Municipal bonds enjoyed a strong quarter amid declining yields, increased demand, reduced issuance, and a successful early-March sale of bonds issued by Puerto Rico, which was downgraded to below investment grade by the major credit rating agencies in February. High yield tax-free bonds were especially robust and outperformed the investment-grade universe, as investors continued to favor securities with a yield advantage. Longer-term Treasury yields declined from the two-year highs reached at the end of 2013, as weakness in certain emerging markets and geopolitical tensions over Ukraine prompted some risk aversion.
The Tax-Free High Yield Fund returned 5.58% in the quarter compared with 4.22% for the Barclays 65% High-Grade/35% High-Yield Index and 5.25% for the Lipper High Yield Municipal Debt Funds Average. For the 12 months ended March 31, 2014, the fund returned −0.44% versus −0.40% for the Barclays 65% High-Grade/35% High-Yield Index and −2.00% for the Lipper High Yield Municipal Debt Funds Average. The fund's average annual total returns were −0.44%, 10.22%, and 4.78% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2014. The fund's expense ratio was 0.67% as of its fiscal year ended February 28, 2013.
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.
Our management of interest rates drove fund performance during the quarter. We maintained a modest underweight to shorter maturities and an overweight to longer-term bonds, which aided results as longer-term yields declined since the end of last year. Sector allocations were positive, reflecting low exposure to general obligations and our holdings in the revenue-backed sector, particularly industrial revenue bonds. We were also underweight in education securities. Credit selection was mixed. Some of our industrial revenue credits underperformed during the quarter, but securities in the health care, transportation, special tax, and prepaid gas sectors offset their negative impact.
Despite recent headlines about problems in Detroit and Puerto Rico, municipal bonds remain sound overall, with low default rates. We expect interest rates to rise due to Federal Reserve tapering and eventual monetary tightening, but rates should stabilize at higher levels. We believe the U.S. economy will continue to improve and inflation will remain subdued. Declining tax-free bond supply has been providing a tailwind for our market, and we expect this condition to continue for the remainder of the year. With elevated interest rates likely to come, the new marginal tax rate for affluent municipal investors will rise, making tax-equivalent yields increasingly compelling as the year progresses.