March 2012 Evolving Equity Investing: Delivering Long-Term Returns in Short-Tempered Markets Kent Hargis Portfolio Manager Low Volatility Equities Director of Quantitative Research Equities This information is issued by AllianceBernstein Limited, 50 Berkeley Street, London W1J 8HA. Registered number 2551144. AllianceBernstein Limited is authorised and regulated in the UK by the Financial Services Authority (FSA Reference Number 147956). This information is directed at Professional Clients only. It is provided for informational purposes only and is not intended to be an offer or solicitation, or the basis for any contract to purchase or sell any security, product or other instrument, or for AllianceBernstein to enter into or arrange any type of transaction as a consequence of any information contained herein. The views and opinions expressed in this document are based on AllianceBernstein's internal forecasts and should not be relied upon as an indication of future market performance. Past performance is no guarantee of future returns. This information is not intended for public use. 2011 AllianceBernstein
Market Conditions Have Presented Many Challenges to Equity Investors Equity returns have been disappointing and volatile Traditional methods of equity diversification have not provided absolute downside protection Traditional active equity strategies have struggled in periods of heightened risk aversion 1
Clients Needs Are Changing Defined Benefit Corporate Plan Changes in Regulatory Environment Individual Investor Demographics/ Fear of Volatility Endowment/Foundation Long Time Horizon Reduce funding volatility, while generating returns Manage risk without fleeing to safety Shift to strategies that are insensitive to benchmarks 2
Delivering Longer-Term Returns in Short-Tempered Markets Focus on return and risk versus client outcomes, not just relative returns vs. narrowly defined benchmarks Incorporating Stability and Benchmark Insensitive Strategies: Provides exposure to long-term returns from equities, with less volatility and downside protection Outperforms in periods of rising volatility, when traditional strategies have underperformed Complements time-tested traditional strategies with an uncorrelated source of alpha Typically provides higher active share 3
Percent Stocks Are Attractively Priced and Look Poised for a Comeback Earnings Yield vs. US Treasury Yield* Frequency of Stocks Beating Treasuries 1946 Present 6 4 2 Earnings Yield Greater 65% 76% 71% 89% 75% 98% 99% 87% 0 (2) (4) (6) Treasury Yield Greater 60 67 74 82 89 96 04 11 One-Year Rolling Three-Year Rolling Five-Year Rolling 10-Year Rolling Typical When Yield Gap > 0** Through December 31, 2011 *Difference between the 10-year average S&P 500 inflation-adjusted earnings yield and the 10-year US Treasury yield **Yield gap is the difference between the 10-year average S&P 500 inflation-adjusted earnings yield and the 10-year US Treasury yield Source: Bloomberg, Ibbotson Associates, Robert Shiller, S&P and AllianceBernstein 4
Equity Strategies Are Evolving to the Meet Changing Client Needs Traditional Style Stability Benchmark Insensitive High Returns, Willing to Take Risk Equity Like Returns, Less Risk High Risk- Adjusted Returns Deep Value Low Volatility Long/Short Long-Term Growth Dividend Yield Source: AllianceBernstein 5
Benchmark Sensitivity Equity Strategies with Lower Volatility and Higher Active Share High Cap Weighted Index Long-Short Equities Low-Vol Equities Equity Income Traditional Long-Only Active Equity Low Cash Market Neutral Lower Risk Risk-Sensitivity Higher Risk Past performance does not guarantee future results Source: AllianceBernstein 6
Seeking Strategies with Greater Downside Protection During Crisis US Dividend Yield Global Low Volatility Stability and Long/Short Equity MSCI World Long/Short Equities Internet Crash Oct 2001 Sep 2002 2% Global Financial Crisis Jul 2008 Feb 2009 Euro Debt Crisis Jul 2011 Sep 2011 (1)% (5)% (15)% (8)% (26)% (10)% (36)% (33)% (32)% (12)% (19)% (46)% (17)% (10)% Stability Equity is the equally-weighted monthly returns of US dividend yield, global low volatility and equity hedge. US Dividend Yield is based on the monthly median return for managers in the evestment Alliance US Dividend Focus universe. Global Low Volatility is the monthly returns of top quintiles within the MSCI World Index as sorted by two-year trailing volatility. Equity Hedge is the HFR Equity Hedge Index that includes managers maintaining both long and short positions primarily in equity and equity-derivative securities. Not intended to portray the results of any AllianceBernstein product. Periods of more than one year are annualized. The results reflect the deduction of estimated investment-management fees. Source: evestment Alliance, HFR, MSCI and AllianceBernstein; see Important Notes on Simulations. 7
Return (Percent) Low Volatility Anomaly Is as Powerful as Other Major Anomalies A Different Source of Alpha As Powerful as Other Major Market Anomalies 20 Traditional Strategies Sharpe Ratio 15 Price Momentum Small- Caps Value 0.5 0.51 0.51 0.63 Low Volatility 10 MSCI World 0.19 MSCI Global Index 5 10 12 14 16 18 20 Less Volatility (Percent) More Small-Caps Low Volatility Value Price Momentum Alpha is sourced from risk-adjusted return Results represent top quintiles within the MSCI World Index as sorted by low price to book, low capitalization, high price momentum and two-year trailing volatility from January 1973 September 30, 2011; Sharpe ratio includes cash; capitalization-weighted MSCI World Index, gross, in USD unhedged Source: MSCI and AllianceBernstein; see Important Notes on Simulations. 8
Low-Volatility Anomaly Is Large, Pervasive and Well Established Low Volatility Effect Is Well Established And Works Across Capital Markets Well Researched** 1972: F. Black, M. Jensen and M. Scholes 1993: E. Fama and K. French 2010: A. Frazzini and L. Pedersen Across Many Asset Classes Government Bonds Short Duration > Long Duration Credit AAA > BBB Also works in currency and commodities Long Standing Academic research shows evidence of success going back to 1920 s In Almost Every Country, Including: US UK Japan Australia Germany Canada Capitalization-weighted MSCI World Index, gross, in USD unhedged *Monthly data sorted for lowest quintile of MSCI World stock universe based on two-year trailing volatility from January 1973 September 30, 2011; Sharpe ratio includes cash. **Details about bibliography available upon request Source: FactSet, MSCI and AllianceBernstein; see Important Notes on Simulations. 9
Low Volatility Provides an Uncorrelated Source of Alpha Low Volatility Less Risk Stability Deep Value Value Growth Long-term Growth Maximize Return Correlation with Low Volatility Relative Returns* Value Small-Caps Price Momentum (0.28) (0.20) 0.20 *Correlations of relative returns for top quintile of global stocks based on low price to book, low market capitalization and high price momentum versus relative returns of the lowest quintile by twoyear trailing volatility, from January 1, 1973 September 30, 2011 Correlation of median manager relative returns using evestment Alliance data with 98 Global Core Equity, 43 Global Growth Equity, and 66 Global Value Equity managers reporting 10 years of monthly returns ending September 30, 2011. Not intended to portray the results of any AllianceBernstein product. The results reflect the deduction of estimated investment-management fees. Source: evestment Alliance, Thomson I/B/E/S, MSCI and AllianceBernstein 10
Return Pattern Is Typically Uncorrelated with Other Active Strategies Global Stock Returns Low Volatility Value Small-Cap Price Momentum MSCI World 1990s Recovery Feb 1991 Apr 1993 Internet Bubble Mar 1997 Mar 2000 Internet Crash Apr 2000 Sep 2002 Global Financial Crisis Jul 2008 Feb 2009 Euro Debt Crisis May 2010 Sep 2011 47% 102% 11% 11% 39% 80% 29% 25% (8)% (9)% 18% (33)% (4)% (2)% 23% 24% 24% (46)% (30)% (46)% (53)% (45)% (49)% (11)% (6)% Cumulative monthly returns of top quintiles within the MSCI World Index as sorted by low price to book (value), low capitalization (small-caps), high price momentum and two-year trailing volatility; capitalization-weighted MSCI World Index, gross, in USD unhedged Source: MSCI and AllianceBernstein 11
Potential Benefits of Stability and Long/Short Equity Strategies Improve Sharpe Ratio of Equity Exposure Reduce volatility without sacrificing return Increase return without increasing volatility by pairing with higher return equity strategies Improve Information Ratio vs. Cap Weighted Benchmark Provide uncorrelated alpha to traditional strategies 12
Percent Smarter Way than Cap Weighted Passive to De-Risk Equities Avoids Dangerous Concentration During Bubbles Weight of 20 Largest S&P 500 Stocks Weight of Japanese Stocks in MSCI World 40 35 38% 34% Included: Microsoft Cisco Systems Intel Oracle Alcatel-Lucent Included: Bank of America Citigroup AIG JPMorgan Chase 50 45 40 35 30 25 20 30 15 10 5 25 89 92 95 98 01 04 07 10 0 80 83 86 89 92 95 98 01 04 07 10 * Monthly data sorted for lowest quintile of MSCI World stock universe based on two-year trailing volatility from January 1973 September 30, 2011 Source: Barclays Capital, Citigroup, FactSet, MSCI and AllianceBernstein; see Important Notes on Simulations. 13
Stability and Long/Short Equities Can Reduce Risk or Increase Return of Equity Allocation Equity Allocation Typical Equity Allocation* Adding Stability and Long/Short Equity Reduce Risk** Increase Return A B Traditional Equity 90% 70% 70% Stability and Long/Short Equity -- 20% 15% Emerging Equity 10% 10% 15% Absolute Perspective Return 6.2% 6.5% 7.0% Higher Return Volatility 17.3 16.1 16.7 Lower Volatility Sharpe Ratio 0.2 0.3 0.3 Higher Sharpe Ratio Returns are based on the weighted average return for each asset class, rebalanced monthly for 10 years ended September 30, 2011.The evestment Alliance manager universes were sorted each year by percentile rank based on P/B for value managers and five-year forward earnings growth for growth managers. The median monthly return was calculated based on the beginning of period valuation percentile rank for each calendar year, using the cheapest half for P/B and the highest half for earnings growth. For the EAFE Large Cap Growth universe from October 1, 2001 December 31, 2005, few managers reported valuation characteristics, so the universe median shown is the median return for the highest-growth half of the universe beginning in January 2006. *Typical allocation: 22.5% US large-cap value; 22.5% US large-cap growth, 2.5% US small-cap value, 2.5% small-cap growth, 20% international large-cap value, 20% international large-cap growth and 10% emerging market **Replaces 20% of typical allocation to US and EAFE Large Cap, taken equally from each allocation, with a equally weighted stability equity portfolio Replaced 20% of typical allocation to US and EAFE Large Cap, taken equally from each allocation, with 15% in equally weighted stability equity portfolio and an additional 5% emerging-markets stocks. Not intended to portray the results of any AllianceBernstein product. Periods of more than one year are annualized. The results reflect the deduction of estimated investment-management fees. Source: Barclays Capital, HFR,Citigroup, evestment Alliance, FactSet, MSCI and AllianceBernstein 14
And Can Improve Information Ratio by Adding Uncorrelated Alpha Equity Allocation Typical Equity Allocation* Adding Stability and Long/Short Equity Reduce Risk** Increase Return A B Traditional Equity 90% 70% 70% Stability and Long/Short Equity -- 20% 15% Emerging Equity 10% 10% 15% Relative Perspective Return vs. ACWI 1.3% 1.6% 2.1% Higher Relative Return Tracking Error 1.8 2.1 2.1 Small Increase in Tracking Error Information Ratio 0.7 0.7 1.0 Higher Information Ratio Returns are based on the weighted average return for each asset class, rebalanced monthly for 10 years ended September 30, 2011.The evestment Alliance manager universes were sorted each year by percentile rank based on P/B for value managers and five-year forward earnings growth for growth managers. The median monthly return was calculated based on the beginning of period valuation percentile rank for each calendar year, using the cheapest half for P/B and the highest half for earnings growth. For the EAFE Large Cap Growth universe from October 1, 2001 December 31, 2005, few managers reported valuation characteristics, so the universe median shown is the median return for the highest-growth half of the universe beginning in January 2006. *Typical allocation: 22.5% US large-cap value; 22.5% US large-cap growth, 2.5% US small-cap value, 2.5% small-cap growth, 20% international large-cap value, 20% international large-cap growth and 10% emerging market **Replaces 20% of typical allocation to US and EAFE Large Cap, taken equally from each allocation, with a equally weighted stability equity portfolio Replaced 20% of typical allocation to US and EAFE Large Cap, taken equally from each allocation, with 15% in equally weighted stability equity portfolio and an additional 5% emerging-markets stocks. Not intended to portray the results of any AllianceBernstein product. Periods of more than one year are annualized. The results reflect the deduction of estimated investment-management fees. Source: Barclays Capital, HFR,Citigroup, evestment Alliance, FactSet, MSCI and AllianceBernstein 15
Best Approach Depends on Client Objectives and Beliefs Which approach to stability and long/short equities is best for each client? Degree of risk reduction/downside protection desired Belief in source of alpha Risks for each strategy Active or passive? Benchmark insensitive or focused on tracking error? 16
Low Vol is a Liquid, Low-Cost and Transparent Alternative to Alternatives Low-Vol Sort* Hedge Fund Return Index** Equity Hedge Funds** Return 8.5% 5.8% 4.6% Volatility 12.3% 6.8% 9.2% Sharpe Ratio 0.5 0.4 0.2 Correlation 0.85 0.83 0.84 Fees ~50 b.p. 2%/20% 2%/20% Lower fees for similar targeted results Long-only, transparent portfolio Liquid, no leverage *Monthly data sorted for lowest quintile of MSCI World stock universe based on two-year trailing volatility from January 2000 September 30, 2011; net of investment fees **Based on the HFRI Fund Weighted Composite Index, a global, equal-weighted index of over 2,000 single-manager funds that report to HFR Database. Constituent funds report monthly net-ofall-fees performance in US dollars and have a minimum of $50 million under management or a 12-month track record of active performance. Does not include funds of hedge funds. Managers maintain both long and short positions primarily in equity and equity-derivative securities, and strategies use a wide variety of investment processes, can be diversified or focused on specific sectors, and can range in net exposure, leverage, holding period, market capitalizations and valuation characteristics. Correlations of relative returns versus the MSCI World Source: Hedge Fund Research, MSCI and AllianceBernstein 17
Capturing Upside in Recoveries US Dividend Yield Global Low Volatility Long/Short Equity Stability and MSCI World Long/Short Equities Great Moderation Oct 2002 Oct 2007 2003 Recovery Mar 2003 Dec 2004 Global Financial Crisis Recovery Mar 2009 Apr 2010 54% 44% 35% 36% 20% 15% 22% 28% 30% 25% 17% 13% 28% 22% 28% Stability Equity is the equally-weighted monthly returns of US dividend yield, global low volatility and equity hedge. US Dividend Yield is based on the monthly median return for managers in the evestment Alliance US Dividend Focus universe. Global Low Volatility is the monthly returns of top quintiles within the MSCI World Index as sorted by two-year trailing volatility. Equity Hedge is the HFR Equity Hedge Index that includes managers maintaining both long and short positions primarily in equity and equity-derivative securities. Not intended to portray the results of any AllianceBernstein product. Periods of more than one year are annualized. The results reflect the deduction of estimated investment-management fees. Source: evestment Alliance, HFR, MSCI and AllianceBernstein; see Important Notes on Simulations. 18
Delivering Longer-Term Returns in Short-Tempered Markets Focus on return and risk versus client outcomes, not just relative returns vs. narrowly defined benchmarks Stability and long/short equity strategies can be a useful complement to time-tested traditional strategies Best approach to incorporating these strategies depends on client objectives and beliefs 19
APPENDIX
Investor Biases Help Explain Outperformance of Low-Volatility Stocks Behavioral Effects Agency Effects Lottery Effect I am looking for the big payoff? Overconfidence I am better at identifying it? Performance Chasing I need to be part of this trend? Performance Measurement Focus on Tracking Error and Relative Return? Fee Structures Incentive to lean into the market? Constraints Can t use leverage to tap Low Beta Effect? Investors: Favor High Beta Stocks Hug Benchmark Source: M. Baker, B. Bradley and J. Wurgler, Benchmarks as Limits to Arbitrage: Understanding the Low-Volatility Anomaly, Financial Analysts Journal, 2011; and AllianceBernstein 21
Different Approaches Have Benefits/Risks Risk Reduction/ Downside Protection Source of Alpha Risks Low Volatility Moderate downside protection Low volatility anomaly Typically quantitative Most dependent on low volatility anomaly/ quantitative skill Fundamental Quality Least downside protection Manager skill Typically fundamental Dependent on fundamental manager skill Market Neutral Greatest downside protection Manager skill Typically more quantitative than fundamental Leverage, short-selling Typically higher fees, less transparency As of December 2011 Source: AllianceBernstein 22