Tax Exempt Fixed Income Strategy

Through the first six months of 2002, municipal bond investors continue to be big winners. This is especially true when returns are compared to continued low inflation, 1.6% annually as reported by CPI, and the low historic yield levels, 1.2% on tax exempt money market funds. In fact, Oakwood tax exempt clients have fully participated in this positive environment.

We see little on the horizon to get in the way of continued strong support for municipal securities. There is an increase in the shortage of new issue supply in many specialty states such as California, in the face of a growing appetite from individual investors, who use tax exempt bonds for asset diversification and tax benefit reasons. On the other hand, yields are now approaching levels that may prompt some investor resistance. This is not to imply that rates will move significantly higher, only that yield levels appear to fully reflect current market conditions and are likely to remain in a more defined yield range.

In this environment, we continue to focus our attention on a modest portfolio restructuring. As an example, for existing California clients, this involves the selective selling of previously purchased general market holdings, in favor of California-specific credits, for an after-tax yield advantage. For new clients with existing securities, we were able to capitalize on a recent period of market volatility by selling smaller, less liquid positions at market highs, in favor of larger, more liquid positions, during a period of market weakness. For all clients, we currently find value in the 3 to 6 year maturity areas, where yield gains are somewhat exaggerated versus short maturity alternatives. As a complement to these choices, we are able to capture even more yield by investing in the 10 to 14 year maturity areas. Furthermore, by targeting above market coupon levels, we are still able to garner sufficient downside market protection should interest rates move higher.

A common denominator for existing holdings and new purchases is an emphasis on credit quality. Specifically, during this period of economic uncertainty and budgetary constraint, we continue to avoid hard-hit states that are highly dependent on personal and corporate tax revenues for survival. In fact, the general obligations of states like California and New Jersey, which have already been downgraded at least once, must have additional insurance backing, to even be considered for inclusion in Oakwood’s client portfolios. Instead, we prefer to concentrate on high quality cities and towns, essential service type issuers and government backed credits, within those states.

While the interest rate picture and demand for tax-free investments remains favorable, we are mindful that preserving capital is of primary importance to all clients. We believe our current mix of bonds is ideal to capture further appreciation potential, without subjecting the portfolio to unnecessary risk. All security choices provide maximum liquidity and ample flexibility to take advantage of market opportunities as they appear.