Taxable Fixed Income Strategy

We are pleased to report excellent taxable bond results for Oakwood clients for the year 2007. In fact, despite all the angst about higher energy costs and a weak U.S. dollar, total returns for Oakwood fixed income strategies easily exceeded reported rates of inflation and their respective benchmarks. As shown in the following graph, since June 30, 2007, Treasury yields, aided by multiple Federal Funds rate cuts, fell precipitously throughout the yield curve.

Investors who chose higher yielding or more complex investment strategies fared poorly and received little or no benefit from the decline in Treasury yields. By contrast, over this period, we systematically reduced our more vulnerable corporate and Federal agency holdings and resisted temptations to “chase yield” in the mortgage backed sectors. Instead, we allowed many of our Agency holdings to shorten or mature. Furthermore, we initiated sell programs in order to accelerate the move to more liquid U.S. Treasuries.

Now that yield spreads have widened dramatically, the yield relationships between the corporate and Treasury sectors favor corporates. Even rock solid companies such as General Electric, Toyota and Costco have seen their yield spreads widen in sympathy to the market. We are in an excellent position to take advantage of this widening. We have begun by investing in Deere & Company and McDonald’s Corporation. Both have been resilient to periods of stock price volatility and remain in an enviable position to grow both domestically and internationally.

Our goal is to move slowly and selectively. While the negative effects of sub-prime housing should soon wane, overall declines in housing values are likely to impact future consumer spending plans. This increases the risks of an even harder landing for the U.S. economy in 2008 and the potential for negative earnings surprises. This could force yield spreads to widen even further.

Furthermore, the recent news on inflation has been somewhat negative, not to mention the import cost implications from a weaker dollar. This may force the Federal Reserve to slow its pace of interest rate cuts. To date, we have been careful to remain fully invested; however, based on historical Treasury price patterns (shown below), we may begin to shorten our durations and utilize cash as a defensive management tool.

As we have seen over the past four years, volatility of long-term Treasury prices provided investors an opportunity to take gains at market highs or position themselves for a rally at market lows. While we ultimately expect yield levels to move much lower, this trading pattern remains intact.

Meanwhile, we will monitor the movements in stock prices, employment, energy and consumer spending patterns for signs that long bond prices will break-out on the upside. So far, most stock market indices have been resilient to the bad news in housing; however, this may start to change as cautious consumers and rising fuel costs turn even more negative.

We stand ready to meet all challenges during the New Year. Our current portfolio choices are ideal for this environment and because they are very liquid, we can modify our current holdings quickly. Overall, our forecast for bonds in 2008 is favorable. Once we get past this short term inflation concern, bond returns should easily outpace inflation. More importantly, our risk sensitive approach to bond management makes good sense as we move forward.