A Word From The Advisor

The Oakwood Fixed Income mission is to produce excellent relative performance in all interest rate environments.

The results of the first quarter of 2004 show that bonds as an asset class outperformed equities on an absolute and risk-adjusted basis, with the Lehman Brothers Intermediate Government/Corporate Index returning 2.5%. After a strong start, the major stock indexes ended almost unchanged for the first quarter of 2004. The Dow Jones Industrial Average finished the quarter down -0.4 %, with the broad S&P 500 Index returning 1.7%, held up by its many household-product stocks. The more volatile NASDAQ composite, whose many technology stocks led last year’s gains and this year’s declines, was down -0.5% for the quarter.

With optimism fighting anxiety, stock market investors are staying the course despite some mixed economic data, higher stock valuations and geopolitical tensions. The fixed income market sees bond loyalists maintaining their portfolios, as new supplies of issues are being absorbed and foreign demand remains strong.

A constant topic is the level of interest rates, in particular the Federal Reserve’s target short-term rate of 1.0%. Concerns are that today’s unusually low interest rates will spark inflation if they aren’t raised before long. For literally decades, the direction of inflation and interest rates has been the same, and while there are indications of inflation in the economy, it has yet to meaningfully filter down to the consumer level.

It is true that the occurrence of a rise in rates does hamper total return for bonds, but price changes represent only part of bond returns. Income is the other critical component. Many bondholders fall into the trap of monitoring the market value of their bond portfolio, when one of the main reasons for investing in bonds is for the income component. As coupon levels rise, it is easier to maintain desired income levels. Income generation is perhaps the biggest advantage over other assets.

For those that are dependent on a stable income to live on, a rise in rates and the ensuing higher income component is a very positive occurrence. A higher interest rate environment can help more conservative investors avoid the trap of chasing inordinately risky, seemingly high returning assets and keep their money in the more stable, conservative asset choice of bonds while earning respectable returns.

The prospect of rising interest rates can be a welcome event to income-seeking bondholders who make full use of Oakwood’s active management strategies. The tendency to chase yields will lead inexperienced investors to intuitively position themselves at the longer end of the yield curve, which may cause them the most damage should interest rates move higher. However, we at Oakwood become more defensive by implementing market protection strategies. This allows us the flexibility to take advantage of an upward move in rates. We use daily volatility in the market to advantageously position the duration of client portfolios to benefit from these moves, rather than to react to them.

Today’s improving economic conditions have another implication for bonds: Stronger economic growth should improve credit quality. Profit and cash flow are picking up for US corporations, and the expectations are for this trend to continue as the pace of economic growth strengthens. These factors have begun to affect how credit agencies are rating corporate debt. Since the beginning of 2003, credit downgrades have begun to fall relative to upgrades. The market has recognized this improving trend in credit quality, as the extra yield available for buying corporate bonds has fallen. Again, the value of Oakwood’s active bond management is brought to light as the selection process for corporate securities for client portfolios includes rigorous research and continuous review.

The Oakwood Fixed Income mission is to produce excellent relative performance in all interest rate environments. Our active-management approach is designed to accept only the amount of risk necessary to achieve your goals. Risk is managed by using only investment grade securities and by employing rigorous sell disciplines to preserve market value.

Oakwood offers both taxable and tax-free portfolio management. A review of Oakwood’s fixed income strategies covers the spectrum of active bond portfolio management in all categories.

Short-Term US Governments Fixed Income. This diversified fixed income strategy invests in all types of US Government securities with a maturity limitation not to exceed five years. The strategy is actively managed around a target duration and seeks higher return potential than that obtained from money market securities without the risk of longer maturity issues. This strategy is suitable for investors who seek moderate income and growth consistent with participation in the highest quality fixed income securities.

Intermediate Fixed Income. This diversified fixed income strategy may own all types of US Government securities and investment grade corporate bonds. The portfolio will generally not hold bonds with maturities beyond ten years. The strategy is actively managed around a target duration. Using the Lehman Brothers Intermediate Government/Corporate Index as a benchmark the goal of the strategy is to generate good returns relative to the benchmark in all interest rate environments. This strategy is suitable for those who seek moderate total return.

Full Maturity Fixed Income. This diversified fixed income strategy makes use of all taxable investment grade fixed income securities. There are no maturity or sector restrictions and the portfolio is actively managed around a duration target. With the Lehman Brothers Government/Corporate Index as a benchmark the goal of the strategy is to exceed the return of the benchmark. This strategy is suitable for those who seek total return in a fixed income portfolio.

Tax-Exempt Municipal Bonds. This fixed income strategy invests in tax exempt securities, both state-specific and general market obligations, depending on client residency and/or market opportunities. The strategy is actively managed and may use the full maturity spectrum for both state-specific and general market bonds. The goal of the strategy is to generate good after tax returns.

Research and active management can generate return where it doesn’t seem readily available. In addition, it is important to remember that bonds play an important role in any portfolio, both as a reliable, income-producing asset and as an anchor for those times that equities underperform.