Arizona Tax-Exempt
as of December 31, 2013
Fund Commentary
Following months of speculation, in December the Federal Reserve finally announced plans to begin tapering its extremely accommodative monetary policy. The central bank was responding to signs of an accelerating economy and to concerns over potential asset bubbles. Bond markets had largely “priced in” this reduction in stimulus. Treasury rates sharply increased during the quarter and the yield curve steepened, continuing 2013’s trend. Yields of municipal issues with maturities longer than five years also rose, as tax-exempt bonds outperformed their Treasury counterparts across the yield curve. The municipal market benefited from a reduction in new issuance despite experiencing steady and sizable withdrawals from mutual funds.

For the fourth quarter, the Arizona Tax-Exempt Fund returned 0.62%, and
-2.50% for the full year. During the period, we slightly reduced the Fund’s duration but kept it neutral versus the benchmark. To take advantage of an historically steep Arizona yield curve, we slightly increased positions in longer maturities. With regard to structure, we added higher-coupon bonds to help protect against rising interest rates. In light of narrow credit spreads, our high-quality bias remains in place. As of year end, the Fund had no holdings of BBB-rated bonds and no exposure to Puerto Rico.

Going forward, we will watch for any significant changes that Chairman Yellen brings to the Federal Reserve. At the federal level, we will monitor the debate concerning tax-exempt debt policy. We will also focus on in-state demand as Arizona residents feel the impact of higher taxes.
Investor Profile

If you are an investor who favors high current income exempt from federal income tax and who is looking for an investment intended to be exempt from Arizona state personal income tax, this Fund may be ideal for you. It is particularly well suited for income-oriented investors in higher tax brackets willing to assume some risk of principal in exchange for higher yield potential. Income from the Fund may be subject to federal alternative minimum tax (AMT), state and local taxes.

  • Concentrate on investments in Arizona state-specific, investment-grade municipal bonds which are exempt from federal income tax and Arizona state personal income tax while maintaining an average maturity, under normal circumstances, between 10 and 30 years.
  • Invest in high-quality securities, primarily investment-grade debt.
  • Select investments on the basis of their relative value with a focus on total return.
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Not FDIC insured | May lose value | No bank guarantee

†Northern tax-exempt fixed income funds' and Northern High Yield Fixed Income Fund's Average Duration is calculated using the modified duration formula. Other Northern fixed income funds show the option-adjusted duration. Duration is a measure of a bond fund's sensitivity to changes in interest rates.

*Distribution rate and tax-equivalent distribution rate represent the annualization of the Fund's distributions for the prior month ending on the date shown, including capital gain distributions. The 30-day SEC yield and tax-equivalent 30-day SEC yield represent the annualization of the Fund's net investment income, excluding capital gain income. The tax-equivalent distribution rate and tax-equivalent 30-day SEC yield are based on an assumed tax rate of 47.9% for Arizona, 55.7% for California and 43.4% for national municipal funds.

**Per share paid out March 24 with a record date of March 21. The amount shown represents dividends paid for net investment income and excludes distributions from capital gain income.

Past performance is not indicative of future results. Institutional investor award winners are chosen by the editorial staff of Institutional Investor magazine based on their market intelligence, performance data and additional information received from the industry following a public call for nominations. Manager winners are also selected by the editors of the magazine based on the results of a survey conducted of U.S. institutional investors.

Please carefully read the prospectus and summary prospectus and consider the investment objectives, risks, charges and expenses of Northern Funds before investing. Call 800-595-9111 to obtain a prospectus and summary prospectus, which contains this and other information about the funds.

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