CS PB Compass August 2012

Portfolio Strategies: Bonds for the Long Run? ..................................... p6

Classic Cars: Your Portfolio’s Midlife Crisis ....................................... p16

David Gergen on the U.S. Political Landscape ............................... p22

Emerging Markets: The New Dividend Play ................................... p26

Compass Volu

me

Five

Navigating the Investment Landscape

Private Banking americas AUGUST 2012

ForwordForewordForewordForeword

This publication is not complete without the “Important Legal Information” at the back of this publication.

Please contact your Relationship Manager if you do not receive it. The Private Banking USA business

of Credit Suisse Securities (USA) LLC is a regulated broker dealer and investment advisor. It is not a

chartered bank, trust company or depository institution. It is not authorized to accept deposits or provide

corporate trust services and it is not licensed or regulated by any state or federal banking authority.

The issuers, securities, investment products, and companies referenced herein are not intended as a

recommendation or solicitation to buy, sell, or hold any securities or implement a specific investment

strategy. Contact your Relationship Manager for Credit Suisse investment research or marketing mate-

rials that contain the investment thesis, risks and potential rewards of particular securities or investment

products. Any potential investment decision should be based on research and analysis and not on the

limited information set forth herein.

Private Banking AmericasInvestment Strategy and Advisory Group:

Barbara reinhard, cFa Chief Investment Strategist, Managing Director [email protected]

samuel Baumann Assistant Vice President [email protected]

Jimmy [email protected]

Philipp Lisibach, cFa [email protected]

scott rosenblattAssistant Vice [email protected]

ryan sullivanAssistant Vice [email protected]

Compass 3

ForwordForewordForewordForewordAs I reflect on 2012 thus far, I am struck by how much has transpired over such a short

period of time. The Eurozone drama has commanded the global stage, Chinese

monetary policy is a discussion point at nearly every client engagement, and the

U.S. economy continues to move in fits and starts. Markets have been volatile and

unpredictable, and investor sentiment remains depressed. During these times, we are

reminded daily of how important it is to have a global view of the world, as markets and

economies are so interconnected.

In this edition of Compass, we focus on yield-based investments and their impact on

portfolios. Barbara Reinhard, our Chief Investment Strategist, pens a relevant thought

leadership piece entitled “Bonds for the Long Run?” She explores fixed income investing

in a broad historical context and advises on how investors should position their fixed

income allocations in the current interest rate environment. Our colleagues from

Private Banking Research in Zurich discuss how emerging market equities are assuming

a leadership role with respect to dividend yields. We also feature an interview with former

presidential advisor and political analyst David Gergen, who was a featured guest

speaker at the Credit Suisse Private Banking Miami Wealth Management Conference.

Finally, it’s not often that cars and investing can be analyzed in the same context. In this

edition of Compass, I am pleased to say, we make this connection. We discuss how

within the last decade, classic car collecting has shifted gears from being a weekend

hobby and passion to being a source of real returns.

Credit Suisse prides itself on being a global leader in Private Banking and we value the

partnerships we create with each of our clients. We are honored that you have chosen

Credit Suisse to help you navigate these challenging markets. We hope you will enjoy this

edition of Compass, and as always, look forward to your feedback.

With warmest regards,

Anthony DeChellis

CEO, Private Banking Americas

Page 16

For many, purchasing vintage automobiles is not simply an investment, it is a passion. Finding the right car and restoring its vintage beauty are leisure pursuits and pas-times that have the potential to reap outsized returns.

Page 22

eventually, we’ll need a bal-anced plan to bring the deficit down slowly without choking off the recovery – it shouldn’t be hard to do, but the pros-pects for our putting such a plan in motion at the end of the year don’t look as rosy as they should. - David Gergen

Page 26

With dividend yields in excess of developed markets in many cases, investors in emerging markets no longer have to forgo income as a component of returns.

4

Inside this issue:

Compass 5

Contents:

Portfolio strategies Bonds for the Long Run?

key Forecasts

conversations with thought Leaders: David Gergen

classic cars Your Portfolio’s Midlife Crisis

emerging markets: The New Dividend Play

Panorama Shifting Dynamics on the World Stage

Where We See Opportunities in Fixed Income

strategic asset allocation

6

8

11

12

14

16

22

26

30

31

A Sample of High Yielding Emerging Market Companies

Wealth Planning Estate Planning with Depressed Assets

6 Portfolio Strategies

Portfolio StrategiesBOnDs FOr tHe LOng rUn?

WRITTEN BY BARBARA REINHARD, CFA, AND

SAMUEL BAUMANN, PRIVATE BANkING AMERICAS

INVESTMENT STRATEGY AND ADVISORY GROUP

speed read:n Over the last ten years, fixed income has

remarkably outperformed equities. With current bond yields at extremely low levels, fixed income returns going forward are likely to be considerably constrained.

n Throw fixed income out of a diversified portfolio? Not so fast. Bonds serve as a diversifier to equities and may help smooth a portfolio’s overall volatility of returns.

n Along with high quality fixed income exposure to investment grade credit and municipal bonds, we see opportunity for additional yield within the riskier part of the fixed income market such as high yield, senior bank loans, and emerging market local currency debt.

As investment strategists, we are often asked by clients to forecast how asset classes such as equities, fixed income, currencies, and commodities will perform over the near term – next week, next month, or next year. Rarely are we asked to opine on what is going to be the best or worst asset class over the long term. That, in our opinion, is a mistake. The one tool private investors have is time, the luxury of taking a long-term view. As private investors, we do not have investment committees to answer to, nor do we have to be slaves to a market benchmark that has little relevance to our personal investment goals. In considering some of the big asset allocation decisions that will affect investment portfolios in the future, we can’t help but think very carefully about the fixed income market. The returns for fixed income over the rolling 1-, 5-, and 10-year periods have been well beyond their historical averages and, remarkably, most bond indexes have beaten the S&P 500 Index (see Table 1). However, with bond yields currently at extremely low absolute levels, it is hard for us not to view fixed income as an asset class that is going to perform very differently going forward than it has over the past decade.

Low Yields – they can stay Lower for Longer Even though most private investors do not invest directly in U.S. Treasuries – preferring the favorable tax treatment of municipal bonds or the more attractive yields available in credit-related fixed income – we pay close attention to the underpinnings of the Treasury market, as it is the grande dame that most other fixed income instruments are priced against. Currently, the 10-year U.S. Treasury yield is near its all-time low of 1.4% (see Figure 1). While U.S. Treasury yields have been falling steadily since 1981, the relative collapse of yields from 3.5% in February 2011 to 1.4% today has been an especially meaningful move.

It feels like a brave new world for many investors to have bond yields at such extraordi-narily low levels. However, in taking a look at financial market history, it is clear to see

table 1Fixed income returns Annualized

As of 06/29/2012 Source: Bloomberg, Ibbotson, Credit Suisse Investment Strategy & Advisory Group

1-Year 5-Year 10-Year

Barclays U.S. Municipal Bond Index 9.9% 6.0% 5.3%

Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index 11.7% 8.4% 7.2%

Barclays U.S. Aggregate Bond Index 7.5% 6.8% 5.6%

Ibbotson U.S. Government Long-Term Bond Index 29.5% 11.9% 8.9%

Ibbotson U.S. Government Intermediate-Term Bond Index 5.9% 7.2% 5.4%

Ibbotson U.S. High Grade Long-Term Corporate Bond Index 23.1% 10.5% 8.5%

S&P 500 Total Return Index 5.4% 0.2% 5.3%

Compass 7

table 2ibbotson U.s. government intermediate-term return composition Annualized

Note: Totals may not add up due to rounding.As of 06/29/2012 Source: Ibbotson

Figure 1U.s. 10-Year treasury Yield Declined significantly since 2011

As of 07/23/2012 Source: Bloomberg

4.0

3.5

3.0

2.5

2.0

1.5

1.0Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12

%

we have been in a similar low yield environment previously (see Figure 2). In the mid-1940s, the Federal Reserve and the U.S. Government used policies to artificially cap short- and long-term interest rates to help service the debt incurred during World War II. Not only were rates low during the 1940s, they remained low well into the 1950s – far longer than almost anyone expected. Today, we see similarities. The Federal Reserve has said it plans to keep interest rates anchored at close to zero until 2014. For different reasons, but out of a similar desire, the authorities are keeping interest rates artificially repressed – this time, to service the heavy debt load that has been built up over the last decade. As in the 1940s, this period of low rates is likely to last far longer than market participants expect, as consumers continue to deleverage.

realistic expectations for Bond returns Although we don’t expect short- or long-term interest rates in the U.S. to rise abruptly – due to continued sluggish U.S. growth, quiescent inflation, and the turmoil in Europe – but, with bond yields extremely low, the road ahead for fixed income returns looks to be narrowing. Fixed income investors earn returns in two ways: price return, as yields fall, and income return, as coupon payments are received and reinvested. When yields are low, both sources of returns are constrained. First, bond yields have limited the price appreciation from current levels. Second, the opportuni-ties to reinvest the coupon payments are curtailed by prevailing interest rates.

Over the last twelve months ended June 2012, the total return of the Ibbotson U.S. Government Intermediate-Term Bond Index was 5.9%. As seen in Table 2, most of the return was price apprecia-tion due to a decline of yields, very little of the return came from coupon and reinvestment of coupon income. In comparison, over the last ten years, the average annual contribution of interest income accounted for over half of the total return.

To consider how this low interest rate environment will play out, we looked at some historical examples. The last time nominal yields were in this neighborhood, in the 1940s and the 1950s, the Ibbotson U.S. Government Intermediate-Term (5-year maturity) and Long-Term (20-year maturity) Bond Indexes returned between 1-3% (see Table 3). We think a similar return scenario is likely going forward.

Pulling it all together, our expectations are for high quality fixed income returns to be well below their historical averages. This view is incorporated into the Credit Suisse Capital Market Assumptions – five year average annual return projections that are critical inputs into our asset allocation analysis (see Table 4).

Don’t throw the Fixed income Baby Out with the Bath Water If we think high quality fixed income is going to deliver returns well below their long-term average, it raises the question, why do we include them in the Credit Suisse Asset Allocation Framework? The answer is two-fold.

First, bonds are a consistent diversifier of returns to higher risk assets such as equities. Equity returns are largely driven by the

18.0

16.0

14.0

12.0

10.0

8.0

6.0

4.0

2.0

0.0Jan-26 Jan-42 Jan-58 Jan-74 Jan-90 Jan-06

1932-1949 1981-2012

Ibbotson U.S. Government Intermediate-Term Bond YieldBond Bull Market

%

total return

coupon and reinvestment of coupon income

Price return

10-Year 5.4% 3.0% 2.4%

5-Year 7.2% 2.2% 4.9%

1-Year 5.9% 0.9% 5.0%

Figure 2Bond Yields in a Historical context Note: Ibbotson data has been used for this analysis due to data limitations on the 10-Year U.S. Treasury Index. The Ibbotson U.S. Government Intermediate-Term Bond Index has an average maturity of five years. As of 06/29/2012 Source: Bloomberg, Ibbotson, Credit Suisse Investment Strategy & Advisory Group

Figure 3Bonds exhibit Low correlation with equities 36-Month Rolling Correlation

Note: The correlation measures the degree and relationship between returns of two assets on a scale of +1 to -1. A correlation of +1 indicates the two returns of the assets move in tandem. A correlation of -1 indicates the returns of the assets move in the opposite direction. As of 06/29/2012 Source: Ibbotson, Bloomberg

table 3Bond index compounded annual growth rates

Notes: 1) The Compounded Annual Growth Rate measures the rate of return over a defined period taking into account annual compounding. 2) Average: 1/31/1926 through 6/30/2012, annualized. 3) Ibbotson data has been used for this analysis as it is has a more comprehensive data history than a constant maturity U.S. Treasury Index. The Ibbotson U.S. Government Long-Term Bond Index, the Ibbotson U.S. Government Intermediate-Term Bond Index, and the Ibbotson U.S. High Grade Long-Term Corporate Bond Index have maturities of 20 years, 5 years, and 20 years, respectively.As of 06/29/2012 Source: Ibbotson

growth of corporate profits. Bonds are the antithesis: their returns are driven by the fixed coupon payment stream and its pur-chasing power, so bonds act negatively to a fast growth environment. These differ-ences in drivers of returns are illustrated by the correlations of returns between these asset classes. Looking at the 36-month rolling correlations of returns of municipal bonds and the S&P 500 Index, the aver-age correlation since January 1983 is 0.25 (see Figure 3). Obviously, correla-tions of returns wander through time, but noticeably, after market shocks, such as the Crash of 1987, the Mexican Tequila Crisis in 1994, and the Financial Crisis of 2008, even though correlations rose, they were able to re-establish their long-term relationship.

Second, bonds are a means of addressing loss aversion. Loss aversion refers to an investor’s tendency to prefer avoiding loss-es over acquiring gains. An entire aca-demic field of study called behavioral finance has developed out of analyzing investors’ emotional behavior. As a practi-cal example, loss aversion explains how people would be more disappointed to lose USD 1,000 than they would be satisfied to win USD 1,000. In an asset allocation context, fixed income investments blunt the volatility of riskier types of assets classes such as equities. It is the smooth-ing of returns that fixed income provides to a portfolio of riskier assets that we find appealing to help investors cope with the emotional side of investing.

Where We see Opportunities in Fixed incomeAlthough we maintain our high-credit qual-ity fixed income exposure in our Credit Suisse Asset Allocation Framework through municipal and investment grade corporate bonds, we also see opportuni-ties for additional yield within the riskier parts of the fixed income market (see Figure 4). High yield and senior bank loans are among the segments within fixed income that we consider attractive. Corporations have record amounts of cash on their balance sheets, which puts them in an especially good position to service their debt and interest expenses. Emerging mar-ket debt also looks appealing, in our view. In

1.0

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4

-0.6

-0.8

-1.0Jan-83

S&P 500 Index/Barclays Municipal Bond IndexS&P 500 Index/Ibbotson U.S. Government Intermediate-Term Bond IndexS&P 500 Index/Ibbotson U.S. High Grade Long-Term Corporate Bond Index

Jan-87 Jan-91 Jan-95 Jan-99 Jan-03 Jan-07 Jan-11

Average Minimum Maximum 0.25 -0.47 0.70 0.09 -0.62 0.68 0.27 -0.26 0.67

ibbotson U.s. government Long-term

Bond index

ibbotson U.s. government intermediate-term Bond

index

ibbotson U.s. High grade Long-term

corporate Bond index

1926-29 5.1% 4.2% 5.3%

1930-39 4.9% 4.5% 6.9%

1940-49 3.2% 1.8% 2.7%

1950-59 -0.1% 1.4% 1.0%

1960-69 1.5% 3.5% 1.7%

1970-79 5.5% 7.0% 6.2%

1980-89 12.6% 11.9% 13.0%

1990-99 8.8% 7.2% 8.4%

2000-09 7.7% 6.2% 7.6%

2010 10.1% 7.1% 12.4%

2011 28.2% 9.5% 17.9%

average 5.7% 5.4% 6.1%

table 4credit suisse capital market assumptions Projected Five-Year Average Annual Return

As of 07/05/2012 Source: Credit Suisse Global Research Capital Market Assumptions (CMAs) - July 2012 Update

U.S. Tax-Exempt, Medium-Term 2.2% U.S. Corporates Long-Term 3.6%

U.S. Tax-Exempt, Long-Term 3.1% U.S. High Yield 7.0%

U.S. Treasuries, Medium-Term 0.4% U.S. Inflation-Linked 1.6%

U.S. Treasuries, Long-Term -1.1% Non-U.S. Fixed Income Developed 0.3%

U.S. Corporates Medium-Term 2.5% Emerging Markets Local Fixed Income 6.1%

expected asset class return

expected asset class return

Compass 9

many emerging market countries, currencies are now quite inex-pensive and inflationary pressures have been alleviated by mone-tary tightening measures and the recent decline in commodity prices. We view all three of these segments of the fixed income markets as complements to our core high-credit quality holdings for investors willing to take additional risk.

issues of today While we favor taking a long-term view to find investment oppor-tunities, we cannot ignore some of the pressing current issues. Specifically, the U.S. fiscal cliff comes to mind.

At the end of 2012, the expiration of the Bush tax cuts and auto-matic sequestration of spending cuts simultaneously will amount

to about 4% of U.S. GDP. With an economy growing at a 2% rate, a fiscal contraction of that magnitude would cause a reces-sion. We continue to think the expiration of all of the measures at the start of 2013 is a highly unlikely outcome, as neither party wants to be blamed for an avoidable economic calamity. An agreement of some sort is likely after the November election in the lame duck session of Congress. The real issue becomes how much the uncertainty about the fiscal cliff weakens the broader economy. Business confidence surveys and capital expenditures are key indicators we are closely monitoring.

Turning to Europe: the European Union Summit at the end of June produced some promising initiatives: the formation of a single banking supervisor for the EU; authorization of the European Stability Mechanism (ESM) to inject funds directly into the banks, rather than recapitalizing efforts flowing through the sovereign governments; and establishing that ESM bonds are no longer senior to government bonds. However, as with so many of the other summits, implementation and execution are still risks. The current muddling through approach adopted by policy makers makes the recurrence of these mini-crises quite likely. While investor expectations for the path forward for Europe are still quite negative, we think politicians are aware that the cost of a Eurozone break-up would be far greater than the cost of a bail-out. We are encouraged by the almost 10% decline in the euro since the end of February as a cheaper currency will help make the value of their exports relatively less expensive, but growth and a mutualization of the debt will be critical for a final resolution for Europe.

These uncertainties add up to continued robust demand for high quality fixed income assets. That demand won’t be satiated in the near term, but a few years of 1-3% returns may prove to be a likely outcome that investors should be prepared for in our view.

Figure 4credit Offers Higher Yields Fixed Income Yields across Asset Classes

1Tax equivalent yieldAs of 07/23/2012 Source: Bloomberg, Thomson Reuters Municipal Market Monitor, Credit Suisse Fixed Income Research

U.S. 10-YearTreasury Note

1.4%

2.5%

4.8%5.1%

5.8%

7.2%

Municipal10-Year

G.O. AAABond1

Moody’sBaa

CorporateBond

EmergingMarketsBond

Credit SuisseLeveragedLoan Index

Credit SuisseHigh YieldBond Index

…with bond yields currently at extremely low absolute levels, it is hard for us not to view fixed income as an asset class that is going to perform very differently going forward than it has over the past decade.


Outlook Summary (As of July 31, 2012)

Source: Private Banking Global Research, Bloomberg, Thomson Reuters DataStream

* 3-month or 12-month forecasts as indicated ** Level with USD as counter currency,

price change with USD as base currency

key

Positive Neutral Negative

Source: Private Banking Americas Investment Strategy and Advisory Group

Arrows represent the current Private Banking Americas Investment Strategy and Advisory Group absolute market view for 6-12+ months.

▼▼

▼

▼

▼

▼

▼▼

▼

equities: U.s. sector

Health Care

Consumer Staples

Utilities

Telecomm Services

Information Technology

Energy

Industrials

Consumer Discretionary

Financials

Materials

▼▼

▼

▼▼

▼

▼▼

▼▼

▼▼

▼▼

▼

USD vs. CHF

USD vs. CAD

USD vs. BRL

GBP vs. USD

USD vs. JPY

USD vs. MXN

EUR vs. USD

NZD vs. USD

AUD vs. USD

currency

▼

▼

▼

▼

▼

commodities

Precious Metals

Industrial Metals

Livestock

Agriculture

Energy

Fixed income▼

▼

▼▼

▼U.S. High Yield

U.S. Investment Grade Corporate

Emerging Markets

U.S. Treasury Inflation Protected

U.S. Municipal

U.S. Securitized

U.S. Treasury ▼

▼▼

▼

▼

▼

▼

▼

equities: regional

Developed markets

Uk

Asia Pacific ex-Japan

Canada

U.S.

Japan

Europe ex-Uk

emerging markets

Asia

Latin America

Europe, Mid East, Africa

▼

▼

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▼

▼

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or Indicates a strong investment conviction in over/underweight position.

or Indicates a modest investment conviction in over/underweight position.

Indicates a neutral investment conviction.

Compass 11 Compass 11

global equity indices 7/31/12 12m

U.S. (S&P 500) 1,379 1,343

Euro Area (Euro Stoxx 50) 2,326 2,571

Uk (FTSE 100) 5,635 6,031

Japan (Nikkei 225) 8,695 9,800

Asia Ex-Japan (MSCI Asia AC ex-Japan) 952 1,077

Brazil (Bovespa) 56,097 71,000

Mexico (IPC) 40,704 45,000

real gDP (in %) 2012e 2013e inflation 12e

Global 3.20 3.50 3.00

U.S. 2.10 1.80 2.10

Euro Area -0.30 0.30 2.20

Japan 2.20 1.20 0.40

Non-Japan Asia 6.40 6.80 3.90

Latin America 3.00 3.70 6.20

interest rates (10-Year government) 7/31/12 3m 12m

U.S. 1.47% 1.5 - 1.7% 2.2 - 2.4%

Euro Area 1.29% 1.4 - 1.6% 1.8 - 2.0%

Uk 1.47% 1.6 - 1.8% 2.1 - 2.3%

Japan 0.79% 0.8 - 1.0% 0.9 - 1.1%

commodities 7/31/12 3m 12m

Energy

WTI Crude Oil (USD/barrel) 88.06 95.00 100.00

U.S. Natural Gas (USD/mmbtu) 3.21 3.00 3.50

Precious Metals (Spot, USD/ounce)

Gold 1614.30 1650.00 1650.00

Silver 27.99 28.00 28.00

Platinum 1415.75 1500.00 1650.00

Base Metals (Spot, USD/pound)

Aluminum 0.86 0.86 0.91

Copper 3.43 3.54 3.81

Agriculture (USD/bushel)

Wheat 8.88 9.75 8.50

Corn 8.07 9.00 7.50

currencies (UsD vs.) 7/31/12 3m 12m

Euro** 1.23 1.21 1.18

Japanese Yen 78.12 79.00 80.00

British Pound** 1.57 1.56 1.54

Swiss Franc 0.98 1.00 1.03

Canadian Dollar 1.00 1.03 1.00

Australian Dollar** 1.05 0.96 0.98

New Zealand Dollar** 0.81 0.74 0.76

Mexican Peso 13.33 13.20 12.40

Brazilian Real 2.06 2.04 1.90

key Forecasts* (As of July 31, 2012)

Source: Private Banking Global Research, Bloomberg, Thomson Reuters DataStream

* 3-month or 12-month forecasts as indicated ** Level with USD as counter currency,

price change with USD as base currency

Overview The Credit Suisse Global Asset Allocation Framework (GAAF) is a dynamic process that sets recommended benchmark weightings for each of the asset classes we believe should be incorporated in a balanced asset allocation. It is comprised of a long-term Benchmark Asset Allocation (BAA) and a shorter-term Strategic Asset Allocation (SAA).

the Benchmark asset allocation (Baa) is based on the Credit Suisse Capital Market Assumptions and is expected to remain relatively static for a full market cycle. It is developed from the ideas and forecasts of the most accom-plished senior strategists at Credit Suisse and incorporates all of the fundamental concepts of asset allocation.

the strategic asset allocation (saa) Based on market behavior and recom-mendations from Credit Suisse’s global strategists, the SAA seeks to establish strategic over- and underweights relative to the BAA. It utilizes a 6-12 month time horizon. The primary goal of the SAA is to generate excess return and/or reduce risk relative to the BAA.

4

5

1516

80

80

3

5

2022

55

54

2120

risk Budget 1: Low risk Budget 2: Low-medium

Baa saa +/-

Cash 5.0% 4.0% -1.0%

USD 5.0% 4.0% -1.0%

Equities 0.0% 0.0%

United States 0.0% 0.0%

Dev. Equities ex-U.S. 0.0% 0.0%

Emerging Markets 0.0% 0.0%

Fixed Income 80.0% 80.0%

USD, Tax-Exempt 56.0% 56.0%

USD, Taxable 24.0% 22.0% -2.0%

Non-USD, Taxable 0.0% 2.0% 2.0%

Alternative Investments 15.0% 16.0% 1.0%

Commodities 2.5% 3.0% 0.5%

Gold 2.5% 3.0% 0.5%

Hedge Funds 5.0% 5.0%

Private Equity 0.0% 0.0%

Real Estate (Property) 5.0% 5.0%

Baa saa +/-

Cash 5.0% 3.0% -2.0%

USD 5.0% 3.0% -2.0%

Equities 20.0% 22.0% 2.0%

United States 10.0% 11.0% 1.0%

Dev. Equities ex-U.S. 6.0% 6.0%

Emerging Markets 4.0% 5.0% 1.0%

Fixed Income 55.0% 54.0% -1.0%

USD, Tax-Exempt 38.5% 38.0% -0.5%

USD, Taxable 16.5% 14.5% -2.0%




Gold 2.5% 3.0% 0.5%





important information: The proposed Benchmark and Strategic Asset Allocations for each of the risk budgets referenced above are created by the Private Banking Americas Investment Strategy and Advisory group. The Benchmark Asset Allocation (BAA), for a 3-7 year time horizon, is the neutral position reflecting the predefined risk budgets and meets investment objectives over a full market cycle.

Recommended (SAA) Neutral (BAA)keY

Source: Private Banking Americas Investment Strategy and Advisory Group

Strategic Asset AllocationFor U.S. Ultra High Net Worth Individuals

(As of July 31, 2012)

55

5

58

2

109

31302

5

4043

30

29

2625

2

5

656730

31

risk Budget 3: medium risk Budget 5: High

Baa saa +/-

Cash 5.0% 2.0% -3.0%

USD 5.0% 2.0% -3.0%

Equities 40.0% 43.0% 3.0%


Dev. Equities ex-U.S. 12.0% 11.5% -0.5%


Fixed Income 30.0% 29.0% -1.0%

USD, Tax-Exempt 21.0% 20.0% -1.0%

USD, Taxable 9.0% 8.0% -1.0%




Gold 2.5% 3.0% 0.5%




Baa saa +/-

Cash 5.0% 2.0% -3.0%

USD 5.0% 2.0% -3.0%

Equities 55.0% 58.0% 3.0%




Fixed Income 10.0% 9.0% -1.0%

USD, Tax-Exempt 7.0% 6.0% -1.0%

USD, Taxable 3.0% 1.5% -1.5%




Gold 2.5% 3.0% 0.5%




Baa saa +/-

Cash 5.0% 2.0% -3.0%

USD 5.0% 2.0% -3.0%

Equities 65.0% 67.0% 2.0%




Fixed Income 0.0% 0.0%

USD, Tax-Exempt 0.0% 0.0%

USD, Taxable 0.0% 0.0%

Non-USD, Taxable 0.0% 0.0%



Gold 2.5% 3.0% 0.5%




risk Budget 4: medium-High


The Strategic Asset Allocation (SAA), for a 6-12+ month time horizon, expresses views resulting in temporary deviations from the BAA to generate expect-ed excess returns or reduce risk. Alternative investments are typically high-risk investment vehicles which are available only to qualified individuals or entities that are willing to assume above average risk and sustain limited liquidity with a portion of their net worth. Please refer to the attached “Important Legal Information” for important disclosures relating to alternative investments.

07.06.2012GDP growth in the Uk is

expected to get a boost from this summer’s Olympic games in London. The GDP impact is expected to reach

nearly GBP 16.5 billion, largely derived from construction contracts with local businesses.

Small and medium-size companies are expected to help deliver more than half of the total GDP contribution.

07.23.2012The Brazilian real fell over 31% against the

U.S. dollar over the past twelve months, the largest decrease among major

emerging market currencies. As a result of the slowdown in economic growth

momentum, Central Bank of Brazil has reduced interest rates by 450 basis points

over the past twelve months.

According to Pew Research, voters will head to the polls in November more polarized along partisan lines than at any point in recent history. The average partisan gap has nearly doubled over the past 25 years, from 10% in 1987 to 18%.02.02.2012

07.22.2012As continental Europe’s largest economy, Germany has financed billions of euros in debt at record low

interest rates. Three years ago, the government forecast that it would have to spend EUR 52 billion to

service its debt in 2013. It now expects that cost to total only EUR 20 billion next year.

In an attempt to contain the current budget deficit, the French government announced plans to raise taxes by over USD 9 billion

this year, targeting wealthy individuals and companies. 07.04.2012

Panorama is a 10,000-foot view of notable events and milestones reported around the world. each event contributes in some way to the accelerating pace of global change, as inde-pendent events collectively shift our global perspective.

Sources: Associated Press (07.22.2012), Bloomberg (06.27.2012, 07.11.2012), Credit Suisse (07.23.2012, 06.11.2012) The Daily Telegraph (07.06.2012), Pew Research (02.02.2012), The Straits Times (04.08.2012), The Wall Street Journal (07.17.2012, 07.04.2012)

06.27.2012 Corn prices have surged more than

50% from mid-June through mid-July, and supplies are declining,

as the worst U.S. drought since 1988 has impacted the world’s

largest harvest.

Pano

ram

a07.17.2012As the global real estate market slowly recovers from the depths of the 2008 lows, Singapore is expecting home sales in 2012 to reach all-time highs. In the first six months alone, sales reached 12,098, units versus the 15,908 units sold in all of 2011.

07.11.2012 kenya will undergo drilling on its first deepwater oil well. The drilling is targeting as much as 700 million barrels, a resource valued at twice kenya’s annual economic output at today’s oil prices.

Compass 15

v5.2012

shifting Dynamics on the World stage

Chinese luxury brand consumption is projected to grow by 18% annually and to account for 20% of the global luxury demand by 2015 – it currently accounts for 10% – primarily driven by China’s fast-growing wealthy middle class. The World Bank expects the share of middle class in China to grow from just above 10% in 2009 to above 70% in 2030.06.11.2012

More than half of India’s population of 1.2 billion currently own cellphones, with over 100 million apps downloaded every month. The market for mobile applications is expect-ed to be worth an upwards of USD 17 billion globally by the end of the year.04.08.2012

Classic Cars:Your Portfolio’s Midlife Crisis

In August each year, 200 of the most prized collector cars in the world roll onto one of the best finishing holes in golf – the eighteenth fairway at Pebble Beach. The occasion is the prestigious Pebble Beach Concours d’Elegance, one of the premier classic car shows. 2012 will mark the third year that Credit Suisse has officially sponsored the Concours. Pictured above is the 2011 Best of Show winner, a 1934 Voisin C-25 Aerodyne.

WRITTEN BY SCOTT ROSENBLATT, PRIVATE BANkING AMERICAS INVESTMENT STRATEGY & ADVISORY GROUP

table 1ten most expensive cars sold at Public auction*

*Commission included 1Nominal valueAs of 07/28/2012 Source: Classic Car Auction Yearbook (data by Historica Selecta)

Classic Cars:Your Portfolio’s Midlife Crisis

What do fashion designer Ralph Lauren, comedian Jay Leno, and hedge fund magnate Ray Dalio have in common? They all collect classic cars.

There are few passions in this world that can bring successful business leaders together from such disparate industries. The resilience of the classic car market over the years, and the sheer joy of owning what many have dreamed of since childhood, are enough to bridge the widest gaps, bringing a diverse and affluent field of investors together behind the wheel.

In Compass, we often navigate the investment landscape on behalf of our clients’ tradi-tional assets such as equities, fixed income, and commodities; rarely do we have the opportunity to literally ‘navigate’ via a tangible investment vehicle like a classic car. As investors and financial professionals grapple with the ongoing volatility in risk assets, the intrinsic value and limited supply in the classic car market have drawn in new collectors and investors alike.

market OverviewThrough the turmoil of the 2008 credit crisis, and in the midst of the current difficulties in Europe, activity and prices at current classic car auctions have reached new heights (see Table 1), buoyed by newly interested investors and a generation of established collectors. Interestingly, classic car collecting has proven to be a tangible investment that is largely uncorrelated to the ebb and flow of mainstream asset classes (see Table 2). In fact, four of the ten most expensive cars have been sold at auction since the Great Recession.


Year car make car model Purchase Price1 Date auction event

1 1957 Ferrari 250 Testa Rossa $16,390,000 Aug-11 Gooding & Company

2 1957 Ferrari 250 Testa Rossa $12,193,236 May-09 RM Auctions Italy

3 1961 Ferrari 250 GT Spyder California SWB $10,910,592 May-08 RM Auctions Italy

4 1931 Duesenberg Model J Murphy-Bodied Coupe $10,340,000 Aug-11 Gooding & Company

5 1931 Bugatti Type 41 kellner Coupe $9,800,000 Nov-87 Christie’s Auction House

6 1937 Mercedes-Benz 540k Special Roadster $9,680,000 Aug-11 Gooding & Company

7 1962 Ferrari 330 TRI/LM Testa Rossa $9,265,438 May-07 RM Auctions Italy

8 1937 Mercedes-Benz 540k Special Roadster $8,090,769 Oct-07 RM Auctions

9 1937 Bugatti Type 57 Atlantic Coupe $7,920,000 Aug-08 Gooding & Company

10 1965 Shelby Daytona Cobra Coupe $7,685,000 Aug-09 Mecum Auctions

speed read:n The classic car market has returned 10.3%

through June and 18.2% year-over-year, outperforming more traditional asset classes such as equities and commodities.

n The intrinsic value of classic cars, com-bined with a limited supply in the market, has driven record auction sales and provided a dependable diversifier and source of returns for savvy collectors.

n Compared to similar collectible invest-ments such as wine or art, classic cars have kept pace and offered less volatile returns in recent years, during points of market stress.

table 2classic car correlation of returns with select asset classes (2009-2012)

Note: The correlation measures the degree and relationship between returns of two assets on a scale of +1 to -1. A correlation of +1 indicates the two returns of the assets move in tandem. A correlation of -1 indicates the returns of the assets move in the opposite direction. The above analysis uses historical monthly returns from 12/31/2008-6/29/2012. As of 06/29/2012 Source: Historic Automobile Group International (HAGI), Bloomberg

18 Classic Cars

As measured by the Historic Automobile Group International’s (HAGI) Top Index, a market index for exceptional historic automo-biles, the classic car market has returned 10.3% through June and 18.2% year-over-year, outperforming more traditional asset classes such as equities and commodities (see Figure 1).

For avid collectors, a diverse collection of cars at the high end of the market has proven especially resilient in the face of market shocks and unease. Since December 2008, the classic car index has cumulatively returned 53%, with European sports cars leading the charge. At a recent auction in Monaco, Ferraris generated over USD 41 million in total sales, led by the rare 625 TRC Spider. Among the 22 Ferraris auctioned, the Spider alone sold for nearly USD 6.5 million. Auction house Gooding & Co.’s Amelia Island sale this past spring reinforced this trend, with more than USD 36 million in sales, mostly devoted to Porsches and Ferraris. The star of that show was the 1973 Porsche 917/30 Can-Am Spyder, which sold for USD 4.4 million, an auction record for Porsche. According to HAGI, auction prices rose by 20% in 2011.

While we do not make room for classic cars in our Strategic Asset Allocation Framework (see page 12), it is clear that those who collect – out of pure passion and interest – have benefited over the past decade. Compared to similar collectible investments such as wine or art, classic cars have kept pace and offered less volatile returns in recent years (see Figure 2).

Buying nostalgiaFor many, purchasing vintage automobiles is not simply an invest-ment, it is a passion. Finding the right car and restoring its vintage beauty are leisure pursuits and pastimes that have the potential to reap outsized returns. Collectors often share this passion with younger generations. At today’s top auctions and classic car shows, you will often find multiple generations of a family collecting and restoring together.

For many participating in today’s record-breaking auctions, their interest lies in the cars they remember fondly from their youth. Value in the market tends to shift in unison with the age of the average classic car collector. With fewer living aficionados, cars from the early part of the 20th century are beginning to take a back seat to those from the 50s and 60s, which are experiencing a swift upswing in interest and price. Currently, the three most expensive cars sold at public auction date from the 50s and 60s, each setting new records in just the last four years.

Ultimately, the power of nostalgia tends to take a back seat to the sheer value associated with rarity of the car. The most expensive and lucrative collectible cars remain those with a finite supply and timeless design. Cars with these attributes have appreciated in value consistently through the decades. One need only look back to 1980, when the ballyhooed Harrah’s collection was made avail-able for sale. Warren Buffet was offered the collection of over 1,000 vintage cars for just under USD 1 million. Weighing the opportunity, Buffet passed on what would have added to his impeccable investment portfolio. Over the subsequent decade, parts of the collection would go on to generate nearly USD 80 million in various private sales. One component of the collection,

600

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02012201020082006

HAGI Top Index1 CRB Commodity IndexMSCI All Country World Index

200420022000

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80Dec-08 May-09 Oct-09 May-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12

ArtPrice Global Index (USD)1 HAGI Top IndexLiv-ex Fine Wine 100 Index2

Figure 1classic cars Have Outperformed equities and commodities

1The HAGI Top Index is designed to measure the rare collector’s automobile market, ranging from pre-war to the new millennium and is currently comprised of 50 car models drawn from 19 different marques. The index is calculated monthly. 2000-2008: Annual returns, back test, equal weighted; 2009-present: market cap weighted As of 06/29/2012 Source: Historic Automobile Group International (HAGI), Bloomberg

crB s&P msci all spot gold Barclays U.s. commodity 500 country Price treasury index index World index index index

HAGI Top Index 0.02 -0.08 -0.07 0.10 -0.37

Figure 2cars Have Been Less volatile than Other collectibles

1 The ArtPrice Global Index is a price index based on the repeated sales, with a sample of more than 400,000 repeated sales gathered from more than 4,500 auction houses worldwide.2 The Liv-ex Fine Wine 100 Index represents the price movement of 100 of the most sought-after fine wines for which there is a strong secondary market. The index is calculated monthly. As of 06/29/2012 Source: Historic Automobile Group International (HAGI), ArtPrice.com, Liv-ex

Compass 19

the 1931 Bugatti Royale Coupe (one of only six built), would have returned Buffet’s investment several times in the coming decades. (It’s worth noting that in the same year Buffet turned down this offer, he was likely focused on completing Berkshire Hathaway’s USD 47 million initial investment in Geico Corp.)

classic Does not always equal valueNot all collectible cars are equally classic. Generally speaking, a car is recognized as a “collectible” when a vintage model exceeds its costs as a new model. More specifically, vehicles holding or appreciating in value that were produced in 1972 or earlier, are generally considered “classics”. Based on these criteria, the pool of collectible cars is quite large, at about 10 million units globally. However, as with many collectibles, classic cars are a highly segmented market. Among the almost three million classic cars located in the U.S., prices range from USD 3,500 to 40 million. The rarer the car, the higher the price. The 1962 Ferrari 250 GTO, originally made for former Formula One racer Stirling Moss, was sold in February for USD 35 million. It has changed hands several times since 1996, when it was originally purchased for a tenth of the price, which reinforced the steep value associated with vehicles that have a notable lineage and an exciting backstory.

According to Winston Art Group, an independent art appraisal and advisory firm with expertise in classic cars and motorcycles, the best investment potential continues to lie in the upper range of the market, which is feverishly active. If one buys the best example of whatever model fits his or her budget and maintains it in good order, there can be solid potential for price appreciation, even as different types and models go in and out of fashion.

a car can Only Be Original OnceBeyond the very best, pristine examples, the extent to which a car has been preserved over the decades is an important factor, con-

tributing to the robust auction results in recent years. Collectors have only recently begun to place value in cars that have remained mostly untouched for the better part of the past century. (On aver-age, they net 25% to 50% more than a comparable restored car.) According to Adolfo Orsi, author of the Classic Car Auction Yearbook and Chief Class Judge of the FIVA Award for “the best preserved car” at the Pebble Beach Concours d’Elegance, the trend is worth noting. “Showing these cars with their cracked paintwork, leather seats marked by use on the green next to their restored counterparts adorned with gleaming chrome, dazzling paintwork and new interiors, shows first-hand the enor-mous difference between the cars as they were when originally manufactured and how they are once restored. The preserved car is therefore the benchmark for all cars undergoing restoration.”

Last year’s Pebble Beach auction offered a prime example of this trend in action, when a preserved 1966 Ferrari 275 GTB sold for USD 1.5 million, almost double the market value of a perfectly restored example of the exact same model. Adolfo notes that these instances are quite rare and apply to a very limited number of cars and fortunate collectors. “Restorers still have a long work-ing life ahead of them.”

investment Drivers of classic cars

n expensesEvery investment has its requisite expense and inherent risk; clas-sic cars are no different. For collectors, expenses typically include upkeep, storage, and insurance. The winning bid at an auction does not reflect the total cost of this investment vehicle over the long run. Experienced owners spend a great deal of time and money restoring models to their vintage conditions and insuring their prized investments. For this reason, most experts advise prospective collectors to look for the best example within their

Ferrari 250 testa rossa (Pebble Beach 2011 auction)Photo by Pawel Litwinski ©2011 courtesy of gooding & company

budgets, as money saved purchasing a vintage vehicle in subpar condition tends to be spent many times over on restoration. Much of this risk can be mitigated through proper collectible advising services, pre-purchase inspections, and by buying cars with no significant restorative needs.

Collectors should be aware of the tax consequences upon the sale of their collectibles. In general, gains from the sale of a collectible held for more than one year remain subject to a 28% federal capital gains tax rate. This rate differs from the general federal capital gains tax rates, which are currently 15% for personal or investment assets held for over a year and up to 35%, if held for one year or less. As for donating collectibles, the deduction amount also will depend on whether the charity’s use of the property relates to its mission. Accordingly, collectors should carefully plan any donations of their col-lectibles with their tax advisor to maximize the tax benefits of their contributions.

n BrandSeveral of the large public automobile companies have also been very active in the classic car market over the last decade, due to the growing demand for their own brands. Manufactures have not only bene-fited from providing spare parts, they also have seen a boost in brand value when one of their vintage models makes history at auction. Aside from the increased visibility, companies such as Ferrari actually provide authentication and certification services, and, like Porsche, handle restorations of their decade-old models directly in-house for the most discerning collectors. One of the manufacturers most directly linked to the classics market is Mercedes-Benz, which purchases, maintains, and sells per-fect examples of its own classic vehicles.

n accessibilityManaging the risks and expenses associated with this asset class can make investing in classic cars inaccessible and cumbersome for anyone lacking a 10-car garage and acumen for the classic auto-mobile scene. Aside from the lofty price tag associated with the best “examples”, car collecting carries the responsibility of storing the physical asset.

20 Classic Cars

ask an expertAnswers from Mckeel Hagerty, CEO of Hagerty

Hagerty is one of the largest specialty classic car insurance providers, insuring approximately 700,000 vehicles worldwide.

can you discuss the general health of the classic car marketplace today? The classic car market is currently very healthy, especially when compared to the volatile investment environment discussed in the news on a daily basis. The highest end of the market is populated by extremely discerning, high net worth collectors (as opposed to speculators) who feel the clock ticking in terms of their ability to acquire their most aspirational classic cars. Each successive auction cycle since 2010 has seen records continually broken in terms of total dollar volume and individual records.

Have you noticed any correlation to events in europe? Those who look at classic cars as investments rather than just objects of enjoyment focus on the safety of investing in tangibles in times of economic uncertainty. Classic cars, unlike other forms of investments, are items of inher-ent worth. While the market may fluctuate, there is no Enron (or Greek default) scenario built into classic car ownership…a Mercedes 300SL Gullwing won’t declare bankruptcy on a Monday and be worthless.

Which segments of the market have fared the best in recent years? The cars that have performed the best in recent years are those that have international appeal. Because of the fact that so many foreign classics were imported to the U.S. and still survive here – and because of the dollar’s com-parative weakness against other currencies – we have seen a large number of these cars repatriated at very strong prices. American muscle cars have had a tougher time over the last few years because of the fact that so much of the money that flowed into that market was related in some way to money made from (or borrowed against) real estate.

We know there is a robust market for classic cars in the U.s. and europe, but what about emerging markets?Some fine vintage car shows have been held in India and the Middle East in recent years, but we have yet to see a high profile Asian show or auction (outside of Japan) that has made a major impact. That said, China is becoming a large market for late-model exotic cars, and, often, interest in classics follows.

How do investors manage the changing tastes in the markets, as different types of vehicles go in and out of favor? The savviest investors tend to focus on cars that have timeless appeal. Certain cars will likely never go out of style, a Jaguar E-type or a Ferrari California Spider or a split-window Corvette are examples of icons that are unlikely to fall out of favor.

One can go out and invest in most other alternative asset classes without concerning one’s self with the storage of, say, gold bullion or a barrel of oil. So, how can those interested in this investment, who lack the time or the means to properly maintain it, gain exposure to classic automobiles in a more diverse and cost efficient way? In recent years, there has been a nascent move-ment toward broadening access to the classic car market. “Classic car funds” aim to provide interested investors with diversified expo-sure to the classic car market by purchasing a basket of classic cars with notable lineages.

n LiquidityWhile the best models typically can find buyers, a classic car is not a very liquid investment. Owners usually need time to adequately market and sell their investment, either via public auction or private sale. As a rule of thumb, the better the car, the more liquid it tends to be. David Gooding, president and founder of auction house Gooding & Company, offers several examples of reliable entry points for aspiring collectors: “We believe in very good examples, of post-war sports cars, such as Jaguar Xk120s (USD 90,000 - 130,000), Mercedes-Benz 280s (USD 50,000 - 90,000), and Porsche 911s (USD 50,000 - 110,000).” However, David cautions that the rarest variants or show-quality examples of each of these will often run more in value.

conclusionClassic cars are an aspirational investment with social motivations. The finite supply and costly barriers to entry, combined with the craftsmanship and design, make it the type of investment owners want to display. Today’s avid collectors, continuously seeking rarer models to enhance their collections, are driving up demand for the most sought-after vintage autos and enticing new entrants. This dynamic, coupled by the relative strength and resilience of this

investment class, has created a virtuous cycle that has helped maintain a level of safety and liquidity at the high end of the mar-ket, driving auction sales higher (See figure 3).

Still, classic cars remain a niche investment, open to those with spirited interest in autos and collectibles. The solid performance and wealth preservation characteristics are clearly evident, but remain so in the upper echelons of the market. For those with the means and the passion, classic car collecting marries treasure with pleasure in the form of a tangible portfolio diversifier.

Compass 21

Figure 3total auction sales

As of 12/31/2011Source: Classic Car Auction Yearbook (data Historica Selecta)

520480440400360320280240200160120

8040

0

USD million

201120092007200520032001199919971995

1936 mercedes-Benz 540k special roadster, courtesy of gooding & company

1957 Ferrari 250 testa rossa, courtesy of Dayerses

1931 Duesenberg model J “Whitell coupe”, courtesy of autoweek

1973 Porsche 917/30 can-am spyder, courtesy of Winston art group

22 Conversations with Thought Leaders

You served as an advisor to four U.s. presidents. give us your view of Obama’s first term, and how effective do you think he has been in righting the ship with regard to the economy?

David Gergen: Ironically, Obama has proven to be a more effec-tive and more popular president in foreign affairs than in domestic affairs. He got Osama bin Laden when no one else could. He managed to navigate the Libyan crisis in a way that ultimately brought down the regime without putting troops on the ground. He extricated troops out of Iraq and Afghanistan as he promised.

But on the domestic side, his chief accomplishment is that he stopped the country from sliding into the abyss. He does deserve some credit on that point. His advisors told him when he took office that there was a one-in-three chance we would have a Great Depression, and we avoided that outcome. I think some credit also belongs to the preceding administration; Obama continued some of the initiatives that began with the Bush-Paulson team.

You say that Obama stopped the U.s. from sliding into the abyss – we are now facing a fiscal cliff which could shave close to 4% off U.s. gDP. How do you think it will be resolved?

DG: The fiscal cliff is a serious danger for our country and our economy. Increasingly, the tenor of both sides has appeared to reflect a belief that voters will speak with a clear voice and the party voted into power will have a mandate to implement its own version of a resolution. That seems highly unlikely to me and, troublingly, when you ask high-placed individuals in both parties “What’s plan B?” you get a blank stare. I think it’s likely we’ll find a way to postpone “Taxmageddon” and, irresponsibly, kick the can further down the road. This is something we’ve been getting quite good at in recent years – but not before the ratings agencies and some of the global markets start to take notice. Eventually, we’ll need a balanced plan to bring the deficit down slowly without choking off the recovery – it shouldn’t be hard to do, but the prospects for our putting such a plan in motion at the end of the year don’t look as rosy as they should.

conversations with Thought LeadersWitH DaviD gergen, seniOr POLiticaL anaLYst FOr cnn anD FOrmer PresiDentiaL aDvisOr

President Obama inherited an economy nearly four years ago that was faced with numerous headwinds.

The ensuing contraction in GDP was so severe, it had some investors thinking the U.S. was on the

verge of another depression. Fortunately, the U.S. was able to avoid that outcome, but it did not escape

a collapse in employment. With the 2008-2009 Credit Crisis now firmly in our rearview mirror, U.S. real

GDP has retraced and is above its pre-crisis level. The employment picture is a different story: jobs,

while growing, are doing so at an anemic pace, far slower than the typical recovery. Employment is

approximately five million below the pre-crisis peak. Moving the needle in employment will be the priority

initiative for the next U.S. president. How to do so is a matter for debate. We have called on a

renowned thought leader to bring some clarity to the political situation, and we are pleased to share the

insights of David Gergen, one of the foremost political commentators, and keynote speaker at the

Credit Suisse Wealth Management Conference in Miami.

INTERVIEW BY JIMMY JAMES, PRIVATE BANkING AMERICAS INVESTMENT STRATEGY AND ADVISORY GROUP

Compass 23

the U.s. economy has added more than two million jobs since the great recession ended, but there are still over five million people who lost jobs and haven’t gotten them back.

DG: Right, that’s the distressing issue, particularly given that the economy is now as large as it was before the recession. This means that a lot of employers have scaled back and are trying to make it with fewer numbers. We are now faced with a suboptimal growth pattern. We’re growing, but at a rate that is so far below what we’ve normally experienced after previous recessions. That, and the deleveraging process currently underway is going to clearly take another several years to play out. So we’re going through a rough patch. I’m not sure whether we will look back and call this a lost decade or not, but for millions of Americans, it sure seems like it.

so how do we move the needle in employment and create jobs?

DG: I don’t think anybody has a quick fix to the unemployment problem. Ed Luce, who is the Washington columnist and commentator for the Financial Times, took a year off to investigate the job situation and then wrote a book about what’s going on in America. He came to see me after he had spent six months on it and said he’d been all over the country asking experts how to fix the job problem. No one had an easy answer.

There is, in policy circles, a general agreement that we would be far better off to have an infrastructure bank of some sort funded by Washington, but run by an independent figure so it doesn’t become a piggy bank for politicians. That would be one way to help.

Bill Clinton has argued we could create far more jobs if we went green and retrofitted a lot of buildings. The construction industry would thrive in that scenario. But that would be a temporary solu-tion. Infrastructure is actually something we need to do anyway. The truth is that the answer to the job problem is going to be two-fold. One is that if we get the economy back on track, some jobs will return naturally. If we can get back to a three or three and a half percent growth rate, then you could see jobs start to flourish again. That’s why Republicans argue if you reset the table of taxes and regulations, companies will naturally grow in this country, and jobs will follow. Democrats, of course, disagree and want to use government as an instrument of growth.

The second part of the answer is longer term, and it is, how do you prepare your work force for the jobs of the 21st century? We need to put far more emphasis on high school graduates getting skill training after high school, not just going to college. If we can make high-end goods, we can create jobs. Germany is a clear example of what a well-educated work force, that has many skilled people, can do in this international economy. Germany has an export surplus with China. That’s because they have highly trained workers who can make high-end products that have a market in a place like China. I’ve seen estimates of up to three and a half mil-lion jobs that are going unfilled in the U.S. because we don’t have

David gergen

David Gergen is a senior political analyst for CNN and has served as an adviser to four U.S. presidents. He is a pro-fessor of public service at the Harvard kennedy School and the director of its Center for Public Leadership. In 2000, he published the best-selling book, Eyewitness to Power: The Essence of Leadership, Nixon to Clinton.

Gergen was born in Durham, North Carolina, where his father taught mathematics at Duke University. He gradu-ated with honors from both Yale College (1963) and Harvard Law School (1967) and served as an officer in the U.S. Navy for nearly three and a half years, posted to a ship in Japan.

Gergen joined the Nixon White House in 1971, as a staff assistant on the speech writing team, a group of heavy-weights that included Pat Buchanan, Ben Stein and Bill Safire. Gergen went on to work in the administration of Gerald Ford and as an adviser to the 1980 George H.W. Bush presidential campaign.

He served as Director of Communications for Ronald Reagan and as adviser to Bill Clinton and Secretary of State Warren Christopher on domestic and foreign affairs.

In his private life, Gergen works as a political journalist and analyst. From 1985-1986 he worked as an editor at U.S. News & World Report, where he also served as editor-at-large. Gergen’s career in television began in 1985, when he joined the MacNeil/Lehrer NewsHour for widely praised Friday night discussions of politics. Today, he appears frequently on CNN as senior political analyst and contributes a monthly column to Parade magazine.

Gergen joined the Harvard faculty in 1999. He is active as a speaker on leadership and sits on many boards, including Teach for America, the Aspen Institute and Duke University, where he taught from 1995-1999. He is a member of the Washington D.C. Bar and the Council on Foreign Relations and holds 19 honorary degrees.

Gergen lives in Cambridge, MA with his wife Anne, a family therapist. They have two children, Christopher and katherine and four grandchildren.

24 Conversations with Thought Leaders

people with technical skills to fill them. Over time, we need to get more people educated with these skilled jobs. Not everybody has to go to college. College is great for many people, but being a welder or being able to handle a computer is very important. There are so many jobs in this country where you cannot succeed unless you have some technical training.

You are a professor at Harvard, how many of the students there graduate with engineering degrees nowadays?

DG: Very few. The Council on Foreign Relations recently had an education task force led by Condoleezza Rice and Joel klein to report on the state of public education in the country. They argued the deterioration of our public schools has become a distinct threat to our national security. They pointed out that six percent of our graduates go into engineering. In China, it’s 33 percent. It makes a big difference.

Besides the labor market, what should be the focus of our new or incumbent president in his first 100 days in office?

DG: Get our financial house in order. But that means in the near term we might have to get worse before we get better. You can’t pull the plug on spending or support for the economy, but you certainly should be able to reach an agreement to put us on a steady glide path to reducing our debt. It should not be impossi-ble. Even though the next administration may have a Democratic president and a Republican Congress, it does not mean we can’t get progress. When Bill Clinton was president and Newt Gingrich was the Speaker, we had four straight years of balanced budgets. It should not be beyond the capacity of the president in the next four years to do exactly that. But what we’ve gone through in the last year and a half suggests it’s going to be darn hard.

How do you propose we get our house in order and close the deficit? Do we grow our way of it? Do we tax our way out of it?

DG: No, we can’t tax our way of this, and we sure can’t spend our way out of it either, but I think we can innovate our way out. Innovation, start-ups, and unleashing the entrepreneurial spirit of the country are important. I do think tax structure and regulatory structure make a difference as well.

You hold people back through cumbersome regulations and oner-ous taxes, we see that in California versus Texas. You know, Texas is doing much better than California economically. I was in Austin earlier this year, when the Bureau of Labor Statistics released its job growth figures. Since 2004, of the top six cities for job growth, five are in Texas. It’s Austin on top, followed by Houston, San Antonio, Fort Worth, and Dallas. That should teach us something about how to create an accommodative regulatory and tax environment, and jobs can become plentiful.

Energy has become a very bright spot for the U.S. New tech-nologies represent a game changer. Especially now with natural gas and the potential to capitalize on shale, we should be growing on the energy front. We could become less oil dependent, more environmentally safe, more competitive economically, and create jobs. North Dakota has almost zero unemployment because the energy sector has taken off there.

You delivered the keynote speech at the credit suisse Wealth management conference in miami, which focused on our Latin american clients. much of the financial media attention concentrates on china, but how important is Latin america, both as an economic and political partner to the U.s.?

DG: Latin America has become an incredibly important partner to the U.S. In fact, we are moving in a direction that Reagan envi-sioned a long time ago, some sort of economic partnership that stretches from Canada down through the tip of Chile. We removed many burdensome trade barriers through NAFTA. But very importantly, so many of the Latin American countries have moved toward embracing market reform. Brazil is now a world class emerging country. Just ten years ago, I don’t think anybody envisioned that Brazil would be in as strong a position as it is today; it’s the sixth largest economy in the world.

If you look beyond what’s going on with the gun trade and the drug trade, there’s a lot of promising growth and development in Mexico. Over time, we’re going to see more and more trade between the U.S. and Latin America.

I believe strongly that the Hispanic community in the U.S. can turn out to be a real asset for us in building up trade with our southern neighbors. There will be a lot of businesses, that are going to be in places like Miami, south Texas, or elsewhere that will be thriving Latino-run businesses.

But china is obviously still an important partner for the U.s. Do you worry about the power they wield by being the largest holder of U.s. treasurys?

DG: Yes. The Obama administration is pivoting from an emphasis on the Middle East to a focus on Asia. That is partly because so

Figure 1gDP Has recovered; Jobs Haven’t U.S. Real GDP and Nonfarm Payrolls

As of 06/29/2012, latest data available Source: Bloomberg

13.6

13.4

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12.6

12.4

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Real GDP Payrolls (r.h.s.)

USD Trillion Million

Q2-06 Q2-07 Q2-08 Q2-09 Q2-10 Q2-11 Q2-12

Compass 25

much of our economic growth comes from Asia. But there are some rising fears in Asia and within parts of the U.S. that our relationship with China may deteriorate. What’s important for the world is that China become a constructive major figure in the world economy and be a source of stability. But there are some fears that China, as it grows, is becoming more nationalistic. It’s got some of its own internal problems, and it’s starting to flex its muscles militarily. It’s building a blue water navy. In the short term, the greatest danger for conflict is with Iran, but in the long term, the greatest danger of conflict is probably in the South China Sea.

circling back to the U.s., romney is the republican nomi-nee, but he never really coasted to victory in the primaries. can romney beat Obama by being the “least bad” candi-date, or does he have to find a way to truly inspire passion or announce game-changing initiatives?

DG: Well, Romney is clearly the best candidate to take on Obama within the original Republican field. Obama started off as an underdog and is now the favorite according to most major polls. Romney has his work cut out for him. Can he win? Yes, I think he can win. There are many different ways that the president can get hurt here in the months ahead. The Eurozone could unravel. That would hurt him. Job growth has already cooled off, and could remain weak into the election. That would hurt him. Though the Supreme Court upheld Obama’s Affordable Care Act, their deci-sion gives Romney a new way to mobilize his base. And it still remains to be seen whether the steady stream of attacks on Romney’s time at Bain and his reluctance to release full informa-tion on his finances will move the poll numbers as Obama has hoped.

in a cnn.com article, you said that one of the biggest issues facing mitt romney is that the gOP is no longer his father’s party. moderate conservatives face purity tests forcing them to move further to the right. You said that eisenhower, nixon, H.W. Bush, maybe even ronald reagan may not have been nominated by today’s republicans. With republicans rigidly defining themselves, is there room for a viable third party?

DG: Clearly, we’re not going to see a third party this time around. The system is stacked against third parties. But if the two main parties continue to become more and more purist, one to the left and one to the right, that’s going to leave a great number of Americans stranded who feel they don’t have a close allegiance to either. People who once felt comfortable as moderates in the Republican Party are going to look for a new home. People who once felt comfortable as moderate conservatives in the Democratic Party are going to look for a new home. The Internet does provide ways to bring people together that you couldn’t use in the past. I think if politics continues in this paralyzed, poisonous way, we will see the makings of a third party.

You mentioned the internet bringing people together. You have 6,000 “likes” on Facebook. if i type your name into Youtube, there are nearly 1,000 videos and results, some of which have been viewed almost 700,000 times.

DG: Surely people have better ways to spend their time! Social media had an enormous impact on the Arab Spring. What hap-pened in Tahrir Square would not have occurred were it not for social media. In this country, I’m not sure it’s going to sway the election very much. It did help Barack Obama mobilize the young vote four years ago, but I don’t think it will sway this election. It’s definitely changed the discourse. Social media is allowing people to find each other, and maybe there will be mobilization, say, of a third party over time. But it’s also coarsened the conversation so that people say some pretty mean things on the Internet. That is, I think it’s contributed more than I would have thought to polarization. That’s my sense of it. I think we’re all trying to figure out how to capture this great tool and mobilize people for good causes, in a more constructive way. I’ll tell you this, one of the great hopes for this country is the younger generation that’s emerging. There are some talented people developing. Maybe they can find each other on a social media venue. There are a lot of social pioneers, social entrepreneurs, and young veterans coming back who are just first class. If given the opportunity, we’re going to get a new generation of leaders who could save the country.

While we may be waiting for these markets to fully “emerge”, they have clearly taken a leadership role in returning capital to investors.

Hong kong

Compass 27

As the global search for yield intensifies, investors are finding much needed investment income from non-traditional sources. One of these relatively new sources is emerging market equities. Generally known for their contribution to the growth portion of a portfolio, emerging market equities have begun to assert themselves as a meaningful source of income through the dividend yield, on par with, or in certain instances, in excess of developed market equities. What’s more, is that we expect this trend to continue. Over the next decade, emerging market economic growth, as measured by GDP, is expected to be a multiple of developed markets (see Figure 1). The changing demographics of emerging markets should continue to shift to a greater domestic consumer-driven consumption model. Further coordinated global stimulus and policy easing to jump start the sputtering developed world economic recovery should bolster corporate profits and benefit emerging markets dividend capabilities considerably. Thus, while we may be waiting for these markets to fully “emerge”, they have clearly taken a leadership role in returning capital to shareholders.

room for Further Fiscal and monetary stimulusSince equity markets troughed from their spring sell-off in early June, the price momentum has been a saw-tooth pattern of ups and downs. It appears that the market needs further policy stimulus to reestablish greater confidence in risky assets. In developed mar-kets, the possibilities are somewhat limited to a further expansion of central banks’ balance sheets via quantitative easing programs (QE), as interest rates are almost near zero and budget targets curtail fiscal flexibility. Emerging markets, though, have more scope to maneuver, especially with regard to monetary policy. The Brazilian central bank, for example, is likely to continue to cut its target interest rate and we are likely to see further reductions in the Reserve Requirement Ratios for Chinese banks. In our view, this should help to prevent an economic hard landing in 2012. In some of the smaller economies, though, the absolute average infla-tion level is lower, inflation dynamics are less favorable, and most central banks are currently on hold. Apart from the Eastern European countries, many emerging market countries do not have direct trade or economic dependencies with the Eurozone, thereby eliminating a larger systemic threat (see Figure 2).

Long-term advantages remain intactAlthough risks prevail in the short term, longer term, emerging market equities should outperform developed market equities

the new Dividend PlayEmerging Markets

WRITTEN BY DOMINIk GARCIA, PASCAL ROHNER, YVES LIECHTI, PRIVATE BANkING GLOBAL RESEARCH

Figure 1 current and expected gDP of Developed and emerging markets

As of 06/29/2012Source: IMF, DataStream, Credit Suisse Global Research

10

8

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4

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0

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-6Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10 Jan-14

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G7 (Developed Markets) GDP Emerging Markets GDP

Figure 2 exports as a % of gDP from emerging markets to the eurozone As of 06/29/2012Source: IMF, DataStream, Credit Suisse Global Research

10 20 30 40 50 60 70 800

HungaryCzech Republic

PolandRussiaEgypt

TurkeyMalaysiaThailand

South AfricaChile

South KoreaPeru

ChinaIndia

ColombiaIndonesia

BrazilMexico

28 Emerging Markets

based on better demographics, a favorable debt and fiscal situation, ongoing urbanization in Asia, and an emerging middle class leading to greater consumer spending. Despite the current economic challenges in the developed world, the IMF still expects emerging economies to outgrow the G7 by some 4% in terms of GDP growth over the next three years (See Figure 1).

valuation Has Become more attractive relative to Developed marketsAfter the recent spring correction in equities, valuations have compressed and are at attractive levels. The MSCI Emerging Markets Index is currently trading at a 12-month forward Price-to-Earnings (P/E) of 9.3x, a 13% discount to its ten-year historical average and a 17% discount to the MSCI World Index (see Figure 3). While consensus earnings per share forecasts for 2012 have been revised lower within the last six months, they have recently stabilized. Importantly, the long-term earnings trend still appears superior compared to developed markets. Profitability, as mea-sured by Return on Equity, remains well above the level of devel-oped markets. Even though there will likely be fits and starts, we believe emerging market equities no longer deserve a valuation discount compared to developed market peers.

Finally, emerging markets are asserting themselves in an area that was once thought reserved for developed markets: dividend yield. To many who consider emerging market investments high-volatility growth engines within a portfolio, it may come as a surprise that the MSCI Emerging Markets Index has a current yield of 3.1%. The availability of quality, high dividend-yielding stocks in the emerging markets presents an opportunity for investors to collect income while at the same time being exposed to regions that are poised to grow at a faster clip than the developed markets.

stocks or Bonds?With a 30-year bull market in bonds globally, interest rates are currently at very low levels. Emerging markets are no different. The gap between bond yields and dividend yields is at record lows. As a result of this collapse in fixed income yields, investors are finding it challenging to generate sufficient returns from yield-based invest-ments. As a result, the obsession with yield has taken many forms. One way investors have sought to make up the difference is by investing in companies that are paying high and sustainable divi-dends. Emerging markets dividend yield, as measured by the MSCI Emerging Markets Index, is currently at 3.1%, above its 10-year average of 2.5%. Compared to other developed market dividend yields, such as the S&P 500 Index at 2.2%, emerging markets dividend-yielding stocks appear attractive, especially due to their above-average growth potential. Additionally, the MSCI Emerging Markets High Dividend Yield Index has shown superior perfor-mance compared to the more broad MSCI Emerging Markets Equity Index. Dividend-focused investment strategies have been working and since the beginning of 1999, high dividend-yielding emerging market equities have meaningfully outperformed the MSCI Emerging Markets Index by an average of 5% per year. Noticeably, high-yielding emerging market stocks have had slightly lower drawdowns during correction phases. (see Figure 4)

Dividends are Becoming a Larger Portion of total returnToday, return expectations remain high for emerging market equities. With the gradual development of many emerging mar-ket countries, it would not be unlikely to see growth rates decel-erate, and index returns converge and eventually be more in line with the developed markets. As a result, the dividend return component of returns is becoming increasingly important. From 1995 to present, the dividend return contributed 36% to the

As yield has become more important over the last few years, several emerging market countries have changed their dividend policies to accommodate the increased focus on dividend payments to investors. The most recent example is Russia.

Compass 29

annual total performance of the MSCI Emerging Markets Index. With progressing maturity, we expect this share in total return to further increase and continue to draw investors’ attention to the emerging markets.

companies Have realized that Paying sustainable Dividends attracts investorsAs yield has become more important over the last few years, several emerging market countries have changed their dividend policies to accommodate the increased focus on dividend payments to investors. The most recent example is Russia. key changes include the shift in the basis on which dividends are cal-culated. In this example, dividend payments until recently were

based on the unconsolidated Russian Accounting Standard (RAS) earnings. Going forward, the calculation is proposed to be based on the consolidated RAS or IFRS earnings – the global accounting standards used in most developed countries. To fur-ther attract capital, Asian companies have raised their dividend payout ratio, which is now in the range of 30% to 40%. Brazil’s legal framework forces companies to pay out more than 20% of net earnings in dividends. In addition to the change in dividend policies, emerging market companies’ fundamentals remain highly attractive with generally low corporate debt levels, growing earnings, and improving governance may lead to a more sustain-able dividend policy through time.

Figure 4 msci emerging markets High Dividend Yield index and msci emerging markets index Performance

As of 06/29/2012, Indices rebased to 100 as of 12/31/1998Source: MSCI, Credit Suisse Investment Strategy and Advisory Group

1000

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700

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0Jun-12Jun-09Jun-06Jun-03Jun-00

MSCI Emerging Markets IndexMSCI Emerging Markets High Dividend Yield Index

Figure 3 12-month Forward P/e of Developed and emerging markets

As of 06/29/2012Source: DataStream, Credit Suisse Global Research

19

17

15

13

11

9

7

5Jun-02 Jun-04 Jun-06 Jun-08 Jun-10 Jun-12

12M Forward P/E

MSCI Emerging Markets Index 12-Month Forward P/EMSCI World Index 12-Month Forward P/E

MSCI Emerging Markets Index Average MSCI World Index Average

istanbul, turkey

table 1a sample of High Yielding emerging market companies

Note: Certain stocks mentioned above may not be covered by Credit Suisse Research. The dividend yield was calculated as of 7/12/2012. The reference to specific securities is for illustrative purposes only. This material should not be regarded as an offer or solicitation of an offer to invest in any security.1Beta: The measurement of stock price volatility relative to index volatility. Beta is the expected percent change in the price of the stock price given a 1% change in the price of the index. For example, if a stock has a beta of 0.8 relative to the index, one would expect the stock to move 0.8% for every 1% change in the index. n/a= not availableAs of 07/12/2012Source: HOLT, Bloomberg, DataStream, Credit Suisse Investment Strategy and Advisory Group

conclusionOn many levels, emerging market investments present more attractive opportunities than those available in the developed markets. They are demographically and structurally sound, and poised for further growth that is frequently a multiple of developed

market growth. With dividend yields in excess of developed markets in many cases, investors in emerging markets no longer have to forgo income as a component of returns.

aDr market cap Dividend name ticker industry country UsD m Yield Beta1

Table 1 provides a sample of 20 companies from the MSCI Emerging Market High Dividend Yield Index, which is comprised of 236 companies. We applied a filter to this index to screen for the stocks that had a beta less than one relative to the MSCI All-

Country World Index (see beta1 explanation below), and an abso-lute dividend yield exceeding 3%. Our screen returned 20 compa-nies that had, on average, a beta versus the global equity market of 0.8 and a dividend yield of 5%.

Turpas-Turkiye Petrol Rafine TUPRF Oil, Gas & Consumable Fuels Turkey 5,401 9.2% 0.9

Telefonica Brasil VIV Diversified Telecommunication Brazil 18,500 8.1% 0.5

EDP- Energias do Brasil SA n/a Electric Utilities Brazil 2,932 6.1% 0.5

Asustek Computer Inc ASUUY Computers & Peripherals Taiwan 6,784 5.7% 0.7

Exxaro Resources Ltd EXXAY Oil, Gas & Consumable Fuels South Africa 7,442 5.5% 0.9

Taiwan Cement n/a Construction Materials Taiwan 4,553 5.5% 0.9

S-Oil Corporation SOOCY Oil, Gas & Consumable Fuels South korea 9,250 5.3% 1.0

China Construction Bank CICHY Commercial Banks China 158,950 5.2% 0.9

Arcelik AS ACkAY Household Durables Turkey 3,259 5.0% 0.9

krung Thai Bank Pub Co Ltd kGTFF Commercial Banks Thailand 5,674 4.9% 0.8

Siliconware Precision Inds SPIL Semiconductors Taiwan 3,128 4.8% 0.9

Telekomunikasi Indonesia TLk Diversified Telecommunication Indonesia 17,548 4.8% 0.4

Eregli Demir Ve Celik Fabrik ERELY Metals & Mining Turkey 3,520 4.6% 1.0

United Microelectronics Corp UMC Semiconductors Taiwan 5,462 4.2% 0.9

Astra Agro Lestari PTABF Food Products Indonesia 3,789 4.0% 0.9

Siam Cement SCVUF Construction Materials Thailand 12,030 3.9% 0.7

Charoen Pokphand Foods CPOkY Food Products Thailand 8,910 3.9% 0.4

Taiwan Semiconductor Manufacturing TSM Semiconductors Taiwan 67,622 3.8% 0.7

Aboitiz Power Corp ABZPF Independent Power Producers Philippines 6,065 3.4% 0.7

China Mobile Ltd CHL Wireless Telecommunication Services Hong kong 227,141 3.2% 0.6

Compass 31

The current tax and market environment provides unique opportunities for estate planning. For the remainder of this year, the Federal lifetime gift tax exemption amount (i.e., the amount that can be transferred free of gift tax) is at an all-time high of USD 5,120,000 per individual, or USD 10,240,000 per married couple. Without further Congressional action, starting in 2013, this exemption will decrease to USD 1,000,000 per individu-al, or USD 2,000,000 per married couple. In addition, as many asset prices are still well below their peak levels of 2007, these relatively depressed assets are especially attractive for gifting. Coupled with the cur-rent low interest rate environment, this year presents significant opportunities for estate planning.

gifting assets with Depressed valueFor those who have seen the value of their investments decline in recent years due to the market downturn, there may be a silver lining. While market values are relatively low compared to a few years ago, individu-als may gift more of their assets while maximizing the use of their Federal lifetime gift tax exemption. This is because the use of the Federal lifetime gift tax exemption is based on the fair market value of the asset transferred at the time of gift. For example, an individual owns 100,000 shares of stock in Hewlett-Packard (“HP”), which was valued at approximately USD 38/share in August 2010. If this individual had made a gift of these shares

to his children in 2010 (a total gift value of USD 3,800,000), he would have incurred a Federal gift tax, as the Federal lifetime gift tax exemption amount was only USD 1,000,000. However, since 2010, the stock has declined approximately 47% in value and, as of this writing, has a current share price of approximately USD 18/share. The individual can now transfer his entire HP position to his children (a total gift value of USD 1,800,000) without paying any Federal gift tax because the current value of the assets is below this year’s Federal lifetime gift tax exemption amount (USD 5,120,000). The combination of the declined asset value and the increased Federal lifetime gift tax exemption created an opportunity for this individual to transfer assets that he otherwise would not have been able to without incurring a Federal gift tax. In addition, the individual still has USD 3,320,000 of his Federal lifetime gift tax exemption available for use for the remainder of the year.

The same applies to other types of assets such as interests in a company or real estate. For example, an individual wishes to retire and transfer his company interests to his children who are also involved with the business. A previous valuation estimated the company interests at USD 6,000,000 in 2007. Because the Federal lifetime gift tax exemption amount in 2007 was only USD 1,000,000 per person, the individual would have only been able to transfer one-sixth worth or USD

Wealth Planning

estate Planning with Depressed assetsWRITTEN BY ALVINA LO, PRIVATE BANkING AMERICAS WEALTH PLANNING

Important Information: The tax calculation exam-ples provided above are for illustrative purposes only and do not represent any actual client account, transaction or tax calculation. Credit Suisse does not provide tax or legal advice. Please consult your accounting, tax and legal advisors to understand the applicability of the tax analyses described herein to your specific situation.

32 Wealth Planning

1,000,000 of his interests in the company to his children without incurring a Federal gift tax. However, since 2007, interests in the company have declined and are now valued at USD 4,000,000. With the increased Federal lifetime gift tax exemp-tion this year, the individual may now gift his entire interest in the company without incurring a Federal gift tax. In addition, the individual has another USD 1,200,000 worth of Federal gifting exemption available that he may use to make additional gifts.

Once gifted, the underlying asset, as well as any associated future income and appreciation, could be removed from the individual’s taxable estate. As a result, there would be no further gift or estate tax on the asset (or on any future income and appreciation thereon). Furthermore, if the assets were gifted to a trust such that the asset could also be protected from gener-ation-skipping tax, the assets could remain in trust transfer tax free for the benefit of future generations. In certain jurisdictions, these trusts can continue in perpetuity (the so-called “Dynasty Trust”).

grantor retained annuity trust (“grat”)Certain estate planning strategies could be particularly attractive in this low interest rate environment. In addition, gifting depressed assets with these structures could generate significant tax savings, as any appreciation could be removed from the donor’s estate and transferred to the next generation without any gift or estate tax. An example of this would be the use of depressed assets in a Grantor Retained Annuity Trust (“GRAT”). A GRAT is an irre-vocable trust to which a donor contributes assets while retaining the right to receive a fixed annuity each year for the term of the trust. The donor is deemed to make a gift equal to the present value of the assets that will pass to the beneficiary (e.g., children) at the end of the trust term. For maximum leverage, the value of the annuity is usually set sufficiently high so that the value of the remainder interest (the value of the gift) is as close to zero as possible. The GRAT must pay the required annuity back to the donor each year, which consists of a portion of the original principal

plus an interest based on a “hurdle rate” determined at the creation of the GRAT. If the trust assets appreciate above the inter-est or hurdle rate, then any excess amount could pass to the children (or to a trust for their benefit) without additional gift or estate tax. Note that the donor must survive the trust term for all of the assets to be removed from the estate.

Depressed assets are ideal for GRATs because all future growth in excess of the hurdle rate can be captured by the GRAT and pass transfer tax free to the children (or to a trust for their benefit). In addition, the current interest rate environment makes GRATs especially attractive because the hurdle rate is at a historic low. For example, assume that an individual has a USD 1,000,000 asset that declined 25% in value over the last few years, such that it has a current market value of USD 750,000. If the individual were to contribute this depressed asset to a 5-year GRAT, and the asset steadily appreciated back to its original level of USD 1 million over the trust term, then approximately USD 136,144 could be transferred to the children at the end of the 5-year term1. This amount would be removed from the individual’s estate essentially free of transfer tax. If the asset were to appreciate above its original level, then the transfer tax savings is even more significant.

In addition to a GRAT, individuals with depressed assets may also wish to consider other strategies that are suitable in the current low interest rate environment, such as intra-family loans and sales to intentionally defective grantor trusts. For individuals who are charitably inclined, charitable lead trusts are also very appropri-ate in today’s environment. In all cases, utilizing depressed assets with these strategies could have significant transfer tax savings.

cost Basis of giftThe cost basis of an asset is an important factor to consider when selecting the appropriate asset for gifting. Generally, lifetime gifts receive carryover basis, which means that the basis of the property in the hands of the donee (the person receiving

For those who have seen the value of their invest-ments decline in recent years due to the market downturn, there may be a silver lining. While market values are relatively low compared to a few years ago, individuals may gift more of their assets while maximizing the use of their Federal lifetime gift tax exemption.

Compass 33

the gift) is the same as that in the hands of the donor (the person giving the gift). In contrast, bequests at death generally receive a step-up in basis to the fair market value at the date of death (unless alternate valuation is elected). Therefore, generally, an individual may wish to gift high basis assets and retain low basis assets so that there may be a step-up in basis at death. This would allow the beneficiaries to receive assets with zero or minimal built-in gain, resulting in less capital gains tax when the beneficiaries ultimately sell the assets.

There are several exceptions to the above carryover basis rule. In particular, the one that is most applicable to gifting depressed assets is as follows: for gifts of property that have significantly declined in value such that the fair market value is below basis, the donee’s basis depends on whether the asset will be sold for a gain or a loss. For purposes of determining loss, the donee’s basis is the fair market value of the property at the time of gift. In contrast, for purposes of determining gain, the donee’s basis is the adjusted basis in the hands of the donor. For example, an individual purchased a share of stock for USD 100 which has since declined in value to USD 80. The individual now gifts the stock to her child. If the donee were to sell the stock for USD 70, she would have a loss of USD 10 because she must use the fair market value at the time of the gift (USD 80) as her basis to calculate the loss. On the other hand, if the donee were to sell the stock for USD 130, then she would have a gain of USD 30 because she must use the donor’s adjusted basis (USD 100) as her basis to calculate the gain. If the sale price falls between the donor’s basis and fair market value at the time of gift, then there is no gain or loss realized. Therefore, it is generally recommended that the donor in this case sell the property to recognize the loss and then make a gift of the sale proceeds to the donee (unless the donee is a grantor trust, as described below).2

When considering gifts of significant size, many choose to utilize a trust structure (as opposed to an outright gift) for maxi-mum flexibility, tax efficiency, and creditor protection. A trust is a separate legal entity

and often a separate taxpayer. Therefore, the same rules discussed above apply when determining the basis of the gifted property in the hands of the trust. A trust may also be structured as a so-called “grantor trust”. A grantor trust is disre-garded for income tax purposes and the grantor continues to be responsible for the income tax associated with the trust assets. Therefore, the basis of the property remains unchanged in the hands of the trust. If the grantor trust were to subsequently sell the assets, then the donor would recognize a gain or a loss as if the donor had held the assets in his individual name.

summaryThe current tax and market environment makes estate planning – and, in particular, gifting – particularly advantageous. The combination of the increased Federal lifetime gift tax exemption, relatively depressed value of many assets, and low interest rate environment makes this year an ideal time to consider making large gifts. Wealthy individuals should take advantage of this opportunity and gift assets with depressed values to maximize the use of their increased Federal lifetime gift tax exemption.

1Assumes a hurdle rate of 1%, which is the hurdle rate used for GRATs created in August 2012.

2The “wash sale” rule generally does not apply to gifts, unless the circumstances are such that a court would find that the substance of the transaction warrants a disallowance of the loss.

The current tax and market environment makes estate planning – and, in particular, gifting – particularly advantageous. The combination of the increased Federal lifetime gift tax exemption, relatively depressed value of many assets, and low interest rate environment makes this year an ideal time to consider making large gifts.

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Unless otherwise specified, the term “Credit Suisse Private Banking” generally refers to the combined capabilities of Credit Suisse Group subsidiaries and affiliates that provide private banking services to high net worth clients world-wide. Each legal entity in Credit Suisse Group is subject to distinct regulatory requirements and certain products and services may not be avail-able in all jurisdictions or to all client types. There is no intention to offer products and services in countries or jurisdictions where such offer would be unlawful under the relevant domestic law.

This material has been prepared by the Investment Strategy and Advisory Group of the Private Banking USA business of CSSU and not by the CSSU research department. It is intended only to provide observations and views of the Investment Strategy and Advisory Group, which may be different from, or inconsistent with, the observa-tions and views of CSSU research department analysts, CSSU traders or sales personnel, or the proprietary positions of CSSU. Observations and views expressed herein may be changed by the Investment Strategy and Advisory Group at any time without notice. Past performance is not an indication or guarantee of future performance, and no representation or warranty, expressed or implied is made regarding future performance. The material set forth above has been obtained from or based upon sources believed to be reli-able but CSSU does not represent or warrant its accuracy or completeness and is not responsible for losses or damages arising out of errors, omis-sions or changes in market factors. The material does not constitute objective research under FSA rules. The most recent CSSU research on any company mentioned is available to online sub-scribers at www.credit-suisse.com/pbclientview.

Private equity funds, hedge funds, and other alternative investments are complex instruments that are not suitable for every investor, may involve a degree of risk, and may be appropri-ate investments only for sophisticated investors who are capable of understanding and assum-ing the risks involved. Before entering into any transaction, an investor should determine if the product suits his or her particular circumstances and should independently assess (with his or her professional advisors) the specific risks and the legal, regulatory, credit, tax and accounting con-sequences. CSSU makes no representation as to the suitability of any alternative investment prod-uct for any particular investor nor as to the future performance of any such products. Any offering of interest in any private equity fund, hedge fund or other alternative investment product shall only be made pursuant to the offering material for each such product, which will be provided to each prospective investor before making his or her investment decision and which contains informa-tion about such product’s investment objectives, the terms and conditions of an investment in such product and tax information and risk disclosures that involve significant risks, such as loss of the entire investment, illiquidity, restrictions or trans-ferring of interests, volatility of performance, and currency risks.

Master Limited Partnerships (MLPs) combine the tax benefits of limited partnership with the liquidity of common stock. An MLP has a partnership structure but issues investment units that trade on an exchange like common stock. In order to qualify, a firm must earn 90% of its income through activities or interest and dividend payments relating to natural resources, com-modities or real estate. MLPs are not subject to corporate income taxes. Instead, unithold-ers of an MLP are personally responsible for paying taxes on their individual portions of the MLP’s income, gains, losses, and deductions. Tax-exempt institutional investment funds such as pensions, endowments, and 401(k) plans are restricted from owning MLPs because the cash distributions received are considered unrelated business taxable income (UBTI) – income that is unrelated to the activity that gives the fund tax-exempt status. This could create a tax liability on any distribution of more than USD 1,000. This is also true for individuals when holding MLPs in an IRA account. CSSU does not provide tax or legal advice. Please consult your legal and tax advisors to understand the tax implications of investing in MLPs.

For the definition of certain benchmark indices referenced herein, please refer to: https://www.credit-suisse.com/us/privatebanking/en/glos-sary_indices.jsp

Internal Revenue Service Circular 230 Disclosure: As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promot-ing, marketing or recommending to another party any plan or arrangement addressed herein.

This material may be distributed in Mexico by Banco Credit Suisse (México), S.A., for informa-tion purposes only, this may not be construed as an offer or an invitation to enter into any trans-action or purchase any security or investment product that may not be undertaken under Mexican applicable regulation.

©2012 Credit Suisse Securities (USA) LLC. All rights reserved

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