Market Sector Update

• The high yield municipal market performed well during the quarter. With the Federal Reserve (Fed) slowly raising rates and relatively benign inflation data, the long end of the high municipal curve returned 40 basis points (bps). The quarter saw strength across the entire curve with the strongest returns in 7- to 10-year maturities which returned 1.50% and 1.11%, respectively.
• We believe the strength in the high yield market should continue in the near term supported by positive inflows within the asset class and risk-on environment. Low levels of primary issuance have created oversubscribed inventory pushing down yields on new bonds coming to market and allowing issuers to grant weaker collateral to investors. Demand continues to outpace supply, which is constructive for positive returns although credit spreads continue to tighten.
• Puerto Rico backed bonds saw positive moves and continue to be the strongest performing sector – returning 8.68% during the period. Puerto Rico debt only makes up 4.14% of the benchmark as downgrades have resulted in its bonds failing out of the index. Much of the debt is now owned by nontraditional investors as municipal bond mutual funds have greatly reduced exposure to the territory. We believe Puerto Rico bonds are dead money meaning investors will receive no income from the bonds for the foreseeable future.
• Longer term, with the rally in rates through 2017 and into 2018, we are less constructive on the high yield municipal space as new issues come to market with historically low absolute yields and weak collateral for investors.

Portfolio Strategy

• The Fund reduced its exposure in non-rated bonds – exposure was 32.01% at the end of quarter. With non-rated bond spreads at record lows, we feel it is prudent to own more liquid rated bonds to provide us the opportunity to exploit any credit widening. Approximately 4% of the portfolio’s non-rated bonds are pre-refunded, which means the bonds are highly liquid even though they are non-rated. The portfolio holds more than 11% of pre-refunded bonds which affords ample liquidity to exploit potential opportunities. We will continue to hold more than 11% of the portfolio in pre-refunded bonds as a source of additional liquidity moving forward. Additionally, the book yields on most of these bonds are well above 6%, which allows us to maintain a strong and stable dividend.
• 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 currently affecting many municipalities. Historically, General Obligations have fared well in Chapter 9 bankruptcies, however that trend was turned on its head post-Detroit and we expect the same outcome in the Title IV filing in Puerto Rico.
• Based on our view of Puerto Rico, along with the Fund’s primary mission of creating high levels of tax-exempt income for clients, we would be remiss to chase these bonds as they offer a high likelihood of offering no income for investors.
• The Fund’s underweight allocation to tobacco bonds positively contributed to performance for the quarter as tobacco detracted 80 bps from the benchmark. Several tobacco refundings are on the calendar and we will continue to look at opportunities to add names at discounts to par.
• 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 as we view the sector as fully priced.

Outlook

• We still believe the municipal market is attractive versus other fixed income asset classes based on strong demand and continued low supply. In our view, debt issuance for the remainder of 2018 will be higher than most estimates, but will remain lower than historical norms. We are more bearish on the credit market as spreads are hovering around the lows of 2007.
• We expect one more rate hike in 2018 as inflation climbs closer to the Fed’s 2% threshold. We are concerned how a possible trade war with both China and the European Union would affect prices and the overall global economy. We will monitor how tariffs might tip the Fed’s hand and whether it will be forced to review current interest rate policy.
• With the Fund’s duration at 75% of its benchmark, we feel appropriately structured to weather the impact of a long trade war. It is important investors realize prudent managers diversify across states and sectors and always limit the amount of exposure to those variables as well as any individual bond.
• Per the upcoming elections, infrastructure is one issue that has bipartisan support. The method in which Congress achieves the funding may impact the inventory municipal bond market. For example, Build America Bonds, single state grants, all may take inventory and normalize supply and demand in a high demand market.
• 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.

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 September 30, 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.

Diversification is an investment strategy that attempts to manage risk within your portfolio but it does not guarantee profits or protect against loss in declining markets.

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.