Asset management STRICTLY CONFIDENTIAL New ways to think about Inflation Protection and Retirement Income in DC Plans Drew Carrington, CFA, CAIA Head of Defined Contribution and Retirement Solutions Group November 15, 2011 US-I

Glide path management: Managing to the right risks Building to retirement Transitioning to retirement Enjoying retirement Not saving enough: Shortfall risk Volatility in market prices: Market risk Risk (NOT Equity) Allocation Cost of living outpacing returns: Inflation risk If the current way to look at the glide path is sub-optimal, then how should we be looking at it? Again, it’s about addressing and managing the four retirement risks and how they change during participants’ life stage. By doing so, we can adjust allocation to our investments … Outliving savings: Longevity risk Source: UBS Global Asset Management For illustrative purposes only. Before retirement Retirement US-I

Glide path management: Managing to the right risks Building to retirement Transitioning to retirement Enjoying retirement Not saving enough: Shortfall risk Volatility in market prices: Market risk Risk (NOT Equity) Allocation Cost of living outpacing returns: Inflation risk If the current way to look at the glide path is sub-optimal, then how should we be looking at it? Again, it’s about addressing and managing the four retirement risks and how they change during participants’ life stage. By doing so, we can adjust allocation to our investments … Outliving savings: Longevity risk Source: UBS Global Asset Management For illustrative purposes only. Before retirement Retirement US-I

Inflation risk: the erosion of purchasing power Managing inflation risk is critical near and through retirement $100,000 today will only purchase $60,269 worth of goods in 20 years—almost a 40% decrease in purchasing power. … 20 years later, at 2.5% inflation, he/she will need this much $164,000 $100,000 Participant has this much at retirement… Age 60 Age 80 Steadily rising inflation (or an inflation spike) makes the basket of goods and services that a participant is accustomed to consuming, permanently more expensive—eroding savings purchasing power For illustrative purposes only. (In 2007 the median account balance at ages 55-64 was $100,000 according to EBRI) US-I

Inflation impact: Purchase less of what you need in the future 60 years old Monthly income: $1500 80 years old Monthly income: $1500 Purchasing power has declined 40% TIPS—inflation linked bonds—protect against inflation because they grow at the rate of CPI, tracking changes in the price of the basket of goods of the average urban consumer For illustrative purposes only. (In 2007 the median account balance at ages 55-64 was $100,000 according to EBRI) US-I

The benefits of using TIPS Designed to protect the purchasing power of investments, especially for near retirees TIPS offer inflation protection that conventional nominal bond investments do not Nominal bonds are negatively correlated to inflation Nominal bond coupon may be too low to compensate for loss of purchasing power due to inflation Erosion of purchasing power may be permanent TIPS are better correlated to inflation Coupons and income grow at a rate closely matching Headline CPI (adjusted monthly with a two- month lag) Protect standard of living by preserving retirement savings purchasing power Principal is also adjusted by CPI, so TIP matures at “real” or inflation-adjusted value TIPS are a proven, reliable inflation hedge Short-term (1yr) TIPS and intermediate term (10yr) TIPS have a track record as reliable hedges against inflation Reliability factor exceeds that of commodity stocks (such as natural resource companies), commodity futures, and REITs TIPS are cost effective US-I

Correlation of TIPS to CPI Historically, the correlation of TIPS to CPI is approximately 0.34, which means its inflation beta or sensitivity closely mirrors CPI. Nominal bond correlation, in contrast, is negative. Source: UBS Global Asset Management research, and various index providers. All data is September 30, 1997 – June 30, 2011. Correlations and standard deviations are based on rolling 12 quarter periods. Asset classes represented by: US nominal bonds: Barclays Capital US Aggregate Bond Index; Equity: S&P 500 Index; CPI; TIPS: Citigroup US Inflation Linked Securities Index. Past performance is no guarantee of future results. US-I

Reducing risk… really? 3 - Year 5 - Year 10 - Year Max Return Risk Drawdown - TIPS 8.3% 4.4% 7.2% 5.3% 6.1% Inflation 1.2 2.9 2.3 2.6 2.4 3.9 S&P 500 25.2 20.7 2.8 18.2 45.8 - REITS 2.0 43.2 2.4 34.2 9.2 26.4 65.4 NCREIF 1.5 9.5 3.4 8.1 7.8 6.3 23.9 Commodities - 15.9 35.1 5.3 34.1 3.5 28.4 66.2 Energy 1.2 29.0 3.4 27.8 10.3 23.2 47.1 Materials 0.6 34.4 1.1 29.2 6.9 24.8 47.4 Source: UBS Global Asset Management; data as of 9/30/11

Active TIPS offer compelling advantages Market size (USD600 billion) – there is room in the playing field Index construction – only 31 issues Supply and demand skews – as new issues enter the benchmarks and change the weights for passive index investors Behavior of TIPS – particularly on-the-run vs. off-the-run TIPS Cost differential between active TIPS and passive managers is relatively low ≈ 15 bp Ability to make active decisions Duration Curve Security selection Break-even inflation bet vs. nominal Treasuries US-I

Behavior of TIPS in various inflation scenarios Annualized expected rates of return of TIPS Rates of return on TIPS under various annual inflation/deflation scenarios if held to maturity MINUS that of similar nominal Treasuries Rates of return on TIPS under various annual inflation/deflation scenarios if held to maturity High inflation Moderate No inflation Deflation Severe deflation For illustrative purposes only. US-I

Ways to incorporate TIPS in DC plans Participant’s menu TIPS embedded in target date funds as the core inflation protecting strategy TIPS as a designated hedging sleeve within a custom target date fund TIPS as a component within an inflation hedging bundle (a real asset bundle) TIPS as a strategy within a retirement income solution Primary; automatic P articularly if potential investment returns are anticipated to provide for future consumption - as is often the case when investing up to retirement. TIPS positioned as investment option to protect against inflation Do-it-yourself For illustrative purposes only. US-I

Glide path management: Managing to the right risks Building to retirement Transitioning to retirement Enjoying retirement Not saving enough: Shortfall risk Volatility in market prices: Market risk Risk (NOT Equity) Allocation Cost of living outpacing returns: Inflation risk If the current way to look at the glide path is sub-optimal, then how should we be looking at it? Again, it’s about addressing and managing the four retirement risks and how they change during participants’ life stage. By doing so, we can adjust allocation to our investments … Outliving savings: Longevity risk Source: UBS Global Asset Management For illustrative purposes only. Before retirement Retirement US-I

What was supposed to be fun, isn’t fun any more “I’m worried that I am going to run out of food.” “I’ve actually run out of food.” “My best friend is a volleyball.”

One of these things is not like the other…

Principles follow us as adults Stocks Bonds Annuities Cash

Historical perspective on investment vs. annuities Asset classes are made up of investments. Annuities are insurance, not investments.  Annuities aren’t an asset class.

We take asset classes and build into efficient frontier US Bonds US Equity Cash Return Risk (Volatility) Source: UBS Global Asset Management; For illustrative purposes only.

Annuities as an asset class + Unique economic drivers 1. Mortality-contingent payments Investment expectations Streams of payments in the future that can be discounted Functions enough like a bond that by discounting, an expected return can be derived The change (or volatility) in expected return can be estimated and modeled Annuities

Annuities can be added to efficient frontier US Bonds US Equity Cash Return Fixed Deferred Annuity Fixed Deferred Annuity Fixed Deferred Annuity Risk (Volatility) Source: UBS Global Asset Management; For illustrative purposes only.

But what if we redefine the risk and return parameters…? Amount of income Risk of running out of money in retirement Return Risk (Volatility) Source: UBS Global Asset Management; For illustrative purposes only.

Annuities become an even more important asset class Cash US Bonds US Equity Fixed Deferred Annuity Amount of income Amount of income Fixed Deferred Annuity Fixed Deferred Annuity Fixed Deferred Annuity Risk of running out of money in retirement Source: UBS Global Asset Management; For illustrative purposes only.

Conclusion: All risks need to be considered in DC plans Building to retirement Transitioning to retirement Enjoying retirement Not saving enough: Shortfall risk Volatility in market prices: Market risk Risk (NOT Equity) Allocation Cost of living outpacing returns: Inflation risk If the current way to look at the glide path is sub-optimal, then how should we be looking at it? Again, it’s about addressing and managing the four retirement risks and how they change during participants’ life stage. By doing so, we can adjust allocation to our investments … Outliving savings: Longevity risk Source: UBS Global Asset Management For illustrative purposes only. Before retirement Retirement US-I

Leaving you with this quiz… You are given a safety mechanism that will likely save your life. It will certainly be more expensive than not having it. It involves an explosion that may injure you. It may affect the look or design. Would you choose the option or not…? Do we even provide the option to include…?

Additional disclosures Past performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss. Any statements made regarding investment performance objectives, risk and/or return targets shall not constitute a representation or warranty that such investment objectives or expectations will be achieved. No part of this presentation may be reproduced or redistributed in any form, or referred to in any publication, without express written permission of UBS Global Asset Management. This material supports the presentation(s) given on the specific date(s) noted. It is not intended to be read in isolation and may not provide a full explanation of all the topics that were presented and discussed. The information and opinions contained in this document have been complied or arrived at based upon information obtained from sources believed to be reliable and in good faith. All such information and opinions are subject to change without notice. A number of the comments in this document are based on current expectations and are considered “forward-looking statements.” Actual future results, however, may prove to be different from expectations. The opinions expressed are a reflection of UBS Global Asset Management’s best judgment at the time this report is compiled, and any obligation to update or alter forward-looking statement as a result of new information, future events, or otherwise is disclaimed. UBS AG and/or its affiliates may have a position in and may make a purchase and/or sale of any of the securities or other financial instruments mentioned in this document. The information contained in this presentation should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this information or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio over the course of a full market cycle. It should not be assumed that any of the securities transactions or holdings referred to herein were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities referred to in this presentation. A client's returns will be reduced by advisory fees and other expenses incurred by the client. Advisory fees are described in Part II of Form ADV for UBS Global Asset Management (Americas) Inc. This presentation does not constitute an offer to sell or a solicitation to offer to buy any securities and nothing in this presentation shall limit or restrict the particular terms of any specific offering. Offers will be made only to qualified investors by means of a prospectus or confidential private placement memorandum providing information as to the specifics of the offering. No offer of any interest in any product will be made in any jurisdiction in which the offer, solicitation or sale is not permitted, or to any person to whom it is unlawful to make such offer, solicitation or sale. The achievement of a targeted ex-ante tracking error does not imply the achievement of an equal ex-post tracking error or actual specified return. According to independent studies, ex-ante tracking error can underestimate realized risk (ex-post tracking error), particularly in times of above-average market volatility and increased momentum. Different models for the calculation of ex-ante tracking error may lead to different results. There is no guarantee that the models used provide the same results as other available models. Any taxation position described in this presentation is a general statement and should only be used as a guide. It does not constitute tax advice and is based on UBS Global Asset Management’s understanding of current tax laws and their interpretation. As individual situation may differ, clients should seek independent professional tax advice on any taxation matters. Strategies may include the use of derivatives. Derivatives involve risks which are different from the risks associated with investing directly in securities, including: the risk that changes in the value of a derivative may not correlate with the underlying asset, rate, index, or market, as well as liquidity risk, interest rate risk, counterparty risk and credit risk. While some derivatives strategies can reduce the risk of loss, the use of derivatives can also reduce the opportunity for gain or result in losses by offsetting favorable price movements in other investments. Derivatives may create leverage and pose the risk of losing more than the amount invested. Services to U.S. persons are provided by UBS Global Asset Management (Americas) Inc. ("Americas"). Americas is registered as an investment adviser with the US Securities and Exchange Commission (“SEC”) under the Investment Advisers Act of 1940. From time to time, Americas’ non-US affiliates in the Asset Management Division who are not registered with the SEC ("Participating Affiliates") provide investment advisory services to Americas' U.S. clients. Americas has adopted procedures to ensure that its Participating Affiliates are in compliance with SEC registration rules. Copyright © 2011 UBS Global Asset Management (Americas) Inc. US-I