Waddell & Reed

Quarterly Fund Commentary

WRA Municipal Bond Fund (prospectus)
September 30, 2014

Bryan J. Bailey, CFA

Market Sector Update

  • Municipal market performance was primarily driven by a severe bond supply/demand imbalance.
  • Defaults in the municipal bond asset class continued to be extremely rare. While we anticipate increased headline risk from municipal issuers that have experienced severe stress and deterioration for many years (Detroit and Puerto Rico), we continue to believe that these problems are not systemic, and that they will remain isolated.
  • Puerto Rico's passage of the Public Corporation Debt Enforcement and Recovery Act, as well as the hiring of a restructuring consultant by the Puerto Rico Power Authority, has introduced a new layer of risk and uncertainty that needs to be monitored closely.
  • The municipal yield curve flattened modestly in the quarter, but it is still very steep historically.


Portfolio Strategy

  • While rates declined marginally in Q3 we do not expect this to be the start of a new bull market trend. The weak, weatherrelated, Q1 economic data has already been reversed with a very strong snap back in Q2. However, recently reported inconsistent U.S. economic data, heightened geopolitical risks, a European recession, and now the Ebola scare, have made us uncertain as to the timing of a move to higher interest rates. The Fund is positioned with a neutral level of interest rate sensitivity versus our benchmark and is holding a significant cash position.
  • Treasury and municipal rates are still extremely low by all historical standards. We remain very cautious as we believe that interest rates will need to normalize at some point in time. While the portfolio duration is currently neutral relative to the benchmark, the benchmark duration is approx. 20% shorter than one year ago, because of re-balancing. We continue to maintain our overweight slant to spread product in the A-BBB range.
  • We will continue to place emphasis on diversification, higher (overall) credit quality and yield curve positioning.
  • As always, the Fund will actively seek to uncover relative value opportunities between states, sectors and security structures while also attempting to exploit opportunities presented by the shape and slope of the yield curve.



  • We remain confident that municipal bond defaults will continue to be much lower than any other fixed-income alternatives, besides U.S. Treasuries.
  • We will continue to monitor the Puerto Rico Public Corporation Debt Enhancement and Recovery Act, the pending U.S. Constitutional challenges to the Act, and any subsequent spill-over into the overall municipal bond market.
  • This year's congressional elections weaken chances of a far-reaching tax code overhaul that would roll back or alter municipal bond's tax exemption. We also expect negative headlines from old municipal bankruptcy cases working their way through the court systems and decisions influencing the actions of other struggling municipalities in the future.
  • We expect Treasury yields to be the primary driver of the investment-grade municipal bond market as we move through 2014. Demand technicals will continue to play a very important role in relative performance.
  • While it is certainly plausible that the long-running bull market in bonds might be over, we are not convinced an outright bear market is beginning. Global central banks appear determined to keep interest rates artificially low. These policies could keep rates low for a longer period of time than many expect, and we are concerned that there will potentially be painful, unintended consequences.


The opinions expressed in this commentary are those of the Fund’s manager and are current through September 30, 2014. The manager’s views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.

Risk factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed-income securities are subject to interest-rate risk and, as such, the net asset value of the Fund may fall as interest rates rise. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.

Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for the mutual funds offered by Waddell & Reed, call your financial advisor or visit us online at www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.

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