February 2007 Investment Report

World stock markets retreat …

U.S. and world stock markets experienced their worst losses since the market drop following the September 11th terrorist attacks. The Dow Jones Industrial Average declined 2.8% for the month. Although international markets posted a slight gain for the month, a broad index of international stocks fell 3.8% in two days. Market observers cited a confluence of events responsible for market declines including the Japanese central bank raising its bank lending rate, remarks from former Federal Reserve Chairman Alan Greenspan regarding a possible U.S. recession, threats from the Chinese government about controlling short term speculation in its stock markets, and a negative economic report regarding orders for durable goods. Many felt that the world stock markets had advanced too sharply after the spring 2006 decline and that they were due for a “correction”.

… despite positive economic signs.

The U.S. manufacturing sector did show some strength as the Institute for Supply Management Index, a measure of manufacturing conditions, unexpectedly rose above 50, signaling that the economy was still expanding. Additionally, February produced data that supported continued growth from consumers as personal income rose a healthy 1% in February, lifted by bonus payments, stock option gains, and federal government pay raises. Consumer confidence also unexpectedly rose as consumers’ assessment of the current state of the economy was positive.

But housing continues to cause concern …

Sales of existing homes were stronger than expected in January (+3%), partially due to the warmer than expected weather. Unfortunately, new home sales plummeted 16.6% in January. Additionally, news and business headlines have highlighted growing concerns regarding so-called “subprime” mortgage loans. Subprime loans are made to borrowers that are less credit worthy and usually carry higher interest rates. Subprime lenders had been very aggressive in originating loans the past several years and many borrowers were seduced by the opportunity to own a home despite their shaky finances and credit history. Recently, many subprime lenders have been warning of increasing default rates on these types of loans. High default rates on subprime loans could portend significant adverse consequences for the U.S. economy as a result of the ripple effect caused on housing prices and consumer confidence.

… and inflation may be trending higher …

Inflation as measured by the Consumer Price Index (CPI), rose 0.3% in January, higher than expected and raising the year-over-year core (excludes food and energy costs) CPI to 2.7%. With fears that inflation appears to be rising, investors are wary that the Federal Reserve may decide to raise interest rates.

… as evidenced by rising crude oil prices.

Oil prices changed direction in February, rising to $63.06/barrell from $58.14/barrell at the end of January. Oil rose as tensions increased with Iran. Despite the threat of sanctions, Iran continues to work on its nuclear energy program. Rumors are prevalent that the Pentagon may take action.

Investment Fund Review

Despite the major drop in U.S. and world stock markets, four of the six daily priced funds offered by the General Board increased in value in February. Bond prices advanced, particularly for high-quality government issued bonds. This is typical market behavior during periods of declining stock prices. Nervous investors will park their capital in low-risk investments, a phenomenon commonly referred to as “flight to quality”, and wait for the period of heightened uncertainty to pass.

The Inflation Protection Fund was the best performing General Board fund in February and gained 2.1% and matched the gain of its performance benchmark. A majority of the fund is comprised of low-risk U.S. government bonds, which benefited from the aforementioned flight to quality. The fund’s 10% allocation to commodities helped the fund’s performance in February as commodity prices rose, though this was offset by the fund’s active manager’s decision to underweight U.S. inflation protected securities. For the year, the fund has gained 2.1%, but slightly trails the benchmark return of 2.2%. The difference is primarily attributable to the fund’s allocation to international inflation-linked bonds, which have not kept pace with the gains of U.S. inflation-linked bonds.

The Domestic Bond Fund also benefited from flight to quality and gained 1.8% in February, outperforming the performance benchmark by 0.1%. Two factors benefited fund performance. Declining interest rates helped increase the value of the fund’s affordable housing investments, which have a longer average maturity than the fund’s benchmark. Fixed income investments with longer maturities will benefit in periods of declining interest rates. Weakness in the U.S. dollar also helped the performance of the fund’s non U.S. bonds. These gains were partially offset by the fund’s exposure to debt from lesser developed countries, which did not keep pace with the broad bond market due to investor fears of a slowdown in global growth. For the year, the fund has gained 1.5%, but trails the 1.7% return of its performance benchmark. Despite February declines in the U.S. dollar, it is stronger relative to world currencies compared to the beginning of the year. Hence, bonds denominated in currencies other than the U.S. dollar have not performed as well as U.S. bonds. The negative contributions of non U.S. bonds, however, were partially offset by gains from the fund’s affordable housing investments.

The Domestic Stock Fund retreated in February, declining 0.8%, but performing better than its benchmark, which was declined 1.6%. As indicated, U.S. markets declined as investors feared an end to U.S. economic expansion. Several factors accounted for the fund’s better than benchmark performance. The fund has higher than average exposure to the stocks of companies of small and mid-sized companies, which performed better than stocks of large companies. Additionally, the General Board’s small and mid-sized company investment managers added significant value compared to their respective benchmarks during the month. A third factor was the positive contributions from the General Board’s private real estate partnerships. For the year, the fund has gained 1.4% compared to the benchmark return of 0.2%. The same three factors responsible for the fund’s excellent performance compared to the benchmark in February are also responsible for excess performance for the first two months of the year.

The International Stock Fund gained 0.2% in February despite the significant drop incurred during the last two days of the month. The fund, however, underperformed its benchmark return of 0.6% largely due to the fund’s larger than average exposure to companies domiciled in lesser developed countries. As with bonds, stocks from lesser developed countries declined more than other investments because of investor fears about risk. For the year, the fund has gained 0.6% compared to the benchmark return of 1.0%. Performance compared to the benchmark is adversely affected by its exposure to stocks from lesser developed countries, which have performed worse than stocks from developed countries.

The Multiple Asset Fund gained 0.3% in February, surpassing its performance benchmark by 0.2%. The fund benefited from the excess performance of the Domestic Stock Fund compared to its benchmark, though this was partially offset by the less than benchmark performance of the International Stock Fund. For the year, the fund has gained 1.4% compared to its benchmark return of 1.0%. This difference is also attributable to the better than benchmark performance of the Domestic Stock Fund.

The Balanced Social Values Plus Fund declined 0.3% in February due to its 60% allocation to stocks. However, the fund performed better than its benchmark, which declined 0.6%. The fund benefited from the better than benchmark performance of the fund’s stock manager as well as gains in the fund’s affordable housing investments resulting from a decline in interest rates. For the year, the fund has gained 1.6% compared to the 0.6% return of the benchmark. The performance differential is attributable to the same two factors cited for February.

Note: The stock market tables that normally appear at the end of this report do not appear this month. We are evaluating meaningful alternative charts to present with this report.

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