Japan Strategic Value Portfolio Performance

Portfolios Underperform as Earthquake Shatters Investor Confidence Display 1 After a strong start to the year, our portfolio performance slid into negative Japanese Stocks Lagged in 1Q:11 territory in March as a massive earthquake ravaged the country and boosted Global Market Returns Percent investor anxiety. Our position in a power company at the center of a quake-induced nuclear emergency weighed on our returns. Still, we believe 5.9 4.8 the market turmoil has also created a broad range of value opportunities.

Earthquake Hits Equity Market despite a solid start (Display 2). They 0.6 Japanese equities ended lower in the marginally outperformed the MSCI first quarter as a massive earthquake Index. We will describe our view

and tsunami in mid-March devastated on TEPCO in more detail in the Portfolio (2.2) the country’s northeast region and Positioning section of this report. Japan World US Europe triggered investor anxiety. Despite a Japan is represented by TOPIX (in JPY), world by MSCI World (in USD), US by S&P 500 (in USD) and Europe by MSCI Europe (in strong start, the TOPIX fell 2.2% for the Other major detractors included EUR). Source: MSCI, S&P and Stock Exchange quarter in yen terms, substantially Takashimaya and lagging other major global markets railroad company East Japan Railway, Display 2 (Display 1). The MSCI Japan Index fell which both suffered from investors’ Earthquake Derailed Positive Trend 2.8% for the quarter. concerns about the quake’s impact. TOPIX Returns by Month Percent Uncertainty over a nuclear plant Still, besides TEPCO, our holdings were 4.6 damaged by the tsunami and prospects largely resilient. Companies that were 1.3 of potential electricity shortages in supported by solid global business eastern Japan—including Tokyo—set off outlook and escaped the disaster a flight to safety among investors and relatively unscathed fared quite well. hurt deep-value stocks. Although the These included semiconductor-wafer (7.6) most heavily affected areas were not manufacturer SUMCO, chemical JSV Relative Performance* (Percent) industrial, damage to some factories company JSR and synthetic-rubber 1.0 0.7 (1.9) that were crucial to the supply chains of producer Denki Kagaku Kogyo. Jan Feb Mar companies elsewhere in the country and In the world deepened the concerns. Turmoil Creates Opportunities As of March 31, 2011 *Based on composite JSV accounts. Past performance is no Despite the setback after the earth- guarantee of future results. The returns presented above are net of fees. Utilities No Safe Haven quake, we remain confident that our Source: and Bernstein While the utilities sector usually offers a portfolios’ value holdings are well safe haven in times of market turmoil, positioned to benefit from an eventual Tokyo Electric Power (TEPCO) was the recovery in investor confidence. We There is no guarantee that the path to a focal point of investors’ anguish this trimmed our exposure where we saw recovery will be as clear-cut as it was time as it operates the stricken Fukushi- increased risks, but we also added back then. But our experience over the ma Dai-ichi nuclear plant. deep-value positions where we saw fit. years suggests that investors will After a panic-driven market sell-off eventually reward stocks that are Due largely to a vertical drop in TEPCO during the 2008 credit crisis, deep-value undervalued. There is little reason to shares, our portfolios slightly underper- companies rebounded in 2009 and believe that this time will be any formed the TOPIX for the quarter drove our portfolios’ outperformance. different, in our view.

These statements reflect the performance of the majority of accounts. Individual account performance may vary due to a variety of factors, including benchmark, account guidelines, investment vehicle implementation (if any), fees charged and timing of cash flows.

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2 1Q 2011 QUARTERLY REPORT Japan Strategic Value Portfolio Positioning

Adversity Creates Value Opportunities Display 1 The March 11 earthquake has significantly changed the dynamics in a wide Recovery Was on Track Before the Earthquake range of industries, creating opportunities as well as risks. While our research-driven value approach remains the same, we have made various Industrial Production adjustments to our portfolios to cope with such changes. Overall, we remain 120

confident about the portfolios’ long-term performance potential. 110

100

Near-Term Economic Setback TEPCO Engulfed in Controversy Index 90 Prior to the March 11 earthquake, the Before the earthquake triggered a crisis Japanese economy was on a recovery at Tokyo Electric Power’s (TEPCO) 80

track. Production was buoyed by global Fukushima Dai-ichi nuclear plant, the 70 demand growth (Display 1), while company was one of the 10 largest 04 05 06 07 08 09 10 11

employment improved and corporate active weights in our portfolios. This was Through February 2011 Last two data points are METI forecasts capital spending was picking up, thanks based on our view that higher utilization Source: Ministry of Economy, Trade and Industry to ample cash flow. In the stock market, of TEPCO’s nuclear capacity would healing investor confidence supported improve its margins and that the firm’s Display 2 undervalued companies, helping our rich cash flow would continue to Earthquake Has Altered Recovery Path

portfolio performance. support its attractive dividend yield. Forecast Japan GDP Growth Profile 8 That picture was significantly altered by Those premises are clearly no longer Post-Earthquake 4 the earthquake. Given the magnitude of valid. After a rigorous review of the

the disaster, a slowdown in business potential outcomes, our decision was to 0 activity cannot be avoided in the near reduce our target weight. No one could Pre-Earthquake (4)

term. But history suggests that, in the sell the stock in any significant volumes YoY Change % longer term, higher economic growth for three consecutive days after the (8) will come as reconstruction begins. earthquake, as the stock dropped by its (12) daily limit. But when it rebounded for a 08 09 10 11 12

A big question hanging over this few days, we trimmed its weight to Actual data through 4Q:2010, forecast through 4Q:2012 recovery scenario is the effect of the what we consider to be the low end of a Seasonally adjusted, in real terms Source: Thomson Datastream and AllianceBernstein estimates power shortages in the greater Tokyo meaningful active position.

area and uncertainty over the troubled Display 3 nuclear power plant. Much remains to The situation remains fluid, but we are TEPCO Nosedived After Earthquake be seen, but taking these risks into approaching this with our typical value Stock Prices consideration, AllianceBernstein’s discipline—keeping risk levels in line 120 economic research team is anticipating a with the opportunity. The market Kansai Electric few quarters of weakness before a appears to have partially priced in a 100

recovery takes root (Display 2). potential nationalization of the firm, but 80 Tohoku Electric we believe that there are reasons to

Index Power 60 The stock market’s rebound toward the expect that the stock’s recent freefall will end of March suggests that investors ultimately prove to be an overreaction. 40 have regained some composure. This, in TEPCO 20 our view, bodes well for value stocks, First, TEPCO has a monopoly in one of Mar 01 7 11 17 24 30 many of which were unduly depressed the most attractive electricity markets in Through March 31, 2011 during the turmoil. the world, and its future revenue flows Source: Bloomberg

1Q 2011 QUARTERLY REPORT 3 are reasonably visible. Second, nuclear We increased our exposure to several Display 4 power is a critical part of Japan’s energy companies that are likely to benefit from 's Motorization Boosts policy, and the government is wary of a change in their industry dynamics after Replacement Tire Demand leaving utilities firms high and dry with the disaster. For instance, semiconduc- Vehicles in Use nuclear liabilities or alienating sharehold- tor-wafer manufacturer SUMCO will 120 ers and bondholders. benefit from a production outage at rival New Cars Shin-Etsu Chemical—at a time when the 90 Of course, the range of possible global wafer market is improving. outcomes is wide, so we are taking a Likewise, oil-and-metals refiner JX 60

cautious approach. Partly because our Holdings will benefit from the damage Units Million portfolio weight has already shrunk at rival Cosmo Oil’s refinery near Tokyo. 30 significantly, we believe that any further 0 negative impact on the portfolio will be Increased Risk Prompts Trimming 05 06 07 08 09 10 11E 12E limited, even in a worst-case scenario. On the other hand, we reduced our As of March 31, 2011 holdings in some companies whose risks Source: J.D. Power and Associates, Ward's Automotive and Tweaking Utilities Exposure have increased. AllianceBernstein The changing industry landscape Display 5 prompted us to tweak our positions in Video-game makers NAMCO BANDAI Tiremakers Are Weathering Higher the utilities sector. For instance, we and may see slower intake from Material Prices increased our position in , game arcades. Department store Impact on Operating Profit which should benefit from an electricity- Takashimaya faces headwinds as fewer 600 conservation mode around the capital. consumers are likely to be in the mood Average Selling Price/Mix/Volumes for a luxury-goods shopping spree, in 500 After the earthquake, Tohoku Electric our view. 400

Power was falling almost in tandem with 300 Raw Material Prices TEPCO—even though it did not have Rotation in Autos and Tires Yen Billions 200 any similar nuclear-liability risks—com- Given the heightened and varying risks 100 pelling us to initiate a position (Display of disruptions to automakers’ supply 3, previous page). Although we could chains, we moved some weights from 0 03 05 07 09 not build up a meaningful position as Motor, Motor and As of March 31, 2011 the stock soon rebounded, we believe Motors to Motor and tiremakers Source: Company reports and AllianceBernstein that our approach to this stock reflects and Sumitomo Rubber. our research-driven value-investing method well. Tiremakers provide a similar profile to a value investor, these companies are automakers’ as they both recover from attractively priced, thanks to concerns in Panic Creates Opportunities the troughs caused by the global credit the market about rising raw-material We believe that the earthquake caused crisis. But the tiremakers also offer some prices. overreaction in a number of stocks, defensive virtues. Even when new car including East Japan Railway and sales slump—be it for slower demand or Given the attractive value opportunities . The railway’s assets did sustain supply-chain disruptions—the demand in our portfolios and the consistent some damage, but that is likely to be a for replacement tires is largely unaffect- fine-tuning we have made based on our temporary factor. Toshiba is a major ed. tried-and-true value principles, we are player in the nuclear industry, but we confident that the portfolios are well believe that any slowing in that business Particularly in China, where new car positioned to ride out the storm and would have a smaller impact on the registration in recent years has dwarfed generate strong returns over time. company’s bottom line than growth in scrappage (Display 4), the number of other areas, such as NAND flash cars in use has grown rapidly. The strong memory. We topped up our holdings in demand base, in turn, underpins the these companies after their sharp tiremakers’ pricing power, supporting declines. their margins (Display 5). In the eyes of

4 1Q 2011 QUARTERLY REPORT © 2011 AllianceBernstein L.P.

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