Professional Documents
Culture Documents
On the Markets
MICHAEL WILSON
Chief Investment Officer
A Treat, Not a Trick
Morgan Stanley Wealth Management
After a strong September, it appeared as if we might avoid
the volatile markets typically experienced in the fall.
Instead, the second half of the month and first half of
October played an early Halloween trick on investors, as
several things conspired to create what we believe
amounted to one of the most aggressive risk-off periods
experienced since the financial crisis of 2008 and 2009.
First, the Fed was scheduled to finally end its controversial Quantitative Easing
program in October. Many investors were nervous that the exit would leave the markets
vulnerable. Meanwhile, geopolitical risk had been rising all year, and the sanctions on
Russia were having an impact on Germany—the healthy part of Europe. Finally, the
Ebola virus hit the US, which was about as welcomed by markets as a Red Sox fan at
Yankee Stadium.
The bottom line is that the Global Investment Committee believes the Fed’s exit from
QE this year is the first stage of monetary tightening in this economic cycle. It is normal
TABLE OF CONTENTS for markets to act jittery as this tightening process gets under way, and we have written
Making the Case for European Stocks about this extensively throughout the year. We believe this latest bout of volatility
2 Growth, inflation, earnings and valuation actually marks the end rather than the beginning of this adjustment, as some pundits
trends could lead to a year-end rally.
have been suggesting this past week. In fact, we believe global equity markets have
Activists at the Gates
Activist investors pressure companies to
much to look forward to during the next six to 12 months.
4
break up and spin off business units. First, earnings continue to come in very strong. To wit, two-thirds of the companies
Better Outlook for Holiday Sales in the S&P 500 Index have reported third-quarter earnings and they have surpassed
5 Higher income and lower gas prices sug- estimates by some 5%—double the expected growth rate going into earnings season.
gest consumers will spend more this year. Europe and Japan are also delivering solid results thus far for the third quarter and are
Head Fake for Bond Investors
showing even stronger growth than US companies. Second, the US midterm elections,
7 As far as yields go, 2014 is turning out to
be the opposite of 2013. scheduled for Nov. 4, have historically marked a good time to own US stocks. Using the
Bullish on High Yield prior 27 midterms as evidence, the S&P 500 has rallied 12% on average during the 10
9 The risk/reward proposition has become months following the election; when the Fed is in the middle of a tightening cycle, the
more attractive. number jumps to 22%.
Anticipating an Upturn in Oil
Finally, energy prices have collapsed during the past four months and, while some
10 In our view, the fundamentals are in place
for a rebound in crude prices.
investors see this is as a sign of collapsing global growth, we believe it’s been more the
Filling the Income Gap result of excess supply. As a result, these declines will act as a sizable tax cut for the
11 Annuities may be able to help investors global consumer which, should begin to positively impact growth as soon as this quarter
navigate the changes in pension plans. and well into 2015. That sounds more like a treat rather than a trick. n
ON THE MARKETS / EQUITIES
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 2
fears about a sharp deterioration of
European corporate earnings this year
Relative to Bonds, Valuation of European Stocks Most
might have been overblown. We continue Attractive in More Than 40 Years
to target 6% EPS growth for this year and
10% for 2015. 4.5
Many of our sentiment indicators are MSCI Europe Index
4.0
Earnings Yield to Bond Yield Ratio
close to capitulation levels. During the Ratio Average
correction, many of our sentiment 3.5
indicators have fallen close to capitulation 3.0
levels. To start with, our Market Timing
2.5
Indicator (MTI) has dropped to -1, a four-
year low and a level that, in the past, has 2.0
been associated with the market rising by
1.5
9% over the subsequent six months. The
market has risen around 80% of the time 1.0
on these occasions. Furthermore, the
0.5
Morgan Stanley Global Risk Demand
Index fell to -3.8 in mid October, the 0.0
lowest level since August 2011. While it '70 '75 '80 '85 '90 '95 '00 '05 '10
has since recovered to -1.2, this is still Source: MSCI, Morgan Stanley Research as of Oct. 24, 2014
only at the 16th percentile of its 10-year Relative valuations are attractive. As age points above the GDP-weighted
range. Finally, hedge fund exposure to a consequence of the sharp fall in core average of European 10-year government
European equities has fallen to the lowest bond yields, relative equity valuations now bond yields, which is the largest gap since
level in nearly two years. At the same look even more attractive than they did the start of our data set in 1970. n
time, outflows out of European-equity before the sell-off. In particular, the MSCI
exchange-traded funds have been running Europe earnings yield stands four percent-
close to eight-year-peak levels.
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 3
ON THE MARKETS / EQUITIES
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 4
ON THE MARKETS / ECONOMICS
Recreation Services
Recreational Goods and
Transportation Services
Accommodations
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 5
front-month futures contracts suggest Falling Gas Prices Could Fuel Holiday Spending
further declines in retail gas prices lie
ahead. On Oct. 30, end-November $ 3.90
Gasoline, US Average Across All Grades, Retail Price per Gallon
wholesale gasoline futures fell to $2.20,
the lowest level since November 2010— 3.80
29 cents lower compared with one month
3.70
ago and nearly 46 cents lower compared
with one year ago. If those wholesale 3.60
prices remain through the year’s end, retail
2013
gas prices across all grades could average 3.50
2014
just under $3 per gallon in the fourth
3.40
quarter compared with $3.37 in the fourth
quarter of 2013. Such a move would free 3.30
up more than $40 billion in consumer
spending power compared with last year. 3.20
Financials. US households’ financial
3.10
well-being continues to improve. With
Jan Feb Mar Apr May Jun Jul Aug Sep Oct
gains in disposable income outpacing
Source: Energy Information Administration, Morgan Stanley & Co. Research as of Oct. 27, 2014
additions to household debt, the debt-to-
battle during the recovery, but it has the short-term outlook for the economy
disposable-income ratio fell to 1.07 in the
generally trended upward. Most recently, and labor market, and are more optimistic
second quarter. At the same time, meeting
the Conference Board Consumer Confi- about their future earnings potential.”
monthly financial obligations remained
dence Index rebounded sharply in October UNEVEN GAINS. Until October, the
extraordinarily low relative to income.
after a brief drop in September following gains in confidence had been uneven
Indeed, in the second quarter, US
four straight months of improvement, across income groups. For example, on a
households devoted the smallest share of
coming to rest 22.1 points higher com- year-over-year basis in September, confi-
disposable income to meet these payments
pared with one year ago. October’s surge dence among households with annual
since 1980, when the data series began.
in confidence is likely in response to the income less than $15,000 had about a two-
Reflecting better debt and income
sharp decline in gasoline prices. point decline, while confidence among
dynamics, delinquency rates on consumer
The headline index comprises two households with annual income greater
debt and mortgages continue to decline.
subindexes, one measuring households' than $50,000 saw a more than 13-point
Yet despite better household finances,
assessment of their current finances and increase. The former is most affected by
consumers have remained unconvinced
one measuring how households feel about long-term unemployment and little-to-no
these gains will be sustained. This lack of
their future finances. On a year-over-year gains in hourly wage growth for low-
confidence in future finances suggests that
basis in October, the present-situation skilled sectors. The latter gets support
consumer pessimism is still a headwind to
index was 21.1 points higher, while the from hourly wage gains among higher-
a broader pickup in spending.
expectations index was 22.8 points higher. skilled industries and substantial gains in
In the press conference following the
This recent surge in expectations is impor- financial equity. In October, however, the
September meeting of the Federal Open
tant to note. surge in confidence was fairly evenly
Market Committee, when asked about the
We have underscored in numerous spread across income groups.
sluggish recovery, Chairman Yellen
analyses how households feel about their Since the financial crisis, uncertainty
explained that the committee sees that
future finances tends to dictate how they about future income has weighed on
“households' expectations about their
spend today. Despite the gains in aggre- spending decisions, and it explains why
likely income paths remain quite
gate jobs and income this year, the lack of real consumer spending has tracked lower
depressed relative to precrisis levels, and
a pickup in consumer expectations—until than gains in buying power. Nevertheless,
that’s something that may be holding back
recently—has suggested households may the gains in income, even if much of it is
consumer spending.” Truer words have
be unwilling to boost spending proportion- saved, will likely be expressed in the form
never been spoken. Encouragingly, more
ately. Until October, survey details have of generosity with more and/or higher-
recent data suggest this pessimism may be
revealed a lack of confidence that recent dollar gifts. That is why the holiday sales
shifting.
financial gains will be sustained. outlook is picking up, and that is what
Consumer Confidence. Posting gains
According to the Conference Board, retailers are counting on. n
in consumer confidence has been an uphill
“Consumers have regained confidence in
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 6
ON THE MARKETS / FIXED INCOME
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 7
yields to rise over the next 12 to 18 Our Muni Sector Recommendations
months, eating into investors’ returns. MS Sector Minimum Rating* Commentary
& Co.’s US Treasury Strategist, Matt Tax revenues are softening; pension
Hornbach, forecasts the 10-year Treasury State General Obligation/Appropriated Debt All challenges exist, but market access is
likely to be maintained.
will be at 2.7% in 12 months. If that were Locals are more dependent on housing;
to happen, investors would be left with a Local General Obligation A2/A
pension challenges exist.
slightly negative total return; that is after a Essential-purpose is beneficial, where
Essential Service (Water & Sewer) Baa2/BBB applicable; however, leverage increasing to
simple rise in yields of just 32 basis points.
meet infrastructure needs.
In our opinion, fixed income investors Near essential-service status, evolving
should continue to favor credit over rate- US Public Power Baa2/BBB power markets may create long-term
sensitive investments, with a strong challenges.
Offers diversified business models, but
preference for high yield credit and lower- State Housing Finance Agencies A2/A direct exposure (positive or negative) to
rated investment grade credit (see page 9). housing market.
We also recommend shorter maturities Expense growth exceeds revenue growth.
Higher Education A2/A
Opt for large, well-known institutions.
over longer maturities. Yet, we believe, as Favor major metro areas and hubs;
the 10-year moves up toward the 2.75%- US Airports A2/A potential for more passengers; oil prices
to-3.0% range, investors should consider must be monitored.
With major changes ahead, larger systems
moving further out the curve and adopting Not-for-Profit Hospitals AA3/AA-
are a conservative choice.
a barbell approach. *Table lists minimum credit rating we are comfortable recommending for buy-and-hold investors.
Please consider referenced rating with a stable outlook. Tactical decisions on whether a bond is
Municipals overvalued or undervalued should be evaluated on a case-by-case basis.
Source: Moody’s, S&P, Thomson Reuters Municipal Market Data and Morgan Stanley Wealth
Considering weak economic data from Management Investment Resources as of Oct. 15, 2014
Europe generally, renewed concerns and austerity policies to fade gradually and the notable exception of selectively selling
volatility for Greece, questions about the continued refinancing opportunities to into strength the sub-4.5% coupon
growth momentum in China, weaker arise for municipal issuers. Furthermore, structures on the long end of the yield
German data and now a spate of lackluster substantial cash on the sidelines has fueled curve.
US economic data amid continued below- US equity gains, which helps state and BARBELL STRATEGY. Other than
target inflation, the idea of 10-year US local pension funds. Indeed, the positive opportunistically using market strength to
Treasury yields in the low-2% area seems impact of low rates and strong equities has improve portfolios, we advocate a barbell
to be gaining acceptance both at home and improved pension funding for the first strategy comprising maturities primarily
on the global stage—and the Fed may time in six years, though the increases within four-to-nine years and some 20-
need to account for this global fragility in have not been consistent nationally and year paper, as well as adding a modest
the coming months. laggards continue to disappoint. allocation to attractively priced floating-
LOWER FOR LONGER. While tax- MS & Co.’s recently adjusted base case rate notes for performance when rates do
exempt yields may be uninspiring for for US Treasuries still calls for higher begin to rise. We continue to suggest a 5%
many muni buyers, lower-for-longer US yields, with the 10-year note forecast to be coupon structure and are maintaining our
Treasury yields combined with mildly 2.40% by the year’s end, suggesting the A-rated parameters for general-obligation
positive US economic momentum, would road to materially higher yields may be bonds, which are more conservative than
likely bode well for states and longer than originally envisioned. That our BBB guidance for essential-service
municipalities. Under this scenario, we said, we would generally maintain revenue bonds (see table). n
expect revenues to grow modestly, duration in municipal bond portfolios, with
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 8
ON THE MARKETS / FIXED INCOME
Jun
Jul
Mar
May
Dec
Jan
Apr
Aug
Sep
Oct
Nov
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 9
ON THE MARKETS / COMMODITIES
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 10
ON THE MARKETS / RETIREMENT
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 11
Annuities With Lifetime Income Payments
Types of Annuities* Key Characteristics
Single Premium Immediate § Highest payout rate of all immediate annuities. Payments made for the duration of contract holder’s life
Payout Phase
Variable Annuity With § Premiums invested in stock and bond investments through subaccounts. Rider provides a guaranteed payout rate
Guaranteed Lifetime for life, which may be significantly lower than a comparable SPIA
Withdrawal Benefits § Income resets higher if contract value is higher than benefit base at anniversary, the “high-water mark”
§ Value grows at a fixed rate for “guarantee period” and resets based on prevailing interest rates
Accumulation Phase
Deferred Fixed Annuity (DFA) § Option to take a lump sum, scheduled withdrawals, defer further or begin taking payments, i.e., “annuitize” value to
an immediate annuity, at the end of the accumulation phase
§ High payout rate, like SPIA, beginning at least a year after the annuity purchase. Payment schedule and growth
rates set at the time of purchase
Deferred Income Annuity (DIA)
§ “Life-only” version is irreversible with no death benefits in the event of early mortality
§ “Life with period-certain” version provides more liquidity and protection for early mortality but lower payout rate
§ Premiums are invested in stock and bond investments through subaccounts. Rider provides a guaranteed minimum
Variable Annuity With payout rate for life which may be significantly lower than a comparable DIA
Guaranteed Lifetime § Benefit base grows at fixed “roll-up” rate during the deferral period regardless of investment performance and resets
Withdrawal Benefits higher at any time if it is lower than the contract value at anniversary—the “high-water mark”
§ Option to take a lump sum or scheduled withdrawals or “annuitize” the value at the end of the accumulation phase
Source: Morgan Stanley Wealth Management GIC *For more about the risks to Annuities, please see the Risk Considerations section
beginning on page 17 of this report.
lower payout rates than those without such some years in the future. Deferred fixed higher to the contract value. A VA’s
a provision, with the payout rate annuities grow at a fixed interest rate for a benefit base typically will not decline
decreasing more as the length of the stated “guarantee period,” after which the regardless of what happens to the contract
period-certain term increases. growth rate depends on the value of future value, which is how the market-protection
VARIABLE ANNUITIES. The second short-term interest rates. Deferred income feature works. Thus, once a benefit base is
major type of annuity is what is known as annuities (DIAs) involve even less reset higher, those gains are locked in.
a variable annuity (VA)—in particular, guesswork as their payment terms, and This is what’s known as a “high-water
variable annuities with guaranteed lifetime thus deferral period growth rates, are fixed mark” provision.
withdrawal benefits. Cash placed in VAs in the contract at the outset and depend During the life of the annuity and
is invested through subaccounts into both largely on long-term interest rates. subject to any restrictions, deferred fixed
fixed income and equity investments. CHANGING VALUES. By contrast, with and deferred variable annuity owners have
While SPIAs pay a predictable, fixed a DIA or deferred fixed annuity, the the option to take a lump sum or scheduled
income stream, the contract value of an contract of a deferred VA with guaranteed withdrawals or to simply “annuitize” the
immediate VA, and therefore its payouts, lifetime withdrawal benefits will change in value into an annual payment stream
can increase based on the performance of value depending on the performance of its similar to an immediate annuity. DIA
the underlying investments of the annuity. underlying investments. Note that a VA’s owners generally do not have the option to
Although the payout rate is lower than minimum withdrawal benefits are cash out—though, as discussed in the
those of a comparable SPIA, VA payments calculated using a separate metric known context of a SPIA, DIA contracts with
have the potential to increase as the value as the benefit base, which is distinct from period-certain provisions tend to have
of the underlying investments moves its contract value. A VA’s benefit base greater liquidity. n
higher. This offers the annuity owner the will typically grow at a fixed rate known
potential to participate in upside market as a “roll-up rate” during the deferral For a complete copy of the white paper,
moves while still receiving a minimum period unless strong investment “Annuities in a Portfolio Solution Context:
income stream. performance propels the contract value Introducing a New Framework,” please
In contrast to immediate annuities, above the benefit base on a specified date. contact your Financial Advisor.
deferred annuity payments begin on a date In that scenario, the benefit base will reset
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 12
Global Investment Committee
Tactical Asset Allocation
The Global Investment Committee provides guidance on asset allocation decisions through its various model
portfolios. The eight models below are recommended for investors with up to $25 million in investable
assets. They are based on an increasing scale of risk (expected volatility) and expected return. Hedged
strategies include hedge funds and managed futures.
CONSERVATIVE >>> MODERATE >>>
4% High 26% 2%
5% High 22% 31%
Yield International Investment
Yield International International
Equity 11% Investment Equity Grade Fixed Equity
Grade Income
Fixed Income 12% Emerging
21% Investment 8% Emerging Markets Markets Equity
Grade Fixed Income 11% Emerging Markets
Equity Equity
AGGRESSIVE >>>
MODEL 7 MODEL 8
12% 35%
Emerging 31% International GLOBAL EQUITIES
Markets International Equity
14% Emerging
Equity Equity
Markets
Equity ALTERNATIVE INVESTMENTS
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 13
Tactical Asset Allocation Reasoning
Relative Weight
Global Equities Within Equities
US Overweight While US equities have done exceptionally well since the global financial crisis, they still offer attractive upside
potential, particularly relative to bonds. We believe the US and global economies continue to heal, making recession
neither imminent nor likely in 2014 or 2015. This is constructive for global equities, including the US.
International Equities Overweight We maintain a positive bias for Japanese and European equity markets given the political and structural changes
(Developed Markets) taking place in Japan and our expectation for an improving economic outlook in Europe. Japan underperformed in the
first half of 2014 due to the recently enacted consumption tax. We expect performance to improve as consumption
rebounds. Conversely, Europe performed well during the first half, but has sold off sharply on concerns about slowing
growth and the lack of an effective policy response. As a result, European equities are now very cheap making them
attractive investments over the next 12-to-18 months. We believe that Europe will avoid a triple-dip recession.
Emerging Markets Underweight Emerging market equities surprised to the upside earlier this year, and we were tactically underweight. However,
performance got ahead of the fundamentals and has since corrected. We remain underweight the region as policy
remains out of sync with what is necessary in many countries. Furthermore, the Fed’s rate-hike cycle began with the
tapering of Quantitative Easing and is likely to lead to further US dollar strength—another negative for this region.
Going forward, the EM will likely remain idiosyncratic and, thus, we recommend selectivity with a focus on India,
Mexico, China, Taiwan and Indonesia.
Relative Weight
Global Fixed Within Fixed
Income Income
US Investment Grade Overweight We have recommended shorter-duration* (maturities) since March 2013 given the extremely low yields and potential
capital losses associated with the rising interest rates. However, we recently reduced the size of our overweight in
short duration as we expect short-term interest rates to move higher as the Fed moves closer to its first rate hikes.
Within investment grade, we prefer BBB-rated corporates and A-rated municipals over US Treasuries.
International Equal Weight Yields are low globally, so not much additional value accrues to owning international bonds beyond some
Investment Grade diversification benefit.
Inflation-Linked Underweight We have been underweight inflation-linked securities since March 2013 given negative real yields across all maturities.
Securities Recently, these yields have turned modestly positive but remain unattractive, in our view, due to the longer-duration
characteristics of TIPS and limited risk for unexpected inflation.
High Yield Overweight Yields and spreads are near record lows. However, default rates are likely to remain muted as the economy recovers
slowly, keeping corporate and consumer behavior conservative. We prefer shorter-duration and higher-quality (B to
BB) issues and vigilance on security selection at this stage of the credit cycle.
Emerging Market Underweight Similar to emerging market equities, we remain underweight on the basis that the beginning of the Fed’s rate hike
Bonds cycle will likely be a disproportionate headwind for emerging market debt relative to other debt markets.
Relative Weight
Alternative Within Alternative
Investments Investments
REITs Equal Weight Falling interest rates have led to very good performance for REITs this year. At current levels, we believe REITs are
fairly valued and offer select opportunities. The industrial and commercial segments tend to outperform at this stage of
the recovery. Non-US REITs should also be favored relative to domestic REITs at this point.
Commodities Equal Weight After a strong start to 2014, we cut our strategic weighting to commodities by 50% in April. Since then, most
commodities have underperformed significantly with energy leading the charge lower. While commodities look more
attractive at this point as a diversifier against poor weather and geopolitical shocks, the fundamental case keeps us
with an equal-weight tactical recommendation.
Master Limited Equal Weight Master limited partnerships (MLPs) should continue to do well as they provide diversification benefits to traditional
Partnerships* assets and a substantial yield that is valuable in a low interest rate world. Many MLPs are levered to commodity
consumption, which is more predictable than prices. Focus on the midstream.
Hedged Strategies Equal Weight This asset class can provide uncorrelated exposure to traditional risk-asset markets. It has outperformed equities when
(Hedge Funds and growth has slowed and has worked well in more challenging financial markets.
Managed Futures)
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 14
ON THE MARKETS
MSCI EUROPE INDEX This index captures large-, S&P 500 INDEX Regarded as the best single gauge
Index Definitions mid- and small-cap representation across 16 of the US equities market, this capitalization-
CONSUMER CONFIDENCE INDEX This developed-markets countries in Europe. With weighted index includes a representative sample
Conference Board index is a proprietary 1,372 constituents, the index covers of 500 leading companies in leading industries in
monthly measure of the public’s confidence in approximately 99% of the free float-adjusted the US economy.
the health of the US economy. market capitalization across the developed-
market countries of Europe.
MORGAN STANLEY COMBINED MARKET TIMING
INDICATOR (CMTI) The CMTI is an average PURCHASING MANAGERS’ INDEX (PMI) These
across the Risk, Fundamentals and Composite economic indicators are derived mostly from
Valuation Indicators. monthly surveys of private-sector companies.
The principal producers of PMIs are Markit
MORGAN STANLEY GLOBAL RISK DEMAND
Group, which conducts PMIs for more than 30
INDEX This index tracks risk sentiment as
reflected in the relative price movements of countries, and the Institute for Supply
seven “risky” assets versus their “safer” Management, which conducts PMIs for the US.
counterparts; plus, three volatility indicators.
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 15
ON THE MARKETS
DEATH BENEFIT The money passed from an IMMEDIATE ANNUITIES A class of annuities whose
Glossary annuity contract to its beneficiary upon the death payments begin immediately after the initial
ACCUMULATION PHASE The period in an annuity of the owner and/or annuitant. This can include purchase.
contract prior to the point at which distributions specific death benefit provisions for which the
to the annuitant begin. In this period, the value annuity holder pays a fee, or the period-certain PAYOUT PHASE The period during which the
of the annuity can grow. provision of a single-premium immediate annuity money accumulated in an annuity is paid out to
or a deferred income annuity, or simply the an annuitant.
ANNUITANT The person or persons whose age residual contract value of a variable annuity upon
and life expectancy the payments are based on death of the owner and/or annuitant. PERIOD-CERTAIN A type of guarantee that if the
during the payout phase. annuitant dies before payments have been made
DEFERRAL PERIOD The time in between when an for a minimum number of years, payments to the
ANNUITY A contract in which an insurance investor originally purchases an annuity and beneficiary will continue until the end of the
company agrees to provide a periodic income when distributions commence. See accumulation stated period.
payable for the lifetime of one or more persons, phase.
or for a specified period. ROLL-UP RATE The roll-up rate is the guaranteed
DEFERRED ANNUITY An annuity contract with a percentage that the benefit base of a variable
ANNUITIZATION The practice of converting an deferral period. For some annuities, such as annuity increases by each year during the
annuity into a fixed series of periodic income deferred fixed or variable annuities, the length of accumulation stage.
payments over the span of one’s life or for a the deferral period is flexible. For deferred
specified period. income annuities, it is set at contract initiation. SINGLE PREMIUM IMMEDIATE ANNUITY (SPIA) An
annuity purchased with a single premium on
BENEFIT BASE The benefit base is used to index DEFERRED FIXED ANNUITY (DFA) A type of which income payments begin within one year of
the payments from a variable annuity with an deferred annuity that grows during the deferral the contract date. With fixed immediate
income rider such as a guaranteed lifetime period based on prevailing short-term interest annuities, the payment is based on a specified
withdrawal benefit. By contrast with the rates, which can fluctuate after an initial interest rate. Payments are made for the life of
contract value, defined below, the benefit base guarantee period. the annuitant(s), for a specified period, or both
does not represent the annuity owner’s equity in (e.g., 10 years certain and life).
the contract, but is rather an accounting DEFERRED INCOME ANNUITY (DIA) A class of
construct by which minimum withdrawal annuities whose payment schedule and growth VARIABLE ANNUITY An annuity contract into
benefits are calculated. During the deferral rates are determined at the time of the initial which the buyer makes a lump-sum payment or
period, a benefit base will typically grow by a purchase. series of payments. In return, the insurer agrees
preset “roll-up” amount regardless of what to make periodic payments beginning
happens to the investments in the annuity. This GUARANTEE PERIOD The period of time a immediately or at some future date. Purchase
feature provides protection from market risk. deferred fixed annuity grows at the rate stated payments are directed to a range of investment
Most typically, if a contract value increases when the annuity was purchased, after which its options, which may be mutual funds or direct
above the benefit base on the contract’s reset growth rate will depend on the prevailing level of investment into the separate account of the
date, the benefit base will reset higher to the short-term interest rates. insurance company that manages the portfolios.
contract value, proportionally increasing future The value of the account during accumulation,
benefits. HIGH-WATER MARK PROVISION When the contract and the income payments after annuitization vary
value of a variable annuity with a guaranteed depending on the performance of the chosen
CONTRACT VALUE The contract value of an lifetime withdrawal benefit rider is higher than investment options.
annuity represents the equity the annuity owner the contract’s benefit base at anniversary, the
holds in that contract. The initial contract value benefit base will be reset higher to the contract VARIABLE ANNUITY SUBACCOUNT A portfolio
is equal to the initial premium paid, and will value. Even if the performance of the underlying that comprises stocks, bonds or money market
fluctuate subsequently based on the net of investments then deteriorates and the contract securities. Subaccounts can either be actively or
additional premiums, withdrawals and the value falls precipitously, the contract’s benefit passively managed.
investment perform-ance net of fees. Contract base will not reset lower, and any guaranteed
value defines the upside, liquidity and death roll-ups will accrue from that level. In other
benefit dimensions of a variable annuity with words, the “high-water mark” refers to the fact
guaranteed lifetime withdrawal benefits. This that, once the benefit base has been reset higher,
contrasts with the benefit base, which is used these gains are considered “locked-in.”
only to index regular payments, and cannot be
liquidated or transferred to a beneficiary upon
death.
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 16
Risk Considerations
Annuities
Morgan Stanley Smith Barney LLC offers insurance products in conjunction with its licensed insurance agency affiliates.
Variable annuities are sold by prospectus only. The prospectus contains the investment objectives, risks, fees, charges and expenses,
and other information regarding the variable annuity contract and the underlying investments, which should be considered carefully
before investing. Prospectuses for both the variable annuity contract and the underlying investments are available from your Financial
Advisor. Please read the prospectus carefully before you invest.
Variable annuities are long-term investments designed for retirement purposes and may be subject to market fluctuations, investment risk, and
possible loss of principal. All guarantees, including optional benefits, are based on the financial strength and claims-paying ability of the issuing
insurance company and do not apply to the underlying investment options.
Optional riders may not be able to be purchased in combination and are available at an additional cost. Some optional riders must be elected at time
of purchase. Optional riders may be subject to specific limitations, restrictions, holding periods, costs, and expenses as specified by the insurance
company in the annuity contract.
If you are investing in a variable annuity through a tax-advantaged retirement plan such as an IRA, you will get no additional tax advantage from the
variable annuity. Under these circumstances, you should only consider buying a variable annuity because of its other features, such as lifetime
income payments and death benefits protection.
Taxable distributions (and certain deemed distributions) are subject to ordinary income tax and, if taken prior to age 591/2, may be subject to a 10%
federal income tax penalty. Early withdrawals will reduce the death benefit and cash surrender value.
MLPs
Master Limited Partnerships (MLPs) are limited partnerships or limited liability companies that are taxed as partnerships and whose interests (limited
partnership units or limited liability company units) are traded on securities exchanges like shares of common stock. Currently, most MLPs operate in
the energy, natural resources or real estate sectors. Investments in MLP interests are subject to the risks generally applicable to companies in the
energy and natural resources sectors, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk.
Individual MLPs are publicly traded partnerships that have unique risks related to their structure. These include, but are not limited to, their reliance
on the capital markets to fund growth, adverse ruling on the current tax treatment of distributions (typically mostly tax deferred), and commodity
volume risk.
The potential tax benefits from investing in MLPs depend on their being treated as partnerships for federal income tax purposes and, if the MLP is
deemed to be a corporation, then its income would be subject to federal taxation at the entity level, reducing the amount of cash available for
distribution to the fund which could result in a reduction of the fund’s value.
MLPs carry interest rate risk and may underperform in a rising interest rate environment. MLP funds accrue deferred income taxes for future tax
liabilities associated with the portion of MLP distributions considered to be a tax-deferred return of capital and for any net operating gains as well as
capital appreciation of its investments; this deferred tax liability is reflected in the daily NAV; and, as a result, the MLP fund’s after-tax performance
could differ significantly from the underlying assets even if the pre-tax performance is closely tracked.
Duration
Duration, the most commonly used measure of bond risk, quantifies the effect of changes in interest rates on the price of a bond or bond portfolio.
The longer the duration, the more sensitive the bond or portfolio would be to changes in interest rates. Generally, if interest rates rise, bond prices
fall and vice versa. Longer-term bonds carry a longer or higher duration than shorter-term bonds; as such, they would be affected by changing
interest rates for a greater period of time if interest rates were to increase. Consequently, the price of a long-term bond would drop significantly as
compared to the price of a short-term bond.
International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and
economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets,
since these countries may have relatively unstable governments and less established markets and economies.
Alternative investments which may be referenced in this report, including private equity funds, real estate funds, hedge funds, managed futures
funds, and funds of hedge funds, private equity, and managed futures funds, are speculative and entail significant risks that can include losses due to
leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack
of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less
regulation and higher fees than mutual funds and risks associated with the operations, personnel and processes of the advisor.
Managed futures investments are speculative, involve a high degree of risk, use significant leverage, have limited liquidity and/or may be generally
illiquid, may incur substantial charges, may subject investors to conflicts of interest, and are usually suitable only for the risk capital portion of an
investor’s portfolio. Before investing in any partnership and in order to make an informed decision, investors should read the applicable prospectus
and/or offering documents carefully for additional information, including charges, expenses, and risks. Managed futures investments are not intended
to replace equities or fixed income securities but rather may act as a complement to these asset categories in a diversified portfolio.
Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to,
(i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events,
war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence,
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 17
technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary
distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.
Physical precious metals are non-regulated products. Precious metals are speculative investments, which may experience short-term and long
term price volatility. The value of precious metals investments may fluctuate and may appreciate or decline, depending on market conditions. If sold
in a declining market, the price you receive may be less than your original investment. Unlike bonds and stocks, precious metals do not make interest
or dividend payments. Therefore, precious metals may not be suitable for investors who require current income. Precious metals are commodities
that should be safely stored, which may impose additional costs on the investor. The Securities Investor Protection Corporation (“SIPC”) provides
certain protection for customers’ cash and securities in the event of a brokerage firm’s bankruptcy, other financial difficulties, or if customers’ assets
are missing. SIPC insurance does not apply to precious metals or other commodities.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk.
Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date.
The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the
maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the
risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk
that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.
Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater
credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives
and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio.
Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax
(AMT). Typically, state tax-exemption applies if securities are issued within one's state of residence and, if applicable, local tax-exemption applies if
securities are issued within one's city of residence.
Treasury Inflation Protection Securities’ (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation
by tracking the consumer price index (CPI). While the real rate of return is guaranteed, TIPS tend to offer a low return. Because the return of TIPS is
linked to inflation, TIPS may significantly underperform versus conventional U.S. Treasuries in times of low inflation.
The initial interest rate on a floating-rate security may be lower than that of a fixed-rate security of the same maturity because investors expect to
receive additional income due to future increases in the floating security’s underlying reference rate. The reference rate could be an index or an
interest rate. However, there can be no assurance that the reference rate will increase. Some floating-rate securities may be subject to call risk.
Rebalancing does not protect against a loss in declining financial markets. There may be a potential tax implication with a rebalancing strategy.
Investors should consult with their tax advisor before implementing such a strategy.
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Investing in smaller companies involves greater risks not associated with investing in more established companies, such as business risk,
significant stock price fluctuations and illiquidity.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the
performance of any specific investment.
The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes. Morgan
Stanley Smith Barney LLC retains the right to change representative indices at any time.
REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited
diversification and sensitivity to economic factors such as interest rate changes and market recessions.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.
Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency,
economic and market risks.
Investing in foreign markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and
market risks. Investing in currency involves additional special risks such as credit, interest rate fluctuations, derivative investment risk, and
domestic and foreign inflation rates, which can be volatile and may be less liquid than other securities and more sensitive to the effect of varied
economic conditions. In addition, international investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These
risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in
countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.
The majority of $25 and $1000 par preferred securities are “callable” meaning that the issuer may retire the securities at specific prices and dates
prior to maturity. Interest/dividend payments on certain preferred issues may be deferred by the issuer for periods of up to 5 to 10 years, depending
on the particular issue. The investor would still have income tax liability even though payments would not have been received. Price quoted is per
$25 or $1,000 share, unless otherwise specified. Current yield is calculated by multiplying the coupon by par value divided by the market price.
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 18
The initial rate on a floating rate or index-linked preferred security may be lower than that of a fixed-rate security of the same maturity because
investors expect to receive additional income due to future increases in the floating/linked index. However, there can be no assurance that these
increases will occur.
Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.
Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not
be offered or sold absent an exemption therefrom. Recipients are required to comply with any legal or contractual restrictions on their purchase,
holding, sale, exercise of rights or performance of obligations under any securities/instruments transaction.
Disclosures
Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This
material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or
other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance.
The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors,
including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors.
Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this
material.
This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any
security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own
independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision,
including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain
material information not contained herein and to which prospective participants are referred. This material is based on public information as of the
specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or
warranty with respect to the accuracy or completeness of this material. Morgan Stanley Wealth Management has no obligation to provide updated
information on the securities/instruments mentioned herein.
The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy
will depend on an investor’s individual circumstances and objectives. Morgan Stanley Wealth Management recommends that investors
independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and
income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates,
securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors. Estimates of future
performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions
may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the
projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any
projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events.
Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not
materially differ from those estimated herein.
This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is
not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not
acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue
Code of 1986 as amended in providing this material.
Morgan Stanley Wealth Management and its affiliates do not render advice on tax and tax accounting matters to clients. This material was
not intended or written to be used, and it cannot be used or relied upon by any recipient, for any purpose, including the purpose of
avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Each client should consult his/her personal tax and/or
legal advisor to learn about any potential tax or other implications that may result from acting on a particular recommendation.
This material is disseminated in Australia to “retail clients” within the meaning of the Australian Corporations Act by Morgan Stanley Wealth
Management Australia Pty Ltd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813).
Morgan Stanley Wealth Management is not incorporated under the People's Republic of China ("PRC") law and the research in relation to this report
is conducted outside the PRC. This report will be distributed only upon request of a specific recipient. This report does not constitute an offer to sell or
the solicitation of an offer to buy any securities in the PRC. PRC investors must have the relevant qualifications to invest in such securities and must
be responsible for obtaining all relevant approvals, licenses, verifications and or registrations from PRC's relevant governmental authorities.
If your financial adviser is based in Australia, Dubai, Germany, Italy, Switzerland or the United Kingdom, then please be aware that this report is
being distributed by the Morgan Stanley entity where your financial adviser is located, as follows: Australia: Morgan Stanley Wealth Management
Australia Pty Ltd (ABN 19 009 145 555, AFSL No. 240813); Dubai: Morgan Stanley Private Wealth Management Limited (DIFC Branch), regulated by
the Dubai Financial Services Authority (the DFSA), and is directed at Professional Clients only, as defined by the DFSA; Germany: Morgan Stanley
Private Wealth Management Limited, Munich branch authorized by the Prudential Regulation Authority and regulated by the Financial Conduct
Authority and the Bundesanstalt fuer Finanzdienstleistungsaufsicht; Italy: Morgan Stanley Bank International Limited, Milan Branch, authorized by the
Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority, the Banca d'Italia and the
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 19
Commissione Nazionale per Le Societa' E La Borsa; Switzerland: Bank Morgan Stanley AG regulated by the Swiss Financial Market Supervisory
Authority; or United Kingdom: Morgan Stanley Private Wealth Management Ltd, authorized and regulated by the Financial Conduct Authority,
approves for the purposes of section 21 of the Financial Services and Markets Act 2000 this material for distribution in the United Kingdom.
Morgan Stanley Wealth Management is not acting as a municipal advisor to any municipal entity or obligated person within the meaning of Section
15B of the Securities Exchange Act (the “Municipal Advisor Rule”) and the opinions or views contained herein are not intended to be, and do not
constitute, advice within the meaning the Municipal Advisor Rule.
This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC.
Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they
provide and shall not have liability for any damages of any kind relating to such data.
Morgan Stanley Wealth Management research, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of
Morgan Stanley Smith Barney LLC.
Please refer to important information, disclosures and qualifications at the end of this material. November 2014 20