As originally published in:

solving for 2012 |

GLOBAL EqUITIES

Market Insights and Outlooks from Senior Investors at Neuberger Berman

Overview: Beneath the Surface, Opportunities Await

Joseph V. Amato, President and Chief Investment Officer

Over the past year, the most commonly used words in relation to the markets were probably macro,

volatility and contagion. The least uttered? Id say fundamentals, as in what differentiates individual
companies at any given time. Clearly, the big picture was front and center in 2011, as investors grappled with an array of unanticipated, significant events often simultaneously. Whether the Arab Spring,
the Japan earthquake, the U.S. Treasury downgrade or the ongoing drama in Europe, these factors coalesced to heighten market turbulence and reinforce the notion that markets are truly interconnected as never before. Looking ahead to 2012, we see little sign that such issues are abating. European nations, despite ongoing dialogue, continue to struggle to achieve a credible solution to the debt crisis. The region, in our opinion, requires concrete steps toward fiscal consolidation followed by meaningful intervention by the European Central Bank. The political process has been taking much longer than markets demand. While this is understandable, given the complexities of the political process, financial markets may yet force the political leadership to move more quickly. In the U.S., Congress has postponed hard decisions about budget cuts until after the November elections. This will likely result in important policy initiatives going into suspended animation. The world is also watching closely as to whether China can successfully achieve a soft landing for its influential economy. In short, it seems like heightened volatility, tight correlations and near-term focus on high-level investment choicessuch as asset class, region and sector will continue to predominate in the short term. Despite this, as evident in our outlook pieces on the U.S., Europe, Emerging and China equities, we believe there are exceptional opportunities for bottom-up investors. For example, if you look past the general gloom in Europe, you find that there are numerous high-quality companies domiciled there with broad global exposure that are providing strong earnings at reasonable multiples. Elsewhere, despite a difficult 2011, emerging markets continue to provide secular advantages over developed counterparts. Economic growth is much faster, governments and individuals carry less debt, and demographics are favorable, as young and growing populations raise their living standards and increase consumption. Among stocks, the sell-off of 2011 has provided ample opportunities for bargain hunters. As for the U.S., individual companies are actually doing better than the sluggish economy would suggest. Many continue to generate healthy earnings and boast cash-rich balance sheets, low financing costs and limited wage pressures. Overall,

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they seem well-positioned to ride out a downturn and perform well should the economy maintain modest growth (our expectation) or surprise on the upside. In all likelihood, 2012 is going to be another eventful year. But if, like us,

you think of current volatility and pessimism as opening and not just shutting doors, then you may also see this as a good time to capitalize on the attractive opportunities that await, especially given that many stocks have seen lower valuations in the wake of undifferentiated market

turbulence. In our view, the key in this environment is to exert patience and maintain investment discipline, while waiting out the structural, big-picture issues that continue to heighten anxiety around the world.

This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. This material may include estimates, outlooks, projections and other forward-looking statements. Due to a variety of factors, actual events may differ significantly from those presented. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Please see disclosures at the end of this publication, which are an important part of this article.

U.S. Equities: In the Back Seat Now, Fundamentals Should Eventually Drive Results
Leah modigliani, multi-Asset Class strategist

Uncertainty abounds as we enter 2012for equities and fixed income, in the U.S. and globally. It could be another trying year. We expect a barrage of macro issues, including questions about the ongoing European sovereign debt crisis, whether China can avoid a hard landing, the health of the U.S. economy and the November elections, to continue to shape investor sentiment. Against this backdrop, strong corporate fundamentals, which are usually a forceful driver of equity returns, continue to take a back seat to daily headlines and the periods of heightened volatility that often follow. While investors could be in for a bumpy ride, we are generally positive on the prospects for the U.S. equity market and the eventual return of fundamentalsdriven performance. 2011: RIsk AVeRsIOn suRged As the YeAR PROgRessed The U.S. equity market, which began the year with much promise, was

soon hampered by a confluence of events that resulted in a significant flight to quality and, at times, indiscriminate selling. The shift from robust risk appetite (risk on) to risk aversion (risk off) began in the late spring. After a period of resiliency in the wake of the uprisings in the Middle East and the devastating earthquake in Japan, investor sentiment started to sour. Data pointed to moderating economic growth, and fears of Greece defaulting on its debt obligations again took center stage. Risk aversion gained momentum in the third quarter due largely to the downgrade of U.S. Treasuries by Standard & Poors. Mixed economic data, fears of contagion from the European sovereign debt crisis, and growing expectations for a double-dip recession compounded investor concerns. At times, investors were willing to park their money in Treasuries earning minimal returns as they took shelter in the rising storm. Despite a strong rally for stocks in October, inves-

tor goodwill soon faded with new concerns in Europe, including fears about Italian debt and a surge in the countrys borrowing costs. Political gridlock in Washington also came to a head as the debt-reduction super committee failed to reach a compromise to meet budgetary targets by the agreed-upon deadline. eCOnOmY, FROnt And CenteR As we look ahead to 2012, the economy, as usual, will be central to the health of the stock market. Unfortunately, economic data have been less than conclusive in gauging a clear course for recovery. Consumer and business spending, manufacturing activity and other metrics have fluctuated from month to month, leading to shifting expectations by turn from expansion to contraction and back again. However, two constants remain: elevated unemploymentrecently at nearly 9%and weakness in the housing market, which has had little momentum after

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Will rebound in Market vol atilit y Continue in 2012? N u m ber of Trading Day s w it h I ntraday Sw ing s A bove 3 % for S & P 50 0 80 70 60 50 40 30 20 10 0 00 01 02 03 04 05 06 07 08 09 10 11*

policy is likely to remain accommodative. This monetary stimulus may be particularly important given that U.S. budgetary pressures and political gridlock suggest that meaningful fiscal stimulus is unlikely to be put into place in the coming year. euROPeAn debt sAgA COntInues With unprecedented connectivity among businesses across global markets, U.S. economic health will depend in part on whats happening elsewherewhether in Berlin, Hong Kong or Tehran, for that matter. At this point, sovereign debtin the U.S., but particularly in Europecontinues to have an enormous impact (at least psychologically) on business and consumer confidence as well as market performance. As we write this report, the European situation continues to shift rapidly. A late October agreement by European Union members to reduce Greeces debt by 50% and substantially increase the European Financial Stability Facility (EFSF), designed to support euro-area member states, was initially viewed by investors as a significant step in quelling the escalating crisis. However, it soon became clear that the various players remain at loggerheads on how to deal effectively with major issues of implementation, timing and funding. Indebted nations bridle under pressure to implement austerity measures and reduce expenditures while core countries (Germany and France) have shown reluctance to bear the brunt of potential bailouts, and the European Central Bank seems cautious about taking on a larger role in quelling the crisis.

Source: FactSet. *As of November 30,2011.

dramatic declines in volume and pricing. These factors, combined with worries about global macro developments, have in turn negatively impacted confidence and consumption. Still, we think the U.S. economy has enough momentum to avoid a double-dip recession in 2012, and grow at a positive, even if subpar, pace. Among the factors that could potentially support growth are the sizable cash holdings of many companies that have been hesitant to deploy capital in an uncertain environment. If confidence improves, the increased use of this cash could augment GDPas could a positive change in spending by consumers, who have been relatively conservative in their spending over the past several years.

Even if the U.S. falls back into recessionwhich we see as the less likely scenariowe think it would probably be relatively shallow, due to what we consider to be a lack of excesses in the economy. In the housing sector, for example, construction starts, residential sales and home prices all declined dramatically for several years, and appear to have little room to fall further from todays depressed levels. Corporations, having cut costs during the depths of the economic crisis, are operating leanly, aided by healthy balance sheets and inexpensive financing. We believe default rates on company debt are likely to come in below average next year. Indeed, given modest inflation numbers and fears about the economy, the Federal Reserves monetary

Corporate bal anCe sheets reMain healthy Perce nt age of A sset s in C ash : S & P 50 0 Co m p a nies ( e x Fina ncials ) 10% 8

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: FactSet, through September 30, 2011.

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France and Germany have called for reworking the European Union (EU) as a whole and amending European treaties to include centralized oversight of national budgets and automatic sanctions against countries in violation of new stricter rules, at least for the 17 eurozone countries. But the U.K. has so far vetoed the proposed EU-wide agreement, and some European voters are voicing complaints as well. Meanwhile, the prolonged inability to come up with a decisive fix to its debt woes appears to threaten the credit ratings of even core eurozone countries. All told, the ongoing uncertainty and hobbled banking system will likely impact economic activity in the near termsomething that new European Central Bank President Mario Draghi acknowledged in noting the potential for a mild European recession by the end of 2011. OtheR Issues: ChInese hARd LAndIng Beyond the maneuverings in Europe, we are keeping a close eye on developments in China, which have significant implications for global growth and the equity markets in 2012. Much has been written about whether China has the ability to orchestrate a soft landing for its economy by ending a two-year tightening cycle that has included numerous interest rate increases and higher bank reserve requirements. Indeed, the countrys economy has decelerated somewhat, from 10.4% GDP growth in 2010, to around 9.2% for 2011. If the Chinese governments measures to cool the property market and tame inflation turn out to have

been too heavy-handedespecially with economic pressures mounting in the developed worldthe resulting slowdown could substantially impact global business activity. From our perspective, although Chinas economic expansion is likely to further moderate in 2012, we dont believe the country will experience anything too severe. Chinas inflation rate now appears to be at, or near, a peak while its property market has shown signs of cooling. As a result, we think that Chinese policymakers have the flexibility to stop or potentially reverse course on their tightening measures in pursuit of the elusive soft landing. eLeCtIOn gRIdLOCk? Finally, one issue that is a bit harder to handicap is the potential impact of election politics in 2012, when the U.S. will choose its President and both the House and Senate have the potential to change hands. (See 2012 Election on page 6.) Despite extensive wrangling, little progress has been made toward reducing the federal budget deficit and level of federal debt, which has now reached a staggering $15 trillion. Moreover,

should the economy soften, as noted, it seems unlikely that there would be agreement on any major stimulus. Indeed, given the political gamesmanship displayed during the debt ceiling crisis and with the failure of the Congressional super committee to reach budgetary compromise, we think that the run-up to the election will only intensify current polarization and extend gridlock. This, in turn, could influence Standard & Poors and other rating agencies as they consider a potential further downgrade of U.S. Treasuries, as well as the willingness of businesses to make major investments in equipment or hiring in an uncertain environment. Although there may be some movement on tax reform, it seems that the most important policy initiatives will probably have to wait until after November. WhAts AheAd FOR stOCks Many of the key issues facing the worlds governments and economies will likely take time to play out. As such, we think that the short-term movements of the U.S. equity market in 2012 will continue to hinge on

unCertaint y, MaCro foCus heightened Correl ation aMong stoCks S & P 50 0 I nd u str y Grou ps : 30 - day Rolling Correlation 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 2004 2005 2006 2007 2008 2009 2010 2011

Source: FactSet, through November 30, 2011.

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signs of improvements and/or setbacks in these key issues, as well as the outcome of economic data along the way. This, in turn, could lead to additional periods of heightened market volatility and a continuation of the risk-on/risk-off investor mentality that characterized 2011. Similarly, with macro issues dominating the markets, we expect that higher-thanaverage correlations among asset classes and among individual securities will continue, making it more challenging for investors to build meaningfully diversified portfolios. Ultimately, where the market ends up on December 31, 2012 will, in our view, depend on whether cumulative progress is made on key fronts, such as Europes debt crisis, Chinas economic path, or U.S. business and consumer confidence. From a fundamental perspective, we believe U.S. stocks are a good value. Low interest rates are extremely supportive and valuations are attractive from

a historical perspective, with the S&P 500 Index trading at a forward price/earnings ratio of roughly 10.9, versus 15.0 over the past 10 years.1 Despite challenging economic conditions, corporate profits generally remain solid. Companies within the S&P 500, for example, are expected to generate earnings per share of $107 in 2012, up from a projected $97 in 2011. As mentioned, corporate balance sheets are generally cashrich, which could provide something of a cushion if the economy stumbles. Using some of this cash for shareholder-friendly activities, such as increased dividends and share buybacks, would likely lend support to the stock market, as would an increase in mergers-and-acquisitions activity. That being said, corporate guidance for 2012 has been vague or noncommittal, given the macroeconomic headwinds; so investors currently lack the clear visibility to increase their confidence from current levels.

Taking into account both the macro issues and underlying fundamentals, we recognize the likelihood of continued near-term market volatility, but we also think that U.S. equities are generally attractive at these levels and have attractive upside potential for long-term investors. Near term, should the economy surprise on the upside, we could see investors begin to rotate from defensive to early cyclical stocks (while, of course, a downturn could have the opposite effect). Regardless, we are encouraged by corporations resiliency since the credit crisis and feel that many businesses are well-positioned to capitalize on opportunities for growth that we expect to materialize once a more stable global framework and a better economic backdrop begin to emerge.

1. Source: FactSet, as of November 25, 2011. This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. This material may include estimates, outlooks, projections and other forward-looking statements. Due to a variety of factors, actual events may differ significantly from those presented. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Investing in the stocks of even the largest companies involves all the risks of stock market investing, including the risk that they may lose value due to overall market or economic conditions. Small- and mid-capitalization stocks are more vulnerable to financial risks and other risks than stocks of larger companies. They also trade less frequently and in lower volume than larger company stocks, so their market prices tend to be more volatile. Please see disclosures at the end of this publication, which are an important part of this article.

2012 Election: An Exercise in Austerity

matthew L. Rubin, director of Investment strategy

Politicians have long recognized the relationship between voter approval and the state of the financial markets and economy. This is most evident in U.S. presidential election years, when campaign promises and stimulus packages become the norm and tend to benefit stocks. In 2012, however, things could be a bit different. Historically, presidential cycles and U.S. stock markets have exhibited some recurring trends, with equity market returns tending to be stronger in the third and fourth years of presidential administrations, as incumbents have pumped stimulus into the economy in hopes of furthering their reelection chances. Since 1926, the S&P 500 total return has averaged 8.2%, 9.0%, 19.4% and 11.0% in years 1, 2, 3 and 4, respectively, of each presidential term. Under President Obama, however, equity returns have been front-loaded, with the S&P 500 returning 26.5% and 15.1% in his first (2009) and
obaMa and the stoCk Market S & P 50 0 Tot al Retu rn by Preside ntial Year 30% 25 20 15 10 5 0 Year 1

second (2010) years as President, and only 1.1% year-to-date as of November 30, 2011. To be fair, the market environment throughout Obamas tenure to date has been tumultuous early gains reflect the rebound from the depths of the March 2009 market lows, while more recently the European debt crisis and economic fears have had a dampening market impact. An AusteRItY eLeCtIOn Looking toward 2012, we do not expect major stimulus measures to be enacted by the federal government, as has often been the case in an election year. Fears over debt levels and the vast political divide in Congress have simply changed the debate. Instead of proposing tax cuts and spending increases, politicians are generally contemplating tax increases and spending cuts. All things being equal, such austerity measures will likely be a drag on economic growth.

As some will observe, the economy is not the stock market and the stock market is not the economy. We agree, but the 2012 elections are particularly uncertain, with the President appearing to be hanging on by a thread and the major political parties defending slim margins in the House and Senate. Moreover, tax reform, health care regulation, international trade and many other issues are still up in the air and may not be decided until after November 6. This will likely prompt businesses and individuals to take a cautious approach until greater clarity emerges. As a result, we anticipate the elections to have a dampening effect on both the economy and stock market in 2012if we do happen to reach the 11.0% average S&P 500 return for year 4 of the election cycle, I highly doubt it would be a result of government largesse.

Year 2 Historical Average

Year 3 Obama

Year 4

Source: FactSet. Year 3 Obama data through November 30, 2011. This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. The views expressed herein are generally those of Neuberger Bermans Investment Strategy Group (ISG), which analyzes market and economic indicators to develop asset allocation strategies. ISG consists of five investment professionals who consult regularly with portfolio managers and investment officers across the firm. This material may include estimates, outlooks, projections and other forward-looking statements. Due to a variety of factors, actual events may differ significantly from those presented. Any views or opinions expressed may not reflect those of the firm as a whole. Investing entails risks, including possible loss of principal. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results. Please see disclosures at the end of this publication, which are an important part of this article.

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Developed International Markets: Looking Beyond the Eurozone

benjamin segal, CFA, Portfolio manager and head of global equity team

With so much uncertainty in the past years global equity markets, courtesy of the eurozone sovereign debt crisis, investors may wonder how much appeal an international equity allocation holdsespecially as the crisis and related concerns remain an ongoing risk. In our opinion, plenty. We think a global perspective, along with a bottom-up, qualityand valuations-focused investment approach, can continue to uncover attractive long-term opportunities for both appreciation and diversification, and help mitigate many of the risks associated with a tougher macroeconomic backdrop. From a regional perspective, we think its critically important for investors to differentiate between sources of opportunity and sources of anxiety in the developed international arena. The weak performance of the MSCI EAFE Index in 2011 was clearly driven by the eurozone, with its news of downgrades, potential defaults and bailout-related political concerns. The eurozone continues to garner attention, as the debt accumulated by the weaker GIIPS economies1 strains stronger nations such as Germany, and taxes the capabilities of the European Financial Stability Facility and commitment of its member states. Additionally, austerity programs and higher taxes aimed at reducing large deficits, while necessary for the longer term, will likely continue to impede growth and weaken consumer and business sentiment in the near term. This

suggests that serious challenges remain as the region works toward economic stability. While the U.K. is not part of the eurozone, the outlook there seems fairly unappealing for many of the same reasons. The U.K. has high levels of consumer and government debt, as well as large government deficits. Attempts to cut government spending have met with significant resistance and have acted as a drag on an already slowing economy. This contrasts with other non-eurozone countries like Switzerland and the Nordic region that offer more economic and fiscal stability. On the other side of the globe, Japan struggles with an aging demographic profile, high public debt levels, and an export sector exposed to an appreciating yen and slowing global economylikely a recipe for continued anemic growth going forward. Elsewhere in Asia, and more broadly in emerging markets,

new middle class consumers and corporations offer opportunity for growth and investment. nAVIgAtIng WeAkeR mARkets With most mature economies seeking to reduce fiscal deficits, we believe economic growth in the developed world is likely to remain weak. As a result, inflation should stay subdued, and interest rates can remain at low levels. We believe that spending will remain weak, and therefore see little appeal in companies that rely on a buoyant consumer in Europe or Japansuch as auto manufacturers and more appeal in companies with a more defensive customer profile. We also believe that prospects for multinational businesses with established operations in North America and Emerging Markets are more attractive than those with operations focused on Europe or Japan. A number of Europebased companies have many decades

eurozone likely to lag, While eM should lead global groWth % Year- over-Year Econo mic Grow t h Projections 2010 Eurozone United Kingdom United States Canada Japan Emerging Markets World Output Source: IMF World Economic Outlook, September 2011. 1.8 1.4 3 3.2 4 7.3 5.1 2011 1.6 1.1 1.5 2.1 -0.5 6.4 4 2012 1.1 1.6 1.8 1.9 2.3 6.1 4

1. Greece, Italy, Ireland, Portugal and Spain.

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of experience operating in emerging markets, offer strong corporate governance and transparency, and trade at attractive valuation levels today. Within Europe and Japan, we believe defensive sectors like health care and consumer staples hold appeal. We also find certain segments of the consumer discretionary sectors attractivesuch as cable TV and satellite broadcastingwhere many companies maintain a recurring stream of revenue that tends to be insensitive to the economic backdrop. We also view parts of the information technology and industrial sectors in the same light, as many companies in these areas derive most of their profits from maintenance or service revenue. Even in mature markets, we believe that telecommunications spending will continue to rise, as consumers adopt more data-intensive devices and applications. Within this area, we believe that cellular operators and equipment suppliers are likely to benefit from greater volumes and capital spending.

In contrast, we are generally pessimistic about the financial sector, as we believe that the developed world is in a prolonged period of deleveraging. Credit markets globally remain vulnerable to policy in Europe, which represents an area of potential risk that it seems prudent to avoid. IdentIFYIng AReAs OF stRength In Europe, once one steps outside the markets at the center of the debt issue, we believe there are attractive investment opportunities. Countries such as Norway and Switzerland are good examples. Norway has retained its own currency, has limited public debt, and maintains significant oil reserves. Switzerland has also retained its currency and is home to several world-class global health care and consumer staples companies that operate in a variety of developed and emerging markets. Similarly, while we expect the U.K. economy to remain lackluster, there are solid companies in Britain that appear well-positioned with global brands and operations.

From our perspective, a well-rounded approach to international equity investing should also consider nonEAFE index exposure. The Canadian economy fared well through the global financial crisis of 2007-09, and is home to some of the worlds leading energy, precious metals and agricultural commodities companies. Emerging markets include many companies that are relatively insensitive to policy changes in their home markets and offer a strong strategic position in global markets. Overall, we believe that international markets offer compelling valuations and select areas for secular growth. While there are countries and sectors to avoid, we think there are also world-class opportunities for longterm investors willing to look beyond the headlines.

This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Investing entails risks, including possible loss of principal. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results. Investing in foreign securities involves greater risks than investing in securities of U.S. issuers, including currency fluctuations, interest rates, potential political instability, restrictions on foreign investors, less regulation and less market liquidity. Investing in emerging market countries involves risks in addition to those generally associated with investing in developed foreign countries. Securities of issuers in emerging market countries may be more volatile and less liquid than securities of issuers in foreign countries with more developed economies or markets. Please see disclosures at the end of this publication, which are an important part of this article.

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Emerging Markets: Real Growth in a Weakening Global Economy

Conrad A. saldanha, CFA, Portfolio manager global equity team

After sharp losses stemming from extreme risk aversion during 2011, we believe emerging markets (EM) equities may be poised for a reboundfirst for larger-capitalization stocks and then smaller-cap issues. In our view, fundamentals remain strong and, after the sell-off, valuations have become compelling. Perhaps most importantly, compared with the headwind that we expect developed market companies to experience, EM companies are currently benefiting from real secular growth. While risks remain, including domestic inflation and ongoing global economic pressures, we believe that EM companies focused on meeting domestic demand have attractive return potential in the year ahead.

seLL-OFF In 2011 WAs IndIsCRImInAte As 2011 began, loose monetary policy in the developed markets helped push commodities and energy prices higher. This caused EM central bankers to focus on taming inflation. The need for vigilance was particularly pertinent in high-growth economies such as China, India and Brazil, and policymakers embarked on monetary tightening programs in an effort to limit the risk of their economies overheating. While this made sense economically, the policy caused EM investors to worry about slowing growth. In the second half of the year, the European sovereign debt crisis intensified. This, along with signs of slowing growth across the major developed economies, and a potential hard landing for the Chinese economy, led markets to a period of massive risk aversion.

Given the risk-aversion sentiment, although fundamentals generally remained strong, investors sold off EM equities. This risk-off trade began in the third quarter, with the MSCI Emerging Market Index declining 22.5%, the worst performance since the fourth quarter of 2008. Now, with valuations at attractive levels, and relatively superior economic growth rates, we view this as an attractive time for investors with a longer-term view to reconsider emerging markets. seCuLAR gROWth And the dOmestIC AdVAntAge From our perspective, the secular advantages emerging markets enjoy over developed markets have only increased, driving and sustaining their longer-term growth trajectories. Gross domestic product (GDP) growth is highin fact, some research suggests

eMerging Markets : unparalleled groW th at a loW priCe Forward Price/Earnings* 35 30 25 20 15 10 5 0 3/06 9/06 3/07 9/07 3/08 9/08 3/09 9/09 3/10 9/10 3/11 9/11 11/11 5 0 15 10 25% 20 Forward EPS Growth Rates

3/06 9/06 3/07 9/07 3/08 9/08 3/09 9/09 3/10 9/10 3/11 9/11 11/11 MSCI World

MSCI Emerging Markets Sources: MSCI, FactSet, RIMES. Data as of November 30, 2011. * Based on one-year estimates. Based on 3-5 year earnings-per-share growth rates.

1. Source: Morgan StanleyGlobal Economics, August 2011. 9

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that up to 80% of global GDP growth will be generated from the emerging markets in 2012.1 In addition, emerging markets countries tend to have strong balance sheets versus the overly indebted developed market countries. Longer term, we believe one of the most important secular drivers for EM economies is their demographic profile: Young and growing populations are rapidly increasing their standards of living and consumption habits, driving growth for many domestically focused consumer staples, consumer discretionary and health care companies. These countries also have to spend on local infrastructure that will benefit local growth, improving efficiency and raising capacity. A new positive shift weve seen is taking place within emerging markets export sectors, which have traditionally been aimed at developed markets. In light of a slow global economy, intra-emerging markets trade has been the key growth driver for the export sector, and has resulted in more exports remaining in EM. Clearly, companies with the brand, distribution and exposure to other growing economies appear, at this point, better positioned than those relying on developed markets for their growth. In terms of market capitalization, we see the most compelling valuations in small- and mid-cap stocks, as they underperformed for much of 2011

when investment fund flows migrated out of EM. With a longer-term view, we think they offer an attractive risk/ reward profile as, in general, they are well-positioned to benefit from the domestic growth. Issues RemAIn but ARe ReLAtIVe The types of issues we see in emerging markets can be categorized either as exogenous (such as effects of the global economic slowdown, EM investor behavior and liquidity issues) or internal (inflation or sub-optimal growth). While any of these could impact equity market performance, we take comfort in the idea that strong secular growth stories with solid company and economic fundamentals should hold investment appeal, particularly in light of the challenges facing developed equity markets. Regarding inflation, while emerging markets companies continued to see strong growth in 2011, higher raw material and input costs as well as higher wages created some margin pressure. We think these effects will start to taper off; and, from an earnings growth standpoint, we continue to feel more comfortable with the domestically oriented sectors. To maintain growth in a slowing global economy, many countries are either already cutting rates or nearing the end of tightening cycles. In cases where inflation has remained

fairly sticky, as in China and India, policymakers appear to want to see evidence that inflation has abated before making definitive moves. On the other hand, in Turkey, Indonesia and Brazil, rate cuts are already underway. For Brazil, specifically, high rates had strengthened the real, which has hurt export sectors. A surprise rate cut last summer was aimed at removing some of the upward currency pressure. The fact remains, however, that there is structural inflation in emerging markets, with wages increasing considerablywhich, in part, also fuels strong domestic demand. To help increase productivity and offset wage pressures, investments in capacity will be needed. A general lack of capacity is an ongoing problem hampering overall growth, but it provides another secular investment theme focused on industrial and materials companies. CAutIOus OPtImIsm As we look to the year ahead, we are cautiously optimistic. When the market returns to focusing on the fundamentals, we think domestically driven emerging markets companies could be a real growth story for 2012.

This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. Investing entails risks, including possible loss of principal. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results. Investing in foreign securities involves greater risks than investing in securities of U.S. issuers, including currency fluctuations, interest rates, potential political instability, restrictions on foreign investors, less regulation and less market liquidity. Investing in emerging market countries involves risks in addition to those generally associated with investing in developed foreign countries. Securities of issuers in emerging market countries may be more volatile and less liquid than securities of issuers in foreign countries with more developed economies or markets. Please see disclosures at the end of this publication, which are an important part of this article.

10

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Greater China: Challenges, Select Opportunities

Frank Yao, senior Portfolio manager greater China equity team

In recent years, China has achieved generally stable and rapid economic growth, averaging 10% gross domestic product (GDP) growth in the last 31 years, and 9.4% in the first three quarters of 2011.1 As we look to 2012, however, the sluggish world economy and market volatility may pose significant challenges for investors. Does the Greater China region continue to provide opportunities? In our view, the answer is yes, especially in view of 2011 market declines; although selectivity, as always, will be important in this relatively volatile segment of the worlds capital markets. gROWth RemAIns stROng, VALuAtIOns COmPeLLIng Projected growth rates for China, albeit lower than those seen recently, remain strong. The Chinese government has targeted GDP growth of approximately 7% for the next five years,2 and we anticipate Chinese GDP growth rates of 8.5% and 8% over the next three and five years, respectively. If GDP growth rates for other economies remain in line with consensus estimates, these figures would be among the highest in Asia and about two times that of U.S. and Europe combined. Chinese per capita GDP and private consumption are much lower than those of other major economies. This reflects the vast gap in living standards between China and developed economies and, we believe, supports the case
1. 2. 3. 4. 5. 6. 7. 8.

for continued strong growth. Also important, bargain-hunting opportunities have emerged following the recent market corrections, with valuations near 2008 lows despite what we consider to be very strong earnings potential. For example, the trailing 12-month price/earnings ratio for the MSCI China Index was 8.4 as of September 30, 2011.3 This is despite projected 2012 earnings-per-share growth in the low teens for MSCI China and mid-teens for the China A-shares market. undeRWeIghted In gLObAL IndICes In our view, Greater Chinas weighting in global indices does not properly reflect its size, importance and influence in relation to global markets. Mainland China is the worlds largest emerging market and Greater China4 (including Hong Kong and Taiwan) is the second-largest equity market in terms of market capitalization. However, the MSCI global indices only include a subset of the Greater China markets and do not reflect the entire opportunity set. The MSCI World Index contains only Hong Kong companies listed in Hong Kong, which represents just 1.3% of the index total.5 Meanwhile, China is captured in the MSCI Emerging Markets (EM) Index only as mainland Chinese companies listed in Hong Kong, and comprises 17.3% of

the index (see display) 6 versus 15.3% for Brazil. In fact, Greater China has a market capitalization of over three times that of Brazil, but the market is under-represented by global indices because only a portion of it is captured. In our view, this misalignment underscores the magnitudeand, therefore, the opportunity setof the potential investment universe within the Greater China equity markets (see display on page 12). shIFt tOWARd dOmestIC COnsumPtIOn Historically, GDP growth in China has been driven by government investment. Today, although still the worlds largest exporter, the country is becoming less dependent on fixed asset investment and foreign trade for growth, reflected by its standing as the worlds second-largest importer. In the first three quarters of 2011, growth of imports outpaced that of exports, up 26.7% versus 22.7%, respectively.7 Another key metric is retail sales, which we consider an important indicator of domestic consumption. Retail sales rose 17.7% yearover-year in September 2011 and 17% in the first three quarters of 2011.8 We believe these shifts in Chinas growth model will contribute to the sustainability of its long-term expansion.

National Bureau of Statistics of China. Outlines for the 12th Five-Year Plan on National Economic and Social Development, March 2011. Bloomberg, as of September 30, 2011. Greater China includes companies incorporated, organized under the laws of, or that have a principal office in, the Peoples Republic of China, Hong Kong SAR, Macau SAR or Taiwan. It also includes companies that derive a majority of their revenue or profits or that have a majority of their assets in mainland China or Taiwan. Barclays Capital, as of August 31, 2011. Greater China represents Hong Kong companies listed in Hong Kong, which is in the MSCI World Index. Barclays Capital, as of August 31, 2011. China represents Mainland China companies listed in Hong Kong, which is in the MSCI Emerging Markets Index. Chinas Foreign Trade to Top $3 trillion This Year: Official, China Daily, October 29, 2011. Total Retail Sales of Consumer Goods in September 2011, National Bureau of Statistics, China. 11

GLOBAL EqUITIES

China index Weightings underWeight Major Market Grow t h , Market C apit aliz ation of L argest Em erging Eq uit y M arket s GDP Real Rate (% as of July 2011) 12% Brazil China1 Mainland China 17.64% 15.32% India Indonisia Russia 6 Brazil 4 Malaysia South Korea Taiwan 0 0 Mexico 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 Market Capital ($ in billions as of September 30, 2011) Source: Bloomberg and CIA World Fact Book, as of September 30, 2011. Size of circle represents size of market capitalization. Mainland China includes A and B shares only. 2.83% Source: Barclays Capital, as of August 31, 2011. 1. China represents Mainland China companies listed in Hong Kong, which is in the MSCI Emerging Markets Index. 2. Others include Chile, Colombia, Czech Republic, Egypt, Hungary. Malaysia, Mexico, Morocco, Peru, the Philippines, Poland, Thailand, Turkey. 7.89% 6.74% 14.38% 6.95% India 10.99% 17.25% Korea Russia South Africa Taiwan Others2 MSCI Em erging M arket s I nde x Con stitue nt s

10

Turkey

InFLAtIOn COnCeRns AbAte Throughout 2011, the Chinese government grappled with balancing slowing growth and the potential for high inflation. Since September 2010, the Peoples Bank of China (the countrys central bank) has been active in its tightening policyraising benchmark interest rates five times and increasing the reserve requirement ratio for major banks to a record 21.5% from 17% last year.9 However, of late, policymakers have eased these measures due to potential concerns over social unrest and slowing growth. Overall inflation (as represented by the Consumer Price Index) peaked in July 2011 at 6.5% and has gradually decreased, easing to 6.2% in August

2011 and dipping slightly below 6.1% in September 2011.10 We expect inflation of approximately 5% for the last quarter of 2011. Compared with the countrys savings rate of approximately 3.5%, the real savings rate (after inflation) is still negative. While we believe it remains too early to confirm that inflation has abated, we feel that the easing to date is a positive indicator. AmId sLOWIng, LOOk tO IndustRY LeAdeRs Looking ahead to 2012, Chinas economic prospects will likely be affected by slower projected growth in the U.S. and Europe. However, we think a healthy job market supported by rising wages reinforces the potential for select opportunities in sectors driven

by economic growth and consumption, such as consumer discretionary and consumer staples. Within these sectors, we are more optimistic about companies that are leading players in their respective industries, with high top- and bottom-line visibility, stable and recurring operating cash flows, and robust distribution channels. More broadly, although short-term uncertainties persist, we believe the Greater China equity markets are at compelling valuations and seem likely to rebound during the coming year. In our view, taking a bottomup approach using on the ground research will be the best way to try to limit the potential pitfalls and capitalize on the opportunities in the region.

9. Corporate Yield Gap Shrinks as China Curbs Ease, Bloomberg, October 30, 2011. 10. National Bureau of Statistics of China. This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Investing entails risks, including possible loss of principal. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results. Please see disclosures at the end of this publication, which are an important part of this article. 12

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