Market Sector Update

• The municipal market posted strong returns in the quarter. Credit spreads continued to tighten with the magnitude of compression incrementally greater the further out on the credit curve, while the yield curve flattened meaningfully.
• Municipal high grade rates (MMD) ended the quarter 16 basis points (bps) and 23 bps lower on 10-year and 30-year maturities, respectively. Mutual fund flows into the asset class continued to be robust, as well as high levels of reinvestment flows from bond maturities, bond calls and coupon income. Tax-exempt new issue supply was not enough to satisfy the insatiable investment demand. High absolute yields compared to the taxable fixed income market also brought in many cross-over buyers, i.e. insurance companies, banks and foreign accounts.
• As yields on the highest quality bonds hovered near all-time low levels, investors moved further out on the credit spectrum, including high yield, in search of higher absolute yields. Credit spreads on BBB rated bonds declined 48 bps while spreads on high yield bonds compressed 55 bps. This reach for yield is occurring while many credit metrics of even historically stable issuers are deteriorating with each passing day. Creditor protections in many lower quality new issues are also being relaxed substantially. In the current yield-seeking environment, investors are showing little concern for bearing this increased credit risk.
• Defaults in the municipal bond asset class continue to be rare and tend to be highly concentrated in the high yield space. While we anticipate these conditions to persist, we also expect many credit downgrades going forward. In our view, there is not a sector in the municipal bond space that will avoid the negative impact of these unprecedented circumstances. We are beginning to see distressed situations in the high-yield space with more frequency. This will need to be monitored closely, as we believe an acceleration of defaults or impairments on a larger scale would impact the high grade space as funds sell the highest quality, most liquid holdings to fund investor redemptions. However, we expect the overall municipal market default rate to remain significantly lower than the corporate default rate, as has been the history between these markets.

Portfolio Strategy

• The Fund posted a positive total return for the quarter while marginally underperforming both the peer group and its benchmark. The portfolio duration is slightly shorter than its benchmark, and the portfolio is defensively structured with a higher quality emphasis.
• We will continue to place emphasis on diversification, higher (overall) credit quality and yield curve positioning.
• Persistent credit surveillance will be critical in this environment.

Outlook

• We remain confident in our belief that investment grade municipal bond defaults will continue to be much lower than any other fixed income alternatives except U.S. Treasuries. However, we expect to see downgrades in the investment grade space, as we believe there is not a sector or issuer that can completely avoid the negative impact of the pandemic. We will continue to strive to avoid any issuer that will be impacted severely.
• We continue to take a long-term approach with credit selection. We will not compromise the overall credit quality of the Fund by chasing lower quality opportunities with poor bondholder protections and deteriorating credit profiles in this very uncertain environment.
• The Municipal Liquidity Facility (MLF) expired at year-end. While not widely utilized, it should be noted that the Federal Reserve is no longer in a position to be the lender of last resort in a crisis.
• State and local governments, as well as almost all revenue bond sectors in the market are facing unprecedented shocks to their revenue streams. Additional assistance from the federal government is widely viewed as the best solution to stave off more budget cuts, mass layoffs, essential program cuts and tax increases in this difficult environment. Unfortunately, the $900 billion Phase 4 stimulus package passed by Congress at year-end provided no assistance to struggling state and local governments, as well as other issuers in the municipal bond market.
• The outcome of the Senate runoff election in Georgia on January 5th is critical. If the Republicans hold the Senate, then we would not expect much fiscal assistance to the municipal bond market. However, if the Democrats take control of the Senate, then a large fiscal assistance package to state and local governments could be forthcoming. A Democratic Congress increases the odds of a reflation trade, which would put upward pressure on long treasury yields, and therefore drag high-grade municipal yields higher.

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 Dec. 31, 2020, 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.

Diversification is a method designed to manage risk but does not guarantee profits or protect against loss in declining markets.

All information is based on Class I shares.

The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

Risk factors: The value of the Fund's shares will change, and you could lose money by investing. 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.