September 2006 Investment Report

Falling Oil Prices Relieve Inflationary Pressures

Despite reaching a high of $78.40 a barrel in July, oil prices declined to below $60 a barrel. Oil speculators appear to be more satisfied with supplies now that the summer "driving" season has concluded and the hurricane season has passed without impacting Gulf Coast refineries. This was good news for an economy that has been adversely influenced by rising oil prices, which have negatively affected consumer spending. Consumers, who account for roughly two-thirds of economic activity, should be able to re-direct personal finances previously spent on gas into the economy for other products. Of course, energy prices impact most businesses, with inflation impacting earnings and higher prices passed onto consumers. Lower oil prices could be the spark that positively ignites the markets. Retailers will welcome increased consumer spending as we enter the all important holiday season.

The Federal Reserve maintained its key interest rate at 5.25% …

… due to falling energy prices that have helped to restrain inflation pressures as well as an economic slowdown stemming in part from a cooling housing market. The Fed is trying to engineer a proverbial "soft landing" for the economy in which growth is slowed enough to keep inflation from getting out of hand. This is the second month in a row that the Fed also left rates unchanged, breaking a record string of 17 rate hikes that had driven the funds rate to its highest level in more than five years.

The economy grew at an annual rate of 2.9% in the second quarter …

… following a 5.3% increase in the first quarter. The slower pace is due to weakness of the once robust housing market, the toll of once surging energy prices and the impact of the Federal Reserve's two-year string of interest rate increases. Many investors view slower growth as an indication that the economy is moderating and the Federal Reserve has discontinued raising interest rates—a good sign for the markets.

Consumer inflation slowed …

… as energy prices moderated. The Labor Department reported that the Consumer Price Index posted a 0.2% increase in August, just half of the 0.4% rise seen in July. Core inflation, which excludes the volatile energy and food sectors, matched the overall number with a moderate 0.2% increase in August. Core inflation is a key measure used by the Federal Reserve when determining interest rates. The new figures demonstrated that core inflation over the past 12 months has risen by 2.8%, the biggest 12-month gain in nearly five years and far above the Fed's comfort zone of 1% to 2% price gains in core inflation.

New oil and gas reserves were discovered in the Gulf of Mexico …

… that could boost U.S. reserves by as much as 50%. The site could hold a very substantial supply of oil and natural gas liquids, the most significant domestic discovery since Alaska's Prudhoe Bay more than a generation ago. It is expected to take years before these reserves are developed so that oil can be delivered and refined.

Hedge fund Amaranth loses a record $6 billion …

… from a failed investment strategy involving natural gas. According to Wikipedia, the word Amaranth derives its meaning from ancient Greece. It was a plant that was supposed to have special healing properties, and as a symbol of immortality it was used to decorate images of the gods and tombs. The fund's investors, however, experienced anything but healing when they discovered that poor execution of the fund's investment strategy lost over two-thirds of the fund's value in less than two weeks. Fortunately, there was little contagion effect resulting from the fund's demise.

Hewlett-Packard Chairwoman Patricia Dunn resigned …

… after negative publicity regarding "inappropriate techniques" to uncover who was leaking boardroom secrets to the media. The company has received significant amounts of adverse publicity as a result of its actions that included private investigators impersonating HP directors and journalists to access the directors' personal phone logs.

Boeing Executive Alan Mulally to Lead Ford Motor …

… as the new president and chief executive officer of the nation's No. 2 automaker. Mulally, executive vice president of the aerospace company Boeing, was widely praised for being a key architect of the resurgence of Boeing's commercial airplanes unit over the past couple of years. Ford recently announced it is cutting more than 10,000 additional salaried jobs, offering buyouts to all of its 75,000 U.S. hourly workers and shutting down two more plants in a plan to end financial losses and remake itself into more competitive car company. In January, Ford announced it would cut 30,000 jobs and 14 facilities by 2012.

Fund Performance

Five of the six General Board's market based funds produced solid results in September with the lone exception of the Inflation Protection Fund. All funds continue to show positive results for the year. Compared to fund benchmarks, performance was mixed with one fund performing substantially better than its benchmark, one fund performing substantially worse, and four of the funds performing comparable to their respective benchmarks. For the year, one fund is outperforming its benchmark, two funds are underperforming their respective benchmarks, and three funds are performing in-line with their respective benchmarks.

The Inflation Protection Fund (IPF) was the only fund that declined during the month producing a -0.5% investment return. As was the case in August, the fund meaningfully underperformed its benchmark return of +0.2%. The continued decline in the price of oil adversely affected the performance of the fund's 10% exposure to commodities. This was entirely responsible for the less than benchmark performance. For the year, the fund has produced a gain of 1.6%, but is the smallest return among the General Boar's funds. The fund is 0.2% below the return of the benchmark. The fund's exposure to commodities has been additive to performance for the year, but this has been more than offset by the impact of investment management and fund administration fees.

The Domestic Bond Fund (DBF) advanced 0.8% in September and slightly underperformed its performance benchmark by 0.2%. Market interest rates fell in September as investors became more convinced that the Federal Reserve would discontinue its rate hikes. Falling interest rates result in higher bond prices and positive investment returns. The below benchmark performance in September was attributable to the fund's exposure to bonds denominated in currencies other than the U.S. dollar. The dollar strengthened in September. For the year, the DBF has produced a positive 4.1% return and has meaningfully outperformed its benchmark return of 3.2%. The primary contributors to this excess performance is the 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. Despite strengthening in September, the dollar has weakened during the year.

The Domestic Stock Fund advanced 2.2% in September matching the performance of its benchmark. Declining interest rates and oil prices were two of the major factors contributing to investors' enthusiasm for stocks. The stocks of large companies performed better than the stocks of smaller companies and this adversely impacted September's results as the fund has a meaningful exposure to the stocks of small companies. However, this was offset by the performance of stocks held by the fund's investment managers, which performed better than the managers' respective benchmarks. For the year, the fund has gained 8.1% which very slightly exceeds the performance of its benchmark. The fund's less than market weight exposure to energy stocks and greater than market exposure to technology stocks have detracted from performance. The fund's exposure to real estate has positively influenced performance.

The International Stock Fund was the best performing fund compared to its benchmark and advanced 0.6% in September compared to its benchmark, which produced no return for the month. The fund's exposure to stocks of lesser developed countries primarily contributed to the fund's excess performance. However, for the year the fund continues to trail its benchmark, though it continues to be the best performing fund offered by the General Board on an absolute return basis. For the year, the fund is up 11.7% after payment of investment management and funs administration fees. The fund trails its benchmark, which has returned 13.9% for the year. This relative performance gap is attributed to poor performance of the fund's investment managers compared to their respective performance benchmarks. Throughout the year, the fund has had a less than market weighting in energy stocks, which have performed well and a greater than market weighting in technology stocks, which have performed poorly.

The Multiple Asset Fund gained 1.2% during September, but slightly underperformed the return of its performance benchmark by 0.1%. The less than benchmark performance is primarily attributable to the less-than-benchmark performance of the Inflation Protection Fund, though offset by better than market performance of International Stock Fund. For the year, the fund has produced a return of 7.4%, which almost nearly matches the performance of the benchmark. The relative performance of the Domestic Bond Fund has positively impacted the fund's performance and the relative performance of the International Stock Fund has detracted from performance.

The Balanced Social Values Plus Fund advanced 1.7% during the month and exceeded the performance of its benchmark return by 0.1%. The fund is positioned with an emphasis on smaller sized companies and companies with earnings growth that is expected to be faster than the overall market. The impact of these two factors essentially offset each other for the month. For the year, the fund is up 2.5%, but trails its benchmark return of 6.3% as a result of its emphasis on stocks expected to grow earnings faster than the overall economy. These stocks have generally underperformed the broad stock market.

Market Indices for September 2006

sp0609 The S&P 500 Index was up 0.7% in September is and up 7.7% for the year.
russ0609 The Russell 2000 Index was up 2.54% in September is and up 7.0% for the year.
msci0609 The MSCI World ex-USA Index was down 0.25% in September is and up 11.9% 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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