Tax-free municipal bonds produced positive returns but trailed taxable bonds in the first quarter of 2016. Limited supply and solid demand have created a strong technical environment for munis, despite the Fed's December rate hike and the potential for additional rate increases this year. Year-over-year issuance has been declining due to a sharp drop in refinancing activity, and muni market inflows have been strong. Intermediate- and long-term Treasury yields fell sharply, while municipal yields decreased to a lesser extent. In the municipal market, longer-maturity bonds outperformed shorter-maturity issues, and lower-quality securities outperformed higher-quality bonds. In terms of sector performance, revenue bonds outperformed state and local general obligation (GO) bonds.
The Maryland Short-Term Tax-Free Bond Fund returned 0.55% in the quarter compared with 0.35% for the Lipper Short Municipal Debt Funds Average. For the 12 months ended March 31, 2016, the fund returned 0.86% versus 0.56% for the Lipper Short Municipal Debt Funds Average. The fund's average annual total returns were 0.86%, 0.83%, and 1.86% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2016. The fund's expense ratio was 0.53% as of its fiscal year ended February 28, 2015.
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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.
We continue to emphasize revenue bonds, favoring the relative security of specific claims on revenues versus the generic pledges of taxing power associated with GO debt. Health care and education remain our two largest allocations. Our exposure in prerefunded securities has increased over the past year but remains well below that of our benchmark; these bonds provide a good source of liquidity for the portfolio. Given our limited opportunities to buy lower-rated, higher-yielding Maryland debt, the majority of the portfolio is allocated to AAA and AA rated bonds. However, we have been able to find some attractive opportunities in the BBB rated category, which now stands at 17% of assets and offers the portfolio potentially higher yields.
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, perhaps just earning the coupon income offset somewhat by modest declines in principal values. Munis should be less susceptible to rising rates than Treasuries given their attractive tax-equivalent yields and the steady demand for tax-exempt income. 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.