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