Tax Exempt Fixed Income Strategy

Following a minor setback in January, municipal securi-ties have generated steady positive returns throughout the first half of 2003. This performance is being aided by an ongoing lowering of key interest rate indicators by the Federal Reserve accompanied by very low inflation. While it may be hard for investors to accept the present low interest rate environment, municipal bonds should continue to attract good interest, as investors adjust to a steady period of low interest rates and yield levels.

In addition, last year’s concern that the huge budget surpluses and steady cuts in federal tax brackets would reduce the advantage of tax-free bonds has all but disappeared. While there is indeed hope that the latest round of tax cuts will contribute to a jump-start in the economy, municipalities on both a state and local basis are beginning to offset the expected benefits by raising taxes. In fact, many experts believe that at least half of the intended stimulus will be offset by tax increases. Even Republican-led governments such as Ohio and Georgia have given in to higher taxes as a method to shore up revenue shortfall. For California, with its $38 billion shortfall, the situation has led to a budget gridlock, where there is as much resistance to expenditure cuts as tax increases. Unfortunately, it appears that both will be needed to reach a compromise.

For individuals investing in tax-free bonds the picture is somewhat brighter. This sector still provides the potential for an after tax-advantage over inflation with less risk than other investment classes. In fact, at Oakwood we feel comfortable with our overall portfolio structure and individual security choices. The Federal government can operate without a balanced budget for an indeterminate time; state and local governments are required to operate within a balanced framework. Therefore, we remain committed to purchasing premier municipalities that have very high quality debt ratings. We continue to reduce even our limited holdings of State-insured issues consistent with our previous decision to avoid the purchase of State-level debt for California residents. In our view, this decision is based on a likelihood of under-performance, not necessarily a fear of default or interest payment delays.

During this period of low interest rates, we intend to maintain an above market coupon profile within portfolios, in order to generate good cash flow to client portfolios. We will continue to modestly extend very short maturity positions for yield improvement in the three to seven year maturity areas. In addition, we are utilizing well-defined callable bonds as a way to further enhance yield within a narrowly targeted maturity band. We believe this strategy will result in good relative returns within a moderate risk framework. This strategy should continue to lead to good performance for the balance of the year. Our goal is to provide your portfolio with bonds of high quality and maximum liquidity.