Category: Shareholder Letters

Letter to Shareholders: March 31, 2022


Dear Shareholder:

After experiencing record-setting inflows and posting solid returns in 2021, the municipal bond market is off to a rocky start this year. Flows into municipal bond funds turned negative, and Treasury and municipal bond yields surged (valuations have declined) as market expectations reset to reflect ongoing fears about persistently high inflation readings, the outbreak of war in Ukraine, and a pivot to a more aggressive monetary policy stance by the Federal Reserve Open Market Committee (FOMC).

The abrupt and unexpected change in market sentiment and the resulting sell-off in the municipal bond market surprised many, including us. In addition to the factors mentioned above, less favorable supply and demand dynamics (i.e., a higher supply of tax-exempt bonds coupled with less demand) also contributed to falling bond prices. This combination of factors and events led to a perfect storm: the municipal bond market suffered one of its worst quarterly losses on record during the first quarter. The Bloomberg Municipal Bond Index provided a -6.23% total return for the 3-month period ended March 31.

Federal Reserve Update

The FOMC raised the fed funds rate by a quarter percentage point to a target range of 0.25% to 0.50% after its mid-March meeting. It also strongly hinted that additional rate hikes will follow at each of its six remaining meetings this year. Elevated inflation, mainly reflecting supply and demand imbalances related to the pandemic and higher energy prices, was the main reason given for adopting a tighter monetary policy stance.

The FOMC released a new economic forecast and dot plot which provide information about the expected path of the fed funds rate. The FOMC anticipates weaker GDP growth this year, and it now expects to raise the fed funds rate a total of ten times (six hikes in 2022 and four hikes in 2023). That means that the terminal fed funds rate range will probably be somewhere between 2.75% and 3.00%. The FOMC also raised its near-term median forecasts for core PCE inflation to reflect the recent increase in prices.

In addition to raising the fed funds rate, the FOMC also indicated that it would start reducing its balance sheet holdings, which consist of Treasury securities, agency debt, and agency mortgage-backed securities. No precise timeline was announced for starting the balance sheet reduction process, but it could potentially start as early as May. Instead of purchasing more securities or replacing securities coming due, the FOMC will simply let securities roll off organically as the debt matures. With approximately 25% of the balance sheet maturing within two and a half years, the FOMC should effectively be able to reduce the size of its balance sheet without having to resort to any open market asset sales.

The Income Component of Fixed-Income Returns

Make no mistake, the volatility and downward price action in the municipal bond market have been gut wrenching. As human beings, our natural tendency is to react emotionally to market sell-offs which almost always leads to poor investment decisions. With bond yields still relatively low and the FOMC embarking on an interest rate hiking cycle, fixed-income investors are understandably a bit anxious and nervous.

Benjamin Graham, known as the father of value investing, believed the key to investment success—in both equity and bond markets—is having the temperament to keep emotions in check and remain focused on long-term results. In his book, The Intelligent Investor, Graham wrote, “For indeed, the investor’s chief problem—and even his worst enemy—is likely to be himself.”

In volatile markets with falling bond prices, investors sometimes forget that the income component of fixed-income investments typically accounts for over 90% of total returns for periods as short as five years. If you are an investor with a reasonably long investment time horizon, it isn’t rational to focus on bond prices alone when the vast majority of the total return of bonds is generated by the income component. While the share prices of all our single-state municipal bond funds have declined recently, each of these funds continues to generate a steady stream of tax-free income that can be counted on, regardless of share price.

Interest rates have remained at historically low levels for close to a decade which has caused the prices of bonds to remain artificially elevated. With yield normalization, bond prices will be returning to more historic levels, and investors will be earning higher yields as new bonds are issued at higher interest rates. In a rising interest rate environment, when it’s time to reinvest bond proceeds from coupon payments, calls, and/or maturities, changes in interest rates do matter. As rates rise an investor can reinvest at higher yields. If an investor has a multi-year investment time horizon, this reinvestment effect means that the investor should ultimately be better off. So, please keep in mind that with rising interest rates long-term bond investors have little to fear and even, potentially, something to gain.

The shift to a buyer’s market from a seller’s market happened quickly and without much warning. From our perspective as portfolio managers, sell-offs like we experienced during the first quarter of this year present great opportunities to find value and build higher and more durable income streams for investors. Rest assured, we are staying busy trying to do just that.

Thank you for the confidence you have placed in us.




Allen E. Grimes, Ill President


Letter to Shareholders: December 31, 2021


Dear Shareholder:

It’s hard to believe, but two years after first emerging the pandemic shows no signs of abating with the omicron variant spreading rapidly across the world and pushing COVID-19 infections to record levels. Our hearts go out to everyone that has been affected by the ongoing public health crisis, and we continue to be grateful for the heroic and valiant efforts of our front-line healthcare workers. We are also keeping our shareholders that may have been impacted by the recent tornadoes in western Kentucky, Tennessee, and Mississippi in our thoughts and prayers.

Municipal Market Update

While 2021 was another tough year in many respects, the municipal bond market managed to turn in a positive performance for the year. For the 12-month period ended December 31, the Bloomberg Municipal Bond Index provided a total return (which includes price changes and interest payments) of 1.52 percent. Municipal bonds outperformed other fixed-income assets such as U.S. Treasuries and investment grade corporates, both of which delivered negative total returns for the year.

The municipal market’s steady performance was fueled by a combination of favorable supply and demand dynamics (i.e., limited supply combined with strong demand), improving credit fundamentals, and passage by Congress late in the year of the $550 billion infrastructure package. Solid tax revenues and unprecedented federal support have helped state and local governments weather the pandemic much better than anticipated. Municipal credit upgrades have outnumbered downgrades this year. Improving credit quality has led to strong inflows into municipal bond mutual funds and exchange-traded funds. While the number of municipal bond defaults has ticked up slightly, defaults remain concentrated almost entirely in the high yield space led by nursing homes, industrial revenue bonds, and charter schools.

Trying to predict future market performance is always hazardous, especially in the middle of a pandemic. Nonetheless, we think a couple of factors will help support the municipal bond market in the coming year.

Credit quality in the investment grade municipal bond market is currently stronger than ever. State and local governments are flush with cash thanks in large part to COVID-19 relief. State and local tax revenues have soared as nominal profits and incomes have risen. Property, corporate, sales, and individual tax revenues have all risen sharply thanks to a strong economic recovery, a frothy stock market, a strong housing market, and ongoing federal assistance. That, coupled with the fact that U.S. municipalities are set for another large multi-year infusion of cash from the infrastructure package, has led many to conclude that municipal bonds may be set for a “golden decade” of credit ahead. The credit quality of each of our Funds is very strong, and we believe that the credit quality will remain strong in light of these factors.

Seasonal factors should also help support the municipal bond market as we start the new year. Historically, the “January Effect” has been supportive of municipal bond performance as reinvestment income from maturities, calls, and coupons significantly outpaces new supply. Continued strong demand, coupled with a net negative supply of municipal bonds, will likely help the municipal bond market get off to a strong start next year and should act as a floor for any potential price declines.

One slightly technical observation and potentially bullish development is also worth noting. Recently, the strong historic correlation between municipal bonds and U.S. Treasuries has weakened. As this year’s performance demonstrated, municipal bonds simply are not tracking U.S. Treasuries the way they used to. One plausible explanation for the decoupling is that the municipal bond buyer base is increasingly comprised of small retail buy-and-hold investors, as opposed to institutional investors which dominate the Treasury market. This “stickier” buyer base has resulted in less volatility for municipal bonds. If this trend continues, it potentially has implications for next year as the weaker correlation makes municipal bonds more attractive as a potential hedge against rising Treasury yields.

Federal Reserve Update

The Federal Open Market Committee (FOMC) met on December 15 and left the federal funds rate unchanged at 0 to ¼ percent. In response to persistently elevated inflation readings, it decided to double the pace of its quantitative easing taper which it first announced in November. The taper should be complete by as early as March. The FOMC’s statement was notable because it abandoned the term “transitory” that it had previously used to describe inflationary pressures which remain stubbornly high. The guidance on interest rate hikes also changed and is now weighted more towards labor market conditions (i.e., future assessments of maximum employment) rather than price stability. Overall, there were no huge surprises. The FOMC is still expected to raise interest rates by the same amount, but interest rate hikes are now expected to start sooner than originally anticipated.

Capital Gain Distributions

Capital gains distributions were made in four of our Funds this year: (i) the Kentucky Tax-Free Income Series, (ii) the Mississippi Tax-Free Income Series, (iii) the North Carolina Tax-Free Short-to-Medium Series, and (iv) the Alabama Tax-Free Income Series. Capital gains distributions were made on December 16, 2021—separate from and prior to end-of-year dividends. These capital gains distributions, along with all transactions made in your accounts in 2021, will be reflected on your end-of-year statements.

Thank you for investing with us. Happy New Year!




Allen E. Grimes, Ill President


Letter to Shareholders: September 30, 2021


Dear Shareholder:

The third quarter was, for the most part, a quiet and uneventful one for the municipal bond market. It was “quiet” because trading volumes and measures of market volatility for the municipal bond market hit new lows. Investors are hanging on to the municipal bonds in their portfolios and also snapping up new issues at a record pace. It was “uneventful” because (with the exception of a small spike in yields at the end of the quarter) municipal bond yields and prices remained range-bound. The Bloomberg Barclays Municipal Bond Index has provided a year to date total return of 0.79%.

The Federal Reserve Open Market Committee (”FOMC”) wrapped up its two-day meeting on September 22. The FOMC kept the fed funds target range unchanged at 0 to 0.25%. One of the main takeaways from the meeting was a signal that the FOMC is close to starting the “tapering” process of winding down its asset purchases. The FOMC will likely announce the start of the taper at its November meeting. Nobody really knows how long the taper will last. However, it is worth noting that the 2008 taper lasted approximately 14 months and the 2014 taper lasted approximately 10 months. Chair Powell has suggested that the taper could potentially be complete by mid-2022.

Regardless of how long it lasts, it’s critical to understand that tapering is not the same thing as tightening. To the contrary, monetary policy will continue to be accommodative as the FOMC’s balance sheet will continue to grow, albeit at a slightly slower pace. Economists estimate that the FOMC’s balance sheet will exceed $8.5 trillion at the end of the taper process, which is roughly double the size that it was two years ago. Moreover, the FOMC’s balance sheet is expected to stay at elevated levels for the foreseeable future.

After the official taper announcement, the focus will then shift to a discussion of the anticipated date of “liftoff” and the future path of the fed funds rate. The FOMC did update its “dot plot” at the September meeting, and several participants pulled forward their assessments of when the first interest rate hike would likely occur (9 of 18 participants now see a first interest rate hike in 2022 versus 7 in June). Nine FOMC participants also expect that the fed funds target rate will be above 1% by the end of 2023. The upward revisions were relatively minor and make sense given that recent elevated inflation readings have been more persistent than originally anticipated.

Discussing the nuances of the taper and trying to predict the date of liftoff are probably best left to economists and strategists. Instead, we think a couple of key points are worth considering as we move a bit closer to the start of a Fed tightening cycle. First, even though on the surface it may sound counterintuitive, interest rate increases are not a bad thing for fixed-income investors. Changes in interest rates matter when it’s time to reinvest proceeds from coupon payments, called bonds, or bonds that have matured. Rising interest rates allow a fixed-income investor to reinvest at higher yields. This is the exact opposite of “financial repression” which is the term used to describe market conditions that have prevailed for the past decade or so where investors have been forced to accept lower yields that are available in the market at the time of reinvestment. As market yields normalize over time, the yields of our funds will also start gradually increasing as we purchase new bonds issued at higher coupon rates.

Make no mistake, what can be bad for short-term fixed-income investors are sudden and large increases in interest rates. The FOMC has been talking about the taper since last December, and it has been very transparent about the criteria that must be met before a first interest rate hike occurs (i.e., maximum employment and inflation that runs above 2.0% for some time). To its credit, the FOMC has devoted a significant amount of time and resources in recent years to improving its transparency and communications. We don’t think the FOMC will want to jeopardize its hard work and credibility by surprising markets with any sudden or larger than anticipated interest rate hikes.

We continue to believe that the tightening cycle will be a gradual and shallow one. The economy continues to face numerous challenges and uncertainties, including significant supply-chain bottlenecks. This, combined with the fact that the starting point for the tightening cycle is near zero, strongly suggests that the fed funds terminal rate (the rate that exists at the end of the tightening cycle) will be substantially lower than it has been in previous tightening cycles.

Some nervous investors might be tempted to sell their bonds in anticipation of rising yields with the idea of buying them back once they cheapen up. We think it’s worth briefly reminding folks that timing the market is almost always a losing proposition. Moving to cash instruments yielding near 0% carries with it a large opportunity cost, especially if yields don’t rise as soon or as much as expected. Reallocating from bonds to stocks when stock market indices are near all-time highs is an even riskier proposition. The upshot is that if you are an investor with a multi-year investment time horizon, there’s really no good reason to fear yield normalization–it’s actually a positive long-term development.

It should be noted that Congress is still busy negotiating the passage of an infrastructure bill and much larger reconciliation bill. The details of the reconciliation bill are changing on a daily basis. Passage of an infrastructure bill will likely have a net positive impact on the municipal bond market. Among other things, higher individual and corporate income tax rates will make holding tax-exempt municipal bonds even more attractive for retail and institutional investors. Higher corporate tax rates should result in increased demand for tax-exempt municipal bonds by banks and property and casualty insurers, both of which significantly reduced their purchases after the 2017 tax reform. With higher tax rates on the horizon, we think it’s more important than ever to have a portion of your overall investment portfolio invested in high quality tax-exempt bonds.

Thank you for your continued trust and support.




Allen E. Grimes, Ill President

Letter to Shareholders: June 30, 2021


Dear Shareholder:

Municipal bonds turned in a mixed performance during the first half of this year. While the first quarter witnessed an unexpected surge in Treasury yields that led to some volatility in municipal bond prices, municipal bonds then proceeded to post positive total returns each month during the second quarter. For the six-month period ended June 30, the Bloomberg Barclay Municipal Bond Index provided a total return of 1.06%.

Favorable supply and demand dynamics, a steady interest rate environment, and improving credit fundamentals all contributed to the steady performance of the municipal bond market. Summertime has historically been a period of strong performance for municipal bonds as reinvestment flows typically outpace new municipal bond issuance. This summer looks to be no different. Bloomberg estimates that $165 billion will be returned to bondholders (due to maturing bonds and interest payments) for reinvestment into the market, which is roughly $45 billion more than what is expected to come to market via new issuance. This “net negative supply” environment should keep bond prices firm in the near-term, especially with continued strong demand for tax-exempt investments.

The macroeconomic outlook continues to improve. Economic growth has strengthened considerably in recent months with real gross domestic product (GDP) increasing at an annual rate of 6.4% during the first quarter of 2021. This rapid growth reflects the continued bounce back in activity from depressed levels as large areas of the country emerge from the pandemic. Consumer spending for goods and services, which accounts for roughly two thirds of the U.S. economy, is increasing at a rapid pace, and the housing market is very strong. The labor market has also strengthened with the unemployment rate in May standing at 5.8%.

The vast majority of states and cities have emerged from Covid-19 with better than expected revenues. Against this backdrop and flush with federal stimulus dollars, governors and mayors across the country are pushing for large increases in spending. According to data compiled by the National Association of State Budget Officers, total general fund spending proposals rose approximately 5% to $963.6 billion for fiscal year 2022, with 39 states forecasting spending increases. At the federal level, Congress is currently debating passage of additional wide-ranging fiscal policy measures to shore up the economy and social welfare programs. All of this is occurring at a time when the Federal Reserve Board (the “Fed”) continues to maintain an accommodative monetary policy.

Not surprisingly, this confluence of events has raised concerns about the potential for an outbreak of inflation. To be sure, inflation readings have increased notably in recent months. The Fed’s preferred inflation measure, the core Personal Consumption Expenditures Index, increased at an annual rate of 3.4% in May (up from 3.1% in April). This rate exceeds the Federal Reserve’s 2% longer-run inflation goal. However, there is an intense ongoing debate about whether the recent increase in prices will be “transitory” in nature as the Fed sees it, or “sticky” as others believe will be the case.

In testimony before Congress, Fed Chair Powell noted that the recent increase in inflation likely reflects four main factors: (1) base effects (i.e., comparisons with the low prices during the Covid-19 shutdown); (2) a rebound in spending as the economy reopens; (3) pass through of past increases in oil prices to energy prices; and, (4) supply bottlenecks which have limited how quickly production in some sectors can respond in the near term. Other Fed officials have also noted that large outliers such as skyrocketing used car and truck prices (+7.3% in May), car and truck rental prices (+12.1% in May), and airfares (+7.3% in May) have accounted for a significant portion of the price increases and are likely to revert to a level closer to the Fed’s longer-run target as demand cools and these transitory supply effects abate.

The counterargument to the Federal Reserve’s position is that some elements of consumer prices have exhibited signs of more sustained price increases. For example, housing prices have moved up sharply in recent months and have showed no signs of cooling. A shortage of semiconductors has also pushed up prices of consumer electronics and appliances. Some economists and investment professionals have also pointed out that the current administration’s focus on reducing wealth inequality and promoting clean energy may support a structural lift to inflation.

The market seems to be signaling that inflation will be transitory. The 5-year and 10-year breakeven inflation rates are currently at 2.51% and 2.35%, respectively. We tend to agree with those who believe that the parts of the economy that are contributing the most to inflation in recent months are merely “reflating” back to normal levels and will likely level off later this year or early next year. We certainly don’t think the temporary spike in prices will lead to runaway inflation.

The Fed has been purchasing $80 billion of Treasuries and $40 billion of mortgage-backed securities on a monthly basis since March 2020 to support the economy. The inflation debate has renewed attention on the issue of when the Federal Reserve will begin to start winding down its asset purchases (also known as “tapering”). The Fed indicated after its most recent meeting which was held in mid-June that it would continue its purchases at the same pace until “substantial further progress” is made on employment and inflation.

The timing and duration of the Fed’s tapering is important because it will likely dictate the timing of any future interest rate hikes. Most Fed watchers expect that the tapering process will be slow and gradual. After the 2008 financial crisis, tapering lasted approximately fourteen months. If history is any guide, and assuming that the Fed begins the process early next year, that would mean that the first interest rate hike could possibly come as early as the first quarter of 2023.

As always, thank you for investing with us. Enjoy your summer!




Allen E. Grimes, Ill President

Letter to Shareholders: March 31, 2021


Dear Shareholder:

Municipal bonds turned in a mixed performance during the first quarter. In January, the municipal bond market got off to a solid start and posted positive total returns. However, things quickly changed in February when an unexpected surge in Treasury yields led to a broad-based selloff in all fixed-income markets. Yields on 10-year Treasuries increased 83 basis points during the first quarter. Yields on 10-year benchmark AAA-rated municipal bonds moved higher in tandem with Treasuries, but to a lesser degree (41 basis points) during the first quarter. As yields rise, bond prices decline.

A number of factors contributed to the sudden spike in yields. Increased optimism about the progress of the COVID-19 vaccine rollout and the re-opening of the economy led many, including the Federal Reserve, to raise their economic growth forecasts. The Federal Reserve is now projecting that real GDP will increase at a 6.5% rate in 2021. The recent passage of an additional $1.9 trillion economic stimulus package (the “American Rescue Plan”) and the prospect of a $2.25 trillion infrastructure bill also contributed to the surge in yields. All of these developments caused the market to increasingly focus on, and price-in, upside risks to inflation.

Yields on Treasuries and municipal bonds decoupled somewhat in March with municipal yields moving lower (prices higher). An improving credit outlook, favorable supply and demand patterns, and the prospect of higher taxes under a new administration all contributed to a slight rebound in municipal bond prices during the month of March. Despite the ups and downs of the market, municipal bonds ended the first quarter almost flat with the Bloomberg Barclays Municipal Bond Index providing a total return of -0.35%.

State & Local Assistance:

The American Rescue Plan is the sixth stimulus bill passed since the onset of the pandemic and the largest to date. In the aggregate, enacted COVID-19 relief funding now stands at $5.2 trillion. The American Rescue Plan provides $350 billion to state and local governments to make up for the financial toll caused by the pandemic. The financial aid will be apportioned based on the share of unemployed workers in each state, meaning larger states will receive the most aid. Approximately $195 billion of the aid package is being allocated directly to states. Local governments across the country will receive approximately $130 billion, split evenly between municipalities and counties. The aid is expected to be released in two tranches, with the first funds required to be delivered by mid-May.

Under the funding formula estimates, Kentucky will receive $2.4 billion in state assistance; Tennessee will receive $3.8 billion; Alabama will receive $2.1 billion; Mississippi will receive $1.8 billion; and North Carolina will receive $5.2 billion.

The stimulus funds come with certain restrictions and must be spent by December 31, 2024. In short, the funds can be used to respond to the COVID-19 public health emergency or its negative economic impacts; support essential workers; provide public services in an amount up to the decrease in revenue versus the prior fiscal year; and finance water, sewer, and broadband infrastructure projects. There are two restrictions: (i) funds cannot be deposited into pension funds and (ii) funds cannot be used to “either directly or indirectly offset a reduction in the net tax revenue.” The tax cut restriction clause does not apply to localities, but the pension clause language remains intact. In the coming months, the Treasury Department will be issuing formal guidance that provides further clarification about permissible uses for the aid money.

Moody’s, Standard & Poor’s, and Fitch Ratings have all raised their outlook on the credit ratings of state and local governments to stable from negative noting that the aid will help stabilize finances and make up for revenue lost during the pandemic. Sectors that were hit especially hard by COVID-19 such as mass transit, airports, convention centers, toll roads, and higher education will receive an immediate boost from the new round of financial assistance.

Overall, the passage of the American Rescue Plan is a big win for the municipal bond market. Now, as one commenter aptly noted, the hard part will begin–giving away all of the money! An improving credit outlook, strong supply and demand technical factors, and anticipated tax reform should all help to support municipal bond prices in the coming months.

Federal Reserve Update:

The Federal Reserve Open Market Committee (“FOMC”) met on March 16-17 and decided to keep the target range for the federal funds rate unchanged at 0 to ¼ percent. The FOMC reaffirmed its current interest rate stance and also announced that it will continue its asset purchases. Chair Powell’s post-meeting press conference comments and his subsequent testimony to Congress suggest that he does not expect that the fed funds rate will be increased before late 2023. He also made it clear that he believes that any stimulus-induced inflationary pressures will likely be “transitory” in nature.

Thank you for the continued confidence that you have placed in us.




Allen E. Grimes, Ill President

Letter to Shareholders: December 31, 2020


Dear Shareholder:

There’s no shortage of articles discussing what an awful year 2020 has been. It’s been a tough year, especially given the unthinkable loss of life that COVID-19 has wrought. Instead of rehashing all of the trials and tribulations of 2020, I thought I would briefly discuss some of the more positive developments that occurred throughout the year and mention a few things to which we can hopefully look forward in the New Year.

The best news of all is that thanks to a very successful and unprecedented public-private partnership a number of vaccines for COVID-19 were developed in record setting speed. Since the novel coronavirus was first reported in late 2019, scientists, physicians, and drug companies around the world have conducted hundreds of research studies focused on the diagnosis, prevention, and treatment of COVID-19. Previously, the fastest vaccine development process was for the mumps vaccine, and that process took four years. It’s really quite remarkable to think that just one year after the onset of COVID-19, we have already begun rolling out vaccines to our front-line healthcare workers, overseas troops, and more compromised populations. With more hard work and a little luck, it’s possible that a good percentage of the population will have received a COVID-19 vaccination by the middle of 2021. Innovative mRNA vaccines developed by several of the leading drug companies are not only highly effective against COVID-19, but also offer the promise of a breakthrough tool that may be used in the fight against other viral diseases.

Another positive and somewhat counterintuitive thing happened this year: financial markets actually performed exceptionally well. In the midst of a global pandemic and the ensuing deep recession, financial markets exhibited a remarkable degree of resiliency. After a gut-wrenching sell-off in March fueled by the onset of coronavirus and liquidity concerns, both equity and fixed-income markets staged impressive rallies and finished the year up sharply. Among other things, an unprecedented level of intervention by the Fed helped support (and potentially inflate) asset prices.

The municipal bond market turned in a very respectable performance with the Bloomberg Barclays Municipal Bond Index providing a total return of 5.2% for the 12-month period ended December 31, 2020. Municipal bonds weren’t spared from the carnage in March (when interest rates soared more than 225 bps in just nine trading days), but the asset class bounced back with tremendous speed and force. Investment grade municipal bonds performed well as the year progressed, even as the number of COVID-19 cases continued to climb and more jurisdictions were forced to implement lockdowns that negatively impacted their economies.

While the pandemic has led to a significant decline in state tax revenues, the news on this front is not all bad. Just like COVID-19 has affected some sectors more than others, it has also affected some states more than others. States that are particularly dependent upon tourism and leisure industries and that have higher unemployment rates and higher virus transmission rates are generally seeing larger impacts on their economies and tax revenues. New York and California have been hit particularly hard. Nonetheless, many people are surprised to learn that state and local governments’ revenues, as a whole, have held up better than expected during these difficult times.

Several factors seem to explain the better than expected numbers. Unlike years with typical investment-driven downturns, 2020 was characterized by a dramatic contraction and re-expansion in consumption. Consumer spending accounts for rough 70% of GDP, so a quicker than expected normalization in consumer spending levels has helped considerably. State income tax receipts have remained relatively buoyant because the majority of the job losses have been concentrated among lower earners who pay a relatively small amount of income tax. Tax receipts have been especially resilient in states that rely on progressive income taxes, as higher earners have successfully adjusted to the work-from-home environment. Additionally, due to a recent change in the law, many states are now collecting taxes on online sales that have boomed during the pandemic. Higher stock market valuations have also led to an increase in capital gains tax collections in many jurisdictions (this should help underfunded state pension plans too). Low absolute yields have aided the COVID-19 recovery by allowing state and local issuers to refinance many projects that were originally financed at much higher interest rates. Lower mortgage rates have led to a housing boom that has resulted in higher property tax collections, which are typically used to support local municipal credits.

Aid to state and local governments via the CARES Act largely offset revenue declines for the last fiscal year that ended in June. However, the fight over additional direct federal assistance to states and cities continues in Washington. We would not be surprised to see a smaller, more targeted relief bill passed next year, but this is purely speculation on our part.

I’m not suggesting that states and cities are completely out of the woods at this point. To the contrary, most states and cities will be faced with making very difficult budget decisions in 2021. However, we continue to believe that the situation is manageable (with or without additional federal assistance). Unlike corporations, states and cities have a tremendous degree of flexibility and a variety of tools at their disposal to manage their finances.

Default rates for investment grade municipal bonds have stayed at low levels. The slight uptick in default rates this year has been confined to the high yield sector with nursing homes representing roughly 40% of the defaults, followed closely by land secured deals involving real estate and industrial projects. The number of credit downgrades of investment grade municipal bonds has also stayed exceptionally low. While the number of defaults will probably trend up next year, we think most of those defaults will continue to take place in the high yield sector. We don’t hold any high yield municipal securities in any of our single-state funds.

We are staying busy keeping a close eye on all of the holdings in our investment portfolios. Many of the factors that helped support the municipal bond market this year (e.g., favorable supply and demand patterns and a slow growth/low inflation environment) will remain intact next year. We expect municipal bonds will generate positive total returns again in the coming year. However, with low absolute rates and bond prices having already rallied strongly this year, it seems likely that much of the anticipated positive performance next year will be derived from coupon income and not price appreciation. Hopefully, we will see less market volatility in 2021.

Thank you for investing with us. Happy New Year!




Allen E. Grimes, Ill President

Letter to Shareholders: September 30, 2020


Dear Shareholder:

Compared to the first half of this year, the third quarter of 2020 was relatively uneventful for the municipal bond market. Bond market volatility was muted, and yields continued to grind slightly lower (i.e., prices moved higher). Despite ongoing worries about the fallout from COVID-19, credit conditions in the investment grade municipal bond sector have continued to hold up remarkably well with only a small number of issues receiving credit downgrades. Favorable supply-and-demand dynamics have continued to act as a tailwind for the municipal market. The Bloomberg Barclays Municipal Bond Index provided a total return of 1.23% for the third quarter and 3.33% on a year-to-date basis.

One slightly unexpected recent development in the municipal market is worth noting. On the supply side, state and local governments are issuing taxable municipal bonds at a record pace due to falling interest rates and the 2017 tax-cut law that restricted issuers’ ability to advance refund tax-exempt issues. The low interest rate environment has allowed state and local governments to refinance debt with taxable securities that cost less than what they are paying on outstanding tax-exempt bonds. So far this year, state and local governments have issued close to $100 billion in debt subject to federal income taxes. If the current pace continues for the remainder of this year, the supply of taxable municipal bonds may come close to or even surpass the $154 billion in taxable bonds issued in 2010 when the Build America Bond program expired. This refinancing activity should help ease budgetary fiscal pressures.

The credit quality of all of our investment portfolios remains very strong. We have taken proactive steps in a few of our funds to eliminate or reduce our positions in certain credits where we felt those holdings had a higher-than-average risk of a potential credit downgrade. Most of the bonds that we have sold (which represent only a small fraction of our overall investment portfolios) were in sectors that have been disproportionately impacted by COVID-19. Examples of such sectors include, but are not limited to, convention centers, airports, small colleges, and small rural hospitals.

From a portfolio strategy perspective, we have a current bias towards essential service revenue bonds that finance critical services such as water, wastewater, and electricity. Essential service bonds offer stable and sustainable revenue streams that are better protected in an economic downturn. We also currently favor bonds issued by school districts, flagship universities, and high quality national and regional health systems. Our portfolio managers are being extra careful when it comes to security selection, and they are spending a considerable amount of their time and efforts watching over all of the holdings in each of our investment portfolios.

The issue of providing additional financial assistance to states and localities is still under consideration by Congress. It looks increasingly unlikely that this matter will be resolved before the election. Regardless of whether additional federal aid is forthcoming, we think it is worth bearing in mind that state and local governments have a wide variety of tools at their disposal to recover lost revenues and manage their finances. Fortunately, most states entered the current economic downturn in relatively strong financial positions, many with sizeable rainy day reserve funds. Additionally, property tax revenue, which supports local debt issued by cities, towns, and counties, has increased as a result of a housing-sales boom stimulated by low mortgage rates.

Federal Reserve Update:

As expected, the Federal Reserve Open Market Committee (“FOMC”) left the federal funds target rate unchanged at 0 to 1/4% at its September meeting. However, in a surprise policy change, the FOMC adopted explicit forward guidance and indicated that any future interest rate hikes would be on hold until “inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” (Emphasis added).

In short, the FOMC has adopted what economists call an “inflation overshoot” into its forward policy guidance. This shift in strategy will permit the FOMC to worry less about fighting inflation and to focus more on achieving maximum employment and improving living standards. This represents a significant departure from past FOMC policy which has always been heavily tilted towards fighting inflation. Many of you probably remember Paul Volcker’s brute-force campaign in the late 1970s and early ‘80s to tame inflation. It appears that, after all of these years, the thinking at the FOMC has evolved.

As a practical matter, the new policy guidance means that interest rates will likely remain anchored at their current low levels for an even longer period of time since the FOMC has indicated that it will not start tightening monetary policy as early in the cycle, even if inflation reaches 2%. The FOMC’s updated economic projections which were released at the September meeting indicate that the majority of FOMC members don’t expect interest rates to rise before 2023. A stable interest rate environment should help municipal bonds continue to perform well.

New Online Access Shareholder Portal:

We are pleased to announce the recent launch of Dupree’s upgraded online access portal. The new portal offers a more user-friendly interface, easier navigation, and enhanced security features. Please note that all shareholders who wish to access the online portal must register with a new user id, even if they were previously registered under the old system. Shareholders may register by following the “Online Access” tab at Please call us if you need any assistance with the registration process.

Thank you for the continued confidence that you have placed in us.




Allen E. Grimes, Ill President

Letter to Shareholders: June 30, 2020


Dear Shareholder:

The first half of this year was in a word: tumultuous. The dictionary defines “tumultuous” as marked by violent or overwhelming turbulence or upheaval. With turbulence and upheaval on many fronts, the first six months of 2020 met that definition. Financial markets were not spared. A sell-off of historic proportions in mid-March caused prices of stocks, commodities, and bonds to plummet as a mysterious respiratory illness caused by a novel coronavirus (COVID-19) evolved into a full-fledged global pandemic. Stock and bond prices bottomed out on March 23, and the rout then reversed itself just as quickly as it started.

COVID-19 has exposed the fragility of our economy. Halfway through this year, 20 million are unemployed in the U.S., entire industries and sectors are shut down or are operating at minimal capacity, and global trade relations are reaching a new low point. It’s not a pretty picture. Nonetheless, financial markets have exhibited a remarkable degree of resiliency over the past few months.

What shape the economic recovery will take is an unresolved question. This is complicated by the fact that many areas are now experiencing a surge in COVID-19 cases. As we have discovered, reopening the economy will not be a linear process, and each city and state will have to make decisions based on its own particular circumstances.

Economists generally describe different types of recessions and recoveries as V-shaped, U-shaped, W-shaped, or L-shaped. While some economists are calling for a V-shaped recovery (a sharp but brief decline with a clearly defined trough, followed by a strong recovery), we tend to think that the recovery will be a long and slow process more akin to a U-shaped recovery. One noted economist described a U-shaped recession/recovery as being like a bathtub: “You go in. You stay in. The sides are slippery. You know, maybe there’s some bumpy stuff in the bottom, but you don’t come out of the bathtub for a long time.”

Cities and states are climbing out of a deep hole. Fortunately, most municipalities and states were in excellent fiscal shape before the crisis. Federal funding under the CARES Act and the ability of states and cities to borrow under the Federal Reserve’s municipal lending facility should help most jurisdictions cover current fiscal year deficits. However, addressing next year’s budget gaps will be a more difficult task. Moody’s Analytics estimates that states and local governments will need approximately $500 billion in additional aid over the next two fiscal years to avoid major damage to the economy. We think additional federal assistance is likely, but it is not a given.

As I pointed out in the March shareholder letter, we are staying busy evaluating the impact of recent events on our individual bond holdings. The fallout from COVID-19 is being felt in many sectors, but some sectors may be impacted more than others. Bonds issued to finance hospitals, nursing homes, airports, convention centers, museums, sporting facilities, small private colleges, and industrial projects are examples of credits that face an increased risk of a credit downgrade and/or default. Lower-rated bonds (i.e., high-yield) issued to finance these types of projects (which represent only a small share of the $3.9 trillion municipal bond market) have the greatest risk of default.

It is important to understand that the municipal bond market is bifurcated into investment grade credits and high-yield credits. Historically, the vast majority of municipal bond defaults have occurred in the high-yield space. We expect that this pattern will repeat itself. Forecasters at Barclays predict that in 2020 default rates for high-yield municipal bonds will be between 2% and 4%, up from about 1% in January. That compares to the historic default rate of approximately 0.18% for investment grade municipal bonds and 1.74% for corporate debt.

All of the bonds we hold in our investment portfolios are investment grade credits. While we do own a small number of hospital, airport, convention center, and stadium facility bonds in several of our funds, they represent a very small percentage of each portfolio’s overall holdings. Our portfolio managers have carefully reviewed (and will continue to monitor) each issuer’s financial statements to ensure that we remain comfortable holding these credits. If we identify any credits with which we are not comfortable, we will not hesitate to make adjustments to our investment portfolios.

At our core, we are risk managers. Frankly, that is where we add value for investors. In times like this, careful security selection and continuous oversight of investments have never been more important. Please know that we are staying very busy actively managing your investments.

Retirement Account Update:

President Trump recently signed into law a measure that suspends for 2020 the required minimum distributions, or RMDs, many retirees must take from tax-deferred 401(k) and individual retirement accounts. The Internal Revenue Service recently issued updated guidance that allows people who took RMDs from retirement accounts this year to put the money back in their IRAs. Please note that the deadline to return RMD’s taken in 2020 is August 31, 2020.

Retirement of William A. Combs, Jr.:

I would like to formally acknowledge the retirement of Bill Combs from our Board of Trustees. Bill joined the Dupree Mutual Funds board in 1988. His steady and strong leadership, sound judgment, and calm demeanor have been a tremendous asset to Dupree Mutual Funds and its shareholders over the years. All of us here at Dupree would like to thank Bill for his dedication and longstanding service to the Funds.

As always, we appreciate the confidence and trust that you have placed in us.




Allen E. Grimes, Ill President

Letter to the Shareholders: March 31, 2020


Dear Shareholder:

As I write this letter to you from the Dupree Mutual Funds office here in Lexington, Kentucky, the novel coronavirus (COVID-19) pandemic continues to take its course throughout the world and here at home as well. Each of us will be impacted by this virus in some way, whether directly or indirectly, and we certainly cannot escape the unsettling effect it has had on all aspects of our individual and collective lives.

For those of you who are directly affected by COVID-19, suffering with illness or the loss of a loved one, our entire team at Dupree sends heartfelt sympathy, thoughts, and prayers. For those of you caring for the ill or for the broader health of our communities, we offer our support and gratitude.

While these are indeed unprecedented and unsettling times in many ways, I want to reassure you that, although we have made some adjustments, very little has changed here at Dupree Mutual Funds. While we are following guidance and recommendations issued by the Centers for Disease Control (CDC) and other public health agencies to ensure the health and safety of our employees and customers, our office is fully operational. Our staff is here to answer any questions that you may have or to assist you with any account service requests. We want you to know that we are committed to maintaining the exceptional customer service that you have come to expect.

Municipal Market Update:

The municipal bond market has not been immune to the uncertainty and volatility caused by the spread of this global health crisis. The municipal bond market enjoyed sixty straight weeks of positive inflows, and then suddenly and without warning, experienced a dramatic downturn. The downturn started during the week of March 9 as fears of COVID-19 mounted and the U.S. declared a public health state of emergency. Along with U.S. Treasuries, municipal bonds faced extreme liquidity challenges. The temporary loss of liquidity in high quality fixed-income markets was a stark reminder that there truly is no such thing as a “safe haven” asset when fear turns to panic.

This is precisely what happened over the past couple of weeks when investors frantically sold large amounts of their highest quality assets (mostly U.S. Treasuries and municipal bonds) to raise cash. The indiscriminate selling led to an unprecedented spike in municipal yields and sharply lower municipal bond prices.

Fortunately, the dislocation in the municipal bond market did not last very long, and the rout reversed itself just as quickly as it started. The Fed announced a wide array of emergency measures and funding facilities to assist financial markets. On March 15 the Fed lowered the target rate for the fed funds rate to 0 to ¼ percent. Subsequently, the Fed also announced a large scale quantitative easing (“QE”) program which includes a pledge to buy an unlimited amount of Treasury securities and agency mortgage-backed securities.

To help support the municipal bond market and to provide additional liquidity to money market mutual funds, the Fed announced a Money Market Mutual Fund Liquidity Facility (MMLF) that will allow eligible borrowers to pledge certain short-term municipal debt with a maturity not exceeding twelve months. Another stimulus measure authorizes the Secretary of the Treasury to inject cash ($454 billion) into the financial system by permitting the Fed to make open market purchases of longer-term state and municipal debt and also by backstopping lending to states, municipalities, counties, and corporations. The combination of newly announced monetary and fiscal policy measures quickly led to a positive change in investor sentiment which helped stabilize the municipal bond market and allowed tax-exempt yields to return to more normal levels. However, states and municipalities will undoubtedly come under additional financial pressure as the long recovery process begins.

Against this backdrop, we think there are a few key points worth keeping in mind. State and municipal issuers are essentially monopolies. Unlike corporations, government issuers have the ability to raise prices (i.e., taxes) to service their debt payments. This additional flexibility makes municipal bonds stronger than corporate bonds with comparable credit ratings. Historically, defaults of investment grade municipal bonds are very rare. Importantly, states are required by their constitutions to balance their budgets. Bonds also provide a valuable hedge against an economic slowdown or recession, which now unfortunately, seems inevitable. Finally, as recent market conditions have painfully reminded us, high quality bonds help smooth out the volatility of an all equity investment portfolio.

We are staying busy actively managing our funds and taking care of the hard-earned dollars you have entrusted to us. Our portfolio managers are working diligently to evaluate the impact of recent events on our individual bond holdings. Among other things, our portfolio managers are identifying and potentially reducing our exposure to any bonds in sectors that may be disproportionately affected by COVID-19. They are also carefully reviewing and monitoring issuers’ financial statements to evaluate credits for potential downgrade risks. In this environment, we believe it’s more important than ever to have an experienced professional keeping a close eye on your municipal bond investments.

Our late founder, Tom Dupree, would never miss a chance when bond markets got choppy and bond prices were volatile to remind me and others that when you invest in our funds you purchase a future stream of income. We think it’s helpful and also reassuring in times like these to remember that the bulk (in excess of 90% for periods as short as 5 years) of the total return of a fixed-income investment is derived from the income component. Over the long run, price changes (up or down) represent a very small component of the total return of a fixed-income investment. You can take some comfort in knowing that regardless of how choppy the market gets and no matter how much the share prices of our funds change, the dividends of each of our funds are expected to remain stable.

I want to take this opportunity to thank our employees for their hard work and dedication during this difficult time. They are a wonderful team of professionals. I also want to thank you for being a loyal and valued customer. None of this would be possible without your support. Please don’t hesitate to call us if we can be of service.

Take care and stay safe.




Allen E. Grimes, Ill President

Letter to the Shareholders: December 31, 2019


Dear Shareholder:

What a difference a year can make. In 2018 virtually every asset class (municipal bonds & U.S. Treasuries being notable exceptions) lost money for investors. This year has been the exact opposite—virtually every asset class has generated strong positive total returns for investors. While a number of geopolitical events created lots of uncertainty and some market volatility, financial markets nonetheless demonstrated remarkable resiliency in 2019.

Like most other asset classes, fixed-income investments delivered above average returns in 2019. The municipal bond market enjoyed its best year since 2014 with demand for safe-haven assets and tax-exempt income pushing bond yields lower and bond prices higher. The Bloomberg Barclays Municipal Bond Index provided a total return of 7.54% for the 12-month period ended December 31, 2019. Tax reform, favorable supply-and-demand technical factors, benign inflation, declining default rates, improving credit quality, and a favorable interest rate environment all contributed to the strong performance of the municipal bond market in 2019.

The $10,000 cap on the State and Local Tax (SALT) deduction that was enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA) increased the tax burden for individuals that itemize deductions and has led to a surge in demand for municipal bonds. The increased demand has been reflected in large municipal bond mutual fund inflows which have set a record this year. Even though the TCJA reduced the corporate tax rate from 35% to 21% (which resulted in banks and some insurance companies reducing their tax-exempt holdings), the decline in demand by these institutions has largely been offset by the surge in demand by retail investors.

At the same time that demand for municipal bonds has increased, the net supply of tax-exempt bonds has continued to decline from the peak levels seen in 2016 and 2017. Issuers have continued to be very efficient at calling higher coupon tax-exempt bonds. That, combined with the elimination of tax-exempt advance refundings under the TCJA, has significantly reduced the net supply of tax-exempt bonds. One of the most interesting developments in the municipal bond market this year is that low absolute interest rates and elimination of tax-exempt advance refundings have caused the supply of taxable municipal bonds to surge as states and municipalities have utilized more nontraditional bond deal structures. Taxable municipal issuance is expected to continue to grow with some analysts predicting that it could approach $100 billion in 2020 if interest rates remain stable.

Inflation is a fixed-income investor’s worst enemy. Fortunately, key measures of inflation have continued to be subdued. The Fed’s preferred inflation gauge, the core PCE, increased at an annual rate of only 1.6% in November which continues to run well below the Fed’s 2% inflation target. Near-term and long-term inflation expectations have also continued to be well anchored.

Default rates of investment grade municipal bonds have continued to run at historically low levels as credit conditions have continued to improve. State and local government revenues have continued to show signs of improvement. According to data compiled by the Urban Institute, combined state and local revenues were up 11.1% in the second quarter of 2019 compared to the same period last year. Many states have been successful in strengthening their rainy day reserve funds. According to rating agency data compiled by Moody’s Investors Service, municipal bond upgrades exceeded downgrades by a wide margin in 2019.

At the end of July, the Federal Reserve Open Market Committee (FOMC) surprised the market and cut the fed funds rate for the first time in over a decade. The July interest rate cut was followed by two additional one-quarter point cuts to the fed funds rate in September and October. Chair Powell has made it clear that the FOMC intends to keep the fed funds rate on hold for the foreseeable future. The FOMC’s pivot towards an easing stance acted as a tailwind for municipal bonds during the second half of this year.

I attended a municipal bond conference in New York City a couple of weeks ago that had lots of really smart and seasoned municipal bond market participants offering their views about where they think the municipal bond market is likely headed in 2020. The good news is there seemed to be a consensus that most of the themes that propelled the municipal bond market’s performance in 2019 would remain largely intact next year leading to solid returns, albeit slightly lower than this year.

One of the other main items discussed at the conference was the fast growing trend in the investment industry towards additional Environmental, Social, and Governance (ESG) investment. ESG investing has been touted as the next “disruptive” change in investment strategy and combines environmental, social, and governance factors into traditional investment evaluations and decisions. Among other things, ESG investing is driven by the concept that investment objectives and goals and personal values aren’t mutually exclusive.

One of the main takeaways was that, in many ways, investing in the municipal bond market represents the original ESG investment. After all, when states and municipalities issue bonds, the proceeds are frequently used to finance environmental or green projects such as wastewater treatment facilities or renewable energy projects (the “E”) or other socially responsible public projects such as hospitals, schools, and affordable housing (the “S”). Municipal bond issuers are invariably subject to good governance practices (the “G”) due to federal tax and disclosure requirements and other compliance obligations such as bond indenture requirements. Citigroup estimates that approximately $2.9 trillion, or 76% of the municipal market, is likely to screen well for ESG investors. We think that’s a powerful and comforting thought.

Thank you for investing with us. All of us here at Dupree appreciate your investment in the Funds and wish you the best in 2020. Happy New Year!




Allen E. Grimes, Ill President