Market Sector Update

• California municipal bonds provided solid positive returns in the quarter. Despite the rebound in the equity market, flows into California municipal bonds remained strong. Spreads have continued to compress with little supply.
• The Federal Reserve (Fed) indicated it will not raise rates in 2019 and expects only one more increase in this tightening cycle. This led to the entire municipal yield curve experiencing positive returns with maturities greater than 20 years providing the strongest returns.
• High yield municipal funds set a record in the first quarter with $4.8 billion of inflows. This resulted in one of the strongest performances in a quarter for high yield municipal bonds. Likewise, this resulted in spreads tightening to levels not seen since 2007. On a ratings basis, AAA versus BBB spreads tightened from 94 to 91 basis points.

Portfolio Strategy

• The Fund had a positive return for the quarter. It underperformed the Bloomberg Barclays Municipal High Yield Index, but outperformed the Bloomberg Barclays Municipal Bond Index.
• The Fund is underweight the tobacco sector with an approximate 8% allocation versus 15% in the Bloomberg Barclays Municipal High Yield Index. The underweight position hurt performance as tobacco bonds returned 3.9%. While we do intend to increase exposure over time, we expect the Fund to maintain an underweight position.
• We are less cautious on California hospitals – we intend to focus on higher quality systems and avoid smaller soleregional providers. The Fund is underweight the hospital sector at 8% versus 13% in the Bloomberg Barclays Municipal Bond Index. Going forward, we anticipate the Fund’s exposure to be in line with the benchmark.
• The Fund has relatively small exposure to insured Puerto Rico bonds (1.2%), whose income is exempt from both California and federal taxes. With the restructuring of the territories sales-tax-backed bonds, we may look for opportunities but they would not represent more than 1% of the Fund's total net assets.
• The Fund’s non-rated exposure currently sits at 25%, which is a maximum for the Fund. We don’t expect this allocation to vary meaningfully.
• We have been measured in investing cash, which is approximately 7%. We will continue to invest based on current market fundamentals with the intent of reducing the cash position to less than 5%. With spreads compressed to 2007 levels, we do not feel comfortable chasing yield and will look for one-off opportunities as they arise.
• We continue to favor revenue bonds over tax-backed debt. We believe revenue bonds provide higher yields and better diversification from general tax and pension issues affecting many municipalities. If recent high-profile defaults in general obligations have taught us any lesson, then it is that revenue bonds with strong collateral recovery fare much better in the event of a default.
• We are seeking opportunities in bonds with more defensive structures as interest rates continue to hover around historically low levels and credit spreads continue to be tight. We remain shorter duration than the benchmark. However, with the slope of the yield curve we feel comfortable adding duration in higher quality names.

Outlook

• We believe the strength in the high yield market should continue in the near term as positive inflows along with low levels of issuance generate positive results.
• We still believe the California municipal market is attractive versus other fixed income asset classes, based on strong demand due to high taxes and continued low supply. In our view, debt issuance for 2019 may be higher than most estimates, possibly up 20% to more historical norms.
• We continue to be cautious when looking at spread product with the compression of spreads due to the rally in the quarter and new investment options that continue to offer little collateral for investors. Along with the Fed’s concern regarding growth, we feel it is more important to focus on quality as we think spreads will widen if the economy slows.
• We expect the Fed to remain on the sidelines for the remainder of the year. We are concerned about potential global trade wars with China and the European Union and the impact on the global economy. On a positive note, with the government shutdown ended, we expect second-quarter gross domestic product to rebound slightly.
• We will continue to monitor how tariffs and the one-year threat of closing the southern border might cause the Fed to reassess current interest rate policy. With the Fund’s duration at 102% of the Bloomberg Barclays Municipal Bond Index and adequate levels of cash, we feel appropriately structured to weather the impact of a long trade war and potential border closure.

The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through March 31, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon Past performance is not a guarantee of future results.

The Bloomberg Barclays Municipal Bond Index is an unmanaged index comprised of securities that represent the long-term municipal bond market.

The Bloomberg Barclays Municipal High Yield Index is an unmanaged index made up of bonds that are non-investment grade, unrated, or rated below Ba1 by Moody’s Investors Service with a remaining maturity of at least one year. It is not possible to invest directly in an index.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. 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. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax (AMT). Exempt-interest dividends the Fund pays may be subject to state and local income taxes. The portion of the dividends the Fund pays that is attributable to interest earned on U.S. government securities generally is not subject to those taxes, although distributions by the Fund to its shareholders of net realized gains on the sale of those securities are fully subject to those taxes. The municipal securities market generally, or certain municipal securities in particular, may be significantly affected by adverse political, legislative or regulatory changes or litigation at the Federal or state level. 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. Because the Fund invests predominantly in California municipal securities, events in California are likely to affect the Fund’s investments and its performance. As with California municipal securities, events in any of the U.S. territories, such as Puerto Rico, Guam and the U.S. Virgin Islands, where the Fund is invested may affect the Fund’s investments and its performance. These events may include economic or political policy changes, tax base erosion, constitutional limits on tax increases, budget deficits and other financial difficulties, and changes in the credit ratings assigned to municipal issuers of California or U.S. territories.