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Letter to the Shareholders: December 30, 2016

Dear Shareholder:

Bond yields have risen suddenly and dramatically (prices falling) since the election on November 8. The spike in yields was completely unexpected and caught financial markets and most investment advisers (including yours truly) off guard. Yields on 10 year AAA-rated municipal securities have increased by over 75 basis points in a little over six weeks. That’s a big move in a short period of time! On December 14, the Fed also raised the target range for the fed funds rate to ½ to ¾ percent. Many of you are probably wondering what the heck is going on and what to expect in the New Year.

Expectations for higher interest rates have climbed following Donald Trump’s election win. The market is betting that a new Trump administration will add a significant fiscal boost to the economy that will lead to higher growth rates, higher inflation, and higher budget deficits. This “reflationary” thesis has led to a pronounced selloff in bonds with yields rising and prices plummeting. The prospect of lower corporate and individual tax rates under a new Republican administration also helped fuel the selloff, particularly in municipal bonds.

Make no mistake; if all of this comes to pass, it is not bond-friendly. Some in the financial press are saying bond prices will decline for an indefinite period of time. In my sixty one years in the municipal bond business, I have witnessed a number of bond market declines (big and small) and, just like clockwork, eager stock brokers and some in the financial press have started warning that “now might be the time for investors to abandon fixed-income portfolios.” I may be wrong, but my advice to you is “don’t believe the hype.” I’m a cautious optimist who believes good things happen just when you think they won’t.

In the case of the bond market, I am confident it will find its equilibrium. From our perspective, higher yields present an opportunity for fixed-income investors, who have been starved for yield for the past eight years, to invest cash at a higher yield and help build long-term growth. When interest rates rise, new bonds pay a higher coupon, increasing the income investors receive. Interest income is the primary driver of bond returns.

Bond prices may well continue to be volatile for the next few months and perhaps even longer. While markets have reacted sharply to the election results, the truth is, it will take a significant amount of time for what has now been dubbed “Trumponomics” to unfold. Even if higher growth rates, higher inflation, and higher budget deficits are in our future, it will take time for all of this to occur. There is a good chance that proposed tax law changes may not take effect until 2018. It typically takes lots of time and effort to pass and implement infrastructure spending plans. In the meantime, what we have now is an economy that is sputtering along at a moderate pace, low inflation levels, and tons of money sitting in banks, unused.

If you are one of those investors thinking about cashing out and getting back in the bond market someday, I think you might be making a mistake. Experience has taught me that bond investors should be in their investments for the long haul. We have voluminous records of our monthly fund prices and dividend histories dating back as long as thirty seven years in the case of the Kentucky Tax-Free Income Series. If you put these figures together you get a number which is known in the industry as “total return.” Looking at these numbers one is immediately struck by how stable the total returns are over longer periods of time. Past performance doesn’t necessarily guarantee future results, but I can tell you the numbers definitely support taking a long term approach to fixed-income investing.

Buying high quality bonds and holding them for the long term is almost always a winning strategy. You need to think in ten year segments or maybe even twenty. The irony of a panicked bond investor who sells when bond prices are falling is that he or she typically doesn’t realize that their dividend hasn’t gone down at all. Even when prices decline, the coupon value of a high quality bond portfolio is still providing meaningful cash flow to an investor.

I have worn out some of our long term shareholders with my milk-cow story, but this is the time and place to remind you of it again:

Bond investing is like buying a milk-cow;

You go to the livestock market in town and buy the best milk-cow you can find;

You choose the one that looks healthy and gives the most and best milk, and pay;

You take her home and enjoy the milk she gives.

You do not go back to the market to find her price every day. You have already paid the price for her and were satisfied it was fair. You are wasting your time at the livestock market because you were buying the milk, not the cow.

We appreciate the trust you have placed in us. I hope you have a Happy New Year!


Very truly yours,
Thomas P. Dupree, Sr.

Letter to the Shareholders: September 30, 2016

Dear Shareholder:

I have a story to tell of something that I witnessed on the bridge of a U. S. Navy Destroyer about sixty years ago. To appreciate it, you have to understand that one of the first rules of the road requires that when two ships are approaching one another, the ship to the right, by law, has to maintain his course and speed. He has the right of way and, must not change his speed or direction until the other ship is clear of him. If you change your course or speed and there is a collision, you will likely end up paying damages. That’s why the Captain of our ship had standing orders to call him to the bridge anytime a passing vessel got close.

One night we were steaming south to Guantanamo Bay, Cuba, east of Charleston, S.C., about one hundred miles off shore. Suddenly a look-out on the bridge reported a light on the horizon. The officer who had the con, acknowledged the report. He also ordered the look-out to keep reporting on the contact. He didn’t believe a light more than seven miles away was a threat to anything, least of all, a collision. After awhile the look-out reported that it was the masthead light of a ship bearing 135 degrees and about 6 miles away. The bearing was not changing. We kept watching and, by now, the ship could be seen clearly in the moonlight. The bearing was not changing. That meant we were on a collision course and we had the responsibility of right of way.

The officer called the Captain to report. The Captain was on the bridge in about two minutes. He took the con (a navy way of saying he took control of the engine and rudder command responsibility.) and we began to wait. The mystery ship was getting closer and closer and the bearing was not changing. We were getting very close to a collision. A signalman had been trying to get an answer from the freighter on several commercial radio frequencies to no avail. Another sailor was flashing a powerful signal light at the bridge of the stranger. She would not acknowledge anything. There was time to remember that many international commercial crews put their ships on autopilot when in the open sea, and go to bed!

It was getting very close now. We could see flakes of rust under peeling paint. The big freighter towered over us; we could hear the wash of its bow wave. Our Captain opened his mouth to give an order but just then a lookout shouted “it’s turning to starboard”, and it was. The big ship’s bow swept down our port side and disappeared as the churning propeller followed. The Captain stood quietly, looking aft at the now disappearing freighter. He uttered one word: “Chicken”. Then he went back to his cabin to sleep.

It’s ironic but true; obeying the letter of the law nearly got us all killed.

I always want our shareholders to be in the know. Interest rates are very low (bond prices high) and there doesn’t seem to be any enthusiasm in financial markets, including the bond market. The Federal Reserve wants to raise interest rates, but can’t do it because the economy is not recovering fast enough. Bond prices may stay high (interest rates low) for some time. The Japanese have had low interest rates for many years, even decades. The Fed met on September 21 and decided to keep the fed funds rate unchanged. Perhaps more importantly, they also reiterated their belief that economic conditions will evolve in a manner that will warrant only gradual increases in the fed funds rate.

I think our portfolios of high quality investment grade bonds should hold up well, whatever occurs. The majority of our shareholders are “true” bond investors who understand the importance and value of buying a reliable stream of income. Investors should look to income and not price appreciation to drive returns for the rest of this year.

I think bonds will remain at or near their current levels until the end of the year. The state of the economy will also have the effect of holding prices of bonds up, if it continues to remain soft. Anything can happen. I think you will be happy to be with us if you are a dedicated fixed income investor.

If you are one of those folks who is looking for more income, look us over on our website which can be found at There you will find a copy of our Prospectus and performance data for each of our 10 funds. We might just be the place to put some more of your un-invested cash to work.

Thanks for being a part of our business. We appreciate each and every one of you.


Thomas P. Dupree, Sr.

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