great global shift whitepaper

New world, New rules

Risk, opportunity and the seismic changes in the balance of power driving today’s markets

T h e g r e aT g l o b a l s h i f T

lisa shalettChief investment Officer, Merril l lynch Global Wealth Management

ian breMMerPresident,

eurasia Group

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Sometimes it seems the world can’t catch a break, between the spiraling debt crisis in the eurozone, gridlock in Washington, slowing

global growth, persistent unemployment and turmoil across the middle east. it can be both disorienting and discouraging. How do you make sense of the stream of apparently unrelated crises coming from so many directions?

At merrill Lynch, we think a good place to start is with the understanding that these seemingly unconnected issues are very connected. they are all part of an ongoing, fundamental transformation in the world’s economic, political and social institutions. in this whitepaper, the eurasia Group’s ian Bremmer and our own Lisa shalett offer a wide-angle view that brings to light the larger pattern of the global economy, revealing a rebalance of economic power on par with some of the most significant paradigm shifts in history. inevitably, change on this scale comes with a great deal of disruption and additional risks, along with new opportunities. in fact, what’s happening in the world right now calls into question many tenets of investing and managing risk that have prevailed for decades.

the quality of insight that merrill Lynch can provide is rare—and especially important—in an era when around-the-clock news and instant analysis seem ever present. it is always our aim to give you a more thoughtful, forward-looking point of view, as well as real solutions that can help you make informed invest-ment decisions.

once you’ve read this whitepaper, i invite you to make it the foundation of your next conversation with your financial advisor. make use of its insights as you work together to adapt your financial life to a new world and its new rules.

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Merrill Lynch Wealth Management makes available products and services offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S) and other subsidiaries of Bank of America Corporation (BAC).Investment products:

Are Not FDIC Insured Are Not Bank Guaranteed May Lose Value

MLPF&S is a registered broker-dealer, a registered investment advisor and Member SIPC.

BY iAn BRemmeR & LisA sHALet t

Risk, opportunity and the seismic changes in the balance of power driving today’s markets

New world, New rules

T h e g r e aT g l o b a l s h i f T

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I t happened after a new round of global financial turmoil, with europe lurch-ing deeper into its debt crisis, the dow

soaring and plunging by more than 400 points on six different occasions, and the U.s. receiving an unprecedented blow to its sovereign credit rating: new York and Washington, d.C., the centers of American financial and political power, were literal-ly shaken. Chandeliers swung in the Capi-tol. traders evacuated the new York stock exchange. the 5.8-magnitude earthquake on America’s east Coast actually caused little in the way of physical damage. But it was strong enough to reinforce a meta-phor in the minds of people across the world: nothing seems to be stable any-more, not even the bedrock.

the very real economic shocks that have rumbled through the U.s. and the rest of the developed world during the past four years may have at last begun to unsettle our

sense of equilibrium. the history of modern commerce has taught us all about cycles. Historically, recessions lead to the inevitable reflation. Crashes contain the seeds of come-backs. markets mend, GdPs rise again and job creation does become real rather than just a piece of political rhetoric. And yet, as much as we’d like to believe otherwise, there’s no denying that this time it’s different.

since the end of World War ii, a powerful West, dominated by U.s. hegemony, grew accustomed to equating itself with the world. the preeminence of Western institu-tions—nAto, the World Bank, the interna-tional monetary fund—meant that global priorities were our priorities. the West set the conditions for economic reform, trans-parency and the rule of law. even the soviet Union, the U.s.’s chief rival for global influ-ence during the Cold War, was primarily a military rival that never posed a true threat to Western economic power.

America’s place in the global economy was like that old New Yorker cover depicting the view from ninth Avenue, across the heartland, to a tiny distant Asia. on a personal level, when we invested for our families and our futures, operating in a West-centric, dollar-dominated world didn’t eliminate the cyclical ups and downs, but it did at least make them seem fa-miliar. so it’s only natural that as we talk about economic “recovery,” what we really want, beyond higher GdP and greater employment, is a return to that old, comfortable balance. When (we can’t help but wonder) will we recover that old sense of equilibrium?

the answer is becoming clearer every day: We won’t. the rapid rise of China and other emerging nations has ushered in sweeping changes being felt from the bauxite mines of Asia to the gas pump on main street to the expensive office space in são Paulo. one of the great paradigm shifts in history appears to be upon us. such periods are always marked by enormous turbulence—and fear, as the market’s recent wild swings may have already be-gun to express. As volatile as the past few years have felt, they are likely to be a mere prelude to a period of global disruption and uncertainty that will endure for years to come.

Change has arrived so swiftly that our largest institutions, while still holding to the paternalistic model of the West as benefactor/protector, are being surpassed by the very countries they were set up to help. during the past two years, China offered more aid to developing nations than the World Bank did ($110 billion vs. $100.3 billion)—even as China continued to receive billions of dollars in aid from the World Bank.1

if the World Bank has been thrust into such apparent contradictions, what are private investors to make of these developments? in disruptive times, even the most conser-vative strategies (buy-and-hold; stay close to home) may not be so conservative at all. navigating an age of risk requires meeting risk head-on, actively and dynamically, and

1“China’s Lending Hits New Heights,” Financial Times, Jan. 17, 2011.

A World Under Stress the Global Financial stress index, introduced by bofa Merrill lynch Global research late last year, was designed to attach a specific value to the symptoms of stress exhibited by the world’s financial markets during this period of profound global change. the index combines and tracks key measures of investor behavior, including volatility, hedging demand and investment flows in and out of telltale “risk-off” asset classes like stocks, bonds and money market funds.

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September 2010 December 2010 March 2011 June 2011 September 2011

iAn BRemmeRis the president of Eurasia Group, a leading consultancy on geopo-litical risk, and is widely regarded as one of the most influential thinkers on global trends.

LisA sHALettis the chief investment officer for Merrill Lynch Global Wealth Manage-ment and head of Investment Manage-ment & Guidance.

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venturing into the strange landscape of a global economy. that’s the tough way of look-ing at it. seen another way, disruption most always creates opportunities. to seize them, we must respond nimbly, adapt, adjust and, perhaps most important, come to terms with just how profoundly the world has changed—and is changing.

A moRe insULAR West

I t’s hard to recall the sense of optimism (some might say smugness) with which the West greeted this century. the birth of the eurozone represented one of the most remarkable political and economic experiments ever attempted in the developed

world. Yet what 11 years ago seemed like the next great step toward Western-style glo-balization now seems like a misstep.

At the time they launched the euro, european leaders lacked the political means to give their new currency the backing of a europe-wide fiscal policy. Amid the euphoria, it was easy enough to kick that problem down the road. But “down the road” has come upon them much more quickly than they imagined. Rolling debt crises, market panics and austerity riots are now forcing europeans to focus less on global affairs and more on how to rework their compact to secure its very survival.

meanwhile, Japan, once hailed as heir apparent to a post-U.s. global economy, has instead endured a long, painful economic stagnation. And this year, just when it seemed it might emerge from the doldrums, the nation was hit by an earthquake roughly 16,500 times more powerful than the recent east Coast temblor, followed by an even more devastating tsunami and nuclear accidents. While showcasing the country’s marvelous stability and resilience in the face of adversity, these combined disasters have rattled the country’s infrastructure and forced Japan, like europe, to turn inward.

in the U.s., preoccupied at the turn of the century with its post-soviet responsibilities as the world’s lone superpower, we must now deal with less lofty but no less serious mat-ters, including stubbornly high unemployment, yawning income disparities, flat wages, sagging infrastructure, a federal debt approaching $50,000 per person2 and the inevita-ble comparisons with Japan. if the eventual accord over raising the debt ceiling held off the immediate threat of a government default, the subsequent credit rating downgrade and market turmoil only emphasized how deep and thorny the challenges remain.

While none of these powers, least of all the U.s., will exit the world stage, all of this inward focus can’t help but destabilize global leadership, financially and otherwise. former U.s. defense secretary Robert Gates, in his final speech to nAto on June 10, sounded a blunt warning that without a concerted effort by europeans to pitch in, Americans could question the wisdom of spending so much on the alliance, confronting nAto with the very real possibility of “collective military irrelevance.”3 Whether that situation comes to pass, clearly the balance is shifting. What will take the place of the old structures looms as the question of our times.

2US Debt Clock, usdebtclock.org. See “Debt Per Citizen.” 3“Washington Wire,” Wall Street Journal, June 10, 2011.

in disRUPtive times, even tHe most ConseRvAtive stRAteGies (BUY-And-HoLd; stAY CLose to Home) mAY not Be so ConseRvAtive At ALL.


WAitinG on tHe emeRGinG WoRLd

I t’s almost too easy to say that emerging nations are driving world growth. the interna-tional monetary fund projects that on a purchasing-power parity basis,4 emerging and developing markets will account for two-thirds of the growth in global GdP this year. still,

that trend, striking as it is, masks extraordinary complexity. emerging markets don’t make up a unified bloc, but rather are vastly different countries with competing goals, standards and agendas—not to mention enormous challenges of their own.

thus far, the remarkable growth of developing countries has been tempered by their unwill-ingness to accept a proportional share of the responsibilities of global leadership. Whether it’s european-style environmental reforms, U.s.-style peace brokering in the middle east or coor-dinating antiterrorism policies, most of the comprehensive initiatives for solving the world’s problems continue to initiate in the West. While China may have developed into a banker and benefactor to Western and developing nations alike, it often tries to attach manifold strings to those trillions it sends overseas. this fall, Chinese Premier Wen Jiabao suggested his na-tion might be willing to step up its monthly lending and other investments in europe to help the eurozone out of its debt crisis—if the europeans extended a way around the “antidump-ing” regulations that prevent Chinese companies from flooding the continent with low-priced goods.5 to be sure, the U.s. and europe often act with self-interest when pursuing their inter-national policies, but China seems to be especially shameless about it. 4The purchasing-power parity rate—defined as the number of units of a country’s currency that are required to buy the same amount of goods and services as one U.S. dollar would buy in the U.S.—is intended to allow for apples-to-apples comparisons between average consumers in different nations.5World Economic Forum’s fifth Annual Meeting of the New Champions, Sept. 14, 2011.

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Rising Influence of Emerging MarketsOn a “purchasing-power parity basis,” which levels the purchasing power of average consumers across different countries, emerging markets have increasingly contributed a greater percentage to global GdP over the past decade than developed nations have.

Source: International Monetary Fund, World Economic Outlook Database, April 2011

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Because of its size and spectacular growth, discussions of emerging markets inevitably start with the People’s Republic. the Chinese today aren’t just producing every kind of goods, and do-ing it with precision; as tens of millions of Chinese move into the middle class, they’ve also begun consuming vast quantities, last year purchasing more cars than did Americans,6 and recently overtaking the U.s. as the biggest PC consumer in the world.7 Why, then, are the Chinese so worried? With the West’s buying power shrinking and their own citizens demanding a greater share of the wealth, China’s top-down economic planners are struggling with whether they must fundamentally restructure their nation’s economy from what is still principally a state-driven, export-oriented system to a more consumption-driven one.

China’s state Council has made the growth of the consumer sector a theme of the country’s lat-est five-year plan. At the same time, it has shown zero willingness to dismantle the network of state-run giants (and some private ventures) that have benefited from the special financing and regulatory shields that the central government has long bestowed on them. this system of privi-lege was meant to fuel the country’s old export-driven growth, and clearly it succeeded. But while the furious development has lifted millions of Chinese out of poverty, it has nonetheless come at a significant cost. With the arrival of a new class of state-sponsored entrepreneurs and bureau-crats, the gap between rich and poor has widened, and the resulting imbalances have spurred what could become a massive power struggle between reformists and entrenched interests that reaches into every strata of Chinese society. As if to illustrate the challenges, the country’s exports as a percentage of GdP have ballooned back to pre-financial-crisis levels, at around 39%, the highest ever.8 China may indeed move toward a more self-focused economy, but we would do well to remember that every Chinese five-year plan is designed as just one step in a 25-year plan.

Beyond China, india and indonesia deserve more serious attention than they get. Both countries have compelling demographics and commodity wealth, plus political and economic systems that aren’t in need of a wholesale overhaul. Here again, though, attempts to classify countries en masse fall short. Umbrella acronyms such as BRiC (for Brazil, Russia, india and China) have a handy ring but convey a level of uniformity that doesn’t exist. Russia, for example, while rich in commodities, is actually losing population and labors under a sluggish bureaucracy and opaque corporate governance. some other, less likely names, meanwhile, may present investors with opportunities at least as BRiC-like. despite a recent uptick in religious conservatism and a disconcerting crackdown on free speech, turkey saw its economy surge 10.2% in the first six months of this year.9 even nigeria, with 155 million people and a burgeoning entrepreneurial spirit, deserves a serious look.

still, none of these nations is jumping at the chance to fill the vacuum that will be left by the inward turn of the traditional Western powers. many observers see a new era characterized by uncoordinated policies from both developed nations and emerging markets. We will experience a world that is multispeed and multidirectional, with varied responses from lawmakers in every spot on the globe, like loose molecules. this has already had an obvious effect, with massive dis-locations in commodities, currencies, credit spreads and asset prices. the takeaway is to expect

6“China Ends U.S.’s Reign as Largest Auto Market,” Bloomberg, Jan. 11, 2010.7“China Tops U.S. as World’s Largest PC Market,” Forbes, Aug. 23, 2011.8tradingeconomics.com/china/exports.9BofA Merrill Lynch Global Research, Sept. 13, 2011.

desPite A ReCent UPtiCk in ReLiGioUs ConseRvAtism, tURkeY sAW its eConomY sURGe 10.2% in tHe fiRst HALf of 2011.


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even more of the same, at least for the time being. that includes trade wars, industrial piracy and the hoarding of resources à la China’s recent stockpiling of vital rare-earth metals. so while investors rightly move to emerging markets for growth opportunities, the search for stability and equilibrium goes on.

tHe deBt, no-deBt PARAdiGm

O ne crucial group of actors in this volatile global shift is the central banks, as nations and markets naturally divide more and more along new fault lines. instead of a world marked by developed and emerging, we may be entering the age of debt vs. no debt.

in the debt World, as you can see above, there are the U.s. and europe. While all of the major players in europe are committed to the eurozone, the continent has a long, hard slog ahead. for the immediate future, markets are likely to punish the europeans, even as they begin to turn things around through austerity programs and tentative steps toward greater fiscal unity. the U.s. position, despite the sting of its own downgrade by standard & Poor’s, has the built-in advantages of a single government (however fractious) rather than many, and a single muscu-lar central bank in the federal Reserve. that said, America’s fiscal problems are real, and the resolve it has shown in facing and overcoming the challenges has so far seemed modest at best.

moreover, as in europe, the struggle to ease the public debt burden is complicated by private debt. in simple terms, the U.s. workforce and economic base were built to be sustained by consumer borrowing and rising home values. the model helped to fuel U.s. GdP by roughly 3%

As of AUGUst 2011, AttitUdes in tHe U.s. ABoUt tHe BUsiness CLimAte And PeRsonAL finAnCes WeRe At neAR A 30-YeAR LoW.

Reversals of Sovereign Fortunestwenty years ago, it was the fiscal crises in south america and the asian tiger Cub economies that riveted investors. today it’s more of the developed nations that are rattling global markets with their high levels of debt and deficits.


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a year from 1996 to 2008.10 But the levels of demand projected going forward are waning—BofA merrill Lynch Global Research recently lowered its U.s. GdP forecast to 1.6% for 2012 and 1.4% for 2013.11 that “missing 1.5%” is at the core of the tragically high structural unemployment that is itself a major drag on growth weighing on the efforts to bring government spending in line with revenues. in the meantime, look for more years of low economic growth, constrained fiscal policy responses and a central bank forced into ever more extreme monetary fixes that, from an investor’s perspective, all amount to the same outcome: lower interest rates.

10International Monetary Fund; Merrill Lynch GWM Investment Management & Guidance.11BofA Merrill Lynch Global Research, Global Economic Weekly, Sept. 23, 2011.

COMMOdities by any Other naMeWith the world clamoring for raw materials, here are three ways to add them to a portfolio—each with its own benefits and risks.

n a world of finite re-sources and rapid growth in developing countries, many investors may

benefit from buying commodities. the question is how. taking ownership of the actual shiploads of grain, oil, steel or gypsum presents obvious chal-lenges. in most cases, then, when we talk about “buying commodities,” what we’re really talking about is buying the rights to purchase commodities or, more commonly still, buying shares in funds whose managers buy and sell the rights to purchase commodities. For investors who may be looking to incorporate commodities as part of a long-term allocation strategy, these ap-proaches can boil down to three main categories:

1. Index and Exchange-Traded Funds the simplest and least expensive way of gaining commodity exposure, index funds seek to match the performance of the major commodity composite indexes, such as the dow Jones–ubs or standard & Poor’s GsCi. because the funds are pas-sively managed to hew to their in-dexes, management fees tend to be lower than for most mutual funds. and daily trading makes the invest-ments highly liquid. exchange-traded funds (etFs) offer similar ease of investment—they’re bought and sold on stock exchanges for a com-

mission—and lower fees, plus the ability to target more specific objec-tives. For example, to hedge against the impact a rise in oil prices could have on the rest of your portfolio, you might purchase shares in an oil-linked etF. One potential drawback is the un-derlying methods these funds use to generate their returns. although etFs generally seek to match the “spot,” or current price for immediate delivery of their commodity, most actually do so by trading longer-dated “futures” contracts. Periodically, when the price of futures outpaces the spot price, as during the big run-up in oil prices in the first half of 2011, the cost of buying new contracts after the old ones expire can eat deeply into the performance of the fund, even if the commodity itself is doing very well.

2. Actively Managed Funds actively managed commodity funds rely on managers’ skill in pursuing more complex objectives, such as out-performing commodities indexes or countering the effects of volatility. historically the leading purveyors of active management strategies were hedge funds (see “even More targeted solutions for Qualified investors,” page 16), which limited the approach to a relatively select group of clients. but in recent years more mutual funds have been getting into the arena. though these “nontraditional” mutual funds

typically don’t offer the same “alpha,” or added upside potential of hedge funds, their fees are generally quite a bit lower and investors face far fewer restrictions on eligibility and liquidity.

3. Market-Linked Investments While all forms of commodity exposure can be effective at adding diversification and reducing overall portfolio risk, these investments provide a way to explic-itly manage the risk of a commodity allocation itself. they’re essentially market-linked bonds (issued by banks and other companies) whose returns can be linked to another asset. using one type of Market-linked invest-ment, for example, you might buy a five-year note tied to the spot price of gold. if the metal continues its rise of recent years, you’d receive a payout at maturity reflecting all or a portion of those returns. but if the price of gold goes down, you’d still get back your original investment.

Purchasers of Market-linked invest-ments take on other risks—chiefly the credit risk of the issuer—and because payouts are usually subject to a “cap,” returns may be less than with a direct investment in the under-lying asset. nonetheless, for many investors, they remain another way of “buying commodities” today that can help meet their specific objectives. no vault or grain elevator required.

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the question now is: What replaces the 1.5%? even as America pays down its debts, public and private, it must begin to tackle the even more fundamental issues glossed over during the hous-ing boom: An enormous baby boomer generation whose entitlements must in large part be borne by younger people facing a less-than-certain financial future. Wealth inequality that hasn’t been this severe since the 1920s. A similarly intensifying disparity between skilled and unskilled workers, with the latter group both growing in size and falling further behind. A social compact that increasingly treats labor as just another variable cost to be shed whenever demand is low.

Underpinning all of those specific issues is something less easy to define but no less real: a lin-gering crisis of confidence. According to the University of michigan Consumer sentiment index, as of August 2011, attitudes in the U.s. about the business climate and their personal finances were at near a 30–year low.12 these findings, bolstered by similar numbers from the Conference Board,13 came at a time when the country was not even technically in a recession. the matter of which must happen first—a return of confidence, or progress on the hard work ahead—is a clas-sic chicken-or-egg question. either way, there’s no denying that reinvigorated capital markets require a bit of swagger, a return of the “animal spirits” that drive capitalism. no doubt that can happen. the world’s biggest economy has too much creativity, too much resilience to stay down forever. Yet the rebound could still be a ways off, and investors must realize that when the American economic giant reawakens, it will be to a global economy governed by new rules and populated by new highly motivated and highly competitive players.

By contrast, China and (bizarrely enough, considering the trillions they have defaulted on in the past) much of the rest of Asia and south America have already begun to exercise the flexibility that comes with membership in the no-debt World. Gradually, fitfully weaning themselves from

12“Surveys of Consumers,” Thomson Reuters, University of Michigan, Aug. 26, 2011.13“Consumer Confidence Survey,” The Conference Board, Aug. 30, 2011.

A Nation of Labor Rentersby steadily increasing their reliance on temporary workers, american businesses are able to treat labor as just another variable cost—aggressively cutting when demand for products is low.

Source: Bureau of Labor Statistics and Merrill Lynch GWM Investment Management & Guidance. Data as of Aug. 31, 2011.

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the rOad ahead 11the GlObal sh i F t 11

dependence on the West, these economies will continue to grow, giving their central bankers increasing sway over the world’s markets. And as their inflation picture sharpens, they may continue on a path much different from that of Western countries.

AdAPtinG to tHe neW WoRLd oRdeR

A s nations become more insular, investors, understandably, may be tempted to do the same. Yet while that might seem a more conservative approach, the insularity of nations actually compels investors to look ever outward, not just to different countries but also

to new and different asset classes that they might not have considered before.

from late 2008 through 2009, some investors swore that diversification had stopped working. After all, markets and regions all seemed to drop and then rise on the same tide. Under the circumstances, it hardly seemed to matter whether you invested in hometown bonds or stocks on the German dAx. But, as shown on the next page, in 2010, natural cycles did start creeping back into the markets—revealing once again the distinct advantages, disadvantages, risks and rewards of different assets and geographies—at least until the latest round of global economic turbulence sent markets around the world into another correlated downdraft. the so-called risk-on/risk-off trade became the rhythm of the markets once again. if the recent period of distress demonstrates anything, however, it’s the long-term trends that have taken hold. it’s possible that episodes of ultra-volatility will continue to rise up and dissipate again and again, giving way to periods of relative calm when the fundamental strengths of emerging markets reassert. the challenge for investors is to develop a long-term strategy that can both withstand the unexpect-ed crises and ride the tide that is likely to be the dominant trend for the next century.

Yet today, while most of us must admit the apparent logic of going global, emotions inter-vene. the science of investor psychology confirms what most observers of financial history already know: investing and clear thinking don’t always go hand in hand. if they did, panic would never grip markets, and euphoria wouldn’t cause investors to disregard fundamen-tals. But it’s not just emotion that keeps us from making the most of fresh opportunities in a changing world. traditional modes of thinking—indeed, some of the most basic orthodoxies of our investing logic—now require serious reconsideration. According to meir statman, the economist and expert in behavioral finance, investors tend to think about risk only in literal, dictionary terms: the possibility of suffering losses. But that can be a limited view. the biggest risk for an investor, statman says, is to find oneself locked into a position that makes it impossible to achieve one’s goals.14 take, for instance, the traditional Western view of what have historically been considered the safe havens of sovereign debt. investing in bonds issued by emerging-market nations like China or even malaysia and indonesia—those former Asian tiger Cub economies that suffered their own financial crises and collapses not so long ago, in the late 1990s—might seem like pure folly in times of chronic uncertainty, especially as compared with U.s. treasuries. But, in fact, if one takes into account

14Meir Statman, What Investors Really Want, McGraw-Hill, 2010.

investinG in Bonds of tHe foRmeR AsiAn tiGeR CUB eConomies dURinG times of CHRoniC UnCeRtAintY CAn seem Like PURe foLLY. BUt it isn’t.

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mAnAGinG Risks in tHis enviRonment ReqUiRes WHAt miGHt onCe HAve seemed BetteR sUited to mARket sPeCULAtoRs.

one’s actual income needs, today’s low treasury yields and the relatively strong balance sheets of the Asian countries, the opposite may be true.

tHe AGe of mAnAGinG Risks

T he first step in going global is to recognize our emotional inclinations and reflexive choices. Are government bonds really the best choice when debt is rising and inter-est rates are plummeting? is buying and holding a handful of traditional invest-

ments really a prudent course when risks and opportunities move restlessly around the globe? the global economy has made volatility structurally higher—meaning that instead of thinking of turmoil as a temporary situation to be endured before the return of a calmer “normal,” we have to adjust to the reality that the world is more turbulent, and that it will almost certainly stay that way.

during a time of change, portfolios must adapt to meet new challenges and opportunities. Risk management is something investors and their financial advisors have to incorporate into each investment decision, giving it as least as much thought as efforts to maximize returns.

Why Diversification Still Mattersduring times of economic stress, the patterns of financial markets tend to converge in something more closely approximating a 1:1 correlation, before natural cycles eventually return. as global disruptions potentially squeeze the interims between such periods, investors will increasingly need a long-term strategy nimble and diverse enough to thrive in both kinds of markets.


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managing risks in this environment requires what once might have seemed better suited to market speculators: an approach more dynamic than old-style investing, more tactical, more flexible and quicker to respond. it’s not enough, for instance, to diversify along tradi-tional lines: risky growth stocks on one hand and stable dividend-paying blue chips on the other. it means knowing how to diversify between countries and regions: between south-east Asian chip manufacturers and south American miners. it means seeking out mutual funds that have broader mandates, with an ability to hedge positions or to range across borders and asset classes. it means taking a look at alternative assets in general, includ-ing commodities and, for qualified investors, hedge funds and private equity to determine whether they’re appropriate for your portfolio.

traditional asset classes, too, must be seen through a more global, dynamic prism. di-versification matters more than ever, but it can no longer be achieved by dutifully filling neatly defined slots with 60% stocks, 30% bonds and 10% cash and then holding on for dear life. Are those stocks positioned to capture global growth, to help protect against currency fluctuations, to provide yield potential? Are you prepared to change directions as new op-portunities arise?

A neW APPRoACH to stoCks

T he truisms we’ve embraced for generations about these familiar securities no longer apply. stocks, in one way of viewing it, could at times fill more of the role tra-ditionally played by bonds. Particularly with many large, blue-chip multinational

companies, profits have recovered, rendering balance sheets as robust as they’ve been in years.15 that means dividends are currently growing16—and likely to expand, since com-panies realize that deploying cash dividends to shareholders may be their most effective way of compensating investors during these turbulent times.

Corporate dividends, then, in an era of historically low U.s. interest rates, have made equity ownership a potentially reliable source of yield. At the same time, blue-chip multinationals with track records of stable dividends can act as a hedge to volatility, just as bonds may. even if stock prices plummet during marketwide sell-offs, dividend recipients can still get paid.

multinational equities possess another valuable trait: Because their operations cut across regions and countries, they can offer investors exposure to global growth. Consid-er that last year 40% of the profits for the companies in the s&P 500 came from overseas.17

still—nice as it would be—you can’t own the world just by owning multinationals. these stocks are part of the answer, but the move toward national insularity means that, over time, foreign countries are likely to tilt their regulatory environments toward domestic companies. so at some point, protecting yourself from a world of risks and gaining the full advantages of its opportunities should have you consider actually investing in those companies directly.

15International Monetary Fund, Global Financial Stability Report, April 2011.16According to Standard & Poor’s data, cash dividends per share on the S&P 500 were $22.73 as of Sept. 26, 2011, compared with $16.27 as of Sept. 26, 2000.17BofA Merrill Lynch Global Equity Research.

it meAns knoWinG HoW to diveRsifY BetWeen CoUntRies And ReGions: BetWeen soUtHeAst AsiAn CHiP mAnUfACtUReRs And soUtH AmeRiCAn mineRs.

6%

18%

21%

4%7%

9%

33%

2%28%

2%

38%

24%8%

14

But how? Just because nigeria may be booming, individual investors aren’t likely to leap into the nigerian stock exchange or to parse the intricacies of investing in indonesia or in a toll road project in China. What they can do, however, is with the help of their financial advisor locate the money managers that invest in emerging-market tech companies. or select one that takes long and short positions on the vicissitudes of the Asian business cycle. of course, the success of active management19 depends on making wise decisions, so due diligence is key.

18All of the sample allocations are based on Merrill Lynch’s model portfolios. The “before” scenario is based on the U.S. RIC Tier 0 Moderate Strategic Alloca-tion; and in the “after” scenarios, the “affluent client” is based on the Global RIC Tier 0 Moderate Strategic Allocation, while the “more affluent client” is based on the Global RIC Tier 2 Moderate Strategic Allocation. The “more affluent client” portfolio includes alternative investments, which are defined as hedge funds, private equity and real assets. Additionally, up to 20% of the Global RIC Tier 2 Moderate Strategic portfolio might be illiquid for three to five years. We define liquidity as the percentage of assets, by invested value, within a portfolio that can be reasonably expected to be liquidated within a given time duration under typical market conditions. Most alternative investment products are sold on a private placement basis, and eligible clients must typically be Qualified Purchasers ($5 million net investments).19The active manager will deviate from various benchmark weights to produce a return that exceeds the passive return with minimal risk.

the GlObal POrtFOliO MaKeOverhistoric change requires a new way of thinking about asset allocations that is more global, more flexible and more dynamic

in its approach to managing risk and seeking returns. here, we show how a typical u.s.-centric investment portfolio can be

updated to embrace the great global shift.18

BEForE

AFTEr

time horizon (30 years) time horizon (30 years)

For qualified clients, “real assets” could include the standard commodity vehicles plus direct investments in farm and timberland.

at a glance, “fixed income” doesn’t seem to change much. but in the “before” model, it’s almost entirely allocated to u.s. bonds, with 14% of all assets dedicated to treasuries and municipals—and just 1.75% to bonds from overseas.

in the “after” models, exposure also grows to include foreign companies based in developed nations like Canada and Japan.

Private equity lets qualified clients invest in companies (and countries) at an earlier stage in their development.

hedge funds offer especially dynamic strategies for managing risk and seeking higher-than-market returns.

in the “after” models, no distinction is made

between u.s. and foreign bonds—

they’re all classified as “global.”

though there’s no specific allocation to “commodities”

for average affluent clients, exposure still comes through etFs listed on u.s. stock

exchanges.

through global managers, even the

most mainstream clients can access

companies based in south america, asia and eastern europe.

time horizon (30 years)

50%

5%

35%

8% 2%

KEy

U.S. Equities

International Equities

Emerging-Market Equities

Fixed Income

Cash

Global Hedge Funds

Global Private Equity

Global Real Assets

Affluent ClientMore

Affluent Client


(see “know Your managers,” below.) there are other ways to tap into specific, otherwise hard-to-reach global investments. market-Linked investments, for example, are bonds with returns that can be linked to the performance of any of a wide range of assets, including the stock-exchange indexes of developing countries—Brazil, say, or China or Russia.

LookinG At Bonds in tHe Context of CURRenCies

T o paraphrase Hunter s. thompson, when the going gets weird, the opportunistic investor turns pro. Consider this peculiar sequence of events: the U.s.’s wobbly debt sparks a near panic in global markets, causing investors to seek protection in the debt of the U.S., a surge

in demand that in turn pulls America’s interest obligations to historic lows. How should inves-tors respond to this bizarre turn? they can either chase yield down the credit ladder, seeking out riskier bonds here at home, or they can adopt a bond strategy as diversified as their approach to other asset classes, with appropriate allocations to higher-yielding municipals, corporates and bonds in other parts of the world. it’s worth noting, for example, that even as the yield on 10-year treasuries dipped to an unprecedented 1.72% in september,20 the yield on comparable

20U.S. Department of the Treasury, Sept. 22, 2011.21Defined by the China Securities Regulatory Commission, a “Qualified Foreign Institutional Investor” (QFII) is an approved overseas fund management institution, insurance company, securities company or other assets management institution that invests in China’s securities market.

investoRs ARen’t LikeLY to LeAP into tHe niGeRiAn stoCk exCHAnGe. BUt tHeY caN LoCAte tHe fUnd mAnAGeRs tHAt invest in emeRGinG-mARket teCH.

KnOW yOur ManaGersWhen it comes to managing a global investment fund, few things matter more than proven experience.

s the geo-shifts accelerate and overseas investments seem to promise better returns, many fund manag-

ers, accustomed to working within nar-row asset classes and styles (u.s. large-cap, corporate fixed income, etc.), are recasting themselves as “global” fund managers. While they may be extremely competent managers, not all have the access and true expertise necessary to tap opportunities in unfamiliar markets. Following are some of the criteria that Merrill lynch’s due diligence team con-siders when trying to separate the best global managers from the pack:

Are they tested in good times and bad? Going back to the technology crash that began in 2000, a decade of extraordi-nary volatility has yielded a large popula-tion of managers seasoned in all phases of the business cycle. long track records

have made it easier to discern the lucky from the good, and to see which manag-ers have performed during the toughest times. as every investor knows, “past returns are not indicative of future re-sults,” but they can be indicative of the disciplines and controls that a fund has in place. Merrill lynch expends consider-able energy each year seeking to reduce due diligence risk by confirming that the approaches advertised by the funds on its platform are backed by consistent patterns of rational decision-making.

Are they truly global? When a fund manager who has made a name in u.s. small-cap stocks starts a multi-asset fund with exposure to emerging mar-kets, there’s no guarantee the transi-tion will go smoothly. Just as the global economy favors large, multinational stocks, it also favors fund managers with proven global reach. For example,

typically only the largest, most experi-enced global funds hold a “Qualified Foreign institutional investors (QFii)” status, crucial for gaining access to Chinese investment markets.21

What do they spend on research? in the same way an innovative manufacturer keeps improving its products through research and development, leading global funds maintain staffs dedicated to tracking events as they unfold and finding opportunities others may miss. the resources a fund commits to in-depth, local and original research into the areas in which it invests can tell you a lot about whe ther it is truly generating original, exciting ideas or simply following popular trends. talk with your financial advisor about how the funds under con-sideration for your portfolio rate on this, and other, key benchmarks as you seek to refine your global investment strategy.

a

16

even MOre tarGeted sOlutiOns FOr QualiFied investOrs volatile times demand creativity. For affluent investors, that may mean looking for alternatives.

here are plenty of ways for today’s globally minded investors to gain access to international markets. the

u.s. stock market trades shares of mul-tinationals as well as foreign companies, and overseas government and corporate bonds are making their way into growing numbers of portfolios. but for investors defined as “qualified” because of higher levels of investable assets and other fac-tors, there are additional, even more so-phisticated vehicles for targeting growth, dialing up diversification and seeking protections against volatility. these in-vestments are not suitable for everyone, and clients need to have the appropriate investment objectives, time horizons, liquidity needs and risk tolerance, but the potential benefits may be worth it.

Private Equity in many emerging mar-kets, particularly the “frontier” markets in africa and southeast asia that may represent some of today’s biggest growth opportunities, public securities exchang-es are rudimentary at best. so to gain access to these growth stories, affluent investors may need to look at funds that trade not in stocks or bonds, but which actually buy and sell whole companies.

the private-equity market has changed considerably since the pre-credit-crisis

days of highly leveraged, exorbitantly priced buyouts. in addition to going more global, the deals getting done now tend to be smaller, with a greater emphasis on cash and less on borrowing. While the formula may make for fewer splashy headlines, it’s a climate that actually favors affluent individual investors.

Many private equity companies also have been enticing investors by distrib-uting regular interest or dividend pay-ments. because private equity requires investors to commit capital for extended periods, getting some income while you wait can ease those illiquidity concerns.

Global Hedge Funds in a volatile global economy, policy makers and govern-ment agencies in Washington, brussels or beijing can jolt international markets with a single speech or regulation. to keep pace, affluent investors may need to rely more on global hedge funds, which can have the flexibility to offset risks and exploit opportunities as they arise. Global macro funds, for example, base their investment models on forecasts and analyses of international politics and policies, relations among countries, interest rates and other factors. event-driven funds, meanwhile, seek to take advantage of temporary market inefficiencies caused by political

developments, natural disasters or other events that may affect compa-nies’ operations.

Ultra-Structured Solutions at a time of rapidly shifting global risks and opportu-nities, growth with safety is a priority for many investors. ultra-structured solu-tions, an exclusive subset of Market-linked investments (see “Commodities by any Other name,” page 9), give qualified investors the ability to custom-ize exposure to a wide variety of global themes across the risk asset classes, all the while building in protective features more characteristic of bonds. an ultra-structured note might be designed, for example, to track the performance of the turkish lira, protecting against the first 10% of any losses if the currency ends up weakening over the next several years. Or a note might allow an investor to benefit from the widening spreads between u.s. and asian bonds while buffering against the first 30% of losses if those spreads start to narrow.

ultra-structured notes do carry credit risk—the company issuing them could default. still, they provide another way of diversifying a complex portfolio and reducing the impact of a volatile invest-ment world while taking advantage of its distinct growth potential.

T

tax-free municipal bonds was tracking at 2.11%,22 with prices holding steady as state gov-ernments got a jump on their federal counterparts in bringing their fiscal problems under control. the spread between U.s. and Chinese bonds is similarly striking. over the past 10 years, Chinese government and corporate bonds as a group have posted total annu-alized returns (the combined returns from price appreciation and interest coupons) of 8.9%, compared with 5.7% for U.s. bonds.23

in light of this disparity, the leap into foreign bonds should feel less strange. But any deci-sion to do so requires an investor to make yet another cognitive jog—and start thinking about currencies. that’s because foreign bonds bring exchange rates directly into play.

22Bloomberg, BVAL Muni Benchmark 10-Year. Data as of Sept. 22, 2011.23Chinese bond market returns are based on the S&P/CITIC Composite Bond Index, and U.S. returns are based on Barclays U.S. Aggregate Bond Index. All indexes in U.S. dollars. Data as of Sept. 30, 2011.



this is not as true in the case of Chinese bonds (although they could have other issues) because China’s currency is unlikely to lose ground to the dollar. But suppose you pur-chase a french bond with an attractive yield. if the euro drops while you own the bond—certainly a possibility, given the eurozone’s debt problems—the extra income from that higher yield could be wiped out when you convert back to dollars. some foreign countries and companies offer bonds transacted only in dollars, which can help mitigate currency risk. However, that approach limits the range of choices, as well as the possibility of gains if currency moves in your favor.

so what do you do? Here again, investors should set aside conventional thinking and embrace the shift—for instance, buying the bonds of emerging-market governments and companies in places like malaysia or indonesia or Peru. the logic is fairly simple. As capital continues flooding into those countries, their currencies will likely gradually keep appreciating as their central banks take advantage of the inflows to lift the purchasing power of their citizens.

As with the new world order in equities, a smart, global approach to fixed-income investment comes down to working with your financial advisor to find the right bond funds led by manag-ers experienced in foreign markets, whether they’re watching emerging markets anywhere in the world or dedicated to a specific region—like those new models of fiscal health, the Pacific Rim and south America.

Commodities foR A sHRinkinG PLAnet

F or all of its complexities, the new age of global risk at some level boils down to the ten-sions among four children forced to share three dolls. As world population rises by a staggering 200,000 per day,24 emerging middle classes demand a steadily higher

standard of living and a greater share of finite resources. to meet demand, according to one estimate, farms worldwide will have to produce more food during the next half century than during the previous 10,000 years.25 Add energy, industrial metals and building materials to the mix, along with the intense pressure being placed on gold prices by central banks that have started buying up gold as an alternative to dollars and euros, and it becomes clear why every macroeconomic and sociological trend points to a similar conclusion: many investors could likely benefit from increasing their focus on commodities.

Commodities do pose risks, and they don’t produce interest income or dividends. But they do provide an important source of diversification. Like stocks, commodities are cyclical and in-fluenced by global growth; and because they are subject to such vagaries as weather, disease, embargoes and tariffs, they’re potentially even more volatile. But whereas equity prices reflect a forward-looking view of company earnings, commodities prices depend more on immediate demand and scarcities. in August, for example, when fears about U.s. and european govern-ment debt drove world stocks into wild swings, the price of oil moved much less, because global demand for energy held firm.26

24The World Bank.25International Forum on Soils, Society and Global Change, 2007.26According to BofA Merrill Lynch Global Commodities Research, the price of Brent crude declined 2% in Aug. 2011.

to meet demAnd, fARms WiLL HAve to PRodUCe moRe food dURinG tHe next HALf CentURY tHAn dURinG tHe PRevioUs 10,000 YeARs.

18

Because most commodities actually are raw materials, they also provide possibly the best natural counterbalance when inflation erodes the value of a bond portfolio or eats into corporate earnings by driving up the cost of manufacturing. investors sometimes over-look commodities during periods in which, as today, weak growth and high unemployment help contain overall U.s. inflation. if anything, though, the hedging power of commodities has historically reached its peak during such times, because inflation is tied more directly to the rising cost of materials on world markets than it is to higher wages or other conse-quences of a faster-growing U.s. economy. in a real sense, owning commodities can offer a hedge not just for your investment portfolio but also against higher consumer prices, be they of groceries or the gas for your car.

seekinG fLexiBiLitY And GRoWtH

For at least 40 years, growth has been the investor’s watchword. success meant craft-ing a portfolio of what appeared to be stable, mostly U.s.-based stocks and bonds that would grow predictably—not in a straight line but with relatively brief interruptions

that would be more than counterbalanced by long stretches of economic expansion. the fundamental strength and resilience of the U.s. economy was the unquestioned foundation on which investors could always build.

27See commodities disclosure on back page.

the neW rules OF GlObal investinGthe global shifts have overturned some of our most basic orthodoxies of investment thinking. here are the new rules that inves-

tors can use to position themselves for protection and growth:

oing global. as nations turn more inward to deal with their domestic challenges, investors may need to

become that much more international in their search for growth, yield, quality and effective ways to manage risk.

Taking a more dynamic approach. although “buy-and-hold” isn’t exactly obsolete, investors may need to consider more dynamic, tactical and flexible ap-proaches to reducing risk and maximizing returns. these may include actively man-aged funds, as well as alternatives like Market-linked investments that explicitly manage downside market exposure.

Getting yield from multinational stocks. look for corporate dividends to become

a more important source of yield as u.s. multinationals deploy the cash on their fast-improving balance sheets to lure investors in volatile markets.

Seeking the safety of emerging-market bonds. With u.s. treasury yields at his-toric lows, global fixed income becomes more attractive, especially in markets that pair higher interest rates with cur-rencies likely to be buoyed by influxes of foreign capital. (a stronger local currency makes for stronger real returns when bonds are converted back to dollars.) ex-perienced global fixed-income managers can help source the right combinations of currency strength and yield.

Buying direct exposure to overseas equities. While u.s.-based multinationals

give some access to emerging-market growth, it’s prudent to have assets that provide more direct exposure to some of the world’s fastest-growing economies (think: China, turkey, Malaysia, even nige-ria). experienced global fund managers, again, are especially critical here, along with Market-linked investments that can be tied to stock indexes or baskets of stocks in less established markets.

reducing risk with commodities. One of the world’s most volatile asset classes can also be one of its best diversifiers. although owning commodities poses its own risks,27 it can reduce overall portfolio risk by providing a hedge against scarci-ties in vital natural resources that can drive up production costs and hurt corpo-rate earnings and consumer spending.

g


now we need to balance that view of the world—and that style of investing. more shocks are doubtlessly coming: climate change, inflation in world food prices and continued movement out of the dollar into gold and other currencies. And there will be other, unexpected crises—natural disasters such as the Japanese earthquake and tsunami as well as man-made upheavals like the Arab spring—that further roil the global landscape. As humans, we will, as always, adapt and re-engineer. As investors, we must be prepared for risk, even in the unlikeliest places. As we saw during the financial crisis, even money market funds are not entirely safe when an outlier event like a freeze in the financial markets occurs (and, given their exposure to the very short-term debt of european banks, there is at least a possibility they could be impacted again). so, we must focus on sustainability, resilience, the ability to deal with the unforeseen and also the wherewithal to capitalize on often fleeting opportunities.

flexibility gives nations the capacity for extraordinary strength and resilience. Japan has pre-sented challenges to investors over the past two decades, but time and again it has been able to rely on its citizens to help pull itself out of crises. most recently, the government announced plans to spend $248 billion on disaster relief funded in part through higher taxes and disaster bonds.28 the country is banking on its citizens’ personal savings to find a way out of a crisis that could have crippled another nation.

As for the U.s., for all the challenges it faces and the noise it sometimes creates, it remains one of the most flexible, stable and sought-after economies on the planet. With just 4.6% of the global population, the U.s. accounts for just as much output in a year as the next three larg-est economies—Japan, China and Germany—combined.29 Judging by reports in the popular media, you would think that the U.s. makes nothing and consumes everything. in truth, the country is still a global manufacturing powerhouse, the world’s second largest, having ceded the top spot to China only in 2008.30 the list goes on and on: When combining goods and services, the U.s. remains the world’s top exporter,31 a fact masked by headline trade-deficit figures. According to just about any consumer survey, the planet’s most recognizable brands are largely American.32 the U.s. has the world’s favorite economy for foreign investors, the larg-est market for it spending and the largest and highest-quality university system in the world.33 All of which is to emphasize the obvious resilience of the U.s. that has brought the nation back resoundingly from crisis after crisis in the past.

As much as the U.s. and other traditional players in the global economy admire the growth of newcomers, the winners among the emerging nations will be those that learn from the devel-oped countries and find ways to move beyond pure growth and adopt the flexibility to survive inevitable shocks of their own.

much the same can be said of investors facing a world they never foresaw. the winners are likely to be those who maintain the flexibility, both in mind and in portfolio, to see and respond to the world as it has become.

28The International Institute for Strategic Studies, “Japan: Life After Kan,” Sept. 2011.29International Monetary Fund.30U.N.31World Trade Organization.32Brandz Top 100 Most Valuable Global Brands 2011.33U.N. Conference on Trade and Development; Economist Intelligence Unit estimates; Quacquarelli Symonds World University Rankings.

As HUmAns, We WiLL ALWAYs AdAPt And Re-enGineeR. As investoRs, We mUst do tHe sAme.

ar96v3M1-1011

The article co-authored by Ian Bremmer was prepared under an agreement with Eurasia Group and is provided for informational and educational purposes only. His opinions, assumptions, estimates and views expressed are as of the date of this publication, subject to change and do not necessarily reflect the opinions and views of Bank of America Corporation or any of its affiliates. The information does not constitute advice for making any investment decision or its tax consequences and is not intended as a recommendation, offer or solicitation for the purchase or sale of any investment product or service. Before acting on the information provided, you should consider suitability for your circumstances and, if necessary, seek professional advice.

This material is not intended to be relied upon as a forecast or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securi-ties or to adopt any investment strategy. The opinions expressed are as of October 20, 2011, and may change as subsequent conditions vary.

Opinions are subject to change due to market conditions and fluctuations, and any of their discussions concerning investments should not be considered as a solicitation or recommendation by Merrill Lynch and may not be profitable. Any investments or strategies presented do not take into account the invest-ment objectives or financial needs of particular investors. It is important that you consider this information in the context of your personal risk tolerance, time horizon and investment goals. Always consult with personal professionals before making any investment decisions.

Investing in securities involves risks, and there is always the potential of losing money when you invest in securities.

Diversification, asset allocation and rebalancing do not assure a profit or protect against loss in declining markets. Rebalancing can pose a tax event.

Any tax statements contained herein were not intended or written to be used and cannot be used for the purpose of avoiding U.S. federal, state or local tax penalties. Neither Merrill Lynch nor its Financial Advisors provide tax, accounting or legal advice. Clients should review any planned financial transactions or arrangements that may have tax, accounting or legal implications with their personal professional advisors.

Past performance is no guarantee of future results.

Market-Linked Investments may not be suitable for all investors. Since Market-Linked Investments have varying payout characteristics, risks and rewards, you need to understand the characteristics of each specific investment, as well as those of the linked asset. It’s important that you carefully read the related disclosure document, which contains detailed explanation of the terms, risks, tax treatment and other relevant information. It’s also recommended that you consult your accounting, legal or tax advisors. Alternative Investments such as derivatives, hedge funds, private equity funds, and funds of funds can result in higher return potential but also higher loss potential.

Mutual Funds, new issue and ETFs are offered pursuant to a prospectus, which contains the investment objectives, risks, charges and expenses and other important information about the UIT or fund. Investors should read the prospectus and, if available, the summary prospectus for mutual funds and money market funds, and carefully consider this information before investing. Please contact your Merrill Lynch Financial Advisor for a prospectus, and, if available, a summary prospectus.

Investment in commodities and gold are investments in natural resource industries that can be significantly affected by events relating to those industries such as variations in commodities markets, weather, embargoes, disease, international, political and economic developments, the success of exploration projects, tax and other government regulations, as well as other factors. Concentrating investments in gold companies means that performance will be more susceptible to factors affecting that particular sector.

Alternative investments are intended for qualified and suitable investors only. Alternative investments involve limited access to the investment and may include, among other factors, the risks of investing in derivatives, using leverage, and engaging in shorts sales, practice which can magnify potential losses or gains. Alternative investments are speculative and involve a high degree of risk. Alternative Investments such as derivatives, hedge funds, private equity funds, and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in alternative investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity, and your tolerance for risk.

International investing presents certain risks not associated with investing solely in the U.S. These include, for instance, risks related to fluctuations in value of the U.S. dollar relative to the value of other currencies, custody arrangements made for a fund’s foreign holdings, political and economic risk, differences in accounting procedures, and the lesser degree of public information required to be provided by non-U.S. companies. Foreign securities may also be less liquid, more volatile and harder to value, and may be subject to additional risks relating to U.S. and foreign laws relating to foreign investment. These risks are heightened when the issuer of the securities is in a country with an emerging capital market.

The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The principal on mortgage- or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Obligations of U.S. Government agencies and authorities are supported by varying degrees of credit but generally are not backed by the full faith and credit of the U.S. Government. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some municipal security investors may be subject to Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.

© 2011 Bank of America Corporation. All rights reserved.

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