Tax-free municipal bonds produced positive returns and significantly outperformed taxable bonds in the fourth quarter. In fact, munis were one of the best-performing fixed income asset classes in 2015, helped by strong demand from investors, diminishing supply in recent months, and insulation from the turmoil in some global financial markets. The continued fiscal deterioration of Puerto Rico, a major muni issuer, and the Federal Reserve's first rate increase in more than nine years had limited impact on the broad muni market as technical factors remained supportive. Long-term municipal bonds outperformed shorter maturities as the yield curve flattened over the quarter, and lower-quality municipals generally outperformed higher-quality issues. High yield tobacco bonds performed particularly well, outpacing the broad municipal market by a wide margin.
The Tax-Free High Yield Fund returned 2.09% in the quarter compared with 1.60% for the Barclays 65% High-Grade/35% High-Yield Index and 2.22% for the Lipper High Yield Municipal Debt Funds Average. For the 12 months ended December 31, 2015, the fund returned 3.85% versus 2.80% for the Barclays 65% High-Grade/35% High-Yield Index and 4.28% for the Lipper High Yield Municipal Debt Funds Average. The fund's average annual total returns were 3.85%, 7.54%, and 5.00% for the 1-, 5-, and 10-year periods, respectively, as of December 31, 2015. The fund's expense ratio was 0.69% as of its fiscal year ended February 28, 2015.
For up-to-date standardized total returns, including the most recent month-end performance, please click on the Performance tab, above.
Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results.
Share price, principal value, and return will vary and you may have a gain or loss when you sell your shares.
The Tax-Free High Yield Fund charges a 2%
redemption fee on shares held 90 days or less.
The performance information shown does not reflect the deduction of the redemption fee;
if it did, the performance would be lower.
The fund's duration, which is a measure of sensitivity to interest rate changes, was slightly longer than the benchmark's duration. This positioning was beneficial as the yields of longer-maturity munis decreased. Our overweight to the industrial revenue subsector and underweight to the special tax subsector also contributed to relative performance. However, security selection in the industrial revenue and health care subsectors detracted. In general, we prefer revenue bonds to general obligation (GO) debt because they offer the relative security of specific claims on revenues versus the generic pledges of taxing power associated with GOs.
We believe that the municipal bond market remains a high-quality market that offers good opportunities for long-term investors seeking tax-free income. While fundamentals are sound overall and technical support should persist, investors should expect modest returns in 2016. Muni investors this year may just earn coupon income, possibly offset somewhat by declines in principal values. Muni bond yields are likely to rise this year along with Treasury yields-although probably not to the same extent. While higher yields typically pressure bond prices, we expect rate increases to be gradual and modest. Ultimately, we believe that T. Rowe Price's independent credit research is our greatest strength and will remain an asset for our investors as we navigate the current market environment.