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Letter to the Shareholders: June 30, 2016

“It’s not the return on my money I’m interested in, it’s the return of my money”
Mark Twain

Dear Shareholder:

The month of June was filled with a couple of big surprises for financial markets which brought to mind the above referenced quote attributed to Mark Twain. The first surprise came on June 15th when the Federal Open Market Committee (FOMC) abruptly changed course and decided to hold short-term interest rates steady. In the weeks leading up to its June meeting, Chair Yellen had signaled that she felt the economy was probably healthy enough to nudge short-term rates slightly higher. The decision from the FOMC not to raise rates was unanimous. That was notable as Kansas City Fed President Esther George had previously dissented in March and April in favor of a rate increase. The FOMC statement emphasized the central bank’s uncertainty about the timing and path of future interest rate hikes and cited “persistent headwinds” such as slow productivity growth, softening labor market conditions, and weak business investment. The Fed acknowledged that these structural forces could keep interest rates on hold for longer than anticipated. The new consensus of Fed Governors to “go slow” with future interest rate hikes caused bond markets to rally with yields grinding lower and prices moving higher.

The second surprise came at the end of the month with the approval of a referendum by the British to exit the European Union (EU). The Brexit “leave” vote caught financial markets completely off guard and led to a dramatic sell off in equities. The British pound plunged to levels last seen in the mid-1980s, and bond yields dropped (prices up) to near historic lows.

The stampede out of stocks and into “safe haven” assets such as U.S. Treasuries and municipal bonds caused an already hot municipal bond market to rally even further.

So where do we go from here in a post-Brexit world? Given the unprecedented political and economic uncertainty that currently exists, we believe municipal bonds offer a win/win situation for investors seeking to preserve capital and earn an attractive return in a world of heightened volatility. Slower economic growth, a continued flight to safety trade, and lingering uncertainty should act as a support for municipal bond prices going forward. The Organization for Economic Cooperation and Development (OECD) recently issued a warning that the global economy is slipping into a self-fulfilling “low-growth trap.” The European Central Bank has launched yet another round of quantitative easing to try to stimulate the economies of the EU member countries.

On the domestic front, a number of economists and market forecasters have raised the odds of the U.S. entering a recession in the next year. Bill Gross, interviewed shortly after the Brexit vote was announced, suggested that the chances of the U.S. entering a recession in the next year are as high as 30% to 50%. Economists at JP Morgan Chase & Co. think the odds of a recession in the next year are the highest since the current expansion began seven years ago. Gross domestic product increased at a 1.1 percent annual rate in the first quarter. That is well below the trend growth rate which is around 3.25 percent. Inflation has continued to be subdued with the latest reading of the PCE deflator (the Fed’s preferred measure) increasing at a 0.9 percent annual rate. That is well below the Fed’s 2 percent inflation target rate.

Municipal bonds typically perform very well in a slow growth/low inflation environment. We think that will be the case during the second half of this year.

In the meantime, credit quality in the municipal bond market has continued to hold up well with default rates at or near historic lows. Market technical factors such as supply and demand are also very favorable. The net supply of municipal bonds is limited and demand for high quality bonds by retail and institutional investors has continued to be very robust.

Interestingly, the demand for municipal bonds is not only coming from domestic buyers, but also overseas from investors in Europe and Japan that currently have negative yields. The favorable supply/demand backdrop should continue to act as a support for municipal bond prices.

We would be remiss if we didn’t at least mention that uncertainty in financial markets and increasing bond prices have a cost associated with them, namely, lower yields.

Benchmark 30-year triple-A rated tax-exempt bond yields have dropped to around 2 percent. From a portfolio management standpoint, as older higher interest rate bonds are either called away from us or mature, it becomes impossible for us to replace them with bonds with the same or even a similar yield. The end result is that the income streams generated by each of our funds have gradually declined over time resulting in lower distribution yields to shareholders.

Notwithstanding lower yields, we continue to believe that municipal bonds offer an attractive risk/reward ratio for investors–especially when the tax exemption is taken into consideration. As always, we appreciate the trust that you have placed in us.


Allen E. Grimes, III
Executive Vice President

Letter to the Shareholders: March 31, 2016

Dear Shareholder:

I have been reading Sidney Homer and Richard Sylla’s A History of Interest Rates, an old standard and currently out in its fourth edition. It is a heavy (substantively and by weight) book with lots of information about the history of interest rates going back to almost the beginning of time. I’ve learned that ancient civilizations were far more sophisticated than we could imagine, and they too went through market swings caused by too much or too little credit, just like we do today. They also went through serious inflationary and deflationary periods and business recessions. While reading the book, it struck me that we have made little real improvement in how we handle our finances. Nothing really changes, yet, paradoxically, nothing remains the same.

Another book I’ve just finished reading is Jorg Hulsmann’s The Ethics of Money Production. Fortunately, it’s a much thinner book, but it’ s got some meat to it. The main focus of the book is on the social, cultural, and spiritual consequences of government-sponsored inflation. This is a book about how mankind has created money through the ages, always by diluting the outstanding currency held by “the people.” That’s us. If you are looking for a nice change of pace from your normal reading fare, I would suggest you consider this one.

One of the most advertised commodities these days is gold. The recurring sales pitch is: “gold will once again become currency, replacing the dollar when it fails.” Then, the conclusion is: “gold will become the only currency used by the government and therefore, priceless.” The fact is gold has declined in price for the five most recent years. In the five years before that, gold prices rose by about the same amount. This is to say, if you bought gold ten years ago you would have no gain t oday, but you would have expenses.

Investing in gold has unique problems. There is the need to keep it safe, so you will have to find a safe vault, preferably not in your home. You’re better off to let your broker or banker keep custody of your gold. This means you don’t get to see it. That’s no fun, and there will be a custody fee.

You can’t buy a chicken with gold, at least not easily. You don’t have the capacity to make change. Neither the buyer nor the seller know for certain that a coin is real gold. In my opinion, there are better options.

I don’t think it will surprise you to learn  that I  believe a  high quality portfolio of municipal bonds is a superior option. I’ve been in the securities business for over half a century; one thing I’ve learned is to never underestimate the importance of having a reliable stream of income. Tax-free income is even better.

Joe Creason, the Kentucky folklorist, tells of an old mountain man who was finally convinced by friends to take his money, buried in a coffee can in the woods, and put it in a bank for safekeeping. He did so with fear and trembling, but the very next morning, he appeared at the bank when they opened, with instructions to withdraw the entire amount. When the money was handed to him, he stood at the cashier’s window and slowly counted it twice. “Isn’t it all there?” the cashier asked. “Yep,” was the grudging reply, “but just barely!” A little skepticism is healthy, but too much will lead to doing nothing, and your income will never change.

Did you know that in my day, Navy officers on sea duty had to pay for their food that they consumed onboard ship? Well, they did, but they had the privilege of eating in the ship’s ward room and having a greater variety and quality of food. They also had sailors that were cooks and prep chefs. Each ship had a loosely run organization called ” officer’s mess” into which every officer paid in about $25 a month (remember, this was about sixty-five years ago). A junior officer was always to be the mess officer. The Chief Steward would buy the food, but the mess officer had to keep the books, collect the money and so on.

I had mess officer duty the month before we were to leave for Korea. We had the ship in dry dock in Boston Shipyards getting our bottom barnacles scraped. The married officers were dreading leaving their wives. The Captain was married, and so it was easy to get him to order all of the unmarried junior officers to stay aboard for extra officer of the deck duties at night, which was not too swift, in our minds. So, two or three of us were determined to even things out a bit. Married officers were arriving at the ship well past 9 a.m., so they didn’t have breakfast, and they went home at 4 p.m. so they didn’t have dinner. We saw an opportunity.

While the ship was in dry dock we could bring wives or dates aboard for dinner. But all the wives were down in Rhode Island, where the ship was stationed. All of the potential dates were in Boston and just hoping they would get an invitation to go aboard our destroyer for dinner. And, what a dinner it was! We were eating caviar, prime beef, prime lamb chops, shrimp cocktail and you name it. The married officers, by going home for dinner and staying home for breakfast, were subsidizing our feast. All they got for lunch was peanut butter and jelly.

It’s an experience like that that made me a good numbers man, I think?


Very truly yours,
Thomas P. Dupree, Sr.