feb basis points-fixed income

7/29/2019 Feb Basis Points-Fixed Income

1/11

PORTFOLIO STRATEGY & RESEARCH GROUP FEBRUARY 5,

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 ofinancial instrument or to participate in any trading strategy. This is not a research report and was not prepared by the Research departments of Morgan StaSmith Barney LLC, Morgan Stanley & Co. LLC, or Citigroup Global Markets Inc. It was prepared by Morgan Stanley Smith Barney sales, trading or other non-resepersonnel. Past performance is not necessarily a guide to future performance. Please refer to important information, disclosures, and qualifications at the end of

material.

Basis Points Fixed Income Strategy

Not in it for the Duration

In the Conservative, Moderate and Aggressive Portfolios, we aretactically reducing our weightings to Investment Grade (IG)

Corporates and reallocating to government/agency MBS. Within

the Tax-Advantaged Model Portfolio, we are reducing our

allocation to Municipals and raising our weighting to UST.

The fiscal cliff deal and temporary suspension of the debt ceilinghas turned the focus in the Beltway to the dual March deadlines

for the delayed sequestered spending cuts and the continuing

resolution (CR).

After starting the new year with upside surprises to economicdata, more recent reports have revealed a softer performance.

The MS tracking estimate for 1Q 2013 real GDP stands at +1.6%,

or essentially the same pace as the prior six-month period.

The UST 10-yr sell-off to begin 2013 is centered around somelayers of uncertainty being removed from the investment

backdrop, as fundamentals have taken more of a back seat. We

are raising our trading range to 1.50%2.25%, but nearer term,

buyers continue to re-enter the longer end of the UST market

when the 10-yr yield moves toward the 2.00%2.05% threshold.

For fixed income investors who are overweight in longer-termmaturities, we recommend lessening duration in their portfolios.

Our preferred strategic target maturities are as follows:o US Treasuries: 3-yr to 5-yro Investment Grade Corps: 3-yr to 7-yro High Yield: 2-yr to 5-yro Tax-exempts: 5-yr to 11-yr

Taxable Fixed Income: Credit spreads continued to narrow inJanuary, but we feel the High Yield (HY) market could be

vulnerable at current valuations.

Municipals: The municipal market cleared one hurdle as thefiscal cliff deal did not include any changes in the tax-exemption

status of these securities, but upcoming federal budget battles

could be a platform for renewed negative headlines.

KEVIN FLANAGANMSSB North America - Morgan Stanley Smith Barney LLCChief Fixed Income StrategistManaging [email protected]

JON MACKAYMSSB North America - Morgan Stanley Smith Barney LLCSenior Fixed Income StrategistExecutive Director

[email protected]

The statistics listed below are as of February 5, 2013:

Fed Funds Target Rate zero to 0.25%

Year-Over-Year Change in CPI 1.7%

GDP (4th

Qtr 2012) (-0.1%)

DXY Index 79.72

Unemployment Rate 7.9%

Source: Morgan Stanley Smith Barney Fixed Income Strategy, Bureau ofLabor Statistics, Bureau of Economic Analysis

Upcoming Federal Open Market Committee Meetings:

March 19 and 20 April 30 and May 1

Source: Federal Reserve Board

Asset allocation and diversification do not assure a profit or protagainst loss in declining financial markets.


2/11

FIXED INCOME STRATEGY / FEBRUARY 5, 2013

Please refer to important information, disclosures and qualifications at the end of this material.

Fixed Income Asset AllocationIn the Conservative, Moderate and Aggressive Portfolios, we

are tactically reducing our weightings to Investment Grade

(IG) Corporates by 5% and reallocating the entire amount togovernment/agency MBS. This decision was purely from a

pre-emptive and tactical vantage point. We still carry IG

corps as our priority overweight in all three models, and also

continue to like the risk/reward dynamics of IG over HY

within the credit space. In the near-term investment horizon,

we see the potential for a slightly more challenging backdrop

for the IG market as upcoming political risk (sequestration

and CR battles) could provide the platform for a risk-off

setting in the markets. In addition, the fundamental outlook

remains a cloudy one as MS economists continue to forecast

only a modest growth track at best, with recent data on GDPand employment falling below expectations. If this near-term

scenario plays out, we feel the government/agency MBS

market could outperform on a relative basis. In addition, the

January FOMC meeting reiterated the Feds current QE

measure, which consists of both MBS and UST purchases.

According to MS Agency MBS strategy, continued QE is

expected to have the desired effect of spread tightening

with Fed purchases as a percentage of gross issuance to rise.

Within the Tax-Advantaged Model Portfolio, we are reducing

our allocation to Municipals by 5% and raising our weighting

to UST by a like amount. Once again, this decision falls underthe pre-emptive/tactical banner as the aforementioned

political debates could provide the platform for renewed

negative headlines regarding the federal tax-exempt status of

municipal securities.

Here are the new weightings in our four models, which are

impacted by our reallocations:

Conservative Model: IG Corps 30%; government/agencyMBS 20%.

Moderate Model: IG Corps 35%; government/agencyMBS 20%.

Aggressive Model: IG Corps 45%; government/agencyMBS 20%.

Tax Advantaged Model: Municipals 80%; UST 10%. OurMunicipal strategists continue to advocate high credit

quality, including mid-tier A or higher general obligation

paper and mid-level BBB or higher-rated essential-

service revenue bonds (such as water and sewer).

Recommended Fixed Income ModelPortfolios

Conservative Fixed Income Portfolio

20 %

10%

20 %

15 %5%

20% Mortgag e-Backed Securities 30% Investment Grade Corpor

10 % Fed eral Ag encies 20% U.S . Treas uries15% Cas h & Eq uivalents 5% TIPS

30 %

Moderate Fixed Income Portfolio

15% 20%

10 %5%5%

5%5%

20% Mortgage-Backed Securities 35% Investment Grade Corpor10% Federal Ag encies 5% Preferred Securities

5% No n-USD 5% TIPS5% Hig h Yield Securities 15% Cash & Equivalents

35%

Aggressive Fixed Income Portfolio

5%5%5%

10 %10 % 20 %

20% Mortgage-Backed Securities 45% Investment Grade Corpor

5% Hig h Yield Securities 5% Preferred Securities5% Non-USD 10% Emerg ing Markets

10 % Federal Ag encies

45%

Tax-Advantaged Fixed Income Portfolio

80%

10%10 %

80% Municipal Securities 10% Federal Agencies 10% U.S. Treas

Source: Morgan Stanley Smith Barney Fixed Income Strategy


3/11



Investment BackdropUST Market: Not in it for the DurationThe recurring question we always seem to receive is when is

The Great Bear Market in Bonds coming. In our opinion,

calendar year 2013 will not be that timeframe. It is important

to keep in mind that all rates are not created equal. To be sure,

trends for shorter-dated maturities as compared to the

intermediate and longer end of the curve do not have to move

in tandem. This is the scenario we continue to see playing out.

Specifically, short-term rates should remain anchored to a fed

funds policy approach that foresees no increases while the

unemployment rate remains above 6% and expectations for

inflation stay no more than a half percentage point above the

Committees 2 percent longer-run goal. In broader terms, we

continue to expect interest rates to stay historically low, but

we also see a landscape of ongoing volatility whereintermediate and longer-dated rates can move higher, at

times. Indeed, weve been down this road before even when

the Fed is actively purchasing Treasuries as is currently the

case with their QE3+/QE4 program.

Since reaching a recent low of 1.70% right before year end,

the UST 10-yr yield moved up above 2% following the jobs

report earlier this month. This sell-off to begin 2013 has been

centered around some layers of uncertainty being removed

from the investment backdrop (the full effects of the fiscal

cliff were avoided, the debt ceiling debate was postponed), as

fundamentals have taken more of a back seat. Let us notforget developments across the Atlantic either. To be sure,

there seems to be a complacency that has set in, as the ECBs

various policy responses to the Euro Zone crisis have created

an environment where it is believed tail risks have been

reduced. The recent announcement whereby European

banks first repayment of LTROs was much larger than

expected added to this reduced demand for a safe-haven asset

like Treasuries. Along these lines, Euro Zone rates in both the

core and periphery countries have remained subdued.

However, weve been down this road before, and one should

not let his or her guard down too much, a point underscored

by recent headlines of potentially renewed political turmoil in

periphery countries.

If the UST market were to go back to focusing just on the

fundamentals, what could the 10-yr yield look like? According

to our analysis, we would first go back to August 1, 2011 right

before the first debt ceiling debacle, attendant US downgrade

and the Euro Zone implosion. At that time, the 10-yr stood at

2.75%. In order to understand what ones portfolio could

potentially look like in such a reset, we did a one-year horizon

or interest rate shock analysis utilizing the yield levels that

existed on the aforementioned date for the UST coupon cu

As one can see in Figure 1, the 2-yr to 5-yr sectors p

modest positive returns while at the other end of

spectrum, the 30-yr would post a negative figure of ne

12%. Against this backdrop, we feel a prudent strategy isinvestors to revisit their fixed income portfolios, and

those who are overweight longer-term maturities,

recommend lessening duration, and keeping to our prefer

target maturity ranges.

Figure 1. US Treasury One-Year Hypothetical HoriAnalysis

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

Percent

Start YieldsEnd Yields

Total Returns

2Y 3Y 5Y 7Y 10Y

Source: Bloomberg. Data as of 2/4/13.

Hypothetical performance should not be considered a guarantee of fuperformance or a guarantee of achieving overall financial objectives. Aallocation and diversification do not assure a profit or protect against lodeclining financial markets.

So, where is the 10-yr yield going? In the near term,

continue to see buyers re-entering the longer end of the U

market when the 10-yr yield moves toward the 2.00%2.0

threshold. For the record, the MSSB Technical Anal

Group has the first level of support at 2.06%, followed

2.28%. However, from a more broader time horizon, we

an escalation in the 10-yr trading range playing out in

months ahead, and we are raising our target band to 1.50

2.25%. Underscoring our volatility theme, the 10-yr y

traded between these two extremes in 2012: 1.39% and 2.3

Econ & The Fed

After starting the new year with upside surprises to econo

data, more recent reports have revealed a softer performan

The MS tracking estimate for 1Q 2013 real GDP stand

+1.6%, or essentially the same pace as the prior six-mo

period. According to MS economists, if the sequestra

slated for March 1 goes into full effect and is not reverse

the CR discussion in any way, the total fiscal drag a

percentage of GDP for 2013 would be 1.7%. Going back


4/11



1960, there have only been two other fiscal years that show

more tightening: 1969 and 1987.

In our opinion, the January FOMC meeting was uneventful,

as the policymakers decided to lay low to begin the new year.

The January jobs report did not improve substantially, and assuch, does not pass the Feds criteria for reconsidering the

size and pace of the current QE program.

Municipal Outlook

Early on in 2013, the municipal market has visibly

outperformed the UST arena. With the fiscal cliff deal not

including any changes of the federal tax-exempt status of

municipal markets, participants were able to shift their focus

to the higher tax regimen that was put in place for upper

income wage earners. While 10-yr UST yields were rising in

excess of 30bp as of early February, the AAA state GO-like

maturity witnessed a far less visible move of only 10bp,

according to Municipal Market Data. As a result, the

percentage to Treasuries ratio dropped from as high as

101.2% on December 28 to 90.1% as of this writing. It is

interesting to note that, other than a quick bout in November,

one would have to go back to January of last year to see ratios

this low. It should also be noted that the lions share of the

outperformance versus Treasuries was more of an early to

mid-January phenomenon. Indeed, the MSSB Municipal

Strategy team noted that recent municipal price movements

matched their 2013 outlook that 10-year muni yields would

mirror UST yield changes. In the near term, the landscapecould become less friendly if the looming political budget

battles in Washington, D.C. bring about renewed negative

headlines regarding the federal tax exemption.

Fixed Income Sector CommentaryCredit Rough Seas AheadThe risk-on trade since the beginning of the year, based

largely on optimism over the fiscal cliff deal, stronger

economic growth and little to no noise out of Europe, seems

to have run into a sobering dose of reality. First, the

resolution of the fiscal cliff simply created three additionalcliffs in the form of sequestration, the continuing resolution

and the debt ceiling, all of which need to be resolved in the

next couple of months. Second, while economic growth has

generally been stronger and data has been meeting or beating

expectations, this strong run of data has pushed consensus

expectations higher, setting the market up for

disappointment. The Citi Economic Surprise Index, which

measures whether or not data is coming in above or below

consensus expectations, recently dropped below zero for the

first time since September 2012 (see Figure 2). Third, Eur

is back in focus as Spanish 10-year bond yields have moved

more than 50bp since they hit a one-year low on January

2013 at 4.87%. The cause of the sell-off is political as Pr

Minister Mariano Rajoy bas been accused of taking bribes the opposition political party is pressuring him to hold n

elections, raising the specter of political turmoil in one of

economically weakest countries in the Euro Zone. Italy is

in the headlines with an election in three weeks an

banking scandal undoing some of the goodwill Pr

Minister Mario Monti has built up over the past year. Ot

peripheral country sovereign bond yields are also on the

in sympathy with Italy and Spain and concerns that a stron

euro will hinder a return to growth.

Figure 2. US Economic Data Is Struggling to Surprise to Upside

-200

-150

-100

-50

0

50

100

150

200

Jan-08

Jun-08

Oct-08

Feb-09Jul-09

Nov-09

M

ar-10Jul-10

D

ec-10Apr-11

Aug-11

Jan-12

M

ay-12

S

ep-12

StandardDeviations

Citi Economic Surprise Index (US)

Source: Bloomberg. Data as of 2/4/13.

Valuation is also troubling, more so in High Yield t

Investment Grade, as low Treasury yields and tighter spre

offer little in the way of cushion if the markets do sell

Investment Grade spreads have tightened roughly 5bp yea

date to 134bp, just shy of the two-year low of 128bp. Howe

the spread tightening has been completely offset by a gre

rise in risk-free rates. If investors were spooked by any or

of the risks we mentioned above, we would expect

opposite to happen. Risk-free rates would rally wInvestment Grade spreads would likely widen, potenti

offsetting each other. The net result for Investment Gr

investors would likely be neutral.

The bigger concern from our point of view is High Yield.

current price of the Citi High Yield Market Index is 105

slightly below the recent all-time high of 106.3

significantly above the average call price of the index, wh

is 103.7. The current yield on the index is 5.8%, just above

all-time low of 5.6% while the spread on the index has b


5/11



sitting below 500bp since the middle of January. Many

investors view High Yield as the total return component of

their Fixed Income portfolio as it can offer a combination of

relatively high coupon income and the potential for price

appreciation. However, at current valuations we believe HighYield no longer exhibits an attractive risk/reward profile and

offers little in the way of price appreciation. We believe

investors are risking dollars of downside while gathering

pennies.

We believe the negative catalysts we discussed above will

outweigh the positive tailwinds the credit markets have

enjoyed recently, and therefore, a tactical approach is

warranted. We continue to favor Investment Grade over

High Yield within the credit space. Yet we also believe a

slight reduction to our Investment Grade weightings within

our Basis Points asset allocation models is warranted asgovernment/agency MBS is likely to modestly outperform

Investment Grade credit in the short term, in our view.

Currently, we believe investors should either improve the

quality of their High Yield holdings or reduce exposure to

High Yield outright and redeploy the proceeds into the

Investment Grade market. Within High Yield, we continue to

recommend BB rated credits over CCC rated issues. In our

opinion, CCCs are trading well through fair value from a

fundamental perspective and appear rich relative to BBs. The

spread difference between BBs and CCCs is below the long-

term average and is approaching levels we last saw in the fallof 2011 when CCCs underperformed BBs by a significant

margin.

Over the coming months we see Investment Grade credit

outperforming High Yield but believe positioning within

Investment Grade is where investors will generate the

greatest amount of alpha. We see value moving down the

ratings curve to BBBs, which trade cheap to As, in our opinion.

We would expect that spread differential to compress further

as investors move further down the risk spectrum within

Investment Grade looking for yield. From a sector perspective,

we continue to like Financials over Industrials. Although thespread differential has tightened significantly over the past

year, we expect further tightening due to continued credit

improvement in the Financials space. We continue to like the

belly of the Investment Grade curve. We see value in

maturities between 3-7 years, especially at the longer end of

that range.


6/11



Fixed Income Snapshots: Treasuries and MunicipalsU.S. Treasury Yield Curve (2s/5s: 2s/10s)

0

50

100

150

200

250

300

350

Feb-08 Jul-08 Dec-08 May-09 Oct-09 Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13

Basispoints

5-Yea r vs. 2-yea r 10 -Yea r vs. 2-Yea r

Source: Morgan Stanley Smith Barney Fixed Income Strategy, Bloomberg. Data as of 2/1/2013.

Differential in yields between U.S. Treasury 10-year maturity and U.S. Treasury 2-year maturity, and differential in yields between U.S. Treasury 5-year maturityU.S. Treasury 2-year maturity.

10-Yr Municipal Yield to Treasury Ratio

60

80

100

120

140

160

180

200


Percent(%)

Source: Municipal Market Data (MMD), Bloomberg. Data as of 2/1/2013.

The 10-yr AAA municipal bond yield as a percentage of the benchmark 10-yr U.S. Treasury note yield. The 10-yr AAA municipal index, which is derived from MMdaily generic yield curves, represents the average yield of non-insured AAA-rated State G.O. bonds and reflects the offer-side of the market determined from traactivity and markets. The benchmark 10-yr U.S. Treasury yield is the yield of the most recently auctioned 10-yr Treasury note reported on a daily basis (as of the pdays close).


7/11



Fixed Income Snapshots: Agencies and Mortgage-Backed Securities5-Year Federal Agencies Spread to Treasuries

0

40

80

120

160

200


Basispoints

Source: Morgan Stanley Smith Barney Fixed Income Strategy, Bloomberg. Data as of 2/1/2013.

Fair Market Value U.S. Government Federal Agency spreads to Fair Market Value U.S. Treasuries for 5-yr maturities. Federal Agency and Treasury indices shownderived from Bloombergs Option Free Fair Market Yield Curves, which provide the composite yield of all outstanding securities around each maturity pointexample, the Federal Agency 5-yr includes all outstanding Federal Agency securities maturing in 2018.

30-Yr Fannie Mae MBS Current Coupon Spread to 10-Yr Treasuries

-50

0

50

100

150

200

250

300


Basispoints

Source: Morgan Stanley Smith Barney Fixed Income Strategy, Bloomberg. Data as of 2/1/2013.Fair Market Value 30-yr FNMA MBS Current Coupon spread to Fair Market Value 10-yr Treasuries. Due to risks of MBS structure (e.g., prepayments and extenrisk), the 10-yr Treasury is used as the benchmark for the 30-yr FNMA maturity. The MBS and Treasury indices shown are derived from Bloombergs Option FreeMarket Yield Curves. The 30-yr FNMA MBS index represents the composite yield of all outstanding FNMA MBS current coupon securities maturing in 2043, while10-yr Treasury index represents the composite yield of all outstanding Treasury notes maturing in 2023.


8/11



Fixed Income Snapshots: Investment Grade and High Yield CorporatesInvestment Grade Corporate Index to Treasuries

0

100

200

300

400

500

600

700


OptionAdjustedSpread

Source: Analytics Provided by The Yield Book Software and Services. 2013 Citigroup Index LLC. All rights reserved. Data as of 2/4/13.

The Citi US BIG Corporate Index is designed to track the performance of US dollar-denominated US and non-US corporate bonds. It excludes US governmguaranteed and non-US sovereign and provincial securities. Bonds must have a fixed coupon, a minimum of one year to maturity and be rated a minimum of BBB-/Bby both S&P and Moody's.

High Yield Corporate Index to Treasuries

0

250

500

750

1000

1250

1500

1750

2000


SpreadtoWorst

Source: Analytics Provided by The Yield Book Software and Services. 2013 Citigroup Index LLC. All rights reserved. Data as of 2/4/13.

The Citi High Yield Market Index is designed to capture the performance of below investment grade debt issued by corporates domiciled in the United StateCanada. Bonds must have a fixed coupon, a minimum of one year to maturity and be rated a maximum of BB+/Ba1 by both S&P and Moody's.


9/11



Disclosures

The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quand accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors. Morgan Stanley Smith Barnnvolved 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/instrumor to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation ofsecurities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review ofoffering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and to wprospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation toyou when information herein may change. We make no representation or warranty with respect to the accuracy or completeness of this material. Morgan StaSmith Barney has no obligation to provide updated information on the securities/instruments mentioned herein.

The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depenan investors individual circumstances and objectives. Morgan Stanley Smith Barney recommends that investors independently evaluate specific investmentsstrategies, 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 rforeign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and ossuers or other factors. Estimates of future performance are based on assumptions that may not be realized. Actual events may differ from those assumedchanges to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly athe projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projecor estimates, and Morgan Stanley Smith Barney does not represent that any such assumptions will reflect actual future events. Accordingly, there can bassurance 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 intendeand should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Smith Barney is not acting as a fiduciary under eitheEmployee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material.

Morgan Stanley Smith Barney and its affiliates do not render advice on tax and tax accounting matters to clients. This material was not intended or writtebe 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 taxpunder 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 result from acting on a particular recommendation.

nternational investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertaintieforeign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatunstable governments and less established markets and economies.

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 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 vof 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 duchanges 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 migh

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 intepayments 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 creditand price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risk tolebefore investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio.

nterest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax (AMT). Typically, 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 citresidence.

Treasury Inflation Protection Securities (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation by trackingconsumer 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 significantly underperform versus conventional U.S. Treasuries in times of low inflation.

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 ofspecific investment.

The indices selected by Morgan Stanley Smith Barney to measure performance are representative of broad asset classes. Morgan Stanley Smith Barney retainright to change representative indices at any time.

nvesting in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and marisks.

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 matnterest/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 invwould 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. Cuyield is calculated by multiplying the coupon by par value divided by the market price.

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 expecreceive additional income due to future increases in the floating/linked index. However, there can be no assurance that these increases will occur.


10/11



Some $25 or $1000 par preferred securities are QDI (Qualified Dividend Income) eligible. Information on QDI eligibility is obtained from third party sources. dividend income on QDI eligible preferreds qualifies for a reduced tax rate. Many traditional dividend paying perpetual preferred securities (traditional preferreds no maturity date) are QDI eligible. In order to qualify for the preferential tax treatment all qualifying preferred securities must be held by investors for a miniperiod 91 days during a 180 day window period, beginning 90 days before the ex-dividend date.

CDs are insured by the FDIC, an independent agency of the U.S. Government, up to a maximum amount of $250,000 (including principal and interest) for all dep

held in the same insurable capacity (e.g. individual account, joint account) per CD depository, through December 31, 2013. On January 1, 2014, the maximum insuramount will return to $100,000 (including principal and interest) for all insurable capacities except IRAs and certain self-directed retirement accounts, which remain at $250,000 per depository.Investors are responsible for monitoring the total amount held with each CD depository. All deposits at a single depository n the same insurable capacity will be aggregated for purposes of the applicable FDIC insurance limit, including deposits (such as bank accounts) maintained direwith the depository and CDs of the depository held through Morgan Stanley Smith Barney. A secondary market in CDs may be limited. CDs sold prior to maturitsubject to market risk and therefore investors may receive more or less than the amount invested or the face value. Callable CDs are callable at the sole discretiothe issuer. For more information about FDIC insurance, please visit the FDIC website at www.fdic.gov.

Contingent return (e.g. index-linked) CDs are treated as having original issue discount (OID) for tax purposes. Although interest is not received until maturity, ths assumed to pay a pre-determined interest rate that will be treated as current income for tax purposes if held in a taxable account. Investors should be made athat contingent return CDs generally feature an averaging method of return calculation, which averages the changes in value of the relevant index as measurepredetermined dates over the life of the CD. Therefore, the CDs return will not mirror the actual index value or return. If the measured index return usinaveraging method is zero or negative, the investor receives no interest. Some contingent return CDs also have a participation rate (the degree to which an inveparticipates in the measured return of the index) that is less than 100%. Interest on contingent return CDs is not eligible for FDIC insurance before the final valudate.

Principal is returned on a monthly basis over the life of a mortgage-backed security. Principal prepayment can significantly affect the monthly income stream and

maturity of any type of MBS, including standard MBS, CMOs and Lottery Bonds. Yields and average lives are estimated based on prepayment assumptions andsubject to change based on actual prepayment of the mortgages in the underlying pools. The level of predictability of an MBS/CMOs average life, and its market depends on the type of MBS/CMO class purchased and interest rate movements. In general, as interest rates fall, prepayment speeds are likely to increase, shortening the MBS/CMOs average life and likely causing its market price to rise. Conversely, as interest rates rise, prepayment speeds are likely to decrease,lengthening average life and likely causing the MBS/CMOs market price to fall. Some MBS/CMOs may have original issue discount (OID). OID occurs ifMBS/CMOs original issue price is below its stated redemption price at maturity, and results in imputed interest that must be reported annually for tax purpresulting in a tax liability even though interest was not received. Investors are urged to consult their tax advisors for more information.

nterest income from taxable zero coupon bonds is subject to annual taxation as ordinary income even though no interest payments will be received by the investheld in a taxable account. Zero coupon bonds may also experience greater price volatility than interest bearing fixed income securities because of their comparatlonger duration.

nvesting in foreign markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Hypothetical PerformanceGeneral: Hypothetical performance should not be considered a guarantee of future performance or a guarantee of achieving overall financial objectives. Aallocation and diversification do not assure a profit or protect against loss in declining financial markets.

Hypothetical performance results have inherent limitations. The performance shown here is simulated performance based on benchmark indices, not investmresults from an actual portfolio or actual trading. There can be large differences between hypothetical and actual performance results achieved by a particular aallocation.

Despite the limitations of hypothetical performance, these hypothetical performance results may allow clients and Financial Advisors to obtain a sense of the rreturn trade-off of different asset allocation constructs.

Indices used to calculate performance: The hypothetical performance results in this report are calculated using the returns of benchmark indices for the asset claand not the returns of securities, fund or other investment products.

ndices are unmanaged. They do not reflect any management, custody, transaction or other expenses, and generally assume reinvestment of dividends, accrued incand capital gains. Past performance of indices does not guarantee future results. Investors cannot invest directly in an index.

Performance of indices may be more or less volatile than any investment product. The risk of loss in value of a specific investment is not the same as the risk of losa broad market index. Therefore, the historical returns of an index will not be the same as the historical returns of a particular investmeclient selects.

nvesting in the market entails the risk of market volatility. The value of all types of securities may increase or decrease over varying time periods. This Analysis does not purport to recommend or implement an investment strategy. Financial forecasts, rates of return, risk, inflation, and other assumptions maused as the basis for illustrations in this Analysis. They should not be considered a guarantee of future performance or a guarantee of achieving overall finaobjectives. No Analysis has the ability to accurately predict the future, eliminate risk or guarantee investment results. As investment returns, inflation, taxesother economic conditions vary from the assumptions used in this Analysis, your actual results will vary (perhaps significantly) from those presented in this Analys

The assumed return rates in this Analysis are not reflective of any specific investment and do not include any fees or expenses that may be incurred by investinspecific products. The actual returns of a specific investment may be more or less than the returns used in this Analysis. The return assumptions are basehypothetical rates of return of securities indices, which serve as proxies for the asset classes. Moreover, different forecasts may choose different indices as a proxythe same asset class, thus influencing the return of the asset class.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.

Credit ratings are subject to change.
http://www.fdic.gov/http://www.fdic.gov/


11/11


Please refer to important information disclosures and qualifications at the end of this material

This material is disseminated in Australia to retail clients within the meaning of the Australian Corporations Act by Morgan Stanley Smith Barney Australia Pty(A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813).

Morgan Stanley Smith Barney is not incorporated under the People's Republic of China ("PRC") law and the research in relation to this report is conducted outsidePRC. 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 buysecurities in the PRC. PRC investors must have the relevant qualifications to invest in such securities and must be responsible for obtaining all relevant approlicenses, verifications and or registrations from PRC's relevant governmental authorities.

Morgan Stanley Private Wealth Management Ltd, which is authorized and regulated by the Financial Services Authority, approves for the purpose of section 21 ofFinancial Services and Markets Act 2000, content for distribution in the United Kingdom.

Morgan Stanley Smith Barney is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, adwithin the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC.

Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and snot have liability for any damages of any kind relating to such data.

Morgan Stanley Smith Barney material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley SBarney.

2013 Morgan Stanley Smith Barney LLC. Member SIPC.

feb basis points-fixed income

Documents