June 2007 Investment Report

Pockets of the economy continue to concern investors in June.

The U.S. housing market continues to be a source of investor concern as data released in June supports the view that housing’s potential adverse impact on the economy has not dissipated. Housing activity remains depressed. There continues to be a high level of homes for sale, the average home price has declined and the foreclosure rate continues to rise. Additionally, there were renewed concerns regarding signs of continued deterioration in the subprime mortgage sector as two hedge funds operated by the investment banking firm Bear Stearns reported significant losses. Market observers believe that a number of other investors have also been adversely affected by losses from their exposure to subprime mortgages.

The ongoing housing issues appear to be impacting the consumer’s psyche as the Consumer Confidence Index fell by more than expected in May. Declining home values and higher foreclosures have made consumers less optimistic with the current economic environment and future prospects. With consumer spending accounting for two-thirds of GDP growth, the consumer outlook is important to the continued growth of the economy.

Consumers have also felt the impact of rising gas prices. Fuel prices continued to rise in June as oil moved above $70/barrel, ending June at $70.68. News headlines of the discovery of two unexploded terrorist bombs in London and a failed terrorist attack in Glasgow, Scotland reminded investors of the continued threat from terrorism.

Interest rates climbed in June.

Despite the adverse economic consequences of housing, other economic data seemed to signal growth. Both manufacturing activity and job creation advanced at a rate better than expected. Consensus economic forecasts are predicting stronger growth for the remainder of 2007. Accordingly, interest rates for U.S. Treasury securities have reacted to the prospects of stronger growth and the likelihood of higher inflation that often accompanies growth. Yields for the 10 year Treasury Note soared from 4.89% to a high of 5.22% on June 14th before stabilizing at 5.03%. Investor inflationary fears subsided somewhat after the release of several government reports indicating that inflation is somewhat subdued. Although the Producer Price Index (PPI), a measure of wholesale inflation, and the Consumer Price Index (CPI) were higher than expected, the core measures, which exclude food and energy, were only modestly higher. Additionally, the personal consumption expenditures (PCE) deflator, the Fed’s preferred inflation measure, dipped below 2% which is just inside the Fed’s comfort zone for inflation of 1-2%.

Some market observers believe that should higher long term interest rate levels persist, higher borrowing costs will adversely affect consumer and business borrowing. Higher interest rates mean higher monthly mortgage payments for home owners with adjustable rate mortgages and higher costs for businesses that borrow. Higher rates also could dampen corporate merger and acquisition activity. Ultimately, higher rates could lead to a slowdown in growth and adversely affect stock prices.

Market Reaction

With concerns over inflation, the future direction of interest rates, and renewed fears in the subprime mortgage sector, both the U.S. stock and bond markets declined in June. The S&P500 fell 1.6%; the Dow was down 1.5%, although the NASDAQ was unchanged for the month. International markets advanced, however, driven largely by excellent performance by the stocks of companies domiciled in lesser developed countries. For the year, the stock indices remain in positive territory with the S&P500 up 7.0%, the Dow up 8.8%, and the Nasdaq up 7.7%. International stock markets continue to perform better than the U.S. markets with a global index of non-U.S. stocks advancing 12.2%. Bonds have produced nominal gains of between 1-2% for the first half of the year.

Investment Fund Review

All but one of the six daily priced funds offered by the General Board decreased in value in June, although every fund matched or exceeded its respective performance benchmark. For the year, all of the funds have produced positive returns and all funds have matched or exceeded their performance benchmarks.

The Inflation Protection Fund marginally declined in June, but outperformed its performance benchmark which declined -0.2%. The fund’s 10% allocation to commodities continued to help the fund’s performance in June, as the fund’s commodities manager outperformed its benchmark. For the year, the fund has gained 2.2%, ahead of its benchmark return of 1.7%. The fund has benefited primarily from its 10% allocation to commodities, which advanced 8.7% for the year.

The Domestic Bond Fund declined 0.4% in June as a result of rising interest rates. The fund’s return matched that of its performance benchmark. The fund benefited from its exposure to non-U.S. dollar denominated bonds as the U.S. dollar weakened in the month. However, the positive contribution from global bonds was offset by the fund’s exposure to credit as investors became somewhat more risk averse as a result of the continued fallout in the subprime mortgage market. For the year, the fund has gained 1.1%, which also matches the performance of its benchmark. Despite June’s adverse contribution from the fund’s exposure to credit through high yield bonds and bonds from lesser developed countries, these two sectors positively contributed to the fund’s performance for the first six months of the year. The fund’s portfolio of emerging market bonds has gained 9.5% so far this year. These gains have been offset, however, by the fund’s affordable housing mortgage portfolio. The portfolio has been adversely affected by investor concerns surrounding the subprime mortgage market. Though the General Board strongly believes that the quality of its portfolio has not been impaired, our discipline for ascertaining the value of these loans is directly linked to the market’s assessment of credit risk for comparable publicly traded securities.

The Domestic Stock Fund declined 1.2% in June, though substantially exceeded the return of its performance benchmark which declined 1.9%. The fund outperformed its benchmark due to strong performance by the fund’s active managers. For the year, the fund has gained 8.4% and exceeds the benchmark return of 7.1%. 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 year-to-date period. Additionally, the General Board’s investment in private real estate partnerships continues to positively add to the fund’s performance.

The International Stock Fund rose 1.1% in June, ahead of its performance benchmark which returned 0.8%. Two factors contributed to the fund’s better than benchmark performance in June. The fund’s lone private real estate investment recognized a very significant gain and the fund continues to benefit from its exposure to stocks domiciled in lesser developed countries which have outperformed stocks of companies from developed countries. For the year, the fund has gained 13.2% compared to the benchmark return of 12.3%. The same two factors that contributed to the fund’s excess performance in June are also responsible for the fund’s excess performance for the first six months.

The Multiple Asset Fund declined in June, falling 0.4%, though the fund outperformed its benchmark which declined 0.8%. The excess performance is attributable to better than benchmark performance from three of the four underlying funds that comprise the Multiple Asset Fund. For the year, the fund has gained 7.1% compared to its benchmark return of 6.1%. This outperformance is attributable to the better than benchmark performance by the Domestic and International Stock Funds.

The Balanced Social Values Plus Fund declined 0.3% in June, though it meaningfully exceeded the performance of its benchmark which declined 1.2%. The primary factor contributing to the fund’s outperformance was the strong performance by the equity portion of the fund. The one month outperformance of the fund relative to its benchmark has erased all of the underperformance for the first six months. For the year, the fund has gained 4.9%, matching the performance of its benchmark.

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