Northern Tax-Exempt Fund Manager Timothy McGregor's Emphasis on Credit Quality has Rewarded Shareholders

January 2012

Timothy McGregor likes the letter A. Especially when two or three of them are strung together, signifying the top end of the investment-grade credit spectrum.

"Historically, the fund has performed well without buying lower-rated municipals," says McGregor, the veteran manager of the Northern Tax-Exempt Fund. "The little extra yield you can pick up isn't worth the risk of not getting paid back."

McGregor also likes to get paid back. Which explains why he sets his sights on higher-quality investments for his 180-bond portfolio.

Out of literally thousands of holdings over the years, the Northern Tax-Exempt Fund has never suffered a default on McGregor's watch.

Trust but verify
Despite the cautious approach, the Northern Tax-Exempt Fund, which recently lowered its net expense ratio by 30 basis points to 0.45%*, has outperformed its Morningstar peer group average as of December 31, 2011, during the last one-, five- and 10-year periods.

That outperformance is no accident, says McGregor, whose experienced research team seeks to identify vulnerable economic sectors and credits before it's too late.

"We respect the credit ratings agencies, but we don't take their word as gospel," he says. "In-depth, proprietary credit research is Northern Trust's calling card."

Aiming to generate competitive returns with less credit risk requires using the full toolkit of fixed-income strategies. These might include accessing the entire yield curve, understanding complex issues affecting industries and local governments, finding pockets of relative value, working with broker-dealers to get optimum trade executions, and deciphering the ultra-fine print of each bond covenant.

"It's highly technical work and probably not something that most individual investors could do well on their own," acknowledges McGregor.

Keep away
Looking ahead, McGregor thinks the unusually choppy environment for municipal bonds that began amid the global financial crisis in 2008 will continue. But he also sees favorable longer-term trends, such as reduced supply, heightened demand and low inflation in a slow-growth world.

And then there's the matter of taxes, the muni market's ultimate reason for existence.

If the top marginal tax rate is raised to help plug the massive federal budget deficit, the value of tax-free income could rise accordingly. McGregor doesn't know if taxes on wealthier Americans are going up, but he's quite sure of one thing.

"They're probably not going down," he says.

* Includes contractual expense reimbursements that, if not extended, will end on December 31, 2012. The gross expense ratio is 0.86%.

Past performance is no guarantee of future performance.

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.

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