News & Letters

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!

Sincerely,

Allen E. Grimes, Ill President

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.

Sincerely,

Allen E. Grimes, Ill President

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!

Sincerely,

Allen E. Grimes, Ill President

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 www.dupree-funds.com. Please call us if you need any assistance with the registration process.

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

Sincerely,

Allen E. Grimes, Ill President

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.

Sincerely,

Allen E. Grimes, Ill President

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.

Sincerely,

Allen E. Grimes, Ill President