INVESTMENT STRATEGY AND PORTFOLIO MANAGEMENT

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1 INVESTMENT STRATEGY AND PORTFOLIO MANAGEMENT Executive Summary October 8 Contents Executive Summary... 1 Economic Outlook... Market Outlook... 3 Performance Recap... Economic Outlook Credit availability shrank at an alarming rate following the collapse of Lehman Brothers and the rescue of several other major financial institutions. The US economy is in the midst of a recession that most likely began late last year and is likely to continue until early to mid-9. Recession will most likely deepen over the next couple of quarters before the recovery process begins. Much of the developed world has joined the US economy in recession. The passage of the Troubled Asset Relief Program (TARP) is a big positive on the policy front. While there is no guarantee that it will prove successful in unfreezing the credit markets, it remains our best prospect to date. For the first time since the crisis began, policymakers are pursuing a systematic approach to the problem, rather than just trying to put out fires as they erupt. Inflation fears are receding due to a rapid slowdown in global growth and a sharp correction in commodity prices. The Fed is likely to cut rates again, perhaps as part of another globally coordinated move. Market Outlook & Investment Strategy Markets remain under extraordinary stress. A firestorm of new initiatives by policymakers has so far failed to stem the panic. The market environment remains highly unsettled, but investors are best served by sticking with well diversified portfolios across asset classes. Selling into plummeting markets in order to hide in cash is often a recipe for locking in losses and missing the benefits of recoveries. In general, we are sticking close to policy weights in stocks, bonds, and cash in a general effort to reduce risk. We have also reined in most of our active equity positions. Current Positions Neutral (%) Recommended Allocation Stocks 65. Neutral Bonds 3. Neutral Cash 5. Neutral Allocation Among Stocks Domestic Stocks Large-cap growth stocks. Modest Overweight Large-cap value stocks. Modest Overweight Small-cap growth stocks. Neutral Small-cap value stocks. Neutral Energy/Resource stocks. Neutral International Stocks EAFE stocks 13. Underweight Emerging market stocks. Neutral Total Stocks 65.

2 Economic Outlook The current financial crisis is unprecedented in the post-wwii era in terms of its breadth and severity. Following the collapse of Lehman Brothers and the rescues of several other major financial institutions, credit availability has shrunk at an alarming rate. The spread between risky and safe credit instruments soared to record levels and the commercial paper market contracted rapidly (Chart 1). September 8 will be remembered as one of the most turbulent months in Wall Street history. The pain became so great that it forced US policymakers to bring forward more radical measures to deal with the crisis than would have been politically possible just a few weeks before. The passage of the Troubled Asset Relief Program (TARP) is a big positive on the policy front. While there is no guarantee that it will prove successful in unfreezing the credit markets, it remains our best prospect to date. If it were to merely restore some calm to financial markets by breaking the vicious cycle of falling asset values and financial failures, that should be considered a success. Chart 1: LIBOR Spread Surges as Financial Crisis Deepens USA: LIBOR (TED) Spread Spread between 3 Month LIBOR and 3 Month Treasury Bills (AVG) Spread between 3 Month LIBOR and 3 Month Treasury Bills -.5 '87 '88 '89 '9 '91 '9 '93 '9 '95 '96 '97 '98 '99 ' '1 ' '3 ' '5 '6 '7 '8 While the continued massive intervention by policymakers should avert economic catastrophe, it will not stop an extended period of deleveraging. Thus, the economy will be facing headwinds for the foreseeable future. In September, US economic data deteriorated rapidly. Motor vehicle sales fell 8.9%, reaching levels not seen since 199. The ISM Manufacturing Index plunged to 3.5 from 9.9 in August, and non-farm payrolls declined by 159,, continuing the streak of job losses in every month in 8. If the credit crisis does not ease soon, much larger job losses and a sharp drop in economic activity are likely for the balance of 8 and into 9. With the tax rebates already spent and unemployment worsening, consumer spending is likely to contract for the first time in 17 years in the third quarter. The net export sector has been a significant contributor to GDP growth for the past six quarters. However, with overseas growth falling sharply and the US dollar strengthening, support from this sector is likely to wane Percent Chart : Inflation Expectations Have Melted TIPS Implied Inflation Rate 1 y ear Maturity, Breakev en Inflation Given the sharp downshift in global growth, commodity prices experienced a brutal correction over the past quarter. As a result, inflation fears in the US nearly evaporated in September (Chart ) as the price of oil and other commodities tumbled from their record levels this summer and wage gains have remained muted despite continued healthy levels of productivity growth. Unit labor costs dropped.%. The economic problems of the US have spread to Europe and elsewhere. Indeed, most major developed economies are now facing recession (Chart 3). Governments around the globe have undertaken numerous actions to stabilize markets and financial institutions. Six central banks have joined in an unprecedented move to cut rates by 5 bps. Further policy action lies ahead ' '5 '6 '7 '8 OECD G7 Leading Indicator Percent Change, Year Ago Chart 3: Major Developing Economies Facing Recession '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '1 '3 '5 '7

3 Market Outlook & Investment Strategy Financial markets remain under extraordinary stress. Despite a firestorm of new initiatives by policymakers, financial markets reached a state of panic over the past quarter. Interbank markets have seized up, equity markets have been pummeled, and volatility reached a record high (Chart 1). Although the market environment remains highly unsettled, we think investors are best served by sticking with portfolios that are well diversified across asset classes. Markets that go down hard are often followed by strong rebounds. Selling into plummeting markets in order to hide in cash is often a recipe for locking in losses and missing the benefits of recoveries. The equity bear market is now well advanced by historic yardsticks of depth and duration. The S&P 5 Index is now down about % from its peak last October. The MSCI EAFE is down 5%, and Emerging Markets are down nearly 55% from peak levels. With global stocks (i.e. the MSCI World Index) priced at 1 times estimated earnings over the next 1 months, markets appear to have already priced in a global recession. When comparing the earnings yield on stocks (1 divided by the P/E ratio) to the yield on bonds, stocks look cheap. However, the impact of the recession on earnings remains unclear. If the credit crisis lingers and consumers pull back substantially in response to a big loss in wealth and uncertain employment prospects, actual earnings likely will come in sharply lower than expected earnings. Current valuations appear to provide a reasonable margin of safety. As the recession progresses, even if earnings expectations fall short by %, equities would still have a relatively attractive earnings yield of 6% compared with government bond yields of generally less than %. Nonetheless, as we have mentioned in the past, valuation is a poor timing tool, as it can remain at extremes for long periods. Although equity markets are extremely oversold and a technical rebound could occur at any time, we would not be adding exposure at this time. Stocks are unlikely to experience a sustainable rally until some sense of normalcy has returned to the credit markets and the damage to the economy is more clearly understood. In general, we are sticking close to policy weights in stocks, bonds, and cash in a general effort to reduce risk. We have also reined in some of our active equity positions. For example, we have moved to a neutral position on growth versus value. The growth index is more levered to revenues generated overseas, and policymakers abroad still appear behind the curve in coming to grips with the scope of the crisis while US policymakers have been much more proactive. For the same reason, we are now overweight US stocks relative to international equities. While US government bonds offer poor value, they are a safe haven and yields are likely to stay low for the foreseeable future '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '1 '3 '5 ' Chart 1: A Market Gripped By Fear '9 '91 '9 '93 '9 '95 '96 '97 '98 '99 ' '1 ' '3 ' '5 '6 '7 '8 Chart : Stocks Valuations Reaching Extreme Territory Earnings Yield Gap Forward Earnings Yield on Stocks minus 1 Year Treasury Rate Style Indices and Level of Foreign Exposure 19 CBOE Volatility Index (VIX) Percent Core Pure Growth Pure Value Source: ISI Portfolio Strategy Large Cap Mid Cap Small Cap

4 Market Recap, Third-Quarter 8 The credit crisis intensified during the third quarter. Significant events included the US government rescue of Fannie Mae and Freddie Mac, the collapse of the investment banking model, the proposal of the Troubled Asset Relief Program (TARP) and a money market fund breaking the buck. As fear enveloped the markets, the only place to hide during the quarter was Treasury securities. As a result, the Russell 3 lost 8.7% and the Lehman Aggregate Index fell by -.5% in the quarter. In addition, commodities plunged, as reflected in the 8% drop in the DJAIG Commodities Index. US Equity Markets US equity markets dropped precipitously during the quarter, approximately 9% in the broad market, as credit markets locked up further, straining an already tough economic environment. In addition, the third quarter will be the fifth consecutive quarter of negative earnings growth, according to Thompson Reuters. Expectations of a global slowdown have caused investors to trim globally oriented growth stocks in favor of value. As oil prices fell almost $ during the quarter, the Energy sector (-.6%) plummeted, while the defensive Consumer Staples sector (+.1%) was the only sector to post positive returns. Non-US Equity Markets The slowdown in the US has clearly moved overseas, with both Europe and Japan posting negative real GDP growth in the second quarter. Conditions have worsened in the third quarter, and the outlook remains bleak. As the developed economies have downshifted, Emerging Markets have not been immune to the current environment. For the third quarter, in US dollar terms, the MSCI EAFE index fell more than %, and Emerging Markets (MSCI EM Equity) lost 7%. Fixed-Income Markets The credit crisis that began last year accelerated in the third quarter, as house prices continued to fall, crippling the balance sheets of companies with assets tied to mortgage securities or other types of loans that were delinquent. Governments around the world have had to intervene by choosing which entities to take over let fail. Extreme risk aversion has enveloped the markets, with Treasuries (+.3%) being the star. During the quarter, the Lehman Aggregate Index (-.5%) posted much higher returns than the riskier Lehman High Yield Index (-8.9%). Performance Summary as of: 9/3/8 3 mo YTD 1 Year Equity Russell Russell Russell 1 Growth Russell 1 Value Russell Russell Growth Russell Value MSCI EAFE MSCI EM Equity MSCI World Fixed Income Lehman Agg Merrill US T-bill (3mo) Lehman High Yield Lehman TIPS Citi Non-US Gov't ($ hedged).7.. Citi Non-US Gov't ($ unhedged) JPM EMBI Other DJAIG Commodities S&P 5 Energy Sector DJ Wilshire REIT

5 Explanation of Indexes Citigroup (formerly Salomon Smith Barney) Non-U.S. World Government Bond Index. This Index is based on the Citigroup formerly Salomon Brothers) World Bond Index, and excludes issues denominated in U.S. dollars. The Index measures the total return of government securities in major sectors of the international bond market. Dow Jones - AIG Commodity Index is a diversified benchmark for the commodity futures market. It is composed of futures contracts on 19 physical commodities traded on U.S. exchanges, with the exception of aluminum, nickel and zinc, which trade on the London Metal Exchange (LME). Dow Jones Wilshire REIT Index. Measures U.S. publicly traded Real Estate Investment Trusts. The index is a subset of the Dow Jones Wilshire Real Estate Securities Index (WRESI). The indexes are weighted by both full market capitalization and float-adjusted market capitalization. JP Morgan Emerging Markets Bond Index Plus. The JP Morgan Emerging Markets Bond Index Plus is an market capitalizationweighted total return index of U.S. dollar and other external currency denominated Brady bonds, loans, eurobonds, and local market debt instruments traded in emerging markets. Lehman Brothers Aggregate. Composed of U.S. investment-grade fixed-rate bond market, including government and credit securities, agency mortgage pass-through securities, asset-backed securities, and commercial mortgage-based securities. Lehman Brothers High Yield Index. Covers the universe of fixed-rate, non-investment-grade debt. Morgan Stanley Capital International (MSCI) Europe, Australasia, and Far East (EAFE) Equity Index. MSCI EAFE acts as a benchmark for developed-market stock portfolios. MSCI Japan Equity Index is a subset of MSCI EAFE. Morgan Stanley Capital International (MSCI) Emerging Markets Equity Index. MSCI EM acts as a benchmark for 7 emergingmarket stock portfolios. Russell 3,, & 1. The Russell 3 is composed of 3, large U.S. companies representing approximately 98% of the U.S. equity market. The Russell 1 represents the largest 1, companies in the Russell 3, and the Russell represents the, smallest companies. The indexes are value-weighted. The Russell indices are trademarks/service marks of the Russell Investments. Russell is a trademark of the Russell Investments. S&P 5 Index. Covers 5 industrial, utility, transportation, and financial companies of the U.S. markets. The valueweighted index represents about 75% of the NYSE market capitalization and 3% of the NYSE issues. Investors cannot invest directly in an index. The comments, opinions and estimates contained herein are based on or derived from publicly available information from sources that Quantitative Management Associates (QMA) believes to be reliable. QMA is a wholly-owned subsidiary of Prudential Investment Management, Inc. and an indirect, wholly-owned subsidiary of Prudential Financial, Inc. We do not guarantee their accuracy. The material is for informational purposes only and sets forth our views as of this date. The underlying assumptions and these views are subject to change. Past performance is not indicative of future results. There can be no assurance that the fund will achieve its investment objective. QMA provides discretionary portfolio management and oversight services to certain asset allocation portfolios. Investors should consult their attorney, accountant, and/or tax professional for advice concerning their particular situation. All views expressed in the research report accurately reflect the research analyst's personal views about any and all of the subject securities or issuers. No part of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in the research report. IFS-A1569 Edition date: 1/8