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Letter to the Shareholders: December 31, 2017

Dear Shareholder:

It’s year-end, so I thought I would recap some of the major factors and events that influenced the municipal bond market in 2017. I’ll also briefly discuss a couple of factors that we think will be in play next year and hazard a guess about how the municipal bond market might perform in 2018.

The municipal bond market experienced a sharp sell-off after the election of Donald Trump on November 8, 2016. The sell-off, although sudden and pronounced, was relatively short lived. The municipal bond market bounced back quite nicely during the first half of 2017 and recouped almost all of the losses experienced after the election. For the full year, municipal bonds turned in a very solid performance with the Bloomberg Barclays Municipal Bond Index posting a 5.45% total return. Favorable supply-and-demand dynamics (i.e., lower supply combined with steady demand) prevailed for most of the year which helped support municipal bond prices. The yield curve continued to flatten over the past year with yields on the short end rising and yields on the long end declining. Longer-dated and lower credit quality bonds (with the exception of Puerto Rican bonds) generally outperformed shorter-dated and higher credit quality bonds during the year. Our decision, made many years ago, never to hold any Puerto Rican bonds in any of our funds has proven to be a wise one.

Starting in November of this year, municipal bond prices broadly declined as tax reform uncertainty took hold. The proposed elimination of the tax exemption for advanced refunding bonds and private activity bonds (PABs) caused issuers to rush to issue bonds that were scheduled to be brought to market in 2018. This “pull forward” effect resulted in a surge in supply, with issuers bringing to market over $55.6 billion in municipal bonds in the month of December alone. This broke the monthly supply record of $54.7 billion which was set back in 1985. The resulting supply-and-demand imbalance caused municipal bond prices to decline towards the end of this year.

The good news is the final version of the Tax Cuts and Jobs Act passed by Congress and signed into law by the President left the tax exemption for interest earned on municipal bonds intact. The compromise tax bill also left the tax treatment for PABs unchanged, but it did eliminate the ability of municipal issuers to issue tax-exempt advance refunding bonds. Most municipal market participants, including us, believe preserving the tax exemption for PABs is a positive development given that PABs make up somewhere between 20-30% of the overall municipal market. PABs are typically used to finance projects such as non-profit hospitals, nursing homes, college and university facilities, and certain airport improvements.

The loss of tax-exempt advance refunding bonds will likely have a mixed impact. This provision of the tax legislation is permanent and will likely lead to a significant reduction in the supply of municipal bonds going forward. Some market commenters have estimated that the total supply of municipal bonds could drop by as much as 25% next year as a result of the loss of tax-exempt advance refunding bonds and the “pull forward” effect. From our standpoint as portfolio managers, the end to advance refunding deals means that that it will almost certainly be harder for us to find bonds next year due to the reduced supply. For issuers, the curb on issuing tax-exempt advance refunding bonds means less flexibility in refinancing projects.

The Tax Cuts and Jobs Act also lowered the highest individual federal marginal tax rate from 39.6% to 37%. Most economists and market participants believe that the relatively small reduction in the top federal marginal tax rate won’t be enough to significantly impact demand for municipal bonds.  Even for investors in lower federal tax brackets, municipal bonds should continue to be very attractive on an after-tax basis. The reduction of the corporate tax rate from 35% to 21% will, in theory, make municipal bonds less attractive for corporate buyers such as banks, property & casualty companies, and life insurance companies. However, it remains to be seen whether the corporate tax rate reduction will actually impact institutional demand since corporate buyers derive other benefits from holding municipal bonds such as lower default rates, liquidity, and diversification.

We’re keeping a close eye on several issues that may impact the municipal bond market in 2018. At the top of this list are escalating unfunded pension liabilities which many states, cities, and counties will have to address. The Commonwealth of Kentucky’s unfunded pension obligations are among the worst in the country. The Commonwealth’s appropriation-backed debt was downgraded one notch from Aa3 to A1 by Moody’s in July of this year because of unfunded pension obligations. A further downgrade is a real possibility if the pension situation is not addressed. Increasing budgetary pressures caused by increased state Medicaid spending are also likely to be in the news next year.

There are a number of other factors that we think will be in play next year. I’ve already mentioned supply-and-demand, which we believe will remain very supportive for municipal bonds in the coming year. It’s pretty clear the Federal Reserve seems intent on raising short-term interest rates several times next year. However, we continue to believe the rate hikes will be very gradual, especially given the fact that key inflation measures have continued to stay stubbornly low. This may well lead to continued flattening of the yield curve with the spread between yields on the short and long ends of the curve being compressed further. After turning in a very solid performance in 2017, we remain optimistic that municipal bonds will deliver positive total returns again next year.

Thank you for investing with us. Happy New Year!


Allen E. Grimes, III
Executive Vice President

Letter to the Shareholders: September 30, 2017

Dear Shareholder:

The Federal Open Market Committee (“FOMC”) met on September 19-20 and, as expected, left the federal funds target rate (“FFTR”) unchanged at 1.00-1.25%. The FOMC’s assessment of the economy was mostly upbeat; however, the FOMC acknowledged continued concern about persistently low inflation. Conventional economic theory would dictate that prices for goods and services should be moving up, not down, in an economy that’s in its ninth year of expansion and nearing full employment levels. The Fed continues to insist that this “lowflation” is transitory in nature and will correct itself. However, other prominent central bankers and economists think this may be a more worrisome problem caused by long-term structural issues impacting advanced economies (other countries are also experiencing this). I feel certain we will hear more about this lively economic debate in the coming months.

The FOMC’s updated “dot plots” which attempt to forecast the future path of the FFTR contained a mixed message. The FOMC’s near-term (2017 & 2018) median FFTR estimates were unchanged. Financial markets interpreted this data as mostly “hawkish” meaning that that the FOMC would likely move forward with one additional quarter point rate hike this year, followed by three additional quarter point rate hikes in 2018 (resulting in a FFTR of 2.00-2.25% by the end of 2018). However, the FOMC lowered its FFTR median estimate for the end of 2019 to 2.7% from 2.9%. It also lowered its longer-run median FFTR estimate to 2.8% from 3.0%. Financial market s generally interpreted these downward revisions to the FOMC’s longer-term interest rate forecasts as “dovish”, hence, the mixed message. From our perspective, the changes to the Fed’s forecasts on the longer end reinforce our belief that the “lower for longer” thesis remains a viable one.

In an announcement perhaps more important than its updated economic projections, the FOMC also stated that it will initiate its balance sheet normalization program in October.  In August of 2007 before the financial meltdown, the Fed had a balance sheet that totalled approximately $869 billion. In an attempt to pump more money into the economy and stabilize financial markets, the Fed implemented a series of quantitative easing (“QE”) measures starting in late 2008 that involved purchasing U.S. Treasury and U.S. Government securities, including those issued by U.S. Government agencies, in the open market. The FOMC ultimately stopped purchasing these securities, but a couple of years ago it introduced reinvestment as a sort of “QE Lite” which essentially has allowed the Fed to buy bonds without growing assets. The Fed’ s current balance sheet is estimated to be just under $4.5 trillion.

Under the balance sheet normalization program, the FOMC will begin trimming reinvestments in U.S. Treasury securities by $6 billion per month and mortgage backed securities by $4 billion. The cuts to reinvestment will be gradually increased on a quarterly basis until they reach $30 billion per month for U.S. Treasury securities and $20 billion per month in mortgage backed securities. The FOMC did not specify an end date to its balance sheet normalization program, but most economists speculate that the Fed will continue to shed assets until its balance sheet approaches the $2.0-2.5 trillion range. Even when the FOMC completes its balance sheet normalization program, it will have a balance sheet substantially larger than it has carried in the past.

Now that the FOMC has outlined its balance sheet reduction plan, the critical question becomes how this might impact financial markets and, more specifically, bond yields? The honest answer to this question is nobody really knows for sure. The fact of the matter is the FOMC is in uncharted waters. Fed Chair Janet Yellen has expressed hope that the reduction in the size of the balance sheet will be “like watching paint dry.” While it remains to be seen how financial markets actually respond, we think there are a number of reasons to believe that the market impact will be relatively muted.

First and foremost, the Fed’s balance sheet reduction plan is passive in nature. We think this is an important point because the balance sheet will ultimately be reduced, not by active sales of assets, but rather by phasing out the practice of rolling over maturing assets. By allowing the balance sheet to shrink in this manner over an extended period of time it should, in theory, maximize predictability and minimize potential market disruption. Financial markets do not like surprises.

Second, the Fed is set to reduce the size of its balance sheet by roughly $300 billion over the next 12 months. Keep in mind that this is a relatively small number in the overall scheme of things. In the aggregate, the G4 central banks around the world have expanded their balance sheets by approximately $11 trillion since 2009. A number of economists have noted that ongoing asset purchases by the European Central Bank and the Bank of Japan, both of which still maintain active QE programs, are sufficiently large to offset the assets shed by the FOMC over the next year.

Third, although this may be somewhat counterintuitive, there appears to be little correlation between the Fed’s ownership share of the Treasury market and yields. If you look at a graph of Treasury yields versus the percentage of total marketable Treasury securities held by the Fed, it reveals that yields have both increased and decreased in the periods after the Fed started purchasing assets. As a practical matter, the Fed’s share of outstanding Treasuries has been in decline since 2015, during which time Treasury yields have actually declined. A wide variety of factors affect bond yields. In short, we’re not convinced that bond yields will move significantly higher as a result of the Fed’s unwinding.

Our annual shareholder meeting will be held on Tuesday, October 24, 2017 at 10:00 a.m. at the Hilton Lexington Downtown Hotel which is located at 369 West Vine Street in Lexington. Proxies have been mailed beginning on September 20, 2017 to shareholders of record as of September 6, 2017. If you haven’t done so already, please sign and return your proxy so that we can ensure that we have a quorum at the meeting.

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


Very truly yours,
Allen E. Grimes, III
Executive Vice President

Letter to the Shareholders: June 30, 2017

Dear Shareholder:

We’re halfway through the year and the municipal bond market turned in a very solid performance. That may come as a surprise to some folks. Not too long ago a number of pundits and market commentators had pretty much written off bonds based on speculation that a new Trump administration would lead to faster economic growth, lower tax rates, higher levels of inflation, and rising interest rat es. Events haven’t exactly unfolded the way some people were predicting back at the end of last year. Here’ s a quick overview of some of the key economic data that has affected the bond market during the first six months of this year.

Real gross domestic product {GDP) increased at an annual rate of 1.4 percent during the first quarter of 2017. That’ s well below the trend rate of growth and approaching what some economists would consider to be “stall speed”. Second quarter GDP growth is expecte d to be slightly bet ter, but still below desirable levels. The Fed’s own economic projections call for real GDP growth over the next three years to be in the range of 1.8 to 2.2 percent. It seems that economic growth is stuck in a 2 percent rut and it may be difficult to break out of it.

Inflation has continued to be subdued and prices for goods and services have actually declined in recent months. The Fed’s preferred inflation measure, the core personal consumption expenditures inde x {PCE), which strips out volatile food and energy prices, increased at an annual rate of 1.4 percent in May. Both the core and headline PCE readings rema in well below the Fed’ s 2 percent inflation target rate. Despite the fact that the economy is approaching full employment {the unemployment rate was 4.3 percent in May), there appears to be little or no wage price pressures that typically can lead to inflation . Generally, a slow growth, low inflation environment tends to support bond prices and that has certainly been the case during the first half of 2017.

Tax re form, both corporate and individual, continues to be discussed in Washington. So far, no real substantive details have emerged with respect to the anticipated overhaul of the tax code. The Trump administration has proposed to cut corporate and individual tax rates and simplify the tax code by eliminating many itemized deductions and/or exemptions. A couple of points are worth mentioning in connection with potential tax reform. Most importantly, the administration’s tax proposal preserves the tax exemption for municipal bonds. While it’s always possible things could change, we are very encouraged by the support that the current administration has shown for keeping the municipal bond tax exemption.

In theory, any reduct ion in marginal tax rates could potentially lead to a decrease in demand for municipal bonds since the exemption becomes less valuable. However, it is worth noting that the administration has proposed reducing the top federal marginal tax rate from 39.6 percent to 35 percent, an amount that is far less than previously thought likely. Most experts that follow the municipal bond market believe that the proposed cut in the top marginal rate is too small to significantly dampen demand for municipal bonds. We agree with that assessment. In the meantime, demand for high quality municipal bonds was very robust during the first half of this year.

On the supply side, net municipal issuance for the first quarter of 2017 declined substantially and came in at approximately -$14.1 billion below consensus estimates. The municipal bond desk at Citigroup estimates that the state and local government debt market will shrink by $39.5 billion over June, July and August as bonds mature faster than they are issued. This comes at the same time that investors will be receiving approximately $44 billion in interest payments. Favorable supply/demand trends helped support bond prices during the first half of this year. We think these positive technical factors will continue to support the municipal bond market during the second half of this year.

Federal Reserve Update:

The Federal Reserve Open Market Committee (“FOMC”) met on June 14 and raised the fed funds target rate an additional 25 basis points to  a range of  1.00-1.25%.  The FOMC statement noted that the FOMC had raised rates “in view of realized and expected labor market conditions and inflation. ” The FOMC acknowledged that inflation had declined recently and was somewhat below its 2 percent target, but suggested that it felt the drop was transitory in nature.  However, a number of Fed Governors  have noted in recent speeches that they believe the recent downturn in inflation and absence of inflation pressures gives the central bank additional scope for patience.

The Fed also released a formal balance sheet reduction plan. Prior to the recession, the Fed’s asset holdings were about $900 billion. The Fed started aggressively buying securities in the open market to support the economy and prop up the banking system in late 2008 and continued its purchases until October of 2014. To date, the Fed has amassed holdings of approximately $4.5 trillion on its balance sheet.

The start date for the balance sheet reduction plan was not specified, but most Fed watchers believe that it will commence later this year. Under the balance sheet reduction plan, the FOMC will gradually reduce its holdings by decreasing its reinvestment of the principal payments it receives from Treasury securities, agency debt, and mortgage-backed securities it currently holds. The goal is to reduce the size of the Fed’s balance sheet over an extended period of time without causing any market disruptions that might be caused if the Fed were to engage in outright sales of securities.

To sum up, despite widespread bearish calls at the beginning of the year, the municipal bond market performed very well during the first half of this year.  We think this is a timely reminder of just how important it is to take a long term approach to fixed-income investing.  More often than not, it pays off   to tune out all of the background noise, as it  may interfere with your ability to make sound investment  decisions.

As always, thank you for investing with Dupree Mutual Funds.


Allen E. Grimes, III
Executive Vice President

Letter to the Shareholders: March 31, 2017

Dear Shareholder:

The Federal Reserve met on March 15 and raised the fed funds rate an additional quarter point to ¾ to 1 percent. This was the third increase in the current rate hiking cycle. Once again, the Fed reaffirmed its view that additional rate hikes would be gradual and that rates would likely remain low for some time. The bond market interpreted this news as mostly “dovish”.There were no ‘hawkish” pronouncements and essentially no material changes to the Fed’s economic forecast.

The Fed’s economic projections continue to call for the fed funds rate to rise gradually over the next three years with the median fed funds rate topping out at 3.0 percent at the end of 2019. These projections are based, in part, on assumptions about what the “neutralrate” of interest is. In layman’s terms, the neutral fed funds rate can be thought of as sort of a “Goldilocks” rate, meaning a rate that is neither expansionary nor contractionary, but one that keeps the economy operating on an even level. In response to questions during the press conference that followed the meeting, Chair Yellen stated that her long-run assumption for the neutral rate is “1% or a little under”. This is a key piece of information because it helps explain the Fed’s current thought process about the appropriate interest rate policy path going forward.

At the risk of oversimplifying things, here’s a stab at explaining how the Fed’s current math and thinking works. The Fed has set an explicit 2% inflation target. If the Fed increases the nominal fed funds rate to 3.0% and inflation is running at 2.0%, then the real fed funds rate which is adjusted for inflation is equal to the neutral rate at 1%. In a perfect world, that is where the Fed would like things to end up in the long run–a rate that is not too hot, and not too cold. Currently, the inflation rate is around 1.80% and the upper range of the nominal fed funds rate is 1%. This means that the real fed funds rate right now is somewhere around -0.80%. Thus, from the Fed’s perspective, its current monetary policy is still very accommodative.

The Fed has begun to reduce the stimulus that it has been giving the economy by gradually nudging the feds fund rate up. In monetary policy jargon, this process is referred to as “taking away the punch bowl”. At some point, the Fed will start to reduce the size of its balance sheet which will also serve to reduce the amount of economic stimulus. The Fed has consistently stated that its policy decisions going forward will be data dependent.

So what does the recent incoming economic data look like? Most of the data reinforce the idea that the economy, in its seventh year of expansion, is continuing to grow at a modest pace with inflation staying relatively subdued. The Commerce Department released its third and final fourth quarter GDP estimate and revised it up slightly from 1.9 to a 2.1 percent annualized rate. The Fed’s economic projections call for real GDP growth to average around 2 percent for the next three years. The Fed’s preferred inflation gauge,·the core PCE, rose at an annual rate of 1.8 percent in February. The unemployment rate in February was 4.7% which is approaching full employment. While the incoming economic data continues to show improvement, we don’t believe it is strong enough for the Federal Reserve to deviate substantially from its “gradual approach” message anytime soon.

We think there is a good chance the current rate tightening cycle may play out in similar fashion to the last tightening cycle with one notable difference. The last interest rate tightening cycle lasted approximately two years from June 2004 to June 2006. During this two year time period the Fed raised the fed funds rate 17 times in 25 basis point increments. The fed funds rate started out at 1.25% and topped out at 5.25%.

It might surprise you to learn that during this two year time frame, municipal bonds experienced positive total returns as measured by the Bloomberg Barclays Municipal Bond Index. Among other things , this is a testament to the value of the income stream generated by bonds that helps to offset price declines. Suffice it to say, for fixed-incomeinvestors, income really does matter. While it is true that a sudden increase in yields can cause an immediate capital loss for fixed-income investors, the long-term total return impact to bonds is generally positive.

Most indicators suggest that the current rate cycle will be a gradual one with small incremental increases in the fed funds rate. However, we think this interest rate cycle will be much shallower than previous cycles meaning that the ultimate or terminal fed funds rate will be much lower than in previous rate cycles. Interestingly, economists at the Fed just published some new research that suggests that the neutral rate may be closer to zero than 1%. If this is true, then it may have significant implications for where the fed funds rate ultimately ends up (e.g., a zero percent neutral rate with 2 percent inflation would support a 2 percent nominal fed funds rate).

While we are relatively confident about where we think things are going from a monetary policy standpoint, the wild card in all of this is fiscal policy. The bond market experienced a selloff back in November on fears that a new Trump administration agenda would lead to more robust economic growth and higher levels of inflation. We mentioned in our last shareholder letter that we felt the “Trump trade” and resulting bond market selloff were somewhat overdone and that the bond market would eventually find its equilibrium. Some of what we said appears to have been accurate. There certainly is nothing easy or quick about pushing a legislative agenda through in Washington these days! The bond market has staged a small rally with yields declining (prices up) as it has become apparent that policy changes will take significantly more time than the market originally priced in.

In our opinion, the bond market will probably trade in a pretty narrow range over the next couple of months as the new administration’s fiscal policies take shape. In the meantime, probably the best advice we can give you is to “keep calm and carry on”. We have said it many times before, but we think it is worth repeating: buying high quality bonds and holding on to them for the long term is almost always a winning strategy.


Thank you for investing with us.

Very truly yours,
Allen E. Grimes, III
Executive Vice President

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