The bond markets continued to experience volatility in the third quarter as participants reacted to the prospect that the U.S. Federal Reserve would soon begin tapering its quantitative easing program. Economic growth was mixed as the eurozone continued to recover from recession and emerging economies that had been growth leaders slowed. The U.S. economy continued to exhibit modest growth and low inflation. Interest rates rose until mid-September when the Fed surprised the capital markets by failing to announce a tapering in its bond purchase program while lowering the forecast for economic growth.
Municipal bond prices responded negatively to improved economic data and speculation over Fed policy. However, municipals were more heavily influenced by Detroits bankruptcy filing, and concerns over Puerto Ricos negative economic growth and high debt burden. In response to credit concerns and rising interest rates, municipal bond mutual funds experienced very heavy outflows. Credit spreads continued to widen during the quarter, with investment-grade credits outperforming high yield. Puerto Rico-related debt experienced forced selling and the largest price declines.
The Fund's return of -1.72% for the quarter underperformed the benchmark. This was principally the result of our overweighting of lower-quality issues versus the Index. However, the Fund outperformed its high-yield municipal fund peer group on our greater exposure to higher-coupon issues that cushioned against price volatility and less exposure to below-investment-grade securities. Our underweight in tobacco and Puerto Rico-related issues also contributed to returns during the quarter.
If you are an aggressive investor seeking a high level of current income that is largely free from federal income tax, you may find this Fund provides an attractive complement to a well-diversified portfolio. The Fund is best suited for long-term higher income investors willing to assume the additional risks associated with investing in high yield securities including above-average share price fluctuations. Income from the Fund may be subject to federal alternative minimum tax (AMT), state and local taxes.
- Concentrate primarily on municipalities that issue medium (rated A and BBB) and lower-quality debt (rated BBB and below). Lower-quality debt or high-yield securities are also commonly referred to as "non-investment grade" or "junk bonds."
- Manage to a benchmark index of 65% investment grade and 35% non-investment grade bonds.
- Select investments on the basis of their relative value with a focus on total return.