Virginia municipal bonds declined in the third quarter of 2013 as interest rates rose across all fixed income markets. Longer-term Treasury interest rates rose to two-year highs through early September. However, bond prices rallied and yields retreated in the final weeks of the quarter when the Fed surprisingly delayed a widely expected mid-September reduction of asset purchases and as an October federal government shutdown and debt ceiling showdown appeared likely. Long-term municipal bond prices fell, as 30-year muni yields rose for the quarter, but finished below their highest levels. Short- and intermediate-term securities performed better than long-term issues as yields declined for the quarter. Lower-quality munis in the investment-grade universe underperformed higher-quality issues. High yield munis also struggled.
The Virginia Tax-Free Bond Fund returned −0.45% in the quarter compared with −1.91% for the Lipper Virginia Municipal Debt Funds Average. For the 12 months ended September 30, 2013, the fund returned −3.73% versus −4.96% for the Lipper Virginia Municipal Debt Funds Average. The fund's average annual total returns were −3.73%, 5.71%, and 3.96% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2013. The fund's expense ratio was 0.47% as of its fiscal year ended February 28, 2013.
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Virginia is a well-managed, bondholder-friendly state. As such, we tend to have larger weights in higher-rated credit baskets, although we are trying to take advantage of the limited opportunities available in lower-quality, investment-grade bonds. We have a significant allocation to transportation issues, where we prefer essential service revenue bonds, particularly airports and toll roads. During the most recent quarter, we added to our transportation allocation by purchasing multiple bonds tied to the toll road projects in Virginia that we favor. Our exposure to Virginia hospitals is also significant given that the state has several large, high-quality hospital systems. We maintain only modest exposure to higher-risk assets, such as lifecare and tobacco, although we will add to these deals when we believe they offer favorable value and we are comfortable with the structure of the bonds. We have been avoiding Puerto Rico debt given the commonwealth's deteriorating fiscal situation.
The decline in municipal bond prices has rattled some investors, but it does not represent a fundamental change in the nature, quality, or risk characteristics of the market. We continue to believe that Virginia municipal bonds offer good investment opportunities for investors with a long-term focus and attractive tax-free income in what is still a very low interest rate environment. The recent underperformance of long-term munis makes their nominal and tax-equivalent yields even more compelling, but if rates continue rising unabated and market outflows persist, further price declines are likely. As always, we are on the lookout for attractively valued bonds issued by municipalities with good fundamentals-an investment strategy that has served our investors well in the past.