Global Asset Management

In recent quarterly reports, Global Asset Management has outlined the poor investment performance in some capabilities, notably parts of core / value equities and fixed income. The business group has taken various steps to address this through realigning its equities business and has made a number of changes to its senior management, focused on recruiting high-performing candidates for its equities and fixed income businesses, and added new capabilities.

In the investment management industry there are normally time lags between making structural and personnel changes and the consequent impact on performance and then on investment flows. Global Asset Management again saw this effect on net new money in first quarter 2008. This is attributable to both its recent investment performance and the generally unsettled investment environment. However, as also mentioned in previous quarters, the business group has reduced its dependency on any one investment capability or market. The relative contribution to profit of equities, fixed income and global investment solutions is now about half, with other capabilities and services including alternative and quantitative investments and global real estate representing the remainder. Nevertheless, Global Asset Management expects the current unsettled market environment and the time lag effects typical to the industry to continue to impact its business in the near term. It has therefore undertaken an extensive expenditure review, the effects of which are already seen in the lower operating expenses of first quarter.

Overall, first quarter 2008 was a challenging period for financial markets as broad indices declined for a second consecutive quarter due to continued investor concerns over the deterioration of the US housing market and a weakening US economy.

The main investment strategies of Global Asset Management returned mixed results in first quarter 2008. Positive results were generated by some core / value equity strategies (including Global Equity and most growth equity capabilities), the single manager hedge funds and some direct real estate capabilities. However, performance was weaker in other core / value equity, fixed income, balanced, real estate securities and funds of hedge funds strategies.

While several core / value equity strategies struggled in first quarter 2008, a notable exception was the actively managed Global Equity composite, which outperformed its benchmark for the quarter but remains below its benchmark for most long-term periods. While first quarter results received modest rewards from stock selection in technology, industrials and banks, these were partially offset by its underweight to the strongly performing materials sector and the overweight in lagging telecoms. Regional equity strategy performance varied over first quarter 2008: Europe and Asia / Emerging Markets strategies were weak, while the US was slightly down.

During the quarter, many of the growth equity strategies performed well. In particular, US Large Cap Select Growth, US Small Cap Growth and Global (ex-US). Each of these strategies outperformed its benchmark by over 200 basis points. These strategies benefited broadly from strong stock selection, particularly in the energy sector. Global (ex-US) All Cap Growth also benefited from overweights to materials and industrials. US Mid Cap Growth and Emerging Markets Growth each trailed their benchmark, in part due to poor stock selection in financials and materials.

The flagship fixed income strategies performed poorly in first quarter 2008, as bond markets continued to be affected by the key themes that dominated the final quarter of 2007, in particular the repercussions of the US sub-prime mortgage market crisis and its consequent disruption of banking activity. Deteriorating prospects for US economic growth led to widespread concerns of potential spillover effects into the global economy and wider credit markets. While measures taken by the US Federal Reserve System seemed to ease financial market stress in the final days of the quarter, further severe price declines in residential mortgage-backed securities and collateralized debt obligations were exacerbated by illiquid trading conditions. This significantly impaired Global Asset Management's fixed income strategies - notably Absolute Return Bond, Global Aggregate, US Core and US Core Plus.

Within global investment solutions, balanced fund performance was mixed in first quarter 2008, with positive overall returns for Dynamic Alpha Strategies (DAS) and significant declines in most equity markets and other asset classes. Market and currency allocation decisions resulted in strong positive contributions, while the short positions in European, Asian and Emerging Market equities were the main drivers of added value from a market allocation standpoint. These positive factors were counteracted to some degree by negative contributions from stock selection. Over longer periods, both equity and fixed income stock selection remained positive across most balanced funds. Currency portfolios gained value in first quarter 2008, following a rise in risk aversion which benefited the active overweight and long positions in the Japanese yen, Swiss franc and Swedish krona. The gain in value resulted from Global Asset Management's "anti-carry" trade bias in its currency market portfolio, which has been in place for the past 18 months as a response to the recent domination of currency markets by carry-trades, whereby investors / traders have borrowed in lower yielding currencies and invested in higher yielding currencies.

The broad hedge funds industry experienced historically negative performance in first quarter 2008, averaging approximately a drop in value of -3 to -5%. Against this industry backdrop, the performance of alternative and quantitative investments' strategies was mixed in first quarter 2008. Fund of funds generally performed negatively, as difficult market conditions impacted several hedge fund strategies, including credit, quantitative and merger and acquisition trading. Positive returns were posted by several of the largest O'Connor single manager hedge funds, including the flagship multi-strategy, fundamental market neutral and currency and rates strategies.

Despite a challenging environment, performance of the German-based direct real estate funds remained positive in first quarter 2008. Swiss-based listed funds performed broadly flat relative to benchmark with the exception of the flagship residential fund, which outperformed its index owing to strong investor demand. US capabilities continued to perform positively, whilst UK-based flagship funds suffered on the back of declining property values in specific sectors. Japanese real estate investment trusts ("J-REITS"), managed in collaboration with the joint venture partner Mitsubishi Corporation, performed positively against benchmark. The performance of global real estate securities strategies against benchmarks was mixed as markets remained volatile and sensitive to negative news flow.

1 Performance data for five years is for UBS AG, NY Branch Large Cap Select Growth Composite, which is managed in a substantially similar manner to the US Large Cap Select Growth Equity Composite. 2 Composite figures since 31 December 1999. For 10-year annualized returns UBS Investment Foundation – AST Immobilien Ausland is used as the performance reference (inception: 9 May 1990). 3 Prior to 2004, the reference index is the GPR General Index Europe (total return in CHF, unhedged) and thereafter it is linked to the benchmark FTSE EPRA / NAREIT Global Real Estate Index (total return, hedged into CHF) to calculate 5- and 10-year returns. Reference index returns are provided for reference purposes only. From 31 March 2004 to 30 September 2005 returns for the FTSE EPRA / NAREIT Global Real Estate Index hedged into Swiss francs are based on published data. Currency translation and hedging into Swiss francs are calculated internally. Thereafter, UBS contracted with FTSE, the index provider, to provide, on a customized request basis, Swiss franc hedged returns for the FTSE EPRA / NAREIT Global Real Estate Index.

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