Style Investing

Kari E. Bayer Director Senior U.S. Strategist 1 Defining Growth and Value Ü Each month we monitor approximately forty different selection strategies. Ü Two of the forty strategies are “pure” growth and “pure” value portfolios. Ü The “pure” growth portfolio is the fifty in the S&P 500 with the highest five-year projected EPS growth rates. Ü The “pure” value portfolio is the fifty stocks in the S&P 500 with the highest earnings . Ü The term “pure” is used because the portfolios are those stocks in the S&P 500 that are made up of the companies that show the most extreme values of the particular characteristic.

2 “Pure” Growth and Value Portfolios

210

190 Equal-weighted Relative Cumulative Performance vs. Equal- Weighted S&P 500 When Growth 170 outperforms, Value "Pure" Growth 150 tends to underperform "Pure" Value and vice versa.

130

110

90

70 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Source: Merrill Lynch Quantitative Strategy

3 Relative Performance of S&P/Barra Growth and Value Indices

Relative Price Performance of the S&P/Barra Growth and Value Indices

1.8

1.6

1.4

1.2

1.0

0.8

0.6

Source: Merrill Lynch Quantitative Strategy

4 Relative Performance of MLQS Growth and Value Indices

Relative Performance of the Growth Mutual Fund Index versus the Value Mutual Fund Index 1.6

1.5

1.4

1.3

1.2

1.1

1.0

0.9

0.8

0.7

0.6 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Source: Merrill Lynch Quantitative Strategy

5 Growth Managers

Ü Growth managers are typically defined as high expectations managers who prefer to search for investments among stocks that have a proven superior track record of earnings growth. Ü usually pay a high premium to hold such stocks because the market realizes the superior qualities of the company. Ü The assumption behind growth stock investing is that the market will continue to reward the superior grower.

6 Value Managers

Ü Value managers are typically defined as low-expectations managers because they tend to search for investments among stocks that are out of favor. Ü The assumption behind is that the consensus views a company overly pessimistically, and that the stock’s will improve once the consensus realizes its mistake. Ü Value managers, therefore, usually search for stocks that sell below the worth of a company’s assets or below the value of its future growth prospects.

7 Good and Bad Managers Growth: CONTRARIAN SELLERS

Value: CONTRARIAN BUYERS 8 Defining Quality

Ü We use the S&P Rankings to define quality. Ü S&P ranks approximately 1500 companies based on their stability in earnings and growth over the last ten years. Ü A company with extremely stable earnings and dividends growth would be rated an A+ whereas a company in bankruptcy or reorganization would be rated a D. Ü The rankings are A+, A, A-, B+, B, B- and C/D.

9 Relative Performance by Quality

Relative Performance MLQS "A+" vs. "C&D"

Relative Performance 1.6

Indices are based on 1.4 S&P Common Stock Ratings. Similar to Growth and 1.2 Value, High vs. Low 1.0 Quality goes through cycles of out- and 0.8 under-performance. 0.6

0.4

0.2

0.0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02

Source: Merrill Lynch Quantitative Strategy

10 Relative Performance by Size

Relative Performance of S&P 500 and Russell 2000

3.0

2.5

2.0

1.5

1.0

0.5

Source: Merrill Lynch Quantitative Strategy

11 The Importance of Profits

GROWTH vs. VALUE - RELATIVE PERFORMANCE AND S&P 500 EPS Yr/Yr % Ch Relative Performance 60% 1.40 Tech Bubble Yr/Yr % Chg S&P 500 4-Qtr EPS disrupts 40% MLQA Growth Fund Index vs Value Fund Index Growth & Value Cycle 1.20 The scarcity or 20% abundance of earnings growth 0% 1.00 drives style rotation.

-20%

0.80

-40%

-60% 0.60 70 75 80 85 90 95 00

Source: Merrill Lynch Quantitative Strategy

12 The Tech Bubble Distorts Growth versus Value Investing

2000 2001 "Pure" Growth -22.4% -33.2% "Pure" Value 20.7% 24.5% MLQS Growth -12.7% -15.8% MLQS Value -4.2% -1.7% A+ Index 22.4% 2.4% C/D Index 0.1% 3.8%

13 High Quality Value?

Proportion of High Quality Stocks in S&P/Barra Growth & Value Indices

70% 65%

60% 60% 58% 54% 54%

50% 50%

40%

30%

20% Composition as of 6/30/00 Composition as of 12/31/01 Composition as of 12/31/01 10%

0% S&P/Barra Growth S&P/Barra Value Source: Merrill Lynch Quantitative Strategy

14 Sector Concentration of S&P/Barra Growth Index

S&P Barra Growth Index By Sector (December 2001)

Other Financials 4% 7% Technology 23%

Industrials 12%

Consumer Staples 15% Healthcare 21%

Consumer Discretionary 18%

15 Change in Composition of SGX

Change in Composition of S&P/Barra Growth Index

40.0%

35.0%

Composition as of 6/30/00 30.0% Composition as of 12/31/01

25.0%

20.0%

15.0%

10.0%

5.0%

0.0% Technology Healthcare Consumer Staples Consumer Industrials Financials Other Discretionary

16 Sector Concentration of S&P/Barra Value Index

S&P/Barra Value Index By Sector

Telecom Staples 3% 3% Discretionary Healthcare 18% 4%

Energy 7%

Utilities 11% Financials 16%

Materials 11%

Industrials 14% Technology 13%

17 Proportion of Sector in S&P/Barra Growth Index

Proportion of Sector Residing in S&P Barra Growth Index (Data as of 12/31/01)

Staples 64.7%

Healthcare 66.7%

Technology 43.6%

Industrials 25.0%

Discretionary 29.5%

Telecom 15.4%

Financials 13.9%

Energy0.0%

Utilities 0.3%

Materials 7.5%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%

18 Style Allocation Benchmarks (2/28/02)

USPC Equity Large Cap Large Cap Small Cap Small Cap Allocation Growth Value Growth Value International Capital Preservation 15% 5% 10% Current Income 30% 5% 25% Income & Growth 45% 15% 20% 5% 5% -Term Growth 65% 15% 20% 10% 10% 10% Aggressive Growth 80% 20% 20% 15% 15% 10% U.S. Strategy Asset 50% 10% 15% 10% 10% 5% Allocation

19