October 2010

If you want it done right …

“Do it yourself,” says Timothy McGregor, the veteran manager of the Northern Intermediate Tax-Exempt Fund. “We don’t rely on outside research to determine if a bond meets our credit standards.”

If you detect a note of caution in McGregor’s approach, you’d be right. Along with his team of credit specialists, McGregor casts a skeptical eye on the economic assumptions, coverage ratios and other key metrics of a bond before adding it to the Fund’s portfolio.

Trust but verify
It’s not that McGregor dismisses outside research. “We respect the rating agencies,” he says. “They have an important role to play.”

It’s just that he doesn’t take their word as gospel.

McGregor notes that the sheer size of the municipal market — over one million bonds from 50,000 issuers — makes it inefficient. The uncertain outlook for the economy adds to the problem.

Except that it’s not really a problem.

“We like inefficient markets because they give us the opportunity to find bonds that we believe have been improperly rated or priced,” he says.

Beyond quality
Besides emphasizing credit quality — more than three-quarters of the Fund’s holdings were rated AA or higher at the end of the third quarter — McGregor strives to mitigate risk by avoiding leverage and derivatives. He also utilizes the entire yield curve, while focusing on maintaining a medium duration.

“We like cushion bonds, which offer coupon rates equivalent to longer-dated issues but are callable within a few years,” he says. The call feature effectively lowers interest rate risk.

As of September 30, 2010, about 15% of the Fund’s holdings mature within a year, providing the potential for additional protection if rates rise. The fact that short-term munis have yielded more than similar-maturity Treasuries is a bonus.

McGregor is sensitive to the tax ramifications that shock some investors in tax-exempt bonds. He notes that the Fund currently has virtually no exposure to securities subject to the alternative minimum tax.

While making no promises, McGregor is proud that the Fund has not suffered a single default during his nearly 12 years at the helm.

There might be a reason for that.

“Markets go up and down,” McGregor says, “but quality never goes out of style.”

Past performance is no guarantee of future performance. All data is as of date indicated and subject to change.

Bond Risk: Bond funds will tend to experience smaller fluctuations in value than stock funds. However, investors in any bond fund should anticipate fluctuations in price, especially for longer-term issues and in environments of rising interest rates.

Tax-Free/AMT Risk: Tax-exempt funds’ income may be subject to certain state and local taxes and, depending on your tax status, the federal alternative minimum tax.