Japan Style Blend Portfolio Performance Portfolios Struggle as Volatility Returns Display 1 Our portfolios underperformed the TOPIX benchmark as the European debt Japanese Stocks Fell in 2Q crisis rekindled investor anxiety. Still, both our growth and value managers Global Market Returns Percent have managed to keep the impact of increased volatility relatively contained and are confident that their respective sleeves are capturing attractive opportunities that could drive their long-term performance. (6.3) Weathering the Storm and Mitsubishi Corp., which fell on Japanese equities fell sharply in the concerns about a commodities tax in (11.4) second quarter as the European Australia and a tighter economic policy (12.7) (13.9) sovereign-debt crisis rekindled investor in China. Mitsui & Co. also suffered anxiety and the global economy showed from worries that it might have to bear Japan World US Europe signs of deceleration. The yen’s rise, some costs related to the Gulf of Mexico As of June 30, 2010 Japan is represented by TOPIX (in JPY), world by MSCI World (in notably against the euro, weighed on oil spill due to a 10% stake that its USD), US by S&P 500 (in USD) and Europe by MSCI Europe (in EUR). Japanese exporters, while the political subsidiary has in the leaking oil field. Source: MSCI, S&P and Tokyo Stock Exchange quagmire that had led to the fifth change in the nation’s prime minister in Contributors were led by a number of as many years dampened hopes of defensive stocks. These included unique market positions. These included sustained economic growth. Mitsubishi Tanabe Pharma, which also sanitary-goods maker Unicharm, which drew strength from prospects of a has been a major beneficiary of the The TOPIX fell 13.9% and the MSCI near-term regulatory approval for its growing purchasing power of the Japan Index dropped 14.8% during the new multiple-sclerosis treatment. middle-class population in China and quarter in yen terms, compared with a other emerging markets. 12.7% fall in the MSCI World Index in Our value sleeve, in particular, was dollar terms (Display 1). Cyclical supported by the defensive holdings, There is no knowing when the turmoil in sectors, such as financials and materials, which it had acquired at compelling the market might subside or erupt were the biggest decliners, while utilities valuations during the market’s yearlong again. But both our growth and value fared better. By style, value marginally recovery through April. Applying the managers are confident that their outpaced growth, with the MSCI Japan same disciplined value-investing rigorous research to identify the most Value Index sliding 14.6%, compared approach, the sleeve increased its attractive opportunities from their with a 15.0% drop in the growth index. exposure to a broad range of attractive respective style perspectives will help opportunities during the quarter, taking them identify and exploit mispricings in Our portfolios underperformed the advantage of the rich discount in their the market that have resulted from the TOPIX during the quarter, although they valuations. renewed investor anxiety. slightly outperformed the MSCI Japan Index. Our industrial holdings and our On the other hand, a lack of utilities Furthermore, by combining the equal- underweight in utilities detracted from holdings was the biggest drag on weighted style sleeves, our blended relative returns, while our healthcare relative performance for our growth portfolios can capture the best ideas of holdings contributed. sleeve. But the sleeve was supported by both teams, while also avoiding the secular-growth names—companies that undesirable impact of the potentially At the stock level, the biggest detractors can generate solid, sustained earnings volatile style-cycle swings. included trading houses Mitsui & Co. growth from their strong products or 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. 2Q 2010 QUARTERLY REPORT 1 This page is intentionally left blank 2 2Q 2010 QUARTERLY REPORT Blend Strategies Market Overview Despite Headwinds, Global Recovery Is Not Likely to Be Derailed Display 1 Volatility returned to financial markets in the second quarter as investors Interbank Rates Below Crisis Levels grew increasingly concerned about unsustainable levels of government debt. Interbank Lending: Cash Spreads While risk aversion has risen, it remains well below the levels of the recent Basis Points crisis. We think it is unlikely that recent market volatility will derail a global 400 economic recovery led by strong demand in emerging-market economies. US 200 Volatility Returns sheets are in great shape and banks are Euro Area Volatility returned to global financial rebuilding their capital. markets in the second quarter as 0 investors began to worry that sovereign- Leading economic indicators continue to 05 06 07 08 09 10 debt problems in Europe might spread show significant improvement in global Through June 30, 2010 and undermine economic growth in economic conditions (Display 2). US data are three-month USD LIBOR versus three-month US Treasury bills; euro-area data are three-month LIBOR in euros other economies. Markets whipsawed as Emerging-market economies are leading versus overnight index swap. investors reacted to these concerns and the recovery, thanks to booming Source: Bloomberg and AllianceBernstein to a host of other new uncertainties, domestic demand. Within the developed Display 2 from the oil spill in the Gulf of Mexico to world, the euro-area recovery is lagging Economic Activity Is Rebounding signs of a softening in US consumer as fiscal austerity measures in Greece OECD Leading Indicators confidence. Stocks fell in both devel- and other high-deficit nations challenge Index oped and emerging markets, and credit economic growth. But not all Europe is 105 spreads widened. But while risk aversion in the same boat (Display 3); core Neutral increased, it remains far below the levels euro-area countries such as Germany are 100 seen during the recent financial crisis. recovering steadily thanks to a weaker For example, interbank lending rates are euro and historically low interest rates. 95 still within precrisis historical norms (Display 1). Fiscal Issues at the Fore 90 Worries about the fiscal position of 00 01 02 03 04 05 06 07 08 09 10 The return of risk aversion and the Greece intensified throughout the Through April 30, 2010 Source: Organisation for Economic Co-operation and recent spate of negative headlines have quarter, causing Greek sovereign bond Development (OECD) sparked concerns regarding the spreads to sharply widen. These worries sustainability of the global economic spread to other peripheral countries Display 3 Not All Europe Is in the Same Boat recovery and, for many observers, have such as Spain and Portugal, while shares revived memories of the dramatic 2008 of French, German and Spanish banks Real GDP Year-over-Year Percent Change crisis. came under pressure as concerns grew 6 about their exposure to troubled Greece 4 But there are several important differ- government debt. Downgrades of 2 ences to note between the recent crisis Greece, Portugal and Spain by the rating Core 0 and the state of the world economy agencies added to the anxiety. (2) today. In late 2008, major industrialized (4) Periphery ex Greece economies were contracting, corporate To be sure, several euro-area countries (6) earnings were weakening and the will face significant challenges in 05 06 07 08 09 10 banking system was in crisis. Today, the refinancing their debt in coming years Through March 31, 2010 Core is weighted average of Germany, France, the Netherlands, global economy appears to be on the (Display 4, next page). But aggressive Belgium, Austria and Finland. Periphery ex Greece is weighted mend, nonfinancial corporate balance policy actions can help buy these average of Italy, Spain, Ireland and Portugal. Source: Haver Analytics, Markit and AllianceBernstein 2Q 2010 QUARTERLY REPORT 3 countries some time to get their fiscal consumption has come from emerging Display 4 houses in order. In early May, euro-area markets—more than double their share Refinancings Will Challenge Euro Area governments and the International in the 1990s. Economies such as China Monetary Fund unveiled a €110 billion and Brazil have become key sources of Government Financing Requirements July 2010–December 2012 support package for Greece and, just demand for a wide range of raw EUR Billions days later, a €750 billion rescue fund to materials and finished goods, from iron 782 aid other troubled euro-area countries. ore to televisions to passenger jets. Retail sales and industrial production in Budget Deficit In addition, the European Central Bank developing economies are booming Redemptions 398 pledged to purchase euro-area public today, supporting the global recovery and private securities in the secondary (Display 5). 120 markets to help preserve market 59 61 liquidity. So far, policy actions have The US has been a major beneficiary of helped stem the threat of contagion to this global rebalancing, as demand from Ireland Portugal Greece Spain Italy global financial markets. Although Italy, developing economies has boosted US Financing requirements are estimated as of May 31, 2010. Source: Bloomberg and AllianceBernstein Portugal, Ireland and Spain all faced exports.