November 2007 Investment Report

Credit-market concerns drove financial markets in November …

More information surfaced during November regarding the holdings of troubled credit instruments by banks, Wall Street brokerage firms, pension funds, and other financial institutions. For example, Citigroup announced that it expected to recognize losses of between $8 billion to $11 billion on its mortgage investments. Wachovia warned of taking another $1.1 billion hit. E-Trade Financial also warned of taking additional write-downs on its mortgage portfolio. Additional companies like Bank of America, J.P. Morgan, and Merrill Lynch warned that credit market conditions would hurt fourth quarter results. The Florida’s State Board of Administration experienced withdrawals from its funds of nearly $12 billion and had to freeze further withdrawals as a result of problems with its investments linked to the credit crisis. Market reaction to this news was harsh as virtually all investments with exposure to any kind of risk lost value. As more and more companies announced write-downs on the value of subprime investments or earnings warnings, investors became very nervous with the extent of the damage and the implications for the broader economy. Government plans to partially control the expected carnage resulting from higher expected payments on some subprime mortgage loans allowed financial stocks to recover some ground at month end.

… and economic data indicating slower growth also concerned investors.

Fortunately, inflation readings were generally positive, with only modest increases despite higher energy prices. The housing markets, however, continued to signal a drag on the economy as the supply of both new and existing homes for sale continued to grow and median sales prices continued to decline. The Conference Board’s index of consumer confidence fell by more than expected as consumers signaled a bleak outlook for inflation, jobs and income, which translates to increasing risk for a reduction in consumption. Manufacturing also seems to be struggling as the Institute of Supply Management manufacturing index unexpectedly decreased, further signaling economic weakness resulting from the housing headwind and credit market issues.

With softer economic data and contained inflation, investors have become hopeful of another cut in the federal-funds rate at the Federal Reserve’s next meeting on December 11th. Fed Chairman Ben Bernanke in a prepared speech noted the financial turbulence and its impact on the economic outlook, suggesting to some that a rate cut could be a possibility.

Market Reaction

Virtually all publicly traded investments with an element of risk, be they stocks or bonds, lost value in November. Investors turned to low risk investments while they analyzed the impact of the recent credit market turmoil and the likely implications for future economic growth. The best performing investment was the safest, lowest risk long-term investment available in the world: U.S. Treasury Inflation Protected Securities (TIPS). An index of U.S. TIPS rose 4% in November. There has been only one other month in the ten year history of U.S. TIPS that the index has produced better performance.

Though not as strong as TIPS, the Lehman U.S. Treasury Index gained 3.0% in November. The interest rate for the 10 year Treasury bond fell to 3.94%. A decline in yield means that the value of Treasury securities increased. However, bonds with credit exposure failed to keep pace with low-risk U.S. government securities. In fact, higher risk bonds actually declined in value. Many investors fervently adhered to the practice of “shoot (sell) first and ask questions later.”

Many market observers believe that the U.S. credit markets are currently undergoing a major transformation. During the past few years, the credit markets have seen an explosion of sophisticated credit products designed to meet the insatiable demands of investors. Investment consultants have been universally cautioning investors that we are in a “low return environment”. Accordingly, investors’ demand for higher yielding investments was answered by Wall Street’s creativity. Unfortunately, it appears that underwriting standards diminished as there appears to have been a massive amount of credit related investments that did not fairly reflect their underlying risk. The only winners from the credit debacle that has recently come to light will be members of the legal profession as it is a virtual certainty that lawsuits will abound as a result of the current credit crisis.

U.S. and international stocks experienced significant declines, though the November results could have been much worse were it not for the partial recovery at the end of the month. The S&P 500 declined 4.2%, the Nasdaq tumbled 6.8%, and the Dow Jones Industrial Average fell 3.6%. The MSCI All Country World (ex U.S.) Index declined 4.5%. For the year, however, the stock indices continue to post positive performance with the S&P500 up 6.2%, Nasdaq up 11.0%, the Dow up 9.6%, and the All Country World (ex U.S.) Index up over 18%.

Investment Fund Review

November was a very disappointing month for the General Board’s funds and worse than August’s sobering results. Five of the daily priced funds offered by the General Board decreased in value in November. Only the Inflation Protection Fund increased in value. Five of the funds underperformed their performance benchmarks in the month, and the two bond funds significantly underperformed. The good news is that all seven funds continue to have positive performance through the eleven months of 2007, though only two of the funds are outperforming their performance benchmark, with one fund matching the performance of its benchmark.

The Inflation Protection Fund gained 1.9%, but significantly trailed its performance benchmark which gained 4.0%. As indicated above, U.S. TIPS was the best performing asset class in the world for November. However, 45% of the Inflation Protection Fund is invested in diversifying asset classes which the General Board believes will provide participants with higher investment performance for longer periods. All three of the diversifying asset classes detracted from the results of the Inflation Protection Fund with commodities detracting most from performance in November as the price of oil decreased during the month. Additionally, the fund’s allocation to inflation-linked debt of international countries also detracted from fund performance in the month. For the year, the fund has gained 10.6%, and trails its benchmark return of 11.9%. The primary detractor of the fund’s relative performance is its exposure to international debt from developed economies. International inflation-linked bonds have gained 7.1% compared to the 11.9% return for U.S. TIPS. Additionally, commodities have also slightly detracted from performance as the General Board’s commodities portfolio is up 10.6%. Emerging country inflation linked bonds, however, have positively contributed to the fund’s relative performance for the year.

The Domestic Bond Fund declined 0.4% in November, and also significantly trailed its performance benchmark return of 1.3%. Once again, deterioration in the credit markets, particularly the commercial mortgaged back securities (CMBS) credit markets, adversely impacted the fund’s performance. As reported for the past several months, approximately 20% of the fund is invested in mortgage loans that fund affordable housing and community development projects (AHCD). However, these loans are privately placed and have no readily available market value. In order to fairly price the units in the Domestic Bond Fund on a daily basis, the General Board derives a price for its loans based on market pricing for CMBS. The continued deterioration of the credit crisis has, in particular, severely impaired the value of CMBS. Differences in the market rate for CMBS and comparable U.S. Treasury securities are at unprecedented levels. Accordingly, the value of the General Board’s AHCD loans has also deteriorated. It is important to note, however, that we have not experienced any increase in loan payment delinquencies or defaults. We are highly confident that our borrowers will continue to pay on a timely basis. For the year, the fund has gained 4.3%, yet trails its performance benchmark return of 6.0%. For the year-to-date period, the fund’s Affordable Housing mortgage portfolio continues to detract from fund performance, although this is partially offset by excellent performance by the fund’s international bonds, which have benefited from the depreciation of the U.S. dollar relative to foreign currencies.

The Domestic Stock Fund declined 4.5% in November matching the performance of its benchmark. As described above, investors’ decreased appetite for risk impaired performance of U.S. stocks. The General Board’s benchmark comparative performance was adversely affected by its greater than benchmark exposure to small and mid-sized company stocks. The Russell 2000 Index of small company stocks declined 7.2% during the month. However, the fund’s exposure to small and mid-sized companies was offset by very good performance compared to benchmarks by several of the fund’s managers. For the year, the fund has gained 7.5%, and still remains comfortably ahead of its benchmark return of 5.8%. Several factors accounted for the fund’s better than benchmark performance. The General Board’s small and mid-sized company investment managers have added significant value compared to their respective benchmarks for the eleven months in 2007. Additionally, the General Board’s investments in private real estate partnerships continue to positively add to the fund’s performance.

The International Stock Fund retreated 4.9% in November, and trailed its performance benchmark return of -4.5%. The fund’s allocation to investments in smaller companies and companies domiciled in underdeveloped countries detracted from performance in November. In particular, an index of stocks of companies from lesser developed countries declined 7.1% as did an index of stocks from small international companies. For the year, the fund has gained 17.6% but trails its benchmark return of 18.4%. The fund holds a smaller allocation to stocks of Chinese companies compared to the fund benchmark and the Chinese market has advanced 74% in 2007 through November. Additionally, the fund’s manager that invests primarily in undervalued companies has underperformed its benchmark by 7%. The fund’s underperformance from these two factors has been partially offset by the fund’s investments in international real estate companies.

The Multiple Asset Fund declined a disappointing 2.9% November, and trailed its benchmark return of -2.2%. The underperformance is primarily attributable to worse than benchmark performance by the International Stock Fund, Domestic Bond Fund, and the Inflation Protection Fund. For the year, the fund has gained 9.2% compared to its benchmark return of 9.1%. This outperformance is attributable to the better than benchmark performance by the Domestic Stock Fund, but offset by the underperformance of the other three funds that comprise the Multiple Asset Fund.

The Balanced Social Values Plus Fund declined -2.2% in November only slightly trailing its benchmark of -2.1%. For the year, the fund has gained 7.7%, outpacing its performance benchmark by 1.3%.

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