Market Sector Update

• For the quarter ending Mar. 30, 2018, municipal funds in the Bloomberg Barclay’s Municipal High Yield Index category had a -.08% return. Municipal fund performance was weaker during the first quarter of 2018, with Bloomberg Barclay’s Municipal Bond Index funds having a -1.37% return.
• We believe several factors contributed to negative performance in the quarter. First, stronger economic data (gross domestic product, employment) released during this timeframe caused rates to rise over the quarter, albeit moderately. Additionally, with the passage of tax legislation and the elimination of Public Activity Bonds, we should continue to see supply within normal ranges of previous years. The Bond Buyer U.S. 30 Day Visible Supply was $11.5 billion at the end of the quarter, which is slightly higher than the same time period a year earlier. We believe forward issuance should be within normal ranges to previous years, however, much of the new issuance will be refinancing of current callable debt. Barring negative fund follows we expect price stability, as investors will be forced to buy the new debt as their bonds are called.
• Municipal bond flows continued to be strong in the first quarter of the year, as measured by year-to-date U.S. Lipper flows of approximately +$6.5 billion. With the rally in rates during previous years as well as a tightening Federal Reserve (Fed), low marginal tax rates and potential talk of increased tariffs, we have become less constructive on the municipal bond space.
• We continue to participate selectively in the new issue market while maintaining larger amounts of liquidity than we have done in the past. Going forward, we still believe the municipal market is attractive vs. other fixed income asset classes. While the Fed is likely to continue to raise rates in 2018, we believe that rate increases will be gradual and that the spillover impact to municipal bonds will be muted.

Portfolio Strategy

• The Fund underperformed one benchmark index, the Bloomberg Barclay’s Municipal High Yield Index, in the quarter due to the continued strength in the high yield market and the Fund’s bias toward higher quality municipal bonds and having a higher level of cash than the index. The Fund performed consistently with its other benchmark index, the Bloomberg Barclay’s Municipal Bond Index, given the higher level of exposure to lower investment grade bonds than the index.
• The team continues to see the greatest opportunity in land secured bonds, also known as Mello-Roos/Community Facility District (CFD) bonds. We also see opportunities in charter school bonds, which have experienced less price volatility than CFD bonds. We believe charter school and CFD bonds offer compelling risk/reward profiles.
• We are cautious with California hospitals and evaluate these borrowers carefully. The Fund is underweight the hospital sector, with 7.33% exposure versus a 13.52% weighting in the Bloomberg Barclay’s Municipal Bond Index. We believe that hospitals carry the most ratings downgrade risk of any sector due to multiple versions of proposed healthcare reform that could lead to a rollback of Medicaid expansion, which will strain operating performance in the sector.
• We continue to favor revenue bonds over tax-backed debt as revenue bonds, in our view, provide higher yields and better diversification from general tax and pension issues currently affecting many municipalities. We feel at this time it makes sense to bring in duration slightly due to our view that the next 12-18 months will not provide as many obvious opportunities for total return as we’ve seen so far this year.

Outlook

• In the near term we believe volatility will continue, as uneven economic data continues globally creating uncertainty for markets. We believe that we are in the middle- to late-stages of the economic recovery and that, even though meaningful tax legislation was passed, it will only serve to extend this part of the cycle by one to three years.
• Given this backdrop, we believe rates will remain subdued and that California-based investors will continue to search for tax-exempt yield due to high state tax rates.

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 Mar. 31, 2018, 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. It is not possible to invest directly in an index.

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.

Diversification does not guarantee a profit or protect against loss in a declining market. It is a method to manage risk.

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.