Tax-free municipal bonds produced strong returns in the third quarter, outperforming taxable bonds. Munis are one of the best-performing asset classes year-to-date, as global markets and other higher-risk assets have fallen sharply in recent months in response to China's economic deceleration and tumbling commodity prices. 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 mid-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.
The California Tax-Free Bond Fund returned 1.74% in the quarter compared with 1.73% for the Lipper California Municipal Debt Funds Average. For the 12 months ended September 30, 2015, the fund returned 3.25% versus 3.37% for the Lipper California Municipal Debt Funds Average. The fund's average annual total returns were 3.25%, 4.85%, and 4.70% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2015. The fund's expense ratio was 0.49% 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.
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Most recent data suggest that the California economy continued its upward trend, and officials expect it to outperform the national economy over the next couple of years. Health care remains a significant allocation in the fund. We continue to favor revenue bonds over general obligation (GO) debt, a reflection of our longer-term concerns regarding pension and health care liabilities. While we have a positive outlook for the state of California's GO debt and the state is the fund's largest guarantor, we are underweight local GO debt due to concerns about the longer-term fiscal challenges facing many localities. Nevertheless, credit quality in California continues to strengthen as the improving economy benefits many municipal issuers.
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 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.