Exchange-Traded Funds

1. Morgan Stanley & Co., Inc. November 15, 2014 Exchange-Traded Funds North America Portfolio Management Institute For Internal Use Only Exchange-Traded Funds We define exchange-traded funds as encompassing passively-managed index-linked exchange-traded funds, HOLDRS, and closed-end funds. This report is focused on US index-linked exchange-traded funds. These funds are registered with the SEC and trade as a single stock under SEC exemptions. U.S. listed, open-end fund ETFs must be offered under and sold only pursuant to a Prospectus. U.S.-listed ETFs may not be marketed or sold in a number of jurisdictions and may not be suitable for all investors. Morgan Stanley Sales Personnel should check with the Law Division to clarify whether they may market the ETFs in a particular jurisdiction.

2. ETF Research Team Legacy Morgan StanleyLegacy SmithBarney Dominic Maister Michael Jabara 212-761-5986 212-761-1629 Dominic.maister@morganstanley.commichael.jabara@mssb.com Mitchell Schorr 212-761-5987 Mitchell.schorr@morganstanley.com David Perlman 212-761-5989 David.perlman@morganstanley.com Stephen Minar 212-761-5991 Stephen.minar@morganstanley.com

3. Where to Find our Research? Legacy SmithBarney • SBLinx • Strategy & Research • Morgan Stanley Strategy • Exchange-Traded Fund Research • Notable CEF/ETF Reports Legacy Morgan Stanley • Morgan Stanley Research Link • Morgan Stanley Ideas • Products • Equities • ETFs • ETF Models • EM Allocation Model • Fixed-Income ETF Assets Allocation Model • STEP Portfolios • Asset Allocation STEP • Franchise ETF Research Products • ETF Weekly Update • Exchange Traded Funds Quarterly Report • ETF Overviews and Strategies • Exchange Traded Funds: Quarterly Cash Flow Report • Annual Tracking Error Study

4. US-Listed Index-Linked ETF Growth • Strongest Areas of Recent Growth: • ETF Assets Rebounded 47% in 2009 • 50% of the rebound came from appreciation, 50% from net cash inflows • Strongest Areas of 2009 Net Cash Inflows • Fixed Income and Commodity • International Equity Source: Morgan Stanley, Bloomberg

5. Index Methodology: Market Capitalization Overlap Source: Morgan Stanley Research

6. Single Inverse ETFs: Rebalancing Strategies Min: Mean: Median: Max: Source: Morgan Stanley Research. Investors using SH effectively as a hedge are likely using it to hedge a portfolio with a beta similar to that of the S&P 500, but one expected to generate alpha. Historical Index volatility and performance are not indications of what the Index volatility and performance will be in the future.

7. Single Inverse ETFs: Rebalancing Strategies Source: Morgan Stanley Research based on data from 6/22/06 through 12/31/09. Example based on a portfolio that is rebalanced to 50% S&P 500 and 50% ProShares Short S&P500 (SH) on each rebalance date. Historical Index volatility and performance are not indications of what the Index volatility and performance will be in the future. Rebalancing examples exclude transaction costs.

8. Index Methodology: Commodities The Shape of the Curve Impacts Returns of ETFs Using Futures Source: Bloomberg, Morgan Stanley Research

9. Tax-Efficiency • Capital Gains Distributions as a Percent of NAV* • S&P 500 SPDR Open-End S&P 500 • ETF (SPY) Index Fund Avg. • 1993 0.00 1.33 • 1994 0.00 1.33 • 1995 0.00 4.76 • 1996 0.12 2.43 • 1997 0.00 3.72 • 1998 0.00 2.24 • 1999 0.00 1.79 • 2000 0.00 2.20 • 2001 0.00 0.51 • 2002 0.00 0.11 • 2003 0.00 0.14 • 2004 0.00 0.50 • 2005 0.00 0.81 • 2006 0.00 0.99 • 2007 0.00 1.75 • 0.00 1.34 • 0.00 0.33 • Average 0.01 1.54 * Year-end NAV Source: Bloomberg

10. Securities (Includes Cash & Commodities) Client (Investor) (Creation) Purchase ETF Sources of Liquidity Fund Increases Order • ETF Market • Underlying Cash Markets or via a Authorized Participant Fund program trade • Futures • Options Sell • Cash Fund Decreases Order • Short ETF position • Basket of securities Client (Investor) Securities (Includes Cash & Commodities) (Redemption) Tax-Efficiency: Creation Redemption Process

11. ETF Tracking Error • We define tracking error as the difference in total return between an ETF’s NAV and its index • Most common sources of tracking error include: -ETF fees & expenses -Index turnover -Portfolio optimization vs. full replication -Compliance with SEC diversification requirements • We found a broader range and magnitude of tracking error in 2009 vs. 2008 • High level of new issuance has broadened the range and complexity of ETF market -Harder to replicate benchmarks increases the use of optimization • In general, lower tracking error is associated with: • Lower fees, easier and cheaper access to underlying markets, which leads to less optimization -US Style ETFs (2009 Average = 54 bps) -US Major Market ETFs (2009 Average = 63 bps) • In general, higher tracking error is associated with: • Markets which are harder and more expensive to access, which tends to lead to increased optimization -International ETFs (2009 Average = 194bps) -Fixed Income ETFs (2009 Average = 144 bps); High Yield (2009 Average = 925 bps)

12. Relative Performance • Holding passively managed indexed assets has become widely accepted • We estimate over $1 trillion is indexed to domestic equity markets • This is mainly in private accounts for pension plans and other institutional investors • Consistent outperformance is very difficult to achieve in efficient markets • Management fees and turnover significantly impact total return • Percent of active open-end funds that underperformed benchmark over the past five years:

13. Disclosure • An investment in an exchange-traded fund involves risks similar to those of investing in a broadly based portfolio of equity securities traded on an exchange in the relevant securities market, such as market fluctuations caused by such factors as economic and political developments, changes in interest rates and perceived trends in stock and bond prices. Investing in an international ETF also involves certain risks and considerations not typically associated with investing in a fund that invests in the securities of U.S. issues, such as political, currency, economic and market risks. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economics. (For specifics and a greater explanation of possible risks with ETFs, please consult a copy of the prospectus.) Investing in sectors may be more volatile than diversifying across many industries. The investment return and principal value of ETF investments will fluctuate, so an investor’s ETF shares (creation units), if or when sold, may be worth more or less than the original cost. ETFs are redeemable only in Creation Unit size through an Authorized Participant and are not individually redeemable from a Fund. ETFs do not charge sales loads or other non recurring fees, but your client may pay a brokerage commission on the purchase or sale of ETF shares. • Please ask your clients to consider the investment objectives, risks, charges, and expenses of the ETF carefully before investing. The prospectus contains this and other information about the ETF and can be obtained by contacting you, the financial professional. Encourage them to read the prospectus carefully before investing.