Spotlight on Tax Exempt Fixed Income Management

We understand that municipal bond clients have several options to manage their tax-exempt needs. The use of a mutual fund or individually selected investments may not result in a properly diversified portfolio, match client goals or be sensitive to tax planning. Our mission at Oakwood is to combine the best features of each option.

Income taxes can be one of the largest burdens on investment performance, reducing the benefits of capital gains and interest payments. In some cases good investment decisions are even postponed because of the untimely effects of taxes. An excellent investment choice for investors seeking protection from a significant amount of this tax liability is the Oakwood Tax Exempt Fixed Income Strategy. This investment approach is ideal for any investor whose income is growing rapidly, investors seeking a complement to other taxable type investments and is a necessity for people in high-income tax brackets, particularly those in states with high state taxes such as California.

Investment Philosophy
Oakwood’s Tax Exempt Fixed Income Strategy is designed to generate strong levels of tax-free income and a generous after-tax total return through sound portfolio construction and active management. The strategy utilizes a fully diversified fixed income portfolio that may own a variety of investment grade tax-exempt securities. All portfolios are managed under the strictest of quality standards utilizing both state-specific and general market obligations (depending on client residency), after-tax benefit and/or market opportunities. Oakwood’s actively managed client-specific fixed income management process ensures that each portfolio is structured according to client needs. We take into consideration year-end tax management to help neutralize gains in other investments as well as liquidity for potential future asset allocation shifts and other unique tax situations.

Investment Process
The municipal bond market is large and complex and it can be very difficult to determine the true value of each investment. Because the municipal market is not nearly as centralized as the stock market and is comprised of thousands of choices, each security must be analyzed and managed with a special set of skills. Over forty years of experience in numerous economic cycles back up our fixed income team’s continuous monitoring of the disparate tax-exempt marketplace. This experience provides our investment professionals with the tools necessary to evaluate individual security provisions, present and future changes in taxing policies, yield ratios and comparisons. This leads to a properly structured portfolio based on risk versus return expectations. Essential to this success is the ability to access all investment candidates and develop an extensive network of sources in order to buy or sell the best securities at the best prices.

Tremendous variety is a hallmark of the municipal bond market in terms of maturity choices, quality type and debt service support, with an approximate $1.3 trillion market value, consisting of over 50,000 issuers and approximately 1.5 million individual general obligation or revenue issues. In order to identify the best issues from this vast marketplace for Oakwood client portfolios, our fixed income professionals employ a well-defined investment discipline which begins with a thorough understanding of the client’s investment profile, including income requirements, acceptable volatility parameters, time horizon, return expectations, and any special tax, legal or personal considerations. This understanding provides a solid foundation for managing risk and achieving the investment goals of our clients.

All security choices are subjected to a rigorous array of fundamental and quantitative modeling to validate rate of return expectations, including return variance and horizon analyses. In rate of return analysis, we quantitatively determine expected rates of return in various interest rate environments, and then assign a confidence level and probability of achieving those returns. In horizon analysis, we go through a similar procedure, using differing time horizons as the key variable. The purpose of this modeling is to match volatility ranges to various time periods that are consistent with client goals.

Tools
In order to provide our tax-exempt management team with all of the tools necessary to seek out securities, and evaluate and construct portfolios, we utilize industry standard state of the art systems. At the heart of this process is the Bloomberg data system for daily monitoring of news and market developments, upcoming new issue calendars, security valuation, yield spread comparisons and options analysis. Also, Bloomberg provides access to thousands of investment candidates from countless sources.

On a daily basis, we receive numerous brokerage inventory sheets and market scales, research reports and institutional quality coverage from a hand picked list of acceptable brokers. We refuse to overpay even for what would ordinarily be an appealing structure. Paying too much for transactions can severely impact the yield and total return benefit of a particular security.

The most important tool to achieving clients’ goals is our management experience and client support operations. Because the municipal bond market is complex, all data must be properly interpreted while the thousands of securities choices need to be narrowed and tailored to each client’s objectives. This interpretation is extremely specialized, as municipal fixed income securities don’t fit into neat classifications as do most taxable fixed income securities. Each municipal security has it own unique structure, including callable versus non-callable. Proper diversification by issuer type, coupon preference, quality and geographic diversification all come together to provide maximum flexibility for both the manager and client. This is backed up with a professional operations team and experienced client service personnel.

Oakwood’s tax exempt fixed income sell discipline is woven into the overall investment process from the beginning, by establishing a clear sell mandate for securities that violate quality standards. Should a bond holding in a client portfolio receive a downgrade by more than one gradation within a ratings category, a sell will result. As an example, if a bond is downgraded from Aa1 to Aa3 it will be sold. We should note, however, that Oakwood has never had a mandatory sell triggered by more than one downgrade. In addition, any major changes in Fed policy, which in turn affects the interest rate environment, inflation dynamics, and the health of the economy, will signal a review of securities held in client portfolios to assure that these particular holdings are still in line with client objectives and meet our strict investment guidelines. This sell discipline is the final link in the chain that provides a comfort level to our clients.