Tax-free municipal bonds produced strong returns in the third quarter and outperformed taxable bonds. Both U.S. Treasury and municipal bonds rallied and yields fell on the news that the Federal Reserve's policymaking committee opted not to increase the benchmark short-term interest rate at its September meeting, as adverse international developments offset ongoing improvements in the U.S. labor market. Longer-maturity municipals generally outperformed shorter-maturity bonds as the municipal yield curve flattened over the period. In terms of sector performance, revenue bonds and general obligation (GO) debt fared about the same in the last three months. High yield tobacco bonds performed particularly well, outpacing the broad municipal market by a wide margin.
The Tax-Free High Yield Fund returned 1.44% in the quarter compared with 1.78% for the Barclays 65% High-Grade/35% High-Yield Index and 1.58% for the Lipper High Yield Municipal Debt Funds Average. For the 12 months ended September 30, 2015, the fund returned 4.26% versus 2.51% for the Barclays 65% High-Grade/35% High-Yield Index and 4.15% for the Lipper High Yield Municipal Debt Funds Average. The fund's average annual total returns were 4.26%, 6.02%, and 4.89% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 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.
We are underweight in GOs as a result of our concerns about the long-term liabilities many state and local borrowers face in both pension and health care obligations to retirees. We prefer revenue bonds in general because they offer the relative security of specific claims on revenues versus the generic pledges of taxing power associated with GOs. Within revenue bonds, the portfolio is overweight in the health care segment, where issuers have bolstered their balance sheets, enhancing their creditworthiness. The fund's duration, which is a measure of sensitivity to interest rate changes, was longer than the benchmark's duration. This positioning contributed to relative returns as yields decreased.
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, there could be hurdles in the months ahead. In particular, with the Fed preparing to tighten monetary policy, we are mindful that rising rates would likely weaken the appetite for bonds with higher interest rate risk. However, with the Fed likely to act cautiously, the transition to higher rates may not be as painful as some fear. 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.