Individually Managed Portfolios

CBIS administered 44 individually managed portfolios (IMPs) at the end of 2007 with $893 million in total assets, representing a decline from the prior year. A large indexed portfolio was closed during the year and several bond portfolios were converted into the RCT Intermediate Diversified Bond Fund. The majority of IMP assets, 56% of the total by market value, were fixed-income mandates. Of the remainder, 24% was in balanced portfolios and 20% in various equity portfolios.

Dodge & Cox manages over 80% of CBIS IMP assets and has been an IMP sub-adviser since 1992. The fixed-income accounts returned from 4.5% to 5.6%, net of fees, depending on specific participant guidelines and cash flows. These results trailed the Lehman Aggregate Index’s 6.97% return for the year. The Federal Reserve began easing interest rates at mid-year in response to the growing liquidity crisis among financial institutions caused by rising subprime defaults, and also in reaction to signs the U.S. economy was slowing significantly. The Dodge IMPs maintained a shorter effective duration than that of the benchmark due to the low absolute level of interest rates and prospects for rising inflation. This was the primary cause of the Fund’s relative performance shortfall, as the ten-year Treasury yield declined by 67 basis points over the year. An overweight position in lower-rated corporate bonds detracted from results as the year progressed due to investors’ heightened risk aversion and growing concern about credit quality.

While value equity portfolio returns trailed growth in 2007, Dodge & Cox was able to add relative value for participants. Equity IMP net-of-fee returns ranged from -0.1% to 0.8% for the year, which compared favorably with the -0.2% performance by the Russell 1000 Value Index. A comparison with the S&P 500’s 5.49% return is less compelling, with the shortfall resulting from the value-style emphasis of the Dodge portfolios coupled with stock selection. Investors shifted focus from financial and cyclical sectors, which benefit from expectations for sustained strong global trade and global demand for resources, into more defensive issues during the second half of the year. Additionally, volatile growth issues in the technology sector were strong performers in 2007. While Dodge had increased its exposure to growth sectors such as technology, healthcare and media, due to their compelling valuations and earnings growth prospects, these were relatively weak in contrast to other growth issues with stronger momentum. Additionally, stock selection in energy, consumer staples and telecom issues detracted somewhat from results. Nonetheless, it is characteristic of Dodge & Cox’s long-term approach to portfolio structuring that its performance may lag as the investment cycle transitions from one theme to another. Such is the case currently, as investors have shifted expectations from high GDP growth to slower growth and have turned away from cyclical and momentum stocks in favor of better-valued issues.

Dodge & Cox produced returns for its balanced portfolios ranging from 1.6% to 3.3%, net of fees, depending on investment restrictions and differences in asset allocation. This trailed the performance of a 60% S&P 500 Index / 40% Lehman Aggregate benchmark, which would have returned 6.2% during 2007. The portfolio’s value emphasis detracted from results relative to the S&P 500 despite a substantial underweight in financial issues, the S&P 500’s weakest sector in 2007. Bond portfolio results relative to that of the Lehmann Aggregate Index were impacted by their shorter duration, as interest rates declined substantially, and by greater exposure to lower-rated corporate debt.

Jennison Associates managed four separate bond portfolios at year-end and produced returns ranging from 7.3% to 8.75%, net of fees, for 2007. These results substantially exceeded the Lehman Aggregate Index’s 6.97% return due primarily to Jennison’s yield curve strategy, as the Federal Reserve began lowering rates at mid-year 2007, steepening the curve, and to the portfolios’ emphasis on high credit quality. The firm has been very successful in profiting from aberrations in yield curve shapes, most recently during 2005, and had viewed credit and mortgage spreads as far too tight at the start of 2007. The portfolio had consequently been underweight in both sectors and emphasized higher quality issues. With subprime concerns making headlines over the summer, this paid off handsomely as corporate and mortgage spreads widened sharply on concerns over market liquidity and a possible recession. As the year ended, Jennison began to expand its mortgage exposure as credit spreads became far more attractive.

RhumbLine Advisers managed two indexed portfolios at year-end, both benchmarked against the S&P 500. Results for the year ranged from 5.5% to 6.25%, matching or exceeding the benchmark’s 5.5% return. Results differed between the two portfolios due to customized SRI restrictions. Of the industries affected by screens — pharmaceuticals and health management, aerospace and defense, and tobacco — many tobacco and defense-related issues produced strong results during 2007, while the impact of healthcare restrictions was mixed. Tobacco stocks, which exhibit defensive characteristics and predictable cash flow, were particularly strong as economic growth slowed globally. Re-weighting and reallocation from the restricted securities to unrestricted names offset some, but not all, of the negative impact of the restrictions. In healthcare, some of the largest restricted pharmaceutical companies posted negative returns, and greater weighting of unrestricted health management and medical device companies contributed positively to results.