U.S. equities overcame U.S. fiscal uncertainty and eurozone instability and rose strongly in the first quarter, with several major indexes hitting multiyear highs. Stocks advanced as the economic recovery continued to grind ahead, buoyed by accommodative monetary policies and improvements in the housing and employment markets. Equities in non-U.S. developed markets trailed U.S. share, but still posted solid gains. Emerging market stocks trailed developed markets amid concerns about weaker growth, lower commodity prices, and higher inflation. U.S. bonds were mostly flat as longer-term Treasury yields increased. High yield bonds outperformed higher-quality issues, as the low interest rate environment prompted investors to take greater risk to boost income. Non-U.S. developed market debt declined in U.S. dollar terms as major currencies weakened against the greenback. Emerging market debt also fell amid slower economic growth, currency weakness, and heightened risk aversion.
The Retirement 2040 Fund returned 7.12% in the quarter compared with 7.80% for the Combined Index Portfolio - Retirement 2040 Broad Index. For the 12 months ended March 31, 2013, the fund returned 11.34% versus 12.11% for the Combined Index Portfolio - Retirement 2040 Broad Index. The fund's average annual total returns were 11.34%, 5.79%, and 9.62% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2013. The fund's expense ratio was 0.78% as of its fiscal year ended May 31, 2012.
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Benchmark Definitions
We remain overweight to stocks versus bonds. Corporate balance sheets appear healthy, profits are good, and stocks remain reasonably valued, while the current low-yield environment is less favorable for bond returns. We increased our overweight to growth versus value stocks. A modest economic recovery favors growth stocks, which tend to be less reliant on a strong economy to generate rising corporate earnings. We trimmed our overweight to emerging market bonds relative to U.S. investment-grade bonds to reduce interest rate risk given the generally longer duration of dollar-denominated emerging market sovereign debt. Over the long term, the fiscal positioning of many emerging market sovereign issuers remains favorable compared with the budget and funding challenges faced by a number of developed market governments.
Our global growth expectations remain modest over the next several quarters. Gradual improvement in U.S. economic activity is supported by the housing recovery, modest job growth, and an uptick in personal income growth yet also challenged by fiscal uncertainty. The Federal Reserve's pledge to continue its accommodative policy highlights concerns about its effectiveness and an eventual exit strategy. Growth in emerging markets appears to be stabilizing following moderation in 2012. Europe continues to struggle with austerity, and the recent Italian election stalemate and Cyprus bank deposit tax underscore ongoing eurozone instability and the ad hoc nature of policy responses. Overall, corporate balance sheets and profit margins remain healthy, and earnings growth is consistent with modest economic growth.
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