June 2006 Investment Report

Markets Focus on the Federal Reserve's Interest Rate Language

The Federal Reserve's impact had a significant influence on markets in June. Markets reeled early in the month after Federal Reserve Chairman Ben Bernanke called inflation increases "unwelcome" developments and suggested the Fed would take all necessary action to control inflation. U.S. markets dropped to 2006 lows, and Asian markets tumbled to their lowest levels in months led by Japanese stocks, which experienced the biggest one-day decline in more than two years.

The markets regained most of the lost ground on June 29, when the Federal Reserve again raised interest rates but signaled a potential end to interest rate hikes. The Federal Reserve indicated additional rate hikes would depend on the economic outlook, particularly inflation. This was a softer position from its previous stance on hikes. Markets cheered the news with some of the best one-day returns of the year, and the Dow Jones Industrial Average experienced its best gain since April 2003.

Inflation Still on the Rise …

… as energy costs creep into consumer goods and services. Core Inflation, a measure excluding energy and food prices, rose 0.3% and is rising at an annual rate of 3.1% through May, compared to a 2.2% rise in 2005. The Federal Reserve keeps a close watch on Core Inflation because it's a better gauge of the economy. Energy and food prices are more volatile and can give a distorted reading of the economy. The Fed has indicated it is uncomfortable with core inflation above 2% and could apply more rate increases to help control inflation.

30-Year Mortgage Rates Climb on Inflation Concerns …

… to a nationwide average of 6.78%, the highest level in four years. With new construction, home sales and house price appreciation slowing this year, economists hope for a gradual and orderly reversion to historical pricing norms. A year ago, 30-year mortgages averaged 5.62%.

Combined with Pain at the Pump …

… higher interest rates (particularly for mortgages) may be keeping retail consumers away from the cash registers. Retail sales registered only a slight monthly gain, and much of that came from a jump in gasoline prices. Many analysts fear a sharp economic slowdown in coming months because consumer spending accounts for two-thirds of total economic activity. While shoppers so far have remained resilient amid rising gasoline prices, consumers may cut back their spending at malls and stores as the heavy summer driving season kicks into gear. Gasoline prices have been soaring this year at an annual rate of nearly 70% as motorists contend with pump prices above $3 per gallon in many parts of the country. When combined with higher interest rates negatively impacting consumer mortgage re-financing trends, the impact on consumer sales seems imminent.

Microsoft Co-founder Bill Gates Plans Withdrawal from Day-To-Day Duties …

… to focus on his charitable foundation while others run the company he co-founded and guided to industry dominance and vast personal wealth. Gates co-founded Microsoft in 1975.

Warren Buffet to Give Away $37 Billion to Charity …

… the largest individual charitable donation in US history. Buffet is the world's second richest man behind Gates. Most of the donation will go to Bill Gates' charitable foundation.

Multi-Billion Dollar Mergers Signal Economic Health …

… as companies typically only execute large deals when they are confident about the future. Mining company Phelps Dodge will pay $40 billion for rivals Inco and Falconbridge; steelmaker Mittal Steel agreed to buy European steel maker Arcelor for $33 billion; and Johnson & Johnson will buy Pfizer's consumer products unit for $16.6 billion.

Fund Performance

For the second consecutive month, investment performance was poor, though not as bad as May, with all but one of the General Board's funds declining in value both in absolute terms and relative to each fund's respective performance benchmark. Five of the General Board's funds lost between 0% and 1% of their value with only the Inflation Protection Fund posting a gain for the month. Despite continued poor performance in June, four of the General Board's funds continue to exceed their respective performance benchmarks for the year.

The Inflation Protection Fund (IPF) gained 0.3% in June and matched the performance benchmark. Continued inflationary fears have driven investors to seek investments that protect against inflation. The fund invests 10% of its assets in commodities. Although the value of a basket of commodities fell during June, the General Board's investment manager added value though its selection of specific commodities. For the year, the IPF has declined 0.7%. However, the strong performance from the General Board's allocation to commodities along with the excellent performance by the General Board's active investment manager has resulted in a 1.0% improvement compared to the performance benchmark, which has declined 1.7%.

The Domestic Bond Fund (DBF) declined 0.3% during June, and its performance benchmark advanced 0.1%. The fund's less than benchmark performance is primarily attributable to two factors. The first is that the fund has a meaningful exposure to bonds of lesser developed countries known as emerging market debt. This component continued to drop in June due to investors fleeing investments perceived to have higher levels of risk. The second is the result of an accounting adjustment to the value of the General Board's Affordable Housing program. The program typically enters into future commitments to finance multi-family apartments after the apartments are built and fully leased. Although not funded until after the commitment period, the General Board agrees to an interest rate on the loan at the time of the commitment. This is consistent with standard lending practices. As a result of the recent rise in interest rates, the value of these future loans has declined. Previously, this decline (or advance) had not been recognized by the fund but will not be recognized consistent with fund accounting principles. For the year, the DBF has declined 0.3%, but remains ahead of its benchmark, which has declined 0.6%. The primary contributors to this excess performance are the fund's contribution from non-investment grade and international bonds, which continue to benefit from the weaker U.S. dollar. These gains are partially offset by the aforementioned losses on the General Board's future Affordable Housing commitments.

The Domestic Stock Fund fell in value by 0.1% in June and underperformed its performance benchmark return of +0.2%. The fund benefited from its exposure to the stocks of small and mid-sized companies, and in particular, its exposure to real estate investment trusts (REITs). However, the fund was impaired by meaningful underperformance by several of the funds' active managers, particularly firms that manage mandates of stocks of small and mid-sized companies. The S&P 500 Index (comprised of stocks of large companies) advanced 0.1% and the Russell 2000 Index (comprised of stocks of smaller companies) advanced 0.6%. For the year, the fund has gained 4.0% and its benchmark has advanced 3.2%. The General Board's greater-than-market weighting in small and mid-sized company stocks has benefited the fund for the first half of the year. Additionally, the outstanding result from the fund's exposure to public and private real estate investments has also contributed to the excess performance.

The International Stock Fund declined in June by 0.7% and once again underperformed the benchmark return of -0.1%. The fund's active managers once again struggled with performing better than their respective benchmarks as five of the six managers produced less than benchmark returns. The sixth manager only managed to match the results of the benchmark. As a group, the General Board's investment managers are meaningfully exposed to the Japanese market compared to the broad benchmark. Also, as a group, the fund has a greater exposure to companies expected to experience more rapid earnings growth. Both of these biases have inhibited performance. For the year, the fund is up 7.1% and is the General Board's best performing fund. However, it meaningfully trails the benchmark return of 9.7%. This relative performance gap is attributed to the same two factors cited above along with the fund's bias to stocks from lesser developed (emerging) countries.

The Multiple Asset Fund declined 0.2% during the month and underperformed the return of its performance benchmark of +0.1%. The less than benchmark performance is primarily attributable to the less-than-benchmark performance of the two stock funds and Domestic Bond fund. For the year, the fund has produced a return of 3.5% and is 0.5% ahead of its performance benchmark The benchmark-relative performances of the Inflation Protection, Domestic Bond and Domestic Stock Funds have enhanced relative performance, though the relative performance of the International Stock Fund has detracted from MAF's benchmark relative returns for the first five months of the year.

The Balanced Social Values Plus Fund continues to struggle and declined 0.5% in June despite an increase of 0.2% for the performance benchmark. The fund is positioned to smaller sized companies and companies with earnings growth that is expected to be faster than the overall market. This continued to negatively impair the fund's performance. For the year, the fund has declined by 0.4%, and the fund's performance benchmark is up 2.2%.

Market Indices for June 2006

sp0606 The S&P 500 Index was up 0.01% in June and is up 1.75% for the year.
russ0606 The Russell 2000 Index was down 0.07% in June and is up 7.02% for the year.
msci0606 The MSCI World ex-USA Index was down 0.33% in June and is up 8.47% for the year.

The performance data for these charts is based on price changes only and do not include the impact of dividend payments.

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