The Federal Reserve (Fed) increased the fed funds rate 25 basis points (0.25%) in December and forecast another three increases for 2018. Short term interest rates increased in response to the rate change and ongoing balance sheet reduction. Long term rates decreased due to well anchored inflation expectations and comparatively lower rates in other developed countries. Congress passed tax reform, reducing the top tax rate, but maintained the tax-exempt status of municipal bond income. Municipal new issue supply spiked as tax reform legislation included provisions to eliminate tax-exempt advance refunding and private activity issuance. Private activity bonds were spared in final legislation. Despite periods of elevated volatility, the municipal market was supported by expectations for a sharp decline in supply to start 2018.
The Fund returned -0.53% for the quarter, outperforming the -0.64% return of the benchmark.
During the quarter, we reduced the Fund's underweight to the three-to-five year range as yields increased in response to the Fed action. The Fund's underweight in the two-to-five year range and overweight in six-to-eight year range enhanced relative performance given the yield curve flattening. We capitalized on heavy supply in the second half of the quarter and resulting periods of high volatility by increasing interest rate exposure to benchmark levels. The added duration should bolster performance in early 2018 given we anticipate a strong technical environment for the municipal market to start the year. A narrowing of investment grade quality spreads detracted from relative performance given the Fund owns primarily AA- and AAA-rated securities.
Holdings are subject to change and current and future portfolio holdings are subject to risk.
Not FDIC insured | May lose value | No bank guarantee
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