Market Sector Update

• The high yield municipal curve performed well during the quarter. Both the long end and front end of the curve performed the best for the quarter, while the middle of the curve underperformed. Notably, the 1-year bond returned 2.73% while 20- and 30-year maturities returned 2.73% and 3.08%, respectively.
• Market participants believe the Federal Reserve (Fed) will cut rates in July or September of this year, which has resulted in short rates performing consistently with the longer end of the curve. It is clear the Fed is very concerned about the negative effects of global trade tariffs and geopolitical risks on the economy along with prospects of slower growth. Overall, we believe the short and long ends of the municipal curve are richly valued relative to Treasuries.
• Puerto Rico bonds continued to perform well for the quarter, returning 3.06%, which was a result of restructuring the island’s sales-tax-backed debt. However, we continue to be wary of Puerto Rico bonds. The restructuring of the general obligation bonds, which constitute the largest amount of debt outstanding, is headed to court. The concern is the 2012 and 2014 debt could be invalidated as unconstitutional, which means it is possible investors could see a total loss on their investments. While we feel this is unlikely, we believe the bonds are trading at higher prices than any possible recovery. Except for the sales-tax bonds, we still believe Puerto Rico bonds are “dead money,” meaning investors will receive no income from the bonds for the foreseeable future. We would be remiss if we pursued an investment with a high likelihood of offering no income.
• Debt issuance was higher in the first half than a year earlier, but remained lower than historical norms. We are confident that supply will rise in the remainder of the year which could put some pressure on interest rates.
• The rally in rates from the first quarter continued during the second quarter. We remain less constructive on the high yield municipal space as new issues come to market with historically low absolute yields and weak collateral for investors. Broadly, we have turned more bearish on the credit market as spreads hover near the lows of 2007.

Portfolio Strategy

• The Fund had a positive return for the quarter, but underperformed its benchmark. The Fund’s underweight in the tobacco sector and Puerto Rico bonds detracted, while the Fund’s short duration versus the benchmark hampered performance.
• The Fund’s duration is 73% of its benchmark, which is closer to the benchmark than the previous quarter. We have been actively seeking attractive opportunities in the new issue market in A- to AA-rated bonds, which we believe offer more relative value with spreads at historically tight levels. This has marginally increased the duration of the Fund, however we remain defensively positioned from a duration standpoint.
• The Fund has been reducing exposure to non-rated bond, ending the quarter with an approximately 24% allocation. Non-rated bond spreads are at record lows, so we feel it is prudent to own more liquid rated bonds to provide us the opportunity to exploit credit widening.
• Approximately 3% of non-rated bonds in the Fund are pre-refunded, which means the bonds are highly liquid despite being non-rated. The Fund holds roughly 9% pre-refunded bonds, which provides ample liquidity to exploit investment opportunities as interest rates rise and credit spreads widen. We plan on continuing to hold pre-refunded bonds in the Fund as a source of additional liquidity. Likewise, with book yields above 6%, the allocation allows us to continue to provide a stable and attractive dividend yield.
• We favor revenue bonds over tax-backed debt. We think revenue bonds provide higher yields and better diversification from the general tax and pension issues affecting many municipalities. While general obligations have fared well in Chapter 9 bankruptcies, this trend changed following Detroit’s bankruptcy and we expect the same outcome in the Title IV filing in Puerto Rico.

Outlook

• We believe the strength in the high yield municipal market should continue in the near term. Municipal bond funds have seen 25 weeks of positive inflows and low levels of issuance have resulted in positive results. We believe demand for municipal bonds will stay consistent with normal levels, but we do expect issuance to increase substantially in the second half of the year which may lead to slightly higher rates.
• We will look for opportunities with more defensive structures as interest rates continue to hover near historically low levels and credit spreads remain tight. We believe it makes sense to remain shorter duration relative to the benchmark as the sector seems fully priced.
• We expect the Fed to cut interest rates in July or September by 25 basis points. We are concerned about potential global trade wars with China and the European Union and the impact on the global economy. While trade tensions clearly are a concern, we do not feel a recession is likely this year.
• We believe investors will continue to search for tax-exempt yield even after the tax legislation was passed. We view the tax cuts as favoring lower-income brackets, but with the top tax rate at 37% we believe municipal bonds remain highly attractive.
• Going forward, we believe supply should increase about 20% from 2018 levels; however we believe the demand is strong enough to handle the increase. One consistent concern is the consolidation of assets into a select few high yield municipal bond funds. With three firms controlling a significant percentage of high yield municipal assets, a potential market disruption may cause an issue if investors decided to redeploy capital into other asset classes. We feel if that was to occur we are well positioned to redeploy capital at more attractive spreads and lengthen duration quickly.

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 June 30, 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.

All information is based on Class I shares.

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.