1) INVESTMENT MANAGEMENT COMMENTARY | DECEMBER 2015 Global Fixed Income Bulletin Central Banks Lead the Market Outlook TABLE OF CONTENTS 1 Outlook Central Bank (ECB) polices, or the anticipation there of. Asset performance and economic health should be viewed through the lens of financial conditions—a central banks scorecard of policy actions. Financial conditions globally became easier in November and global asset prices broadly improved as a result. • We expect U.S. rates to rise in line with current forwards, but with a bearish bias. Since we expect the Fed to follow a dovish hiking path, we believe that any aggressive market re-pricing of short-term U.S. Treasuries could be disappointed. In light of this, we remain underweight U.S. duration. • Broadly, we expect a rebound in emerging markets (EM) growth in 2016 and 2017 as the negative impact from Brazil and Russian lessens. In China, we continue to believe that the country will avoid a hard landing. We expect further stimulus in the form of additional, most likely quarterly, interest rate/required reserve ratios (RRR) 1 cuts, infrastructure spending, and easing of credit conditions. Following the much-anticipated inclusion of the yuan (CNY) in the International Monetary Fund’s (IMF) special drawing rights (SDR)2 in early December, we believe that Chinese economic policy makers may widen the trading band but continue to hold the CNY relatively stable against the USD over the medium-term to avoid talk of Chinese “currency wars.” • Current credit spreads are above the long-run averages across markets, and in the U.S. are over one standard deviation above long-term averages. The market seems to be pricing in a more stressed economic backdrop than is our base case for continued positive, but below par, growth, combined with abundant central bank liquidity. As such we feel that current valuations offer an attractive investment opportunity, with the potential positive excess returns as spreads recompress to levels more appropriate to the risks we observe. • We believe non-agency mortgage-backed securities (MBS) remain one of the more stable and attractive fixed income asset classes. We remain positive on the U.S. housing market given the strength of the U.S. economy, continued low mortgage rates, and above-average home affordability. We are cautiously overweight commercial mortgage-backed securities (CMBS). Currently, we favor seasoned CMBS issues over 2015-vintage originations. Seasoned CMBS have improved credit conditions due to this property price appreciation, over newly originated deals which may have somewhat inflated property valuations as part of its underwriting. Interest Rates & Currency Outlook 2 • Asset performance in November was dominated by Federal Reserve (Fed) and European 2 EM Outlook 3 Credit Outlook 4 Securitized Outlook 4 Market Summary 5 Developed Markets 6 Emerging Markets 7 External 7 Domestic 7 Corporate 7 Corporate Credit 8 Securitized Products November was a month where price-actions for assets were largely dominated by well-advertised and anticipated central bank events from both the Fed and the ECB. The Fed is expected to hike rates at the December FOMC meeting and the ECB is expected to add additional policy stimulus. As a result, U.S. yields rose and the USD strengthened while European government bond yields fell and the euro weakened. What is perhaps more important is that despite an anticipated rate hike from the Fed and a strengthening USD, risk asset prices such as equities rose and credit spreads were The Required Reserve Ratio (RRR) is the fraction of deposits that regulators, in this case, the Federal Reserve, require a bank to hold in reserves and not loan out. 1 Special drawing rights (SDR) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund. 2 The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.
2) GLOBAL FIXED INCOME BULLETIN stable to tighter. In terms of financial conditions, improvement in equities and credit spreads was sufficiently strong enough to offset the rise in yields and in the USD such that U.S. financial conditions did not tighten and, in fact, eased a little bit. This suggests that the market is not worried about the first rate hike in nine years and expectations are that the Fed will hike rates very slowly. We expect continued ECB purchases to push euro periphery real yields lower, if not into negative territory, similar to what happened in the U.S., in order to bring about the necessary financial and economic rebalancing to increase inflation expectations. Based on this view, we continue to be overweight inflation-protected bonds in Italy and Spain and somewhat neutral on Euro Area duration. In Europe, the markets well anticipated and priced in a substantial easing from the ECB the first week of December. This dominated price action as the euro weakened, core yields fell and peripheral spreads tightened. Additionally, riskier assets also improved as equity and credit spreads performed well. This added up on all counts to a substantial easing of financial conditions across the Eurozone. The question then for the markets in the months ahead is if the boost provided by ECB policy stimulus will be sustainable and enough to negate disinflationary fears. We expect that a China-related commodity-based slowdown and slow growth should keep monetary policy in Australia and New Zealand easy. We believe that Australia and New Zealand government bonds should outperform, if not trade through, U.S. Treasuries in the next one to two years. We continue to be overweight these markets. Emerging markets were wobbly in the face of the policy moves from the Fed and ECB. Perhaps more important to emerging markets was performance from China. The Chinese economy has shown some signs of stability as officials continued to support easier policies. Some markets, such as Australia and New Zealand, were beneficiaries of the recent stability in China as economic data has rebounded a bit in those countries. We view this as only temporary, as China will likely continue to slow. The question, of course, is if the slowdown is orderly. Early indications are that it might be. In summary, asset performance in November was dominated by central bank polices, or the anticipation there of. This has been a common theme throughout the crisis. Asset performance and economic health should, therefore, be viewed through the lens of financial conditions—a central bank’s scorecard of policy actions. Financial conditions globally became easier in November and global asset prices broadly improved as a result. Interest Rates & Currency Outlook Economic data in the U.S. has stabilized since mid-October suggesting that spillover concerns from the turbulence created by China were misplaced. U.S. financial conditions have eased since August/September. The combination of October’s improvement in U.S. data and the return of VIX (widely viewed as the financial market stress indicator) to normal levels has been sufficient to allow the Fed to signal that lift-off is likely in December. We expect U.S. rates to rise in line with current forwards, but with a bearish bias. Since we expect the Fed to follow a dovish hiking path, we believe that any aggressive market re-pricing of short-term U.S. Treasuries could be disappointed. In light of this, we remain modestly underweight U.S. duration with a bias towards being underweight intermediate and longer-maturity yields. 2  In terms of currency positioning, we see the trend towards a stronger U.S. dollar resuming as the Fed prepares to hike and thus remain overweight the currency. We have been underweight the euro in expectation of further easing from the ECB. On the back of moderate global growth, China slowdown, and dovish central banks, we have also been underweight commodity and Asian currencies. EM Outlook Over the next few months, the primary risks that we will continue to monitor include the path of Chinese economic growth, currency and monetary policy, the potential for rising U.S. interest rates, and the direction of commodity prices. We think that any volatility generated by the Fed lift-off could provide interesting entry opportunities for select EM assets as we think that the Fed will be very cautious with future hikes and that its rate hiking cycle will end well before its current expectations. Broadly, we expect a rebound in EM growth in 2016 and 2017 as the negative impact from Brazil and Russian lessens. In China, we continue to believe that the country will avoid a hard landing, supported by higher frequency economic indicators pointing to an ongoing stabilization at a lower level of growth. We do believe, however, that “actual” Chinese economic growth will fall far short of the official targeted growth rate of 7 percent this year and approach 6 percent. Next year’s likely target of 6.5 percent growth is also likely to be missed even though significant fiscal and monetary stimulus remains in the pipeline. With manufacturing PMI releases stabilizing at low levels, we expect further stimulus in the form of additional, most likely quarterly, interest rate/RRR cuts, infrastructure spending, and easing of credit conditions. Property prices continue to show signs of stabilization/recovery, which should continue to support growth. Following the much-anticipated inclusion of the CNY in the IMF’s SDR in early December, we believe that Chinese economic policy makers may widen the trading band but continue to hold the CNY relatively stable against the USD over the medium term to avoid talk of Chinese “currency wars.” The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.
3) COMMENTARY | DECEMBER 2015 With challenges facing several EMs due to a difficult external growth and commodity price backdrop, their sovereign ratings are seen to be increasingly at risk. In particular, we monitor those countries on the cusp of losing their investment grade (IG) status, as it can result in a higher cost of financing. The fall from IG to high yield (HY) can impact a country’s inclusion in key benchmark indices and also limits the ability of many institutional lenders to invest in the country as they often have credit rating restrictions. Given the general election outcome in Turkey, we now expect the country to hold on to its IG rating as long as it re-commits to fiscal discipline and avoids attempts to once again put into question central bank independence. Conversely, we continue to expect that Brazil, given the disappointment in terms of fiscal discipline and growth, will lose the second of its three IG ratings at some point before the end of the first quarter of 2016 unless there is a significant shift in policies or regime change. Moody’s may very well downgrade Brazil by mid next year. Bucking the negative ratings trend, there are upgrade candidates in EM. Early next year for example, we expect Hungary to regain its first IG rating in five years, and the Philippines to be upgraded. Despite a narrowing of the EM/developed markets (DM) growth differential and a weakening of fundamentals since the global financial crisis, EM economies are still in better health than they were 10 to 15 years ago with lower levels of external debt as a percentage of GDP, freely floating exchange rates, relatively large buffers in the form of foreign currency reserves, and growing local debt markets supported by generally robust and well-capitalized banking systems. In the absence of extremely attractive valuations and/or an improving fundamental outlook, EM economies must recommit to structural reforms to address economic challenges and restore widespread faith by the investment community. The election of reform-minded candidates, like those in Indonesia, India, and most recently Argentina, are steps in the right direction for these economies. For long-term investors, EM debt still offers attractive real yields for an IG asset, on average, providing carry and potential spread compression, which could provide a buffer should interest rates begin to rise in the U.S. With many in the market forecasting moderate growth and low inflation, we believe EM debt should perform well for investors looking for diversification, yield/carry, and total return potential (via yield and spread compression). We note that with valuations reaching extreme levels during the global sell-off in September, value is once again starting to emerge in some assets. Of note, local currency EM debt may have already adjusted sufficiently to compensate for the more challenging global environment in the year ahead. Credit Outlook On the macro front, the focus of the market remains the divergent direction of monetary policy. The market is increasingly pricing in the Fed announcing an increase in the fed funds rate at their December meeting, with much commentary from Fed board members indicating that economic conditions are strong enough to support such a move. Not only is monetary policy diverging, but the differing economic outlook has also been a key driver of management behavior and risk appetite. After three or four years of positive economic growth, the U.S. economy has entered into a more mature stage of the credit cycle. Margins and earnings have peaked, equity multiples are high, and management have sought for alternative ways of rewarding shareholders. This has been achieved in part through debt-funded acquisition, share buybacks and elevated dividend payments. Global mergers and acquisitions (M&A) has reached a new peak of over $2.5 trillion3, and the U.S. has seen the majority of this activity, as companies have sought to buy growth. Furthermore, U.S. share buybacks are close to their pre-crisis peak, and have exceeded free cash generation on an aggregate basis. This late cycle re-leveraging has resulted in weaker credit metrics and significantly higher volumes of bonds issued to the U.S. credit markets. The credit cycle in Europe is much less advanced, with the last leg of the sovereign crisis still fresh in management’s consciousness and economic growth continuing to run below trend. Consequently, management risk appetite in Europe remains lower, credit metrics remain sound, and we have seen lower volumes of issuance in the primary market. Credit spreads remain elevated relative to historical levels, particularly in the U.S. where late cycle corporate leveraging, active primary market issuance and the expectation of tighter monetary policy from the Fed lowering demand for fixed income assets have resulted in higher risk premiums. Credit spreads in Europe have been pulled wider in line with the U.S. market, despite more supportive technical and fundamental conditions. Current spreads are cheap to the long-run averages across markets, and in the U.S. are over one standard deviation above long-term averages. Historically, these levels of spreads have been associated with periods of economic recession or systemic stress. The market seems to be pricing in a more stressed economic backdrop than is our base case for continued positive, but below par, growth, combined with abundant central bank liquidity. As such, we feel that current valuations offer an attractive investment opportunity, with the potential positive excess returns as spreads recompress to levels more appropriate to the risks we observe. 3 Source: Bloomberg. Data as of November 30, 2015. The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.   3
4) GLOBAL FIXED INCOME BULLETIN Securitized Outlook We remain slightly underweight Agency MBS. Agency MBS have performed reasonably well in 2015, but they remain expensive by historical measures. Mortgage rates and prepayment speeds have been range-bound, helping support the performance so far, but with the possibility of a Fed rate hike in the coming months, volatility and absolute rate levels could rise and MBS duration extension concerns could return. There is also the additional risk that the Fed could end their MBS purchase program, which is currently buying 25 to 30 percent of all new origination,4 at some point in 2016. Although current MBS carry is moderately attractive, we believe the potential risks to supply and performance over the next six months possibly outweigh the benefits of this carry, and thus we remain underweight. We also believe that the current opportunities in more credit-sensitive securitized sectors, particularly non-agency MBS and CMBS, offer better risk-adjusted relative value than Agency MBS Non-agency MBS remains one of the more stable and attractive fixed income asset classes. Given the attractive carry, improving fundamentals, and shrinking net supply, we remain overweight the non-agency MBS sector. Non-agency MBS offers spreads of 175 to 225 basis points (bps) above U.S. Treasuries for IG bonds, and 275 to 375 bps for non-IG bonds on a loss-adjusted basis.5 We remain positive on the U.S. housing market given the strength of the U.S. economy, continued low mortgage rates, and above-average home affordability. From a supply perspective, we project outstanding non-agency MBS to decline by $60 billion to $70 billion this year, while new securitizations are projected to only amount to $40 to $50 billion in 2015. We are cautiously overweight CMBS. We expect that commercial real estate fundamental conditions will continue to improve as the U.S. economy strengthens, and we believe CMBS is poised to perform well as a result, but we have some concerns over supply/demand dynamics given the recent spread volatility and our expectations of future increases in new origination and issuance. We also have some concerns over 2015-vintage origination CMBS due to the substantial increase in property values over the last few years. We favor seasoned CMBS issues, which have improved credit conditions due to recent property price appreciation, over newly originated deals which may have somewhat inflated property valuations as part of its underwriting. Although we expect continued volatility in CMBS towards the end of the year, we still believe that CMBS offers attractive relative value and should continue to benefit from improving fundamental market conditions. In Europe, we believe the recent spread widening in UK and peripheral Europe represents an attractive buying opportunity. The fundamental conditions in both the UK and continental Europe are improving. The UK economy is gaining strength, which should benefit commercial and residential real estate prices. Within the European Union (EU), the ECB appears to be committed to its stimulus policies, which we believe will help reflate asset prices, similar to what the U.S. has experienced over the past six years. We expect to see increasing European ABS supply, but also improving fundamental conditions in Europe in 2016. Display 1: Asset Performance Year-to-Date Japan Nikkei 225 Dollar index Italy 10yr gov. bonds MSCI developed equities Spain 10yr gov. bonds ML Euro HY Constrained US S&P 500 JPM External EM Debt UK 10yr gov. bonds German 10y Bund ML US Mortgage Master Japan 10yr gov. bonds US 10 year Treasury S&P/LSTA Leveraged Loan Index Barcap Euro IG Corp Barcap US IG Corp ML US HY JPY vs. USD MSCI emerging equities MSCI Asia ex Japan GSCI soft commodities Gold EUR vs. USD JPM Local EM Debt Brent crude oil Copper -40% 15.0 11.0 6.6 4.9 3.8 3.7 3.0 2.8 1.8 1.7 1.5 1.2 1.2 0.4 0.3 0.1 -2.1 -2.7 -4.4 -5.2 -9.2 -10.1 -12.7 -13.0 -22.2 -27.8 -30% -20% -10% 0% 10% 20% Note: U.S. dollar-based performance. Source: Thomson Reuters Datastream. Data as of November 30, 2015. Market Summary Global bond performance diverged as markets anticipate policy tightening in the U.S. and easing in the Euro Area. For the month, U.S. yields were higher, while U.K. and European yields ended the month lower. The dollar broadly rallied against the rest of the world.6 Over the month, 10-year U.S. Treasury yields increased by 6 bps while the 2s10s curve flattened by 14 bps. Ten-year German yields decreased by 4 bps, while 2-year German bund yields decreased by 10 bps. Ten-year yields in Ireland, Italy, Spain, and Portugal decreased by 6 to 22 bps.7 Meanwhile, the Greek government successfully concluded its review to unlock the first tranche of bail-out payment. Greek 10-year government yields 4 Source: Federal Reserve. Data as of November 30, 2015. 6 Source: Bloomberg. Data as of November 30, 2015. 5 Source: Credit Suisse. Data as of November 30, 2015. 7 Source: Bloomberg. Data as of November 30, 2015. 4  The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.
5) COMMENTARY | DECEMBER 2015 decreased by around 36 bps on the month. Japanese government bond (JGB) 10-year yields were unchanged.8 In November, the dollar strength continued. The pound lost 2.4 percent against the dollar.9 The euro was among the biggest losers in the month, losing around 4.0 percent. Hungarian forint and Polish zloty also lost 4.1 percent and 4.4 percent, respectively. The Japanese yen lost 2.0 percent against the dollar for the month.10 Crude oil (Brent) prices dropped from $50 to $45.11 Developed Markets In the U.S., the Fed released the minutes to the October meeting. In regards to the lift-off, most participants thought conditions for policy normalization could be met by the time of the next meeting. Some were concerned that a delay in policy firming would increase uncertainty in financial markets, increase the buildup of financial imbalances due to very low rates, or erode the Federal Open Market Committee’s credibility. Moreover, the Committee noted that it should underscore at the time of the lift-off that the expected path, rather than the timing of increase, is more important for financial conditions. The minutes revealed that the Committee discussed the short-run equilibrium real interest rate, the rate that would result in the economy operating at full employment and price stability, and estimated it to be around zero. The long-run equilibrium is likely also lower compared to that of pre-financial crisis. The market, thus, expects the long-run nominal fed funds rate to likely be lower than it was in previous periods. In terms of data, October nonfarm payrolls increased 271,000 versus expectations of 185,000, and September nonfarm payrolls were revised lower to 137,000 from 142,000. The unemployment rate decreased from 5.1 percent to 5.0 percent, in line with consensus. Average hourly earnings rose 2.5 percent, above the previous print of 2.3 percent.12 The ISM manufacturing index declined to 48.6 in November from 50.1 prior, below consensus expectations of 50.5. Q3 GDP was revised to 2.1 percent from 1.5 percent, in line with consensus expectations. Headline CPI was 0.2 percent and core CPI was 1.9 percent for October.13 In the Euro Area, the ECB published accounts of the October meeting, which was dovish and consistent with the tone of the October press conference. The Governing Council acknowledged that market expectations for easing had increased. Some in the Council argued for action in the October meeting while others wanted to avoid reaching premature conclusions from the latest data. Risks to growth were seen to be on the downside due to the outlook in emerging markets, though domestic demand has proved to be resilient. In terms of survey data, final Euro Area manufacturing PMI came in at 52.8 in November, above 52.3 in October, and above consensus expectations of 52.3.14 The initial Q3 GDP print was 0.3 percent quarter-on-quarter, slightly below consensus expectations of 0.4 percent. Euro Area inflation was revised higher to 0.1 from flat in October.15 In the U.K., the Bank of England (BoE) voted 8-1 to keep monetary policy unchanged. The meeting gave little indication as to the timing of a possible lift-off. The Monetary Policy Committee (MPC) also published the November Inflation report. Growth was lowered by 0.1 to 2.7 percent and 2.5 percent for 2015 and 2016. It revised lower the near-term inflation but revised higher the 2-year and 3-year inflation to 2.06 percent and 2.22 percent, respectively. Finally, the MPC expects the unemployment rate to fall to 5.3 percent in Q4 of 2015 and then reach 5.2 percent by Q4 of 2016. In terms of data, headline CPI inflation was -0.1 in October, unchanged from September and in-line with consensus.16 The unemployment rate, three-month average, ticked down to 5.3 percent in September from 5.4 percent in August. UK manufacturing PMI decreased to 52.7 in November, from 55.2 in October, below consensus expectations of 53.6.17 The Bank of Japan (BoJ) voted 8-1 to keep monetary policy and asset purchases unchanged in November. The BoJ maintained that the economy has continued to recover moderately. However, the BoJ made a change to its inflation expectation language, acknowledging that indicators recently show some relatively weak developments, though the long-term trend seems to be still rising. On the data front, manufacturing PMI was 52.8 for November, up from 52.4 in October. The October core national CPI (ex-Food & Energy) came in at 0.7 percent, down from 0.9 in September, and below consensus expectations of 0.8.18 8 Source: Bloomberg. Data as of November 30, 2015. 14 Source: Bloomberg. Data as of November 30, 2015. 9 Source: Bloomberg. Data as of November 30, 2015. 15 Source: Bloomberg. Data as of November 30, 2015. Source: Bloomberg. Data as of November 30, 2015. 16 Source: Bloomberg. Data as of November 30, 2015. Source: Bloomberg. Data as of November 30, 2015. 17 Source: Bloomberg. Data as of November 30, 2015. 12 Source: Bloomberg. Data as of November 30, 2015. 18 Source: Bloomberg. Data as of November 30, 2015. 13 Source: Bloomberg. Data as of November 30, 2015. 10 11 The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.   5
6) GLOBAL FIXED INCOME BULLETIN Display 2: Government Bond Yields For Major Economies 2YR YIELD MONTH LEVEL CHANGE COUNTRY (%) (BPS) 5YR YIELD MONTH LEVEL CHANGE (%) (BPS) 10YR YIELD MONTH LEVEL CHANGE (%) (BPS) Australia 2.01 27 2.31 24 2.86 25 Belgium -0.34 -7 -0.06 -9 0.78 -3 Canada 0.63 6 0.91 3 1.57 3 Denmark -0.58 -9 0.14 -16 0.74 -11 France -0.33 -5 -0.01 -10 0.79 -8 Germany -0.42 -10 -0.18 -10 0.47 -4 Ireland -0.20 -2 0.11 -18 0.99 -12 Italy -0.03 -6 0.37 -13 1.42 -6 Japan -0.01 -1 0.04 0 0.31 0 Netherlands -0.39 -9 -0.13 -9 0.63 -5 New Zealand 2.58 4 2.96 23 3.54 24 Norway 0.53 -9 0.62 -14 1.45 -14 Portugal 0.14 -19 1.01 -28 2.32 -22 Spain -0.03 -6 0.50 -16 1.52 -15 Sweden -0.47 -2 0.11 8 0.75 11 Switzerland -1.10 -26 -0.98 -16 -0.36 -9 United Kingdom 0.60 -2 1.21 -6 1.83 -10 United States 0.93 21 1.64 13 2.21 6 Source: Bloomberg LP. Data as of November 30, 2015. Display 3: Currency Monthly Changes versus U.S. Dollar Currency Monthly Change vs. USD (+ = appreciation) 1.2 Australia 1.0 Malaysia 0.2 Brazil -0.5 Mexico -0.7 Singapore -0.8 Indonesia -1.5 South Korea -2.0 Japan Canada -2.1 Sweden -2.2 UK Following a strong October rally, EM asset performance took a breather in November. Over the month, risky assets weakened and U.S. Treasury yields drifted higher as seasonally low liquidity exacerbated investor repositioning ahead of anticipated interest rate hikes by the Fed in December. Sovereign spreads slightly tightened while domestic debt yields rose and corporate credit spreads widened over the month. EM fixed income investors continued to withdraw money from the asset class, removing roughly $6 billion in November, bringing the year-to-date total to an estimated $22 billion in outflows.19 Politics and policies took center stage over the month. In Argentina, voters elected the market-favored candidate Maurico Macri. The market hopes Macri will be able to tackle the monumental tasks of settling the outstanding debt dispute, liberalizing the exchange rate, addressing rampant inflation, and implementing the needed reforms to revitalize the Argentine economy. Croatian parliamentary elections raised hopes that a reformist coalition government would be formed as the thirdlargest party, MOST (a coalition of independents), performed better than expected. In Romania, after a large nightclub fire prompted protests, political pressure forced the resignation of Prime Minister Victor Ponta, after which a technocratic government was appointed by the President. Another reformist leader, Indian Prime Minister Narendra Modi, suffered one of his biggest setbacks since taking office with a defeat in a crucial state election, dealing a blow to his push for economic reforms. His opponents, led by incumbent Bihar Chief Minister Nitish Kumar, won 73 percent of seats in the state’s 243-member assembly, with the Modi-led National Democratic Alliance taking 24 percent. Turkish elections brought back an outright majority to the ruling AKP party, reducing political uncertainty for the country as it faces ongoing economic and geopolitical challenges. Many central banks across EM held interest rates steady with the exception of Colombia and South Africa, which hiked rates 25 bps each. Indonesia’s central bank reduced required reserve ratios to stimulate the economy without cutting interest rates, which could further weaken its currency which has already been under pressure. -2.4 Norway Emerging Markets -2.4 -2.8 Chile New Zealand -2.9 Russia -3.7 Switzerland -4.0 Euro -4.0 Hungary -4.1 South Africa -4.3 Poland -4.4 Colombia -6.7 -8 -6 -4 -2 0 2 % Change Source: Bloomberg LP. Data as of November 30, 2015. Note: Positive change means appreciation of the currency against the U.S. dollar. 6  19 Source: Standard Chartered. Data as of November 30, 2015. The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.
7) COMMENTARY | DECEMBER 2015 External EM external sovereign and quasi-sovereign debt returned -0.06 percent in the month, measured by the JP Morgan EMBI Global Index, bringing year-to-date performance to 2.77 percent.20 External sovereign and quasi-sovereign assets held in well compared to corporate and domestic debt as U.S. Treasury yields rose, leading to credit spreads tightening 3 basis points. Oilrelated credits performed well as Venezuela, Kazakhstan, Angola and Ecuador outperformed the broader market. Malaysian bonds also performed well after the sovereign wealth fund, 1MDB, announced a planned asset sale which would provide a cash injection. Lower-yielding, higher-rated countries such as Chile, Indonesia, Turkey, Peru, and Mexico underperformed the broader market as U.S. Treasury yields rose in the period. Egyptian bonds underperformed the most in the period as investors priced in reduced tourism revenues after a Russian passenger plane leaving Egypt was brought down by a bomb planted by terrorists. Display 4: EM External and Local Spread Changes COUNTRY Brazil EM domestic debt returned -2.16 percent in the quarter as measured by the JP Morgan GBI-EM Global Diversified Index.21 EM currencies depreciated -2.35 percent versus the U.S. dollar and EM bonds returned 0.18 percent in local terms.22 Colombia, South Africa, Poland, Romania and Hungary underperformed the broader market as currency weakness versus the U.S. dollar drove the negative performance. Colombian and South African domestic debt were also negatively impacted by central bank rate hikes. Domestic debt from Indonesia, Malaysia, the Philippines and Thailand outperformed the broader market, driven primarily by local bond returns as currency performance was mixed. Corporate EM corporate debt returned -0.52 percent in the month as measured by the JP Morgan CEMBI Broad Diversified Index.23 As in other areas of EM debt, higher-yielding, lower-quality companies outperformed IG companies in the month on a relative basis. Regionally, companies in Europe and Asia outperformed those in Latin America, Africa and the Middle East. In particular, companies in Russia, Poland, Hungary, China, Singapore, and Taiwan outperformed the broader market while those in Brazil, Colombia, Mexico and Bahrain lagged. The Metals & Mining sector was the largest underperforming sector in the month while the Real Estate sector posted the strongest returns. 20 Source: JP Morgan. Data as of November 30, 2015. 21 Source: JP Morgan. Data as of November 30, 2015. 22 Source: JP Morgan. Data as of November 30, 2015. 23 Source: JP Morgan. Data as of November 30, 2015. MTD CHANGE (BPS) INDEX LOCAL YIELD (%) MTD CHANGE (BPS) 450 11 15.9 11 Colombia 286 3 8.1 37 Hungary 180 -5 2.7 6 Indonesia 323 15 8.7 -25 Malaysia 216 -68 4.0 2 Mexico 280 5 6.1 11 Peru 224 4 6.9 -4 Philippines 125 7 4.8 -7 Poland 91 2 2.2 0 Russia 273 -14 9.7 -18 South Africa 326 -6 8.9 24 289 10 10.2 43 2605 -87 – – Turkey Venezuela Domestic USD SPREAD (BPS) Source: JPM. Data as of November 30, 2015. Corporate Credit November was a moderately positive month for global risk markets continuing the positive momentum from October, and markets have now recovered much of the weakness of the 3rd quarter. Credit spreads were moderately tighter across the developed markets, and excess returns were positive. The one notable area of weakness in the fixed income markets was U.S. HY, where a large market exposure to commodity prices combined with sustained mutual fund and (exchanged traded funds) ETF redemptions to result in spreads giving back much of October’s gains. EM stabilized in November, consolidating October’s strong returns, despite weakness across the commodities complex. Crude oil prices fell back to the levels last seen in the summer, while metals fell to multi-year lows. Despite some weakness in the first half of the month, equity markets recovered in the second half to end the month largely unchanged. VIX followed a very similar pattern with volatility rising in first half of the month, but falling back to the bottom of the recent range by month end. The global credit markets generated moderately positive excess returns, with the U.S. and Europe reporting 0.22 percent and 0.29 percent excess returns respectively, reflecting credit spreads that tightened by 2 to 3 bps. The financial sector materially outperformed the Industrial sector, both in the U.S. and Europe. This, in part, reflects the relatively lower volume of net issuance into the financial sector, while IG Industrial issuance continues to run at a record pace, both on a gross and net basis. In addition, the secular trend for banks continues to be one of de-risking, while corporate issuers, particularly in the U.S., are in a period of late cycle leveraging. Total returns in HY markets continued to diverge, with the U.S. HY market reporting The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.   7
8) GLOBAL FIXED INCOME BULLETIN materially negative total returns of -2.22 percent, while the Pan European HY index generated positive returns of 0.61 percent, in part reflecting the significantly higher exposure of the U.S. market to commodity sensitive issuers, and in part the continued search for yield in the face of further ECB monetary policy accommodation. Display 5: Credit Sector Changes SECTOR USD SPREAD MONTH LEVEL CHANGE (BPS) (BPS) EUR SPREAD MONTH LEVEL CHANGE (BPS) (BPS) Index Level 155 -4 130 -3 Industrial Basic Industry 268 +24 255 +7 Industrial Capital Goods 121 -6 111 -1 Industrial Consumer Cyclicals 140 -4 134 -3 Industrial Consumer Non Cyclicals 126 -7 107 -1 Industrial Energy 250 +3 125 -6 Industrial Technology 133 -5 92 -2 Industrial Transportation 146 -5 113 -2 Industrial Communications 184 -7 132 -2 Industrial Other 127 -5 158 +7 Utility Electric 145 -1 134 -1 Utility Natural Gas 150 -3 122 -1 Utility Other 161 -4 115 +0 Financial Inst. Banking 118 -10 109 -5 Financial Inst. Brokerage 151 -10 122 -9 Financial Inst. Finance Companies 125 -4 107 -5 Financial Inst. Insurance 155 -4 250 -6 Financial Inst. REITS 169 -5 161 +0 Financial Inst. Other 126 -9 164 +26 Source: Barclays Capital. Data as of November 30, 2015. Securitized Products Agency MBS underperformed U.S. Treasuries in November as the likelihood of a Fed rate hike and higher interest rates became more probable. Current coupon agency MBS were essentially unchanged in nominal spread at 100 bps above interpolated U.S. Treasuries.24 Thirty-year fixed rate mortgage rates decreased 19 bps to finish at 3.82 percent in November.25 The Fed purchased roughly $24 billion agency MBS over the past month, consistent with their forecast and with previous months’ purchase volumes. The Fed’s total MBS holdings remain at $1.75 trillion, or roughly one-third of the agency MBS market.26 Non-agency MBS prices were largely unchanged in November, after having declined in September and October. Fundamental market conditions underlying the non-agency MBS market remain very strong. Home prices rose 0.2 percent in September, and were up 5.5 percent year-on-year from September 2014.27 Despite some mixed headlines, home sales data was very positive in October. October existing home sales were down 3 percent from the very strong September numbers, but remain 4 percent higher than October 2014.28 New home sales in October increased 11 percent from September and were up 5 percent over October 2014.29 The volume of outstanding homes for sale decreased 2.3 percent in October and is now 4.5 percent below a year ago. The 2.14 million available homes for sale represent a 4.8 months’ supply, well below the historically normal equilibrium level associated with a stable housing market.30 The U.S. homebuilder confidence index fell slightly in October, but remains near post-housing-crisis highs.31 Fundamental mortgage performance remains positive. Mortgage defaults in October ticked up slightly from 0.76 percent to 0.81 percent, but remains down from 0.96 percent in October 2014 and well below the nearly 6 percent level in 2009.32 We expect new defaults to remain low given the strength of the housing market, and we expect MBS cash flows to slowly increase as more borrowers are becoming eligible to refinance with rising home prices. 24 Source: Bloomberg, Yield Book. Data as of November 30, 2015. 25 Source: Bankrate.com. Data as of November 30, 2015. 26 Source: Federal Reserve Bank of New York. Data as of November 30, 2015. 27 Source: S&P Case-Shiller 20-City Index. Data as of November 30, 2015. 28 Source: National Association of Realtors. Data as of November 30, 2015. 29 Source: U.S. Census. Data as of November 30, 2015. 30 Source: National Association of Realtors. Data as of November 30, 2015. Source: National Association of Home Builders. Data as of November 30, 2015. 31 Source: S&P/Experian First Mortgage Default Index. Data as of November 30, 2015. 32 8  The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.
9) COMMENTARY | DECEMBER 2015 CMBS spreads widened again in November, marking the fourth straight month of spread widening. AAA-rated CMBS widened 0 to 5 bps on the month, while BBB spreads were 5 to 10 bps wider. BBB spreads are now 100 to 150 bps wider on the year. New issuance volumes decreased slightly to $8 billion in November, after exceeding $10 billion in October.33 The CMBS market remains on-pace for the first $100+ billion issuance year since 2007. Fundamentally, the CMBS sector remains healthy. Retail sales continue to climb, with October numbers up 0.1 percent from September and up 1.7 percent from October 2014, but consumer confidence declined in October.34 Hotel occupancy rates are at their highest levels in more than 15 years at over 65 percent occupancy so far in 2015.35 For comparison, the previous credit cycle peak of 2004 to 2006 averaged roughly 63 percent occupancy. These high occupancy rates are boosting the performance of the hotel sector of CMBS. The improving economy and employment numbers are also helping reduce office space vacancies. National office vacancy rates fell to 0.1 percent to 13.4 percent in Q3 2015.36 Office vacancy rates have either been flat or declined for 22 consecutive quarters. Industrial availability rates declined to 9.6 percent in Q3 2015, also having been flat or declined for 22 consecutive quarters.37 Multifamily vacancy rates declined 0.2 percent from a year ago to 4.2 percent in Q3 2015.38 33 Source: Deutsche Bank. Data as of November 30, 2015. Source: U.S. Census and The Confidence Board. Data as of November 30, 2015. 34 35 Source: Deutsche Bank. Data as of November 30, 2015. Source: CBRE. Data as of November 30, 2015. 38 Source: European Central Bank. Data as of November 30, 2015. 40 Source: CBRE. Data as of November 30, 2015. 37 39 Source: Statistica.com. Data as of November 30, 2015. 36 European ABS spreads tightened in November, particularly in the UK and non-core Europe. European spreads had widened over the past six months, but are beginning to see more demand at these wider levels. The ECB purchased only €600 million Euros of ABS in November, increasing their total ABS holdings to almost 15.2 billion euros.39 European ABS issuance remained low in November, totaling €7.2 billion, and pushing the yearto-date total to €74.7 billion.40 2015 European ABS issuance is on pace to exceed 2014 and record the highest post-crisis annual ABS issuance. Source: CBRE Data as of November 30, 2015. The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.   9
10) GLOBAL FIXED INCOME BULLETIN The views and opinions are those of the author as of the date presented and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. The views expressed do not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers. INDEX DEFINITIONS The indices shown in this report are not meant to depict the performance of any specific investment and the indices shown do not include any expenses, fees or sales charges, which would lower performance. The indices shown are unmanaged and should not be considered an investment. It is not possible to invest directly in an index. All information provided is for informational and educational purposes only and should not be deemed as a recommendation. The information herein does not contend to address the financial objectives, situation or specific needs of any individual investor. In addition, this material is not an offer, or a solicitation of an offer, to buy or sell any security or instrument or to participate in any trading strategy. Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. Past performance is not a guarantee of future performance. The value of the investments and the income from them can go down as well as up and an investor may not get back the amount invested. There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline. Accordingly, you can lose money investing in a fixed income portfolio. Please be aware that a fixed income portfolio may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall. In a declining interest-rate environment, the portfolio may generate less income. Credit risk refers to the ability of an issuer to make timely payments of interest and principal. Interest-rate risk refers to fluctuations in the value of a fixed-income security resulting from changes in the general level of interest rates. In a rising interest-rate environment, bond prices fall. In a declining interest-rate environment, the portfolio may generate less income. High yield securities (“junk bonds”) are lower rated securities that may have a higher degree of credit and liquidity risk. Sovereign debt securities are subject to default risk. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. The currency market is highly volatile. Prices in these markets are influenced by, among other things, changing supply and demand for a particular currency; trade; fiscal, money and domestic or foreign exchange control programs and policies; and changes in domestic and foreign interest rates. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging-market countries are greater than the risks generally associated with foreign investments. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto. 10  Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The J.P. Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for traded external debt instruments in the emerging markets, and is an expanded version of the EMBI+. As with the EMBI+, the EMBI Global includes U.S. dollar-denominated Brady bonds, loans, and Eurobonds with an outstanding face value of at least $500 million. The JP Morgan CEMBI Broad Diversified Index is a global, liquid corporate emerging-markets benchmark that tracks U.S.-denominated corporate bonds issued by emerging-markets entities. The JP Morgan GBI-EM Global Diversified Index is a market capitalization weighted, liquid global benchmark for U.S.-dollar corporate emerging market bonds representing Asia, Latin America, Europe and the Middle East/Africa. The ISM Manufacturing Index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys. The Volatility Index (VIX) is the ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 index options. It represents one measure of the market’s expectation of stock market volatility over the next 30-day period. The VIX is quoted in percentage points and translates, roughly, to the expected movement in the S&P 500 index over the next 30-day period, which is then annualized. The Pan-European High Yield Index measures the market of noninvestment grade, fixed-rate corporate bonds denominated in the following currencies: euro, pounds sterling, Danish krone, Norwegian krone, Swedish krona, and Swiss franc. Inclusion is based on the currency of issue, and not the domicile of the issuer. The index excludes emerging market debt. All charts and graphs referenced in this piece are for illustrative purposes only and are not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. This communication is a marketing communication. This communication is not a product of Morgan Stanley’s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. This communication is only intended for and will be only distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations. The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.
11) COMMENTARY | DECEMBER 2015 EMEA: Issued and approved in the UK by Morgan Stanley Investment Management Limited, 25 Cabot Square, Canary Wharf, London E14 4QA, authorized and regulated by the Financial Conduct Authority, for distribution to Professional Clients only and must not be relied upon or acted upon by Retail Clients (each as defined in the UK Financial Conduct Authority’s rules). U.S.: Morgan Stanley Investment Management does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation. NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT Hong Kong: This document has been issued by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to “professional investors” as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this document have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this document shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This document may only be communicated in Singapore to those persons who are “institutional investors”, “accredited investors” or “expert investors” each as defined in Section 4A of the Securities and Futures Act, Chapter 289 of Singapore (collectively referred to herein as “relevant persons”). Australia: This publication is disseminated in Australia by Morgan Stanley Investment Management (Australia) Pty Limited ACN: 122040037, AFSL No. 314182, which accept responsibility for its contents. This publication, and any access to it, is intended only for “wholesale clients” within the meaning of the Australian Corporations Act. Morgan Stanley is a full-service securities firm engaged in a wide range of financial services including, for example, securities trading and brokerage activities, investment banking, research and analysis, financing and financial advisory services. Morgan Stanley Investment Management is the asset management division of Morgan Stanley. All information contained herein is proprietary and is protected under copyright law. The views and opinions expressed are those of the portfolio management team as of December 2015, and are subject to change based on market, economic, and other conditions. Past performance is not indicative of future results.   11
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