Market Sector Update
- Municipal bond market performance was driven primarily by the Treasury market, which sold off sharply as speculation regarding eventual Federal Reserve (Fed) tapering of quantitative easing activities began to dominate trading. The municipal market was under additional pressure as a result of the City of Detroit bankruptcy filing as well as negative headlines on the overall credit quality of all Puerto Rico, issuers which resulted in indiscriminate liquidations and heavy redemptions in the municipal bond fund asset class.
- Defaults in the municipal bond asset class continue to be extremely rare and heavily concentrated in the high-yield category. While we anticipate increased headline risk from cities and counties that have experienced severe stress and deterioration for many years (i.e. Detroit and Puerto Rico), we continue to believe that these problems are not systemic, and that they will remain isolated.
- In general, municipal credit quality has returned to pre-recession levels.
- High-grade yields increased dramatically in the quarter, and there was a very high level of volatility week to week and month to month. The municipal yield curve flattened dramatically in the quarter.
- We entered the period anticipating a continuation of the backup in interest rates that materialized in the quarter, although the market snapped back on the Fed's surprise non-taper actions as well as concerns over the chaos on Capitol Hill. The Fund is positioned with a lower interest rate sensitivity versus our benchmark and is holding a significant cash position.
- While we expect issuers to remain austere, an unexpected increase in supply could prove problematic for the market to absorb and could potentially put upward pressure on rates.
- While interest rates backed up dramatically during the quarter, they are still very low historically. We remain very cautious as we believe that interest rates will need to normalize at some point in time. However, the market is currently being held hostage by the Fed and Capitol Hill. Therefore, the portfolio duration is quite a bit shorter than our benchmark. We continue to maintain our overweight slant to spread product in the A-BBB range.
- We will continue to hold a larger percentage of longer maturity bonds in an attempt to exploit the steep slope of the yield curve, and 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 defaults will continue to be much lower than any other fixed-income alternatives, besides U.S. Treasuries.
- We expect heightened negative headline risk in the fourth quarter as the municipal bond exemption will continue to be under attack in the press from time to time. We also expect negative headlines from old municipal bankruptcy cases working their way through the court systems and ultimate decisions influencing the actions of other struggling municipalities in the future.
- Increasing Treasury yields as a result of either increased inflation expectations, a change in market expectations regarding Fed tapering actions, or a rotation into what is perceived as a more attractive asset class could put pressure on the municipal bond market.
- While it is certainly plausible that the long-running bull market in bonds might be over, we are not 100% convinced that an outright bear market is beginning. This will need to be validated by continued economic growth, reversal of unprecedented Fed activities, and a rotation out of safe harbor assets and into risk assets.
The opinions expressed in this commentary are those of the Fund’s manager and are current through Sept. 30, 2013. 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 signif cant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax. These and other risks i are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.
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