Tax Exempt Fixed Income Strategy

Similar to the taxable bond market, the tax-free bond market continues to search for a clear direction. From month to month, security values are either up or down depending on shifts in market sentiment, even though year-to-date returns are nearly unchanged. Oakwood has protected value through generous tax-free cash flow. Adding to market confusion is a tug-of-war between strong and weak economic reports and conflicting reports on inflation.

During this year, we have tried to avoid overmanaging portfolios by reacting to short term trends in market data and overreacting to data releases. As a result, we continue to hold an overweighting in short investments due to the passage of time and the avoidance of temptation to invest aggressively. In fact, sector comparisons show that intermediate 2 to 7 year tax-free yield levels versus taxable counterparts are at narrow spread levels not seen since the 1990s. Recently, we have witnessed some return to more normal ratios and spreads, as municipal yields adjust to continuing Fed tightening and as newly issued bonds set future yield levels.

For your review, we are beginning the second half of the year with the following maturity structure.

As shown, we are limiting new money purchases in the 2 to 7 year maturity areas, unless yield levels reach 75% to 80% of taxable Treasury yields. Fortunately, because the municipal yield curve is abnormally flat, there is little yield loss by staying short. In addition, we feel there is good value in the 7 to 15 year maturity areas with levels between 4.20% and 4.65%. For investors in highest tax brackets, this tax-free yield equates to a taxable equivalent of 6.46% and 7.15%, respectively.

For the first time in over two years, we are beginning to invest in State of California specific general obligation issues with insurance supplement in the short maturity areas. California, like most municipalities, has enjoyed the benefits of a strong economy and improved tax receipts. These factors, coupled with reductions in new issue supply and strong demand, have favored municipals. Strong demand for this sector should continue; however, we remain mindful that the trend in interest rates remains currently upward. As a result, we continue to emphasize an above market coupon, 5% or higher, in order to focus on income.

We believe that patience is the key and endorse the Fed’s stated objective to monitor ongoing data for signs that the economy will slow and inflation will trend lower. Our strategy is designed to take incremental steps toward preparing for a lower interest rate environment. This means that we will only hold bonds with maximum liquidity and maintain flexibility to extend maturities as opportunities surface.