Tax Exempt Fixed Income Strategy

Municipal bond markets enjoyed a good finish to 2005, as yield levels either held steady or trended lower. History shows that unlike the taxable bond markets, high quality municipal securities seem to sidestep much of the daily emotion from conflicting economic data, and instead are more affected by underlying market fundamentals and overall trend direction. In our current environment of interest rate uncertainty and stock market fluctuations, municipal bonds continue to provide investors solid tax-free income and a necessary level of market protection. This is evident in Oakwood client portfolios as returns were positive for the year.

Similar to our forecast on the taxable markets, we believe municipal yield levels will begin to trend lower in all maturity areas during 2006. As shown below, longer municipal rates have already begun to respond to favorable inflation news.

As we near an end to Federal Reserve monetary tightening, we expect short yields to follow the direction in longer yields. As a result, for your review, the following reflects recent changes to maturity in our portfolio structure. These changes are reflective of an overall average maturity of 7.50 years and a duration target of 5.75 years.

As shown, we increased our allocation in the 10+ year maturity area to 25% while lowering holdings in short maturities. These changes are designed to improve the overall yield in client portfolios and provide dependable tax-free cash flow from future coupon payments. Furthermore, we continue to emphasize investments that have good call protection and to avoid bonds that are subject to alternative minimum tax (AMT). It is estimated that 20 million taxpayers will be affected by AMT and even a minor tax restructuring by Congress to eliminate this broadening tax consequence seems unlikely.

As you are aware, the economy has been able to handle the seemingly endless round of Federal Reserve interest rate hikes which have resulted in higher tax collections. As a result, tax receipts are running ahead of schedule for most state and local municipalities. This provides support for their outstanding debt obligations. Despite this, we will continue to own only the highest quality investments with an emphasis on issuer diversification. This entails a conscious effort to diversify both geographically within each state of client residency, and to diversify the various revenue sources backing the payment structure of each holding.

As previously stated, we are forecasting a good year for tax-free bonds as strong demand for this investment class continues. New bond sales during 2006 should top $400 billion as the infrastructure needs of this country are expected to grow exponentially. We note that many individual investors have become wedded to very short bonds and we expect to see a move to lengthen these holdings. This process should begin to materialize as investors respond favorably to the continued Federal Reserves efforts to keep inflation and the economy in check.