July 2006 Investment Report

Geopolitical Tensions Spur Record Oil Prices and Volatile Markets

July was another volatile month as markets reacted to escalating Middle East violence. The Israeli-Hezbollah conflict on the Lebanese border escalated after the abduction of two Israeli soldiers, the bombing of Beirut's airport and missile launches into northern Israel. Oil prices rose sharply over supply fears. Compounding supply concerns are market tensions concerning Iran's nuclear aspirations, threats of supply disruptions in Nigeria and the Gulf of Mexico hurricane season. Oil closed at a record high of $77.03. Investors fear increasing oil prices will add to inflationary pressures and result in the Federal Reserve once again raising interest rates when it meets August 8.

Inflation heated up …

… as core prices—those excluding food and energy—jumped by 2.9% in the second quarter. Core prices are a key gauge watched by the Federal Reserve. Inflation is running above 2%, which is outside the Fed's comfort zone and could provide incentive for another interest rate increase. The second-quarter number was up from a 2.1% increase in the first quarter and marked the highest inflation reading since the third quarter of 1994, when core inflation rose by 3.2%.

The economy slowed …

… as rising gasoline prices left Americans with little extra spending money. The gross domestic product (GDP) measures the value of all goods and services produced within the United States and is considered the best barometer of the country's economic growth. GDP grew only 2.5% during the second quarter, the slowest pace since a 1.8% growth rate in the final quarter of 2005, when the economy was suffering fallout from the devastating Gulf Coast hurricanes. A fast-paced economy is often accompanied by inflation. Slowing the economy without stalling it into a recession will be a delicate balancing act for the Fed.

The European Union fined Microsoft $357 million …

… saying the company failed to obey a 2004 antitrust order to share technical information that would allow rivals' software to communicate better with Windows. Microsoft is appealing the decision, saying it has been cooperating with the order.

Enron founder Kenneth Lay died …

… unexpectedly of a heart attack July 5th. Lay and former Enron CEO Jeffrey Skilling were convicted in May of fraud for repeatedly lying to investors and employees about the company's financial health before Enron careened into bankruptcy proceedings in December 2001. Lay was to be sentenced September 11 and faced up to 165 years in prison.

Indian stocks rose a surprising 3% …

… despite a series of train bombings that rocked Mumbai, the country's financial capital. The bombings killed at least 190 people and injured hundreds more on trains during evening rush hour.

Intel cut 1,000 management jobs …

… as the computer chip maker tries to become more efficient amid stiff competition and weaker demand for personal computers.

Fund Performance

Performance for July was mixed with four of the six unitized funds advancing during the month. Performance relative to performance benchmarks was also mixed with two funds outperforming and four funds underperforming. For the year to date period through the end of July five of the General Board's funds have gained in value and four of the funds have matched or exceeded their performance benchmarks after all management and fund administration fees.

The Inflation Protection Fund (IPF) gained a meaningful 1.7% in July and slightly exceeded the performance benchmark. Investor expectations of a pause in Federal Reserve rate hikes were positive for bond markets. The fund's exposure to commodities once again helped performance as a result of rising commodity prices, particularly oil and natural gas. For the first time this year, the year to date performance of the fund is positive at +0.9%. This compares very favorably to the benchmark return of -0.1%. 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 contributed to the fund's favorable performance compared to the benchmark.

The Domestic Bond Fund (DBF) also advanced 1.7% in July and exceeded it performance benchmark by 0.3%. Virtually the entire excess return was attributable to the fund's exposure and performance of its emerging markets debt (EMD) portfolio. The EMD strategy gained 5.9% during the month. This performance reversed a significant decline in the value of EMD during May and June. For the year, the DBF has produced a positive 1.4% return which is 0.8% better than the performance benchmark. The primary contributors to this excess performance is the aforementioned performance of the fund's emerging market debt strategy and the fund's contribution from international bonds denominated in currencies other than U.S. dollars. The dollar has continued to weaken this year.

The Domestic Stock Fund fell in value by 0.9% in July and meaningfully underperformed its performance benchmark return of -0.1%. Two factors contributed to the fund's underperformance compared to its benchmark. First, the fund has a meaningful allocation to the stocks of small and mid-sized companies. As in May and June, stocks of larger companies continued to perform better than their smaller and mid-sized brethren. Additionally, the General Board's investment managers have collectively reduced their portfolios' exposure to energy stocks and increased their portfolios' exposure to technology stocks. Energy stocks continue to perform well and technology stocks continue to suffer. The negative contribution from these two factors, however, was somewhat offset by the fund's exposure to real estate. The General Board's real estate investments in the Domestic Stock Fund have continued to produce attractive results for its participants. For the year, the fund has gained 3.1% which now matches the performance of its benchmark. The aforementioned underweight of energy stocks and overweight of technology stocks has impaired performance but is offset by the excellent returns of the fund's real estate investments.

The International Stock Fund advanced 0.6% in July but once again trailed its performance benchmark, this month by 0.4%. As has been the story throughout the year, the fund's active managers once again collectively struggled with performing better than their respective benchmarks. However, three of the six managers produced better than benchmark returns. The primary contributor to below benchmark performance was the fund's exposure to the stocks of small companies. As in the U.S., small company stocks performed worse than stocks of large companies. Despite the worse than benchmark performance, the International Stock Fund has the highest return among the General Board's funds so far in 2006 and is up 7.7%. However, it meaningfully trails the benchmark return of 10.8%. This relative performance gap is attributed to poor performance of the fund's investment managers compared to their respective performance benchmarks. The General Board continues to have confidence that its investment managers' strategies will add value over long periods.

The Multiple Asset Fund advanced 0.3% during the month but underperformed the return of its performance benchmark by 0.4%. The less than benchmark performance is primarily attributable to the less-than-benchmark performance of the two stock funds although this was slightly offset by the better than benchmark performance of the two bond funds. For the year, the fund has produced a return of 3.8% and is 0.1% ahead of its performance benchmark. The benchmark-relative performances of the Inflation Protection and Domestic Bond have enhanced relative performance, though the relative performance of the International Stock Fund has detracted from MAF's benchmark relative returns for the first seven months of the year.

The Balanced Social Values Plus Fund continues to struggle and declined 1.3% in July despite an increase of 0.2% for the performance benchmark. As has been reported in past monthly reviews, the fund is positioned to smaller sized companies and companies with earnings growth that is expected to be faster than the overall market. These two factors continued to negatively impair the fund's performance. For the year, the fund has declined by 1.7%, and the fund's performance benchmark is up 2.6%.

Market Indices for July 2006

sp0607 The S&P 500 Index rose .5% in July and is up 2.2% for the year.
russ0607 The Russell 2000 Index declined 2.7% in July but is up 4.0% for the year.
msci0607 The MSCI EAFE Index rose .8% in July and is up 9.4% for the year.

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

close (X)