of improvingcredit market conditions,investors may choose tolessen the credit quality oftheir bond holdings by focusingon a broader rangeof credit ratings, possiblyincluding lower-ratedissues, within the globalinvestment grade bonduniverse. Non-US dollarFixed Income Securitiesholdings are consideredto be hedged into USdollars, unless otherwisenoted. In a rising US dollarenvironment, the return toUS dollar-based investorsfrom unhedged non-USdollar investments will belower than US dollar returns.In a falling US dollarenvironment, the return toUS dollar-based investorsfrom unhedged non-USdollar investments will behigher than USdollar returns.12. Short duration investmentgrade bonds areconsidered here to befixed income instrumentswith a Moody’s/Standard& Poor’s credit qualityrating of Baa3/BBB- orhigher with duration oftwo years or less. Durationis a measure of theaverage cash-weightedterm to maturity of a bondand is a frequently usedmeasure of the sensitivityof a bond’s price and thepresent value of its cashflow relative to interestrate movements.13. Certain equity industrygroups and their specificcomponent companiesmay entail exposure to theforces and factors affectingalternative/absolute returninvestments, including: (i)real estate; (ii) commodities(including energy,agriculturals, base metals,24 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryIndex Definitionsstandard & poor’s 500index Widely regardedas the best single gauge ofthe US equities market,this capitalizationweightedindex includes arepresentative sample of500 leading companies inleading industries of theUS economy.msci all countryworld index This freefloat-adjustedmarketcapitalizationindex is designedto measure equitymarket performance in thedeveloped and emergingmarkets.russell top 200 indexThis index measuresthe performance of thelargest-cap segment ofthe US equity universe. Itrepresents approximately63% of the total marketcapitalization of the Russell1000 companies.russell midcap indexThis index includes the800 smallest companies inthe Russell 1000 index. Itrepresents approximately27% of the total marketcapitalization of the Russell1000 companies.russell 2000 indexThis index measuresthe performance of thesmall-cap segment of theUS equity universe. Thecompanies in this indexrepresent approximately8% of the total market capitalizationof that index.msci emerging marketsindex This isa free-float-adjusted,market-capitalizationindex designed tomeasure equity marketperformance in the globalemerging markets.barclays capital usaggregate corporateinvestment gradeindex This indexrepresents securities thatare investment grade,SEC-registered, taxableand dollar denominated.barclays capital usaggregate corporatehigh yield index Theindex includes publiclyissued US-dollar-denominatednon-investmentgrade, fixed-rate, taxablecorporate bonds that havea remaining maturity ofat least one year, are ratedhigh yield using the middlerating of Moody’s, S&P andFitch, respectively, andhave $600 million or moreof outstanding face value.citi global emergingmarkets sovereignbond index This indexincludes Brady bonds andUS dollar-denominatedemerging marketsovereign debt issuedin the global, Yankeeand eurodollar markets,excluding loans.barclays capital usemerging marketsbond indexThis index includes fixedandfloating-rate USdollar-denominateddebtfrom emerging marketsin the following regions:Americas, Europe, MiddleEast, Africa, and Asia. Forthe index, an emergingmarket is defined as anycountry that has a longtermforeign currency debtsovereign rating of Baa1/BBB+/BBB+ or below,using the middle rating ofMoody’s, S&P, and Fitch.dow jones-ubscommodity indexThis index comprisesfutures contracts on 19physical commodities.These include energy,industrial metals,precious metals andagricultural commodities.msci world indexThis free-float-adjustedmarket-capitalizationweighted index isdesigned to measureequity marketperformance of 22developed-marketcountries in NorthAmerica, Europe, and theAsia/Pacific Region.hfri fund of fundscomposite index Thisis an equal-weightedindex of 650 hedge fundswith at least $50 millionin assets and 12 monthsof returns. Returns arereported in US dollars andare net of fees.hfri macro indexInvestment managerswho maintain positionsin companies currently orprospectively involved incorporate transactions ofa wide variety includingbut not limited tomergers, restructurings,financial distress, tenderoffers, shareholderbuybacks, debt exchangessecurity issuance orother capital structureadjustments.hfri relative valueindex This index tracksmanagers that maintainpositions in which the investmentthesis is predicatedon realization of avaluation discrepancy inthe relationship betweenmultiple securities. Managersemploy a variety offundamental and quantitativetechniques to establishinvestment theses,and security types rangebroadly across equity,fixed income, derivativeor other security types.hfri event drivenindex Investment managersmaintain positions incompanies currently orprospectively involved incorporate transactions ofa wide variety includingbut not limited to mergers,restructurings, financialdistress, tender offers,shareholder buybacks,debt exchanges, securityissuance or other capitalstructure adjustments.hfri equity hedgeindex Equity hedge strategiesmaintain positionsboth long and short in primarilyequity and equityderivative securities. Awide variety of investmentprocesses can be employedto arrive at an investmentdecision, includingboth quantitative andfundamental techniques;strategies can be broadlydiversified or narrowly focusedon specific sectorsand can range broadlyin terms of levels of netexposure, leverage, holdingperiod, concentrationsof market capitalizationsand valuation ranges oftypical portfolios.26 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryDisclosuresThis 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 otherfinancial instrument or to participate in any trading strategy. This is not a research report and was not prepared by the Research Departments of Morgan StanleyLLC 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 andopinions 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, includingquality 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 investigationof the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a reviewof any offering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and towhich prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligationto 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 dependon an investor’s individual circumstances and objectives. Morgan Stanley Smith Barney recommends that investors independently evaluate specific investmentsand strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes ininterest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companiesand other issuers or other factors. Estimates of future performance are based on assumptions that may not be realized. Actual events may differ fromthose assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur andmay significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/orcalculation 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 materiallydiffer 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 intendedto, 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 eitherthe 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 writtento 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 thetaxpayer under US federal tax laws. Each client should consult his/her personal tax and/or legal advisor to learn about any potential tax or other implicationsthat may result from acting on a particular recommendation.International investing entails greater risk, as well as greater potential rewards compared to US investing. These risks include political and economic uncertaintiesof foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may haverelatively unstable governments and less established markets and economies.Alternative investments which may be referenced in this report, including private equity funds, real estate funds, hedge funds, managed futures funds, funds ofhedge funds, private equity, and managed futures funds, are speculative and entail significant risks that can include losses due to leveraging or other speculativeinvestment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delayof information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds and risksassociated with the operations, personnel and processes of the advisor.27 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.

global investment committeeaugust meeting summaryInvesting 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 insupply 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, includinglack of liquidity, participation of speculators and government intervention.Physical precious metals are non-regulated products. Precious metals are speculative investments, which may experience short-term and long term price volatility.The value of precious metals investments may fluctuate and may appreciate or decline, depending on market conditions. If sold in a declining market, the priceyou receive may be less than your original investment. Unlike bonds and stocks, precious metals do not make interest or dividend payments. Therefore, preciousmetals may not be suitable for investors who require current income. Precious metals are commodities that should be safely stored, which may impose additionalcosts on the investor. The Securities Investor Protection Corporation (“SIPC”) provides certain protection for customers’ cash and securities in the event of a brokeragefirm’s bankruptcy, other financial difficulties, or if customers’ assets are missing. SIPC insurance does not apply to precious metals or other commodities.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. Bondsmay 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 marketvalue of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturityvalue 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 theissuer 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 principaland/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 creditrisk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risktolerance 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 withinone’s city of residence.A taxable equivalent yield is only one of many factors that should be considered when making an investment decision. Morgan Stanley Smith Barney and itsFinancial Advisors do not offer tax advice; investors should consult their tax advisors before making any tax-related investment decisions.Treasury Inflation Protection Securities’ (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation by tracking theconsumer 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 maysignificantly underperform versus conventional US 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 pricefluctuations and illiquidity.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 performanceof any specific investment.REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited diversification andsensitivity 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 US Securities Act of 1933, as amended, and, if not, may not be offered orsold absent an exemption therefrom. Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, sale, exercise of rightsor 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 andmarket risks.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 businessaround 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 highvaluations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.Past performance is no guarantee of future results. Estimates of future performance are based on assumptions that may not be realized. This material is not asolicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.This material is disseminated in Australia to “retail clients” within the meaning of the Australian Corporations Act by Morgan Stanley Smith Barney Australia PtyLtd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813).Morgan Stanley Smith Barney is not incorporated under the People’s Republic of China (“PRC”) law and the research in relation to this report is conducted outsidethe PRC. This report will be distributed only upon request of a specific recipient. This report does not constitute an offer to sell or the solicitation of an offer tobuy any securities in the PRC. PRC investors must have the relevant qualifications to invest in such securities and must be responsible for obtaining all relevantapprovals, licenses, verifications and or registrations from PRC’s relevant governmental authorities.Morgan Stanley Private Wealth Management Ltd, which is authorized and regulated by the Financial Services Authority, approves for the purpose of section 21of the Financial Services and Markets Act 2000, content for distribution in the United Kingdom.Morgan Stanley Smith Barney is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advicewithin the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC.Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide andshall not have liability for any damages of any kind relating to such data.Morgan Stanley Smith Barney material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney.© 2011 Morgan Stanley Smith Barney LLC. Member SIPC. Graystone Consulting is a business of Morgan Stanley Smith Barney LLC.6831709 Graystone 08/1128 | august 2011Please refer to important information, disclosures and qualifications at the end of this material.